Free Economics Notes - Kevin Bucknall

Free Economics Notes

By Kevin Bucknall BSc(Econ), PhD

Copyright 2012 Kevin Bucknall

Published by Kewei Press at Smashwords

ISBN 978-0-9561823-3-3

The cover photograph was taken in Japan during the Meiji period by the famous Japanese
photographer Enami about 1892-95. It shows women winding silk in what seems to be
cottage industry. Photograph by courtesy of http://www.t-enami.org/services

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My wish for you: may you achieve all that you want in life and remember - it’s worth
working hard to get it!

~~~

Contents

Chapter 1 An Introduction to Economics in 5,000 Words and a Bit
Chapter 2 Trying to Make Sense of Economic Policy—Part 1: What Do Governments Try to
Do?
Chapter 3 Trying to Make Sense of Economic Policy—Part 2: Why is it so Difficult to Get it
Right?
Chapter 4 Business Cycles, Recessions and Economic Booms
Chapter 5 Understanding Economics: a Summary of the Advantages and Disadvantages of
the Price Mechanism
Chapter 6 Notes on the Difference Between “Economic Growth” and “Economic
Development”
A free sample from the book Going to University: the Secrets of Success
Other books by this author
Videos by this author

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Introduction

This free eBook is a collected set of articles and notes about economics that I wrote over
the years to help my students. Some of the material was prepared for students at school
who were working towards university entrance; some was designed for students who were
already studying at university at the undergraduate level and, in the case of the research
chapter, at the postgraduate level. You can pick and choose what interests you and
concentrate on what you find useful. The search function in eBook readers and word
processors is pretty good for finding what you need. I hope you find at least some of it
both interesting and useful.

~~~

Chapter 1 An Introduction to Economics in 5,000 Words and a Bit

Authors Note

Many years ago when I was doing research as a Visiting Associate Member at St. Antony's
College, Oxford, I shared a house with several grad students from various different
disciplines who were studying for their D.Phil. I was struck by the number who asked me
what economics was about and would I please write an elementary piece some day, so
that an intelligent and well-educated person could learn what it was about. I never
forgot. This chapter is a simple introduction to the discipline, or at least as simple as I
can make it. Economics courses tend to contain a lot of mathematics or a lot of diagrams,
or both. This chapter uses neither. It might be useful to you if you are similarly
intellectually curious; or if you are just starting a course in economics and looking for an
easy overview; or perhaps are contemplating studying the subject and wondering what
the heck you might be getting into. If it interests you and you would like to learn more,
please check out my free book An Introduction to Economics that sticks to using diagrams
with only the tiniest bit of algebra in one small section.

What is economics?

Economics is a subject notoriously difficult to define clearly for outsiders: a formal
definition might be that it is a social science that deals with the production, consumption
and distribution of goods and services. In simpler terms it deals with how people produce
and work, in order to survive in this world. Mainstream economics covers things such as
how prices are determined in the market; how best to organise the economy for efficiency
and growth, and what sort of things can prevent a perfect solution; how wages are
determined; what causes undesirable events like inflation and unemployment and what
can be done about them; and how and why countries interact through foreign trade and
foreign investment.

Sciences attempt to be value-free and objective; economics is no exception, and for this
reason words like "ought" or "should" tend to be avoided, as they are “normative” and the
discipline sticks to facts which are “positive”. It has to be confessed that it is harder to be
completely objective in the social sciences, dealing as they do with human beings and
their behaviour, than in the natural sciences, most of which are concerned with the
inanimate world and non-human life forms.

In life we constantly make choices and each time we decide to do something, let us call it
"X", then we choose not to do something else, we can call "Y". Economists refer to this as
the opportunity cost, i.e., what is given up to get what is actually chosen. It is most
clearly seen when constructing a budget and deciding how to allocate money between
competing uses, but it applies everywhere. Opportunity cost lies behind all financial cost
calculations and cost curve diagrams: the cost of buying is the amount of money that has
to be paid by person A to get to use the stuff (iron ore, the service of a worker, a delivery
truck...) rather than let someone else (person B) use it.

The study of the economy is traditionally divided into two sections, microeconomics,
which looks at a bit of the economy (think of looking down a microscope at something
small), especially prices, what firms decide to do about price and output decisions, and
wage determination. Then there is macroeconomics, which looks at the entire economy
and as such is concerned with things like the size of total output, the level of inflation,
the amount of unemployment, and foreign trade. We will look at these in turn.

Microeconomics: the determination of prices in the market and the system known
as the price mechanism or the market mechanism

When I started out in economics we students used to be taught to chant in unison "Prices
are determined by supply and demand" and no doubt some still are. If we think of some
item (again we shall call it X) if no one wants it at all, then it has no price—there simply is
no demand. Probably a wrecked and burnt out car would fit this description. If some
people actually want X then it will have a price, as whoever owns X can sell it and use the
proceeds for some purpose or other. Will the price be high or low? It all depends on supply
and demand. Think of an auction: if there are three old pianos for sale and twelve people
really want to buy one, the price will be bid up and up, and therefore be high. Supply and
demand! But if there are thirty pianos for sale and again twelve people want a piano, the
price of each will be lower. That is the way that prices are roughly determined in the
world. Economists use diagrams or mathematics to show and analyse this in detail.

An increase in demand occurs if at a later auction some eighteen people turn up wanting a
piano and there are still only three instruments to bid on. This increase in demand leads
to an increase in the price of the pianos.

A decrease in demand occurs if at a later auction only four people turn up wanting a piano
rather than the original twelve. Assuming we still have three pianos to bid on, this would
lead to a lower price than in the week before.

An increase in supply occurs when, say, eight pianos appear in the auction rather than
three. This increase in supply causes the final price to be lower.

A decrease in supply? If instead of three pianos, the number falls, say to one (and with an
unchanged twelve people trying to buy) the “going-going-gone price” will increase.

These simple examples illustrate the working of supply and demand, which operates
outside auction rooms as well as inside them. Notice that the process of the analysis is to
start in equilibrium then alter just one element, holding all the other features unchanged.
In economics we mostly do this and then look at the result. This is referred to as
comparative statics: "comparative" because we compare two equilibrium states; and
"static" because time is not considered and everything simply works through to equilibrium
where things cease to change. Dynamic analysis is different as things keep altering over
time. A course in elementary economics does not normally get as far as dynamic analysis.

There is one objection to the theory of price setting which on the surface seems valid, but
is in fact false. Some people object that firms simply decide on what price to set and that
is all there is to it—the theory of price is just wrong. However, if we think about it, if a
firm sets its price too high it will wind up with unsold stock, which is costly to store; but if
it sets it too low the firm will run out of produce quickly but still have to pay wages,
lighting and heating bills etc. Either way the firm could do better: it is not profit
maximising. If a firm persists in such poor pricing it will go bankrupt. If firms want to do as
well as they can, they have to set a price that just clears the market, i.e. they sell it all
apart from the minimum stock they need to hold. So it's back to supply and demand! But
what if they do not choose to profit maximise? Competition will eventually force them out
of business. It is no accident that most economists have an inbuilt urge to promote
competition wherever possible. Only those economists paid by organisations trying to cling
on to a monopoly position tend to be against it. Are they bad economists? No, just like
lawyers, they are paid to promote the interests of their client but they do not have to
believe in it. We will not even think about political spin doctors.

What about the operation of the price mechanism (market mechanism)?

When a firm believes that it could make a profit by producing something, call it X, which
it can sell for a relatively high price the firm moves in and does so. This increases the

supply of X and drives the price down. As different firms in different industries constantly
chase profits in this way, resources (land, labour and capital) keep being reallocated from
what they are producing to going into something else, as someone hopes that they will
make more profit in the new area. In this way, the price mechanism constantly reallocates
resources to where they are most needed and high prices (indicating that people want to
buy X), along with potentially high profits, act as signals to producers.

Why did I say earlier "this is the way that prices are roughly determined in the world"? It is
rough because various things can get in the way and prevent a perfect solution being
achieved, particularly if we are interested in the whole of society. Let us list some of
these intruding elements.

1. Some people own all or most of X so they can dribble it onto the market at a slow rate
and get a higher price as a result (monopoly).

2. Some people do not know what is available and where it is to be bought so they do not
demand X at all (information failure).

3. Some people have a lot of money and others have little or none (unequal income
distribution) so that very expensive cars, watches, yachts and the like are produced—
there is a demand from the rich for these. But on the other hand, not enough food is
grown and some people are hungry or even starve; these are the really poor, who cannot
afford to buy enough food.

4. Some people will not move from where they live to get a job elsewhere. The result is
that firms trying to expand are unable to find enough workers (factor immobility).

5. Some goods and services are provided in too small quantities for what are perceived as
the needs of society, such as health and education (merit goods). Contrariwise, some
goods and services may be over-consumed for society, perhaps cigarettes and alcohol,
which contribute to ill-health and accidents (demerit goods).

6. Some goods and services might be needed by society as a whole but few individuals are
willing to pay for them. Examples include the defence of the country, a police force to
protect citizens, a court system for settling disputes, or street lighting (public goods
without exclusion). As individuals who choose not to pay cannot be prevented from
enjoying the benefit of such goods, either society goes without or we have to make the
people as a whole pay for the service.

7. Some goods and services, when consumed, might have an adverse impact on people
other than the person consuming (externalities). Common examples of external
diseconomies are pollution, congestion, noise, and litter. Opposite these we see external
economies that when consumed by X provide benefit to others. These include such things
as:

— Training and education: when one firm trains workers and they subsequently leave,
other firms get the benefit.

— Public education: this is widely believed to benefit society, so that many countries
provide at least elementary education for free, outside the market system. If people
cannot read, jobs will be unfilled, safety regulations will be flouted, and possibly crime
rates would be higher when those without work opt to steal food rather than starve.

— Television and radio broadcasting which spread information rapidly—again many
countries provide at least one channel without charge. In attempted revolutions and
coups, seizing the radio and TV stations is high on the list of the insurgents to control the
flow of information.

— Health provision: if we quickly treat those with tuberculosis it does not spread to
others. So the state may step in.

All the above points prevent a free market system from reaching a perfect solution as to
what shall be produced and in what amounts.

Wages and wage determination

Wages, like prices, are roughly determined by supply and demand. Again it is only
“roughly” as several factors get in the way of a pure market solution. The demand for
workers comes from firms and organisations who want to hire people to work for them.
The firm, if trying to be as efficient as possible, hires people until the last person adds
less revenue to the firm than it has to pay to that person. In the jargon it is called when
the marginal product equals the wage. If the organisation pays out more as a wage than it
gets back from the efforts of the individual, clearly it is not maximising profits but losing
money.

On the supply side of labour there may be all kinds of restrictions

Obvious ones include differences in intelligence, paper qualifications (degrees, diplomas,
GCE A-level results...), physical strength, previous experience, and so forth. The need to
meet such criteria tends to mean fewer people may be qualified or able to do a particular
job.

We can list a few more general factors that can affect supply and prevent wage equality.

1. Non-competing groups: shelf-stackers in a supermarket do not compete for work with
neurosurgeons in hospitals. A shortage of surgeons does not lead to shelf-stackers applying
to do surgical operations.

2. Trade union and government restrictions may exist that establish a minimum wage. The
result of this usually means fewer employed people, but a greater reward for those who
can actually find a job.

3. Labour immobility: people will not always move to a new job. The reasons may include:

— Information failure (people unemployed in locality X do not know about jobs and
conditions that are available in locality Y).

— Local factors that restrict movement, e.g. people with a state-supplied cheap house in
area X will not give it up to move to area Y.

— Pension schemes—workers who have paid into a company scheme for years may lose
some or all their pension if they move.

— Social groups like family, friends and members of clubs—few people like leaving them
and going off to new and unknown pastures.

— Knowledge and familiarity with the local scene, so that people know where it is best to
go for food, entertainment, to buy things, or just find their way around. If they move they
lose this and have to start again.

