The government of Kazakhstan paints a rosy picture of the national economy. The value of production is to grow 7% per year, a torrid pace compared to those of most nations that are several times richer than any in Central Asia. Since the population has been growing 1% to 2% annually for several years, income per capita in Kazakhstan would rise 5% to 6% per year. At that rate, your means for buying things would double every 14 years or so (Note 1).
This forecast is not entirely detached from reality. Global oil prices have doubled over two years – always good news (for a few years, anyway) for an oil exporter like Kazakhstan. Some speculate that rising demand for automobiles in China may push the global price of a barrel over $100 again. This winter, the price for West Texas Intermediate crude should average $83, estimates the U.S. Department of Energy.
Unfortunately, Kazakhstan’s economy remains basically the same, warts and all, as during the 2008 financial crash. Although the government has pumped billions of dollars into the commercial banks, they are still as weak as kittens. This May, bad loans totaled $17 billion, over a fourth of the nation’s bank portfolio, said the International Monetary Fund (which lends foreign currency to countries in emergencies). At that time, the IMF projected 4% growth for Kazakhstan’s economy but conceded that it might manage 6% in years to come if the banks would get their act together, presumably orchestrated again by Astana. (The IMF has since raised its 2010 forecast to 5%.) In a gallant gesture to the government, the IMF in public forebode enlarging clearly upon the possibility that the bank bailout, and the increased deposit insurance, might tempt banks to return to go-go lending someday. At the moment, Kazakhstani banks aren’t lending.
Well, OK, the press release from the IMF actually said: “The ongoing sharp increase in nonperforming loans (NPLs) across banks and economic sectors reflects banks’ excessive exposure to currency induced credit risk stemming from the combination of a low and dollarized deposit base, the reliance on foreign funding, and risky lending practices.” Perhaps the IMF would favor us with a translation into English. It might have meant that Kazakhstani bank loans were going bad because, after the tenge lost a fourth of its value in February 2009, borrowers paid banks back in weaker tenge than they had received; the foreigners who dominated loans to the banks were demanding stronger dollars than they had lent; and, the devaluation aside, the banks lent recklessly.
The IMF is not the only moderate skeptic of the claim of robust economic health here. A few months ago, the Asian Development Bank – which addresses long-run prosperity – put economic growth in Kazakhstan at just 2.5% this year and 3.5% next year, contingent on $80 oil barrels. The ADB noted weak banks, over-reliance on oil and gas exports, and a stubborn government deficit.
If you live on the eastern shore of the Caspian Sea, then you may share the government’s enthusiasm. In Atyrau, home of the Kashagan oil project, investment in immobile assets rose a fourth over the year, accounting for more than a third of the nation’s fixed investment. In the oblasts of Mangistau and Western Kazakhstan, pay in the first half of this year rose more than 8% (even adjusting for price changes) compared to 2009. Atyrau and Mangistau also had the nation’s highest pay rates -- 140,000 and 120,000 tenge per month, respectively.
What about Almaty, the central nervous system for the economy? Prosperity is, er, just around the corner.
In the first quarter of 2010, fixed investment in the city had dropped by a seventh over a year, or twice as much for Kazakhstan.
Construction in the city also disappointed. In the first three quarters of 2010, the number of apartments started in Almaty rose only 6% from 2009, a year of world recession. The increase in square feet here was 3%. On both dimensions, Almaty lagged Astana.
Homebuilding in Almaty fell 30% over a year, although it had risen slightly for the nation -- and sharply for Astana, where the value of construction exceeded Almaty's by nearly a third.
The rising star is not the city of Almaty but the oblast. It accounted for more than a fifth of the nation's homebuilding value in early 2010, rising by a fourth over a year.
Pay in the city of Almaty remained high in early 2010 at 100,000 tenge per month -- more than a fourth above that of the oblast and the nation. Adjusted for inflation, pay in the city rose less than 4% over a year, about the same pace as for the nation.
To some extent, such trends would hold for even a healthy economy. High pay rates often rise less rapidly than low rates, because of their larger base. A 10% rate of growth is easier to achieve on a wage of 20 tenge (add two tenge) than on 20 million tenge (add two million). The outskirts of a mature city grow more rapidly than the downtown because of more abundant, and hence cheaper, land. Almaty’s new subways may strengthen the temptation to move to the sticks, by helping suburbanites commute in comfort to downtown. Finally, Almaty has many vacant residences; why build more?
