Monday, 30 April 2012

Economics of the Manchester Derby

Reclaiming past honour
Tonight is arguably the biggest football match, at least of this season, in the English Premier League; as Manchester City take on Manchester United for this year's title and bragging rights for years to come[!]. But more so it is a collision of two very different financial models.

United have since 2005 been owned by the Glazer Brothers through a leveraged buyout; who brought the club into private hands after its public flotation on the London Stock Exchange in 1991. The debt incurred from the leveraged buyout has been paid down with the equity generated through United's earnings; Draining out at least half a billion dollars from United in recent years.

In contrast, City's fortunes have turned in the last decade, from festering in the third division of English Football to Premiership dominance, due to the direct ownership of the club by the Sovereign Wealth Fund of the Abu Dhabi Investment Group since 2008. City's Debt was converted to equity, enabling further spending on lucrative contracts for topflight players. Last year City reported a loss of over $300 million bankrolled by its profligate owners. Chelsea have followed a similar model through the ownership of the Russian Oligarch, Roman Abramovich.

Both Models allow for low risk-averse strategies; but succumb to the single-minded pursuit of economic profits. The English Premier League in general has a more competitive and less regulatory environment since it was founded in 1992; compared to the strangling duopoly of Barcelona and Real Madrid in La Liga, the top-flight division in Spain. However, the Premier League's mercenary and fleeting nature does not engender club and team camaraderie, which has reflected in England's anti-climactic performances in the Euros and the World Cup since 1992; in contrast to the replete trophy cabinets of its continental rivals.

The Premier League's financial model differs greatly from the the Bundesliga, the top division in Germany, where many of the clubs like Bayern Munich are majority owned directly by the fans. This fosters a long term relationship between the club and the community but allows for high risk-averse strategies both on the field of play and in management. The difference is also reflected at the macro level in the century-old variation of financial institutions between market-led Anglo-Saxonism and bank-based corporatism of Teutonic models.

European wide club competition is limited compared to the level and intensity of sports played out in other big economies, like the US. Only in a greatly integrated European league would the different mindsets be thoroughly tested, the Champions' League unfortunately does not offer that platform. Nevertheless, here is hoping for a Blue Moon over a goal-fest derby tonight!

Sunday, 29 April 2012

Multiplier Effects

Flexing for expansion
The contrasting impacts of government spending are shown in the above graph under two very different exchange rate regimes: flexible and fixed. Under a fixed exchange rate regime the level of the exchange rate is predetermined as was the case under Bretton Woods for the US Dollar and has been the case for a number of European currencies prior to the adoption of the Euro under the European Monetary System.

In essence, under the Mundell-Fleming Model of Open Economies, a fiscal expansion in fixed rate regimes leads to higher output and crowds out monetary policy. In order to maintain the fixed rate, monetary policy is eased and money supply expanded to return interest rates to the equilibrium level. The fiscal consequences under a flexible rate are reflected in the appreciation of the currency; which with higher interest rates offsets any positive effects of increased fiscal spending.

The relevance of the above graph, which is made with long run data from 1960 to 2007 of 45 economies, shows the fiscal multiplier, the change in output given a change in government spending, of the two different regimes. The fiscal impact after four quarters turns negative under a flexible rate; whereas after four quarters the fiscal multiplier is higher than one under a fixed rate, such that a given increase in £1 of government spending leads to more than £1 increase in output.

We should handle the relationship with a grain of salt as it would depend on the cyclicality of fiscal spending, controlling for the sizes, openness, government debt levels of different economies, and so forth. Yet compared to the policy response to the last known global crisis, the Great Depression in the 1930s, the impact of current fiscal boosts in advanced economies is accommodated by lax monetary policy and the spillover effects of increased trade for emerging economies. During the Great Depression a zero-sum protectionist game of tit-for-tat was mercilessly played out which laid the foundations for radical ideologies and future wars.

Thursday, 26 April 2012

Prices of Gold

A hardy Double Centurion* (not out)
The above graph chronicles the real price of a troy ounce of Gold for the past two centuries. After maintaining the Classical Gold Standard's price level stability between the Napoleonic War and World War I, Gold had a largely turbulent time in the twentieth century being held under rigid international monetary systems at one end and freely-determined private markets at the other; the latter saw Gold as a viable investment.

Under the modern International Monetary System, an abortive outcome of the collapse of Bretton Woods in the early 1970s, Gold reached its real price peak before collapsing like a house of cards only to be sought again from fleeing investors in the wake of the Dotcom crash in 2001. Investors have perennially seen Gold as an intergenerational safeguard against inflation, financial repression, and other forms of imprudent investments. The chart has not been updated for post 2010, but currently Gold has been trading above $1650 in current prices; around $1500 in 2010 prices, still below the peak reached in the early 1980s.

Tuesday, 24 April 2012

El Dorado

A tale of two Cities
Like the lost City of Gold, El Dorado, Mexico's potential has never been found. In the post-World War II (WWII) environment, only the US stood apart as the reservoir for potential economic growth. In designing the international monetary system, US policymakers opted for a world economy centred around stable dirigisme. Capital controls effectively blocked speculation and bank-led credit growth. The environment was conducive to capturing the 'social capabilities' of war ravaged Europe and Japan, who by the end of Bretton Woods had joined the US at the core of the Global Economy.

Following the collapse of Bretton Woods by 1973, a number of economies took over the responsibilities of Europe and Japan and started on the long arduous path of catchup and convergence; one of which was South Korea. After the smooth transition to democracy in 1987, from three decades of 'benevolent' dictatorships of Chun Doo-hwan and Park Chung-hee, South Korea developed sound institutions and globally-competitive corporate Chaebols. South Korea is currently the twelfth largest economy and sixth largest exporter in the world; a far cry from the conclusion of the Korean War in 1953 when it was poorer than India.

