Issue 13 by Nottingham Economic Review

Issue 13 FEBRUARY 2014

The predictability of markets: Can financial crises be prevented?

ALSO INSIDE THIS ISSUE:

FINANCIAL FAIR PLAY: FAIR OR FOUL

Help to buy scheme political prowess or economic inadequacy?

Does an increase in healthcare spending necessarily make us better off?

Letters

The Nottingham Economic Review

Vice-Chancellor’s Foreword Dear Nottingham Community, As Vice-Chancellor and Professor of Economics, I am delighted to provide my support for the Nottingham Economic Review. The School of Economics attracts students of the highest calibre and its scale means it can offer a very wide range of learning opportunities. On a personal level I am delighted to be able to continue contributing to the School’s teaching, with my Year 1 ‘Current Issues in Economics’ module. The Nottingham Economic Review offers commentary and insight on current issues, and interviews with key commentators. It is an excellent publication. It was initiated by our undergraduate students in 2007 and has gone from strength to strength. I am delighted the NER it is still thriving and continues to be managed and edited entirely by current students. I am also pleased to see that its Editors are now collaborating with other excellent universities worldwide to broaden it into a genuinely international publication. The Nottingham Economic Review reflects well on the quality, initiative and organisational skills of our students. Well done! Professor David Greenaway Vice-Chancellor

Congratulations to our February 2014 Prize Winners Gainsborough Prize Winner: Kevin Sharp The Predictability Of Markets: Can Financial Crises Be Prevented? Gainsborough Prize Runner-up: Wilson Chow Financial Fair Play – Fair or Foul? NER Prize Winner: Nelson Auner and Redi Pilch Evaluating Chicago’s Violence Reduction Initiative 02

The Nottingham Economic Review

Letters

Dear Readers, It is our pleasure to present the 13th issue of The Nottingham Economic Review. Since our founding in 2007, the NER has sought to promote increased student engagement with important current economic, political and social issues, whose wide ranging consequences affect the very fabric of society in which we live in. Following the financial crisis many of the challenges faced by both developed and developing countries remain as of yet unresolved. Issues such as widening income inequality, the lingering fragility of financial & regulatory systems and the growing economic prominence of developing countries are all topics the NER has touched upon by providing critical analyses of underlying trends and the challenges presented to decision makers when attempting to tackle them. In light of these topics we are proud to present our discussions with Martin Wolf, Chief Economist and Associate Editor for the Financial Times, and Nick Bridge, the UK Ambassador to the OECD, whose unique insight we hope you will find as exciting as we did. We are also delighted to feature guest contributions from Philip Watson (former Nottingham alumnus) and Professor Wyn Morgan, Assistant Pro-Vice-Chancellor for Learning at The University of Nottingham. This semester we have expanded our prize offerings, with both the Gainsborough and the NER Prize, the former of which has been awarded to Kevin Sharp for his article on ‘The Predictability of Markets’ whilst the joint winners of the ‘NER Prize’ are Nelson Auner and Reid Pilch, from the University of Chicago for their research on ‘Evaluating Chicago’s Violence Reduction Initiative‘. This year the journal enacted a series of radical transformations, including the implementation of a streamlined peer and faculty review process, the launch of our new website, and an extensive rebranding, all of which will serve as a strong foundation, for many quality issues to come. In addition to the exciting Nottingham student contributions to this issue, we are proud to introduce international student voices on pivotal economic issues such as Aman Navani’s (Columbia University ) lucid examination of conditional cash transfers. Every issue reflects the dedication and support of a wide variety of individuals whose efforts make the production of this journal possible. We would like to thank the Vice Chancellor Sir David Greenaway, and the School of Economics along with the Head of School Professor Kevin Lee for their continued and unwavering support. We would also like to thank Philip Watson for his generous intellectual and financial contribution. Our deepest gratitude however lies with the NER team from the Design Board and Associate Editorial Board to the Sponsorship and Marketing manager, whose unparalleled enthusiasm and commitment made it not just a pleasure but a privilege to work with them. Finally, we would also like to extend our sincerest thanks towards all the students who took the time and effort to contribute to the journal this semester. Thus we are excited to share with you the 13th issue of the NER, and we trust you will find the content in these pages informative and inspiring. Sincerely,

Anthony Jackson, Usman Saleem and Gabriela D’Mello

The NER Team

The Nottingham Economic Review

The NER Team About us:

The Nottingham Economic Review is a student run bi-annual journal whose purpose is to showcase undergraduate research and promote ongoing advancements in economic thought. Every semester we gather submissions and publish those who we believe contain the most thought provoking, insightful arguments while simultaneously capturing the interest of our readers. We also publish a section dedicated to features and editorials concerning current affairs alongside interviews and Q&A sessions.

Co-Editors in Chief: Anthony Jackson and Usman Saleem

Managing Editor: Gabriela D’Mello

Associate Editors: Adam Goldstein Antonina Hassouni Ben Hodges Diana Beltekian James Longman Hannah Kirby

Finance and Marketing Manager: Dominic Moir

Special thanks to: Philip Watson Hilary Clayton Sue Berry Louise Hemming Wyn Morgan Charles Gedeon

Cover image credit: Antonio Morales García via Flickr

Contact:

General: team@neronline.co.uk Advertising: marketing@neronline.co.uk Submissions: submissions@neronline.co.uk Website: neronline.co.uk Facebook: /nottinghameconomicreview Twitter: @TheNEReview

Design:

Katherine Whitehead Grace McLaughlin

GET INVOLVED!

Submit your research and articles to NER Deadline date: 28th of March 2014. £500 Gainsborough Prize for the Best Submission For more info, including our latest issues, visit www.neronline.co.uk or email team@neronline.co.uk 04

Contents

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Contents 02

Vice Chancellor’s foreword and prize winners

03 Editorial 04

The team

Contents and competition

Features 06

What the west can learn from the east, Beltekian

The wild west, Hodges

Help to buy scheme - political prowess or economic inadequacy? Longman

Evaluating Chicago’s violence reduction initiative, Auner and Pilch

Financial fair play – fair or foul? Chow

Conditional cash transfers: a radical overhaul to social support for the poor, Navani

The predictability of markets: Can financial crises be prevented? Sharp

The Free Trade Debate – Developmental Catch Up or Heightened Dependency, Ward

(NER Prize Winner)

(Gainsborough Prize Runner-up)

(Gainsborough Prize Winner)

23 Saudi Arabia withdraws from UNSC, Cuello - Perez 25 Understanding Putin’s foreign and economic policy correlation, Maitra 28

Does an increase in health care spending necessarily make us better off? Hassouni

Interviews 34

A conversation with Martin Wolf, Jackson and Longman

A conversation with Nick Bridge, Tripathi and Saleem

Guest Contributions 37

A short note: Are basic statistics important? Watson

Indigestion? Food inflation revisited, Morgan

Prize Competition Former Alumnus Philip Watson is offering a £100 prize to all our readers who can solve this problem. The semi-mathematical problem requires “De Bono” thinking. DRILLING A CUBE A cube of 1 unit side is drilled through from all three sides with a drill size of 1 unit in diameter. What is the volume of one of the eight corner pieces that remain? There is a solution available if required. The prize will be given to the first timed and dated by email that is correct. Please email the answers to team@neronline.co.uk

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What The West Can Learn From The East Diana Beltekian (BSc Economics, ‘16, The University of Nottingham)

With the emergence of China, many countries and their governments have been in awe of the double digit growth that it has built for itself asking whether it will last and when China is set to overtake the US as the world’s largest economy. Instead of speculating on what may or may not happen, what countries should be asking is what they can learn from China’s success, how they can kick start their own economies after the turbulence of the 2008 financial crisis and the Eurozone debt crisis which has caused much aggravation in the West. Britain’s economy would do well to incorporate select strategies China has employed in its own to nurture long term growth and keep its economy healthy after the crises which have plagued it. Friend or foe? The political approach in China and the government’s relationship with the public would surprise many Britons. Whilst many would associate a one-state party following a pre-set policy, China’s own governance adopts a lithe flexibility allowing the country to quickly adapt to changing economic conditions. The Development Research Centre (DRC), a think-tank serving China’s cabinet has submitted a reform plan; the “383” plan . Its reform principles include 8 areas of reform: breaking up monopolies, reforming land ownership and reforming state-owned enterprises amongst other policies . Whilst not all of the recommendations will become a political reality, the action itself, a think-tank with the ability to volunteer these areas of economic improvement to the government illustrates the efforts China has taken of adopting a pragmatic approach towards developing relevant economic policy in the current economic climate. China demonstrated this flexibility during Deng Xiaoping’s vice-premiership when he advocated China reform and open policies which were met with great success, rural standards of living rising within three years of reform implementation . It is this careful experimentation and adoption of what works which prove to yield results. England’s political parties could better serve the public interest through adopting clear economic policies rather than converge to a middle ground in a concerted attempt not to scare away voters with policies containing visible ideological leanings. Today it is difficult for England’s voters to differentiate between party policies leaving 06

the electorate with very little effective choice and encouraging voter inertia. Voter turnout in the UK has been steadily declining, from 1950 where it was at an all-time high of 83.9% turnout to a lowly 65.1% in 2010 . Electorate inertia has struck the UK and the problem has only been becoming more severe with no government of the day receiving more than 50% of the vote for decades. Thus there is a need to re-orientate the state’s relationship with the people so that there is a greater level of trust between the politicians representing the masses and the voters’ faith is renewed in effective government. The secret in China has been that the state has been seen as intrinsic to society rather than an unwelcome sovereign authority that is viewed with hostility and suspicion . Thus the cultural placement of the state is an important factor determining how it is perceived by its subjects and thus the confidence invested in the state making it more effective in benefiting the electorate. Expanding Horizons Britain can also learn from China’s tenacity in striking trade agreements that point towards a less insular economy. While China has far to go before opening up to foreign investment and competition in its own economy, it is, however, taking tentative steps in the right direction. China joining the World Trade Organisation (WTO) in 2001 , explicitly illustrates China’s desire to increase its trading horizons. On the other hand, Britain has been a drifting towards more inward and insular policies and decisions. David Cameron’s coalition has pledged to reduce net immigration to ‘below 100,000 a year targeting students, low earners outside Europe while trying to encourage skilled and wealthy immigrants.’ Whilst still keeping the borders open to active contributors to the UK’s economy, the message this has sent out, is a reduced tolerance for immigrants by a country known for and proud of its multiculturalism. This policy initiative’s significance is confirmed by Chris Cummings of The City UK, who raises the issue that investors invest in countries they are familiar with, namely where they have gone to university. Therefore discouraging potential future investors can harm Britain’s long term development. While China has been negotiating trade agreements; the Trans-Pacific Partnership with the US currently in process, its investments in Africa anticipating its future powers, and talks with South Korea; the

United Kingdom has, in comparison, seemingly resigned itself to the turmoilridden European Union. With the impending rise of the BRIC economies, Britain has not been as engaged in international agreements as it should be to ensure it has solid economic ties with these countries. Arguably the UK has remained overdependent on the European Union, with 50% of its exports going to Europe , while it need not be so. Although exports have never been Britain’s strongest selling point, it has, in recent years, become successful in its entertainment exports of shows such as Britain’s Got Talent and The X-Factor with versions now existing in 40 different countries. Thus Britain should take the plunge and step into the lime light. Although recognised for exporting its financial service, the 2008 crisis has provided a much needed push to nudge the economy towards diversifying its exports into other goods and services. Developing its entertainment exports, as a starting point, and kick starting manufacturing- essential for the health of an economy- would ensure Britain has not gambled on a single export and has credits on its current account arriving from a variety of channels. Yin Yang Undoubtedly China has achieved significant economic growth in recent years and has given Britain much to reflect on in terms of its own economic procedures. However its model is far from perfect and should take heed of Britain’s own social policies. China’s Hukou household registration system, initially set up in 1958 was a scheme to restrict labour mobility. Still in place, it has done just that. It has segregated the population into two categories: rural and urban that prevents mobility amongst the population. Its effects today have excluded much of the rural population from gaining access to healthcare, education and public services. Citizens wishing to move from one province to another required Hukou conversion in order to be eligible for the state service provided there. However it is very difficult to do so and overseen by the state. The restrictions of the policy are an important area for improvement. These fixes can be observed in the achievements of the British economy. The National Health Service which provides free health care at delivery since 1948 embodies universal service provision. With China’s government

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taking an active role in the economy, it should also introduce more progressive policies to which all citizens are eligible. It should be conceded that China’s population far outstrips that of Britain and the management will be on an entirely different scale but the point stands. A gradual transformation to accommodate greater mobility will be a start. The government should apply the flexibility it adopts in trade to its state provisions in order to improve the opportunities for its rural citizens that have been side-lined by this outdated policy. To add to China’s troubles, its steadily ageing population is a ticking demographic time bomb which will have to be addressed, sooner rather than later. With the strict implementation of China’s One Child Policy, it has created a bottleneck in the population with a married couple needing to look after two sets of parents, looking after one’s own parents a stressed cultural feature in Confucian society. As the working age population declines, it will be necessary to formulate a plan to sustain the economically inactive population building up in China. One way to do this, could be the liberalisation of the Hukou household registration system which would allow for more labour mobility to protect against unemployment and underemployment. With more of the population earning incomes, it will go a small way towards long term measures of combating this demographic pressure. Competitive Pressure With China labelled as ‘one of the most selfcontained developments of any civilisation’ it is hardly surprising that its economy is not as open to competitive pressures as those in Britain. Therefore, it would do well to introduce more competition that it has seen in the past. Britain has been open and encouraged foreign competition in its economy, as well as receiving foreign direct investment (FDI). This year’s annual

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report has shown that the UK has not only retained but improved its position as the primary European destination for FDI. A report by Ernst and Young, among others, have shown that ‘despite global FDI flows falling by 18%, FDI flows in the UK have risen by 22%.’ China, in the area of FDI, has also attracted much foreign investment, with FDI inflows in 2012 at 253.4 USD billion. Despite the attraction of foreign investors, China has stubbornly kept its economy closed to foreign companies which has led to the formation of state monopolies and declining consumer welfare. With the meeting of the Communist Party in China, there has been agreement to break down administrative monopolies and introduce competitive business. China’s resolve has been confirmed in the end of Macau’s fixedline telephone monopoly ending with the issue of two new landline licences issued by the government. This will see a fall in the prices charged as more competition permeates the economy. While changes have been made, the government could go further in encouraging more competition as it is still lagging behind its potential openness. The establishment of an independent institution, the Chinese equivalent of the UK’s Competition Commission, could exert pressure on the government to open China’s markets and once sufficient competition had been achieved, to police it to ensure no monopolies arose.

making rash decisions that can have severe repercussions on its economic performance. China is working towards opening up its markets to competition but it is not clear to what degree it will be introduced into the wider economy as of yet.

China has cautiously introduced greater competition over time through the establishment of ‘Special Economic Zones’ such as the Shanghai Free Trade Zone. There will be a loosening of regulation within the pilot zone to trial the success of reduced restriction on foreign investment and interest rates being set by the market. Therefore, China is by no means looking backward to close off its economy to international markets, but it is taking extensive precautions to ensure it does not rush into

way, November 9th , p.7 special report

Thus only time will tell whether both the British and Chinese economy take heed of one another’s strengths and recognise the faults within their own economies. Only with active encouragement and political resolve will these issues be able to be overcome and a stronger economy created. The international markets will be hoping both do so, not only for their sake, but for the sake of the global economy too. References: The Economist (2013) Changing the economy, The Long Weekend, November 2nd, p.60-61 Deng Xiaoping. People Daily, [viewed 24th November 2013]. Available from: http://english.peopledaily.com.cn/ data/people/dengxiaoping.shtml General Election Turnout 1945-2010. UK Political Info, [viewed 24th November 2013]. Available from: http://www. ukpolitical.info/Turnout45.htm Li. E.X (2013, June). Eric X. Li: A Tale of Two Political Systems [Video File] retried from http://www.ted.com/talks/ eric_x_li_a_tale_of_two_political_systems.html Understanding the WTO: The Organisation. The World Trade Organisation, [viewed 24th November 2013], Available from: http://www.wto.org/english/thewto_e/whatis_e/ tif_e/org6_e.htm The Economist (2013) Exports and the economy, Paying its Europe remains the dominant market for UK exports and imports of services. Office for National Statistics, 28th February 2013, [viewed 24th November 2013]. Available from: http://www.ons.gov.uk/ons/rel/itis/international-tradein-services/2011/sty-international-trade-in-services.html The Economist (2013) Special Report, the exception, November 9th , p.6 special report CHAN, Kam Wing. [online]. [viewed 24th November]. Available from: http://faculty.washington.edu/kwchan/Chanhukou.pdf Understanding the WTO: The Organisation. The World Trade Organisation, [viewed 24th November 2013], Available from: http://www.wto.org/english/thewto_e/whatis_e/ tif_e/org6_e.htm CAMERON, Rondo NEAL, Larry. (2003) A Concise Economic History of the World: From Paleolithic Times to the Present. 4th ed. p 82 UK confirmed as leading European destination for foreign direct investment. Gov.UK, 24th July 2013 [viewed 24th November 2013]. Available from; https://www.gov.uk/ government/news/uk-confirmed-as-leading-europeandestination-for-foreign-direct-investment FDI in figures, OECD. April 2013 [viewed 24th November]. Available from: http://www.oecd.org/daf/inv/FDI%20in%20 figures.pdf China to tackle monopolies, introduce competition: CPC. CCTV.com 15th November 2013, [viewed 24th November 2013] Available from: http://english.cntv. cn/20131115/105213.shtml HO, Jolie. Macau’s fixed-line telephone monopoly ends with new licences. South China Morning Post. 4th June 2013, [viewed 24th November 2013] Available from: http://www. scmp.com/business/companies/article/1252887/macausfixed-line-telephone-monopoly-ends-new-licences Shanghai Free-Trade Zone Launched. BBC News Business, 29th September 2013 [viewed 24th November 2013]. Available from: http://www.bbc.co.uk/news/business-24322313

Image from China Daily Europe

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The Wild West

Ben Hodges (BSc Economics, ‘15, The University of Nottingham)

Disney, the world’s largest children’s entertainment provider, exerts a heavy influence on young people that grow up in rich, western countries. Early exposure to their classic films, which have a brilliant tendency to focus on issues of underrepresentation, unfairness and imbalance in society, play a vital role in forming our beliefs of what is right and wrong. We are told to focus on inner beauty, that true love is probably worth searching for, and, more importantly for this article, that the presence of large disparities of wealth and power are detrimental for society and should be condemned. Indeed, we are offered hope to such inequality and social oppression by Nottingham’s Robin Hood, a rather elaborate transfer payment scheme, and by Cinderella, who reminds us of the importance of being able to attend the ball, no matter what your social background may be. We learn the morals from these great stories. As we grow older and wiser, we acknowledge that in many parts of the world there still exist terrible regimes and societies which discriminate, oppress and constrict the masses to a considerably lower standard of living compared to those who hold the power. While we hold this in our minds, and hope that things will one day change, we are thankful that we were born into countries which are free and have equal opportunity. In the United Kingdom, for example, our well established welfare system has made old