All this notwithstanding, Almaty’s economy still relies on ailing banks. Rising oil prices in 2007 obscured the banks’ weakness and so made their plunge more precipitous. Here we go again? – Leon Taylor, tayloralmaty@gmail.com
Good reading
Asian Development Bank. 2010. Outlook 2010: Macroeconomic management beyond the crisis, pages 117-8. Kiyoshi Taniguchi and Asset Nussupov wrote the chapter on Kazakhstan. www.adb.org/Documents/Books/ADO/2010/ado2010.pdf
Baskin, Brian. 2010. China's oil demand is poised to push up prices. The Wall Street Journal. November 8. www.wsj.com
International Monetary Fund. 2010. Regional Economic Outlook: Middle East
and Central Asia. October. www.imf.org/external/pubs/ft/reo/2010/mcd/eng/10/mreo1024.pdf
References
Silk Road Intelligencer. 2010. IMF ups growth forecast. June 11. www.silkroadintelligencer.com
Silk Road Intelligencer. 2010. Kazakhstan adjusts growth forecast as GDP grows by 7.6 percent in first four months. May 12. www.silkroadintelligencer.com
The Statistical Agency of Kazakhstan. 2010. Source of raw data used here on construction, investment and pay. www.stat.kz
The United States Energy Information Administration. 2010. Short-Term Energy Outlook. November 9. www.eia.doe.gov/steo/contents.html
Notes
1. Given some continuous rate of growth r, income follows an exponential function over time t: Y(t) = Y(0) e^(rt), where 0 indexes the initial time. We want to know how quickly income will double, so we seek t* that satisfies Y(t*) =Y(0)e^(rt*) = 2Y(0). Simplify the last equation to get e^(rt*) = 2. Taking natural logs, rt* = nl 2. Roughly, t* = 70/r%, the Rule of 70. In our example, r is 5% or 6%, so income doubles in 70/5 to 70/6 – 14 years or a little less.
Friday, November 19, 2010
Tuesday, November 16, 2010
Trends in major economies, 2010-2011: The winter of our discontent?
By Dmitriy Belyanin
An exporter of natural resources, Central Asia prospers only if the world economy does. What shape is the globe in? Dmitriy gives us a Cook’s tour
Two years after the financial crash, the global economy has yet to recover everywhere. Some economies in the West are picking up speed – as well as China and India, of course. But the economies of the United States and many European countries still look wobbly, with unemployment rates more reminiscent of a depression than of a recovery.
Exchange rates manifest the economic unevenness. For at least two months, the euro has been strengthening and the dollar weakening. Why these puzzling trends? A survey of national economies may clue us in.
The U.S.: Unemployment continues
The government's attack on virtual depression has created more income than jobs. The unemployment rate -- i.e., the share, in active adults, of those who look futilely for work -- in the U.S. is rising from 9% in 2009 to 10% this year, estimates the International Monetary Fund (IMF). Whatever its merits, the government's program was expensive. It spent $700 billion to shore up commercial banks via the Troubled Asset Relief Program. The public debt is $13 trillion, almost 90% as much in value as the American economy produces when running on all cylinders.
While such a debt burden may look modest to the Japanese, it has eviscerated political support in the U.S. for more spending by Washington to stimulate the economy. The American central bank, the Federal Reserve, has taken charge, printing money to encourage spending. The bloated supply of dollars is pushing down the foreign value of a buck. In the short run, investors won’t add dollars to their portfolios.
In the long run, a weaker dollar should make U.S. exports cheaper for the world to buy. The rise in demand should create U.S. jobs. This has yet to happen, although U.S. export prices probably won’t rise sharply for at least another year.
China: Conflicting interests
The People’s Republic has pegged its exchange rate to the dollar since 1948, when the gold-backed buck became the standard currency for the postwar world under the Bretton Woods system. (True, in the 1970s, the Communists let the yuan appreciate from 2.5 per dollar to 1.5.) During the 1980s, Beijing gradually devalued the yuan to make exports more competitive. China’s economy grew at double-digit rates in the early 1990s. It slowed during the Asian financial crisis of the late 1990s but took off again after China joined the World Trade Organization in November 2001. To pay for the increasing exports from China, world demand grew for the yuan, tending to raise its exchange rate. Catering to exporters, the Chinese government held the yuan's value below market levels.
The U.S. has long pressed China to let its currency strengthen. This would help the U.S., and much of the rest of the West, to sell more to the world, relative to what it buys from it. (In shop talk, the U.S. balance of trade would improve.) In July, China allowed some floating but not enough to satisfy the U.S. So the Fed is weakening the dollar.
By helping foreign producers, a floating yuan could alleviate damages done by the global financial crisis. And it would relieve the People’s Bank from the need to spend in order to support the exchange rate. But China’s exports are diverse, and its exports exceed its imports. China may fear that a stronger yuan would endanger its trade surplus in many industries. Economic growth and employment might tailspin.
In coming months, the yuan will strengthen only mildly against currencies other than the U.S. dollar and those pegged to the dollar. Against the dollar itself, the yuan won’t fluctuate much.
Europe in turmoil
Unemployment is increasing in almost all countries of Western Europe. In Spain, the unemployment rate forecasted for 2010 is 20%; in Greece, 12%; Portugal, 11%. Norway, an oil exporter, has performed comparatively well; unemployment there is to increase slightly to 4%, well below the European average. Germany, Austria and Switzerland are recovering mildly, though unemployment in Germany remains high (7%).
When the dollar depreciates in terms of the euro, investors switch to the latter, which indeed has been appreciating since mid-September. A stronger euro reduces export sales in many European countries, slowing their economies and destroying jobs. Effects on debt are mixed: Dollar debts are easier to pay, but governments might have to borrow to fight the slowdown.
