December 09, 2006
Intergenerational Accounting and Long-Term Policy Problems
Ok, this one is a bit misclassified in the article as a "remedy" or "solution" or fix for a long-term policy problem. Intergenerational accounting as a practice simply computes the total cost to a government of addressing a problem over time. In the case of public pensions, like Social Security, this would involve computing the total amount the government would have to pay out under current law and reasonable projections about how long people will live, and computing how much income it will have in Social Security taxes (involving assumptions about how many people will be working and how fast the economy will grow, etc.). Then you compare the two numbers. To be a long-term policy problem, almost by definition the costs have to be greater than the expected income. (If we were expecting enough money to pay for it, then it wouldn't really be a problem, would it?) In some cases, it's a really big gap - some countries have pensions obligations that are more than 2 times their annual GDP, which is an enormous number of times more than their annual pensions tax income.
For a case like pollution abatement or stopping global warming, the "intergenerational accountants" would compute the expected amount of pollution they'll have to clean up over time (and how much it would cost to do the clean up and fix anything else that goes wrong as a result), and the expected income of any pollution taxes or government funding. Again, it shows about how much the projected value of current efforts falls short of what will be needed to fix the problem.
Posted by lpowner at 08:03 PM | Comments (0)
What Is Speculation? How Do You Do It?
Entries may be shorter than most previous ones; I want to try to get as many of them done as I can before the exam.
Speculation is a specific form of arbitrage (the process of buying something where/when it's cheap and selling when/where it's costly). In our context, it refers pretty exclusively to efforts by international currency traders to make money off of changes in exchange rates (especially fixed rates).
To recap, fixed exchange rates are set by a government or central bank and declare a set rate at which foreign currency will be exchanged for local currency. To make this concrete, let's use a real example: China has pegged its currency, the yuan, at 5Y to US$1. (1Y = $0.20). Anyone who does business with China and exchanges currency at the central bank (the only legal place to change currency; banks use it on behalf of their clients) will get that rate, any day or any time or anyone.
The 'speculation' part comes from currency traders. Experts estimate, based on lots of math, that if it were allowed to float freely, the Chinese yuan would probably end up being worth 9Y = $1 (or 1Y = $0.11). According to these calculations, the yuan is clearly overvalued - the government says it's worth a lot more ($0.09, or almost half its declared value) than 'the market' thinks it's really worth.
Let's say now that currency traders think that there is something wrong or out of balance in the Chinese economy to the point where they feel the long-term ability of the Chinese central bank to uphold that 5Y=$1 rate is doubtful. Perhaps the pattern of global trade shifts drastically as a result of labor unrest in major Chinese cities, or cheaper production venues become available, or consumer tastes shift away from the kinds of things China produces for export. If currency traders begin to have private doubts about these kinds of things, they may begin to sell off their holdings of yuan. Every trader wants to sell his/her yuan back to the central bank before the central bank runs out of dollars; the dollar doesn't go through major shifts so it's a safe currency to hold. When one trader sees others selling yuan, they may investigate and perhaps start selling their yuan too. Currency traders who are convinced that the central bank will be unable to sustain the high rate for long may also try to buy yuan from other investors or traders at current market prices and then sell them back to the Chinese central bank to get their hands on even more dollars. As one trader sees others selling off yuan, he too will sell in fear of having the central bank run out of devalue the currency before he got rid of his holdings. The result is a "herd effect" or "stampede."
The net result of all of this is that the market is flooded with a large supply of the currency - and, in the case of a speculative attack, demand goes down because no other market actors are willing to buy it. As we all know, when supply goes up, and demand goes down, pries will fall. (Graph it out if you're not clear on why that relationship holds: do a starting supply and demand, then S2 (higher) and D2 (lower) and see what happens to price.)
For a currency with a floating exchange rate, this is somewhat problematic but not fatal, so long as the value of the currency doesn't drop tooooo far. A central bank that is committed to a fixed exchange rate, though, faces a much more serioius challenge. To keep the price of its currency (its exchange rate) from dropping, it must personally intervene in currency markets to create demand for the currency. The Chinese central bank must buy all available yuan - pay dollars for all the yuan that actors are trying to sell, at the established rate - to keep the price of its currency at the target level. This gets incredibly expensive, and can only continue as long as the central bank doesn't run out of reserves.
Currency traders command much greater amounts of money than the central bank does, though, so the real issue is not "if" but "when."
