Tuesday, September 27, 2005

Economics Lost Lesson

Hurricanes Katrina and Rita have been first and foremost, human tragedies. But, there are important economic consequences as well. Several analysts, who should know better, are misunderstanding these consequences. A recent Wall Street Journal article (Tuesday September 27, 2005) exemplifies this mistake. The article reports on a recent National Association of Business Economics economic forecast survey (www.nabe.com). According to the forecasters, U.S. economic growth will slow in 2005; however and here is the kicker, higher government spending will offset declines elsewhere sustaining economic growth. Other analysts are even claiming that growth in the fourth quarter will be even better than previous estimates due to the increased government spending.

Bad ideas just never seem to go away. As Henry Hazlitt famously noted in his 1962 book “Economics in One Lesson”, you cannot create economic growth by breaking windows. Yes, the government will be “pumping” in billions of dollars into the Gulf Coast economy. This money is not free. The money will be taken from people who would have spent it on something they valued and will be funneled to re-create something that was destroyed – not a growth enhancing proposition. And, this assumes that the money sent to the Gulf Coast will be spent wisely – a dubious assumption given the infamous politics surrounding New Orleans and Louisiana politics.

There is more. The current administration and Congress are spend-a-holics. Disregarding the calls to the contrary, Congress and the President will most likely finance the higher expenditures with higher U.S. budget deficits. These deficits will have real consequences. These will include more U.S. dis-saving, higher U.S. interest rates, as well as pressure to rescind (as opposed to extend) the capital gains and dividend tax relief implemented in 2003. All of this will reduce U.S. economic growth and consumption – one of the two current engines for global economic growth.

To end on a positive note, these impacts will not be large enough to derail the current economic expansion. They do represent the “costs” of the hurricane reconstruction – and this is the bottom line. Natural disasters are just that – disasters. They hurt economically, and require sacrifice to overcome. These sacrifices will be made whether the government is willing to admit it or not. It is as simple as economics first lesson: destroying capital does not create economic growth.

A Pretty Face is Not Enough



Remember her? Pretty? Sure. Smart? Well....

The lady in the picture is Yulia Tymoshenko, who a week ago was kicked out of her seat as prime minister of Ukraine.

Reason for her ouster: It turns out that Ms Tymoshenko is a big fan of big government. And while in office, she messed up Ukarine' economy through government policies that undermined property rights.

The result: For the past eight months, "economic growth has plummeted from an annual 12 per cent last year to 2.8 per cent so far this year, driven by a fall in investments." This is from FT, read on.

Hat tip to my former teacher Tyler Cowen up at Marginal Revolution for the pointer.

Monday, September 26, 2005

Price Gouging: Who's Fault is it Anyway

Due to various reasons, gasoline price at the pump has risen a lot of late in the US. Politicians of course are the very first ones who come out and complain about this price gouging behavior on the part of gasoline suppliers. Russell Roberts at Cafe Hayek has this very good post on price gouging.

What I find a bit strange is that not too many commentators have analyzed the issue from the demand side. Why blame it on suppliers alone?

Suppose all car owners, fearing to pay a high price for gasoline knowing something has happened that will casue its price to rise, start using public transport rather than their own cars when they go to work, when they run their errands , when they do their grocery shopping. Then I believe that no matter what happens on the supply side that will cause a rise in gasoline price, the magnitude of increase will be minimal if it happens at all due to the incidental inward shift of the gasoline demand curve as more and more people switch to public tranport. So why blame it all on the part of "greedy suppliers"? Demanders could have done the adjustment to the negative supply shock on gasoline equally well.

In other words, for all those critics that have their fingers pointed at the "greedy suppliers of gasoline", they should have their fingers pointed in reverse direction as well. Demanders of gasoline are equally at fault in not making less use of gasoline just when its supply is experiencing some kind of negative shock.

So from now on, suppliers of gasoline should organize themselves and start blaming the demanders of gasoline for failing to conserve on the usage of gasoline just when its supply is reduced temporarily for various reasons.

Sunday, September 25, 2005

Is Debt Relief the Right Way to Help?

