Tuesday, January 31, 2006

Is Too Much Capital in the Hands of the Chinese Government?

Arnold Kling at Econblog wrote:

"At lunch last week, Tyler Cowen and I both expressed pessimism about China. Our view is that the state appears to control too much capital." Read the whole thing here.

If one just looks at the amount of savings in the vaults of the 4 largest state-owned banks (the funds of course are owned by the public but the presumption is that the state-banks still are not motivated to allocate the capital to the most valued uses), the capital embodied in state-owned enterprises and the forex reserves in the hands of the Chinese government, the above statement made by Cowen and Kling made a lot of sense. But they forget the other side of the coin, the amount of capital that is not controlled by the government.

Indeed, private entrepreneurs in China rely heavily on informal financial institutions for their working and start-up capital. John Hopkins scholar Kellee Tsai is an expert in this area, read her paper here and you may also want to get her book on the same topic.

There is no denying that the capital now in the government's hands is a contraint on growth, but it has been that way ever since reform started in 1978 and this fact has not prevented the 9% annual average growth rate for the past two decades from happening. In other words, growth in China has occured for the two decades since reform despite the fact that the government has a lot of capital in its hands. And with the listing of the state banks on the capital market, the situation will certainly improve in the future.

Tuesday, January 24, 2006

Sir John Cowperthwaite 1915-2006

I am deeply saddened by a story in today's edition of South China Morning Post:

"Sir John Cowperthwaite, the former financial secretary credited with launching Hong Kong's economic success by introducing laissez-faire government, has died in Scotland."

It is no exaggeration to say that Sir John singled-handedly laid the foundations for a free market economy here in Hong Kong. It is depressing to see Hong Kong officials betraying his memory by slowly but steadily taking apart the very foundation that Sir John laid. A slew of interventionlist policies that are already in the pipeline include sales tax, anti-trust law, minimum wage, maximum hours...

Milton Friedman recalled in 1997:

I met Cowperthwaite in 1963 on my next visit to Hong Kong. I remember asking him about the paucity of statistics. He answered, “If I let them compute those statistics, they’ll want to use them for planning.’’ How wise!

Economics of Tipping

Tipping has long been a puzzle to economist.

In a forthcoming article in Southern Economic Journal, Ofer Azar provides yet another attempt to solve this puzzle:

Here is the abstract:

This article examines the optimal choice of monitoring intensity when workers face external incentives (incentives that are not provided by the firm), such as tips, satisfaction from working well, or the desire to build reputation in order to be more attractive to other employers. Increase in such external incentives reduces optimal monitoring intensity but nevertheless increases effort and profits unambiguously. The model explains why U.S. firms supported the establishment of tipping in the late 19th century but raises the possibility that European firms make costly mistakes by replacing tips with service charges.

Sunday, January 22, 2006

Time for China to have an Open Government?

A story in New York Times wrote "Land grabs by officials eager to cash in on China's booming economy are provoking mass unrest in the countryside and amount to a "historic error" that could threaten national stability, Prime Minister Wen Jiabao said in comments published Friday...Local officials operate with impunity in the one-party state and have little to fear from a legal system that answers to the party. " Read the story here.

To preserve social stability, what can the central government do?

1) The central government can of course organize internal clean-up campaign in a bid to get rid of bad elements (read corrupt officials). But the government seems to have tried this route many, many times and this does not seem to work very effectively.

2) Of course, with piles of Forex in its treasury and decent fiscal health, the central government can simply use money to compensate the victims, then again this method can only be a short term solution because it can only rectify old problems but not stopping new ones from occuring. Indeed, knowing that central government will clean up their mess, this policy will only encourage more of such corrupt behavior on the part of local officials (moral hazard).

This method has another problem as well. You need someone to give the money to the victims don't you? And whom you are going to rely on? Corrupt local officials who make a mess in the first place!

3) If the central government cannot deal with its own corrupt local officials, can it simply use force to silence those angry victims of government policies? No. Again, knowing that the central government will clean up their mess (like option 2, only this time with sticks rather than carrots), the same moral hazard problem will occur and future protests are bound to come up again and again.

4) An open government(by that I do not mean democracy but a govenment characterized by rule of law and protection of individual liberty). You can't use force (at least not in a scale comparable to that used in June 1989), you can't trust your own people to rein in their own behavior (they are corrupt and are thus the source of the problem in the first place), what else can you do other than opening up your government?

