Saturday, December 12, 2009

High points of the last week

This is the end of my first week in Guadalajara. Here are the high points:

1. Last night I went to the opening of Susana's uncle's new gay club, Velvet. It was fun, though not my scene (something about being straight). We also went to Circus, one of his other gay clubs. It was far more grungy, and a lot more my style.

2. Today, I was making some gnocci and prawns, which required rosemary and basil. Susana's mother is basically a disinfecting machine (apparently it's a common Mexican trait). She scrubbed and disinfected the rosemary and basil. There is no chance of me picking up any bugs here.

3. I went with Chewy, Susana's brother, to the wholesale markets. These markets put Melbourne's to shame. There are stores which sell nothing but onions, by the tonne. Others sell just piñatas. A fantastic experience.

4. We bought some wedding rings.

5. Books started this week:

Boswell: life of Samuel Johnson

Dambisa Moyo: Dead Aid

Gareth Evans: Responsibility to Protect

Freakonomics (Thanks, Dean!)

And I've finally hit the second half of David Kilcullen's The Accidental Guerilla. I will write a review of it next week.

Friday, December 11, 2009

Lost in translation: 1

At Walmart yesterday, we were cruising the DVD aisles, when I came across the most splendidly translated film title: Grease, translated to `Vasolina´.

When I think of Grease, I think of machinery, slick hair, and sex. When I think of Vaseline, I think of chaffing on babies' bottoms.

Monday, December 7, 2009

First impressions of Guadalajara

I arrived in Guadalajara yesterday, after a stopover in LA. I've been to neither city before, so it's been a couple of days of exploring for me.

There is something funny about being away from your home city. I first encountered it when I moved to Melbourne. Even as an Australian, I found it amazing how many people would talk to me on trams and trains, and wrongly concluded that all Melbourners love talking on public transport.

Of course, the phenomenon really is that people (in general) enjoy showing off their cities---and I, apparently, seem to have a big sign hanging around my neck saying "foreigner". My day in LA was marked by arguing over steak about health care reform in the US, and being asked to attend (and attending) an art opening at the LACMA.

From the 50 or so people I spent the day talking to, I've figured that, essentially, LA-ers (I can't say "Californians", let along "Americans", because LA-ers think of themselves as being different) are a fairly friendly, well educated, and politically aware bunch. They also speak in exactly the same vernacular as in the movies. I wasn't sure people actually said "son-of-a-bitch retard", but that was the description of a driver I heard a policeman shout out.

I found LA more or less as I expected. I went to Downtown, Hollywood, Westwood, and Santa Monica. All but Santa Monica struck me as kind of revved-up versions of Paramatta, which is not being endearing. Santa Monica was just a big St Kilda (some may find that endearing, others won't). The people also smell of fairy floss.

Guadalajara is a great city. It's big, messy, smelly, industrial, and fun. The centre is full that wonderful colonial grace you would expect. The fun, though, comes from being with Susana's family. Her father is one of 14, and every Sunday, they cook and eat a lot of food. Since that's more or less how I like to roll, I think I'll fit in, as soon as mi Español improves.


Thursday, December 3, 2009

I've been slack

I've not posted anything lately. Between camping and marking, I haven't had the time to have an opinion, let along think or write about it.

That all changes today. Tonight, I leave to go to the States, Mexico, and Cuba, from which I will file a weekly KE column. I'll be there for almost three months.

Following that, I'm off to work in the Macroeconomic Group of the Treasury, on climate abatement modelling. Depending on the nature of the job there, I may have to give up writing all my nonsense. Half-yer-luck!

Saturday, November 21, 2009

Golf, Graphs, and Government: a problem with using econometric studies as bases for policy development

On Friday, I sat in on an interesting seminar presentation by Pr. Renée Adams of UQ, on the potential consequences of bank representation on Federal Reserve bank boards in the US.

Her paper, which has been a continuing work over a decade or so, looks at how the market digests the news that a director of a particular bank gets voted to a Fed board (there are twelve in the States). Unsurprisingly, big banks, and those with more assets, are better represented on Fed boards, and the market digests the news favourably.

The two reasons she supposes explain this are (1) the election of a board member to a Fed board is a vote of confidence in the bank, and (2) board members may be privy to better information, improving the competitive position of the bank. The second, more malignant explanation is not without some appeal: Stephen Friedman was simultaneously on the boards of the FRB of NY and Goldman Sachs during a time when the TARP programme had AIG pay some $8B of debt back in full to Goldman Sachs (along with paying back other creditors in full), despite the fact it had been negotiating the principle down in the period before government involvement. While Friedman has not been shown to be in any way linked to this, it certainly raises questions about who is playing golf with whom.

A key problem with the kind of findings Prof. Adams has, is that they cannot distinguish between the permissible (reputation) and fishy (perceptions of insider information) causes for stock price movements. This in turn weakens any argument which could be generated from such work, detracting from its potential impact in terms of policy.

