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Wednesday, July 30, 2003

Squeezing the Saudis

Steven Den Beste had a post last weekend about putting pressure on Saudi Arabia after the recent war in Iraq. In it he says this:

I think part of the plan, and yet another reason why Iraq was a good choice as target of invasion and occupation, was to gain control of Iraq's oil fields. Not, as many will instantly claim, so as to let Bush's oil buddies in Houston get rich, but rather because we could use Iraqi oil output to compensate for declines in Saudi oil shipments. During the "oil for food" program, Iraq did ship a lot of oil, but the potential is there for shipments to be even greater, not to mention for those shipments to not be under the bureaucratic thumb of the UN.

Claudia Rosett, worried more about OPEC, write in today's Wall Street Journal:

The great myth, heard even in some parts of the West, is that OPEC is doing us a favor with its self-avowed mission to "achieve stable oil prices, which are fair and reasonable for producers and consumers." OPEC's notion of what's fair and reasonable has less to do consumer interests than with OPEC's basic problem, classic for any cartel, that above a certain price, it becomes so profitable for members to cheat (and for nonmember high-cost producers to increase supply) that the cartel falls apart.

The Saudis are, of course, entitled to offer oil at any price they want, including the OPEC target price of $22 to $28 a barrel for oil that costs them $1 to $2 a barrel to produce. But the Saudi-led collusion that goes into keeping world oil prices high enough to command prices that OPEC deems "fair and reasonable" is the kind of stuff that would get private capitalists in the U.S. fried on prime-time TV and thrown in prison.

Things are not quite that simple. Saudi Arabia's impact on oil markets is somewhat (though not entirely) symmetric--it poses a risk not just by ceasing to pump oil, but also by deciding to pump too much. In 1998, when OPEC's controls had collapsed and prices hit $10 a barrel, may experts seriously worried about the possibility, and impact, of $5 a barrel oil; in such a situation only the Saudis would make any money. A 1999 New York Times story describes what would happen:

[T]he desert kingdom can pump more than 10 million barrels a day at minimal extraction costs of $1 a barrel. This flooding would bring prices down to as low as $5 a barrel in a few months. Few oil-producing countries can take this possibility lightly. In the long run, it would put many producers out of business in the United States, the Caspian Sea, Russia and the prolific North Sea shared by Norway and Britain, where production costs range from $5 to $10 a barrel.

The Saudis may not be able to do this very quickly--while those fields have low running costs, it will take some investment to bring additional wells online. Iraq's fields, though, won't be fully online for a number of years yet, though. The Saudi Arabian ability to flood the market, though, will allow them to keep markets volatile, even though this could hurt them as much as it hurts their major customers. Their excess capacity also allows them to run OPEC as they do--only they can credibly threaten members and non-members alike to drive the price down. This is the reason why oil experts value the stability that OPEC's blatant collusion brings--when it works, oil prices are reasonably predictable, reducing uncertainty.

Ironically, the Journal's Rosett may have a good partial solution to the OPEC situation, by supporting privatisation of he Iraqi oil industry; this, however, may reduce the ability of the US to use Iraqi supplies for directly political ends. David Warsh once noted that "Perhaps the Gulf Wars are best understood as being antitrust policy for oil — industrial reorganization by force in the aftermath of successful monetary stabilization." Liberalising the oil market is something that may be valued on its own, for the benefits it would bring to both producers and consumers.

Saturday, July 26, 2003

Legal Markets

In a 1994 leader on "A Future for Socialism", the Economist wrote:

In framing market-friendly policies . . . left-of-centre parties actually have two decisive advantages over their conservative counterparts. First, they can more readily attack certain sorts of privilege. In many countries in Europe and elsewhere, the fiercest opponents of change are those who have traditionally benefited from the restrictive practices established over the years by the middle-class professions: doctors, accountants, lawyers and so forth. The left may be -- and certainly ought to be -- less willing than the right to defer to such interests. Second, the left's motives in reform are less in doubt. As a result. as "socialist" governments in Australia and New Zealand have shown, leftist reformers can often be more radical than right-of-centre governments in pursuit of efficiency, as well as in pursuit of equity.

Britain's Labour party, the main (but not exclusive) target of this leader, has been generally a disappointment in these terms. It's most successful policies, ironically, have been either when it followed this advice and built markets (such as in furthering electricity deregulation, which has drastically brought down consumer prices) or gotten out of the way (as in Gordon Brown's establishment of the Bank of England's Monetary Policy Committee). Aside from this, the government's interventions have been far from optimal, and, in the case of railways, even been welfare-destroying. The government also over-intervenes, reacting to, and having a position on, every issue that comes up. Not a good record to build on.