May be I am too optimistic, but I just don't see China's central authority has that many choices open to them other than opening up the government. Hopefully we don't need to wait for too long.

Thursday, January 19, 2006

New Studies on Democracy and Growth

Two more important new papers on the relationship between democracy and growth are out. One is called "Democracy and Development: The Devil in the Details" by T. Persson and G. Tabellini (forthcoming in the American Economic Review), and the other one is called "Economic Development and Democracy: A Perspective on Recent Research" by James Robinson at Harvard.

Show me the money, Comrades!

In today's South China Morning Post, a story said that the Chinese government has decided to spend a lot of money in a bid to revive Marxism. Read the story here.

Two thoughts:

1) The fact that the central government has to use monetary incentives rather than resorting to the old way of launching some sort of violent campaign to make more people learn Marxism tells us how much China has improved in terms of individual liberty (albeit still limited) since reform started more than 2 decades ago.

2) Market reform means Chinese people are becoming less and less dependent on the government for their livelihoods. People's views on the role of the government necessarily change as a result. Now Chinese people see the government more as the source of trouble(corruption, regulatory burden, and a defective legal system) that limit their opporunities than their source of welfare or income as in the past. The government's legitimacy crisis follows. The bid to revive Marxism is an attempt on the part of Chinese leadership to deal with this legitimacy crisis. Will it work? Not in a million years!

Tuesday, January 17, 2006

Why accountants care about Hong Kong's fiscal health?

A partner at PricewaterhouseCoopers was cited by the Hong Kong Standard as saying that GST will help stabilize government revenues against economic fluctuations and broaden the tax base, read the story here.

A puzzle that has to be resolved is why accountants in HK care so much about Hong Kong's fiscal health than say the local economists. That is certainly not the case in the US and the question is why?

I do not have the full answer, but I know this bit:

1) Accountants are out looking after their own interests, not HK's. So their eagerness to see GST introduced in HK may have something to do with their personal interests. For instance, GST may serve as a new source of income for accountants as businesses may need their help in filing tax forms.

Accountants can claim their private interests are not at stake when they come out in support of GST only if they can credibly commit that they will not do any GST related business. The keyword here is "credible". This can be achieved through posting a bond (say a few millions dollars or whatever discounted future income streams that are expected from GST related business plus a bit more) that will get confiscated once the accountants break their promises and conduct GST related businesses. I dare HK's accountants to do just that to prove their innocence.

And here is my conjecture:

2) In the US, with a mature democracy, lobbying is far more institutionalized than is the case in Hong Kong. In that case, accountants as a group do not need to come out and say what taxes they like or they don't like. If they want to lobby for a tax that will bring new source of income, they will simply call up their lobbyist in Washington DC.

This is not so in Hong Kong. Accountants only have one representative in HK's 60-member legislature and lobbyist as a profession is not as well developed here as in the US. Under such circumstances, accountants may then need to speak out for their favourite pork-barrel policies in the public.

Saturday, January 14, 2006

Median Voter

In responding to a law passed at the Maryland legislature that requires Wal-mart to raise its spending on employee health care, Arnold Kling at Econlog wrote:

"Economics says that ultimately this will reduce the wage income of low-skilled workers in Maryland. That is, Wal-Mart is not going to suddenly increase compensation for low-skilled workers. It either has to cut wages, cut hiring, or both.

How can the state of Maryland justify this interference with how Wal-Mart chooses to compensate workers?

1. The legislators may believe that they know better than workers what is good for them." Read the post here.

My response is, what about the role of voters here? Afterall, aren't legislators' actions merely a reflection of what their voters want? So Arnold's justification no.1 cited above may be rephrased as follows.

The voters may believe that they know better than Walmart employees what is good for them.


1. This may imply that the median voter does not work for Walmart. For if he does work for Walmart, presumably he will not support a restriction on freedom of contract that will harm himself. The median voter may even think that he has done a good job in helping push for a law that will improve the welfare of unskilled workers (expressive voting?).

2. Voters are stupid. That is to say even if the median worker does work for Walmart, not equipped with the knowledge of economics, he may mistakenly believe that by asking the government to press for Walmart to raise its medical spending, Walmart will not do anything to offset this and his overall compensation package will indeed rise.

