ILO
Short for international labour organisation, founded in 1919 as part of the treaty of Versailles, which created the League of Nations. In 1946, it became the first specialised agency of the UN. Based in Geneva, it formulates international labour standards, setting out desired minimum rights for workers: freedom of association; the right to organise and engage in collective bargaining; equality of opportunity and treatment; and the abolition of forced labour. It also compiles international labour statistics. One reason for its formation was the hope that international labour standards would stop countries using lower standards to gain a competitive advantage. From the 1980s onwards, the ilo approach came under attack as attention turned to the costs of high labour standards, notably slower economic growth. Universal minimum labour standards might also work against free trade. Imposing rich-country labour standards on poorer countries might help keep the rich rich and the poor poor.
IMF
Short for international monetary fund, referee and, when the need arises, rescuer of the world's financial system. The imf was set up in 1944 at bretton woods, along with the world bank, to supervise the newly established fixed exchange rate system. After this fell apart in 1971-73, the IMF became more involved with its member countries' economic policies, doling out advice on fiscal policy and monetary policy as well as microeconomic changes such as privatisation, of which it became a forceful advocate. In the 1980s, it played a leading part in sorting out the problems of developing countries' mounting debt. More recently, it has several times co-ordinated and helped to finance assistance to countries with a currency crisis.
The fund has been criticised for the conditionality of its support, which is usually given only if the recipient country promises to implement imf-approved economic reforms. Unfortunately, the IMF has often approved 'one size fits all' policies that, not much later, turned out to be inappropriate. It has also been accused of creating moral hazard, in effect encouraging governments (and firms, banks and other investors) to behave recklessly by giving them reason to expect that if things go badly the IMF will organise a bail-out. Indeed, some financiers have described an investment in a financially shaky country as a 'moral-hazard play' because they were so confident that the IMF would ensure the safety of their money, one way or another. Following the economic crisis in Asia during the late 1990s, and again after the crisis in Argentina early in this decade, some policymakers argued (to no avail) for the imf to be abolished, as the absence of its safety net would encourage more prudent behaviour all round. More sympathetic folk argued that the IMF should evolve into a global lender of last resort.
Income
The flow of money to the factors of production: wages to labour; profit to enterprise and capital; interest also to capital; rent to land. Wages left for spending after paying taxes is known as disposable income. For countries, see national income.
Income effect
A change in the demand for a good or service caused by a change in the income of consumers rather than, say, a change in consumer tastes. Contrast with substitution effect.
Income tax
A much-loathed method of taxation based on earnings. It was first collected in 1797 by the dutch batavian republic. In the uk it was introduced in 1799 as a “temporary” measure to finance a war against napoleon, abolished in 1816 and reintroduced, forever, in 1842. In most countries, people do not pay it until their income exceeds a minimum threshold, and richer people pay a higher rate of income tax than poorer people. Since the 1980s, the unpopularity with voters of high rates of income tax and concern that high rates discourage valuable economic activity have led many governments to reduce income-tax rates. However, this has not necessarily reduced the amount of total revenue collected in income tax (see laffer curve). Nor do governments that have reduced income tax rates always cut other sorts of taxes; on the contrary, they have often increased them sharply to make up for any revenue lost as a result of lower rates of income tax.
Incumbent advantage
The importance of being there already. Firms that are in a market can have a significant competitive advantage over aspiring entrants to that market, for instance, through having the opportunity to erect barriers to entry.
Index numbers
Economists love to compile indices aggregating lots of individual data, so they can analyse broad trends in the behaviour of an economy. Inflation is measured by an index of consumer (retail) prices. There are indices of all sorts of things that are bought and sold of which perhaps the best known are share price indices like the Dow jones industrial average or ftse-100. The main challenges in compiling an index are what, exactly, to include in it and what weight to give the different things that are included. A particularly tricky question is how to change an index over time. Measures of inflation are based on the price of a basket of things bought by a typical consumer. As the quality and choice of products in the basket change over time, the inflation index ought to take this into account. How, exactly, is much debated.
Indexation
Keeping pace with inflation. In many countries, wages, pensions, unemployment benefits and some other sorts of income are automatically raised according to recent movements in the consumer price index. This allows these different sorts of income to retain their value in real terms.
Indifference curve
A curve that joins together different combinations of goods and services that would each give the consumer the same amount of satisfaction (utility). In other words, consumers are indifferent to which of the combinations they get.
