Helge Nome :

The key to controlling humans does not lie in building fences around them, but to steer their minds away from unwanted questions.

By HopeForTheDismalScience
(William P Bell)

The elimination of courses in the history of economics has contributed to the Global Financial Crisis (GFC) by eroding institutional memory that allowed the dismantling of structures designed to prevent a re-occurrence of the Great Depression.  With little space in the curriculum for reflection on the past, graduate economists feed on a diet of neoclassical mathematics produces an extreme form of bounded rationality where history is both irrelevant and unknown, which makes for a very powerful ideology by steering minds away from unwanted questions.

Earlier posts, titled Economic history: A Renaissance? and Death of the history of economics? discuss further the demise of economic history.

I have some questions which I would like to ask everyone, and they are; how did everyone rate their gifts? Were you happy with them? Are they useful? Will you actually use them? And most importantly what would you have paid for them?

I was hoping to post this last week but I was too busy eating ham, turkey and Christmas pudding! Oh and unwrapping the few presents I was given to assess the economic value they would provide me.

To me as nice as Christmas is and as much utility as we gain from gifting others, I cannot help but think it is all somewhat of a waste of money… and I don’t appear to be the only one to think this.

In a recent article in the Sydney Morning Herald, Adele Horin’s article ‘Christmas, a waste of time, money and presents’ discusses the situation in Australia with Richard Denniss, who is the Executive Director of The Australia Institute.  What was found was that last Christmas 6 million Australians (which equals approx. 27% of the population) received presents they never used or gave away. Richard Denniss said unwanted gifts represent $798 million of waste, time, money and resources. The article also notes that about one quarter of Australians expect to give a gift to someone they do not want to and according to Denniss ”The growing culture of obligatory giving only brings joy to the big retailers and the big banks whose credit cards are largely funding the annual splurge”.

According to Joel Waldfogel; the author of ‘Gifts, Cash and Stigma’ from the journal Economic Inquiry; each year individuals in the United States transfer between $50 and $72 billion in resources in the form of noncash holiday gifts, despite the fact that recipients are found to value their noncash gifts by an average of 10% less than the price paid for by the giver.

So if this is the case, why do we bother giving gifts at all? Why not give cash? It would make more sense as you would be able to buy what you like and or allocate the funds appropriately. However if we all did that then it would definitely be awkward for two people to exchange envelopes of cash with different amounts inside. Waldfogel found evidence that “the decision to give cash is influenced by the givers’ ability to choose desired noncash gifts, and we rationalize the rarity of cash gifts with a stigma that givers attach to giving cash, relative to giving noncash gifts”.

I suspect we probably persist with gift giving simply because we like to receive gifts ourselves. It is fun receiving gifts, even though it has been proven we usually assign a lesser value and obtain less utility from the item than if we had made the purchase ourselves.

Armin Falk the author of ‘Gift Exchange in the Field’ from the journal of Econometrica discusses the importance of gift exchange. In his study, he requested donations for a charitable purpose and found that the likelihood people would reciprocate with a donation increased by between 17% – 75% depending on the size of the gift they received. Looking at these results it is now easy to see why we still persist with giving gifts… Perhaps just so we can get one back!

Related Articles

• Christmas a waste of time, money and presents (theage.com.au)
• The economics of gift-giving: Of crackers and turkeys | Editorial (guardian.co.uk)
• Jodi Beggs: An Economist’s Guide to Holiday Gift Giving (huffingtonpost.com)

Why this concern over debt? Debt needs to be serviced. This is done by paying interest. Interest on government (or sovereign) debt is obtained via taxes. Taxes are raised from productive individuals and businesses. As government expenditures increase, certainly beyond the level of received taxes, it must raise this money through the issue of government debt (i.e. treasuries or bonds).