Robin Hood redundant, and there is surely no better way to highlight our socially mobile society than by looking at the story of Kate Middleton, our real-life Cinderella. This view, that Western countries must no longer worry about such issues, is held by many. The debate regarding the allocation and structure of power and wealth in society is not new. This writer argues, however, that rich, democratic, western countries are at a critical point, because recent changes in wealth inequality have occurred at such unprecedented levels. In this article I aim to discuss this critical point, by looking at how such high levels of income inequality have come about; discussing why many people have not acknowledged it as a problem despite the risks involved; and how we are now starting to see a shift in opinion and a more public challenge of the status quo. Perhaps the West does not conform to Disney’s ideals as much as we may think. A recent OECD report outlines how over the twenty years prior to the global financial crisis, its member countries (generally consisting of rich, western and democratic countries) have seen their real disposable household incomes increase by an average of 1.7% a year. Over the same period, the incomes of the richest 10% grew faster than those of the poorest 10%, resulting in

an increase in income inequality. In OECD countries today, we see a ratio of 9 to 1 when considering the average income of the richest 10% compared to the poorest 10%. It is worth mentioning that among these countries, some have experienced growing disparity more than others. Few countries, like Greece, actually experienced a fall in inequality, although they were very much bucking the trend, as fig.1 shows. Furthermore, the Gini coefficient, a measure of inequality that ranges between 0 and 1 (0 represents equal incomes and 1 represents all of the income going to one person) increased in recent years by almost 10% amongst OECD countries, having changed from an average of 0.29 in the mid 1980’s to an average of 0.316 in the late 2000’s. Analysis of smaller percentage increments at the top reveals more shocking statistics. In 1980, the top 1% of income recipients in the U.S earned 8% of all pre-tax income ; by 2008, their share had risen to 18%. In 2007 the richest 1% of the American population owned 34.6% of the country’s total wealth. This trend was mirrored by many other OECD countries. In the UK today, the 1000 richest individuals (0.003% of the electorate) increased their wealth by £35 billion in the last year alone, to a total of £449 billion . From 1980 to 2008, New Zealand’s top 1% captured 20% of total income growth. It is important to note that the disproportionate rise of the super rich is a

Figure 1

Image by ajagendorf25

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relatively recent phenomenon. At present you need £430m to feature in the top 200 of the Sunday Times’s annual rich list for the UK; the year 1990 required a relatively meager £50m. What has evoked such a change? Rising disparity has been attributed to several factors, about which there has been much debate, contributing to an ongoing literature. It mostly focuses on reasons including: the impact of regulatory reforms in labor and product markets, a change in tax and benefit systems and the impact of technological change and globalization. On globalization, opinion is mixed. Traditional trade theory (e.g. Kremer & Masking, 2006) states that an increase in trade integration will lead to skilled workers in rich countries receiving greater relative wages to those who are less skilled, thus contributing to greater levels of inequality in those countries. But several cross-country studies (review by Milanovic and Squire, 2005) find that trade integration results in an inequality hike for countries that have either higher or lower wages, which directly conflicts with the traditional theory. Leading trade economists like Paul Krugman, who previously held the view that the effect of trade on inequality was at most slight, now believe globalization to be more important. Technological change, which can often be difficult to disentangle from globalization, has also been thought to contribute to an increase in income inequality, because ICT advances tend to be skill-biased and lead to a disproportionate benefit. Indeed, the IMF found in 2007 that “technological progress had a greater impact than globalisation on inequality within countries.” Image by Ebony Inyangete

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Lastly, there is considerable evidence that changes to institutions, regulations and policy choices are very influential. For example, reductions in tax levels, the removal of trade barriers and the rationalisation of a country’s welfare state have all been shown to affect income inequality. It is difficult to attribute the recent growth in inequality to specific factors measurably. It seems likely that while different OECD countries may have traversed down slightly different paths depending on how specific policy measures were implemented, all of the paths were carved by a strong current of globalization and technological change, and thus lead to similar results. The recent rise in western inequality has split opinion. While some people are unaware or indifferent, others believe that the recent surge in inequality is an acceptable and arguably beneficial part of modern life. A popular view is that inequality is simply a necessary by-product of our capitalist society. It is therefore a reasonable price to pay in order for everybody’s standard of living to improve. Public figures like Alan Sugar, who didn’t come from rich backgrounds but are self-made millionaires, are often brought up in conversation to highlight that these days anybody can be rewarded by hard work. The argument suggests that society requires rich people to act as walking incentives for others to work hard and succeed; we can all aspire to be Lord Sugar’s apprentice. Indeed, the presence of monetary incentives and the resulting rise in incomes of several

entrepreneurial individuals was a key factor in enabling the first period of sustained economic growth in history: the industrial revolution. While these claims can be argued, they disregard several important issues. There are other ways of thinking. Firstly, Alan Sugar does not conform to the norm. The Sutton Trust , who aim to improve social mobility through education, have shown that in the UK: “over half of today’s 500 leading figures across five different sectors were educated at independent school, even though these account for just 7 per cent of the school-age population.” The industrial revolution took place at a time of inherent inequality, where a small elite group ruled over millions of others. The commendable development of secure and inclusive institutions allowed ingenuity and entrepreneurial spirit to be rewarded with large profits, and led to Britain and other Western countries becoming very rich, and more unequal. But we are now over a hundreds years on from the industrial revolution, and we are forgetting the fact that between now and then there was an almost global pressure for redistribution, resulting not only in the rise of communism but also in great changes within capitalist economies, including the introduction of social protection, government regulation and progressive taxes. The result of this was that for several decades in the mid-twentieth century the income of those at the top of the distribution curve grew slower than those at the bottom and the middle. Importantly, while this was going on, it didn’t prevent growth from occurring. It is therefore 09

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a misconception that growth cannot occur without rises in inequality. Indeed, it could be argued that the ability for countries to provide for their citizens in such a manor was the most significant achievement of the industrial revolution, not the vast riches attained by a small group. The arguments against income inequality go further than just a rebuttal. We must acknowledge the gross extent to which the current levels of inequality can pose a genuine, active and substantial threat to Western society and the opportunities of future generations. Firstly inequality may directly contribute to reduced well-being, because citizens see society as unfair. It is likely that in our increasingly unequal western society, the utility loss from being relatively poor is greater than the utility gain from the few who are very rich. More importantly we must consider the effects inequality can have on opportunity. Young people who come from wealthy families are provided with the environment and resources that those from less wealthy families do not have, making them more likely to succeed, realise their potential and play an active role in contributing to society. It was not a coincidence that such a disproportionate amount of the UK’s 500 leading figures came from independent schools. The opportunities they had as children were better than those who came from poorer families, and so they were more likely to realise their potential and succeed. Millions of young people are constrained from achieving all they could for this reason. This is not just a social problem but an economic one too, given the inefficiencies that arise from competition being limited to those who had good opportunities. Thirdly, inequality impacts upon politics. Admittedly wealth cannot bring political power in the same ways that it can in many less developed countries, which suffer from poor institutions and excessive corruption. However extensive research into the importance of institutions, including that of economists like Acemoglu and Robinson , shows that the problem of economic power influencing political power occurs in pluralistic and democratic societies too (this currently takes the form of backing election campaigns, lobbying and meeting with politicians). We must be wary. Today’s levels of wealth and inequality have arrived so quickly and on such a grand scale, that we simply do not know the true extent to which this may influence politics and the way we live in the near future. If the problems associated with income inequality are so great, why hasn’t more be done to stop it? In the few decades

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preceding the 2008 financial crisis, very little was said or done publically to combat inequality in the west. Views of indifference and arguments similar to those we discussed earlier were very common. While many still hold these opinions, the global crisis has undoubtedly acted catalytically in provoking a growing movement and shift of public opinion against such a high level of inequality. The crisis dug up the road for many people in the west living comfortably in growing economies, encouraging them to question what had become the status quo. Perhaps the most vivid manifestation of this can be found in the ‘Occupy movement,’ the international protest movement against social and income inequality which was established in 2011.

One of the objectives of the Occupy Movement is to press for the universal adoption of a financial transactions tax (FTT) – the ‘Robin Hood Tax’ – which would apply on trades of financial products. The taxable amount would vary around an average of just 0.05%, and would generate billions in revenue which could be used for redistributive purposes. The European Commission found in September 2011 that an EU FTT on its 27 member states could raise €57 billion every year . While it has received support from many European countries, some, like the UK and Sweden, are still refusing, despite opinion polls in the UK implying that 61% support the tax (19% oppose). The tax has received strong global support, including that of movie stars and Nobel Prize winners for Economics Paul Krugman and Joseph Stiglitz. Another indication of the public speaking up against inequality can be found in New York, as recently elected mayor Bill de Blasio won with a mandate centred on combating income inequality. Inequality is an issue especially prevalent in New York - the ‘tale of two cities’. That he was the city’s first Liberal Democrat mayor in twenty years and won by a landslide victory, highlights the growing anti-inequality sentiment.

In the UK income equality campaign groups such as ‘The Equality Trust’ and ‘Positive Money’ are gaining support. A groundbreaking referendum in Switzerland took place in November 2013 questioning whether executive pay should be capped at 12 multiples of the lowest paid workers in the firm. The cap was in fact rejected by a small margin; however the fact that a referendum took place at all suggests that current systems are being challenged. It seems unlikely that the changes which have occurred so far will have a considerable direct impact on restricting the increasing rate of income inequality. This does not mean such attempts were futile. The shift we are seeing in public opinion has occurred relatively recently and is still evolving. Even if the collective effect has simply been to make the presence of inequality (and the risks it poses to society) more widespread and known, then it has served a purpose. This is because big policy measure changes take time to construct, and are usually first preceded by significant pressure from the electorate, which requires public opinion to be forceful like we have seen in New York. Over the two centuries since the industrial revolution the west has sustainably and consistently grown, but the high levels of income inequality we currently see have not always occurred. It is important to challenge the idea that capitalist societies inherently rely upon such high levels of inequality. We must continue to consider the threats that allowing such great rises in income inequality can pose, such as ostracising millions of young people from contributing fully to society, and allowing a select few to manipulate the way we all live. In doing this, it is important to continue to question and challenge the way our societies function, applying the necessary forward momentum for significant and tangible change to occur in the future. References: http://www.oecd.org/social/soc/49499779.pdf http://oecdinsights.org/2013/10/24/rich-man-poor-manare-the-1-worth-it/ http://www.michaelmeacher.info/weblog/2013/04/richest1000-persons-in-uk-have-increased-their-wealth-in-lastyear-by-35bn/ http://www.suttontrust.com/news/news/the-educationalbackgrounds-of-500-leading-figures/ http://www.economist.com/economics/by-invitation/questions/how_does_inequality_matter http://en.wikipedia.org/wiki/Robin_Hood_tax http://classonline.org.uk/docs/YouGov-Class_Polling_Results_120522_Economic_Policies.pdf http://www.bbc.co.uk/news/business-25004132

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Help To Buy Scheme:

Political prowess or economic inadequacy? James Longman (BSc Economics, ‘15, The University of Nottingham)

The government’s Help to Buy scheme, first announced in Osborne’s ’13 budget should, via the stimulation of housing demand, translate into new housing being supplied. On the face of it this is good news for those in search of a home in the UK, where the average price is £172,000, rising to more than £250,000 in the South-East. With banks currently offering mortgages with a maximum loan-to-value (LTV) of 75%, the average buyer will need £43,000 up front. A decreased deposit should entice buyers into the market, especially considering that, at a median wage of £23,000, they may have needed to save for almost a decade before affording the aforementioned price. Despite this the nature of the UK housing market, namely that it is supply inelastic, suggests that the government’s efforts will not bear fruit and will instead increase house prices, thus out-pricing the young buyers the policy was designed to serve. How can this be? Indeed the policy is directed at first time buyers, however it is also open to homeowners, in fact a broad range of people wishing to buy up to a value of £600,000. No doubt the result will be an increase in demand and, ceteris paribus, an increase in price. Policy makers hope that a stimulus in demand for housing will encourage the building of new homes, however it is not that simple. In the immediate term there will be no opportunity for an increase in the supply of housing due to planning and construction lags, thus prices will increase in the short run. The issue is that in the UK, even in the long run, supply is not responsive to demand shocks. This is predominantly down to the inflexible planning system which, on an international level, is uncompetitive to say the least. On the local level there are virtually no fiscal incentives to promote new builds, meaning that local planning authorities bear most of the costs despite receiving few benefits. This is coupled with the fact that construction of new homes is often at the resistance of homeowners in the area.

price per square meter in the world, topped only by Monaco, despite offering new builds that, when compared to similar areas in the Netherlands and Germany, are 38% and 40% smaller respectively. With a surge in demand as a result of the Help to Buy scheme there is a risk to the tax payer that, in the event of the housing bubble bursting, there will be a significant gap between the value of the mortgages and the houses that underwrite them. Consider the case in the USA. Even during the pre-crisis housing boom Freddie Mac and Fannie Mae only guaranteed and securitised mortgages up to an 80% LTV, with the excess being taken care of by private mortgage insurance companies. The magnitude of a hit to the UK housing market would need not be nearly as big as the crisis of 2008 to cause significant trouble, sending the loans under water. This is because the UK government will take the first hit as they will not have the cushion of the private mortgage firms as was the case in the US. Interestingly the estate agent Hamptons have warned that despite requiring only a 5% deposit, the 95% mortgages in most parts of the UK will be more expensive than renting. It is only in London and the SouthEast, where house prices have continued to rise over the stagnant counties further North, that mortgages will be cheaper. The long term effects of home ownership in terms of capital gain are financially a better decision than renting, however for many young lowearners, the monthly savings achieved by renting may put them off buying. There is also concern over the fact that the Help to Buy mortgages are only affordable due to the teaser rates which, typically after a couple

of years, will increase causing monthly mortgage repayments to drastically increase. This is especially true if you consider that the base rate is likely to start increasing within the next 3-5 years in line with the Bank of England’s forward guidance. Neil Hudson, an analyst at Savills, has researched claims of the new help to buy mortgages costing 24% of household income. The chart shows historical data for the cost of mortgages as a percentage of income, and makes a clear case for the help to buy mortgages making up a larger percentage of income for both first time buyers and home movers. It must be noted that the help to buy scheme has only been active for a few months, so there is not currently enough data for a detailed analysis. A month following the introduction of the scheme, David Cameron announced that out of the 2,384 applications, 75% of applicants were first time buyers. This shows that the scheme is broadly aiding those that it set out to, though should the 25% figure of non-first time buyers increase, further questions over the scheme may be raised. So where does that leave us? Previous sceptics against the scheme had previously hoped that it would die a quick death due to a lack of interest in the market. Recent figures suggest that there has been modest interest, though the real concern is that we will be left with a policy that does more harm than good but that is also hard to get rid of. A way forward might be to increase supply side incentives to meet the increased demand, or perhaps reform the current council tax and stamp duty in favour of new builds. Either way, the scheme is in its infancy, and time will tell where the true costs lie and who shall end up paying for them.

Recent studies by Wouter Vermeulen and Christian Hilber, both involved in research at the LSE, published a paper in September 2012 “The Impact of Supply Constrains on House Prices in England”. They demonstrate strong evidence that an increase in local demand together with planning contains are in fact principally responsible for extraordinarily high house prices, especially in Greater London Area. The result is that parts of the UK have the 2nd highest house 11

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Evaluating Chicago’s Violence Reduction Initiative Nelson Auner and Redi Pilch (Economics, University of Chicago)

Abstract This paper aims to measure the success of the Violence Reduction Initiative (VRI), a recent strategy by the Chicago Police Department to target specific high-violence districts through increases in officers and partnerships with federal authorities. Utilizing publicly available crime and census data, we develop and test models using OLS methods (with crime rate as the dependent variable), and negative binomial methods (using crime counts as the dependent variable). We fail to find a significant drop in crime in target districts relative to other districts, after controlling for district effects, time effects, and temperature. Given the importance of the VRI’s goals, as well as its substantial long-term costs, we believe further research is necessary in evaluating the merits of the program. 1. Introduction Whilst crime rates have fallen in many major US cities over the last decade (namely Los Angeles and New York), crime, and in particular violent crime, has remained largely constant in Chicago. The stubbornly high level of crime remains a serious problem, and the city often features in national discussions on gun violence and homicides. Heading into his term as mayor, Rahm Emanuel vowed to make tackling crime one of his top priorities. At the beginning of 2012, Emanuel, and then Chicago Police Department (CPD) Superintendent Gary McCarthy, announced the “Violence Reduction Initiative”(VRI), a multi-pronged approach to reduce violence related crime in the 7th and 11th districts (Englewood and Harrison, respectively). At the time, these two districts accounted for nearly a quarter of all murders and shooting incidents in Chicago, despite being home to only five percent of Chicago’s 2.7 million residents. Several months after the start of the VRI, an official press release from the mayor’s office labelled the program a success and called for its expansion. Although crime counts and homicides did decrease in target districts following the VRI, our analysis indicates 12

that this effect can be largely explained by other factors unrelated to the crime reduction program; namely the weather effect on crime, district-level effects, and a city-wide phenomenon of lower violent crime in 2012. In order to account for the possibility of an unknown start date of the VRI, we test start dates over a period of nearly 9 months, from one month prior to the press release announcing the start of the VRI to eight months post press release. Our results do not find significance for the efficacy of the VRI using any start date in the nine month period. 2. Literature review Previous literature has focused on the effect of weather on criminal behaviour, as seen in ‘The dynamics of Criminal Behaviour: Evidence from Weather Shocks’ (Jacob et al., 2004). It uses lagged temperature as an instrument to test the effect of lagged crime on current crime, and finds evidence in favour of a displacement effect. That is, after controlling for temperature, spikes in past crime actually lead to lower crime today, and vice-versa. In this research, we use temperature as a control in our models in order to account for its effect on crime. For example, some in the CPD anecdotally attributed to year-on-year decreases in homicides in 2012 compared to 2011 on “Officer Weather”, given colder temperatures during spring of 2012 compared to 2011. Likewise, many blamed a spike in homicides in summer 2012 on heat waves. We account for these potential issues by including maximum temperature and interactions between maximum temperature and other variables within our model. Program evaluation of CPD policy remains largely absent from publicly available academic literature. A recent report published by the Department of Justice evaluated the effectiveness of the “Deployment Operations Centre”, a system that defined hot spots for crime and allocated police teams accordingly (Alderden et al., 2011). The Department of Justice placed crime researchers within CPD units and

tested crime count data, adjusting for lagged crime counts and socioeconomic variables. They found that the Deployment Operations Centre did not have any significant effect on any type of crime data, and offer a variety of explanations for why the DOC did not produce any significant drops in crime. Program evaluation literature generally focuses on a single, known start date and uses a Chow test to check for structural breaks. When the start date is unknown, however, this testing can become more difficult. Morrison (2003) tests a Boston initiative to reduce youth homicide when the start date is unknown. They test for possible announcement effects, as well as lagged implementation effects. They take the supremum of the Wald statistic as the effective “start” date of the program, but because the supremum of a Wald statistic does not have the same critical values as the Wald statistic in a standard test, they use Monte Carlo methods to test finite sample properties. We also test for rolling implementation effects, and we find that even under conventional critical values, no start date in the given period produces significant results. 3. Overview of the VRI At the beginning of 2012, as part of Mayor Emanuel’s crime-reduction strategy, the City of Chicago and the CPD announced the “Violence Reduction Initiative” targeting districts 7 and 11 (Englewood and Harrison, respectively). According to the CPD, these districts were based on the number of violent crimes committed, specifically those involving guns and those resulting in homicide. The violent crime rate is approximately 3 times higher in these two districts than elsewhere (see Table 1). According to a press release from the mayor’s office, the program began at the beginning of 2012. We typically use February 1, 2012 as the start date, although we test start date specifications ranging from January 2012 through to September 2012. The VRI consisted of redeployment of officers from other districts, almost entirely by moving administrative officers from other

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districts to patrol in target districts. The shift in police tactics was accompanied by greatly increasing officer overtime, whereby officers working in other districts could work extra patrol shifts in target districts. The CPD also enlisted the help of federal agencies such as the Federal Bureau of Investigation, the Drug Enforcement Agency, the Department of Justice, and the Bureau of Alcohol, Tobacco, Firearms and Explosives. Approximately one month after the introduction of the VRI, CPD Superintendent McCarthy revealed that the program showed signs of success. On August 31, 2012 (approximately 8 months after the apparent start of the VRI), a press release from the mayorâ&#x20AC;&#x2122;s office formally announced the program a success. Although the CPD did not release the metrics used to evaluate the success of the program, a press release issued by Superintendent McCarthy claimed that the VRI prevented 90 murders. Table 1 indicates that in the year post-VRI, murders in target districts decreased by approximately one-quarter, while murders in non-target districts increased by thirty percent. Moreover, a simple examination of the violent crime rate before and after the VRI indicates that violent crime did decrease in the two target districts, and based on news reports, we believe that CPD used a reduction in crime counts as part of the metric of success. Despite this, we believe that this analysis ignores many other factors influencing crime, namely district heterogeneity, weather effects and systematic shifts in crime over time.