Economists are overly suspicious of ethnographic studies for being lacking in hard, testable data. There are plenty of situations, however, where such studies have plenty of merit. If 99 bank directors on FRB boards behave well, but 1 does not, an econometric study will not conclude that bank directors behave badly, which is good--in this case, they normally don´t. An ethnographic study, however, will focus on the poor behaviour of the one director.

For researchers, the decision on whether to use an ethnographic method---and I think this will certainly increase in the coming years---will really depend on how much faith they put in the precautionary principle. Is the studs-up behaviour of the one director cause enough for changing the rules?

Tuesday, November 17, 2009

Reasons I'm marrying the right woman #792

A few weeks ago, Susie sent me an email wanting to know how to write in LaTeX. She liked the look of my documents, and thought her papers would look better if they were properly typeset.

I wrote a little how-to-get-started guide for her, with a couple of screen-shots, explaining the basic stuff. I thought, if she was really keen, she'd read one of the real manuals. After that, I didn't hear much, and assumed she must have given up on the whole thing---she is, after all, researching security and strategy, and doesn't need to write any equations or tables. On top of that, she writes in Spanish, requiring plenty of áccénts, which are a little tricky to do in LaTeX.

She emailed me one of her documents yesterday, and I had the shock of my life. It was laid out better than anything I've done yet. I know I shouldn't be attracted to Susie because of her typesetting skills, but it's hard not to be...

Monday, November 16, 2009

Can Governments be Ponzi Lenders?

For a paper I'm writing, I've been doing a little reading up on the Fiscal Theory of the Price Level. This theory, depending on to whom you listen, is either a piece of logical brilliance, or lunacy.

The basic premise is that the real value of government debt must equal the discounted expected future primary surpluses of the government. Should the government acquire debt beyond its capacity to repay, bond holders will realise this, selling the bonds down, which drives up interest rates. As a sovereign cannot default on debt denominated in its own currency, the central bank is forced into buying these bonds, expanding the money supply, and boosting prices until the point where the nominal debt becomes repayable.

The big argument about this theory is whether the `fiscal limit', described above, is an equilibrium condition determining prices, or a limit on government behaviour. Roughly, Christopher Sims, Michael Woodford, and John Cochrane have argued the `equilibrium condition' line, while Willem Buiter has argued the fiscal limit is a `constraint'.

Both of these arguments are, though, difficult to logically justify.

The first---that the price level is implicitly determined by the stock of government debt relative to expected future budget balances---is easy to defeat. The problem with this thesis is that it requires all government savings to be made in the expectation of some future primary deficit. Should one government ever run a fiscal surplus despite having noexpectations of future primary deficits, then (without some further strong assumptions) the model fails.

The second---that the fiscal limit defines the maximum borrowing a government could make before provoking inflation---is more complicated to argue. Assuming the Buiter argument is true implies governments could lend money continually without ever expecting to run a primary deficit. This is irrational, and violates what is known as the "no-Ponzi-game" condition, which forbids actors from either holding positive or negative balances at the day of reckoning (which occurs into the infinite future). Therefore, the Buiter hypothesis necessitates assuming one of the main actors in models only behaves irrationally: a very strong assumption. Or is it?

This raises a question:
For any actor that has an infinite life and expects never to deplete their savings, are their savings irrational? Remember---infinity periods is a very long time. Can a government be a Ponzi-lender?

Monday, November 9, 2009

Reflections on finishing a thesis

I submitted my honours thesis yesterday, with a bit of relief. Now I have submitted it, I know there are a few things I should have done differently.

1) Go vanilla: there's nothing wrong with the basic formula of a thesis (lit review, model, regressions, conclusion). I began the year wanting to incorporate natural resource price shocks into a multisector DSGE model (of my own design), and finished the year building natural resources into a two sector growth model (of Uzawa's design).

2) Don't attempt a theoretical thesis. The fact is it takes a decade to get to the bleeding edge of economic theory, and once there, one's capacity to explain the world is diminished by the having depleted all social skills required to explain anything, due to the act of getting to the bleeding edge! There is nothing wrong with empiric studies.

3) Don't teach three subjects with 12 hours of teaching per week. I love my students, but I think they suffered from my less-than-perfect organisation over the semester.

and 4) Make your supervisor push you. My supervisor (who is also my boss) was excellent, and a brilliant help, though didn't want to stress me out. I think honours should be about stress. So when I get to the point of supervising people, I think I'll push a bit harder than I was pushed.

Friday, November 6, 2009

Congratulations, sister!

This morning, my younger sister was interviewed on Radio National, about her latest article in Eureka Street.

The central point of her article is that women, including those `liberated' in the sense they are allowed to show more skin, are really subjected to much the same kind of pressures women face in less `liberal' societies. The Brownlow medal ceremony is a great example: the wives and girlfriends are decoration, and there exists no equivalent institution where the "husbands and boyfriends" of prominent women are objectified in the same sense.

