Saying goodbye to pneumonia

Written By Sarah Martin

In the poorest countries in the world millions are dying every year from diseases that modern medicine can treat and prevent. Surprising but true, in Africa pneumonia claims more children’s lives than AIDS.

Vaccination against pneumococcal disease, which causes pneumonia, meningitis and other lethal illnesses, could greatly reduce child fatality rates in the developing world. The problem is that no such vaccine exists.

So far there has been no incentive for drug companies to develop and produce vaccines for the diseases that claim the most lives worldwide. Where these vaccines are needed the most, people are too impoverished to demand them. In developing countries as little as £9 or less is spent per person per year on health care. Shockingly, over 90 percent of drug investments go to diseases that affect the richest 10 percent of the world’s population.

The Advance Market Commitment (AMC) for vaccines is market-based solution to this market failure. Originally proposed by Harvard economist Michael Kremer and the Centre for Global Development, an AMC is a pledge to subsidise future purchases of a vaccine not yet available.

A pilot AMC is underway for a vaccine to prevent pneumococcal disease. Six of the world’s richest countries (including the UK) and the Bill & Melinda Gates Foundation have pledged a total of £750 million pounds. It is estimated that it could save the lives of as many as 5.4 million children by 2030.

This is how it works: When a safe and effective vaccine is developed, the benefactors of the scheme subsidise the price down to a level more affordable for developing countries, thereby spurring demand. The promise of this demand is an economic incentive to supply the vaccine, and thus a market for the vaccine is created. The AMC provides the subsidy for an agreed period of time, after which the pharmaceutical company is obligated to provide the vaccine at a low price.

And this is why it could work: An AMC is not a purchase guarantee, there is only a cost once a vaccine is available that is actually demanded by developing countries. The competition for demand means that the best and most cost-efficient vaccine will prevail. The subsidy will provide enough return on the drug company’s investment in research and development to justify supplying the vaccine at a low price after the AMC ends.

The main obstacle now is to determine what subsidised price to provide the vaccine at. At the moment a price of about £2-3 is being discussed. This would involve a 90 percent reduction in price, the steepest drop ever seen in the price of vaccine in its first year of production.

However, some are concerned that this is still too expensive. They question whether a vaccine could be produced at lesser cost in by drug companies in India rather than in the West.

If successful the AMC for pneumococcal disease could be the first in a series of AMCs for vaccines against such diseases as malaria, tuberculosis and AIDS, and in the long term AMCs could save literally millions of lives.

Microfinance: Panacea for all economic ills?

Written By Shamanthy Ganesha

From ancient slums and impoverished villages in the developing world to the tired inner cities and frayed suburbs of America’s economic fringes, these and millions of other women are all part of a revolution. Some might call it a capitalist revolution . . . As little as $25 or $50 in the developing world, perhaps$500 or $5000 in the United States, these microloans make huge differences in people’s lives . . . Many Third World bankers are finding that lending to the poor is not just a good thing to do but is also profitable.
(Brill 1999)

Over the past few decades, the popularity of microfinance as a poverty alleviation tool has increased vastly. The UN declared 2005 as the year for Microcredit while Dr. Mohammed Yunus, well known as ‘The Father of Micro Finance’ won the Nobel Prize for Peace in 2006 for his work. Microfinance industries in many countries such as India, Bangladesh and Indonesia have been growing exponentially. There has been a giant wave of interest amongst people from many quarters, including economists and policy makers. In broad terms, microfinance is the provision of microcredit, microsaving and microinsurance services to people who are usually otherwise excluded from formal financial markets. While there is much reason to be highly optimistic about the potential of microfinance, I adopt a more sceptical view of it. I spent this summer working as intern at a well known microfinance think tank in Chennai, India. My work their involved constant interaction with both urban and rural microfinance clients. In this article, I detail how the information that I gained from informal interviews with these microfinance clients made me question some typical assumptions that are made about microfinance and its functioning.

It is a well known fact that the world’s poor generally do not have access to formal sources of credit. There is an essential asymmetric information problem between the providers of formal credit and the poor. The costs of monitoring how the poor use their debts by far outweigh the benefits that they accrue to formal credit providers. They have low propensities to save given that they are highly liquidity constrained. Moreover, under usual circumstances the poor own little or no assets at all. Thus the effectiveness of using collateral as a form of screening device is severely limited. The group lending mechanism which is often hailed as the greatest innovation of microfinance is said to get around this moral hazard problem by allowing the borrowers themselves distinguish between ‘safe’ and ‘risky’ individuals. Given that each individual is jointly responsible for the entire group’s loans, economic reasoning tells us that individuals who have relatively high coefficients of risk aversion will form groups with other risk averse individuals while the individuals with relatively low risk coefficients are screened out. Also, once the individuals receive their loans, they have an incentive to monitor each other’s activities if they are to make regular repayments and be eligible to borrow in the future. The task of monitoring the use of borrowed funds is effectively transferred from the lenders to the borrowers themselves.

Firstly, it does not seem to be the case that group formation takes part on the basis of risk type. Quite a few of the women with whom I spoke told be that they had not known all, if any of their group members before they joined the Joint Liability Group (JLG) or Self Help Group (SHG). The common practice is for one of the women to initiate the group (the group leader). This group leader then invites other women to be part of the group. Most often than not, this group leader invites women who live in close proximity to her, maybe in the same street. To me, it seems more likely that women segregate themselves by geographical proximity, caste and religion than by their relative risk types. Also, even once the loans are received it is unlikely for the women to be actively engaging themselves in monitoring each other’s business activities. Very few of the women I spoke to had any information regarding the type, costs and profits of the businesses of other women in their groups. One reason for this could be that monitoring is not costless for the women. Given that nearly all these women have to manage their time between their duties towards their families and nurturing their own businesses, very little time and energy is left for monitoring their peers’ activities. It is only when one of the women repeatedly fails to make repayments that the other members will make a visit to her house to inquire about what is happening. In my opinion, it seemed that there was less social cohesion among group members than is commonly assumed in the literature.

Moreover, it is common to assume that microfinance organisations have low interest rates and require no collateral and that it follows that they should be preferred to the mean usurious moneylenders who charge exorbitant interest rates. There are several misconceptions in the above statement. Firstly, the real rates of interest (as opposed to the quoted nominal rates) that the MFIs offer may not be very much lower in comparison to the professional moneylenders’ interest rates. Secondly, it is not always true that MFIs do not ask for collateral. In some cases the MFI asks prospective borrowers to make an advance deposit equivalent to some percentage of the loans that they are to receive before releasing funds. Thirdly, the moneylender is not always the mean and usurious man he is made out to be in the traditional literature. More often than not, the local moneylender will be a family friend of the borrowers. The women to whom I spoke to would never refer to them as moneylenders but usually as ‘acquaintances of the family’. In fact, it could be that in some particular cases the moneylenders are actually preferred to MFIs. One reason for this could be that the money lenders do not stipulate strict repayment schedules. Given that they have an informational advantage over the MFIs and other formal providers of credit and live in close proximity to their clients, they are unlikely to stipulate a strict repayment schedule. The borrowers pay back their loans as and when they make enough money to do so. Further, it seems quite a common practice for women to borrow from money lenders while they are borrowing from micro finance institutions. As mentioned above, some MFIs have deposit requirements. The women go to the moneylenders to obtain funds to make the deposit. The initial microfinance loans tend to be small and may not be sufficient to start up an enterprise from scratch. At times of emergencies such as illness in the family or a daughter’s wedding the women which require one-off expenditures that will not provide any direct revenue, the poor have little choice but to reach out to the local moneylenders.

Another reason why people believe that microfinance is an invincible tool is the high repayment rates that are reported by various MFIs. It is common for most MFIs to quote a repayment rate of 95% and above. Does it mean that the women’s income generation activities are producing very high returns? Many of the clients with whom I interacted did not use their loans solely for their enterprises. A good part of the loan may actually be used for consumption purposes. Moreover, some of the women were engaged only sporadically in their respective enterprises (Some of their services and produce were demanded only seasonally). Also it is more likely for the women’s enterprises to be a supplementary source of income for the household. Thus the enterprises don’t always have very high returns. It is slightly puzzling to me therefore as to how the women manage to make regular repayments. An important question to ask here is whether the repayments are made voluntarily. I was told by some of the women that peer pressure induced them to go to the moneylenders, thus they become indebted involuntarily to the money lenders. Also, anecdotal evidence suggests that some MFIs may use strict enforcement schemes on groups that fail to make repayments that are not very different to the methods used by professional money lenders.