Latin America has, on the other hand, reverted to dictatorship and misrule following WWII; Latin America during the first age of globalisation, 1880-1913, was the emerging power of the times. Up to the 1980s, Mexico seemed to have been on the path to convergence with the advanced economies. Mexico suffered from political instability, corruption, and degenerative institutions, culminating in the 1994 Tequila Crisis; when the peso was devalued and a rescue package from the IMF and the US treasury was required.

Generally, Latin America defaulted on its debts in the 1980s after global capital markets tightened. However, Brazil in the past seventeen years has had a stable political climate under the presidency of Fernando Cardosa, 1995-2002, and Luiz Inacio Lula da Silva, 2003-2010; the current president, Dilma Rousseff, is fighting off entrenched nepotism and rent-seeking within the economy.

For an economy like Mexico, bordering the largest economy of the twentieth century, not to have achieved sustained growth is appalling. Alas, the economic heart of Latin America now lies southwards in the sprawling megalopolises of Sao Paolo and Rio de Janeiro.

Monday, 23 April 2012

Oceanic Trade

The first age of International Trade
The map above shows the cumulative shipping journeys of British vessels between 1750 and 1800. What we can see here is a treasure trove of data describing the historical narrative. Firstly, you can make out Captain James Cook's three voyages to the pacific between 1768-79.

Secondly, World trade is booming between civilisations that had no option but to use the 'middleman' in the past; which led to inefficiencies, costly transactions, and low economic growth. The main middlemen in the middle ages were the Mediterranean city states and Middle Eastern traders; the Venetians had more or less a monopoly on spices to Western European Markets.

However, once the Portuguese discovered a sea route to India through Vasco Da Gama in 1498, there was finally a route to the thriving eastern civilisations which avoided the egregious middlemen. Through a series of good fortune, sound institutions, and the English Channel, the British established a global trading network which by the late eighteenth century connected nearly all parts of the known world.

Thirdly, we can also see the summerly voyages of whaling ships to Hudson Bay and the Northern regions of Canada. A similar pattern existed with Dutch whaling voyages to Spitsbergen, present day Svalbard.

Fourthly, the triangular trade in Slavery between Africa, the Americas, and Europe, is rife and rampant. Britain dominated the triangular trade in slaves, sugar, and goods. It was not until the vigilant campaigning by William Wilberforce, the Quakers, and others, the Slave Trade Act of 1807 abolished the trade, but not slavery itself, in the British Empire. It was not till 1833, earlier in history than most other 'civilised' parts of the world, when slavery was finally banned in the empire.

Lastly, you can make out the clear wind patterns which determined the journeys of pre-industrial oceanic trade. Most clearly visible in the Indian Ocean, where monsoonal patterns completely reverse the direction of the wind from Winter to Summer.

Saturday, 21 April 2012

F1 Ignominy

A bloodied sport
If there is any sport of questionable moral value then it is Formula One. Setting aside arguments over its gas-guzzling octane fuelled stagings, the noise, air, and visual pollution of hectares of vintage land across the globe, and its greedy financial model, the sport, if one can call it such, is morally corrupt. None more so exemplified then by the boss of this private empire, Bernie Ecclestone.

Money from race hosting rights trumps television advertising and other sources of revenue. Leading Mr Ecclestone to cater to emerging markets in recent years by establishing the Indian, Chinese, Singaporean Grand Prix on the race calender. The Bahrain Grand Prix, being held over this weekend, was setup in 2004 with much aplomb at the fixture's novelty, which included 'dressed' Pit Girls, non-alcoholic drinks, and glued sand; opening up an enormous middle eastern market.

By not recognising the Bahrain race's significance in justifying the minority-absolute rule of another Middle Eastern Despot, Mr Ecclestone and his sport become morally vacuous. Sport has always been loaded with politics. It is the cultural symbolism of sport that enables the appeasement of the masses. Bahrain is currently locked in a one-sided battle to oppress its majority shia population in favour of an extractive elite. By neglecting this, Formula One has lost its appeal to many, including myself.

Links of the Week

This Week's recommended economic writings:

Friday, 20 April 2012

Thirty-six Views of Mount Fuji

The Great Wave off Kanagawa
Building from an earlier post on exchange rates, the recent upward wanderings of the Japanese yen is a lingering concern over the future health of the Japanese economy. The rate went under 77 Yens to the dollar in recent months, from a competitive value of 360 yens back in the good ole' days of Bretton Woods; as an aside, Japan maintained an undervalued currency for nearly thirty years following World War II, enabling catch-up growth under the Japanese Economic Miracle to occur; contrast this with the immediate present-day demands for the rebalancing of China's supposedly undervalued currency.

In the last two 'lost' decades Japan has stumbled along; even though the growth in Japanese Total Factor Productivity, which is the measure of the efficiency in which capital and labour are used, and GDP per capita in recent years have been higher than the US and the other G7 economies, respectively. Nevertheless, Nominal GDP in the third quarter of 2009 sank below its level in 1992, the Nikkei 225 is a far cry from its reach of 39000 at the height of the Japanese asset bubble in 1989, and wretched deflation has not lessened its grip, helped along by the chronic mishandling of the economy by its conservative and cowardly central bank, the Bank of Japan.
Rainstorm Beneath the Summit
Last year, Japanese merchandise trade, the blue line above, moved into deficit for the first time since 1963. The income stream from her foreign assets, enabled Japan to report an overall current account surplus but the signs of the coming effects of pervasive structural weaknesses and corporate laxity are there. I admit, the trade deficit in 2011 is partly due to the devastating March Tsunami, which disrupted supply chains, dented exports, and increased fuel imports. However, with the abruption of the Carry Trade, which was a common lucrative pastime in arbitrage back in the Great Moderation, the Japanese yen is unlikely to get any weaker.

At its simplest, the current account surplus is the positive identity of savings minus investment. Saving rates have declined with a rapidly ageing population; under the life-cycle hypothesis the young save the most. As a proportion of Japanese household incomes, savings have declined from 14% in 1990 to 2% in the last couple of years.

