The Khaki Economist

New blog

2011-09-26T07:38:00.000-07:00

I have started a new Khaki Economist blog at www.khakieconomist.com. Please follow!

Soccer in Mexico

2010-01-09T17:57:00.000-08:00

Mexico does most things pretty poorly. But that's the topic of my next post. This topic is about something Mexico does pretty well: fútbol.

Last night, I went to see the pre-season so-called "Tapatíos" match, that is, between the two biggest Guadalajara-based (Tapatío) teams, Chivas (Goats), and Atlas.

The match itself was about the same quality as A-League matches, which means `pretty low'. However, I enjoyed the match immensely more than I do most A-League matches. I think there were a few specific reasons:

-having two teams from the same city means there can be a noisy contingent of fans from both sides. It's good to see the A-League admitting second-team franchises from Sydney and Melbourne.

-A more liberal allowance of drums and musical instruments. They create atmosphere, which is a clear substitute for the quality of the game.

-Roving booze/food salespeople.

-Much better half-time entertainment. They had teenagers in jumpsuits running a Gladiators-ish obstacle course, which was genuinely funny--and perhaps more interesting than the soccer.

Unfortunately, Chivas, the team which I bought the jersey of, lost 0-1.

Making (special) Znoud el-Sit in Mexico

2010-01-06T19:04:00.000-08:00

It started out a fairly simple task: I wanted to make for my new, extended family, my favourite Lebanese sweets---Znoud el-Sit. For those unacquainted with them, they are pure bliss. They are filo pastry wrapped around clotted cream, deep fried and drizzled in rose-water sugar syrup.

Easy, I thought.

The first problem I found was that filo pastry is not available in Mexico. They have no Turks, Greeks, Maltese, Italians, French, or Pan-Slavic people here. This meant I had to make filo pastry. It takes a five year apprenticeship to make good filo pastry, and with my limited (I read three recipes, and watched two YouTube how-tos) training, I failed miserably. The best description of my "sheets" of filo pastry would be "dough".

The second problem was that Ashta, or Lebanese clotted cream, is not available in Mexico. This meant I had to make it myself. This wasn't a complete failure. The instructions are pretty easy: take 5 tins of Carnation Milk, two tablespoons of flour, and simmer, stirring, for five hours.

Having wrapped my dough around my ashta, I deep fried them (they looked like pigs feet), and took to making the sugar syrup. That was meant to be easy. Sugar, water, rose-water. Unfortunately, rose-water is not (really) available in Mexico. Resigned to this fact, I made my sugar syrup the old fashioned way--just sugar and water.

Susana's mother, though, rocked up, just as I'd finished the sugar syrup. She had rosewater!

In Mexico, rose-water isn't used in cooking so much as it's used in cosmetics, as a skin-cleanser. The bottle she brought was almost a litre, so I stirred in a few capfuls, and poured them on top of the Znoud, garnishing with crushed pistachios (available in Mexico).

It was then, having spent no fewer than 8 hours preparing this horrible meal, that I thought to taste the sugar syrup. I dipped in my finger, and gave it a good lick, only to bend over gagging: the rose-water was almost half soap.

Nonetheless, I served the (cleansing) Znoud to my new family for Christmas dinner, and several went for seconds. One asked for the recipe--I wonder what she'd have done if I explained the secret ingredient?

Buying brides in Mexico

2010-01-05T08:25:00.000-08:00

In Timor, a few years back, some of the locals told me that bride-selling was pretty much the norm. If you wanted to marry someone´s daughter, your parents would have to pay her parents the bride price, normally in livestock. This served as a massive incentive to have daughters. And often having daughters led to having sons.

In Mexico, there is no bride selling by families (fortunately: the price on Susie´s head would likely be beyond my budget). However, the custom has been taken up by the immigration ministry, who demand $2658Pesos from foreigners for a ¨license¨ to marry a Mexican.

This seems a hugely efficient tax. Demand for Mexicans spouses, presumably, would be very inelastic to the price of this license. I, personally, would pay double that for Susana, or triple.

In one of my many questions for the Mexican bureaucracy, I ask: how did they come up with the bride price of $2658?

Paul Romer, Town Planning, and Eating Gays in the Land of the Deep-Fried Taco

2010-01-03T01:21:00.001-08:00

Sorry guys, the first post of this didn't contain the links.

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Dear Friends & Colleagues,

Two weeks ago, I went to see The Brothers Bloom in a Mexican Cinema. In Mexico, most Western films are released in both subtitled and dubbed formats; people with thick-rimmed glasses and skivvies overly attend the subtitled sessions, and those with pick-up trucks choose the dubbed sessions. For me, the only memorable part of the film [two and a half stars], was when one brother Bloom said to another brother Bloom "I don't want to impugn an entire country, but Mexico is a terrible place". All the political science students in their berets giggled, nervous, and offended, but unwilling to not get the joke. They knew that fifteen thousand people have been murdered here since President Calderón stupidly declared war on the drug cartels, but are also tired of being the butt of supposedly affectionate jokes in the west. Being proud of being Mexican is difficult.

Mexican national pride, from what I can reckon, is based on cuisine, custom, and saying "bugger off" to the Spanish, one hundred and ninety-nine years ago. In 1810, a charismatic priest called Miguel Hidalgo y Costilla, irritated by the authorities in Madrid ordering private vineyards destroyed, including his (they would threaten the Crown Monopoly), raised an army and took the silver-mining town of Guanajuato. His attempt at gaining Mexican independence was immediately unsuccessful---the Spanish shot him in Chihuahua, then cut off his head and put it on a spike in front of the grain warehouse in Guanajuato (for a decade, to let the message sink in). Eleven year later, though, Hidalgo's "bugger off" resonated with a greater proportion of those in power, and Spain ceded control.

After seeing the film, Susana and I visited Guanajuato, staying in a hotel metres from where Hidalgo's head was. The town itself is unlike the rest of Mexico; it seems to have `got it together'. It is a tourist town in the purest sense. Throngs clog its cobblestone streetlets for the permanent carnival atmosphere, take tours of the dungeons, castles, and silver mines, or drink tequila in the lane-way bars. It is a lucky town, with something to sell: picture the Warrumbungles, minus the trees, with all the seventeenth century pomp of a pious European city, glued together with the walkways, parks, and restaurants of Sydney's The Rocks, in permanently mild weather. The physical beauty, however, is not the sole reason to go to Guanajuato. For Mexicans, visiting the town is an escape from their dirty, industrial Mexico, where pedestrians give way to cars that give way to trucks. In Guanajuato, pedestrians have de facto right of way; cars get around in their underground cobblestone tunnels, and there are no trucks. Guanajuato exists in a different kind of normal.

Normal, unsurprisingly, is a fairly important concept in development economics. As pointed out by Daron Acemoğlu, an important development economist, Mexico´s normal is comparatively dismal:

"On one side of the border fence, in [Nogales,]Santa Cruz County, Arizona, the median household income is $30,000. A few feet away[, in Nogales, Sonora], it's $10,000. On one side, most of the teenagers are in public high school, and the majority of the adults are high school graduates. On the other side, few of the residents have gone to high school, let alone college."

Economists call the different versions of normal that exist on either side of the fence bordering Arizona and Sonora institutions. Institutions are not schools, or hospitals (unless they are), but the shared common accepted rules between a group of people. Kissing hello is one institution. My lentil burgers are another. Today I saw a fantastic example of a proud Mexican institution: a bus had been pulled up by a motorcycle police-man, for running a red light. Underemployment in Mexico is around the quarter of willing workers, and the driver---knowing that he could be easily replaced---"fixed" the policeman right there, five metres from Susana and I.

