Do you like getting things for free? Most people do, but did you know that there is a hidden cost associated with all goods or services? For instance, there is no such thing as a free cinema ticket – even if you did not pay any monetary value for it. That may seem strange at first; however, you paid for it in time. Even if your friend offered you a spare ticket to go with him or her to see the new Harry Potter movie, you would have to give up your time to get to and from the cinema and watch the film, so in fact you are forgoing the chance of doing anything else with your time. You could potentially spend that time doing something else, like working or performing any other activity.
If I had to choose the most important economic concept I would have to pause, not for long, but I would still have to consider if anything could challenge the idea of opportunity cost. I believe that opportunity cost is such a powerful and universally applicable concept that it would be my number one. The theory goes back to the foundations of economics and was developed by John Stuart Mill in the classical period. The theory is embedded into much of the thinking at the time and was actually informally understood before Mill’s conceptualisation. David Ricardo understood opportunity cost because it was intrinsic to his comparative advantage theory.
Opportunity cost describes the relationship between scarcity and choice. Formally it is defined as the opportunity foregone of the alternative option. The resources used to acquire a certain good or service could have been put to an alternative use, which cannot be enjoyed because they have already been utilised. The alternatives are therefore mutually exclusive and play an important role in deciding what to do with the limited resources that are available to us. The real cost a good or services takes does therefore not only depend on how big its monetary value is. Its real value also takes time, utility and foregone opportunity into account and is therefore a much better estimate than an accounting value.
The richer the economy the more we spend on things that are less important to our survival. In the most advanced economies around the world the average household spends more money on its leisure budget than on food. Apparently the question: “do I really need this?” is not a good enough barrier in our quests to satisfy an ever-growing consumer need. In pre industrial times all that was earned went to feed the family and have a place to live. In those times life was much harder than it is today and families often had to work from morning until evening in the fields just to make a living. On the other side of the industrial revolution economic activity has accelerated at a breathtaking pace and the average purchasing power of an individual has risen dramatically. This has been associated with the development of more specialised functions in society that benefit overall production and increase efficiency. However, some of the jobs that have been created in this economy I seriously do not understand! Why is there such a thing as a dog-stylist or a celebrity on a reality show about Botox parties? These things are totally irrelevant and a complete misallocation of resources!
It can sometimes make me so frustrated that I consider running for government with the mission to tax these markets starting with gossip magazines! Why are we not spending all that money on fighting hunger, AIDS, malaria or something else useful? That is because we are irrational human beings – all of us – including this economist. Why does anyone play the lottery when the expected value is so small? Dan Ariely, one of the world’s top behavioral economists, jokingly put it: “playing the lottery is like a tax on stupidity”! Adam Smith touched upon this as early as the 18th century in his work “The Theory of Moral Sentiment” when he described our desire to seek the approval from the impartial spectator. We are all biased towards promoting our own best self-interest be that getting a good job, finding an appropriate spouse or receiving recognition from our peers. This drive has a big influence on how we spend our income. In a perfectly rational world we would consider what is best for us, both individually and collectively, and only spend our money on things that truly benefit society like finding a cure for cancer. However, we are much more selfish than that and living in a perfectly rational world would also be boring.
Our consumer choices are dictated by many factors such as: looking good, getting more money, saving time, feeling comfort and many more. In this aspect it can be quite useful to look at Maslow’s pyramid. Abraham Maslow described in this pyramid our hierarchical needs from physiological needs to self-actualisation. This goes some way in explaining the allocation of a household’s demand. Especially how it can vary over time and depends on a given person’s situation. When a lower level is sufficiently saturated we become complacent and crave to satisfy higher desires. However, why do these useless things arise on the supply side in the first place? This is perhaps a harder question to answer but it is probably because marketers understand these needs and lay out very persuasive messages to the public about becoming successful if you watch their show or buy theirs product and nobody want to be left behind. In this perspective supplier powers are much greater than that of the demand side and with a bit of collusion it is not hard to imagine that very few can dictate what the new trend is going to be. Industrial lobbies are, for instance, fully integrated into the political process; however, one does not see many consumer groups putting pressure on producers of dog outfits or dog jewellery.