Given the fairly real content of Ellie's article, though, it was a bit disappointing that the discussion on RN focussed on the difference between dressing skankily and suavely, rather than the more meaty problems.

Congratulations, Ellie!

Thursday, November 5, 2009

Some clichés are less equal that others

Whenever I have difficulty throwing a sentence together, I find it helpful to go over Orwell's famous essay `Politics and the English language' (1946). Orwell hated phrases that have

lost all evocative power and are merely used because they save people the trouble of inventing phrases for themselves. Examples are: Ring the changes on, take up the cudgel for, toe the line, ride roughshod over, stand shoulder to shoulder with, play into the hands of, no axe to grind, grist to the mill, fishing in troubled waters, on the order of the day, Achilles' heel, swan song, hotbed.

Perhaps a few more people who quote Orwell should have read him:

Saturday, October 31, 2009

Jonothan Safran Foer on Dog-Eating

In a column in this weekend's WSJ, JS Foer presents his case for eating dogs.

[What we're already doing is]rendering—the conversion of animal protein unfit for human consumption into food for livestock and pets—[which] allows processing plants to transform useless dead dogs into productive members of the food chain. In America, millions of dogs and cats euthanized in animal shelters every year become the food for our food. So let's just eliminate this inefficient and bizarre middle step.

Friday, October 30, 2009

Global imbalances & US monetary policy

I'm currently doing a research paper for Jan Libich, one of my supervisors, on Fiscal-Monetary interaction.

A key area of research in the field is determining the game theoretic relationships between fiscal players---who are overly viewed as pouring fiscal `gravy' onto the electorate at any given chance---and monetary players, who are inflation hawks, and so take away Greenspan's punch as the party gets going. Jan knows about as much as there is to know with this game theoretic relationship (though he is more modest of himself than I am of him), and so his papers are worth reading. The essential insight from this strand of research is that independent central banks have the capacity to punish overly expansionary monetary policy if a few conditions are satisfied.

In layman's terms, the conditions boil down to the assumption monetary policy tightening hurts the same people who enjoy licking up the government's gravy. So in countries with no political business cycle (dictatorships), and in monetary unions, like the EU, the model requires modification, which is partly what my paper-in-progress is about.

What hasn't been researched in this literature so far (to my knowledge) is how central banks, which are mandated by law to target price stability, output gaps, or both, may have had their hands tied in punishing governments for reckless deficit spending. This view would say that Greenspan kept interest rates low well into the 00s because the Fed's implicit price target was not breached, due to the huge disinflationary pressure of Chinese imported goods.

If this holds, then blame for the explosion in house prices in the US can not only be pinned to China and the GCC for running huge surpluses---the so-called `global imbalances thesis'---but establish a degree of causality between Chinese currency policy (which kept export prices low in UD dollar terms) and US monetary/fiscal policy during the period.

Kevin Rudd goes moonlighting up north

I read somewhere that Kevin Rudd had spent somewhere around a quarter of his time in office overseas.

I took this photo somewhere between Malang and Mojo in East Java, during Indonesian parliamentary (DPR) elections during January. I thought I'd lost it, which is a shame, as it is definite proof that Kevin Rudd is leading a double life. Thankfully, I haven't lost it, so I can bring down the government for which I'm about to start working :p

Kevvy could probably have done better than run in PDI Perjuangan, though.

Thursday, October 29, 2009

Why people leave Mexico

Mexico is good at exporting people. It´s third largest foreign currency earner, after oil and manufacturing, is remittances.

This little article about the political situation in Mexico gives a few good reasons why.

Sarko's shower

Susana and I are are marrying in late January in Mexico. We´re both fairly young to be married (23), though this isn´t an issue to us; on the contrary, we are completely happy spending a lot of time with each other. I joke that one of the main reasons we get along so well is that we can wake up and talk about Hezbu´allah, or Sarkozy.

Gideon Rachman, from the FT, in his blog yesterday posted a nice little piece about the great French President:
For those of you who have not yet made it to p.24 of the second section (UK edition) of today’s FT, may I bring your attention to what seems to the single most amusing/interesting fact in today’s paper.

Paul Betts in his European View notes that, during the French EU presidency, France hosted a three day “Union of the Mediterranean summit” that cost 16.6m euros. He goes on - “On the occasion of that summit, a shower was specially installed in the Grand Palais in Paris at a cost of €245,000 for the personal use of the president. Mr Sarkozy never used it.”

Wednesday, October 28, 2009

On tutoring Macro 3

Today, sadly, is my last day (possibly ever) of tutoring Macro 3.

Over the last two years, I have taught (and tried to remember the names of) about 500 students at pre-university foundation level, first year, second year, and third year levels. Three things constantly surprise me.

1) While naturally bright students can do relatively well during first year without much work, during second and third years, sweat is the best determinant of success. I have probably two douzen very gifted third year students, and most this semester have been outperformed by sheer persistence of a few students,.

