Economics in Action

Here is a personal take on the situation in Iceland and the rest of Europe by our new contributor Harry Simmons:

Iceland has been the world’s whipping boy for the last few years.  The collapse of its banking system uncovered huge international systemic failures leading to the economic crisis.  The snowy nation has had a rough time of it.  But as we begin 2011, I ask the question, are they really still in that much trouble?  Figures released by the International Monetary Fund in December 2010 showed that Iceland’s GDP grew by 1.2% in the third quarter, ending the recession caused by the actions of those in its banking sector.  What about those European countries still in economic strife?

In direct contrast to the actions taken by almost all other western countries and most significantly Ireland, Iceland let its banks fail.  It was able to do so because the international risk of contagion is comparably lower than many of the European countries currently receiving bail-outs.  This forced foreign creditors and the banks themselves to foot the bill of failure, rather than the taxpayer.  Essentially, Iceland stuck to free market principles.  Those institutions that operated in an economically viable manner were able to survive; those that chose to take on too many liabilities in foreign currency must face the consequences.  In a system such as banking where when times are good, the mechanisms of capitalism and free market economics define the actions of agents in market, why should those mechanisms not also define what happens when it goes wrong?  In addition to the economic reasoning, there is also the moral issue of the taxpayer having to pay for the mistakes of a small elite.  The actions of many other governments in bailing out the banks served as an attempt to prop up an already unsustainable bubble.  These actions have exacerbated existing public finance problems further, the implications of which are to be felt by those who have not caused the problem.

During the recession Iceland’s economy shrank 11 – 15% depending on your source, but it did so with inflation peaking at 18%, which devalued its debt.  The soaring inflation was furthermore caused by the Icelandic central bank’s decision to halve the value of its currency, the Kroner.  The difference in terms of inflation between Iceland and those euro-zone countries thought to be in the worst economics position, the PIGS (Portugal, Ireland, Greece and Spain), is quite stark.  Iceland’s inflation soared whilst Ireland, for example, is still going through through a sustained period of deflation

Iceland’s inflation is now down to a respectable 3%, hence interest rates are now at 4.5% from an 18% peak.  These inflation rates are, however, higher than the PIGS.  Iceland’s debt situation is also looking up.  Forecasts for 2011 predict a deficit of 6.3% which will soon turn to surplus approaching the mid-point of the decade.  The IMF said Iceland has turned a corner and that its economic performance “compares favourably against other countries hard hit by the crisis”.

Iceland’s current account balance suffered greatly at the beginning of the crisis with the nation running a 26% of GDP trade deficit with the rest of the world, which is much greater than any of the PIGS.  However, due to the high inflation rates and devaluation of its currency, the trade deficit in 2010 fell to just 0.9% of GDP, with a surplus forecasted in 2011.  Comparably, the PIGS are still running significant deficits approaching and exceeding 10% of GDP.  The long-term effects of these deficits are yet to be seen.  One thing is clear, the PIGS do not have the monetary sovereignty of Iceland and hence cannot devalue their debt, they must in effect, toe the economic line of the European Monetary Union and European Central Bank.

Many have portrayed the path chosen by Iceland and subsequent recovery as a model for other beleaguered economies, such as the PIGS group in the EU.  However, such comparisons must be contextualised.  Iceland’s economy is comparably tiny and would have little chance of bringing the entire world economy down if it walked away from its liabilities compared to the aforementioned PIGS.  Defaulting in one of those economies would risk contagion throughout the euro zone and possibly beyond.

Iceland’s monetary independence from the European Monetary Union has been sighted by many as a possible reason for its recent good performance.  Having experienced the worst financial crisis in memory, the country has emerged ahead of many of its contemporaries having endured less punishment than many EU member states.  Greece and Ireland have already been forced to accept bail-outs, and it appears Portugal will soon follow with an €80bn rescue package mooted.

But how sustainable is this recovery?  Iceland’s public debt has reached in excess of 115% of GDP, over four times what it was in 2007.  Furthermore, Government bonds issued in foreign currency are becoming more and more expensive to repay due to the devaluation of the kroner.  Domestic austerity was aided by this devaluation and the subsequent increase in inflation; however, many commentators have indicated this had little to do with the recent return to positive growth.  The turnaround is attributed to the return to current account surplus from deficit.  Moreover, the aforementioned debt burden is not only applicable to government finance; house prices have plummeted in the crisis leaving many homeowners in negative equity.  By no means is Iceland out of the woods, its current account turnaround from deficit to surplus has been accredited to falling imports rather than a surge in exports.  More tough times are ahead.