— Racial or religious ties to an area.

4. Time lags: it can take years before people become aware of problems locally and
opportunities elsewhere, then consider the matter carefully, and finally decide to change
their job or move to a new area.

5. Non-monetary rewards: it is clear that not all human beings strive to make as much
money as possible and some will take work that gives them satisfaction at a lower wage. If
this is not true, it is not easy to explain convincingly why so many choose to become
teachers or nurses, or why some drop out of highly-paid positions in the finance industry in
order to take up furniture-making and the like.

Competitive circumstances and the theory of the firm

As noted, economists generally prefer more competition rather than less. Three different
states of competition are widely recognised:

1. Perfect competition, which is at one end of the spectrum and, as the name suggests, is
the most competitive situation of all.

2. Monopoly, or one firm supplying all (or almost all) of the output is at the other end of
the spectrum; and

3. Imperfect competition (also known as monopolistic competition) which is the bit in the
middle; it is fairly competitive but with some restrictive features.

More minor variants, such as duopoly (two firms), and oligopoly (a few firms make up the
industry, a situation that is reasonably common in the world) exist but the main attention
focuses on the three above.

Under perfect competition, price is the lowest and output is not restricted at all;
resources are well allocated, although of the things that get in the way listed above, the
items 3-7 can still produce a less than perfect allocation of resources.

Under monopoly, output will be deliberately restricted to achieve a higher price and
profits; resources will be poorly allocated, and income distribution will be worsened, as
the monopolist really rakes it in.

With imperfect competition we are in the middle, i.e. some output restriction, middling
prices, and resources are reasonably well allocated to the demands of consumers but less
so than with perfect competition. There will be some short-term widening of the
distribution of income. Some observers claim there will also be faster growth as the short-
term high profits can be used for research and development, and in addition there is
enough competition between firms to ensure that each tries hard.

Production theory

The theory of production deals with the factors of production (land, labour and capital),
particularly how much of these a firm will choose to use. Much attention is paid to the
case of labour. Production theory, using the idea of marginal productivity, supplies the
foundation for wage theory. The law of diminishing returns states that after an initial
period, the amount added to total output by each extra person employed must fall. This
must be true: if you consider a back garden devoted to vegetable growing. One person can
produce quite a lot; two people working it can do more; a third person would perhaps add
a little more; the fourth might get in the way of others and total output might decrease a
bit. By the time we get to, say, 200 people in the garden they will be shoulder to shoulder
and no vegetables will be produced! From this law of diminishing returns we can derive
the demand curve for labour, which is needed in wage theory.

The decision on how many people to employ and how much capital (the choice of
technique) also derives from the theory of production; simply put, in an environment with
a lot of cheap labour, as found in many poor developing countries, firms use more people
and less capital (labour intensive techniques) but in rich industrialised countries the
reverse is the case (capital intensive techniques).

Managing the economy as a whole (macroeconomics)

There are ten major goals, or economic areas of concern, that all governments in all
countries may have. Each government, and political party, can choose which of them to
place stress on, and which to take more lightly. Because some of the goals clash, a choice
between them is often necessary. Each government or party can prioritise all of these in
their preferred order but few probably do. The way it mostly seems to work is that there

are often a few main policies established and from then on the government tends to react
to events as they arise.

So what are these ten main economic goals?

1. Inflation—avoiding or reducing it.

2. Unemployment —often reducing the level, but sometimes deliberately doing the
opposite to cool down an over-heated economy.

3. Economic growth—usually we wish to increase it.

4. The balance of payments—either balancing it or aiming for a small surplus.

5. The value of the currency—in the UK this means maintaining the value of the pound, in
the USA the value of the dollar, and so forth.

6. Improving the allocation of resources—this often means moving towards a more
competitive market-determined solution; but the government has its own agenda too,
such as it may wish to increase resources to education, defence, or the National Health
Service.

7. The distribution of income—this often means trying to make it more equal, or at least
paying lip-service to this.

8. The standard of living—a high standard of living is preferred, so increasing the level is
often a goal.

9. Taking care of the environment—this is a relatively new goal, but one that is rapidly
increasing in importance.

10. Avoiding unnecessary and undesired fluctuations in the above nine points.

As a quiet bit of fun, take a couple of minutes and pretend you are the person in charge of
your country and consider what order of priority you yourself would choose. Does your
best friend agree with you?

How can governments try to manage the economy?

In a market economy there are only two main ways: monetary policy (altering the supply
of money or the rate of interest) and fiscal policy (altering the level or structure of
taxation and/or subsidies).

In the case of monetary policy, in the UK the government lost the ability to directly alter
the rate of interest in 1997. It gave this authority to the Bank of England's Monetary Policy
Committee. The central goal of this Committee is curbing inflation; it attempts to keep it
within one per cent of the annual goal set by the Chancellor of the Exchequer, which is
usually two percent. The other goals of government are not the concern of the Committee
although it sometimes seems to broaden its own remit a little here.

In the UK, fiscal policy is administered largely through the annual budget which occurs in
April each year. Such once-a-year changes do not provide a flexible policy tool but
admittedly some of the effects do come into play quite quickly.

Both these policies are used to alter the level of aggregate demand (the total level of
private spending on consumption and investment, plus government expenditure , and then
adding in export earnings while subtracting imports,) in the desired direction, if the
government wishes to depress the economy, it reduces aggregate demand which will
eventually lower the rate of inflation, increase the level of unemployment, and improve
the balance of payments. The authorities can do this by increasing the level of taxation
(fiscal policy) or the rate of interest (monetary policy). Both measures take money out of
the economy: if a family has to pay extra tax it means that less discretionary spending is
possible; if the rate of interest is increased it means that repayments on many borrowings,

including the important mortgage repayments, increase (which leaves less in the pocket
for consumers to spend). It also means that firms wishing to borrow to expand or to fund
the purchase of machinery find it will cost them more, so they postpone it wherever
possible thus reducing the overall level of investment.

Why it is difficult to get it just right? (For a more detailed discussion see Chapter 3)

1. Information lags—when a decision has to be made we do not know where the economy
actually is at that time, only where it was earlier as revealed by the statistics available.

2. Information reliability—errors creep in; there never is totally accurate information
available. "Garbage in, garbage out" (GIGO) is a reasonably accurate description.

3. Different policy measures have different time lags before they take full effect. This
means that as policy changes some older measures probably have not fully worked
through; then the new measures kick in, and each at different speeds, so we tend to
blunder along. Hopefully we are going in the right direction although even this is not
always certain.

4. Some goals contradict others, so that there is no possible way of "getting it right"
anyway. As one example, under normal circumstances if we increase the level of
aggregate demand to lower unemployment it tends to increase the rate of inflation. This
in turn tends to reduce exports and increase imports, so worsening the balance of
payments. It also increases output and tends to widen the distribution of income.

5. We are not smart enough to get it right. As we are dealing with human beings and they
have the freedom to make new decisions and do things differently, it is possible that we
never will be clever enough. The historical record of what happens when we changed the
rate of interest by half a percent may not apply the next time we do it as we will live in a
different and rapidly changing world.

The foreign sector: trade and investment

The above discussion was concerned with a domestic economy in isolation. In reality, no
country is alone in the world and few wish to be isolated. There is a high economic price
to be paid for isolation: those who cut themselves off suffer slow growth, great
inefficiency, and a low standard of living. Most countries choose to trade with others as a
result.

Why do they do it? What are the gains from trade?

1. Comparative advantage—a country produces what it is good at (agricultural produce,
light industrial goods, services such as banking and finance...whatever) and sells these to
the world. It then imports what it is not so good at from those countries which can
produce the item more efficiently and cheaply. This explanation is the main reason for
trade. If all countries were equally good at everything, why bother to trade? As a personal
example, if you are extremely good at playing football and a rotten cook, it pays to earn a
substantial income playing sport and eat out at restaurants or employ your own cook. Your
comparative advantage is on the sports field not in the kitchen.

2. Economies of scale—if it is cheaper per item to produce in large quantity, then
countries can specialise in a few things and sell them to others in exchange for things that
the other countries specialise in.

3. Variety—consumers in a country might enjoy some foreign products, import them, and
sell stuff back in return. Motorcar production in Europe springs to mind as an example as
each country buys cars from the others.

4. Sheer absence of an item—it is difficult to grow bananas in Iceland or make
refrigerators in the Saharan desert, so things that are lacking may be imported. Not that it

is impossible to grow bananas etc., in Iceland, merely very expensive to do so; this
suggests that this is often really a specific case of comparative advantage.

Despite the established benefits of trade, there seems to be a widespread instinct towards
insulating the economy from foreign competition, i.e. protecting jobs and protecting the
profits of domestic companies. Each individual sector would like to be protected, although
it does not mind much if all other sectors are not. In fact, this would be the best outcome
for the small protected part, as it would gain all the benefits of cheaper goods and
services plus rapid economic growth, but without giving up a thing.

Since the end of World War Two, economies have gradually opened up and reduced the
level protection although not at a steady rate. The views of economists, pressure from
politicians such as Margaret Thatcher and Ronald Reagan, negotiations via a series of
meetings at the international level, and the widespread but not complete collapse of
communism, have all played a part.

Globalisation is the ultimate stage of this process of opening up domestic economies by
reducing protection, increasing foreign trade, and liberalising the flows of foreign
investment. The world as a whole benefits from this; but there can be, and there are,
losses to some. While companies in major, powerful, and rich countries can gain from
investing in poor countries, the local people may suffer. The influx of foreign capital can
easily damage or destroy the existing local industry and agriculture. It is a specific case of
an extremely wide income distribution producing a poor market solution in this case on
the global scale—the market operates to supply what is demanded by those with the
money to spend. So with globalisation many of those living in richer countries (including
their poor) gain; the world as a whole is better off; but this is scant consolation to those in
poor countries who may suffer. These are often the poorest of the poor.

Is globalisation then acceptable? Is it fair or just? Such questions worry a lot of people. It
is an emotive issue in which morals, ethics, and values are often hotly debated. Those
institutions that work to reduce protection and increase globalisation, such as the World
Trade Organisation (WTO), are often attacked verbally and their officials and meetings
physically. The antagonists are people who hold strong, some would say extreme, views
that globalisation hurts the poor and is simply wrong. The protagonists say that the world
as a whole benefits and most are better off. The reply to this is that some are definitely
made worse off, they are already the weak, the poor, and the suffering, and they are not
compensated in any way by the greedy and selfish winners. Some respond to this view that
that is just the way the world is, and in addition, there is no going back. The reply to this
response may well be unprintable.

It has to be stated that economics, and the workings of an economy, are amoral; morality,
ethics and justice simply do not appear. We believe that the price mechanism, free trade,
and ultimately globalisation produce a more efficient system, a higher standard of living,
and faster economic growth which all work for the benefit of many. But it involves losers
too and these are too often the poorest amongst us and the least able to cope. Welfare
economics tries to deal with this and considers compensation possibilities.

How do we measure the degree of interaction with other countries?

This is done in the balance of payments, an account that shows our financial dealings with
the rest of the world. It was traditionally divided into two parts, the current account,
which includes trade in goods (the visibles that we can see) and services (things that we
cannot see and are called invisibles); and the capital account, which in broad terms
explains how the current account is being financed. If imports exceed exports, a country
either pays the difference by transferring foreign exchange or else borrows to cover this
difference and this shows up in the capital account. (A once popular exam question was to
explain how the entire balance of payments could be described as in balance when there

was a clear surplus or deficit in the current account; the answer is that someone either
pays the debt or still owes it and this is the balancing figure in the capital account!)

Since 1998 the UK has adopted a four part approach to the balance of payments but the
distinction between current and capital account persists.

1. The current account: the export and import of goods and services plus incomes flowing
to and from abroad, both earned by workers and from investments made.

2. The capital account: changes in the financial size of ownership of fixed assets and what
migrants bring in and take out as they come and go.

