Time is Money?

Last week’s and this week’s blog have moved away from the current state of the UK economy, Brexit, trade wars and other depressing areas and look instead at some of the techniques economists use when making comparisons between different projects.

When comparing alternatives, it is necessary to identify all the costs and benefits – monetary and non-monetary – and compare them. This involves finding a way of expressing them in money terms. Last week’s blog looked at how economists value a human life while this week’s considers the value of travel time (VTT), the amount of money a traveller is willing to pay to save time, measured in pounds per hour. This is important when considering whether to pursue major transport infrastructure projects since savings in travel time are an important benefit to be considered, as well as construction costs, savings in vehicle running costs from shorter or less congested journeys and reductions in accidents and fatalities.

When trying to value time saved by drivers and passengers, we first need to identify whether the journey is for work or non-work, (leisure and commuting) since the two are valued differently. A government paper in 2015 suggested commuting time saved should be valued at £11.21 per hour while leisure time is worth only £5.21. Time spent travelling for business is more complex with an average of £18.23 per hour, considerably more valuable than non-work time. This average contains considerable variations. For example, an hour saved on a business journey by car is worth £25.74 if the journey is more than 100 miles while, if it is less than 20 miles, the value is only £8.21 per hour. Time spent on rail travel, which might be expected to be less valuable because of the opportunity to work on the train, is actually more valuable, with an hour saved on a rail journey of more than 100 miles worth £28.99 per hour. This could be because the government paper takes into account the quality of the travel experience and considers such factors as whether the mode of transport is likely to be early or late and whether, on a train there are many, few or no seats free. Therefore, an hour spent in a car listening to the radio is far less of a cost to the employee than having to travel in a crowded train.

The final way in which time needs to be considered is in how we value costs and benefits accrued at different stages of a project. In a typical infrastructure project, the construction costs are front-loaded while the benefits, such as time saved and revenue generated occur over a longer period. If you were asked whether you preferred £100 today or the same sum in five years, you, along with the majority of the population, would prefer the former, not least because you could put the £100 in a savings account and it would be worth more than £100 in five years. Therefore economists “discount” the value of future costs and benefits and express the costs and benefits in terms of the “net present value” – the monetary value today of future costs and benefits. In a simple example, if the interest rate today were 5% and a project incurred costs of £100m today, the project would need at least £105m of revenue in a year’s time to be viable. In reality, one is not looking at one cost and one revenue figure but a series of figures over many years. The interest rate chosen is crucial since it would require revenue of £161 in five years to cover costs of £100 today at 10% but only £110 at 2% – a figure much closer to today’s borrowing rates. Hence the argument that now is an ideal time for our government to be improving the UK’s infrastructure.

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What is the value of a human life?

Imagine you are an economist in the Department of Transport advising the Minister who has to chose between two alternative transport options. One is significantly more expensive than the other but will have a greater impact on road safety because it improves a major blackspot, notorious for fatal accidents between pedestrians and cyclists. Alternatively, if you were working for a health authority, you might have to advise on allocating scarce resource between areas which particularly benefit the elderly, such as hip replacements, or putting the money into areas which benefit other sectors of the population such as paediatrics. Although it might seem difficult and subjective, economists working in these areas have to place monetary values on a human life.

One way of valuing a human life is the VSL (Value of a Statistical Life) which uses  the money a person would pay to save one human life. This is not asking what they would pay to save their life or that of a member of their family or a friend, but the value they would place on an anonymous life. Alternatively, rather than carrying out surveys, economists consider future average earnings. Therefore the value of a life varies according to the age of the people being considered, hence actions which save a child’s life are more valuable than those which benefit the elderly. More problematical, this implies that saving lives in a high-income area is of greater value to society than in a depressed region.  Unsurprisingly, there is very little international agreement about the answer. The UK government figure is around €2.02m while the USA Department of Transport figure is €8.75m, indicating the way the VSL varies according to income levels.

A study in Sierra Leone illustrated this by looking at people’s preferred transport options to get from the capital, Freetown, across water, to the airport. By examining the different methods of travel (ferry, water taxi or  hovercraft) and considering the duration of the journey and the risks involved, the study found that the VSL of an African traveller ($577,000) was lower than that of a non-African traveller ($924,000) which was largely explained by the level of income, with higher income earners choosing the safest method – water-taxi-  even  though it was more expensive and took longer.