The implications of bail-outs on the PIGS are also uncertain.  What is obvious is the political motivation behind their economic choices; the European Union needs the single currency.  It is those with vested interests in the Union that have the most to lose; there is an unnerving air of inevitability in what is happening.  Interest rates are remaining low, aimed at a sluggish Germany, whilst those euro-zone countries experiencing increasing inflation desperately need interest rates to rise.  Where the European project falls down is, in throwing hugely different nation economies under a single monetary policy, it lacked the complete supranational economic governance and social mobility required.

On balance, Iceland has taken a radical path of devaluation which saw violent shifts in economic measures, which all looked terrible whilst it was happening.  It may however appear preferable to the long-term damage that may be seen in those countries which have chosen austerity, debt deflation and bail-outs, but like driving a car using only the rear-view mirror, we will not know until it has happened.

About the author: Harry is a fist year undergraduate studying Politics and Economics (BA) at the University of Leicester.

Recently, the Centre for Economic Performance (CEP) celebrated its 21^st Birthday by holding a series of lectures at the London School of Economics and Political Science (LSE). The chief economist at the International Monetary Fund, Olivier Blanchard, gave the first lecture on the state of the world economy. Last Tuesday, the second lecture of the series was given by Professor John Van Reenen on the topic of restoring economic growth.

The Economics Network received an invitation to attend both lectures, and as a new guy on the job, I was appointed to go. However, being a second year student with a very busy schedule means I could only attend one of the lectures. Since I was doing economic growth as part of my macro course, I decided to go to the latter lecture.

I arrived in London quite late, but managed to quickly find my way to the lecture theatre in the LSE’s Old Building where the talk was held. The CEP has reserved a front row seat for me, so not only did I have the best view; I also managed to take many photos. There was a brief introduction of John Van Reenen by Stuart Corbridge before the lecture started.

John divided the lecture into three sections: the problems we currently face, the sources of growth and the policies we need. He started by saying the beginning of the current recession was a lot worse than the Great Depression; however, the government has not made the same mistakes it did in the 20s. Bank capitalisation, loose monetary policy and stimulus packages instead of spending cuts and tax raises have resulted in a much faster recovery for the UK. He also stressed that accelerated budget cuts proposed by the current coalition government will harm the economy in both short and long terms.

The three main sources of growth identified by John in his lecture were: technological innovation, management practices and microeconomic structural reforms. The main accent was made on the link between productivity and management. John argues that productivity growth is what matters, not absolute growth of GDP. Increases in productivity will drive real wages and consumption up, which in turn can
facilitate distribution. He also made a very interesting point about happiness. Current economic theory focuses on maximising income and consumption, but John thinks that after a certain level, addition to growth will not lead to more happiness. In my opinion, this is definitely something economists could focus more on.

He went on to analyse productivity in the UK. According to the findings, the UK’s relative productivity has improved compared to France and Germany. However, there is still a big gap relative to the US. John argues that this is all down to management practices. His data shows that the US has very few badly managed firms, hence, it has high productivity. On the other hand, in developing countries where there are many family businesses, management is much worse. John thinks that competition in the labour market ultimately leads to better selection of managers, which has a great impact on how firms’ productivity.

So what can we do to restore growth? The lecture concludes that structural reforms and macro policies should do the trick. Things like competition policy, public sector planning and better human capital management at the low end (apprenticeship scheme) are going to improve productivity in the long run. Finally, John argues that the austerity measures proposed by the current government will affect long-term employment as private sector cannot speedily adjust to the fiscal shock.

Here are the links to the webcasts of the two lectures if you want more:

Lecture 1: The State of The World Economy (Olivier Blanchard)

Lecture 2: Restoring Growth (John Van Reenen)

About the CEP

The CEP is an interdisciplinary research centre at the LSE Research Laboratory. It was established by the Economic and Social Research Council (ESRC) in 1990 and is now one of the leading economic research groups in Europe. Its current Director is Professor John Van Reenen.

The CEP studies the determinants of economic performance at the level of the company, the nation and the global economy by focusing on the major links between globalisation, technology and institutions (above all the educational system and the labour market) and their impact on productivity, inequality, employment, stability and wellbeing. Its researches have affected numerous Labour policies, in particular the apprenticeship scheme.

As part of the ongoing development of Why Study Economics and Studying Economics, we are now looking for student contributors. Because the websites are aimed at Economics applicants and students respectively, we think it is very important for us to have students’ views reflected in our content.

The content provided can be in any format about anything related to Economics: current affairs and politics to day-to-day activities, such as analysis of economic concepts in movies and music. We also encourage entries about the social life of Economics students. Most entries will go to Economics in Action blog, but there is a possibility to write a material for other sections of the websites.

Being a contributor for us will be beneficial for you in many ways. Firstly, if you want to pursue journalism, this is a great way to start. The websites are very popular with lecturers and students, so you will have an audience. If you become a frequent contributor, we will make sure your name appears on the websites, and this will look great on your CVs. Finally, writing something contemporary and interesting will widen your views about Economics as well as distract you from all the maths you have to do for your course.