3. The financial account: changes in the financial size of assets the UK residents buy
abroad and foreigners living abroad buy in the UK.

4. The international investment position: the total stock of assets that UK residents own
abroad and foreign residents own in the UK.

Which part of the balance of payments matters? All of it! We look at the part of the
balance of payments that gives us the answer to whatever question we are interested in.
Having said that, attention mostly focuses on the current account and changes in it,
because it shows how well we are currently doing.

That's it, economics in a nutshell. Warning! It is necessarily a limited explanation and
misses out much; it is no more than a simplified, basic introduction to a complex and
fascinating discipline. There are many articles and books written about virtually all of
the individual topics just mentioned. If you believe that you have got what you wanted,
then you can stop reading now! On the other hand, if you feel that you would like to go
further and understand more, then you can download and read my free book An
Introduction to Economics that explains this article in much greater detail. It also
provides diagrams to illustrate and help analyse the issues.

~~~

Chapter 2 Trying to Make Sense of Economic Policy—Part 1: What
Do Governments Try to Do?

Note: this is a detailed examination of an issue that was touched on briefly in Chapter 1.

There are several areas of concern for the leadership of a country. Domestic politics
obviously loom large and are the main area of concern but there are other important
issues, such as economics, foreign affairs, defence, and social issues. A major reason for
taking economic policy seriously is that economic growth provides the extra resources that
are needed to spend in these other areas of interest. In a very poor country with little or
no growth it is difficult to have much by way of government spending. To develop a
comprehensive welfare system, build infrastructure or engage in domestic or foreign wars,
requires a lot of resources. Without growth, the people of the country would suffer
deprivation in order to pay for such things.

All governments need to have some idea of an economic policy, however vague or ill-
defined this might be. Having achieved power (the first law of politics) and then kept it
(the second law), then those in charge will wish to use this power to some purpose.
Whether power was gained through a democratic process, taken by military force or
inherited, does not affect the fact that power, once achieved, has to be used to do
something. Even if a leader is a simple dictator with few aims other than power for its
own sake, he still has to make decisions about what is good or bad and what is desirable or
not. Such matters might be given consideration in their own right or else the views might
be a simple reaction to events arising within the country or abroad.

In the economic sphere there are ten areas of concern that governments in all countries
might consider and for which they can develop policies or goals. Each government need
not have a strong interest, or indeed any interest, in each of the ten areas but whether
the government has or not, the issues do not go away. If what is happening is acceptable
to those in charge, they can choose to ignore it completely. However, when something
goes wrong or events occur that the ruling elite do not like then a policy is needed to deal
with the issue. Refusing to develop a policy is itself a decision, in this case to let things
slide.

What are these ten fields which can require economic policies and decisions?

Listing them, although not in any priority area, the first seven are domestic-related,
numbers eight and nine are foreign-related, and the last one is of general application.

1. Inflation

2. Unemployment

3. Economic growth

4. Taking care of the environment

5. The allocation of resources

6. The distribution of income

7. The standard of living

8. The balance of payments

9. The value of the currency

10. Avoiding undesired fluctuations in the above nine points.

How to prioritize these is an issue for the governing authority, i.e. in what order should
they be placed and also how strong an effort should be devoted to each. There is no "one

size fits all" answer to these issues and the authorities in each country make up their own
minds. In the real world, it is often the case that inflation and unemployment are taken
more seriously and so are higher on the list.

Many governments appear to pursue some or all of the possible goals in a somewhat
uncoordinated fashion and some decisions that help the achievement of one goal can
easily make it harder to achieve another. Some time ago a British government, realizing
the possibility of such contradictions, came up with the slogan of "joined-up government"
which meant that a set of coordinated policies should be adopted in which contradictions
and anomalies should have no part. The catchphrase proved much easier to invent than
implement and was quietly dropped when the difficulties involved became apparent. Good
idea! Next time make it work!

The way many governments approach their job is to start by deciding on a few main
economic policies; in a democracy, these may appear in an election manifesto and, once
elected, a government can claim that it possesses a mandate for them. Many of the other
economic goals tend to be put to one side and perhaps ignored until some event, possibly
a disaster, focuses attention on them. In this case a government is reactive, i.e.,
responding to events, rather than being proactive and choosing a direction by means of a
definite and acknowledged policy.

One rule of thumb is that governments tend to place a higher value on domestic affairs
than foreign ones, largely because in democracies at least, voters care more about
domestic issues, especially those that affect them directly. These often include health,
education, schooling, taxation levels, inflation and unemployment. The first three are
matters of resource allocation, the fourth is concerned with raising money to spend (again
resource allocation) and the final two are what it says on the can.

The ten economic policy fields in more detail

1. Inflation

The aim is often to prevent it from happening or to contain it to some acceptably low
figure. A total absence of price increase is often not wanted as it is easier to make
economic adjustments, such as producing a bit more or less of some product, if prices are
not totally static. Slowly rising prices also make it easier for firms to achieve a profit, as
raw materials may have been bought earlier at a low price while wage increases often lag
behind price increases. Both events make for easier profits and these encourage a happier
climate of business opinion which causes entrepreneurs to be more optimistic and active.
In turn, this may promote further investment.

More investment means faster economic growth. Growth then makes it easier to reallocate
resources from where they are less needed to newer areas where they are more needed.
Changes in consumer taste or fashion as well as the emergence of new inventions,
technology and goods and services means that constant readjustment is normal. What was
produced last year, as well as the way it was produced, are unlikely to be exactly what is
desirable now.

In the UK in the early Twenty-First century there was a strong interest in avoiding inflation
and the policy was to try to contain it to 2 per cent a year, which is considered to be
reasonable price stability. A figure higher or lower than this is not wanted although it has
happened quite regularly. In Zimbabwe, by contrast, there was little or no interest in this
goal, or the economy in general, and by 2008 the rate of inflation was probably in the
region of 100,000 per cent. Domestic politics, i.e. his own survival, appeared to be the
sole interest of President Mugabe so that a series of unfortunate and disastrous political,
social, and economic decisions adversely affected the economy and involved intense social
suffering and human rights violations.

2. Unemployment

Most governments prefer to keep unemployment at a low level, partly for economic
reasons—more people working means more output—but probably the main motives are
political and social. The government can lose the support of the people if unemployment
is high; and large numbers of the unemployed can lead to social unrest and the danger of
people taking to the streets. This can be a problem in both democracies and less liberal
countries.

Despite this, many governments are prepared deliberately to increase the level of
unemployment in the short term in order to help the attainment of other goals. The rate
of inflation and the level of unemployment tend to move in opposite directions, so that if
the government wishes to reduce the level of inflation it might deliberately increase the
level of unemployment, using fiscal policy (mainly taxation changes) and monetary policy
(mainly the money supply and the rate of interest). If the economy is considered to be
overheated, when the level of aggregate demand is felt to be too high, one possible
solution is to increase the level of unemployment.

These days it is less easy to talk in terms of old-fashioned left wing and right wing politics,
as the differences between political parties have often begun to blur. Still, the left wing,
the more radical labour party members and trade unionists tend to regard keeping
unemployment low as a more important priority than the right wing, employers or
conservative party members might favour. Similarly, the left might be prepared to accept
rather higher levels of inflation in preference to increasing the level of unemployment. In
the United States, the Republican Party tends to be right wing and Northern Democrats
more liberal while Southern Democrats are often conservative. As far as priorities are
concerned, factions within a government or party can be important, as different groups
with different ideas struggle to take over the leadership.

3. Economic growth

As a long term goal, most governments seem to like economic growth and try to adopt
policies to promote it. A higher rate of economic growth means that we can enjoy a higher
standard of living, it gives us a greater ability to improve resource allocation, and also
provides the surplus out of which we can take better care of the environment. Against
this, the process of economic growth is frequently bad for the environment, especially by
causing pollution of air and water while increasing the level of noise. Environmentalists
are particularly worried by such consequences of growth, particularly the short term ones
which are rapidly encountered and easily visible; they doubt that governments will
restrain growth in areas of need and are dubious that the extra surplus will actually be
used to deal with environmental issues.

4. Taking care of the environment

This is a relatively new goal, but one that is rapidly increasing in importance, particularly
as evidence of global warming increases. In recent decades, several international
conferences about world environment issues have led to agreements, such as the Kyoto
Protocol (1997) to which many, although not all, national governments signed up. The
environmental goal involves changing resource allocation, for example from oil-fired
power generation to wind power, or taxing vehicle fuel at higher rates in an attempt to
reduce private use.

5. Improving the allocation of resources

Improving the allocation of resources means using land, labour and capital in a different
way. The changes are often marginal. Sometimes, however, they can have a major impact
on a particular group of people, such as coal miners and steel workers, or geographical
regions, especially if a particular industry is heavily concentrated in one or two specific
areas.

In a dynamic economy, resources are constantly being adjusted as producers react to the
changing demands of people and new technology emerges. For an economist, an
improvement in resource allocation often means moving towards a more competitive
market-determined solution and away from distortions caused by monopoly elements or
laws and other restrictions. But the government has its own policies that it wishes to
implement: nearly all of these would alter the allocation of resources. It may, for
instance, wish to strengthen education, defence or the transport system but has not the
resources to do all three properly. Each government will have a different agenda and will
also change its mind and alter its priorities in light of new information becoming available,
emerging events causing a reaction, or perhaps realignments in the power holders within
the party bringing new views to the fore.

Government efforts to alter the allocation of resources can include the passing of laws and
regulations that promote or limit certain activities; the establishment of quangos (quasi-
autonomous non-government organizations); the awarding of contracts; subsidies to
various groups of people or industries (e.g., the UK Disability Allowance which affects
labour directly by reducing the pressure on those with physical or mental problems to go
out and work); and taxation. If the tax on certain products or industries is increased (or
subsidies reduced), it might lower consumer demand for the products and in turn reduce
the number of firms and workers producing the goods.

6. The distribution of income

Income distribution relates to the proportion of people within the country who are rich, in
the middle, or poor. It is often measured as percentiles or deciles or more formally by
using a technical measure, the Gini Coefficient. If you want more information you can
download a free book An Introduction to Economics as a zipped PDF file.

Journalists might present the issue in the form of how much of the country is owned by
what per cent of the people. As an example, in the USA in the year 2001, the top 10 per
cent of the people of the country owned 69.8 per cent of the wealth, compared with 56.0
per cent in the UK in the year earlier. Strictly speaking this is wealth distribution, rather
than income distribution, but the two are closely related.

Improving the distribution of income often means trying to make it more equal or at least
paying lip-service to this goal. We regularly read that despite efforts there has been little
or no "improvement" in the distribution of income for several decades.

Some see "improvement" as meaning “more equal” but for others it seems to be exactly
the opposite, i.e., providing greater rewards for those who strive hard and succeed in life.
This latter view often seems to involve less restriction on creative entrepreneurs and on
high-ranking executives in private companies. Those supporting this latter view are
frequently wealthy, political conservatives, or else believers in liberalism and economic
freedom. The result of adopting a policy of greater rewards would be to widen the
distribution of income.

7. The standard of living

A high standard of living is preferred by almost everyone. One notable exception to this
occurred in socialist countries, such as the Soviet Union in the past, where the state had a
strong preference for promoting industrialization and economic growth rather than raising
the current living standards of the people. As a result, wages and prices were fixed at a
low level to ensure a just about adequate life for all and the surplus was extracted for
reinvestment in the economy. Forced industrialization of this kind is only possible with
strong central control and restricted levels of freedom; this does not occur in Western-
style democracies with their free voting. Any government attempting it would be voted
out at the next election. It is now widely accepted that such a process of forced
industrialization ensures poor resource allocation as well as low living standards and few

countries subscribe to it. North Korea is one of the few left to do so and the standard of
living is so low that the people are reportedly five centimetres shorter on average than
those in South Korea owing to malnutrition.

8. The balance of payments

The balance of payments is the account that shows a country's dealings with the rest of
the world. It is commonly divided into the current account, revealing the value of the flow
of goods and services, and the capital account, which roughly shows how the current
account is financed and deals with capital flows. Many governments wish either to balance
the current account or perhaps aim for a small surplus. A deficit on current account,
particularly if large and continuing lowers the value of the currency (violating goal nine)
and this weakening is often regarded as a bad thing especially by some politicians. The
word "weaker" carries negative connotations, although under certain circumstances a
lower value of a currency can be a good thing as it promotes exports and can raise both
living standards and the rate of economic growth.

Even with a substantial current account deficit, if other countries are willing to hold the
currency as part of their gold and foreign exchange reserves, the deficit need not be a
problem. This was the case for the United Kingdom before the Second World War; since
then the USA has been like this, running current account deficits and the rest of the world
holding dollars. By 2007 the dollar had weakened notably and it seemed as if this ability of
the USA might be starting to weaken.

9. The value of the currency

In much of Europe it refers to the value of the Euro, in Mexico the value of the peso, and
so forth. As mentioned, many politicians, and some others, regard a strong currency as a
mark of strength and hence it is felt to be desirable. A strong currency is one that buys a
lot of units of other currencies.

What can make it strong?

— The country is successfully exporting a lot, so the current account is in surplus.

— Foreigners trust the currency and are willing to hold it as part of their reserves of
foreign currency.

— People expect that a rise in the value of the currency will occur and buy in as a gamble
or in investment in order to make a future profit.

10. Avoiding unnecessary and undesired fluctuations in the above nine points.

Stability and security are preferred, so that fluctuations, especially unexpected large and
frequent ones, are undesirable. The authorities often try to prevent or offset a
fluctuation, for example, if the American dollar starts to slide in value, the Federal
Reserve might raise the rate of interest in order to attract foreigners to buy dollars and
slow, then reverse, the fall in the value of the dollar.

As globalization proceeds, it is hoped that the allocation of resources at the world level
will get better. This would improve economic growth and the standard of living generally;
hopefully it would also improve income levels in poorer countries. The latter point is
disputed, and the possibility of achieving faster global growth and a higher standard of
living for richer countries which is accompanied by little improvement of, or an actual fall
in, income levels and living standards in poorer ones has been suggested more than once.
Many believe that this is already happening.

This increasing globalization transmits international shocks more rapidly than previously
and in the future might increase the frequency and size of undesirable fluctuations.

Conclusion

Of these possible economic goals, only a few are likely to be central and of major
importance to the authorities; and what is regarded as central can change. It is not
possible to achieve all of these economic aims simultaneously, either because some goals
clash with others or the available resources are too small to allow the pursuit of more
than a few of them at any one time. For such reasons a choice must be made and the
goals placed into some order, however vaguely defined, so that policies can be framed to
tackle what is felt to be the core government intentions of the day.