What then to make of this article in Friday's Guardian?

Supermarkets could draw up wills and handle accident compensation claims under proposals being considered by the lord chancellor, Lord Falconer.

The Tesco law option will be looked at by a wide-ranging review of the way legal services are regulated, with the aim of increasing competition and providing a better deal for consumers.

The government favours "one-stop" shops - with solicitors, accountants and other advisers under one roof - and wants big corporations to be allowed to offer legal services.

I first read of restrictive practices in professions like law in Milton Friedman's book Capitalism and Freedom; the issues he brought up are just as relevant as they were 40 years ago when they were first published. The legal profession, as currently structured, exists because of government favour and protection, and if the government is predisposed to shifting the balance towards consumers, then the power to it. The proposals are not revolutionary (multidisciplinary practices, for one, have been around for a years, especially in the "big four" accounting firms) but important, and could improve access while broadening the market for legal services.

Like all established interests, the response of the Bar Council is not surprising:

The bar's chairman, Matthias Kelly, said barristers would fight the proposals for one-stop shops with lawyers and accountants practising together "tooth and claw", because they would lead to the "Enronisation" of the legal profession.

The Lord Chancellor's proposals were prompted by a report from the Office of Fair Trading, the government's independent competition watchdog. In a progress report on restrictive practices in professions, the OFT writes:

Freedom to compete is a fundamental theme throughout our work. At no point do we prescribe, even tentatively, how professional services should be supplied. We believe that this is generally best determined by unfettered competition
between producers for the custom of consumers. Where others restrict the freedom of patterns of supply to evolve and improve, it is right that the onus should be on them to justify the restriction or remove it. The freedom to compete that results will benefit those who use professional services and those who serve them well.

This is indeed an odd thing for a government body to be saying. The government may not be going very far--to start with, it's review will last 18 months, followed by yet another consultation; drafting legislation will take even longer, as will its passage. (The OFT first looked into this in 2000.) Still, if the reforms develop in the way they are proposed, British competition policy will have gone a long way towards improving consumer welfare. Another example of the government doing better by setting up markets and getting out of the way.

Wednesday, July 23, 2003

Working Time

In microeconomics it is commonly assumed that labour is a normal good--more of it is consumed as incomes rise. This is sometimes used to explain the difference in per capita incomes between the US and Europe. While European productivity rates, (especially in France and Germany) have been high since the second world war, annual hours worked per capita since the mid-1970s are drastially lower than in the US. It can (and has, by Will Hutton, Adair Turner and others) been argued that the higher postwar productivity of Europeans have been used to "purchase" more leisure time, which they find welfare enhancing. The assumption of the normality of leisure is still questionable, though; the greater vacation time and family leave that Europeans enjoy has, in large part, been a matter of statute; to what extent have they chosen this outcome, rather than have it chosen for them by labour unions and symphathetic politicians? In a paper last year, Northwestern's Robert Gordon writes:

By definition, the remaining causes of Europe's low standard of living relative to its high relative productivity must be accounted for by some combination of a higher structural unemployment rate and a lower labor force participation rate. The higher unemployment rate in Europe is at least partly due to more generous unemployment compensation, and the welfare adjustment is not obvious. But part of the unemployment is related to laws that have lengthened vacations and shortened weekly work hours, making workers more expensive to employ. German firms are refusing to expand employment and capital investment in in Germany, preferring to invest in nearby formerly communist countries to the east and southeast, as well as such far-flung countries as Mexico, Brazil, and India.

The "purchase" of greater leisure time may have been cumpulsory, if somewhat indirectly and disguisedly so. Not that the European public (if it can be called that) is complaining.

Is this the end of the story, though? This week's Economist has an article (subscribers only) about the changing working-hours patterns in the UK. There is an apparenly decline in the hours worked by full-time workers, and this is only partly explained by the European Union's working time directive. An excerpt:

In October 1998, the EU working-time directive came into force in Britain. This set a limit of an average of 48 hours a week for most workers and gave workers the right to four weeks' paid annual holiday. The introduction of the directive neatly coincides with the start of the reduction in working hours. If it is responsible for the reduction in working hours, the decline may not be over. In August, the directive will be extended to cover more than 700,000 workers in the transport industry. Next year it will be extended to trainee doctors.