It has been a source of constant fascination for me how the physical layout of a city can influence these institutions, and how they become re-enforcing. Guadalajara, for example, is a big city--about the size of Sydney--and has about the same quality of roads and transport as Sydney would if no maintenance work was carried out for 5 years or so. The size, coupled with the presence of plenty of heavy industry and cheap petrol, means the pick-up truck (American style, not the more efficient Japanese type), is omnipresent. In many industries, owning a pickup-truck can be the deciding factor in one's employability. These factors further result in traffic problems, road damage, and a potential enormous "friction" when Mexico eventually faces a real oil constraint.

But pick-up trucks are not a bad institution per se, and nor are sprawling cities necessarily riddled with corruption and "isolated communities". There is something else going on.

If I were to have to pick a single metric for development, it would be the level of maintanance of the space between a road and houses. Certainly, poor footpaths do not cause a poor society; in contrast, they are the weather-bell of development. In general, people look after their houses. It has ceased to surprise me that in supposed "slums" one can find well-maintained dwellings with more mod-cons than I had in my Brunswick share-house. Similarly, in some of the poorest parts of the world, I have travelled on beautiful, smooth roads (I admit, fairly infrequently).

People take care of their houses because they stand to directly benefit from it: economists say their time spent housekeeping is consuming a "private good", in that others cannot freely consume it. Roads (public goods) are a different story. In general, good roads only happen in places where those who stand to benefit from the roads have some power or economic importance (ie. farming districts, or infamous smooth-highways-to-the-
governer's-house examples). Footpaths, though, are a necessity only for the marginalised (the blind, the crippled, and the old), and it is no surprise their existence, let alone quality, is the marque of a society that has got it together.

More geekily: the existence of high quality footpaths indicates that people implicitly care about the existence of footpaths (a public good) almost as much as their own houses, and do this either by taking care of the footpaths themselves, or paying a tax in order to have an administrator do it for them. This general idea--that development occurs due to institutions equating perceived private returns with public returns--is fairly central to the work of Douglass North, who won the Bank of Sweden (Nobel) Prize for economics in 1993, and who all economics students should be forced to read.

Footpaths are, of course, fairly insignificant in the scheme of things, but they are a good allegory for public good-provision in general. The people of Guanajuato (and their clean streets, which are, incidentally, primarily cleaned by the residents, not council) left me with something to think about: they care for their footpaths because the rest of Mexico would judge them harshly were their streets filled with litter (the norm in Mexico). Why is there not the same degree of shame attached to Mexico's other ills: drug crime and corruption? If Landscape Architects and Urban Planners have the capacity to engineer our emotions to accept ownership of land that is not ours, and treat it as so, is it not the task of economists and other policy-makers to figure ways to attach popular sentiment (and more importantly, action) to behaviour in the public good?

An interesting thinker on the topic of Cities and Institutions is Stanford Professor Paul Romer, whose Charter Cities idea has been quite a hit this year. The general concept is this: poor countries' governments have proven to be fairly bad administrators, for whatever reason; similarly colonialists didn't do a really flash job managing the same countries either, and so re-colonising countries is not a palatable option. However, cities are a fairly proven method of improving livelyhoods, and most cities in rich countries are run well. It follows that if rich countries were to establish cities and allow people from poor countries to populate them (accepting the rules and institutions of the city), everyone would benefit. The best example of this sort of thing, historically, is Hong Kong, which was administrated by the UK until 1997, and is one of the most prosperous cities on the planet. Here are a list of candidates proposed by Romer.

On balance, I think the idea is a fantastic one, though not without some flaws, which I'll write on another time. My biggest criticism is, so far, the lack of detail of what a charter city would look like. I would not say that contemporary suburban design inspires "ownership" of a city in the way the nooks, hills, and churches of Guanajuato do. Urban design can, simply, make the job of instilling good institutions easier.

To get a better idea of the so-called "International Best Practice" in urban design, I plan to go this year to the Shanghai Expo 2010. I will likely go in July, if the Treasury wants to give me some time off. If you're interested in joining me, shoot me an email.

Mexican Food and Language

2010-01-02T22:04:00.001-08:00

This year, while trying to write a thesis, I put on almost 10kg. After a few of my closest friends made a few comments ("Jim! You're looking so... portly!") I went on the CSIRO diet with my parents, and lost almost all of it. That was before coming to Mexico.

The Mexicans, I can safely say, are a fat bunch. Among the hundreds of pieces of mother-to-daughter knowledge that are passed down (bi-carb in the fridge keeps the smells away; bless yourself in front of a church or be condemned to hell; cut--don't rip--the plastic bag you put in the tortilla maker, etc.) the link between fat content of food and the fat content of people has not been made.

In contrast to the CSIRO diet---which is easy, tasty, and removes almost all fat and carbs from the diet---the Mexican diet consists of tortillas (carbs), melted cheese (min. 40% fat), and fibre (beans), give or take some cilantro, onion, lime and chili for savor. Every meal is washed down with soda. It is no surprise the former CEO of Coca Cola here, Vicente Fox, became president: it wasn't a great increase in influence for the man.

Needless to say, I'm losing the fight of keeping that weight off.

I am, though, happy to report that my Spanish is improving, slowly. Learning a language is a difficult process, especially when there are small differences between the innocent and offensive. I recall a good friend of mine, from Russia, once asking a female tram driver "Does this tram go to St Kilda Bitch?", and buying a "bottle of cock" from 7/11.

My 7/11 experiences have been no better. For the first two weeks, at every store I visited, I asked the price of the store attendant "¿cuánto cuestas?" where I should have asked for the price of the product "¿cuánto cuesta?"

After spending a while scrubbing myself up (I needed scrubbing) to go to Sue's Uncle's new gay club, I stood in front of her family and proudly announced "Yo como un homosexual", in place of "Yo parezco como un homosexual". The latter translates as "I look like a gay", and the first as "I eat a gay".

High points of the last week

2009-12-12T21:00:00.000-08:00

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.

Lost in translation: 1

2009-12-11T10:57:00.000-08:00

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.

First impressions of Guadalajara

2009-12-07T15:46:00.000-08:00

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.

Cheers,
Jimbito

I've been slack

2009-12-03T21:56:00.000-08:00

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!

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

2009-11-21T04:21:00.000-08:00

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?

Reasons I'm marrying the right woman #792

2009-11-17T04:24:00.000-08:00

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...

Can Governments be Ponzi Lenders?

2009-11-16T04:16:00.000-08:00

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?

Reflections on finishing a thesis

2009-11-09T15:49:00.001-08:00

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.

Congratulations, sister!

2009-11-06T14:36:00.000-08:00

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!

Some clichés are less equal that others

2009-11-05T23:13:00.000-08:00

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:

Jonothan Safran Foer on Dog-Eating

2009-10-31T18:55:00.001-07:00

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.

Global imbalances & US monetary policy

2009-10-30T16:21:00.000-07:00

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

2009-10-30T05:14:00.000-07:00

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.

Why people leave Mexico

2009-10-29T14:48:00.000-07:00

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.

http://www.economist.com/world/americas/displaystory.cfm?story_id=14416623

Sarko's shower

2009-10-29T14:39:00.000-07:00

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.”

On tutoring Macro 3

2009-10-28T15:26:00.000-07:00

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!

2009-10-28T15:24:00.000-07:00

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

nosp4m_javage@gmail.com

Jim

Should smokers and non-savers face longer prison sentences?

2009-10-25T19:27:00.000-07:00

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?

2009-10-25T04:36:00.000-07:00

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.

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

2009-10-22T18:13:00.000-07:00

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.

Against

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.

Melbourne Honours Symposium: Call for papers!

2009-10-20T00:17:00.000-07:00

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 j.savage@latrobe.edu.au

Cheers,
Jim

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

2009-10-19T23:41:00.001-07:00

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?

