## A guide to input output model multipliers (part 1)

Photo by Thomas Galvez, togalearning.com

This series of posts is intended for individuals with a basic understanding of input output models but with no practical knowledge on how to derive output, income and employment multipliers.

From my own personal experience, I have found that the online literature regarding multipliers is neither easily accessible, clear nor concise.  Furthermore, this topic was not covered during both my undergraduate and post graduate economics degrees and I feel this may also apply to other university courses.  I therefore hope this post will be useful for any individual looking for a quick and practical guide to derive multipliers using input output models.  Please feel free to post any questions or comments below.  This first post will deal with the calculation of the simple (or Type I) output multiplier.

To get the ball rolling, it is necessary to calculate the direct requirements matrix (A).  The direct requirements matrix describes the amount of inputs needed from other industries to produce one unit (or \$1 in this case) of output in a given industry. This is relatively straightforward to calculate.  Using the intermediate outputs and primary inputs table (see Table 1), simply divide each column by the column total to derive the direct requirements matrix (see Table 2).

Table 1: Combined intermediate and primary table

Table 2 shows that to produce an extra dollar’s worth of output in the agricultural industry, the manufacturing industry must produce an extra \$0.13 worth of output, the transportation industry an extra \$0.07 worth of output and so on.  This is known as the first round effect i.e. the amount of output each industry must produce to meet an one unit increase in demand/output in a given industry.  The total first round effect can be calculated from summing the column values for each industry e.g the first round effect of a \$1 increase in output is \$0.37.

Table 2. Direct requirements matrix (A)

Similarly, if the manufacturing industry (as an example) increases output by \$0.13 it will induce additional outputs from other industries across the economy and these in turn induce extra output and so on.  It is therefore necessary to generate the Leontief inverse matrix to assess these effects.  The Leontief inverse matrix is formally defined as:

(I-A)-1

This is the inverse of the identity matrix minus the direct requirements matrix (derived above).  I will not discuss the derivation of this formula as it would constitute a separate post altogether!  Nevertheless, I have found a useful four part video series on Youtube that I belief provides a good intuitive introduction to the Leontief inverse matrix – the link can be found here.  Using simple matrix functions in Excel gives the Leontief inverse matrix in Table 3 below.

Table 3. Derivation of the Leontief inverse (I-A)-1 in excel

Note: when using Excel for matrix operations use the array command (i.e. shift + ctrl +enter), I have used the MINVERSE function for the (I-A)-1 matrix

The output multipliers are simply the column totals for each industry.  For example, the (I-A)-1  matrix shows that a \$1 increase in agricultural sector output will induce an additional \$1.63 of output in the overall economy.  This is the derivation of the simple or Type I multiplier as it is now more commonly know.  In the next post I will move on to the income and Type II multipliers.

/52460+-+Information+Paper+-+Introduction+to+Input+Output+Multipliers.pdf

## Fulfilling the ‘Indonesian Dream’

Photo: State Dept./Erik A. Kurniawan

Last month, Joko Widodo, commonly known as “Jokowi”, helped mark a move towards the consolidation of the world’s third largest democracy by winning the 2014 Indonesian presidential election.  A former furniture maker turned politician, Jokowi’s win represents a shift away from the country’s political and military elite, which has traditionally dominated the post.  Jokowi himself has compared the victory to fulfillig the ‘Indonesian dream’ by stating “now, it’s quite similar to America, yeah?  There is the American dream, and here we have the Indonesian dream”.

However, many commentators predict that Jokowi’s tenure will be marked by a number of economic as well as political challenges.  For instance,  in the first quarter of this year Indonesia’s economic growth fell to 5.2%,  representing a new four year low.  Despite being South East Asia’s largest economy, Indonesia has struggled with a host of issues that have hampered economic growth, such as high levels of corruption, a dependence on natural resources and strained public finances, amongst others.

Many in particular have highlighted the high level of energy subsidies as a potential sticking point during Jokowi’s presidency.  Energy subsidies currently represent 16% of government expenditure and 4% of total GDP.  Government spending on subsidising energy prices is three times more than the allocation for infrastructure (roads, water, electricity and irrigation networks), and three times the level of government spending on health.  This has led a study by World Bank to conclude that Indonesia’s energy subsidies crowd out investment into other crucial areas of the economy.

This is something I find hard to disagree with.  After visiting Indonesia earlier this year, I saw first hand the country’s need for infrastructure spending – if you have ever been stuck of one Jakarta’s infamous traffic jams you too will understand this fully.  But it is not just new roads that are required.  As this article in the Jakarta Post points out, the country’s infrastructure suffers from a myriad of problems, ranging from frequent blackouts to poor internet connections.  As a result, Indonesia’s overall level of infrastructure ranks 82nd out of 144 countries in the World Economic Forum’s most recent Global Competitiveness Report .