In the previous two 'lost' decades, lack of private savings were offset by rising corporate savings leading to a current account surplus; besides structural reasons, this is no longer going to be the case for the following dynamics. Government debt to GDP is currently touching 130%, second only to Greece in the developed world. Bond yields have been low thus far due to the captured domestic bond market; 95% of government debt is held by Japanese investors. With a current account deficit, sustaining a budget deficit of 10%, as it did in 2011, will require foreign capital inflows which would put pressure on hitherto artificially low yields to increase. High yields will cut into Japanese corporate earnings and require liquidation of Japanese foreign assets, further depriving already weak global capital markets and cutting Japanese corporate savings.

Indeed there is enormous room for improvement in Japan. However due to its political stasis and lack of consumer culture, Japan is likely to further suffer from a hat-trick of 'lost' decades.

Wednesday, 18 April 2012

"I'm Spartacus"

Pax Americana et al
The Stockholm International Peace Research Institute published last year's updated military expenditures; the global total was nearly $1.75 trillion, around 2.5% of Global GDP. Of the top ten spenders, shown in the table above, four are emerging economies, five are advanced economies, and one is an oppressive feudal state. Purchasing Power Parity measured prices should increase emerging economies' expenditure by a factor of 1.5 to 2.

In Market Exchange Rate conversions, Russia has seen a notable increase of 9% compared to 2010, overtaking Britain and France for the third spot. The US still maintains more than four-tenths of the share of global military expenditure. India and China have seen increases corresponding to their economic growth. Brazil, nevertheless, maintains a smaller share of GDP, lacking the military-industrial complex which occupies many a government complexes from Riyadh to the Kremlin.

Much of the military capital stock for emerging economies is outdated compared to advanced economy militaries. India is restocking its air force with a $10 billion contract won by the French aviation manufacturer, Dassault; much to the chagrin of Britain's Eurofighter Typhoon and DFID's Aid Budget. Also on 19th of April, India successfully tested an intercontinental ballistic missile; a critical instrument for sustaining détente.

China has launched its blue water navy in recent years with plans to fortify the 'first island chains'. Nevertheless, the accumulated military capital stock of the US is enough for it to be the dominant military hegemon at least until the middle of this century; for instance, the US currently maintains eleven naval carrier strike groups, each capable of amphibious assault. Other states currently with similar strike capabilities are arguably only France, India, and Russia, with one carrier strike group apiece; China and Britain are set to join them by the end of this decade.

However, with Britain and France starting to pool their military resources, and with the slight possibility of other European nations joining in, there are likely to be five or six global standing military blocs with the capital stock and manpower threshold to maintain concerted regional and global power projection capability. Leading to a scenario in which if one bloc, say China, discharges some long held grudge it would be ganged up on by the others. A foreseeable global military order in which there are several permutations of détente and containment being played out; but an order which is increasingly likely to be testy and belligerent with an "I'm Spartacus" conformism.

Financial Repression

gimme' your money
Some estimates of the global public sector support to financial institution during the 2008-09 Financial Crisis have been totalled to at least $14 trillion (Alessandri and Haldane, 2009); around 20% of Global GDP. Reinhart and Rogoff have pooled together estimates of Government Debt of a number of economies for long time periods. The Great Moderation had some of the lowest shares of government debt in advanced economies in the long swathe of economic history.

In addressing high government debt, major economies have in the past used various tools of financial repression. Some include low nominal interest rates, negative real interest rates, inflation, captive domestic audience, caps on interest rates, ownership of banks, and planned allocation of investment and consumption (Reinhart and Sbrencia, 2011). Britain reduced her government debt following the Napoleonic wars from 260% to 100% of GDP in less than forty years. She bettered the feat from 240% to 60% in the Bretton Woods period following World War II, in less than half the time.

One particular concern, in the next few decades, is whether we shall see a repeat of the stealth financial repression tax in order to reduce high levels of government and private debt taken on from the recent financial crisis; transferring incomes from creditors to borrowers in doing so. With increasing present day scrutiny of demand management tools and awareness of past historical naivety which led to investors suffering a real loss after World War II in nearly all economies, it is unlikely we will see a foreseeable drastic decline in debt through financial repression.

The two aforementioned episodes in British Economic History, when government debt plummeted, were preceded by pyrrhic victories from long fought wars. During wars, governments are predisposed to control much of the real economy for the purposes of engagement. At the conclusion of wars, governments take time to relinquish control of key sectors and industries. Similarly tools of demand management and economic policy can be easily geared towards alleviating long term burdens like the debt incurred during wars.

Barring a future global conflict, currently [and fortunately] governments do not have the luxury to use instruments of financial repression without incurring political and economic backlash. Additionally, due to varying levels of regional government debt, with most emerging economies carrying relatively lesser burdens, a co-operative international monetary system based on something akin to Bretton Woods will not reappear.

Wikipedia's Weltanschauung

[This article reads like an editorial or opinion piece and may require cleanup]
Recently, I got into a wrangling with editing at Wikipedia, the online encyclopaedia; and since then my account of seven years has been "blocked indefinitely". I have on occasions added some thoughts on several articles at the website, its purpose to free knowledge for all is an attractive cause to subscribe towards. However the 'crowdsourcing' model, Wikipedia relies upon, is increasingly betraying its own origins.

Aside from criticisms of its accuracy and financial model, Wikipedia is simply too bureaucratic. It has a complex hierarchy based supposedly on 'merit'. At the top of it are around 1500 volunteers known as administrators, of which over 90% are men, with influential vetoes from the selection of new articles to content. They roam the site tracking edits and digressions; working with ad hoc rules, ironically devised to make the entire platform more democratic and accountable. New Administrators are chosen by an elite body of veteran administrators and "staff"; with several standards of 'objectivity', editing thresholds, and 'neutrality' applied towards the selection procedure.

