Two major policy decisions yesterday by the Government of India.
1. Export duties on steel products increased, customs duty on pig iron and mild steel scrapped, import duties on skimmed milk powder and butter oil lowered. These came as part of the Government's inflation control measures involving removing supply side constraints. The lowering of import duties is aimed at keeping imports cheaper, while the higher export duties are aimed at discouraging exports.
They achieve their objective when the producers transfer a significant share of the duty cuts to the consumers, thereby lowering the prices. How do we ensure this? Does the market mechanism and its functioning ensure the allocation? Eco 101 teaches us that the incidence of tax between the consumers and producers is determined by the price elasticities of demand and supply.
In the instant case, for say, steel and cement, demand is soaring and given the massive ongoing infrastructure and construction projects and overflowing work orders of major firms, we can safely say that demand is likely to be extremely inelastic to prices. On the supply side, the steel and cement prices are ruling high in the world markets. In an integrated global market, these products will flow to those markets where the prices are highest (some of the committed orders will be willing to pay higehr prices) and which are the largest (which we surely are one). Therefore, we can assume that supply will be more elastic, especially when it comes to large markets like India.
In this context, Eco 101 tells us that any tax cut is most likely to be cornered by the producers, both domestic and external. The Government's objective would therefore fail, and the tax cuts would only add to the producers' bottom-lines, already swelling from the historic high prices. The challenge therefore is to get the producers to transfer a greater share of the tax concessions to the consumers, so that the general price level comes down.
There is recent precedent too on this. The large tax concessions given in this year's budget has all gone into swelling the producer's coffers and has contributed little to lowering prices. The Finance Minister has been talking to steel and cement manufacturers and has threatened action if the producers do not pass on the tax cuts by way of lower prices. Maybe such non-market action is necessary to achieve the objective. But can even this achieve it? Let us evaluate after two or three months!
2. Fiscal concessions to STPIs and EOUs extended by a year till March, 2010, and duty on newsprint lowered to 3%. The concession to the software companies will benefit them to an extent of 5-7% on the effective tax rate. These subsidies to the producers are surprising since software and newspaper industry in India is not facing any crisis other than that arising from competitive pressures while competing in a world economy.
The tax concessions under Section 10A to software companies could have been justified in the initial stages when our software industry was finding its feet. But now after having established themselves as highly competitive world-wide, protection and support by way of tax concessions are no longer required. The only purpose to be served by continuing these concessions is to boost the bottom-lines of software companies. In that case, the same logic will be applicable in March 2010 too - for further extension!
Wednesday, April 30, 2008
Tuesday, April 29, 2008
Why rice trade will not solve the problem?
This post is in continuation to my previous post on the role of trade in lowering global rice prices. Globally rice prices have risen spectacularly, with the FAO figures showing that the price of medium-grade Thai rice is up 120% since February, from $310 to $795 on 2nd April, 2008.
Experts argue that the major reasons for high rice prices include rising long-term demand in as continent sized numbers of Asians emerge out of poverty every year, weather and pest induced supply shocks in some large rice exporters, urbanization and diversion of land for industrial purposes (SEZs etc), and increased demand for alternate staples like rice due to biofuel induced higher corn prices. The relevance and relative importance of each reasons can be verified only with more controlled studies.
This post is from a largely Indian perspective. India is the 2nd largest producer, 3rd largest exporter and one of the biggest consumers, and is currently experiencing foodgrain price inflation. Indian rice production though has been robust, and is estimated to grow to a record 94 mt in 2008. The Government of India had recently responded to the rising inflation by imposing an export ban on all non-basmati category rice grains. The Government hopes that this will keep rice inflation under control here.
Too many of the arguements in the ongoing blog debates has been about how higher prices will incentivize farmers to expand their rice production. It is also felt that farmers will get a better deal from this. And international trade will facilitate all this. However, arguements that price signals will incentivize farmers to move into expanding their rice farmlands is not borne out by reality. Unlike other commodities, rice farming has many distinct characteristics that are likely to come in the way of the aforementioned simple benefit transmission.
1. Farmers do not automatically get higher prices merely by producing. In the absence of adequate access to credit, storage facilites, markets, and other linkages like commodity futures, the major share of the higher prices is skimmed off by the traders and middlemen. The overwhelming share of farmers in developing Asia face this dismal scenario. And breaking this stranglehold is not a simple issue of more investments in agriculture. More about this in a later post.
2. The returns from other produce intended mainly for the rich country markets are much higher, while that from farm diversion to other activities is many times higher and immediate. Thanks to contract farming and the presence of the major export companies, the production of export crops are more organized. But unfortunately, these organized groups prefer the larger farmers, and see limited utility in the smaller farmers.
