Microfinance Glossary

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Assets

Things that’s have earning power or some other value to their owner.

Source: Essentials of Economics, Matthew Bishop

Asymmetric information

When somebody knows more than somebody else. Such asymmetric information can make it difficult for the two people to do business together, which is why economists, especially those practicing game theory, are interested in it. Transactions involving asymmetric (or private) information are everywhere. A government selling broadcasting licenses does not know how likely a borrower is to repay; a used-car seller knows more about the quality of the car being sold that do potential buyers. This kind of asymmetry can distort people’s incentives and result in significant inefficiencies.

Source: Essentials of Economics, Matthew Bishop

TopBank

Starting out as places that would guard your money, banks became the main source of credit creation. Increasingly, however, borrowers are turning to the financial markets and to non-savings institutions, such as credit-card companies and consumer-finance firms, when they need a loan. This is reducing the profitability of traditional bank lending and has led many banks to enter new areas of business, such as selling insurance policies and mutual funds. Increasingly, too, traditional banks are selling off parcels of their loans in the financial markets by a process called securitization.

What the most efficient split is between bank lending and other sorts of lending is debatable. Economists argue endlessly about whether an economy such as the United States, in which firms rely more heavily on equity and debt markets than on banks to fund their investment, is better than one such as they say, Germany, in which banks have traditionally been the main source of corporate finance.

Banks come in many different forms. Commercial banks, also known as retail banks, cater directly for the general public and lend to (mostly small and medium sized) firms. In the past, they did so largely through a network of bank branches, although increasingly these are giving way to ATM machines, the telephone and the internet. Wholesale banks largely transact with other banks and financial institutions. Investment banks, also known as merchant banks, concentrate on raising money for companies from private investors or in the financial markets, by finding buyers for their equity and corporate bonds. Universal banks do most or all of the above including, through bancasasurance, selling insurance. These banks have long been a feature of continental European economies. However, in the United States financial laws such as the Glass Steagall Act have separated different forms of banking from each other and kept banks out of the insurance business. These laws were abolished in 1999, although during the preceding couple of decades regulators effectively dismantled them by changing the way they were applied. Even so, because of these and other laws, which for many years stopped banks from operating across state borders, the United States has far more lending institutions per 100,000 people in the United States, compared with fewer than one per 100,000 in the UK and France.

Source: Essentials of Economics, Matthew Bishop

Bankable

Bankable people are those deemed eligible to obtain financial services that can lead to income generation, repayment of loans, savings, and the building of assets.

Bankruptcy

When a court judges that a debtor is unable to make the payments owed to a creditor. How bankrupts are treated can affect economic growth. If bankrupts are punished too severely, would-be entrepreneurs may be discouraged from taking the financial risks needed to make the most of their ideas. However, letting off defaulting debtors too readily may discourage potential creditors because of Moral Hazard.

America’s bankruptcy code, in particular its Chapter 11 protection for firms from their creditors, is particularly friendly to troubled borrowers, allowing them to borrow more money and giving them time to work out their problems. Some other countries quickly close down a bankrupt firm, and try to repay its debts by selling off any assets it has.

Source: Essentials of Economics, Matthew Bishop

Barriers to entry (or exit)

How firms keep out competition- an important source of incumbent advantage. There are four main categories of barriers.

• A firm may own a crucial resource, such as an oil well, or it may have an exclusive operating license, for instance, to broadcast on a particular radio wavelength.
  
• A big firm with economies of scale may have a significant competitive advantage because it can produce a large output at lower costs than can a smaller potential rival.
  
• An incumbent firm may make it hard for a would-be entrant by incurring huge sink costs, spending lots of money on things such as advertising, which any rival must match to compete effectively but which have no value if the attempt to compete should fail.
  
• Powerful firms can discourage entry by raising exit costs, for example, by making it an industry norm to hire workers on long-term contracts, which make firing an expensive process.

Source: Essentials of Economics, Matthew Bishop

Bonds

“Gentlemen prefer bonds,” punned Andrew Mellon, an American tycoon. A bond is an interest-bearing security issued by governments, companies, and some other organizations. Bonds are an alternative way for the issuer to raise capital to selling shares or taking out a bank loan. Like shares in listed companies, once they have been issued bonds may be traded on the open market. A bond’s yield is the interest rate (or coupon) paid on the bond divided by the bond’s market price. Bonds are regarded as a lower-risk investment. Government bonds, in particular, are highly unlikely to miss their promised payments. Corporate bonds issued by blue-chip “investment grade” companies are also unlikely to default; this might not be the case with high-yield “junk” bonds issued by firms with less healthy financials.

