Tag: costs

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Vetting vets

The Competition and Markets Authority (CMA) is proposing to launch a formal Market Investigation into anti-competitive practices in the UK’s £2bn veterinary industry (for pets rather than farm animals or horses). This follows a preliminary investigation which received 56 000 responses from pet owners and vet professionals. These responses reported huge rises in bills for treatment and medicines and corresponding rises in the cost of pet insurance.

At the same time there has been a large increase in concentration in the industry. In 2013, independent vet practices accounted for 89% of the market; today, they account for only around 40%. Over the past 10 years, some 1500 of the UK’s 5000 vet practices had been acquired by six of the largest corporate groups. In many parts of the country, competition is weak; in others, it is non-existent, with just one of these large companies having a monopoly of veterinary services.

This market power has given rise to a number of issues. The CMA identifies the following:

  • Of those practices checked, over 80% had no pricing information online, even for the most basic services. This makes is hard for pet owners to make decisions on treatment.
  • Pet owners potentially overpay for medicines, many of which can be bought online or over the counter in pharmacies at much lower prices, with the pet owners merely needing to know the correct dosage. When medicines require a prescription, often it is not made clear to the owners that they can take a prescription elsewhere, and owners end up paying high prices to buy medicines directly from the vet practice.
  • Even when there are several vet practices in a local area, they are often owned by the same company and hence there is no price competition. The corporate group often retains the original independent name when it acquires the practice and thus is is not clear to pet owners that ownership has changed. They may think there is local competition when there is not.
  • Often the corporate group provides the out-of-hours service, which tends to charge very high prices for emergency services. If there is initially an independent out-of-hours service provider, it may be driven out of business by the corporate owner of day-time services only referring pet owners to its own out-of-hours service.
  • The corporate owners may similarly provide other services, such as specialist referral centres, diagnostic labs, animal hospitals and crematoria. By referring pets only to those services owned by itself, this crowds out independents and provides a barrier to the entry of new independents into these parts of the industry.
  • Large corporate groups have the incentive to act in ways which may further reduce competition and choice and drive up their profits. They may, for example, invest in advanced equipment, allowing them to provide more sophisticated but high-cost treatment. Simpler, lower-cost treatments may not be offered to pet owners.
  • The higher prices in the industry have led to large rises in the cost of pet insurance. These higher insurance costs are made worse by vets steering owners with pet insurance to choosing more expensive treatments for their pets than those without insurance. The Association of British Insurers notes that there has been a large rise in claims attributable to an increasing provision of higher-cost treatments.
  • The industry suffers from acute staff shortages, which cuts down on the availability of services and allows practices to push up prices.
  • Regulation by the Royal College of Veterinary Surgeons (RCVS) is weak in the area of competition and pricing.

The CMA’s formal investigation will examine the structure of the veterinary industry and the behaviour of the firms in the industry. As the CMA states:

In a well-functioning market, we would expect a range of suppliers to be able to inform consumers of their services and, in turn, consumers would act on the information they receive.

Market failures in the veterinary industry

The CMA’s concerns suggest that the market is not sufficiently competitive, with vet companies holding significant market power. This leads to higher prices for a range of vet services. However, the CMA’s analysis suggests that market failures in the industry extend beyond the simple question of market power and lack of competition.

A crucial market failure is asymmetry of information. The veterinary companies have much better information than pet owners. This is a classic principal–agent problem. The agent, in this case the vet (or vet company), has much better information than the principal, in this case the pet owner. This information can be used to the interests of the vet company, with pet owners being persuaded to purchase more extensive and expensive treatments than they might otherwise choose if they were better informed.

The principal–agent problem also arises in the context of the dependant nature of pets. They are the ones receiving the treatment and, in this context, are the principals. Their owners are the ones acquiring the treatment for them and hence are the pets’ agents. The question is whether the owners will always do the best thing for their pets. This raises philosophical questions of animal rights and whether owners should be required to protect the interests of their pets.

Another information issue is the short-term perspective of many pet owners. They may purchase a young and healthy pet and assume that it will remain so. However, as the pet gets older, it is likely to face increasing health issues, with correspondingly increasing vet bills. But many owners do not consider such future bills when they purchase the pet. They suffer from what behavioural economists call ‘irrational exuberance’. Such exuberance may also occur when the owner of a sick pet is offered expensive treatment. They may over-optimistically assume that the treatment will be totally successful and that their pet will not need further treatment.

