Royal Economics – or, why British taxpayers should celebrate the birth of a new prince…

Net Tax Revenue Royal Family

Whenever Buckingham Palace finds itself in the spotlight of global media attention, an ancient debate is revived, a debate that some experts estimate might be older than the monarchy itself: The debate of whether the royal family is still worth the taxpayers’ money in the 21st century.

At first, this might seem like a dispute that ought to be confined exclusively to British pubs, starring the Royals’ loyal supporters on one side and the isolated republican troublemaker on the other. Greatly diverging estimates of the costs attached to maintaining the Royal family can be exchanged  there, and then compared to the torrential flows of tourists who would have stayed at home were it not for the chance to catch the occasional glimpse of Queen Elizabeth II behind the windows of Buckingham Palace.

In these debates, the monarchists seem to have the edge over their subversive counterparts; for who could possibly argue that an average of GBP 42 million of Civil List payments (the Royal family’s annual income from the Treasury) in real terms over the past decade outweighs an added GBP 500 million in tourist spending on Royal castles, Royal towers, Royal mugs, and Royal mugs with Royal castles and Royal towers on them?

This squares well with 69% of British subjects agreeing that they would be worse off without the monarchy, against only 22% of unappreciative respondents in a 2012 survey by the Guardian. It is important to stress here that this argument is not based on the common misconception that the taxpayers receive about GBP 300 million from Royal assets every year. This income is generated by the Crown Estate, a collection of assets worth GBP 7.3 billion that has been surrendered to the Treasury by King George III as early as 1760 in return for a steady income through the Civil List.

Nevertheless, there is a case to be made to move the discussion out of the pubs and introduce economic reflection. So far, we have compared apples and oranges—government expenditure that has to be raised through tax revenue, and tourist spending, which needs to be taxed. This is like saying that it is reasonable for a simple employee to buy a GBP 40 million mansion because he just secured a GBP 500 million contract for his company.

Average Cost Royal Family

In order to answer the question, one has to make specific assumptions about how increased consumer spending will affect the economy. In traditional economic theory, an increase in demand for tourism represents an increased demand for exports. In a small open economy with flexible exchange rates and nearly perfect capital mobility, i.e. a country like the UK, an increase in export demand puts upward pressure on the interest rate, which draws in foreign capital. This increases demand for pound sterling on the foreign exchange market and therefore leads to an appreciation of the exchange rate until the pressure on the interest rate subsides. At this point, according to theory, the increased demand for tourism has been offset by a drop in exports (manufactured goods etc.) of the same magnitude. Overall, the output of the economy therefore remains unchanged.

Now what does this mean for tax revenue? Most tourist expenditures will be taxed at the VAT—so the tax revenue from increased spending on tourism is 20% of the increase in expenditure. At the same time, exports go down by an equal amount, but since exports are not usually taxed, tax revenue does not decline. While profits increase in the tourist sector, they decline in the export sector. Depending on gross profit margins in both sectors and the corporate tax rate, overall tax revenue therefore rises by slightly less than the VAT revenue due to increased tourist spending.

All of the following are assumptions within the framework laid out above and may be replaced by the reader in the attached Excel sheet.* The estimates have been chosen according to conservative estimates and available economic data. While most of the assumptions are self-explanatory, the fiscal multiplier can be used to assess the change in GDP due to an increase in domestic spending or an increase in export demand (both affect GDP and the exchange rate equivalently). In accordance with an econometric analysis by the IMF, it is here assumed to be zero—although an increase does not significantly change the results. Secondly, the VisitBritain estimate of the increase of consumer spending has been decreased by 30% because GBP 500 million in added tourist expenditure already include GBP 90 million in spending on admission to the Tower of London, Westminster Abbey, and the National Maritime Museum.

These figures include an estimated increase in consumer spending of GBP 413 million in 2011 due to the Royal Wedding, and an increase of GBP 243 million due to the Royal Baby. On the other hand, the wedding also increased security spending in 2011 by GBP 21.1 million. While this is a rough estimate, one also has to consider adverse incentives that reduce innovation and productivity increases in the export sector due to crowding out. Even without counting these long-term effects, it seems that the Royal Family is not worth the money.