~~~

Chapter 3 Trying to Make Sense of Economic Policy—Part 2: Why is
it so Difficult to Get it Right?

The ten main economic goals for any government were discussed in Chapter 2. Here we
look at why the task of achieving these economic goals can be formidable indeed.

There are at least a dozen reasons why it is extremely difficult—in fact impossible
—to achieve all of our economic goals simultaneously

First, resources are limited so that the government cannot afford to place a great effort
on all of the goals at the same time. This means that a choice must be made about which
of the goals are the more important and should be strongly pursued, and which can be
downgraded to a lower position, or be placed on the back-burner and ignored for quite
some time.

Secondly, we simply are not good enough, or know enough, to attain most of these goals
at the same time. Perhaps we will get better with time and technology; we can but hope
but I confess to pessimism here.

Thirdly, there are statistical and interpretation problems. The statistics we have to work
with are not perfect and some are simply wrong. It is common for official statistics to be
published, then revised and republished; but the policy decisions are taken on the basis of
the earlier and quite likely inaccurate figures. GIGO! There are also lags before many of
the statistics become available, and even then not all of the relevant series appear at the
same time, as some are harder to compile and therefore slower than others to arrive. This
means that a policy decision may be made with statistics of varying degrees of reliability
and in part referring to different periods.

Fourth, economic growth does not proceed steadily at an unchanging rate, so the economy
often includes cycles (see Chapter 4). In view of the statistical problems above we often
do not know exactly where we are in the cycle. If we think something is happening but we
are in fact wrong, all efforts to deal with this "something" might well make things worse.
Diagram 3.1 explains this. The curve of output graphed against time shows what can be
expected to happen naturally, if the government takes no action and the dotted red line
shows what can happen if the government intervenes but gets it wrong.

If our latest statistics refer to time period A, when growth is rapid and inflation is
probably high, the government might take strong action to rein in the economy and slow
the economic growth. That's fine if we are actually at A, i.e., there is no time lag and
there are accurate statistics. The result would be we would get it right, manage to
moderate growth, and with any luck prevent the downswing that would naturally start
after C.

If, however, the statistics are a bit out of date—say we are not at A but are actually at B
where the economy has already begun to slow down—then the action taken is likely to be
too strong. In this case, government intervention to reduce growth would reinforce the
slowdown and push us into a downswing earlier than otherwise would have happened (the
dotted line). The downswing is also likely to be greater in depth, and possibly in length of
time, before the next upswing can be expected.

The worst case scenario would be if we are actually at C, with statistics still coming in
from the period A. In this case the government action to restrain the economy, based as it
would be on well out of date statistics, would force a major downturn and could push us
into a recession or even a depression which is an even worse state of affairs (see Diagram
4.1). A recession is technically defined as two quarters of the year in a row where there is
negative growth—in effect we are sliding backwards. There is an old joke among
economists that a slow-down is when you read about someone being unemployed; a
recession is when your neighbour is unemployed; but a depression is when you yourself are
unemployed.

Governments always face time lags in statistics and knowing this still have to take
decisions. To try to get it right they examine several different series—perhaps the most
recent figures they can get on unemployment, inflation, production, and exports and
imports, as well as surveys of moods of business people, and then compare these with

changes from the previous period. On occasion some of the figures conflict, some
indicating a slowdown is coming, others suggesting the reverse, so that fine judgement is
required. Sometimes it is not clear whether the best course of action would be to expand
the economy, contract it, or simply do nothing. It is not easy! My own view is that if you
do not know whether to expand or contract, doing nothing is definitely the best option.

The fifth problem with attaining the economic targets is connected with the main policy
instruments available to the authorities—fiscal policy and monetary policy. Both
instruments have problems attached that may prevent the attainment of desired economic
goals, i.e., to get where we want.

Fiscal policy: this means using taxation, and to a lesser extent subsidies. Usually the aim is
to alter the overall growth of the economy and in particular the levels of inflation and
unemployment. It can also be focused directly on areas such as altering the distribution of
income, the allocation of resources, and increasing the protection of the environment.

In many countries, fiscal policies are implemented in an annual budget although a second
mini-budget in a year is possible. An annual policy change is not a very flexible way of
dealing with issues as they arise and therefore the budget can be something of a blunt
instrument. It probably works better at altering the distribution of income, the allocation
of resources, and protecting the environment than dealing with the overall
macroeconomic policies on inflation, unemployment and growth.

Other than this inflexibility, a major problem is that many tax and subsidy levels are
difficult to change for social and political reasons; for instance it can be difficult or
impossible to reduce the level of pensions or other welfare payments or to increase the
rate of income tax. Some taxes and subsidies might have been fixed for a given period by
previous announcements or cannot be changed owing to international obligations. The
discretionary element, the part that the authorities can actually alter, may be quite
small.

Monetary policy: this means using changes in the rate of interest and the supply of money
to alter the level of aggregate demand. This policy is largely used for the overall
macroeconomic targets of inflation, unemployment and growth. In contrast to fiscal
policy, monetary policy can be altered quickly, perhaps monthly or quarterly as needed,
and therefore is flexible. However, the affects can be slow to arrive and some of them
may take a year or more to filter through completely, reducing the immediacy of their
impact.

A sixth and related problem is that at the time the actual decision has to be made on
whether take action at all, and what particular action to take, the full effect of measures
already taken in the past has probably not yet been felt, and things are still working their
way through. Allowance may be made for this but in ignorance of how much has actually
worked through. Tricky indeed!

A seventh problem that prevents the simultaneous achievement of all of our goals consists
of the lags in recognition, decision, and implementation.

— Recognition lags: it takes time before people become aware that a problem exists; the
statistical problems mentioned above are largely responsible for this.

— Decision lags: it takes time to make a decision about what, if anything, to do about the
economic problem. Meetings may have to be organized, stakeholders consulted, and
possibly objectors may need to be pacified

— Implementation lags: once the first two lags are over and a decision is reached it takes
time to make any necessary changes and put the new policy into practice. There will then
be a lag while we wait for the results to emerge.

An eighth reason for our inability to achieve all that we would like is that we are dealing
with human beings who have the ability to change their behaviour or responses and they
may no longer follow the pattern established in the past. This means that the statistics on
previous behaviour that we have accumulated may no longer apply quite as well. If people
alter their behaviour patterns, it might mean that the authorities make a bad decision out
of ignorance of the new trend.

The increasing globalisation means that more countries and people are available to change
their minds and behaviour which may make this problem worse.

Another reason for it being difficult to devise accurate solutions to tackle and solve
economic problems is that we are not always dealing with hard statistics. Part of the
information used may consist of projections or estimates rather than actual figures. By
their nature, projections and estimations are less reliable than facts and might more
easily let us down. Projections often produce three possible outcomes, high, medium and
low. One of these has to be selected as the basis of any policy response: flipping a coin is
not normally the route chosen but one has a nasty suspicion that sometimes it might give
at least as good a result.

A tenth problem is that while we can expect the unexpected, we never know what this
will actually be. A sudden external shock can occur—they often do—and it is impossible to
build this into the decision-making process. Events around us conspire to get in the way,
especially international ones. We can scream "Help! We've been hit by a stochastic
variable!" but it does not get us anywhere.

In eleventh place, we face the cock-up factor. Human beings are fallible and make
mistakes; systems are often imperfect; computer programs can contain errors or be unable
to cope with an unexpected event, and so forth. This suggests that Murphy was probably
right when he formulated his famous Law "What can go wrong, will go wrong." We hear
that his wife once said “And Murphy was an optimist!” which is a bit scary.

And finally, it is always impossible to achieve all ten goals simultaneously for the simple
reason that some of them interact: to do well at one often means doing badly at another—
there is a trade-off involved.

So what are these trade-offs?

Which of the economic goals interact, so that an effort to pursue one can have an impact
on and prevent the achievement of another? Let’s list some of the most important ones.

Inflation versus Unemployment

Fighting inflation is likely to clash with a full-employment policy: to reduce the rate of
inflation a government might raise interest rates, reduce the money supply, and/or
increase the level of taxation. This would have the desired effect of lowering the level of
demand but would also have the undesirable effect of increasing unemployment. The
opposite is also the case: striving for full-employment can cause inflation. A common
problem for a country is that it faces inflationary pressures (which might suggest the
government should increase interest rates) and at the same time is suffering high or rising
unemployment levels (which suggest that interest rates should be lowered). Ouch!

Unemployment versus the balance of payments

Following a policy of full-employment can adversely affect the balance of payments by
causing more imports of consumer goods (because more people are in work, income levels
are higher, and people spend more). Imports of producer goods and raw materials (to
make some of the things people are now buying) will also increase. In addition it may be
harder to increase exports if people are consuming domestically more of what is being
produced.

If the government is worried about the balance of payments and decides to tackle it by
deliberately reducing the level of demand, we would automatically see higher levels of
unemployment.

Measures to improve local employment versus resource allocation and growth

When a government influences a foreign investor to come to the country and, say, build a
factory at Merseyside in the UK, this will provide more jobs (which the government is
likely to publicise in triumph). However, if this means the investment is being placed in an
area where it is not the most likely to succeed and is not where the company would
naturally choose to invest then resources are not allocated in the best way. As a result,
economic growth will probably be slower as will the future average standard of living
although those now in work at Merseyside will of course be better off. It’s a trade-off.