Vets cite another information asymmetry. This concerns the costs they face in providing treatment. Many owners are unaware of these costs – costs that include rent, business rates, heating and lighting, staff costs, equipment costs, consumables (such as syringes, dressings, surgical gowns, antiseptic and gloves), VAT, and so on. Many of these costs have risen substantially in recent months and are reflected in the prices pet owners are charged. With people experiencing free health care for themselves from the NHS (or other national provider), this may make them feel that the price of pet health care is excessive.

Then there is the issue of inequality. Pets provide great benefits to many owners and contribute to owners’ well-being. If people on low incomes cannot afford high vet bills, they may either have to forgo having a pet, with the benefits it brings, or incur high vet bills that they ill afford or simply go without treatment for their pets.

Finally, there are the external costs that arise when people abandon their pets with various health conditions. This has been a growing problem, with many people buying pets during lockdown when they worked from home, only to abandon them later when they have had to go back to the office or other workplace. The costs of treating or putting down such pets are born by charities or local authorities.

The CMA is consulting on its proposal to begin a formal Market Investigation. This closes on 11 April. If, in the light of its consultation, the Market Investigation goes ahead, the CMA will later report on its findings and may require the veterinary industry to adopt various measures. These could require vet groups to provide better information to owners, including what lower-cost treatments are available. But given the oligopolistic nature of the industry, it is unlikely to lead to significant reductions in vets bills.

Articles

CMA documents

Questions

  1. How would you establish whether there is an abuse of market power in the veterinary industry?
  2. Explain what is meant by the principal–agent problem. Give some other examples both in economic and non-economic relationships.
  3. What market advantages do large vet companies have over independent vet practices?
  4. How might pet insurance lead to (a) adverse selection; (b) moral hazard? Explain. How might (i) insurance companies and (ii) vets help to tackle adverse selection and moral hazard?
  5. Find out what powers the CMA has to enforce its rulings.
  6. Search for vet prices and compare the prices charged by at least three vet practices. How would you account for the differences or similarities in prices?
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The costs of Brexit: a clearer picture

At the time of the 2016 referendum, the clear consensus among economists was that Brexit would impose net economic costs on the UK economy. The size of these costs would depend on the nature of post-Brexit trading relations with the EU. The fewer the new barriers to trade and the closer the alignment with the EU single market, the lower these costs would be.

The Brexit deal in the form of the EU-UK Trade and Cooperation Agreement (see also) applied provisionally from January 2021, after the end of the transition period, and came into force in May 2021. Although this is a free-trade deal in the sense that goods made largely in the UK or EU can be traded tariff-free between the two, the deal does not apply to services (e.g. financial services) or to goods where components made outside the UK or EU account for more than a certain percentage (the ‘rules of origin‘ condition). Also there has been a huge increase in documentation that must be completed to export to or import from the EU.

Even though the nature of the Brexit deal has been clear since it was signed in December 2020, assessing the impact of the extra barriers to trade it has created has been hard given the various shocks that have had a severe impact on the UK (and global) economy. First COVID-19 and the associated lockdowns had a direct effect on output and trade; second the longer-term international supply-chain disruptions have extended the COVID costs beyond the initial lockdowns and acted as a brake on recovery and growth; third the Russian invasion of Ukraine imposed a severe shock to energy and food markets; fourth these factors have created not just a supply shock but also an inflationary shock, which has resulted in central banks seeking to dampen demand by significantly raising interest rates. One worry among analysts was that the negative effects of such shocks might be greater on the UK economy than on other countries.

However, the negative effects of Brexit are now becoming clearer and various institutions have attempted to quantify the costs. These costs are largely in terms of lower GDP than otherwise. This results from:

  • reduced levels of trade with the EU, thereby reducing the gains from exploiting comparative advantage;
  • increased costs of trade with the EU;
  • disruptions to supply chains;
  • reduced competition from European firms, with many no longer exporting to the UK because of the costs;
  • reduced inward investment;
  • labour market shortages, particularly in certain areas such a hospitality, construction, social care and agriculture as many European workers have left the UK and fewer come;
  • a reduction in productivity.