Costs and Benefits

Obviously, these numbers will hardly impress staunch monarchists who have been supporting the Windsors for centuries—just like it will be difficult to convince die-hard republicans that the necessary inequality is acceptable as long as the Royals attract enough tourists. However, everyone can benefit from moving the argument beyond the exercise of shouting out the highest numbers in pubs. There is still cause for celebration: When everyone gets together and celebrates Royal weddings and babies, the monarchy heals Britain’s wounds of the financial crisis.

*Unless indicated as 2013 prices, the figures given refer to the respective year.

By: Marvin Gouraud

Sources: Centre for Retail Research, IMF, World Bank, The Economist, Yahoo Business, The Guardian, Slate, Intelligent Life, Reuters, Consultant-News, VisitBritain, The Telegraph, royal.gov.uk, European Commission, Office of National Statistics (UK)

A Generation at Risk: The Global Youth Unemployment Crisis

student protest

The world, according to the business leaders at Davos 2012, is “sitting on a social and economic time bomb:” global youth unemployment. Many leaders at the World Economic Forum’s meeting last year iterated that failing to employ the youth today amounts to a “cancer in society,” which not only affects economic growth now but will significantly stifle future growth. The figures have not improved since Davos 2012: as of last year  12.4 percent of people aged 15 to 24 worldwide were unemployed, which has increased to 12.6 percent in 2013. Now, young people are three times more likely to be unemployed than adults.

According to the International Labor Organization (ILO), in a global labor force of 3.3 billion, some 200 million people are unemployed, 75 million of which are between the ages of 15 and 24.  ILO’s Global Employment Trends for Youth 2013 report points out that the weakening of the global recovery in 2012 and 2013 has further aggravated the youth jobs crisis—youth unemployment increased by as much as 24.9 percent in the Developed Economies and European Union between 2008 and 2012. Both developed nations and emerging economies alike are struggling to create pathways to employment for their young citizens. Youth unemployment rates, which have continued to soar since 2008, are particularly high in three regions: Developed Economies and European Union, the Middle East, and North Africa. The lowest regional youth unemployment rates in 2012 were South Asia, with 9.3 percent, and East Asia at 9.5 percent. The highest were 28.3 percent in the Middle East and 23.7 percent in North Africa. In the advanced economies, the statistics are equally worrying.  In the European Union, the rate was at a 10-year high of 22.6 percent in 2012—with Greece at a staggering 54.2 percent and Spain at 52.4 percent—while  16.3 percent of the youth in the United States was unemployed.

Unemployment rates alone do not demonstrate the scale of the issue, given the 290 million young people more broadly classed as NEETs (not in education, employment or training). According to the Organization for Economic Co-operation and Development (OECD), 14.8 percent  of young Americans were qualified as NEETs in the first quarter of 2011, while the figure was 13.2 percent in the European Union. In the OECD area as a whole, one in six young people were without a job and not in education or training. The proportion of young people neither working nor studying illustrates how well economies manage the transition between school and work, which has become particularly problematic in developed economies.

The skills mismatch in youth labor markets is an underlying cause of this persistent and growing trend. McKinsey, a global management consulting firm, reported that in the nine countries that it studied (America, Brazil, Britain, Germany, India, Mexico, Morocco, Saudi Arabia and Turkey) 40 percent of employers were struggling to find candidates with adequate skills for entry-level jobs. In contrast, almost 45 percent of young people said that their current jobs were not related to their studies, and of these more than half viewed their jobs as temporary and said they were planning to leave. Another survey by Accenture found that in the United States, 41 percent of college graduates from the last two years had to take jobs that do not require a degree. The skills mismatch shows that over-education and over-skilling coexist with under-education and under-skilling.  This is particularly the case in most developed economies, where the job market is split between high-paying jobs that most workers are not qualified for and low-paying, low-skill jobs that do not provide a sufficient income.