Kornai on Soft Budget Constraints

2009-10-17T14:32:00.000-07:00

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:

2009-10-17T06:09:00.000-07:00

Paul Romer on Elinor Ostrom:

http://chartercities.org/blog/72/skyhooks-versus-cranes-the-nobel-prize-for-elinor-ostrom

Harry Clarke on climate change:

http://www.harryrclarke.com/2009/10/17/policy-responses-to-global-warming-under-uncertainty/

The Financial Times on a surprisingly peaceful bit of Afghanistan:

http://www.ft.com/cms/885d7916-e3aa-11dc-8799-0000779fd2ac.html?_i_referralObject=10620134&fromSearch=n

The problems with mis-specifying proxies (part 2)

2009-10-17T05:48:00.000-07:00

...continued.

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)

2009-10-17T05:31:00.001-07:00

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.

Refugees, Australia, & Boats

2009-10-16T22:18:00.000-07:00

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?

Favourable selection at the beach

2009-02-28T20:43:00.001-08:00

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

2009-02-28T20:41:00.000-08:00

Sir,

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

Economics of dating: Contestable markets, moral hazard, and my stomach.

2008-11-24T16:55:00.000-08:00

There was a documentary on SBS a while ago, in which an old, fat Italian lady, sitting like a beached whale on the edge of the South Adriatic, stared at a flock of pert `classical looking' young Italian girls. "Italian women are-a-very-very beautiful," she said, "until dey get-a married."

In Middle Park, Australia, where I work, the married women are less rotund. They drive Audis, and jog. They sometimes stay pretty well past forty.

Two economic concepts go a long way to explaining the disparity in these waistlines. The first is `moral hazard', and the second `contestable market hypothesis'.

Moral hazard is the better know of these two; it states that when someone is certain of an outcome, they will alter their behaviour. So the driver with comprehensive insurance and a layer of pillows over their car will drive slightly worse than my grandmother, while the driver whose steering wheel has a large spike ripe for impaling will drive more cautiously.

Contestable market hypothesis states that a monopolistic firm will behave like a competitive firm if the barriers to entry in the firm's industry are low. So the sole airline flying a certain route will charge a competitive price if there are no barriers to other airlines flying that same route--if it jacks its price up, other airlines will enter, compete, and drive prices down.

Assuming we are talking about monogamous relationships, we can readily apply both of these concepts.

In a secure, long-term relationship, the consequences of `letting yourself go' are less--a loving partner certainly wouldn't dump you over a bit of extra flab, would they? This is classic moral hazard.

At the other end, the men and women who compete with salsa instructors and tennis coaches for their partners' attention are far more likely to keep their bottoms firm and chests proud. Though their partners remain entirely faithful, the sheer prospect of anything unsavoury happening is incentive enough for the morning's push-ups. This is what contestable market hypothesis is all about.

It follows, if one wishes to keep both themselves and their partner in good shape:

-increase the likelihood of a negative outcome from sloppy behaviour. Tell him: "Look honey, I love you, but if you don't stay toned, I will leave you."

-not behave jealously. Jealousy increases the barriers to entry both for the potential suitor of your girlfriend (who is fearful of you thumping him), and barriers to exit for your girlfriend (who is fearful of you thumping her). Competition is key. If you have to compete with her favourite barista, you will keep in better shape. Or, alternatively,

-institute a strong anti-trust policy, encouraging promiscuity for both partners. The additional competition will make them narrower.

Kook on wheels.

2008-11-18T13:43:00.000-08:00

In Malaysia, I recently came across one of the main obstacles to world peace. Click to get a better look.

Robert Solow does it again.

2008-11-16T23:16:00.000-08:00

If you're keen to spend the next twenty minutes improving, read this article:

http://www.nybooks.com/articles/22080

Khaki Economist on dating troubles

2008-10-17T05:49:00.000-07:00

Dear Khaki Economist,

I'm a bit of a dating disaster and thought when the world of philosophy has failed to answer the question of why I'm still single, I should go back to my true roots and seek the mechanical (and logical) answers of economics.

I feel that I am essentially a "good" in the wrong market. Therefore this means that there is no demand for my dear self. The current market I am in there is an abundance of idiots, so finding a partner in here is more scarce than crude oil.

As mentioned earlier, the main attribute I seek in another is one with equal intellect to myself in order to have real and deep conversations. I feel like a 25 year old amongst a bunch of teenagers who will be waiting a while for everyone to catch up to her.

What should I do?

Jess

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Dear Jess,

There are several ways of tackling this problem.

First, ignoring the golden rule of entrepreneurship in capitalism (do not open a business in a competitive market with low barriers to entry), you have chosen to join an essentially homogeneous market. In development, micro-business homogeneity is a real problem; poor countries tend to have lots of petty entrepreneurs (for there is no welfare system, and little large-scale investment), but these entrepreneurs all sell the same thing. I have some great videos of kilometres of streets in Indonesia, lined with hundreds of the same store--all selling the same collection of soft drinks, chewing gum, and biscuits. Prices are driven down, and economic profits tend towards zero. In your model, the easiest girl with the best makeup job and largest breasts gets the cake.

You could also think about this along the lines of trade theory. Generally, a country will specialise in an industry that uses inputs that country is most endowed with. So, Australia specialises in industries like minerals (which it has a lot of), agriculture (which uses land, which it has a lot of), and education (it has many English-speaking academics). The problem is, when a certain endowment increases, the rents to that endowment reduce; an increase in China's population would lower their wages, all else equal.

In your model, you are a micro-business selling chips in a street of micro-businesses selling chips; another tech worker in Bangalore's job market. Unless you can reduce your price, or increase your quality, this market is unfavourable to you.

I recommend then changing markets.

What you want to find is a market with many smart guys, and very few females--be the scarce commodity. The glaringly obvious example is the Dungeons and Dragons community. Gamers and comic-fans are starved of such pretty female company as yourself (whether rightly or wrongly), and so would be able to lavish you with steep economic rents. There may be drawbacks--poor personal hygiene, for one--but given your opinions of most young men, these drawbacks would be mere collateral.

Dating Markets and the Sub-Prime Crisis

2008-10-13T07:10:00.000-07:00

I wrote in a previous post about various mate selection models. These are based upon the idea that, in the period before you develop an emotional attachment to someone, you will work out whether hooking up with them is optimal. If they look to be about as high-quality as you can manage, you will begin to become emotionally attached, otherwise let them go and continue the hunt.

This is fine and well, but leaves aside a possibility. What if the initial due diligence process returns the `all clear--engage emotions' report, but the underlying partner is of poor quality? They are junk bonds spliced, diced and packaged up to be AA-rated debt?

This is the situation our banks find themselves in today. They have wed themselves to large amounts of debt--holdings over houses which are plummeting in value--without the knowledge of their partner's hidden drug addiction, or shoe fetish.

Singles periodically find themselves in cycles of `crush and crash'. They meet a prospective partner, and after an initial attraction build up a large picture of how they imagine that partner to be. This is entirely rational; we find it difficult to manage incomplete pictures of people, even though these pictures may not be correct. On becoming emotionally attached, and spending some more time around the person, the picture is gradually painted over by reality. The reality could be much like the assumptions, or the girl could end up being a nutjob.

Whether or not the crush couples or crashes is dependent on how initial behaviour is altered by the perceived value of prospective partners. That is, if a man meets a lady, and perceives her to be of a certain quality, he may alter his behaviour in order to woo her. This is like the bank, which on acquiring what it thought was high-quality debt, accelerates its loan-writing, comfortable with the strength of its balance-sheet. If the lady meets the man's expectations, his altered behaviour is rewarded. However, if she fails to meet his expectations--the bank's purchased debt is junk--his efforts were emotionally damaging. The bank's balance sheet ceases to balance.

