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.

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.

…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.

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.

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. 

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.