Thanks to Mostly Economics for pointing to this brilliant lecture by Alan Blinder on the market failure in the demand-supply of good policy advice by economists to politicians. He illustrates the difference between good economic advice and good politics and the need for economists to reconcile their advice with the compulsions of their political bosses, especially in a market where demand for any type of economic advice is very weak, even at best of times.
Prof Blinder refers to a few reasons for the apparent divergence between economic advice and political decisions - contrasting time horizons (myopic concentration on the here and now against economists' telescopic concentration on the distant future) and the related transition costs; the need to generate ideas with superficial sound appeal (that often sweeps over sound economics); differing standards of evidence of good policy ("If a proposal sounded good, either in its design or, more commonly, in its objectives, it was taken to be good policy"); swift, quick-fix and hasty as opposed to orderly and deliberate decision making process; legislative sequencing of policy decisions and packaging a bundle of issues/policies so as to carry all political constituents together; and the need to service narrow special interests or specific constituents (is part of the larger issue of fairness in distribution, which is not addressed by efficiency-focused economics).
Also he offer several pieces of sound advice for economic policy advisers
1. The word democracy means rule by the people, not by the technocrats
2. It is not for economists to say whether one group of people should be favored over another. It is for elected politicians
3. To push through important pieces of legislation, "slogans and symbols are more effective than learned dissertations, for mass politics displays little tolerance for complexity"
4. "Politicians are surely guilty of myopic concentration on the here and now. But economists are often equally guilty of telescopic concentration on the distant future. Our particular brand of analysis is wont to focus doggedly on the long-run consequences of any policy action, to the exclusion of many of the transitional problems that loom so large in the lives of ordinary people."
5. About the requirements to push through important policies, he writes, "That means coalition building, vote trading, logrolling, difference splitting—and compromise, compromise, compromise. The policies that emerge from such political horse trading are unlikely to follow the neat contours designed by economic technicians. More likely, they will be ungainly creatures whose central organizing principles are hard to fathom, if indeed they exist at all. It’s a bit like attaching the head of a cow and the tail of a pig to the body of a camel. But technicians must learn to live with such homely creations, even if they never grow to love them."
6. "Policy without politics is neither feasible nor desirable. But politics comes in various shapes and sizes. The trick is to emphasize what I’ll call the 'high politics' — the mediation of competing claims and ideas and clashes between competing philosophies and visions of government - and deemphasize the 'low politics' — politics as sporting event. The latter manifests in the form of damaging populism, opposing policies on purely partisan grounds, name calling, personal attacks, scandal mongering etc."
Friday, September 18, 2009
Price ceilings in power exchanges
In a landmark decision, the Central Electricity Regulatory Commission (CERC) has finally imposed a price band on electricity sales in power exchanges and bilateral markets, in an effort to curb the runaway price increases and volatility in a massively deficient electricity market (peak shortage estimate of 18.1% for 2009-10). The price band from 10 paise per unit to Rs 8 per unit would cover all inter-state day ahead trades for a period of 45 days.
Generators and traders had opposed any price ceilings on the grounds that it would deprive the market of generation capcity. However, by fixing the price ceiling by taking into account the prevailing market price of the high cost liquid fuels, the CERC has ensured that there is no economic incentive for generators to keep their plants idle.
The CERC points to the increase in prices of electricity traded in the Indian Energy Exchange (IEX) between 6 and 7 PM from Rs 5 per unit to Rs 14.5 per unit in the period from 3.08.2009 to 13.08.2009. Given the fairly stable global fuel prices, cost considerations cannot explain this steep 2.89 times rise in the 10 day period. Let us model the market by assuming Rs 5 per unit as the equilibrium market value based on the actual cost of production and Rs 14.5 as the equilibrium traded price in the exchanges.
The quantities demanded at exchange equilibrium price of Rs 14.5 is Qe, at the ceiling price of Rs 8 is Qc, and at the initial market price of Rs 5 is Qm. At a market price of Rs 8, from the generators original supply curve (based on their cost of production) it is clear that they would be willing to supply a quantity of Qc(sup). Since Qc > Qe, the quantity of electricity generated and consumed increases with the price ceiling, thereby lowering the deadweight loss.
A price ceiling that is fixed at the marginal cost of the highest cost fuel is the most efficient rationing price. At this price, all the available generators will be able to get back atleast their marginal cost of production. The CERC has accordingly placed the ceiling price at Rs 8, equivalent to the marginal cost of production of high cost liquid fuel generators. At a lower price ceiling, there will be idle generation capacity.
Generators and traders had opposed any price ceilings on the grounds that it would deprive the market of generation capcity. However, by fixing the price ceiling by taking into account the prevailing market price of the high cost liquid fuels, the CERC has ensured that there is no economic incentive for generators to keep their plants idle.
