Saturday, January 31, 2009

99 balloons

You and I in a little toy shop
Buy a bag of balloons with the money we've got
Set them free at the break of dawn
'Til one by one they were gone
Back at base, bugs in the software
Flash the message, something's out there
Floating in the summer sky
Ninety-nine red balloons go by
No real connection to IB Economics...
(just that there are only 99 days left to HL and SL P1)

I can just feel the dirty looks....

Friday, January 30, 2009

On the prospect of US deflation by Paul Krugman

Krugman in his post Damnification explains:

But there’s at least one more form of damnification that has me really worried: the paradox of deflation. An individual company or worker can preserve a business or a job by accepting a lower price; but when everyone does it, we get debt deflation — a rising real burden of debt, which weighs on the economy — and also start to have deflationary expectations built into lending and investment decisions, which further depresses the economy. And once you’re in a deflationary trap, it’s very hard to get out.
This really should be the key point in the stimulus debate. Yes, the effects of fiscal policy are uncertain; yes, running up large debts is risky; but doing nothing is even riskier, because there’s a high probability that if we don’t act strongly deflation will get embedded in the economy. We may be damned if we do, but we’ll almost surely be damnified if we don’t.



Check it out at the new Easterly blog.

Tuesday, January 27, 2009

Giffen goods, prostitutes, rice, Levitt and fallacies...

Kudos to our very own VasH (University of Chicago, class of 2013 and soccer player par excellence) for bringing this one to my attention.

It's from Levitt's NYT blog: What Do Prostitutes and Rice Have in Common?:

In an excellent series of guest posts to this blog earlier this year, economist Robert Jensen described his personal quest to prove that rice is a Giffen good for peasants in China.

On The Economist magazine’s Free Exchange blog, the same claim is made about prostitutes:

Less attractive and even cheaper prostitutes may still be available, but for a variety of very good reasons, the customer will not desire the cheapest option, suggesting prostitution services can be classified as a Giffen good.

Are prostitutes Giffen goods? Absolutely not. And understanding why provides a useful economic lesson.
In it there also reference to the Jensen paper that I had mentioned in class on noodles in the North and rice in the South of China. He is referred to as the Indiana Jones of Economics. Read the stuff here and here.

Monday, January 26, 2009

Krugman on the arguments against the fiscal stimulus plan

The article, as usual, is engaging but I find this quote especially worth posting
Next, write off anyone who asserts that it’s always better to cut taxes than to increase government spending because taxpayers, not bureaucrats, are the best judges of how to spend their money.

Here’s how to think about this argument: it implies that we should shut down the air traffic control system. After all, that system is paid for with fees on air tickets — and surely it would be better to let the flying public keep its money rather than hand it over to government bureaucrats. If that would mean lots of midair collisions, hey, stuff happens.
Lots will be written against it I'm sure but the analogy does have a point!
And, he continues, explaining that
The point is that nobody really believes that a dollar of tax cuts is always better than a dollar of public spending. Meanwhile, it’s clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created (see the previous fraudulent argument) — because a large fraction of any tax cut will simply be saved.

This suggests that public spending rather than tax cuts should be the core of any stimulus plan. But rather than accept that implication, conservatives take refuge in a nonsensical argument against public spending in general.

Then he explains why, even though easy monetary policy may be preferable to reflate an economy, at this juncture there is no room for an interest rate cut as interest rates are effectively down to zero:
Finally, ignore anyone who tries to make something of the fact that the new administration’s chief economic adviser has in the past favored monetary policy over fiscal policy as a response to recessions.

It’s true that the normal response to recessions is interest-rate cuts from the Fed, not government spending. And that might be the best option right now, if it were available. But it isn’t, because we’re in a situation not seen since the 1930s: the interest rates the Fed controls are already effectively at zero.

That’s why we’re talking about large-scale fiscal stimulus: it’s what’s left in the policy arsenal now that the Fed has shot its bolt. Anyone who cites old arguments against fiscal stimulus without mentioning that either doesn’t know much about the subject — and therefore has no business weighing in on the debate — or is being deliberately obtuse.

Well, in the US at least they got the option to employ fiscal policy! Here (in Greece) there is no monetary (or, exchange rate) policy and there is virtually no room for a fiscal stimulus to be employed....

On widening current account deficits...

Some of you must remember that in class I had been questioning the sustainability of the Greek current account deficit figures we saw published week after week in the Economist. Anything over 5% or 6% of GDP is a threat and Greece was recording 10% all the way (more recently) to 15%. How could that be? Well, it was the Euro, stupid! But, the interest rates the Government has to pay 'investors' is now surging: the so called 'spread' is at 3% points (the difference between what the Greek government has to pay and what Germany has to pay for issuing debt).
But Greece’s problems are probably the worst. The country has been an easy target for the vigilantes of the European bond market, and recently it has been shaken by a wave of violent protests.

The omnipotent hand of the Greek state produced a public debt of more than 90 percent of Greece’s total economic output. The relentlessly rising demand of its consumers, who were able to put off the day of reckoning because they enjoyed the shelter of the low-inflation euro, has created a current-account deficit of 14 percent of its gross domestic product — estimated to be the highest in Europe.
This NYT article is not going to make you happy (if you are Greek, or for that matter, a Spaniard, Portuguese, Irish or an Italian).