The working assumption in markets is that government debt is risk free. This is usually reflected by an investment grade rating attributed to that debt by a ratings agency. Governments, like individuals, can only temporarily spend beyond their available means; as the level of debt increases so does the interest bill to be paid on that debt. If the debt to income (i.e. GDP) ratio increases, then the proportion of regular income required to pay the interest bill also rises. Markets participants perceive the ability of governments to pay their interest is commensurate with the performance of the economy and, therefore, the amount of taxes that can be raised from current income. The constraining factor is the level of GDP, from which taxes may be obtained. The tax rate can be increased only so much before the motivation for hard work diminishes, as does the amount of taxes collected.

The ability of markets to absorb increasing amounts of debt is also constrained, particularly if governments need to access capital markets to raise further debt. This can result in issues that are not fully subscribed. It also increases the supply of credit on the market, which can lead to a reduction in the price of these securities and a rise in the yield or cost of servicing that debt. Another reason for the rise in yield is the risk premium attached to debt securities, which reflects a concern over a government’s ability to repay interest; it may also reflect an expectation of inflation.

As governments enter capital markets to raise debt, and with such issues purchased by eager investors, less funds remain for capital investors who seek to raise debt for commercial purposes. An example of an investor is a bank or a provider of loan capital. This separation of the allocation of funds into government and private debt issues is an interesting phenomenon. Government capital projects aside, only individual or corporate entrepreneurs are productive and produce items of real wealth, which are purchased by consumers keen to improve their standard of living. Government investment is an oxymoron, because while governments allocate monies to projects, they do not, as such, produce anything of real wealth.

Thus government monies, raised via taxes, are consumed in the present as a present economic good. The government acts as an agent, which transfers the monies from taxpayers via government to welfare recipients (or taxpayers). When government allocates monies via the use of debt, it borrows from taxpayers’ future income; this allocation is not invested but consumed in the present.

These funds are not obtained in capital markets by private entrepreneurs for production, but consumed in the present by recipients of government welfare. It is the absence of the productive output by entrepreneurs that is most noticeably visible when governments spend beyond their means, because the crowding out of capital markets by governments limits the availability of credit to entrepreneurs due to a short supply or a re-pricing of that capital. The cost of credit to commercial enterprises via banks increases when the cost of capital rises on international capital markets. The inference to be drawn from this scenario is the impact that governments can have on the productive capacity of a country and, therefore, our standard of living.

http://au.wiley.com/WileyCDA/WileyTitle/productCd-0745651631.html

http://www.telegraph.co.uk/finance/comment/liamhalligan/8196283/Market-alarm-as-US-fails-to-control-biggest-debt-in-history.html

http://www.spiegel.de/international/europe/0,1518,735023,00.html

Let us give thanks for the robust export performance of the German economy...

The economic pages of most newspapers this week were dominated by the news of the Irish banking crisis and the impending threat of contagion. So while the discussions of the plight of the financial sector in the PIIGS (Portugal, Ireland, Italy, Greece, Spain) have the talking heads spinning in circles on television, I thought that it being Thanksgiving and all that, this blog should spend some time on a cheerier macroeconomic story: Germany. Even though its quarterly growth rate cooled to a respectable 0.7% from a vertigous 2.2% there is plenty that the interconnected world can feel thankful for as Germany remains an island of economic and financial stability in the midst of the EU’s surfeit of troubles. But, as students of economics, we should ask ourselves: what accounts for this dramatic difference between Germany and its less fortunate fellow Eurozoners?

Recently I had an extended e-mail exchange on this topic, during which, while we did not positively conclude the root cause of the Deutsche Wirtschaftswunder v2.0, we did come up with a plethora of very good reasons why the German export engine remains unstalled. I thought that the readers of this blog might appreciate the highlights:

1. Germany did not have a domestic housing bubble - the prices of homes have actually been steadily decreasing for the past decade. There are a few reasons for this. First and foremost, Germans had a major housing bubble in the 1990s as a result of extremely generous tax incentive following the reunification. That went bust in 1998/9 and put Germany in a recession for most of the last decade – essentially offsetting their business cycle from the rest of Europe. Second reason is based on simple supply and demand – an aging, shrinking population did not need more housing. Third, of course, is the supposed German national (both public and private) preference for savings over investment or consumption. Indeed, much econometric computing power has been expended to try and explain the Germanic frugality.