In addition, infrastructure spending still remains under its pre-Asian financial crisis levels. With a lack of investment in infrastructure projects, some have argued that foreign companies have been deterred from making investments in the country.  Moreover, others have stated that the drag placed upon growth by poor infrastructure could lead to Indonesia falling victim to the middle income trap.  Freeing up public funds away from energy subsidies could thus have major long term economic benefits.

However, in a country where 100 million people live on less than \$2 a day, past decisions to cut fuel subsidies have been met with violent protests.  For instance, only last year a decision by the government to raise petrol prices sparked demonstrations and clashes between police and protesters outside parliament.  Cutting fuel subsidies even contributed to the final ousting of the former dictator Suharto, who had been in power for more than 30 years.  Jokowi therefore faces somewhat of a policy dilemma.

Nonetheless, even if Jokowi reduces Indonesia’s energy subsidies it remains to be seen whether the country has the institutional capacity to deliver the key investments that are needed.  Corruption is a major issue in Indonesia and funds earmarked for projects are frequently eaten away by local officials and ministries.  The success of Jokowi’s tenure will therefore not be determined by solving short term issues such as energy subsidies, but by combating more systematic issues that hinder Indonesia’s long term growth, namely its weak institutions and corruption.

## Surprising statistics that may change your perception of London

So on the day that the super cars of the super rich descended on London, it was also announced that ‘world’s greatest city‘ has more millionaires than any other city worldwide.  In addition, London now accounts for 72 billionaires – almost 10 per cent of all the billionaires in the world. Some would see this as great news, a true testament of London’s economic might and status as a global powerhouse and  – you don’t have to go far to hear this kind of rhetoric from the media and politicians nowadays.

While it is true that London alone, is currently the ninth biggest economy in western Europe and represents 22.5% of the entire UK economy, there also is another side to the city.  A side where 2.14 million people (28% of the population) live in poverty and 10% of the population own 60% of the assets, and where child poverty sits at 36% and 25% of economically active young adults (aged 16 to 24) are unemployed.  These statistics (which I came across today whilst at work), among others, make for grim reading but serve as a reminder of the stark contrasts and challenges within this ‘great’ city.

The website from which these statistics are taken (www.londonspovertyprofile.org.uk), provides a great insight into the challenges faced by the city through visualisations and summary statistics – I highly recommend a visit.  From my point of view it would be interesting to see where London ranked among the world’s cities if a full range of socio-economic indicators (such as those listed on the website) were taken into account.  It might just turn out to be the case that we have to think more carefully about how we use the term ‘great’.

Photo courtesy of Simon and his camera : Neon Westminster London City – Blended Big Ben , please consult page and licence before reproducing

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## Is the circular economy a utopian concept?

Recently at work I have been asked to look at the concept of the circular economy (CE) for an upcoming project.  You may have heard of the concept via the media, in fact you have probably been bombarded with advertisements with one of the most successful CE business models each day.  Studies even predict that the adoption of CE business models within the EU could lead to net materials cost savings worth up to \$630 billion per year by 2025.  However, the more I read into the CE, the more I question whether it is a quasi-utopian concept.

So what is the circular economy?

Well, for the past one hundred or so years economic growth has relied on the ever increasing consumption of cheap and abundant natural resources.  In today’s economy resources are extracted, turned into products and eventually discarded.  This so-called linear economy, has been criticised as unsustainable by a number of economists.  For instance, in the UK alone 80% of products are discarded after a single use.

The CE is an attempt to decouple economic growth and prosperity from resource consumption.  In a CE, large amounts of raw materials are captured and reused within the economy, in what are termed resource loops. The system mimics self sustaining processes within the natural world whereby one organism’s waste is another’s food.

One of the key ideas behind the CE is that material flows can be differentiated into two types:

• biological nutrients – which are non-toxic and can be readily returned to the biosphere, and
• technical nutrients – which are designed to circulate at high quality without entering the biosphere

The fundamental principle here is that there is no waste.  Hence biological materials are simply composted whilst man made materials are designed to be used again with minimal energy and the highest level of quality retention.  This is where the concept differs from just recycling.  CE begins at the design phase where waste is ‘designed out’ of the final product and the product’s value is maintained over a number of uses.  On the other hand, recycling refers generally to a process whereby there is a reduction in quality and the material is returned as feedstock.

Access-over-ownership

One of the most interesting aspects of the circular economy is the concept of access-over-ownership.  Essentially this concept states as individuals we only require the services that goods provide, not ownership.  Renting and leasing are therefore key components of the model whereby the business retains ownership of the good and the consumer accesses the service it provides.  This not only incentivises the manufacturer to provide a high quality and durable good, but also reduces the quantity of the goods manufactured thus reducing the consumption of raw materials.

Mud Jeans is one business pioneering this type of access-over-ownership model.  Within the model, customers can rent jeans for €5 a month and after one year the users have three options: either swap their jeans for a new pair; pay an extra deposit of €20 and keep the jeans indefinitely; or return the jeans and end the contract.  For those that decide to keep the jeans there are added financial incentives to return them to Mud after usage.