Table 1 Summary of violent crime in Chicago

(Violent crime rate is annual count per 100,000 people) Violent crime rate

Homicides

District no.

District

Population

2011

2012

2011

2012

Central

56,188

1,593

1,675

Wentworth

95,419

1,903

1,768

Grand Crossing

76,708

2,907

2,919

South Chicago

128,039

1,988

1,943

Calumet

81,796

2,440

2,340

Gresham

97,547

2,526

2,492

Englewood

72,353

3,638

3,330

Chicago Lawn

246,916

991

947

Deering

162,704

1,100

1,047

Ogden

110,892

1,504

1,550

Harrison

70,770

3,449

3,236

Near West

69,828

1,038

1,234

52,268

1,510

1,301

Shakespeare

118,985

990

900

Austin

58,267

2,861

2,679

Jefferson Park

229,083

345

331

Albany Park

152,349

582

492

Near North

114,725

802

696

Town Hall

204,410

578

564

Foster

89,864

544

545

Morgan Park

106,850

1,135

1,160

Rogers Park

142,963

688

720

Grand Central

201,990

1,041

1,021

Target districts

143,123

3,544

3,283

104

Non-target districts

2,597,791

1,264

1,231

331

431

City

2,740,914

1,446

1,396

435

510

4. Data 4.1 Crime data Our data is drawn from publicly available crime data released by the CPD on the Chicago Data Portal. The CPD crime data consists of individual level crime data with variables for primary type, day, time, location (by block and also latitude, longitude), district, as well as several other factors. We aggregate the primary type for each crime into three categories: Violent Crime, Property Crime, and Other. We classify each crime according to the definitions listed by the Federal Bureau of Investigation. Violent crime consists of homicide, forcible rape, robbery, and aggravated assault. Property crime consists of burglary, theft, motor vehicle theft, and arson. 4.2 Population data In order to analyse changes in crime rate, we need to find population for each district. As this data is unavailable, we use census data from the American Community Survey 2011 five-year estimates, which measures

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population at the census tract level. Most census tracts lie entirely within a single district, but for overlapping census tracts we assign its population to the two districts proportional to the number of crimes committed in each district for that census tract. Our underlying assumption is that crime is uniformly distributed within a census tract. After obtaining population at the district level, we collapse the data to both the day and week level, by type of crime and district.

temperature variable when using day is the maximum temperature, and our temperature variable when using week is the average daily maximum temperature throughout the week. Figure 1 Violent crime vs temperature in Chicago

4.3 Weather data Previous literature has found that temperature has a strong effect on crime, with hotter temperatures correlating to higher crime rates (see Section 2). An OLS regression of the daily count of violent crimes on maximum temperature for the city of Chicago supports this result. We test temperature in our models using data from the National Oceanic and Atmospheric Administration as reported by Oâ&#x20AC;&#x2122;Hare International Airport. Our 13

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Table 2 Log violent crime rate: linear model

Variable

Figure 2 T-Values for interaction between post-VRI and target dummies

2010-2013

1yr Pre/Post

6mo Pre/Post

(1)

(2)

(3)

4027

2451

1311

Temperature

.009

.0097

-.011

(0.0014) Post Temp x Target Post x Target

-.1868

(0.0023) *

-.1207

(0.0038) *

-.375

(0.0195)

(0.0275)

(0.0897)

.0016

.0017

.0003

(0.0017)

(0.0024)

(0.0031)

-.0375

-.0472

-.0075

(0.0396)

(0.0516)

(0.0664)

Temp x Post

.0052

.0033

.0133

(0.001)

(0.0014)

(0.0031)

5. Empirical results 5.1 Model We found that whilst crime decreased across the entire city in 2012, the reduction was not limited to target districts. Moreover, we found that while overall violent crime counts decreased more in target districts than elsewhere, this result can be explained by the fact that crime counts are generally higher in the target districts. In terms of proportions, the crime rate did not decrease noticeably more in target districts than in non-target districts. Overall, our findings indicate that, after controlling for other factors, the VRI did not reduce the violent crime rate in target districts. Let the log violent crime rate (per 100,000 people) at week t in district i be a function of temperature and dummies for target district and post-VRI: (Model 1)

log Yit = αm + γi + β1Tempt + β2Tempt × Iitarget+ (δ1 + δ2 × Iitarget + β3Tempt) × Ipostt where Yit is the weekly violent crime rate per 100,000 people in district i at week t; αm is a month fixed effect; γi is a districtlevel fixed effect; Tempt is the average daily maximum temperature for week t; Iitarget is an indicator variable equal to 1 if the district is a target district and 0 otherwise; It is an indicator variable equal to 1 if the week occurs after the start of the VRI. The variables are interpreted as follows. The variable αm reflects the month fixed effects. The variable γi, a district-specific fixed effect, reflects unobserved qualities of district i that we assume do not change over the period we examine (2010-2013). The variable Tempt captures the weather effect on crime to control for temperature in our analysis. 14

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For example, many academics blamed the record murders in 2012 on warmer weather. We interact temperature with a target district indicator and a post-VRI indicator to test for different effects of temperature on both the marginal crime rate in target districts, and what happened after the start of the VRI. Table 2 (above) shows the results of Model 1 (left) given above under three specifications that vary the time period of consideration. Specification (1) considers all crime from 2010-April 2013; specification (2) considers crime from 1 year prior to the VRI to one-year post-VRI; specification (3) compares 6 months prior to the VRI to 6 months post. The start date of the VRI for all three specifications is the same: February 1, 2012. Under all three specifications the violent crime rate is positively related to temperature, with approximately a 1% increase in the violent crime rate for every one degree Celsius increase in temperature. Over the period following the VRI, citywide crime in Chicago decreased significantly in each specification.

before, at the city level. We also test using multiple start dates, from January 1, 2012 through to September 2012, following Morrison, 2003 to test for announcement effects or lagged implementation effects (see Section 2 for details). Figure 2 (below) shows the t-values associated with the coefficient on the interaction between the Post-VRI dummy and the target district dummy. Even at the supremum, the t-value does not reach significance at the 5% level, and as Morrison shows, the critical values for the supremum of a Wald statistic far exceed the conventional critical values. A represents the full period, whereas B represents the full period excluding the last 2 weeks of each year (holiday period), since crime tends to fall dramatically below trend during these times.

The coefficient of the interaction between temperature and target is not significant under any specification, suggesting that the VRI did not have any differential effect on violent crime in target districts (that is, there was no slope change in the line regressing the violent crime rate on temperature). Similarly, the coefficient of the interaction between target and post is never significant, suggesting there was no parallel downward shift in that line for target districts. Finally, it can be seen that the interaction between temperature and post is significant. The positive coefficient shows that in the time period following the VRI, temperature had a larger differential effect on violent crime than

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5.2 Monte Carlo simulation Following the procedure used in Morrison, we also run a Monte Carlo Simulation to control for the possibility that the asymptotic critical values are not appropriate for the Wald statistics due to a small sample size. We randomly re-assign each observation of the outcome variable (crime rate) to an observation from the set of explanatory variables, and then take the supremum t-value for the set of possible program start date as described in the previous subsection. We repeat this process 1,000 times to bootsrap a distribution of the maximum t-value over possible program start dates. For each coeffecient of interest, we find that the supremum t-value at the 95th percentile of the t-value statistic from the simulated data is higher than that from the original data. These results give support to our initial finding of the non-significance of the VRI program dates on crime rates. 5.3 Count data and non-linearity To ensure robustness of our results, we also test a model using a negative binomial regression for several reasons. Firstly, the model in Equation 1 uses log of the violent crime rate for district i in week t, meaning the model is not suitable if there are districts without any reported violent crime in a given week (this occurs in 9 out of 4038 observations, and we exclude these 9 observations in the above model). A negative binomial regression allows for this. Secondly, we want to test non-linearity in our model. Thirdly, the above model uses the crime rate, although we would also like to test a model that uses crime counts as the outcome variable. The negative binomial distribution is often used in the regression analysis of count data, as it is a generalised form of the Poisson distribution that allows for a variance not equal to the conditional

mean (the mean count of violent crimes in a district in a week is 29, while the variance is 225). The signs and the significance of the coefficients are very similar to those obtained from the linear model (see Table 3, above right). 6. Conclusion We find that after controlling for other factors such as district heterogeneity, time fixed effects, and temperature, there is no significant effect of the VRI on violent crime. Using simple metrics such as violent crime count and homicide count before and after the VRI, the results show that crime decreased in target districts following the VRI. However, the effect of the VRI is entirely inconclusive when using more sophisticated techniques. Our analysis calls for further investigation into the VRI and CPD policy in

1yr Pre/Post

(1)

4027

2451

(2)

1311

Temperature

.0104

.0105

-.0044

-.09

-.3679

(0.0011)

Temp x Target Post x Target

-.1522

(3)

(0.0016) (0.0204)

(0.1423)

.0012

.001

.0003

(0.0011)

(0.0015)

(0.0020)

-.0329

-.0386

-.0104

(0.0322)

Morrison et al. (2003). Testing for Structural Breaks in the Evaluation of Programs, The Review of Economics and Statistics, Vol. 85, No. 3 (Aug., 2003), pp. 550-558 Office of the Mayor, City of Chicago (2012). Mayor Emanuel, US Department of Justice and Chicago Police Department Expand Successful Violence Reduction Initiative to Additional Districts, Mayor’s Press Office. [Online]. Accessed from: www. cityofchicago.org/city/en/depts/mayor/press_room/ press_releases/2012/august_2012/mayor_emanuel_ usdepartmentofjusticeandchicagopolicede html

(0.0421)

Temp x Post

.0035

.0018

.0113

(0.0008)

(0.0010)

(0.0044)

Image by Sumi-I via Flickr

(0.0036)

(0.015)

(0.0104)

Alderden et al., (2011). Gang Hot Spots Policing in Chicago: An Evaluation of the Deployment Operations Center Process, report for the Department of Justice. [Online]. Accessible from: www.ncjrs.gov/pdffiles1/nij/grants/239207. pdf

Levitt (1998). The Relationship Between Crime Reporting and Police: Implications for the Use of Uniform Crime Reports, Journal of Quantitative Criminology. Vol. 14, No. 1.

6mo Pre/Post

Variable

Post

References:

Jacob et al., (2004). The dynamics of Criminal Behavior: Evidence from Weather Shocks, NBER. [Online]. Accessed from: www.nber.org/papers/w10739

Table 3 Violent crime rate: negative binomial model 2010-2013

general. Further areas of research include using domestic violence as a control, given the idea that the VRI should have reduced non-domestic violent crime while leaving domestic violence virtually unchanged, as the VRI involved assigning more patrol officers to the street (which will presumably have negligible effects on domestic violence). In addition, research into the social benefit/cost of the VRI is warranted, given the expense of the program. This could involve examining changes in property values in response to changes in the violent crime rate.

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Financial Fair Play – Fair or Foul? Wilson Chow (BSc Economics, ‘14, The University of Nottingham)

The world record of football transfer fee has once again been broken after 4 years since the transfer of Cristiano Ronaldo at £80 million to Real Madrid in 2009. This time, it is Gareth Bale, a Welsh national playing at Tottenham, whose transfer fee reaches £85.3 million. Although the direct link between money and football success is ambiguous, football clubs with a considerable amount of capital can strengthen their team by acquiring star players, which helps increase the possibility of winning matches. This practice of highprofile transfers has become fairly common since the start of 21st century where high net worth individuals are injecting money into football clubs in hopes of winning trophies. Unsurprisingly, the result has been mixed: some clubs over-leveraged and declared bankruptcy, for example, Leeds United in early 2000s and Glasgow Rangers in 2010. However, some clubs splashed money to build stronger squads that successfully brought in trophies; such as Chelsea and Manchester City. The landscape of the football industry has undergone significant changes since the influx of capital from outside inflated footballers’ salaries and transfer fees. The current situation is worrying because many football clubs are running deficits and rely on their wealthy owners to pay the debt. According to a UEFA (Union of European Football Association) benchmarking report in 2009/10, 372 out of 665 (i.e. 56%) European clubs are in debt. To remedy the situation, UEFA approved the first-ever Financial Fair Play Regulations (the FFP regulations) in 2009 and then applied it in 2011/12 season to monitor the financial status of football clubs. The main objective is to promote long-term financial sustainability in football clubs, and hopefully, structural stability in the industry. Before we discuss the impact of the FFP regulations on the football industry, it is important to understand how the industry has been doing so far and the details of the FFP regulations. The ecosystem of the football industry We can use a two-factor model to understand how a football club operates. It is a fairly simple model in which the 16

football club produces a ‘service’ in form its performance, which can be quantified by, but not limited to, the number of wins or trophies in each season. Football clubs (sellers) are highly differentiated from one another because each of them has a distinctive squad, playing style and management philosophy etc. The interaction between football clubs in different leagues reached a new era after the decision from the European Court of Justice, also known as the Bosman ruling, which allows EU players to enjoy freedom of transfer to another football club at the end of a contract without a transfer fee. (Article 39, EC Treaty) Unlike a commercial business, a football club does not necessarily aim at profit maximisation. A football club as a utility maximiser was a concept firstly mentioned by Sloane (1971) where he stated that the utility objective of a football club is a function of fan welfare and satisfaction subject to financial constraints. This is consistent to what we have observed. Some football club owners are willing to inject substantial amount of capital and sacrifice monetary return for football success.

“According to a UEFA (Union of European Football Association) benchmarking report in 2009/10, 372 out of 665 (i.e. 56%) European clubs are in debt.”

On the other side of the model, football fans are buyers of the football service produced by football clubs. They support their football clubs by buying match tickets and relevant official products, such as football shirts and training kits. The total number of seasonal ticket sales increases from 445,281 in 2004/05 to 476,776 in 2012/13 and prices range from £299 to as high as £985 (BBC Sport Price of Football study). Despite that, gate receipts are not the biggest source of revenue at a football club. In fact, they contributed only 19% of

the total revenue combined by all UEFA member clubs in 2011, the same proportion as commercial gain and other income. (Q.32, UEFA 2011) The biggest revenue comes from broadcasting (37%), followed by the advertising and sponsorship (25%). Broadly speaking, broadcasting companies and sponsors are also buyers of the football service. However, football fans are ultimately the ones who spend. For instance, pay-TV companies need people to subscribe to their football channels and most likely these consumers are football lovers who hold a high value in watching live football on TV. With more and more people watching their paid channels, broadcasting companies are able to attract more advertisements and hence willing to pay a skyrocketing fee to compete for the exclusive broadcasting rights. That is exactly what we have seen. The price of broadcasting rights surges every 2-4 years when a new deal is negotiated. Indeed, the most recent £897 million paid by BT was previously priced at £395 million by BSkyB and ITV. This deal to secure exclusive rights to broadcast the Champion League and Europa League for three seasons, starting from 2015, has highlighted how much profit the exclusive broadcasting rights can potentially generate from a business perspective. Now, we have understood the main parties in the football industry. Football clubs produce matches in return for money that comes from gate receipts, broadcasting rights, sponsorships etc. Similar to any professional sport, it is crucial to maintain the competitive balance in the football industry. Competitive balance in football implies a situation where no football club is too big and holds significant advantages over the others. Simon Rottenberg, who did an influential research in the economics of professional sports, discussed the importance of uncertainty in outcome in sporting occasions to ensure the competitive balance. The uncertainty of outcome hypothesis states that revenue is affected by the winning percentage. This winning percentage is decreasing at the margin until a certain level at which the club becomes too dominant and revenue begins to decline. (Rottenberg 1956) In other words, an optimal equilibrium would be the situation where

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Table 1 Total broadcasting payments to the Premier League football clubs in season 2012/13 (according to the ranking) Club