Source: Essentials of Economics, Matthew Bishop

TopCapital Markets

In securities such as bonds and shares. Governments and companies use them to raise longer-term capital from investors, although few of the millions of capital-market transactions everyday involve the issuer of the security. Most trades are in the secondary markets, between investors who have bought the securities and other investors who want to buy them. Contrast with money markets, where short-term capital is raised.

Source: Essentials of Economics, Matthew Bishop

Capital Structure

The composition of a company’s mixture of debt and equity financing. A firm’s debt-equity ratio is often referred to as its gearing. Taking on more debt is known as gearing up, or increasing leverage. In the 1960s, Franco Modigliani and Merton Miller (1923-2000) published a series of articles arguing that it did not matter whether a company financed its activities by issuing debt, or equity, or a mixture of the two. (For this they were awarded the Nobel Prize for economics.) But, they said, this rule does not apply if one source of financing is treated more favorably by the taxman than another. In the United States, debt has long had tax advantages over equity, so their theory implies that American firms should finance themselves with debt. Companies also finance themselves by using the profit they retain after paying dividends.

Source: Essentials of Economics, Matthew Bishop

Catch-up effect

In any period, the economies of countries that start off poor generally grow faster than the economies of countries that start off rich. As a result, the national income of poor countries usually catches up with the national income of rich countries. New technologies may even allow developing countries to leap-frog over industrialized countries with older technology. This, at least, is the traditional economic theory. In recent years, there has been considerable debate about the extent and speed of convergence in reality.

One reason to expect catch-up is that workers in poor countries have little access to capital, so their productivity is often low. Increasing the amount of capital at their disposal by only a small amount can produce huge gains in their productivity. Countries with lots of capital, and as a result higher levels of productivity, would enjoy a much smaller gain from a similar increase in capital. This is one possible explanation for the much faster growth of Japan and Germany, compared with the United States and the UK, after the Second World War and the faster growth of several Asian “tiger”, compared with developed countries, during the 1980s and most of the 1990s.

Source: Essentials of Economics, Matthew Bishop

Central Bank

A guardian of the monetary system. A central bank sets short-term interest rates and oversees the health of the financial system, including by acting as lender of last resort to commercial banks that get into financial difficulties. The Federal Reserve, the central bank of the United States, was founded in 1913.The Bank of England, known affectionately as the “Old Lady of Threadneedle Street”, was established in 1694, 26 years after the creation of the worlds first central bank in Sweden. With the birth of the Euro in 1999, the monetary policy powers of the central banks of 11 European countries were transferred to a new European Central Bank, based in Frankfurt.

During the 1990s there was a trend to make central banks independent from political intervention in their day-to-day operations and allow them to set interest rates. Independent central banks should be able to concentrate on the long-term needs of an economy, whereas political intervention may be guided by the short-term needs of the government. In theory, an independent central bank should reduce the risk of inflation. Some central banks are legally required to set interest rates so as to hit an explicit inflation target. Politicians are often tempted to exploit a possible short-term trade-off between inflation and unemployment, even though the long-term consequence of easing policy in this way is (most economists say) that the unemployment rate returns to what you started with and inflation in higher. An independent central bank, because it does not have to worry about persuading an electorate to vote for it, is more likely to act in the best long-run interests of the economy.

Source: Essentials of Economics, Matthew Bishop

Charity

“Bah! Humbug”, was Scrooge’s opinion of charitable giving. Some economists reckon charity goes against economic rationality. Some have argued that the popularity of charitable giving is proof that people are not economically rational. Others argue that it shows that Altruism is something that people get pleasure (utility) from, and so are willing to spend some of which the state is competing with private charity when it redistributes money from rich to poor or spends more on health care and whether this is inefficient.

Source: Essentials of Economics, Matthew Bishop

Collateral

An asset pledged by a borrower that may be seized by a lender to recover the value of a loan if the borrower fails to meet the required interest charges or repayments.