Here is a summary of the findings of different organisations.

The Office for Budget Responsibility (OBR)

The OBR has argued that Brexit as negotiated in the Trade and Cooperation Agreement:

will reduce long-run productivity by 4 per cent relative to remaining in the EU. This largely reflects our view that the increase in non-tariff barriers on UK-EU trade acts as an additional impediment to the exploitation of comparative advantage.21

In addition the OBR estimates that:

Both exports and imports will be around 15 per cent lower in the long run than if the UK had remained in the EU.21

Recent evidence supports this. According to the OBR:

UK and aggregate advanced economy goods export volumes fell by around 20 per cent during the initial wave of the pandemic in 2020. But by the fourth quarter of 2021 total advanced economy trade volumes had rebounded to 3 per cent above their pre-pandemic levels while UK exports remain around 12 per cent below.22

This assumption was repeated in the November 2022 Economic and Fiscal Outlook (p.26) 23. What is more, new trade deals will make little difference, either because they are a roll-over from previous EU trade deals with the respective country or have only a very small effect (e.g. the trade deal with Australia).

The Bank of England

The Bank of England, ever since the referendum in 2016, has forecast that Brexit would damage trade, productivity and GDP growth. In recent evidence to the House of Commons Treasury Committee5, Andrew Bailey, the Governor, stated that previous work by the Bank concluded that Brexit would reduce productivity by a bit over 3% and that this was still the Bank’s view.

His colleague, Dr Swati Dhingra, stated that, because of Brexit, there was a ‘much bigger slowdown in trade in the UK compared to the rest of the world’. She continued:

The simple way of thinking about what Brexit has done to the economy is that in the period after the referendum, the biggest depreciation that any of the world’s four major economies have seen overnight contributed to increasing prices [and] reduced wages. …We think that number is about 2.6% below the trend that real wages would have been on. Soon afterwards and before the TCA happened came the effects of the uncertainty that was unleashed, which basically translates into reduced business investment and less certainty of the FDI effects. Those tend to be very long-pay things.

She continued that now we are seeing significantly reduced trade directly as a result of the Brexit trade agreement (TCA).

Her colleague, Dr Catherine Mann, argued that ‘the small firms are the ones that are the most damaged, because the cost of the paperwork and so forth is a barrier’. This does not only affect UK firms exporting to the EU but also EU firms exporting to the UK. Reduced imports from EU firms reduces competition in the UK, which tends to lead to higher prices.

The Institute for Fiscal Studies

The IFS has consistently argued that Brexit, because of increased trade barriers with the EU, has reduced UK trade, productivity and GDP. In a recent interview6, its Director, Paul Johnson, stated that ‘Brexit, without doubt, has made us poorer than we would otherwise have been’. That, plus other convulsions, such as the mini-Budget of October 2022, have reduced foreigners’ confidence in the UK, with the result that investment in the UK and trade with the rest of the world have fallen.

Resolution Foundation

In a major Resolution Foundation report24, the authors argued that the effects of Brexit will take time to materialise fully and will occur in three distinct phases. First, in anticipation of permanent effects, the referendum caused sterling to depreciate and this adversely affected household incomes. What is more, the uncertainty about the future caused business investment to fall (but not inward FDI). Second, the Trade and Cooperation Act, by introducing trade barriers, reduced UK trade with the EU. But trade with the rest of the world also fell suggesting that Brexit is impacting UK trade openness and competitiveness more broadly. Third, there will be structural changes to the UK economy over the long-term which will adversely affect economic growth:

A less-open UK will mean a poorer and less productive one by the end of the decade, with real wages expected to fall by 1.8 per cent, a loss of £470 per worker a year, and labour productivity by 1.3 per cent, as a result of the long-run changes to trade under the TCA. This would be equivalent to losing more than a quarter of the last decade’s productivity growth.