When the central bank nears the end of its reserves, it has two choices: devalue the currency (require more yuan for each dollar it dispenses) or stop exchanging currency. Both are effectively admissions that the market is right and the policy is "wrong" - even if later research suggests the opposite, and so doing either destroys the market's confidence in the currency's value. (This is probably the biggest impediment to recovering from a currency crisis, this lack of confidence - not the loss of reserves or the need to rebuild reserves.)
Posted by lpowner at 07:28 PM | Comments (0)
November 20, 2006
How Does the LLAP Affect States' Decision-Making? Or Is It Just a Scholarly Device?
The Law of the Least Ambitious Program (LLAP) is primarily a scholarly device used to simplify conclusion-making under some fairly common assumptions like unanimity voting. The LLAP says that under unanimity voting, the 'least ambitious' program -- the one that wants to do the least, on whatever the issue is -- will be the outcome. Unanimity voting is the most common form of decision rule in international organizations, whether de jure (by law) or de facto (in practice), so on its face this 'law' would help us predict a lot of outcomes if we know states' preferences.
Since unanimity is the default rule, and states are familiar with this, they recognize something like the functional equivalent of the LLAP. It's a generally accepted tenet of interstate bargaining that the biggest holdouts or most reluctant parties will need some inducement (via side payments or whatever) to get them to agree to anything besides their most preferred outcome. Thus there is bargaining advantage to be had from being a preference outlier under unanimity voting.
Posted by lpowner at 04:19 PM | Comments (0)
November 11, 2006
How Do All These Economists' Models of Trade Differ?
We've talked about three models of trade: Hecksher-Ohlin, Stolper-Samuelson, and Ricardo-Viner. The first two together (sometimes summarized as HOSS) produce one set of predictions, about factor-based cleavages; Prof. Sprinz discussed these models in lecture. The second, RV, produces predictions of sector-based cleavages, and we elaborated this as "Model 2" in section. Let's walk through the logic.
Land, labor, and capital are the factors of production. All goods and services in an economy are made from some combination of these three. A state's factor endowment is its holding of these factors relative to one another and to the world economy. In any economy, some factors are relatively more abundant than others. Canada, for example, is relatively well endowed with capital and is very well endowed with land, but is very poorly endowed with labor. Bangladesh is very well endowed with labor - at least, with unskilled labor - but capital and land are both scarce. Following the general law of scarcity, scarce factors can demand a higher price. For labor, this is wages; for capital this is interest rates or rates of return. Abundant factors, on the other hand, before trade can demand a very low price. Any holder of that factor who tries to demand a high price will not find buyers; buyers will just search for one of the many other holders who is asking a lower price.
[Note on Terminology: By definition, any state that is poor or developing is scarce in capital. Capital is what we commonly understand as 'wealth'; countries that lack capital lack wealth.]
Hecksher and Ohlin reached the conclusion that since the abundant factor is cheap in a given country, that country's comparative advantage will be in products that use the abundant factor extensively. Because labor is cheap in Bangladesh, labor-intensive products are relatively cheap to make there - particularly compared with their cost to make in, say, Canada. This will lead Bangladesh to specialize in exporting things that are labor-intensive: it can produce labor-intensive goods and services more cheaply than many other states, even once the cost of shipping the products is included. Once Bangladesh starts to trade, demand for its labor-intensive products comes from both the domestic market and also from the world market. This higher demand for the abundant factor - which is nowhere near as abundant on the world market as it is in Bangladesh - translates into higher prices for Bangladeshi labor-intensive goods on the world market than in the domestic market. They can sell the goods for higher prices abroad because even with the mark-up (over Bangladeshi domestic prices), the goods are still cheaper than the importing countries can produce for themselves.
Canada, on the other hand, has an abundance of land - particularly land that is good for farming. Farming used to be labor intensive, but since the early 1900s developments in technology have allowed Canada to substitute capital for some of the labor needs: tractors and combines replace people. Since capital is abundant in Canada as well, it too was cheap. The combination of cheap land and cheap labor-replacing capital has given Canada one of the most efficient (read, least expensive) agriculture sectors in the world. If Canadian farmers tried to sell all their wheat in the domestic market, they would only be able to get a very low price because they had so much of it available. By selling some of their wheat on the world market, they can boost the price they get on the domestic market and also get a good price on the world market, where countries with less efficient agriculture sectors go to buy wheat and other products more cheaply than they can grow them for themselves.