2) Filtering the whey from the curds works. La Trobe is in a bit of a tough spot when it comes to finding great first year students. The four main demographics of the student population are

(a) the chaff--students who've made it through school and whose parents have told them to do a degree,

(b) smart students from sloppy state schools--they tend to do well, though were probably either too lazy or too il-taught at school to get into Melbourne,

(c) rogues from private schools--these students did poorly in good schools, and are from fairly prosperous backgrounds; they tend to improve over their degrees, and

(d) mature age students from the Northern Suburbs--these students generally have a hard time getting started, but once adjusted, tend to go very well.

The problem with La Trobe's new expansion strategy is that it targets school leavers in order to improve numbers. This strategy will uncover a few good students. One of my best students from last semester would have probably fit in category (a) before he came to uni. He is from a Lebanese Australian background, born in the Northern Suburbs, and speaks with a broad Northern Suburbs accent. At first glance, the crass judgement would be that he probably studies accounting and drives a fully sick VL. Now at uni, he seems to have discovered that a whole deal of hierarchy depends on the amount of knowledge one has---a beautiful thing! Yesterday, he educated me about the finer points of the Malaysian monarchs.

Unfortunately, the majority of school leavers we get are not as inquisitive as the Wikipedia addict above. Many drop out, which is good for the other students, though it would be great if they were good students to start with.

A more sensible number-increasing strategy, I think, would be to target an increase in the number of the students from the most successful demographic. In economics, our mature aged students---most of whom have made too many lattés, or dealt too many hands of cards, and know the value of eduction---get great grad positions in most of the good government departments.

The problem is targeting these potential students. Should the university send out scouts to cafés and hand pamphlets to baristas who enjoy talking politics?

3) Despite the fact we have so many great third and fourth year economics students--certainly of the same standard to those from any other uni--so many continue to actually want to go into finance or accounting. For some reason, Economics has not successfully been made sexy the same way accounting and finance has. Could it be that economics is simply not sexy? Or have accreditations like CA, CPA, and CFA been marketed as being superior? Do we even want those who've been able to be attracted by the prospect of becoming an accountant barging in our territory?

Camping trip!

I am organising a big camping trip for friends and students on December 2-4. If you are keen, send me an email.


Sunday, October 25, 2009

Should smokers and non-savers face longer prison sentences?

This post is co-authored by Timur Behlul.

This follows from my post last night, which essentially states that virtuous behaviour is more or less the same as behaviour associated with not discounting the future: exercise, saving, temperance, and good manners. Conversely, acts of vice are associated with higher subjective discount rates.

If this line of thought is correct, then the following story should hold:

Two potential thieves consider robbing a store. They both have the same expectation of being caught, and the punishment for both potential thieves would be the same. If the two potential thieves differ only in their subjective discount rates, then there exists some level of punishment which will induce criminal behaviour in the potential thief with the higher discount rate, and will result in the thief who considers the future with more value not doing the crime.

Likewise, if the two thieves are able to be punished with different sentences, there exist two different sentences at which both thieves will not engage in the crime at the margin. The thief with the lower discount rate requires a shorter potential sentence as a deterrent than the other.

To the extent to which these two statements are true, there exists an argument that the deterrent sentences imposed on different criminals should be proportional to their subjective discount rates.

However, for a prospective criminal to be aware of the potential consequences of their actions, there must be complete knowledge over how their punishment is elastic to the court's perception over their subjective discount rate. This would require a publicly known set of proxies for discounting to be known.

So if people who smoked, saved little (relative to peers in their income bracket), had plenty of speeding fines and the like, were made aware their potential crime would result in a higher length of imprisonment than if they didn't smoke/did save/didn't speed, there would simultaneously exist incentives for people to review their potentially in-virtuous behaviour at both ends---crime and smoking.

Can a Society aim to be virtuous?

I should qualify this post with a disclaimer: I really enjoy vanilla economics. I like talking about tax systems, bank regulation, development, and town planning.

Sometimes, however, I get a little bit excited, and start to think about other things---the kind of dancing that in Strictly Ballroom loses Pan-Pacific Grand Prix tournaments.

The Virtuous Society: A worthy aim?

Economists generally have fairly concrete aims: inflation, unemployment, efficiency, growth, disease, education, crime, etc. The one very big one doesn't seem to be mentioned much---I think partly due to a lack of the Common Balls, and partly due to the fact that those who have mentioned it in the past have been genocidal maniacs---is `virtue'. Virtue is almost certainly the aim of all societies; this aim is reflected in law, religion, and many of those little social customs which help determine the social standing of people. I think also that virtue is inextricably bound to economic behaviour.

Virtuous behaviour is synonymous with economic temperance. The virtuous man is one who does not discount the future when making his decisions: he exercises rather than eating chocolate, abstains rather than drinks, studies rather than shirks, and never sleeps in. The man of vice trades the future for something a bit more immediate. A sugar hit.