These are a few reasons as to why I believe that the results of microfinance that are commonly reported should be looked at more critically. This does not mean that I think that microfinance is not a good thing and is an absolute failure. What I do believe is that microfinance is not as perfect as it is made to sound. The way forward would be to acknowledge it’s shortcomings and devise appropriate ways to overcome them.

An Uneconomic Look at the Economics of Local Eateries

Written by Jan Henning
(with thanks to Judith Shapiro for the Beta)

Given English Michelin-star restaurant economics these days, can LSE students still hope to eat out in WC2? Read on…..

In a recent interview, chef Heston Blumenthal announced that his fish-and-chip platter contained a total of five chips.

Checking the sample menu at Heston’s restaurant; I’d estimate the price of the fish-and-chip platter at around £30 (His à la carte 3-course menu weighs in at £80; platter probably a Main); so, if we assume that the fish covers about 2/3 of overall price, each chip would be worth £2.00
Given that an average bundle of chips from a traditional fish shop takeaway runs into at least double figures (for approx £1.50), we might infer any or all of three things about Heston’s variety.

• The five chips are so huge as to stretch the definition of “chip” to its uttermost boundary;
  
• They are extraordinarily labour-intensive to produce;
  
• They contain an above-average to-die-for factor.
  

If you’d really like to pay these prices (as well as the price of a trip out of London to Bray), here’s the link to the Fat Duck - http://www.fatduck.co.uk/

However, it might be less time-consuming, more profitable and indeed, pleasurable, to look at what’s on the doorstep.

The following establishments (a random personal choice) are all within walking-distance of LSE. Some have even been known to serve chips (NB: if these are described in the menu as “French fries”, you should rigorously apply the to-die-for factor [dff]).

1.The White Horse Pub
Sheffield Street WC2

Walking-time from St Clements Building: 0.5 minutes

Ambience and comfort-factor: Limited. It’s a tiny establishment with a bar-stool fixation – only one table-with-chairs. One average-size party of miscellaneous admin staff will crowd it out. (Students are also now welcomed, following a recent management-policy change).

Menu: Limited to sandwiches and toasties.

Dff: Also limited, but that’s not what you’re paying very reasonable prices for (around £2.65 per sandwich). The sandwich variety is very good, if maybe a little hearty-meat-oriented – sausages feature quite a lot. The drinks are reasonably priced also.

Miscellaneous: the two-man bar/cooking staff work well together, and are kindly and welcoming.

2.Coopers Wine Bar:
49a Lincolns Inn Fields, WC2A 3PF
http://www.london-eating.co.uk/5784.htm

Walking-time from St Clements Building: 1 minute

Ambience and comfort-factor: Depends on when you visit. A crowded lunchtime can be very unrestful. They have a ground-floor restaurant, and a cellar-bistro (more limited menu, lower prices); so you very rarely get turned away for lack of tables.

Menu: Regarded as reasonably-priced for its neighbourhood; it can actually be a bit high, if you go for things like the crab-starter. On the other hand, the other starter-size salads are very reasonable, and quite exciting (try their signature dish of lightly smoked chicken with salad and lime and honey dressing). No one minds, BTW, if you just have a starter-portion. They’ll also do you a single bowl of chips, if you ask. Price approx £1.60 – but they’re “French fries” (which means uniformly thin. You suspect they’ve been factory-extruded and bought in by the packet). Not terrible, for all that.

The wine list, is of course, what makes the profit, so be prepared for high-ish prices on all drinks (soft drinks also somewhat overpriced). A good choice of wines at all prices, however.

Dff: When things are at their singing best at Coopers, some of the food is delicious, and well above the level you’d expect. They can have off-days, however.

Miscellaneous: Coopers is fairly well-established. The owners are always friendly and welcoming; but the turnover of agency staff sometimes renders service a little uneven.

3. The Terrace
Lincoln’s Inn Fields WC2A 3LJ
http://www.london-eating.co.uk/7026.htm

Walking-time from St Clements Building: 1.5 minutes
Ambience and comfort-factor: This relatively new restaurant is situated in a hut behind the tennis courts, and can be a bit draughty. Also when it’s crowded (which is frequently), your neighbour’s elbow comes very near to being in your soup.

Menu: This is owned by a Named Chef – Patrick Williams – who blends Caribbean and French cuisine. It’s thus not cheap from the à la carte, but the 3-course “taster” lunch at a set price (around £11 a few months ago) is excellent value.
The chips – which here come with a beefburger all set out on a square wooden block; are hearty and MAY be authentic. The wooden block is a trial, however.
Wine menu is extensive but expensive. So is the bottled water.

Dff: Can be sublime. Jerk chicken with plantain, the signature dish, is wonderful. Desserts are a bit blah.

Miscellaneous: The service is often agonisingly slow; so don’t go there if you’re in a hurry. Staff are pleasant, but they’ve somehow never solved the time-factor. They may need Gordon Ramsay!

4. Oops
31 Catherine Street. WC2
http://www.fluideating.co.uk/Oops_Restaurane_Vinateria_WC2B.restaurant

Walking-time from St Clements Building: 7 minutes
Ambience and comfort-factor: This is a newly-opened tapas restaurant, with probably the worst name in London – EVERYONE’S told them about this, but they stick stubbornly to their guns. The interior is a rather gloomy brown too.

Menu: The food redeems the name with a really exciting variety of smallish dishes to suit every palate and every pocket. The lunchtime set-menu costs £12.95 for four dishes, plus a glass of wine. The à la carte can be a bit pricier (and more varied too, to be fair); and there’s a blackboard of specials every day; which includes delicacies like fried razor clam and real calamari complete with tentacles. Well, whatever floats your boat!
Wine is actually quite reasonably priced here.

Dff: You may find a lot of exciting new experiences here – not all to die for, to be sure (super-hot pimentos, anyone?). However, the basics – chorizo, morcilla, doritos are all delicious; and you can’t go wrong with the octopus!

Miscellaneous: Service can be sketchy at times. Also – beware of matinee day – Thursday. The restaurant is situated exactly opposite the Lord of the Rings musical.

The Subprime Crisis

By Soumya Gupta

Everywhere you see especially in any financial paper or journal, seem to be harping on the fact of Credit Crunch and the subprime crisis. I realised how big it is when it started affecting an everyday person, be it through market chaos, lowering growth rates or simply the market uncertainty underlying the economic situation.

What actually happened?

How can some defaults on mortgages affect the economy on such a huge scale!!! Its all thanks to the new and innovative financial instruments which have been developed uniquely to make money for the big banks and hedge funds and other financial intermediaries.

House Mortgages were being provided on a large scale, even to consumers whose paying back capacity was really low. This is basically what a sub prime loan is, that is the risk is extremely high. All was hunky dory, as house prices were rising, making mortgages attractive to buyers and sellers. Subprime borrowers paid a higher rate of interest which benefited the lenders. Thus demand was high and supply was very forthcoming.

Now the banks wanted all this debt out of their balance sheets, so they created Special Purpose Vehicles (SPV’s), which took on the debt, securitised it and sold it in forms of bonds and securities. A lot of big investors invested in these, like pension funds, hedge funds, who had personal investors, corporate investors and leveraged debt.

This turmoil spread like wild fire because if one sector that is the mortgage holders get hit and cannot cough up the interest payments or the principle amount, the repackaged securities/ derivatives called the Residential Mortgage backed securities (RMBS) which were sold to a variety of investors don’t get their returns and this one glitches turns into an ugly vicious cycle resulting in chaos and like this time a credit squeeze. A credit squeeze because most of these SPV’s lent long and borrowed short, now the investors know about the instability and lack of return and unwilling to lend further accentuating losses.

What it resulted in?

Well as can be observed, there is major chaos in the financial sector. Stability has been undermined, the U.S.A. has sneezed and the world is catching the cold. The risk was so widespread that no one knows the extent of the loss. No one is willing to lend, the consumer confidence is dipping like the house prices further leading to lowering of growth rates and spreading of recessionary tendencies.

What is forecasted?