2. The industrial, export-oriented structure of the German economy coupled with the inability of its export markets to devalue their currency against Germany. Now those same partners are either part of the Eurozone, peg their currency to it, or still end up being otherwise caught in its expanded bow wave. Actually one of the arguments making their way around Brussels lately is that the funds Germany had to put up to prop up the finances of Greece et. al.  should be thought of as a wealth transfer compensatio for the “South’s”  inability to devalue their currency against Germany – which of course was the favorite remedy for reducing imbalances with Germany before the Euro came about. An argument perhaps better indicative of intra-European attitudes, but it still provides interesting food for thought.

3. German commercial banking was more robust to the slowdown for two reasons connected to the above arguments:  a) German banks are allowed to invest and hold shares of German companies –  the latest figure I heard was that about 25% of capital and a similar number  of votes on governing boards of major German industrials are bank-owned and controlled. Given the positive performance of German industry, that part of the balance sheets served to buoy the banks against any problems from losses in more ”creative” investments; b) Healthy domestic savings rate and absence of bad domestic mortgages resulting from argument #1, further helped the balance sheets remain in the black. The net effect was that exposure to the Great Recession came mostly from bad bets on investment “products” connected to the housing/credit markets in the US, Britain and Spain. This made them relatively easy to isolate into a “bad bank” and thus successfully insulate the rest of the balance sheet.

4. Effective German governance efforts in restraining growth of public sector employment, vs. that in private sector. Unlike Germany, elsewhere in the EU (especially in the PIIGS), public sector employment has grown along with the expansion of public spending. There is probably something to be learned from the German public sector labor force policy – their ability to relatively painlessly deal with the 50% expansion that happened after reunification with the GDR in the 1990s and then bring the number of servants in the unified Germany to a level lower than the number that former West Germany used to have before 1989 was particularly impressive. While a portion of that can be attributed to the 30% cut in manpower of the Bundeswehr,  the achievements of the coalition governments are certainly laudable – thus perhaps creating a blueprint for Britain in the coming years. Speaking of the Bundeswehr – the latest discussion about abolishing conscription in Germany is fascinating – most of the opposition comes from the NGOs whose business models rely on the low labor costs resulting from the employment of the 80% of German youths who substitute civilian service for that in the military.

5. The importance of restraining public sector growth relates to export growth, moreover, private sector growth in Germany means export growth pari passu. Germany’s trade and current account surpluses are now world’s second largest (after China); These were certainly helped in part by the bonus effect to the German auto sector resulting from Toyota’s technical problems and the follow-on bad public relations response , as well as the deep round of structural restructuring in the American automotive sector that, in the short term, reduced competitive pressures.

6. Sustained and impressive German labor productivity and total force productivity combined with Germany’s remarkable recent record of using the kurzarbeit device to ease the burden on workers and companies through a reduced work week instead of expanding unemployment. Of course, this reinforced the pre-recession structure of the economy, but given Germany’s export focus, this is not necessarily a bad thing.

Determining the relative effect size of all of these developments of German performance would be a wonderful modeling exercise.  Nonetheless, if I was to undertake it at this time, it is highly likely that my thesis adviser would defenestrate me for focusing on something other than the dissertation… so under the shadow of that unspoken threat, I will just remain thankful that the export engine of the German economy keeps chugging along just like a good piece of German engineering ought to…

While this deal only applies to about 450 workers at the moment, Tony Sheldon, the TWU federal secretary said the deal would be a model for other agreements. The union will be pursuing similar agreements on behalf of its 35,000 workers in the transport sector and 15,000 in the aviation industry.

Mr. Sheldon states “it does set a benchmark and a precedent.” And this is especially the case considering there are no productivity trade-offs required to be meet in exchange for the pay increase. While it makes sense for most of us to think the more wages a worker receives the better off they will be, it is far from being as simple as that.