But Francis Green, professor of economics at Kent University, argues that the directive is neither the only nor the most important reason. He points out that the self-employed are also working fewer hours, even though the directive does not affect them.

It may simply be that people are now doing what they always wanted to do. Mark Taylor and Rene Boheim, both economists at Essex University, have analysed the working-time preferences of workers throughout the 1990s. A third of them consistently said that they wished to work fewer hours even if this meant a commensurate loss of earnings.

Why do people now seem to feel they can do that? Probably because, as unemployment has fallen over the past decade, they feel more secure in their jobs. It may have something to do with family life, too. As the balance of power in households shifts, men may be listening harder to women's demands that they should occasionally show up in time for the bed-time story; and as more women join the workplace, men are needed at home more than they were.

The government, by going on about the "work-life balance" may have helped persuade people that staying at home isn't necessarily skiving. Attitudes among graduates are changing. "They are less willing to devote life and soul to their companies in their early years," says Nigel Meager, deputy director of the Institute for Employment Studies.

The arguments may involve a bit of conjecture, and the timeframe is a bit short, but there does appear to be something of a discernable trend. Britons are finding that, if they can "afford" it (including any cost to job security) they will choose more leisure time, with leisure broadly defined as time not spent working. Choice is still not entirely clear; European governments, through employer sanction and public exhortation, are trying to influence preference formation, and there is no comparable control to suggest what would have happened without this. Generalising to the whole of Europe, this "choice" many have some interesting and unpredictable impications, especially given the dire demographic situation pointed out in the Economist's Charlemagne column. One wonders if European consumers know exactly what they're getting by taking so much time off.

Monday, July 21, 2003

Intergenerational Transfers

The Independent's economics columnist, Hamish McRae, is de digeur reading, especially his Sunday column. This week's installment is about fiscal policy, and our children paying for our present consumption:

With a growing economy and, equally important, a growing population, some net borrowing seems quite acceptable. But with the prospect of slower growth and a stable or falling population, the burden becomes huge.

A typical maturity for government borrowing is 20 years and some debt issues will not be repaid for 30 years. It is reasonable to make a distinction between current and investment spending, for money invested should bring some future flow of income to pay back the debt. However, much of what governments call investment is actually disguised consumption - it just sounds better. And any government that borrows to consume is saying to voters that the extra resources they get now, be they in the form of tax cuts or higher spending, will be paid for by their children.

There is a moral dimension to this. In a democracy, people have the right to vote for higher public spending and higher taxation. Different electorates make different choices. But do current voters have the right to impose higher taxation on children too young to vote, or on the unborn? If we have a duty to future generations to follow ethical environmental standards, as many of us believe we do, surely we also have a duty to follow ethical fiscal standards too?

In the past, large increases in government borrowing have taken place in time of war. You can make a solid argument that the cost of financing the Second World War should be carried by the entire post-war generation, not just people who were voters between 1939 and 1945. But when the spending is on, say, a subsidy for European farmers, is it reasonable to expect our children to foot the bill? I would argue not.

This comes a couple of days after the Economist published an article on Europe's demographic situation and its implications. I don't have much to add to what Edward Hugh and Brad DeLong have written good about this. Journalists love to read each other, and today there is a leader about implicit liabilities in the Financial Times. It talks up transparency as a first step:

Ideally governments should display long-term discipline, while retaining the ability to respond flexibly to the economic cycle. It would be difficult to design such a policy. But the next step should be for finance ministries to publish annual estimates of their governments' implicit liabilities, to lay out their assumptions clearly and to subject themselves to cross-examination.

This would no doubt provide finance ministers with a few sticky moments. But such public discussion would help them make the case for the needed reform of pensions and healthcare. This, then, is the second reason transparency should be encouraged. The third is that, even if governments still do not take the required action, the public debate should help individuals to see the need to make their own provision.

In the absence of such a regular and open discussion of implicit liabilities, where do we stand? The US fiscal system has the desirable level of short-term flexibility but lacks long-term discipline. The euro area countries are in an even more unfortunate situation: they lack the necessary long-term discipline over their implicit liabilities but suffer from short-term rigidities. This is the exact opposite of the ideal model.