Source: Essentials of Economics, Matthew Bishop

Competition

The more competition there is, the more likely are firms to be efficient and prices to be low. Economists have identified several different sorts of competition. Perfect competition is the most competitive market imaginable in which everybody is a price taker. Firms earn only normal profits, the bare minimum profit necessary to keep them in business. If firms earn more that this (excess profits), other firms will enter the market and drive the price level down until there are only normal profits to be made.

Most markets exhibit some form of imperfect or monopolistic competition. There are fewer firms than in a perfectly competitive market and each can to some degree create barriers to entry. So firms can earn some excess profits without a new entrant being able to compete to bring prices down.

The least competitive market is a monopoly, dominated by a single firm that can earn substantial excess profits by controlling either the amount of output in the market or the price (but not both). In this sense it is a price setter. When there are few firms in a market (Oligopoly), they have the opportunity to behave as a monopolist through some form of collusion. A market dominated by a single firm does not necessarily have monopoly power if it is a contestable market. In such a market, a single firm can dominate only if it produces as efficiently as possible and does not earn excess profits, another more efficient or less profitable firm will enter the market and dominate instead.

Source: Essentials of Economics, Matthew Bishop

Compound interest

If a deposit account of $100 earns an interest rate of 10% a year, then at the end of the year the account will contain $110. If all of that money is left in the account, then the 10% interest will be paid on the $110, so at the end of the second year $11 of interest will be added, making $121 in all. This is known as compound interest. By contrast, simple interest pays the 10% only on the original sum in the account.

Source: Essentials of Economics, Matthew Bishop

Credit

A loan extended or (sometimes) taken by, for example, delayed payment of an invoice.

Source: Essentials of Economics, Matthew Bishop

Creditor

A lender, whether by making a loan, buying a bond or allowing money owed now to be paid in the future.

Source: Essentials of Economics, Matthew Bishop

Crowding out

When the state does something it may discourage, or crowd out, private-sector attempts to do the same thing. At times, excessive government borrowing has been blamed for low private sector borrowing and, consequently, low investment and (because the economic returns on public borrowing are typically lower than those on private debt, especially corporate concern in recent years as government indebtedness has declined and, because of globalization, firms have become more able to raise capital outside their home country. Crowding out may also come from state spending on things that might be provided more efficiently by the private sector, such as health care, or even through charity redistribution.

Source: Essentials of Economics, Matthew Bishop

TopDebt

“Neither a borrower nor a lender be,” wrote Shakespeare in “Hamlet”. Actually, the availability of debt, and the willingness to take it on, is a crucial ingredient of economic growth, because it allows individuals, firms and governments to make investments they would not otherwise be able to afford. The price of debt is interest. Until recently, lending was an activity dominated by banks (although mortgages for individuals buying their homes have long been available from special housing savings institutions). Since the 1960s, debt has become increasingly available from other sources. Companies have sold trillions of dollars worth of bonds to investors in the financial markets. Individuals have been able to borrow with credit cards, and for those who have nowhere else to turn there are pawn shops and loan sharks, which charge very high rates of interest. Total private-sector debt in 2003 was around 150% of GDP in the United States, compared with less than 100% in 1928. In most countries, by far the biggest single borrower is the state, through the national debt.

Source: Essentials of Economics, Matthew Bishop

Demand curve

A graph showing the relationship between the price of a good and the amount of demand for it at different prices.

Source: Essentials of Economics, Matthew Bishop

Developing economics

Spawned by the end of the colonial era in 1950s and 1960s a whole branch of economic theory grew up around the question of how to promote economic development in poor countries. The proposition on which development economics was built was that poor countries were intrinsically different from rich ones and so needed their own set of economic models. Some development economists argued, for instance, that the self-interested, rational individual (homo economicus) did not exist in traditional tribal societies. They claimed that because many poor countries had large agricultural populations and foreign exchange earnings, economic policies and suited rich countries would not work for them.

With hindsight, much of this was misguided, and policies based on it had disastrous effects. Development economists believed that the state had to play a big role in fostering modernization. Instead, the result was huge, inefficient bureaucracies riddled with corruption, massive budget deficits and rampant inflation. During the 1990s, most governments of developing countries started to reverse these policies and undo the damage they had done by introducing based on similar economic models to those that had worked in rich countries. However, the sequencing of these new policies seemed to make a big difference to how well they worked. Doing the right things in the right order is crucial.