Nuffield Trust

One of the key effects of Brexit has been on the labour market and especially on sectors, such as hospitality, agriculture, construction, health and social care. These sectors are experiencing labour shortages, in part due to EU nationals leaving the UK. In 2021, the Nuffield Trust looked at the supply of workers in health and social care25 and found that, as a result of increased bureaucratic hurdles, the number of EU/EFTA-trained nurses had declined since 2016. In social care, new immigration rules have made it virtually impossible to recruit from the EU. A more recent report looked at the recruitment of doctors in four specific specialties.26 In each case, although the number recruited from the EU/EFTA was still increasing, the rate of increase had slowed significantly. The reason appeared to be Brexit not COVID-19.

Ivalua

Research by Coleman Parkes for Ivalua18 shows that 80% of firms found Brexit to have been the biggest cause of supply-chain disruptions in the 12 months to August 2022, with 83% fearing the biggest disruptions from Brexit are yet to come. Brexit was found to have had a bigger effect on supply chains than the war in Ukraine, rising energy costs and COVID-19.

Centre for European Reform

Modelling conducted by John Springford27 used a ‘doppelgängers’ method to show the effects of Brexit on the UK economy. Each doppelgänger is ‘a basket of countries whose economic performance closely matches the UK’s before the Brexit referendum and the end of the transition period’. Comparing the UK’s performance with the doppelgänger can show the difference between leaving and not leaving the UK. Doppelgängers were estimated for GDP, investment (gross fixed capital formation), total services trade (exports plus imports) and total goods trade (ditto).

The results are sobering. In the final quarter of 2021, UK GDP is 5.2 per cent smaller than the modelled, doppelgänger UK; investment is 13.7 per cent lower; and goods trade, 13.6 per cent lower.

Economic and Social Research Institute (ESRI) (Ireland)

Similar results for UK trade have been obtained by Janez Kren and Martina Lawless in research conducted for the ESRI.28 They used product-level trade flows between the EU and all other countries in the world as a comparison group. This showed a 16% reduction in UK exports to the EU and a 20% reduction in UK imports from the EU relative to the scenario in which Brexit had not occurred.

British Chambers of Commerce (BCC) survey

According to a BCC survey of 1168 businesses33, 92% of which are SMEs, more than three quarters (77%) for which the Brexit deal is applicable say it is not helping them increase sales or grow their business and 56% say they have difficulties in adapting to the new rules for trading goods. The survey shows that UK firms are facing significant challenges in trying to trade with EU countries under the terms of the Trade and Cooperation Agreement. What is more, 80% of firms had seen the cost of importing increase; 53% had seen their sales margins decrease; and almost 70% of manufacturers had experienced shortages of goods and services from the EU.

Academic studies

Research at the Centre for Business Prosperity, Aston University, by Jun Du, Emine Beyza Satoglu and Oleksandr Shepotylo20, 29 found that UK exports to the EU ‘fell by an average of 22.9% in the first 15 months after the introduction of the EU-UK Trade and Cooperation Agreement’. The negative effect on UK exports persisted and deepened from January 2021 to March 2022. The research involved comparing actual trade with an ‘alternative UK economy’ model based on the UK having remained in the EU. What is more, the researchers found that there had been a reduction of 42% in the number of product varieties exported to the EU, with a large number of exporters simply ceasing to export to the EU and with many of the remaining exporters streamlining their product ranges.

Research at the LSE’s Centre for Economic Performance by Jan David Bakker, Nikhil Datta, Richard Davies and Josh De Lyon31 found that leaving the EU added an average of £210 to UK household food bills over the two years to the end of 2021. This amounted to a total cost to consumers of £5.8 billion. This confirmed the findings of previous research30 that the increase in UK-EU trade barriers led to food prices in the UK being 6% higher than they would have been.

Finally, a report from the Migration Observatory at the University of Oxford32 examined the effects of the ending of the free movement of labour from the EU to the UK. Visas are now required, but ‘low-wage occupations that used to rely heavily on EU workers are now ineligible for work visas, with some limited exceptions for social care and seasonal workers’. Many industries are facing labour shortages. Reasons include other factors, such as low pay and unattractive working conditions, and workers leaving the workforce during the pandemic and afterwards. But the end of free movement appears to have exacerbated these existing problems.