I am not religious, though virtuous behaviour is put well by Luke 12: 37-38

Blessed are those servants whom the master finds awake when he comes; truly, I say to you, he will gird himself and have them sit at table, and he will come and serve them. If he comes in the second watch, or in the third, and finds them so, blessed are those servants!

Should Virtue actually be our unspoken social aim (I think it is, though I'm happy to be persuaded otherwise) then there are two distinct possibilities of its nature, each with their consequences for policy.

The first is that virtue is learned temperance. Social institutions, in this case, have the role of determining the norms of discounting. The Singaporese, who save almost half their private incomes, are normalised in a culture which places some (economic) weight on the distant future. In Guinea-Bissau and Burundi, they worry about today more---both countries were on average disinvesting between 2000 and 2005 (World Bank 2005). The difference is between their common social perceptions of the value of the future. Surprisingly, is it not due only to poverty---Haiti saves a greater proportion of private income than does Australia.

Should virtuous behaviour be just learned temperance, then policywise, there is an ethical dilemma: what is the acceptable cost in terms of liberty of "nudging" society into having a more distant gaze? This question recognises that any policy which is based upon having people modify not only their consumption choices, but also their choices of non-economic behaviour (like the decision whether or not to engage in road rage), requires some level of negative payoff. In this respect, Deepak Lal's thesis---that many Eastern societies govern individual behaviour by concepts of familial honour---is interesting: moderating influences are enforced by the group to which the ultimate consequences of individual indiscretion flow.

Judging most policy against this first possibility, it is hard to see that government believes wholly that virtue can be learned. `Consenting adults', the cornerstone of the brand of liberalism I enjoy, seems to have influenced most policy, save drugs and bicycle helmets.

The second possibility is that virtue is not learned temperance, but actually the capacity of only a few virtuous people. Under this scenario, there is little that can be done to make one obey virtuous behaviour; there are simply good eggs and bad eggs. What role is there for policy in this circumstance? Save recognising and helping good eggs (which already happens)---very little.

Thursday, October 22, 2009

Do we really know much about host-country effects of refugee immigration?

This recent wave of media hype on Tamil, Burmese and Afghan asylum seekers has stimulated some fairly spirited discussion lately. I fear though, much of the commentary involves people speaking beyond their competencies. This raises a question: in a debate in which most commentators have put "feelings in place of ideas", how much do we really know about the host-country effects of settling refugees?

I will ignore the (non) question of whether or not Australia should accept refugees, and focus on the discussion of what kind we should be allowing.

Harry Clarke disagrees with a few of his readers. They argue lines like:

Boat people have demonstrated their motivation and enterprise and are therefore differentially likely to make good citizens.


Encouraging queue jumpers on the grounds that they show entrepreneurial zeal and enterprise would be about the most daft policy I could imagine.

Meanwhile, over at Core Economics, Josh Gans argues that refugee immigration is a case of revealed preference over institutions

When we do not have free migration, we stop people being able to match different rules to their preferences. Personally, if someone in Sri Lanka prefers our rules, why should they be forced into convincing everyone else around them to adopt them rather than just moving?

The problem with both sides of this argument is that there seems to have been a lack of objective research into the relative successes of a cross-sectional sample of refugees, rather than a cross-sectional sample of immigrants. We do not know which of our Afghans, our Vietnamese, our Tamils, have done better than the others---the boat-people? former store-owners looking for good institutions? sign-up-and-wait rule abiders?

With this gap in knowledge, it is simply impossible to develop policy that minimises the loss/maximises the gain of refugee immigration in Australia.

Tuesday, October 20, 2009

Melbourne Honours Symposium: Call for papers!

I am currently organising a symposium, jointly sponsored by the La Trobe School of Economics & Finance, and the Economics Society of Australia, for students having just completed their honours theses.

It will be held on Friday the 27th of November, at La Trobe university.

If you are interested in coming along (perhaps to spot future talent/PhD candidate), or presenting a thesis, please email me on


Monday, October 19, 2009

The problem with assuming depletable natural resources are... er... depleting

My thesis research this year, on modelling the effects of natural resources on economies, has led me to ask a particular problem: is it reasonable to model depleting natural resources as actually depleting?

At first glance, it seems as though depletable natural resources should of course be modelled as depleting. How dare I suggest not! That is the approach taken by some really big names: Dasgupta & Heal (1974), Stiglitz (1974), Romer (in his textbook), Jones (in his textbook), Vernon Smith (in a bunch of papers in 69 and 69), etc.

The problem with this approach---despite it being correct physically---is that the amount of natural resources we know about has not actually been depleting.

Below is a little graph I did using data from the BP Statistical Survey 2009, graphing the aggregate stocks of "proven" reserves. These reserves may come on and off-line as prices fluctuate. A good example is Canada's Athabasca oil sands, which were included in Canada's proven reserves in the early 80s, only to be partially removed during the late 90s when oil prices were too low to make them viably extracted.