Many economists think that such a systemic mismatch requires policymakers to reform rigid labor markets and implement education policies that would close the gap between the world of education and world of work. Creating vocational and technical programs and forging stronger relations between future employers and future employees are seen as remedies to ease the school-to-work transition. Germany, where apprenticeships and vocational training have long been the norm, has the second lowest rate (8.2 percent) of youth unemployment in the European Union. Such training programs, backed by a certification system, would allow employees to have skills transferable across companies and industries. However, only less than a quarter of education-providers offer similar practical courses involving hands-on learning in the classroom or training on the job.

It is also unclear if similar training programs would produce similar results in other countries, given that Germany’s export-driven economy is characterized by high-tech manufacturing, which employs many highly-trained manual workers. Thus, determining country-specific needs will be crucial for employing wide-ranging and well-targeted reforms. The ILO suggests that some labor market policies, such as targeting the employment of disadvantaged youth, promoting self-employment to assist potential young entrepreneurs, and implementing international labor standards ensuring that young people receive equal treatment at work, are necessary to revamp youth labor markets across countries.  Without significant reforms, it is estimated that there will be a global shortfall of 85 million high- and middle-skill workers for the labor market by 2020.Unless bold reforms are undertaken, many fear that the economic and social costs of long-term unemployment, discouragement and pervasive low-quality jobs will not only continue to undermine the growth of many economies but will also put a whole generation at risk.

By: Sera Tolgay

Sources: BBC News, Huffington Post, International Labor Organization, The Economist, Time Magazine, CNN, Business Week

Photo Credit: Paris January 15th, 2009 Student Protest courtesy of Flicker user frog and onion

The politics of debt – why overcoming structural deficits might be both easier and more difficult than generally assumed

debt word collageOver the past few years, it seems that politicians have suffered an important loss of independence. Instead of displaying leadership and shaping economic policy, they are being chased by “the markets”. Central banks around the world have heeded politicians’ calls for help and reduced interest rates to historic lows. Nevertheless, growth remains slow, unemployment high, and investors nervous.

Not least in Europe, governments and the European Central Bank (ECB) outbid each other in their efforts to contain market fears and return the common currency to stability. It took no less than Mario Draghi’s announcement of the ECB’s “Outright Monetary Transactions Program”—the ECB’s commitment to buy unlimited government bonds on the secondary market—to break the vicious circle of spiraling government debt and bank rescues. Investor fears remain, however: Cyprus’ bailout in March this year warrants further caution on this front and when the Federal Reserve recently hinted at a possible end of Quantitative Easing next year, stock markets fell.

The reasoning underlying loose monetary policy in the current crisis is based on solid economic theory and most economists agree—at least in principle—that this approach is right. Similarly, all rescue measures following the initial Greek bailout certainly prevented a dangerous domino-effect. However, government bail-out packages in the Euro area, central bank bond-buying programs, and low interest rates share a common feature: they merely deal with problems in the short-term.

At first, this does not seem like a revolutionary statement—most economists will reply that monetary policy obviously only affects the short run and politicians will maintain that they are well aware of the need for structural reform. After all, long-term reforms require time to take effect; loose monetary policy, bailout and bond-buying programs are therefore dictated by current circumstances without leaving much room for alternatives. To a certain extent, this is true and in this sense, politicians and central bankers are merely reacting to the crisis. However, this story suffers from two oversimplifications.

First, it neglects the effect of short-term relief on politicians’ incentives to tackle long-term problems. Decision-makers have to strike a balance between the costs of reform and the costs of inactivity. On the one hand, implementing painful budget cuts and structural reforms that lower real wages and pension benefits creates discontent and therefore cost governments their popularity and votes. On the other hand, the immediate crisis results in political pressure that requires a reaction and the provision of solutions by politicians. By nudging central banks to loosen monetary policy and providing short-term relief in the form of rescue-packages, governments can avoid costly structural reforms while displaying activity and reducing popular pressure. The result is that—although economically sound—short-term relief might actually harm the process of necessary long-term structural reforms by reducing politicians’ incentives to implement it.

Second, the story ignores the immediate positive effects that the adoption of long-term reform measures can have. The reason why the Eurozone had to adopt several subsequent ultima ratio rescue packages is that the governments never provided a credible roadmap for sustainable reform of their public finances. Similarly, postponing decisions about the public pension reforms and other demographic challenges creates uncertainty in the business environment which severely reduces private investment.