3. The incentive of higher prices is not likely to expand rice production also because, unlike other foodgrains and agriculture commodities, the overwhelming share of rice is cultivated by farmers in small landholdings. They have limited resources and flexibility to respond to higher price signals.
If higher prices translated into better deal for farmers, then Thai and Vietnamese farmers ought not be giving away their valuable farmlands at alarming rates. For example, land under cultivation in Thailand fell 13% in the 1995-2005 period, and Vietnam is losing about 1 lakh acres of rice growing lands to construction activites every year. Merely promoting trade without addressing these more deeper issues will only lead to a deepening of the crisis. As I wrote earlier, it will only get "the wheat producers in the Gangetic plain and rice producers in the Krishna-Godavari basin in India shift to sugar cane, in response to a massive demand for sugar cane based ethanol bio-fuel".
There is an interesting analogy here with the sub-prime crisis. The US Fed and a number of commentators treat it as a liquidity crisis and have been inclined to keep lowering the interest rates, so as to ease the financial sector out of the crisis. However, the more important and serious issue of solvency which dictates that somebody has to, at some time, own up these massive losses on their balance sheets, (unless we can roll over indefinitely from one bubble to another) has been quietly sidelined. Similarly, ignoring fundamental issues and focussing on rice trade will only fuel the party further, till the spectre of starvations looms large!
Theoretical principles rarely give simple solutions to complicate socio-ecconomic problems. There is a lot of distance to be travelled between theory and solutions. Economic trade theory needs to be distilled in light of the specific contexts of each commodity and country, for drawing meaningful conclusions.
Food security (and energy security) is too important an issue to be left to the workings of a long-term strategy that promotes trade. The present food crisis only highlights the fact Governments need to have clear policies on food security issues. Democratic governments, especially those facing elections, can apply logically consistent economic principles, without any tangible short or medium-term results, only at their peril. If not, in the real world, ruling parties will lose elections and as Keynes said, "in the long run, we are all dead"!
Update 1
Gary Becker traces the current price pressure on foodgrains to "the boom in petroleum prices and subsidies to ethanol and other biofuels". During the past year, one quarter of American corn production, and 11 percent of global production, was devoted to biofuels, and the acreage devoted to corn in the United States increased by over twenty percent in 2007-8, while that devoted to soybean production declined by more than fifteen percent.
He argues against export restrictions like those imposed by countries like India, Argentina, Russia and Vietnam. He feels that while these controls help in temporarily keep a lid on domestic prices, it harms domestic farmers and prevents them from getting the best deal for their produce.
Prof Becker's contention that these restrictions adversely affect the farmers and favor the urban consumers may be off the mark, especially in the context of the developing countries. Unlike in the developed economies, the overwhelming share of rice and other foodgrain farming in countries like India are done by small farmers, on smaller land holdings. In the absence of adequate upstream linkages, the predominant share of farmers - small and marginal farmers - are likely to benefit little from higher global prices. The middlemen knock away these benefits. In any case, the domestic foodgrain procurement policies, as that involving the Minimum Support Prices (MSP) in India, most often reflect the rising international market prices.
Experts argue that the major reasons for high rice prices include rising long-term demand in as continent sized numbers of Asians emerge out of poverty every year, weather and pest induced supply shocks in some large rice exporters, urbanization and diversion of land for industrial purposes (SEZs etc), and increased demand for alternate staples like rice due to biofuel induced higher corn prices. The relevance and relative importance of each reasons can be verified only with more controlled studies.
This post is from a largely Indian perspective. India is the 2nd largest producer, 3rd largest exporter and one of the biggest consumers, and is currently experiencing foodgrain price inflation. Indian rice production though has been robust, and is estimated to grow to a record 94 mt in 2008. The Government of India had recently responded to the rising inflation by imposing an export ban on all non-basmati category rice grains. The Government hopes that this will keep rice inflation under control here.
Too many of the arguements in the ongoing blog debates has been about how higher prices will incentivize farmers to expand their rice production. It is also felt that farmers will get a better deal from this. And international trade will facilitate all this. However, arguements that price signals will incentivize farmers to move into expanding their rice farmlands is not borne out by reality. Unlike other commodities, rice farming has many distinct characteristics that are likely to come in the way of the aforementioned simple benefit transmission.
1. Farmers do not automatically get higher prices merely by producing. In the absence of adequate access to credit, storage facilites, markets, and other linkages like commodity futures, the major share of the higher prices is skimmed off by the traders and middlemen. The overwhelming share of farmers in developing Asia face this dismal scenario. And breaking this stranglehold is not a simple issue of more investments in agriculture. More about this in a later post.