The surprising trend is that known oil reserves, despite rising extraction, have increased continually.

Given this, and given the fact we know one day proven oil reserves must fall, should depletable natural resources be modelled as depleting?

Saturday, October 17, 2009

Kornai on Soft Budget Constraints

In his guest post on Willem Buiter's Maverecon, János Kornai gives an interesting take on the Global Financial Crisis through his research on Soft Budget Constraints (SBCs).

During the communist period in Hungary, firms, despite being given material incentives to be profitable (including profit shares to the owners), they also faced very high rates of rescue by the state when in financial trouble. Kornai argues the real effect of rescues like this is a modification of the budget constraint faced by the firm, to one that is effectively "soft". That is, the short-term spending decisions of a firm will be looser should there be little chance of firm closure.

This argument is subtly different from the Moral Hazard argument. Moral Hazard tells the story of what happens to a firm's taking of risk when it becomes either implicitly or explicitly insured. SBC theory tells us that a firm will not necessarily take more risk, but their spending decisions will generally be brought forward, as their intertemporal budget constraint is perceived as being "soft".

My third year students, who've just covered the Keynes-Ramsey condition in intertemporal consumption choice, will be able to see this as a direct application. If a firm's internal discount rate is greater than the perceived cost of capital (which is decreased, due to the likelihood of rescue), then present expansion of the firm will appear to be a cheaper "option" than waiting later to expand.

Weekly Links:

Paul Romer on Elinor Ostrom:

Harry Clarke on climate change:

The Financial Times on a surprisingly peaceful bit of Afghanistan:

The problems with mis-specifying proxies (part 2)


The famous paper in proposing Resources Curses as being more or less a fact was Sachs & Warner (1995). In their paper, they regress, against 1970-1990 GDP growth, a bunch of variables including: primary produce exports to GNP, land per capita, number of coups, revolutions, assasinations etc., school enrolment rates, and the like.

This paper is super-influential: Google Scholar says it is cited by 1416 other papers. Unfortunately, though, the result it concludes---that natural resource `abundance' is correlated with low economic growth---is ill-gotten. It all comes down to the choice of proxy: in their case, using natural resource exports to GNP as a proxy for natural resource abundance. This was picked up by Stijns (2005), who replicated their regressions but using per-capita coal, gas, and oil production as the proxy for the same explanatory variable---not a perfect proxy either.

This next bit should come as a real lesson to economists and students everywhere about the choice of choosing a proxy variable. The picture below is lifted directly from Sachs Warner (1997)---an updated version of their paper. It shows Zambia as being the most `resource abundant' country in the sample. According to natural resource estimates for 2000 by the World Bank (2005), Zambia had a proven stock of natural resources of $17.5B USD. Venezuela, according to the same study, at the same time had an estimate of proven stock of natural resources of $658B USD---some 38 times the `abundance'.

An incredible problem with the choice of a proxy like this is that it not only that it messes up the magnitudes, but also the ordering. It allows researchers to say very little about what they are trying to explain.

As far as the Sachs Warner paper goes, although it shows fairly conclusively there is a negative relationship between natural resource exports and economic growth (though this is likely an endogeniety error; name a rich country whose exports are comprised almost exclusively of resources), it fails to say much about "Natural Resource Abundance and Economic Growth"---the title.

The problems with mis-specifying proxies (part 1)

At the moment, my thesis research is on identifying ways of modelling the consequences of countries' endowments of natural resources. There is a huge literature on this topic, and so it is quite hard to try to include them all. However, at the very core, the claim which echoes through the literature is that of the so-called `Resource Curse'.

The Resource Curse hypothesis is that countries with large endowments of natural resources will grow slower than resource-poor countries. This counter-intuitive proposition uses several channels to explain itself. They can be divided into the Dutch-Disease literature, the Institutional literature, and the Learning-by-Doing literature.

The Dutch Disease literature claims that countries that export natural resources will see an increase in their real exchange rates, either through currency appreciation or inflation, and this squeezes out producers in other sectors. This argument is often extended to include that natural resource exports also increase labour and credit costs, also increasing the cost of doing business for factories and pubs.

The Institutional literature claims that the presence of natural resources changes the incentive structure of countries, and so to the extent that a country allows itself to become over-run by robber-barons (either domestically-bred or foreign), natural resources cause economic stagnation.

The Learning By Doing literature says that in countries with natural resource abundance, a greater proportion will be induced into working in the resource sector. This results in a smaller proportion of the population working in the services and manufacturing sectors---both of which tend to be associated with higher skills, and continual opportunities to Learn by Doing. The long-term consequence of this is that people spend too little time acquiring skills, and too much time digging holes.

Friday, October 16, 2009

Refugees, Australia, & Boats

In an interview on the 7.30 Report a few nights ago, the Australian minister for Immigration, Chris Evans, made a strong point. Of the 438 asylum seekers onboard the Tampa, a Norwegian cargo ship which was refused entry to Australian waters in 2001, only one was not granted asylum by Australia or New Zealand.