As one of the greatest products of the Internet, Wikipedia has enormous potential to advance scientific progress by pooling the vast volume of Human knowledge into a single platform. However, concomitantly Wikipedia's entire body of governance is due for an overhaul and reduction to simplicity. Wikipedia's Nurse Ratcheds have dissuaded your blogger, amongst many others, from making further contributions to its cause.

Monday, 16 April 2012

Economist of the Decade: 1930s


A man for all seasons
Arguably, Economics as a subject was born perhaps much earlier than the Eighteenth Century; in Plato's Republic there is mention of the specialisation of labour and production within a society; in Aristotle's Politics, money was a means as opposed to an end: "[money] is worthless [...] not useful as a means to any of the necessities of life". The compound etymology of Economics comes from the Greek Oikonomia; from the transliteration of Oikos and Nomos, translated into 'house' and 'rule', respectively.

However, I shall focus on the subject in its present evolution from the Scottish Enlightenment. I will start with the 1930s; a decade which for all intents and purposes has been more instrumental in creating the world as we know it today than any other decade. Without the unfortunate descent into global fratricide and economic depression at either ends of the 1930s, a counterfactual world would be entirely unrecognisable.

When The General Theory on Employment, Interest and Money was published in 1936, Lord John Maynard Keynes was already an intellectual giant. In his magisterial three volume biography of Keynes, Lord Robert Skidelsky describes the man as occupying that frontier area where economic theory met philosophy, morality, culture, finance, and the arts. Keynes as a man was described by his wife, Lydia Lopokova, a famous russian ballerina, as "more than an economist"; Keynes described her as "my bubbling brook of surprises".

Keynes occupied a world which had suffered already from a calamitous global war and was slowly descending into the chasms of another. Economics as a subject was drained of all the economic realities of unemployment, suffering and pervasive destitution. Keynes had a relatively low opinion of the subject, the "purpose of economics [...] was to solve the economic problem [...] so that mankind could live wisely, agreeably and well". Keynes saw the subject as a means as opposed to an end in and of itself. The "end" was the Aristotelian "good life" as expounded by his intellectual mentor at Cambridge, G.E. Moore.

During the Great Depression, in the early part of the decade, Keynes' tour de force against Classical Economics, which continues to squatter in some form or the other to this day, as inadequate in describing the downturn, decried the belief that supply always creates its own demand. Governments need to step in to prevent persistent unemployment and manage demand during downturns.

However, Lord Skidelsky insists the "centrepiece of Keynes' theory [...] is the existence of inescapable uncertainty about the future". In uncertainty, consumers delay their spending plans; companies halt their capital expenditures; the "animal spirits" become depressed. Entirely free market economies are inherently unstable which require stabilisation. Keynes' General Theory was a reduction of his long standing beliefs of the deleterious effects of business expectations, connections between uncertainty and money, and economic disturbances stemming from finance and moving into the real economy.

Lord John Maynard Keynes is my Economist for the 1930s. His impact on the subject and economic policy since has been prodigious. At the conclusion of World War II, Keynes laboured for a stable and rule-based International Monetary System. Keynes passed away on April the 21st, 1946, after a long battle against heart disease; he was Britain's 'de facto Chancellor of the Exchequer' for much of his later life. Lionel Robbins wrote of Keynes: "He gave up his life for his country [and economics], as surely as if he had fallen on the field of battle".

Friday, 13 April 2012

Bagehot's Children

Father of Depression Macro
Walter Bagehot, editor of The Economist, wrote in 1873 in Lombard Street the essential role behooved of a Central Bank in alleviating Financial Crises. In his life, Bagehot had seen exponential, post-Malthusian economic growth and transformation of British Society and Culture by the Industrial Revolution. However concomitantly, with the onset of Industrial Business Cycles, the first modern financial Crisis in 1825-26 was a precursor for many to come in Bagehot's generation. Notably, since the publication of Lombard Street the number of Global Financial Crises have steadily declined in occurrence. After 1873, there were major global crises in 1884, 1893, 1907, 1929-33, and 2008-present.

With the full scope of Modern Economic History behind him, Bagehot observed the single transmission mechanism in a Financial Crisis which leads to an economic downturn is the investor flight to safety. Investors in a crisis realise ex post their ex ante holdings are risky and illiquid; resulting in greater demand for a limited supply of liquid and safe assets, such as government bonds. In turn the essential tasks performed by financial institutions in providing risky capital and investment to the real economy are broken down; leading to falling demand, production and output. This feature of crises is almost universal. Bagehot recommended four rules for Central Banks in order to placate private investors by giving them all the risk-free assets they may want.

Firstly, a Central Bank should limit the fall in the supply of safe assets and to do so by "lending freely to all" who have a level of collateral; secondly, it is unwise to set an ex ante limit of the amount a Central Bank will commit to in a lender of last resort operation; thirdly, all financial institutions and Banks should be treated the same, otherwise favouritism introduces unnecessary risk, aka Lehman Brothers; and fourthly, Central Bank should lend at a "penalty rate" to prevent investors going off the hook and creating future moral hazard, an area for ample, lifetime's worth of research in the context of the current crisis and the 'Bernanke Put'.

The monetary responses, or the lack thereof, to the Great Depression were the antithesis to the Bagehot Rules. A liquidationist Gold Standard and Austrian Mentality was the law of the land in the late 1920s. Leading to stasis, infamously summarised by Herbert Hoover's treasury secretary Andrew Mellon: "liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate [...] it will purge the rotteness out of the system". With the current crisis, the Fed and the Bank of England were on the mark in terms of responding frantically with the Bagehot Rules; here and here.

Thursday, 12 April 2012

Institutional Wunder

Sharing whilst you still can
Recently, I have become part of an essay pooling network. It allows one to share one's work and essays whilst reading those of others; the system runs on a shared email address where all the work is pooled from the individual recipients. The token input to partake in it is not specified; ending in some 'mediocre' individuals putting in one flimsy off-topic essay, like your ever agnostic blogger, whilst other 'benevolent' individuals their entire corpus.

