Category: Economics

Will the Middle East run out of water?

Farmers, who account for 70 percent of the world’s water consumption, are often hugely uneconomical about it.  For example, in growing water-intensive crops they derive a less-than-optimal nutrition content from a given quantity of water.  Agriculture, in fact, is one of the real villains in the global water drama…Half the water used by the world’s farmers generates no food…A 10 percent improvement in the distribution of water to agriculture would double the world’s potable water supply.

Middle Eastern countries could solve many of their water problems with free trade, economic diversification, and better agricultural incentives, and yes that means don’t grow bananas in the desert.  Yemen needs to stop growing qat; this addictive drug accounts for over seventy percent of their water use.

Ideally the relatively water-rich Syria, Lebanon, and Turkey could be selling water to the rest of the region but for political reasons don’t expect much of that anytime soon.  Sometimes the easiest way to trade water is inside a tomato.

As for desalination, the costs have fallen dramatically over the last decade, and may continue to fall.  The real problem is not producing the water but rather transporting it uphill.  Desalination won’t solve your problems if you live in the mountains.

The above passage is from Fredrik Segerfeldt’s excellent Water for Sale: How Business and the Market Can Resolve the World’s Water Crisis, published by Cato, and thanks to Alex for the pointer.

Voltaire: Game Theorist

Voltaire didn’t just champion markets he used them to his advantage.  In one scheme he successfully cornered the market on a poorly-designed government lottery buying all the tickets to score a sure profit.  Jerry Muller writing in his excellent The Mind and the Market: Capitalism in Western Thought speculates that Voltaire’s legendary hypochondria also had an economic basis.

Voltaire loaned large sums of money to members of the royalty, in return for a lifelong annual payment…He lived for eight-four years, and throughout the last four decades of his life, he spoke of illness and his imminent demise.  Since his debtors had to make the full annual payments only as long as the original lender was alive, those to whom Voltaire loaned funds were more likely to agree to a higher annual rate if they had reason to think that his life would be short.

Glenn Hubbard on the global savings glut

To what extent is weak financial intermediation in Asia part of the problem?

The Japanese case illustrates a general point absent from a discussion of a savings glut. The Keynesian reasoning assumes a simple black box between desired saving and investment–the financial system at home and abroad costlessly transforms lenders’ funds between savers and borrowers. A weak financial system–reflecting an underperforming banking system, poor investor protection and corporate governance, or fragile securities markets–yields a high cost of financial intermediation. For any given return on an investment project, savers’ net return is lowered by the high costs of intermediating funds. More broadly, regulatory restrictions in goods markets and labor markets reduce returns on domestic investment.

In a closed economy, high costs of financial intermediation increase the relative attractiveness of liquid, safe government obligations. (Again, household purchases of JGBs in Japan come to mind.) In an open economy, the international capital market offers the possibility of investing domestically generated savings in countries with a low cost of financial intermediation and/or a safe nominal anchor in government bonds–the U.S., for example.

Here is the full argument.

Is CAFTA a good idea?

Here is one lengthy criticism of the treaty.  Look there for the details, but here are my views:

1. The Bush Administration has not negotiated the treay on a bipartisan basis.  In part this is Bush’s core style, in part the Democrats have not offered much useful assistance.  If the treaty passes, the "pork cost" to swing Republicans will be high.

2. The worst parts of the treaty limit anti-AIDS drugs by extending intellectual property rights to Central America too strictly.  Yes drug companies will try to price discriminate, but the Brazilian solution may be better.  What will happen to generic medicines in Costa Rica?  Of course patent-breaking is a bad international precedent, but is Central America the relevant international tipping point for the destruction of intellectual property rights?  The net effect is difficult to estimate, read more here.

3. On the other hand, sooner or later these stronger patent protections might be imposed anyway, as Central American nations develop and join the global mainstream.  The question is how many people will die in the meantime.

4. More generally, the U.S. is setting bad precedent by using free trade treaties as leverage to negotiate other non-trade deals.