The jeans are made with 30% recycled content and 70% organic cotton.  Once returned the jeans are processed in three ways.  If they are in good condition they are cleaned and re-used. If they are repairable the company will carry out the repairs and resell the items.  If they are beyond repair, the jeans will be returned to manufacturer whereby the materials are recycled.  The model thus divorces usage and ownership whilst simultaneously reducing the need for raw materials.

The problems

Whilst I have been generally intrigued with the idea of the CE I do have a number of reservations about the feasibility of such a concept.  Although Felix Preston rightly points out that mass paradigm shifts have happened in the past, such as the transitions to mass and flexible production, I believe a change of this magnitude would require, what is termed in development economics as a ‘big push’.  In this sense I believe our current path on a linear economy can be seen as a coordination failure i.e. many individuals want to invest in the CE approaches but the true benefits of doing so are only realised when others do the same.  As Preston points out (on page 15), for business moving towards a CE:

..there will inevitably be significant up-front investment costs and risks for businesses – e.g. retooling machines, relocating whole factories, building new distribution and logistics arrangements and retraining staff

Such high up front costs and risk may lock companies and industries into a linear economic model, unless there is concerted drive by economic actors to move to the CE.  To think of it in a more general way ask yourself the following question: why would I as a company invest heavily in a risky CE business model, when my competitors are not going to do the same?  It can therefore be argued that there is a need for governments to legislate and invest in a ‘big push’ towards the CE (something of which has arguably yet to happen).

Aside from this there is also the issue of developing countries.  According to McKinsey, developing countries account for 70 to 85% of the global resource productivity potential. However, although countries such as China are making strides towards promoting resource efficiency and the CE, there is still a lot to be done.  I feel one issue here is that the concept of CE could be seen as asking developing countries to forego a economic model that has brought prosperity to the developed world.

Developing countries may ask why they should pay, through investments in CE, when today’s developed economies harnessed the linear economy during their periods of industrialisation.  That is not to say that there aren’t benefits to moving to the CE for developing countries, but I do believe this could be a major stumbling block in the short term.  The issue is further compounded by the fact that the developed world already exports a significant amount of its waste to developing countries.

Final word

This post has looked briefly at the aims and theory behind the CE.  It has also taken a short look at what I see as two of the biggest obstacles to its implementation.  It should be noted that in addition to these obstacles there are a number of political and logistical hurdles that have not been mentioned (Felix Preston’s paper summarises these well).

Although the title might suggest otherwise, this post should not be seen as an attack on the CE but rather a questioning of the concept’s feasibility in the real world.  It has also been intended to promote discussion of the topic and look at ways of circumnavigating the obstacles stated above – so if you have taken the time to read this post please feel free to leave your thoughts below.

Photo courtesy of  woodleywonderworks

## Norwich North, the land that time forgot?

Whilst walking home from the city a few months ago I saw the above sticker posted in the subway by Anglia Square.  At the time it made me laugh as I have always heard comments from people regarding the north of the city and how it is fares unfavourably to the south.  Furthermore, escaping the north of the city has always been a long running joke between me and my friends.

After initially forgetting the sticker, my interest was sparked again whilst looking through the ONS Annual Survey of Hours and Earnings for a recent work assignment.  Out of interest, I scrolled down to view the statistics for the Norwich North and South constituencies.  The results indeed showed a marked difference between the wages in the north and the south of the city (see Table 1 below).

 Table 1. Earnings in Norwich North and South Constituencies, 2013 Norwich North Norwich South Gross Hourly Pay £12.35 £14.19 Gross Weekly Pay £397.70 £466.80 Gross Annual Pay £21,708.00 £24,110.00 Source: ONS Annual Survey of Hours and Earnings (2013)

The table shows a clear difference in the levels of earnings between the two sections of the city, with individuals living in the south of the city expected to earn on average £2,402 (gross value) more than their northern counterparts.  Furthermore, an individual in the south of the city is on average likely to earn nearly £2 per hour more than an individual working in the Norwich North constituency.

A closer look at the unemployment figures within the city reveals a much sharper divide.  Table 2 presents data from the Norwich City Council’s Economic Barometer report.  A map of the ward boundaries can be found here.

 Table 2. Ward Level Jobseeker’s Allowance Claimant Count Unemployment, March 2014 Count % of total Bowthorpe 255 2.8 Catton Grove 318 4.0 Crome 228 3.4 Eaton 59 1.0 Lakenham 237 3.6 Mancroft 407 5.2 Mile Cross 399 4.9 Nelson 98 1.2 Sewell 235 2.5 Thorpe Hamlet 326 3.8 Town Close 211 2.6 University 134 1.6 Wensum 314 3.5 Source: Norwich Economic Barometer (March, 2014)

The table shows that the Mancroft, Mile Cross and Catton Grove wards have the highest level of benefit claimants within the city, all displaying rates of over 4%.  In particular, Mile Cross has nearly 7 times the amount of benefit claimants (in absolute terms) than Eaton – located in the south of the city.