Economic growth versus the balance of payments

Achieving high levels of economic growth automatically sucks in imports and worsens the
current account on the balance of payments. Any action taken to improve growth
naturally worsens the balance of payments. The imports consist of consumer goods for the
increasing levels of income and the newly employed, as well as raw materials and capital
goods to fuel the growth.

A higher standard of living versus the balance of payments

As the people of a country grow richer they tend to alter their pattern of demand away
from basic survival items, such as simple food, clothing and shelter, towards luxury
imported goods and services, such as posh motor cars and foreign holidays. The increase in
imports then worsens the current account of the balance of payments.

Economic growth, or the balance of payments, versus the value of the currency

Pursuing growth can affect the value of the currency. The most likely outcome of a higher
rate of growth would be to strengthen the value of the currency, as foreigners appreciate
that growth is good for the country. However, as the growth will probably be accompanied
by a worsening balance of payments, this can frighten some foreign investors who may
ditch the currency—and these currency sales then lower the value of the currency. People
abroad make their own assessment and act accordingly. Their expectations of the future
of the country and its currency play a major role.

If the balance of payments worsens for reasons other than successful economic growth,
this tends to lower the value of the currency immediately it is observed or even if it is
expected and feared.

Taking care of the environment versus resource allocation, the distribution of income,
the standard of living, and inflation

Taking action to help protect the environment can have many effects. As an example, if
the act involves raising taxes on fuel to reduce vehicle emissions and hopefully reduce
global warming this would alter the allocation of resources—some would argue for the
better, others for the worse. It would also affect the existing pattern of income
distribution; reduce the standard of living of motor car drivers immediately and increase
the cost of transporting all goods; and this would push up prices generally. This of course
violates the anti-inflation goal.

Improved resource allocation versus many other goals

Resources can be altered in a variety of ways, so that generalizations are difficult for who
gains and who loses depends on how resources are altered. If incomes in rich countries
were to be made very much more equal it would improve the standard of living of many
(but by a tiny amount each), while worsening it for the few very rich (but by a lot more

each). This would mean fewer luxury items like Porsche motorcars or Patek Philippe
watches being demanded.

In general, improved resource allocation is usually good for long term growth and future
higher living standards overall.

Conclusion

Given all the above difficulties of achieving what we want and reaching most of the more
important economic goals, the biggest wonder is that the authorities ever get it even
remotely right and yet they do! Those guys do their best and really are good, especially
when one imagines that they need to know economics, mathematics, statistics, a bit of
psychology and, most important of all, have an awful lot of luck.

~~~

Chapter 4 Business Cycles, Recessions and Economic Booms

What are business cycles?
They are periodic swings in production when we see national income rising and falling
rhythmically over time. They may last for months, quarters of the year, or even years. The
event is variously called the business cycle, the economic cycle or perhaps regular
economic fluctuations.
What does the cycle look like and what are the various elements called? See

Diagram 4.1

One also gets terms like "minor recession" or "major recession"; “a depression" lasts longer
than a recession, possibly for several years, and might also go lower. In the UK, as in many
countries, "a recession" is defined as two successive quarters of falling output. A recession,
then, tends to last at least six months. In 2009 it became fashionable to refer to "The
emergence of green shoots" as a phrase to indicate the hoped-for start of an upturn.
That’s journalists for you.
Generally we draw the above diagram sloping slightly upwards, to reflect long term
economic growth.
What might we expect to see?
In the upswing, prices and profits rise fast, but wages tend to lag. In a downswing, profits
fall rapidly; wages still lag behind events and so by contrast they continue to increase for
a short time before levelling off or even eventually falling.
Between 1992 and 2008 Britain was in a continuous upswing—a very long time and indeed
it seems to have been the longest period of economic expansion on record. Then in 2008

came the financial crisis or the credit crunch, and the real economy turned down. This
was a global event so the UK was not alone in this.

When did the business cycle first appear?

The cycle seems to have appeared about the mid Eighteenth Century, as the first
industrial economies began to develop; by the mid Nineteenth Century the business cycle
was clearly in place and recognised.

During the long expansion for much of the 1990s and up to 2008, some asked if the
business cycle had ended and the then Chancellor of the Exchequer, Gordon Brown (later
to become Prime Minister) said it had ceased to be and there would be no more boom and
bust. He was of course completely wrong. It is possible, however, that business cycles may
become a little less common in the long term. Perhaps information technology and rapid
restructuring is making it easier to head them off? Against this, the increases speed of
communication and economic transmission belts may make it harder. We simply do not
know yet.

Why are cycles important? There are many reasons

1. In a slump, we lose output that we could have had; unemployment rises, the newly
unemployed are worse off and suffer a lower standard of living; school leavers find it hard
to get a meaningful job; and people face increasing uncertainty and worries. Crime rates
may also rise.

2. When output turns down it means that the average long term growth rate is lower—and
so is the standard of living.

3. The more extreme lunacies of a boom may distort resource allocation, e.g., too much
went into dotcom and hi tech companies in the late 1990s.

4. Slumps may lead to a distortion in resource allocation if the government decides to
protect a few groups that it favours, e.g., banks, motorcar manufacturers or farmers, and
subsidise them or bail them out.

5. The cycle interferes with government budgets. In a boom, government revenue rises
from items such as income tax, company tax, and VAT (a form of sales tax) which all
increase. At the same time, because the level of employment is increasing, government
expenditure on welfare payments and social security falls. With both increased revenue
and reduced expenditure, the government surplus expands.

The reverse happens in a slump: revenue falls and welfare expenses increase, so a deficit
emerges (or increases should one already exist). The government may have to borrow to
cover the deficit—which can interfere with other government targets like the Public Sector
Net Borrowing requirement. In the UK, in 2009 government debt increased sharply and it
became a major headache for the future. The government policy is, or rather used to be,
to balance its budget over the cycle but it has significantly failed to do so.

6. If the government reduces the rate of interest to try to increase the level of aggregate
demand, which is likely, then borrowers gain, savers lose, and individual mortgage
repayments fall. In other words, there is a redistribution of income.

7. If there is an extended recession or a depression, prices may actually fall, in which case
pensioners and other fixed income groups see some gain as their living standards rise.
Pensioners on balance still tend to lose as many of them rely on interest earned on savings
to supplement their income—and interest rates are likely to be low. Similarly, those
pensioners wishing to purchase an annuity (a guaranteed income for the rest of their life
bought with a large lump sum upfront) find that low interest rates mean a much smaller

annuity income and a worse end-of-life experience than they had anticipated. They are
more likely to out with a whimper than a bang.

8. In a slump, firms may put off investing which can prolong the slump and perhaps lead to
a full recession. This lower investment is also likely to lead to slower growth in the future.

9. If we could only better predict the timing of the peaks and troughs the government
could improve the timing of its interventions and smooth out the cycle to some extent.

Why do cycles occur?

This is the big question! There are lots of different explanations, but certainty certainly
eludes us. Someone once said "There are two kinds of business cycle forecasters: those
who do not know, and those who know that they do not know!" And that is about right.

1. The Classical School

Here it was felt that long term recessions were not possible, for if production was
occurring it meant that people were working and thus had incomes; they spend the money
to buy goods and in this way supply creates its own demand (Say’s Law). Keynes claimed
that the Classical School had no theory of cycles and they just felt that cycles were an
aberration which time would solve automatically, which is to say that the system was self-
correcting. The Classical School felt that in a slump, prices would fall and would continue
to do so until they wiped out the lack of demand and the economy would start up again.
Prices and wages should go up and down in a cycle, rather than production doing so. Since
we actually see real output going up and down instead, the problem must be sticky wages
and prices. It has to be some problem in the system that prevents prices and wages from
falling in a slump and it is this that should be tackled.

2. Karl Marx

He claimed that the nature of the capitalist system is to produce very efficiently because
costs are always being squeezed; output increases rapidly under capitalism but people do
not spend all their income so that ultimately demand will be less than supply. In the end
there must be a downturn as supply outruns demand and the result is that there will be
business cycles. Over time the downturns will get bigger until the people have had enough
—then there will be a political revolution and capitalism will collapse. A function of the
Communist Party is to hasten this event.

3. J.M. Keynes (and others who pushed the analysis further).

Aggregate demand can be deficient—contrary to the claims of Say's Law, supply does not
create its own demand. Workers do not spend all their money but save a proportion. To
combat deficient demand the government can increase aggregate demand via fiscal and
monetary policies which will wipe out unemployment and in this way prevent a major
depression. Without such government intervention, wages will be sticky in the downward
direction and neither wages nor prices will fall far enough to wipe out unemployment.

The liquidity trap, in which interest rates cannot fall enough to stimulate investment, can
prevent the successful working of monetary policy; we saw this in Japan after 1991 and
well into the Twenty-First Century, when interest rates were effectively zero but the
Japanese economy continued to stagnate. According to Keynes, fiscal policy and direct
government spending has to be the answer when this happens.

4. The stock (inventory) cycle explanation of the business cycle

It is the way of the world that as firms sell they run down their stocks then have to
reorder. In any one industry, firms tend to do this about the same time, for they all face
the same market conditions. If all firms suddenly order large amounts it kicks off an
upswing but when they stop it causes a downswing. These stock cycles may last for three
to five years.

Probably this was once more important than it is now—the development of "just in time"
ordering and the use of computers mean that each firm can manage with smaller stocks
and adjust more rapidly than it could some decades ago.

5. The fixed investment cycle (7-11 years)

Firms in an industry have to replace old machines as they wear out and also when newer
and better machinery comes available. Again the firms all tend to do it around the same
time, owing to the workings of competition.

6. Government may actually start the swings—and also worsen existing ones:

The argument of the Austrian School is that central banking and the monopoly control over
the supply of money is the cause of the problem. A government sees an upswing is
underway and fears that inflation will start to increase, so it tightens monetary and/or
uses fiscal policy to curb the boom. It gets it wrong and credit expansion and contraction
is greater than the free market would promote. (see diagram 3.1).

It must be admitted that there is a serious lag problem that makes it hard for the timing
of government decisions:

— Data lag: we do not know where we are because the data may be months or even
quarters late—and then will get revised again in future as they were incorrect initially.
The leading indicators may be: the unemployment rate, the rate of utilisation of
productive capacity, commodity prices, the alterations in business inventories, and
changes in worker productivity.

— Recognition lag: we do not see we have a problem soon enough.

— Response lag: it takes time to decide what to do about it.

— Implementation lag: it takes time for policy to work through and take full effect.

As a result of such lags, by the time the government acts it may be too late; the economy
may have already started to turn down but this is not yet recognised. In this case the
government action will inadvertently worsen the cycle.

7. The imported cycle

When other economies abroad boom, we increase our exports to them and as exports are
part of our total aggregate demand we expand in turn. Should the other countries later go
into recession, our exports will decline as they buy less from abroad (including from us).
This then can force us into a downturn. The USA is particularly important in this respect
because it is dominant internationally and imports much. It used to be said that “When
America sneezes the world catches cold” although up-and-coming countries such as China
and India may gradually take over this influential role.

8. The property or stock market cycles

As people become better off they wish to save or invest their surplus—and generally want
to become wealthier. If the stock market is rising that is a good place to put any surplus
funds in order to achieve long term capital gains as well as short term income. The stock
market cycle feeds on itself: when stock market prices start to fall, some people pull out
and this worsens the fall in prices. Others sell in turn. Expectations play a large role here
with speculators, and those simply trying to maintain their position rather than make
extra money, playing a role.

Should large numbers of people choose to put their money into property instead of into
the stock market a similar cycle is observed in the housing and commercial property area.

9. Various psychological explanations of the business cycle

— The feeding frenzy

Once a boom starts, people behave irrationally—a feeding frenzy sets in, as it sometimes
does with sharks in the sea, and people rush to buy. Eventually the boom gets too big to
sustain and it finally collapses. Then people overreact once more, sell in quantity and
drive the market too low for its fundamentals. This buying frenzy to be later followed by a
selling hysteria occurs now and then, giving us cycles.

This can apply to the stock market, the property market, pork belly futures, indeed to any
market where people buy and sell and hope to make a profit from the price differential
over time.

— Business confidence

When businesspeople are confident, they invest for the future—and this increases demand
and can cause a boom to develop. When they become less confident they cut back on
investment and this can push us into a downturn. We have a cycle!

— Consumer confidence

Similarly, high consumption via credit card purchases seems to have kept the UK economy
growing in the first decade of the Twenty-First Century. Then credit became something of
a dirty word, spending was cut back, and this helped to push the economy into a
recession.

Consumers may feel confident for several reasons: the stock market gains of the past led
to many feeling better off and perhaps this induced them to spend more easily. Similarly,
the steady rise in house prices for the first eight years of the new millennium led to many
people feeling richer which again may have led them to be more willing to spend.

There is also a socio-political argument that blames "Thatcher's Children" who, following
the dictum of the movie character Gordon Gecko that "Greed is Good", adopted the slogan
"What do we want? Everything! When do we want it? Now!" W see the emergence of a
generation that is not prepared to go without or save up for what is wanted. This probably
accounts in part for the credit card fuelled boom.

The younger generation is very brand conscious and many members wish to be trendy and
a respected member of their peer group. Being seen wearing the correct trainers, etc.,
matters a lot and maxing out credit cards is one way of achieving this happy state of
affairs. As long as things trundle along happily there is no need to worry. Confidence can
continue until some major upset occurs.

10. Schumpeter's Innovation Cycle

Joseph Schumpeter pointed out that now and then a firm invents something or comes up
with a new product and puts it into production. This is a technical innovation. Initially the
firm gets high profits because it is the sole supplier, the demand is good, and for a period
the firm dominates the entire market (it is the innovator). After a time other firms start to
enter and produce a very similar product thus competing with the first firm and eroding
the initially high profits. Eventually all these profits of innovation get wiped out and
stability returns to the industry. The cycle starts with the successful innovation, continues
as other firms join in, but runs out eventually. Technical change and innovation are
therefore at the heart of the business cycle.

The innovation cycle may be getting shorter because of computers and the ease of
communication, particularly as many governments have removed a lot of barriers to
competition. This means that new, cheaper, competing goods are able to come on the
market more rapidly.

11. The Kondratiev cycle

This was first pointed out by Nikolai Dmitriyevich Kondratiev, hence the name. These are
long cycles, perhaps 50-70 years in length. The big discoveries or inventions, like electric

power or mass-produced motor vehicles, kick off such a long cycle. This seems like a good
explanation of the long historical sweeps in production that we see but has little obvious
relevance for the short term business cycle.

12. A natural built-in reason

As the economy passes through the initial upswing and develops into a full boom, we see
unemployment fall; workers thus increase their power and ask for, and gain, wage
increases. These higher costs feed through to price increases. This domestic inflation
means that exports become harder to make as they are dearer, so aggregate demand
eventually falls and the downswing commences automatically.

13. The multiplier-accelerator linking event

Putting the multiplier (an increase in consumption or investment multiplies the effect on
income as people spend most of what they receive and the new recipients spend again)
together with the "accelerator" (a change in consumption demand of a given percentage
causes a much greater change in the demand for machines to make those extra needed
consumer goods) can generate a cycle. The economist Paul Samuelson proved this
mathematically back in 1939.

14. Shocks to the system

Any shock can have an impact—e.g., the New York bombing on Sept. 11 2001 ("9/11",
when terrorist-seized ‘planes destroyed the Twin Towers building) hit a lot of tourist-
related industries and not only in the United States. As a result of the incident many
Americans refused to fly or travel abroad so other countries too saw a fall in aggregate
demand.

15. The "Sunspot Theory" of the Nineteenth Century

This was once popular: after sunspots occurred on the sun, which happens roughly every
eleven years, it was observed that crops tended to fail causing an economic recession.
When I was an undergraduate this was laughed at as a quaint and bizarre theory of the
Victorian era but more recent observations suggest that it may have had some validity.
This was really a “specific kind of shock” explanation but has its own name. The
Schumpeter and Kondratiev cycles are also examples of specific shocks bearing a name.

The business cycle and the SAS/AD model

Many arising events can affect either the short-run aggregate supply (SAS) curve or the
aggregate demand (AD) curve for better or for worse.

Many of the destructive "shock" explanations, e.g., 9/11 in the United States, sunspots, or
sudden weather change can reduce the AS curve—they move it to the left, reduce the
level of gross domestic product (GDP) and increase the rate of inflation—see Diagram 4.2.
This might cause, or worsen, a downturn in the cycle.

On the side of aggregate demand, such things as announcements of bad news by
governments, sudden increases in the rate of interest, or perhaps fear of war might induce
people to save more and spend less, thereby shifting the AD curve leftward, and reducing
the level of both GDP and inflation (see diagram 4.3). This too might cause, or worsen, a
downturn in the cycle.

By contrast, all beneficial shocks, such as a sudden boost in consumer or producer
confidence or perhaps the announcement of good financial news, can push the AD curve to
the right (demand increases when people buy more or businesses invest more). This means
the start or continuation of an upswing in the cycle (see Diagram 4.4).

Aggregate supply increases when we get new discoveries of raw materials, an increase in
the supply or quality of labour, technical progress and the like. Generally an increase in
the quantity or quality of any of the factors of production, or inputs into the production
process, will do it (see diagram 4.5). With an increase in the AS curve we see an increase
in output and a fall in price, which of course can spark off or increase the economic
growth part of the cycle (see diagram 4.5)

Conclusion

The business cycle is not new, and cycles seem to be inherent in the economic system.
They are not regular and are often unforeseen, although after the event some may claim
to have predicted them. A few economic commentators regular predict an imminent
downswing or upswing. Bear in mind that if one continually predicts something in this way
eventually one must turn out to be right! Success! Of course, this is only as long as one
ignores the preceding continuous string of failures...

There are a lot of explanations of the cause of business cycles and we do not really know
for certain why they all occur. It is possible that if we look at any individual cycle it might
have just one cause—or perhaps several causes all coming together at once. It is probable
that different cycles have different causes too.

With globalisation, which means more interlinked economics and faster transmission belts
for the effect of events, it seems likely that cycles may get larger and more world-wide
than they once were but even this is not certain. We still have a lot to learn: perhaps we
always will have.

