Economics in Action

Figures this released by the ONS on this week show that the UK has officially entered a recession; the second recession the UK has suffered in three years. David Cameron has said that these figures were very disappointing while Ed Miliband has called them catastrophic. But how catastrophic is a double dip recession for the UK? There are a number of reasons to doubt the media’s, and some politicians, doomsday predictions.

First, a technical recession has a very strict definition, namely two successive quarters of negative economic decline. Such a rigid definition gives rise to anomalies. It could be argued that the UK is currently in one of those anomalies. In 2011Q4 the UK’s output fell by 0.3%, in 2012Q1 it fell by 0.2% (preliminarily). Compare this to the last UK recession, which began in 2008Q2 and finished in 2009Q2, where the average quarterly fall in GDP was 1.5%. Granted no one can be sure where this current downturn will end but to compare both periods like for like by defining them both as a ‘recession’ is nonsensical.

Second, it is important to look at the economic performance of the UK prior to the current recession. In the four quarters prior to the recession (2010Q4 – 2011Q3) GDP grew 0.2%. Moreover, GDP growth between 2010Q3 and 2011Q4 has alternated between positive and negative rates every quarter. This low average level of GDP growth and large fluctuations in GDP growth during the year prior to this recession is more worrying for the UK economy than the last two quarters of very small GDP contractions.

Third, GDP growth in services actually rose during 2012Q1, after falling in 2011Q4. Services accounts for a vast majority of the UK’s total output and growth in this sector will be vital for a prosperous UK economy in the decades to come.

Although the UK economy is going through difficult economic times, critiquing the rhetoric that many politicians and media outlets spew can result in much different conclusions. Perhaps policy makers should be less concerned with avoiding a double-dip recession and more concerned with creating a long-term stable environment for UK businesses and the public.

Why Study Economics? is a website that encourages students from all educational backgrounds to study economics as their first degree. It also provides information to teachers and parents.

Where can students study economics? Over 95 departments across the UK offer an Economics degree. Some of these are straight (‘single’) Economics degrees. Normally they are simply called Economics, but sometimes they are more specialist, e.g. Agricultural Economics or Business Economics. Other degrees combine Economics with another subject (‘joint degrees’). The titles of these joint degrees includes: Economics and Management; Economics and Finance; Economics and Philosophy; Economics and Accounting; Economics and Business; Economics and History; and Economics and Politics.

What will economics students do at university? Most economics students will experience a generic first year at university which builds a solid foundation. The most important modules for a first-year economics student are Introductory Microeconomics, Introductory Macroeconomics and Quantitative Methods for Economics (statistics/mathematics). The concepts taught in these three modules will be used throughout an economics undergraduate degree. In their second, and particularly third, year at university, economics students will have a number of optional units. Students will be able to specialise in Development Economics, Managerial Economics, Labour Economics, Monetary Economics and so on. If students are on a joint degree they will have modules in their other subject in all three years, some of which will be compulsory. Students on either single or joint economics degrees may also be able to do an optional module in another subject area such as a modern language.

“Until studying a course like economics not a lot of people are aware of how the world works, including industries, businesses and governments. You realise that it’s very important to be educated in this type of thing even if it gets to the stage where you become annoyed with family and friends for moaning about taxes!”

The workload at university is generally heavier than at A-level. Students can expect around 10 – 15 hours of contact time a week, consisting of a mixture of lectures and tutorials/seminars/workshops. In addition to this, students will be expected to put in a minimum of 20 hours per week of independent study. The number of contact hours will normally fall between years one, two and three but the amount of independent study will rise (at least it should do!).

Why do students enjoy economics? Economics is the perfect combination of numbers and words, problems and essays, calculations and interpretations. It is both an art and a science subject. Students have the opportunity to build models which give insights into the real world, and then to critique these models on the basis of their assumptions. There is rarely a right answer in economics but any argument put forward must be backed up by quantitative evidence. Students ultimately enjoy economics because it allows them to employ and develop analytical and evaluative skills.

“My decision to pursue an Economics degree has been the single most valuable investment I have made to date.  It sharpened my ability to critically assess information, deliver disciplined and well structured arguments and become a more confident team player.”