2. The returns from other produce intended mainly for the rich country markets are much higher, while that from farm diversion to other activities is many times higher and immediate. Thanks to contract farming and the presence of the major export companies, the production of export crops are more organized. But unfortunately, these organized groups prefer the larger farmers, and see limited utility in the smaller farmers.
3. The incentive of higher prices is not likely to expand rice production also because, unlike other foodgrains and agriculture commodities, the overwhelming share of rice is cultivated by farmers in small landholdings. They have limited resources and flexibility to respond to higher price signals.
If higher prices translated into better deal for farmers, then Thai and Vietnamese farmers ought not be giving away their valuable farmlands at alarming rates. For example, land under cultivation in Thailand fell 13% in the 1995-2005 period, and Vietnam is losing about 1 lakh acres of rice growing lands to construction activites every year. Merely promoting trade without addressing these more deeper issues will only lead to a deepening of the crisis. As I wrote earlier, it will only get "the wheat producers in the Gangetic plain and rice producers in the Krishna-Godavari basin in India shift to sugar cane, in response to a massive demand for sugar cane based ethanol bio-fuel".
There is an interesting analogy here with the sub-prime crisis. The US Fed and a number of commentators treat it as a liquidity crisis and have been inclined to keep lowering the interest rates, so as to ease the financial sector out of the crisis. However, the more important and serious issue of solvency which dictates that somebody has to, at some time, own up these massive losses on their balance sheets, (unless we can roll over indefinitely from one bubble to another) has been quietly sidelined. Similarly, ignoring fundamental issues and focussing on rice trade will only fuel the party further, till the spectre of starvations looms large!
Theoretical principles rarely give simple solutions to complicate socio-ecconomic problems. There is a lot of distance to be travelled between theory and solutions. Economic trade theory needs to be distilled in light of the specific contexts of each commodity and country, for drawing meaningful conclusions.
Food security (and energy security) is too important an issue to be left to the workings of a long-term strategy that promotes trade. The present food crisis only highlights the fact Governments need to have clear policies on food security issues. Democratic governments, especially those facing elections, can apply logically consistent economic principles, without any tangible short or medium-term results, only at their peril. If not, in the real world, ruling parties will lose elections and as Keynes said, "in the long run, we are all dead"!
Update 1
Gary Becker traces the current price pressure on foodgrains to "the boom in petroleum prices and subsidies to ethanol and other biofuels". During the past year, one quarter of American corn production, and 11 percent of global production, was devoted to biofuels, and the acreage devoted to corn in the United States increased by over twenty percent in 2007-8, while that devoted to soybean production declined by more than fifteen percent.
He argues against export restrictions like those imposed by countries like India, Argentina, Russia and Vietnam. He feels that while these controls help in temporarily keep a lid on domestic prices, it harms domestic farmers and prevents them from getting the best deal for their produce.
Prof Becker's contention that these restrictions adversely affect the farmers and favor the urban consumers may be off the mark, especially in the context of the developing countries. Unlike in the developed economies, the overwhelming share of rice and other foodgrain farming in countries like India are done by small farmers, on smaller land holdings. In the absence of adequate upstream linkages, the predominant share of farmers - small and marginal farmers - are likely to benefit little from higher global prices. The middlemen knock away these benefits. In any case, the domestic foodgrain procurement policies, as that involving the Minimum Support Prices (MSP) in India, most often reflect the rising international market prices.
Monday, April 28, 2008
Coasean bargains on civic issues
There is an interesting blog debate going on between Megan McArdle and Kathy G on the application of Coase Theorem.
The debate was triggered off by Megan McArdle's suggestion that Coasean bargain would take care of any conflict of preferences between two neighbours on enjoying loud music and silence. Kathy G reponded that a Coasean bargain is not possible in such a situation, since both transactions costs (information costs on locating the relevant rules, enforcement costs in getting police to register cases) are high and property rights ill-defined (Rules on loud music, silence etc).
The Coase Theorem states that, in a dispute concerning an externality, if transaction costs are low (or nonexistent) and property rights are well-defined, the parties can bargain their way to an Pareto efficient outcome(with no one being worse off and at least one person being better off). The Coase Theorem is value neutral, in so far as it is silent on fairness.
Kathy G illustrates this with an example, "A poor person living near a toxic waste dump may have a very strong preference indeed to see that waste dump removed. But even if transaction costs are zero and property rights are well-defined, that doesn't mean she'll prevail in a Coase bargaining scenario. If she has less money than the polluter, her preference, no matter how strong, will not be realized. All the Coase theorem says is that, after bargaining, she won't end up worse off. But if her resources are less than her opponent's, her preferences would not be satisfied."