Source: Essentials of Economics, Matthew Bishop

TopEconomies of scale

Bigger is better. In many industries, as output increases, the average cost of each unit produced falls. One reason is that overheads and other fixed costs can be spread over more units of output. However, getting bigger can also increase average costs (diseconomies of scale) because it is more difficult to manage a big operation, for instance.

Source: Essentials of Economics, Matthew Bishop

Elasticity

A measure of the responsiveness of one variable to changes in another. Economists have identified four main types.

• Price elasticity measures how much the quantity of supply of a good, or demand for it, changes if its price changes. If the percentage change in quantity is more than the percentage change in price the good is price elastic; if it is less, the good is price inelastic.
• Income elasticity of demand measures how the quantity demanded changes when income increases.
• Cross-elasticity shows how the demand for one good (say, coffee) changes when the price of another good (say, tea) changes. If they are substitute goods (tea and coffee) the cross-elasticity will be positive: an increase in the price of tea will increase demand for coffee. If they are complementary goods (tea and teapots) the cross elasticity will be negative. If they are unrelated, (tea and oil), the cross-elasticity will be zero.
• Elasticity of substitution describes how easily one input in the production process, such as labor, can be substituted for another, such as machinery.
• Source: Essentials of Economics, Matthew Bishop

Entrepreneur

The life and soul of the capitalist party. Somebody who has the idea and enterprise to mix together the other factors of production to produce something valuable. An entrepreneur must be willing to take a risk in pursuit of a profit.

Source: Essentials of Economics, Matthew Bishop

TopFinancial intermediary

A middleman. An individual or institution that brings together investors (the source of funds) and users of funds (such as borrowers). May be increasingly at risk of disintermediation.

Source: Essentials of Economics, Matthew Bishop

Financial system

The firms and institutions that together make it possible for money to make the world go round. This includes financial markets, securities exchanges, banks, pension funds, mutual funds, insurers, national regulators, such as the Securities and Exchange Commission (SEC) in the United States, Central banks, governments and multinational institutions, such as the IMF and World Bank.

Source: Essentials of Economics, Matthew Bishop

TopGini coefficient

An inequality indicator. The Gini coefficient measures the inequality of income distribution within a country. It varies from zero, which indicates perfect equality, with every household earning exactly the same, to one, which implies absolute inequality, with a single household earning a country’s entire income. Latin America is the world’s most unequal region, with a Gini coefficient around 0.5; in rich countries the figure is closer to 0.3.

Source: Essentials of Economics, Matthew Bishop

TopHuman Development Index

The “good life” guide. Calculated since 1990 by the United Nations Development Programme, the Human Development Index quantifies a country’s development in terms of such things as education, length of life and clean water, as well as income. Since the mid-1970s, the quality of life for humans throughout the world has improved enormously overall. America’s human development index rose my around 40% and Indonesia’s by nearly 50%. Even so, in 2001, some 54 countries were poorer than in 1990, and in 34, mostly in Africa and the former Soviet Union, life expectancy had fallen, reversing an impressive long-term trend, largely because of the HIV/AIDS epidemic and crime. Some 21 countries had a lower overall human development index in 2003 than in 1990.

Source: Essentials of Economics, Matthew Bishop

TopIncome

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.

Source: Essentials of Economics, Matthew Bishop

Income effect

A change in demand for a good or service caused by a change in the income of consumers rather than, say, a change in consumer tastes.

Source: Essentials of Economics, Matthew Bishop

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.

Source: Essentials of Economics, Matthew Bishop

Inelastic

When the supply or demand for something is insensitive to changes in another variable, such as price.

Source: Essentials of Economics, Matthew Bishop

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 wealthier people from working as hard as they would have done under a friendlier tax regime. However, inequality in rich countries may now widen significantly because of an increasingly winner-takes-all distribution of financial rewards.

Source: Essentials of Economics, Matthew Bishop

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.

Source: Essentials of Economics, Matthew Bishop

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 countries 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.

Source: Essentials of Economics, Matthew Bishop

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 globalization, may never be true in the long run, as countries with low savings can attract investment from overseas and foreign savers lacking opportunities at home can invest abroad.

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.

Source: Essentials of Economics, Matthew Bishop

TopLiquidity

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 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.