Read it - I would say it is required reading: Once a Boon, Euro Now Burdens Some Nations

Sunday, January 25, 2009

The Pain in Spain and why the Euro may hinder European Recovery

Paul Krugman on the downside of the Euro and its effects on Spain, Italy, Ireland and of course, Greece. Enjoy

The pain in Spain …

… isn’t hard to explain. Spain was basically Florida, with a housing bubble inflated by both resident and holiday purchases, and now the bubble has burst.

But Spain is in worse shape than Florida, for two reasons — reasons familiar to anyone who was involved in the great debate about whether the euro was a good idea.

First, Europe doesn’t have a central government; Spain, unlike Florida, can’t draw on Social Security and Medicare checks from Washington. So the burden of recession falls entirely on the local budget — hence the country’s declining credit rating.

Second, the United States has a more or less geographically integrated labor market: workers move from distressed regions to those with better prospects. (The housing bust has, however, reduced mobility because people can’t sell their houses.) Europe does not: yes, there’s a fair bit of mobility both among the elite and among low-wage workers at the bottom, but nothing like the US level.

So what can Spain do? It needs to become more competitive — but it can’t have a devaluation, because it’s a euro country. So the only alternative is wage cuts, which are desperately hard to achieve (and create big problems for debtors.)

Contrary to what everyone seemed to be saying even a few weeks ago, being a member of the eurozone doesn’t immunize countries against crisis. In Spain’s case (and Italy’s, and Ireland’s, and Greece’s) the euro may well be making things worse.

And Britain’s plunging pound, unpopular though it is, may turn out to have been a very good thing.

On aid, malaria, education and Bill Gates

Another one by Kristof, this time on Bill Gates and his efforts in the area of development economics.

Remember what we said in class concerning the Sachs article 'Reforming Aid ' and the J-PAL efforts and research? Remember also the Higher Level Economics Data Response Question from May 2005Q5 on 'Africa’s economic problems have a medical solution'

Well, first of all, there is yet (unfortunately) a malaria vaccine as question (b) sort of implies: Quoting from the NK article:
“We’re on the verge of some big advances,” Mr. Gates said. In particular, a promising malaria vaccine will enter its final phase of human trials this year, with others behind it. Mr. Gates said he is “absolutely confident” that a successful malaria vaccine will be achieved, probably within a half dozen years, and an AIDS vaccine 10 or more years from now.

Bill Gates is also (together with Rotary International and the British and German governments) 600 million dollars for the eradication of polio 'a crippling and sometimes fatal disease that still paralyzes children in parts of Africa and Asia'

The next quote seems (or, is) irrelevant but I have had such a difficult time explaining this exact point to friends a few years ago when my older daughters were about to enter 1st grade that I have to post it (and, perhaps, share it with the same people):
“It is amazing how big a difference a great teacher makes versus an ineffective one,” Mr. Gates writes in his letter. “Research shows that there is only half as much variation in student achievement between schools as there is among classrooms in the same school. If you want your child to get the best education possible, it is actually more important to get him assigned to a great teacher than to a great school.”
I firmly believe in this (and there is research to support it...)

Institutions and Development: A lecture by Acemoglou at the LSE

Last week, we had a discussion on the role of institutions in the process of development related to the May 2007 Higher Level Paper 3 (Question 5(d): ' Using information from the text and your knowledge of economics, evaluate how institutional and political factors can impact upon the process of economic development').

I had initially planned to ask you to skim through the paper 'Understanding the Relationship between Institutions and Economic Development' but it seems a bit too much for our purposes. I do think though that you could definitely check out this lecture that Prof. Acemoglou gave a few years back and benefit from just a quick reading. The format is easier and faster for a some note taking.

The lecture is titled 'Understanding Institutions'.

Acemoglou on the origins of the current crisis

I recently read this article by Daron Acemoglu of MIT (The Crisis of 2008: Structural Lessons for and from Economics) in which he points at 'three notions (which) impelled us to ignore these impeding problems and their causes'.

The first one was the mistaken belief that 'the era of aggregate volatility had come to an end'.
We believed that through astute policy or new technologies, including better methods of communication and inventory control, the business cycles were conquered
But, he continues, 'greater interconnections that are an inevitable precipitate of the greater diversification create potential domino effects among financial institutions, companies and households'. Also, much of the Schumpeterian 'creative destruction' that takes place at the micro level may (now) have aggregate implications as replacement of core businesses by new forms and new products takes place (now) in companies that are large in size.

The second notion focuses on the role of institutions but not as they relate to the development process (an issue we discussed recently in class) but as they change 'in the face of ever evolving economic relations' in advanced economies.
Forgetting the institutional foundations of markets, we mistakenly equated free markets with unregulated markets. Although we understand that even unfettered competitive markets are based on a set of laws and institutions that secure property rights, ensure enforcement of contracts, and regulate firm behavior and product and service quality, we increasingly abstracted from the role of institutions and regulations supporting market transactions in our conceptualization of markets.

