Archive for the 'Economic systems' Category

Oct 08 2012

Is Switzerland becoming a feudal state?

Switzerland “could become a feudal state” claims an economist. – swissinfo

One Zurich economist thinks so:

In Switzerland 71 per cent of the wealth is concentrated in the hands of just ten per cent of the population – a figure that economist Hans Kissling finds alarming.

Kissling tells swissinfo that the gap between the rich and everyone else is growing and that this could threaten traditional Swiss democracy and the economy. He makes a call for an inheritance tax for the wealthy.

Statistics show that the 300 richest people have become 40 per cent wealthier in the past eight years, whereas most of the population has a lower income than at the beginning of the 1990s

Kissling has nothing against wealth, he just thinks that if someone did not earn their wealth but inherited it instead, they should have to share a bit with the rest of society.

I call for a tax on very high inheritances, from SFr1 million ($900.000) upwards, and only on the excess value of that. I certainly don’t want people to think that they can’t pass on their family home to the next generation.

I’m only interested in trying to stop any creeping feudalisation, to avoid having huge clans like in South America, which threaten the economy and the political world

He’s most concerned that if the gap between rich and middle class continues to widen and the middle class of Switzerland don’t start benefiting from the country’s growing wealth, there could be a dangerous backlash against the free market system.

…the richest one tenth of a percent in Zurich – there are no full Swiss statistics – had 677 times more wealth than an average citizen in 1991. By 2003, 12 years later, the richest one tenth of a percent had 1,027 times more wealth. So the gap has really grown.

The middle classes, unlike the lower classes, have not benefited from any concessions, such as health insurance or childcare allowances. Here they have to use up all their assets before they receive any support. The lower classes have help from the beginning. This is why the middle classes are threatened

Discussion Questions:

  1. Why does a growing gap between rich and middle class threaten social stability in Switzerland?
  2. What threats do growing inequality pose to Economic growth?
  3. What are the benefits of an inheritance tax as a means to reduce wealth and income inequality? What are the arguments against such a tax?
  4. What other types of government policies could reduce the wealth and income inequality that exists in Switzerland?

13 responses so far

Aug 14 2012

My first Economics lesson – Scarce Chairs!!

The following lesson is a great way to start an IB or AP Economics class for the year. I just tried it this morning for the first time and it went great!

Instructions:

  • Before your Econ students arrive for their first full class meeting, remove chairs until there are only half as many as you will have students. I stuck mine in the library, well out of view of the students coming to my class.
  • Tell students that the custodian removed the chairs for repairs, or they were taken to another room for a presentation or something. Anyway, you don’t know when they’ll come back and it may be a couple of weeks.
  • For now, we are stuck with this many chairs, and we have to figure out a way to resolve this problem!
  • Tell the students it’s up to them to decide how our limited number of chairs will be allocated. Have them brainstorm solutions out loud while you write their suggestions on the board.
  • Try to come up with 6-10 possible solutions, then have the students vote on the one they would like to see enacted. They can only vote once! Write the tallies next to each option on the board.
  • If there is a tie for #1, have the whole class vote between the two or three options you’ve narrowed it down to until there is one clear winner.
The Economist’s Solution:
  • Once the students have voted on their favorite solution, share with them the economist’s favorite solution. It is known as a sealed-bid auction.
  • Give each student a slip of scrap paper and have him write two things: 1) His name, and 2) the maximum price he would be willing and able to pay each class period to have a chair to sit on.
  • Collect the results, and in front of the students, organize their bids from highest to lowest. If there is a tie on the margin, have the students whose bids were identical bid again, writing their highest price on the back of the same slip of paper, then re-rank.
  • The students with the highest bids will get a chair! For example, I had 17 students, and only 8 chairs. The highest bid was $10, while three students were not willing to pay anything. Four kids were willing to pay $1, but there were only two chair left at that point. When they re-bid, one was willing to pay $2, one $1.75, $1.25 and $1.20. Therefore, the two remaining chairs went to the students willing to pay $2 and $1.75.
  • Finally, tell the winners that they can take a seat, and that everyone else must stand! At this point, of course, you can send the lowest bidders out to fetch the missing chairs and begin your debrief.
Economic concepts illustrated by the Scarce Chairs exercise:

Scarcity exists:

  • When something is limited in supply and in demand, it is scarce.
  • Everyone wants to sit, but the chairs were missing… chairs were scarce.
  • Scarcity is a function of both demand and supply. The greater the demand relative to supply, the more scarce something is.