Indirect taxation
Taxes that do not come straight out of a person's pay packet or assets, or out of company profit. For example, a consumption tax, such as value-added tax (see expenditure tax). Contrast with direct taxation, such as income tax. Indirect taxation has become increasingly popular with politicians because it may be less noticeable to people paying it than income tax and is harder to avoid paying.
Inelastic
When the supply or demand for something is insensitive to changes in another variable, such as price.
Inequality
Does economic growth create more or less equality? Do unequal societies grow more or less slowly than equal ones? Economists have debated these questions for as long as anyone can remember. One problem is to agree which sort of inequality matters: equality of outcome (that is, income) or of opportunity? Another is how then to measure it. Equality of opportunity, which, in theory, should make a difference to growth, because it is about giving people the chance to make the most of their human capital, is probably beyond the ability of statisticians to analyse rigorously. The most often used measure of income inequality is the gini coefficient.
The evidence suggests that extreme poverty is more likely to slow growth than income inequality itself. This is because very poor people cannot buy the education they need to enable them to become richer and their children may be forced to forgo schooling in order to work for money.
Economic growth has generally reduced inequality within a country. This has been partly as a result of redistributive tax and benefits systems, which have become so significant that they may now be causing slower growth in some countries. The availability of welfare benefits may have discouraged unemployed people from seeking out a better job; and the high taxes needed to pay for the benefits may have discouraged some wealthy people from working as hard as they would have done under a friendlier tax regime. However, the new economy may see inequality in rich countries widen again, thanks to its alleged winner-takes-all distribution of financial rewards.
Inferior goods
Products that are less in demand as consumers get richer. For normal goods, demand increases as consumers have more to spend.
Inflation
Rising prices, across the board. Inflation means less bang for your buck, as it erodes the purchasing power of a unit of currency. Inflation usually refers to consumer prices, but it can also be applied to other prices (wholesale goods, wages, assets, and so on). It is usually expressed as an annual percentage rate of change on an index number. For much of human history inflation has not been an important part of economic life. Before 1930, prices were as likely to fall as rise during any given year, and in the long run these ups and downs usually cancelled each other out. By contrast, by the end of the 20th century, 60-year-old Americans had seen prices rise by over 1,000% during their lifetime. The most spectacular period of inflation in industrialised countries took place during the 1970s, partly as a result of sharp increases in oil prices implemented by the opec cartel. Although these countries have mostly regained control over inflation since the 1980s, it continued to be a source of serious problems in many developing countries.
Inflation would not do much damage if it were predictable, as everybody could build into their decision making the prospect of higher prices in future. In practice, it is unpredictable, which means that people are often surprised by price increases. This reduces economic efficiency, not least because people take fewer risks to minimise the chances of suffering too severely from a price shock. The faster the rate of inflation, the harder it is to predict future inflation. Indeed, this uncertainty can cause people to lose confidence in a currency as a store of value. This is why hyper-inflation is so damaging.
Most economists agree that an economy is most likely to function efficiently if inflation is low. Ideally, macroeconomic policy should aim for stable prices. Some economists argue that a low level of inflation can be a good thing, however, if it is a result of innovation. New products are launched at high prices, which quickly come down through competition. Most economists reckon that deflation (falling average prices) is best avoided.
To keep inflation low you need to know what causes it. Economists have plenty of theories but no absolutely cast-iron conclusions. Inflation, Milton Friedman once said, 'is always and everywhere a monetary phenomenon'. Monetarists reckon that to stabilise prices the rate of growth of the money supply needs to be carefully controlled. However, implementing this has proven difficult, as the relationship between measures of the money supply identified by monetarists and the rate of inflation has typically broken down as soon as policymakers have tried to target it. keynesian economists believe that inflation can occur independently of monetary conditions. Other economists focus on the importance of institutional factors, such as whether the interest rate is set by politicians or (preferably) by an independent central bank, and whether that central bank is set an inflation target.
Is there a relationship between inflation and the level of unemployment? In the 1950s, the phillips curve seemed to indicate that policymakers could trade off higher inflation for lower unemployment. Later experience suggested that although inflating the economy could lower unemployment in the short run, in the long run you ended up with unemployment at least as high as before and rising inflation as well. Economists then came up with the idea of the nairu (non-accelerating inflation rate of unemployment), the rate of unemployment below which inflation would start to accelerate. However, in the late 1990s, in both the United States and the uk, the unemployment rate fell well below what most economists thought was the nairu yet inflation did not pick up. This caused some economists to argue that technological and other changes wrought by the new economy meant that inflation was dead. Traditionalists said it was merely resting.
