John Kay on Models

"As a student of finance, I never expected to see the efficient risk-return frontiers I drew on the blackboard feature in PowerPoint presentations to meetings of trustees: or that these trustees would view the numbers that emerged as statements of fact rather than illustrations of possibilities". John Kay

Family Planning is not Economic Stimulus

Reading this piece on the online of the Wall Street Journal, I found out that there is a curious item in the large bailout plan that the administration of president Obama intends to carry out. All arguments for and against the bailout plan are based on the degree to which investment in infrastructure and tax cuts would provide a stimulus for the US economy. To state it clearly, I think that the efficacy of monetary policy in the present situation is nil as interest rates are close to zero. As a result, a Keynesian approach is rationale and more likely to work as I argued in this post.

The surprise to me is that a small but not insignificant portion of the stimulus plan provides for family planning services. This would be extremely atrocious on its own without the Malthusian arguments that accompanied Nancy Pelosi's statements. To my mind, it is arguable that a stimulus would allow low income US citizens to keep their jobs, expand their consumption and get businesses to stay open. For all its merits, the insertion of a family planning initiative in the stimulus package is a bad idea. Notwithstanding the fact that I have found the arguments in support of the stimulus package more convincing, this revelation merely shows that large public programmes often end up paying for ridiculous things. family planning is not an appropriate instrument for economic stimulus.

Cato Institute Supports Obama's Views on Security

In as much as it finds it difficult to find a label, the Cato Institute is a respected libertarian think tank in Washington DC. Its policy orientation is such that it would be difficult to find a congruence with president Obama's political views. Still, it appears that they are strange bedfellows in respect to the necessary approaches to the response to terrorism. Their ideological differences apart, this article by Michael Newman in Slate Magazine finds mention in this blog for two main reasons.

The first and most obvious is the fact that president Obama and Cato Institute are able to reach a nearly common view on the issue of national security in spite of the fact that the orientation of the think tank would make it more easily aligned to a Republican stance. Secondly, my view is that despite the claim that the last administration of the US prevented another attack on US soil, this is not unqualified evidence of a successful policy. It may just be that the terrorists are unable to immediately respond or are biding their time. Cato and the Obama administration are both right in stating that it is not necessary for the US to trade off civil rights in exchange for security. That is not only a false choice, but is also bound to be ineffective. As the story states, the maintenance of a detention facility in Guantanamo Bay does not reflect well on the credentials of a country built on the quest for human freedom.

So while I too find myself differing both with Cato Institute's policy prescriptions in limited respects and with President Obama's too, I think that the president would do well to cast a wider net towards catching policy ideas from a larger proportion of the excellent think tanks found in Washington DC. His country may not only be all the better for it, but he may just have more intellectual ammunition for the change that US citizens started.

Eliot Spitzer Speaks for Competition

To my mind, one of the most effective forces of an open economy is the fact that it produces the compulsion for firms to compete to supply services and goods. In essence, the competing firms have to work for the good of their clients in order to work for themselves. Writing in Slate Magazine, Eliot Spitzer makes an eloquent case for why the GM corporation on the one side and the Security exchange Commission are now in the uneviable state.

For the SEC, he refuses to accept that the series of unethical practices that some institutions and individuals engaged could not be promptly detected because of the lack of resources and statutory authority. Invoking the virtues of economic competition, Eliot Spitzer states that the SEC was merely interested in protecting its turf without responding to the threats that existed. Mr. Spitzer is not only correct in this assertion but I would add that it is clear that an augmentation of its powers would not help the regulatory institution at all.

Taking on GM, the piece states correctly that this corporation opted to negotiate a safe path with the unions and eschewed economic competition. This preference for protection as opposed to competition led the corporation to place the interests of the unions as a paramount feature and forgot to supply the appropriate automobiles that its customers would purchase. It is difficult to disagree with Spitzer that the reluctance to expose firms to competition soon shows its poor results. While it is clear that the US economy is one of the most open and that is more tolerant to competition in comparison to others, the piece that its creative destruction is required cannot be refuted.

Are High Net Worth Individuals Daft?