Thursday, January 12, 2006

A Conceptual Framework for Understanding Recorded Human History

The title of this post is the same as the title of a paper by Douglas North coauthored with Barry Weingast at Stanford and John Wallis at U of Maryland. As I am not allowed to cite the paper without their permission, read it here, it is stimulating.

Trade Off

In a WSJ story today, the authors reported that one consequence of the widespread adoption of just-in-time inventory management is the low stock level of medicine. The authors consider the current stock level of medicine as insufficient in view of the risk of the possible outbreak of a flu pandemic, read it here.

The criticism is flawed, in my view, because the authors pretty much assume scarcity away in their criticism of the just-in-time inventory. Yes, of course we can have as many stockpiles of medicine as we want. But in a world of scarcity, the nagging question reappears: at what costs?
Resources used up in the production of medicine imply there are less resources that can be used in other things that we value (say building whatever is needed in Lousiana that could help it withstand another hurricane like Katrina better). As in everything in life, we have to make tradeoffs. And medicine is no exception.

Near the end of the story, an emergency physician made a similar point, "You can't plan for a surge capacity in an emergency room of 500 or 1,000 patients from the 20 you see in a day...Nobody could afford to do that. You can't have 10 doctors and 100 nurses sitting around waiting for something to happen."

Tuesday, January 10, 2006

Hong Kong Fact of the Day

What follows is from a story in Hong Kong Economic Journal, a local financial paper (sorry no link):

In fiscal year 1995-1996, government expenditure on social welfare was HK $ 12.6 billion.

Ten years later in fiscal year 2005-2006, the same expenditure is expected to be at HK $ 34.3 billion.

Do I need to say more?

Fatal Conceit

Our Financial Secretary Henry Tang is always funny, he never fails to entertain. Here is the last installment:

Reporter: Many economists say there is room for marginal tax cuts for the Hong Kong Government, ... everything is turning fine and we don't expect there will be a huge deficit, how well do you agree with them?

Financial Secretary: We must not be too shortsighted. I know while Hong Kong is recovering and is enjoying a fairly robust economic growth, hopefully and likely for a second consecutive year, but we must take a broader perspective and be more macro in terms of what are the external economic factors that may affect us, what are the internal structural healthiness of our economy, and thirdly how to address some of the wishes of our people. I think I will have to address the need of the people and at the same time take a prudent financial management approach. So I will have to strike a balance and I will announce whatever measures I have on February 22.

Read the whole thing here.

What's funny about his answer? Well, he mentioned that the government "must take a broader perspective and be more macro in terms of what are the external economic factors that may affect us..."

The fact is NEITHER him nor anyone, I mean no one, in the government will be able to figure out what the Financial Secretary claimed that could be done in that passage quoted above. Indeed, even individual market participant who is in a far better position to learn about the market conditions than government officials does not have access to that kind of knowledge mentioned in the Financial Secretary's quote. Hayek mentioned back in 1945 that knoweldge is dispersed and the very existence of the market is to help us solve the dispersed knowledge problem effectively.

Another funny thing about his answer is this, in the quote above he said "and thirdly how to address some of the wishes of our people." Why Hong Kong people's wishes need to be addressed by him, why can't they figure it all out all by themselves? Afterall, they are not his children and why we need him to take care of them?

Why a government with a dollar in its hand (extracted through taxation) can figure out a better way to satisfy a person's wishes (from which the dollar is taken through taxation) than a dollar in his/her own wallet? How does the government find out what the person wants?

Monday, January 09, 2006

Let them compete!

China's securities-market regulator yesterday published rules to enforce risk controls in the brokerage sector, and its top official indicated that foreign companies may find it difficult to invest in local brokerage firms until overhaul of the sector is finished.

"The securities sector is undergoing cleanup now and during the cleanup period, there are some practical difficulties for foreign investors to take stakes in restructuring local brokerages," China Securities Regulatory Commission Chairman Shang Fulin was quoted by the official Shanghai Securities Journal as saying.

That is from a story in WSJ, read it here.

Question: Shouldn't competition through opening up of the sector to both foreign and local entries be one of the main pillars, if not the only pillar, of the clean up process?

Chairman Shang should consult this book on the benefits of financial liberalization.

Armen Alchian on Evolution, Information and Cost

Three themes unify Armen Alchian's work on economics. Together, they outline both a coherent methodology for doing economics, and a view of the world that celebrates the importance of individual liberty.