References

    Videos

  1. The Brexit effect: how leaving the EU hit the UK

    2. Financial Times film (18/10/22)

  2. What impact is Brexit having on the UK economy?

    3. Brexit and the UK economy, Ros Atkins (29/10/22)

  3. Why Brexit is damaging the UK economy both now and in the future

    4. Economics Help on YouTube, Tejvan Pettinger (5/12/22)

  4. Why the Costs of Brexit keep growing for the UK economy

    5. Economics Help on YouTube, Tejvan Pettinger (17/10/22)

  5. Treasury Committee (see also)

    6. Parliament TV (25/11/22) (see 15:03:00 to 15:08:12) (Click here for a transcript: see Q637 to Q641)

  6. UK economy made worse by ‘own goals’ like Brexit and Truss mini-budget, IFS economist says

    7. Sky News, Paul Johnson (IFS) (18/11/22)

    Articles

  7. Brexit and the economy: the hit has been ‘substantially negative’

    8. Financial Times, Chris Giles (30/11/22)

  8. ‘What have we done?’: six years on, UK counts the cost of Brexit

    9. The Observer, Toby Helm, Robin McKie, James Tapper & Phillip Inman (25/6/22)

  9. Brexit did hurt the City’s exports – the numbers don’t lie

    10. Financial News, David Wighton (9/11/22)

  10. Brits are starting to think again about Brexit as the economy slides into recession

    11. CNBC, Elliot Smith (23/11/22)

  11. Brexit has cracked Britain’s economic foundations

    12. CNN, Hanna Ziady (24/12/22)

  12. Mark Carney: ‘Doubling down on inequality was a surprising choice’

    13. Financial Times, Edward Luce (14/10/22)

  13. Brexit: Progress on trade deals slower than promised

    14. BBC News, Ione Wells & Brian Wheeler (2/12/22)

  14. How Brexit costs this retailer £1m a month in sales

    15. BusinessLive, Tom Pegden (22/11/22)

  15. Brexit Is Hurting The UK Economy, Bank Of England Official Says

    16. HuffPost, Graeme Demianyk (16/11/22)

  16. Brexit and drop in workforce harming economic recovery, says Bank governor

    17. The Guardian, Richard Partington (16/11/22)

  17. Brexit a major cause of UK’s return to austerity, says senior economist

    18. The Guardian, Anna Isaac (14/11/22)

  18. 80% of UK businesses say Brexit caused the biggest supply chain disruption in the last 12 months

    19. Ivalua (28/11/22)

  19. Brexit added £210 to household food bills, new research finds

    20. Sky News, Faye Brown (1/12/22)

  20. Brexit changes caused 22.9% slump in UK-EU exports into Q1 2022 – research

    21. Expertfile (8/12/22)

    Research and analysis

  21. Brexit analysis

    22. OBR (26/5/22)

  22. The latest evidence on the impact of Brexit on UK trade

    23. OBR (March 2022)

  23. Economic and fiscal outlook – November 2022 (PDF)

    24. OBR (17/11/22)

  24. The Big Brexit (PDF)

    25. Resolution Foundation, Swati Dhingra, Emily Fry, Sophie Hale & Ningyuan Jia (June 2022)

  25. Going it alone: health and Brexit in the UK

    26. Nuffield Trust, Mark Dayan, Martha McCarey, Tamara Hervey, Nick Fahy, Scott L Greer, Holly Jarman, Ellen Stewart and Dan Bristow (20/12/21)

  26. Has Brexit affected the UK’s medical workforce?

    27. Nuffield Trust, Martha McCarey and Mark Dayan (27/11/22)

  27. What can we know about the cost of Brexit so far?

    28. Centre for European Reform, John Springford (9/6/22)

  28. Brexit reduced overall EU-UK goods trade flows by almost one-fifth

    29. Economic and Social Research Institute (Ireland), Janez Kren and Martina Lawless (19/10/22)

  29. Post-Brexit UK Trade – An Update (PDF)

    30. Centre for Business Prosperity, Aston University, Jun Du, Emine Beyza Satoglu and Oleksandr Shepotylo (November 2022)

  30. Post-Brexit imports, supply chains, and the effect on consumer prices (PDF)

    31. UK in a Changing Europe, Jan David Bakker, Nikhil Datta, Josh De Lyon, Luisa Opitz and Dilan Yang (25/4/22)

  31. Non-tariff barriers and consumer prices: evidence from Brexit

    32. Centre for Economic Performance, LSE, Jan David Bakker, Nikhil Datta, Richard Davies and Josh De Lyon (December 2022)