What do students need to have studied to read economics at university? Some universities have A-level Maths as a prerequisite for their economics degrees. Even if it is not required, A-level Maths is still very useful for university level economics, especially those degrees with a heavy number of quantitative modules. Those institutions that do not require A-level Maths still require a good GCSE in Maths. Furthermore, some universities may look more favourably on candidates with other quantitative subjects, such as Physics or Accounting. No university requires students to have studied A-level Economics, but it helps if they have. Aside from the subjects studied, students should only choose to read economics at university: if they enjoy keeping up with current affairs; if they are comfortable working with numbers; and if they are willing to write a number of essays.

But how can a student, who has never studied economics before, prepare for their degree? One way is through work experience, especially when this involves handling money or making any form of economic choice. Reading economic articles in newspapers and/or subscribing to The Economist will give students an edge over their peers when it comes to writing their first essay. Students could also read a couple of the books on their course’s reading list, particularly those that give lots of background information (e.g. “Fool’s Gold” by Gillian Tett). Alternatively, a lot of the popular economics literature, such as the Undercover Economist or Freakonomics, will show students that economics can be used to explain virtually any phenomena.

“Economics places a key role in all aspects of life and is an important subject worth knowing more about.”

To get an idea of the level of maths involved in their economic modules, students should have a flick through a first year textbook and have a go at some of the problems set. Finally, students should brush up on their statistics either by going back to their notes or, if they did not study maths, by working through some problems in an A-level statistics textbook. Statistics is vital for students to understand econometrics, a technique used by many authors in a number of economic journals.

And what can students do after an Economics degree? Economics graduates are well equipped, having analytical and problem-solving skills, numerical and computer skills, as well as the ability to work well either alone or within a team. All of these skills are very transferable allowing economics graduates to branch into anything from investment banking and financial services, business and public-sector management and research, to working with charities, teaching or the media. There is little restriction on what students can do afterwards.

“By the end of the degree you emerge as a student who can read as well as a law graduate, compute as well as an accountant, and analyse data as well as a statistician.”

And of course there is money. Economics graduates typically earn £4000 more than the average graduate in their first position.

Economic history is a bit of an unloved child within economics. Once at the centre of the subject it has fallen by the wayside in the rush to be scientific of recent years. Indeed most undergraduate courses no longer teach any economic history as a core subject and many don’t offer any option whatsoever. So why am I going on about economic history? Well, it turns out it’s very interesting indeed…

A Scientist for Every Issue

What sparked my interest in economic history was actually a book which had very little to do with the past. It was ‘The Cult of Statistical Significance’ by Steven Ziliak and Deirdre McCloskey.  The book was, as you have probably guessed about statistics; furthermore the authors argued that statistics was having a negative effect on the way that economists undertook research. They argued that economists liked to appear scientific and one of the ways to do so was to use statistical significance. A clean cut, simple procedure that gives a right or wrong answer appeals because it seems to offer a degree of certainty to a researcher’s findings. Does smoking lead to an increase in the use of other drugs? Do a t-test and you have your answer. However what exactly does the test of statistical significance prove? The answer, to the authors, was not much.

I am not going to talk more about this debate here (as it is quite technical, divisive and will likely bore the pants off anyone that isn’t interested in doing research in the social and natural sciences). One of the points that I did take away and thought would be interesting to talk about, was that economists can benefit from grounding their work in a wider context.

How to Build a Discipline from the Ground Up

This is where economic history can really play a part. Firstly modern neoclassical economics, the stuff that gives us supply and demand diagrams and the toolkit for how a central bank should be run, is based on a number of key assumptions about the nature of the world. Many of the debates on these assumptions happened over a hundred years ago.

Take for example the theory of value. What should the price of a good be? Should it be decided by how much of each input goes into its production?  Or should it be decided by how much use that people get out of it? Why don’t we just let the market decide and take that as its value? If the first case is true then is the value of the internet, which as a service is very cheap to provide for each user, valueless? Likewise if we use the third option and let the market decide then the internet is still pretty cheap. However, people clearly get a lot out of the internet. It has created a great deal of what economists call consumer surplus; that is what consumers get in value above and beyond the price they pay.