If the majority of boatpeople are eventually granted asylum in Australia, and if Australia really wants to do something to stop people-smugglers, then there exists a smart way in which we could do so. Currently, asylum seekers pay smugglers tens of thousands of dollars to ferry them through South East Asia or the Mediterranean. I'm not against this pur sei---they're only filling a need---but they tend to do nasty things to their passengers from time to time. They don't observe Duty of Care.

If Australia ends up giving asylum seekers refuge, and if we don't like people-smugglers, then why doesn't Australia's government enter the market, and set a price on the processing/transportation of asylum seekers? Presumably, a price could be reached that would be high enough to limit numbers to an absorb-able figure, and similarly undercut people smugglers. If this was coupled with very strong policy against people smugglers (like sinking their boats), they wouldn't be able to reduce their price.

Isn't that pragmatic?

Saturday, February 28, 2009

Favourable selection at the beach

Have you wondered why people look better in bikinis than in clothing? Wonder no more!

The other day, sitting on St Kilda beach, I got looking at all the pretty people. You are all aware I am an amazingly handsome man, with fully sick pectorals, and a washboard stomach; despite these (genetic) advantages, my Irish skin (which happily alternates between pink and white) had me keep my shirt on. I was able to resist taking my shirt off, in part, because the slightly more handsome men around me (who had that Mediterranean skin my kiddies will) would make me look ugly by comparison. I'm way to vain to be comparatively ugly.

A central idea in economics, credited to Akerlof (1970), is `adverse selection'. It states that when information about the quality of a good is known only by its seller, buyers will be prepared to pay only for the average quality. This leads sellers of superior goods to withdraw their goods from sale, lowering the average quality, and so the price buyers are willing to pay, ad infinitum.

`Favourable selection' then, is the inverse, and I believe, the reason for the beach being a damn sexy place.

Let's say we start with a warm day, and the average population at the beach. There are pretty people, and there are ugly people. The pretty people feel good (for they are pretty), and the ugly people feel less confident (for they are ugly).

The next warm day comes along, and everyone considers going to the beach. But, the ugly people remember last time--the beach made them feel ugly--and so choose to stay at home. This time, the average quality of the people increases, and people who felt good last time (for being less ugly than the truly ugly people) now feel ugly. This bunch stays at home next time, raising the quality again, and again, and again.

Hey presto, and St Kilda beach becomes a sample of the most tanned, buff, Goose-in-Top-Gun-looking people in the human population, while the ugly stay at home playing PS3.

From a policy perspective, this presents a problem, as the beach ceases to be a public good, and becomes effectively excludable (even if the ugly exclude themselves)--there is a transfer of welfare (use of the beach) from the ugly to the pretty.

Do we have any ideas on how to correct this market failure?

Reading Ken Rogoff on the Isle of Singing Politicians


I begin with an admission: when it comes to popular culture, my knowledge doesn't extend much past the third season of Macgyver. In Melbourne, this flaw results only in me being excluded from trivia teams. In Jakarta, a large Muslim town known as much for its love of western pop music as its corruption, such ignorance is up there with pork.

While driving through the city, our host, Wibi, asked me: "Mr James, do you know the Pussycat Doll?" Not exactly sure with what question he was propositioning me, and thinking (given the time of year it is) he may be referring to those good-luck-to-the-Chinese-bringing golden cats with waving arms, I looked about the car, hoping to clue on to what he was talking about. The passengers in the back seat (two friends from LaTrobe, our Javanese guide, and my girlfriend) were singing along to an irritating song on on one of Jakarta's dozen western channels, "I'm telling you, loosen up my buttons, baby (Uh huh)." "No, Mr James! The Radio!" Wibi pointed "Pussycat Doll!". As the clock rolled over 6.27, the Pussycat Doll song finished, with a tarty "Say what you going to do to me". Suddenly, the Adhan Maghrib (sung call to dusk prayer) sounded over the radio, and the singing in the back seat stopped. Ulluh here seems more omnipresent than at home.

A little over a decade ago, this country fell apart. Investors from home and abroad, in actions inevitable in an environment of poor policy and panic, pulled their investments from Indonesia, triggering bank failures, student riots, inter-ethnic massacres, and ultimately a revolution, in which Suharto, their longtime dictator, was deposed. From these events, the country is permanently marked. Now, democracy blooms; Reformasi has brought electoral advertising to every street corner and newspaper; editorials and satire alike highlight the flaws of the current rulers and the contestors; and average Abduls openly voice their political grievances--all of these, explained one host, would have resulted in vanishings under Suharto.

Despite this, many Indonesians have fond memories of Their Suharto: the Rich, because his pro-business rule (and patronage) saw them accrue Toorak lifestyles proper; the Poor, because his stable regime saw the most escape poverty and get refrigerators. Playing to this sentiment, the contenders for this year's election--the first direct election of a president in the young country's history--parade posters of themselves at His deathbed. Whether they are promising more of that kind of rule, I'm not sure.

