Tag: incentives

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Climate tipping points


Politicians, business leaders, climate scientists, interest groups and journalists from across the world have been meeting in Dubai at the COP28 climate summit (the 28th annual meeting of the Conference of the Parties (COP) to the United Nations Framework Convention on Climate Change (UNFCCC)). The meeting comes at a time when various climate tipping points are being reached or approached – some bad, but some good. Understanding these tipping points and their implications for society and policy requires understanding not only the science, but also the various economic incentives affecting individuals, businesses, politicians and societies.

Tipping points

A recent report (see first reference in articles section below) identified various climate tipping points. These are when global temperatures rise to a point where various domino effects occur. These are adverse changes to the environment that gather pace and have major effects on ecosystems and the ability to grow food and support populations. These, in turn, will have large effects on economies, migration and political stability.

According to the report, five tipping points are imminent with the current degree of global warming (1.2oC). These are:

  • Melting of the Greenland ice sheet;
  • Melting of the West Antarctic ice sheet;
  • Death of warm-water coral reefs;
  • Collapse of the North Atlantic Subpolar Gyre circulation, which helps to drive the warm current that benefits Western Europe;
  • Widespread rapid thawing of permafrost, where tundra without snow cover rapidly absorbs heat and releases methane (a much more powerful source of global warming than CO2).

With global warming of 1.5oC, three more tipping points are likely: the destruction of seagrass meadows, mangrove swamps and the southern part of the boreal forests that cover much of northern Eurasia. As the temperature warms further, other tipping points can interact in ways that drive one another, resulting in tipping ‘cascades’.

But the report also strikes an optimistic note, arguing that positive tipping points are also possible, which will help to slow global warming in the near future and possibly reverse it further in the future.


The most obvious one is in renewable energy. Renewable power generation in many countries is now cheaper than generation from fossil fuels. Indeed, in 2022, over 80% of new electricity generation was from solar and wind. And as it becomes cheaper, so this will drive investment in new renewable plants, including in small-scale production suitable for use in developing countries in parts not connected to a grid. In the vehicle sector, improved battery technology, the growth in charging infrastructure and cheaper renewable sources of electricity are creating a tipping point in EV take-up.

Positive tipping points can take place as a result of changing attitudes, such as moving away from a meat-intensive diet, avoiding food waste, greater use of recycling and a growth in second-hand markets.

But these positive tipping points are so far not strong enough or quick enough. Part of the problem is with economic incentives in market systems and part is with political systems.

Market failures

Economic decisions around the world of both individuals and firms are made largely within a market environment. But the market fails to take into account the full climate costs and benefits of such decisions. There are various reasons why.

Externalities. Both the production and consumption of many goods, especially energy and transport, but also much of agriculture and manufacturing, involve the production of CO2. But the costs of the resulting global warming are not born directly by the producer or consumer. Instead they are external costs born by society worldwide – with some countries and individuals bearing a higher cost than others. The result is an overproduction or consumption of such goods from the point of view of the world.

The environment as a common resource. The air, the seas and many other parts of the environment are not privately owned. They are a global ‘commons’. As such, it is extremely difficult to exclude non-payers from consuming the benefits they provide. Because of this property of ‘non-excludability’, it is often possible to consume the benefits of the environment at a zero price. If the price of any good or service to the user is zero, there is no incentive to economise on its use. In the case of the atmosphere as a ‘dump’ for greenhouse gases, this results in its overuse. Many parts of the environment, however, including the atmosphere, are scarce: there is rivalry in their use. As people increase their use of the atmosphere as a dump for carbon, so the resulting global warming adversely affects the lives of others. This is an example of the tragedy of the commons – where a free resource (such as common land) is overused.

Inter-generational problems. The effect of the growth in carbon emissions is long term, whereas the benefits are immediate. Thus consumers and firms are frequently prepared to continue with various practices, such as driving, flying and using fossil fuels for production, and leave future generations to worry about their environmental consequences. The problem, then, is a reflection of the importance that people attach to the present relative to the future.

Ignorance. People may be contributing to global warming without realising it. They may be unaware of which of the goods they buy involve the release of carbon in their production or how much carbon they release when consumed.

Political failures

Governments, whether democratic or dictatorships, face incentives not to reduce carbon emissions – or to minimise their reduction, especially if they are oil producing countries. Reducing carbon involves short-term costs to consumers and this can make them unpopular. It could cost them the next election or, in the case of dictatorships, make them vulnerable to overthrow. What is more, the oil, coal and gas industries have a vested interest in continuing the use of fossil fuels. Such industries wield considerable political power.

