Labour
One of the factors of
production, with land, capital and enterprise. Among the things that determine
the supply of labour are the number of able people in the population, their
willingness to work, labour laws and regulations, and the health of the economy
and firms. Demand for labour is also affected by the health of the economy and
firms, labour laws and regulations, as well as the price and supply of other
factors of production.
In a perfect market, wages
(the price of labour) would be determined by supply and demand. But the labour
market is often far from perfect. Wages can be less flexible than other prices;
in particular, they rarely fall even when demand for labour declines or supply
increases. This wage rigidity can be a cause of unemployment.
Labour intensive
A production process that
involves comparatively large amounts of labour; the opposite of capital
intensive.
Labour market flexibility
A flexible labour market is
one in which it is easy and inexpensive for firms to vary the amount of labour
they use, including by changing the hours worked by each employee and by
changing the number of employees. This often means minimal regulation of the
terms of employment (no minimum wage, say) and weak (or no) trade unions. Such
flexibility is characterised by its opponents as giving firms all the power,
allowing them to fire employees at a moment's notice and leaving workers
feeling insecure.
Opponents of labour market
flexibility claim that labour laws that make workers feel more secure encourage
employees to invest in acquiring skills that enable them to do their current
job better but that could not be taken with them to another firm if they were
let go. Supporters claim that it improves economic efficiency by leaving it to
market forces to decide the terms of employment. Broadly speaking, the evidence
is that greater flexibility is associated with lower rates of unemployment and
higher gdp per head.
Labour theory of value
The notion that the value of
any good or service depends on how much labour it uses up. First suggested by Adam
smith, it took a central place in the philosophy of karl marx. Some
neo-classical economists disagreed with this theory, arguing that the price of
something was independent of how much labour went into producing it and was
instead determined solely by supply and demand.
Laffer curve
Legend has it that in November
1974 Arthur laffer, a young economist, drew a curve on a napkin in a Washington
bar, linking average tax rates to total tax revenue. Initially, higher tax
rates would increase revenue, but at some point further increases in tax rates
would cause revenue to fall, for instance by discouraging people from working.
The curve became an icon of supply-side economics. Some economists said that it
proved that most governments could raise more revenue by cutting tax rates, an
argument that was often cited in the 1980s by the tax-cutting governments of
ronald reagan and margaret thatcher. Other economists reckoned that most
countries were still at a point on the curve at which raising tax rates would
increase revenue. The lack of empirical evidence meant that nobody could really
be sure where the United States and other countries were on the Laffer curve.
However, after the Reagan administration cut tax rates revenue fell at first.
American tax rates were already low compared with some countries, especially in
continental Europe, and it remains possible that these countries are at a point
on the laffer curve where cutting tax rates would pay.
Lagging indicators
Some economic statistics move weeks or months
after changes in the business cycle or inflation. They may not be a reliable
guide to the current state of an economy or its future path. Contrast with
leading indicators.
Laissez-faire
The belief that an economy
functions best when there is no interference by government. It can be traced to
the 18th-century french physiocrats, who believed in government according to
the natural order and opposed mercantilism. Adam smith and others turned it
into a central tenet of classical economics, as it allowed the invisible hand
to operate efficiently. (But even they saw a need for some limited government
role in the economy.) In the 19th century, it inspired the British political
movement that secured the repeal of the corn laws and promoted free trade, and
gave birth to the economist in 1843. In the 20th century, laissez-faire was
often seen as synonymous with supporting monopoly and allowing the business
cycle to boom and bust, and it came off second best against Keynesian policies
of interventionist government. However, mounting evidence of the inefficiency
of state intervention inspired the free market policies of Ronald Reagan and Margaret
thatcher in the 1980s, both of whom stressed the importance of laissez-faire.
Land
One of the factors of
production, along with labour, capital and enterprise. Pending colonisation of
the moon, it is in fairly fixed supply. Marginal increases are possible by
reclaiming land from the sea and cutting down forests (which may impose large
economic costs by damaging the environment), but the expansion of deserts may
slightly reduce the amount of usable land. Owners earn money from land by
charging rent.
Land tax
Henry George, a 19th-century
American economist, believed that taxes should be levied only on the value of
land, not on labour or capital. This 'single tax', he asserted in his book,
progress and poverty, would end unemployment, poverty, inflation and
inequality. Many countries levy some tax on land or property values, although George’s
single tax has never been fully implemented. This is mainly because of fears
that it would drive down land prices too much or discourage efforts to improve
the quality (that is, the economic value) of land. George addressed this
concern by arguing that the tax should be levied only against the value of
'unimproved' land. Certainly, a land tax has obvious advantages: it is simple
and cheap to levy; evasion is all but impossible; and it penalises owners who
do not put their land to work.