A new approach, used particularly in healthcare economics, estimates the “Value of a Statistical Life Year” (VSLY) which measures the value of one additional year of life. If a medical process, such as a heart transplant for an elderly patient, costs £50,000 and increases life expectancy by one year yet costs £60,000 then in economic terms it is not cost-effective. However if the same treatment were provided for a child which increased their life expectancy by fifty years, then it would be extremely cost-effective. This approach has been made more sophisticated by introducing the idea of a Quality-Adjusted Life Year which is defined by NICE (the National Institute for Health and Care Excellence) as:

 “A measure of the state of health of a person or group in which the benefits, in terms of length of life, are adjusted to reflect the quality of life. One QALY is equal to 1 year of life in perfect health.
QALYs are calculated by estimating the years of life remaining for a patient following a particular treatment or intervention and weighting each year with a quality-of-life score (on a 0 to 1 scale). It is often measured in terms of the person’s ability to carry out the activities of daily life, and freedom from pain and mental disturbance.”

The World Health Organisation uses a range of between one and three times per capita GDP of the country per additional QALY while a value of £30,000 per QALY has been identified as the upper limit for treatments deemed cost effective in the UK,  approximately the value of per capita GDP.

Whether this figure is too low is a question for politicians rather than economists.

A Libra Update

Four months ago, Facebook announced the prospective launch of Libra, its global, digital currency which is intended to change the way people (or some of them)  transfer money and make payments. Since then the path to its launch has been rocky. First the French and German banking authorities expressed concern and  suggested they would refuse to allow it to be used and G7 ministers expressed concern that currencies like Libra might  potentially destabilise the international monetary system. The European Central Bank   launched an investigation  to examine  how the currency might impact on competition and Mark Carney expressed concern over  money laundering and data protection.

However a further very large blow has been the announcement by PayPal on Friday that it is withdrawing from the Libra Association (the group of businesses backing Libra which have agreed to invest at least $10 million in the project). Although the reasons behind PayPal’s departure are not clear, it is likely that concerns raised by central banks, such as the Bank of England and the Federal Reserve over the way in which transactions involving the currency will be regulated, might be a major cause. If other key parties, such as Visa and Mastercard also withdraw, then the future of the Libra will be in doubt.

 

Facebook, Libra and the meaning of Money.

People asked the question “What is Money” talk about cash – notes and coins. Some,  with a historical background, might also talk about precious metals such as gold and silver while others include bank deposits. Economists asked the same question will talk about anything which fulfils the four functions of money – a medium of exchange, (anything which is used to buy goods and services and allows an economy to move away from a barter economy), a unit of account, (allowing the value of goods and services to be related via a common standard – if a loaf of bread costs £1 and a jar of marmalade costs £2, then the latter is worth twice as much as the former), a store of value, (allowing wealth to be saved), and a standard of deferred payments (allowing borrowing and repayments over a long period). Economists are quick to point out that, in today’s economy, 97% of money is held not in the form of notes and coins but in bank and building society accounts and the majority of transactions by value are done via money in bank accounts not cash. As contactless technology becomes more common, the use of cash will diminish even further.

In June, the question of what counts as money moved away from the bottom of the financial pages to the front pages as Facebook announced it was planning to launch a crypto-currency called Libra in 2020. UK users, for example, will be able to change pounds into Libra and use the latter to send money to friends via Whatsapp and Messenger and buy things on-line and in shops. Facebook has joined 27 other companies, including Spotify, Uber, Visa and Vodafone, to establish this new, digital currency which will be run by a subsidiary called Calibra, based in Geneva. According to Mark Zuckerberg, the new currency will be cheap and easy to use and will be of benefit to those people, particularly in developing countries, who do not have bank accounts. In these countries, the plan is that people will be able to go to places where they can change their domestic currency into Libra which they can then spend or send elsewhere. And migrant workers will be able to send Libra back home which their family can then access. Libra charges to transfer money will be significantly lower than those currently levied by banks and firms such as Western Union.