Even if governments want the world to reduce carbon emissions, they would rather that the cost of doing so is born less by their own country and more by other countries. This creates a prisoner’s dilemma, where the optimum may be for a large global reduction in carbon emissions, but the optimum is not achieved because countries individually are only prepared to reduce a little, expecting other countries to reduce more. Getting a deal that is deemed ‘fair’ by all countries is very difficult. An example is where developing countries, may feel that it is fair that the bulk of any cuts, if not all of them, should be made by developed countries, while developed countries feel that fixed percentage cuts should be made by all countries.

Policy options

If the goal is to tackle climate change, then the means is to reduce the amount of carbon in the atmosphere (or at the least to stop its increase – the net zero target). There are two possibilities here. The first is to reduce the amount of carbon emissions. The second is to use carbon capture and storage or carbon sequestration (e.g. through increased forestation).

In terms of reducing carbon emissions, the key is reducing the consumption of carbon-producing activities and products that involve emissions in their production. This can be achieved through taxes on such products and/or subsidies on green alternatives (see the blog ‘Are carbon taxes a solution to the climate emergency?‘). Alternatively carbon-intensive consumption can be banned or phased out by law. For example, the purchase of new petrol or diesel cars cold be banned beyond a certain date. Or some combination of taxation and regulation can be used, such as in a cap-and-trade system – for example, the EU Emissions Trading System (EU ETS) (see the blog ‘Carbon pricing in the UK‘). Then there is government investment in zero carbon technologies and infrastructure (e.g. electrifying railways). In practice, a range of policy instruments are needed (see the blog ‘Tackling climate change: “Everything, everywhere, all at once”‘).

With carbon capture, again, solutions can involve a mixture of market mechanisms and regulation. Market mechanisms include subsidies for using carbon capture systems or for afforestation. Regulation includes policies such as requiring filters to be installed on chimneys or banning the felling of forests for grazing land.

The main issue with such policies is persuading governments to adopt them. As we saw above, governments may be unwilling to bear the short-term costs to consumers and the resulting loss in popularity. Winning the next election or simple political survival may be their number-one priority.

COP28

The COP28 summit concluded with a draft agreement which called for the:

transitioning away from fossil fuels in energy systems, in a just, orderly and equitable manner, accelerating action in this critical decade, so as to achieve net zero by 2050 in keeping with the science.

This was the first COP summit that called on all nations to transition away from fossil fuels for energy generation. It was thus hailed as the biggest step forward on tackling climate change since the 2015 Paris agreement. However, there was no explicit commitment to phase out or even ‘phase down’ fossil fuels. Many scientists, climate interest groups and even governments had called for such a commitment. What is more, there was no agreement to transition away from fossil fuels for transport, agriculture or the production of plastics.

If the agreement is to be anything more than words, the commitment must now be translated into specific policy actions by governments. This is where the real test will come. It’s easy to make commitments; it’s much harder to put them into practice with policy measures that are bound to impose costs on various groups of people. What is more, there are powerful lobbies, such as the oil, coal and steel industries, which want to slow any transition away from fossil fuels – and many governments of oil producing countries which gain substantial revenues from oil production.

One test will come in two years’ time at the COP30 summit in the Amazonian city of Belém, Brazil. At that summit, countries must present new nationally determined commitments that are economy-wide, cover all greenhouse gases and are fully aligned with the 1.5°C temperature limit. This will require specific targets to be announced and the measures required to achieve them. Also, it is hoped that by then there will be an agreement to phase out fossil fuels and not just to ‘transition away’ from them.

Reasons for hope

Despite the unwillingness of many countries, especially the oil and coal producing countries, to phase out fossil fuels, there are reasons for hope that global warming may be halted and eventually even reversed. Damage will have been done and some tipping points may have been reached, but further tipping points may be averted.

The first reason is technological advance. Research, development and investment in zero carbon technologies is advancing rapidly. As we have seen, power generation from wind and solar is now cheaper than from fossil fuels. And this cost difference is likely to grow as technology advances further. This positive tipping point is becoming more rapid. Other technological advances in transport and industry will further the shift towards renewables and other advances will economise on the use of power.

