Wednesday 22 June 2022

The economics of unions

With the ongoing rail strikes I wanted to talk about the economics of unions. Why do some jobs have unions that you can join and others don't?

There is a simple answer to this: power.

This might sound surprising coming from an economist, but actually power is an extremely important concept for markets and we implicitly talk about it all the time.

When you hear economists talk about "competitive" markets or an increase need for "competition", the word conjures up images of John McEnroe getting in red in the face over an umpires decision. If you were to describe someone as "competitive", let's be honest here, you are saying they are a bit of a dick. The type of person who throw a monopoly board in the air if they lost.

I do think this another instance of a badly named word in economics. Competition in markets doesn't mean people actually having to be competitive in a sporting sense. All that has to happen is that no firm can have so much influence that they can determine the price alone: they do not have the power. No one can charge really high prices as there is always someone there to undercut that price. This is why we think monopolies, where we have a single producer, are bad. We think they are so bad in fact, that we have an office of fair trading that determines if markets are "competitive" enough. 

Just as there are markets for goods and services, there are also markets for work which we call the labour market. The question as to whether or not the labour market is competitive depends on a simple question: if you lost your job, how easy would it be to find another one? That is, how much power does your employer have over you. 

The reason why this is a problem, is that if an employer has a lot of power, they can give you lower wages then you would have in a competitive market. If there were a single provider of jobs, we would call this situation a monopsony.

If you think about the last time you got a raise at work, it might have been because you threatened to leave or even had an outside offer. But if you have a single employer, say you work for the NHS, how can you get an outside offer?* Unions are an attempt to rebalance this power, between the employer and workers. It is why public sectors has many unions for teachers, nurses and rail workers have unions. 

The slightly annoying thing about this is that public sector pay debates seem to come up time and time again. I would like the UK to follow a policy by economist Pedro Gomez who proposes two rules. 1) That the level of pay in the public sector should be slightly lower than the private sector due to higher job security. 2) That the rate of public sector pay should be the same over time. That is, if the average private sector pay rises by 2%, that public sector pay should increase by 2% too. This means that incentives to join the private sector over the public don't diverge over time. 

Of course you will have some debate about levels of pay in the public sector, if job conditions change or we need more nurses, for example. But talking about levels is a much better way to doit than talking about rates and avoids strikes like we are currently seeing.

Now I am not arguing that all unions and strikes correctly address this balance of power in either direction. But I wanted to highlight the economic justification for them.

What I do find slightly annoying, however, is when people give the helpful advice of "join a union" to any issue arising in the labour market. About 25% of those that are employed are currently in a union. Obviously not everyone who has the option of joining a union, does, but it won't make that figure much higher if everyone who could join a union, did.

Although decline in labour market power is one reason for bad jobs with low wages in high-income countries, it isn't the only. There are all sorts of other reasons these wages have declined such as globalisation and low productivity to name but two. Unions are not panaceas to low pay, but are certainty helpful in rebalances market power in some industries.

*Perhaps one of the most famous unions in the UK are in mining. The reason why the employer had power over workers here was due to the fact that if you lost your job in Durham say, you could not easily move to a Welsh mine. 

Monday 20 June 2022

Why the value of Bitcoin is falling: an explainer

When I was young, before I even knew what economics was, I would stare at the pink front page of the Financial Times, wondering why anyone would be interested in the merger of two companies that no one has ever heard of.*

But sometimes, there is some financial news that I think people are genuinely interested in, they just have no idea what is going on. And because most of what is written about finance is for those in the know, it will forever remain a mystery to them.

There are a lot of things in life that are near impossible to enjoy unless you have some background understanding. It is why most lay people think cricket is dull or ballet boring. What makes matters worse is that when asking fans of a particular niche how to get into it, they usually say that you will just pick it up. I was once told by a poetry buff friend to just read poetry and I will pick it up. I read it, didn't get it, and put it down.  

It takes quite a lot of willpower to get through the early phases of a hobby, so I think any way you can make this learning curve less steep is great. This is why I started writing this blog, to help people understand economics. And who knows, some of you may even go on to to read an article... in the Financial Times.


The value of Bitcoin is going down. The reason it is going down, is because of inflation. To understand why this is interesting we need to look at what usually happens with two other types of investments when inflation happens: stocks and gold.