After World War 2, Stolper and Samuelson added to this by noting the logcial extension that if the price for the abundant factor's goods was increasing, then the income to those who own that factor would increase as well. Those who hold the abundant factor (or whose incomes depend on using that factor intensively) would benefit from trade because trade increases their incomes; they would thus band together to promote free trade. On the other hand, those who hold the scarce factor (or use it intensively) find that they are now competing with foreign holders of the same factor, where it may not be as scarce. For example, think about Bangladeshi farmers. Before trade, the price of agriculture products in Bangladesh was rather high: land was scarce, so the amount of agriculture was limited, and the scarcity of agriculture products brought their price up in the markets. When Bangladesh starts trading with Canada, though, Bangladeshi consumers can choose to buy Canadian agriculture products, which are substantially cheaper (and so the consumers can buy more of them). Less business for Bangladeshi farmers at their old prices leaves them the options to lower their prices, or else to close. Either option lowers their income, which makes us expect that land-based or intensive land-using individuals would protest free trade in Bangladesh. The HO-SS model thus predicts that we should see cleavages (social/political divisions) based around factor ownership. Holders (or intensive users) of plentiful factors will profit from free trade; holders (or intensive users) of scarce factors will suffer from free trade. [Note for Memory: Match the P's and S's to recall who benefits and who is harmed. The two S's in 'scarce' and 'suffer' remind us that it goes with the Stolper-Samuelson model.]
A very key assumption from the HO-SS model, however, may or may not hold in practice. HO-SS assumes, as was reasonable through much of the early 20th century, that factors were in general mobile across sectors. Mobile factors can change industries (i.e., move between sectors) easily and at very little cost. Unskilled labor in an assembly line, for example, can pull a lever, push a button, or tighten a screw in a car, a toaster, a sewing machine, etc., with very little retraining time or cost. Cash is a mobile form of capital. Other forms, though, are substantially less mobile: recovering one's investment in a steel mill to invest in another industry, for example, requires selling the steel mill to someone else. An assembly line used to produce stereos today cannot begin producing cars tomorrow. Labor that is specific to a particular industry, like most forms of skilled labor, is usually stuck in that particular industry.
Viner noticed this. He built on Ricardo's theory of comparative advantage to produce a prediction that when exposed to free trade, less-efficient industries (those which depend heavily on factors that are relatively scarce) will be under pressure to produce more cheaply. Unless they can lower their costs to meet those of producers where the same factors are abundant, they will eventually be pushed out of business. For example, US steel producers in the 1970s were faced with competition from the developing world. Labor there was much cheaper, since it was substantially more plentiful (lower cost of living plus labor is the relatively scarce factor in the US). Capital was more expensive, so the plants cost more to build, but the newer plants used much more efficient technology than the older US plants. As a result, foreign steel was substantially cheaper than American steel, so many firms (in the US and elsewhere) bought their steel from non-American producers. US producers were unable to reduce their costs: labor costs were high and fixed as a result of union labor contracts, and shareholders were not willing to pay the high costs of investing in newer technology. As a result, a large share of US steel firms were uncompetitive; they couldn't sell their goods and so they had to close.
While this was happening, US steelworkers and US steel plant owners banded together to lobby for protection. Because steelworkers lacked skills to do anything other than work steel, and steel plant owners were unable to use their factories to produce anything other than steel, both factors had a vested interest in the health of the industry. When we relax the assumption that factors are mobile and allow them to be specific to a particular industry (immobile), then, the result is that we expect to see sector-based political coalitions.
Posted by lpowner at 11:50 AM | Comments (2)
November 08, 2006
What's the Difference Between 'Mobility' and 'Liquidity'?
'Mobility' is a term used to refer to the ability of factors of production - land, labor, and/or capital - to switch between uses in different industries (sometimes called 'sectors'). Land, for example, is a particularly immobile factor. Land used for farming can be used for a parking lot only after paying substantial costs to pave it - assuming that it's in an area where anyone might want to park, since agriculture usually occurs in rural ares. Unskilled labor is fairly mobile; sweeping floors at McDonald's (in the restaurant sector) is not a lot different from sweeping floors in a hospital (in the health care sector) or in a bank office (in the financial services sector). Most forms of skilled labor, on the other hand, are not particularly mobile. Their factor of production are specific to a particular sector. Gym teachers cannot easily become brain surgeons; investment advisors cannot easily become automotive engineers. These factors would incur a substantial cost to shift from one industry to another. As you might guess, then, mobility is a continuous variable - factors can have different degrees of it - rather than a yes/no variable where a factor totally is or totally isn't mobile.