Inflation target
The goal of monetary policy in many countries is to ensure that inflation is neither too high nor too low. It became fashionable during the 1990s to set a country's central bank an explicit rate of inflation to target. By 1998, some 54 central banks had an inflation target, compared with just eight at the end of 1990, the year in which New Zealand’s reserve bank became the first to be set a target. In most industrialised countries, the target, or, typically, the mid-point of a target range, for consumer-price inflation is between 1% and 2.5%. The reason it is not zero is that official price indices overstate inflation, and that the countries would prefer a little inflation to any deflation.
Monetary poilcy takes time to have an impact. So central banks usually base their policy changes on a forecast of inflation, not its current rate. If forecast inflation in two years' time, say, is above the target, interest rates are raised. If it is below target, rates are cut.
Why has an inflation target? Setting an inflation target usually goes hand-in-hand with allowing a central bank considerable discretion in setting policy, so transparency in its decision-making is vital and is therefore usually increased as part of the process of adopting a target. More fundamentally, by making it easier to judge whether policy is on track, an inflation target makes it easier to hold a central bank to account for its performance. The pay of central bankers can be designed to reward them for achieving the target. But some central bankers argue that an inflation target restricts their policy flexibility too much, which is one reason why the world's most powerful central bank, america's federal reserve, has argued (so far successfully) against having one.
Information
The oil that keeps the economy working smoothly. Economic efficiency is likely to be greatest when information is comprehensive, accurate and cheaply available. Many of the problems facing economies arise from people making decisions without all the information they need. One reason for the failure of the command economy is that government planners were not good at gathering and processing information. Adam smith's metaphor of the invisible hand is all about how, in many cases, free markets are much more efficient at processing information on the needs of all the participants in an economy than is the visible, and often dead, hand of state planners. Asymmetric information, when one party to a deal knows more than the other party, can be a serious source of inefficiency and market failure. Uncertainty can also impose large economic costs. The internet, by greatly increasing the availability and lowering the price of information, is helping to boost economic efficiency. But there are inefficiencies the internet will not be able to solve. Uncertainty will remain a huge source of economic inefficiency. Alas, potentially the most useful information, about what will happen in the future, is never available until it is too late.
Infrastructure
The economic arteries and veins. Roads, ports, railways, airports, power lines, pipes and wires that enable people, goods, commodities, water, energy and information to move about efficiently. Increasingly, infrastructure is regarded as a crucial source of economic competitiveness. Investment in infrastructure can yield unusually high returns because it increases people's choices: of where to live and work, what to consume, what sort of economic activities to carry out, and of other people to communicate with. Some parts of a country's infrastructure may be a natural monopoly, such as water pipes. Others, such as traffic lights, may be public goods. Some may have a network effect, such as telephone cables. Each of these factors has encouraged government provision of infrastructure, often with the familiar downsides of state intervention: bad planning, inefficient delivery and corruption.
Innovation
A vital contributor to economic growth. The big challenge for firms and governments is to make it happen more often. Although nobody is entirely sure why innovation takes place, new theories of endogenous growth try to model the innovation process, rather than just assume it happens for unexplained, exogenous reasons. The role of incentives seems to be particularly important. Although some innovations are the result of scientists and others engaged in the noble pursuit of knowledge, most, especially their commercial applications are the result of entrepreneurs seeking profit. Joseph schumpeter, a leading practitioner of austrian economics, described this as a process of 'creative destruction'. A firm innovates successfully and is rewarded with unusually high profits, which in turn encourages rivals to come up with a superior innovation.
To encourage innovation, innovators must be allowed to make a decent profit, otherwise they will not incur the risk and expense of trying to come up with useful innovations. Most countries have patents and other laws protecting intellectual property, which allow innovators to enjoy a (usually temporary) monopoly over their innovation. Economists disagree over how long that protection should last, given the inefficiencies that result from any monopoly.
For most of the second half of the 20th century, governments played a crucial role in funding and directing pure research and early-stage development. In the 1980s, however, legal changes in the United States started to reduce this role. One change aimed to move technological development out of the country's state-financed national laboratories. Another allowed universities, not-for-profit research institutes and small businesses doing research under government contract to keep the technologies they had developed and to apply for patents in their own names. This appears to have contributed to a surge in innovation in the United States, as government researchers and university professors teamed up with outside firms, or started their own. Hoping for similar results, many other countries have followed suit.