Inflation is the average rise in prices. So if inflation was 100%, a pint that was previously £5 would now cost £10. If you had £10 in your pocket, it would only buy 1 pint rather than 2.

In order to control increasing inflation, central banks will raise interest rates that ultimately determine the interest rate you get from your bank. You can read a brief explainer on the theory behind this here, but the upshot is that raising interest rates make saving more attractive.

If you looked at the interest rate you could get on your savings account over the last few years, whether it is an ISA or bond, you would be lucky to get anywhere near 1%. This meant that most people would try and look for higher returns elsewhere. In order to get higher investment returns, you usually need to invest in something more risky, like the stock market. 

If you put your saving into a bond, they are pretty much risk free - a safe asset. Usually you just have to give the bank your money for a set amount of time (1 or 2 years, say) and you are guaranteed a return. A share in a company, however, is a risky asset. It may give you much higher returns but it's not for certain. The fact that returns to safe assets have been so poor over the years is one reason why the stock market has been so high. 

So when inflation happens, people move their assets away from risky assets like the stocks into safe assets like saving bonds. This is why the stock market isn't doing so well now.

Another thing that happens with inflation is that gold increases with value. Traditionally, gold has been viewed as a "hedge" against inflation. A "hedge" is just something that protects yourself against a financial loss. This is because with inflation, the purchasing power of currency goes down (you can only buy 1 pint instead of 2). Gold is a precious metal and has a value of its own so won't necessarily lose value due to inflation. Why it has a particular value is difficult to get your head round but the easiest (and best?) answer is that gold is shiny and people like it. 

So what does all this have to do with Bitcoin? Well Bitcoin was invented to be an alternative currency to regular old pounds and dollars. Fan of Bitcoin's say that you cannot completely trust government controlled "fiat" currencies: governments can simply print money out of thin air (unlike crypto) and you will just get inflation. I don't buy this argument, but it is an argument nonetheless.

So given that cryptocurrency is an alternative currency, you would expect Bitcoin to be a hedge against inflation. So you would expect more people to invest in Bitcoin when inflation happens. But this has not been the case. In fact, the opposite has happened. 

This is because many investors think Bitcoin resembles a risky asset (like a stock) rather than a safe asset (like gold). This also suggests that part of the dramatic rise in Bitcoin was due to the fact that returns on savings bonds have been so poor. Even if there was a a 1 in 1000 chance of Bitcoin becoming a global currency, it might be worth a punt as the returns could be huge! But this becomes a less attractive bet when the return on safe assets, such as savings bonds, are rising.

This may or may not be particularly good news for crypto fans. It suggests that most investors are not massively convinced by the overall claims of it being an alternative currency. However, part of of what makes a good currency is stability - you are less likely to spend your Bitcoin if you believe that it will be worth twice as much tomorrow! Perhaps this crash brings a period of stability that makes it more usable as a currency. So the crash might be bad news if you invest in crypto but good news if you believe in the overall project of it being an alternative currency. 

*I love reading the FT now, but I still think mergers are extremely boring.

Thursday 16 June 2022

Doves, Hawks and the Politics of Interest Rates

Everything is political. 

This phrase annoys me. It is often used as a way for people to steer the direction of an argument towards something they would prefer to talk about: politics. 

For example, how do interest rates affect inflation and unemployment? Of course this question has political ramifications, how can it not? And yes, people's views on this will be affected by political bias. But at some point, moving interest rates up or down may actually do something to these variables and maybe, just maybe, that is an interesting question in itself?*

But in this case I actually want to talk about the politics of interest rates. I was partly inspired to write about this by the rather odd statement from Andrew Bailey suggesting workers shouldn't ask for pay rises in response to inflation. But also because I think the Left vs Right view of interest rates is misguided.

I have written a brief explainer about how we think interest rates work but feel free to skip the next section if you are au fait with monetary policy.

Intro to Interest Rates

Interest rates are the tool most modern economies use to control inflation and unemployment. You may be aware that the UK has a target rate of inflation of 2%. What you may not realise is that they also target unemployment implicitly (the US they are explicit about this in the Fed's target and state it as a 5% unemployment rate).

This is due to the view that there is a trade-off between inflation and unemployment, AKA the Phillips curve. 

Imagine an economy where unemployment is high that there is a surge in demand for new goods. Firms will hire people who are unemployed to meet this extra demand and so there is no real pressure for prices to increase.