Trial and error, a 10000 year experiment

Secondly it allows us to enrich many of the theories we have to explain the world as it is today. I am currently reading another book (this is the last I will mention I promise!) called ‘Structure and change in economic history’ by Douglas North. In the book he attempts to create a theory which can explain why economies over time fair well and poorly.

For example, we can explain why humans moved from a hunter gatherer society to organised agriculture. For the first million and a half or so years of our history humans occupied a very small area of the globe. There was a lot of space and so as our population grew there was little pressure on hunting resources as new groups or clans could simple move into territory unoccupied by other humans. However, as the world began to be filled up the amount of free space decreased. This caused a decline in the marginal benefit of hunting as there were fewer animals to go around, and there was no incentive for tribes to not exploit all of the animals that surrounded them. If they decided to not hunt a herd or buffalo, some other tribe would. Hunting suffered from what the tragedy of the commons. At some point, the marginal productivity of hunting must have fallen below that of agriculture. When this happened it became in the interest of tribes to start farming, as extra hunters had very little effect on how much game a tribe would catch. Over time agriculture became more and more productive (from breeding crops, improving techniques etc.) and eventually replaced hunting as the main form of food production.

There are no ways of testing such a theory, but it is interesting none the less. It also demonstrates how central property rights and natural resources, two items usually omitted from modern economical analysis, can be in examining the nature of the world.

For any economist seeking a job, check out page 36 of this issue of the Gateway

Ever wondered why demand and supply are so important? Wonder no more …

Part 1 – The private sector

What are the opportunities available to students studying economics? If you are in the second or final year of your economics degree and interested in securing an internship or graduate job you will be faced with a bewildering array of options. To give yourself the best chance of securing a role you must focus on applying to one industry and know that industry like the back of your hand. Submitting applications across a variety of industries should be avoided because it is not time effective. Below is a list of sectors that seek to employ economists every year. This list is by no means exhaustive but it should give you an idea of where to focus your time and efforts.

Investment banking

Advantages:

• Very high starting salary
• Variety of work
• The opportunity to network with senior management

Disadvantages:

• Extremely competitive
• For many roles ‘who you know’ is more important than ‘what you know’
• Many of the banks have target universities
• Very long hours with weekend shifts seen as standard
• High stress environment
• Low job security

Every year investment banks draw a huge number of applications from economic students for their internship and graduate schemes. With starting salaries of £40,000+ and bonuses, it is easy to see why. Moreover, many of the positions offered by investment banks are tailored to the skills of an economist. For example, a position on the trading floor requires graduates to analyse a particular firm or sector, weigh up costs and benefits and understand risk. All of these skills come naturally to students from an economics background. Furthermore, economic students are often much more aware of current issues surrounding the economy as well as the banking sector. This is why so many of the positions within this sector are given to economists.

However, any undergraduate considering a career in investment banking should not do so lightly. It will require an enormous amount of time and effort. If you do have your heart set on this career path then the earlier you begin tailoring your CV the better. Most graduates who gain a position at an investment bank do so through an internship. To gain an internship your first-year academic results need to be impressive. This will mean that your first-year experience will be very different from that of your best friend who is studying film. And remember, even if you spend all three years of your university life achieving fantastic academic results, being president of the banking society and playing five different sports, this may not be enough to secure you a role at an investment bank simply because you go to the wrong university or your dad is not the CEO of Lloyds Banking Group. Having said that, do not be discouraged from applying to this challenging, exciting and highly rewarding industry. Just be aware of the sacrifices that need to be made in order to be successful.

Professional services

Advantages:

• High starting salary
• The opportunity to complete a professional qualification
• Large graduate investment

Disadvantages:

• Very competitive
• Many roles are exam orientated

When someone mentions the professional services industry the first thought in every undergraduate’s head is ‘The Big Four’ (PwC, Deloitte, KPMG and Ernst & Young). Much of the work these big four firms undertake, as well as others in the industry, does depend on the economic climate and regulation. Economists’ knowledge of both of these factors makes them especially attractive to professional services firms.