5. The treaty remains hostage to the interests of Big Sugar, as the sugar quota is barely weakened.  Nonetheless the sugar lobby still opposes the treaty, fearing a slippery slope of further erosion of privilege.  This is a good sign for the treaty.

6. Don’t worry that the agreement does little for labor rights or environmental protection in Central America.  Imposing such policies, before the recipient countries are wealthy enough to support them, is usually counterproductive.

7. The net move toward free trade is relatively small.

8. The biggest benefit of the treaty may be symbolic, by encouraging the Central American nations to embrace democracy more strongly and also to develop closer trade relations with each other.

9. Failure of the treaty would be a disaster, again for symbolic reasons.  Trade negotiations would slow down significantly, and the age of trade agreements might be over.

The bottom line: This is probably a treaty we should pass, but it is not a treaty we should be proud of.

By the way, Heritage is now running a CAFTA blog.  Russ Roberts has a more positive take on the treaty.  Matt Yglesias says thumbs down.

New book — The Market for Aid

…measures of aid quantity and aid quality seem to be correlated…The United States and Japan not only have the lowest effort among major donors, they also do relatively little targeting of aid to poor countries and to those with good policies…

That is Michael Klein and Tim Harford, two of the smartest people in the International Finance Corporation.  Are you interested in putting aside the polemics, and learning how foreign aid really works, or sometimes doesn’t?  Order the book here.

Do we have too much choice?

Ralphs shoppers aren’t overwhelmed by 724 kinds of produce because they don’t experience every variety as a separate choice. The exotic fruits are grouped together, as are the potatoes and yams, the lettuce bags, and the apples. Godiva sells its chocolates in selections–nuts and caramels in one box, dark chocolates in another, truffles in another–not piece by piece. Businesses have strong incentives not just to offer options but to help customers navigate those choices.

Outside the artificial constraints of a psychology experiment, people adapt pretty effectively to proliferating choices. We go back to our favorite restaurant and order the same dish because we know we’ll like it. We find a toothpaste that suits us and stick to it. We don’t always choose anew.

That is from Virginia Postrel, read more here.  Michael at 2Blowhards.com has more.

Will customers trust businesses to select for them?  If too much choice alienates you, won’t the store put the high-margin items on the front table right before your eyes?  Maybe so, but competition across firms should limit such mark-ups.  And if the mark-up gets too high, people will cope.  Schwarz himself notes: “A small-town resident who visits Manhattan is overwhelmed by all that is going on. A New Yorker, thoroughly adapted to the city’s hyperstimulation, is oblivious to it.”

The bottom line: I’m still upset that Rainier cherries — finer than caviar to my depraved, barbecue- and curry-obsessed palate — are available for only a few months a year.  Comments are open.

Bubble Schmubble

Is there a housing bubble?  Some say yes, some say no.  I say who cares?  The real question is not whether there is a bubble the question is, What are the chances that housing prices will fall dramatically?  Contrary to popular belief, knowledge of whether prices are following fundamentals or a bubble tells us very little about this question. 

An efficient market is not necessarily a stable market.  Indeed, an efficient market can be as or even more volatile than a market plagued by bubbles.

Consider the stock market – the price to earnings ratio can be written (using the Gordon Growth Model) as P/E=D/E*(1+g)/(r-g) where g is the growth rate of dividends and r is the discount rate.  Since r and g are small a small change in g can have a large effect on the P/E ratio – so much in fact that it is very difficult to reject a model of stock prices based solely on fundamentals (see my paper with Gary Santoni or the Barsky and DeLong classic Why Does the Stock Market Fluctuate (JSTOR).)

The principles are similar with respect to the housing market.  Do note that only a small fraction of the housing stock is available for sale at any one point in time.  When we hear about the high price of housing prices we think that the stock of housing must have gone up a lot in value.  But in fact all that has occured for certain is that the price for the marginal house has increased.  When the supply is inelastic (as it is on the coasts) and demand is fairly inelastic (as it is for most people who like to live where they work) small changes in either demand or supply can change the marginal price dramatically.  Thus, even if house prices are at fundamental values today and will be at fundamental values tomorrow a small change in say interest rates or the economy could make tomorrow’s price considerably lower than today’s. 