Ranking

Equal Share

Facility Fee

Merit Payment

Overseas TV

Total

Manchester United

13,803,038

12,961,615

15,117,620

18,931,726

60,913,999

Manchester City

13,803,038

11,047,387

14,361,739

18,931,726

58,143,890

Chelsea

13,803,038

8,654,602

13,605,858

18,931,726

54,995,224

Arsenal

13,803,038

11,525,944

12,849,977

18,931,726

57,110,685

Tottenham Hotspur

13,803,038

11,047,387

12,094,096

18,931,726

55,876,247

Everton

13,803,038

7,697,488

11,338,215

18,931,726

51,770,467

Liverpool

13,803,038

11,525,944

10,582,334

18,931,726

54,843,042

West Brom

13,803,038

5,783,260

9,826,453

18,931,726

48,344,477

Swansea City

13,803,038

5,783,260

9,070,572

18,931,726

47,588,596

West Ham United

13,803,038

7,697,488

8,314,691

18,931,726

48,746,943

Norwich City

13,803,038

5,783,260

7,558,810

18,931,726

46,076,834

Fulham

13,803,038

5,783,260

6,802,929

18,931,726

45,320,953

Stock City

13,803,038

5,783,260

6,047,048

18,931,726

44,565,072

Southampton

13,803,038

5,783,260

5,291,167

18,931,726

43,809,191

Aston Villa

13,803,038

7,697,488

4,535,286

18,931,726

44,967,5538

Newcastle United

13,803,038

8,654,602

3,779,405

18,931,726

45,168,771

Sunderland

13,803,038

7,697,488

3,023,524

18,931,726

43,455,776

Wigan Athletic

13,803,038

5,783,260

2,267,643

18,931,726

40,785,667

Reading

13,803,038

5,783,260

1,511,762

18,931,726

40,029,786

QPR

13,803,038

6,261,817

755,881

18,931,726

39,752,462

Source: Barclays Premier League

people are uncertain of the match outcome and that no club is in domination over a long period. Bizzachi et al. (2003) define this as the dynamic competitive balance. Intuitively, it means that a football league as a whole is considered to be successful if clubs have approximately equal chance to win a match. Imagine if there is always a dominating club getting all trophies, football fans will probably feel bored of the game. Therefore, the fewer the number of fans who watch matches in the league, the less the amount of revenue generated by the league and eventually, it hurts every single club. In short, the ‘ecosystem’ of the football industry requires the symbiotic relationship between football clubs. It is not an optimal situation for a club to be a monopoly for a long period of time. Financial fair play – time to breakeven The FFP regulations come into play against the backdrop of worsening financial status of football clubs and inflationary pressure on footballers’ salaries and transfer fees. In the updated 2012 edition, there are 74 articles in the UEFA Club Licensing and Financial Fair Play Regulations. Any breach of these regulations may result in different disciplinary measures, e.g. a fine, a ban from participating in the UEFA competition for one

year, a withdrawal of revenue from a UEFA competition or the withdrawal of a title, etc. Although the full FFP regulations also take into consideration no overdue payments, here we primarily focus on discussing Article 58-63, which contain the controversial breakeven rule. To understand how the breakeven rule works, we must firstly get to know two important terms, relevant income and relevant expenses. The word ‘relevant’ can be understood as ‘football-related’ activities. So, relevant income includes revenue from gate receipts, broadcasting rights, sponsorships, advertising etc., but does not include income from non-football operations. Meanwhile, relevant expenses include cost of sales, salary paid to footballers and other operating expenses. Certain kind of expenses are excluded, namely, expenditure on youth development, depreciation of tangible fixed assets, direct cost incurred in stadium constructions etc. The breakeven rule requires that the maximum aggregate deficit for a football club is limited to €45 million over the monitoring period in 2013/14 and 2014/15. The monitoring period consists of the latest three seasons, with an exception of two monitoring periods in 2013/14 because of the inception of the FFP

regulations in 2011/12. The aggregate deficit is further limited to €30 million over the next three seasons ending in 2017/18. However, in any season, if owners do not inject equity into the club, the acceptable deficit would be €5 million per season. The objective of the breakeven rule is to stop any clubs from spending more than their income. This is a direct response from the regulatory body to encounter the practice of overspending by football clubs who are heavily subsidised by wealthy individuals. Equity injection does not fall into the relevant income and hence the amount of equity from club owners to cover losses is restricted. As a result, it will be no longer possible for club owners to input considerable amounts of money to buy short-term glory without breaking even. In 2012/13, the aggregate losses of UEFA members decreased 36% from €1,670 million in 2011/12 to €1,066 million in 2012/13. This is a significant step towards financial sustainability. While the breakeven rule deserves credit in relation to the reduction in aggregate losses, whether it has made the industry more attractive is worth further discussion.

Divergence or convergence? In my opinion, the biggest problem of the FFP regulations is its inequality nature. The breakeven rule is more likely to be a protection to the interests of existing big clubs in the European Championship League. Under the breakeven rule, football clubs cannot spend more than what they can earn. Big clubs can generate more revenues from achieving higher position in the league and uneven sharing of total broadcasting payment, so they will continue to be those clubs to spend big. In Table 1, we can observe a strongly positive relationship between league position and broadcasting income (correlation = 0.9619.). Let alone the amount of sponsorship and commercial gains, the football industry inherits a factor of divergence in which ‘success can breed success’. Arguably, equity injections from club owners are the most direct way for small clubs to break the status quo and boost performances with the acquisitions of stronger players. This is a risky move as there is no guarantee of success by injecting millions of pounds into the transfers of star players. Indeed these star players are also subject to injury and can potentially face problems such as a style of football that does not suit their qualities. However, it is purely a business decision and football clubs, as rational decision makers, are aware of underlying threats of their decisions and should be allowed to make a bet. A maximum cap on club deficit by the FFP regulations does not stand a very good argument in this aspect. The counter argument to the absolute freedom to spend is that this kind of unrestricted spending behavior has inflated the industry in the transfer market, increased player salaries, inflated costs of broadcasting rights, etc. It is seen that the FFP regulations are necessary to stop this irrationality and slow down the inflationary pressure. The argument for FFP regulations also includes the creation of greater long-term sustainability regarding competition between football clubs. This is seen in terms of their football quality and youth development. While the valuation of a player is fairly complicated, a simple view is that a transfer can only be made if the expected value added to the buying club is larger than the transfer cost, which has covered the value loss to the selling club, i.e. Value increase (buying club) > Transfer cost > Value loss (selling club). The price is never too high if there is a buyer, and on the other hand, the price cannot be set that high if there is no buyer. It is simply a transaction under the free market model where both buyers and sellers are mutually beneficial. 18

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Advocates of the FFP regulations would also consider the risks of football clubs overspending. Indeed, a clubs overspending may lead to a financial collapse or the club going into administration. It is argued that such an event may adversely affect the ecosystem of the industry. This argument requires detailed quantitative analysis into the impact of systematic risks triggered by a collapse of one, or more, football clubs on the league that they are in, which is out of the boundary of this article. However, there is hardly a situation where a club is too big to fail in a matured and structured league with well governance in play, especially when in the UEFA European Championship League or the Europa League. If a club was relegated or declared bankruptcy, it would be normal to see top players being signed by other teams while champion-following fans switched their support. The contagion effect of one club falling on the others seems not to be significant. The main issue seems to be that the restriction of any football clubs ability to pay significant transfer and salary costs may lead to a less competitive league. It is argued that it is not the business of regulatory bodies to downsize the amount of debt within the football clubs; such issues should be left as independent business decisions. The sunken iceberg We should not lose our sight that the real threat to the financial status of the football industry is not trophy-driven club owners, but the uncontrolled salary increases of players. Over last 5 years, the average salary growth (8.16%) outpaced the revenue growth (5.64%). At such a high rate, football clubs will end up in debt since outflow of capital is increasing faster than inflow. The majority of clubs spent over 60% of revenue on salary costs and 12% of total number of clubs spent over 100%, i.e. salary accounted for more than their revenue. (UEFA Club benchmarking report 2013/14) This is an alarming result and due to the rigidity of football contracts, it is going to be a hidden danger if nothing is done to deal with the issue. Investigating the possibility of imposing a maximum cap on salary on all teams would be a positive reaction to this. Professor Stefan Szymanski, the author of Soccernomics, found a positive correlation between the average league position and the average of player salary. Table 2 gives the empirical evidence where the scatterplot diagram revealed a positive slope between league points and total salary paid. By imposing a ceiling on salary payment in the league, it could effectively reduce the inflationary pressure on player salary as well as introducing a sense of fairness into the game when no clubs paid significantly more than others on salary.

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Table 2 Total amount of wages paid and points gained by clubs in the Premier League in season 2010/11, 2011/12 and 2012/13 Slope of line: 0.82712394 250 200 Salary (£ million)

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150 100 50 0

Points gained Source: adapted from the statistics in Ed Thompson

Further research can be done on the detail and implementation. The salary cap in National Basketball Association serves as a good reference model. In conclusion, the implication of the FFP regulations should deserve credit as UEFA has shown the courage to act and regulate a debt problem that affects many of its members. However, the inclined protection given to the existing big clubs is likely to worsen the competitive balance in leagues and lead to small clubs finding it even harder to catch up. In the near future, it is necessary to address this problem of rising player salaries instead of the debt problem in my opinion. Unchangeable is the fact that the FFP regulations have already been imposed. For football clubs, it is not a suitable time to discuss how to get rid of them nor to take advantage of loopholes, but a high time to reflect on its own management philosophy and how to cope with challenges. What is the best form of governance structure? How to nurture homegrown talents in youth development programs? For UEFA, the determination in enforcing the FFP regulations is a real test of its creditability. Is UEFA ready to impose sanctions on big clubs, for example, Chelsea, Real Madrid, PSG, etc if rules are violated even if it means a loss of commercial value by imposing restrictions?

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Conditional Cash Transfers:

A radical overhaul to social support for the poor Aman Navani (‘16, Columbia University)

Conditional cash transfer programmes have been the topic of intense debate in development policy circles recentlyespecially after the apparent success of these programmes in Brazil and Mexico. Becoming popular in the 1990s as a replacement for general subsidies, conditional cash transfers (CCTs) entail supplying money to poor families provided that they fulfil certain requirements such as sending their children to school or attending health facilities for routine check-ups. In this way, these programmes not only provide short-term income support for the poor, but also encourage long-term improvements in human welfare by incentivizing parents to send their children to school as well as taking them for regular health checkups. Moreover, CCTs are a more efficient method of providing social support to the poor as compared to more traditional public service delivery mechanisms,. This is because the cash goes straight from the central government to the recipient’s bank account, avoiding layers of bureaucracy and middle men Despite these advantages, it remains to be proven whether cash transfers are indeed the game changer that many development practitioners claim them to be. Whether the apparent success of cash transfers programmes in Brazil and Mexico can be replicated in other developing regions such as India and Africa is debatable. Finally, their effectiveness in reducing the intergenerational transmission of poverty is still unclear. This article seeks to evaluate the effectiveness of CCTs in replacing more traditional social support programmes. Are they really the silver bullet that can contribute to ending poverty? Cash transfers certainly have major advantages to traditional social support programmes. These traditional safety net programmes are prone to inclusion and

exclusion errors as poverty lines remain ever changing. Determining the poverty line itself is often a controversial and politically loaded exercise. Furthermore, social assistance programmes often prove to be fiscally irresponsible and often have a short-term focus. They are sometimes simply mechanisms for political patronage. Clientelism, paternalism and corruption are common features of these programs in developing countries. CCTs mark a shift away from simple short-term income support towards the more long-term goal of eradicating inter-generational poverty by incentivizing investments in human capital formation. Traditionally, the poor have tended to underutilize public schools and health clinics, partly because of difficult access to these services. There is more of a focus among these people on meeting their daily needs, as opposed to taking a longterm view of the future benefits of providing good health care and education for their children. By making these human capital investments more attractive, CCTs directly address the lack of demand for health and education facilities. CCT programs have notably improved government accountability in developing countries. They have often been implemented solely by a state’s national government and without the interference of local government or service providers. As a result of this, CCTs have facilitated more intimate relationships between the national governments and the beneficiary (Rawlings 144). If there is a delay in the transfer of cash grants, for example, or if a family is failing to receive a cash transfer despite living below the poverty line, the institution responsible for the lapse can be easily identified by the beneficiary. Conditional cash transfers also ensure that families use the money they receive responsibly. The conditions attached to the transfer counters criticisms of CCT programmes as mere handouts. CCT programmes encourage responsible behaviour on the part of both the national government and the beneficiaries. However, there is a school of thought that CCT programs divert attention away from much needed reform of public services (Rawlings 152). National governments have tended to focus upon implementation of the CCTs at the cost of actually improving the quality of public education and health

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facilities. Without CCTs being implemented alongside easy access to good quality the much needed improvement and public health and education services for the poor, conditions of the transfers will result in families being forced to use low quality health and education providers. This may do little to improve the level of welfare of these people. There is a risk that the success of CCT programmes might lead to national governments ignoring or underestimating the need of providing high quality health and education services, especially in rural areas. Another area which calls for concern is the sustainability of CCT programs. These programmes are financed predominantly by tax revenues, as well as domestic and foreign borrowing. Therefore nominal cash transfers must keep up with levels of inflation in the future. The ability of CCT programmes to act as safety nets in times of economic crises should also be questioned. In the face of decreasing tax revenue in a crisis as well as an increase in short-term poverty, CCTs may prove to be fiscally unsustainable when the economy is in a downturn. Despite there being long run concerns regarding the sustainability of CCT programs, as well as their real impact in reducing the transmission of intergenerational poverty, there is no doubt that they have marked a positive shift in the design of social support policy in developing countries. Tangible policy achievements such as the CCT programmes insulate matters of development policy from partisan politics because they force both sides of the political spectrum to adopt and build on a successful and popular programme. For example, Vicente Fox who took over as President of Mexico in 2000 after the PRI lost its hold on power, actually expanded the conditional cash transfer programme (Banerjee and Duflo 264). Perhaps the biggest success of conditional cash transfers is that they forge a political consensus on the importance of having a long-term development perspective, rather than simply focusing on short-term clientelism and patronage to gain political power. References: Banerjee, Abhijeet and Duflo, Esther. Poor Economics. USA:PublicAffairs, 2011. Print. Rawlings, Laura B. “A new approach to social assistance: Latin America’s experience with conditional cash transfer programmes.” International Social Security Review, Vol 58, 2005. Print

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The Predictability Of Markets: Can financial crises be prevented? Kevin Sharp (BSc Economics, ‘14, The University of Nottingham)

This year’s Nobel Prize for Economic Sciences was awarded to three economists whose work has contributed to most of what we currently know about the predictability of asset prices. Two of the three recipients however have directly opposing beliefs about the way markets work. The first, Eugene Fama, is a firm believer in the efficiency of markets and they’re predominantly unpredictable nature while denying the existence of bubbles. The other, Robert Shiller is famous for his warnings of unsustainable bubbles and market crashes along with his belief that markets display predictable tendencies, especially in the longer term. How can such contradictory beliefs work in unison to further the understanding of the functions of stock markets and which, if either, is correct? The other member of the trio, Lars Hansen, also needs mentioning. His work in the statistical field and his development of the Generalized Method of Moments (GMM), provided economists with a means of empirically analysing the two theories, something that had previously proved too difficult to do. The Efficient Market Hypothesis (EMH) The EMH states that it is impossible to predict what asset prices will be in the future. This is because any news or information about tomorrow’s price will affect the behaviour of investors today, so that today’s price already reflects the information about that future price. If news points to the fact that the price of a stock will be higher tomorrow, then investors will buy the stock today and increase today’s price to reflect this new information. These movements persist so that the expectation of tomorrow’s price becomes today’s price and the expected return is therefore zero. Eugene Fama is an avid believer in the efficiency of markets and, after all, it does make intuitive sense; if money can be made then investors will not pass away that opportunity, especially with managerial and shareholder pressures to make quick profits. There is a lot of evidence to support the EMH. In his empirical work in the early 1960’s, Fama showed that recent asset prices are of no use in predicting future short term prices and evidence from the last five years states that very few investors can consistently beat the market. The latter fact suggests investors are not very skilful, at

least not in the standard measure of skill we may use to rate footballers or chess players. But how does this explain those that often generate above average returns? Well much like the famous octopus that supposedly predicted the 2010 football World Cup results, they are most likely just products of luck rather than skill. Notwithstanding Robert Shiller has provided some evidence to the contrary. His work has shown that asset prices fluctuate a lot more than can be explained by their theoretical fundamental value i.e. what the stock is worth in terms of the present value of future dividend payments. Shiller, then, would be likely to criticise the efficiency of markets and look more favourably toward the work of behavioural economists, which describes how systematic human errors can provide some predictability to future asset prices, thus undermining the power of the EMH. Shiller has also found that over the longer term, data contained in the deterministic parts of asset returns, such as price-earnings ratios, can allow average prices to be forecasted. This suggests there is longer term predictability in markets and the EMH is more relevant in explaining short term prices. Behavioural finance The EMH relies on the fact that investors are rational; they correctly process all available information using Bayes’ Law, a mathematical theorem which allows investors to update the probability of events occurring based on new information or evidence they receive. However, buyers and sellers of stocks know that they have the same information and yet trade still takes place; this is primarily because they have differing opinions. The buyers think that the price is too low and likely to rise, while the sellers think that the price is high and likely to fall. The puzzle is why buyers and sellers both think the current price is wrong. Advances in Behavioural Economics have offered insights into this financial market puzzle, by looking at the role that human nature may play in the market. Due to humans’ behavioural traits and crowd psychology, there are predictable behavioural patterns in stock markets. Making investment choices is hard and investors often rely on heuristics or rules-of-thumb to make choices instead of working out optimal decisions based

on financial theory. Harry Markowitz, who was awarded a Nobel Prize for his work on financial economics, admitted: “I should have computed the historical covariances of the asset classes and drawn an efficient frontier.” Instead … “I split my contributions fifty-fifty between bonds and equities… My intention was to minimize my future regret.” Even the greatest thinkers in the field cannot overcome human nature. This causes individual investors to make mistakes which can create observable inefficiencies in markets. These mistakes include: possible overreactions to news or trends which can formulate bubbles, as well as a loss aversion principle which creates an unwillingness to sell shares that achieve nominal losses. In most cases however these human errors are cancelled out through the interaction of buyers and sellers, which many would argue leads to the EMH being a very good approximation of how asset markets actually function. However, there are cases when these human errors do not cancel out at all and are very much one sided, as investors all herd together. In fact, in the case of bubbles, investors have incentives to keep prices rising; unlike standard goods such as the price of rice, higher prices can actually increase demand because if prices keep rising then profits can continue to be made. Where markets can be identified as displaying the characteristics of a bubble (some, such as Fama, may argue this can never be the case), there is some predictability that future prices will generally be greater than today’s, no matter how far in excess of the fundamental value these prices are at. There continues to be two conflicting schools of thought regarding the predictability of asset markets. Those, like Fama, who adhere to the EMH, believe that markets are efficient and unpredictable because investors operate rationally. Others, like Shiller, who believe investors can act irrationally, believe this can sometimes make markets inefficient and to some extent predictable, especially in the longer term. Black Swans and Dragon Kings In light of the recent global financial crisis, scenarios such as bubbles and crashes have become increasingly important to policy makers, as this is where financial