A criticism of cryptocurrencies is that they fluctuate in value enormously. One bitcoin was worth $19,783 on 17th December 2017, by 22nd December, 2017 it had fallen to $13,800 and by 5th February 2018 it was worth only $6,200. Facebook hopes to avoid such volatility by pegging  Libra to a basket of other currencies and it will be backed by a reserve fund, meaning that holders of Libra will be able to change their holdings back into “real” currencies without difficulty.

Facebook has referred to the Libra as a potential global currency; given that the number of active Facebook users in the first quarter of 2019 was 2.38 billion, this is not an exaggeration. However, there are significant issues over the stability of the new currency and its impact on the financial system. Given that the account holders must “buy” Libra with existing currencies, their purchase of Libra could potentially significantly reduce the reserves held in the banking system, causing a reduction in lending.  A key issue for government finance ministers is whether Libra is a currency requiring regulation or simply a new way of making payments which are still based, ultimately, on individual nations’ currencies.

Another issue is how Libra will be regulated. There are concerns over the security of users’ data and the potential for it to be used for money laundering. Finance ministers from the G7 (the world’s 7 major economies) met in July and expressed their concern that the Libra might become a world reserve currency (one used internationally and held by governments as part of their international reserves as gold was and the dollar still is) but would not be subject to regulation. They therefore argue that if Calibra accepts deposits like a bank, it should be controlled as banks are, with regulations over their reserves. However, since the G7 meeting, the Bundesbank (the German Central Bank) has suggested that the new digital currency might significantly reduce the cost of making transactions and force existing current banks to improve their existing, expensive payment systems, which can reach 7% for international movements of money, thereby benefiting consumers and business worldwide.

What faces a new government?

With an election being discussed, it is interesting to speculate on key economic issues which should feature in the parties’  manifestos, but, with the focus on Brexit, have had little attention given to them over the past three years.

The UK’s economic outlook is looking better than it has for many years; unemployment is at 3.9%, the lowest level for 45 years, inflation in June was running at the government’s 2% target and the budget deficit is down to 1.1% of GDP from 9.9% in 2010, although predicted to rise to 2% following the Chancellor’s recent announcements. Although not something the UK can control, what happens overseas will impact on the UK but is difficult to predict with certainty. Although China’s economy grew at an annual rate of 6.2% between April and June, 2019, a rate far beyond anything we can dream of, this represents a slowdown from 6.4% in the first quarter. This 0.2% fall is not large, but it does indicate that the Chinese economy is slowing, possibly caused by tariffs imposed by the US or by a more general slowdown in their economy which the Chinese government have been trying to tackle by encouraging bank lending and cutting taxes. This matters for the UK because China is such a significant part of the world economy and their slowdown will impact on UK exports. How we respond to such issues will be affected by how the new government addresses our long-term problem of low productivity.

Another issue which has an economic impact is the action which the country takes to offset global warming and reduce climate change. Ironically, if government measures to reduce the use of fossil fuels are successful, there is likely to be a significant impact on government revenue since fuel taxes and vehicle excise duties (not levied on electric vehicles) contribute significantly to government revenue. The Office for Budget Responsibility estimate that fuel duty will raise £28.4 billion this year, 3.5% of all government receipt, equivalent to £1,000 per household, 1.3% of GDP. They also expect VED to raise £6.5 billion in 2019-20 representing 0.8% of government receipts and equivalent to approximately £230 per household, 0.3% of GDP.

Possibly the key issue, not unique to Britain, is our ageing population. In 1991, 65 year old males and females had a life expectancy of 79 and 83 respectively; by 2012, this had increased by four years and is continuing to increase. This will have four effects. Firstly, there will be an increased demand for goods and services used by older people of which a major one is health care. As medical technology improves and people live longer, there is an increased burden on the NHS. As increasing numbers of people reach their early 80s, 85% are likely to have a long-term health condition, needing medical treatment which is increasing the burden on the NHS as people who would previously have died in their 60s or 70s are now living into their 80s and 90s because of medical improvements.

Secondly, there will be an increased need for social care. By the time people reach their late eighties, more than one third experience difficulties undertaking daily living tasks unaided and therefore require assistance either from their local authority or paid for privately. Currently the adult social care bill accounts for 1.2% of GDP and this is expected to increase significantly as life expectancy increases. Who pays for this is a key question.