The policy response for both dating markets and mortgage markets is mandating better levels of transparency. Failing the government's giving all prospective partners comprehensive personality tests (which, funnily enough, a girl I dated once gave me, before ceasing to date me), those prospective partners must employ better due-diligence techniques. They must abstain from emotional attachment until they have thoroughly examined each other's books (or bookshelves, which I've always thought to be a good indicator), and decide upon purchase, or partnership, only when it looks like the books are in order.

I wonder if Moody's offers potential partner risk analysis?

2008-10-11T05:06:00.000-07:00

Today's question, from Roslyn, is:

I read today that Zimbabwe's inflation rate has hit 231 million percent. What drives inflation so high in some countries? How can Zimbabwe return inflation to a reasonable level?

Roslyn,

I'm not sure inflation has ever been described more eloquently than by Ronald Reagan, who complained America's inflation problem was of "too many dollars chasing too few goods." That is, an increase in all prices will occur due to an increase in the number of dollars floating about. Zimbabwe has simply printed too many dollars.

We've all heard about those hyperinflations, like the Weimar inflation of 1923-24, when an old guy would cash out his retirement savings to buy a sodapop. But for what reason do countries allow them to happen in the first place?

The answer can be told by looking at a few historical hyperinflations. An early hyperinflation occurred in what we now call New England, during the seventeenth century. Lacking a superior monetary authority, the de facto currency of the region was tobacco, which was durable, divisible, and transportable--all good traits of money. As hoards of pilgrims landed in Boston harbour, one could wander down to the docks with just a few pounds of tobacco, and purchase a freshly imported wife. The savvy bachelors among Boston's small population saw a good deal here, and began to plant tobacco, wholesale. This increased the money supply, and so, like in Zimbabwe, began to increase the price of brides. Just a few years later, the cost of wiving had rocketed in terms of tobacco; one would have to horse down cartloads of dried leaf for the purchase of even an ugly girl. The lesson, however, was not learned.

A few centuries later, an uncharacteristically smart Irishman called David O'Keefe came across Yap, an island now in Micronesia (I'm not sure where it was before). The Yapese used small round stones specific to Palau, a boat-ride away, as their currency. As the fairly primitive Yapese had trouble transporting these rocks, they formed an acceptable currency. O'Keefe, with his large boat, smelled opportunity. With a taste for Melanesian ladies and sea cucumbers, he saw the small cost of sailing to Palau to collect rocks worthwhile, for what (or who) he could purchase. In increasing the Yapese money supply in this manner, the currency was debased, requiring larger and larger denominations--just like the Zimbabweans, who until August had denominations up to the trillion. The rocks became larger.

Today, Yapese villagers still use large stones for some transactions, though they use US dollars for small ones. The stones, in some cases up to three or four metres across, can be used to purchase livestock, houses, and (you guessed it) brides. Some stones--the especially large ones--are not even moved around, but merely transferred in ownership between one holder and another. I guess that saves a trip to the bank.

While these two examples are entertaining, they do not exactly describe why Zimbabwe has needed to expand the money supply so violently. The cause lies, unsurprisingly, in the madness of their dictator, Mugabe, and the international reaction to his rule. When a government needs to raise money, it can do so in two ways--either tax or borrow. When subjects aren't able to be taxed, the government will borrow. When the citizens are too poor to borrow from, the government must borrow from abroad.

As Mugabe destroyed Zimbabwe's export economy, by removing efficient white farmers of their land,
he also starved the country of access to foreign capital. This meant when the government went cap in hand to international financiers, the cap stayed empty.

The only option left to the government was then the worst--to monetize the deficit. This involves the government selling bonds (which they repay only by selling more bonds) to the central bank, who pays them in currency. This is when the money supply begins to accelerate. The inflation accelerates because, at any given level of inflation, more money supply growth must occur for the government to have any additional purchasing power.

The solution, without revolution, is simply to dollarise (or randise). This involves giving up on domestic currency (and the lack of credibility of the domestic monetary authority), and importing credibility of a foreign central bank. Whilst this has costs--relinquishing monetary policy, and the capacity to absorb exogenous shocks via exchange-rate depreciations--they would, in Zimbabwe's case, be less than the cost of inflation.

The other option is regime change, though this has not been shown to restore confidence in the monetary authority (Feige, 2003; Kraft, 2003; Velarde, 2002). My Zimbabwean friend Bethel tells me unofficial dollarisation is occuring, though access to foreign currency is very limited.

Poor bloody country...

Khaki Economist: Bank of Sweden Prize in Economics--a Roundup of the Horses

2008-10-10T16:24:00.000-07:00

With the financial world falling apart, crisis inspiring suicides, and the Great Abyss of collapse more or less dependent on next Monday's stock-market reaction to today's Washington crisis talks, now is a great time to be thinking about the Nobel Prize in Economics. The prize, for those unaware, is handed out on Monday, to the economist considered most good-looking.

For the punters amongst us, there are precious few form-guides available in this betting market. This is a great failure. Below, then, is my round-up of the favourites.

Martin Feldstein Odds-on favourite at $8, but not mine.

An American economist, Feldstein is a good macroeconomist and public finance theorist. His close association with the Reagan and Bush administrations earned him the early short odds in this race, though recent events may have changed all this. His eating trough was poisoned earlier in the month, diminishing his prospects for the prize, when the financial products division of AIG, of which he is the chief director, lost a couple of bets. This has cost the US government (so far) around US$115B, which is quite a sum.

His association with Bush, Reagan, and AIG lead me to not recommend your putting money on him.

Thomas J. Sargent paying $12

Sargent is another American macroeconomist, who played an important role in theorising `rational expectations'. Rational expectations allow economists to make a (quite realistic) assumption that people form expectations over the future based on rationality, and vary their behaviour accordingly. Non-economists would be quite shocked to learn economists have not always done this--once upon a time, expectations were assumed to be formed by present conditions, or yesterday's--which is why rational expectations, and the theory's founders, are favoured to win a gong sooner or later.

While I have no doubt of the depth and influence of this theory, I'd not think it fitting to give this years' award to someone in this field, simply due to the Crisis. On the other hand, the voters may want to award a pure theorist, and not a crisis economist.

Robert Barro paying $13--my tip

The second most influential economist not to have won a Nobel already, Barro is a hero of mine. He is, predictably, another American macroeconomist, though specialises in public finance during economic crises--quite a good thing to have specialised in, this week.

His notable papers have included one on `Ricardian equivalence'*, which is when people perceive government debt as personal wealth. Equivalently, this is like people increasing their savings to pay off government debt in the future. I have always had a problem with the Ricardian equivalence argument, as it sounds to me like another endogeniety problem (when one thing looks to have caused another, but it may be the other way around). That is, it would require very foresighted savers to plan to pay off government debt in the future; it is more likely, as governments borrow off the private sector (or foreigners), the savings must be a precondition for government borrowing to occur in the first place.

Another paper, of use today, "On Determination of Public Debt" (1979), presents a situation of a large crisis, during which the government optimally increases debt and the money supply, inflating away some debt, smoothing the crisis, and maintaining tax rates. While this paper is not his most influential, I reckon a lot of policy advisers will be trawling through it and those it influenced over the coming weeks.

*Barro, R., "Are Government Bonds Net Wealth?", Journal of Political Economy, 1974, vol. 82, no. 6

Paul Romer Paying $13

An American growth economist, Romer has been named amongst the 25 most influential Americans by Time (1997), though only makes IDEAS' top 100 economists. His contribution has been to take exogenous growth theory, and look at technological and environmental constraints. This can best be summed up by a quote:

"Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. History teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material."

Paul Krugman--Paying $16

Rounding up my guide is Paul Krugman, a Princeton professor and New York Times columnist. A favourite among liberals and Democrats, he is equally hated by conservatives and libertarians. This is partly because, as such an industrious economist (and commentator), he provides a large target. Daniel Klein, an economist, wrote "The principle reason I scrutinize Krugman is that he is brilliant, outspoken, relatively candid, industrious, and highly visible and influential. Investigating him is a way of investigating a larger cultural phenomenon" which "is ready to sacrifice poor people's interests for the sake of social-democratic values".