The second is changing attitudes. With the environment being increasingly included in educational syllabuses around the world and with greater stress on the problems of climate change in the media, with frequent items in the news and with programmes such as the three series of Planet Earth, people are becoming more aware of the implications of climate change and how their actions contribute towards the problem. People are likely to put increasing pressure on businesses and governments to take action. Growing awareness of the environmental impact of their actions is also affecting people’s choices. The negative externalities are thus being reduced and may even become positive ones.

Articles

Questions

  1. Use a diagram to demonstrate the effects of negative externalities in production on the level of output and how this differs from the optimum level.
  2. Use another diagram to demonstrate the effects of negative externalities in consumption on the level of consumption and how this differs from the optimum level.
  3. What was agreed at COP28?
  4. What incentives were included in the agreement to ensure countries stick to the agreement? Were they likely to be sufficient?
  5. What can governments do to encourage positive environmental tipping points?
  6. How may carbon taxes be used to tackle global warming? Are they an efficient policy instrument?
  7. What can be done to change people’s attitudes towards their own carbon emissions?
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Till death do us part? (updated)

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.

Presenteeism

What we have described is an example of presenteeism. But how would we define it? 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.

The effect of presenteeism

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. Jack Ma, the Chinese billionaire and owner of Ali Baba, has 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.
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A four-day week – a solution to sluggish productivity growth?

In two previous posts, one at the end of 2019 and one in July 2021, we looked at moves around the world to introduce a four-day working week, with no increase in hours on the days worked and no reduction in weekly pay. Firms would gain if increased worker energy and motivation resulted in a gain in output. They would also gain if fewer hours resulted in lower costs.

Workers would be likely to gain from less stress and burnout and a better work–life balance. What is more, firms’ and workers’ carbon footprint could be reduced as less time was spent at work and in commuting.

If the same output could be produced with fewer hours worked, this would represent an increase in labour productivity measured in output per hour.

The UK’s poor productivity record since 2008

Since the financial crisis of 2007–8, the growth in UK productivity has been sluggish. This is illustrated in the chart, which looks at the production industries: i.e. it excludes services, where average productivity growth tends to be slower. (Click here for a PowerPoint of the chart.)

Prior to the crisis, from 1998 to 2007, UK productivity in the production industries grew at an annual rate of 6.1%. From 2007 to the start of the pandemic in 2020, the average annual productivity growth rate in these industries was a mere 0.5%.

It grew rapidly for a short time at the start of the pandemic, but this was because many businesses temporarily shut down or went to part-time working, and many of these temporary job cuts were low-wage/low productivity jobs. If you take services, the effect was even stronger as sectors such as hospitality, leisure and retail were particularly affected and labour productivity in these sectors tends to be low. As industries opened up and took on more workers, so average productivity fell back. In the four quarters to 2022 Q3 (the latest data available), productivity in the production industries fell by 6.8%.

If you project the average productivity growth rate from 1998 to 2007 of 6.1% forwards (see grey dashed line), then by 2022 Q3, output per hour in the production industries would have been 21/4 times (125%) higher than it actually was. This is a huge productivity gap.

Productivity in the UK is lower than in many other competitor countries. According to the ONS, output per hour in the UK in 2021 was $59.14 in the UK. This compares with an average of $64.93 for the G7 countries, $66.75 in France, £68.30 in Germany, $74.84 in the USA, $84.46 in Norway and $128.21 in Ireland. It is lower, however, in Italy ($54.59), Canada ($53.97) and Japan ($47.28).

As we saw in the blog, The UK’s poor productivity record, low UK productivity is caused by a number of factors, not least the lack of investment in physical capital, both by private companies and in public infrastructure, and the lack of investment in training. Other factors include short-termist attitudes of both politicians and management and generally poor management practices. But one cause is the poor motivation of many workers and the feeling of being overworked. One solution to this is the four-day week.

Latest evidence on the four-day week

Results have just been released of a pilot programme involving 61 companies and non-profit organisations in the UK and nearly 3000 workers. They took part in a six-month trial of a four-day week, with no increase in hours on the days worked and no loss in pay for employees – in other words, 100% of the pay for 80% of the time. The trial was a success, with 91% of organisations planning to continue with the four-day week and a further 4% leaning towards doing so.

The model adopted varied across companies, depending on what was seen as most suitable for them. Some gave everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis.