The European Central Bank may be the most independent of major central banks. It largely ignores groups that pursue their vested interests at society’s expense. But balancing the interests of 16 nations is hard. If the Bank strengthens the euro, export-led countries like Norway will object. If it weakens the euro, the inflation-phobic like Germany will complain -- as will countries with debts that must be repaid in foreign currency.
Prospects for the euro-dollar exchange rate are uncertain. In the short run, the euro will keep appreciating, thanks to the easy-money policy of the Fed. Fears that the Eurozone will dissolve (though it probably won’t) may reduce the euro's value. Both currencies are risky, so investors might consider the dollars of Australia and Canada.
Fortunate economies
In a rarity for the West, Australia and Canada are clearly recovering. For Australia, the IMF projects a growth rate in gross domestic product (GDP, the value of domestic production) of 3% in 2010, compared to 2% in 2009. (The IMF lends foreign currencies to countries facing emergencies.) Unemployment is to fall from 6% in 2009 to 5% in 2010. In Canada, unemployment decreased slightly to 8% in 2010. Real GDP (that is, adjusted for price changes), which had declined by 2% in 2009, is to increase by 3%.
Unlike the U.S., Australia managed to create workplaces. High and rising world demand for farm products boosted its exports but thus sent the Aussie dollar soaring to its record peak, in October.
Canada benefited from well-regulated banks. Unlike Europe and the U.S., Canada did not loosen regulations. Regulators know personally the top executives of the five dominant banks. Canada was the first country to increase interest rates, which pushed up its dollar.
The Asian tigers are even more impressive. The IMF forecasts growth in real GDP of 9% in Taiwan and 15% in Singapore, compared to declines of 2% in 2009 for Taiwan and 1% in Singapore. Unemployment fell from 6% to 5% in Taiwan and from 3% to 2% in Singapore. South Korea is recovering as well, with unemployment falling to 3%, from 4% in 2009. Real GDP, stagnant last year, is rising by 6%.
The Pacific Rim – Asia’s chunk of it, anyway – is cashing in on the globe’s growing reliance on computers. Electronic sales are clicking along for Taiwan, South Korea and Singapore. Early recovery in Asia feeds back into it: Taiwan sells 40% of its exports to the surging economies of China and Hong Kong. Because exports account for half of its GDP, Taiwan may be more vulnerable to external shocks than are economies more oriented towards sales to domestic households, such as China's.
Technically advanced, Singapore profits from the growing global market for drugs. In yearly terms, the economy grew by nearly a fifth in the first half of 2010. The Singapore dollar strengthened by 8%, peaking at about 1.3 per U.S. dollar in October. Manufacturing in Singapore began to contract this autumn. But, fearing inflation, the Monetary Authority of Singapore said it would not rein in its dollar.
South Korea benefited from higher demand at home and abroad, but its economy is to grow more slowly in 2011 (4%), due in part to rising global risks. To some degree, this slowdown may be deliberate. In July, the Bank of Korea raised the interest rate by a fourth of a percent to 2.25%, fearing that volatile global markets might fuel inflation. [Sang Lee addresses this point in next week’s blog. – lt]
Less fortunate is Japan, South Korea’s neighbor and the world’s third largest economy (after the U.S. and China). Its public debt is twice as large as GDP; its population is aging and shrinking. The Bank of Japan held the interest rate to zero throughout the year. The IMF forecasts economic growth of 3% this year; last year, GDP fell 5%. Although unemployment rose slightly to 5.2%, the yen appreciated in September and October.
Conclusions
The economies of the U.S. and Europe remain troubled by unemployment, growing public debt, and uncertainty in foreign exchange markets. China and the U.S. clash over undervaluation of the yuan. Australia, Canada, and the Asian tigers perform better than most Western countries but remain in heavy weather due to fluctuations in export demand.
Dmitriy Belyanin, an MBA graduate of KIMEP, assists the associate dean of KIMEP’s MBA program in research. He writes often about economics and finance in Central Asia.
Coming issues: If Almaty is the engine of Kazakhstan’s economy, why isn't it firing on all cylinders?
References
Adam, Shamim. October 14, 2010. Singapore to allow stronger currency even as economy contracts. www.bloomberg.com/news/2010-10-14/singapore-s-economy-shrinks-as-manufacturing-slows-currency-band-widened.html
The Associated Press. June 21, 2010. Canadian economy: The envy of the world. www.cbsnews.com/stories/2010/06/21/business/main6602637.shtml
BBC News. September 1, 2010. Australian economy picks up pace to three-year high. www.bbc.co.uk/news/business-11149283
Bloomberg. 2010. Government bonds: Japanese government bonds. www.bloomberg.com/markets/rates-bonds/government-bonds/japan/
Chinability. July 13, 2010. Renminbi (Chinese yuan) exchange rates, 1969-2010.
www.chinability.com/Rmb.htm
Eisen, Sara and Allison Bennett. February 17, 2010. European Union should limit appreciation of euro, Mundell says. www.businessweek.com/news/2010-02-17/italy-is-biggest-threat-to-euro-nobel-winner-mundell-says.html
Froomkin, Dan. October 15, 2010. Job Creation Idea No. 10: A lower dollar would level the playing field. www.huffingtonpost.com/2010/10/15/jobcreation-idea-no-10-a-_n_763862.html
International Monetary Fund. October 2010. World economic outlook database. www.imf.org
Lee, Sang H. November 15, 2010. E-mail message on South Korea’s monetary policy.