The lowest claimant counts can be found in the wards of Eaton, Nelson and University, all displaying counts of less than 2.0%.

Interestingly, Mancroft (the ward with the highest level of claimants) is considered to be part of the Norwich South constituency.  This is despite the fact that the area around Anglia Square and Magdalen Street, which many would consider to be in the north of the city, lies within the ward,

The graphic below transposes the values from Table 2 onto a map of the Norwich wards (click to enlarge).  From the graphic it can be seen that the areas with the highest levels of claimants are located in the north/north western region of the city, whilst those areas with the lowest are located in the south western corner.

Despite this, for many the biggest symbol of the decline of the north of the city is Anglia Square.  Described by some as an ”architectural abortion”, the area has experienced physical and economic decline for several decades.  Noticing the gradual decline the council adopted a ‘Northern City Centre Area Action Plan” in 2006, with an aim to encourage investment and growth within the area.  The belief was that the construction of new flats and offices would revamp the area and in turn attract new cafes, restaurants and shops.  However, the plan was badly hampered due to the recession and to date the only one real change, the introduction of a one way road system (St.Augustines gyratory scheme), has taken place.   In an area of relatively high unemployment (in comparison to the rest of the city), such a regeneration scheme could create a number of much needed, new jobs and opportunities.

However, whilst the council has held out for a private investor for the scheme, other areas such as the Norwich Research Park (albeit not in the City Council’s jurisdiction) have received £26 million in state funded investment.  While no one can doubt that such an investment will bring new jobs and growth to the area, it does question the allocation of state funds by the government to a research park and area which has been prospering since the 1960s.  For now, progress on Northern City Centre Action Plan remains painstakingly slow and it remains to be seen whether the real changes required within this part of the city will ever come to pass.

## The world’s largest free trade area is being negotiated and it’s taking place behind closed doors

Chances are, you probably haven’t heard about the TTIP.  Last month the fourth round of the Transatlantic Trade and Investment Partnership (TTIP) negotiations took place between the US and EU.  These so-called ‘secretive talks‘ have been hailed as an ‘assault on democracy’ by some commentators.  Indeed, the negotiating mandate for the EU remains a restricted document, but what is the TTIP and why is it causing such a stir?

The Goals of the TTIP

The main aim of the TTIP is to remove a number of trade barriers between the EU and US ‘to make it easier to buy and sell goods and services between the EU and the US‘.  The negotiations will not only focus on removing traditional barriers to trade such as tariffs but they will also attempt to remove so-called non-tariff barriers (NTBs) to trade.   NTBS refer to prohibitions, conditions or specific market requirements that make the importation or exportation of products more costly or difficult.  NTBs between two trading partners can arise in a number of different forms examples include, differences in domestic testing standards, differences in mandatory labelling requirements and divergent customs and administrative procedures.  The TTIP has highlighted NTBs in a number of key sectors including chemicals, pharmaceuticals, automobiles and cosmetics.

What are the Potential Benefits from the TTIP?

NTBs can impact upon trade in to two ways.  Firstly, NTBs can restrict market access through traditional methods such as import quotas.  Such quotas can restrict supply of foreign goods into the domestic market and thus impact consumers through higher prices.  Alternatively, NTBs can raise the costs of doing business for firms by, for example, necessitating the costly reconfiguration of products to meet stringent technical standards.  Such regulations can make foreign firms less competitive in a domestic market.  The EU states that costs of dealing with unnecessary bureaucracy is the equivalent to adding a tariff of 10-20% to the price of goods, an extra expense which is paid by the consumer.

A number of studies have predicted that the elimination of both tariffs and NTBs, and thus a move towards regulatory convergence between the US and EU, could significantly boost trade between the two economic powers.  For instance, CEPR argues that:

An ambitious and comprehensive transatlantic trade and investment agreement could bring significant economic gains as a whole for the EU (€119 billion a year) and US (€95 billion a year). This translates to an extra €545 in disposable income each year for a family of 4 in the EU, on average, and €655 per family in the US.

In addition, CEPR states that EU exports to the US could increase by 28% (equivalent to an extra €187 billion of EU exports) whilst an earlier study, conducted by Ecorys in 2009, argues that the deal could lead to gains in GDP of 0.7%  and annual wage increases of 0.8% for the EU. German think tank Bertelsmann Foundation takes a different approach by stating that the European countries that currently have the most trade with the U.S. will gain the most from the agreement.  The countries set to benefit most are listed below.

Overall the results of the study, show that the deal could lead to increases in GDP of up to 4.82% and 1.31% for the US and EU respectively (figures derived from the study by OFSE).

So the TTIP is a win-win situation?