Like labor, different forms of capital also have different degrees of mobility. Cash is the ultimately mobile form of capital - it can be moved from investment in one industry (through stocks or bonds) to investment in another sector's stocks or bonds with very little cost. Other forms of capital assets are also fairly mobile, such as computers or office buildings (the same office building that currently houses a law firm might tomorrow house a group of accountants, a small software firm, or the like). Some forms of capital are highly immobile: once you invest money in buying a steel plant, that money is not available for investment elsewhere until and unless you find a buyer for the steel plant, nor can you easily use the resources in the steel plant to produce, say, semiconductor chips. Railroad cars are another immobile asset; owning a bunch of railroad cars can't help you produce higher education services, health care, etc.
A Note on Terminology: When we refer to 'mobile' factors, we normally mean mobility between industries within a particular country. The exception to this is financial capital (cash), where references to 'capital mobility' normally refer to the ease with which capital can cross national borders in search of the highest rate of return.
'Liquidity' is refers to the ease with which a particular capital asset can be converted to cash. It too is a continuous variable, with some forms of capital more or less easy to convert than others. It is not the same as mobility - mobility refers to ease of conversion between use in different sectors of the economy - but the two are related. The most liquid forms of capital are, in descending order, cash, stocks and bonds and other forms of portfolio investment, precious metals, and then physical and fixed assets (machines and buildings). The first few things are highly liquid because you can always find buyers for them who will pay you a rate fairly close to what you paid for the asset in the first place. The further down the list you go, the less likely you are to find a buyer for it, and the more likely the price offered will be substantially below what you paid for the asset in the first place.
Highly liquid assets are fairly mobile; once I've turned it into cash, I can invest that cash in any sector that I choose. Highly mobile factors, on the other hand, may or may not be highly liquid. A personal computer is a highly mobile capital asset - the same laptop I use in the higher education sector can be used in the healthcare sector, the public services sector, the business world, or elsewhere - but it cannot be converted to cash as easily as a stock or bond can be, and the cash value I would get for a used laptop would be substantially below what I originally invested in purchasing that asset. Likewise, an office building that can be used for many different sectors of economic activity can't be converted into a hospital, chemical plant, or police station without substantial costs or investments.
Posted by lpowner at 01:49 PM | Comments (0)
What are the Current and Capital Accounts?
Together, the capital and current accounts make up a state's 'balance of payments.' These two accounting devices show us the total flow of funds into and out of a country.
The current account is like a 'national checking account.' It has four main components: trade in goods, trade in services, dividends (interest), and foreign aid and remittances. Dividends (interest paid by us to foreigners and also interest paid by foreigners to us) is a rather small amount; remittances and foreign aid can be rather important for some smaller, less-developed states. The first two elements, trade in goods and trade in services, are by far the largest components. Think of exports as 'credits' on the national current account (+), since they're money paid to us by another state, and imports as a 'debit' (-) since we pay some other state for those goods. So, the current account looks something like:
(exports of goods - imports of goods)
+(exports of services - imports of services)
+(dividends paid to us - dividends we pay to others)
+(net of remittances and/or foreign aid)
current account balance
If the current account balance is positive - in other words, we have more funds flowing into the country than out of it in a given year - we have a current account surplus. If the current account balance is negative - in other words, more money is flowing out of the country than into it in a given year - we have a current account deficit.
The capital account consists of investment coming into and out of a country. (Note: This is the value of the investment itself, not the returns on the investment. Those are in the 'dividends' category of the current account since they're paid regularly, whereas the investment itself is a one-time thing.) This includes both portfolio investment (stocks and bonds) as well as foreign direct investment (building factories, etc.) As with the capital account, if the net balance is positive the capital account has a surplus and if the net balance is negative the capital account has a deficit.
The reason it's called the 'balance of payments' is that the capital and current accounts must balance. A surplus in one must be offset by a deficit in the other. Why? Because my currency isn't of any use to anyone outside my country. If I'm sending a lot of goods and services abroad (i.e., have a current account surplus), I've got a lot of foreign currency that others have paid me for my goods, and since I can't use it, I invest it elsewhere. A state like the US can only finance its enormous current account deficit by attracting investment to cover the gap between its hard currency coming in from exports and its hard currency going out from exports and investment abroad.
