Tag: incentives

Economists are often criticised for making inaccurate forecasts and for making false assumptions. Their analysis is frequently dismissed by politicians when it contradicts their own views.

But is this fair? Have economists responded to the realities of the global economy and to the behaviour of people, firms, institutions and government as they respond to economic circumstances? The answer is a qualified yes.

Behavioural economics is increasingly challenging the simple assumption that people are ‘rational’, in the sense that they maximise their self interest by weighing up the marginal costs and benefits of alternatives open to them. And macroeconomic models are evolving to take account of a range of drivers of global growth and the business cycle.

The linked article and podcast below look at the views of 2019 Nobel Prize-winning economist Esther Duflo. She has challenged some of the traditional assumptions of economics about the nature of rationality and what motivates people. But her work is still very much in the tradition of economists. She examines evidence and sees how people respond to incentives and then derives policy implications from the analysis.

Take the case of the mobility of labour. She examines why people who lose their jobs may not always move to a new one if it’s in a different town. Partly this is for financial reasons – moving is costly and housing may be more expensive where the new job is located. Partly, however, it is for reasons of identity. Many people are attached to where they currently live. They may be reluctant to leave family and friends and familiar surroundings and hope that a new job will turn up – even if it means a cut in wages. This is not irrational; it just means that people are driven by more than simply wages.

Duflo is doing what economists typically do – examining behaviour in the light of evidence. In her case, she is revisiting the concept of rationality to take account of evidence on what motivates people and the way they behave.

In the light of workers’ motivation, she considers the implications for the gains from trade. Is free trade policy necessarily desirable if people lose their jobs because of cheap imports from China and other developing countries where labour costs are low?

The answer is not a clear yes or no, as import-competing industries are only part of the story. If protectionist policies are pursued, other countries may retaliate with protectionist policies themselves. In such cases, people working in the export sector may lose their jobs.

She also looks at how people may respond to a rise or cut in tax rates. Again the answer is not clear cut and an examination of empirical evidence is necessary to devise appropriate policy. Not only is there an income and substitution effect from tax changes, but people are motivated to work by factors other than take-home pay. Likewise, firms are encouraged to invest by factors other than the simple post-tax profitability of investment.

Podcast

Article

Questions

  1. In traditional ‘neoclassical’ economics, what is meant by ‘rationality’ in terms of (a) consumer behaviour; (b) producer behaviour?
  2. How might the concept of rationality be expanded to take into account a whole range of factors other than the direct costs and benefits of a decision?
  3. What is meant by bounded rationality?
  4. What would be the effect on workers’ willingness to work more or fewer hours as a result of a cut in the marginal income tax rate if (a) the income effect was greater than the substitution effect; (b) the substitution effect was greater than the income effect? Would your answers to (a) and (b) be the opposite in the case of a rise in the marginal income tax rate?
  5. Give some arguments that you consider to be legitimate for imposing controls on imports in (a) the short run; (b) the long run. How might you counter these arguments from a free-trade perspective?

With university fees for home students in England of £9250 per year and with many students receiving maintenance loans of around £9000 per year, many students are graduating with debts in excess of £50 000. Loans are repaid at a marginal rate of 9% on incomes over £25 716.

Many students also study for a masters degree. The average fee for a taught, classroom-based masters (MA) is £7392 and for a laboratory-based masters (MSc) is £8167 but can be considerably higher at some prestigious universities where demand is high. Government loans of up to £10 906 are available to contribute towards fees and maintenance. These are paid back at a marginal rate of 6% for people earning over £21 000, giving a combined marginal rate of 15% for first and masters degrees.

For high earners on the 40% income tax rate, the combined marginal rate of payment out of income is 40% tax, plus 2% national insurance, plus 15% for those with undergraduate and masters loans. This gives a combined marginal rate of 57%.

Average student debt in England is higher even than in the USA, where the average is $37 000. US university courses are more expensive than in the UK, costing an average of $34 000 per year in tuition alone. But undergraduates can borrow less. They can borrow between $5500 and $12 500 per year in federal loans towards both fees and maintenance, and some private loans are also available. Most students do some paid work during their studies to make up the difference or rely on parents contributing. Parental contributions mean that students from poor families end up owing more. According to a Guardian article:

Race is a huge factor. Black students owe an average of $7400 more than white students when they graduate, the Brookings Institution found. After graduation, the debt gap continues to widen. Four years after graduation, black graduates owe an average of nearly $53 000 – nearly double that of white graduates.

Student debt looks to become one of the key issues in the 2020 US presidential election.