Not exactly, although the TTIP sounds good in theory some have challenged the methodologies applied for by these studies.  The most comprehensive criticism comes from a recent study by the Austrian Foundation of Development Research.  The authors argue that the studies focus mainly on the large overall gains of the TTIP, whilst failing to point out that such benefits are only projected to accrue over a period of around 10 to 20 years.  Consequently, even in the most optimistic scenario for the EU, the gains would amount to only 0.13% growth in GDP annually (1.31% spread out over the lower bound of ten years).

In addition, the authors argue that many of the studies fail to highlight the social issues that could arise due to the deal.  For instance, the elimination of NTBs and the adoption of a common regulatory standard could require to a loosening of regulations in the EU.  This could lead to a welfare loss for society as public policy goals such as consumer safety, public health and environmental safety are compromised.  For instance, in the US only eleven substances are restricted in cosmetics compared to over 1300 in the EU (Euractiv.com).  Adopting the lower standard in many industries could therefore have implications for consumers.

The authors also point out that the macroeconomic adjustment costs – in terms of unemployment, changes to the current account balance and losses of public revenues –  could be substantial.   For example, tariffs are important income source for the EU – in 2012 roughly 12% of the EU budget was financed by tariffs.  The report states that the loss of tariff revenues from US imports could lead to a permanent annual revenue loss of 2.7% for the EU budget.

A much bigger issue at stake?

Despite the economic concerns many argue that there is a much bigger issue at stake, namely investor-state dispute settlements (ISDS). With the US pushing for its inclusion in the deal, ISDS has become the main source of disagreement between the negotiators.  In essence, ISDS empowers foreign investors to challenge national authorities in international courts, in order to claim financial compensation if they deem that their investment potential (and related profits) are being hindered by regulatory or policy changes that have occur at the national level.

ISDS are controversial for many reasons.  For instance, in 2011 tobacco giant Philip Morris sued the Australian government over a new law making plain packaging mandatory on cigarettes, stating that the plan violated a bilateral investment treaty.  Critics claim that ISDS challenges a country’s sovereignty through non-transparent and unaccountable arbitration tribunals which bypass the national court system.

The TTIP therefore raises some important issues for the EU.  To date the EU has launched a public consultation amid concerns, however the lack of transparency within the deal leaves, for many, alot to be desired.  As the largest bilateral trade deal ever attempted it begs the question whether the public should have more of a say on such a deal.

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## Economic growth and Boris Johnson inequality debacle

After returning from an unpaid internship in Austria for the last three months, I was very interested to see Boris Johnson’s latest comments on inequality. After reading a number of articles focusing specifically on his comments relating to IQ, I  believe many had not picked up upon another important part of his argument – the implied justification that the current level of income inequality is acceptable because it a key and necessary driver of economic growth.

The argument that inequality drives economic growth goes back to the roots of economic theory itself. The theory argues that inequality generates incentives for individuals to work hard, compete and innovate within a market economy. A level of inequality allows for there to be winners and losers from this process and drives economic progress as individuals strive to reach the top. The theory therefore predicts that more unequal countries should grow at a faster rate. However, despite the strengths of this argument there are a number of reasons why an unequal distribution of income and assets within an economy may do precisely the opposite.

Many economists argue that highly unequal income distributions can lead to a number of economic efficiencies. Firstly, when the vast majority of wealth is concentrated in the hands of the few, it means that a smaller fraction of the population qualifies for credit because they lack the necessary collateral to obtain loans. As a result they may not be able to invest in the education of their children or gain sufficient funds to start a business. Productive investments within an economy, which stimulate growth, are therefore foregone.

Secondly, a higher level of inequality may lower the overall level of consumption within an economy. This is because people with lower incomes tend to spend a higher proportion of their income than those at the top. Consequently, if most of the national income is concentrated at the top, it is argued that overall consumption may fall. Moreover, the wealthy tend to spend a higher proportion of their incomes on luxury import and foreign travel whilst they may also seek tax havens for their saving abroad. This affects the economy through a process known as capital flight, such investments do not contribute to a country’s productive resources and can therefore hinder the prospects for economic growth.

Other authors have looked at the political economy implications of high levels of inequality for economic growth. For instance, when wealth is concentrated in the hands of the few, these individuals may take measures to safeguard their assets or capture more wealth instead of increasing their own productivity. Individuals may partake in disruptive rent seeking activities such as excessive lobbyingprovide large political donations or engage in bribery. In turn, all of this leads to inefficient use of resources as they are diverted away from productive activites which could stimulate economic growth.

A more recent argument is that high levels of income inequality may precipitate credit bubbles and financial crises. Here the argument is that when incomes grow at the top and those at the bottom stagnate, the demand for cheap credit increases. At the same time there is a push by those at the top for policies that sustain and build upon their wealth, such as lobbying for looser financial regulations. As explained by an influential study by the IMF, the end result is a viscious cycle of inequality whereby more and more individuals at the bottom have to borrow to keep afloat thus increasing the risk of a financial crisis.