The Federal Reserve is trying its best to counter the situation by lowering interest rates, making money more easily available, and instructing big market players to come to rescue. The big problem; the big market players themselves are suffering. Everyday the papers talk about write off or a series of top officials resignation. The situation is predicted to last until next Christmas and be multi-national in nature. However, the thing that is strange is even though there has been massive globalisation with India and China massively relying on Foreign Investment to grow, they don’t seem to have suffered.

Impact on EME’s

I believe we can observe here the phenomena of decoupling on economies. Decoupling basically means the lessening of correlation or dependency between variables. This seems to be the case presently, that though the U.S. economy is suffering, that is low consumer and investor confidence, low growth and hence low exports etc, the EME’s do not seem to have taken the hit that badly. The EME’s are steadily growing and have ever increasing growth projections.

There could be many reasons for this. Though we are moving towards a more globalised world, the dependency between developing EME’s and the U.S. is decreasing. These countries are indulging in bilateral and multi lateral trade treaties where USA is not necessarily a party. They are increasingly trading with other growing economies and the ROW and not only the USA. Therefore this just mellows down the impact that the export oriented industries would have suffered previously, where a USA recession would have meant a world recession.

Also the growth in EME’s, commenting on India is more fundamental than financial. That is there is real growth in production, consumption and investment through growth in own population income and production as well. With extremely low labour cost and other incentives given by the government it is easier and cheaper for many multi nationals to actually shift parts of business to India. This helps in raising employment, income and overall consumer confidence and economic growth.

Taking the BPO industry, for example, that is the call centres been outsourced to India for its large, extremely cheap English speaking labour force. It was affected as the companies which had outsourced suffered, this Indian industry suffered, the IT industry suffered. However this was not large scale enough to offset the gains from increasingly effective manufacturing and the growing services industry.

Also since the developed world has been hit, and with returns higher from India and China and other fats growing, recently called the 3rd world, suddenly seem extremely exciting and safer. With the tax payer’s money being used to save Northern Rock, the better investment opportunity seems like the country who is galloping towards growth and overtaking the mighty-but-in-trouble big brothers. This flow of investment and growth in real sector has definitely been termed as fundamental and hence will aid the EME’s progress and prosper.

Some authors have gone to the extent of concluding that the growth of the EME’s is good enough to offset the recession in the developed world market. This might not be the case though, but it is fundamental enough to give back steady and high returns for a long period of time to come. It is just proving to be that stage on scene when it is end of Act 1 and the actor is refusing to leave, but Act 2 players are already on stage giving a brilliant performance.
The Emerging Economies are coming of age.

Impact on Students in the U.K.

I-banking seemed extremely lucrative to pay back the student debt… think again, I believe the opportunity cost to applying to these big banks is greater than attending that Econometric lecture as they are not recruiting very few anyway.

Those of us from the EME’s trade off between staying and earning in pounds is definitely decreasing as compared to returning home to better jobs. Our IC is becoming steeper.

Hoping the pound will follow the dollar in decreasing, we can spend more on clothes and parties....

Surveys

Q.6 Average amount spent daily on foodstuffs bought at the LSE (in pound sterling).

0-2 : 20% (10 of 50 respondents)
2-5: 62% (31 of 50 respondents)
5-10: 18% (9 of 50 respondents)
10 or more: Nil

Rationale reckons:

1. The average amount spent on foodstuffs bought at LSE is £3.72.

2. This is a significant amount and the LSE Catering Service should take note and try to absorb more of the LSE student clientele from the large shares commanded by Subway and Wrights Bar.

Conducted and compiled by Avnish Srivastava

Surveys

Q.5 Have you read the previous Economic Society journal – ‘Ekanamiks’?

Yes: 8% (4 of 50 respondents)
No/What is that anyway? : 38% (19 of 50 respondents)
I’m New (I wasn’t here last year): 54% (27 of 50 respondents)

Rationale reckons:

1. The respondents who did not read the last issue were probably jealous students from the Anthropology or Sociology Department.

2. Well this year we are seeing to it that the proportion of yes grow manifold by making ‘Rationale’ a roaring success. We treat this as an indicator and our aim of conducting this survey is to ensure that a couple of editions on, we get a 100% positive response.

Conducted and compiled by Avnish Srivastava

Surveys

Q.4 Do you think the LSE campus has become more crowded this year compared to last year?

YES: 40% (20 of 50 respondents)
NO: 6% (3 of 50 respondents)
I’m New (I wasn’t here last year): 54% (27 of 50 respondents)

Rationale reckons:

1. The very fact that more than half the respondents are new to the LSE seems to speak volumes about the number of new students on campus this year.

2. More than 40% of the respondents seem to agree that the LSE is more crowded this year than it was compared to the previous years. Will the LSE please take note?!!

Conducted and compiled by Avnish Srivastava

Surveys

Q.3 Approximately how many hours on an average do you spend in the LSE Library daily?

0-2 hours: 8% (4 of 50 respondents)
2-5 hours: 54% (27 of 50 respondents)
5-10 hours: 34% (17 of 50 respondents)
10 or more hours: 4% (2 of 50 respondents)

Rationale reckons:

1. The average number of hours spent in the Library by the average LSE student is 4.92 hours.

2. Students seem to be taking refuge in Library due to the seeming lack of other activities to do in and around the LSE campus.

3. It is scarce wonder then that the Library is overcrowded. The British Library of Political and Economic Science boasts of only 1700 study spaces which include 450 networked PCs and is supposed to cater to over 6500 daily visits from student and staff. The math is quite straightforward.

4. There is an urgent need to increase the number of study spaces in the Library and to provide alternate activities for LSE students in and around campus. We, the students of LSE are turning into a generation of Library junkies.

Compiled and conducted by Avnish Srivastava

Surveys

Q.2 Where do you prefer to eat at LSE?

Wrights’ Bar: 28% (14 of 50 respondents)
Brunch Bowl: 20% (10 of 50 respondents)
The Quad: 12% (6 of 50 respondents)
Garrick: 4% (2 of 50 respondents)
The Three Tuns: 6% (3 of 50 respondents)
Nosh (newly opened on Kingsway): 6% (3 of 50 respondents)
Subway (on Kingsway): 16% (8 of 50 respondents)
Other/I bring food from home: 8% (4 of 50 respondents)

Rationale reckons:

1. The battle for the share of the LSE student pie seems to be a three way war between Wrights Bar, the Brunch Bowl and Subway.

2. Other significant entries include the newly opened Nosh on Kingsway which has immediately started attracting a substantial share of LSE lunch-time money.

3. The absence of John Watkins Plaza and Café Pepe from the list is conspicuous and the LSE Catering Service should take note and encourage students to use these facilities as well.

Conducted and compiled by Avnish Srivastava

Surveys

Q.1 Do you own an Mp3 Player? Is it an Apple product?

Apple: 64% (32 of 50 respondents)
Non-Apple/Other: 22% (11 of 50 respondents)
None/ I do not own an Mp3 Player: 14% (7 of 50 respondents)

Rationale reckons:

1. Apple Products clearly dominate the Mp3 player segment at the LSE and seem to be the most popular choice amongst the students interviewed.

2. Apple market share is thought to be much larger in the global market. Apple iPod sales in 2006 alone are thought to be more than 23.5 million units (Source: Macworld). This was at a time when it was yet to release its new revolutionary touch screen iPod Touch player. Apple estimates that 100 million iPod units have been sold since their launch in 2001 (Source: CNN)

Conducted and compiled by Avnish Srivastava

Economics in Everyday Life.

Written By Naitik Shah

The sky was dark, the street looked familiar but I couldn’t recall the name. The sound of rain was the only sign of life on this lonely night. I wondered what it was that brought me to this deserted place. Suddenly, the door in front of me swung open and I heard a loud screech. I thought to myself, “I have heard this sound before, where was it? Why can’t I remember?” and then it dawned on me, “Oh my god! It’s my alarm; I have to go for the economics class. I am late!”

I am sure many of you must’ve had similar experience, while here at LSE. To tell you the truth, this is what I hate the most about my student life. Having to wake up at seven am each morning, all I can do while lying there in bed is cook up reasons for not getting out of the bed. Most of the days, these reasons elude me and I end up at the eight o’ clock lecture, however on some lucky days I do cook up a good reason and end up sleeping in. You maybe wondering what does this have to do with economics; actually everything.

