Thursday, August 27, 2009

Poor Incentives

If you were prudent enough to save and invest your money rather than spend and borrow more money, you have probably taken a hit in your shares portfolio and will face rising inflation in the next few years as a double dip recession (a W shaped recovery) takes place, eating away at your cash holdings. The banks that have been rescued and recapitalised using reserve infusions are loath to lend under the current environment and therefore will not raise rates on cash and term deposits even as the reserve rates increase given that they are awash with cash.

If you were a rural bank, saving and loans company or credit union that maintained a healthy balance sheet and avoided risky derivatives, then you were not in line for a government guarantee or a subsidised line of credit during the height of the financial crisis. You instead would have the added burden of competing with larger subsidised commercial banks with AAA credit rating not as a result of their prudential risk taking but as a result of sovereign guarantees. Your employees have probably been faced with pay cuts or no bonuses unlike the corporate executives of the bailed out entities courtesy of taxpayer dollars.

If you are in a business that was deemed “too small to rescue” having been cautious in leveraging your operation and prudent in evaluating expansion projects, then you probably did not receive any cash handouts through the stimulus plan, unlike the relics of some old smokestack age that got heaps of support to remain open. You will probably be facing higher taxes in the coming years as the need to repay the deficits in a slower growth environment forces many governments to raise taxes from “productive” units of the economy.

If you are a relatively low polluting, eco-friendly operation, then you are definitely not going to be in line for a “free” carbon credit courtesy of the government unlike trade exposed carbon intensive industries. You instead are going to have to absorb the full cost of what little emissions your outfit produces.

Is it just me, or do others see that something is truly going haywire in the system of incentives that the current crises-busting policies have adopted (by “crises”, I mean both the GFC and the CPC or Carbon Pollution Crisis)?

Tuesday, August 18, 2009

Child-rearing: no longer a luxury for the rich?

This is a follow-up to a previous entry to this blog in which I posed the question, Is child rearing a luxury for the rich? The evidence cited back then showed that providing a baby bonus creates a rise in fertility across all social classes and not just disadvantaged ones.

The long-held belief in the economic community is that as countries get to be more affluent, their preference for large families declines. This has historically been the case, and the phenomenon has been labelled the demographic shift. Poorer countries aspire to reach it, richer ones dread it. It now appears to tell only half the story.

A recent study published by Dr Mikko Myrskyla from the University of Pennsylvania and his colleagues using repeated cross-country data shows that as countries breach a level of affluence, their ability to have more offspring returns, reversing the demographic shift. This is depicted in the graph below taken from the study.

This graph plots the fertility rate of countries against their HDI or human development index, a measure used by the United Nations which is a composite of per capita income, life expectancy and level of education. The highest value of the index is 1. Back in 1975 Canada scored the highest on this index with 0.89. The kink in the demographic J-curve seems to be around 0.95. Since 1975, more and more countries have breached this threshold, and as a result fertility rates in these countries are now approaching 2 per woman.

This is good news for policy makers in these countries, who previously were forced to project declines in fertility in their indigenous populations and recommend high levels of inmigration just to balance the workforce demands of an aging population. What this study does is point out that with the right set of policies, like the baby bonnus and family friendly work practices, that the fertility decline may be reversed.

Saturday, August 15, 2009

Of Thoroughbreds and Clunkers

Is it possible to design policies that simultaneously reduce carbon emissions and stimulate the economy?

This past week saw the Australian Federal opposition led by Malcolm Turnbull and independent senator Nick Xenophon unveil a controversial alternate emissions trading scheme in a bid to outflank the Labor government in terms of its "green" credentials while at the same time shoring up its support from emitters in paticular the Minerals Council of Australia by limiting the effects the scheme would have on energy generators.
The minister for climate change Penny Wong quickly dismissed the proposal as a “mongrel” of a scheme while another minister and former union leader Greg Combet suggested that it sounded too good to be true. The Business Council of Austalia through Heather Ridout assailed it for passing the cost on to consumers and industry. The scheme it was said suffered from MPS or Magic Pudding Syndrome. The question is, are such schemes truly unworkable? Is it truly unrealistic to envisage something that reduces emissions and at the same time stimulates the economy?
Meanwhile in the US, the “cash for clunkers” program which saw many motorists trading in their old gas guzzling vehicles for cash as part of the American stimulus package got an additional appropriation of $2 billion from the US Congress as the original allotment of one billion was quickly exhausted in less than a week.
As made evident by its popularity such schemes are often unsustainable because they quickly run out of funds. The unfortunate thing was that the US government had to resort to deficit spending in order to finance it. But what if its financing came instead from another source? Such a question has been answered by Todd BenDor who modelled a workable system of Feebates, or rebates offered to retire old and undesirable vehicles (or to purchase fuel efficient ones) which are in turn funded by fees charged on fuel inefficient models.
BenDor's modelling shows that such a program would be sustainable and lead to immediate and long term reductions in vehicle emmissions. Much like the “sin taxes” imposed on tobacco and alcohol products and used to fund public health programs, this type of redistribution for the benefit of the environment is yet to be explored. There are other possible policies that can be designed with similar features. Can you think any? Post your ideas and comments here (scroll down to the bottom of the screen).
image credit:

Sunday, August 9, 2009

The Intellectual Capital Market

An ingeniously crafted article by Philip Gerrans, a reader of philosophy at Adelaide University appearing in the Times Higher Education likens the asset bubble that happened in financial markets with the trading of intellectual capital in the Humanities.

He explains it in this manner
The academy, too, is a market - a large one in which the value of any piece of research is ultimately secured against the world. If the world is not as described or predicted in the article or book, the research is worthless...The academic market is also like the financial market in another way. Stocks trade above their value, which leads to bubbles and crashes.
So what are the safe havens in the “intellectual securities” mart? For Gerrans, the AAA rated bonds would be found in the Science department, as
... stocks in science (the papers, grant applications and CVs that secure appointments, salaries and grant funding) trade fairly close to their real value. It is hard to leverage them because there are a lot of investors who are trying to cash in their investments rather than passing them on to some other dupe and taking a fee. Other scientists want to see if the theorem is proved, the prediction verified, the world accurately described or the technology workable.
And the junk bonds? Well, according to him, this distinction belongs to the Humanities as
a lot of the market is unsecured and highly leveraged. By this I mean that people in the humanities often do not write about the world or the people in it. Rather, they write about what somebody wrote about what somebody else wrote about what somebody else wrote... None of this would matter if the market were basically self-correcting like the science market ... When people do not write directly about the world, it is hard to compare what they say against the world. So the main corrective mechanism in the humanities is reputation built on publication and, since publication is often based on reputation, the danger of a bubble is extreme.
Just as it became impossible to distinguish good picks from bad ones with the bundled financial products called CDOs or collateralised debt obligations, it has become as difficult according to Gerrans for governments and universities to do the same with the “mixed bag” existing in their humanities departments.

(Actually, economists will tell us that the practice of bundling commodities, such as packing apples, performed by sellers, has been created in order to economise on transactions costs by preventing buyers from inspecting each item before making a final purchase decision)

From a public investment point of view, Gerrans argues, what is the point of governments bailing out these departments and forcing those from lower socio-economic families who he claims lack the “marks, self-esteem or cultural savvy to get past the government and university spin” to accept the toxic debt of investing in these fields of “anti-knowledge” when they become unemployable in the end?

Unlike a one-off purchase of a disposable commodity like fruit, the choice of field in higher education is something one will have to live with for the rest of his or her working life (live with the debt at least). Surely better information systems can be put in place to help improve decisional quality of aspiring college and training graduates.