Is innovation all it is cracked up to be, or is it just change for change's sake? A few years ago, Robert Solow, a nobel prize-winning economist, observed that 'you can see the computer age everywhere these days except in the productivity statistics'. Although new computer technology clearly had affected people and firms in visible and obvious ways, the slowdown in productivity growth that had afflicted the American economy since the 1970s did not appear to have been reversed. Believers in the new economy argued that the 'solow paradox' no longer holds true; in the late 1990s, the computer revolution started to deliver the productivity growth long promised. Even so, this shows that innovation can take a long time to deliver the goods.
Insider trading
A practice that was made illegal in the united states in 1934 and in the uk in 1980, and is now banned (for shares, at least) in most countries. Insider trading involves using information that is not in the public domain but that will move the price of a share, bond or currency when it is made public. An insider trade takes place when someone with privileged, confidential access to that information trades to take advantage of the fact that prices will move when the news gets out. This is frowned on because investors may lose confidence in financial markets if they see insiders taking advantage of advantageous asymmetric information to enrich themselves at the expense of outsiders. But some economists reckon that insider trading leads to more efficient markets: by transmitting the inside information to the market, it makes the price of, say, a company's shares more accurate. This may be true, but most financial regulators are willing to sacrifice a degree of accuracy in pricing to ensure that outsiders (the great majority of investors) feel they are being treated fairly.
Institutional investors
The big hitters of the financial markets: pension funds, fund-management companies, insurance companies, investment banks, hedge funds, charitable endowment trusts. In the United States, around half of publicly traded shares are owned by institutions and half by individual investors. In the uk, institutions own over two-thirds of listed shares. This gives them considerable clout, including the ability to move the prices in financial markets and to call company bosses to account. But because institutions mostly invest other people's money, they are themselves prone to agency costs, sometimes acting against the best long-term interests of the people who trust them with their savings.
Insurance
In economic terms, anything used to reduce the downside of risk. In its most familiar form, insurance is provided through a policy purchased from an insurance company. But a fuller definition would also include, say, a financial security (or anything else) used to hedge, as well as assistance available in the event of disaster. It could even be provided by the government, in various ways, including welfare payments to sick or poor people and legal protection from creditors in the event of bankruptcy.
Conventional insurance works by pooling the risks of many people (or firms, and so on), all of whom might claim but in practice only a few actually do. The cost of providing assistance to those that claim is spread over all the potential claimants, thus making the insurance affordable to all.
Despite the enormous attraction of insurance, private markets in insurance often work badly, or not at all. Economists have identified three main reasons for this.
Private firms are unwilling to provide insurance if they are uncertain about the likely cost of providing sufficient cover, especially if it is potentially unlimited.
Moral hazard means that people with insurance may take greater risks because they know they are protected, so the insurer may get a bigger bill than it bargained for.
Insurers are at risk of adverse selection. The people who are most likely to claim buy insurance, and those who are least likely to claim do not buy it. In this situation, setting a price for insurance that will generate enough premiums to cover all claims is tricky, if not impossible.
Insurers have found ways of reducing the impact of these problems. For example, to counter adverse selection, they set higher health-insurance rates for people who smoke. To limit moral hazard, they offer reduced premiums to people who agree to pay the first so-many dollars or pounds of any claim.
An efficient system of insurance, in its broadest sense, can contribute to economic growth by encouraging entrepreneurial risk taking and by enabling people to choose which risks they take and which they protect themselves against.
Intangible assets
Valuable things, even though you cannot drop them on your foot - an idea, say, especially one protected by a patent; an effective corporate culture; human capital; a popular brand. Contrast with tangible assets.
Intellectual capital
The part of a country's or a firm's capital or an individual's human capital that consists of ideas rather than something more physical. It can often be protected through patents or other intellectual property laws.
Interest
The cost of borrowing, which compensates lenders for the risk they take in making their money available to borrowers. Without interest there would be little lending and thus a lot less economic activity. The charging of interest is contrary to sharia (Islamic) law, being considered usury. Some american states also have usury laws, imposing tough conditions on the terms set by lenders, although not actually prohibiting interest. Yet, as the recent rise of a substantial banking industry in islamic middle eastern countries shows, when economic growth is a priority, ways can usually be found to pay lenders to lend.