"A deal to forgive up to $56 billion in debts owed by poor nations cleared an important hurdle Saturday, winning the endorsement of the International Monetary Fund's steering committee." This is from a story in Wall Street Journal, read on.(Subscription required)

But is that really the right way to help poor countries around the globe?

A commentator characterizes the current approach to help poor countries on the part of the rich world, including the debt relief plan mentioned above, utopian. Following are what the commentator believes as the problems inherent in this approach to helping the world's poor countries: "It is promising more than you can deliver. It is seeing an easy and sudden answer to long-standing, complex problems. It is trying to solve everything at once through an administrative apparatus headed by "world leaders." It places too much faith in altruistic cooperation and underestimates self-seeking behavior and conflict. It is expecting great things from schemes designed at the top, but doing nothing to solve the bigger problems at the bottom."

No, the commentator is not Hayek, he is Bill Easterley at New York University, read on. If you find Bill's comments sensible, learn more about the subject from his justly famous book "The Elusive Quest for Growth" and preorder his forthcoming one here.

Thursday, September 22, 2005

Economics is Easy, Applying it is Hard

Russell Roberts up at Cafe Hayek has a very good post on the topic of whether economics is easy or not, read on. What I find more interesting though is his quote from Milton Friedman:

"Economics is easy. All you have to remember is that people act in their own self-interest and demand slopes downward. It's applying these insights that's hard."

Steven N.S. Cheung has almost said the same thing using the same language, albeit in Chinese in his three volume works entitled "Economic Explanations".

Another thing I notice is that it seems no longer common for economists to use the term Price Theory, instead they call it Microeconomics...as if there is no difference between the two.

Will Conditional Fees Lead to More Frivolous Lawsuits?

"Conditional fees are a form of "no-win, no fee" arrangement. If the case is unsuccessful, the lawyer will charge no fees. In the event of success, the lawyer charges his normal fees plus a percentage "uplift" on the normal fees.

Conditional fees are different from the American form of contingency fee, where the lawyer's fee is calculated as a percentage of the amount of damages awarded by the court. At present, conditional fees, like other forms of "no win, no fee" arrangements, are unlawful for civil legal proceedings involving the institution of legal proceedings. The restriction has its origins in the ancient common law crime and tort of champerty and maintenance."

The above is from a consultation paper just released a few days ago here in Hong Kong, read more here.

Some commentators here have already voiced their concern about the rise of frivolous lawsuits if current ban on such payment scheme is lifted. I am no expert in this area, but I do have two observations to make regarding this legal service pricing scheme.

1) The current payment arrangement between lawyers and their clients here in Hong Kong might not be the most efficient one from an economic standpoint. Restriction on conditional fee arrangement artificially limits contractual forms that are available to parties involved in transactions. That inevitably will force some legal cases that would best be handled through such a pricing scheme to be handled instead by other pricing/contractual schemes that are less suitable. In other words, limited choice on payment arrangments between lawyers and their clients raises the cost of operating the legal system. (Note that I am only drawing out the implications of the prohibition on conditional fees here. There may be a very good reason why such a ban is introduced in the first place, but that is not my concern)

2) Though conditional fees arrangement as described above is not exactly like the contingency fee scheme used in the US, incentives generated by the two schemes are quite similar. And the US experience suggests, contrary to the dire consequences predicted by some pundits here, that "contingent-fee lawyers reduce the number of frivolous cases!" This is from a study conducted by my former classmate at George Mason, Alex Tabarrock, now a professor at the same university. Read on.

Tuesday, September 20, 2005

The Beauty of Simple Economics

Economists sometimes tend to forget how simple tools can go a long way in helping us to understand the real world. So we spend a great amount of time trying to construct complicated models that ironically driving us further and further away from reality.

A lot of real world puzzles can indeed be explained by concepts as simple as demand and supply. Take the example of the real estate boom in the US. Many pundits have pointed their fingers to irrational expectations on the part of buyers' as the root cause of the recent housing boom. That may be true. But we have also learned from Econ 101 that prices are determined by supply and demand.