Dr. Kim Hawtrey’s article ‘Dynamic Behaviour of a Unionized Solow-Swan Economy’ in Economic Record argues that it may not be in the best interest for unions to intervene in the setting of wages as the “union’s choice of wage rate (and hence employment level) has an impact on the level of output and hence the amount of saving available for investment, which will in turn govern output in future periods.” This means that higher wages today will equate to less capital stock available for use tomorrow and hence it may be potentially optimal for the union not to exercise its power.  After all I’m sure the last thing the unions want is for their own policy to drive the economy to approach a zero capital ratio… then where would the jobs be?

Related Articles

• Freight workers set to strike (news.theage.com.au)

Mainstream economic thinking proposes that mathematical reasoning is the correct tool for use in economic theorizing; but mathematical reasoning is also timeless. Applied to the problems of satisfying human want, the method of mathematical reasoning fails.

Individuals have needs and wants that can only be fulfilled in real time. The data of everyday life is met by the individual with reason: needs are adjusted to cater for changing circumstances. Hunger can be put off until later due to a work requirement that has arisen and must be dealt with immediately. As we mature, we use our reasoning powers to adjust to such situations; we also apply our moral and emotional maturity to each situation.

As time unfolds, the perennially changing nature of objective data must be confronted with the perennially changing status of our subjective evaluations. Thus the economic value of abstract objects (e.g. ideas, services) and concrete objects (e.g. tangible things: food, houses) also changes; prices logically follow the changing nature of subjective value.

What is hidden from the casual observer is the subtle nature of mathematical economic models: the logical relationship between economic variables is calculated and weighed, and conclusions are drawn. The two hidden aspects of this method are time and the objects under consideration. Individuals do not respond to events with instantaneous precision; but mainstream mathematical economic models represent themselves as offering precise conclusions. Individuals are sentient beings; but mainstream economic models represent them as objects that represent a bundle of choices.

The unreality of many mathematical models is that they operate using logical time, and not real time, in which events adjust immediately. The unreality of many mathematical models is that individuals are represented as objects, rather than subjects, which interact with other objects (such as interest rates or exchange rates). Economic reasoning cannot assign the subjectively evaluating individual the status of object that operates within the metaphor of logical time; it must proceed assuming that individuals (subjects) interact with and respond to the data of the market in real time or over time.

Are environmental regulations hurting local economies? Looking from the international trade point of view, economists hypothesize that they will:  As domestic environmental regulations become more stringent in a country, the polluting industries within that country will relocate to countries where environmental regulations are less stringent. And because there is a positive relationship between the per capita income in a country and the stringency of environmental regulations in a country (with the exception of the lowest income countries), the above hypothesis claims that the developed countries with higher per capita incomes and more stringent regulations will lose their competitiveness in polluting sectors. In return, the developing countries with lower per capita incomes and less stringent regulations will gain a comparative advantage in polluting sectors. Eventually the polluting sectors will relocate to developing countries from developed countries. This hypothesis is called pollution haven hypothesis (PHH). Some economists also believe that countries will engage in a “race to the bottom” in order not to lose their competitiveness; they will cut environmental regulations to attract foreign direct investment (FDI) if the pollution haven hypothesis is true.

Yet the pollution haven hypothesis has proved to be highly controversial. The hypothesis has been tested many times by economists since it was first introduced about two decades ago. It was refuted by the data according to many studies including a recent 2008 study. This study examined whether Japanese outward FDI was affected by the difference between Japanese regulations and other South East Asian countries over the period 1986-1998. It refuted the hypothesis and proposed that the reverse case may be true. A 2005 World Bank study found that FDI from OECD countries is attracted to areas with higher environmental regulations in China.  Yet there are several studies that find evidence in favor of the hypothesis including another 2008 study. This study suggested that imports to the U.S. from Canada and Mexico rose the highest for the industries whose abatement costs increased the most over the period 1977-1986.