Thirdly, there will be an impact on the housing market since, as people live longer and are often on their own, there should be an increased demand for smaller accommodation such as one person flats and retirement homes. However, the costs of moving and stamp duty, which is paid by the buyer on the value of the purchased property on a sliding scale above £125,000, deter some older homeowners from downsizing.

Finally, and possibly most importantly, as people live longer, the pension burden increases. Even with the raising of the retirement age, pension spending is due to increase from 5% of GDP to 6.9% in 50 years. To pay for this, will the working population need to pay more, will retirement ages be increased still further or will today’s workers be expected to save more for their retirement?

 

 

 

 

 

Why bother with GDP?

Modern GDP statistics (“the value of goods and services produced in a given period”) have their origin in the USA around the 1930s with the work of Kuznets, who produced the first national income data in order to see the impact of the Great Depression on the US economy. They became more important during the Second World War when the UK government, prompted by Keynes, and the US government needed to be able to manage the war effort to maximum effect while still providing enough resources for consumption.

A major criticism of GDP is that it takes no account of what is produced, merely its value. As a result,  disasters can be good for GDP if they involve countries reconstructing roads or buildings damaged in the disaster. War is also a good way of boosting GDP since it will involve producing more tanks, weapons and aircraft! Similarly, two forks are, in GDP terms, as useful as a knife and fork, but less useful in reality when trying to spread butter. GDP and GDP per capita also take no account of how the income is shared among the population. A rich oil producing country might have a high GDP per head but, if the income is concentrated in the hands of a few, the standard of living of the majority might be below that of a country with a lower average of GDP.

Measurement of GDP is difficult since it is impossible to measure every transaction and therefore relies on surveys e.g. the Living Costs and Food Survey for about 5,000 households and monthly surveys of approximately 45,000 businesses. The development of technology has made the measurement of GDP more difficult. The UK Government set up an inquiry under Charlie Bean – OB and former Deputy Governor of the Bank of England – who identified activities which are now much harder to measure and value such as using Google Maps rather than buying a paper OS map or streaming films rather than buying or renting DVDs. Another problem is that many things have become cheaper and better – my new DVD recorder is easier to use and records more than a previous model but, in GDP terms, it is less valuable because it is cheaper.

There have been many debates over what should be included in GDP and although these might seem largely irrelevant, they matter when trying to compare countries’ GDP. In the past certain things, such as the sale of cannabis in cafes in Holland were legal and therefore recorded while a similar purchase in Romford would not be counted. However Eurostat wanted consistency among its members and decided that all transactions for goods or services involving money were to be recorded, whether they are legal, illegal, good or bad. Therefore, in a purely numerical way, those who argue in favour of increasing GDP as being a key government objective, could argue that encouraging the sale of drugs or prostitution is as valid as increased spending on education or health – something even an economist would find hard to justify! More relevantly sales of guns in the UK are part of the shadow economy but in the US they are legal, widespread and contribute to GDP.

GDP data is particularly suspect in developing countries where a significant percentage of production takes place in the hidden economy; for example, in Zimbabwe only 6% of the labour force is formally employed. Similarly, my purchase of bottled water from Sainsbury’s is counted in the UK’s GDP, but the effort of an African villager who spends hours walking to and from a stream to collect “free” water has no value according to GDP statistics. There are also basic measurement difficulties in LDCs, such as obtaining accurate population figures, accurately measuring inflation and valuing the hidden economy, e.g. only half the maize produced in Nigeria is sold in a shop or market.

There is now a consensus that we are trying to measure too many things in our single GDP number and, although we can improve it by using GDP per head or median GDP or NNP, it is still deficient.

Economists have therefore started both to consider other possible methods of estimating economic activity and to develop alternative measures which go beyond simply the output of goods and services. One way of tackling the former is to look at light intensity to indicate economic activity in different areas with increases in intensity over time indicating growth. Such methods indicate that the proportion of economic activity occurring in villages, and not always measured, is more significant than thought and therefore the GDP of many developing countries is, similarly, larger than previously calculated. It also provides a fascinating snapshot of the difference between the North and South Korean economies.