~~~

Chapter 5 Understanding Economics: a Summary of the Advantages
and Disadvantages of the Price Mechanism

(Note: not all the issues are purely economic: some of the issues are social or political)

The price mechanism lies at the heart of western economic theory. Anyone studying
economics comes across the phrase “price mechanism” (or “market mechanism”) and it is
a popular topic for setting in essays or in examinations. Here we look at what is good
about it and what is bad.

The advantages of a totally free market

* It allocates resources where people want them; we get maximum consumer satisfaction.

* It works automatically, is essentially costless, and requires no bureaucracy to run it.

* This means no wasted resources in providing a huge civil service; so people are left with
more to spend rather than pay a higher proportion of their income as tax, which means
they can enjoy either an increased level of personal consumption or else save more for
their future.

* It allows the maximum economic freedom to the people to spend their own money in
their own way.

* People have the choice for whom they will work and in what industries or service sectors
they will spend their lives.

* People have the freedom to set up their own businesses and try to do better in life for
themselves and their families.

* This means that there is a strong incentive effect. People are encouraged to work hard
and get on in life as they have the freedom to try anything they want. This can stimulate
economic growth.

* Competition forces out the inefficient firms, which means lower prices for consumers,
and it also releases resources needed by the more efficient firms.

* Forcing out the inefficient firms and releasing their resources for better uses encourages
faster economic growth.

* There is a constant striving to improve production methods and distribution chains,
which is a stimulus to technical progress. Technical progress is an important source of
growth and is the major source in developed countries.

* With a totally free market there is less for the national government to do. This might
help to prevent the emergence of a dictatorial government that spends money and
behaves in ways that the people do not want. Totally free markets also tend to go along
with some form of democracy. A free market cannot prevent a brutal dictatorship but if it
goes hand in hand with a democratic system it does lessen the danger of this as the
government knows that it will be voted out if it goes too far.

The disadvantages of a totally free market

* There is no guarantee that growth will be maximised under perfect resource allocation;
the macro-economic side, and aggregate supply and demand, matter here.

* The allocation of resources is determined by the distribution of income; and incomes are
usually distributed unequally. The rich get more “economic votes” than the poor so the
economy produces a lot of luxury goods. One result can be that the poor and needy might

suffer and at the same time the dogs in rich areas, like Hollywood, probably eat better
than some babies in the ghetto.

* Those who are physically or mentally challenged would suffer greatly in a totally free
market and unless they have a caring family or private charity help their life, in the words
of the political philosopher Thomas Hobbes, would be poor, nasty, brutish, and short.

* In similar fashion, the elderly would not do well. There would be no state pensions if the
market is left to do everything. Not everyone can, or chooses to, accumulate enough
wealth to take care of their own old age. Those without families would be especially
vulnerable: in the developed countries of the West the extended family, which used to
take care of its own vulnerable members, has broken down and largely disappeared.

* Economic growth may be slower, rather than faster, if the people choose to spend more
and save less. This would mean lower investment levels now which in turn mean slower
growth to come.

* Public goods, such as defence, a police force, and a justice system will not be provided
unless the state does it. The safety of the nation and individuals cannot be guaranteed.
Street lighting would not exist, as whoever paid for it could not prevent others from using
or benefiting from the free light. Similarly, a state education system or national health
system would not be provided only private ones and these would be of a more limited
coverage.

* Some economic endeavours, such as a nation-wide transport system or postal system,
may not be established by private enterprise, and where they are, they may favour only
the rich, well-populated areas.

* Abilities and resources are not equally distributed, so that rather than a host of perfectly
competitive firms we commonly see a small number of firms in imperfect competition
which can form cartels or raise prices and make monopoly profits. This distorts consumer
choice, resource allocation, and the distribution of income.

* Monopolies too are likely to exist, with similar distortion implications.

* Advertising wastes may occur, where virtually identical products are heavily advertised
as being different from and better than rival products. The rival firms compete with each
other by using advertising and the total spent in that area increases. Much advertising is
“percussive” i.e., repeatedly hitting consumers with statements to influence their
purchases, rather than “informative”, or telling people the product exists and what it
does.

* The rise of a few rich and powerful companies, and monopolies, results in the emergence
of a small number of very rich and powerful people. “Monopoly capitalism” arises. Power
tends to corrupt and these powerful individuals gain the ear of the government,
influencing what laws will be passed; these often help this small group of people to the
disadvantage of society as a whole. The Rupert Murdoch empire has been accused of this.

* Lack of knowledge is common, for example the decisions by workers on what job to
pursue is taken in ignorance of the full range of opportunities available; producers do not
know what their rivals are going to do either in the near future or in the longer term; and
consumers lack knowledge about the range and especially the quality of goods and
services that are available or about to become available.

* The factors of production (land, labour and capital) are not fully mobile, especially in
the case of workers who often will not or cannot move to where the jobs are for social or
other reasons.

* Many of the “better” jobs in the professions, such as lawyers, doctors, or dentists may
require lengthy training during which time the young trainee is out of the workplace and
not earning. Socially, this frequently means the rich and middle class parents are the only

ones who can support their children through the training period. The children of the poor
and of the working classes, while not excluded, make up a much smaller proportion of
such professions than their innate abilities suggest they should.

* Gender issues arise too. In a free market, women often find it more difficult to get equal
access to higher level positions in industry, commerce and government. “The glass ceiling”
is a commonly seen description of this. It would seem that in many countries social values
and centuries of male-dominated systems are responsible.

* When firms make decisions to maximise profits, only private costs are considered; public
costs and benefits are ignored. As a result, there is too little production of “merit goods”
and too much output of “demerit goods”.