OANDA. 2010. Historical exchange rates. www.oanda.com/currency/historical-rates
Sim, William and Eunkyung Seo. July 25, 2010. South Korea economy expanded faster-than-expected 1.5% in second quarter. www.bloomberg.com/news/2010-07-25/south-korea-economy-grew-1-5-in-second-quarter-from-three-months-earlier.html
Sung, Chinmei and Jay Wang. February 18, 2010. Taiwan economy probably exited deepest recession, survey shows. www.businessweek.com/news/2010-02-18/taiwan-economy-probably-exited-deepest-recession-survey-shows.html
An exporter of natural resources, Central Asia prospers only if the world economy does. What shape is the globe in? Dmitriy gives us a Cook’s tour
Two years after the financial crash, the global economy has yet to recover everywhere. Some economies in the West are picking up speed – as well as China and India, of course. But the economies of the United States and many European countries still look wobbly, with unemployment rates more reminiscent of a depression than of a recovery.
Exchange rates manifest the economic unevenness. For at least two months, the euro has been strengthening and the dollar weakening. Why these puzzling trends? A survey of national economies may clue us in.
The U.S.: Unemployment continues
The government's attack on virtual depression has created more income than jobs. The unemployment rate -- i.e., the share, in active adults, of those who look futilely for work -- in the U.S. is rising from 9% in 2009 to 10% this year, estimates the International Monetary Fund (IMF). Whatever its merits, the government's program was expensive. It spent $700 billion to shore up commercial banks via the Troubled Asset Relief Program. The public debt is $13 trillion, almost 90% as much in value as the American economy produces when running on all cylinders.
While such a debt burden may look modest to the Japanese, it has eviscerated political support in the U.S. for more spending by Washington to stimulate the economy. The American central bank, the Federal Reserve, has taken charge, printing money to encourage spending. The bloated supply of dollars is pushing down the foreign value of a buck. In the short run, investors won’t add dollars to their portfolios.
In the long run, a weaker dollar should make U.S. exports cheaper for the world to buy. The rise in demand should create U.S. jobs. This has yet to happen, although U.S. export prices probably won’t rise sharply for at least another year.
China: Conflicting interests
The People’s Republic has pegged its exchange rate to the dollar since 1948, when the gold-backed buck became the standard currency for the postwar world under the Bretton Woods system. (True, in the 1970s, the Communists let the yuan appreciate from 2.5 per dollar to 1.5.) During the 1980s, Beijing gradually devalued the yuan to make exports more competitive. China’s economy grew at double-digit rates in the early 1990s. It slowed during the Asian financial crisis of the late 1990s but took off again after China joined the World Trade Organization in November 2001. To pay for the increasing exports from China, world demand grew for the yuan, tending to raise its exchange rate. Catering to exporters, the Chinese government held the yuan's value below market levels.
The U.S. has long pressed China to let its currency strengthen. This would help the U.S., and much of the rest of the West, to sell more to the world, relative to what it buys from it. (In shop talk, the U.S. balance of trade would improve.) In July, China allowed some floating but not enough to satisfy the U.S. So the Fed is weakening the dollar.
By helping foreign producers, a floating yuan could alleviate damages done by the global financial crisis. And it would relieve the People’s Bank from the need to spend in order to support the exchange rate. But China’s exports are diverse, and its exports exceed its imports. China may fear that a stronger yuan would endanger its trade surplus in many industries. Economic growth and employment might tailspin.
In coming months, the yuan will strengthen only mildly against currencies other than the U.S. dollar and those pegged to the dollar. Against the dollar itself, the yuan won’t fluctuate much.
Europe in turmoil
Unemployment is increasing in almost all countries of Western Europe. In Spain, the unemployment rate forecasted for 2010 is 20%; in Greece, 12%; Portugal, 11%. Norway, an oil exporter, has performed comparatively well; unemployment there is to increase slightly to 4%, well below the European average. Germany, Austria and Switzerland are recovering mildly, though unemployment in Germany remains high (7%).
When the dollar depreciates in terms of the euro, investors switch to the latter, which indeed has been appreciating since mid-September. A stronger euro reduces export sales in many European countries, slowing their economies and destroying jobs. Effects on debt are mixed: Dollar debts are easier to pay, but governments might have to borrow to fight the slowdown.