Choices must be made:

  • Because scarcity exists, we must make choices about how to allocate our scarce resources
  • We had to choose between competing systems for allocating the chairs

Rationing systems:

  • When faced with scarcity, a system must be decided upon to ration the scarce items.
  • The systems we decided upon ranged from a lottery to first come first serve to a merit-based system.

Something that is scarce has value:

  • Everyone wanted a chair, yet they were limited. Because the chairs provide us with benefit, we value them, and are therefore willing to pay to have one.
  • Value is a function of scarcity. The scarcer something is, the more valuable it becomes (gold), while less scarce items are less valuable (drinking water).

Consumer surplus:

  • Consumer surplus is the difference between what you are willing to pay and what the price is.
  • Sofia would have had lots of consumer surplus if she only had to pay $2 , because she was willing to pay up to $10.

Equity versus Efficiency:

  • Equity means fairness, while efficiency requires that resources go towards their most socially optimal use, so that those who value something most end up getting that which they value. 
  • The tradeoff between equity and efficiency is a major theme of the IB Economics course.
  • What is most efficient (an auction to determine who is willing to pay the most for the chairs) may not be equitable (or fair).
  • When the richest students end up in the chairs, those with lesser ability to pay feel that they’ve been treated unfairly.
  • A lottery in which names would be drawn from a hat to determine who gets a chair is certainly more equitable, but is actually less efficient, since those who get the chairs may not be those who place the greatest value on having a chair.
  • Auctioning the chairs assures that those who value them the most will end up getting them, therefore resources are allocated most efficiently.

 

19 responses so far

Nov 21 2008

Eight basic economic arguments against a bailout of the auto industry

This week the CEOs of the “Big Three” US auto makers boarded their private jets in Detroit and touched down in Washington to beg and plead in front of Congress for a “low-interest bridge loan” from the US government to help them avoid bankruptcy. They are asking Congress for $25 billion of taxpayer money to give them the chance to re-structure and re-equip themselves for the future.

[youtube]http://www.youtube.com/watch?v=gLuLvCR2bYE[/youtube]

Below are eight arguments based on basic economic principles for why a bailout of the United States automobile industry is a bad idea and is bound to fail:

  1. Incentives matter: A bailout of the US auto industry ignores the basic economic principle that incentives matter. Individuals and firms respond to incentives, pursuing behavior that is likely to bring them the greatest rewards. In the face of falling demand for their product and ever-increasing competition from more efficient foreign producers, providing a $25 billion bailout creates a disincentive to drastically reduce costs and increase competitiveness, and an incentive to continue using tired old techniques and providing the same old models for which demand has declined among Americans for over a decade.
  2. Comparative advantage: The basic economic principle of comparative advantage states that in an era of free trade and globalization, countries should produce the types of goods for which they have the lowest opportunity cost. Since the average American car of a particular class costs the Big Three $2000 more in wages and benefits for workers than its Japanese counterpart, it makes sense that Japan (and other lower-cost countries) produce more cars, and the Big Three produce less.
  3. Efficient allocation of resources: The United Auto Workers Union has a member ship of over 400,000 workers. Since the 1970s the union has lost over 1 million workers. Clearly the US auto industry has been in decline for decades, a fact that should be taken as a sign: resources employed in America’s car industry are inefficient and represent a over-allocation of resources. A drastic down-sizing of the auto industry, while resulting in short-run hardships for the hundreds of thousands whose jobs will be lost, will in the long run strengthen the US economy as labor and other resources will be freed up to be employed in sectors in which the US has comparative advantage.
  4. Economic Darwinism or “the survival of the most efficient”: America has stood for free trade in the world since helping found GATT in 1948 and later the WTO. The gains from embracing free trade are shared among all stakeholders in the economy. Consumers enjoy lower prices (thus higher real income), firms enjoy access to cheaper inputs and larger markets for their products, and governments enjoy the increased tax revenues from rising incomes driven by export-led economic growth. To bail out an uncompetitive, inefficient, and long-declining industry is to spit in the eye of free trade and denies America any moral suasion it may hold in the future over potential trading nations in our attempt to open their markets to our nation’s products. To protect our own dying industry now will send a clear message to our trading partners. “America does NOT stand for free trade”. If we believe in free trade and the allocative power of markets, then we must let the dinosaurs of American industry meet the fate the natural selection of the marketplace has determined for it.
  5. The benefits enjoyed by the few represent costs born by the many: A bailout by the US government of the auto industry will protect a few hundred thousand jobs for a few years at the most but spells a reduction in the disposable incomes and spending power of millions for years to come. The US does not have $25 billion laying around to give the Big Three, which means the money must be borrowed. Increased government borrowing raises interest rates now (further tightening the credit markets) and will result in increased taxes down the road. All government debt must eventually be paid off, and in the immediate future interest on this debt must be paid directly from tax revenue. A $25 billion bailout is the same as a subsidy, meaning it redistributes income and welfare from consumers to producers. Millions are asked to sacrifice for the continued survival of a few hundred thousand in an industry that has failed to evolve in a global auto market that has seen increased competition and efficiency from foreign firms for decades.
  6. Moral hazard: Bailing out the Big Three today represent a classic case of moral hazard. When American industries fail to take steps to increase their efficiency and remain competitive in the face of increased global competition, they find themselves not surprisingly on the brink of collapse. To reward these firms by taking money out of Americans’ pockets and handing it to them to do as they will, we send the wrong message and create the wrong incentives in the American economy. The message is: “Don’t worry, the market doesn’t choose the winners and losers in the economy, the government does, and certain industries are too big to fail”.
  7. Market failure, or Firm Failure?: The fate of the auto industry is in the hands of the US government. But so is the fate of the free market. My fear now is that the pendulum will swing too far to the left in America’s state of panic over the ill-fated downfall of the financial markets, rooted in the irrational exuberance and over-leveraging of big financial institutions. The failure of the financial markets, however, is an entirely different story from that of a dinosaur industry like automobiles. The Big Three have had decades to reform themselves, lower their costs, improve their products, and remain competitive. THEY have failed, NOT the market. Government intervention is necessary in instances of market failure, but NOT IN CASES OF FIRMS’ FAILURE TO COMPETE IN A WELL FUNCTIONING MARKET like the global auto industry.
  8. Inflexible labor markets: I saw the president of the UAW on the news today giving 101 reasons why the government should approve a bailout deal for the Big Three. In fact, the unions that supposedly represent American Auto Workers are a big part of the problem the industry is facing. For decades the UAW has fought against wage and benefit cuts for auto workers, lobbying instead for higher tariffs and other barriers aimed at keeping foreign cars out of the country. This anti-competitive behavior is a major reason the Big Three cannot compete with European and Asian car makers today. Wage inflexibility leads to higher unemployment. Unions keep wages from going down, leaving the Big Three with one of two choices: Drastically downsize your workforce and employ fewer high paid auto workers, or beg the government for a multi-billion dollar subsidy to that the unions can be placated and you can survive for a couple more years until you’re in the same situation all over again. The unions helped cause the problem, now they should pay the price by experiencing the downsizing their demands inevitably foretold.

The US government should allow the free market to function and let the dinosaurs go extinct. Cars will still be made in America, they’ll just be made by the better, more efficient firms that emerge from bankruptcy when this is all over, as well as the numerous foreign firms already making cars in the US. Survival of the most efficient, that’s what markets are all about. Allowing the market to work will strengthen the US auto industry far more than a “short-term low-interest bridge loan” ever will, it will free up labor and capital resources to be employed by industries the country is better at, and make sure household income is NOT reallocated to inefficient firms to be squandered on the manufacture of a product for which demand has steadily declined for the last decade plus.