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markets can cause serious damage to the real economy. In attempting to predict and avoid these catastrophic events, it can be useful to look at two concepts: ‘Dragon Kings,’ and ‘Black Swan’s, which tie in with the two conflicting views on the way markets operate. They both refer to the impact of extreme and outlying observations in complex and random systems, such as asset markets, but with one important difference: Dragon Kings can be forecasted while Black Swans cannot. Black Swans, popularised by statistician Nassim Nicholas Taleb, assert that an outlying observation or event occurs that is inherently unknown and unexpected from the realms of models and past trends, but which has an extreme and lasting effect on the system. Much like the sighting of a black coloured swan when all swans were perceived white, they shatter all current beliefs and in a stable complex system they can create havoc. Due to their unpredictable nature, they comply with the EMH and cannot be reflected in current prices. Another important feature of Black Swans is that human nature finds plausible and causal reasons after they have occurred which makes the unpredictable events seem inevitable with hindsight. The less well known Dragon King theory, in contrast, suggests that these extreme observations or changes in regimes can be predicted before the event occurs; that crashes can be predicted in real time. This concept has been developed by physician Didier Sornette who established and currently works at a “Financial Crisis Observatory.” In using advanced statistical procedures developed in chaos theory, he suggests that the outliers, such as major financial crashes, are generated inside pre-existing mechanisms that can be modelled and predicted. The shocks do not come from outside the system; they are not exogenous like a Black Swan, but instead are characterised by the system’s behaviour, possibly as a result of behavioural factors. According to this way of thinking, the major crises could have been diagnosed in advance. As described by Sornette in his recent Ted Talk, he has twice predicted the regime change of unsustainable Chinese stock market prices before they began to fall. He claims to be thoroughly transparent in his predictions so that he cannot be accused of only releasing his successful ones. His predictions of regime change are either accurate, or simply very persuasive and a result of luck. The problem here is that what Mr Sornette predicted was the inflation and then a slow deflation of an otherwise increasing bubble. If one was to predict and then subsequently prevent a crash from happening, then the prediction was inherently wrong, or at least can never be proved. Image by Ebony Inyangete

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However it does not seem too farfetched to suggest that trusted commentators such as Shiller and Sornette could have the power to persuade investors against creating unsustainable prices in the market. The model that we can use to describe the 2008 financial crisis therefore depends on whether or not it could have been predicted. With hindsight we can see that such a crash was certain, but that is of course the very nature of Black Swans. It is true that very few commentators confidently stated what was about to happen and few financial institutions fully insured themselves against the upcoming events, while the minority that did publicise warnings were generally ignored. Alan Greenspan, the former Federal Reserve’s chairman who is of the same view as Fama, insists that bubbles are impossible to predict when they are being formed. When dealing with Black Swans, policy makers have no scope to prevent crashes from happening, and predicting such events seems hopeless. Could the crisis be described as a Dragon King though? Robert Shiller has highlighted the extremity of US house prices in the decade prior to the 2008 crisis in comparison with historical rates, and has also analysed the extent to which stocks were excessively traded in comparison with profit streams during the dotcom bubble. The extremity of the US house prices, a major catalyst for the crash, and the predictability of longer term prices, suggests that the bubble and the subsequent crash could have been diagnosed in real time. Again there is still scope for the two to coexist: It may be quite possible to predict an environment where a Dragon King could hide but due to the human and herd instinct of bubbles and the incentives for ever increasing prices, it may still take an inconspicuous Black Swan to trigger a great crash. Conclusion As the financial sector and real economy have become increasingly intertwined it has become ever more necessary for economists to continue researching and learning about how markets work, especially in trying to eliminate crashes. The evidence that very few investors can consistently beat the market makes a strong argument in favour of efficient markets; if there is easy money to be made then the EMH makes perfect sense, and when the markets are theoretically inefficient it is incredibly hard to say when and how to capitalise on misalignments. It is also true that over the longer term there is scope for positive returns to be made; this does not undermine the unpredictability of short term trading.

In the case off explaining major financial events we can learn from the work of both Fama and Shiller. According to the EMH, predicting the timing of a crash is impossible and all crashes must be the result of a Black Swan. Others argue that because of the insights gained from behavioural finance, and due to the predictability of asset prices over the longer term, it can be possible to predict Dragon Kings, and therefore the inevitable future market crashes. In preventing future crashes, work must go towards the latter, Dragon Kings, as predicting the former is inherently impossible. Policy makers must try to predict, where possible, environments where bubbles are forming and attempt to tame the feisty herd of investors in the hope that they’ll rationally process this information. References: Methods for all moments The Economist http://www.economist.com/news/finance-and-economics/21588059-nobelprize-economics-reveals-how-little-we-know-about-behavio ur?zid=317&ah=8a47fc455a44945580198768fad0fa41 Daniel Kahneman: How cognitive illusions blind us to reason. The Observer http://www.nepistemology.com/sites/ default/files/kahneman.pdf the prize in economic sciences 2013 the royal swedish academy of sciences http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2013/popular-economicsciences2013.pdf Michenaud, S., & Solnik, B. (2008). Applying regret theory to investment choices: Currency hedging decisions. Journal of International Money and Finance, 27(5), 677-694. Dragon King beats Black Swan: Ted Talk with Didier Sornette. Reszatonline http://reszatonline.wordpress. com/2013/06/18/dragon-king-beats-black-swan-ted-talkwith-didier-sornette/ Didier Sornette: How we can predict the next financial crisis. Ted Talks http://www.ted.com/talks/didier_sornette_how_ we_can_predict_the_next_financial_crisis.html Asset prices: A very rational award The Economist http:// www.economist.com/news/leaders/21588090-investorscan-profit-insights-years-nobel-prizewinners-economics-ver y?zid=317&ah=8a47fc455a44945580198768fad0fa41

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The Free Trade Debate:

Developmental catch-up or heightened dependency Henry Ward (BSc Economics, ‘15, The University of Nottingham)

The uneven development of international markets is, and will continue to be, a major issue for the global system. The general consensus amongst economists suggests free trade is the best way to address this global inequality, however it still has its critics. Free trade is characterised by the removal of all tariffs and quotas on imports and exports in order to allow the free flow of both goods and services. The debate as to whether free trade could lead to developmental catch up is countered by those who believe free trade prolongs underdevelopment. I argue that free trade employed as Ricardo and other fathers of the free market intended it to be is the best way to achieve global equality. In the current global order there has been hostility to free trade. This is largely due to a reluctance of states to expose their domestic markets to the international market as the resulting loss of jobs through increases in efficiency is a significant fear of developing states. Take, for example, the opposition to the Doha Round, which states that many developing countries reject proposals on the grounds that they constrain their ability to deploy adequate development policies. Developing countries simply do not feel they will be able to manoeuvre effectively enough on the international stage to protect their own development. The activist group, War on Want, provides that trade liberalisation leads to the collapse of their industries and the loss of their jobs - developing country opposition is predicated around this fear making it unpopular. This widespread fear and suspicion of the employment of the free market as a strategy of development are misplaced due to an unrealised employment of true free market principles.

On the other side of the debate, critics like Martin Hart-Landsberg argue that free trade will not lead to any form of developmental catch-up. He argues further that, referring to the dependency theory; trade liberalisation contributed to the deindustrialisation of many third world countries, thereby increasing their import dependence. First postulated in the late 1940’s, dependency theory, and later world systems theory, have been concerned with the existence of core and periphery states. As a part of this world system the core will extort the periphery and prevent their ability to develop their own infrastructure and industry by destabilising social structures and by depleting their resources. As a result the core is able to remain dominant and to stunt the development of the periphery. A semi-periphery will also emerge, unable to progress to the core due to its technological weaknesses. Supporting these ideas, Theotonio dos Santos argues that dependency shapes a certain structure of the world economy such that it favours some countries to the detriment of others and limits the development possibilities of the subordinate economies. Andre Gunder Frank provides further analysis claiming there has been a ‘development of underdevelopment’. This is characterised by the uneven structures within underdeveloped states, exacerbated and enforced by free trade. World systems theory has however faced great criticism; most commentators note that the theory places too high a value on economic theory, causing a failure to

recognise the structure of redistribution within states. Using real world evidence, one can see situations where unrestricted access to the market will allow foreign corporations to exert a positive influence on the developing world. This is primarily via the introduction of technology into developing markets, such that the barriers of protectionism, as advised by critics of the free market, actually act as a disincentive to these corporations to invest in the protectionist developing state. An industry where this positive influence is seen clearest is the technology sector. The giants of Silicon Valley have the potential to promote unparalleled growth, but only if the relevant states can access the technology at the lowest possible price. In a paper on the transfer of technology at the United Nations Conference on Trade and Development it is argued that developing countries still pay more in royalties and license fees than they earn from their efforts to attract technology. Without a liberalisation of trade in technology the developing world will not be able to benefit from developments in this sector. Transnational Corporations such as Google are aiming to overcome some of the greatest barriers to development by building a framework for the mass distribution of information and technology. The magazine Foreign Policy correspondingly recognises the benefits of technological growth, claiming that connecting the world’s remaining 5 billion offline people to the internet will turbocharge global development.

The Ricardian theory of comparative advantage dictates that through the specialisation of production all states can benefit from free trade: O’Brien and Williams provide a simple explanation of Ricardo’s theory. Free trade will be of particular benefit to developing countries because they will be able to trade with any nation that possess products of potential. Developing countries will then be able to reap the rewards of trade, which will essentially lead to increased welfare. Due to the capital which free trade will attract, there will in turn be an increase in employment prospects and potential wealth for general populations.

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The TheNottingham NottinghamEconomic EconomicReview Review Developmental catch-up is undeniably linked to the availability of technology to the world. Under the dependence relation, there is a lack of transferability of technology between the core and the periphery. World systems theorists such as Vernengo are cautious; fearing the barrier presented by the global technological inequality will not be solved by free access for corporations looking to implement technology. He fears that without the infrastructure to develop their own technology, states will be incapable of developing and benefitting from technology, creating a greater dependence on the developed world and a greater divide within the state. This however is not the case; technological advances tend to filter through societies to benefit all. We have seen products and vaccines that were researched and developed in some countries make a massive impact on the development of others. An article in The Economist, “Printing: A Third-World Dimension” highlights the potential benefits of 3D printing for developing countries. It could redefine

Features Features the production process in a renewable and efficient way, allowing unparalleled potential for catch-up. The distribution and maintenance of these products also requires employment and therefore increases the number of jobs available around the world, but particularly in the third world, where labor tends to be the primary economic factor of production. Keohane and Nye refer to the unprecedented globalisation of communications networks as evidence of this. They cite low cost telephone calls around the world as being the result of the expanding networks of corporations around the globe. The growth of telecommunication technology has increased access to many of the necessary factors of development creating employment, which generates incomes and multiplies within the economy. Examples such as this have facilitated a faster catch-up. Developing countries need to accept that in order to achieve a global equality, they must

risk the dangers of the free market, which should eventually enable a developmental catch up. Without free trade between nations it will be impossible for third world states to develop. They must be able to access the technological advances that the next century will produce. With an ever-increasing population, technology will be the key to a sustainable and environmentally friendly growth in unindustrialised nations. The restrictions of protectionism will limit access the third world has to advances and as such will stall their development. Paul Krugman offers this account: “free trade is a pretty good if not perfect policy, while an effort to deviate from it in a sophisticated way will probably end up doing more harm than good”. This is the crux of the problem we see today, that states have tried to adopt a partially free trade stance as exhibited by the rapid growth in the number of trading blocs. Until they embrace the entirety of free trade, there cannot be the growth it would herald in developing countries.

Saudi Arabia Withdraws From UNSC Felipe Cuello-Perez (BA Philosophy and Economics. ‘14 The University of Nottingham)

No recent event has rippled through the international community as quickly and confusingly as the Saudi refusal to step up to the United Nations Security Council, supposedly the pinnacle of international diplomatic architecture. To the untrained eye, it might seem like a reckless move, but if you have been paying attention to developments in the Middle East, it is more than the ‘flash in the pan’ that the headlines portrayed. For the spectator in isolation, a primer: The United Nations Security Council (UNSC) is the only body in the world with the power to authorize military intervention in any sovereign nation-state. For example, one of the reasons the Iraq war was such a controversial international issue is that it never actually got proper authorization from the UNSC. However, the UNSC does not hold as much power as one might assume; the Council is a negotiating table made up of regional members. Created in the immediate aftermath of the Second World War, in an attempt to promote peace, different regions sit on the council in order to debate how to deal with international issues. Several states are permanent members on the council - their job is to try and ensure that any international intervention is not just a colonial expedition - but a genuine attempt to keep the peace in the world. China, France, Image by veterans news now

Russia, The United Kingdom and the United States (commonly known as the “P5”) have all sat on the Security Council since the UN was established in 1945. With Permanent member status comes enormous power; any proposals put before the council can be automatically vetoed by a no vote from any of the P5 (sharper readers will have

noticed that “regional representation” is quite theoretical; there is no permanent member for Africa or South America). The other 10 members are rotating regional seats: three for Africa, Two for Asia-Pacific, two for Latin America, one seat for

Figure 1: A map of the current UNSC. Non-permanent members in Green. The colour of the circle indicates the region the country belongs to in the UN system, if not necessarily geographically.

Features Eastern Europe (another relic of the Cold war paradigm) and two for the “Western European and Others” group, which includes Australia, who currently sit on the council, and Israel, who were unwanted by the African and Asian groupings. These “rotating seats” are elected for two-year terms by their respective regional groupings to represent the interests of the region. This system of regionalism is why, for example, many Latin American countries support Argentina in the Falkland/Malvinas dispute; whether or not you have a genuine interest, you must support your regional allies. The same is true for any number of issues where patterns of regional voting can be seen. Saudi Arabia is different from other states in that it benefits from an unwritten rule; the Africa and Asia groups alternate one of their rotating seats for an “Arab country”. What this means, and has created much controversy around, is that Saudi Arabia must win support from two thirds of the Asia group to be elected a seat. Within the UN, campaigning for a UNSC seat is a difficult job, there are countries, like my own Dominican Republic, who are founding members of the UN yet have never had a turn at sitting on the UNSC. It was therefore surprising when Saudi Arabia’s foreign minister, Prince Bandar Bin Sultan, directed his permanent representative to the UN to withdraw from the council, despite being elected for the first time. This was predominantly in relation to continued Russian support for Bashar Al-Assad and the vetoes Russia often impose upon Syria-themed UNSC resolutions. The flaccid reactions from the Obama administration were no doubt the last straw. Why campaign for a seat you have no intention in using? The Syrian situation has been going on for more than two years but it would never have made the headlines if they ran as a sort of protest candidate, as some pundits have suggested. In the diplomatic world this would never have worked; supporting a countries’ candidacy is worth its weight in gold in diplomatic favours once the country does sit on the council. Nobody would have voted for the Saudis if they pursued a protest strategy. The rationale put forth by the Saudi Government is quite understandable ; No matter how much diplomatic capital the Saudis put into the 2-year seat, they would never have been able to overturn the Russian veto. They have already tried to bribe and threaten the Russians into relenting , but to no avail. The seat, in essence, would have been a massive white elephant. By withdrawing at the time they did, underlining the failings of the council to carry out its duties (nobody can argue that global peace and security is furthered by maintaining the current proxy war scenario in Syria, especially after chemical weapons 24

The Nottingham Economic Review a precedent-setting occurrence, which may even have some positive effects. Though it has clearly failed to spark the final rally against Assad, it has put “dangerous ideas” in the heads of other UN member states and provided the base for the redrawing of allegiances in the region as the USA changes its attitude towards Iran.

use) they have brought to public light just how dysfunctional the UNSC really is, 68 years after its creation. Security Council reform is one of those eternally impossible pie-in-the-sky projects, which, alongside Nuclear disarmament, is usually the realm of speculative International Relations papers and idealistic Model United Nations delegates. However, the Saudi move puts the P5 in Checkmate; either you convince Russia to allow a resolution to be passed, or the clamor from the international community (in general) will get louder and louder for Security Council reform, something no member of the P5 wants. One conclusion that can be drawn is that the P5 are probably having a lot more closed-door meetings with each other to avoid that. Saudi Arabia has seen a decline in its influence in recent years, particularly in relation to the American government. Although the two allies were always divided over Palestinian statehood, it was during the Arab spring, when the Saudis put down a revolution in Bahrain with no American support, that things began to deteriorate. The Sunni-Shi’a divide, evidenced in Bahrain and across the Middle East, is cleaved between a Saudi camp and Iran’s Shi’a axis. Given that Iran is Saudi Arabia’s main geopolitical rival, it shouldn’t surprise anyone that recent American diplomatic openings to Iran have resulted in the Saudi withdrawal of diplomatic relations with the USA. America’s attitude towards Egypt is the worst example, twice abandoning a key ally in the region (Mubarak, who the Saudis supported, and Morsi, with whom they reluctantly came to an understanding). Was this a precondition to moving against P5 hegemony in the UNSC? Maybe, but what we can say with certainty is that they have no good reason to pull any punches with the Obama administration, which has kept the Saudis out in the cold. The most worrying issue is that Saudi Arabia has threatened unilateral action against the Syrian regime, which would be an escalation of epic proportions. Assad is still technically the President of Syria; it would be the first national war in the area since the Yom Kippur war in 1973. Whether or not it comes to that, Saudi’s withdrawal from the UNSC is

The recent Nuclear deal between permanent members and Iran has failed to impress the Saudi government. The generally USsympathetic consensus (which includes wayward allies from Israel to Jordan to the Saudis themselves) is appalling; never in their worst nightmares did the Saudis think that the US would lift sanctions for as light a price as they did in mid-November. The Iranian lifeline of money, ammunition and outright troops are mainly what has kept Assad from faltering under the various Saudi- and Gulf-funded Jihadi groups. With US$ 7-9 Billion of sanctions being lifted in exchange for almost nominal inspection regimes, and a few promises that Iran has broken many times before, it is easy to sympathize with how livid the Saudis and Israelis feel. “I am afraid Iran will give up something to get something else from the big powers in terms of regional politics — and I’m worrying about giving Iran more space or a freer hand in the region…The government of Iran, month after month, has proven that it has an ugly agenda in the region, and in this regard no one in the region will sleep and assume things are going smoothly.” -Abdullah Al-Askar Chairman of the Shura Council The Saudis are seeing Iran’s influence spill across the entire Middle East after decades of opposing it. And though withdrawing from the Security Council won’t help them with that, it will mark one of the greatest geopolitical shifts of our time. References: Saudi Press Agency, http://www.spa.gov.sa/English/details. php?id=1158978 Contains the official press statement citing “The failre of the UNSC to make the Middle East a free zone of all weapons of mass destruction” leaves little doubt they were referring to Iran’s nuclear program and Syria’s use of Chemical weapons, Accessed Nov 2013. Ambro Evans-Pritchard, (2013), http://www.telegraph.co.uk/ finance/newsbysector/energy/oilandgas/10266957/Saudisoffer-Russia-secret-oil-deal-if-it-drops-Syria.html, Accessed Nov 2013 Reuteurs, (2013) http://www.dailymail.co.uk/news/ article-2472680/Saudi-Arabia-severs-diplomatic-ties-USresponse-conflict-Syria.html, Accessed Nov 2013 Ben Hubbard and Robert Worth, (2013), http://www. nytimes.com/2013/10/26/world/middleeast/saudis-faultingamerican-policy-on-middle-east.html, Accessed Nov 2013 Austin Peterson, (2013), http://thelibertarianrepublic.com/ saudi-arabia-threatens-us-failure-bomb-syria-crush-protestors/, Accessed Nov 2013 Elias Groll, (2013), http://blog.foreignpolicy.com/ posts/2013/11/25/bad_metaphor_watch_iranian_nuclear_ deal_edition, Accessed Nov 2013 Owen Dorell, (2013), http://www.usatoday.com/story/news/ world/2013/11/24/iran-deal-middle-east-fears/3691673/ , Accessed Nov 2013