Few among us will argue today that market monitoring is sufficient against opportunistic behavior. Many inside and outside academia may view this as a failure of economic theory. I strongly disagree with this conclusion. On the contrary, the recognition that markets live on foundations laid by institutions -that free markets are not the same as unregulated markets- enriches both theory and its practice. We must now start building a theory of market transactions that is more in tune with their institutional and regulatory foundations. We must also turn to the theory of regulation -of both firms and financial institutions- with renewed vigor and hopefully additional insights gained from current experience. A deep and important contribution of the discipline of economics is the insight
that greed is neither good nor bad in the abstract. When channeled into profit-maximizing, competitive and innovative behavior under the auspices of sound laws and regulations, greed can act as the engine of innovation and economic growth. But when unchecked by the appropriate institutions and regulations, it will degenerate into rent-seeking, corruption and crime. It is our collective choice to manage the greed that many in our society inevitably possess. Economic theory provides guidance in how to create the right incentive systems and reward structures to contain it and turn it into a force towards progress.
The last notion is that the discipline considered that 'even if we could not trust individuals, particularly when information was imperfect and regulation lackluster, we could trust the long-lived large firms'. These large companies would 'monitor themselves and their own because they had accumulated sufficient reputation capital'. We had called this 'reputation capital' in class 'brand name'. We had mentioned (I think) that Burger King, for example, would not serve lower quality burgers anywhere, even on a highway, because it would risk losing millions it had invested in its brand name image.
Our trust in the self-monitoring capabilities of organizations ignored two critical difficulties. The first is that even within firms, monitoring must be done by individuals -the chief executives, the managers, the accountants. And in the same way as we should not have blindly trusted the incentives of stockbrokers willing to take astronomical risks for which they were not the residual claimants, we should not have put our faith in individuals monitoring others simply because they were part of larger organizations. The second is even more troubling for our way of thinking about the world: reputational monitoring requires that failure should be punished severely. But the scarcity of specific capital and know-how means that such punishments are often non-credible. The intellectual argument for the financial bailout of the Fall 2008 has been that the organizations that are clearly responsible for the problems we are in today should nonetheless be saved and propped up because they are the only ones that have the 'specific capital' to get us out of our current predicament. This is not an invalid argument. Neither is it unique to the current situation. Whenever the incentives to compromise integrity, to sacrifice the quality, and to take unnecessary risks are there, most companies will do so in tandem. And because the ex post vacuum of specific skills, capital and knowledge that their punishment will create make such a course of action too costly for the society, all kinds of punishments lose their effectiveness and credibility.
(but, even if it makes sense to 'save' the organizations, what is it that prevents punishment of (some) of the individuals? I must admit that I lost his argument here)

The rest of the article is also interesting. I want to conlude this post with one last quote from this short paper:
It is one thing for the population at large to think that markets do not work as well as the pundits promised. It is an entirely different level of disillusionment for them to think that markets are just an excuse for the rich and powerful to fill their pockets at the expense of the rest.
The article is useful for IB economics candidates as it exposes them to higher level arguments (beyond referring to the subprime crisis) in discussions regarding the possible origins of the current mess(for exams, commentaries, presentations etc).

Thursday, January 22, 2009

On the Kristof post

When we discussed in class the post 'Where Sweatshops are a Dream' some, most notably Achileas V., voiced objections to what NK was suggesting. My main argument in support of NK was that it is perhaps the only realistic perspective within the actual constraints these countries face.

That same evening I tumbled upon a much more critical comment to the post: 'Recycling Free Market Myths' from
Kristof, in a time when the rich are richer than ever and the U.S. government can find trillions of dollars to bail out the big banks, wants us to believe that the best the world's poor can expect is a chance for a sweatshop to open up in the neighborhood. In his sick version of reality, the labor movement, those who seek better wages, benefits and working conditions for the people who produce this wealth, is portrayed not as a champion of the poor but as an obstacle in their way.
I don't think the solution proposed in this article has any merit whatsoever (try to think why) and in my opinion NK does not want us to believe anything - he just exposes a (sad) reality. Also, the labor movement the critic is referring to is that in the US and one could easily find instances where the true -unstated- goal is only to prevent imports from developing countries to protect the interests (jobs) of US workers, something NK explicitly mentions in his post. Even if we disagree it's still interesting to read!

Sunday, January 18, 2009

Sweatshps, labor standards and garbage dumps

A shocking article and a shocking video.

The article is 'Where Sweatshops Are a Dream' and is written by Nicholas Kristof who defends his (seemingly) controversial position here.

Read the article and watch the video as we need to get a better feel for what is going on outside our sheltered universe when discussing development issues in class.

More by Kristof on YouTube here. You can also connect with him at FB.

On lentils, randomized controlled trial techniques and development economics

Was checking these out this morning and thought to share them with you:

1. A Forbes article on 'controlled trial techniques': Trial and Error

2. 'Improving immunisation coverage in rural India: A clustered randomised controlled evaluation of immunisation campaigns with and without incentives': Methodology (what I promised to find for you in class the other day)

3. 'One reason anti-poverty policy has not worked better than it has is because we went into it naively, without enough of an understanding of what makes it hard.' Read the paper by Abhijit V. Banerjee 'Why fighting povery is hard' to realize the types of problems faced when trying to deal with this issue.