A state usually preserves a bit of any hard currency coming into a country beyond what is needed to balance the accounts and puts it into the central bank's reserves. The reserves are a sort of a rainy-day fund which can be used to cover short-term shortfalls in the balance of payments. This isn't sustainable in the long run - a persistent negative balance will eat away at the rainy-day fund until it's gone - but it can cover for a few months if a short slump occurs. The reserves can also be used to make small interventions in international currency markets in defense of one's currency. For states with a fixed exchange rate, that pool of reserves directly governs (through some proportional formula) how much of its own currency it can issue. As the gap between the surplus and the deficit sides of the balance of payments grows, the reserves increase as well, and the state can issue more currency. In this way, the promotion of exports (or alternatively, the attracting of investment) allows the state to expand its money supply over time and grow its economy.
Posted by lpowner at 11:52 AM | Comments (0)
November 07, 2006
What are 'Beggar-thy-Neighbor' Policies?
'Beggar thy neighbor' policies are manipulations of international economic policies with an intent to shift the costs of domestic economic adjustment to one's trading partners.
Answering this requires backing up a step. When countries are in recession - that is to say, their economies are shrinking or at least are not growing fast enough to keep up with growth of the labor force and other stuff like that - the country's economy needs to adjust to alleviate this. Adjustment is costly, though. Some part of the economy will need to be restructured - some people will need to find new jobs, some industries might close, etc. This adjustment occurs internally through a process of "creative destruction." Less efficient firms close and their workers need to find new jobs (presumably in more efficient industries). As you might imagine, this is politically costly to politicians who rely on those workers (or on owners of capital in less efficient industries) for electoral support.
Beggar-thy-neighbor policies refer to a class of strategies for adjusting one's economy by displacing the costs of adjustment onto one's trading partners. By putting up tariffs, for example, a state can protect its less efficient industries from international competition. Tariffs are taxes that raise the price of imported goods until those prices are similar to the prices domestic producers must charge. Those inefficient domestic firms are able to remain in business longer than they "should." What happens, though, is that firms in your trading partner's country are no longer able to sell their goods in your market, and so because they have nowhere to sell their goods, they close. So instead of YOUR workers in that less competitive industry being out of work, your PARTNER's workers in that industry (which is presumably more competitive, which is why they were successfully exporting to you), are now out of work. The costs of adjustment (or perhaps, rather, non-adjustment) in your economy are being paid by your trading partner.
This is a bad thing by itself, for one country to do, but when a bunch of countries do this, total trade drops. Now, we're both losing: we lose both export markets (and the jobs those create), and we lose the specialization created by trade. With the decline of trade, some things that we had previously imported from more efficient producers abroad now must be produced at home by our less efficient producers; this means that they'll produce less stuff for more cost, and GDP will decrease. So everyone in a country is made worse off, overall, by beggar-thy-neighbor protectionism - even if some individuals benefit from the protection.
Similar effects occur from devaluing a fixed exchange rate. A lower exchange rate - where one of my currency buys fewer of yours - means that imported goods are no longer as attractive. Let's say the US dollar was fixed to the Japanese yen at a rate of US$1 = Y100. Before the devaluation, my $1 bought a good worth 100 yen. If the US devalues now, so that my US$1 is now only worth Y90, I can't buy as much of the foreign good as I could before. Buying the same Y100-valued good would now cost me $1.10 instead of $1. So what would a consumer do? He'd buy a domestic good instead - the price of the domestic good hasn't changed. What happens to the Japanese producers, though? They lose market share in the US export market, and so they pay the cost of the US government's steps to increase domestic economic activity. Trade shrinks as a result of this, too.
This was a hugely popular way of increasing domestic economic activity (or trying to, at any rate) headed into the Great Depression. States defected from the classical Gold Standard left and right, trying to stay one step ahead of their trading partners. What ended up happening is that these frequent devaluations scared off international investors and traders, who had benefited from the stability of the fixed rate, and so trade and investment dropped even more. After the competitive devaluations, the net result was that both sides had paid the other's adjustment costs (loss of export jobs, etc.), trade had dropped as a result, and the investors were spooked. Everyone was worse off than they would have been had they resisted the urge to protect.
Posted by lpowner at 11:40 AM | Comments (0)