But what if very few people were unemployed and demand increased? Prices are likely to increase in this case. The only way firms could get people to make these new products is by hiring from other firms or ask people to work more hours. But in order to do this, you need to increase wages. But increasing wages means people have more money to spend and this increases demand for products further, so firms increase prices again. This is the so called wage-price spiral.

So in order to control inflation, central banks increase interest rates in order to encourage saving rather than spending. This takes some of the demand out of the economy and so firms won't need to find workers and raise prices to meet this demand. 

If unemployment is high, however, we don't expect much demand in the economy and so expect inflation to be low. The central bank would seek to cut interest rates to discourage saving and increasing spending so that firms will employ more workers.

Doves vs Hawks

Being a "Dove" on interest rates entails caring more about unemployment than inflation, so you would be less likely to increase interest rates with signs of inflation. This is often associated with being more Left-wing. Being a "Hawk", is the opposite, caring more about inflation than unemployment and is usually associated with being more Right-wing. 

The historical reason for this political alignment is probably easiest to think about in a rich class (Right-wing) vs poor class (Left-wing) way. 

Poorer workers are more likely to be unemployed or become unemployed, so should intrinsically care more about unemployment. They also have have very little savings or assets which is aversely affected by inflation. 

For example, if  inflation was 100% and I were on £10 an hour and had zero in savings, then due to the demand present within the economy (so the theory goes) I would be able to get a wage rise in line with inflation to £20 an hour. Capitalist get most of their income via assets rather than labour, so if they had £1 million in savings then 100% inflation would mean they would affectively lose £500,000. So in this case the rich have far more to lose from inflation than the poor.

The first issue I have with this is that (in the UK at least), wages are not currently rising with inflation. There are number of reasons for this that we know of, not least the decline in unions and bargaining power of workers. But also that inflation is being driven in quite a large way by supply-side issues, through energy prices, Covid in China and the war in Ukraine. So the standard demand side view of inflation (as described in the previous section) isn't really the dominant factor in what is happening. What this means is that inflation is hurting both poor and rich alike. And although it may affect the rich proportionally more, the poor are less able to cope with inflation - hence, the cost of living crisis.

The other issue I have is that the rich also care about unemployment (not in a benevolent sense). By this, I mean the rich care about demand in the economy. If you are a big fat cat capitalist, you actually want people to go out and buy your wares. Unemployed people tend to not have very much money, so from a purely selfish point of you, the rich want you to be employed. So even though they may care about inflation more than unemployment, economy-wide unemployment is still bad for the rich.

I have only touched upon the politics of interest rates in so far as how they affect inflation and unemployment. But interest rates have a politics of their own. Home-owners (who tend to be richer) would want to keep interest rates low so they don't have to fork out so much in your monthly mortgage repayments. If you are saving up for a deposit for a house you would most likely benefit from higher interest rates in your savings account. 

The thing is, people don't always fall neatly into the above classes. Each individual will likely have their preferences depending on the make up of their wealth, the type of job they do and age etc. It might be true that on average that a Doveish stance may be slightly more pro poor and Hawkish more pro rich. But I would say this average has a lot of variability. I would also argue that these preferences are not absolute e.g. I may care more about unemployment than inflation, but this all depends on how high inflation is!

Andrew Bailey's Political Intervention

Saying all this, I do find it rather odd that Andrew Bailey suggested you shouldn't ask for a wage rise in response to inflation. What he implicitly said here was don't ask for raise or else we will have to increase interest rates further. If he said that a rare rise would be a consequence of increasing wages then fine (even though increasing wages isn't the main cause of inflation this time around, it will not exactly help bring inflation down).

But by explicitly arguing that people should not ask for a wage rise isn't in the governors remit. I would even go as far to say that it is a political intervention**. For many people (especially those on low-income with few assets), a wage rise would be in their interest, even if it contributed to higher inflation. He needs to take what people do as given, and respond with interest rates accordingly.

* "But ignoring the politics of this question is political!" you say, steeringly.

** When Mark Carne talked about Brexit uncertainty and was also accused of political intervening. To my mind, this is quite different. He was not telling people what to do or even suggesting Brexit was wrong. You could argue his political bias affected his reasoning but then you go down the everything is political rabbithole.

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