One of the major benefits of this industry is that firms make a large investment in all of the graduates they take on. Part of this investment is to put all of their graduates through a professional qualification. These qualifications will be taken alongside your day-to-day responsibilities and can last from three years (ACA and CIMA) up to six (actuarial exams). Students studying economics will often get exemptions from some of the exams in the first year of these qualifications. Economists will also find their degree very relevant to the modules they have to study in subsequent years of these qualifications and the projects their company will place them in.

Studying for a professional qualification may not be to the liking of some graduates who want to leave their exam-taking days behind them. Moreover, if you fail any of your exams twice your contract with your employer may be terminated. This can be very stressful for graduates. However, getting one of these qualifications on your CV does look very impressive.

If you are interested in following this career path make sure you spend a lot of time researching the service line you want to apply for and each firm’s core competencies. Both of these factors will be heavily scrutinised in any interview you may get.

Multinational companies

Advantages:

• Good starting salary
• High job security
• Under-applied to by economists
• Large number of roles
• International work opportunities

Disadvantages:

• Graduates may feel detached from senior management
• Work may not have much impact

The types of organisations that I would include under this heading are Unilever and P&G, but the list is long. For example, most organisations in the food industry, the car industry and the aviation industry will have employees working for them across the globe. These firms have many roles which particularly suit economic students such as finance, strategy and research. During a graduate placement, students will often get to experience more than one of these business areas. As well as the opportunity to experience different roles, some of these organisations will offer students time in one of their foreign offices. Moreover, since economists tend to apply to the first two sectors already mentioned in this article, competition between economic students for these placements is relatively low. However, don’t think that you will be able to walk into one of these companies. There will still be fierce competition from students from every academic background. There are negatives to working in a large international organisation. First, as you will likely be buried underneath many layers of hierarchy there could be limited scope for innovation or creativity. Second, the work you are doing may seem far away from the mission statement of the organisation. Despite these concerns, ambitious young economists should give more consideration to a career in this sector.

Others

Asset Management (M&G, Baillie Gifford) – Similar to investment banking with slightly less pay and slightly less competition

Retail Banking (NatWest) – Lower pay than its glamorous big brother but far fewer working hours

Market research (Nielsen) – An area of work where economists can put econometric and statistical theories into practice

U.K. firms (Sainsbury’s) – Many U.K. firms will offer management schemes perfect for those economists who want to become future leaders

Advice

Regardless of the industry or organisation you would like to work in, there are some general tips to help you succeed:

• Start thinking about your desired career as early as you can. The best way into many organisations is through an internship, which requires students to work hard during their first year.
• Be realistic. Do not apply to investment banks if you have three Bs at A-level; you will just be wasting your time.
• Once you have chosen a sector, do as much research around that sector as possible. Good places to start are your family and friends, the university careers service and this website: www.studyingeconomics.ac.uk.
• Expect to be disappointed. When you are applying to U.K. internships and graduate schemes you are competing with the best students from around the globe. The quicker you can learn to deal with rejection the easier the whole process will become.
• Be persistent. Applying to jobs while studying towards a degree can be very difficult, especially when your job applications don’t appear to be going anywhere. As long as you meet the minimum requirements and do your research you will get an interview eventually, so apply to as many companies as it takes.
• Try to enjoy it. Interviews and assessment centres can be nerve-racking and daunting prospects. But people are rarely as intimidating as you think they will be. To make these experiences enjoyable and rewarding, think of each interview and assessment centre as opportunity to learn about yourself and the people that work there.

A house of cards

Unless you have been living in a hole for the last year then you have probably heard that the European financial system is in a bit of a mess. Put simply, the countries of the Euro-zone have borrowed quite a lot of money. Some of the people that governments have borrowed this money off of have become less than convinced that the euro-zone countries pay it back. As a result debt holders have been selling a lot more than buying, which has forced the price/value of these loans down and interest rates up. All-in-all, not too pretty.

The question most people are asking, is how likely is it that the cost of debt gets so high for a country (say Italy), that it will have no choice but to default on its debt. This is a very hard question to answer.