4. Read this interview of Esther Duflo and Abhijit Banerjee where poverty interventions they view as consistently effective are discussed.

5. On microfinance this and this.

...and quoting from the interview (#4 above):
PA: On that point specifically, what would you say is the biggest wrong belief currently present in development circles?

ED: The biggest wrong belief is that there is a magic bullet and I can find it.

The Obama Stimulus (Deficit Spending) Plan -- Posner & Becker

The whole post (Jan 11) is interesting and the concluding paragraphs revealing:

I do not think the tax cuts are a good idea. Most of the increase in after-tax income is likely to be saved, rather than spent on buying goods and services. One of the reasons why the recession has turned into a depression is that Americans have meager savings, most of them in overpriced houses and overpriced stocks, and so they are sensibly reallocating income from consumption to saving. And there is much evidence that even in normal times, people spend less out of temporary income spurts than they do when they receive what they think will be a permanent increase in in-come. There is no such thing as a permanent tax cut, because the Congress that enacts a tax cut cannot bind subsequent Congresses (there is a new one every two years) not to rescind it.

I also think the transfer payments are a bad idea. The goal of a Keynesian deficit-spending program is to restore demand to X, not to increase it. If instead of demand rising as a consequence of the program from X - Y to X, it rises from X - Y to X + Z, there will be inflation because demand will exceed supply. Programs to transfer wealth are very difficult to abolish, because interest groups form about them. The problem is somewhat less serious with public-works programs, especially road-building and other infrastructure projects, and especially those infrastructure projects that were planned or begun by states or municipalities and interrupted or deferred because of the fall in tax revenues resulting from the depression. The federal government can finance these projects until the depression is over, and then the states can continue them with its own tax money.

There is a legitimate concern that many of the projects undertaken by the federal government will yield costs in excess of benefits. But the concern is exaggerated, because it ignores the benefits that such projects confer on fighting the depression as distinct from simply improving the nation's transportation system or reducing carbon emissions or buying military equipment to replace what has been lost in the Iraqi and Afghan wars. To the extent that the projects by increasing demand reduce unemployment, and reduce fear of unemployment by those who are not laid off (yet), they not only increase people's spendable income (unemployment benefits are lower than the wages they replace) but by reducing job insecurity reduce the fraction of wages that people save rather than spend. The saving rate has soared in recent months and is one of the major factors in reducing consumption and pushing us to the edge of a deflation.

In addition, public-works spending has a multiplier effect. The government's expenditure on buying goods and services (a road, a bridge, or whatever) increases output directly, but it also does so indirectly because the company that builds the project with government funds pays its employees and suppliers, and they in turn spend part of the money they receive, further stimulating output.

Properly structured, a Keynesian program can help to check a downward economic spiral. With monetary policy apparently inadequate to avert a downward spiral big enough to trigger deflation, there may be no good alternative to such a program.

As Posner and others have indicated, there appears to have been a huge conversion of economists toward Keynesian deficit spenders, but the evidence that produced such a "conversion" is not apparent (although maybe most economists were closet Keynesians all along). This is a serious recession, but Romer and Bernstein project a peak unemployment rate without the stimulus of about 9%. The 1981-82 recession had a peak unemployment rate of about 10.5%, but there was no apparent major "conversion" of economists at that time. What is so different about the present recession compared to that one, and to other recessions since then, that would greatly raise the estimated stimulating effects of government spending on various types of goods and services?

It is relevant in answering this question that the origins of this recession were in the financial sector, and especially in the excessive mortgage credit to sub prime and other borrowers. The widespread collapse of the financial sector, and the wholesale retreat from risky assets, clearly has called for a highly pro-active Fed. But it is not obvious why this should lead to greater confidence in the power of government spending stimulus packages. Of course, perhaps the prior emphasis on crowding out, and skepticism toward the stimulating effects of government spending, were wrong, or that recessions were too short and mild after the 1981-82 recession to call for Keynesian-type stimulus packages.

Time will tell whether I am right that a spending and tax package of the type analyzed by Romer and Bernstein may stimulate the economy as measured by GDP and employment, but that the stimulus will be smaller then they estimate, and its value to consumers and taxpayers could be even smaller.

EU Economic Sentiment Indicator: Greece

Doesn't look good, for whatever it's worth...

Friday, January 16, 2009

Way to go, Elizabeth!

When I mentioned today in class (doesn't B4 suck?) Esther Duflo and the Poverty Lab, Constantinos L. got excited: 'Oooops, I know that! My sister works there'!
Elizabeth Linos
B.A. in Government and Economics, Harvard University

Research Assistant, Paris
Elizabeth holds a Bachelors Degree in Government and Economics from Harvard University. Before joining J-PAL, Elizabeth worked in Boston on health care provision to immigrants, in Peru, conducting field research on the quality of teachers and in Honduras, studying a government social transfer for poor households. She joined J-PAL in 2007, as a field-based research assistant in Bangladesh where she worked on a female empowerment project. She is currently working on evaluations of microfinance in Morocco, student sponsoring in France, and an ultra poor program in Pakistan.
Way to go Elizabeth! I hope her work inspires some of you to work on such issues later on in your career!