Economics is the study of how individual, faced with unlimited wants and limited resources maximize their utility, which in essence boils down to choosing between various alternatives. We experience this everyday, whether it is deciding between attending the morning class versus getting some more sleep or going to that party on the weekend and getting drunk versus staying up all night to study for the approaching exams.

So one might ask how does one bargain over these wants? The answer is simple, every choice that we make has a cost and some benefit associated with it. And we simply choose those actions whose additional benefit exceeds the additional cost incurred to undertake those actions. However, you may now ask how do we calculate the cost of two different things like studying and sleeping. The answer in this case is not that simple.

Every individual has a set of beliefs, ideals, preferences and goals in life; these are what make them unique, and also form the basis for our cost/ benefit analysis. Depending on what we value more we make our choices. Let’s take the example of choosing between sleeping in or attending the morning class. The cost analysis here is simple; the cost of going to class is forgoing your sleep and dream, of course if it’s a nightmare then the cost ends up being zero. On the other hand the benefit is attending the lecture and learning something, which in turn would mean you get a good grade. Thus, if you value getting good grades over sleep and your dream then you would choose to go to class. On the other hand if you know that the professor is simply going to read the handouts he has already put online, then the additional benefit of attending the class is reduced greatly. As a result, you get to sleep in just like me, on those lucky days, when I knew that the professor was just going to repeat what he had done in class and I was able to sleep in.

On that note, let me give you a couple of examples from everyday life to reinforce the idea. Choosing to work part time is another good example. Here the cost is the time spent away from studying, which I guess not a lot of you would look at as a cost, however the benefit is the extra money you make. Similarly, choosing what to during the Easter break can be seen as a cost benefit analysis. It’s a choice between studying for the impeding exams or enjoying your time off.

Before I end this discussion let me point out another interesting feature of this cost - benefit analysis, which I am sure you must’ve guessed by now; the value of cost and benefit changes depending on the circumstances facing a person. Let's analyze the case of procrastination to get a better understanding of this.

Let's say it’s the first week of class, you have just attended the first lecture and the professor informed you about the exam that is going to take place at the end of 10th week. At this point you are least worried about studying for it. The benefit of starting preparation are minimal as there is a high probability that you might forget what you studied before the exams, besides there’s a lot of time for you to prepare. On the other hand, the cost is too high as you would have to forgo all the fun you plan to do like joining different societies, going to the fresher bash, etc. With each passing day the benefit of studying increases. If you don’t study you could fail and then end up disappointing yourself as well as ruining your chances of getting a good job; the cost on the other hand stay the same. At some point in time the benefit would exceed the cost and you will stop procrastinating and start studying.

Thus the next time you are faced with a decision, think about what you have learned in economics and apply it to reap the benefits of your education.

Thoughts on the Subprime Crisis

Written By Drew Vincent

For anyone interested in economics and finance (and especially for those of us who are American) the past six months have provided a fascinating, perhaps textbook-worthy insight into the dangers posed by the subprime market. The effects of the crisis are broad and well-publicized, but the causes remain quite open to speculation. Many have criticized the increased securitization of subprime lending (up to 62.5% in 2002 from 31.6% in 1994)1 for its creation of tranches with seemingly inflated credit ratings. Following the crisis, I became interested in how such errors in credit assessment might occur even in a relatively static market, as well as how other factors might influence the default rate over time but remain overlooked by financial institutions.

In trying to understand how so many financial institutions were, to put it bluntly, caught with their pants down, I focused first on the way in which these institutions assess risk. Most of my insight into this field comes from the work of mathematician Benoit Mandelbrot. Mandelbrot has studied market behaviour since the 1960s and recently crystallized some of his ideas in a new book, The (mis)Behaviour of Markets. He criticizes the tools he has observed in use at the majority of corporations and financial institutions, namely the Capital Asset Pricing Model (CAPM,) Markowitz Portfolio Theory, and the Black-Scholes formula*2; furthermore, he denounces more recent inventions of mainline financiers (one of these being GARCH,) saying “...such ad hoc fixes are medieval.*3” Mandelbrot's central argument is that 'orthodox' financial theories fundamentally underestimate volatility. Taking equities as an example, the traditional idea is that prices variations lie within the normal curve, infinitely familiar to anyone who has taken a statistics course. This means that small price changes are quite common, with large changes being quite rare. Indeed, this concept is taught today at the LSE, along with the idea that prices change via a random, coin-flip process with no connection between one change and the next.

Numerous events, some of them occurring notably during the subprime crisis, seem to refute the normal curve model of price changes. The most clear example was the market crash of 1987, where the DJIA lost 29.2 percent of its value in one day. Under the normal curve model, a change this extreme is, for all practical purposes, statistically impossible; thus, it seems likely variations lie within a different function: a power law function, Mandelbrot suggests*4. It can also be shown that the coin-flip or 'random walk' model of price changes simply does not produce charts that mimic actual price charts. Mandelbrot provides compelling evidence that these changes can be modelled much more accurately using fractals, geometric constructs that are self-similar regardless of scale (daily behaviour resembles monthly resembles yearly behaviour,) and generate charts with the degree of randomness observed in actual price charts, as well as many other types of sequential, random movements, perhaps including default rates. Fractals are already in wide use providing convincing computer generated images for theatrical special effects, and it is highly likely that fractals could provide a much more reliable system for assessing risk. Unfortunately, the mathematics involved with these models are more complicated than those in CAPM and its companions. For the time being, if Mandelbrot is correct, financial institutions will likely continue to underestimate risks and volatility (at least mathematically.)

Another possible factor influencing default rates is the continuance of widespread illegal immigration into the United States, as well as the government's seeming inability to address this issue. As of January 2006, the US Department of Homeland Security conservatively estimated the population of unauthorized immigrants at 11,550,000*6. These immigrants represent a large market, and banks have been lining up to offer their services. As reported on CNN.com, “an increasing number of banks are seeing an untapped resource for growing their own revenue stream and contend that providing undocumented residents with mortgages will help revitalize local communities.”*7 One bank representative claims that illegals are “no more likely to default than a documented resident.”*8 I find this extremely difficult to believe based on the current political climate and personal experience.

Illegal immigrants and the companies who employ them face increasingly difficult odds as their presence becomes more widely felt and governments begin to respond. For example, my own home state of Georgia recently passed legislation that denies public benefits to undocumented workers and imposes severe punishments on companies found employing said workers. Such actions are likely to cause job loss for illegal immigrants (whose positions were already unstable as they could be terminated randomly with no legal recourse) as well as family troubles as benefits disappear. Both of these are denoted as 'trigger events' for default in the Danis and Pennington-Cross paper on sub prime mortgage delinquency*9. Having worked in the construction industry for two summers, I have heard many of these concerns voiced by both contractors (who face prosecution for employing illegals) and workers who admitted they were not legal residents. One man I worked with quite often, who came to America illegally but was later granted legal status, frequently lamented his credit score as he had in earlier years been forced to default on a mortgage as a result of his uncertain financial situation.

In conclusion, I could not hope to develop an exhaustive explanation of the subprime crisis. However, I hope to have shown that factors such as systemic underestimation of volatility in various markets and banks' lending to undocumented workers merit further investigation as likely contributors to the institutional crisis observed this year. It is my hope that even if the crisis does not prompt reform of the mathematical tools of financial institutions, perhaps it will at least increase the instinctive caution of those considering investment in the subprime market.

1. Danis, Michelle A., and Pennington-Cross, Anthony. “The Delinquency of Subprime Mortgages.” Journal of Economics and Business In Press, Corrected Proof (2007).
2. Mandelbrot, Benoit, and Hudson, Richard L. The (mis)Behaviour of Markets. New York: Basic Books, 2004. 60.
3. Ibid, 104.
4. Ibid, 13.
5. US Department of Homeland Security, 2007. “Estimates of the Unauthorized Immigrant Population Residing in the United States: January 2006,” http://www.dhs.gov/xlibrary/assets/statistics/publications/ill_pe_2006.pdf
6. Pasha, Shaheen. “Banking on Illegal Immigrants.” CNNMoney. 8 August 2005 http://money.cnn.com/2005/08/08/news/economy/illegal_immigrants/
7. Ibid
8. Georgia General Assembly. Senate Bill 529. http://www.legis.state.ga.us/legis/2005_06/fulltext/sb529.htm
9. Danis, Michelle A., and Pennington-Cross, Anthony. “The Delinquency of Subprime Mortgages.” Journal of Economics and Business In Press, Corrected Proof (2007).