So turning to the other side of the story, what happens if a country defaults? I thought it would be interesting to take a look back at one of the more colourful periods in financial history, the Spanish Bankruptcies.

A little History

In 1492, Rodrigo de Triana became the first European to set sight on the Americas in almost 500 years. Few at the time would have thought that the sighting of land sailor on la Pinta, one of three ships in the expedition led by Christopher Columbus, would transform the shape of Europe. The ships had been sent to discover a trade route around the east of the globe to the orient. The goal was to ship spices, which were extremely valuable is Europe at the time from the east, thus making a fortune. The Portuguese would get the spice route as it later became known but the Spanish got a lot more.

It became apparent, over the next few decades that the Americas were extremely rich. Areas that now include Mexico, Peru and Bolivia had huge reserves of gold and silver. At Potosi, there was a mountain which contained the largest reserve of silver ever found. So large in fact that it is still being mined to this day. The value of gold and silver was particularly important in the 16^th century as it was literally used as currency. The influx of gold and silver made the Spanish exceedingly rich, unfortunately this didn’t last.

What would you buy with all the gold in the world?

By the time the Spanish had begun to realise the extent of their new-found wealth a new family had come to power, the Habsburgs. The Habsburgs were extremely ambitious and used their money to finance a large number of wars in order to consolidate and expand their power. They fought for control of Italy, they fought against France and later they fought against protestants in the form of the Dutch, the English and later still many Germans. They didn’t just fight. They donated huge amounts to the catholic church, building the Vatican in its current form. They even built a brand new city from the ground up, which would become their capital, Madrid.

One of the problems they faced was that while the government had a lot of money to spend, by spending it they increase the supply of money in their own lands and inevitably throughout Europe. The rate at which the money supply grew was like nothing Europe had ever seen. Not only that but it grew far faster than the Spanish economy, causing a huge amount of inflation. This impoverished the lower and middle classes and the domestic economy stagnated.

The well dries up

By 1557 Spain’s finances were extremely overstretched and the Spanish were forced to declare a state bankruptcy. This caused chaos in the European financial system of the day. It bankrupted a large part of the Fugger family which had been the Habsburgs main financiers. At the same time the Spanish crown began to borrow large amounts of money, largely from the Genoese (ironically Columbus was born in Genoa).

Continued borrowing and debt led to more bankruptcies in 1576 and in 1596. They lost the great bulk of their European possessions outside of Spain itself and the financial mismanagement in the 16^th century set the stage for the perennial decline of the Spanish Empire over the next two hundred years.

I am not saying that the west is going to go bankrupt. The two situations are not very comparable. It was fiscal mismanagement, a high growth in the money supply and overspending on foreign wars that caused the Spanish Empire to decline. It’s worth not forgetting just how bad, bad economic policies can be.

I was originally going to write a bit on the crisis in Europe. However, when I started looking for the chart that sparked off the idea, I stumbled upon The Economists Daily Chart section (you can see it here).

Essentially the lovely people over at The Economist publish a chart every day on pretty much everything. Not only are they extremely shiny, they are also usually both topical and interesting. They even have an advent calander!

So apart from all of the eye candy, just why are graphs so awesome? I think they allow you to summarize a huge amount of whats going on in just a small area. Not only that but they can be great tool on which to frame a discussion. Here are some charts that I found particularly interesting:

1. European Borrowing and Lending

This graph shows how much banks have been able to raise in the bond markets. Put simply, how much extra cash they have managed to get invested into their business. Investors in exchange for providing this money now, get a rate of return on what is called a bond. The graph firstly shows that banks are having major issues in getting more cash, which they need to meet the new Basel Rules*. Secondly it shows that investors are unwilling to issue these bonds unless they are covered. A covered bond is a bond which is linked to an asset proportional in value to the bond issued. So if the bank cannot pay the bond interest then the investors can take control of the asset to get there money back. Fundamentally this graph shows just how little liquidity and how much paranoia is driving the behavior of European banks.