There was little difference in outcomes across different types of businesses. Compared with the same period last year, revenues rose by an average of 35%; sick days fell by two-thirds and 57% fewer staff left the firms. There were significant increases in well-being, with 39% saying they were less stressed, 40% that they were sleeping better; 75% that they had reduced levels of burnout and 54% that it was easier to achieve a good work–life balance. There were also positive environmental outcomes, with average commuting time falling by half an hour per week.

There is growing pressure around the world for employers to move to a four-day week and this pilot provides evidence that it significantly increases productivity and well-being.

Articles

Questions

  1. What are the possible advantages of moving to a four-day week?
  2. What are the possible disadvantages of moving to a four-day week?
  3. What types of companies or organisations are (a) most likely, (b) least likely to gain from a four-day week?
  4. Why has the UK’s productivity growth been lower than that of many of its major competitors?
  5. Why, if you use a log scale on the vertical axis, is a constant rate of growth shown as a straight line? What would a constant rate of growth line look like if you used a normal arithmetical scale for the vertical axis?
  6. Find out what is meant by the ‘fourth industrial revolution’. Does this hold out the hope of significant productivity improvements in the near future? (See, for example, last link above.)
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The UK’s poor productivity record

In its latest World Economic Outlook update, the IMF forecasts that the UK in 2023 will be the worst performing economy in the G7. Unlike all the other countries and regions in the report, only the UK economy is set to shrink. UK real GDP is forecast to fall by 0.6% in 2023 (see Figure 1: click here for a PowerPoint). In the USA it is forecast to rise by 1.4%, in Germany by 0.1%, in France by 0.7% and in Japan by 1.8%. GDP in advanced countries as a whole is forecast to grow by 1.2%, while world output is forecast to grow by 2.9%. Developing countries are forecast to grow by 4.0%, with China and India forecast to grow by 5.2% and 6.1%, respectively. And things are not forecast to be a lot better for the UK in 2024, with growth of 0.9% – bottom equal with Japan and Italy.

Low projected growth in the UK in part reflects the tighter fiscal and monetary policies being implemented to curb inflation, which is slow to fall thanks to tight labour markets and persistently higher energy prices. The UK is particularly exposed to high wholesale gas prices, with a larger share of its energy coming from natural gas than most countries.

But the UK’s lower forecast growth relative to other countries reflects a longer-term problem in the UK and that is the slow rate of productivity growth. This is illustrated in Figure 2, which shows output (GDP) per hour worked in major economies, indexed at 100 in 2008 (click here for a PowerPoint). As you can see, the growth in productivity in the UK has lagged behind that of the other economies. The average annual percentage growth in productivity is shown next to each country. The UK’s growth in productivity since 2008 has been a mere 0.3% per annum.

Causes of low productivity/low productivity growth

A major cause of low productivity growth is low levels of investment in physical capital. Figure 3 shows investment (gross capital formation) as a percentage of GDP for the G7 countries from the 2007–8 financial crisis to the year before the pandemic (click here for a PowerPoint). As you can see, the UK performs the worst of the seven countries.

Part of the reason for the low level of private investment is uncertainty. Firms have been discouraged from investing because of a lack of economic growth and fears that this was likely to remain subdued. The problem was compounded by Brexit, with many firms uncertain about their future markets, especially in the EU. COVID affected investment, as it did in all countries, but supply chain problems in the aftermath of COVID have been worse for the UK than many countries. Also, the UK has been particularly exposed to the effects of higher gas prices following the Russian invasion of Ukraine, as a large proportion of electricity is generated from natural gas and natural gas is the major fuel for home heating.

Part of the reason is an environment that is unconducive for investment. Access to finance for investment is more difficult in the UK and more costly than in many countries. The financial system tends to have a short-term focus, with an emphasises on dividends and short-term returns rather than on the long-term gains from investment. This is compounded by physical infrastructure problems with a lack of investment in energy, road and rail and a slow roll out of advances in telecoms.


To help fund investment and drive economic growth, in 2021 the UK government established a government-owned UK Infrastructure Bank. This has access to £22 billion of funds. However, as The Conversation article below points out:

According to a January 2023 report from Westminster’s Public Accounts Committee, 18 months after its launch the bank had only deployed ‘£1 billion of its £22 billion capital to 10 deals’, and had employed just 16 permanent staff ‘against a target of 320’. The committee also said it was ‘not convinced the bank has a strategic view of where it best needs to target its investments’.