Irrational acts on the part of buyers that result in high prices do not explain why suppliers of housing fail to profit from the high housing prices by simply building more houses. So what is the reason that prevents suppliers from taking profit from the real estate boom in the US. Steven Landsburg at Slate has the answer, read on. Once you finish reading it, you may not yell eureka but I bet you will agree with me that simple economics does go a long way in helping us to understand the real world.

Wednesday, September 14, 2005

Learn from Hong Kong, not Harvard

Bryan Caplan at George Mason University has this to say regarding the latest World Bank report on business regulations around the globe (which I mentioned in earlier post), read the report here.

One gets a sense of big relief after reading Bryan's post and knowing that Jeff Sachs has not been involved in China's economic reform. Put it in another way, it is China's great fortune not to have Jeff Sachs on board of its economic reform team during it's past twenty five years of economic reform.

Tuesday, September 13, 2005

Steven N. S. Cheung and the New Empirical Economics

I have mentioned Steven N.S. Cheung as deserving a Nobel prize in my previous post. I would argue the case for Cheung not only because of his contribution to the economics of contract and property rights, but for his instillation of a new sense to the term "empirical economics"that has long been treated as equivalent to econometrics to most economists.

What is this new empirical economics that Cheung creates?

Starting out with the simple premise of constrained maximization, and the simplest economics tools available (doward sloping demand curve), Cheung urges fellow economists to go out to the real world to examine exactly what the real world contraints are in affecting peoples' choices.

Indeed, he has written an extremely important piece on how economists should go about conducting research on real world constraints. The paper is entitled "A Theory of Price Control," Journal of Law and Economics, 1974. If you have access to JSTOR, you can read it here. If not, you can wait for Steve's forthcoming collection of essays that is due out in October.

Singaporization of Hong Kong

The World Bank has just released its third study on the burden of business regulations around the globe, read some background info about this report here.

The top ten business environments in the world, as measured by the 'Ease of Doing Business index':
1. New Zealand 2. Singapore 3. United States 4. Canada 5. Norway 6. Australia 7. Hong Kong, China8. Denmark9. United Kingdom 10. Japan.

The surprise here is that Singapore gets a much higher ranking than that of Hong Kong. Hong Kong has long been seen as much less interventionist than that of Singapore, and one would naturally incline to think that the former should have obtained a much higher ranking than the latter. So what is going on here?

I do not have the full answer. But my sense is that Hong Kong, used to be seen as the last bastion of the free market, is undergoing some sort of transformation right now. It is turning itself into a place that looks very similar to what Singapore used to be. Hong Kong government, with the backing from Beijing, not only wants to have a tight grip on all matters political, at the same time it slowly but gradually has extended its visible hand on economic matters. Witness the increasing number of "public-private partnership projects" that are launched since the handover of Hong Kong back to China in 1997. The list includes projects like Cyberport, Hong Kong Disneyland....

In sharp contrast, Singapore is trying very hard to become more and more like Hong Kong. Not the Hong Kong as is now, but the one when the principle of Lasseiz-Faire used to rein. Thus, Singapore has recently lifted the ban on gambling, partially lifted the ban on importing chewing gum, asking people to be more bold and not afraid to express themselves in a bid to boost entrepreneurship....all with the aim of letting people to have more say in what they do.

Bottomline: Hong Kong is gradually drifting away from its free market past and getting more and more interventist right at the same time that Singapore tries hard to shed its interventionst past to embrace the free market. Ironic? Yes. Sad? Definitely.

And the Winner is....

Come October, it is again time for the annoucement of this year's Nobel prize winner in economics. A few names have surfaced of late and they are considered to be serious contenders for the prize.

The list includes, Bob Barro at Harvard, J. Bhagwati up at Columbia, Gene Fama at Chicago, Paul Romer at Stanford Business School, and yes Paul Krugman's name is on it as well. And Tyler Cowen at Marginal Revolution has this to say with regard to the list, read on.

What about Steven N.S. Cheung? Some people may say he has not written much since his last piece "The Contractual Nature of the Firm" appeared in the 1983 issue of Journal of Law and Economics. My response is one should always judge the importance of an economist on the basis of whether he has made substantive contribution to the field of economics, not on the basis of whether that contribution is made twenty or two years ago.