However a major concern is how we measure the damage which our focus on output is doing to the environment. China’s focus on growth has resulted in 40% of its river water being undrinkable and one cannot always see the stars at night because of pollution. GDP does not take into account depreciation of natural resources lost to build houses and factories and damage to the environment but this is not easy to do. How does one put a monetary value on a rainforest, beautiful view or footpath by a river? One way is to make an estimate based on how much people pay to see them and, for things which benefit the environment, how much it would cost to replicate them. The UK government in 2012 formed the “Natural Capital Committee” to advise the government on things such as ‘forests, rivers, minerals and oceans’ and by 2020 the ONS must include a measure of natural capital in the UK’s national accounts. The aim is to move towards sustainable growth. Along the same lines, a US think tank has invented Earth Overshoot Day – the date when the earth used up its regenerative capacity for the year. In 2018 this occurred on 1st August.

Other measures include the Genuine Progress Index – a measure of economic welfare which is currently in use in Maryland. GDP is the base but invisible “goods” e.g. leisure time, volunteering, & housework are added while “regrettables” e.g. crime prevention spending such as burglar alarms, pollution and commuting time are subtracted. The Happy Planet Index tries to measure what matters – namely sustainable wellbeing for all and tells us how well nations are doing at achieving long, happy, sustainable lives.  Some countries have followed Bhutan which developed a Gross National Happiness index which sets out priorities such as psychological well-being, health, education, living standards, good governance and ecological resilience. Before adoption, all new projects must undergo a GNH impact review. We carry out an annual happiness survey as does the OECD and many of its members. These focus on six key variables which determine happiness – GDP/head, healthy years of life expectancy, having people to turn to, trust in others, freedom to make decisions and donations to charity.

An Ageing Population

The world is getting older and this has significant implications for the working population, those who have retired and those about to enter employment. The country facing the most immediate crisis is Japan with its rapidly ageing population. Those over 65 years old now account for 28% of their population and their life expectancy is 84 – the highest in the world. It is predicted that over half of the babies born there today will live to over 100 years old.  In addition, it has the lowest birthrate since its records began 120 years ago and therefore its population is falling. In the UK the population is ageing. The proportion aged 65 or over in 2016 was 18% of the population (11.8 million) and the ONS predict that by 2066 this figure will have increased to 26% of the total population (20.4 million).

We can expect this to result in an increasing budget deficit as pension payments increase because of longer life expectancy. Governments will face increasing costs of health care as people live longer and consume more health care which is becoming increasingly expensive for those in later life as medical science has improved. Linked to this, the tax burden on those of working age will increase as the proportion of the population not working increases. Partially offsetting this, there has been an increase in the proportion of older people working as their health has improved; for example, in the UK, the proportion of over 70s working has more than doubled in the last ten years but it is still only one in twelve. However if people are working longer, their ability to provide care for elderly relatives will diminish. A key concept to consider is the “Old age dependency ratio” (OADR) – the number of people of State Pension age (SPA) per 1,000 people of working age. In the UK this is forecast to increase significantly beyond 2030, therefore suggesting either increased taxes, reduced levels of care, increased immigration,reduced real pensions or making the elderly pay an increased proportion of costs currently paid by the state.

The impact on the structure of the economy is also significant. Many older people live in houses which are too large for them, bought when they had children who have now left home. A shortage of suitable smaller accommodation, combined with the relatively high costs of down-sizing prevents some of them from moving, thereby restricting the supply of housing for younger families. There is also an increasing need for workers in the NHS and care industries to look after the rising number of elderly people. There is also a regional impact since proportionately more elderly people live in rural and coastal areas, placing a proportionately higher burden on local authorities and the NHS in those areas. Another issue is that over the past few years, the relative income of UK pensioners has increased due to the introduction of the “Triple Lock” in 2011 – a government commitment to increase pensions annually by the highest of average earnings, the rate of inflation or a minimum of 2.5%.  Since then both inflation and earnings growth have been low and the 2.5% increase has therefore increased pension incomes relative to earnings. This is supported by a government study which looked at the percentage of people in 2015/16 of different age groups reporting it “quite or very difficult to get by financially” which showed that the lowest percentage of those in difficulty were the two highest age groups, 65 – 74 and 75 and over, which reported 3.1% and 1.4% respectively. These returns compare with the next lowest, the 16 – 24 age group, who reported 5.8% in difficulty.