Short-termism is dominant in politics, with ministers keen on short-term results in time for the next election, rather than focusing on the long term when they may no longer be in office. When the government is keen to cut taxes and find ways of cutting government expenditure, it is often easier politically to cut capital expenditure rather than current expenditure. The Treasury oversees fiscal policy and its focus tends to be short term. What is needed is a government department where the focus is on the long term.

One problem that has impacted on productivity is the relatively large number of people working for minimum wages or a little above. Low wages discourage firms from making labour-saving investment and thereby increasing labour productivity. It will be interesting to see whether the labour shortages in the UK, resulting from people retiring early post-COVID and EU workers leaving, will encourage firms to make labour-saving investment.

Another issue is company taxation. Until recently, countries have tended to compete corporate taxes down in order to attract inward investment. This was stemmed somewhat by the international agreement at the OECD that Multinational Enterprises (MNEs) will be subject to a minimum 15% corporate tax rate from 2023. The UK is increasing corporation tax from 19% to 25% from April 2023. It remains to be seen what disincentive effect this will have on inward investment. Although the new rate is similar to, or slightly lower, than other major economies, there are some exceptions. Ireland will have a rate of just 15% and is seen as a major alternative to the UK for inward investment, especially with its focus on cheaper green energy. AstraZeneca has just announced that instead of building its new ‘state-of-the-art’ manufacturing plant in England close to its two existing plats in NW England, it will build it in Ireland instead, quoting the UK’s ‘discouraging’ tax rates and price capping for drugs by the NHS.

And it is not just physical investment that affects productivity, it is the quality of labour. Although a higher proportion of young people go to university (close to 50%) than in many other countries, the nature of the skills sets acquired may not be particularly relevant to employers.

What is more, relatively few participate in vocational education and training. Only 32% of 18-year olds have had any vocational training. This compares with other countries, such as Austria, Denmark and Switzerland where the figure is over 65%. Also a greater percentage of firms in other countries, such as Germany, employ people on vocational training schemes.

Another aspect of labour quality is the quality of management. Poor management practices in the UK and inadequate management training and incentives have resulted in a productivity gap with other countries. According to research by Bloom, Sadun & Van Reenen (see linked article below, in particular Figure A5) the UK has an especially large productivity gap with the USA compared with other countries and the highest percentage of this gap of any country accounted for by poor management.

Solutions

Increasing productivity requires a long-term approach by both business and government. Policy should be consistent, with no ‘chopping and changing’. The more that policy is changed, the less certain will business be and the more cautious about investing.

As far a government investment is concerned, capital investment needs to be maintained at a high level if significant improvements are to be made in the infrastructure necessary to support increased growth rates. As far as private investment is concerned, there needs to be a focus on incentives and finance. If education and training are to drive productivity improvements, then there needs to be a focus on the acquisition of transferable skills.

Such policies are not difficult to identify. Carrying them out in a political environment focused on the short term is much more difficult.

Podcasts

Articles

Data

Questions

  1. What features of the UK economic and political environment help to explain its poor productivity growth record?
  2. What are the arguments for and against making higher education more vocational?
  3. Find out what policies have been adopted in a country of your choice to improve productivity. Are there any lessons that the UK could learn from this experience?
  4. How could the UK attract more inward foreign direct investment? Would the outcome be wholly desirable?
  5. What is the relationship between inequality and labour productivity?
  6. What are the arguments for and against encouraging more immigration in the current economic environment?
  7. Could smarter taxes ease the UK’s productivity crisis?
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Black Friday vs the Rational Consumer

When building supply and demand models, the assumption is usually made that both producers and consumers act in a ‘rational’ way to achieve the best possible outcomes. As far as producers are concerned, this would mean attempting to maximise profit. As far as consumers are concerned, it would mean attempting to achieve the highest satisfaction (utility) from their limited budget. This involves a cost–benefit calculation, where people weigh up the costs and benefits of allocating their money between different goods and services.

For consumers to act rationally, the following assumptions are made:

  • Consumer choices are made independently. Their individual choices and preferences are not influenced by other people’s, nor do their choices and preferences impact on other people’s choices.
  • The consumer’s preferences are consistent and fixed.
  • Consumers have full information about the products available and alternatives to them.
  • Given the information they have and the preferences they hold, consumers will then make an optimal choice.

Black Friday can be seen as a perfect occasion for consumers to get their hands on a bargain. It is an opportunity to fulfil a rational need, for example if you were needing to replace a household appliance but were waiting until there was a good deal before committing to a purchase.