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please comment......

Dear Economist

By Soumya Gupta & Avnish Srivastava

Q:

A lot of times when I go out with friends someone ends up suggesting ordering a number of different dishes and sharing them. I do not like this idea (because it is messy and it dilutes the pleasure of choosing), but once the suggestion is made, it seems churlish and anti-social to object. How can I break this cycle, while retaining my friends?

Answer:

I feel the same way. Why should I be obliged to trade my delicacy with a rubber tasting chicken piece. Still, there is more to this than simply finding a polite way to object.

The basic difficulty is judging the cost of your dislike against the benefits derived by your friends in sharing. Sharing should occur if your irritation at the practice is outweighed by their delight; and should not occur otherwise. Who is to make this judgment? Also another problem here is consumer preference is not truly revealed, because some of your friends like you might not be revealing their preferences just like you.

Fortunately, the Coase theorem, developed by our own LSE Nobel Laureate Ronald Coase, predicts an optimal and mutually satisfying outcome if property rights are clearly specified. You could suggest that everyone could order their own dishes, specifying clear property rights and sharing wherever the trading is leads to a pareto optimal condition. This should ensure that splitting dishes occurs only when socially efficient, and you will not be obliged to participate, although an excellent offer of compensation may persuade you to do so.

Looking at your situation in terms of the Coase theorem, the problem is that the property rights are not clearly specified. Once this is done it will provide a solution for a community (here your friends and you) welfare maximization.

Dear Economist

By Soumya Gupta & Avnish Srivastava



Q.

I am a final year undergraduate student of Economics and seem headed for a career in investment banking to pay off my student debt, but theatre is my passion. Should I follow my heart and do theatre even if it seems risky.
Befuddled

Answer:

Aahh… The classical dilemma of making choices under uncertainty. Here you as a consumer have to make a choice to maximize your welfare under conditions of uncertainty. However, here not only does your consumption depend on your choice but so does your endowment. I would suggest you separate the choices you make on your Production possibilities frontier(PPF) and your Indifference Curves(ICs), this would help in maximizing your benefit from your income first and then taking this income as given and maximizing your consumption and hence welfare.
I would draw my PPF between returns from a career in I-Banking and returns from a personally satisfying career in theatre.

x : Returns from Theatre
y: Returns from I banking

I would consider that returns from I-banking, assuming that you already have a job, are certain and will help you pay off your student debt and also live comfortably.

Returns from entering theatre are uncertain, that is you don’t know if you can make it big, also your income will be uncertain on the number of projects you get and taking the probability of success and failure may not suffice for paying of your debt in the short term, however being set off by the fact that it gives you much more welfare benefit as a consumer.

I believe that as a person staring your career, investment is more important so that it can help you grow further in monetary terms.

P.S. Work for a few years in I banking and earn some moolah and use that to pay off your student debt. Once you find that you are in a comfortable state of finances and are short by a few years of sleep, I believe that would be a great time to foray into theatre.

Dear Economist

By Soumya Gupta & Avnish Srivastava

Q :

I stay at one of the LSE halls, and we share common kitchens. I prefer buying groceries and storing them in the common fridge. However, many a time I have discovered my items to have been used or aren’t there anymore. Why don’t people buy their own groceries? Is there a solution?
Hungry Rosebury-en

Answer:

Your difficulty is that the property rights here are not secure and your food might end up being treated as a public good (or a semi-public good). In economics, public goods are goods which are non-rival and non-excludable. When you keep things in the fridge, people might use them for their own consumption because at that moment they become non excludable. It becomes very difficult, to find out who used whose food, as there is no mechanism to check and also property rights are not well defined. There also exists another mechanism where people end up consuming your goods. The opportunity cost of going out at night or in the rain is much higher than just using someone else’s milk, which is a small proportion of the entire bottle to make a cup of tea. This might be the case for other goods as well when you need to have breakfast and are running late. I would like to term this into a phenomenon of unclear property rights and conversion of private, excludable goods to semi-public goods.
P.S: Please label your goods and you’ll definitely see an improvement in the situation. The risk of getting caught using someone else’s labelled stuff is much higher that buying your own goods.

A critical analysis of the concept of rationality

Written by Naitik Shah

I still remember the day I attended my first economics lecture. It was the first day of my high school and unfortunately it was also my first class of the year. I was nervous as I had absolutely no clue as to what economics meant. The professor entered the class and took his seat. He placed his books down and then stood up went on to write the following four things on the board. First, “Economics is the study of how rational individuals maximize their unlimited wants given their limited resources”, second, “individuals are rational”, third, “Wants are unlimited, because rational individuals would want everything they can lay their hands on”, and finally, “the resources available to these individuals are limited.” These four statements form the very basis of economics and is the very first thing that anyone is taught. Of these four statements, the rationality assumption forms the basis of all economic theory; on its shoulders lies the entire canonical of economic theory. However, have you ever stopped for a minute and asked yourself what if this assumption doesn’t hold? What if rationality is too strong an assumption? Let’s step back for a minute and analyze what it implies to be rational and the implications of this assumption.

Simply put rationality implies that each and every individual in the economic model should act in a manner that will maximize his/her well being. Although this makes perfect sense, since if everyone in the society maximize their well being then the well being of the society as a whole will be maximized. However, this in turn also implies that if individual X can improve his well being by cheating he should; if firm X can increase its profits by using underhanded tactics and creating a monopoly for its good then it should. This clearly contradicts what we are trying to achieve as if someone cheats then one person, who cheats, is going to be well off at the cost of the person he cheats. The total well being of society could still be maximized depending on how much individual X who cheats gains and individual Y who is cheated looses, but this is not what economics is trying to achieve. The purpose of economics is to promote the well being of all individuals in society. Another drawback of rationality is it leads to the exclusion of concepts of charity, generosity, voluntary work and equity. These have been either are called instruments of indirect self-interest or normative science. But don’t you think that these concepts aren’t merely an instrument of normative science or a side-effect of indirect self-interest? I believe that they are conscious actions taken by rational individuals with the sole purpose of helping others and I am sure you would agree with me. As a result, reducing them to mere indirect self-interest denies an important aspect of human nature, i.e. selflessness; something that cannot be understood in the conceptual framework of a self-interested economic man.

The way this problem can be solved is by expanding the concept of rationality so that it includes concerns for welfare, justice and the effects of ones action on others. Thus economic agents will now be concerned about not only their well being but also the effects their actions will have on others, giving then a new conscience. This newly found conscience will allow then to take into consideration the effects of their actions on others, making them more likely to provide complete information as well as ensuring that there are no externalities generated by their actions. This in turn will solve problems like coordination conflict encountered in current models of market. Finally, it will make our economic agents more sociable, and bringing them closer to reality, which in turn will allow us to talk about communities, governments and common beliefs. This will also lead to the introduction of a new mesolevel in our analysis of society, something which is vital but has been missing until now. The reason that this level of analysis is important is because a lot of our policy decision as well as preferences are decided on this level; for example our stand on abortion more or less depends on our upbringing, which in turn is determined by our parents and their beliefs. These are things that are determined as communities and not as individuals, hence reducing such decisions to an aggregate of individuals decisions would be a big mistake and wouldn’t provide any insight into the process through which these decisions are arrived at.

Thus what is need right now is for us to realize that when we say economic agents are rational, it implies that individuals maximize their well being, while taking into account the effects of their actions on others. If this is how we would have been taught economics then global warming wouldn’t have been a problem today, neither would have we seen the crash of Enron, or the declaration of dividends for its shareholders by Northern Rock.

“To contract out or not to contract out – that is the question!”

By Jagoda Sumicka

Not more, not less – let’s try to answer it.

Once upon a time…

Maybe I will surprise you, maybe not, but in the 1930s and 1940s, almost all the economists, and in fact almost all of the Nobel laureates, were in favour of government ownership of an industry if only they suspected any market imperfections around. This was so because what was at the centre point of the economic discussion back then was competitive pricing, rather than ownership.