The CERC points to the increase in prices of electricity traded in the Indian Energy Exchange (IEX) between 6 and 7 PM from Rs 5 per unit to Rs 14.5 per unit in the period from 3.08.2009 to 13.08.2009. Given the fairly stable global fuel prices, cost considerations cannot explain this steep 2.89 times rise in the 10 day period. Let us model the market by assuming Rs 5 per unit as the equilibrium market value based on the actual cost of production and Rs 14.5 as the equilibrium traded price in the exchanges.
The quantities demanded at exchange equilibrium price of Rs 14.5 is Qe, at the ceiling price of Rs 8 is Qc, and at the initial market price of Rs 5 is Qm. At a market price of Rs 8, from the generators original supply curve (based on their cost of production) it is clear that they would be willing to supply a quantity of Qc(sup). Since Qc > Qe, the quantity of electricity generated and consumed increases with the price ceiling, thereby lowering the deadweight loss.
A price ceiling that is fixed at the marginal cost of the highest cost fuel is the most efficient rationing price. At this price, all the available generators will be able to get back atleast their marginal cost of production. The CERC has accordingly placed the ceiling price at Rs 8, equivalent to the marginal cost of production of high cost liquid fuel generators. At a lower price ceiling, there will be idle generation capacity.
Thursday, September 17, 2009
How does H1N1 virus look like?
Chris Blattman points to artist Luke Jerram's glass microbiology works on disease causing viruses and bacteria. Swine flu virus looks like this...
HIV like this...
And E Coli looks like this
HIV like this...
And E Coli looks like this
Deficient polices caused the crisis
Market enthusiasts have argued that the financial market does an effective role in efficiently allocating resources to the most productive of activities. However, events from the past two decades provide ample proof against this and the possibility of market failures that cannot be repaired or remedied without an intrusive role by the government.
After the recent events, only the ideological zealots, ignorant and foolish would cling to the view that markets are efficient in allocating resources and are self-correcting. It is now widely accepted that governments should play an important role in not only regulating financial markets, but also in addressing macroeconomic issues and trends that have the potential of generating financial market distortions. In other words, after two decades of aggressive de-regulation and liberalization, financial market and macroeconomic policy making has taken the centerstage with a bang.
Conservatives in the US have accused China and the emerging economies of Asia for causing the asset bubbles that have caused so much financial and economic devastation over the last one year. They blame the excessive savings, depressed private consumption and a gargantuan appetite to accumulate reserves by increasing exports, among emerging economies, and their preference for the safety and liquidity of US Treasuries, as being responsible for the flood of capital into the US. It is alleged that this coupled with the cheap imports from the same countries of all kinds of consumer durables and non-durables, in turn fuelled the asset bubbles and consumption binges in the US. In other words, as some critics have claimed, the on going crisis was "Made in China"!
However, it may be more appropriate and correct to lay the blame for the crisis at the doorstep of policymakers and regulators at home. As Menzie Chinn and Jeffry Frieden write, "We view the current episode as a replay of past debt crises, driven by profligate fiscal policies, but made much more virulent by a combination of high leverage, financial innovation, and regulatory disarmament... This disaster is merely the most recent example of a 'capital flow cycle', in which foreign capital floods a country, stimulates an economic boom, encourages financial leveraging and risk taking, and eventually culminates in a crash."
Here are five resons why the aforementioned arguement may only be a convenient ruse to blame others and wash off the guilt from faulty and deficient policies followed by policymakers at Washington.
1. Fed's monetary policy - It is now well-acknowledged that the reluctance of Alan Greenspan to "take the punch bowl away when the party got going" and raise interest rates in the face of overwhelming evidence that an asset bubble was well underway, was a single biggest contributor towards asset price mis-matches and the build-up of financial market distortions. It set the stage for the "age of leverage" that both financial market actors and consumers feasted on.
2. Inadequate and weakly enforced financial market regulation - The biggest share of the blame for the financial market crisis has to be borne by the financial market regulators who allowed a large and unregulated shadow banking system with its alphabet soup of financial engineering products to emerge and pose massive systemic risks on the entire financial market and even the real economy. The financial market de-regulation of the nineties set in motion a tsunami of unregulated speculative activity and proliferation of risky instruments in the equity and debt markets that effectively forced the crisis on us.
3. Failure to prevent mis-allocation of resources - The existing policies (or the lack of appropriate ones) ended up channelling a disproportionately larger share of resources into the financial markets and the real estate, thereby inflating asset bubbles in both these markets. As James Kwak argues, the majority of external borrowings and inflows found its way into non-tradable goods, such as housing and financial services, necessarily pushing up valuations. Policy makers stayed and watched and even applauded as a spectacular mis-allocation of resources towards the financial markets (and specific instruments) inflated bubble after bubble and led the world economy into this crisis.