* Similarly, externalities are ignored in the decision-making process. This means that when
there are external benefits, too little is produced; and when there are external costs too
much will be produced for society.

* Economies of scale can result in one or a few companies growing large enough to develop
monopoly power which they can then use for their own benefit at a cost to society in
general.

* Economic cycles naturally occur, involving booms and slumps. In a boom there can be
inflation and shortages of various goods and services. In a slump, people can be suddenly
laid off and become unemployed, with severe personal consequences, such as difficulty in
meeting the rent or mortgage payments, feeding themselves and their family, and paying
off things bought earlier on credit. These social problems are created by the system and
none of this is the fault of those caught up in it and suffering.

* Anti-social groups like the Mafia in Italy or the USA may behave in ways that damage the
economy, e.g., by offering to remove and properly process toxic waste at a low price then
simply dumping it untreated in or near reservoirs or water catchment areas, thereby
poisoning crops, animals or people.

Conclusion

The price mechanism has advantages and disadvantages attached. No economic system is
perfect. Many economists prefer the market mechanism because of its advantages over
economic planning but many sociologists and political scientists are unhappy with it as the
focus of their disciplines is different. There are few real world economies that are purely
market mechanism, although Hong Kong perhaps approaches it more closely than most.
There are equally few economies that are run purely under a system of economic planning
and those that are, such as North Korea, are poor and, to put it mildly, life there seems
unattractive to many foreign observers. For such reasons, a mixture of market mechanism
and state planning or intervention is most commonly observed in the world in which we
live.

More detailed information about the price mechanism and its working can be found in my
book An Introduction to Economics, which you can download for free.

~~~

Chapter 6 Notes on the Difference between “Economic Growth”
And “Economic Development”

Why are we interested in the difference?

* We need to understand the processes of each better; it is useful information if we are to
understand the way the world works.

* We need to know in order to advise governments on policies and what they can do to
improve their performance in promoting the economy.

* Many issues and problems in third world countries either help or hinder economic growth
or development but may do so differently. The more we know, the better.

*Growth may itself create problems for economic development, for example pollution will
probably increase.

* Focussing heavily on economic growth as the main desirable target can lead to
undesirable consequences in a nation.

* Growth and development often seem to clash.

Economic growth

What is growth?

This is reasonably unambiguous; it is the change in national income over time, usually
measured over one year. National income is the amount produced by a country in one
year.

How can we measure growth?

We measure it by the percentage change in the level of national income, again usually
over the period of one year.

There are three ways of working out the growth rate. We can count up:

— production, or

— incomes, or

— expenditure.

On the production side:

— GDP = gross domestic product (produced only within the country).

— GNP = gross national product (includes income coming into or going out of the country).

— NNP = net national product (an adjustment is made to GNP to allow for the depreciation
of capital or the machinery that wears out or becomes obsolete during the year).

Each of these three measures is useful, depending on what we wish to know or the
question we wish to answer. GDP is the one most commonly encountered. It is the easiest
to get of the three different measures.

National income per capita often matters if we looking at how well off the people are in a
country; how well the country is doing for its people; or when comparing one country with
another.

Some problems in measuring National Income and Growth

* Statistics are unreliable:

— They are often late arriving.

— They are often inaccurate or wrong.

— They are sometimes not strictly comparable across national boundaries because of
different definitions and standards.

* There can be much excluded data:

— Non income-earning producers, e.g. housewives/husbands, care workers within the
family, and children or other family members, who might be producing goods or
services within the household.

— The "Black Economy" is excluded—in Italy it has been suggested that it may be as
high as 30 per cent of national income.

— Environmental damage is ignored.

— Leisure time is not counted as a benefit.

— All activity that is done for fun is excluded. Yet people engaging in sport or visiting
a gymnasium to keep fit or engaging in pursuits that require mental effort may
reduce the need for society to spend on health care, perhaps reduce the rate of
heart attacks or the incidence of Alzheimer’s disease and alleviate the burden sick
people place on families and society.

— Welfare or happiness is ignored and is impossible to measure with any certainty in
any case. Interpersonal comparisons are fraught with problems: I cannot honestly
claim to be 12.5 per cent happier than you! Or sadder, come to that. The
statement just does not mean anything.

— Voluntary workers are excluded despite producing goods but probably rather more
services.

— The activity of those who swap services, e.g., Baby Sitting Clubs, or those who
barter goods with each other is missing.

— Recycling goods via organisations such as Free Cycle is ignored. Recycling improves
the standard of living of both the recipients (who get something for nothing) and
the donors (who save space, get rid of unwanted gear, and probably feel good
about their activity).

— Income distribution is ignored: five people might have £10 million a year, the rest
might have only £1,000 a year each so most are not well off at all—but the average
income of £100,000 looks pretty good.

Cross country comparisons involve special difficulties:

* Data reliability varies.

* It is hard to get the same years for comparisons: the latest data on Japan maybe 2011
but on Saudi Arabia maybe 2008. Should we compare the same year for all (2008 in this
case and ignore the later data we have for some countries and be out of date already), or
should we use the latest there is for each country and mix the years? We often do the
latter and then mark those countries whose data is earlier and say what year applies to
these dissimilar countries.

* Not all goods and services may be available in some countries.

* In countries such as France life is simply better for most people than it is in an oil rich
Middle East desert although the latter may have a similar national income level and
growth rate.

* We have to use foreign exchange rates to get to one currency (usually US$) so we can
compare. This has problems: some countries overvalue their currency deliberately as they
feel that "strong" is the same as "good". This means that exports are too expensive to sell
well and imports are cheap and therefore most attractive. The result is that the country
gets a balance of trade deficit. For example, if the exchange rate should be (market rate)
US $1=10 “Zel” but the country sets it at 1 Zel, then when the country produces an item
for 10 Zel, it has to try to export it for $10 rather than the $1 it should be! Exports are
going to be very difficult to make.

Other countries keep their currency valuation low in order to encourage exports and build
up a healthy trade surplus. China has been accused of this in the past.

Using these different and somewhat artificial rates to reduce the various currencies to
dollars gives us inaccurate and misleading results.

Advantage of using the growth measure

* It is simple, clear, and easy to get for most countries. This is perhaps the best thing
about it.

* We can adjust it for differences in purchasing power parity—for example, in Chengdu,
China, £20 buys a lot more than it would in Hull, Yorkshire.

Disadvantage of using the growth measure

It is a crude measure with all the problems mentioned above.

Economic development

What is it?

The exact meaning of "development" is in dispute—there is no general agreement about
what it is or what should go in the definition. It tries to see "how well off" people are in
ways that include more than just income. There is a feeling of change and improvement
about it, as well as "better off". It is not just "more of the same" which is really what
"growth" is concerned with.

How can we try to measure this elusive development— It’s tricky!

* As we cannot agree on what it is and are unable to agree on what should be measured
then there is no clear way to decide on how we might do this.

* A person's values are influential here; for instance, what is felt to be important to person
A might well be unimportant or even totally irrelevant to person B.

* In particular, religious or political views can vary immensely on what might be regarded
as “a good thing” and hence should be counted as part of development.

* Fashion can be a factor. For example, in some periods and in some countries freedom
may be valued highly. The United States has a Constitution that places a specific value on
freedom and this seemingly affects the way people in that society think and the relatively
low priority they give to things such as a national health service. Freedom counts,
compulsion is found distasteful. Some other countries appear to place less importance on
“Government of the people, by the people and for the people”.

* Tastes vary too, for instance hot baths matter a lot in Japan but much less so in Australia
where showers are more the norm.

* Geography can play a part. Central heating may be pretty much an essential in cold
Finland, but air conditioning matters greatly in Singapore. Countries around the
Mediterranean may need to spend less on either, so have more income left over for
enjoying food and drink, for instance.

Measuring development: a physical statistical approach

We can count good things, such as the number of people in various professions, the
quantity of goods and services, and the amount of infrastructure and work out the
proportion in society. For instance, we can examine the number of doctors, nurses or
engineers per thousand (or ten thousand) of the population; or we can count such things
as the number of hospital beds, telephones, newspapers, TV sets, or radios per thousand.

The higher the figure the "more developed" the country registers. This is a simple and
somewhat crude measure but using it to make comparisons between countries can be
instructive.

The Human Development Index (HDI )

This was invented by the United Nations Development Program (UNDP) in 1990 and refined
in 1994. The UNDP sees "human development" as meaning that people live a long life, are
well educated, and enjoy a high standard of living. So in their measure they include three
items:

— Life expectancy.

— Adult literacy (making up 2/3 weight of “education”) and average years of schooling
(1/3 weight).

— GDP per capita, adjusted by purchasing power parity (PPP) which means how much the
money buys in that country.

Each country receives a final score of between 0 and 1. The number 0 = the worst
possible. This figure is derived from statistical records going back thirty years and the
worst recorded figure observed for any country is defined as being zero (really bad). A
score of 1.0 then indicates the top (i.e., the best recorded over the same thirty years).

The UNDP took these results, varying between zero and one, and broke the countries down
into three broad groups, defined as follows:

— A score of less than 0.5 shows "a low level" of human development in that country
(currently mainly African countries).

— 0.5-0.8 reflects a "medium level of human development".

— A country scoring over 0.8 reflects " a high level of human development".

You will observe that although this measure is useful both when making comparisons
between countries, or judging the degree of progress of one country over time, it misses
out things that many observers feel are important in terms of human beings. These might
include such issues as the freedom to worship (or not if one so chooses), the availability of
employment, equality before the law, equal opportunity for males and females as well as
for the young and the aged, and even access to clean water and decent sanitation. You
might think about it and see if you would like to add more of your own views as to what
might be missing; after all, what is being included for measurement merely reflects
someone’s opinions and values. Your ideas matter too.

The "Misery Index"

This is sometimes used in the USA where an economist called Arthur Okun, one-time
advisor to President Lyndon Johnson, felt that being unemployed is bad and also inflation
is bad. So he added the percentage unemployed to the percentage rate of inflation to get
"The Misery Index". What can we say about this index?

* It is simple, clear, and easy to work out.

* It is perhaps too simple and it misses out many of the important facets of a good life,
mentioned above.

* Some observers feel that it really measures the political significance of the state of the
economy at the time and is more concerned with the degree of support that can be
expected from the voters.

* Simply adding the two rates together, as is done, gives them equal weight. Yet a survey
suggested that people feel that being unemployed is worse than inflation, and on average
an increase of one percent unemployment is felt by many people to be as bad as 1.7 per
cent inflation. Humans like to work and prefer to have a job and watch prices rise a bit
faster.

* It has been observed that an increase in the Misery Index predicts an increase in the
crime rate reasonably well, after a lag of a year or so. This might be valuable information
for the police force.

* It has been worked out for the UK and some other countries but outside the USA few
seem to take it really seriously.

* And The Misery Index has now become the name of a rock group!

The "Genuine Progress Indicator" (GPI)was invented in 1995.

When calculating how well the economy is doing those things that cannot be measured are
just ignored and left out of GDP. The GPI tries to put some of them back in. It takes the
normal measure of growth then adjusts it to take account of welfare changes. It attempts
to tackle the question “Does the growth we see really make people better off?”

Faster growth might carry in its wake various undesirable features, such as the depletion
of resources, an increase in the amount of ozone, air, water and noise pollution, the loss
of farmland, wetlands and green spaces like parks, and the destruction of habitat that
significantly reduces or perhaps even eliminates a wide range of animal and plant life.

It is not only at the level of the nation that we can make this measure; in the USA it has
been estimated down to the level of some States and even to a few cities.

How does it work?

* It adds in an estimate of the value of non-monetary-reward jobs, like housewives, charity
workers and volunteers. All of these are seen as good positive things yet are ignored in
calculations of GDP and so forth.

* It subtracts an estimate of the natural resources depleted or used up in the year.

* It also subtracts the costs of cleaning up the environment and combating crime from the
figures for growth. The logic is that in these areas we are simply trying to correct a bad
thing and get back to where we should already be, so that spending money in this way
does not add to welfare in any real sense.

It was discovered that in the USA using the ordinary measures of economic progress, in the
period 1975-95 growth was rapid; but when we measure the change using the GPI, the USA
actually went backwards. Those sometime irritating senior citizens who look back in
nostalgia and talk reverently about "the good old days" may actually have a point!

Problems of using any of the "economic development" measures.

* There is no general agreement on which measure to use let alone what particular items
should be included in the measure.

* Whichever measure we choose there is still a lot that is excluded and ignored.

* Development is seen as desirable but it does involve change. Yet change itself upsets a
lot of people, threatens old values including some religious beliefs, and creates tensions in
society. Is this a good thing?

The advantages of using the "economic development" measures.

* It reminds us that things like less leisure time, higher debts, more pollution and a
degraded environment generally do matter and if we are interested in genuine progress
then focussing simply on economic growth rates is partial and misleading.

* Economic development measures are broader than the simple "growth" ones and we get
more and valuable information.

* This information can be important when we are considering making changes, including
economic, political and social ones, and need to evaluate whether they are desirable and
how much so.

* In general, the HDI is slowly becoming something of a standard but it does not yet hold
total sway.