The assumption that people act rationally has been at the forefront of economic theory for decades. However, this has been questioned by the rise in behavioural economics. Rather than assuming that all individuals are ‘rational maximisers’ and conduct a cost–benefit analysis for every decision, behavioural economists mix psychology with economics by focusing on the human. As humans, we do not always behave rationally but, instead, we act under bounded rationality.

As economic agents, we make different decisions depending on our emotional state that differ from the ‘rational choice’ assumption. We are also influenced by our social networks and often make choices that provide us with immediate gratification. Given this, Black Friday can also be viewed as a great opportunity to fall prey to irrational and emotional shopping behaviours.

Black Friday originated in the USA and is the day after Thanksgiving. During this annual shopping holiday, retailers typically offer steep discounts to kick off the holiday season. The Black Friday shopping phenomenon is less than a decade old in the UK but it’s now an established part of the pre-Christmas retail calendar. Between 2010 and 2013, Black Friday gradually built up momentum in the UK. In 2014, Black Friday became the peak pre-Christmas online sales day and many online retailers haven’t looked back.

Arguably, from a behavioural economist’s perspective, the big problem with Black Friday is that all the reasons consumers possibly have to partake can be largely illusory. Consumers are bombarded with the promise of one-off deals, large discounts, scarce products, and an opportunity to get their holiday shopping done all at once. However, on Black Friday, our rational decision-making faculties are tested, just as stores are trying their hardest to maximise consumers’ mistakes.

There are many ‘behavioural traps’ that consumers often fall into. The following two are most likely to occur on Black Friday:

  • Scarcity and loss aversion. Shoppers may fear that they will miss out on the best sales deals available if they don’t buy it now. Retailers commonly spark consumers’ interest by highlighting limited stocks available for a limited time only, which raises the perceived value of these goods. This sense of scarcity can further trigger the need to buy now, increasing the ‘Fear of Missing Out’. Consumers therefore need to ask themselves if they are really missing out if they don’t buy it now? And is the discount worth spending the money today, or is there something else I should be spending it on or saving for?
  • Sunk cost fallacy. Once consumers have started to invest, they often struggle to close out investments that prove unprofitable. On Black Friday, customers have already made the initial investment of getting up early, driving to the shops, finding parking and waiting in a queue, before they have purchased anything. Therefore, they will be inclined to buy more than they initially went for. It is important therefore to think about each purchase in isolation.

This year, however, there is also the added complication of the rising cost of living. Whilst this may deter some consumers from unnecessary, impulse purchases, some consumers are using Black Friday as an opportunity to stock up on expected future purchases, hedging against likely price rises over the coming months.

It is thought that more consumers will be looking for a combination of high quality but low price to make sure their purchases are affordable and can last for a long time. According to PwC, many consumers have closely monitored their favourite brands in anticipation that big-ticket electronics, more pricey winter wear or Christmas stocking fillers will be discounted. Consumers are also in search of bargains more than ever given rising inflation. This would suggest a shift in attitude, meaning consumers will be more aware of what they cannot afford rather than giving in to emotional temptation brought on by Black Friday.

Retailers are fully aware of the cognitive biases that surround Black Friday and take full advantage of them. ‘Cyber Monday’ follows right after Black Friday, giving retailers an extra opportunity for them to keep those ‘urgent’ or ‘unmissable’ sales going and increase their revenues.

Black Friday is one of the biggest shopping days of the year. However, the way retailers approach it is growing increasingly mixed. Stores such as Amazon, Argos, Currys and John Lewis have started offering Black Friday deals much earlier in the month, leading some to refer to the event as ‘Black November’. Other stores, such as M&S and Next, didn’t take part at all this year.

Ultimately, Consumers can use insights from behavioural economics to empower them to make more rational decisions in such circumstances: ones that better align with their individual budgets. Nevertheless, the Black Friday sales mania can trigger our deepest emotional and cognitive responses that lead to unnecessary spending.

Articles

Video

Questions

  1. Discuss what is meant by the term ‘rational consumer’. Is it a useful generalisation about the way consumers behave?
  2. Discuss what is meant by the term ‘rational producer’. Is it a useful generalisation about the way firms behave?
  3. What is cost–benefit analysis? What is the procedure used in conducting a cost–benefit analysis?
  4. In addition to scarcity and loss aversion and the sunk cost fallacy, are there any other reasons why consumers may not always act rationally?
  5. Are people likely to be more ‘rational’ about online Black Friday purchases than in-store ones? Explain.