Kathy G writes, "Libertarians tend to be fond of the Coase theorem, but that is because they often misunderstand it. They're likely to be enamored of the idea of autonomous actors in a free market bargaining their way to an efficient solution, with government staying out of the matter entirely. They especially prefer the Coase solution to the Pigouvian mechanism, in which the externality is internalized via a tax. But in the real world, a Coase solution to an externality is not necessarily going to be any more efficient than a Pigouvian one."
Though it is widely accepted that a Coasean bargain is difficult in the real world, Coasean-style transaction costs can be used as an analytical tool to understand how, and under what conditions, markets work.
I had dwelt with the possibility of Coasean bargains in urban areas in an earlier post in the context of Kaldor-Hicks test to determine whether an outcome is efficient or not.
The problem, as Kathy G points out, lies in the transaction costs and definition of property rights that are necessary to strike the locally negotiated bargain. This is why libertarian solutions to neighbourhood civic problems fail, thereby necessitating intrusive Government regulation. But such regulations invariably develop a web of bureaucracy, with its attendant corruption and other distortions, that detracts from achieving its objectives. In the circumstances, the right way forward would appear to be taking adequate steps to lower transaction costs (local dispute settlement/negotiating mechanisms) and more clearly define individual and common property rights.
Update 1 (2/8/2010)
NYT reports of a windfarm in Oregon paying $5000 to buy silence of neighbors on the sounds made by wind turbines.
The debate was triggered off by Megan McArdle's suggestion that Coasean bargain would take care of any conflict of preferences between two neighbours on enjoying loud music and silence. Kathy G reponded that a Coasean bargain is not possible in such a situation, since both transactions costs (information costs on locating the relevant rules, enforcement costs in getting police to register cases) are high and property rights ill-defined (Rules on loud music, silence etc).
The Coase Theorem states that, in a dispute concerning an externality, if transaction costs are low (or nonexistent) and property rights are well-defined, the parties can bargain their way to an Pareto efficient outcome(with no one being worse off and at least one person being better off). The Coase Theorem is value neutral, in so far as it is silent on fairness.
Kathy G illustrates this with an example, "A poor person living near a toxic waste dump may have a very strong preference indeed to see that waste dump removed. But even if transaction costs are zero and property rights are well-defined, that doesn't mean she'll prevail in a Coase bargaining scenario. If she has less money than the polluter, her preference, no matter how strong, will not be realized. All the Coase theorem says is that, after bargaining, she won't end up worse off. But if her resources are less than her opponent's, her preferences would not be satisfied."
Kathy G writes, "Libertarians tend to be fond of the Coase theorem, but that is because they often misunderstand it. They're likely to be enamored of the idea of autonomous actors in a free market bargaining their way to an efficient solution, with government staying out of the matter entirely. They especially prefer the Coase solution to the Pigouvian mechanism, in which the externality is internalized via a tax. But in the real world, a Coase solution to an externality is not necessarily going to be any more efficient than a Pigouvian one."
Though it is widely accepted that a Coasean bargain is difficult in the real world, Coasean-style transaction costs can be used as an analytical tool to understand how, and under what conditions, markets work.
I had dwelt with the possibility of Coasean bargains in urban areas in an earlier post in the context of Kaldor-Hicks test to determine whether an outcome is efficient or not.
It is commonplace to have complaints against some objectionable shop or commercial establishment located in predominantly residential areas, causing inconvenience to its neighbours. There is a simple solution to this problem. Assume Mr Welder wants to set up a welding shop in Soundfree Colony. Assume also that the Plant generates costs on the neighbours amounting to Rs A, and it would cost Mr Welder Rs B to relocate elsewhere. If Rs B > Rs A, then there is a possibility for a mutually beneficial bargain between the parties and Mr Welder continuing his business in Sound free colony. (The cost could for example be the amount required for setting up sound proofing system)
The problem, as Kathy G points out, lies in the transaction costs and definition of property rights that are necessary to strike the locally negotiated bargain. This is why libertarian solutions to neighbourhood civic problems fail, thereby necessitating intrusive Government regulation. But such regulations invariably develop a web of bureaucracy, with its attendant corruption and other distortions, that detracts from achieving its objectives. In the circumstances, the right way forward would appear to be taking adequate steps to lower transaction costs (local dispute settlement/negotiating mechanisms) and more clearly define individual and common property rights.
Update 1 (2/8/2010)
NYT reports of a windfarm in Oregon paying $5000 to buy silence of neighbors on the sounds made by wind turbines.
Sunday, April 27, 2008
Rice trade and lower prices
Tyler Cowen feels that the solution to lowering foodgrain prices is to have more trade in foodgrains. In view of the recent restrictions on rice exports in rice-producing countries like India, Indonesia, Vietnam, China, Cambodia and Egypt, global trade in rice is expected to decline by 3%. Cowen feels that restrictions on rice trade, which sees trade and production as a zero-sum game (one country's gain is another's loss), distorts the long run incentives for producers and chokes production.