Several explanations are proposed to explain why there may not be a pollution haven effect. One of them is the difference between the relative factor prices in developed and developing countries. The polluting industries usually are capital intensive – using capital intensively rather than labor – and capital is relatively cheaper than labor in developed countries, which provides a comparative advantage to developed countries in the production of pollution intensive goods. A big enough advantage in capital abundance may overcome the cost savings that a polluting firm might gain by relocating to a country with relaxed environmental laws. A 2005 study claims this partially explains why PHH may not be a rule.

Another explanation for why PHH may not be true is Porter’s pollution hypothesis. According to this theory, higher environmental regulation will encourage introduction of cleaner technologies which improve efficiency and productivity at the same time. A 2010 study empirically investigated the short- and long-run effects of Clean Water Act regulation and found that the regulation improved firms’ financial performance, with the positive effect being larger in the long run as the firms have more time to innovate over the long term.

Is the race to the bottom hypothesis actually realized? Several studies (2001, 2003 and 2007) show that the states of the U.S. do not compete for FDI by relaxing state environmental regulations. The positive relationship between per capita income and stringency of regulations shows that high income countries do not compete for FDI at least “to the bottom”. It may be because PHH is proved not to be a rule, or that their citizens have higher environmental consciousness. It may also be the case that the high income countries being developers of new technologies rather than adopters have more to lose if they fail to set the rules for the future, as they expect regulations worldwide to grow more stringent in the future.

An object is valued for various reasons. Some believe that value is reflected in the prices assigned to an object: such prices reveal the inherent value. Others believe that an object is valued according to an individual’s hidden scale of values. This scale comprises a series of needs and wants, which are ranked in the order of importance; an effort is made to satisfy each need or want up to a certain point. This perspective on value implies that it is subjective. The prices reflected in the market on goods and services reflect this value.

Time therefore demarcates the satisfaction of each need between the present and future. Savings reflect the implicit notion that individuals cannot have all of their wants satisfied in the present. Due to the changing status of the requirement for goods and their availability in any one market, prices may reach such a height as to preclude an individual from obtaining possession of them today. Patience and savings are called for.

When one has saved enough money, then the item can be purchased. Thus is satisfaction obtained for one item on our scale of needs and wants. The individual can then work at satisfying another need. We usually attend to fulfilling the most urgent needs first and then the less important ones.

Because there are not enough goods and services to satisfy all needs and wants at the same time, there is also a limit on the availability of money (which is an exchange commodity or currency used for exchange). We must of course exchange something of a lower value (to us), such as our labour time and skill, for something of greater value, such as currency (e.g. dollars, euros, pounds), in order to obtain those goods or services that satisfy the needs on our scale of needs and wants.

Time, we noted, demarcates satisfaction between the present and the future. Money, we noted, has as its purpose exchange for goods and services in the market, either in the present or the future; therefore money has value in exchange. If we bring the notions of time (which separates value) and money (which is exchanged for value) together, we can then attribute time to money. This leads us to an interesting conclusion about money: there is a difference between the money which can be exchanged for goods in the present and (the same quantity of) money which can be exchanged for goods in the future. The element separating money in the present and future is the same element that separates the availability of goods for satisfaction in the present and future – time.

Moreover, it is easy to appreciate a distinction between the value we attribute to the availability of necessary food in the present and that same food in a week’s time. We place a higher value on that necessary food in the present than we do on its availability in a week’s time. We have, as it were, a sliding scale of food value from the present to a week from now, with food in a week’s time reaching its lowest point of value to us now. We can refer to this as the time cost of food. This same reasoning is applied to money (because money can be exchanged for goods that satisfy needs and wants): money in the present has a higher value than money available in a week from now. Thus we have a time cost of money. This is otherwise referred to as interest, or interest rates.

We noted above the subjective value that individuals place on goods, which is reflected in money prices on the market. The same notion is applied to money, with time being the contingent factor that separates the value of money in the present and the future; this is reflected in the time price of money on the market – or the market rate of interest.

How then is it possible that a central bank can justify imposing very low overnight (i.e. short term) or cash rates on central bank (e.g. FRB or ECB) funds on the market? One thing is obvious: such rates have not been set by you or I on the market; they have been imposed. Such action distorts the valuation decisions made by individuals on the market. What is notable is that it is the central bank rate of interest that determines many other time-based rates of money, or market rates of interest, on the market. This ability to set the time cost of money is a state monopoly that distorts the subjective time cost of money of individuals.