So if he is just a shit-stirrer, why would he be paying these (relatively) short odds? Apart from penning one of my favourite columns, which mainly deals with political economy, he also has been a loud voice on trade theory and international monetary economics. In the early 90s, he savaged the (doomed) fixed exchange-rates of Asia, earning (maybe undeservedly) something of a prophetic reputation--though he denies having called the Asian Financial Crisis. He also recently predicted housing price drops in the US would be between 25 and 50%--rates individual suburbs in New Mexico, Arizona, and Florida are already experiencing.

Despite being so well known, and having so much clout, he is unlikely to pick up the cup this year. The Bank of Sweden prize tends to go to those who've made great contributions to theory, not analysis. Krugman is probably the best analyst around, but enjoys popular influence more than academic.

Khaki Economist: Bill Easterly and the happy-clappy rice farmers

2008-10-10T01:45:00.000-07:00

The main problem with governing over Indonesia, for there is a main problem, is it doesn't really exist. Owing to its colonial past, its difficult geography, and a great fertility which for centuries allowed many Austronesian tribes to exist more or less independent of one another, Indonesia is made up of some 300 distinct ethnic groups, each in a different valley, on a different island, with different aims and different outlooks. One of these, met by Dutch missionaries in the Western Sumatran jungle in the sixteenth century, and by us last week, has maintained quite a distinct culture. The Dutch then were surprised at the Minangkabau people's level of advancement. They were already with schooling, the written word, fenced agriculture, a matriarchal property system, and, unlike their Batak co-islanders, didn't enjoy barbecued man. Today, the Minangkabau carry on many of their ancestral habits: the child takes the mother's name; property is passed from mother to daughter; and traditional buildings are ubiquitous amongst the Soeharto-era concrete. And they are proud of it. Tour companies everywhere offer a more matriarchal experience, with more bull-horned buildings, and less of that Javan crap.

Thought the Minangkabau have continued some tradition, the tour companies don't advertise the other great cultural influence—that which rubbed off during the 350 year Dutch visit. As missionaries, the Dutch were useless: there's a mosque on every corner. But below every portrait of Susilo Banbang Yudhoyono, their president, sits a vase of fake tulips. There are entire villages of Dutch-style country houses, dotting the mountain trails. And dozens of towns, peculiarly, light their main shopping strips with large neon windmills.

A long swim off the West Sumatran coast, in the direction of Sri Lanka, lies Nias island, where the story could not be more different. On arriving, the Dutch found a megalithic (large rock worshipping) society, and, undeterred the Nias' national sport was leaping over large stones, almost converted them to Protestant Christianity. Compared with selling daughters for pigs, building houses without nails, and leaping over rocks for fun, the Lutheran and Dutch Reformed churches didn't offer the Nias much excitement. As compensation, the islanders continue their traditional—probably heretic—lifestyles, simultaneously worshipping spirits and rocks alongside Allah (for that is what they call H-m), and attending mass on Sundays as joyous, songful, cheating monotheists. Culture trumps religion. Every single time.

Culture also, every time, trumps economic rationality. This makes the job of development economists, who are trained to make guesses about how slightly rational people act, more difficult. Thankfully, most people, most of the time, behave in ways that look vaguely rational. This allows economists to be of a little value. But when a culture places great value on the irrational, as in Nias, the development economist must face a whole lot of (can I say `human questions' without inferring economists, who are smart, don't normally ask them?) human questions.

A famous paper came to mind, while I was interviewing a rice farmer, while swiping away at big anopheles mosquitoes, while larvae scooted around the stagnant paddy next to us. In the paper, Bill Easterly and Ross Levine*, two economists, showed of all former colonies, current livelihoods can largely be explained by latitude, crop makeup, and their propensity for disasters. Colonisers, so it went, would export their solid institutions to easily habitable colonies, like Australia and Canada. The unfortunate colonies where (wimpy) European colonisers would catch typhus, or tapeworms (like Burundi, where 280 in every thousand colonialists died every year), would have `extractive institutions' forced upon them. These allowed the most efficient exploitation of colonies, which, lets face it, was what the game was all about.

Nias is poorly positioned to be `easily habitable'. In the past while, it has had a large tsunami (which did more damage in Aceh, just across the way), and a few large earthquakes. The larger of these was the twelfth largest ever, lasting more than two minutes, and raising bits of the shoreline two feet. Together, these killed about 1000, though improved the surf, increasing Lagundri's famous seven-second right-hander to nine seconds. The island has also a healthy population of Anopheles, which spread malaria, an impenetrable jungle covering, and your regular cash crops—cocao, rubber and rice. None of these attributes, unfortunately for Nias, lend themselves to making development easy.

The story, though, is not all sad. While Aceh, described by a UNDP worker we interviewed as a "sexy aid destination", gets most attention, a little development aid has trickled on. Most of this seems to have gone into improving the agricultural methods of farmers, which, I admit, sounds dull, but is actually very exciting. The techniques popularised in the 60s and 70s by CNIAR, an agricultural research body credited sometimes with the world's not being in perpetual famine, never really caught on in Nias. The development organisations there want to reverse this, and bring farmers from the twelfth century into the present. The problem is, many of the farmers we spoke to were unsure the present was a nice place to be.

Our rice farmer, whose parents, grandparents, and great-grandparents were also rice farmers, was introduced by the UNDP to a new breed of rice, from Java, which yields twelve tonnes per hectare, three times per year. This compares favourably to her Nias variety, which yields five tonnes a hectare twice a year. After its first harvest, she ate some, decided it tasted different to her old variety (though the difference wasn't apparent to our translator), and replanted her Nias variety, willingly forgoing twenty-six tonnes of rice per hectare per year. The ten tonnes produced are bartered at market for pigs, and carrots, buying her a poor life.

The rice farmer, though, has it easy, because even in a barter market prices can change. Our rubber farmer wasn't as lucky. On Nias, the only Mercedes Benz are driven by partai bosses, and fly partai flags from their bonnets. In return for bribes (I presume), ethnic Chinese merchants are somehow exclusive in their buying produce from certain regions. The rubber farmer had the option to sell her rubber, extracted in the same inefficient way her grandfather did, to one of these, and one only. Economists call this situation, where these is only one buyer, `monopsony', and fear it like any other market failure. The price paid to her does not change, and is about a quarter of the price offered on the mainland. She lives today in a poverty caused by corruption, culture, and tradition.

Naomi Klein and her leafletters would have us believe the world was hunky-dory before the West came along and began exploiting the poor. Don't worry. The poor have perfected the art of exploiting themselves.

Markets don't fail. People do.

Khaki Economist: F Von Hayek and the Caravan of Doom

2008-10-10T00:41:00.000-07:00

A label best applied to Sumatra's economy--and society--is "Accidentally Hayekian".

The rulers of Sumatra probably haven't read their Friedrich Von Hayek, the 20th Century economist who, by witness of some of the nastier sides of Statism (fascism, Communism, etc.), thought it silly to let governments meddle with much. They have, though, created a Society to make Fred proud. People go about their way here guided mainly by ritual and self-preservatory instinct, but not by rules. The state limits itself to its most proper role--revenue collection--without much appearing from the other end. No roads, hospitals, or General Order.

The lack of Sanctioned Order, while apparent, does not mean Sumatra is a place without systems. Traversing the island, en rout to our destination, Pulau Nias, provided us the opportunity to see "market organisation" at its most efficient.