Pressure to cancel student fees and debt in the USA

Most of the Democratic candidates are promising to address student fees and debt. Student debt, they claim, places an unfair burden on the younger generation and makes it hard for people to buy a house, or car or other major consumer durables. This also has a dampening effect on aggregate demand.

The most radical proposal comes from Bernie Sanders. He has vowed, if elected, to abolish student fees and to cancel all undergraduate and graduate debt of all Americans. Other candidates are promising to cut fees and/or debt.

Although most politicians and commentators agree that the USA has a serious problem of student debt, there is little agreement on what, if anything, to do about it. There are already a number of ways in which student debt can be written off or reduced. For example, if you work in the public sector for more than 10 years, remaining debt will be cancelled. However, none of the existing schemes is as radical as that being proposed by many Democrats.

Criticisms of the Democrats’ plans are mainly of two types.

The first is the sheer cost. Overall debt is around $1.6tn. What is more, making student tuition free would place a huge ongoing burden on government finances. Bernie Sanders proposes introducing a financial transactions tax on stock trading. This would be similar to a Tobin tax (sometimes dubbed a ‘Robin Hood tax’) and would include a 0.5% tax on stock transactions, a 0.1% tax on bond trades and a 0.005% tax on transactions in derivatives. He argues that the public bailed out the financial sector in 2008 and that it is now the turn of the financial sector to come to the aid of students and graduates.

The other type of criticism concerns the incentive effects of the proposal. The core of the criticism is that loan forgiveness involves moral hazard.

The moral hazard of loan forgiveness

The argument is that cancelling debt, or the promise to do so, encourages people to take on more debt. Generally, moral hazard occurs when people are protected from the consequences of their actions and are thus encouraged to make riskier decisions. For example, if you are ensured against theft, you may be less careful with your belongings. As the Orange County Register article linked below states:

If the taxpayers pay the debts of everyone with outstanding student loans, how will that affect the decisions made by current students thinking about their choices for financing higher education? What’s the message? Borrow as much as you can and wait for the debt to be canceled during the next presidential primary campaign?

Not only would more students be encouraged to go to college, but they would be encouraged to apply for more costly courses if they were free.

Universities would be encouraged to exaggerate their costs to warrant higher fees charged to the government. The government (federal, state or local) would have to be very careful in auditing courses to ensure costs were genuine. Universities could end up being squeezed for finance as government may try to cut payments by claiming that courses were overpriced.

Even if fees were not abolished, cancelling debts would encourage students to take on larger debt, if that was to be cleared at some point in the future. What is more, students (or their parents) who could afford to pay, would choose to borrow the money instead.

But many countries do have free or highly subsidised higher education. Universities are given grants which are designed to reflect fair costs.

Articles

Videos

Questions

  1. Assess the arguments for abolishing or substantially reducing student fees.
  2. Assess the arguments against abolishing or substantially reducing student fees.
  3. Assess the arguments for writing off or substantially reducing student debt.
  4. Assess the arguments against writing off or substantially reducing student debt.
  5. If it were decided to cancel student debt, would it be fair to pay students back for any debt they had already paid off?
  6. Does tackling the problem of student debt necessarily lead to a redistribution of wealth/income?
  7. Give some other examples of moral hazard.
  8. If student fees were abolished, would there be any problem of adverse selection? If so, how could this be overcome?
  9. Find out what the main UK parties are advocating about student fees and debt in the nations of the UK for home and non-home students. Provide a critique of each of their policies.

You’ve had a busy day at work. You check your watch; it’s almost 5pm. You should be packing soon – except, your boss is still in their office. You shouldn’t really be seen leaving before your boss, should you? You don’t want to be branded as ‘that guy’ – the one who is ‘not committed’, ‘not willing to go the extra mile’, ‘not flexible enough’, first out of the door’ – you don’t want to have that label pinned on your performance appraisal. After all, your boss is still hard at work, and so are your other colleagues.

So you wait, pretending to work – although you do not really do much – perhaps you’re checking Facebook, reading the news or similar. And so does your boss, not wanting to be seen leaving before anyone else. But what example is this going to set for you and your other colleagues. You all wait for someone to make the first move – a prisoner’s dilemma situation. The only difference is that it’s you who is the prisoner in this situation, also known as ‘presenteeism’.

What is presenteeism? If you search the term on Google Scholar or Scopus, you will come across a number of articles in the fields of health and labour economics that define presenteeism as a phenomenon in which employees who feel physically unwell choose to go to work, or stay on at work, rather than asking for time off to get better (see, for instance, Hansen and Andersen, 2008 and several others). This is also known as ‘sickness presenteeism’.