Even laissez-faire economists at that time were accepting nationalisation, if it was to achieve presence of competitive prices. Henry Simons wrote in “A Positive Program of Laissez Faire”: “The state should face the necessity of actually taking over, owning, and managing directly, both the railroads and the utilities, and all other industries in which it is impossible to maintain effectively competitive conditions.”

During the World War II everything that could be nationalised was nationalised. In Europe this tendency was somewhat preserved in the post-war period, when many countries opted for state ownership of strategic sectors of the economy i.e. mines, electricity, heavy industry, food provision etc. An extreme case of such an approach was found in the communist countries of the Eastern Europe, where virtually everything became state-owned.

… and now.

We all know how communist ideas ended up and that the approach towards state-ownership has changed completely – a few decades ago no one would ever suspect that a private bus company could ever be successful. Or garbage collection. Or electricity provision. And they all work!

Today, people usually agree that certain items should be provided by the state, but they still disagree whether they should be produced publicly or privately.

And whereas it is quite difficult to find the adversaries, supporters of contracting-out are as visible as opponents of American troops in Iraq. One can even get an impression that – provided - A - you are not an unionised worker of a state-owned company – B - you are not a politician in a country of dozens of people falling into the category A described above – then probably you should support contracting-out. What would make you think so?

Maybe the following [Shleifer 1998]:

Turkish state-owned coalmining company running annual losses per worker equal to six times the per capita national income.
A state-owned power utility in the Philippines shutting off electricity for seven hours a day in many parts of the country.
A state sugar-milling monopoly in Bangladesh employing 8,000 unneeded workers while forcing the price of sugar in the country to stay at twice the international level.
A Tanzanian state-owned shoe factory which, even with the World Bank’s help, could not get its production to rise above 4 per cent of capacity before shutting down.

If there was no World Bank in the footnote, you would hardly believe it.# When I asked my friends to guess the year in which all these took place, the answers varied from 1950s to 1980s.. In fact, these events all took place in 1995 so not a long time ago.

So it seems that contracting-out is a good idea, right? But is this always the case?

I do not think so. Of course, you can argue that something is always true, but such a statement is highly questionable in a diverse world we live in. What is relevant to apply to one environment may be incredibly foolish to use in some other setting. For instance, I would not recommend having your water pipes installed outside of your house in Alaska, whether in England it is actually a good cost- and space-saving strategy.

Thus, we need to approach contracting-out versus state-ownership dilemma from several different angles to find a general recipe for deciding whether government should contract out a service or not.

First, we will think of the market environment i.e. we will examine the importance of competition and the problem of being incapable of writing fully-specified contracts. Then, we will relax the assumption of the benevolent government and how much impact it has on our discussion. Having done that we should be ready to inspect the simplest cases of the contract-out-do-not-contract-out dispute.

Ready. Steady. Go.

“It’s the competition, stupid!”

Those who favour privatisation over state-ownership often highlight the importance of competition.

Imagine a government setting up a contract, not more, no less, but to contract out a specific service. The minister of infrastructure, who has set up the scheme, is planning to open a bottle of champagne, since after a couple of months she is sure of reaping off the benefits of the presence of competition.

Unfortunately, this is not always the case. Think, for instance, of natural monopolies, where a high fixed cost associated with entering a particular market leads to economics of scale, whereby the average cost of production falls as quantity of output rises. Hence, in equilibrium, there will be only one firm in this market. If this firm goes private, there will be no competitive pressure for this firm to deal with due to the impossible-to-overcome barriers of entry. Then such a firm will under provide at a higher cost to consumers than a state-owned company would normally do. Thus, when thinking of privatisation of industries following this pattern - electricity, gas, land-line telephone providers - one must make sure that competition will be introduced by dividing the company into a few separate ones with managers who would not collaborate with one another, and that specific anti-monopolist laws will be enforced, if service is going to be contracted out to only one company.

Another thing is that competition requires perfect information. This is extremely important, especially when it comes to consumer’s knowledge on cost and quality of a product. Take the very famous dilemmas of whether schooling and medical care should be contracted out. Both cases seem very similar at first glance – the society cannot go on without them, innovation is important, incentives of their state-employed staff are rather weak, and the damage from cost-cutting would be enormous for both of them. What differentiates these two is customers’ access to information. When you choose a primary school for your kids, in many cases it is enough to ask your neighbours for advice. But when you are to choose medical treatment, the case is much more complicated as consumers usually have poor ability to assess the quality of health care they receive [Hart, Shleifer, Vishny, 1998]. In this case, not only is the cost of acquiring information very high (Spending a couple of years doing a degree in medicine is not a cheap business..), but also the cost of making bad decisions is enormous (The stake is often your life!).

Now, take a step back and think why we do actually want competition. Well, this is because individual suppliers fight for their consumers by reducing cost, which can be achieved through innovation. And it is hard to argue against what Alfred Marshall said at the dinner of the Royal Economic Society on the 9th of January 1907: “A government could print a good edition of Shakespeare’s works, but it could not get them written.” Yes, government is generally a poor innovator.

Indeed, entrepreneurship is what makes the economy grow, it is what makes good become better, and expensive - cheaper. Unfortunately, the two usually do not go together. A firm can achieve cost-reduction by lowering product’s quality. Hence, a case in which quality is non-contractible, is generally a case against contracting-out, provided reputation-building mechanisms are non-existent (Would you produce low-quality goods, if you knew that the customers would not buy them again?).

“Power tends to corrupt and absolute power corrupts absolutely” – relaxation of the assumption of benevolent government.

The case for contracting-out is becomes if corruption and patronage enter our calculation. When it comes to the latter, it is rather obvious that trade unions around the world are typically strongest opponents of contracting-out, since they can obtain benefits in exchange for political support. This is a clear counterargument for state-ownership.

As for corruption, it is more ambiguous. On one hand, government provision often puts people in a position to take bribes for obvious reasons. But contracting-out is definitely corruption-free as politicians may award contracts to their friends (Guess of which very famous Vice-President I am thinking right now?) or inefficient providers in exchange for bribes. This is actually quite easy – just write a bad contract that fails to make the firm accountable to quality.

So if corruption may take place no matter if the government contracts out or keeps public services state-owned, the optimal idea may be to rely completely on unregulated market supply. For example, it may be better to have private garbage collection than either by government employees, or that by the private contractors who got their concessions by bribing officials. Also, a good idea may be to make sure that contracts would be awarded by competitive bidding to make sure that no nepotism is present.

To sum up, it seems that public services should be contracted out when innovation is important and, there is no serious damage to quality from cost-cutting, there is relatively good information available on the market, reputation-building arguments are strong, and corruption and patronage – not widespread.

Sources:
A Shleifer (1998), “State versus Private Ownership”, Journal of Economic Perspectives, 12:4, Fall, 133-150.
O Hart, A Shleifer, R Vishny (1998), “The proper scope of government: Theory and an application to prisons,” Quarterly Journal of Economics, 112:4, 1127-1161.

Is Russia a new Economic Miracle or just another Petro-state?

Written by Andre Tartar

In 2003 the investment bank Goldman Sachs came out with a report that established a new acronym, BRIC, that has fundamentally transformed how most people think of the global economy. It stands for Brazil, Russia, India, and China, the new behemoths on the block which can also be thought of as the world’s “big, rapidly industrializing countries”. These four giants represent a hefty portion of the world’s landmass, population, and economic potential. To this effect, the past decade has seen them embracing global capitalism like never before and reaping the benefits of the boom. China has experienced double-digit growth fueled by a billion-strong consumer class, India has witnessed the birth of the world’s newest batch of billionaires and IT champions, and Brazil leads the world on sustainable resource use. So how did Russia make it into this club?

Unlike the other three, Russia has already once been an economic powerhouse, a global superpower. So this is ostensibly its second chance to make prosperity stick. The last time around command-and-control politics and central-planning economics led to grossly inefficient allocation of resources and knowledge. The Soviet Union poured billions into military research but none into commercial research. As a result it had many fighter jets but few cars. In the Soviet model, a central-planning committee normally set a (high) production quota and a (low) price, in order to spread the benefits of production to the people (the mantra of the Communist Revolution). What normally resulted were chronic shortages of most goods, with producers unable to meet their quotas because of loss-inducing low prices.