The point here is that the way out of the current economic crisis lies in the adoption of both short-term and long-term measures. The rationale should be that a real solution is the adoption of structural reforms and the reduction of structural budget deficits. A simultaneous loosening of monetary policy together with emergency provisions for the stabilization of the financial sector are equally important, but they merely buy time for the former to take effect. While a tendency to myopic economic policy represents a systemic difficulty of any democratic system, more weight should therefore be placed on the benefits of reducing political window-dressing and increasing transparency and accountability in economic policy-making. If politicians stop blaming the markets for being suspicious of their policies, they can co-opt them and thereby regain control of the situation.

 

By: Marvin Gouraud

Sources: European Central Bank, Journal of Economic Policy Reform, The Economic Journal, Critical Review, The Wall Street Journal, Journal of Public Policy, Capital Markets Law Journal, Business Week, Council of the European Union, The International Spectator

Bitcoin and the Challenges of Virtual Currency

bitcoinAlthough Bitcoin, the “world’s first decentralized digital currency”, was launched in 2009, it has only recently gained popularity as a currency. Unlike other existing currencies, Bitcoin lacks a central monetary authority, which creates problems for financial regulators. In place of a traditional central monetary authority, a computer network composed of Bitcoin users self-regulates the currency. Members of this Bitcoin network “monitor and verify” the creation of new Bitcoins and also regulate transactions between users.

Bitcoins are generated through a virtual process known as “mining.” A unique serial number is allocated to each Bitcoin after it is created. However, the total number of Bitcoins that can be produced is limited to 21 million. There are currently about 11 million Bitcoins in circulation, equivalent to approximately $1.2 billion. Popularity of the Bitcoin currency has recently surged, as Bitcoins have recently become available to “ordinary customers and businesses.” Many small businesses are therefore beginning to accept Bitcoin as a viable form of payment. Small businesses in particular benefit from Bitcoin’s swipe fees, which are on average about 2% lower than those of credit cards. Owners of small businesses also favor the simplicity of using a virtual currency as opposed to cash or other forms of payment.

Various complications have emerged as authorities attempt to regulate Bitcoin’s use as a currency. Because Bitcoin users can maintain anonymity in transactions, Bitcoins are likely to be used for illicit purchases or transactions. As a result, federal and state regulators “are taking steps to prevent people and companies from using them for illegal activities.” In a recent interview, Benjamin Lawsky, superintendent of New York’s Department of Financial Services, stated, “Virtual currency firms inhabit an evolving and sometimes murky corner of the financial world.” However, authorities must gain a deeper understanding of Bitcoin’s mechanics before instituting effective regulatory measures. As Tony Gallippi, CEO of Bitcoin-handling company BitPay, explained, “You can’t apply the rules for the horse and buggy to an automobile.”

Bitcoin has recently faced a stream of legal difficulties. Last week, two prominent officials of the Bitcoin Foundation travelled to Washington to meet with federal officials, attempting to prove their willingness work within federal laws. General council of Bitcoin, Patrick Murck, told officials, “There’s a myth about Bitcoin that it is an anonymous payment network. That is not true. [Bitcoin has] an open public ledger that shows every transaction.” Although Bitcoin’s ledger is public, there is no formal mechanism to tie Bitcoin addresses to the identities of their owners. It is also unlikely that Bitcoin will mandate user identification in the future, as this would alter the configuration that made it successful in the first place.

So far, Bitcoin has lacked stability as a currency and many argue that Bitcoin is losing steam. In January 2013, Bitcoins were worth $13, rising to $266 by April, and falling to about $100 today. Due to the general novelty of online currency, Bitcoin’s future remains uncertain. Perhaps with tighter regulations and less volatility, Bitcoin and other virtual currencies will gain prominence in the global market.

By: Marjorie Baker

Sources: Wall Street Journal, Economist, Economic Times, NBC News, Washington Post

Photo Credit: Bitcoin courtesy of flickr user Electric-Eye