~~~

I hope you have found this eBook useful. Here is a free sample from my latest paperback
book Going to University: the Secrets of Success.

Free sample from the book Going to University: the
Secrets of Success

1. University, here I come!

OK! HOW CAN I DO WELL AND ALSO ENJOY MYSELF?
:) Life at university is fun, fun, fun! And of course quite a bit of work.

Well done! You have made it to a university or college and this is the start of a really
great time, now you are out of your school daze. If you have been told that these were
the happiest days of your life, you were probably being lied to. University is far better in
almost every way: you have much freedom, little responsibility, and an interesting set of
new friends. I confess I rather envy you your good fortune. Still, been there, done that,
bought the T-shirt; now it’s your turn.
One of the main things you will almost certainly have to do is learn how to learn. You
probably assume that you know how to do this but many students have mostly been taught
by others and have not really had to learn much on their own. From now on you will be
doing a lot of learning so you might as well do it efficiently. Think about it! If you study
efficiently it leaves you with a lot more time for doing things that you really enjoy!
Three elements seem to be common to those who do well at university. Firstly, they go to
all set lectures, tutorials, seminars, and workshops or laboratory sessions, where they pay
attention, and take notes. Secondly, they work for hours on their own, outside the formal
class time. Thirdly, they use their time effectively. What makes them work hard is strong
motivation. With a determined will to succeed you can achieve almost anything you want
in life. Such determination is crucial if you want to do well; think how much you already
know about a particular sport or hobby that really interests you. Try to increase your
motivation by following the advice below and regularly doing the things suggested.
Determination plus adjustment equals success
A good way to start your adjustment to university life is to think about why you are going
and make your own list of reasons. Keep this and read it regularly—reminding yourself of
your original reasons can help strengthen your determination to succeed.
WHY DO I WANT TO GO TO UNIVERSITY ANYWAY? SOME POSSIBLE REASONS (BUT MAKE
YOUR OWN LIST USING YOUR OWN WORDS)
* My parents and family expect me to go
* My friends are all going so I’m off too

* I wish to enjoy the life of a student, which sounds and is attractive
* I ’m postponing decisions about what to do with my life
* I am unable to find a job
* I want qualifications for a particular career I have in mind
* I wish to learn about something that really interests me
* I want a job with real power (though power is like a steep cliff: only reptiles and eagles
tend to get to the top easily)
* It would be nice to broaden my mind and improve my quality as a human being (OK, it’s
rare!)
* I’d like to find intellectual stimulation and enjoyment
* I may be returning to study after some years in the work force because I need a
challenge, or can now afford to get an education
* Like Aristotle, I believe that education is the best provision for old age.
* I want to earn decent money once qualified—yes!

Why bother to make a personal list? Because it can help increase your motivation when
you reread it later; in a sense your own list is an extension of you. A stronger motivation
increases your determination and also makes your learning more enjoyable, hence easier.
WHAT’S IN IT FOR ME?
Going to university gives you the opportunity to think creatively, to learn how to organise
your thoughts, and then to express them clearly. You get three major benefits:
knowledge, skills and personal development.

1. Knowledge
* In its broadest sense, knowledge consists of facts and theories; it helps you break out of
your ignobubble.
* But knowledge gets out of date quickly—it matters in the short-term for when you are
doing exams, but it is probably the least important benefit in the long run. Even in
practical subjects like medicine and law, facts and theories are subject to change but
both the other skills remain of value to you for ever.

2. Learning transferable skills for your whole working life: a prime gain
These are portable skills that go with you; if you want a good well-paid job you definitely
need them. People now tend to switch direction several times during their working life: to
climb the ladder of success you need to be lord of the rungs. Onward and upward is the
way to go!
The skills you can get include the ability to do the following both quickly and
competently:
* Communicate (orally and in writing) effortlessly

* Manage your time effectively
* Work in a team successfully
* Organise information properly
* Tackle questions and problems sensibly
* Win people over to your view as you argue persuasively
* Analyse issues logically and convincingly
* Prioritise your tasks quickly
And:
* Make and keep a wide circle of personal friends
* Develop a network of business contacts

3. Developing as a human being: another real gain
* Expanding your mind, engaging in self-discovery and furthering your personal
development.
* Building self-discipline and self-confidence
* Growing up: well, it has to be done sometime

University is different from school or working in a job

Compared with going to school: it’s a lot better!
* There are no teachers to control or bug you
* There is usually no check-up on whether you attend classes or not
* There are no parents to force you out of bed in a morning: watching High Noon in bed is
possible
* The freedom is genuine and really great
* To an extent this can all be alarming as you are now on your own
* But you will learn below how to cope with and enjoy the new freedom without losing
track of your main goal: getting that degree

:) When arguing about food, you shouldn’t tell a Frenchman that it’s a crock monsieur.

Compared with working in a job: it’s fantastic!
* There are no set hours
* There is no boss
* There is no profit and loss to worry about
* There are no dress standards
* There are no office or factory politics to keep you on your defensive toes
* The freedom can be exhilarating and you now have the time to do stuff you really want
* But you have no regular pay packet: bummer!

TIME TO JOIN THE GROWN-UPS

:) Sometimes I sits and thinks, and sometimes I just sits.

We all grow up as individuals with our own unique set of experiences. Growing up involves
uncertainty and worry about the physical and emotional changes which occur; concern
about who we are turning into; coping with mood-swings and feelings of insecurity;
concern about dealing with relationships; and maybe developing critical views of your
parents, finding them embarrassing, and feeling that they do not understand you.

Self-development involves

Taking responsibility for your actions
No longer can you blame others (parents, teachers, or friends) for what you do: you are
now responsible for your own behaviour.

Gaining experience
Gaining experience means trying new things, but if any of these involve losing control of
rational decision-taking ability, you should either avoid it or be very careful indeed.
Experimenting with drugs, for example, can be addictive, cause personality change, or
lead to behaviour you might not normally contemplate. Experience is a good teacher but
at the price she charges she certainly ought to be.

Facing challenges and tackling them
If you tackle challenges successfully it is excellent, but even a failure can provide a
valuable learning experience—you can consider what went wrong, what you might have
done to avoid it, and how you can do better the next time around.

Hard work and persistence
In life, nothing important comes without effort, and you will have to strive hard for what
you want. Motivating yourself is often the key.

Learning about the big world out there

Increasing your experiences
Going to university is a major change in your life and will provide many new experiences,
many interesting, some valuable, and a few wonderful.

Learning from others
There is little point in reinventing the wheel. You should take the chance to study and
learn from those who have gone before.

:) Smoke bomb = a student who regularly enjoys marijuana then fails the exams.

Making your own mind up about that knowledge
Not everything you read or are told by others is true, or perhaps not the whole truth. You
must think about what you learn and whilst remembering it, question and criticise it. All is
not what it appears—True Lies was not just the name of a movie.
Shaping up to the new life
Your life at university will consist largely of three elements: studying in a variety of
different ways; being involved in clubs or societies; and socialising.
Studying
This is your main aim—you need that degree—so you do not get much benefit from
dropping out early or failing. You are about to learn how to learn. Lectures, tutorials,
workshops, lab time, sitting around discussing issues and arguing until late at night....
there’s a lot to do so let’s try to enjoy it.
Social life and partying

This is an important and enjoyable area. You need to relax and enjoy your university
experience—it is the best time of life for many people. Get in there! But be careful not to
overdo it.... except in Fresher Week when you must participate strongly.
Even mathematicians are not sure of the shortest distance between two pints. You may
still have to learn how much you can drink safely without suffering. If you throw up, suffer
the whirling pit when you close your eyes, or cannot remember all of the previous
evening, you really drank too much. In fact, you were probably pewted as a niss.

END OF EXCERPT FROM CHAPTER 1; ON TO CHAPTER 7
7. Write on baby! Way to go!

If your school used to let you have several bites at the cherry
Some schools allow students first to go and talk to a teacher about what to put in an
essay; then to hand in a draft essay and get comments back; and finally to submit the
essay proper. At university you are expected simply to prepare, write, and put the essay in
—and that’s it.

Preparing to write

Writing up is simply the last stage of the assignment process. Always be sure you know
what you think and wish to say before you start to write. “I cannot write” often really
means “I have not read and thought enough and do not know what I really want to say”.
It’s common to prepare several different outlines before you start writing.

It’s time to do the essay

You must write out your essay properly in sentences and never do it in note form. Write it
on a computer if you can; it is easy to move sections around, spell check it, and print it
up. At the printing stage, it is a good idea to set wide margins on both sides of the paper
as this encourages the marker to make more comments and these can help you a lot.

If you have any diagrams to put in, it is usually acceptable to draw these neatly using a
ruler and pen. There are excellent drawing programs for computers (CAD—computer
assisted design) but they take quite some time to get to grips with (see Appendix B for
suggested free programs).

If you do not have access to a computer (rare), then typing up your essay is the next best
way. Try not to put in a handwritten assignment, which looks poor, and can earn you
lower marks if the assessor gets fed up trying to read it. If you must write by hand, use
black or dark blue ink, and remember to leave wide margins to encourage comments.
Never write in pencil. However you write it, you should draw any diagrams and figures
carefully using a ruler, and if they are complex use more than one colour. It’s best not to
pick red, because the marker may wish to use red to correct or add to the diagram and
you never want to annoy a marker.

ESSAY TIPS: A LIST OF THINGS TO AVOID

“Before I answer this question I shall....”

Never begin with this phrase; it ensures you are sidetracked at once; it automatically
causes you to answer a question that you were not asked; and it is likely to convince the
marker that you are not all that bright. Disasterville!

Lyk, dude, it’s so-o-o kwl n gr8 yeah? Any 1 no y? Ezpz m8! Geddit?

Right! Now I have your attention, texting spelling, gangsta rap, slang and colloquialisms
have no place in written essays. Note, however, that in oral presentations a judicious use
of slang or the vernacular can sometimes be effective as long as it is in very small doses—
perhaps once.

Humour

Few people have the gift of being able to write amusingly and their efforts to entertain
are sometimes painful to read. Unless you’ve ever been asked who writes your material or
else your name is Woody Allen or John Cleese you’d better avoid trying to be funny.

:) Sign in an English butcher’s shop: “Buy our sausages; you’ll never get better.”

Abbreviations in essays: take care!

You must avoid all short forms like “can't”, “won't” and “isn't” and write the words out in
full. Written English is a bit different from spoken English. (I deliberately broke several
rules in this book in order to make it more accessible—“Don’t do as I do, do as I say!”)

You should be aware that the first time you use an acronym you should spell it out, for
example “The Organisation of Petroleum Exporting Countries (OPEC)....”; after that you
can use the acronym alone without further explanation.