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

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 21^st 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.

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.

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)

Do traditional measurements misinterpret global trade?

As the world economy becomes more interconnected, it has become clear that import/export trade figures by themselves do not fully capture how much the US contributes to global commerce. Imports and exports merely measure the trade in completed products between nations and present a flawed picture. On the other hand, metrics such as US foreign affiliate sales provide information on longer-term investment and entrenchment in foreign markets, thereby giving a substantially different, and perhaps more accurate, look at what the US provides in goods and services.

Taking a look at exports trade data, a country like Ireland looks inconsequential to US trade with only $7,276 million (USD) in exported goods. However, Ireland is actually an important hub for transnational companies, and rakes in huge amounts of investment as shown by the foreign affiliate sales which puts Ireland at around $171,895 million, a number that eclipses Mexico at $143,478 million. Using only exports, Mexico is our number two trading partner for exports, but when we use the Sales/Export ratio, Mexico stands at 0.9, whereas Ireland is at 23.6.Without accounting for foreign affiliate sales, policy makers would have no idea of the importance of Ireland to US commerce. In addition, using foreign affiliate sales sheds light on other trade relationships, including Germany a country that many policymakers are worried about due to our supposed trade imbalance. In actuality, while US exports with Germany are only at $48,161 million, the US foreign affiliate sales are at $244,785 million and a ratio of 5.1. This means that the US is very much invested into Germany and the trade imbalance is not as nearly as significant when looking at both sets of metrics. This also presents an interesting note on the relative significance of trading partners. Policy-makers often stress the importance of China to US trade, but when looking at foreign affiliate sales, China is only at $138,991 million compared to Germany’s $244,785 million. This has the implication that the US actually has more trade interests in Germany, which is something that is completely unacknowledged when measuring using only export trade.

Using only export numbers presents an incomplete depiction of US trade. It is very difficult to make smart policy that improves US trade potential if the true trade relationships between the US and foreign countries are not understood. In terms of trade importance to the United States, opportunities lie with the newly proposed Trans-Atlantic Trade Agreement at almost $1,473,483 million in foreign affiliate sales. The United States must begin to rely more on foreign affiliate trade data or at least use it to supplement traditional import/export measurements to get a more accurate representation of US trade interactions.

Posted by: Matthew Goldberg

Sources: U.S. International Trade Commission, Vox, OECD, U.S. Census Bureau

Guest Contributor William Krist- Obama’s Goal to Double Exports: A Midterm Analysis

Today’s report on the U.S. trade performance for May 2012 shows that the Obama Administration is roughly on track to achieve the President’s lofty goal of doubling U.S. exports over the five year period ending in 2014.  President Obama made this commitment, which would mean increasing exports from the 2009 level of $1.56 trillion to over $3 trillion, in his 2010 State of the Union address.  The objective of expanding exports is to promote U.S. employment, particularly in high paying manufacturing jobs.

To put this goal in perspective, exports just barely doubled in the ten years from 1999 to 2008. In fact, exports have not doubled over a five year period since the 1970s, and even then the doubling was mostly due to inflation.

Shortly after his 2010 State of the Union speech, Obama created the National Export Initiative and an Export Promotion Cabinet by executive order, giving them the responsibility of increasing U.S. exports.  While the Administration deserves a lot of credit for progress made to date, it needs to be noted that it is difficult to untangle the effects of U.S. export promotion activities from other uncontrollable effects such as changes in foreign demand and global business cycles, and the import policies of other countries.

Additionally, even as our exports have increased rapidly, U.S. imports have grown at an even faster rate. This means that the overall net effect of trade on our economy continues to be negative.  While doubling U.S. exports is a worthy goal, a better goal would be to achieve a balance of our exports and imports over the course of the business cycle.

For a more in-depth analysis of the Administration’s export initiative click here.

William K. Krist is a Senior Policy Scholar at the Woodrow Wilson Center.  He is a former Senior Vice President of the American Electronics Association.  He has written extensively on trade, development, and the environment. Anthony Gausepohl is a Research Assistant at the Woodrow Wilson Center.

Optimism for America’s Export Industry

This year’s May/June issue of The American Interest featured an article by Tyler Cowen arguing that we can expect the growth rate of American exports to continue increasing for the next decade. Even though American manufacturing jobs have been hurt by outsourcing, there are three main reasons to believe that the U.S. export industry is undergoing a revitalization – enough to make America “an export powerhouse.”

First is the ongoing revolution in high end technologies driven by American innovation. Advances in computing power and capabilities will make production more efficient. As firms rely more and more on these “smart machines,” wage rates become relatively less important, bringing manufacturing jobs back from China.

Second is the development of natural resources through the discovery of new fossil fuel deposits and new technologies that will “boost domestic production of oil.” The U.S. will be able to supply an increasingly energy-hungry world market with exports of oil and natural gas.

Third is the growing demand by developing countries’ for goods that the U.S. has an advantage in producing, such as machinery, equipment, pharmaceuticals, and entertainment. The growing middle classes of developing nations are accompanied by a shift in demand from primary sector goods to secondary sector goods.

Cowen believes that a boom in the export industry will mean higher wages for skilled laborers and lower pay for the low-skilled. However, the working class will still benefit from more affordable health care and education, and hopefully a more “dependable and stable” salary structure.

 

Posted by: Pokyee Yu

Sources: The American Interest

Photo Credit: Made in…courtesy of flickr user alistairas.

Production’s Role in Innovation

Since the State of the Union, “winning the future” has emerged as a hallmark of the Obama administration’s strategy for economic recovery, in an attempt to “out innovate, out educate, out build the rest of the world.”  With a nod to the innovative “spark” of the American people as the key to regaining lost manufacturing output, the President’s plan focuses on revamping science and math education and doubling exports in the next five years.

The United States has increased its exports 20% so far in 2011, but a simultaneous increase in imports has expanded the trade deficit close to 4% of GDP.  Susan Houseman, a senior economist at the W.E. Upjohn Institute, noted that the fraction of American goods made with foreign parts has risen from 17% to over 25%  since 1997—if counted, meaning more than a 1% drop in the reported American output.

A weaker manufacturing sector has implications for the entire American economy, and several business leaders point to production as another important tool for revival.  Mark Pinto, Executive Vice President of Applied Materials, suggested that investments in scale and technology beyond R&D innovations can attract business and keep American producers at the head of the market.  He argues that, by keeping production more local, the economy can retain the skilled workers that make the products, who Houseman and others believe play an integral role in the process of innovation.  “The big debate today is whether we can continue to be competitive in R&D when we are not making the stuff that we innovate,” Houseman said. “I think not.”

These theories do not discount the importance of a strong education system, but instead provide a supplementary theory of how United States manufacturers can stay competitive in the near term.  John Seely Brown, a former head of Xerox’s Silicon Valley research center recently told the Financial Times that “We really have to get back to building things.  We can’t just design things.”  Advocating spending on research and digital and physical infrastructure, Brown sees a “new kind of 21st-century economy that still has us building stuff.”

Posted by: John Coit

Sources: The New York Times, Financial Times, Wall Street Journal, Foreign Policy, Whitehouse.gov

Photo Credit: Industrial Construction – Automotive Industry courtesy of flickr user grayconstruction