According to Cooper and Lu (2016), however, the use of the term can be extended to describe a wider situation in which a worker is physically present at their workplace but not functioning (by reason of tiredness, physical illness, mental ill-health, peer pressure or whatever else). As explained in Biron and Saksvik (2009):

Cooper’s conceptualisation of presenteeism implied that presenteeism was a behaviour determined by specific determinants (i.e. long working hours and a context of uncertainty). This tendency to stay at work longer than required to display a visible commitment is what Simpson (1998) calls ‘competitive presenteeism’ where people compete on who will stay in the office the longest.

Unsurprisingly, the effect of presenteeism on the wellbeing of workers and the economic performance of firms has been looked at extensively from different angles and disciplines – including health economists, organisational behaviour and labour economists – for a recent and comprehensive review of the literature on this topic see Lohaus and Habermann (2019). Most of these studies agree that the effects of presenteeism are negative; in particular, they identify significant negative effects on the physical health of workers (Skagen and Collins, 2016); emotional exhaustion and mental health issues (Demerouti et al, 2009); persistent productivity loss (Warren et al, 2011); lower work engagement and negative feelings (Asfaw et al, 2017) – among several others. There seems, therefore, to be plenty of convincing evidence that presenteeism is bad for everyone – business owners, managers and staff.

So next time that you find yourself stuck at work working silly hours, feeling totally unproductive and just staying to be seen, email this blog to your boss and other colleagues – and ask them if they wish to join you for a drink or a walk.

You’re welcome!

(By the way, there’s a saying that in the UK the last one to leave the office is seen as the hardest working, whereas in Germany the last one to leave the office is seen as the least efficient!)

Articles

References

Questions

  1. ‘Presenteeism leads to lower productivity and firm performance and should be discouraged by business owners and managers’. Discuss.
  2. In a recent interview given to Reuters, Jack Ma, the Chinese billionaire and owner of Ali Baba, defended his ‘996 work model’ (working 9am to 9pm for 6 days a week) as a ‘huge blessing’. Find and review some articles on this topic, and use them to write a response. Your response should be substantiated using relevant economic theory and empirical research.
  3. Have you or anyone you know found yourself guilty of presenteeism? Share your experience with the rest of the class, focusing on effects on productivity and your attitude towards your employer and work colleagues.

Firms are increasingly having to take into account the interests of a wide range of stakeholders, such as consumers, workers, the local community and society in general (see the blog, Evolving Economics). However, with many firms, the key stakeholders that influence decisions are shareholders. And because many shareholders are footloose and not committed to any one company, their main interests are short-term profit and share value. This leads to under-investment and too little innovation. It has also led to excessive pay for senior executives, which for many years has grown substantially faster than the pay of their employees. Indeed, executive pay in the UK is now, per pound of turnover, the highest in the world.

So is there an alternative model of capitalism, which better serves the interests of a wider range of stakeholders? One model is that of employee ownership. Perhaps the most famous example of this is the John Lewis Partnership, which owns both the department stores and the Waitrose chain of supermarkets. As the partnership’s site claims, ‘when you’re part of it, you put your heart into it’. Although the John Lewis Partnership is the largest in the UK, there are over 330 employee-owned businesses across the UK, with over 200 000 employee owners contributing some £30bn per year to UK GDP. Again, to quote the John Lewis site:

Businesses range from manufacturers, to community health services, to insurance brokers. Together they deliver 4% of UK GDP annually, with this contribution growing. They are united by an ethos that puts people first, involving the workforce in key decision-making and realising the potential and commitment of their employees.

A recent example of a company moving, at least partly, in this direction is BT, which has announced that that every one of its 100 000 employees will get shares worth £500 every year. Employees will need to hold their shares for at least three years before they can sell them. The aim is to motivate staff and help the company achieve a turnaround from its recent lacklustre performance, which had resulted in its laying off 13 000 of its 100 000-strong workforce.

Another recent example of a company adopting employee ownership is Richer Sounds, the retail TV and hi-fi chain. Its owner and founder, Julian Richer, announced that he had transferred 60% of his shares into a John Lewis-style trust for the chain’s 531 employees. In addition to owning 60% of the company, employees will receive £1000 for every year they have worked for the retailer. A new advisory council, made up of current staff, will advise the management board, which is taking over the running of the firm from Richer.

According to the Employee Ownership Association (EOA), a further 50 businesses are preparing to follow suit and adopt forms of employee ownership. As The Conversation article linked below states:

As a form of stakeholder capitalism, the evidence shows that employee ownership boosts employee commitment and motivation, which leads to greater innovation and productivity.
 