This time around Russia does have a freer economy, relying on the market mechanism to allocate resources more efficiently. The theory here is that by allowing producers to compete on price for consumer demand, the price of goods should end up reflecting the true cost of producing the good and not exceed consumers’ willingness to pay for it. It is not hard to see where this has born fruit: Russian supermarkets are actually stocked with consumer goods and people are free to buy and sell virtually anything they desire. But is this freeing up of the consumer market really what is fuelling Russia’s boom?

With annual growth rates of between 4,7% and 10% for several years running [1], Russia’s GDP has tripled from less than that of the Netherlands in 2001 to nearly $1 trillion in 2006 [2]. Simultaneously average wages in the country have more than doubled form what they were a decade ago [3]. And so much wealth has poured into Moscow that it has surpassed London as the most expensive city in the world. Clearly Russians are richer than ever. But a closer look at the numbers will suggest a very different story, one closely intertwined with Russia’s emergence as a major energy player.

According to the US Department of Energy, Russia has the largest natural gas reserves and eighth largest oil reserves in the world. No surprise, then, that it is the world’s largest exporter of gas but it also happens to be the second largest oil exporter. This means that its economy is more sensitive to oil prices than virtually any other. The DOE estimates that for every $1 increase in the price of a barrel of oil, Russia’s government revenues increase by 0,35% of GDP [4]. Just imagine the boom to the overall economy from that $1 increase. Given that the price of oil was under $25 in 2003 and currently pushing $100, this translates into truly staggering growth.

But real per capita incomes may not be benefiting as much from this boom as some might think. Just factor in the double-digit inflation rates caused by skyrocketing wages [2]. Then consider that much of this newfound mineral wealth has either ended up overseas in Russia’s engorged foreign reserves, worth $447 billion by the Bank of Russia [5], or in its stabilization fund, now valued at $80 billion [4].

Oil is certainly a major ingredient in the Russian economic mix. There can be no doubt on that point. Take Russia’s enormous trade surplus, second largest in the world after Saudi Arabia, the leading oil exporter. They have surpassed $160bn by some estimates, up from a mere $40bn in 2000 [3]. Crude figurations show that most of this windfall comes from oil receipts.

Yet progress can be seen in some of the economy’s fundamentals. Investment currently stands at 18% of GDP, similar to the investment rates that have seen China through it’s growth spurt [3]. And manufacturing has been growing at a steady clip [3]. So there has definitely been growth in the economy outside the oil and gas sectors. But is it enough to propel Russia upwards through a post-oil future? At the moment, I would have to argue in the negative.

On the one hand Russia must prepare itself for a smaller population; its population declined by about 2 million people since 2001 [3]. Therefore it must invest more in a knowledge-based, service-centered economy. At present Russia is a net importer of services [3]. Secondly, Russia must insure that its companies are globally competitive. As I have tried to show, Russia’s economy is heavily skewed toward the energy sector. Only its main government-controlled energy companies, Gazprom and Rosneft, operate on an international level. And that’s solely because they are Europe’s main energy providers, not because of any inherent competitiveness. Too much government intervention and slow-moving regulatory bureaucracies are holding the rest of the country’s industrial complex back.

For the moment, then, it seems that Russia’s boom is more the result of realigning itself as a petro-state than a true economic miracle. For this proud nation to embrace its global economic potential, the Kremlin must relax its involvement in the economy. Russia must instead focus on unleashing its competitive strengths, much like China has.


[1] World Bank. Data and Statistics for the Russian Federation. May 2006.
.

[2] World Bank. Russian Federation Data Profile. April 2007.
.

[3] OECD Statistics: Russian Federation.
.

[4] Energy Information Administration: Country Analysis Briefs: Russia. US Department of Energy. April 2007. .

[5] Bank of Russia. 2007. <>.

PAKISTAN makes the headlines again.......for all the wrong reasons

A state of emergency was declared in Pakistan on 3rd November 2007 resulting in total suspension of the constitution. Hundreds of anti-government activists, lawyers and leaders of the opposition parties are being clapped up in jails and all private news channels in the country are being barred from airing. Not only is this having adverse effects on the political, judicial and media sectors of Pakistan, it is also harming the economy. Already, as an aftermath of the declaration of emergency, prices of basic commodities like wheat(staple food) and ghee(oil) have shot up and further inflation is being predicted by business men and economists.

“Whenever emergencies are imposed in the country, it results in price hike, uncertainty prevails and illegal trade flourishes,” Farooq Azam Khawaja, an eminent importer is quoted to have said.

The emergency is also predicted to cause a rise in price of imports and adversely affect export industry while deterring foreign investment inflow in to the country. This is precisely what the country doesn’t need right now; an economical slowdown on top of its chaotic political troubles.

Tangents wonder:

• To what extent is Musharraf willing to go to retain power?
• To what extent will the people of Pakistan put up with Musharraf's high-handedness?
• And perhaps most importantly, to what extent will America continue to support Musharraf in view of him being 'their man' and keeping an eye on the country's nukes?

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pic from flickr again with some rights reserved(attribution etc)

Mugabenomics: Zimbabwe's predicament

Zimbabwe’s economy is collapsing under the weight of its fiscal deficits, hyper-inflation and economic policies controlled by political agenda. It is really not a matter of whether it is going to buckle; it’s a matter of when. So how did the economy plummet in to a dysfunctional, broken down state? And more importantly, what can be done to save it from crumbling?

For two decades, the fate of Zimbabwe has been solely in the hands of Robert Mugabe, the once popular liberation leader now known as a human rights abusing dictator in the west. During this period, the country has undergone many structural changes in its socio-cultural, political ,and economic fields. Its international image and foreign relations with its immediate neighbours as well as world community at large have suffered badly due to the high handed policies of Mugabe in utter disregard of the world opinion. All these changes are inevitably reflected in its economy.

From being a thriving economy relying largely on its agricultural sector, it has come to the brink of a collapse. Once it produced enough to feed the nation and be a potential bread basket for its neighbours, was the second largest producer of tobacco, and the grower of best cotton in the world . However it is now facing an economic meltdown described by world bank as the worst ever outside a war zone. The agricultural productivity for 2006-2007 is nearly 30% lower than what it was in 2000 which has left millions starving due to severe food shortages and over 80% of the population unemployed. Inflation has risen from 133% in 2004 to somewhere between 7600 %(gov. sources) and 15000% (independent sources) making basic commodities of life unaffordable for the common man in Zimbabwe. Four out of five of the 12 million people live under the poverty line and many rely on grain handouts for survival. It is estimated that about a quarter of the population has emigrated. HIV/AIDS is prevalent in 20.1% of its adult population thus further reducing the active work force while at the same time increasing the economic burden on the economy.

The cause of this economic crisis is predominantly attributed to the chaotic and violent land reforms involving seizures of farms owned mostly by minority white farmers for the so-called ‘ benefit of the general public of Zimbabwe', implemented by a corrupt government. These farms have been handed over to landless members of the black community . They have generally found their way in to the hands of veterans and supporters of Mugabe. This has been a transfer from willing, skilled and resourced farmers to those who either lack the will and have sold infrastructure, irrigation pumps and other agri machinery etc for quick liquidity and economic gains, or those who have the will but not the skills or do not have collateral resources. This has led to decreased capacity utilization aggravated by the monetary policies of the government.

But that is not the sole cause of the crisis. Economically incorrect decisions like the handing out of unbudgeted awards to the veterans of the independence struggle by Mugabe due to political expediency and the decision to send troops to republic of Congo from 1998-2002 have struck a severe blow to the economy. It is estimated that Zimbabwe spent around 13 million dollars per month on this war. The inability of the government to repay loans and hence defaulting on IMF loans means that Zimbabwe is no longer eligible for further loan. Human rights abuses and repression of people by violent means has resulted in isolation of the country and indifference of the international community. Over and above all this are the limited sanctions imposed by the US government and the EU.

Severe shortages of fuel, food and other essential goods have resulted in skyrocketing inflation. However the government refuses to devalue its currency realistically and by enough to control the escalating prices of inputs. This in turn has led to manufacturing debacle as more businesses are being shut down due to shortages of inputs and the high cost of imported inputs that are available.