Looking at the state of most financial markets together with performance of most economies today, it is difficult to defend the view that most people should be left to their own devices and that there's little justification for heavy-handed economic regulation. The excesses and outright folly that led to the mortgage crisis and the financial crisis will not be rehashed here. Still, in looking at the disclosures that have arisen detailing the the fraud executed by Bernard Madoff here and similar unethical action by Arthur Nadel here, leads me to ask the question that is the title to this post.

These two examples are obviously not the norm in the financial services industry but I reckon that there are probably enough funds announcing returns that are fictitious and enough gullible investors putting in more money. With the benefit of hindsight, it is possible to see that the returns were just too good and that many more people ought to have been suspicious. In both cases, it appears that some objective person asked the questions but was totally ignored and probably derided.

Secondly, the calibre of people who invested in both funds are not the typical street chap with a low income and who should be "protected" by intrusive regulation as the argument is often framed. To my mind, it is clear that Bernard Madoff and Arthur Nadel deceived very educated and presumably sophisticated professionals who were also quite affluent.

Thirdly, I am even more suspicious of any investment manager who claims that the success of the firm is dependent on a proprietary instrument programme such as the one used by Arthur Nadel's firm.

The final point is that industry newsletters are probably not the best sources of objective information primarily because they are avenues for seeking business or self-promotion. Judging from their long record of deception and the fact that Arthur Nadel was once declared Top Money Manager in the US, most business journalists appear to be just as naive. The most worrying point for me is not that such deception took place but that the clients who in many cases entrusted both firms with lifetime earnings did not identify the mistakes contained in their reports as this ought to have led to the demand for better information.

There's no good solution here and it is clear regulators and most industry peers were completely clueless even when the consistent returns should have led to the suspicion that this was a very unlikely record. Perhaps this is the time to review all the monthly newsletters from investment advisory firms. I am certain that a number will show that Madoff and Nadel are not alone. What this portends is the rise of savvy data analysts who should make some money from reviewing industry reports to identify inconsistencies that may reveal these errors. These people are most likely to be found in the market than in a regulatory office.

Did Caste System Produce India's Best Entrepreneurs?

Being a person with a keen intellectual interest in economics on the one hand in addition to the business culture and income growth among citizens of large countries, China and India have featured severally on this blog. In reviewing literature and other discussions on these countries, I have come to see the human tendency to carefully pick out what cultural aspects have contributed to the rapid rise of incomes and human development across societies. I had missed this article by Durcharan Das, in the NYT and received it from a discussion group a couple of days ago.

This story is especially poignant for me because of two reasons. First, I visited India less than two weeks after the terrorist attacks in Mumbai to which the author refers. Notwithstanding the fact that I was visiting New Delhi and not ground zero, I could clearly tell that the tenor of the public voice was that there's to be no fear shown because the terrorists would declare victory against all India. To that extent, I agree with the writer's suggestion that there was an audit about the failures that allowed the killings to take place without any overreaction that would betray fear. The Bombay Stock Exchange's index and other proxies for business activities were not affected adversely.

The second point was that on my third trip to this great nation built upon an old civilization, I could still clearly see the effects of long-standing discrimination and injustice owing to the caste system. I am therefore appalled that the author alludes to the caste system as a possible cause of the growth of the country due to the creation of strict entrepreneurial class known as the Vaishyas. I am surprised that a person whose name suggests Indian heritage can reasonably argue this point because stratification has always existed in India for ages. So how come it has only spurred rapid growth in the last two decades? That a preponderant amount of the Indian nationals appearing in the Forbes List are Vaishyas cannot be evidence of the success of the caste system because of the inherent self-selection and the failure to account foe the adverse effects of the same system on lower caste Indians. Indeed, if the caste system conferred exclusive advantages on the Vaishya caste, then their appearance on the Forbes list speaks to its success at limiting the capability of the other caste groups.

Malcolm Gladwell argues in his most recent book, Outliers, that what is often perecived as the special ability by a selected group may be the result of differences and decisions that provided an advantage. It may well be that a status conscious society is less willing to provide capital, business education or other amenities that allow the lower caste children to become leading businessmen too.

One only needs to review the indicators recording the special and economic achievements of India's lower caste people to realize that the picture drawn by Durcharan Das is far from complete. My thinking is that all factors considered, the caste system is not a positive factor in India.