Source: Essentials of Economics, Matthew Bishop

TopMicrocredit

Microcredit is a small amount of money loaned to a client by a bank or other institution. Microcredit can be offered, often without collateral, to an individual or through group lending.

• Group lending, also known as solidarity lending, is a mechanism that allows a number of individuals to provide collateral or guarantee a loan through a group repayment pledge. The incentive to repay is based on peer pressure; if one person in the group defaults, the other group members make up the payment amount.
• Individual lending, in contrast, focuses on one client and does not require other people to provide collateral or guarantee a loan.

Microentrepreneurs are people who own small-scale businesses that are known as microenterprises. These businesses usually employ less than 5 people and can be based out of the home. They can provide the sole source of family income or supplement other forms of income. Typical microentrepreneur activities include retail kiosks, sewing workshops, carpentry shops and market stalls.

Microfinance refers to loans, savings, insurance, transfer services and other financial products targeted at low-income clients.

Microinsurance is a system by which people, businesses and other organizations make payments to share risk. Access to insurance enables entrepreneurs to concentrate more on growing their businesses while mitigating other risks affecting property, health or the ability to work.

Microsavings are deposit services that allow people to store small amounts of money for future use, often without minimum balance requirements. Savings accounts allow households to save small amounts of money to meet unexpected expenses and plan for future investments such as education and old age.

Money Supply

The amount of money available in an economy. In the heyday of monetarism in the early 1980s, economists pounced upon the monthly (in some countries, even weekly) money-supply numbers for clues about future inflation. Central banks aim to manage demand by controlling the supply of money though open-market operations, reserve requirements and changing the rate of interest (to be exact, the discount rate).

One difficulty for policymakers lies in how to measure the relevant money supply. There are several different methods, reflecting the different liquidity of various sorts of money. Notes and coins are completely liquid; some bank deposits cannot be withdrawn until after a waiting period. M3 (M4 in the UK) is known as broad money, and consists of cash, current account deposits in banks and other institutions, savings deposits and time restricted deposits. M1 is known as narrow money, and consists mainly of cash in circulation and current account deposits. M0 (in the UK) is the most liquid measure, including only cash in circulation, cash in banks' tills and banks' operational deposits held at the bank of England.

Although it is a poor predicator of inflation, monetary growth can be a handy leading indicator of economic activity. In many countries, there is a clear link between the growth of the real broad-money supply and that of real GDP.

Source: Essentials of Economics, Matthew Bishop

Moral Hazard

One of the two main sorts of market failure often associated with the provision of insurance. The other is adverse selection. Moral hazard means that people with insurance may take greater risks than they would do without it because they know they are protected, so the insurer may get more claims than it bargained for.

Source: Essentials of Economics, Matthew Bishop

TopNGO

Short for non-government organization. Although such groups have existed for generations (in the early 1800s, the British and Foreign Anti-Slavery Society played a powerful part in abolishing slavery laws), recent social and economic shifts have given these typically voluntary, non-profit, “issue-driven” organizations new life. The collapse of communism, the spread of democracy, technological change and economic integration (globalization, in short) have each helped NGOs grow. Globalization itself has exacerbated a host of worries about the environment, labour rights, human rights, consumer rights, and so on. Democratisation and technological progress have revolutionized the way in which citizens can unite to express their disquiet.

Governments have been at the sharp end of pressure from NGOs. Arguably, however, it is inter-governmental institutions such as the world bank, the IMF, the UN agencies and the world trade organization (WTO) that have felt it more, owing to their lack of political leverage. Few parliamentarians will face direct pressure from the IMF or the WTO, but every policymaker faces pressure from citizens’ groups with special interests. Add to this the poor public image that these technocratic, faceless bureaucracies have developed, and it is hardly surprising that they are popular targets for NGO “swarms”. How governments and inter-governmental organizations respond to NGOs could have huge implications, including for the world’s economies. Equally important will be how NGOs themselves respond to greater scrutiny and to growing concern about how accountable they are, and to whom.

Source: Essentials of Economics, Matthew Bishop

TopOECD

The Organization for Economic Co-operation and Development, a Paris-based club for industrialized countries and the best of the rest. It was formed in 1961, building the Organization for European Economic Co-operation (OEEC), which had been established under the Marshall Plan. By 2003, its membership had risen to 30 countries, from an original 20. Together, OECD countries produce two thirds of the world's goods and services. The OECD provides a policy talking shop for governments. It produces forests-worth of documents discussing public policy ideas, as well as detailed empirical analysis. It also publishes reports on the economic performance of individual countries, which usually contains lots of valuable information even if they are rarely very critical of the policies implemented by a member government.