Initially, I was sceptical of such an arrangement. It is prone to the universal Tragedy of the Commons; a fate befallen many a poorly organised open venture. It happens when many individuals take advantage of a collaborative venture by acting rationally and depleting or denying others of access and consumption. The resulting short term payoffs are higher than long term payoffs, which these 'rational individuals' discount for their respective time horizons. Such modern day Tragedies include over-irrigation, over-fishing, public parks, pollution and other free-riding activities. Diverging Solution offered include ownership or privatisation of the Commons, to overbearing government regulation.

On the other hand, Elinor Ostrom, the first woman Nobel Laureate in Economics, has downplayed the supposedly frequent occurrence of the Tragedy of the Commons. In her research on 'Common Pool Resources', she conducted on-field research, ranging over decades, from Turkey to Sri Lanka studying the various open access, and centuries-old arrangements in farming, fishing, grazing, and so forth. Many of these arrangements are sustained over the long term by a tight knit system of rules and institutions. Rules such as the definition of boundaries, quota of provisions, and sanctions [social or otherwise]; Institutions such as monitoring, accountability, and 'nested enterprises'. Ms Ostrom's work has been extraordinarily influential in highlighting the moot observation of the 'milk of human kindness', but more so for the impact it has had on solutions towards climate change mitigation to intergovernmental pacts and resource sharing.

Returning to the essay pooling network; being the sceptical economist, initially I contributed a flimsy piece adapted from a post at this very open access weblog. This was done in order to confirm for myself the authenticity of the institutional arrangements in place; gaining no friends in doing so. Having received an email telling me off for my token offering, I obliged with one of my 'original' essays on the Monetary Mechanisms of the Classical Gold Standard.

I still very much doubt the long term sustenance of the essay network. It lacks the rules and institutional frameworks, suffers from a version of Akerlof's lemons problem, in that mediocre essays drive out good essays, and additionally its just a 'one-period game', in that once in the network one's further contribution is not necessary; very much like a Ponzi Scheme: access to additional work relies on gaining further members. Plus the entire network is run on Gmail!

Tuesday, 10 April 2012

A Case for BIICs

The East Indies: Explosive Potential
Goldman Sachs, never an Investment Bank to shy away from the spotlight, published a paper in 2003 entitled "Dreaming with BRICs"; thus the oft-used acronym BRIC was born, which stood for a bright future of a world rebalancing towards the heady future economic giants of Brazil, Russia, India and China. Indeed the Investment Bank predicted by 2010 the four economies would comprise 10% of World Output; that was ex ante to the 2008 Financial Crisis, they comprised 15% at the closing of the last decade. All four are currently in the top ten premier-leagues for nominal GDP and PPP.

Despite all the euphoria surrounding a new world order built on BRICs, each of the individual components has its own unique set of challenges and problems. Brazil is prone to a pugnacious labour force and macroeconomic mismanagement; Russia is misruled and institutionally weak; India is ill-governed and a political pandora's box; and China has enormous unsustainable imbalances in consumption, savings and investment and a chronic lack of social institutions.

Yet there is no doubt these economies, despite their pitfalls, have great unrealised potential. Amongst many forecasts of future GDP, last week I made a GDP ranking based on an adjusted Solow model for 2050. India and China by now are economic superpowers, in a tripartite global economic order, alongside the United States. Brazil is not far behind; both PwC, Goldman Sachs, and I, predict it to be the fourth largest economy in a few decades; it recently overtook the frail British economy to become the sixth largest.

However, Russia's economic success, despite its enormous unused capital base and natural resources, is tentative. Whereas Indonesia, an archipelago of islands stretching the equator in South East Asia, clearly is seldom mentioned as a future success story. Indonesia is still scarred by the 1997 Asian Financial Crisis when its currency, the Rupiah, came under severe speculative attack on the heels of a successful self-fulfilling attack on the Thai Baht. Indonesia suffered the most amongst the East Asian nations; losing 13.5% of GDP that year.

Indonesia had under Suharto put into place institutional liberal reforms led by a coterie of hardheaded economists, known as the 'Berkeley Mafia'. Since the restoration of democracy and the 1997 crisis, Indonesia has seen robust growth. The islands are blessed by diverse ethno-linguistic groups and a culture which is a gamut of historical interactions. Indonesia deserves to be on par with Brazil, India and China. It is now a low-wage competitor to China and slowly integrating itself into Global Supply Chains. With an underused population of nearly 240 million and rising, Indonesia has enormous room for improvement which it is slowly realising.

I propose the adoption of a re-coined acronym: BIIC. Russia is sadly too politically repressed; it lacks proper functioning property rights, contracts, and rule of law to sustain long term capital intensive economic growth; befitting an advanced economy. Indonesia should take its place in the pantheon of emerging nations.

Monday, 9 April 2012

A Pound of Flesh

Marshalsea Prison
In Payback: Debt and the Shadow Side of Wealth, Margaret Atwood notes the Aramaic word for debt and sin are one and the same. With the courtesy of The Economist, the graph above shows the cumulative private and public debt in 2008 of major economies. Since the collapse of Bretton Woods there has been a gradual rise in leverage. In Britain, whose total debt since 2008 has soared to nearly 500% of GDP, the current coalition government is bent on deleveraging as fast as possible; Britain's public and private debt levels are set to grind down to the levels of circa 300% in a decade or so.

The increase in the share of financial and non-financial corporate debt has been the worrisome trend of the Great Moderation induced credit binge in Advanced Economies. Leveraged buy outs and takeovers, which were all to common a few years ago, were the hallmarks of the euphoria. Hedge Funds and Private Equity firms, which rely on borrowed money to finance their returns, required only sustained economic growth, so the debt could be repaid, and rising asset markets, so that companies could be sold off.