Image by François @ Edito.qc.ca

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Does An Increase In Healthcare Spending Make Us Better Off? Antonina Hassouni (Economics, â&#x20AC;&#x2DC;14, The University of Nottingham)

The World Health Organization has always been keen on portraying improvements in health as great investments in the economy. However, over the past few years we have been seeing a decline in the overall benefit and utility that increased investments have had on healthcare in developed economies. What is the cause of this decline? The main reasons include a rise in unhealthy lifestyle choices and an increasingly aging population. One other question that will be posed is whether healthcare could actually be a luxury good. Firstly letâ&#x20AC;&#x2122;s begin with the distinction between developed and developing economies. The question of whether improving health care would lead to greater returns to the economy depends on the country that we are looking at. Developed and developing countries vary greatly both in their health and economic needs. For example, the prevalence of noncommunicable diseases, such as asthma, is much higher in developed countries versus the higher prevalence of communicable diseases in developing countries. Thus, increased investment on healthcare in developing countries would most definitely bring about increased utility for people in the country as well as bring about a boost to the economy. This is because in developing countries, the improvements in health would bring about productivity increases as human capital is raised. Furthermore, as health

improves, investment and education are bound to increase in the country as people are living longer. So in a developed country that already has high levels of education, investment and human capital, what are the benefits accrued from increased investment in health care? People in developed countries sometimes take healthcare for granted, such as in the UK, where many of the diseases are curable at early stages for free. This causes people to be more complacent with their lifestyle choices. In the UK alone, over the past 20 years there has been a substantial rise in both the occurrence and amount spent on chronic diseases. Also, in the US, a 42% increase in chronic disease cases is expected by 2023 adding trillions of dollars to treatment costs leading to losses in economic output and misallocation of resources. Chronic diseases, such as problems with circulation, could mostly be prevented as they come as a result from a bad diet for instance. In fact, 12% of health spending in the past few years has been linked to obesity in the US. Thus, in this scenario, increased spending on healthcare is not making us better off and in fact it could be harming us by making us more complacent with our health. A solution to this is to invest in health outside traditional healthcare systems such as investing in

campaigns to raise awareness of smoking, bad diets and even lack of sleep. One great way is to start with the younger generations by encouraging healthier meals at school for example. The aging population across developed countries is bound to create a strain on healthcare expenditure in the future. In the UK alone, there are currently around 10 million people over the age of 65 and that number is expected to rise to around 19 million by 2050. Figure 5 shows a variation of these predicted demographics. State benefits and the NHS amounted to just under half of total government expenditure in 2010, most of it directed to the elderly. This leads to the dependency ratio causing a strain on our economy. Figure 6 illustrates this ratio in different countries. The implications of this are great. Firstly as shown by the dependency ratios, there will be a shrinking working population posing a risk for tax government revenue which will no doubt decrease. Lower tax revenue and higher spending commitments are sources of concern for Western governments who already face high debt burdens. Furthermore, policies would be put in place to increase the retirement age in order to cope with the burden of public services costs. The implications on the

Figure 1

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Figure 2

Figure 3 economy could be even higher if income taxes were to increase, leading to incentives and investment declining potentially causing a fall in economic growth. Sectors in the economy could also start to change in terms of an increase in markets catering to an aging population (such as retirement homes). Thus, the increase in healthcare spending in an increasingly aging population doesn’t necessarily make us better off or healthier as the costs mostly go towards managing the health problems that occur at an older age rather than actually treating any disease. Also, we must remember that an increased life expectancy doesn’t necessarily mean we are leading longer lives in better health. With increasing chronic diseases in developed countries especially, there is a question of how much utility we are getting from living longer. Life expectancy has long been an indicator of sound health; however, is living longer in poorer health necessarily “better”? The ONS (The Office for National Statistics) publishes 26

“In the US, a 42% increase in chronic disease cases is expected by 2023 thus adding trillions of dollars to treatment costs leading to losses in economic output and misallocation of resources.” two types of health expectancies, HLE and DFLE. Healthy life expectancy (HLE) estimates lifetimes spent in “very good” or good” health. Disability-free life expectancy (DFLE) estimates lifetime free from a limiting

disability or illness. What is interesting to see from that data is that for example, the life expectancy in London is on average 79.3 years but the HLE is just 63.0 – a huge gap between the two! As a whole, there are many interesting and prudent reasons to think much harder about what the aging of society will imply for a range of social and economic phenomena. Over the past few years, the increase in healthcare expenditure was higher than that of national income, especially in the US. Thus, can healthcare actually be considered a luxury good? A luxury good is one where the income elasticity is greater than one. Income elasticity of demand in this case would be the percentage change in healthcare expenditures (HE) associated with a 1% change in income (I). The formula is given below: e_1=(∂HE/∂I)(HE/I)

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Figure 5

Figure 4 This debate started when Newhouse (1977) brought up the question of whether health expenditure increases faster than per capital income. Since then, there have been several studies on the topic. Gerdtham, Johnson, Kleiman, Abel-Smith and Newhouse performed analyses on the determinants of health expenditure and they all found that the income elasticity was greater than 1. Newhouse concluded that “medical care services at the margin have less to do with common measures of health status … and more to do with … relief of anxiety, somewhat more accurate diagnosis and heroic measures near the end of life”. Cullis and West also stated that “at the margin [healthcare] may contribute little to physiological health” and that healthcare is a luxury good. Thus, from these studies, it can be said that the amount of health care

spending could merely be a reflection of economic growth rather than actual health needs, which of course doesn’t mean we accrue any benefits from any extra spending. Again, this can be seen in the US where despite of its extremely high levels of healthcare spending per person, they still don’t live longer than people in developed countries which spend less. Of course, we cannot rule out the fact that in the US versus the UK for example, people need to rely on insurance and therefore a significant part of the population which is uninsured tend to require care at later stages of a disease leading to higher costs. As a whole, watching how healthcare costs have increased in developed countries and how those projections could end up harming the overall economy is one to pay attention to. It is also worth analysing whether any further increased spending in health care is actually benefiting our health in any way. As presented in this essay, increasing our spending on healthcare doesn’t necessarily mean we are becoming any healthier. It is merely a mirror of the increasingly aging population, an increase in unhealthy lifestyles and perhaps just a sign of economic growth. There are many ways to approach resolving these issues including continued investment in health outside traditional health care systems, which should help to encourage consumers to be more mindful of their lifestyle choices.

Also, an increase in medical research and technology that would lead to actually curing/ preventing diseases rather than merely managing them ought to help with overall healthy life expectancy (HLE) thus helping us to not only live longer, but live longer in better health. References: http://www.aetna.com/health-reform-connection/aetnasvision/facts-about-costs.html#spending http://www.huffingtonpost.com/2013/10/03/health-carecosts-_n_3998425.html http://www.forbes.com/sites/danmunro/2013/10/27/sugarlinked-to-1-trillion-in-u-s-healthcare-spending/ http://www.parliament.uk/business/publications/research/ key-issues-for-the-new-parliament/value-for-money-inpublic-services/the-ageing-population/ Barendregt, J.J., Bonneux L., & Van Der Maas, P.J. (1997). The health care costs of smoking. New England Journal of Medicine, 337, 1052-1057. Rice, D.P., & Fineman, N. (2004). Economic implications of increased longevity in the United States. Annual Review of Public Health, 25, 457-473. Vladeck, B.C. (2005). Economic and policy implications of improving longevity. Journal of the American Geriatric Society, 53, S304-307. http://ec.europa.eu/health/ph_overview/Documents/health_ economy_en.pdf Spence, M. J. (2010). Health and growth. Washington: World Bank. Flessa, S. (2007). Investing in health. Journal of Public Health, 15, 415-421. http://www.ons.gov.uk/ons/dcp171778_327530.pdf

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Understanding Putin’s Foreign And Economic Policy Correlation

How Russia used its economy as a weapon under Putin Sumantra Maitra, University of Ontago, New Zealand

From Russian gestures towards Washington right after 9/11, which almost bordered on an alliance formation, to the Russian tanks rolling into Georgia in the summer of 2008, the timeframe between 2001 and 2008 marked the return of Russia as a great power and major international player after decades of relatively reduced influence and decline in status post-Cold War. The new Russia was more economically stable due to burgeoning oil wealth and energy revenuemore authoritarian, but considerably less free and democratic than even a decade ago under Yeltsin, and possibly more revanchist. Russia is also not shy to exercise hard power and its renewed strength and confidence, as evident by the 2008 gas crisis with Ukraine resulting in a subsequent squeeze on Europe, the South Ossetian war of 2008, and its rigid non-negotiating stance to the European Ballistic missile defense shield. But, to understand this re-invigorated Russia one needs to look at the first two terms under Vladimir Putin and his economic policy. The Russian discourse on international relations in the post-Cold War era was more or less centered on a realist paradigm, partly due to its diminished influence and 28

to its sense of victimhood. Although it saw moments of optimism and co-operation during the Boris Yeltsin era, the traditional idea of Russia as an encircled, endangered and victimized nation remained deep seated in the psyche of the upper echelons of Russian society, enforced and exploited smartly by the Russian political class for domestic political gains.1 Vladimir Putin initially was also optimistic about doing business with the US administration. The September 11 attacks brought this relationship between the two largest nuclear powers to a more stable footing. Russia was one of the first countries in the world to support United States during the preparation stage ahead of the invasion of Afghanistan during the beginning of the “War on Terror”. 2 3 Putin was apparently determined to do something which had eluded his predecessors: to try to reinstate Russia as a Great power. He realized this to be a great opportunity. Initially regarded as an energetic modernizer, Putin’s pro-Western line was measured and broke down completely in 2007 in the now infamous Munich Conference presentation where he accused the United States of

being unilateral and not ready to respect the boundaries of any sovereign state in the world. The study of this timeframe is extremely important, as it shows the reasons Russia stepped back from its rapprochement with United States. The return of Russia as a great power, and the subsequent frosty relation with the United States, which largely coincided with the first two terms of Vladimir Putin at the Kremlin, can be explained in one major narrative, Putin’s Economic Realism. “While it remained weak, Russia saw a special partnership with United States, as the effective route to power and influence in the World. With Russia’s pre 2009 energy fueled revival, Moscow once again found itself in a position to act autonomously on the international stage and less in need of a United States that never seemed to take Russia’s interests seriously anyway”, explains Jeffrey Mankoff.4 The re-emergence of realism in Russia The post-Soviet era gave rise to something of a conceptual vacuum, and Russian policy makers were not always ready to address that challenge. In the early days of the post-Cold War, with the seeming victory of liberal democracies, the dominant discourse was led by the liberal enthusiasts in Russia Image by Olga Kruglova via Flickr

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who were mostly pro-Western and wanted Russia to be a partner of the global West. They regarded Russia to be a mainly Western-European power that sought more engagement and integration with the West. This became known as the Atlanticist school in Russian political circles.5 The immediate post-Cold War was an era of openness and liberalism, under the “Atlanticists” like Boris Yeltsin and Andrey Kozyrev, and to some extent Yegor Gaidar. The immediate post-Soviet leaders after Gorbachev wanted to capitalize on the liberal momentum of Russian relations with the erstwhile foes and went ahead with their idea of convergence of their interests with those of the West. The Atlanticists believed that Russia and the West were not two distinct identities and that the similarities between the two should be in plurality, democratic rule, free market economy, and individualism. “Russia has from time immemorial been with Europe, and we must enter the European Institutions, the council of Europe and the common market, and we must also enter the political and economic unions…” Yeltsin declared, in 1992. 6 Kozyrev, Yegor Gaidar and other liberals under Yeltsin believed that the road to the free market was the ideal way for Russia and that the liberal West would be the ideal partner. However, the domestic environment of Russia immediately after the Cold War was anarchic and chaotic without any central order or strong centralized institutions. Myriad interest groups vied for power at this time of political and economic transition but with massive structural flaws. The Russian dream of being a part of the West slowly started to collapse. Another important factor that added to this collapse was the scarcity of investment in Russia and the hardship faced by the people as the Yeltsin economics of “Shock Therapy”. Even with all its good intentions, it didn’t quite work as planned. The internal economy stabilized with loans from the IMF and World Bank but, along with that came the cost of internal stagnation, collapsing government sector, breakdown of social services, job losses, and massive poverty.7 Between 1993–95 the antiAmerican sentiment amongst the general public went up from 26 to 44 percent, and amongst elites from 27 to 53 percent. 8 By April 1993, President Yeltsin moved away from the “liberal Westernizing” idea and the convergence of “establishment” to the “pragmatic nationalist” viewpoint. Oil and gas exports and general trade increased due to proper regulations, structural reforms and institutional changes and policies resulting in an unprecedented economic boom. The social welfare programs improved as a result of a strong economy as

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did the general living conditions and wages of average Russians after a decade of chaotic post-Soviet experiments. The pride and prestige of being recognized as a great power started to sink in again.

Russia’s entrance to the G8 and a US Loan of $20 billion to dismantle strategic weapons. Russia also took up the Americans’ offer to support Russia’s accelerated membership of the World Trade Organization.11

With Vladimir Putin, Russia’s economic and subsequently foreign policy underwent radical change. “Putin restored stability to the country by reigning in forces of decentralization and competition, creating the ‘power vertical’, restoring control over the country by the Kremlin (increasingly staffed by veterans from the intelligence services) and its allied party United Russia, and recapturing state control over the commanding heights of the economy.” 9 Putin’s Russia was in essence a completely Tsarist centralized state; however, with burgeoning oil wealth it was dubbed as

Oil and energy boom: Return of Great power Russia

“According to the World Bank and the IMF, each dollar increase in the price of oil augments Russia’s GDP by about .35 percent.” Russia Inc. by scholars.10 Under this government system, political and economic elites became connected and the Kremlin officials who managed the affairs of state also started to manage and largely control the state’s major economic assets. The chairmen of the boards of most of Russia’s strategic industries, including energy companies, were members of the presidential administration or holders of high government office. Foreign policy decisions were influenced by commercial decisions which were in turn increasingly driven by political interests. The centralized hierarchy became similar to the Soviet system except that this time it came with oligarchs and a free market, with a highly interfering state capitalist authority. The domestic ‘power vertical’ slowly extended to foreign policy which was formed by a narrow circle of people, especially the predominance of former intelligence officials in the Kremlin. That resulted in the increasingly confrontational rhetoric from Putin’s second term, and the Siloviki’s approach to the West closely started to resemble the Soviets’. The West was viewed as the “glavnyi protivnik” (main enemy) out to weaken Russia and overthrow or destabilize the government. The September 11 attacks in the US (temporarily) changed the strategic framework between US and Russia, simply because Russia needed US to support

Russian economic thinking under Putin can be traced back to the Soviet times. Putin’s own economic thinking was hinted at in his Master thesis (Kandidatskaya dissertation). Putin wrote about “Dual Track” planning, underlining that Russia was still in a transitional phase on its way to a proper functioning market democracy, and that there should be a certain amount of rationalizing and stabilizing government control while Russia was in this phase. Putin’s work in the KGB gave him a basic idea of the hierarchical model KGB followed leading him to believe that a hierarchical state model was also a proper economic model for Russia.12 Economic determinism was the pressing model for a realist Russia and this was reflected in the RF Security Council document of May 2002, which states, “Russia has to avoid being cornered by ideological notions of division between friends and foes. Economic benefits for Russia should become the main factor and criteria of foreign policy orientation.”13 Russia’s goal was to use all opportunities for economic development to prepare Russia to face any potential security challenges, and in order to do that, initial rapprochement with the West was not to be ruled out. The 2000 to 2008 were the most successful years in the Russian economy. Economic growth was around 7 percent, and national income was doubled. The total size of the economy increased six fold from US $ 221 Billion to US $ 1348 Billion. The Russian economy grew even faster than that of China’s.14 Russia benefited from the growth, as real consumption raised by an average of 15 percent annually, more than twice the size of the GDP. The federal budget surplus rose from 1.5 percent of GDP to 5.5 percent. Revenue surged at an amazing rate due to economic growth, tax reforms, and most importantly due to oil exports revenue taxation. Russia which had no central bank reserve during the mid-1990s had the third largest reserve after a decade, only after Japan and China. By 2007, official reserves covered all foreign debt, and the economy not only grew and continued growing, it actually stabilized. Russia used this new found wealth and economic prowess to pursue a more active foreign policy in the geopolitical arena. Russia and Saudi Arabia are the two biggest energy producers in the world, so far. Energy provides over two thirds of Russia’s export 29

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revenue, and about half of its fiscal revenue. Energy has been the center of Russia’s political economy since the early years of Putin’s reign, when much of the power was taken from the hands of the oligarchs by the state. Much of Russia’s energy sector falls under resource nationalism limiting the role of foreign actors and strengthening the direct role of the state. Russian oil reserves are 5.6 percent of the total global oil reserves - the world’s seventh largest. Taxes on oil and gas provide 37 percent of the Russian national budget. According to the World Bank and the IMF, each dollar increase in the price of oil augments Russia’s GDP by about .35 percent. Moscow’s recent aggressive campaigns to renationalize energy companies at home, leverage foreign debts for extra-territorial control over energy assets, discourage rival energy projects, use strong arm tactics to coerce rival oil companies, buy out stakes of foreign companies like BP by Rosneft, and bypass pipelines seem to underscore the Kremlin’s commitment to matching words with deeds for employing energy as a strategic instrument of realism and energy imperialism.15 The most interesting implication of Russia’s oil power was the correlation with its assertive foreign policy. An “aggression index” based on 86 events in Russian foreign policy from January 2000 to September 2007 was compiled by American Enterprise Institute in a report, a paragraph of which is quoted below: “We found that as the price of oil rose, the aggressiveness index increased: that is, the more valuable oil became, the more hostile Russian foreign policy became. The reverse was also true: when oil prices dropped in 2001 and 2002, so did Russia’s aggression. The relationship proved strongest at the annual level: a $1.48 increase in oil prices yearly correlated with an additional “point” increase in Russian aggression.”16 The graph below shows that correlation:17 Combined to this is the apparent dependence of the West, especially Europe’s, on Russian gas and oil. Below is a graph from CFR showing European dependence: Of course, oil prices are not the sole determinant of Russia’s foreign policy, but perhaps it is not completely co-incidental that Putin’s Munich conference speech came in 2007, a few months after it had entirely paid off its International Monetary Fund obligations which totaled $16.8 billion in 1999. Russia no longer needed Western cash to keep its economy alive. On the contrary, Europe desperately needed Russian energy. The British House of Lords Report noted that the EU/Russia Energy Dialogue was essential for energy security.18 30

In fact, the most co-operative time between the Russian Government and Washington was during July 2001 to February 2003, with only one aggressive action. “This pause corresponded with a fluctuation in global oil prices: they dropped from a high of $30.35 a barrel in November 2000 to $17.37 a barrel in December 2001. Oil prices did not hit $30 a barrel again until February 2003.”19 Putin’s idea of a “European Great Power” has been based on playing main actors against each other, namely the trio of France – Germany – Italy against the EU Commission (and the West), and in a minor way, playing Germany against Poland, or any consumer of Russian gas against Ukraine. The main asset of this balancing, was energy.20 In 2003 the Russian energy strategy turned this “petro-confidence” into official foreign policy: “ensuring national security—that is the fundamental task of the energy policy.” After the forced re-nationalization, close ties between the Kremlin and the energy industry have brought these policy goals within reach. The Russian Foreign Minister Sergei Lavrov stated that “it would be right to say that we view our role in global energy supply as a means for ensuring our foreign policy independence.” 21 Russia would repeatedly use this energy power as a persuasive, coercive diplomatic tool against the European Union by stopping the supply of oil and gas to Ukraine. Russia provides approximately a quarter of the natural gas consumed in the European Union and approximately 80% of that supply travels through pipelines across Ukraine prior to arriving in the EU. But one can gather that this was Russia’s response to intimidate the color revolutions, supported by the United States, which was happening in Georgia and Ukraine.