The European Central Bank may be the most independent of major central banks. It largely ignores groups that pursue their vested interests at society’s expense. But balancing the interests of 16 nations is hard. If the Bank strengthens the euro, export-led countries like Norway will object. If it weakens the euro, the inflation-phobic like Germany will complain -- as will countries with debts that must be repaid in foreign currency.
Prospects for the euro-dollar exchange rate are uncertain. In the short run, the euro will keep appreciating, thanks to the easy-money policy of the Fed. Fears that the Eurozone will dissolve (though it probably won’t) may reduce the euro's value. Both currencies are risky, so investors might consider the dollars of Australia and Canada.
Fortunate economies
In a rarity for the West, Australia and Canada are clearly recovering. For Australia, the IMF projects a growth rate in gross domestic product (GDP, the value of domestic production) of 3% in 2010, compared to 2% in 2009. (The IMF lends foreign currencies to countries facing emergencies.) Unemployment is to fall from 6% in 2009 to 5% in 2010. In Canada, unemployment decreased slightly to 8% in 2010. Real GDP (that is, adjusted for price changes), which had declined by 2% in 2009, is to increase by 3%.
Unlike the U.S., Australia managed to create workplaces. High and rising world demand for farm products boosted its exports but thus sent the Aussie dollar soaring to its record peak, in October.
Canada benefited from well-regulated banks. Unlike Europe and the U.S., Canada did not loosen regulations. Regulators know personally the top executives of the five dominant banks. Canada was the first country to increase interest rates, which pushed up its dollar.
The Asian tigers are even more impressive. The IMF forecasts growth in real GDP of 9% in Taiwan and 15% in Singapore, compared to declines of 2% in 2009 for Taiwan and 1% in Singapore. Unemployment fell from 6% to 5% in Taiwan and from 3% to 2% in Singapore. South Korea is recovering as well, with unemployment falling to 3%, from 4% in 2009. Real GDP, stagnant last year, is rising by 6%.
The Pacific Rim – Asia’s chunk of it, anyway – is cashing in on the globe’s growing reliance on computers. Electronic sales are clicking along for Taiwan, South Korea and Singapore. Early recovery in Asia feeds back into it: Taiwan sells 40% of its exports to the surging economies of China and Hong Kong. Because exports account for half of its GDP, Taiwan may be more vulnerable to external shocks than are economies more oriented towards sales to domestic households, such as China's.
Technically advanced, Singapore profits from the growing global market for drugs. In yearly terms, the economy grew by nearly a fifth in the first half of 2010. The Singapore dollar strengthened by 8%, peaking at about 1.3 per U.S. dollar in October. Manufacturing in Singapore began to contract this autumn. But, fearing inflation, the Monetary Authority of Singapore said it would not rein in its dollar.
South Korea benefited from higher demand at home and abroad, but its economy is to grow more slowly in 2011 (4%), due in part to rising global risks. To some degree, this slowdown may be deliberate. In July, the Bank of Korea raised the interest rate by a fourth of a percent to 2.25%, fearing that volatile global markets might fuel inflation. [Sang Lee addresses this point in next week’s blog. – lt]
Less fortunate is Japan, South Korea’s neighbor and the world’s third largest economy (after the U.S. and China). Its public debt is twice as large as GDP; its population is aging and shrinking. The Bank of Japan held the interest rate to zero throughout the year. The IMF forecasts economic growth of 3% this year; last year, GDP fell 5%. Although unemployment rose slightly to 5.2%, the yen appreciated in September and October.
Conclusions
The economies of the U.S. and Europe remain troubled by unemployment, growing public debt, and uncertainty in foreign exchange markets. China and the U.S. clash over undervaluation of the yuan. Australia, Canada, and the Asian tigers perform better than most Western countries but remain in heavy weather due to fluctuations in export demand.
Dmitriy Belyanin, an MBA graduate of KIMEP, assists the associate dean of KIMEP’s MBA program in research. He writes often about economics and finance in Central Asia.
Coming issues: If Almaty is the engine of Kazakhstan’s economy, why isn't it firing on all cylinders?
References
Adam, Shamim. October 14, 2010. Singapore to allow stronger currency even as economy contracts. www.bloomberg.com/news/2010-10-14/singapore-s-economy-shrinks-as-manufacturing-slows-currency-band-widened.html
The Associated Press. June 21, 2010. Canadian economy: The envy of the world. www.cbsnews.com/stories/2010/06/21/business/main6602637.shtml
BBC News. September 1, 2010. Australian economy picks up pace to three-year high. www.bbc.co.uk/news/business-11149283
Bloomberg. 2010. Government bonds: Japanese government bonds. www.bloomberg.com/markets/rates-bonds/government-bonds/japan/
Chinability. July 13, 2010. Renminbi (Chinese yuan) exchange rates, 1969-2010.
www.chinability.com/Rmb.htm
Eisen, Sara and Allison Bennett. February 17, 2010. European Union should limit appreciation of euro, Mundell says. www.businessweek.com/news/2010-02-17/italy-is-biggest-threat-to-euro-nobel-winner-mundell-says.html
Froomkin, Dan. October 15, 2010. Job Creation Idea No. 10: A lower dollar would level the playing field. www.huffingtonpost.com/2010/10/15/jobcreation-idea-no-10-a-_n_763862.html
International Monetary Fund. October 2010. World economic outlook database. www.imf.org
Lee, Sang H. November 15, 2010. E-mail message on South Korea’s monetary policy.