Who is hurt by scalping?

Quiggin admits that resale possibilities will increase the overall demand for tickets and thus increase the overall revenue for charity.  But he sees a caveat:

Geldof is relying on donated services from musicians who would otherwise be selling them. To the extent that lottery tickets go to people who could not otherwise afford to pay, the musicians are giving up time, but not money (and getting good publicity). But with resale, the charity concert becomes a substitute for attendance at a standard concert. Musicians might reasonably change their minds about participation.

In other words, a charity concert — with tickets allocated by non-price mechanisms — might cannibalize the demand for other concerts less than would a market-clearing price event.  So the musicians can be better off with no ticket resale. 

But keep the following in mind.  Let’s say it is feasible to prevent or at least limit resale (otherwise there is nothing practical to argue about).  Any musician could limit resale for a selected non-charity concert, and allow resale for a charity concert.  The resold charity tickets would then be reaching a new group of buyers, rather than cannibalizing demand.  If you are not selling your tickets at market-clearing prices, why not allocate some of that surplus to the charitable event, rather than to scalpers for the non-charitable concert?

At the very least, Geldof is being hypocritical.  First, his rhetoric does seem to be simply anti-capitalist.  Second, he claimed that the ticket resale was being funded off the back of the world’s poor.  That is not true.  Most likely resale boosts charitable receipts, increases consumer welfare, and maybe lowers the future income of the participating musicians.  Those musicians are the backs in question, and no those people are not the world’s poor.

Deterrence

I am in Michigan today speaking to a large group of judges on criminal
deterrence.  It should be a fun talk, judges are good listeners (or at
least they are good at pretending to listen) but I did have a dream
last night in which hundreds of judges were banging their gavels
shouting at me "guilty, guilty, guilty."  Damn conscience.

Coinidentally, some of my work on crime was featured in the latest Economic Scene
column in the NYTimes (thanks Virginia!).  Here is my powerpoint presentation for the judges which surveys some of the new literature on
crime and deterrence (the notes page in the powerpoint provides some
references and calculations).

Are market-clearing prices so bad?

The state House of Representatives gave preliminary approval yesterday to a bill intended to crack down on private parking lot operators around Fenway Park who illegally charge exorbitant fees on big game days.

Mayor Thomas M. Menino sought the legislation, which would raise the fine for price-gouging from $300 to $1,000, after hearing that some lot operators were charging fans as much as $100 to park on opening day.

”The prices are so high, it’s hard for the average person to afford them," said Thomas J. Tinlin, the city’s acting transportation commissioner. ”If these open-air lot parking providers don’t want to do right by the people visiting the city and violate the terms of their license, we need to make them pay for that, and obviously $300 wasn’t getting it done."

Here is the story, courtesy of Michael Costello.  And here is a bit from the rock star who runs our development policy:

Scores of free tickets for the 2 July concert in London – won through a text contest – had been put up for sale [on ebay].

Live 8 organiser Bob Geldof branded the attempted sale of the tickets as "sick profiteering" and welcomed the move.

He said people had realised that "the weakest people on our planet" were being exploited and they were "sickened by that".

The minister for music, James Purnell, said he "wholeheartedly shared" Geldof’s annoyance and had asked the site to halt the sales.

Thanks to David Nishimura for that story; see also Lynne Kiesling.

India has a long, long, way to go

…most of the country is still denied access to free markets and all the advantages they bring. India opened its markets in 1991 not because there was a political will to open the economy, but because of a balance-of-payments crisis that left it with few options. The liberalization was half-hearted and limited to a few sectors, and nowhere near as broad as it needed to be.

One would have expected India’s growth to be driven by labor-intensive manufacturing but, almost by default, it instead came in the poorly licensed area of services exports. The manufacturing sector, ideally placed in terms of labor and raw material to compete with China, never took off. India’s restrictive labor laws, a remnant of the socialist infrastructure that India’s first prime minister, Jawaharlal Nehru, put in place in the 1950s and 1960s, were politically impossible to reform. It remains excruciatingly difficult for most Indians to start a business or set up shop in India’s cities.