Wednesday, September 07, 2005

Moon Cake Economics

Mid-autumn festival is coming soon and businesses across China are busy preparing all kinds of things that consumers will want to buy for celebration. One of the things people will usually buy to celebrate the festival is moon cake, a cake-like confection.

In the name of protecting the interests of consumers, the local government in Shanghai has recently promulgated a law restricting the amount of expenses that moon cake producers can spend on packaging. Starting from now, packaging costs cannot exceed 20% of the retail price of a box of moon cake. (Usually there are four pieces of moon cakes in a box)

But why 20%? If indeed the government thinks packaging is useless to a consumer, then to protect the interests of the consumer, one will certainly think that the smaller the ratio of packaging expenses to the retail price of a box of mooncake the better it is to the consumer. So why stop at 20%, why not limiting that ratio to 15%, 10%, or 5%? Even better, why not the government simply sets down a rule that prohibits packaging. Once we ponder questions like these, one immediately sees the folly of governmental regulation in the name of safeguarding our interests.

A deeper question regarding government protecting our interests is: how does the government know what are our interests? In a market, we reveal our interests through money votes. Without such mechanism, how can the government discover what our interests are.


Furthermore, given each individual's interest is different from one another, how can the government set a one size fits all policy that protects all consumers' interests. In the moon cake example above, what if the very reason I purchase a box of moon cake is simply for the sake of its packaging but nothing else. If so, then how can the government policy that restricts the amount spent of packaging enhances my interests?

Another question I would like readers to think over is this: Let say for some mysterious reason, the government actually knows what each and every individuals' interests are, and all officials do not have hidden agendas of their own other than serving the interests of the public, is there ground for having the government setting policies to safeguard our interests? Comments are open.

Ronald Coase on Opportunity Cost

I presume most if not all economists have read Ronald Coase's essays on the nature of the firm and on the problem of social costs. But probably not too many people know that Coase has written a piece on the concept of opportunity cost. The essay, entitled "Business Organization and the Accountant," is now online.

And You Think the Concept of Opportunity Cost is Easy

In any introductory economics textbook, the concept of opportunity cost is usually defined and explained in the first few chapters. So anyone who has taken an introductory economic class can legitimately claim he or she understands the concept.

Is the concept really that simple? It turns out that such a seemingly "easy" concept is not well grasped by even professional economists!! You hear it right, PROFESSOINAL ECONOMISTS who do economics for a living!

Read this and this as well. And my former professor at George Mason University Tyler Cowen has this to say, and I totally agree with his conclusion about the concept of opportunity cost being a gross but not a net concept.

Paul Krugman's Mentor

In the latest issue of Finance and Development, a magazine published by the IMF, there is a very nice article on free trade guru J. Bhagwati, a professor of economics at Columbia University. Who is J. Bhagwati? Better save it for you to discover by reading through the article. All I will say is that he was Paul Krugman's teacher. Read on.

Monday, September 05, 2005

Japan's 9/11

I am not suggesting anything like the tragedy that occured on 9-11-01 in the US is going to repeat in Japan on that day. However, something equally important is also going to happen in Japan that same day this year. I am talking about the parlimentary election that will be held on that day. Here, I try to provide a story about why events are unfolding this particular way. Comments are open.

In Mancur Olson's 1982 book "The Rise and Fall of Nations", he attributes the post war economic success of Japan to the devastation of intimate ties formed between various interest groups and the government.

Such ties tilt the playing field towards those who are connected to the government. Without such connection, the rest of the society suffers from all sorts of discriminatory policies. As a result, the cozy relationships between interest groups and government retard economic growth. WWII changes all this. Without the hinderance created by the tight connection between special interests and the government, Japanese economy recovers rapidly in the aftermath of the war.

However, with social and political stability in Japan soon restored after the war, interest groups reappear and ties are once again formed between them and the government. A symbol of this tight link between the interest groups and the government is the almost uninterrupted rule of the LDP in Japan for the past five decades since the war. Signs of weaknesses begin to surface in the Japanese economy in the late 1980s.