OANDA. 2010. Historical exchange rates. www.oanda.com/currency/historical-rates
Sim, William and Eunkyung Seo. July 25, 2010. South Korea economy expanded faster-than-expected 1.5% in second quarter. www.bloomberg.com/news/2010-07-25/south-korea-economy-grew-1-5-in-second-quarter-from-three-months-earlier.html
Sung, Chinmei and Jay Wang. February 18, 2010. Taiwan economy probably exited deepest recession, survey shows. www.businessweek.com/news/2010-02-18/taiwan-economy-probably-exited-deepest-recession-survey-shows.html
Thursday, October 7, 2010
Lies, damned lies, and government statistics
Are the numbers what they seem?
Among culinary arts in Central Asia, the cooking of government statistics is one of the most entertaining. Here are a few favorite recipes:
The student-faculty ratio. The Ministry of Education and Science wants colleges to reduce the number of students taught by a typical instructor because it regards smaller classes as better. Recently, a Ministry official threatened to suspend KIMEP’s license, largely for a student-faculty ratio of allegedly 20 (that is, 20 students per professor). KIMEP estimates its ratio as below 2 for graduate students and as 15 or 16 for undergraduates. Probably the official was confused by a rule-of-thumb here that an undergraduate class with 20 students will earn enough tuition to pay for itself. In principle, classes with fewer than 20 registrants would lose money, so KIMEP would cancel them. That rule is honored in the breach. KIMEP often approves a small class that students need in order to graduate or that they express a strong interest in taking. The modus operandi here is the same as at most universities – large introductory classes subsidize small, advanced classes and classes (such as in foreign languages) that require a lot of attention to each student. (A large class makes money because the teacher’s pay is spread over more students, each of whom pays the same tuition for this class as for a small one.)
In his newspaper interview, the official’s tone of shocked outrage suggested that scheduling a college class of 20 students was a venal sin. In reality, scholars have debated the impact of class size on student performance for more than a half century. Twenty years ago, the consensus of economists, from statistical studies, was that class size did not affect learning systematically.
Since then, as often happens in empirical research, studies taking new approaches have qualified the original blunt conclusion. The impact of class size in colleges may differ from that in primary and secondary schools -– the settings for most studies -- since college class sizes vary a lot. Third-graders rarely sit in 300-student lecture halls. Standardized test scores -– the usual proxy for student achievement -- may not measure learning well, since instructors often teach the test and nothing else; perhaps we should use the graduate’s wages. Class size may matter more in poorer countries, where students cannot afford such aids as Cliff’s Notes to cope with monster classes.
Warm bodies, cold statistics
Despite such caveats, one cannot ignore the sheer weight of scores of estimates that have failed to find that class size matters much. Of 112 estimates surveyed by Hanushek in 1986, 89 found no statistically significant effect of class size on student achievement. Only nine were statistically significant and carried the negative sign -- that is, students learned less in larger classes. (In a general comment on Hanushek’s work, econometrician Alan Krueger asserts that drawing several estimates from the same flawed study may give it undue weight in the survey of all studies. This particular survey was of 33 publications.) The idea that large classes stunt learning may merit the Scots’ Verdict – “Not proven.” I am not a specialist, but my impression is that the one durable conclusion from econometric studies of student achievement is that students with richer and more educated parents do better.
In any event, the Ministry wanted KIMEP to cut its student-to-faculty ratio to 8. Unfortunately, the Ministry apparently calculates this ratio in terms of warm bodies. A student who takes one course every year counts just as much as a student who takes 15. Consequently, the ratio may mean virtually anything. Suppose that a school has one professor and eight students. Then the student-faculty ratio is eight if every student takes one course per year. It is also eight if every student takes 15 courses per year. Obviously, the professor can devote more time to a student in a given class in the former scenario. In the latter, he would be overwhelmed by preparations of 15 times as many classes.
The Ministry could get a more accurate picture of the quality of learning at, say, Java College by calculating its ratio in terms of full-time equivalents, which is what experts do. At KIMEP, a fulltime professor teaches eight courses per year, and a fulltime student takes 10 courses. Two students, each taking five courses per year, would count as one fulltime-equivalent student. In our two earlier scenarios, the first has .8 of a fulltime-equivalent student, and the second has 12. If the professor teaches fulltime, then the student-faculty ratio is .8 in the first scenario and 12 in the second. Now it’s clear which school is truly crowded.
As is its wont, the Ministry has neglected the likely consequences of its policy. If only warm bodies matter, then schools will satisfy the student-faculty maximum by hiring the cheapest warm bodies around. Those would be adjuncts, who receive a fraction of the salaries, and none of the benefits, of regular faculty. Since adjuncts often have only a fraction of the learning of regular professors, the Ministry’s policy may torpedo its stated intent of improving education.