Investments in Carbon-free Energy Sources

Few things are debated any more than the fact that there's need to reduce world dependence on fossil fuels. The reasons range from the strategic to the environmental ones but the quest for cleaner fuels is on. Elisabeth Rosenthal of the NYT and reminded me of that point poignantly in addition to disabusing me of the view that the countries of the Middle east would be surprised by a switch.

As the story states, the Persian Gulf country of the UAE is dedicating significant finances to research for alternative methods of energy generation. It is clear that the approach is well-though out because these countries have decided to develop research partnerships by buying some of the best brains in the area. Should some of these be successful, then the Persian Gulf countries may still hold significant power in the provision of alternative energy. However, it is not by coincidence that the United Arab Emirates and Qatar are at the forefront of this initiative because they are those very countries whose oil reserves have been depleted the fastest.

Whether petroleum is replaced as quickly as is desired or not, it is clear that the search for cleaner fuels is on. As this approach shows, the researchers are looking beyond automobiles and gadgets and focusing on city level energy demand. On a per capita basis, it appears that these Persian Gulf nations are investing more in finding alternative fuel sources that are not as carbon intense.

Who's Next for Federal Bailout?

Given the debates that have gone on about providing subvention to banks and automobile corporations, one still gets surprised at who's demanding a bailout too. Whereas I consider the demand stated here as made in jest, all it shows is that once public money starts to be spent to protect industries, it becomes difficult to draw a clear line about who should be allowed to fail. Now, it will take very serious thinking to tell why the coming refusal to support the adult industry is not discriminatory.

The federal government should keep tax payers money away from these and other hands.

Stimulus will Be Testing Ground for Theories

One thing that I have noticed among professional economists is that the ongoing recession and perhaps the oncoming depression has taken away the possibility of ideological neutrality. Again, while I am not a citizen of the US, it is noticeable that the more reasonable blog writers are debating what the administration of the incumbent could have done differently while debating whether president-elect Obama will have more or less options.

In the view of a number of respectable economists, the main argument is whether a recession such as is being faced by most of the large economies in the world today has obvious policy remedies. For instance, the economists that conventionally favor government intervention would argue for the government to institute a large stimulus package to get consumption going and avoid more job losses than would otherwise occur. In opposition to these Keynesians are the monetarists who maintain that the most appropriate approach is to concentrate on reducing taxes further in order to enable banks to lend to entrepreneurs who may then spur economic activity. In the view of the monetarists, the failure of the present businesses or banks should not be used for more intervention than is required.

Going back to the US, it is clear that in spite of his conservative orientation, president Bush and policy advisers designed the large plan totalling US$ 700 billion to cushion banks from further collapse. There's much to say for the design and the size of the package as the numbers are not informed by any scientific rule. To a large extent, the Treasury and the Federal Reserve Bankers are making educated guesses about what is required. In spite of this, it is clear that this is hardly enough and the incoming administration is arguing for a proper stimulus plan in order to forestall catastrophic contraction and job losses. The Obama team is defining this as a programme designed in the fashion of the New Deal that was put together by president Roosevelt.

Judging from the press, a number of economists who are possibly market purists keep arguing that the New deal was not only a waste of public resources but also harmful overall. William Anderson's post on the Foundation for Economic Education's site here sets out the arguments. In fairness though, there are also professional economists such as Martin Feldstein who advised President Reagan who favour a measure of government intervention today. As stated in this story, the conventional narrative has been adjusted and it appears that public spending in tandem with tax cuts is considered a reasonable response for the moment.

While my orientation id decidedly libertarian on many issues, I think that Keynesian response is reasonable in light of the fact that there's been a significant reduction in employment and that contraction of the economy is clearly evident. In spite of this, I am less clear what the size of the stimulus ought to be but agree with Paul Krugman in the statement that it would be better to err on the side of a larger rather than a smaller one. He explains the stimulus arithmetic on his blog post here.

Finally, one of the positive things that emerges is that the arguments are well-placed and the policy responses properly debated. this means that the major economies are now a virtual laboratory for testing the ideas and to help in resolving the arguments when the expected results show. All we can do is wait and see whether the pure monetarists are vindicated. Teachers and students of macroeconomic theory will greatly benefit from this.