This point I find particularly relevant as I believe it builds upon the Marxist theory that rising inequality would lead to the ultimate collapse of an economy. The basic argument here is that as business owners become richer by applying downward pressure on wages, the economy will come to a point where no one can afford to buy what the business owners are selling. At this point the economy will stagnate and reach the point of collapse. From this viewpoint, credit is just merely just a mechanism that allows individuals to spend above their means thus postponing the inevitable credit crisis.

But what about the empirical evidence.  Take the much cited case study of the Philippines and South Korea for example. In the early 1960s, both of the countries were similar on a number of macroeconomic indicators. They had comparable levels of GDP per capita, urbanisation, population size and primary and secondary education. However, over the period 1960-1988, the per capita income in the Philippines grew, on average, by only 1.8% a year. In contrast, per capita income in South Korea grew, on average, by 6.2% a year over the same time period. However, what is most interesting about this story is that, compared to South Korea, the Philippines exhibited a significantly more unequal distribution of income over the period measured. In 1965 the Philippines’ gini coefficient was nearly 17 points higher than that of South Korea. This clearly contradicts the argument that more unequal economies grow at a faster rate.

A number of more rigorous empirical studies have also found that high levels of income inequality have a negative impact upon growth. For instance, a frequently cited study by Alesina and Rodrik (1994) finds that the gini coefficient has a consistently negative effect upon economic growth. Likewise, Deininger and Squire (1997) investigate whether initial income inequality has a strong impact upon long term growth rates. They find that link between income inequality and economic growth is not strong however they do find that inequality in the distribution of assets (in this case land) exerts a strong negative effect upon growth.

On the whole the empirical evidence on the relationship between income inequality and economic growth is inconclusive at best. The studies conducted suffer from numerous data issues. For instance, inequality is measured in many different ways across countries making comparisons difficult. Conclusions made from many of the studies available are therefore tentative at best. As a result there is no clear evidence that income inequality has any impact on growth whatsoever.

The debate has still not been won by either side. While many accept (and I do too) that a level of inequality is necessary to drive economic development, it is not justification for the significant increases in income inequality we have seen over the past few decades. Furthermore, high levels of income inequality can have far more widespread ramifications for a country besides economic growth. As this interesting lecture by Richard Wilkinson shows, high levels of income inequality can have negative impacts upon a number of socio-economic factors such as health, life expectancy and levels of trust within society. Furthermore, a number of a studies have found a negative relationship between inequality and levels of overall happiness.

Nonetheless these are issues which will not be regularly mentioned within the political sphere. There is still a strong focus on crude indicators such as economic growth to gauge the success of our economy. Unfortunately politicians such as Boris Johnson are still very focused on this narrow gauge of development and therefore fail to see the negative socio-economic impacts that the forces of greed, envy and ultimately, inequality, can lead to.

## How the economic machine works

This video by Ray Dalio is probably one of the most informative I have seen for a long time and it gives those without a background in economics a very simple and easy to understand model of what has been driving the recent financial crisis. It should be noted however that the model is very simplistic and doesn’t take into account a number of other factors such as international trade.

## Are Hungary’s Unorthodox Economic Policies working?

In 2010, Hungary elected the Fidesz party and its leader Viktor Orban into power. Since then the government has implemented a range of unorthodox economic reforms which have drawn criticism from economists and financial analysts alike. However recent reports indicate that the Hungarian economy may have finally exited a year long period of negative growth. The Hungarian Central Statistics Office estimates that the gross domestic product of Hungary ‘increased by 0.5% in the second quarter of 2013 compared to the corresponding period of the previous year’.  In addition the budget deficit now sits at 1.9% of GDP, well under EU mandated target of 3%. This means that Hungary now displays one of the lowest deficits among the EU 27 and is free from the EU’s Excessive Deficit Procedure monitoring procedures.

Inflation has also dropped to a record low. The Hungarian Consumer Price Index now sits at the lowest level since Hungary’s transition to a market economy. In July it fell unexpectedly to a new low of 1.8% (year on year) compared to 1.9% in June.  When this drop is decomposed we can see that food prices declined by 1.4 percent from the previous month in July, whilst household energy costs fell by 0.4 percent.

Naturally the Fidesz government has claimed that its unorthodox policies are at the heart of this change. What I find interesting about such policies is that they could prove very popular in many European countries, such as my own, where there is a feeling that many banks ‘got let off the hook’.

Since coming to power Orban has introduced biggest tax in Europe on banks and financial companies and imposed large levies upon energy, retail and telecommunications companies. In addition Orban has announced plans to fix the exchange rate for loans taken by individuals in Swiss Francs. In particular, this attempt to lessen the debt burden for such individuals could lead to losses in the banking sector of up to 4.1 billion. In another popular move the government forced energy firms in January to slash their prices by 10% with the promise of another imposed 10% cut in October. Further unorthodox policies include interfering with central bank independence, nationalizing \$14 billion in assets from private pensions and a steep 18% hike in the minimum wage.