34 responses so far

Sep 07 2008

The importance of incentives in achieving poverty alleviation: Venezuela vs. Brazil

Managing Globalization: To reduce poverty, money isn’t everything – International Herald Tribune

Two developing countries: Venezuela and Brazil. Two ideologies underpinning economic growth and development: command in Venezuela versus free market in Brazil. Which system has worked better for the people of these two large South American countries?

How much can governments do to fight poverty? In South America, a couple of answers are emerging in the growing economies of Venezuela and Brazil. Both governments have publicly pledged billions of dollars to raise living standards – but have they succeeded?

Overall income is moving upward in both countries, if for different reasons. Venezuela is riding the black tide of high-priced oil, while Brazil’s relatively firm economic policies have built confidence in its business prospects among both locals and foreigners.

The president of Venezuela, Hugo Chávez, has portrayed himself as an ardent socialist and a disciple of Fidel Castro. Reducing inequality is fundamental to his agenda, whether by dividing up Venezuela’s oil wealth or, as he has obliquely suggested this month, through land reform. His consolidation of executive power has brought Venezuela closer to a centrally planned economy and, as such, has given him the opportunity to invest heavily in social programs.

But identifying the results isn’t easy. The poverty rate in Venezuela was about 50 percent when Chávez’s presidency began in 1999, according to the government’s own figures. Since then, roughly equal numbers of people have fallen into and out of poverty at various times, with a spike to more than 60 percent in 2003 and a drop below 40 percent in 2005…

Rodríguez also questioned whether Chávez’s programs could be completely effective because of the way they were managed. Some of the world’s most successful initiatives for improving the well-being of the poor, he said, linked families’ benefit payments to useful actions like their children’s attendance in school or visits to the doctor. In Venezuela, he said, the link is to political loyalty instead.

“The level of political polarization has become so high that not only is loyalty to the regime the key determinant of your access to benefits, it is also the key determinant of your capacity to be involved in the administration of those benefits to others,” Rodríguez said.

One example of this problem was a program intended to improve literacy. “The government had no system of accountability to monitor performance other than the reports of its own administrators,” Rodríguez said. “When program administrators learned that it was more important to show loyalty to the regime than to effectively run the program, any incentives that they had to administer resources efficiently, from a social point of view, disappeared.”

In Venezuela, president Chavez’s socialist inspired, command policies, paid for by the sale of expensive oil to the rest of the world have led to benefits primarily for those citizens willing to show political loyalty to Chavez and his party. Hard work and productivity is not rewarded as much as loyalty and support for the government. This system of incentives leads to some poor outcomes. The result? Only mediocre improvements in poverty rates, literacy, employment and health of the people.

In Brazil, where free market principles underlie much of the economic development policies, monetary benefits for development workers and the families they serve are linked not to political affiliation but to actual behavior of households and government employees. The result, not surprisingly, has been real improvements in education, health, and poverty levels amongst Brazilians.

Meanwhile, in Brazil, progress appears to have been more widespread. Figures compiled last year by Rômulo Paes de Sousa of the Ministry of Social Development and Fight Against Hunger, covering the period from 1999 through 2004, painted a rosy picture: School attendance was up, while illiteracy was down. Life expectancy was up, but hospital visits were down. Employment was up, and child labor was down.

Again, however, it’s difficult to say with certainty where the credit should go… [perhaps] to the simple fact that Brazil’s monetary benefits for families are indeed linked to actions like attendance in school, prenatal care and childhood vaccinations?

The lesson here? In a command economy like Venezuela’s, in which the government decides how resources are to be allocated, it appears that real improvements in people’s lives are not as important as political loyalty. Because most people involved in economic development work for the government, they focus on making themselves appear more dedicated and loyal to president Chavez, in order to make sure they get paid more and promoted up the ladder.