I do not care about what Katy Parry does or who becomes the next top model, neither am I interested in the Kardashians! But apparently other people are because otherwise they would not have paparazzi chasing them or there would be no such show as Big Brother 12. People that buy gossip magazines and watch these reality shows give incentives to these industries to push on. Should they be banned during times of crisis or scarcity? With the risk of being inconsistent it could be argued that it not a bad idea, however, I believe in free choice and I therefore have to accept others wish to buy useless things. However, I do encourage a more critical approach by consumers towards spurious producers of things we don’t really need. It seems like such a waste, especially in difficult economic times when people are out of work when others take their dogs to get kitted up.
The 2008 crisis was first dubbed: “the Credit Crunch” because of its squeeze on lending – initially a housing bubble burst in the USA releasing concerns about the amounts of debt in other markets. The London Interbank Offered Rate (LIBOR), which is the rate set for financial institutions in the interbank market, spiked in October 2008, meaning that lending ceased causing outright panic. After years of leveraging and excessive indebtedness a sharp deleveraging shock incurred that would become more than just a financial bubble. Northern Rock, a UK bank, was the first victim of this crisis and was hit by a bank-run, which forced it to require loan facilities from the Bank of England and later the bank had to be privatised. This was the first warning of things to come. At the peak of the crisis it claimed the heads of several financial institutions that either failed, were acquired or were privatised. By then it became clear that the crisis would not be contained within the financial markets and that it would affect other parts of the economy, as it turned out, it became a global crisis that severely dampened economic activity.
At that point governments threw in the ‘neo-liberal’ towel and sought Keynesian fiscal stimulus to try and pick up demand. Because it spread to most part of the economy I argue that it is a true crisis of capitalism in a sense that institutions, governance and regulation will irreversibly change. I am confident, however, that economies will eventually emerge from this crisis but I am also confident that a new order will be established. This order will shift economic, political and social perceptions, which will again change the face of capitalism. The reason why capitalism has been the main economic paradigm is that it has previously survived two severe crises and emerged stronger: first the great depression of the 1930s and then the stagflation of the 1970s. The previous crisis, the dot-com bubble, was different in both its scale and scope and it was confined to a narrower part of the economy. It was no more than a ‘bump’ on the road and was not a capitalist crisis. It is, however, important to note that every crisis is unique and arguable more complex over time.
Certain observers, particularly Gordon Brown, proclaimed that the boom and bust cycles were a thing of the past and that the economy was quick enough to adjust itself to any changes in the economy. However, a financial crisis is neither a supply-driven nor a demand-driven crisis. Fundamentally it is a result of too much debt that was encouraged by financial institutions, which by securitization were able to spread the risk to others but it simply resulted in severe systemic risk. The accumulation of debt was made possible by huge deregulations in the financial sector in the late 1970s, mainly in the USA and UK under Ronald Reagan and Margret Thatcher respectively. The other powers at the time, Germany and Japan, did not seem to have the answers – experiencing economic difficulties they were left behind a powerful American economy. However, it appears now that these other countries could be in for a revival and become a counterweight to total American dominance along with China, Brazil and possibly Russia and India. In the long run it would appear that the booms and busts of the countries that did not go down the route of comprehensive financial deregulation experience a smoother cycle, which is more stable for long run growth.
In many ways the economy has become more efficient and transparent, which means that it is quicker to react to changes, however, as we have all seen, effective financial regulation is necessary and cannot be left to its own device. These events have therefore brought new thinking into practice and prompted the introduction of Basel III in the near future, which is a set of international regulations for the financial sector.
What is different about the 2008 crisis is that it is a first real global recession, which was made possible by certain international imbalances. Alan Greenspan, chairman of the Federal Reserve, was able to pursue expansive policies that were targeted at stimulating the economy because of cheap imports mainly from China, which kept American inflation low. Following the dot-com crisis American interest rates were kept very low and the George Bush administration moved the federal budget from surplus into deficit letting the economy race on. The loose money conditions in turn fuelled the housing bubble and raised demand for construction and equity. It seems that the policies adopted by America over more than a decade made the economy come crashing down even harder. As other international imbalances persist, like the huge American debt, sovereign debt of Euro countries and global current account balance of payments imbalances, it is not unrealistic to think that these disparities will have to be smoothened out and indeed this is already happening as part of automated mechanisms, however, international cooperation is necessary to synchronise a joint recovery. The dominant position of America has already taken a serious hit and there appears to be other political, social and economic ideas that can challenge the State for the first time since the end of the Cold War. Undoubtedly the USA will still be a leader on many areas, however, the gap has been significantly narrowed and it will no longer dominate single-handedly.