Sunday, January 11, 2009

Mankiw: what has to considered when evaluating fiscal stimulus

This is an editorial in the NYT written by Prof. Mankiw of Harvard. Prof. Mankiw is not so sure the fiscal stimulus plan (expansionary fiscal policy: increasing government spending G and/or lowering taxes T) that the Obama team is pushing for will do the trick. He raises some questions that any IB economics candidate should have in mind when evaluating expansionary fiscal policy.

The issues he raises include:
1. What is the size of the expenditure multiplier? Is it perhaps too small?
2. What will the Government spend on? We've mentioned in class that capital spending is the obvious choice but is 'a brigde to nowhere?' a good idea?
3. The tax multiplier is according to theory smaller (because part or all of the extra euro in our pockets following the tax cut may be saved and never spent). Empirical work though by Christina Romer (the new chief of the Council of Economic Advisors of President-elect Obama; Mankiw also held the position under Pres. Bush) finds otherwise...So, maybe tax cuts (the question is for whom?) should be also considered (and, they are)
4. Will this renewed interest in Keynesian interventionism lead us into other types of problems? This is the old question of what is the right balance between markets and the government...

The article is written in Mankiw's elegant and simple style (otherwise his principles textbook wouldn't have been as popular as it is and sell at over $200.00) and he is a (very) top notch economist.

For IB economics purposes just following Mankiw's and Krugman's blogs may be the best Macro preparation for the May exams.

The article's title is Is Government Spending Too Easy an Answer?. Read it. (please?)

PS: Check out this comment on Mankiw by Mark Thomas which includes reference to the latest paper/reply by Romer herself which became available only yesterday.

Saturday, January 10, 2009

Athens, traffic police tickets, accidents and revenue collection

The story in Athens (Greece) goes that traffic police is out only to issue tickets and thus collect money from drivers. Well, there may be nothing wrong with that. Maybe if the city(?)/ state(?) was a bit more strapped for cash there would be fewer injuries and deaths related to car accidents.

I saw the post on the paper More Tickets, Fewer Accidents: How Cash-Strapped Towns Make for Safer Roads by Makowsky and Stratmann at the Marginal Revolution blog (Jan 9 post). You can download it for free. Has there been any such research using Greek data?

University applications

Just read this in the Christmas issue (DEC 20 - JAN 2) of the Economist. Interesting stuff but it's probably too late for you (IB candidates) so pass the info on to IB zero or IB minus 1 friends (i.e. potential applicants to the program).

According to research published earlier this month, many may have chosen the wrong ones, and damaged their chances of getting into a highly regarded university. Policy Exchange, a centre-right think-tank, looked at the A-levels offered by successful applicants to a group of 27 very selective universities—some ancient, some modern—and concluded that, despite the fact that all subjects are notionally equal, in reality admissions tutors think more of some than of others.
I'm sure that roughly the same applies for IB higher level choices. The title of the article is Getting in: Strategic thinking for the aspiring student

Tuesday, January 6, 2009

On automatic stabilizers

Often the role of automatic stabilizers is discussed with the argument going that in a recession the fall in real output/income is not as severe if unemployment benefits are part of the institutional framework. This is the case at least for more developed economies.

As the decrease in economic activity increases (cyclical) unemployment, unemployment benefits automatically kick in for those who lose their jobs permitting them to continue spending and thus creating some demand for output that others produce.

But what if ...

( this to find out - interesting, short, easy to understand; plus, potentially useful for evaluations)

Saturday, January 3, 2009

A primer on collusion

Collusion exists when oligopolistic firms agree to fix prices and to engage in other anticompetitive behavior. The firms behave as if they were a monopoly setting price and aiming at maximizing joint profits. Collusion is illegal in the US and the EU and in many other countries so firms take extreme precautions to remain undetected. Such collusion is referred to as tacit collusion. If the collusive practices are revealed then the structure is referred to as a cartel. The term cartel also refers to the rare cases of explicit collusion such as OPEC or the De Beers 'family (!) of companies' (a favorite example of my dear friend MM).

This IHT article ('Oil companies carved up the market for paraffin in style') is a beauty in its description of cartel practices:
Surrounded by a moat and four watch towers, the ancient Château d'Ermenonville is not the kind of place anyone would associate with a product as mundane as paraffin.

But the château, a discreet luxury hotel about a 40-minute drive northeast of Paris, and a circuit of others around Europe served for more than a dozen years as bases for executives from some of the biggest names in oil - Exxon Mobil; Royal Dutch Shell; Sasol, of South Africa; and Repsol YPF, of Spain - to fix prices of paraffin, the overlooked wax byproduct of crude oil, that is used in candles, paper cups, lip balm and chewing gum.
(chewing gum????? ughhhh)
The scheme drove up prices to consumers in a plot that probably touched most every household, according to the European commissioner for competition, Neelie Kroes, whose office punished nine oil companies with more than half a billion euros in penalties.
Most cartels operate in secrecy, destroying documents, encrypting e-mail messages or using prepaid phone cards to erase communication traces. But the paraffin cartel was rare in that some members - notably Tibor Toth, a manager with the Hungarian oil company MOL - kept minutes, and attendance lists.