He writes, "Export restrictions send a message to farmers that their crops are least profitable precisely when they are most needed. There is little incentive to plant, harvest or store enough rice — or any other crop, for that matter — as a hedge against bad times."
Cowen also argues that the very fact that an increasing proportion of major foodgrain production comes from poorer countries itself contributes to an inability to adjust quickly to global demand-supply mismatches. These poor countries are more likely to be protectionist, have stifling regulations, have restrictions on internal trade, and Government monopolies in trading.
These poor countries are also constrained by corruption in the rice supply chain, poorly conceived irrigation systems, terrible or even nonexistent roads, insecure property rights, ill-considered land reforms, and price controls on rice. Cowen argues that these countries could easily increase their production manifold, if they could adopt many of the aforementioned practices and institutions, and thereby incentivize their farmers to respond quickly to global demand-supply mismatches.
I am inclined to believe that Cowen has got this one wrong on many counts. In the first instance, the article has little to illuminate as to how the central problem, that of higher rice prices, can be controlled by merely opening up economies to trade.
Secondly, the trade in agriculture commodities is very low not because of lack of incentives to trade, but because all these commodities have large captive domestic markets. In fact, in many countries, the domestic demand itself is too large to be covered by domestic production alone.
Third, rice and other staple food grains like wheat, especially in the poorer countries, are unlike other commodities. They exhibit inelastic characteristics - both from the supply and demand sides. On the demand side, these staple food grains do not have any substitutes and will have atleast the same demand, whatever be the price rise. On the supply side, it is very difficult to increase production significantly in the short term by bringing more land under cultivation or shifting from other crops or introducing technology and innovative practices to increaswe productivity.
Fourth, most countries and their farmers do not need the incentives of global trade to increase their production. The internal demand itself is booming in countries like China and India and their producers are not able to keep up with the growing demand. It is true that easing the internal restrictions and constraints that Cowen writes about, will help in incentivizing farmers to produce more.
Fifth, even higher production need not necessarily lead to lower prices, given the large and complex factors that determine global food prices - weather, bio-fuels, energy prices, agriculture policies in developed countries etc. Historically, foodgrain prices have fluctuated sharply in response to many of these aforementioned factors.
Sixth, even if global agriculture trade is deregulated and farmers have the full freedom to shift production in response to price signals, it will not ensure that the poor consumers in Asia and Africa are insulated from price rises for their staple grains. In fact, a free and unregulated market will exacerbate the crisis. Imagine what it would do to food security in India and across the world, if the wheat producers in the Gangetic plain and rice producers in the Krishna-Godavari basin in India shift to sugar cane, in response to a massive demand for sugar cane based ethanol bio-fuel!
Seventh, the major demand for rice and similar staple foods are mainly in the poorer developing countries, whereas the major demand for competing substitutes like bio-fuel crops etc come from the developed world. In an open global market in agriculture commodities, the price signals will always incentivize farmers to cater to the developed markets.
Finally, the whole objective is not to have, as Cowen claims, trade in rice "flow to the places of highest demand", but to have food security for all. It is undoubtedly true that trade will ensure that rice will flow to the countries with highest willingness to pay. Translation, the rich and well off will get their rice, while the others starve!
It is therefore critical that there be pro-active Government intervention to both ensure that staple foodgrain production is increased and these grains are available to the poorest at affordable prices. The answer to food security surely does not lie in Milton Friedman.
He writes, "Export restrictions send a message to farmers that their crops are least profitable precisely when they are most needed. There is little incentive to plant, harvest or store enough rice — or any other crop, for that matter — as a hedge against bad times."
Cowen also argues that the very fact that an increasing proportion of major foodgrain production comes from poorer countries itself contributes to an inability to adjust quickly to global demand-supply mismatches. These poor countries are more likely to be protectionist, have stifling regulations, have restrictions on internal trade, and Government monopolies in trading.
These poor countries are also constrained by corruption in the rice supply chain, poorly conceived irrigation systems, terrible or even nonexistent roads, insecure property rights, ill-considered land reforms, and price controls on rice. Cowen argues that these countries could easily increase their production manifold, if they could adopt many of the aforementioned practices and institutions, and thereby incentivize their farmers to respond quickly to global demand-supply mismatches.
I am inclined to believe that Cowen has got this one wrong on many counts. In the first instance, the article has little to illuminate as to how the central problem, that of higher rice prices, can be controlled by merely opening up economies to trade.
Secondly, the trade in agriculture commodities is very low not because of lack of incentives to trade, but because all these commodities have large captive domestic markets. In fact, in many countries, the domestic demand itself is too large to be covered by domestic production alone.