*(Basel 3 is the latest set of guidelines issued for global banking. Passed after the financial crisis they required banks to keep a far greater proportion of their assets as cash, the kind of money you carry around in your pocket everyday, as opposed to investments, say mortgages)

2. Bribery and Corruption

This graph shows perceived corruption within the public sector on the Y-axis graphed against a survey-based score for how likely private companies are to engage in bribery on the X-axis. A higher score suggests bribery is less common. It is worth noting that the companies Bribe Payers Index is the likelihood of companies using bribes when doing business in foreign  countries. There are some interesting results here. Italy and Turkey rank as the most corrupt amongst the OECD (developed) countries. Hong Kong has one of the least corrupt administrations in the world, despite being part of the China which ranks quite poorly on this scale. Perhaps unsurprisingly the Russian oligarchy is bringing up the rear amongst the major economies.

3. Dangerous Places

When it comes to crime it is often very difficult to make comparisons between countries, partly because the chance of a crime being reported differs greatly across cultures. One of the better measures to get around thus problem are murder rates, as murders tend to be reported. It seems that less developed countries have higher murder rates. Rather surprisingly while Mexico hasn’t topped the chart, they didn’t even make the top ten. Afghanistan has a lower homicide rate than the USA. Quite whether this makes Afghanistan a safer country would be hard to believe.

http://www.zerohedge.com/news/charting-fundamental-cash-supply-demand-dilemma-europe

http://www.economist.com/blogs/dailychart/2011/11/bribe-payers-index

http://www.economist.com/blogs/dailychart/2011/10/homicide-rates

Disclaimer: All of the charts here are reproductions from the websites linked above.

Ever wondered where all the money in the world is and where it is spent? Have a play with this amazing map to find out: http://xkcd.com/980/huge/

If you ask a philosopher for his thoughts on economics or any other social science you are likely, amongst some long words and even longer sentences, to hear the time honed phrase that correlation does not imply causation. If you have not heard it before then you can forgive yourself. Very few economics courses will even mention it, let alone go into any detail. Yet this little statement may be one of the most important problems faced by economists, and in many ways is the single largest problem we will face. So what is it?

It has throughout history had many names. Philosophers today call it the problem of induction. At its heart it says that although we observe events happening, we cannot prove that an explanation of the process behind why these events happen is the right explanation. This is because the process behind the events is entirely unknown to us and in many cases will prove exceedingly complicated.

Say you want to look at the effect of alcohol taxes on car accidents. You postulate that higher taxes on alcohol will cut its consumption, and thus cut the amount that people drink and drive. If people drive less while drunk, then less of them will be driving into trees, shopping malls and other objects that get in their way.

You decide, being a classical economist, that the best way to explain this relationship is to form a linear model linking alcohol taxes to car accidents. A linear model is essentially one that says a rise or fall in one variable (taxes) will lead to a proportional change in the other variable (car accidents). You then estimate this model using some form of regression analysis (this is how economists by and large estimate relationships) and find that a rise in taxes of 1 penny on the pound leads to a fall in car accident rates of 0.6%.

So we have found our result! The problem we now have is that we cannot be sure that these estimates are accurate. Economists will now turn to a concept called statistical significance. Essentially, is the relationship between alcohol taxes and car accidents a fluke of the data or did it arise because higher taxes tends to coincide with fewer accidents? Say our data passes all of these tests, what has our study learned?

This is where the problem of induction exists. At heart all we have shown is that higher taxes tend to be seen with lower rates of car accidents. We cannot say how this has come about. It could be because people drink less. But is it because the amount of drunk drivers on the road is lower? Or is because the drivers are now less drunk? Perhaps it is because areas with higher alcohol taxes tend to have safer drivers?

If the last reason is the main cause behind fewer car crashes and the government decides as a result of our study to raise alcohol duty in order to cut car crash numbers then they are likely to be very disappointed. This is why this is such a problem.

Perhaps the worst bit about it is that we won’t know when this problem is important and when it isn’t.

Here are a few links to look at if you are interested in reading more into it:

http://www.myhealthnewsdaily.com/a-hike-in-the-price-of-booze-could-make-us-all-healthier-0432/

http://en.wikipedia.org/wiki/Problem_of_induction

http://www.economistsdoitwithmodels.com/2011/04/06/why-publication-bias-matters-in-one-cartoon/