Cartel members e-mailed invitations and sought RSVPs. They booked each other's rooms and played host to open bars. Documents found when investigators first raided the companies in April 2005 included handwritten notes on stationery from hotels on the cartel's itinerary: the five-star Kempinski in Budapest or Château de Montvillargenne in the bucolic horse country of Chantilly, France.

"Next price increase May/June 2000," a Shell executive scribbled in a note after a meeting in Paris. Toth, writing in Hungarian, recorded new prices in West German marks, or Deutsche marks. "Raise in January unless first-quarter quantities are reduced, otherwise raise in season, DM 120."

The behavior of this group and its undoing pose significant concerns.

The relaxed clubiness of the paraffin conspirators stokes worries about the hold that price-fixing cartels have on European commerce.

With Kroes cracking down on cartels involving elevators, cement, automotive glass and drugs, total annual fines in the past five years have more than tripled, reaching €2.27 billion, or $3 billion, this year. The money goes into the EU general budget.
A couple of issues here. First that perhaps fines are not enough to stop such behavior. As long as the collusive practices remain undetected the executives reap the benefits of increased profits under their direction while if the scheme is revealed then it's the company that pays the fines. Perhaps the risk of being sent to prison works better...(Read on this the article 'Well-dressed thieves: Why the threat of prison is necessary to deter cartels' here and here).

We know that cartels are unstable structures because each menber has the incentive to cheat. A cartel structure is less likely to collapse if there are few members controlling most of the industry's output, if the good is homogeneous, if cost structures are similar, if demand is buoyant etc. We notice that cartels have been operating in the elevator, cement, automotive glass and drugs industries as well as marine hose industry (used to funnel oil from tankers to storage facilities), glass and cardboard industries etc. Most involve homogeneous products that are typically used as inputs by other firms. (but, read this for a counterexample). Also, we read in the article that:
...their nine companies controlled 75 percent of the European market
which is considered big enough to pull it off (but, OPEC now controls only 40%!)

Check out the full article to get a feeling of how collusion works outside textbooks.

PS for Greek students: read this article (in Greek) from Kathimerini on the cartel situation in Greece and on the threats and pressure that the members of the competition commission face from several companies......
(But I found this brief note in the English edition::
Competition watchdog wants backing from MPs in its probes

The president of Greece’s Competition Commission, Spyros Zisimopoulos, pleaded with Parliament yesterday for the country’s politicians to support his efforts to crackdown on improper market practices. Zisimopoulos informed deputies that the competition watchdog is investigating a number of sectors of the economy, including cosmetics, cement production and fertilizers. “The commission has opened up a lot of fronts where there are some powerful interests at stake,” he told MPs, as he alleged that some companies are trying to undermine the watchdog’s work. Zisimopoulos did not name any firms.)

Friday, January 2, 2009

Check out these trade barriers

'In Indonesia, the third most populous country in Asia after China and India, the government is already acting to limit imports of garments, electronics, shoes, toys and food — five large categories in which Indonesian producers are struggling to compete with China. Starting in the new year, importers of these products will have to be registered with the government, use only five designated ports for their shipments, arrange for a detailed inspection of goods before they are loaded on a ship or plane bound for Indonesia and then have every single container exhaustively inspected on arrival by Indonesia’s notoriously slow customs bureaucracy. The plan, intended to comply with W.T.O. rules, was adopted after heavy lobbying by Indonesian manufacturers and labor unions'

This was spotted here, a discussion of how much China's exports may slow down at this juncture.

I think our Poitiers example will (at last) be updated....

New 'kids' on the block

This one is for my (IB) kids planning to do economics later in college. It is a list of very young economists who, according to The Economist, seem most promising. Who are they?

Jesse Shapiro of the University of Chicago
Roland Fryer of Harvard
Esther Duflo of MIT
Amy Finkelstein of MIT
Raj Chetty of Harvard
Iván Werning of MIT
Xavier Gabaix of New York University
Marc Melitz of Princeton University

Well, VasH, make sure you sign up for Dr. Shapiro's courses!!

Concerning Ms. Esther Dufflo, I would like to quote the following, as (supposedly) you (Candidates 2009) are immersed in the study of development related issues:

Esther Duflo of the Massachusetts Institute of Technology (MIT) received more recommendations than any other economist. With her colleague, Abhijit Banerjee, Ms Duflo have remade development economics, nudging it away from its concern with policies, towards a preoccupation with projects.

They study economic development as seen from the field, clinic or school, rather than the finance ministry. They might be called the “peace corps” of economists, bringing the blessing of their investigative technique to the neglected villages of India or the denuded farms of western Kenya.

Ms Duflo has made her name carrying out randomised trials of development projects, such as fertiliser subsidies and school recruitment. In these trials, people are randomly assigned to a “treatment” group, which benefits from the project, and a “control” group, which does not. By comparing the average outcome of each group, she can establish whether the project worked and precisely how well.

In one study, Ms Duflo and her colleagues showed that mothers in the Indian state of Rajasthan are three times as likely to have their children vaccinated if they are rewarded with a kilogram of daal (lentils) at the immunisation camp. The result is useful to aid workers, but puzzling to economists: why should such a modest incentive (worth less than 50 cents) make such a big difference? Immunisation can save a child’s life; a bag of lentils should not sway the mother’s decision either way.