Third, rice and other staple food grains like wheat, especially in the poorer countries, are unlike other commodities. They exhibit inelastic characteristics - both from the supply and demand sides. On the demand side, these staple food grains do not have any substitutes and will have atleast the same demand, whatever be the price rise. On the supply side, it is very difficult to increase production significantly in the short term by bringing more land under cultivation or shifting from other crops or introducing technology and innovative practices to increaswe productivity.
Fourth, most countries and their farmers do not need the incentives of global trade to increase their production. The internal demand itself is booming in countries like China and India and their producers are not able to keep up with the growing demand. It is true that easing the internal restrictions and constraints that Cowen writes about, will help in incentivizing farmers to produce more.
Fifth, even higher production need not necessarily lead to lower prices, given the large and complex factors that determine global food prices - weather, bio-fuels, energy prices, agriculture policies in developed countries etc. Historically, foodgrain prices have fluctuated sharply in response to many of these aforementioned factors.
Sixth, even if global agriculture trade is deregulated and farmers have the full freedom to shift production in response to price signals, it will not ensure that the poor consumers in Asia and Africa are insulated from price rises for their staple grains. In fact, a free and unregulated market will exacerbate the crisis. Imagine what it would do to food security in India and across the world, if the wheat producers in the Gangetic plain and rice producers in the Krishna-Godavari basin in India shift to sugar cane, in response to a massive demand for sugar cane based ethanol bio-fuel!
Seventh, the major demand for rice and similar staple foods are mainly in the poorer developing countries, whereas the major demand for competing substitutes like bio-fuel crops etc come from the developed world. In an open global market in agriculture commodities, the price signals will always incentivize farmers to cater to the developed markets.
Finally, the whole objective is not to have, as Cowen claims, trade in rice "flow to the places of highest demand", but to have food security for all. It is undoubtedly true that trade will ensure that rice will flow to the countries with highest willingness to pay. Translation, the rich and well off will get their rice, while the others starve!
It is therefore critical that there be pro-active Government intervention to both ensure that staple foodgrain production is increased and these grains are available to the poorest at affordable prices. The answer to food security surely does not lie in Milton Friedman.
Role of rating agencies
The aftermath of the sub-prime mortgage crisis has brought to sharp focus on the role played by the credit rating agencies in inflating the bubble. Roger Lowenstein chronicles the anatomy of these ratings and the evolution of rating agencies in a revealing NYT article.
Frank Partnoy, a professor at the University of San Diego School of Law who has written extensively about the credit-rating industry, says that thanks to the industry’s close relationship with the banks whose securities it rates, they have behaved less like gatekeepers than gate openers. This was best manifested in the numerous sub-prime mortgage loan backed securities being rated tiple -A! Last year, Moody’s had to downgrade more than 5,000 mortgage securities — a tacit acknowledgment that the mortgage bubble was abetted by its overly generous ratings.
Frank Partnoy, a professor at the University of San Diego School of Law who has written extensively about the credit-rating industry, says that thanks to the industry’s close relationship with the banks whose securities it rates, they have behaved less like gatekeepers than gate openers. This was best manifested in the numerous sub-prime mortgage loan backed securities being rated tiple -A! Last year, Moody’s had to downgrade more than 5,000 mortgage securities — a tacit acknowledgment that the mortgage bubble was abetted by its overly generous ratings.
Saturday, April 26, 2008
End of Easterlin Paradox?
Justin Wolfers and Betsey Stevenson have just presented their latest paper which claims to lay to rest the "Easterlin Paradox", which had argued that only relative income matters to happiness. They claim that "the relationship between subjective well-being and
income within a country (that is, contrasting the happiness of rich and poor members of a society) is similar to that seen across countries (contrasting rich and poor countries), which in turn is similar to the time series relationship (comparing the happiness of a country as it gets richer or poorer)".
In 1974, Richard Easterlin, then an economist at the University of Pennsylvania, published a study in which he argued that economic growth didn’t necessarily lead to more satisfaction. Justin Wolfers describes the Paradox as the juxtaposition of three observations:
1) Within a society, rich people tend to be much happier than poor people.
2) But, rich societies tend not to be happier than poor societies (or not by much).
3) As countries get richer, they do not get happier.
Numerous subsequent studies, including by Nobel laureate Daniel Kahneman, pointed to a "hedonic treadmill", in which we must keep consuming more just to stay at the same level of happiness.
Marshalling an impressive array of post-war data, especially from happiness surveys from across the world, Wolfers and Stevenson observed the evolution of GDP and happiness through time, and conclude that
1) Rich people are happier than poor people.
2) Richer countries are happier than poorer countries.
3) As countries get richer, they tend to get happier.