In Padang, the capital of West Sumatera, we found there was no "four hour bus to Sibolga" as advertised online. The motorcycle hirer laughed at us, refusing us any of his fleet. The bemo driver was less mean; "I take to someone" gesturing wildly "Sibolga". That someone knew someone else, until we were ping-ponged into an empty ticket office in Bukittinggi, West Sumatra. "Wait!" Our last driver told us. We didn't for long; the perfect deregulated transport market, with its little profit-seeking actors, hadn't made us wait all day--it wasn't going to start now.

A main argument for the regulation of markets, though this necessarily implies inefficiencies, is for the creation of standards: product standards, quality standards, method standards, etc. When the benefit of standards exceeds the cost of them, in terms of efficiency, their adoption is a good bet. It is my professional opinion, as an immensely unqualified trainee economist, that the long-haul busing system in Sumatra wants standards.

It seemed normal enough. We were given printed tickets, seat numbers, and had our bags put in vans. From our trip up, I knew vans made sense in this terrain; Sumatra is slung on a spine of volcanoes, like a large wet towel on a small picket fence. Navigating the place requires a decent understanding of "North". The driver also seemed quite normal, by Sumatran standards--an open shirted chainsmoker, with a twitch. The ticket-master smiled, waved, and wished us a safe fifteen hour trip.

A frequent criticism of unregulated Capitalism, especially by namby-pamby leafletters with limited personal hygiene, is that in pursuit of profit, shortcuts will be taken. We argue back that those who spike their baby-milk powder with melamine will be taken aside and shot, in a process Schumpeter (probably in German) called "creative destruction". The Omniscient Market would quickly discover their shortcuts, and drive them from business, leaving only the most efficient, high quality firms.

Somehow, our bus operator has escaped a creative destruction, I reckon by sheer luck. CV Nasional's petrol-saving shortcut is to lower the wind resistance on their buses, by having them draft off each other. This method of power conservation is very effectively used in pro-cycling, like in the Tour de France, but there to save Powerbars, and is normally something I'm ok with--I am, after all, very tough.

This peleton of minibuses, though, brought me an indescribable amount of fear. It wasn't all got by their petrol-saving closeness (each three or four feet from the next), so much as their incredible speed--at least double any other vehicle's.

Sumatra, about the size of Victoria, has forty million, most living in villages strung along the main highways. The Caravan of Doom roared past half these, as they looked in horror. Mothers, hearing the four buses' honkings, gathered their children and herded them inside. Youths threw themselves from the streets, leaving their satay sticks. And oncoming traffic, seen by the lead driver as an obstacle, swerved off in hope of longer life.

On-board, the feeling was rather like being held by the scruff off a high cliff, for the entire ten hours, with no knowledge of how to tell the dangler "excuse me, Sir, but I'd prefer you don't dangle me from this cliff".

I'd read in last week's Economist the brain, when under-slept and over-stressed, was capable of inserting REM dreams into a woke conscious, resulting in hallucinations, like the Simpson's Apu thinking he was a hummingbird. My sister pictured Michael Jackson in the front seat. I, a catholic Athiest, began to pray. I can verify now those moments before certain death are the longest.

We arrived in Sibolga, ominously, as the dawn prayers rang through the city. "الله أكبر", they began, "God is Great!".

The Economics of Big Love

2008-10-10T00:33:00.000-07:00

The pursuit of potential partners can be distracting to singles. The whole process of dating, meeting, wooing, etc., can be a drag. There needs to be a solution. I propose this model is it.

Let's begin with the single person, and the quality of partner they can expect to attract. A classic study in 1973 (Becker) found, unsurprisingly, people generally pick up other people of similar quality. This is why, unless a lot of money is involved, nice pretty people tend to pair up with other nice pretty people, and not slobs.

A more recent study (Fishman et al, 2004) found people tend to pair up with others of similar aggregate qualities of traits--pretty people with few brains could attract far smarter, though uglier people. In that study, also, men tended to be attracted to women who they perceived as of slightly lesser quality than themselves, which probably says as much about men's perceptions of themselves as their perceptions of women.

Building on these ideas, we can say that `singles have a budget constraint of qualities--looks, intelligence, humour, riches, etc.--with which to shop for a mate'. This is illustrated in Figure 1 below by the curve concave to the origin (joining the axes).

You will notice the budget constraints for any given trait (we use here Looks and Brains) exceed one's own endowments of them. That is, one could possibly date someone far more beautiful than they, or far smarter. However, according to Becker, it is unlikely they pick up someone who is better at everything, which is why the constraint passes through their own combination of looks and brains.

We also need to think about what people are attracted to. If we separate one's attraction to potential partners into bundles of qualities, there must be levels of indifference between qualities for each person. That is, one may be equally attracted to a cuter, boring potential mate and an uglier, interesting one. I for one like funny girls, but compromise willingly if they have an excellent knowledge of geopolitics, or are very beautiful. These levels of indifference are illustrated in Fig. 1 below, by the curves convex to the origin, labelled "Attractiveness level 1", "2", and "2.3".

On each of those curves, one is equally attracted to a potential partner on it. So, for every combination on "Attractiveness level 1", I am equally attracted to them. If they are on "Attractiveness level 2", I am more so.

The curve which bisects the axes is the 'budget constraint'--the area within is the quality of people one could 'afford' to mate. The curves convex to the origin join bundles of characteristics of equal attractiveness--one may be indifferent between one hot dumb person and a smart ugly one...

Now, to optimising.

Under the conventional, monogamous approach, we consider it `optimal' here to snag the best quality mate within one's budget constraint. To hook up with someone, when one could do better, leads to inevitable cheating and separation (unless emotions become involved, but we don't like to deal with emotions here--they're harder to graph).

This optimal `purchase' of a mate is represented here on figure 1, by the tangent point of the budget constraint and the highest attractiveness level, here "2.3". They lived happily ever after...

But wait, there's more!

Under the above model, we limit ourselves to just one partner. Asking how "I can give all this love to just one man" is a valid question here. How do we adapt our model to deal with the nymphs, sluts, philanderers, and womanisers?

I suggest we look at what drives the polyamorist.

Let's say for a moment that one `consumes' mates not as bundles of qualities, but as individual qualities. So, one may decide to have a smart girlfriend, a pretty girlfriend, a funny girlfriend, a bushwalking girlfriend, a rich girlfriend etc. (I am a modern gentleman--women under this model are happily able to have multiple lovers, too).

How do we represent this on our model?

In figure 2, instead of dating the "optimal partner" from above, we date two people--one smart, one pretty--but both less attractive than the optimal partner by themselves. In aggregate, however (all summed up), one is dating someone far beyond their budget constraint! In loving many, they have `purchased' a (non-existent) partner so far out of their budget constraint, they would otherwise need much surgery, much education, and many riches to woo.

Welcome to the Khaki Economist

2008-07-26T19:03:00.000-07:00

While, ideally, I'd not be the Khaki Economist, but Macgyver, I'm going to play the hand dealt me.

There was always something vaguely boyish about Macgver. Well, not that vaguely. Week to week, he saved the world, or at least a pretty lady, from crazed Russians---who, let's be frank, want nothing less than chaos. He did so using his Victorinox, a chocolate bar, and his first-year chemistry course.

Being a vigilante, however, is probably beyond my capacity. Just yesterday, I almost broke down in tears telling a customer he was being rude. What isn't beyond my capacity, though, is pretending to be the Macgyver of Economics (yes, it deserves a capital).

This blog then, will with the odd reference here and there to my heroic aspirations, address a combination of problems:

The first are economic problems in the developing world. The editorial perspective here is one of cynicism.
The second is students' economics. The aim here is to provide links for students to read, and to dispel `simplistic economics' as a tool for analysis.
The third and final is to introduce economic analysis into areas not normally thought of as economic.

Bob Birrell, wrong.

2008-05-06T06:26:00.000-07:00

Reflecting on a seminar I went to, quite a while ago, I remembered Dr Bob Birrell from Monash University's Centre for Population and Urban Research (CPUR) saying something like "people want to live in the fringe suburbs---that's why they build them."