Randomised trials “give you the chance to be surprised”, Ms Duflo says. Had they arrived at this result using some other method, she and her colleagues would have assumed they had made a mistake. But randomisation removes such doubts, showing that it was indeed the lentils that made the difference. The result cannot be dismissed; it must be explained.

The approach has its critics. A randomised trial can prove that a remedy works, without necessarily showing why. It may not do much to illuminate the mechanism between the lever the experimenters pull and the results they measure. This makes it harder to predict how other people would respond to the remedy or how the same people would respond to an alternative. And even if the trial works on average, that does not mean it will work for any particular individual.

The randomistas, as Ms Duflo and her comrades are called, liken their studies to the clinical trials that prove the efficacy of new drugs. But the ultimate ambition of economics is for something more akin to anatomy. Researchers hope to dissect the underlying physiology of an economic problem, revealing how the leg bone is connected to the thigh bone. With a full anatomy of behaviour—what economists call a structural model—they can determine if a policy or project will work even before it has been attempted.

The early anatomists of the human body suffered from a shortage of fresh cadavers to work on. Medical students would trek long distances to watch a dissection performed. Economists often find themselves in a similar predicament. Short of good empirical meat, they have to rely on elaborate theory and guesswork to fill in what they cannot observe.

The full article can be found here and I would advise you to read it. I was made aware of it thanks to Levitt's (he had made the list!) blog, Freakonomics

Thursday, January 1, 2009

Information and economics

Professor Lord Robert Skidelsky is at Warwick and is best known for his 3 volume biography of Keynes. We've referred to him before in a couple of older posts. This article is interesting not only because it presents the basic idea(s) behind asymmetric information, the Akerlof 'lemons' paper and adverse selection in simple terms but also on how it relates the issue of information or lack of it to the current crisis.
Although designed before the current crisis, these models seem to fit current observations rather well: banks lending to entrepreneurs who could never repay, and asset prices changing even if there were no changes in conditions.

But a moment’s thought will show why these models cannot explain today’s general crisis. They rely on someone getting the better of someone else: the better informed gain – at least in the short-term – at the expense of the worse informed. In fact, they are in the nature of swindles. So these models cannot explain a situation in which everyone, or almost everyone, is losing – or, for that matter, winning – at the same time.

The theorists of asymmetric information occupy a deviant branch of mainstream economics. They agree with the mainstream that there is perfect information available somewhere out there, including perfect knowledge about how the different parts of the economy fit together. They differ only in believing that not everyone possesses it. In Akerlof’s example, the problem with selling a used car at an efficient price is not that no one knows how likely it is to break down, but rather that the seller knows perfectly well how likely it is to break down, and the buyer does not.

And yet the true problem is that, in the real world, no one is perfectly informed. Those who have better information try to deceive those who have worse; but they are deceiving themselves that they know more than they do. If only one person were perfectly informed, there could never be a crisis – someone would always make the right calls at the right time. But only God is perfectly informed, and He does not play the stock market.

“The outstanding fact,” John Maynard Keynes wrote in his General Theory of Employment, Interest, and Money , “is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made.” There is no perfect knowledge “out there” about the correct value of assets, because there is no way we can tell what the future will be like.

Rather than dealing with asymmetric information, we are dealing with different degrees of no information. Herd behavior arises, Keynes thought, not from attempts to deceive, but from the fact that, in the face of the unknown, we seek safety in numbers. Economics, in other words, must start from the premise of imperfect rather than perfect knowledge.
It may then get nearer to explaining why we are where we are today.

(Akerlof's nobel prize lecture in pfd form is here; you can watch him deliver it here It is much broader than you may think discussing in a crisp manner issues that have been touched upon in class)

Couldn't resist....

Went to see it with my kids and I think I enjoyed it more than they did...

Pretty sad stuff

If you have (or, had) me in class you all know how upset I am about certain facets in our (greek) society and how disillusioned I get when some of these work their way through into school and manifest themselves not (only) in the behavior of 30 and 40 and 50 year old teachers but in the behavior of 16 or 17 year old kids.

Read this:
......One suggestive finding comes from a cross-cultural study carried out by three economists and published earlier this year in the journal Science. Simon Gächter, Benedikt Herrmann and Christian Thöni invited subjects in 16 cities across the world to play a “public goods” game, in which players had to choose, repeatedly, between contributing to a pot for the benefit of all or selfishly hoarding their own resources.

Earlier research had found that if players were given the option of punishing the selfish by removing their resources, they did so and near-full co-operation quickly emerged. Gächter and his colleagues found that, in many societies, the opposite occurred: rather than accepting their punishment and co-operating, those who had been punished tended instead to take revenge.

The results were striking: co-operative behaviour seemed to flourish in countries where market democracies were long established.

The Americans, Australians, Britons and Swiss were the least likely to inflict recriminatory punishment. Russians, Greeks and Saudis were most prone to reprisals. Co-operation was best sustained in the US, Denmark and Switzerland, and fell apart in Turkey, Saudi Arabia and Greece.

Cooperation requires trust. Remember what Dasgupta writes about trust in his 'Very Short Introduction to Economics'?