Theme no.1: For Alchian, the unit of analysis is always the individual; hence, the theory must be consistent with each person acting as an individual utility or wealth maximizer.

Theme no.2: Economic theory must be as general as possible. It must apply to both sides of the market, to markets for all types of goods and services, and to the decisions of all economic agents.

Theme no. 3: Finally, both theory and theorist are constrained, indeed governed, by the facts. Rather than the other way around, theory must always confront and conform to the facts. The theory must yield refutable implications.

This is from a paper by Clemson University's Daniel Benjamin, read it here.

For those of us who are familiar with Professor Steven N.S. Cheung's work, we will not fail to notice the close affinities between the two professors' views on economics. Afterall, Professor Cheung wrote his path-breaking doctoral thesis, The Theory of Share Tenancy, under Professor Alchain!

Thursday, January 05, 2006

Dumb Luck!

Arnold Kling at Econlog wrote:

"...If institutions are important, then this raises questions about how institutions get to be what they are. Are there strategies for achieving institutional reform, including ending corruption or strengthening property rights? Can institutions change suddenly, or do they evolve gradually? Why are we fortunate enough to have institutions that are conducive to growth, while other societies are stuck with dysfunctional institutions?"

Economists certainly know far more about how institutions perform once they are there already than how they come about in the first place. This is why it is so dangersous, in my view, for economists to give advice to countries that are underdeveloped.

These economists know almost nothing about how the relatively well functioning institutions come about, they only know some institutions once in existence (well defined and enforced property rights, relatively free media, check and balances in the political system) can generate good outcomes. Equipped with such extremely narrow and limited knowledge, they then tour around the world and give advice to underdeveloped countries. Needless to say, knowing how existing institutions function is a very different kind of knowledge from knowing how to bring about good institutions. And the record of economists in helping underdeveloped countries grow is dismal, I am afraid.

As to Arnold's question on why some countries have institutions that are conducive to economic development, while others are stuck in bad institutions, my answer is simple: DUMB LUCK!

I will write more on this topic...

A Bridge Too Many!

Today's edition of The Hong Kong Standard has a story on an economist's forecast of Hong Kong's economic growth this year.

"As exports and consumer demand weaken in the latter part of this year, future growth momentum needs to come from increased land and construction investments, which have lagged the rest of the economy in the past few years," said Alan Siu, associate professor at the university's school of economics and finance.

What should then be done to prop up growth?

"Siu said the government needs to approve big-ticket infrastructure projects such as the West Kowloon Cultural District and the Hong Kong-Zhuhai-Macau bridge."

So professor Siu thinks that prime-pumping is the way to go in order for Hong Kong to maintain its growth momentum. Hmmm, if promoting growth is indeed so easy, Japan's economy should have recoverd long ago after so many years of massive government spending.

Guess professor Siu has never read stuff written by Frederic Bastiat, who in 1848 wrote:

"[P]ublic spending is always a substitute for private spending, and that consequently it may well support one worker in place of another but adds nothing to the lot of the working class taken as a whole." (Italics in Original)

That is from Bastiat's What is Seen and What is Not Seen.

Tuesday, January 03, 2006

Government Cannot Eradicate Scarcity

In today's South China Morning Post, a story reports that:

"Florists in the popular Mongkok Flower Market have called on the government to help them survive rent increases of up to 60 per cent."

What happens is that the market judges selling flowers no longer is a good idea in the shops now occupied by the florists. What's wrong with that?

Afterall, the visible hand cannot eradicate land scarcity, which is one of the underlying forces which drive up rents in the first place.

Hayek vs Stiglitz: Who is Right?

I was re-reading Hayek's 1945 piece, "The Use of Knowledge in Society" a couple of days ago.

As I understand it, one of Hayek's main messages in that piece is that due to the dispersed nature of certain kinds of knowledge (knowledge of particular time and circumstances), market is the best institution (compared with other known alternatives of course) humans have stumbled upon to help them utilize such knowledge in productive ways.

If so, then how should we reconcile Hayek's insight with what people like G. Akerlof and Joe Stiglitz, have argued: dispersed knowledge (or in their terms information asymmetry) is the source of market failure!

How can markets deal with the problem of dispersed knowledge effectively in one case (Hayek's view) and fail to deal with the same problem in the other (Akerlof's and Stiglitz's view)?

Comments are open.