If you are interested, please email Anh with your details and a possible entry. We can also discuss what sort of material you would want to write or feel comfortable writing.

Jobs for graduates- from any discipline- are not as plentiful as they were 2 years ago. After 40 failed job interviews, economics graduate Daniel Seddiqui was fed up and decided to experience lots of different jobs in a short amount of time, 50 jobs in 50 states in 50 weeks.

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The following is quoted from Andy Ross’ keynote speech at the recent Developments in Economics Education conference in Cambridge. Ross is the Deputy Director of the UK’s Government Economic Service, the largest employer of economists in the country.

“Most of the things that economists do don’t even look like economics: adoption policy; money laundering (detecting!)… The range of topics is truly astonishing. From Becker’s early re-widening of mainstream economics, We now analyse

• Auctions
• Sex and race discrimination
• Sport
• What you can and can’t get on the NHS and why
• Competition and quality of education
• Value of time and even life
• Happiness itself (more…)

In the latest of a series of interviews from the Royal Economic Society Conference 2007, Romesh Vaitilingam talks to Victoria Prowse about the ‘Part-time Occupational Penalty’ for UK women.

Listen to the interview

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No matter what qualifications they have or how big their family is, British women face a substantial occupational penalty if they work part-time. That is the central finding of new research by Victoria Prowse, presented to the Royal Economic Society’s 2007 annual conference at the University of Warwick. (more…)

In the third of a series of interviews from the Royal Economic Society annual conference 2007, Romesh Vaitilingam talks to Stephen Drinkwater about self-employment among Britain’s Asian community.

Listen to the interview

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The typical Asian working age male is now younger, better educated and more likely to be UK-born than his parents generation were. According to research by Ken Clark and Stephen Drinkwater, each of these factors contributes to lower rates of self-employment, particularly among men of Indian and Chinese ethnicity. This suggests greater assimilation of these groups into the UK labour market and education system.

But the study, presented to the Royal Economic Society’s 2007 annual conference at the University of Warwick, also finds relatively stable rates of self-employment among Pakistani and Bangladeshi men. It seems likely that discrimination in paid employment against these groups is keeping them in self-employment, working long hours in relatively poorly rewarded sectors such as catering and taxi-driving

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Listen to the interview

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Britain’s national minimum wage has not only raised the pay of low-paid employees. It has also led to a reduction in the rate of these employees absence through sickness  and hence improved their productivity. That is the finding of new research by Marco Ercolani and Martin Robson, presented at the Royal Economic Society Conference 2007. This effect might help to explain why the introduction of the minimum wage was greeted with apparent equanimity by many employers.

Employee sickness absence is widely recognised as a major problem for the economy. In recent years, for example, it has been calculated that the direct costs of sickness absence in terms of the value of lost output amount to over £11 billion per annum; around 1% of the country’ annual GDP.

On top of this, there are the indirect costs such as the loss of employee morale among those required to cover for absent colleagues. While many instances of employee sickness absence represent genuine cases of ill health, a significant proportion almost certainly does not. (more…)

Wages tend to rise in British firms taken over by US multinationals: on average, in the two years after an acquisition, skilled workers see their earnings increase by 8% while unskilled workers pay goes up by 13%. But there are no such effects for takeovers by multinationals from continental European Union countries.

These are the findings of new research by Holger GÃrg and Sourafel Girma, which explores whether acquisitions of British companies by foreign multinationals are a threat to domestic labour.

Their study, presented at the Royal Economic Society’s 2006 Annual Conference at the University of Nottingham, looks at one aspect of this topical question: whether wages change in firms after they have been taken over by foreign firms.

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There is a strong link between the earnings of fathers and sons, according to new research by Professor Robin Naylor and colleagues. What’s more, the likelihood of a son having earnings similar to his father’s is greater for those born into particularly rich or poor backgrounds. And especially in the UK and the United States, the sons of earners in the top 20% are very unlikely to end up in the bottom 20% of earners.

The study, presented at the Royal Economic Society’s 2006 Annual Conference at the University of Nottingham, examines how intergenerational mobility compares between the UK, the United States and the Nordic countries of Norway, Denmark, Sweden and Finland. The main results are that:

Despite the commonly-perceived view of the US as an open society with ready opportunities for individuals to rise from poverty to affluence (from rags to riches), the evidence shows that the opposite is true. On average, a son’s earnings are more closely related to his father’s earnings in the United States than in any of the other countries.

In the UK, the connection between sons earnings and fathers earnings is weaker than in the United States, but stronger than in the Nordic countries. There is substantial earnings persistence across the generations in all countries.

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