Source: Essentials of Economics, Matthew Bishop

TopPoverty

The state of being poor, which depends on how you define it. One approach is to use some absolute measure. For instance, the poverty rate refers to the number of households whose income is less than three times what is needed to provide an adequate diet. (Though what constitutes adequate may change over time.) Another is to measure relative poverty. For instance, the number of people in poverty can be defined as all house-holds with an income of less than, say, half the average household income. Or the (relative) poverty line may be defined as the level of income below which are, say, the poorest 10% of households. In each case, the dividing line between poverty and not-quite poverty is somewhat arbitrary.

As countries get richer, the number of people in absolute poverty usually gets smaller. This is not necessarily true of the numbers in relative poverty. The way that relative poverty is defined means that it is always likely to identify a large number of impoverished households. However rich a country becomes, there will always be 10% of households poorer than the rest, even though they may live in mansions and less caviar than the other 90% of households).

Source: Essentials of Economics, Matthew Bishop

Price elasticity

A measure of the responsiveness of demand to a change in price. If demand changes by more than the price has changed, the good is price-elastic. If demand changes by less than the price, it is price-inelastic. Economists also measure the elasticity of demand to changes in the income of consumers.

Source: Essentials of Economics, Matthew Bishop

Purchasing power parity

A method for calculating the correct value of a currency, which may differ from its correct market value. Purchasing power parity (PPP) is helpful when comparing living standards in different countries, as it indicates the appropriate exchange rate to use when expressing incomes and prices in different countries in a common currency.

By correct value, economists mean the exchange rate that would bring demand and supply of a currency into equilibrium over the long-term. The current market rate is only a short-term equilibrium. It says that goods and services should cost the same in all countries when measured in a common currency. It is the exchange rate that equates the price of a basket of identical traded goods and services in two countries.

PPP is often very different from the current market exchange rate. Economists argue that once the exchange rate is pushed away from its PPP, trade and financial flows in and out of a country can move into disequilibrium, resulting in potentially substantial trade and current amount deficits or surpluses. Because it is not just traded goods that are affected, some economists argue that PPP is too narrow a measure for judging a currency's true value. They prefer the fundamental equilibrium exchange rate (FEER), which is the rate consistent with a country achieving an overall balance with the outside world, including both traded goods and services and capital flows.

Source: Essentials of Economics, Matthew Bishop

TopRegulation

Rules governing the activities of private-sector enterprises. Regulation is often imposed by government, either directly or through an appointed regulator. However, some industries and professions impose rules on their members through self-regulation.

Regulation is often introduced to tackle market failure. Externalities such as pollution have inspired rules limiting factory emissions. Regulations on the selling of financial products to individuals have been introduced as protection against unscrupulous financial firms with better information than their customers. Rate of return regulation and price regulation have been used to combat natural monopoly, sometimes instead of nationalisation. Some regulation has been motivated by politics rather than economics, for instance, restrictions on the number of hours people can work or the circumstances in which an employer can dismiss employees.

Even when introduced for sound economic reasons, regulation can generate more costs than benefits. Regulated firms or individuals may face substantial compliance costs. Firms may devote substantial resources to regulatory arbitrage, which would leave consumers no better off. Regulation may lead to moral hazard if people believe that the government is keeping an eye on the behaviour of the regulated business and so do less monitoring of their own. Regulation may be badly designed and thus lock an industry into an inefficient equilibrium. Rigid regulation may hold back innovation. There is also the danger of regulatory capture. In short, then, regulatory failure may be even worse for an economy than market failure.

Source: Essentials of Economics, Matthew Bishop

Remittances

Remittances are transfers of funds from people in one place to people in another, usually across borders to family and friends. Compared with other sources of money that can fluctuate depending on the political or economic climate, remittances are a relatively steady source of funds.

Returns

The rewards for doing business. Returns usually refer to profit and can be measured in various ways.

Source: Essentials of Economics, Matthew Bishop

TopSavings

Any income that is not spent. Ultimately, savings are the source of investment in an economy, although domestic savings may be supplemented by capital from foreign savers or themselves be invested abroad.