Consider an English class of 24 students, taught by a native speaker for $900. To satisfy the Ministry’s mandate, Java College replaces the teacher with three adjuncts, each willing to teach eight students for $300. Now each student can receive thrice as much time from a teacher as before. Unfortunately, his new teacher knows only a few words of English.
Shrinking classes isn’t cheap. The college must either cut back on something else, like teacher quality, or pass on the cost to someone else, namely, the student. The cost may be justified, but in any event it must be considered.
One reason for the continuing controversy over class sizes is that they affect much of what a school does. Reducing class size changes other school traits, which themselves affect learning. When we ask whether class size matters, do we mean just its direct effect on learning? Or also its indirect effects?
“…While class size always affords opportunities for increased investment in each child’s learning, it is not obvious that every school takes up such opportunities,” writes economist Caroline Hoxby. “The actual effect of reducing class size will depend on the incentives a school faces.”
Understating unemployment
The unemployment rate. Most people think that this is the share of potential workers who don’t have jobs. In that light, the rate may approximate one’s chances of going jobless. In reality, the unemployment rate is the share of the labor force that seeks work but can’t find it. (The labor force is the sum of the employed and unemployed.) What if you’re so discouraged that you quit even looking for a job? Does the government count you as unemployed? Nope: It counts you out of the labor force. Consequently, the unemployment rate understates joblessness. This is useful to keep in mind, because Kazakhstan’s government often attributes falls in the rate of unemployment entirely to its own programs to create jobs.
Some governments try to estimate the number of discouraged workers. In the United States, the Bureau of Labor Statistics telephones or personally interviews 60,000 households each month. In August 2010, 1.1 million Americans were too discouraged to look for work -– about one-sixth of the number who still sought jobs although they had been unemployed for at least half a year (“chronic” unemployment). About as many Americans drop out of the labor force in order to go to school, recover from illness, or to look after their families, or for similar reasons, as because they give up on finding jobs.
Employment rates. It’s logical to define the employment rate as 1 minus the unemployment rate. Kazakhstan, with an unemployment rate of 6%, would have an employment rate of 94%; i.e., 94% of the labor force has jobs. However, economists rarely use this statistic, because it adds nothing to what we already know from the unemployment rate.
More interesting is the share of those able to work who have jobs. The employment-to-population ratio is defined in terms of those aged 15 or older. This statistic gives us a sense of whether the economy is operating at full capacity. When the ratio is high, then employers may have trouble finding workers and thus will raise their wage offers. A general increase in wages will force up prices as employers try to pass on their costs to consumers. Hello, inflation.
In Kazakhstan, the employment-to-population ratio is just under two-thirds, according to the World Bank. It is significantly higher for men (roughly 70%) than for women (below 60%).
A way to gauge a nation’s willingness to work is to look at the share of the labor force in the working-age population, called the “labor force participation ratio.” In 2008, this ratio in Kazakhstan was 75% for men and 63.5% for women, according to the United Nations. In the United States, the long-run rate has been about two-thirds and declining (to 65% in August 2010). In August 2010, it was 71.7% for men and 58.6% for women, according to the U. S. Bureau of Labor Statistics. Severe recession has undoubtedly lowered the American rates for August, and they are not seasonally adjusted. Still, one wonders whether Kazakhstanis work harder than Americans.
People sometimes argue that a fall in the unemployment rate -– or, if you will, a rise in the employment rate -– must boost production. That argument confuses the rate of employment with the number employed. An example may clear this up. Suppose that 100 adults comprise the labor force; of them, 50 work and 50 look for work. The unemployment rate is 50%, and so is the employment rate (when defined as 1 minus the unemployment rate). Now, 25 of the unemployed stop searching for jobs; so they drop out of the labor force. Seventy-five remain in the labor force. The new rate of unemployment is 33% (25/75), and the rate of employment is 67% (50/75). The employment rate has risen sharply -- but output remains unchanged, because we still have just 50 on the job.
Labor statistics. Employment and unemployment rates are usually calculated in terms of workers. The government counts you as employed even if you work only one hour per week. You will count as much as does someone who works 60 hours a week.
But the 60-hour worker provides 60 times as much employment as the one-hour worker. Thus employment ratios distort our view of the economy’s performance. In a recession, when firms put workers on a part-time basis, the ratios overestimate the economy’s use of labor. In a strong recovery, when firms pay overtime because they have trouble finding new workers, employment ratios underestimate labor use. Policymakers who rely on these ratios to signal impending inflation may be in for a nasty surprise. Measuring employment in terms of hours worked would correct these faults; the underemployed worker would be recognized as such.
Maybe someday Astana’s chinovikii chefs will consider serving up statistics that are less piquant and more nourishing. -- Leon Taylor, tayloralmaty@gmail.com
Disclaimer: I don’t speak for KIMEP.