Plotting the average level of happiness against average national incomes (log scale)for 132 countries from the 2006 Gallup World Poll, they find an incredibly high correlation of greater than 0.8.
Wolfers argues that far from there being an income "satiation point" beyond which you just don’t benefit from greater income, the slope gets steeper after national income crosses $15000! Further, a $100 rise in income has many times more effect on happiness in low income countries than in the high income ones.
Justin Wolfers tracked the evolution of happiness with increasing incomes in US, Japan and Europe (9 nations) in the 1973-2007 period, and found that in general happiness increased with incomes, though there were a few notable exceptions.
Comparing happiness within countries over a period of time and between countries, the authors get more conclusive evidence that comparisons of rich and poor yield the same conclusions as comparisons betweene rich and poor countries. The arrows in the figure below shows the slope of the well-being-income gradient for each country, while the dots show the average level of happiness and G.D.P. for each country. The dashed line shows the best fit through these dots.
Angus Deaton had dealt with the issue earlier here.
Update 1
Chris Dillow links to evidence suggesting that happiness is infectious and how other people’s high incomes might make us more aware of our relative poverty.
income within a country (that is, contrasting the happiness of rich and poor members of a society) is similar to that seen across countries (contrasting rich and poor countries), which in turn is similar to the time series relationship (comparing the happiness of a country as it gets richer or poorer)".
In 1974, Richard Easterlin, then an economist at the University of Pennsylvania, published a study in which he argued that economic growth didn’t necessarily lead to more satisfaction. Justin Wolfers describes the Paradox as the juxtaposition of three observations:
1) Within a society, rich people tend to be much happier than poor people.
2) But, rich societies tend not to be happier than poor societies (or not by much).
3) As countries get richer, they do not get happier.
Numerous subsequent studies, including by Nobel laureate Daniel Kahneman, pointed to a "hedonic treadmill", in which we must keep consuming more just to stay at the same level of happiness.
Marshalling an impressive array of post-war data, especially from happiness surveys from across the world, Wolfers and Stevenson observed the evolution of GDP and happiness through time, and conclude that
1) Rich people are happier than poor people.
2) Richer countries are happier than poorer countries.
3) As countries get richer, they tend to get happier.
Plotting the average level of happiness against average national incomes (log scale)for 132 countries from the 2006 Gallup World Poll, they find an incredibly high correlation of greater than 0.8.
Wolfers argues that far from there being an income "satiation point" beyond which you just don’t benefit from greater income, the slope gets steeper after national income crosses $15000! Further, a $100 rise in income has many times more effect on happiness in low income countries than in the high income ones.
Justin Wolfers tracked the evolution of happiness with increasing incomes in US, Japan and Europe (9 nations) in the 1973-2007 period, and found that in general happiness increased with incomes, though there were a few notable exceptions.
Comparing happiness within countries over a period of time and between countries, the authors get more conclusive evidence that comparisons of rich and poor yield the same conclusions as comparisons betweene rich and poor countries. The arrows in the figure below shows the slope of the well-being-income gradient for each country, while the dots show the average level of happiness and G.D.P. for each country. The dashed line shows the best fit through these dots.
Angus Deaton had dealt with the issue earlier here.
Update 1
Chris Dillow links to evidence suggesting that happiness is infectious and how other people’s high incomes might make us more aware of our relative poverty.
Friday, April 25, 2008
Role of mega-regions in the global economy
Richard Florida claims that the real drivers of global growth are mega regions.
He writes,"While there are 191 nations in the world, just 40 significant mega-regions power the global economy. Home to more than one-fifth of the world's population, these 40 megas account for two-thirds of global economic output and more than 85% of all global innovation.
The world's largest mega is Greater Tokyo, with 55 million people and $2.5 trillion in economic activity. Next is the 500-mile Boston-Washington corridor, with some 54 million people and $2.2 trillion in output. Also in the top 10 are mega-regions that run from Chicago to Pittsburgh, Atlanta to Charlotte, Miami to Tampa, and L.A. to San Diego. Outside of the U.S., you can find megas around Amsterdam, London, Osaka and Nagoya, Milan, Rome and Turin, and Frankfurt and Stuttgart.
Mega-regions are the true force driving the rise of emerging economies. Some 40% of Brazil's total economy is made up of a corridor stretching from Rio to São Paolo. Russia is propelled by the Moscow mega. India's economy is shaped by the mega-regions of Bangalore and Mumbai."
He argues in favor of urban policies that favor densification, improving fast-rail transit between mega-region nodes, modernizing airports, and achieving greater cross-border flows of goods and people.
Paul Krugman however feels that mega-regions may not contain the density necessary to reinforce the positive spillovers from a large concentration of talent. He favors considering a smaller geogrpahical area as the basic economic unit because they are amenable to greater labor mobility and noer positive externalities arising from information spill-overs and network effects.