I wrote earlier in a post that you (the kids) are the future. Please change it and trasform this society to the better. You can start today.

The full article can be found here.

PS1: I just read this on that little 'text':
Dasgupta is supremely well qualified to write an overview of economics for the layman. Originally, he says, he had it in mind to lay out what he understood to be the research frontier. "But even though the analytical and empirical core of economics had growth from strength to strength over the decades," he writes, "I haven't been at ease with the selection of topics that textbooks offer for discussion (rural life in poor regions -- that is the economic life of some 2.5 billion people -- doesn't get mentioned at all, nor with the subjects that are emphasized in leading economic journals (Nature rarely appears there as an active player)." The result is a serious textbook treatment shaped around the lives of two ten-year-old "literary grandchildren," Becky in a small Midwestern suburb where her father works for a firm specializing in property law, Desta in a village in southwestern Ethiopia, where her father farms half a hectare of land.

Photographs depicting the wealth of a typical European or American family, laid out in the driveway of a two-car garage, contrasted with the meager personal belongings of a family arrayed before their thatch-roofed hut, have become common enough in introductory texts in recent years, but Dagupta follows his conceit throughout his book, demonstrating with particular force the extent to which institutional arrangements are at the heart of the differences between both places.

He concludes, "Perhaps the best that Becky's world can do for Desta's is to offer financial and technical assistance so as to promote and support local enterprises -- including those involving education and primary health care -- that people there are all too keen to create even as they see from a distance how people elsewhere have been able to improve their conditions of living. And perhaps the best that Desta's world can do for Becky's is to alert it to the enormous stresses economic growth there has put on Nature. There is, alas, no magic potion for bringing about economic progress in either world."

PS2: The above reminded me of a paper by PD. Read this:
I will be using the word "trust" in the context of someone forming expectations about those actions of others which have a bearing on her choice of action, when that action must be chosen before she can observe the actions of those others. Trust is of importance because its presence or absence can have a bearing on what we choose to do, and in many cases what we can do.

The clause concerning the inability to observe others’ actions at the time one chooses one’s own action is central. But it should be noted that this inability need not be due to one’s choice of action temporally preceding those of others. For example, it could be that what I ought now to do depends on whether you have done what you said you would do, in circumstances where I cannot now, or possibly ever, verify whether you have actually done it.
The paper is not the easiest to read but important parts are accessible and those of you who are a bit more socially sensitive and are willing to read (or, at least skim through) papers / books outside the 'required' may find the paper here. The 1 through 10 list in pp 9-11 is interesting - think about this country while reading it.

Quections for 2009

Dani Rodrik's Dec 31 post outlined the major issues - questions that in his opinion will define the way 2009 will unfold in the world.
Will the U.S. policy response be “bold” enough?

Barack Obama has promised that it will be, echoing at least part of FDR's famous call for “bold, persistent experimentation” at the height of the Great Depression in 1932. In particular, he will need to go beyond Keynesian policies of fiscal stimulus to heal the deep wounds to economic confidence that lie at the root of the present crisis. So far, confidence-building measures have been limited to financial markets, but the needs of Main Street are no less important. Workers who worry about being laid off are unlikely to go on a spending spree regardless of how much money fiscal stimulus puts in their pockets. Just as banks are hoarding cash, households will try to preserve wealth by increasing their saving. To counter this, incentives targeted directly at preserving employment will have to be part of the solution.

Will Europe get its act together?

This could have been Europe’s moment. After all, the crisis originated in the U.S. and left American policy focused on its domestic troubles, opening up room for global leadership by others. Instead, the crisis has demonstrated the deep divisions within Europe—on everything from financial regulation to the requisite policy response. Germany has dragged its feet on fiscal stimulus, stymieing what should have been the second leg of a globally-coordinated fiscal action plan. Alas, the best that can be hoped at this stage is that Europe will not undermine the global fiscal stimulus which even the International Monetary Fund—the guardian of fiscal orthodoxy—regards as absolutely essential.

Will China hold together?

China is a country of enormous tensions and cleavages beneath the surface, and these will find more occasion to erupt into open conflict in difficult economic times. Experts on China differ in their estimate of the rate of economic growth the country needs to create employment for the millions that flock into its urban areas every year. But it is virtually certain that China will fall short of this threshold in 2009. The question is whether policy actions to date will do enough to stem a socially and politically dangerous slowdown in the economy.

Will there be enough global economic cooperation?

When domestic needs become paramount, global economic cooperation suffers. But the costs of protectionism in trade and finance are especially large at moments like these. So far the International Monetary Fund has reacted with new-found vigor, establishing a much-needed short-term lending facility and warning against too little fiscal stimulus. The World Trade Organization, meanwhile, has wasted valuable time on the irrelevant Doha round. It should have focused its efforts on monitoring and implementing the commitment made by the Group of 20 countries not to raise trade barriers.

Each of the above should give us plenty to think about (to evaluate?). Each of the above could be easily transformed into an IB Economics long essay.

Happy New Year!

Well, this is the first post for 2009!

I wish you all the very best. I wish all IB (Economics) candidates 2009 to find themselves on their PPF (which with a wise allocation of their time now will have shifted outwards) and in their University of choice.

Above all, I wish you health and happiness. You are the future.