However there are many who question whether such policies are sustainable in the long run.  Many economists are concerned that such policies will threaten foreign direct investment (FDI) into the country. The general argument is that the current regulatory unpredictability (i.e. high taxes on banks) may damage investor’s confidence and lead to large outflows of capital. This is significant because Hungary’s economy is heavily dependent upon foreign direct investment. For instance UNCTAD’s new inward FDI contribution index, which measures the importance of FDI to a country’s economy, ranks Hungary first among the 79 nations studied.

As discussed by the IMF, the large levies placed upon banks may place an additional drag upon growth. Hungary’s financial sector is heavily dependent upon foreign funding which is worth around €35–40 billion annually. To put this into perspective, foreign firms account for 90% and 70% of the insurance sector and investment banking sectors respectively. The deleveraging process now present in many financial institutions has meant that Hungary has experienced negative credit growth for the last several years and the IMF predicts this could further hinder economic growth.

In addition to this some economists are concerned that the new central bank chief Gyorgy Matolcsy (regarded as Orban’s ‘right hand man’) will opt for a plan of quantitative easing in order to stimulate the economy. This could be problematic because injecting money into the economy may increase imports and the debt burden whilst, at the same time, foreign capital is leaving the country. This could significantly affect Hungary’s ability to finance itself.

Despite these concerns there are still some positive signs for the economy. Germany, which accounts for 24.7% of Hungarian exports, has registered strong growth in the last quarter and now many expect the economy to return to a steady rate. The Hungarian economy will also receive a boost from the opening of a new Audi plant in Gyor which equates to €900 million in additional investment. Other investors have also expressed their desire to keep operating in the country despite regulatory pressures. In a recent interview with FDI Intelligience magazine,  Rhydian Pountney of the UK based engineering company Renishaw PLC stated that,

We are acutely aware of the political issues of the regime but we take the long view and we are not likely to be scared off by the ups and downs of politics,”

Could economists be wrong about the impending crash in FDI? Data from the OECD also suggests otherwise. According to preliminary estimates FDI inflows are now above pre-crisis levels at \$13.5 billion. Conjointly the data shows that FDI outflows have also increased in 2012, to \$10.6 billion – however this figure is still \$2.9 billion below inflows.

Although I do not agree with many of the Fidesz party’s other policies, I believe it will be interesting to observe whether its economic policies will pay off in the long run. If so, it would be interesting to see how the economic community accounts for the success of a number of policies which have aimed to boost consumption at the expense of inward investment.

## Scroungers and immigrants, a British obsession

In recent times the UK has begun suffering with a what seems to be a social benefits and immigration neurosis. It seems that since 2009 any group seen to be taking from the state undeservedly is now a target. What started as a media fueled obsession has now been set ablaze by the government. Wide ranging reforms have been made to the welfare state and immigration, all due to the fear that someone might be getting something for nothing. However as always the situation is blown up to proportions which scarcely resemble the reality. To show this lets start with the issue of benefits.

Britain’s ‘scroungers’ and the Dependency Culture

Recently the word ‘scrounger’ has been creeping evermore into the media. The Sun for example launched its campaign to ‘Stop the £1.5 billion benefits scroungers‘ whilst the daily mail is never hesitant to remind us that there is a family with 10 kids living nearby claiming your hard earned tax money. Dealing with the general public I hear the complaints day in day out; anyone who diverges from this attitude is also generally targeted as I found out in a recent debate with a customer in my store.  In a joint report by Elizabeth Finncare and the University of Kent, the paper found that attitudes have charged in the last 20 years with more people viewing claimants as undeserving – this is backed up by the British Social Attitudes survey which find that 62% of people believe that unemployment benefits are too high and discourage work. In addition the paper found that the usage of negative vocabulary in media articles, such as the word ‘scrounger’, has increased since the recession.

So what is the reality. Well firstly, as the Prime Minister is all too happy to remind us, we are spending more than ever on welfare. As the graph below, from the guardian, shows the welfare bill has increased in nearly all areas in period 2011-12 compared to 2001-02.

Graph 1. Total Welfare Spending by type

Source: The Guardian

This is a fact a lot of the media would like to cling to. The Sun for instance has taken pleasure in proclaiming ‘benefits have increased 20% in the last 5 years’ whilst the daily mail has cried out that benefit spending has rose by 60% since 1997/98. With such exclamations one could not be forgiven for believing that the increase in spending on welfare is the result of a long term upward trend.

Graph 2

However as the graph above shows, when welfare spending is viewed as a proportion of GDP, the story changes. For instance in the late 1980s and early 1990s the proportion of GDP spent on welfare was over 10%. Since then it has come down to a more manageable level, with a recent increase from 2008 on wards. Why? Well recessions are a underlying cause of unemployment and unemployment means more claimants! So much for the usual George Osborne mantra of a ‘welfare state we cannot afford’.