Digital Rights Management Falls

Reading this NYT article today, I am reminded of writing this blog post, in which I agreed with the argument by Steve Jobs that the placement of codes into music files to prevent copying for any reason was futile. As Steve Jobs then argued, each holder of the iPod had bought merely 22 songs out of the average of a thousand songs resident on the devices. This made it altogether unnecessary to continue to impose the Digital Rights Management system.

It seems that the music majors have finally seen the logic of this argument and have authorized Apple to strip all music sold on the iTunes site of the DRM. As it stood, the DRM was driven by the fear that music would be pirated widely in spite of the absence of evidence that it was capable of hindering dedicated music pirates. As it stood, Digital Rights was merely an expensive and demonstrably ineffective technological stunt.

Will the Diamonds Trade Move from Antwerp?

Unlike a number of industries that rely on steady income growth to maintain sales, the diamond industry is different because the purchasers of the products tend to be less affected by the business cycles and economic shocks. However, the ongoing world recession is definitely in a different category judging by the extensive and adverse effects that it has had on consumption, employment and incomes in most of the high income countries and emerging economies thus far.

John Tagliabue, writing this story in the IHT reports that the Hasidim Jews based in the Belgian city of Antwerp are seeing signs of the depression in the sales of diamonds. This compression in the market is an important index altogether because nearly 80% of the world's uncut diamonds are traded. The industry cluster for diamonds in Antwerp is also unique for its dominance by the Hasidim Jews with an eastern European ancestry. As the story states, a significant portion of the trade is moving away to cheaper destinations in India and Israel.

This drift of the market suggests that in addition to the recession, there may be a permanent move towards cheaper destinations for the more labour intensive and lower technology portions of that trade. It is unclear to me whether all this is driven by the recession but I wager the bet that this severe recession and its effects on consumption have merely exacerbated that change in the centre for diamond trade. Due to the existing expertise and institutional links, it is unlikely that the diamonds trade will shift completely from Antwerp but even after the recession, there will be a progressive reduction in the proportion of that trade that is conducted in Antwerp.

The fascinating thing for a student interested in how markets form is that the story does not suggest that the industry associations are calling for public subvention, unlike the motor industries in other countries.

Will Ireland Continue to Grow?

I am a great admirer of Ireland and especially in the sensible tendency to adopt plain economic thinking to its problems and have covered some of that in this blog. I attribute its growth almost entirely to the sensible economic policies that are now used to explain the rise of this country's citizens from one of Europe's most indigent to virtually its most affluent, all within two decades. In spite of the good economic understanding that its leadership has shown, Ireland's people are now caught in the global recession.

Landon Thomas Jr writes in the NYT here about the tribulations of Ireland by tracing the effects of very low interests rates and the subsequent debt overhang and unprecedented expansion of the real property markets. More particularly, the story focusses on one of the country's most ambitious property developers and the acquisition of expensive real estate whose value in the future is now doubtful.

The rapid expansion of the real estate market was partly supported by the myth that property prices will never fall and it appears that even seasoned investors were fooled by this dictum. To my mind, the business problems being faced by a single developer are not an appropriate metaphor for a dynamic economy like Ireland's. Therefore, my guess is that outcomes will definitely be better for the whole economy irrespective of the outcomes of Sean Dunne's expansion. Granted that immigrants are leaving at the moment but they are bound to return once the economy recovers. It is unlikely though that the properties market will constitute as large a proportion of the economy as it does now. I am certain that growth will return to Ireland.

Losing to both the Taliban and the Poppy

The president-elect of the United States will be inaugurated against a very tough economic and political background. there's no need to debate the part about the economy because its effects are felt almost universally now. All that's being debated is whether the auto industry in the US should be supported with tax payers money or not. Still, with the very well-chosen team at the Treasury and the advisors at hand, I am confident that the new administration will steer the economy excellently.

To my mind, the more precarious situation is the one regarding the two wars in Afghanistan and Iraq. There are no prizes for guessing that here too, one is going far better than the other. Indeed, Iraq is momentarily stable and the big decisions only relate to the draw down date for the US troops. regarding Afghanistan, I think that the administration will have to consider its options more clearly and redefine the theory of engagement because the Taliban are not only resurgent but the neigbourhood has became less stable with the attacks on Mumbai by terrorists earlier this month.