Governments are paying for the commitments of the present in part by adding them to the promises of the future; policymakers are thus making huge demands of long run economic performance, and demographic trends are not helping. Sustained long-run economic growth, as Robert Lucas points out, is the next frontier in macroeconomic policy, and the stab at solutions that the Economist mentions--immigration, pension reform, childbearing incentives--don't actually do anything about this; throwing more people at the problem, with the set of economic policies as it presently stands, is bound to run into diminishing returns sooner or later.

The FT's suggestion on implicit liabilities is a useful start; it could lead, if done well, to a shift in popular expecatations. In a speech last November departing Undersecretary of the Treasury for Domestic Finance Peter Fisher said that "Federal budget decision-making needs to follow good business practice and move on from cash accounting to accrual accounting. If we can do this, maybe the federal government can learn how to better align the promises that we make with those that we can keep." Fisher's advice is difficult politically and methodologically, and I can't say where it could lead. The public could either feel the need to rely on themselves more for their own "welfare" provision, or could demand that the government do more somehow to stave off a bleak future. At present, though, these questions remain a bit academic; proper accounting would allow a proper public debate a chance.

UPDATE: Jane Galt has more on implicit liabilites, saying that "long term deficit spending is deeply immoral: those alive get all the fun, while those unborn get all the bills." Very true.

Thursday, July 10, 2003

Winters of Discontent

In last week's Spectator Simon Nixon says that Britain may face an energy crisis as soon as this winter:

As things stand, we will be dependent on gas transported thousands of miles from some of the most politically unstable countries on the planet, such as Algeria, Iran and Russia. What’s more, these pipelines must first pass through many other gas-needy countries. And Britain has not got the facilities to store the gas when it gets here. Most European countries have the capacity to store up to 20 per cent of their annual needs, but Britain can store only 4 per cent — or enough for about 48 hours’ supply in winter. If we don’t start building new storage facilities now, we won’t be equipped to cope with a cold winter in three years’ time, says Nial Trimble. ‘The lights will go out. I guarantee it.’

Nixon's concern in prompted by a report by Britain's Institution of Civil Engineers, which warns of dire consequences if the government does not do something about energy security. The thing is Britain's energy regulator, Ofgem, has done a great service to the consumers of energy by reducing regulation; it no longer regulates energy prices, for example. It's approach to market design has been very successful at lowering prices, which has fallen by 13 percent in real terms since 1999; this has made nuclear energy, for instance, more uncompetitive than it already was. It has also improved environmental outcomes, by pushing the shift from coal to natural gas. Ofgem's creditable focus is on improving final outcomes for energy users, not on on the structure of the system.

None of this is to say that the future will be the same, but neither is it cause for panic. Britain will have to adjust to a period when it can no longer rely upon North Sea gas; this need not be a disaster, though, and in all likelihood the shift to foreign sources could well be accomodated within current energy market arrangements. The market for natural gas is a world market, not one in which Britain operates in isolation. In the end there is the price mechanism--prices will adjust towards a market-clearing level, in energy more than in other markets. There therefore should not be any "shortage"--as long as they're willing to pay the prevailing price, Britons should not suffer for lack of energy.

Wednesday, July 09, 2003

Drug Legalisation

Responding to Mark Kleiman Calpundit posts about the costs and benefits of legalising cocaine. Kleiman thinks its a bad idea because drug abuse will rise, wheras Calpundit thinks that any legalisation is better than the very costly status quo. There is a lively debate in Calpundit's comments section. Any accounting for costs and benefits of drug legalisation has to take account of how drugs are legalised, and, unless there's a shift in the Senate, the United States cannot legalise drugs. Why not? because of the US-backed 1988 United Nations Convention against the Illicit Traffic in Narcotic Drugs and Psychotropic Substances. The following is Article 3:

1. Each Party shall adopt such measures as may be necessary to establish as criminal offences under its domestic law, when committed intentionally:
a) i) The production, manufacture, extraction; preparation, offering, offering for sale, distribution, sale, delivery on any terms whatsoever, brokerage, dispatch, dispatch in transit, transport, importation or exportation of any narcotic drug or any psychotropic substance contrary to the provisions of the 1961 Convention, the 1961 Convention as amended or the 1971 Convention;

ii) The cultivation of opium poppy, coca bush or cannabis plant for the purpose of the production of narcotic drugs contrary to the provisions of the 1961 Convention and the 1961 Convention as amended

Unless there are some drastic political changes in Washington, legalisation can't simply happen; the most that could happen politically is an effective decriminalisation, similar to the Dutch policy of looking the other way on soft drugs. (Contrary to popular belief, drugs are still illegal in the Netherlands; the Dutch simply ignore some parts of the Convention.)