  32. How is the End of Free Movement Affecting the Low-wage Labour Force in the UK?

    33. Migration Observatory, University of Oxford, Madeleine Sumption, Chris Forde, Gabriella Alberti and Peter William Walsh (15/8/22)

  33. The Trade and Cooperation Agreement: Two Years On – Proposals For Reform by UK Business

    34. British Chambers of Commerce (21/12/22)

  34. The Detriments of Brexit

    35. Yorkshire Bylines (June 2022) (see also)

Questions

  1. Summarise the negative effects of Brexit on the UK economy.
  2. Why is it difficult to quantify these effects?
  3. Explain the ‘doppelgängers’ method of estimating the costs of Brexit? How reliable is this method likely to be?
  4. How have UK firms attempted to reduce the costs of exporting to the EU?
  5. Is Brexit the sole cause of a shortage of labour in many sectors in the UK?
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JIT or illegit?

With the bounce-back from the pandemic, many countries have experienced supply-chain problems. For example, the shortage of lorry drivers in the UK and elsewhere (see the blog Why is there a driver shortage in the UK?) has led to empty shelves, fuel shortages and rising prices. The problem has been exacerbated by a lack of stock holding. Holding minimum stocks has been part of the modern system of ‘just-in-time’ (JIT) supply-chain management.

JIT involves involves highly integrated and sophisticated supply chains. Goods are delivered to factories, warehouses and shops as they are needed – just in time. Provided firms can be sure that they will get their deliveries on time, they can hold minimum stocks. This enables them to cut down on warehousing and its associated costs. The just-in-time approach to supply-chain management was developed in the 1950s in Japan and since the 1980s has been increasingly adopted around the world, helped more recently by sophisticated ordering and tracking software.

If supply chains become unreliable, however, JIT can lead to serious disruptions. A hold-up in one part of the chain will have a ripple effect along the whole chain because there is little or no slack in the system. When the large container ship, the Ever Given, en route from Malaysia to Felixtowe, was wedged in the Suez canal for six days in March this year, the blockage caused shipping to be backed up. By day six, 367 container ships were waiting to transit the canal. The disruption to supply cost some £730m.

JIT works well when sources of supply and logistics are reliable and when demand is predictable. The pandemic is causing many logistics and warehousing managers to consider building a degree of slack into their systems. This might involve companies having alternative suppliers they can call on, building in more spare capacity and having their own fleet of lorries or warehousing facilities that can be hired out when not needed but can be relied on at times of high demand.

When the ‘bounce back’ subsides, so may the current supply chain bottlenecks. But the rethinking that has been generated by the current problems may see new patterns emerge that make supply chains more flexible without becoming more expensive.

Articles

Questions

  1. What are the costs and benefits of a just-in-time approach to logistics?
  2. Are current supply chain problems likely to be temporary or are there issues that are likely to persist?
  3. How might the JIT approach be reformed to make it more adaptable to supply chain disruptions?
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Support for firms forced to close: guaranteeing revenue?

Some firms in the high-Covid, tier 3 areas in England are being forced to shut by the government. These include pubs and bars not serving substantial meals. Similarly, pubs in the central belt of Scotland must close. But how should such businesses and their employees be supported?

As we saw in the blog, The new UK Job Support Scheme: how much will it slow the rise in unemployment?, the government will support such businesses by paying two-thirds of each employees’ salary (up to a maximum of £2100 a month) and will give cash grants to the businesses of up to £3000 per month.

This support has been criticised by local leaders, such as those in Greater Manchester, as being insufficient. Workers, they argue, will struggle to pay their bills and the support for firms will be too little to prevent many closing for good. What is more, many firms and their employees in the supply chain, such as breweries, will get no support. Greater Manchester resisted being put into tier 3 unless the level of support was increased. However, tier 3 status was imposed on the authority on 20 October despite lack of agreement with local politicians on the level of support.

Jim O’Neill, Vice Chair of the Northern Powerhouse partnership, has argued that the simplest way of supporting firms forced to close is to guarantee their revenue. He stated that:

The government would be sensible to guarantee the revenues of businesses it is forcing to shut. It is easier, fairer and probably less costly in the long run – and a proper test of the government’s confidence that in the New Year two of the seven vaccines the UK has signed up to will work.