Instead, the government has resorted to administrative measures to control spiralling inflation. However the price ceilings imposed by the government are economically inefficient and practically ineffective .These have led to further aggravation of the situation as firms now have to buy from alternative black markets at even higher prices. The subsidies provided by the government on fuel and other inputs to the farmers are exploited as many do not use subsidised items for production but sell them in the black market at substantial prices making immediate profits.

The official foreign exchange rate is ridiculously high and foreign exchange reserves of the country badly depleted. The current official foreign exchange rate has increased to 15 000 Zimbabwe dollars to one US dollar ,as compared to 1 Zimbabwe dollar to 1 US dollar in 2003. The demand for foreign currency is so high and its supply so limited ,that the black market traders are selling it to the highest bidder at rates like Z$300,000 to one US dollar! With the central bank now buying at the illegal market rates to pay its mounting debts for power and fuel utilities, it is increasing everyday. Thus prices of imported inputs which are already very high are ever increasing and with the price control on products introduced by the governments, more and more businesses are shutting down. This has resulted in the lowering of productive capacity utilisation from 60% to 25%which is expected to decline further. This in turn is fuelling further poverty and unemployment and emigration leading to further brain drain of much needed skilled workers in Zimbabwe.

To top it all the government has warned of a possible electric supply collapse and breakdown of water supply .Absence of clean drinking water has led to another break out of the water transmitted disease I-e cholera. The country is plummeting fast and the economy is in a nose dive with living standards hitting rock bottom. Zimbabwe is in dire need of international aid and relief to have any chance of economic survival.

So what should the government do? Or simply, what can the government do? It should first of all drop price control. Again, it should pragmatically devalue its currency and bring black market operations to a close by essentially letting the market do its job and determine the price of goods and the exchange rate.

Mineral resources are enormous potential wealth for Zimbabwe with large deposits of gold, nickel, platinum, coal and methane gas. But to exploit these and to increase the productive capacity, international investment of capital is essential. However it is unlikely to be forthcoming in view of the present unfriendly policies of the government and unstable political environment.
Another historically strong sector is the tourism industry which is suffering right now due to the violence, chaos, and human rights abuses etc attributed to this regime. Unless a better image of Zimbabwe is portrayed in this world, foreign currency inflows through this sector cannot be obtained.

Zimbabwe can not survive any longer without international support and aid. The Zanu-PF under Mugabe should co-operate with the SADC led by the South African president and undertake reforms to ensure free and fair elections. Such reforms will end the international isolation of Zimbabwe and help in providing the much needed economic assistance ,food aid and other relief to the starving population. The west also needs to lift its sanctions on food and humanitarian aid ,and subject to acceptance of the terms of SADC provide financial assistance to start the process of reconstruction.

But for some people, the most important and the only solution to this milieu is for Mugabe to go. According to economist Robert Nelson : ‘… the Zimbabwe economy will continue to go down the tubes until they get some political stability and, as long as Mugabe is there, that's not going to happen.’ That might not happen because the opposition is still disunited amongst itself and despite allegations of rigging against Mugabe in 2005 elections, his party is still in control. However, in the words of a Harare based analyst, ‘the big problem about Zimbabwe is that the one thing you can’t rig is the economy. When it fails, it fails. And that can have unpredictable effects.”
*Sources for quoted statistics: CIA fact book, BBC website, Zimbabwe Independent, and New York Times.

Show me the money!

On the 5th of November, members of the Writers Guild of America (WGA), which represents 12,000 screenwriters, went on strike. The walkout occurred after negotiations between the union and the Alliance of Motion Picture and Television Producers (AMPTP), which represents the studios, collapsed.

The walkout is largely due to deadlock over an agreement on higher fees for writers from sales of DVDs and contents streamed over the Internet. At the time of writing, the WGA and the AMPTP have agreed to reopen negotiations on 28th November, but the strike is expected to last a while longer.

Although many shows have stockpiled on scripts in anticipation of production delays from the strike, many daily talk shows (such as The Daily Show, and the Late Show with David Letterman) which rely on writers for topical jokes have shut down. Shows such as Heroes have also been affected, as writers are not able to do last-minute rewrites. The new season of 24 has been delayed for the foreseeable future, and Lost may see the same fate. Similarly, production on the 2008-2009 blockbusters such as Angels and Demons and Harry Potter and the Deathly Hallows may have to be pushed back.

The last WGA strike took place in 1988 and lasted five months, costing over US$500 million. The current strike is expected to result in about US$1 billion of losses.

Tangent’s take:

• (can someone knowledgeable in labour economics please comment?)
• There has been a show of solidarity across the industry, with many 'writers-producers' / show-runners (basically the head writer/ boss) joining the strikes. What would happen if these show-runners decide to go back to work...?
• If the WGA's strike is successful in getting the AMPTP back to the negotiation table, would other guilds, like the Screen Actors' Guild or the Directors' Guild of America, likely follow suit?
• Why? Why Lost???

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Picture again from flickr, here. Again, nonderiv, attrib license.

Rules of the game

The Nobel Prize in Economic Sciences this year went to the American economists Leonid Hurwicz, Eric S. Maskin and Roger B. Myerson for “having laid the foundations of mechanism design theory”.

Mechanism design theory provides a framework to design rules of a game to achieve specific outcomes, even though players may be self-interested. A simple example of such ‘rules’, provided by BBC’s Evan Davis at Evanomics, is how a mother lets one child divide a cake in two, and the other to choose first which half of the cake to have. Apart from dividing cakes, mechanism design theory allows for the analysis of allocation mechanisms such as regulations, market prices and management, focusing on problems associated with private information and incentives.

Tangent’s take:

• Keep a look out for Economic Society’s own (albeit amateur) experiments in this area—with pizzas!

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Please add or edit as you see fit.

Lovely picture of pie taken from here. It's an Attrib-NonDeriv license, which means you would need a link to the pic if you use it. But the picture's not really necessary -- I'm hungry, that's all.

Dollars aren't a girl's best friend?

It has been widely reported that the world’s best paid supermodel, Gisele Bündchen, has stipulated that companies are to pay her in euros instead of US dollars over fears of the latter’s shrinking value. According to the reports, Ms Bündchen demanded to be paid in euros to represent Pantene hair products for Procter & Gamble Co., and similarly for her contract with Dolce & Gabbana to promote it’s The One perfume. The dollar has lost 34% of its value since 2001, and dollar reached its lowest level against the sterling since 1981 in early November.

Ms Bündchen’s agent has denied the stories, but even if they were true, her client would not have been the first prominent public figure to bet against the dollar—Warren Buffet has been vocally bearish on the dollar in October, albeit under much less attention from the press.

Tangent’s take:

• Does it make any economic sense for someone based in NYC to not accept US dollars?

• If everyone is betting against the US dollar, does it really matter that it’s value keeps on sliding?

• If everyone is betting against the US dollar, shouldn’t it have weakened to the point it can’t get any weaker?

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Amazingly, picture is available on Wiki Commons. ie. free to use.

And the Oscar--er, Nobel goes to...

The Nobel Peace Prize was shared by Al Gore and the UN’s Intergovernmental Panel on Climate Change (IPCC) for their efforts to raise awareness on climate change.

The IPCC was established in 1988, by the World Meteorological Organization and the United Nations Environment Programme. It is tasked with evaluating the risk of climate change due to human activity. Mr Gore’s film on global warming, ‘An Inconvenient Truth’, won an Oscar earlier this year, and was a box-office hit. It had also seen the headlines recently when a British judge criticised it for being alarmist and containing errors.

In related news, Mr Gore’s fund management company set up with David Blood – Generation Investment Management – has agreed to cooperate with Kleiner Perkins Caufield & Byers, a venture capital firm, to invest in areas such as alternative energy companies. This is seen as a further attempt to combat climate change.

Tangent’s take:

• A Nobel for being famous for talking about climate change? Really?

• Although governments have been touting the importance of fighting climate change, much of the investments needed has been left to the private sector. Perhaps Blood and Gore (a much better name for a fund, in Tangent’s view) may start a new trend in directing private investments towards green industries?

• Even thought there is still debate on the exact scientific consequences of climate change, the economic effects are real – see Tayyibah Arif’s piece on pasta price fluctuations

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Please add or edit as you see fit, especially with the 'Tangent's Take' section.

Picture of earth is in the public domain. Pictures of the Nobel Prize are NOT, hence, why the earth. And also because it's prettier.