Law and economics
Laws can be an important
source of economic efficiency - or inefficiency. Early economists such as Adam
smith often wrote about the economic impact of legal matters. But economics
subsequently focused more narrowly on things monetary and commercial. It was
only in the 1940s and 1950s, at the university of Chicago law school, that the
discipline of law and economics was born. It is now a substantial branch of
economics and has had an impact beyond the ivory towers.
The "economics" of
law and economics is firmly in the liberal economics camp, favouring free
markets and arguing that regulation often does more harm than good. It stresses
the economic value of having clear, enforceable property rights, and of
ensuring that these can be bought and sold. It has encouraged many antitrust
policymakers to focus on maximising consumer welfare, rather than, say,
protecting small firms or opposing big ones just because they are big. It has
also ventured into broader sociological issues, for instance, analysing the
economic causes of criminality and how to structure legal incentives to reduce
crime.
Leading indicators
Economic crystal balls. Also
known as cyclical indicators, these are groups of statistics that point to the
future direction of the economy and the business cycle. Certain economic
variables, fairly consistently, precede changes in gdp and certain others
precede changes in inflation. In some countries, statisticians combine the
various different leading indicators into an overall leading index of economic
growth or inflation. However, there is not necessarily any causal relationship
between the leading indicators and what they are predicting, which is why, like
other crystal balls, they are fallible. Contrast with lagging indicators.
Lender of last resort
One of the main functions of
a central bank. When financially troubled banks need cash and nobody else will
lend to them, a central bank may do so, perhaps with strings attached, or even
by taking control of the troubled bank, closing it or finding it a new owner.
This role of the central bank makes credit creation easier by increasing
confidence in the banking system and minimising the risk of a bank run by
reassuring depositors that their money is safe. However, it also creates a
potential moral hazard: that bank will lend more recklessly because they know
they will be bailed out if things go wrong.
Leveraged buy-out
Buying a company using
borrowed money to pay most of the purchase price. The debt is secured against
the assets of the company being acquired. The interest will be paid out of the
company’s future cashflow. Leveraged buy-outs (lbos) became popular in the
united states during the 1980s, as public debt markets grew rapidly and opened
up to borrowers that would not previously have been able to raise loans worth
millions of dollars to pursue what was often an unwilling target. Although some
lbos ended up with the borrower going bust, in most cases the need to meet
demanding interest bills drove the new managers to run the firm more
efficiently than their predecessors. For this reason, some economists see lbos
as a way of tackling agency costs associated with corporate governance.
Liberalisation
A policy of promoting
liberal economics by limiting the role of government to the things it can do to
help the market economy work efficiently. This can include privatisation and
deregulation.
Libor
Short for london interbank
offered rate, the rate of interest that top-quality banks charge each other for
loans. As a result, it is often used by banks as a base for calculating the
interest rate they charge on other loans. Libor is a floating rate, changing
all the time.
Life
Human life is priceless. But
this has not stopped economists trying to put a financial value on it. One
reason is to help firms and policymakers to make better decisions on how much
to spend on costly safety measures designed to reduce the loss of life. Another
is to help insurers and courts judge how much compensation to pay in the event
of, say, a fatal accident.
One way to value a life is
to calculate a person's human capital by working out how much he or she would
earn were they to survive to a ripe old age. This could result in very
different sums being paid to victims of the same accident. After an air crash,
probably more money would go to the family of a first-class passenger than to
that of someone flying economy. This may not seem fair. Nor would using this
method to decide what to spend on safety measures, as it would mean much higher
expenditure on avoiding the death of, say, an investment banker than on saving
the life of a teacher or coal miner. It would also imply spending more on
safety measures for young people and being positively reckless with the lives
of retired people.
Another approach is to
analyse the risks that people are voluntarily willing to take, and how much
they require to be paid for taking them. Taking into account differences in
wages for high death-risk and low death-risk jobs, and allowing for differences
in education, experience, and so on, it is possible to calculate roughly what
value people put on their own lives. In industrialised countries, most studies
using this method come up with a value of $5m-10m.
Life-cycle hypothesis
An attempt to explain the
way that people split their income between spending and saving, and the way
that they borrow. Over their lifetime, a typical person's income varies by far
more than how much they spend. On average, young people have low incomes but
big spending commitments: on investing in their human capital through education
and training, building a family, buying a home, and so on. So they do not save
much and often borrow heavily. As they get older their income generally rises,
they pay off their mortgage, the children leave home and they prepare for
retirement, so they sharply increase their saving and investment. In
retirement, their income is largely or entirely from state benefits and the saving
and investment they did when working; they spend most or all of their income,
and, by selling off assets, often spend more than their income.