Such a decriminalisation effectively means that 1) there won't be any tax revenues, for an "illegal" product cannot be taxed or state-distributed; and 2) enforcement (or, in this case, the lack of it) will be uneven, as jurisdictions exercise their prerogative to uphold the law. This unevenness is likely to lead to conflicts between adjoining states if their enforcement regimes are different. It may also make states tort-liable for non-enforcement, especially when people under the influence commit an even greater crime. Such a decriminlaisation policy could thus prove quite costly to state governments even if the law is equally not enforced.

I am in favour of legalisation, but for it to work a proper policy would have to be devised, including either an amendment to (or, failing that a withdrawal from) the 1988 convention. Even countries proposing changing drug laws don't mention either option, as the US, its chief advocate, can inflict "punishment" on such countries. (The current US threats to cut aid if it does not get an exemption from the jurisdiction of the International Criminal Court is a case in point.) The idea of drug legalisation is as old as John Stuart Mill; unless someone comes up with a way of making it happen politically, it will remain just that--an idea.

Monday, July 07, 2003

Reversal of Fortune

In a tie-in with the post below, some ironic news; India is now a net creditor to the IMF.

Moving Up

In her book of essays How to be Human, Though an Economist Deidre McCloskey says that the Economics Department of the Univerisity of Chicago has become a copy of MIT's--the creative Chicago School is now not much more than a an excellent, conventional neoclassical economics department. She perhaps overstated her case, i think. A lot of the real action in contemporary Chicago economics is now at the Graduate School of Business, with stars like Kevin Murphy, Eugene Fama and Richard Thaler, to name three, continue to take economics into new areas. (Steven Levitt, this year's John Bates Clark Medal winner, shows that the good old department still has action in it.)

Last week the International Monetary Fund named Chicago GSB economist Raghuram Rajan to replace Harvard's Kenneth Rogoff as Economic Counsellor (chief economist). Rajan is perhaps best known for his book, Saving Capitalism from the Capitalists, co-authored with his Chicago colleague Luigi Zingales. (Read the Washington Post review here.)

The FT last week stressed that Rajan's background was in finance, not macroeconomics, while some Indian commentators have made much of the fact that he is the first Fund chief economist from a developing nation. The imporant thing, though, is that Rajan will be taking office in September, in a difficult time for the world economy. How would he approach it? In an interview with the Indian news site Rediff.com Rajan chuckles at an ironic reversal:

I mean the richest country in the world is the biggest debtor while poor countries are lending tremendously to rich countries (laughs). I don't say it is wrong in some ethical way. I am saying it is just funny that this should be the situation in the world economy. The question is how much is enough? It's a sign of some success. If we carry it too far, it will reflect some failure also.

His comments are mainly about India, but the point can easily be generalised to the world as well. Rogoff, to his credit, has done a lot to strengthen the IMF, and it is up to Rajan to make the IMF to have a greater postive impact on the world economic situation. Wish this Chicago lad well.

Sunday, July 06, 2003

Passive Investing

This is my first day off work and without overseas visitors in weeks, and I have decided to dedicate a small part of this day to my long-neglected blog. A whle ago I noticed an article by James Glassman on John Allen Paulos's new book A Mathematician Plays the Market. The following passage stood out:

[I]f all investors were convinced that markets were efficient, they would simply sit on their holdings, never buying or selling. In such a world, new information about stocks would never enter the market, moving the prices of stocks in an efficient way.

"The [Efficient Markets Hypothesis] is true," [Paulos] said, "to the extent that people believe it to be false and so, by their exertions, bring about efficiency."

This is a very interesting paradox, and it made me think about mutual funds. Consider the Motley Fool's simple advice, which many consider the best one can give to retail fund investors:

Buy an index fund.

This advice sort-of follows the Efficient Markets Hypothesis: buy a fund that tracks the overall market, for in the long run most actively managed funds can't beat the market. The thing about this is that market performance may depend to some extent on people ignoring this advice. Most of the large players in capital markets are institutional investors like pension and mutual funds. Some of these manage to produce above-market returns through active managment, but most don't, a fact that many retail fund investors are either oblivious to or apathetic about. (A form of rational ignorance perhaps?) The trouble is that the activities of these funds provide the market information that produces "market performance" to begin with.

In the end, all successful passive fund investors owe a debt of thanks to those who are not as "enlightened" as they. Another paradox to think about.