This is painstakingly illustrated in “Law, Liberty and Livelihood”, a new book edited by Parth Shah and Naveen Mandava of the Center for Civil Society in New Delhi, which documents the obstacles in the way of any Indian who wishes to start a business in one of India’s big cities. Messrs. Shah and Mandava write: “Entrepreneurs can expect to go through 11 steps to launch a business over 89 days on average, at a cost equal to 49.5% of gross national income per capita.” Contrast the figure of 89 days with two days for Australia, eight for Singapore and 24 for neighboring Pakistan.

That is from The Asian Wall Street Journal, read more here.  Do not forget that "outsourcing jobs" are about one percent of the Indian labor force.  Most of the country is agriculture, and while the Green Revolution fed millions, agricultural productivity has made few other strides into the modern age.

What are the gains to illegal immigration?

Not the gains the U.S., I wish to know how much the migrants are better off.

Typically a rural Mexican goes from earning two dollars a day to ten dollars an hour.  Over a year’s time this could amount to a difference of about $25,000.  Multiplied by many millions of immigrants, this is a considerable sum.

But other economic arguments point to lower numbers.  First, it costs about $1500 to cross the border illegally. (N.B.: That’s not $1500 a year, that is $1500 for the entire crossing, which may keep you in the U.S. for years.)  After all, life in Mexico is more fun and keeps you closer to your family.  The illegal migrants I have known have mixed feelings about life in the U.S. and many have returned to Mexico. 

So is that the value of a marginal crossing?

The $1500 figure does not measure the option value of crossing.  You might not pay $1500 to cross now, but the ability to cross in general is worth more.  But even an option value of 10x use value only gets us up to $15,000.

Consider another argument.  Transactions costs aside, in equilibrium the average returns to being a rural Mexican in Mexico should equal the average returns to being a rural Mexican illegally in Texas.  If not, migration will bring about equalization.  Those average returns cannot differ by more than $1500 per person, no? 

A further question is where — rural Mexico or El Paso — you find greater economic congestion.  To me the answer is not obvious, but this could lower the social value of illegal Mexicans in Texas.  If another Mexican crosses, the greatest costs are imposed on the Mexicans already present in the U.S..

Could it be that the greatest gains are reaped by those back home who get the remittances?   

How about infra-marginal values?  Some pay $1500 to cross but value the experience at much more.  Still, if we are considering marginal shifts in border policy, the $1500 figure still seems relevant.

Might credit constraints matter?  The difference between willingness to pay and willingness to be paid?

How about the next generation?  Perhaps we should use a very low social discount rate to evaluate these future benefits.  If you will be born in El Paso in 2019, you are not, in the meantime, sitting around feeling costs of impatience.  And since you will not have grown accustomed to life in Mexico, you are much better off in the United States.

I conclude that we do not have a very good handle on this question.

Assurance contracts

Here is an excellent Wikipedia entry.  Here is my favorite part:

Dominant Assurance Contracts, created by Alex Tabarrok, involve an extra component – if a quorum is not formed, every contributor is not only released from the pledge, but is given a bonus. Tabarrok asserts that this creates a dominant strategy, which means that in a game-theory decision matrix, it is always the best move for someone considering whether to pledge or not, no matter what other players do.

Thanks to Travis Corcoran for the pointer.  Here is another Wikipedia entry, though it cries out for some additional work…

Markets in everything — elephants all the way down

Remember the guy who threatened to kill and eat the bunny rabbit, unless he was paid $50,000?  Was it real?  Here is the continuing saga, from a supposed friend:

Make a donation and help me expose Bion [the original perpetrator of the Toby scheme, supposedly]. Once I have received $5,000 in donations, I will publish Bion’s full contact information HERE.

Think about it: Bion’s contact info will be published to the net

  • Everyone will have the chance to openly ridicule Bion
  • We will make Bion rue the day he threatened to kill Toby
  • The internet community will get what it wants
  • The $5,000 will make me feel better about loosing [sic] a best friend

Here is my earlier post on Toby.  Do notice that the equilibrium price is falling.