Lax financial regulation, lack of institutional checks, and drowsy rating agencies, who would serve as a key circuit breakers for financial markets [in theory at least], failed to stall the rising tide upto 2008. Such were the blatant signs of excess and declining marginal products that even average ratings of the quality of corporate debt declined over time:
Stating the obvious
A speech by Fabrizio Saccomanni, the Director General of the Bank of Italy, goes some way to elucidate the times ahead. Mr Saccomanni calls the current post-crisis period of slow deleveraging as a solution to the new "Global Triffin Dilemma" of overwhelming indebtedness.

Saturday, 7 April 2012

Premodern Growth

Rotten Luck
Michael Kremer published an all-encompassing paper on Growth Economics in 1993 entitled Population Growth and Technological Change: One Million BC to 1990. A part of the paper I found worthy of sharing is the table above which shows the descending order of the sizes of Land Masses which were settled by Humans from the long migration out of Africa.

In 1500, the Old World which consists of Eurasia and Africa had a higher population and population density than other parts of the habitable Globe; with several thriving civilisational powers. The Americas by 1500 had an agricultural society in Central Americas and the Andes with moderately complicated structures and advanced forms of instruments, like the Calendar. Australia, which since the Ice Age had separated from the Eurasian Land mass remained an hunter gathering primitive society numbering some 200000. Coming further down in size, Tasmania, an island of the south eastern coast of Australia, had an even smaller population without the hunter gathering techniques of their cousins across the Bass Straits; and the habitants of Flinders Island, an island the size of London off Tasmania, had died of starvation and thirst after the separation of their island by rising sea levels, albeit after suffering first from a technologically regressive society.

In the evolution of Western-led modernity and eventual Industrial Revolution, the paper highlights a key feature of premodern growth: the necessity of contiguous habitable land for technological progress and sustenance for a large level of population. Allowing for a number civilisations to develop, trade, and compete.

Friday, 6 April 2012

The Wealth of Nations

A New World Order
I have constructed an economic forecast of Annual GDP of countries in 2050, the results of the top twenty are shown in the above graph which are comparable to those predicted by Goldman Sachs, PWC, amongst other Investment Banks' and Central Banks' Forecasts. I have attached a link to the excel file, which you can download here; enclosed are the various calculations and assumptions I have chosen that I will expand upon in the following paragraphs.

I use a simple Solow Model with some tweaks of my own. The Solow model is an exogenous growth model based on Labour, Capital and Productivity. I have done away with Capital Deepening, Population Growth, and Asset Depreciation Effects; which would be difficult to model.

The first set of data points I chose were the population estimates for 2050 calculated by the International Data Base Division of the United States Census Bureau. In the excel file, you can see this in the sheet entitled "2050 GDP forecast Calculations". India is now the country with the largest population, 1.66 Billion, China is at 1.3 Billion having reached fertility replacement ratio by 2035, and US is still the third largest at 422 million due to immigration; other noteworthy countries are Nigeria which has 400 million souls, Ethiopia at 280 million, and Russia which has declined to 109 million.

I assume real exchange rates are constant, in that inflation differentials are the only determinants of exchange rates. Additionally, an average worker of the global labour force has a value-added baseline output of $20000 in current dollars. This is a weak assumption explained by the constant exposure to non-rivalrous and non-excludable Knowledge, and the insignificant differing effects of culture, religion, and ethnicity on human ability and sentience.

Thus far, we could show those economies with the largest populations would have the largest economies. The reasons for economic divergence are the differing qualities and quantities of capital and levels of productivity which are determined by 'types'. Such that economies like Nigeria and Ethiopia, due to current and past histories and poor social institutions, are endowed with 'low' productivity and capital; economies like China and Brazil are endowed with 'medium' productivity and capital; economies like the US and UK with 'high' productivity and capital; and finally economies like India and Indonesia which have both 'medium' and 'low' types of institutions and environments are described as 'lowmed'.

Baseline figure for capital per worker is $20000; which is scaled for low, lowmed, medium and high capital types by multiplying the baseline with 0.5,0.75,1, and 1.5, respectively; you are welcome to change the arguments of the products to construct your own rankings. With both labour and capital sorted; productivity is a measure of the efficiency with which both labour and capital are used and the application of the levels of technology. The sum of labour and capital are multiplied by 0.5,0.8,1.2 and 2 for low, lowmed, medium and high productivity types, respectively. The conclusion of which gives the income per capita.

Economies like the US and UK have an income per capita of $100000 in 2050, whereas Bangladesh has $15000; compared to $500 today, economies like Bangladesh have relatively converged to the levels of advanced economies by 2050 due to prolonged access to global capital and technology, and rising human capital and education of the labour force. However at the same time with diminishing returns but  technological improvements and perhaps paradigm shifts, advanced economies have not stagnated. The results are oversimplified, consequence of which leads to economies like Russia having overestimated GDP. Russia is classified as having 'high' capital and productivity when it should have 'lowmed' productivity because of its institutional weaknesses and, due to its vast resources, 'high' capital; a venture for another day.

Additionally I had some fun in calculating military expenditures for the countries in 2050. The types are 'strong', 'average', and 'weak' reflecting the willingness to maintain power projection and a standing military; spending 5%, 2%, and 1% of 2050 GDP, respectively. The results are alongside in separate sheets in the excel file. The graph below is the ranking:
Hey big spender
Just slightly changing the weightings for Capital and Productivity types alters the rankings. Nevertheless when dealing with long term economic growth, a county's population size matters. Brazil, India, China, and Indonesia feature prominently as economic giants by 2050. In the following experiment, I have reclassified Russia as 'middle' type. The weightings of capital are 0.2, 0.7, 1.2, and 1.6 and weightings for productivity are 0.4,0.8,1.2 and 2, for low, lowmed, medium, and high, respectively. The new rankings are in the graph below and the new excel file is accessible over here. As with all economic forecasts, long term especially, we should read it with some care.
Another World Order

Thursday, 5 April 2012

Links of the Week

I am currently on a packed train to Liverpool for the extended Easter Weekend. Here is this week's recommended Economic Writings:

One Thousand and One Nights

Sowing the Seed through the Sands of Time
Simply put, the wonders of Economic History allows us the application of Economics and Econometrics to History; identifying long term trends without which ideas and issues become diluted. An intriguing paper, which I wish to handle with some care, comes to the conclusion that the current autocracies of the Islamic world are conterminous with the broad geographical spread of the Islamic Caliphates of the late-first and early-second Millennia


The relationship is robust because when we compare the Muslim majority countries outside of the conquered lands of the 'Islamic Golden Age', we find they do relatively well in Democratic Scores compared to those within the perimeter of the Black line, in the map above. No other indicator except the conquered lands of the early Islamic Empires, the author of the paper, Eric Chaney, concludes comes to explain this 'democratic deficit' in the Islamic World. Indicators such as Islamic culture or the Arab-Israeli Conflicts; both often being dallied around willy nilly in debates over Islam and her effects.

The implications of which raises concerns as to whether the early centuries of Islam were inherently different from those of the later centuries. In particular, the form of Islam practised within present-day countries which were conquered by the first Caliphates is different from that practised outside of the 'Caliphate'; in countries such as Indonesia, the world's largest Muslim Democracy, Bangladesh, or, even, Senegal.

Many scholars of Islam and the Koran, know that the sacred book has been in constant change. Caliph Uthman, the forth ruler of the Muslims, established a single, definitive version when he realised several different versions of Angel Gabriel's Message to Muhammad were circulating. Interpretations of the Holy book on issues such as the abolition of slavery, or literalism of "slay the unbeliever wherever you find him" are ultimately peculiar to the tumultuous birth of the religion in the Seventh Century.

Extending the thought further, it could be seen those Islamic economies with an entrepreneurial class and a vibrant society are the ones which add nuance to the interpretation of the Koran and happen to be outside of the conquered lands. A similar analogy could be made with the schisms in Christianity, in the literal interpretations of Saint Paul and his Apostles, and long term economic success and political openness. Using an indicator which measures the extent to which a society literally interprets the Suras of the Koran could be an hidden instrumental variable and an area of further research to explain the past and present diverging institutional weaknesses of Islamic economies.

Wednesday, 4 April 2012

The Comedians

Losing will

Lately, I have become very fond of a Weblog by Messrs Acemoglu and Robinson. It is partly a way for them to publicise the book they co-authored, Why Nations Fail; which is an outstanding read and would be a fitting Easter Desert Island Book. Yesterday they had two excellent posts on Haiti and its Economic History: here and here.

The Island of Hispaniola in the Caribbean is shared by two countries: the Dominican Republic, in the East, and Haiti, in the West. Messrs Acemoglu and Robinson incite the reader by showing them a graph of the respective diverging fortunes of the two economies, which I reposted above. The two economies despite sharing a common geography and history have diverged since World War II.

The Comedians, in Graham Greene's eponymous novel, are three hapless men entangled in the mesh of Haitian Anarchy. To describe his situation, Mr Brown, the novel's protagonist, says "there is no point of return, unremarked at the time, in most lives". Haiti has always been at the point of no return never more so than in the murderous reign of Francois Duvalier, portentously known as Papa Doc.

It is a society that is, for the lack of a better word, fragmented. In Haiti: The Aftershocks of History, Laurent Dubois argues Haiti has always been susceptible to "powerful political leaders and institutions, inside and outside the country, [who] have ignored and suppressed the aspirations of Haiti’s majority". The majority of Haitians, in fact, themselves have held a long reluctance to accept the economic inducements of Globalisation, and the investment and specialisation that comes with it. Haiti, despite gaining formal independence in 1825, is a stagnant economy, the product of its past and present; and which occasionally makes an appearance in the mainstream media when it is subjected to dire famine or natural disasters. That is an all too sad story in and of itself.

Tuesday, 3 April 2012

Austrians gone Mad

Fair is Foul, Foul is Fair: Hover through the fog and filthy air
Recently, your Blogger has been following Alex Goodyear's Weblog. Mr Goodyear is sympathetic to an heterodox school of economic thought that stems from the collective and evolving philosophies of Murray Rothbard, Ludwig Von Mises, Fredrick Hayek, inter alia; mislabelled the 'Austrian School of Economics'. Let us not confuse it with true Austrian inspired philosophies from the Vienna Circle of Logical Positivism, whose impact on Economics and Science since has been invaluable, to the beginnings of Psychoanalysis in the City of Dreams, and further still, of the extraordinary musical wunder from Mozart to Mahler.

The Austrian School unfortunately is anything but 'Austrian'. Its serious practitioners [those not including past and current Republican presidential runners!] have a deep mistrust of econometric techniques and an insouciance towards the scientific application in and of Economics. Their theories on Monetary Economics is based on an ephemeral natural rate of interest determined by the fundamental forces of the 'free market' and not by a seigniorage haemorrhaging Central Bank; What Austrians think of as 'free markets' are ultimately unfree, they are a political dystopia, a Hobbesian State of Nature. Further, Austrians prod for a return to the good ole' Unit Free-banking days which would prevent all the vices that come with credit-binges, or so it is claimed!

Their theory on business cycles ignores market defects, sticky wage inflexibility and rigidity. Any government induced stimulus prevents the long term, albeit ahistorical, structural adjustment required of labour and product markets to get rid of the excesses of the past. Additionally, their theories on money longs for a return to the supposed nominal anchor and stability provided by precious weights like Gold; I have argued in the past against its worth! The gold standard was an accident of its time. Any return to it would be calamitous.

So it is not surprising, that I look askance at the Austrian School. Paul Krugman has described it "as worthy of study as [the] phlogiston theory of fire". Imposing overt ideology on Economic History, one of the few natural experiments Economics has, is ultimately poisonous. It is best to read old thinkers, like Von Mises and Rothbard, with a grain of salt.