Russian oil and gas blackmail was repeatedly mentioned and protested by Western powers, both European and American. “It is necessary to say politely and with a friendly smile that we are free and we will do what we want, We will not be manipulated or blackmailed, and if you threaten that you will not deliver gas to us, well then, keep it.” said Vaclav Havel, former Czech President from 1993 until 2003 and who also led the anti-Soviet revolution in 1989.22 Just after the color revolutions in both Georgia and Ukraine, President Yushchenko of Ukraine and President Saakashvili of Georgia gave joint statements calling the world to boycott Russia. “Ukraine’s President Viktor Yushchenko said Eastern Europe’s energy supply routes must diversify away from Russia and not succumb to “energy blackmail.” 23 Mikheil Saakashvili said Russia had turned into an “export monopolist of all energy supplies both its own and those of Central Asia”, and accused Moscow of undermining the ideal of a common European energy market.24 The strongest words came from the United States Vice President, Dick Cheney, when he accused Russia of using blackmail and intimidation in its energy policy towards Europe. In one of Washington’s sharpest rebukes to Moscow, Mr. Cheney said it was not acceptable for Russia to use its vast gas and energy supplies to bully its neighbors. “Russia has a choice to make,” Mr. Cheney told Baltic leaders during a summit in Vilnius. “No legitimate interest is served when oil and gas become tools of intimidation or blackmail, either by supply manipulation or attempts to monopolize transportation.” 25 EU leaders such as Schröder, Silvio Berlusconi and Jaques Chirac happily discarded pre -agreed EU positions in their attempts to forge a special relationship

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with Russia. Since 1991, Russia has attempted to practice energy coercion on at least 60 different occasions, with over 40 of these incidents resulting in cut-offs of energy supplies against the Baltic and CIS countries. Moscow’s repeated and gratuitous resort to the oil weapons towards the Baltic states clearly represents “the blatant use of strong-arm tactics in economic disputes.” 27 26

Russian leaders like Lavrov openly talked about the country’s energy power as the fulcrum for the nation’s revival and survival, as well as the basis for realizing competitive advantages and most importantly to what they perceive as a way of standing up to so called US unipolarity. High profile energy showdowns against Ukraine, Moldova, Belarus, Georgia, Lithuania, Estonia, Latvia, Armenia, and Turkmenistan clearly demonstrates that Moscow was not unwilling to use energy as a potent and lethal weapon to subjugate and coerce smaller powers in what it considered as a Russian sphere of influence. Europe’s reliance on Russian gas, coupled with tightening energy resources globally adds to Russian hostility to foreign ownership of significant strategic reserves at home. Desire to take control of the geographic checkpoints to alternative international transit routes seem to compliment Moscow’s resource nationalism and its tightening strategic grip over Europe and Asia. Russia even proved, ominously if one may add, at potential economic, political, and reputational cost, that it is absolutely willing to use Energy as a weapon, by cutting off gas supplies to Europe, and choking Georgian oil, eventually leading to war in 2008.

Image by Ebony Inyangete

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As a whole, with the majority of the Chechen war winding down, a new-found slow surging economy based on the consolidation of oil and gas resources and the stabilization of the internal economy gave Russia a new found confidence, especially during the Iraq invasion of 2003. Russia also successfully lobbied for membership in the World Trade Organization, dealt with the Chechen rebel problem hijacking the global war on terror agenda, suppressed internal dissent without a single proverbial finger pointed, and got the economy on a strong footing as an oil and gas superpower. Russia’s limited goals of opposing the Iraq war were for limited economic bandwagoning with European powers and for taking advantage of internal dissent and inter NATO rivalry without jeopardizing relations with United States. Putin mentioned the BRIC countries of Brazil, Russia, India and China as an upcoming bloc, with the potential of economically balancing the West. Russia’s post 9/11 honeymoon with USA seemed officially over with the Georgian war. The Georgian war was under the Presidency of Dmitri Medvedev, the protégé of Vladimir Putin, who positioned himself as a Prime Minister and continued to take decisions. The new government under Barack Obama a year after the war started a “reset” with President Medvedev and later with Vladimir Putin, which inevitably failed. When Putin came to power in 2012 again, Fyodor Lukyanov, editor of Global Affairs, compared his Realism with Medvedev’s, “Where President-2010 sees opportunities and prospects; President-2012 discerns threats and reasons for concern… Medvedev proceeds from Russia’s domestic developments and looks for how events on the world arena could promote Russia’s growth. Putin, by contrast, starts with the global picture and draws conclusions on how external events can influence domestic processes.” 28 I therefore humbly submit the following conclusion. Russian foreign policy runs on the following principles: • Strengthening Russia’s position as a Great power. • Taking care of internal dissent and Caucasus problems by exploiting the “War on Terror” template for its purposes. • Using new found oil and gas wealth to its advantage to be a dominant power player in the energy market. • When all else is achieved, to portray itself as a regional heavyweight still capable of blocking US unipolarity. The reason behind Russia’s revanchist and aggressive foreign policy is realism and economic strength, which as evidence suggests is highly correlated.

Whether it continues in the future is not under the scope of this discussion although it is safe to speculate that Russia is not going to give up on its economic weapons as a part of its aggressive foreign policy anytime soon. References: Trenin, Dmitri. “Putin the peacemaker?” February 28, 2012, Foreign Policy Magazine

Bush, George W. “Decision Points” Pg 639, Random House, 2010.

Mankoff, Jeffrey. “Russian Foreign Policy: The return of Great Power Politics”, pg 97. Rowman and Littlefield, 2009.

Sergunin, Alexander A. “Russian Post-Communist Foreign Policy Thinking at the Cross-Roads: Changing Paradigms” Journal of International Relations and Development. Volume 3, No. 3 (September 2000)

6 Edited by Ginsburg, George; Rubinstein, Alvin; Smolansky, Oles “ Russia and America : From Rivalry to Recognition ” Library of Congress 1993, Pg. 4.

Tsygankov, Andrei P. “Russia’s Foreign Policy – Changing and continuity in national identity” Rowman and Littlefield, 2006. Pg. 24

Ibid

Shevtsova, L. 2008 . ‘Think Again: Vladimir Putin’ . Foreign Policy , 64 ( January–February )

Trenin , D. 2007 . ‘Russia Redefines Itself and Its Relations with the West’ . The Washington Quarterly , 30 (2)

“ Russia’s engagement with the West “ – Blair, Rubel, Shevtsova Edited. Library of Congress Publications, 2005 , pg 242

Ibid pg 38

Isakova, Irina : “ Russian Governance in twenty first century “ Cass Contemporary Studies, 2005

Gaddy, Clifford and Ickes, Barry. “ Russia after the Global Financial Crisis “ http://www.brookings.edu/~/media/ research/files/articles/2010/5/russia%20financial%20 crisis%20gaddy/05_russia_financial_crisis_gaddy.pdf

Anita Orban, Power, Energy, and the New Russian Imperialism (Wesport, CT: Praeger Security International, 2008

Szrom, Charlie; Brugato, Thomas (2008-02-22). “Liquid Courage”. The American. Retrieved 2010-08-02.

Ibid

Isakova, Irina : “ Russian Governance in twenty first century “ Cass Contemporary Studies, 2005

Szrom, Charlie; Brugato, Thomas (2008-02-22). “Liquid Courage”. The American. Retrieved 2010-08-02.

Baev, Pavel – “ Russian energy Policy and Military Power – Putin’s quest for greatness “ Routledge, 2008

Ibid

“ Reject Russia’s Energy ‘Blackmail’, Vaclav Havel Urges Europe “ - Bloomberg, 16/6/2009 http://www.bloomberg. com/apps/news?pid=newsarchive&sid=aqTWszWwXO6o

“ Ukraine president warns of Russia ‘energy blackmail’ “ – AFP 23/5/2008 http://afp.google.com/article/ ALeqM5j9tEM0XJ-MMU-Et8wWn1Sb5h4aoA

Ibid

“ Russia is blackmailing Europe over energy, says Cheney “ - Guardian, 5/5/2006 http://www.guardian.co.uk/ world/2006/may/05/usa.oil

Barysch, Katinka : “ Russia, realism and EU unity “ – Center for European Reform, 2007

Dmitri Trenin, “Energy Geopolitics in Russia-EU Relations,” in Barysch (2008), pp. 15-24

Lukyanov, Fyodor : “ Uncertain World: Putin the Realist, Medvedev the Liberal “ 12/07/2012 http://en.rian.ru/ columnists/20120712/174569615.html

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Interview with Angus Naismith: NER Alumni and PwC Associate Angus Naismith, BSc Economics at Nottingham, now working in Assurance in Embankment Place in London

What is a typical week like at PwC as an associate?

What else have you been involved in at PwC?

It’s actually fairly hard to describe a ‘typical’ week because of the fact that all of us graduates have been working on all sorts of different things - there really is a lot of variety to the job. When you’re doing client work, you’ll spend a good portion of your time working with your team towards completing the audit of your client’s financial statements, but you also spend a lot of time asking questions and picking up information about the auditing process and your client’s business. You will spend part of your first couple of years studying for your ACA exams. They’re quite tough, but the knowledge you pick up really is very useful on the job and there’s enough support that if you put the work in you’ll get through them.

There’s a great social side to work at the firm. A lot of people say in some ways it’s almost as if you’ve never left University as you’re working alongside a bunch of other graduates. There are about 50 of us in my business unit so there’s always something going on!

your colleagues - there’s a huge amount of diversity at the firm. What would you have liked to know before joining?

There are also all sorts of sports and other activities going on outside the day-to-day job - I’m soon going to get involved with running or cycling with colleagues.

The last few months have been brilliant, but also really, really busy! I moved down to London just before starting, but have felt at times I could’ve done with another week or two before to get settled. If you’re joining the firm I’d recommend not booking your pre-induction holiday to arrive back the day before starting!

What were your expectations before joining? Were they met?

What has surprised you about your role/ the firm since you started?

I knew PwC had a reputation for having great people - but this expectation was definitely exceeded. I don’t have a bad word to say about anyone - everyone I’ve met at the firm is so welcoming and friendly, and you quickly realise the range of talents of

The office atmosphere is more laid back than I thought it might be. While people do work very hard - especially when there are deadlines to meet - there isn’t any stuffiness and you feel you can really relax and be yourself.

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How did you decide on PwC? I spent six weeks of my penultimate Summer at University on the PwC internship. That was a really good introduction to the firm and its culture. I really enjoyed my time there and so took up the offer for a full-time position. On a side note, while the internship was a great experience, it certainly isn’t a pre-requisite for a Grad role. How did you decide on Audit? It’s a terrific way to quickly get a solid grounding in understanding how businesses function. In 3 years you will have had exposure to a range of different industries and companies, as well as learning how to deal with some fairly important individuals at these companies. There’s also a whole range of other skills you’ll pick up - in general, it’s just a great learning opportunity after University.

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What process did you have to go through and what would be your top 3 hints and tips? I went through the standard PwC application process for the internship, which lead to a full-time role. My top three tips for the application process would be: • To use the resources available to you. There’s a wealth of information on the firm and the application process on PwC’s website, Accountancy Age, TheStudentRoom and other websites, for example, and there are always various PwC events running on campus. • At any stage of the application, make sure you don’t get hung up on one or two small mistakes you make. On their own, they’re unlikely to damage your chances too significantly, but if you fixate on them it’s hard to recover. • Make sure you’re prepared - and when you get to each stage of the process, go in confidently, knowing you’ve done your preparation. For example, make

sure you’ve got a page of your key competencies on hand to refer to during the phone interview. What has been the highlight so far? It’s hard to pin down one! In terms of work, I spent a fascinating day shadowing a Partner who, amongst other work, advises firms on their internal cultures and which firm-wide behaviours it’s important for them to try to encourage. It shows there’s a real breadth of work going on across the company. It’s also always good fun celebrating finishing your exams! Why should others consider a career in audit in PwC? In one sentence, it’s a fantastic learning experience with a very prestigious firm and brilliant people.

The experience stays with you

Layo at PwC’s More London office

Assurance Actuarial Consulting Deals Tax Technology All degree subjects Voted employer of choice by students in The Times Top 100 Graduate Employers survey for ten years running.

Opportunities with the UK’s number one graduate employer Offices across the UK » Join spring, summer or autumn Your career is just that; yours. You choose it. You live it. You make it happen. To get the best from it, you need the best opportunities. That’s why opportunities are at the heart of a career with us. Opportunities to grow as an individual, to build lasting relationships and make an impact in a place where people, quality and value mean everything. For Science graduate Layo, that meant exploring the business world on our Tax Summer Internship – she did so well she was offered a job with us at the end. Now she works on major tax projects, helping the employees of some of the world’s biggest companies manage their complex tax affairs. Join PwC – we’re focused on helping you reach your full potential.

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Interview

A Conversation with Nick Bridge UK Ambassador to the OECD Saurabh Tripathi and Usman Saleem

Could you provide us with a brief outline of your talk today?

Nick Bridge, a University of Nottingham Economics alumnus is the Permanent Representative of the United Kingdom to the OECD. Mr Bridge was previously Chief Economist at the Foreign and Commonwealth Office and head of Global Economy Department. He has served for over a decade in diplomatic postings to the China, Japan and the United States. He previously worked in the Treasury where he co-led a $4 billion facility to immunize half a billion people in the developing world, and was an economist in the Ministry of Agriculture, Fisheries and Food. Mr Bridge was at the University to deliver a talk titled ‘Economic Diplomacy in the 21st Century’ as a part of the Nottingham Globalization Lectures. We sat down with Mr Bridge before his lecture to discuss the OECD and his thoughts on current economic and political issues.

I want to cast light on economic diplomacy. There are two aspects to diplomacy, which are very intertwined and yet quite distinct. The first one is international security, which is the traditional understanding of diplomacy. This entails the UN Security Council and the peace process in Syria, for example. Then there is economic diplomacy, which is the ‘prosperity side’ to diplomacy. Economic diplomacy is about how countries can work to gain mutually from the opportunities of trade and investment in a highly globalised world. Hence, I will focus on economic diplomacy and highlight how there are direct links between studying economics and its application in the real world, especially in a place like the Foreign Office.

“We think it is in every countries’ own selfinterest to make a radical transition to low carbon economy – not to wait for others to move first.” I will be using an innovative software, called Gapminder, which is a fun way of presenting the economic history of regions over the past 200 years. Through that simulation, we can understand where we currently stand and take it as a baseline to identify the challenges facing us in the 21st century. There will be some discussion on the demographic trends, the digital economy and setting out the trends in the context of India, China and Africa. The fundamental story is that if we pursue sustainable, inclusive and employment-generating policies, we will have the best chance of handling the global challenges that we are currently faced with. The only way to tackle these problems is through stronger policies, robust global institutions and a clearer shared understanding of a rules-based system.

That’s very interesting. From our understanding, a dominant part of the economic diplomacy revolves around international trade. Yes that is true, and one area, which I will speak about, is international trade policy. There are some new analytical frameworks, which diverge away from the traditional method of calculating imports and exports (X-M) and understanding the value added to trade across different regions. There is a new set of analysis, which the OECD has completed, and is called ‘trade in value added’. It is a vast set of data, which encompasses 98% of world trade, and essentially highlights that imports are as important as exports. High quality imports tend to fuel high quality exports in return. It is quite useful since there is an enormous amount of geopolitical tension between China and US trade relationship and if we use the trade in value added instead of traditional methods, the trade surplus will drop by 25 percent, thereby easing the tension. Does the OECD then help set these analytical frameworks for policy-making decisions? The OECD is composed of thirty-four of the most advanced democratic market economies, who came together after the Marshall Plan to set and share standards that encourage prosperity. We get involved in data collection and analysis to formulate policy. My job is not influencing its decisions but to make sure that the UK benefits from all the work that the OECD does. These analyses help not just the 34 countries within the OECD, but also the emerging economies, with whom we engage with particular vigor. The Iranian government has recently said that it sees nuclear talks finishing within one year. Do you think that is hopeful and secondly within that time? And do you think we might see the easing of sanctions? Well I don’t think we can put a timeline on it. There will be a lot of discussion over a long period of time, which will be very political, technical, and scientific. The best way to approach this is to continue the good work

Interview

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that we are doing, which is the continued reinvigorated desire to reach a common understanding. In a sense, we have to give some space, before we know what the value of our leverage in other areas is, vis-à-vis economic sanctions. Regardless, we need sanctions to be carefully designed so they have the intended effect rather than unintended consequences, which harm vast majorities of innocent populations.

treaties for various reasons. They think it is not in their benefit to transform their economies. From a UK point of view, we are the first country to have binding legislation to deliver the carbon emissions reduction. We have also drawn carbon budgets, which will help us get there. In our experience, it is seen that negotiation is needed to reach these ambitious targets. Through economic and environmental discussions, we will find a way to get there.

are involved in aid, there’s an upcoming philanthropic base, which includes the Gates Foundation and George Soros among others. We also have some new unlikely players such as China, South Africa and India. The Second trend is that there is a growing dialogue between developed and developing countries, which is that there is the need of a partnership and a dual relationship. That is not changing the focus on aid but is reflecting the broader reality.

We were pleased to read your blog post on climate change and the road to the Paris Conference of Parties. In your opinion, how long until we can expect countries to publish green national accounts, measuring their impact on natural capital? After all, you cannot manage what you do not measure.

The Democratic Republic of the Congo is the largest recipient of aid in Africa today, and is yet the poorest country in the world by per capita GDP. Most of the developing countries have enormous reserves of untapped mineral wealth, which could spur economic development a lot faster in growing economies. Do we need a shift from ‘more aid’ to ‘more investment’?

The DRC is definitely one of the specific examples of what I have mentioned earlier. I don’t think we should reduce aid, but the government definitely needs to start policy conversations on more responsible investment. However, for that new structures and less corruption are required. That is the golden thread of these conversations now.

