Port Talbot & A’level economics

A’level economics students frequently moan  that what they have been taught is not relevant to what is going on around them while economics teachers complain that students do not relate what they have been taught to the real world!

The recent events at Port Talbot provide an ideal example to use economics concepts.

The multiplier can be used in assessing the costs to the area should Port Talbot close since not only will steel jobs be lost if the plant closes, additional jobs will also be at risk as steel workers suffer lower disposable income and cut back on expenditure,  particularly in non-essential areas.

In considering the type of unemployment created, one can use the idea of structural unemployment since many of the steel workers affected will not have the skills needed in newer, growing industries.

The possible closure of the plant is relevant to the arguments about the benefits of free trade and the theory of comparative advantage whereby UK steel purchasers benefit from cheaper steel imports from China which need to be set against the  job losses among UK steel producers. This aspect can be expanded to consider whether the Chinese are dumping steel on the world market and, if so, what action should be taken, especially in the light of the tariffs on Chinese steel imposed by the USA and those imposed by China on imports of steel from the EU and elsewhere.

A final example is in the  field of market failure where Tata have complained that the UK Government’s environmental policies have raised energy prices and helped make UK produced steel (and heavy industry generally) uncompetitive. UK electricity prices are almost double those in the rest of the EU and more than double those in China and while these high prices help to subsidise renewable forms of energy, they make life difficult for UK firms.

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CEO pay – an example of economic rent, rather than transfer earnings?

A recent report by the London School of Economics (LSE) on executive pay has cast light on a rather forgotten corner of labour market theory – that of economic rent and transfer earnings.  The wages of most workers can be divided into two different parts.  The first part is the transfer earnings, or money which must be paid to the worker in order to persuade them to do the job.  This can be thought of as the bare minimum the worker will accept.  This may well be affected by such factors as the next best employment option open to them and the wages it might bring.  The rest of their salary is known to economists as economic rent, or the extra they receive above their transfer earnings.  This can be seen as the earnings equivalent of supernormal profits to a firm.  It is extra payment which the worker does not really need in order to persuade them to do the job, but which they receive in any case.

The recent LSE report, prepared after extensive interviews with the headhunters who recruit CEOs, came to some interesting conclusions.  The first is that the average annual salary for a FTSE 100 CEO is now £4.6m per year.  It is often suggested that the for most of those individuals the vast majority of this money represents transfer earnings rather than economic rent.  Why?  Those of us who earn considerably less, which is statistically most of us, are told that there are very few who can actually do such jobs and that there is a global market for this limited supply of very talented individuals.  If large UK firms do not pay these high salaries then these workers will go elsewhere, particularly the US.  In other words, the opportunity cost for them in accepting a job with a UK firm is very high because of the other options open to them.  Therefore, even if their salaries are in the eye-watering region of £4.6m, they are receiving little in the way of economic rent.

However, they LSE reveals that headhunters think differently.  Firstly, they describe most FTSE 100 CEOs as “mediocre” and they comment that 100 people could have filled the job just as ably as those who actually are chosen.  This suggests that these workers are not as limited in supply as they themselves would have us believe, and therefore that the opportunity cost for them of accepting a CEO post might not be as high as the picture they have painted because they would find it difficult to earn such a salary elsewhere.  If much of their salary is, in fact, economic rent then labour market theory suggests it can quite safely be taken in the form of tax without altering their behaviour in the slightest and without affecting economic efficiency  It is possible that Thomas Piketty could make some useful suggestions in that direction………..

Links to newspaper articles on the LSE reports can be found below:

http://www.independent.co.uk/news/uk/uk-bosses-pay-absurdly-high-and-slashing-salaries-of-ftse-ceo-would-not-hurt-economy-say-top-head-a6915126.html

http://www.theguardian.com/business/2016/mar/05/pay-for-uk-bosses-absurdly-high

 

 

 

Natural monopoly and competitive markets

Any economics student who has studied long run cost curves should be familiar with the idea of natural monopoly.  Many utilities, such as telephones, water and electricity supply are natural monopolies.  This creates a problem when it come to privatizing a state monopoly, because a private monopoly can result.

In some cases the British government solved the problem by separating the natural monopoly, the network part of the business, from the supply section.  So we have UK Power Networks and a number of competing gas and electricity firms.  In the case of BT that was not the case and the privatized firm was allowed to keep its network.  However, this may be about to change, as this article shows:

http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/telecoms/11903239/Taking-Openreach-out-of-BT-could-backfire-warns-Ed-Vaizey.html

There will certainly be advantages and disadvantages to separating the network from the operator, but economic theory suggests it could be a good move.

CMA to investigate 2500% price hike by pharmaceutical firms

http://www.independent.co.uk/news/business/news/pfizer-and-flynn-pharma-accused-of-overcharging-for-epilepsy-drug-10444660.html

Pfizer and Flynn Pharma are in trouble with the Competition and Markets Authority after hiking the price of a drug they sell to NHS by a percentage that wouldn’t look out of place at the end of a payday loan advert.

A few things here. Drug firms spend a lot of money and time (about 17 years) researching and developing drugs, some of which go on to succeed in the market, whilst others fail. Pfizer may argue that the price increase is a result of a business pricing strategy of selling cheap upon entry to the market and then increasing the price as brand loyalty builds. In addition, they may argue that the profits made by Phenytoin Sodium will be used to fund the R&D of new drugs that NHS patients will benefit from in years to come.

You may ask why doesn’t the NHS shop around? Well, they can’t, because the drug is patented. A patent acts as a barrier to entry as it stops other firms from copying a new drug that a firm has spent years and, potentially, billions of pounds developing. After all, who would spend all that time and money if the day after launch a series of copycat firms come and along and copy all your hard (and costly) work? Firms wouldn’t develop new drugs, and new drugs are good, so patents are good?! The problem is that patents prevent competition, for the 25 year life span of the patent at least, and so firms can exploit their monopoly power by charging extortionate prices. It’s a question of balance, and it appears that the CMA believe the scales are weighted too much in favour of the producer in this instance.