This would certainly help firms to survive and allow them to pay their employees. But would guaranteeing revenues mean that such firms would see an increase in profits? The questions below explore this issue.

Articles

Questions

  1. Identify the fixed and variable costs for a pub (not owned by a brewery).
  2. If a pub closed down but the wages of workers continued to be paid in full, what cost savings would be made?
  3. If a pub closed down but was given a monthly grant by the government equal to its previous monthly total revenue but had to pay the wages of it workers in full, what would happen to its profits?
  4. On 19 October, the Welsh government introduced a two-week lockdown for Wales. Under these restrictions, all non-essential retail, leisure, hospitality and tourism businesses had to close. Find out what support was on offer for such firms and their workforce and compare it to other parts of the UK.
  5. What type of support for leisure and hospitality businesses forced by the government to close would, in your opinion, be optimal? Justify your answer.
  6. Is there any moral hazard from the government providing support for businesses made unprofitable by the Covid-19 crisis? Explain.
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Automation revisited

It’s been a while since I last blogged about labour markets and, in particular, about the effect of automation on wages and employment. My most recent post on this topic was on the 14th of April 2018 and it was mostly a reflection on some interesting findings that had been reported by Acemoglu et al (2017). More specifically, Acemoglu and Restrepo (2017) developed a theoretical framework to evaluate the effect of AI on employment and wages. They concluded that the effect was negative and potentially sizeable (for a more detailed discussion see my blog).

Using a model in which robots compete against human labor in the production of different tasks, we show that robots may reduce employment and wages … According to our estimates, one more robot per thousand workers reduces the employment to population ratio by about 0.18–0.34 percentage points and wages by 0.25–0.5 percent.

Since then, I have seen a constant stream of news on my news feed about the development of ever more advanced industrial robots and artificial intelligence. And this was not because of some spooky coincidence (or worse). It has been merely a reflection of the speed at which technology has been progressing in this field.

There are now robots that can run, jump, hold conversations with humans, do gymnastics (and even sweat for it!) and more. It is really impressive how fast change has been happening recently in this field – and, unsurprisingly, it has stimulated the interest of labour economists!

A paper that has recently come to my attention on this subject is by Graetz and Michaels (2018). The authors put together a panel dataset on robot adoption within seventeen countries from 1993 to 2007 and use advanced econometric techniques to evaluate the effect of these technologies on employment and productivity growth. Their analysis focuses exclusively on developed economies (due to data limitations, as they explain) – but their results are nevertheless intriguing:

We study here for the first time the relationship between industrial robots and economic outcomes across much of the developed world. Using a panel of industries in seventeen countries from 1993 to 2007, we find that increased use of industrial robots is associated with increases in labor productivity. We find that the contribution of increased use of robots to productivity growth is substantial and calculate using conservative estimates that it comes to 0.36 percentage points, accounting for 15% of the aggregate economy-wide productivity growth.
 
The pattern that we document is robust to including various controls for country trends and changes in the composition of labor and other capital inputs. We also find that robot densification is associated with increases in both total factor productivity and wages, and reductions in output prices. We find no significant relationship between the increased use of industrial robots and overall employment, although we find that robots may be reducing the employment of low-skilled workers.

This is very positive news for most – except, of course, for low-skilled workers. Indeed, like Acemoglu and Restrepo (2017) and many others, this study shows that the effect of automation on employment and labour market outcomes is unlikely to be uniform across all types of workers. Low-skilled workers are found again to be likely to lose out and be significantly displaced by these technologies.

And if you are wondering which sectors are likely to be disrupted most/first by automation, the rankings developed by McKinsey and Company (see chart below) would give you an idea of where the disruption is likely to start. Unsurprisingly, the sectors that seem to be the most vulnerable, are the ones that use the highest share of low-skilled labour.

Articles

Questions

  1. “The effect of automation on wages and employment is likely to be positive overall”. Discuss.
  2. Using examples and anecdotal evidence, do you agree with these findings?
  3. Using Google Scholar, put together a list of 5 recent (i.e. 2015 or later) articles and working papers on labour markets and automation. Compare and discuss their findings.