4. Supply-side policy of cutting taxes - The large tax cuts of the Bush administration had the effect of increasing the disposable incomes available with consumers. In the context of low interest rates, growing asset prices, and cheap imports, this increased availability of disposable incomes was an evident recipe for amplifying the bubble and the resultant incentive distortions.
The tax cuts were not only not followed up with efforts to bring down government spending, but also ran parallel with increases in government spending (on defense and the Iraq war). The result was a huge increase in public debt and fiscal deficit that found a ready source of funding from the "savings glut" in the emerging economies. Accordingly, the large tax cuts also set the stage for the huge deficits that left the government with limited fiscal space for stimulus spending when the Great Recession took hold.
5. Refusal to support efforts to create a global reserve currency - The moral hazard created by the dominant role of dollar as the global reserve currency meant that the US Government could run up massive current account deficits with the assurance that they had the luxury of simply printing more greenback if situation so demanded. It also fuelled the confidence, will all its incentive distortions among all stakeholders, that the US could borrow without limit and at low interest rates (as was prevailing) from outside. The absence of a global alternative to dollar means that this moral hazard will persist and leave open the possibility of similar incentive distortions in future.
Even as the global macroeconomic imbalances continue to build up alarmingly and as the global economic power balance shifts eastward, policy makers in Washington have tended to turn the other side and ignore the reality that dollar cannot continue to remain as the dominant global reserve currency. As Joe Stiglitz argues, the burgeoning deficits and the fear that policy makers in Washington may be tempted to reduce the real value of its debts by inflation, may be enough to undermine the role of dollar as a reliable and risk-free store of value.
After the recent events, only the ideological zealots, ignorant and foolish would cling to the view that markets are efficient in allocating resources and are self-correcting. It is now widely accepted that governments should play an important role in not only regulating financial markets, but also in addressing macroeconomic issues and trends that have the potential of generating financial market distortions. In other words, after two decades of aggressive de-regulation and liberalization, financial market and macroeconomic policy making has taken the centerstage with a bang.
Conservatives in the US have accused China and the emerging economies of Asia for causing the asset bubbles that have caused so much financial and economic devastation over the last one year. They blame the excessive savings, depressed private consumption and a gargantuan appetite to accumulate reserves by increasing exports, among emerging economies, and their preference for the safety and liquidity of US Treasuries, as being responsible for the flood of capital into the US. It is alleged that this coupled with the cheap imports from the same countries of all kinds of consumer durables and non-durables, in turn fuelled the asset bubbles and consumption binges in the US. In other words, as some critics have claimed, the on going crisis was "Made in China"!
However, it may be more appropriate and correct to lay the blame for the crisis at the doorstep of policymakers and regulators at home. As Menzie Chinn and Jeffry Frieden write, "We view the current episode as a replay of past debt crises, driven by profligate fiscal policies, but made much more virulent by a combination of high leverage, financial innovation, and regulatory disarmament... This disaster is merely the most recent example of a 'capital flow cycle', in which foreign capital floods a country, stimulates an economic boom, encourages financial leveraging and risk taking, and eventually culminates in a crash."
Here are five resons why the aforementioned arguement may only be a convenient ruse to blame others and wash off the guilt from faulty and deficient policies followed by policymakers at Washington.
1. Fed's monetary policy - It is now well-acknowledged that the reluctance of Alan Greenspan to "take the punch bowl away when the party got going" and raise interest rates in the face of overwhelming evidence that an asset bubble was well underway, was a single biggest contributor towards asset price mis-matches and the build-up of financial market distortions. It set the stage for the "age of leverage" that both financial market actors and consumers feasted on.
2. Inadequate and weakly enforced financial market regulation - The biggest share of the blame for the financial market crisis has to be borne by the financial market regulators who allowed a large and unregulated shadow banking system with its alphabet soup of financial engineering products to emerge and pose massive systemic risks on the entire financial market and even the real economy. The financial market de-regulation of the nineties set in motion a tsunami of unregulated speculative activity and proliferation of risky instruments in the equity and debt markets that effectively forced the crisis on us.
3. Failure to prevent mis-allocation of resources - The existing policies (or the lack of appropriate ones) ended up channelling a disproportionately larger share of resources into the financial markets and the real estate, thereby inflating asset bubbles in both these markets. As James Kwak argues, the majority of external borrowings and inflows found its way into non-tradable goods, such as housing and financial services, necessarily pushing up valuations. Policy makers stayed and watched and even applauded as a spectacular mis-allocation of resources towards the financial markets (and specific instruments) inflated bubble after bubble and led the world economy into this crisis.
4. Supply-side policy of cutting taxes - The large tax cuts of the Bush administration had the effect of increasing the disposable incomes available with consumers. In the context of low interest rates, growing asset prices, and cheap imports, this increased availability of disposable incomes was an evident recipe for amplifying the bubble and the resultant incentive distortions.