Broadly speaking, this
theory is supported by the data, though some economists argue that young people
do not spend as much as they should on, say, being educated, because lenders
are reluctant to extend credit to them. One puzzle is that people often have
substantial assets left when they die. Some economists say this is because they
want to leave a generous inheritance for their relatives; others say that
people are simply far too optimistic about how long they will live.
Liquidity
How easily an asset can be
spent, if so desired. Cash is wholly liquid. The liquidity of other assets is
usually less; how much less may be measured by the ease with which they can be
exchanged for cash (that is, liquidated). Public financial markets try to
maximise the liquidity of assets such as bonds and equities by providing a
central meeting place (the exchange) in which would-be buyers and sellers can
easily find each other. Financial market makers (middlemen such as investment
banks) can also increase liquidity by using some of their capital to buy
securities from those who want to sell, when there is no other buyer offering a
decent price. They do this in the expectation that if they hold the asset for a
while they will be able to find somebody to buy it. Typically, the higher the
volume of trades is happening in a marketplace, the greater is its liquidity.
Moreover, highly liquid markets attract more liquidity-seeking traders, further
increasing liquidity. In a similar way, there can be vicious cycles in which
liquidity dries up. The amount of liquidity in financial markets can vary
enormously from one moment to the next, and can sometimes evaporate entirely,
especially if market makers become too risk averse to put their capital at risk
in this way.
Liquidity preference
The proportion of their
assets that firms and individuals choose to hold in varying degrees of
liquidity. The more cash they have, the greater is their desire for liquidity.
Liquidity trap
When monetary policy becomes
impotent. Cutting the rate of interest is supposed to be the escape route from
economic recession: boosting the money supply, increasing demand and thus
reducing unemployment. But Keynes argued that sometimes cutting the rate of
interest, even to zero, would not help. People, banks and firms could become so
risk averse that they preferred the liquidity of cash to offering credit or
using the credit that is on offer. In such circumstances, the economy would be
trapped in recession, despite the best efforts of monetary policymakers.
Keynesians reckon that in
the 1930s the economies of both the United States and the uk were caught in a
liquidity trap. In the late 1990s, the Japanese economy suffered a similar
fate. But monetarism has no place for liquidity traps. Monetarists pin the
blame for the great depression and japan's more recent troubles on other
factors and reckon that ways could have been found to make monetary policy
work.
Long run
When we are all dead,
according to Keynes. Unimpressed by the thrust of classical economics, which
said that economies have a long-run tendency to settle in equilibrium at full
employment, he wanted economists to try to explain why in the short run
economies are so often in disequilibrium, or in equilibrium at high levels of
unemployment.
Lump of labour fallacy
One of the best-known
fallacies in economics is the notion that there is a fixed amount of work to be
done - a lump of labour - which can be shared out in different ways to create
fewer or more jobs. For instance, suppose that everybody worked 10% fewer hours.
Firms would need to hire more workers. Hey presto, unemployment would shrink.
In 1891, an economist, D.F.
Schloss, described such thinking as the lump of labour fallacy because, in
reality, the amount of work to be done is not fixed. Government-imposed restrictions
on the amount of work people may do can actually reduce the efficiency of the
labour market, thereby increasing unemployment. Shorter hours will create more
jobs only if weekly pay is also cut (which workers are likely to resist)
otherwise costs per unit of output will rise. Not all labour costs vary with
the number of hours worked. Fixed costs, such as recruitment and training, can
be substantial, so it will cost a firm more to hire two part-time workers than
one full-timer. Thus a cut in the working week may raise average costs per unit
of output and cause firms to buy fewer total hours of labour. A better way to
reduce unemployment may be to stimulate demand and so increase output; another
is to make the labour market more flexible, not less.
Lump-sum tax
A tax that is the same
amount for everybody, regardless of income or wealth. Some economists argue
that this is the most efficient form of taxation, as it does not distort
incentives and thus it has no dead weight cost. This is because each person knows
that whatever they do they will have to pay the same amount. It is also cheap
to administer, as there is no complex process of measuring each person's income
and assets in order to calculate their tax bill. However, because rich and poor
people pay the same, the tax may be perceived as unfair - as Margaret thatcher
found out when she introduced a lump-sum 'poll tax', a decision that was later
to play a large part in her ousting as British prime minister.
Luxuries
Goods and services that have
a high elasticity of demand. When the price of, say, a Caribbean holiday rises,
the number of vacations demanded falls sharply. Likewise, demand for Caribbean
holidays rises significantly as average income increases, certainly by more
than demand for many normal goods. Contrast this with necessities, such as milk
or bread, which people usually demand in quite similar quantities whatever
their income and whatever the price.
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