The inner economist in me wanted to question this. "Don't people show what they want by how much they're willing to pay to get it?" That's pretty fundamental to economics. If somebody wants one thing more than another, they will pay more for it. Consistent with this, when one person's income increases, their capacity to afford what they want increases, and so their consumption of desirable goods increases.

So do people really want to live in the fringe suburbs, as Dr Birrell would have us believe?

It would seem not. People live in the fringe suburbs because of budget constraints. As many times as you tap your toes together, the fact people pay more per square foot to live close to public amenities (and life) seems not to go away.

Shouldn't we be looking at why the outer suburbs are cheap, and assessing why they are so, determining it is because they are not inner suburbs, and designing future fringe developments like inner suburbs? I think so.

Bogan Tax

2008-05-06T04:56:00.000-07:00

On the 250 bus, I bumped into an old friend, Genesis. We talked, as economics students do, of economics, and joked on that topic too. But there was a serious point made. (Actually, this resulted from a commonly had conversation on public transport---that public transport use increases as you increase the number of services, but service providers are often reluctant to run extra services because of the low initial patronage). The point was that people that live in the inner suburbs subsidise the lives of those in the outer suburbs. This goes a way to explaining the cost differences between inner an outer suburbs (there are many, but these are for future blogs).

Urban sprawl is expensive. The per-unit cost of attaching houses on quarter-acre blocks to public utilities---gas, water, roads, schools, etc.---is higher than in denser, more central suburbs. Under the universal service obligations of our utilities providers, however, somebody in Brunswick pays the same utilities rates as someone in Cragieburn, despite the fact it costs far less to provide that service to the Brunswickian. This means that necessarily inner suburbs subsidise the inefficient outer suburbs.

Normally, when we have negative externalities occurring from a type of consumption, we try to dissuade this type of behaviour. A common prescription is a tax: think cigarettes, alcohol, or gambling. Such taxes are generally easier to impose, as there is often already a cultural bias against those activities; anything which lessens that sort of behaviour is more acceptable. How, then, can governments dissuade people from living in outer suburbs, which have many negative externalities, and have not reflected in their housing costs their true costs imposed on society?

Any government which imposed a 'bogan tax' on the outer suburbs would have limited prospects, electorally. Such a sentiment may not be rational, but it would be. You simply could not say to outer suburbs resident: 'because you can't afford to live in the inner suburbs, you must pay an additional tax.' (which of course, is how it would look).

I would say that a far better way to impose such a tax, would be to slowly unravel universal service obligations, to reflect the marginal costs of providing services to specific areas, and properly assign the different marginal willingness to pay of different regions. Such a setup would allow utility companies to make their money from regions with the capacity to pay more (say, the Pilbara Coast, to which city residents effectively pay subsidies), and lower utility fees for suburbs without the means to afford them, or that cost less to provide services to.

Until we get the incentive mix right, town planning in this country will continue to favour the inefficient, ecologically unsustainable fringe developments of our major cities. Is that what our governments really want?

An idea for the 2020 summit

2008-04-12T18:44:00.000-07:00

Alert friends will recall a time I aspired to ALP hackdom. That time, having past and having altered my view, created my skepticism; good ideas infrequently go realised. There is, unfortunately, a wide chasm between our political machines, and our industry, and between the great ideas of the educated population. Happy we should be then at Chairman Kevin's thousand blooming flowers in Canberra next weekend. It will be a talkfest, and little will come of it, but it at least provides a forum outside the media, the political machinery, and the moneyed lobbies for ideas of all colours to blossom. Below, despite my absence from the forum, is my contribution.

The expansion of supply is key to improving prosperity. A friend recently had difficulty digesting this, during an argument, proposing instead that prosperity be encouraged by more, bigger, income transfers.

Of course such a proposal is nonsense.

The only way to make everyone better off is to have more stuff created. The incentive to produce fewer things under a regressive, ultra-re-distributive tax regime exists, and so limits prosperity.

Instead, the affluent society will (in some disagreement with St Galbraith) create instead a tax regime which looks both to supply-side-expansion, and medium-run re-distributive targets. Such a scheme would limit excessive income disparity (which we social progressives find abhorrent), and maximise the productive possibilities of our industry. How? To be viable, it would increase the marginal productivity of our least-productive employees in our most efficient businesses.

What would the scheme look like?

Keeping in mind this proposal is where tax policy meets industry polity, its architecture, and effects should look a little like this;

Firms would have a portion of their company tax payments returned to them as vouchers to be redeemed at recognised training bodies, for spending on (or at least given priority to) employees earning under a certain threshold, or over a certain age
Firms would, presumably, have a better clue of what skills are required in the marketplace than unguided (or unknowing) individuals, and so training programmes---the more productivity-enhancing of which would proliferate under the scheme---would better suit economic conditions of the time
More profitable firms, which pay more tax, and are better at their business, would benefit more than struggling firms, which pay less tax and would receive fewer vouchers. This would stimulate the efficiency-creating winds of Schumpeter's 'creative destruction', and so increase output in aggregate
Labour productivity would otherwise increase (this is simplified, and design of this policy must consider that many poor have difficulty learning, which contributes to their poverty). Productivity increases would be, in the medium run, be matched by wage increases---a general rule which seems to hold.

Any crusade against inflation must directly target productive-capacity constraints. Making more stuff, and printing fewer dollars, goes a long way! In tandem with the current monetary-policy tightening bias of the RBA, a sensible policy allowing our most demanded industries---which are currently more profitable, and would be the recipients of such grants---to address their capacity constraints, would help. The issue also of providing real, immediately-applicable skills training to low income earners also sits well with a progressive social agenda. Yay.

The great de-coupling myth

2008-04-09T18:04:00.000-07:00

Current economic circumstances allow us to test an interesting proposition, that an increased degree of economic integration can actually allow two economies to grow in different directions. This view, put forward by Eichengreen and Krugman (and Discussed by Frankel, 1999) would suggest that increased integration would lead to increased specialisation---a situation under which exogenous shocks affect the two economies differently. Antithesis to this view, is the conventional wisdom, held by Frankel: an increase in economic integration will lead to increased income correlation.

It has been interesting to watch, then, the popular media speculating China's present rate of growth can be maintained, or at least remain relatively high, in the face of a US recession. Not one to believe what Fairfax tells me, I decided to check this out, and you can too. Pull off the quarterly growth data for China and the US from 1979 (a handy reference year, as China began to open up) off the OECD website. Now, test the income correlations between the US and China for every business cycle (1979-1982, 1982-1991, 1991-2001, and 2001-2007). What is quite surprising, that is, if you are a true believer in the de-coupling myth, is the increase in income correlation (with fewer, smaller, errors) for every subsequent business cycle in that period. This would tend to suggest, at least in this example, that the conventional wisdom would seem to hold: increased integration between China and the US has further 'coupled' their economies; there is no 'loose caboose'.

What does this mean? Basically, we could say that should this model not break down instantly, that should the US be in recession (which it almost certainly has started), China will indeed slow. This is partly due to lower US demand for Chinese goods, partly due to the currency effect (to be discussed in a future blog) and partly that lower US demand for foreign goods will, ceterus paribus, lower foreign demand for Chinese goods. Exports make up some quarter of the Chinese economy, and from my figures, I'd predict about a 10-12% fall in this. This would equate to a cut of some 2.5-3% off current Chinese economic growth. Should current orders not be scrapped, this will probably set in in the third and fourth quarters this year.

What will this mean for Australia? Thankfully, Australia's exports to China contribute less to the manufacture of durable manufactureds, and more to fixed capital investment---think iron ore and coking coal (which is used to make steel). Fixed capital investment in undertaken on a long-view basis, and is less elastic to short-term income fluctuations than other areas of investment. Indeed, demand for Australian commodities would be likely to rise should the US slow. This would occur if China decides to enact countercyclical fiscal policy in fixed capital expenditure---build freeways and powerplants to employ workers affected by a slow in export growth.