The Free Exchange differs and favors larger geogrpahical areas as the basic unit of economic growth. It highlights the importance of "forward and backward linkages--that is, the importance of being near to suppliers and customers in a world where transportation costs are non-negligible".
Quoting a paper by Anthony Venables and Stephen Redding, it argues that market potential--the nearness of a place to other economically vibrant places - can explain quite a bit of the differences in global wealth.
Florida's hypothesis is the policy logic behind the fast risisng support among policy makers in India for the Mumbai-Delhi and Chennai-Bangalore growth corridors. The Government of India have been actively pursuing this idea. The Japanese Government has evinced considerable interest in the Mumbai-Delhi mega region growth corridor, and a Detailed Project Report (DPR) is currently under preparation with Japanese government assistance.
However, I am more inclined to believe that while such mega regions may promote and hasten growth in those regions with an already established critical mass of entreprenuerial or industrial activity, it may achieve little in under and un-developed areas. In these areas, it may be necessary to concentrate on more important specific policies that can stimulate the local economy. Further, a mega region approach, while very efficient for promoting manufacturing and industrial gorwth, may not be relevant in case of knowledge-based industries like software and biotechnology R&D, which do not involve the same extent of linkages.
A mega region approach may be more appropriate to the Mumbai-Delhi corridor, as it would string together the numerous, already established industrial growth centers there, and promote backward and forward linkages among them. This would take care of the many inefficiencies inherent in the economic growth in these regions. In contrast, it may achieve little in the barren and undeveloped space between Chenna and Bangalore. In many ways, mega regions are something similar to the concept of integrated regional economic planning.
He writes,"While there are 191 nations in the world, just 40 significant mega-regions power the global economy. Home to more than one-fifth of the world's population, these 40 megas account for two-thirds of global economic output and more than 85% of all global innovation.
The world's largest mega is Greater Tokyo, with 55 million people and $2.5 trillion in economic activity. Next is the 500-mile Boston-Washington corridor, with some 54 million people and $2.2 trillion in output. Also in the top 10 are mega-regions that run from Chicago to Pittsburgh, Atlanta to Charlotte, Miami to Tampa, and L.A. to San Diego. Outside of the U.S., you can find megas around Amsterdam, London, Osaka and Nagoya, Milan, Rome and Turin, and Frankfurt and Stuttgart.
Mega-regions are the true force driving the rise of emerging economies. Some 40% of Brazil's total economy is made up of a corridor stretching from Rio to São Paolo. Russia is propelled by the Moscow mega. India's economy is shaped by the mega-regions of Bangalore and Mumbai."
He argues in favor of urban policies that favor densification, improving fast-rail transit between mega-region nodes, modernizing airports, and achieving greater cross-border flows of goods and people.
Paul Krugman however feels that mega-regions may not contain the density necessary to reinforce the positive spillovers from a large concentration of talent. He favors considering a smaller geogrpahical area as the basic economic unit because they are amenable to greater labor mobility and noer positive externalities arising from information spill-overs and network effects.
The Free Exchange differs and favors larger geogrpahical areas as the basic unit of economic growth. It highlights the importance of "forward and backward linkages--that is, the importance of being near to suppliers and customers in a world where transportation costs are non-negligible".
Quoting a paper by Anthony Venables and Stephen Redding, it argues that market potential--the nearness of a place to other economically vibrant places - can explain quite a bit of the differences in global wealth.
Florida's hypothesis is the policy logic behind the fast risisng support among policy makers in India for the Mumbai-Delhi and Chennai-Bangalore growth corridors. The Government of India have been actively pursuing this idea. The Japanese Government has evinced considerable interest in the Mumbai-Delhi mega region growth corridor, and a Detailed Project Report (DPR) is currently under preparation with Japanese government assistance.
However, I am more inclined to believe that while such mega regions may promote and hasten growth in those regions with an already established critical mass of entreprenuerial or industrial activity, it may achieve little in under and un-developed areas. In these areas, it may be necessary to concentrate on more important specific policies that can stimulate the local economy. Further, a mega region approach, while very efficient for promoting manufacturing and industrial gorwth, may not be relevant in case of knowledge-based industries like software and biotechnology R&D, which do not involve the same extent of linkages.
A mega region approach may be more appropriate to the Mumbai-Delhi corridor, as it would string together the numerous, already established industrial growth centers there, and promote backward and forward linkages among them. This would take care of the many inefficiencies inherent in the economic growth in these regions. In contrast, it may achieve little in the barren and undeveloped space between Chenna and Bangalore. In many ways, mega regions are something similar to the concept of integrated regional economic planning.
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