The deadline is in 2015, by which time every country will be signing up to binding carbon emissions targeting. Some countries are further ahead than the rest, while some others don’t want binding international

One of the interesting trends regarding aid is the diversification of the donor base. It is not just the developed nations that

A Conversation with Martin Wolf

Chief Economics Commentator at The Financial Times Anthony Jackson and James Longman

Martin Wolf is chief economics commentator at The Financial Times, and was awarded a CBE in 2000 “for services to financial journalism”. Mr Wolf is an honorary fellow of Nuffield College, Oxford; honorary fellow of Corpus Christi College, Oxford University; an honorary fellow of the Oxford Institute for Economic Policy (Oxonia) and an honorary professor at the University of Nottingham. He was a member of the UK government’s Independent Commission on Banking in 2010-2011. Mr Wolf was at the University to deliver a talk titled ‘Have we fixed the financial system?’ as a part of the Nottingham Globalisation Lectures. We sat down with Mr Wolf before his lecture to discuss the issues regarding the recovery of the UK and the EU as a whole.

In your opinion do you think that we have fixed the financial crisis? It’s difficult to say. If you mean by that have we have changed the financial and other systems in such a way that such a crisis could not recur, I think the answer is no, we probably haven’t. It is also important to note that all crises are different, so it may be that even if we dealt with the causes of this crisis, we mightn’t have eliminated the causes of some other crises. I would say that we have reduced the probability of such a crisis occurring - the events that would trigger a crisis of this magnitude would have to be more extreme than they were before. They were however relatively acute, mild events economically speaking. For example quite a small house price adjustment. Therefore my answer is that we have identified the origins this time, but in the next time the origins could be different. We have reduced the fragility of the system which would reduce the probability of a financial crisis occurring but that has not been reduced to zero.

Interview

The recovery in the EU has been relatively slow, do you think that is more to do with economic or political effects in terms of European decisions? Well it’s both. It’s mostly economics. This is a different sort of crisis, a different sort of recession than any of the others since World War Two. It’s much more like the sort of crisis that market systems had before World War Two. Work by Carmen Reinhart and Kenneth Rogoff suggest that these earlier crises have tended to be more severe, with slower recovery than the post war period. In the post war period we had pretty robust, well controlled financial sectors, which didn’t generate much macroeconomic risk in the developed world with the exception of Japan in the late 1990’s. Prior to that, the main source of recessions was periodically the governments, either through monetary or fiscal policy, over expanded the economy. The economy most of the time tended to run close to full employment, certainly for the first quarter of the century after the war. Demand tended to be very strong, real interest rates were consistent and positive, and the main problem was containing demand. If demand was not contained enough then inflation occurred. However, in the past 20 years the main problem has been a tendency for demand to be very weak and this is a consistent pattern. We have a financially liberalised economy used to generate additional demand, and that’s created very large periods of credit growth, very large expansions of balance sheets and also financial fragility. There was next to no inflation going into the system and thus when the financial system collapsed there was mass bankruptcy. The problem after such a crisis, which is the first balance sheet recession since the war, is that it’s very difficult to generate demand. Far from having an environment from basically very strong demand, which you are trying to constrain, you are trying to generate demand that is very, very weak. That’s why you get to the zero lower bound, with interests rates going from 0 to negative. Recovery from such a crisis is therefore much weaker, as there is no demand engine. We are at a very early stage of understanding how you manage such a crisis. The politics has also entered into this dynamic, because one of the symptoms of the crisis is a large fiscal deficit, which led to politicians being frightened, thus they tried to cut back fiscal support. You could argue that all our response, particularly after the first year, has been less aggressive than it could have been. I think that the

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“We have identified the crises origins this time, but in the next financial crisis those origins could be different.” fundamental reason is that it’s a new sort of crisis for us, it’s unfamiliar, and has completely different dynamics from the previous crises. The economists haven’t really found a solution to such a crisis and therefore, to some extent, the weakness of the recovery was inevitable. Another key challenge is that of income inequality. Do you think this lack of demand you mentioned, was created by debt in middle-income households? How does this relate to the savings glut? It could relate, obviously. The savings glut phenomenon can be best measured by a price rather than savings, because savings and investments on the global scale have to match, and we know that real interest rates on safe securities were very low from ’97 onwards, which is a good measure of an excess supply of savings since the equilibrium was at a very low price, dramatically low - about 2% which in a fast growing world is a bit of a puzzle. There is a secondary round of features: as you said, the main users of these net savings up to this crisis were governments and households. There are two aspects then that we have to explain. First, the corporate sector was consistently a net saver. Therefore, instead of being a net user of funds, which you would expect of a non-financial corporation, their retained earnings exceeded their investments so they were net buyers of claims on the rest of the economy. That is perverse, because by definition they are responsible for pretty much all of the investment in the economy. If they want to supply savings to the rest of the economy, it has to be consumed, thus it cannot be efficient. It’s obviously wasteful. Then the offsetting consumption, which is by households or governments, relates it to the housing boom. However, what is not clear to me is how far the phenomenon of houses running financial deficits and how much of that was related to inequality amongst households. What I described in the corporate sector was clearly related to the distribution of income between labour and capital earnings in general, so there was clearly a shift towards corporate profits.

When we talk bout inequality there is a functional link of income distribution between labour and capital. There clearly was a rise in inequality in labour earnings as well, because capital income tends to be owned by a relatively small number of households, so that it reinforces the income inequality between households. It is possible, but I haven’t seen any convincing evidence (Joseph Stiglitz is the one who argued this most thoroughly) that the credit dependency of households, the enormous growth of credit required to get the households sector to spend more than its income which was required for macroeconomic balance, was related to inequality. This is because some households are going to spend more, predominantly middle income, with a declining share such that they tend to borrow. I think it’s a perfectly plausible argument, but I haven’t seen any good evidence for it. We don’t know much, though it seems to me that it’s the structure of income and spending throughout the whole economy. There has been political pressure to reform the financial sector. Ed Miliband recently proposed that the 4 big banks be restructured to increase competition in the market. Do you think this is the right approach? I don’t think that it would bare much either way with systemic risk if you have 4 banks or 8. What really matters is that they do really fundamental things from each other; if 8 banks are doing the same thing, systemic risk is unchanged. It’s certainly not clear that if you had 8 banks rather than 4 that competition would necessarily be stronger. As a member of the Independent Commission on Banking I have been involved with these discussions, and we suggested the ring-fencing of investment from retail banks. Somebody says break up a bank - what does that mean? Banks are immensely large and complex institutions with global actives in most cases, some to an enormous degree. How would you divide them? Would you randomly cut the branches? Where do you send the assets? One major pitfall for example is what to do with the legacy computer systems - you can’t have two. The split of Lloyds Bank and TSB has turned out to be incredibly difficult, and as such I think that if you are going to say we are going to halve all banks, all banking in this country would stop for 5 years. I think it would take at least that. It would be just insane, which is why we decided it wasn’t worth doing.

Guest Contributors

The Nottingham Economic Review

Guest Contribution Philip Watson A short note:

Are basic statistics important? Philip Watson, a University of Nottingham Economics alumnus and was the Chief Statistician of the International Rubber Study Group (IRSG) between 1984 and 1999. He is also an elected fellow of the Royal Statistical Society (RSS) and the Institute of Statisticians (IoS) and was granted Chartered Statistician Status by RSS and IoS in 1993. Mr Watson has also held other various offices throughout his career such as Chairman of Intergovernmental Organization’s (IGO) Group of Statisticians amongst others. He has written over 40 papers on the world’s rubber and tyre markets (1985-2002) published by the IRSG. In 1979 I joined the International Rubber Study (IRSG) in London (now located in Singapore) and couple of years later I became its Chief Statistician. My main pre-occupation there for the next 23 years, before I took early retirement, was to improve the accuracy and coverage of the data sets for natural and synthetic rubber, tyres and general rubber goods. The only area, where I was not able to make much progress was in the field of general rubber goods, as there is in this sector over about main 100 end uses of elastomers. Furthermore I was also the author of nearly 50 published research papers. Thus, my main task and pre-occupation was to improve the quality and reliability of the volume statistics for natural rubber, synthetic rubber and the major types of tyres – i.e. those fitted to cars, light trucks and heavy commercial vehicles and trailers. The data for synthetic rubber production, with this type of rubber being derived as a by-product from the production of oil and hence industry based are relatively easy to assess as rather stringent records are kept. On the other hand, as about 85% of the world’s natural rubber production is sourced from small-holdings normally being cultivated on less than 2.5 hectares of land. With respect to tyre production, also industry based, extensive records are kept by the ‘tyre’ manufacturing agencies in the major producing countries. Consequently, much

of my time was spent in seeking out the most statistically correct data set and series for natural rubber for the world, so that associated government agencies, especially in Malaysia, Indonesia and Thailand, would have a better current picture. Furthermore, international agencies like the World Bank in conjunction with the Food & Agricultural Organisation and the International Monetary Fund would have a sound basis on which to make forecasts of sensible scenarios for the future consumption of natural rubber. Briefly, natural rubber (Hevea braziliensis) is a tree crop – a native tree to Brazil. It requires heavy rainfall with high humidity with an equable climate and high daily temperatures, with reasonable lengthy periods of sunshine. Rubber grows well in highly weathered soils. The gestation period of a rubber tree is about 7 years (normally the girth size will be at least 50cm.) when tapping becomes feasible. Latex production from the tree increases annually until year 11, when the maximum flow is reached. The economic life of a rubber tree is about 25 years. The output of rubber trees is converted into three main types – ribbed smoked sheet (RSS), technically specified rubber (TSR) or concentrated latex. A smallholding with about 2 hectares under rubber will normally, if well laid out, accommodate about 800-1000 trees. Natural rubber, with over 80% of its production being derived from smallholdings, is truly almost an ‘instant’ cash crop. Rubber smallholders are basically subsistence farmers working in small family groups. They, originally, had little access to modern plantation techniques and agricultural practices, and often poorer land quality. Basically a small farmer taps the trees on his smallholding for about 2-3 hours when daylight breaks. He then returns home. At about 11.00am he then collects the latex from the trees. A couple of hours later he sells it to the ‘market’ man, who visits his village or takes it to the local cooperative, where he receives the ‘farm-gate’ price for his labours. This price is normally determined and based on yesterday’s price

on the world market – i.e. it is a derived percentage price, normally based on a specific formula. Given that natural rubber is mainly produced on smallholdings then with the gestation period of about seven years, government agencies in the main producing countries are intimately involved with the funding of this ‘gap’, the replanting of trees and clone development for higher yields. Furthermore they are closely associated with any developments in the maintenance and stabilisation of the world market price for natural rubber (International Rubber Organisation from 1979 to 1999, followed by the International Tripartite Rubber Organisation in 2001, which launched in October 2003 by the International Rubber Consortium Ltd.) Also any forecasts by learned and international organisation concerning the future over next 10-20 years of the demand for natural rubber accurate data sets on rubber consumption, vehicle trends and tyre production are paramount in their decision making. Given the foregoing scenarios about natural rubber it is vitally important that the basic historic data collected on all the variables associated with future rubber demand are as accurate and transparent as possible. This was my main preoccupation. It is interesting to note that mid-forecast of natural rubber consumption given in the late 1970s by the World Bank indicated that natural rubber consumption would reach 10 million tonnes by the year 2000, compared to a figure of about 3.5 million tonnes in the mid-1970s. These forecasts, being based on poorly collected data on rubber consumption and its derivatives, were so ‘off-target’ that the figure of 10 million for natural rubber consumption was not reached until nearly 2010! The data set of the variables on which these forecasts had been made had a consummate error in the basic series of rubber data of +/- 5% and in some cases with respect to the component parts of heavy truck tyres (a major use of natural rubber) the over-estimation of their rubber content was greater than 25% above the norm. Also 37

Interview

with respect to the behaviour of heavy truck tyre demand, the devastating aspect of the cannibalisation of truck tyres on trailers on the spikes in the natural rubber price was not even considered – this theory of the causes of price spikes was originally given at the International Rubber Conference in Malaysia in October 1997. Consequently, the formation of INRO in 1979 was really a blessing in disguise as there was certainly likely to be an over production of natural rubber. Consequently my ‘raison d’etre’ at the IRSG was to improve the reliability data series on the main macro statistics for natural rubber production and consumption, as well as for synthetic rubber production and consumption – the latter was made quite a lot easier because of the existence of the International Institute of Synthetic Rubber Producers Inc., located in the USA. Furthermore it was also important to assist

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other organisations in the gathering of micro data, which forms any kind of input, as a variable, for producing an econometric model of elastomer demand used for forecasting. With respect to the overall statistical data on rubber the error in the data was reduced to about +/-0.5% by the year 2000. In the case of micro data such as weight of raw rubber in tyres by type and country, previously over-estimated by some 25%, this figure, with the help of major rubber associations throughout the world, meant that the error was greatly reduced +/- 0.005. Therefore the corollary of this improvement in the various data sets related to elastomers has now meant better forecasting of demand for natural rubber and hence proper re-planting policies (and to a limited extent new planting). This work on statistics in conjunction with the work of rubber associations on

new clone development for higher yields, better husbandry advice from government agencies, assistance from experienced planters and a better understanding of the commodity market has meant that in the major producing countries the ‘farm-gate price’ has increased by about 15 percentage points. In conclusion, therefore, given that there are about 6-7 million small farmers and their rubber small-holdings support and 5-6 members of their respective families, getting the ‘basic data’ correct (in conjunction with and work by other agencies) has over my 20 or so years at the IRSG seems to have assisted in the improvement the living standards of about 35 million people in SE Asia. Philip J Watson BA Hons.(Econ); C.Stat. Chief Statistician, IRSG (1979-2002)

Guest Contribution: Wyn Morgan Indigestion? Food inflation revisited Wyn Morgan is the Assistant Pro-Vice Chancellor for Teaching and Learning at The Univeristy of Nottingham. He has been a member of staff at Nottingham since 1990 and became a Professor in August 2010. His research interests lie in global food prices and their volatility; competition in vertical food chains; price transmission; commodity futures markets; food price inflation. His teaching interests lie in microeconomics and options and futures markets. Wyn gained one of the first Lord Dearing Awards for Excellence in Teaching and Learning in 1999 and in September 2007 he gained a commendation in the Student Nominated category of the Economics Network Annual Learning and Teaching Awards. One of the fascinating aspects of life as an academic economist is that every day throws up new challenges, problems and conundrums, leading to us asking ourselves “Now, why did that happen?” or “Well that is unexpected!”. It is this variety I feel that makes economics a vibrant, interesting subject and helps inform the teaching of its

principles in undergraduate programmes. However, this also implies that there some areas remain a challenge over time; as our understanding evolves the questions we ask change and we have to refocus our research lens in a new way to try and find sensible and robust answers. That doesn’t mean to say we get things wrong, just that new approaches and crucially new data allow us to be more inquisitive and able to shed new light on old problems. So where is this preamble taking us? Well, I wrote a piece for an earlier edition of NER based on food price inflation in the UK and noted how world commodity markets played a significant but not unique factor in driving retail food price inflation. Since that time, I have, along with my colleague Tim Lloyd, been involved in an EU funded project on the “Transparency of Food Pricing” which draws together economists from 13 universities across 9 countries to examine food pricing and especially food inflation. Food inflation matters; it drives overall CPI inflation and is regressive, hitting the poorest in society hardest as they spend a greater

proportion of their income on food. As such policy makers are concerned about its causes so as to devise policy solutions if at all possible. Starting from a simple idea, all countries use the same raw commodities (wheat, corn, soybeans etc.) in the production of their food and often import much of this from world Figure 1 Annualised food inflation 1997(11) - 2011(12)

Source: OECD

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Table 1 Selected EU member state food inflation rates 1997(11) – 2011(12) Country

Average

Maximum

Minimum

France

1.88

6.87

-1.62

Germany

1.33

7.87

-3.16

Italy

2.15

6.09

-0.66

Netherlands

1.54

8.05

-5.91

Portugal

1.86

8.20

-6.53

Spain

2.79

6.95

-2.78

Sweden

1.63

7.71

-1.76

United Kingdom

2.70

12.31

-2.38

Greece

2.99

12.09

-2.58

Czech Republic

1.40

11.36

-7.33

Hungary

6.79

18.24

-2.73

Poland

3.73

12.68

-3.91

Slovakia

3.18

9.96

-5.86

Slovenia

3.08

13.61

-15.89

Old Members

2.13

8.53

-3.39

New Members

3.69

13.84

-7.06

Figure 2 Combined market share of the five largest retailers (2004,2007)

Source: Bukeviciute, L., Dierx, A. and Ilzkovitz, F. (2009) “The Functioning of the Food Supply Chain and Its Effect on Food Prices in the European Union” Occasional Papers 47, European Economy. (page 23) Source: OECD

markets, so surely if there is an increase in the world price of these commodities then there should be an equivalent impact on retail prices, right? Sorry, but no. Food price inflation experience across the EU Member States has been remarkably variable (See Table 1 and Figure 1). Yes, there was a common and significant shock in world commodity prices – between 2006 and 2008 world wheat prices for example rose some 136% and corn 125% (FAOstat) - but implicit in our initial assertion is a belief that there is a simple and prefect transmission from this common world food price into domestic retail food prices and challenging this assumption is where we start to find an answer as to why food inflation differs. Price transmission along vertically related markets – the way in which prices change as a commodity moves through stages of production – can be affected by a range of factors. If the world were entirely perfectly competitive and there was only one world currency then you would expect perfect transmission to take place that would reflect the share of the raw commodity in the costs of the final retail product. However, the world is not shaped in that way. First, of course, we need to account for the fact that global and domestic prices are usually in different currency units so exchange rates will matter; but even allowing for that, other factors also come into play. A major issue is the structure of the supply chain for the good, meaning the extent of competition amongst firms.

Food retailing and to a lesser extent food processing is characterised by high degrees of market concentration meaning that price transmission is not necessarily going to be perfect in a world where price setting and strategic behaviour could be important factors. The nature of the food supply chains vary hugely across the EU Member States as Figure 2 highlights for the retailing sector.

wheat and oil prices and a common currency – the Euro – we still do not get an identical inflation outcome, showing the importance of domestic factors, the most important of which is market structures. Exploring the nature of the food chains across the various MS is a key concern for the EU Commission and it continues to monitor the way in which food prices for its citizens change over time. As I write food prices remain relatively high and thus still squarely in the gaze of policy makers, so, maybe in another few years after the reader has digested this piece, I can write a further article about this topic but perhaps with different questions!

So, given we have differences in the food chain, can we highlight how much they affect price inflation? Well yes we can but it is only going to be a partial answer. In simple terms we tend to look at very aggregate data – world food prices, domestic food retail inflation – and this can hide a myriad of variety. For example, the domestic food inflation index is based on a basket of goods Figure 3 which is different in each MS. Thus we could Selected EU member states bread not expect equivalence in experience at inflation (%) 1998(1) 2011(12) that level of aggregation. To get round this, we decided to explore a single product – bread – and look at inflation in retails bread prices across 11 MS. The reason for this is that bread is consumed everywhere and is relatively un-processed in relation to the raw product, namely wheat, and we can explore the role of energy costs in its production too through the inclusion of oil. In this way we can get a clear sense of transmission as wheat prices change. Figure 3 shows retail bread inflation across the EU. Our time-series modelling results show that even where we have countries that appear to have a common set of variables – world

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