I do not have ready answers for Obama but as I have stated on this blog severally and more specifically here, the main objective in Afghanistan ought to be to beat the Taliban. This task is difficult enough on its own without conflating it unnecessarily with the fight to eradicate opium poppy. As this story in the Guardian states, there's already corruption and the beneficiaries of the drugs trade are the more influential politicians and large farmers. Clearly, it is the economic imperative that leads the villagers to prefer opium poppy in spite of the lack of rain. It suggests that the fight is not about the eradication of plants though the fear and loathing of the Taleban is more widespread.

Breaking the Cartel of Steel

This story in the Times of London reports that the Competition Council in France conducted a three year inquiry and determined that a number of firms in the steel industry had colluded to set prices and raise barriers for entry to potential rivals. As has been monotonously stated on this blog, one of the clearest justifications for regulatory policy is in the quest to enhance industry competition. Adam sage's story reports that the Competition Council has levied a record fine of €575 million on 11 firms.

Again, while I am convinced that light regulation is important, the story suggests that there was a finding that this was an elaborate price fixing and barrier raising cartel. I applaud the Competition Council of France because price fixing and lessening of competition is without doubt harmful to competitors and to consumers of steel products. What I am less clear about is the manner in which the size of the fine is determined. It is unclear what assumptions are employed in reaching the fine and the apportionment across the colluding firms. I am also unsure that this is indeed the largest fine in real terms because the comparisons being made are all in nominal terms.

Finally, the mere evidence that the managers of the firms met is insufficient reason to assume that a cartel is in place but the other evidence involving market sharing, price fixing and other collusion in punishing members who do not adhere to the agreements demonstrates the nefarious effects of this cartel. This is one instance in which the use of the word cartel is not a smear word for a dominant set of corporations.

Why Vodafone Should Keep England Sponsorship

Nobody doubts the view that the recession has now extended to the real economy and that corporations outside the main financial service providers are faced with the need to make decisions on funding cuts. This places sports teams in a difficult situation as corporate sponsorship is essential for most sports. Among others, the Jamie Jackson reports in the Guardian that England cricket team suffered from the withdrawal of sponsorship by Vodafone, its main sponsor.

In spite of the argument presented on this blog here questioning the real benefits of corporate sponsorship following the decision by GM and Tiger woods to mutually agree to an end to a sponsorship deal, it is clear that Vodafone should retain the deal in a restructured form. The tenor of the blog post was that the structure of the sponsorship deals makes it difficult to ensure that both sides get real value. Taking forward that argument, I think that the corporations that are throwing aside sponsorships are being short sighted. These deals may be expensive in light of the financial strictures today but economic recovery is definite in the medium term.

For that reason, this is the best situation to renegotiate the sponsorship deals with the knowledge that the economy would recover. If I were to advise Vodafone or the corporations with businesses, it would be that they would look to reduce the absolute sponsorship size and lock in a longer term contract. In that way, Vodafone would get a better deal over the long term rather than wait for the economic upturn before coming back to the table when the England team may have more interested sponsors. To my mind, a sponsorship deal involving the England cricket could be sufficiently adjusted downwards to make it lucrative in the longer term.

Quote of the Day

"The market economy promotes diversification when the future is uncertain and there are differences of view. This is one of its fundamental strengths. But the market economy does not achieve enough diversification when the future is uncertain and there is commonality of view. This is one of its fundamental weaknesses". John Kay

Classifying the UN Membership

One just has to attend international meetings with lots at stake such as the Ministerial meetings of the WTO or negotiations regarding the reduction in greenhouse gas emissions as took place last week to see the absurdity in the manner that the countries are conventionally classified. This absurdity is most evident in intuitive classifications such as developing countries and developed countries. Taken a step further, one finds very quickly that countries with very different development and welfare circumstances are classified together.