As a trainee economist, Java is both exciting and irritating. Virtually all of those who were acutely poor in 1985 are now not. The children in the relatively poor villages surrounding Probolinggo, Malang, Yogyakarta, and Jakarta--the towns we stayed--live the lives of our grandparents: filled with kites, bicycles, cigarettes, and directing traffic. There is still a massive division of wealth (there always has been), but the ranks of the elite are no longer closed to those close to political power. Our hosts in Malang, who have a waterfall in their house, are a fine example of what is achievable. Hermin, the mother, moved to Australia in the mid-1990s to pursue a PhD at LaTrobe, and now lectures in Chemistry at a University. Edy, the father, used savings he earned picking grapes in Mildura to open a series of restaurants, the revenue from which he plans to use to send his two sons to Melbourne to study. The future is bright.

Even the lives of peasant farmers, who are poor in most of the world, are more prosperous. A combination of their fine work ethic, fertile soil, modern methods, and willingness to till any hill or cliff, has provided most with high quality housing and the capacity to pay for highways to their villages. A few months ago, I went to Pulau Nias, an Indonesian island in the Indian Ocean, and saw the exact opposite. Farmers there, using inefficient organic methods (mainly for subsistence), contributed to the poverty of the place. And still I have friends who think the subsistence village lifestyle idyllic.

Away from the villages, in the cities, memories of the 1997-1998 financial crisis are fresh and rare, and those in charge recall what happened to Suharto. Consequently, the financial system has been reformed along two lines: the first would be termed `Conservative Finance', and the second `Populist Insurance'. Conservative Finance emphasises maintainable debt levels and economic efficiency, and has become popular in much of the world scarred by the crises of the 1990s--like Brazil, Malaysia, and Indonesia. Populist Insurance is my term for government policies which artificially increase employment to reduce the political tensions it causes, mainly by introducing employment incentives like tax breaks. Conservative Finance is great. It creates stability, encourages investment (by resulting in lower real interest rates), and reduces the likelihood of crises--remember, the current crisis is partly the result of very liberal approaches to debt. However, the Populist Insurance tendency of Indonesia's government concerns me. As it artificially reduces the cost of labour for businesses, firms tend to over-employ, and so divide simple tasks into unnecessarily labour-intensive steps. Three people man every bowser at a petrol station. It reminds me of an anecdote:

During the cultural revolution in China, Mao invited a western economist to witness some of the giant public works. The economist was taken to a damn under construction, and saw thousands of men in those wok-hats, each with a shovel, hard at work. "Why are your men using shovels?", he asked.
"Because it reduces unemployment." the party official responded.
"If it is unemployment you are trying to eliminate" the economist replied "why not give them spoons?"

There is an argument for reducing unemployment, but having people paid to be in unproductive positions simply reduces their earnings, by reducing the incentives to find employment in relatively highly productive high-wage sectors. A further adverse effect of these policies, which are designed to ease potential political tensions created by unemployment in favoured industries, is that it has resulted in a remarkably thin selection of things to spend one's money on. We four travellers, three being economics students, joke that in Indonesia you can buy only 47 different kind of widget, but have 6 billion of each. This makes the country more susceptible to problems.

Indonesia will escape the current financial crisis; it's house is in order, largely thanks to its Finance Minister, Sri Mulyani Indrawati, and her predecessor, Boediono. But given the problems in the world today, there still is much to be done. Ken Rogoff, one of my favourite economists, has written much on international economics (and was at one stage a senior economist at the IMF), but two of his pieces of research stand out in relation to Indonesia. The first*, from 1995, two years before the Asian Financial Crisis turned Indonesia inside out, was practically a how-to guide for hedge funds on how to target countries with fixed exchange rates for devaluation--a good way to make money quickly, but to also destroy an economy. (The authors were not so malicious in writing this work, but meant it instead as a policy analysis against fixed exchange rates). His warning was ignored by Indonesia--a fatal mistake. I highly recommend a more recent paper**, comparing past financial crises, their causes, and their results. It shows the Indonesian crisis as one of the largest, but shows the current crisis as fairly mild--there is quite a bit of `down-side'. If the short-term future looks anything like what Prof. Rogoff's research suggests could be possible, and Indonesia is used as a guage of the transformative power of crises, the next few years could be interesting.

While the candidates for this year's election in Indonesia sing in public (a strange campaign technique which seems to work) and the world lurches towards the economic abyss, it will not only be Indonesia who has learned from its crisis. Much of the advice being given today is in direct contrast to the advise given to Indonesia then. I only hope Messrs Swan and Rudd do not proscribe spoons to the economy as a sensible solution.

*Rogoff, K., Obstfeld, M. `The Mirage of Fixed Exchange Rates', Journal of Economic Perspectives, 1995
** Reinhart, c., Rogoff, K. `This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises', NBER Working Paper, 2008