Indeed, a study of employee ownership models in the US published in April found it narrowed gender and racial wealth gaps. Surveying 200 employees from 21 companies with employee ownership plans, Joseph Blasi and his colleagues at Rutgers University found employees had significantly more wealth than the average US worker.
 
The researchers also found that the participatory management practices that accompanied the employee ownership schemes led to employees improving their communication skills and learning management skills, which had helped them make better financial decisions at home.

But, although employee ownership brings benefits, not only to the employees themselves, but also more widely to society, there is no simple mechanism for achieving it when shareholders are unlikely to want to relinquish their shares. Employee buyout schemes require funding; and banks are often cautious about providing such funding. What is more, there needs to be an employee trust overseeing the running of the company which takes a long-term perspective and not just that of current employees, who might otherwise be tempted to sell the company to another seeking to take it over.

Articles

Report

Questions

  1. What are the main benefits of employee ownership?
  2. Are there any disadvantages of employee ownership and, if so, what are they?
  3. What are the main barriers to the adoption of employee ownership?
  4. What are the main recommendations from The Ownership Effect Inquiry? (See linked report above.)
  5. What are the findings of the responses to the employee share ownership questions in the US General Social Survey (GSS)? (See linked Global Banking & Finance Review article above.)

Source: Wikimedia Commons: author, Today Testing (https://todaytesting.com)
In his Budget on 29 October, the UK Chancellor, Philip Hammond, announced a new type of tax. This is a ‘digital services tax’, which, after consultation, he is planning to introduce in April 2020. The target of the tax is the profits made by major companies providing social media platforms (e.g. Facebook and Twitter), internet marketplaces (e.g. Amazon and eBay) or search engines (such as Alphabet’s Google).

Up to now, their profits have been very hard to tax because the companies operate in many countries and use accounting techniques, such as transfer pricing (see the blogs Disappearing tax revenues: how Luxembourg saves companies billions and Starbucks pays not a bean in corporation tax, thanks to transfer pricing), to declare most of their profits in low-tax countries, such as Luxembourg. One way of doing this is for a company’s branches in different countries to pay the head office (located in a tax haven) a ‘royalty’ for using the brand.

The proposed digital services tax is a 2% tax on the revenues earned by such companies in the UK. It would only apply to large companies, defined as those whose global revenue is at least £500m a year. It is expected to raise around £400m per year.

The EU is considering a similar tax at a rate of 3%. India, Pakistan, South Korea and several other countries are considering introducing digital taxes. Indeed, many countries are arguing for a worldwide agreement on such a tax. The OECD is studying the implications of the possible use of such a tax by its 36 members. If an international agreement on such a tax can be reached, a separate UK tax may not go ahead. As the Chancellor stated in his Budget speech:

In the meantime we will continue to work at the OECD and G20 to seek a globally agreed solution. And if one emerges, we will consider adopting it in place of the UK Digital Services Tax.

The proposed UK tax is a hybrid between direct and indirect taxes. Like corporation tax, a direct tax, its aim is to tax companies’ profits. But, unlike corporation tax, it would be harder for such companies to avoid. Like VAT, an indirect tax, it would be a tax on revenue, but, unlike VAT, it would be an ‘end-stage’ tax rather than a tax on value added at each stage of production. Also, it would not be a simple sales tax on companies as it would be confined to revenue (such as advertising revenue) earned from the use in the UK of search engines, social media platforms and online marketplaces. As the Chancellor said in his speech.

It is important that I emphasise that this is not an online-sales tax on goods ordered over the internet: such a tax would fall on consumers of those goods – and that is not our intention.

There is, however, a political problem for the UK in introducing such a tax. The main companies it would affect are American. It is likely that President Trump would see such taxes as a direct assault on the USA and could well threaten retaliation. As the Accountancy Age article states, ‘Dragging the UK into an acrimonious quarrel with one of its largest trading partners is perhaps not what the Chancellor intends.’ This will be especially so as the UK seeks to build new trading relationships with the USA after Brexit. As the BBC article states, ‘The chancellor will be hoping that an international agreement rides to his rescue before the UK tax has to be imposed.’

Articles

Government documents

Questions

  1. How do multinational digital companies avoid profit taxes (corporation tax in the UK)?
  2. Explain how a digital services tax would work.
  3. Why is a digital services tax likely to be set at a much lower rate than a profit tax?
  4. Explain the difference between tax avoidance and tax evasion.
  5. Would it be possible for digital companies to avoid or evade such taxes?
  6. Is there a possibility of a prisoners’ dilemma game in terms of seeking international agreement on such taxes
  7. How does a digital services tax differ from a sales revenue tax