Michael Levi, writing in the Slate Magazine here addresses this issue of the problem with classification of country’s during the climate negotiations held recently in Poland. The very rough ways of classifying countries through a single metric such as the nominal GDP per capita or an income threshold results in classifying Singapore, China and Togo together. Given the concessions that are required, it is easy to see why countries such as India, China and Brazil are insisting on a classification that is patently absurd but whose results ensure that they would have to make fewer reductions to carbon emissions.

Throwing away useless mantras such as developing country solidarity and all the rest, I am clear that an algorithm considering the industrial base, population size, per capita incomes adjusted for purchasing power parity, infrastructure base and levels of poverty would yield an imperfect but better classification system. Such an algorithm is not too difficult to draw and would probably lead to a more useful result than is suggested by the very arbitrary classification that the larger countries such as India, Brazil and China are gaming so clearly. In all, it shows that the United Nations or the WTO ought to invest in developing a new mechanism for classifying its broad and diverse member base. A competition would yield a more efficient outcome so that the negotiations may then concentrate on the matter at hand as opposed to the politics of classification.

Should Children Fire Uzi's at Gun Shows?

This blog has featured some of the ideological arguments for gun control. One notices that policy debates arise soon after a tragedy has taken place with both sides of the divide stating even more loudly why any tragedy would not have happened had there been less freedom with gun purchase or with stronger gun control policies. As reported here by AP in the Boston Herald, the recriminations are back following the indictments after the death of a child at a gun show.

Looking at the sad incident at a gun show during which a child suffered fatal injuries while firing an Uzi, I have to state my view that this debate is taking on the same tired lines. It is clear here that there's no direct and clear culpability as this was a self-inflicted wound albeit aided by very poor supervision. To my mind though, I favour freedom and parental responsibility but worry that a child should be allowed to fire an Uzi at a gun show. the court case and the acrimony merely ensure that a proper discussion for gun control and regulation will not occur.

Admittedly, the law in Massachusetts allows children to fire shot guns or rifles with parental consent. I create the distinction that an Uzi would probably require more careful handling than the other two and to allow any 8 year old to take shots does not betray sufficient care. It is also surprising that a law enforcement officer is attached to a corporation that sponsored the show.

Krugman Gives Detroit 3 Small Chance

Commenting on the ongoing debate to inject public money into the Detroit three, I have had objections that fall into two categories. First, it is neither clear that public money should be given to the three corporations in spite of the claim that they can all be brought back to profitability. The second and more important is that there are options related to bankruptcy that the firms should resort in order to be allowed to reorganize.

The Washington Post covers Paul Krugman's comments made in Stockholm during the week preceding the award of the Nobel prizes. As he states, the forces of economic geography and structure of US economy suggests that the three firms may cease to exist despite the bailout plan. The idea of a bailout may be politically popular, but it is clearly unsound.

Update: A post on Paul Krugman's blog made a correction to this report. The Nobel Laureate did not state that the three automakers are doomed to failure.he appears to have spoken of its as a probability and not necessarily as a definitive declaration. That is an important distinction.

Economics for Pirates

In the recent weeks, Somali pirates, operating off the East African coast have been in the public limelight for taking over not only a large oil tanker destined for the US but also for the successful negotiations for ransom for a number of ships in their control.

Needless to state, perceptive economists such as Peter Leeson in this interview in the Scientific American magazine, not only see similarities between these pirates and the pirates of yore but also state categorically that piracy is a form of employment. One ought not to be surprised therefore that the total number of piracy incidents on the east coast of Africa have risen this year as the pirates have been able to extract ransom from the owners of the ships that they have held. This interview published in the Scientific American Magazine uses economic theory appearing in a book to explain the facts that obtain.

Taking just two examples from the dozens of ships that have been taken over by these buccaneers, one involved a Ukrainian ship carrying tanks and other heavy weapons as reported by NYT here and the other was the oil tanker carrying nearly a million barrels of crude petroleum. As economic theory would predict, the activity is based on expectations of profit even when it is clear that the pirates can neither offload the battle tanks reportedly held in the former ship nor refine the crude petroleum held in the latter. All they understand is that the ship has valued property whose release the owners will be anxious to negotiate for.

Now that the book by Peter Leeson is out, I expect that law enforcers and cargo shippers will read it carefully. perhaps the best day for sea pirates on the East african coast are now because they will ultimately face the same fate as their predecessors three centuries ago.