A Companion to Economic Forecasting. Edited by: Michael P. Clements and David F. Hendry.

Did moral hazard play a role in the accident? In other words, would the accident have happened if the responsible parties had to pay for the full damage? Moral hazard arises when a party takes risky actions that it wouldn’t have taken if it would have to pay for all the consequences. First of all BP and its contractors Transocean and Halliburton may have incentives to take risks to increase profits if they know they wouldn’t have to bear the whole cost of an accident because they are insured. Today, this option seems unlikely as BP was self insured and had to make huge payments to people who suffer because of the accident.

Secondly, moral hazard may have arisen due to accountability issues: The parties are closer to moral hazard when there is no clear means to point out who is responsible for the accident. Despite continuous efforts, the responsible party in the Gulf of Mexico case is still not clear; companies or managers and technical staff, machinery or human failure, risky behavior or negligence.

Thirdly, the moral hazard may have happened at managerial level.  The costs of an accident due to risky decisions may not be as clear to the managerial and technical staff as much as the benefits from increased profits due to risky decisions. A 2009 study shows that managers may not share unfavorable information with the rest of the firm. Moral hazard at managerial level can arise as managers are protected by limited liability laws in the case of an accident but they usually reap the benefits from short- to medium-term hikes in profits. According to a 2010 study the  optimal contract maximizes the expected value of the company from an incentive feasible risk prevention policy by two instruments: the compensation scheme of the manager and project size management through investments in the project. Accordingly, the optimal contract compensates managers based only on their long-term track records and suggest a decrease in compensation with large losses.

However there are problems. There is a high cost in maintaining the network and infrastructure with not enough returns (ticket sales) to cover this cost. In terms of demand from the people, HSR is much more expensive compared to the traditional slower rail network, and so therefore does not service the lower income population, whom are mostly from the Western China regions, and the Western Economic Triangle.

A question needs to be asked. Is the expansion of HR justified given that a majority of users are content to use the cheaper and slower rail network? The HSR is not yet a viable substitute for traditional rail because the savings in travel time is not enough to justify the cost of a HSR ticket for most of the population (in Western China at least). The confounder in this question is that the Chinese government may financially support the maintenance of the network, and potentially prevent rises in ticket prices to cover rising operating costs due to maintaining aging infrastructure, and thus help to keep prices artificially “low” (or at least stable).

So what is the implication for developing economies from this situation? Because China has the financial power to invest in HSR even without adequate consumer demand to cover its cost of operation, we should ask whether advancing infrastructure ahead of adequate demand can create economic prosperity and eventually adequate demand (by attracting business investment due to good infrastructure being present)? Or should we hold a somewhat traditional view of economic development and allow an adequate build up of consumers (demand) for better rail services before addressing the needs of the people by then expanding the HSR network?

There are some assumptions we need to make. We will assume that there are no substitution effects between rail and roads, even though China has built an extensive road system. There is also the “China factor” where a few unique factors are in play – a huge population that is increasing in wealth, albeit unequally geographically, it is not a totally free market, and ideas and projects that might fail in a competitive and free market may be given a lifeline by government intervention, and there is a big investment momentum. International investments and companies may be driving the demand for HSR, and better infrastructure, which in turn may attract more investments.

Even though it may seem that there is a fair amount of subsidising going on for the costly HSR, and probably an unsustainable financial balance sheet for its operation and expansion (in a free economy context anyway), I believe along with other commentators that its presence will provide the poorer Western regions with a positive link with the more prosperous Eastern seaboard. The continued economic growth in China may make the supply of infrastructure far ahead of proven consumer demand something that may be a bet that will give China big economic and social rewards. Given the complexities of China’s semi-free market, economic growth, and social change, it will be interesting to see if the HSR will become a symbol for China’s economic prosperity for all of its citizens?