Born to Rule

Anointed Progeny
John Strachey, a 19th-Century British civil servant, when disembarking into Calcutta remarked "there is not and never was an India". The form of India that exists today is the product of misguided Fabian-Nehruvian economic policies. On the heels of the assassination of Mahatma Gandhi in 1948, newly born India was shaped by the one-sided socialist ideals of self-sufficiency and industry proclaimed by its first prime minister, Jawaharlal Nehru.

The Nehruvian settlement confined India to the whims of a narrow class of english-speaking rent-seekers. The Indian Global Diaspora, since, has been a testament of the fifty years of unrealised potential following independence in 1947; without opportunities at home and alienated by a self-selecting line of rent-seekers, many able Indians felt their hopes would lie in emigrating. An economy which is unable to retain its best and brightest can never claim to be on the path of success.

India is still sorrowfully hijacked by an intergenerational political class. Of which the Gandhi-Nehru scion stands out, who have no lineage to Mahatma Gandhi and have had a stranglehold on Indian Governance. Notions of introducing stringent caste based reservations of places in government-aided educational institutions and public employment would only go to further severely prevent any foothold of much-needed meritocracy to enter in Indian Society and Politics.

Recent purging in China of a Maoist Politician, Bo Xilai, is the continuing legacy of Deng Xiaoping's determination to reverse Mao's assault on meritocracy; Mao's Cultural Revolution, which was nothing to do with culture, was a genocidal culling of China's Intellectuals and Liberal Class in the 1960s. Nevertheless, China's next generation of political leaders, to be selected this year, have come from a highly educated, technocratic class of meritocratic mandarins.

If India is to follow in China's economic footsteps, it significantly needs to change this mindset of having pre-ordained birth rights entitled to a narrow set of economic and political elites; spreading literacy, establishing efficient public provisions, reducing draconian labour regulations and further liberalising the Indian economy should be the political objectives of the day as opposed to toeing the short termism of current stagnation in Indian Politics.

Ill-governed India has grown in the last 15 years due to the private initiatives of a number of enterprising caste-less individuals; one only hopes the Indian government stops obstructing this momentum as it perennially is bent on doing so every now and then, playing to an illiterate populist gallery. If one is to define multi-cultural and ethnically diverse India, it is most apt to think of it as the product of each generation of her peoples. Thus far, the past generations of 'free Indians' have failed to define India and have lived up to Mr Stratchey's indictment.

Sunday, 1 April 2012

A War between Two Unequals

Marching to different Goals
Tomorrow is the 30th Anniversary of the Argentinian invasion of the Falkland Islands, a windswept archipelago with a dusting of some 3000 inhabitants of British Descent in the South-West Atlantic. In the subsequent two and a half months, Britain regained control of the islands against a poorly defended Argentine invasion force. The conflict stood out in the Cold War Period in terms of its duration, intensity, and the concurrent Economic Histories of the two belligerents.

Argentina gained its independence from Spain in 1816; with British and French investment it quickly became a melting pot of cultures from Western and Southern Europe and the breadbasket of South America by the late 19th Century. Argentina, at the outbreak of World War I, was amongst the ten richest economies in the world. From then till the Falklands Conflict, Argentina was misruled by a series of Military Juntas and populist leaders like Juan Peron. It adopted a pan-Latin American economic philosophy of isolationism and self-sufficiency, known as Import Substituting Industrialisation (ISI), which brought economic stagnation and decay. No economy in economic history has seen long term catchup growth from the misguided rent seeking policies of ISI. With one possible exception: South Korea had a short term affair with ISI before it joined the East Asian bandwagon of Export Oriented Industrialisation.

Argentina since the Falklands Conflict returned to a sort of semi-Democracy. The governments, which followed, quickly switched to neoliberal economic policies which ultimately culminated into an ill-thought capital account sequencing of financial and industrial sectors; in turn, leading to the Dollarisation of the economy through a currency board with the US in the 1990s that ended into a Greek-style Financial crisis in 2001-02; worsened by faulty profligate government balances.

Argentina in the last decade, has been ruled by Nestor Kirchner and, then after his passing, his widow, Cristina Fernandez de Kirchner. Argentina is still the same misruled economy of the past century. Ms Kirchner has succumbed to the old ways; she has assaulted and trampled over the independence of the Central Bank, established draconian capital controls, brought back rent seeking monopolies, and reignited jingoistic claims over the Falkland Islands.

In contrast to Argentina, Britain moved on from the Falklands Conflict with a redefined sense of purpose. Her military was revamped, her Politics and Economy were solidified towards the legacy of Thatcherism, and her position in the World was reinvigorated to the heady heights it once had. The Falklands Conflict was a war between two unequals but which has left for both an enduring but contrasting generational legacy.

Mumbai's Dabbawalas

Delivering to Success
In India's growing Financial Capital there is an extraordinary supply chain which delivers lunches to 400000 famished office workers each day. This organisation requires uncanny economic efficiency in one of the most densely populated parts of the world. Mumbai is located on a triangular shaped island, called Salsette, with the financial hub at its southern most tip. This bottleneck makes it all the more astounding that an erroneous delivery occurs every one in six million lunches; a virtue that has not gone unnoticed by Fortune 500 Firms eager to replicate the organisation's logistics.

The Dabbawallas ,however, are unique to the particularities of Mumbai. The system has a smooth and stakeholder-based hierarchy, with an input from each of the 5000 strong employees. The incentive structure within this caste based organisation prevents theft, time loss, and inefficiencies. Each Dabbawalla, literally meaning a person with a box, upon joining provides a wooden crate, two bicycles, and a 'Gandhi cap'. What the Dabbawallas lack in education they make up in commitment. The language of the system has evolved such that the syntax used for directions, end user, and collection point require just a simple comprehensible colour coding.

Dabbawallas are a constant reminder of the ubiquitous, resourceful, and dirt cheap ingenuity which is oft-ignored in the micro-solutions offered by overpaid business gurus to firm-specific problems here in the advanced economies.