The tax cuts were not only not followed up with efforts to bring down government spending, but also ran parallel with increases in government spending (on defense and the Iraq war). The result was a huge increase in public debt and fiscal deficit that found a ready source of funding from the "savings glut" in the emerging economies. Accordingly, the large tax cuts also set the stage for the huge deficits that left the government with limited fiscal space for stimulus spending when the Great Recession took hold.
5. Refusal to support efforts to create a global reserve currency - The moral hazard created by the dominant role of dollar as the global reserve currency meant that the US Government could run up massive current account deficits with the assurance that they had the luxury of simply printing more greenback if situation so demanded. It also fuelled the confidence, will all its incentive distortions among all stakeholders, that the US could borrow without limit and at low interest rates (as was prevailing) from outside. The absence of a global alternative to dollar means that this moral hazard will persist and leave open the possibility of similar incentive distortions in future.
Even as the global macroeconomic imbalances continue to build up alarmingly and as the global economic power balance shifts eastward, policy makers in Washington have tended to turn the other side and ignore the reality that dollar cannot continue to remain as the dominant global reserve currency. As Joe Stiglitz argues, the burgeoning deficits and the fear that policy makers in Washington may be tempted to reduce the real value of its debts by inflation, may be enough to undermine the role of dollar as a reliable and risk-free store of value.
Verdict on Obama
Getting to govern and actually governing are quite two different things...
- William Buiter's verdict on President Obama.
Clearly, the qualities one needs to get elected to high office in western democracies are not qualities that are likely to be helpful once you have achieved high office and are expected to govern and lead. To survive the selection process to become president you have to be able to stitch together a coalition of special interests that can provide sufficient financial and sweat equity resources to win this grueling race to the top. Once you get there, you should shed the unfortunate baggage you accumulated on your way up and govern in the interest of all the people. Few can do that. Apparently Obama is not one of them.
- William Buiter's verdict on President Obama.
Wednesday, September 16, 2009
Recessions and sticky wages
David Leonhardt points to one of the more remarkable aspects of the current recession - the lack of decline in wages and even small increase in wages. Businesses appear to have responded to the downturn by virtually freezing new hires. However, unlike previous recessions, there was no sharp increase in lay-offs and discharges nor widespread wage cuts. This trend is a testament to the increasing premium commanded by skilled work forces in the modern economy.
In other words, all the opportunities for new workers were virtually blacked out. And even for those laid off, finding newer jobs became a huge challenge, taking those out of work for more than six months to its highest ever share. Leonhardt describes this trend of some firing and virtually no hiring as "concentration of pain".
As economies become more skill-driven and globally integrated, businesses will increasingly lose the flexibility to lower wages in response to slowdowns. Wage cuts would have the effect of de-motivating the remaining workforce and/or drive them elsewhere across the world. In the circumstances, wages will become even more sticky downwards.
In the absence of freedom to lower wages, businesses will resort to firing their most dispensable category of workers. An indicator of this trend is the steep jump in unemployment rates from 6.7% in 2007 to 15.5% in May 2009. Though detailed category-wise lay-off figures are not available, I am inclined to believe that those lower down the knowledge chain bore the brunt of the firings during the Great Recession and will continue to do so in the future. In fact, the BLS figures for lay-offs and separations show the largest increases in retial trade, hospitality and construction industries. This would ironically mean that those least responsible for economic downturns will be the worst affected during bad times. The poorest are the worst affected by recessions (US poverty rate rose from 12.5% to 13.2% from 2007 to 2008). Heads you win, tails I lose!
In other words, all the opportunities for new workers were virtually blacked out. And even for those laid off, finding newer jobs became a huge challenge, taking those out of work for more than six months to its highest ever share. Leonhardt describes this trend of some firing and virtually no hiring as "concentration of pain".
As economies become more skill-driven and globally integrated, businesses will increasingly lose the flexibility to lower wages in response to slowdowns. Wage cuts would have the effect of de-motivating the remaining workforce and/or drive them elsewhere across the world. In the circumstances, wages will become even more sticky downwards.
In the absence of freedom to lower wages, businesses will resort to firing their most dispensable category of workers. An indicator of this trend is the steep jump in unemployment rates from 6.7% in 2007 to 15.5% in May 2009. Though detailed category-wise lay-off figures are not available, I am inclined to believe that those lower down the knowledge chain bore the brunt of the firings during the Great Recession and will continue to do so in the future. In fact, the BLS figures for lay-offs and separations show the largest increases in retial trade, hospitality and construction industries. This would ironically mean that those least responsible for economic downturns will be the worst affected during bad times. The poorest are the worst affected by recessions (US poverty rate rose from 12.5% to 13.2% from 2007 to 2008). Heads you win, tails I lose!
Global debt map
Excellent comparison map of public debt across the nations of the world from The Economist (via Economix).
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