In an economic sense, savings include purchasing of shares or other financial securities. However, many official measures of a country's savings ratio - total savings expressed as a percentage of total income - leave out such financial transactions. At times when the demand for financial securities is unusually high, this can give a misleading impression of how much saving is taking place.

How much individuals save varies significantly among different age groups and nationalities. Everywhere, people of all ages save more as their income rises. The supply of savings rises when interest rates rise; a rise in interest rates causes demand for funds to invest to fall; a rise in demand for investment funds may cause interest rates, and thus the cost of capital, to rise. The level of savings is also influenced by changes in wealth and by taxation policies.

Source: Essentials of Economics, Matthew Bishop

Scalability

The ease with which the supply of an economic product or process can be expanded to meet increased demand. Recent technological advances have led some economists to talk about the growing importance of instant scalability. For example, once a piece of software has been written it can be made available in an instant over the internet to unlimited numbers of users for almost no cost. This potentially allows a new product to enter and win market share far more quickly than ever before, intensifying competition and perhaps accelerating the process of creative destruction.

Source: Essentials of Economics, Matthew Bishop

Securitisation

Turning a future cash flow into tradable, bond-like securities. Creating such asset-backed securities became a lucrative business for financial firms during the 1990s, as they invented new securities based on cash flow ranging from future mortgage and credit-card payments to bank loans, movie revenue and even the royalties on songs by David Bowie.

Securitisation has many benefits, at least in theory. Issuers gain instant access to money for which they would otherwise have to wait months or years, and they can shed some of the risk that their expected revenue will not materialise. By selling securitised loans, investment banks are able to finance their customers without tying up large amounts of capital. Investors can hold a new sort of asset, less risky than unsecured bonds, giving them the risk reducing benefit of diversification. But there are dangers. The future cash flow underlying the securities may flow earlier or later than promised, or not at all.

Source: Essentials of Economics, Matthew Bishop

Spread

The difference between one item and another. A much used term in financial markets. Examples are the differences between:

• the bid (what a dealer will pay) and ask or offer (what a dealer will sell for) price of a share or other security;
• the price an underwriter pays for an issue of bonds from a company and the price the underwriter charges the public;
• the yield on two different bonds.

Source: Essentials of Economics, Matthew Bishop

Supply

One of the two words economists use most, along with demand. These are the twin driving forces of the market economy. Supply is the amount of a good or service available at any particular price. The law of supply is that, other things remaining the same, the quantity supplied will increase as the price increases. The actual amount supplied will be determined, ultimately, by what the market price is, which depends on the amount demanded as well as what suppliers are willing to produce. What suppliers are willing to supply depends on several things:

• the cost of the factors of production;
• technology;
• the price of other goods and services (which, if high enough, might tempt the supplier to switch production to those products); and
• the ability of the supplier accurately to forecast demand and plan production to make the most of the opportunity.

Source: Essentials of Economics, Matthew Bishop

Supply curve

A graph of the relationship between the price of a good and the amount supplied at different prices.

Source: Essentials of Economics, Matthew Bishop

TopTransaction costs

The costs incurred during the process of buying or selling, on top of the price of what is changing hands. If these costs can be reduced, the price mechanism will operate more efficiently.

Source: Essentials of Economics, Matthew Bishop

Unbanked describes people who have no access to financial services (services that include savings, credit, money transfer, insurance, or pensions) through any type of financial sector organization such as banks, non-bank financial institutions, financial cooperatives and credit unions, finance companies, and NGOs. Implicit in this definition is that financial services are usually available only to those individuals termed “economically active” or “bankable”.

TopUsury

Charging interest, or, at least, an exorbitant rate of interest. Plato and Aristotle reckoned that charging interest was “contrary to the nature of things”; Cato considered it on a par with homicide. For many centuries, the Catholic Church regarded as sinful the charging of any interest by lenders and it was not allowed in Catholic countries, although Jews were exempted, provided they did not charge excessive rates. According to Pope Benedict XIV, in 1745, interest should be regarded as a sin because “the creditor desires more than he has given”. In most modern economies, interest is recognized as a crucial part of the economic system, a reward to the lender for the risk taken in making a loan. Even so, many countries have some for of usury law imposing limits on how high interest charges can be to protect borrowers from being exploited by unscrupulous loan sharks.