Interest rate
Interest is usually expressed at an annual rate: the amount of interest that would be paid during a year divided by the amount of money loaned. Developed economies offer many different interest rates, reflecting the length of the loan and the riskiness and wealth of the borrower. People often use the term 'interest rate' when they mean the short-term interest rate charged to banks. For instance, when a central bank raises or cuts interest rates, it changes only the price it charges to banks borrowing money overnight, expressed as an annual rate. Bond yields are a better measure of the interest rate on loans that do not have to be repaid for many years. Unlike short-term interest rates, bond yields are determined not by central bankers but by the supply and demand for money, which is heavily influenced by the expected rate of inflation.
International aid
A helping hand for poor countries from rich countries. This, at least, is the intention. In practice, in many cases aid has done little good for its intended recipients (improved health care is a notable exception) and has sometimes made matters worse. Poor countries that receive lots of aid grow no faster, on average, than those that receive very little. By contrast, perhaps the most successful aid programme ever - the marshall plan for rebuilding europe after the second world war - involved rich countries giving to other hitherto rich countries.
During the second half of the 20th century rich countries gave over $1 trillion in aid to poor ones. During the 1990s, however, flows of official aid stagnated. In 2001, official aid was a little over $50 billion, roughly one quarter of the gdp of donor countries. On top of this were private-sector donations from ngos (non-government organisations) worth an estimated $6 billion. Increasingly, such sums were exceeded by private foreign direct investment. In an attempt to reinvigorate international aid, in 2000 the un committed itself to eight ambitious millennium development goals for reducing global poverty by 2015.
Why has aid achieved so little? Donations have often ended up in the offshore bank accounts of corrupt politicians and officials in poor countries. Money has often been given with strings attached, so that much of this 'tied' aid is spent on companies and corrupt politicians and officials in the donor country. War has ravaged many potentially beneficial aid projects. Moreover, some aid has been motivated by political goals - for example, shoring up anti-communist governments - rather than economic ones.
The lesson of history is that aid will often be wasted unless it is carefully aimed at countries with a genuine commitment to sound economic management. Analysis by the world bank sorted 56 aid-receiving countries by the quality of their economic management. Those with good policies (low inflation, a budget surplus and openness to trade) and good institutions (little corruption, strong rule of law, effective bureaucracy) benefited from the aid they received. Those with poor policies and institutions did not. This accounts for the growing popularity of conditionality in aid.
Intervention
When central banks try to influence an exchange rate by buying the currency they want to appreciate and selling the one they want to weaken. The evidence seems to suggest that it is at best a short-term measure. In the longer term, governments probably do not have the resources to beat market forces.
Investment
Putting money to work, in the hope of making even more money. Investment takes two main forms: direct spending on buildings, machinery and so forth, and indirect spending on financial securities, such as bonds and shares.
Traditionally, economic theory says that a country's total investment must equal its total savings. But this has never been true in the short run and, as a result of globalisation, may never be even in the long run, as countries with low savings can attract investment from overseas and foreign savers lacking opportunities at home can invest abroad (see foreign direct investment).
The more of its gdp a country invests, the faster its economy should grow. This is why governments try so hard to increase total investment, for instance, using tax breaks and subsidies, or direct public spending on infrastructure. However, recent evidence suggests that the best way to encourage private-sector investment is to pursue stable macroeconomic policies, with low inflation, low interest rates and low rates of taxation. Curiously, economic studies have not found evidence that higher levels of investment lead to higher rates of gdp growth. One explanation for this is that the circumstances and manner in which money is invested count at least as much as the total sums invested. It ain't how much you do, it's the way that you do it.
Invisible hand
Adam smith's shorthand for the ability of the free market to allocate factors of production, goods and services to their most valuable use. If everybody acts from self-interest, spurred on by the profit motive, then the economy will work more efficiently, and more productively, than it would do were economic activity directed instead by some sort of central planner. It is, wrote smith, as if an 'invisible hand' guides the actions of individuals to combine for the common good. Smith recognised that the invisible hand was not infallible, however, and that some government action might be needed, such as to impose antitrust laws, enforce property rights, and to provide policing and national defence.
Invisible trade
Exports and imports of things you cannot touch or see: services, such as banking or advertising and other intangibles, such as copyrights. Invisible trade accounts for a growing slice of the value of world trade.