Please feel free to comment.
Jim

Thoughts on housing prices

2007-10-31T20:28:00.000-07:00

High housing prices are good.

Well, let me not arrive too far ahead of myself: Indebtedness is a good thing good, and it seems to go hand in hand with higher housing prices.

Hang on. I'm sounding like a neo-liberal! Let me begin afresh.

Low interest rates are great. There we go -- nice, general statement, not going to frighten any horses anywhere. Low interest rates create jobs. They allow entrepreneurs to borrow money to build factories to employ people. They allow hospitals to cheaply upgrade their equipment and allow the best roads to be built. They allow more social goods.

And here we are, well into the second Golden Age, having successfully disinflated the global economy and entrenched low inflation rates. Surely the cause for this was Volker's disinflationary monetary policy of the early 80s in the US, and Fraser's in the 90s in Australia? In part -- no doubt. Though today we will look at the role of the housing market - particularly speculation and asset price inflation in entrenching our low interest-rate environment.

PART 1 - the mechanics of housing price inflation

For this analysis, we'll construct a very, very simple model.

Let us assume housing prices are the product of three endogenous variables: firstly people's savings (which include non-debt proceeds from selling any assets -- ie. asset price inflation); secondly their incomes -- banks will lend more to folk whose capacity to repay is greater; and thirdly, interest rates -- these affect peoples' capacities to repay, and thus have a negative relationship to housing prices in the short run.

Nothing too scary there, and it's all pretty intuitive.

Now, let's look at what happens in the medium run in similar economic situations which we have experienced since 1983 (which we'll assume is the beginning of the modern Australian economy). Nominal wages? up. Interest rates? Tuned for disinflation from 89-92, now pretty steady at 5-7%. Savings? ahah! Read on.

When one goes to the bank to borrow money for a house, they must provide a non-debt deposit. The reason for this is to allow the bank to foreclose the loan if the housing market turns sour, and even sell in a market down 10% (which is rare) to recoup the entire loan sum.

The bank, however will only loan an amount to the prospective borrower which they can afford to repay on their current income (which is, in finance speak, the present value of a proportion of the current income of the borrower for their working lives). Most people, especially in the new economy do not stay on a single income for their entire lives. As they acquire new skills, their marginal productivity increases, and their potential earnings increase. Also, the incomes of society at large increase roughly proportional to the increase in economic activity.

What does all this mean in the real world?

Well, this means that as your income increases, you can afford to comfortably borrow more money, and move into a better house. The thing is, everyone else's incomes have increased too -- the nominal value they can borrow has also increased. So, in a competitive housing market like ours, and with people who all simultaneously want to live in better houses, places, all borrow as much as they can comfortably afford to.

This means housing prices go up. Which is good, no?

Yes and no.

This is a problem which has insiders and outsiders. Insiders, who have some claim on property, benefit from price inflation. The amount they must repay to their creditor stays the same (is not fixed to the property price), though in the conditions outlined above (which lead to increasing property prices), their nominal claim value inflates -- they become wealthier, and their savings increase. When they sell their property to upgrade (having had their income increase, or interest rates decrease), they do not consider the nominal value of the property they intend on purchasing, just the proportion of their current income which must meet repayments.

That is quite peculiar. The rational home-buyer then, must not care how much the property they purchase costs, just the repayment value. If one can afford the repayments on a $400,000 loan, and they have had via this mechanism an increase in their savings of some $600,000 dollars, there is no reason they should baulk at purchasing a $1M property.

For outsiders, though, the picture is not quite so rosy.

While insiders have benefited from society's ability to borrow more (by having higher nominal incomes, from tax credits encouraging speculation, and from the first home-owners' grant), outsiders most certainly have not. Their ability to borrow is only proportional to their income, as they have not accumulated the increase in savings (which, may I add has not occurred due to the home owner's hard work, but the success of greater society), they cannot afford to live in established addresses.

So, that's why Cragieburn exists.

Transitory suburbs, then exist to allow people who have not been long in the property market to live while accumulating an increase in their non-debt savings (using the mechanism described above).

This means that two people on the same income may not be able to afford to live in the same address if they have not made the same real estate investments in the past.

PART 2 - Housing prices and monetary policy

Where is the social good in that? Given there can be two people whose contribution to the economy is the same, and ability to borrow is the same, but who cannot afford to live in the same house, isn't this symptomatic of an entire system which values real-estate speculation above investing in factories, hospitals etc?

Yes. Yes it is. But we have a problem.

If people's income increases more than their productivity, and they don't increase the amount they spend on repayments, we suffer inflation elsewhere. So, to reduce their demand on money (so we can print less of the stuff) we increase interest rates. This makes factories and hospitals more expensive to build. Bugger.

So, people must continually revise upward their price expectations for their houses; they must maintain a fairly constant level of debt as a proportion of their income (and do this by getting into as much as they pay off -- moving into better houses and buying more expensive cars), otherwise the effect of monetary policy (interest rates) on their spending is withered away, and it becomes a less useful tool for controlling inflation.

Here we come to my initial statement: high housing prices are good.

High housing prices, if they occur with high indebtedness, allow monetary policy to do its trick and vary the residential sector's demand for money. But, such prices create losers -- those who cannot afford to enter the market. These people then, are not as susceptible to variance in the interest rate, and will not vary their demand for money as elastically with a marginal change in the interest rate. Monetary policy becomes a larger and larger sledgehammer, to paraphrase Dr John Hewson, being used to tune a smaller and smaller Lamborghini.

PART 3 - The policy response

So, what can we do, in the imaginary world where electoral politics does not exist, in creating a policy platform to maintain the benefits of high housing prices without the huge social cost -- misallocation of capital, outsiders and blunted monetary policy?

Firstly, we would want to attack the non-debt base of the residential housing market. Before I get any death-threats for seeming anti-wealthist, hear me out.

The non-debt base, the 'savings' component of the housing market exists, as we have seen is the reason for the continued increase in housing prices. It is the cumulative amount equal to the entire amount borrowable by the borrowing population in period two less the entire amount borrowable by the same folk in period one (See my website).

As we have seen, people do not care about the actual price of a house if they have already been in the housing market for some time -- only the cost of repayments. So the medium term social costs of targeting this component of housing price would be very little: people will still move to better housing when their incomes increase sufficiently.

The design of such a policy would be a bit harder.

Firstly, its design would have to make specific effort to reducing price inflation by the saving variable, not reverse it. A sensible way for this to be done would initiate a progressively increasing "tax" on all capital gains, which would increase by the amount of the increase in the non-debt savings component each year. This would eliminate possibility of damaging the beneficial price inflation due to income increases or interest rate decrease each year.

Secondly, such a policy must not include a tax - not only for political reasons, but for economic efficiency reasons. It is estimated that for every dollar of an increase in taxation in Australia, there is a 20c "tax and churn burn" in the greater economy, due to the government's inability to behave like a price sensitive business (which it shouldn't have to anyway, just ask Opera Victoria!) A very workable alternative to a tax would be mandating that a proportion of the capital gain (equivalent to that year's "tax") would be set aside to the seller's superannuation, or to be invested in a new equity float or debt capital raising. This would hopefully maintain the seller's overall wealth, but merely transfer some of it into fields where its social benefit would be greater.

The other effect of this policy would be to align housing price inflation with wage growth, and over time eliminating the outsider's effect.

People would still increase their overall wealth, though in a more diversified way, monetary policy tools would become sharpened, and the marginal benefit of being an insider would be decreased, the need to speculate in property would decrease, to everyone's benefit.

Pity is, under the current arrangement, it is so easy for dumb people to make money.

The End.

Please feel free to argue with me

Jim