The peripheral countries in the Euro have been subject to speculative attacks by investors and capital markets, which is putting pressure on the monetary and economic union in Europe. This tension has put the future of the Euro in question and certain observers suggest that the existence of the Euro is in danger of collapsing. Greece felt pray to rising costs of lending 6 months ago, which resulted in the government not being able to service its rather large debt. To avoid a default like the one that hit Argentina approximately a decade ago the EU and IMF put together a bail-out in the form of a steady supply of very favourable lending conditions. Now Ireland has found itself in a similar position and received supports form the EU but capital markets have not responded well and remain sceptical. This has put the heat on countries in a similar fiscal position and resulted in medium term bond yields to rise on the Iberian Peninsula and in Greece. The EU has reacted by trying to cure the symptoms but is not seriously addressing the problem at the core of issue, which is institutional reforms and fiscal integration. This proposed reform did not receive much attention as long as things were going well, however, now that the members of the EU have reacted asymmetrically to the shock of the recent recession its initiation seem more pressing. The Euro has got a future but will depend of the willingness of its members to undertake reforms, otherwise, the Euro could fall apart and much of the integration could be reversed. Opinions on what the right thing to do are abundant and have much political sentiment, however, economically it is clear where different routs will lead.
Angry students protesting against big rises to tuition fees have flooded White Hall, the main artery of London. Today’s demonstration is the second large protest following an earlier manifestation of dissent, where the headquarters of the conservative party was under siege and got vandalised. The coalition government have transferred much of the cost of undertaking studies at university level onto students and have set fees at £6,000 with an upper tier of £9,000. This is almost a triple increase, which inevitable will means that fewer individuals will opt for a university degree. In another senseless move, the coalition government has introduced a cap on non-EU immigrants that will mainly hit the trained and highly skilled workers by restricting their entry into the UK. This cap is being introduced because of election pledges and a growing sentiment among politicians, mainly conservative, that something must be done about the unemployment amongst native workers. Politically it may take some courage to say that these policies are not suited to stimulate a fragile recovery, but from an economic perspective they are clearly very ill-advised.
The magnitudes of various factors in economic growth theory are difficult to establish because it is very difficult to construct a counter factual. However, many agree that one of the most important factors for economic growth is education or put in another way: human capital. This factor is proving to play an increasingly important role as the demand for unskilled workers is dropping fast in the developed economies such as the UK. The production of cheap manufactured goods has been outsourced to transition economies such as China, which has experienced an astonishing export lead growth. The strong forces of globalisation have meant that education and life-long-learning has become more important than ever.
In this context it seems absurd that the government introduces a strict cap on migrant workers, as the previous Labour government has long overcome the problems of unskilled workers coming in to the UK. This move is being opposed by businesses and Vince Cable, Business secretary, has also lauded his fear of undermining future growth. Likewise, the move towards American conditions in education has damaging effects on future growth too because individuals will struggle to get the qualifications needed in a highly competitive global environment, especially with the rise of many new economies that have huge populations with skilled labour. So the proportion of unskilled native workers is likely to increase with no foreign workers able to step into these roles. There does not seem to be any consistency with the policies at Westminster, which seriously threaten the fragile economic situation and future growth.
The government should be a provider of education for the reasons above, but also because schooling is the best way to create equal opportunities. This does not only mean providing free universities but also short courses that will give workers better qualifications on all levels. This strategy has successfully been implemented in the Scandinavian countries where the labour participation rate is one of the highest in the world and unemployment is kept down with active labour market policies. The cap on immigration should equally be revised because in its current form it is likely to cut off a supply of skilled labour.