In Brazil’s free market economy, on the other hand, rewards are based on performance, not political loyalty. Brazilians have enjoyed access to a wider variety of efficiently run development programs than Venezuelans, despite Hugo Chavez’s pledge to alleviate poverty. Correct incentives explain why the market system is more efficient and effective than a command system, and the examples of Venezuela and Brazil illustrate this observation quite nicely

Discussion Questions:

  1. Why do command economies fail efficiently allocate resources to where they are needed the most?
  2. What does Brazil do that Venezuela does not that has led to real improvements in people’s lives?

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16 responses so far

Aug 29 2008

Free markets and free societies may not go hand in hand

Capitalism and democracy: friends or foes? | Free exchange | Economist.com

How Capitalism Is Killing Democracy – Foreign Policy (abstract only)

“Why is FREEDOM so important in a market economy? If people in society are not free, can a market economy truly succeed?”.

Friday’s class discussion focused on the different answers to the basic economic questions offered by centrally planned versus market economies. 

The question I left them to ponder over the weekend had to do with an apparent paradox visible in China today: that of a free market economy seemingly thriving in a society where political and social freedoms are severely limited by the communist dictatorship. It has long been claimed that free markets will be followed closely by political freedom, and vis versa. The two are thought to go hand in hand. According to the Economist.com’s blog, Free Exchange:

The late Milton Friedman emphasized that economic freedom promotes political freedom and is also necessary for the sustainability of political freedom over time. His underlying logic is that competitive capitalism separates economic power from political power. One could point to Chile, Taiwan and South Korea as examples where Friedman’s logic seems to hold.

So if, as Friedman said, free markets lend themselves to free societies, then how has China’s thriving market economy not resulted in a freer society, even after 30 years of economic liberalization? Robert Reich, writing in the Foreign Policy Journal examines the issue in some depth:

Conventional wisdom holds that where either capitalism or democracy flourishes, the other must soon follow. Yet today, their fortunes are beginning to diverge. Capitalism, long sold as the yin to democracy’s yang, is thriving, while democracy is struggling to keep up. China, poised to become the world’s third largest capitalist nation this year after the United States and Japan, has embraced market freedom, but not political freedom. Many economically successful nations ”from Russia to Mexico” are democracies in name only. They are encumbered by the same problems that have hobbled American democracy in recent years, allowing corporations and elites buoyed by runaway economic success to undermine the government’s capacity to respond to citizens’ concerns.

Of course, democracy means much more than the process of free and fair elections. It is a system for accomplishing what can only be achieved by citizens joining together to further the common good. But though free markets have brought unprecedented prosperity to many, they have been accompanied by widening inequalities of income and wealth, heightened job insecurity, and environmental hazards such as global-warming.

What can explain the recent divergence of capitalism and democracy in countries like China, Russia and Mexico? The Free Exchange blog explains:

The cause of this divergence, Mr Reich contends, is that companies seeking an advantage over global competitors have invested increasing amounts of money in government lobbying, public relations and bribery. This process of corporations’ writing their own rules has weakened the ability of average citizens to have their voices heard through the democratic process.

So it appears that as capitalism and free markets have flourished, freedom of the individual has been trumped by freedom of the corporation to lobby and thus influence government into creating favorable environments for investment and growth, often times at the expense of society’s health and the best interests of the public as a whole. We will learn a term for this kind of activity in AP and IB Economics: rent-seeking behavior.

As firms grown larger and industrial and commercial power becomes concentrated in powerful multi-national corporations, the priorities of governments seem to be shifting away from individual freedoms and civil rights and towards the interests of the corporate world, whose money and influence run deep through the veins of the world’s governments.

So perhaps I was wrong. Maybe Milton Friedman was wrong too. Perhaps the 21st Century has bred a new relationship where free market capitalism is wed not to democracy, but to a new kind of corporatocracy, a term used by Noam Chomsky, in which governments bow not to the will of the people they govern, rather to the pressures from corporate entities. Freedom and justice for all (firms, that is). Gives you something to think about, huh

Discussion Questions:

  1. Do free markets lead to free societies?
  2. Is political freedom a prerequisite for a successful market economy?
  3. Has “corporatocracy” surpassed democracy as the dominant influence in the rich, developed countries of the world?
  4. In what ways could economic strength come at the expense of individual freedom?

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69 responses so far

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