In addition, when we measure the share of welfare paid out as unemployment benefit (% GDP) we find that the UK ranks the third lowest in Europe at 1.13% – only Italy and Slovakia rank lower.

Even more so, when we look at the rising cost of welfare in nominal terms (see graph 1) we see that it is the rising number of pensioners which has added the most to the welfare bill not the unemployed. But hang on what about all those families who feed off the state with up to 5 or more dependent children? What about Mick Philpott and his 17 children, doesn’t this bring into question the welfare state? Isn’t the welfare state encouraging those receiving benefits to have more children and become ever dependent? The data says otherwise.

In truth this is a very small problem, as the Economist explains in 2011 there were only 130 families with over ten children claiming at least one form of out-of-work benefit. Similarly only 8% of claimants had 3 children or more. The Economist then goes on to declare that current evidence shows that on average unemployed people have similar numbers of children compared to those who are employed – dispelling the myth that benefits encourage large families! In addition to this the Joseph Rowntree foundation has found that benefits do not encourage inter generational claimants.

If more evidence is needed that Britain’s ‘dependency culture’ is overstated, then take a look at a recent study by the government department for work and pensions. In a sample of 32-33 year olds who had claimed job seekers allowance (JSA) in 2010-11, over 40% had not made a claim in the previous four years. Furthermore 63% of the sample had not claimed JSA for a period of more than 6 months in those previous 4 years. This again challenges the common perception that many claimants are ultimately dependent on JSA and are part of a ‘dependency culture’.

Britain and the soft touch myth on immigration

This brings me onto the next issue of immigration and the common perception that most immigrants flock to the UK for its generous welfare system whilst giving nothing in return. In a number of key speeches David Cameron has vowed to crack down on the problem and shed the UK’s image as being a soft touch. But how serious is the problem and what would happen is we cut net immigration to zero (A recent YouGov poll found 64% of UK participants in the study wanted net immigration reduced to 0%).

Firstly it should be noted that economically, a majority of studies agree that immigrants are a benefit to the UK. For instance a recent OECD report found that immigrants make a net contribution equivalent to 1.02% of GDP or £16.3 billion. This is because the majority tend to be of working age and are therefore more economically active.  Moreover the Office of Budget Responsibility (OBR) predicts that if net immigration was reduced to zero, public sector debt would rise by £18 billion in the next five years. Increase this time span to 50 years and by 2062-63 the OBR predicts that net debt to GDP ratio could increase to 174%. To put this in perspective Greece’s current level of national debt is 161% .*

Okay, but what about the benefits these immigrants claim I hear you ask. Isn’t Britain turning into a prime location for welfare tourism? A commonly cited report by the government Department for Work and Pensions (DWP) claims that there are 371,000 immigrants claiming benefits from the state. Chris Grayling, the employment minister, has also used this statistic to highlight the issue of benefit tourism, arguing that the past Labour government opened the doors to such problems. Naturally before the study was properly analysed, the media pounced on the story with papers such as the daily telegraph proclaiming that there are, ‘370,000 migrants on the dole’.

In fact due to the statistical method used, the actual number is closer to half the cited figure*. As the DWP explicitly points out, the study shows;

These statistics do not provide a measure of non-UK nationals currently claiming benefits based on their current nationality. The statistics do provide an estimate of the number of  people currently claiming benefit who, when they first registered for a NINo (that is, first entered the labour market), were non-UK nationals. (pg. 4)

This means that the number includes migrants who may have emigrated to the UK decades ago, worked, subsequently claimed UK citizenship and unfortunately now find themselves claiming benefits. In fact the DWP estimates that 54% of the ‘370,000 migrants on the dole’ are actually UK citizens! Furthermore the report shows that the number of migrants claiming benefits unlawfully or fiddling the system is as low as 2%.  Not quite the wide scale problem that some would like us to believe.

A more useful overview of the situation is provided by economist Jonathan Portes of the National Institute of Economic and Social Research. In his post, Portes uses the data compiled by the DWP and the ONS Labour Force Survey to summarize the extent of migrant claimants in the UK. He shows that:

• migrants represent about 13% of all workers, but only 7% percent of out-of-work claimants;
• migrants from outside the European Economic Area (EEA) represent about 9-10% of all workers, but about 5% of out-of-work claimants
• foreign nationals from outside the EEA represent about 4.5% of all workers, but a little over 2% of out-of-work benefit claimants.

When these claimant figures are compared to those from the native population the story changes. It turns out that migrants are much less likely to claim benefits than us Brits. This again is explicitly highlighted in DWP study which explains;

As at February 2011, 16.6% of working age UK nationals were claiming a DWP working  age benefit compared to 6.6% of working age non-UK nationals.

Yet again this challenges the misconceptions held about immigrants who come to the UK. More importantly, it should be questioned why some of our most read newspapers and senior ministers failed to highlight this.