Japan has to reform to survive under such circumstances. But reform will not be easy to push through as long as the cozy relationships between the LDP and its supporting interest groups are intact. The burst of the property bubble in the early 1990s together with the gradual accumulation of huge governmental debt that simply cannot be maintained indefinitely into the future thus act sort of like what WWII does to the tight relationships between the interest groups and the LDP old guards. These factors generate momentum for reform.

When the attempt to privatize postal service failed earlier last month, prime minister Junichiro Koizumi immediately called for a snap election of the parliament. This election, held on the eleventh of this month, will definitely be a watershed in Japanese history. For if Olson is right, and Koizumi's faction within LDP wins, that will mean ties between the LDP old guards and the special interests (like the construction companies, farmers, and postal workers) are permanently gone. And Japanese economy's rise from the ashes will only be a matter of time.

Friday, September 02, 2005

Government is Always and Everywhere the Wellspring of Problems

The book by Martin Meredith entitled "The Fate of Africa" is reviewed in the August 31th edition of the Wall Street Journal (link here, subscription required). To reviewer Robert Guest, the book successfully shows:

"Most African countries have been atrociously governed in the past half-century. A lack of institutional checks has allowed an array of incompetent strongmen to rule as they pleased until the money ran out, at which point northern donors oftern tossed them an extra bundle of cash."

Foreign aid advocates, Jeff Sachs and Bono type folks should all get hold of a copy of this book.
Bottom line: Government Sucks. Period.

Supersize It

The State-owned Assets Supervision and Administration Commission (SASAC), the government body in China responsible for overeeing state-owned enterprises under central government control, recently annouces its plan to merge some of the firms under its supervision to create giant enterprises that can compete in the world market.

The sad thing about this piece of news is that after more than 20 years of miraculous economic growth, Chinese officials still don't get the message that planning does not work. How do we know large is necessarily better? How large is large? How do we know combing A firm and B firm will bring synergies but not merging firm B and firm D?

They simply just do not get it. Firm size is a result of market competition. No one knows when Sam Walton first started his business that Walmart will turn into a giant multinational business. And herelies the marvel of the market: NO ONE NEEDS TO KNOW. Competition in the market place will sort it all out!

Thursday, September 01, 2005

Two Wrongs Do Not Make One Right

Recently there is an oil shortage in the sourthern part of China. Long lines develop and the government is concerned such incidents may eventually lead to social unrest. In today's Hong Kong Economic Journal (the journal is a local equivalent to Wall Street Journal focusing on economic news), there is a story saying that the Chinese government has announced a ban on the export of oil (refined oil not crude) in a bid to bring the shortage problem under control.

This is a typical case of how one regulation, after producing some unwanted and unintended consequences, leads to more regulation. The reason why there is shortage in the first place is simple: In China today, the government still controls the retail price of refined oil but not the price of crude as the price of the latter is determined by world demand and supply. So with the retail price set below the market level while the price of crude is shooting up like there is no tomorrow, it is not hard to see that firms will have no incentive to import crude and process it. That is one reason why shortage develops in China: Firms simply stop production to minimize losses.

Another reason is export. As processed oil can fetch a far higher price in the world market than the domestic one, it is only rational for firms in China to sell their processed oil abroad. So supply originally planned to sell domestically is now diverted overseas as a result of the price control.

The source of oil shortage in China thus originates from state regulation, and now the government wants to rectify the shortage problem not with eliminating the price control but through introducing yet another regulation: banning the export of processed oil! But can they? Smuggling activity is definitely going to rise generating lots of opporunities for corruption. Will more corruption help in maintaining social stability, you tell me.

In China, the oil producing firms are privatized in name only. The central government remains the absolute majority shareholder. After shortage surfaced, the central government prevailed upon these oil companies to assume greater social responsibilities, i.e. to ensure adequate supply so as to prevent social unrest, even if that means they will have to suffer temporary losses. In other words, private minority shareholders' interest be damned -- for the time being anyhow.