Good reading
Angrist, Joshua D. and Victor Lavy. 1999. Using Maimonides’ rule to estimate the effect of class size on scholastic achievement. Quarterly Journal of Economics 114: 2, May, pages 533-575. In the 1100s, the Talmudic scholar Maimonides wrote: “Twenty-five children may be put in charge of one teacher. If the number in the class exceeds 25 but is not more than 40, he should have an assistant to help with the instruction. If there are more than 40, two teachers must be appointed” (page 534). Public schools in Israel still use the rule. This gives researchers an unusually clear chance to study the impact of class size on student performance, because Maimonides’ rule can affect performance only through class size -- not through other factors that are hard to control for. The study finds that making classes smaller will increase test scores for fourth and fifth graders but not for third graders.
Card, David, and Alan Krueger. 1992. School quality and black-white relative earnings: A direct assessment. Quarterly Journal of Economics 107, February, pages 151-200.
Card, David and Alan B. Krueger. 1996. School resources and student outcomes: An overview of the literature and new evidence from North and South Carolina. The Journal of Economic Perspectives 10:4, autumn, pages 31-50. This innovative analysis links smaller classes to greater adult earnings.
Hanushek, Eric A. 1997. Assessing the effects of school resources on student performance: An update. Educational Evaluation and Policy Analysis 19: 2, summer, pages 141-164. “The close to 400 studies of student achievement [in the literature on educational production] demonstrate that there is not a strong or consistent relationship between student performance and school resources, at least after variations in family inputs are taken into account” (page 141).
Hanushek, Eric A. 1996. Measuring investment in education. The Journal of Economic Perspectives 10:4, autumn, pages 9-30. Spending may fail to boost student achievement because of diminishing returns to spending and because of a lack of incentives for teachers like merit pay. (By “diminishing returns,” I mean that spending another dollar does less and less good.)
Hanushek, Eric A. 1986. The economics of schooling: Production and efficiency in public schools. Journal of Economic Literature 24: 3, September, pages 1141-1177. This influential survey of 147 econometric estimates concludes that “differences in [school] quality do not seem to reflect variations in expenditures, class sizes, or other commonly measured attributes of schools and teachers. Instead, they appear to result from differences in teacher ‘skills’ that defy detailed description but that possibly can be observed directly” (page 1142).
Hoxby, Caroline M. 2000. The effects of class size on student achievement: New evidence from population variation. Quarterly Journal of Economics 115: 4, November, pages 1239-1285. This study of 649 elementary schools controls for some factors that determine class size. It finds no statistically significant effect of class size on student achievement. The quote in the text above is from page 1240.
Kazakhstan Today. 2009. Unemployment rate in Kazakhstan to decline. June 8. The government credited its own anti-recession policies with halving the rate of unemployment.
Krueger, Alan B. 2002. Economic considerations and class size. National Bureau of Economic Research Working Paper 8875, April. “…Hanushek’s pessimistic conclusion [in his 1997 survey] about the effectiveness of schooling inputs results from the fact that he inadvertently places a disproportionate share of weight on a small number of studies that frequently used small samples and estimated misspecified models” (page 2). When one gives all studies the same weight, or a weight that increases with the quality of the journal, then class size affects student achievement significantly.
United Nations Statistics Division. Online at data.un.org . International statistics, including economic data for Kazakhstan.
United States Bureau of Labor Statistics. Online at www.bls.gov . Labor data and explanations.
Revised on October 9, 2010.
Among culinary arts in Central Asia, the cooking of government statistics is one of the most entertaining. Here are a few favorite recipes:
The student-faculty ratio. The Ministry of Education and Science wants colleges to reduce the number of students taught by a typical instructor because it regards smaller classes as better. Recently, a Ministry official threatened to suspend KIMEP’s license, largely for a student-faculty ratio of allegedly 20 (that is, 20 students per professor). KIMEP estimates its ratio as below 2 for graduate students and as 15 or 16 for undergraduates. Probably the official was confused by a rule-of-thumb here that an undergraduate class with 20 students will earn enough tuition to pay for itself. In principle, classes with fewer than 20 registrants would lose money, so KIMEP would cancel them. That rule is honored in the breach. KIMEP often approves a small class that students need in order to graduate or that they express a strong interest in taking. The modus operandi here is the same as at most universities – large introductory classes subsidize small, advanced classes and classes (such as in foreign languages) that require a lot of attention to each student. (A large class makes money because the teacher’s pay is spread over more students, each of whom pays the same tuition for this class as for a small one.)
In his newspaper interview, the official’s tone of shocked outrage suggested that scheduling a college class of 20 students was a venal sin. In reality, scholars have debated the impact of class size on student performance for more than a half century. Twenty years ago, the consensus of economists, from statistical studies, was that class size did not affect learning systematically.
Since then, as often happens in empirical research, studies taking new approaches have qualified the original blunt conclusion. The impact of class size in colleges may differ from that in primary and secondary schools -– the settings for most studies -- since college class sizes vary a lot. Third-graders rarely sit in 300-student lecture halls. Standardized test scores -– the usual proxy for student achievement -- may not measure learning well, since instructors often teach the test and nothing else; perhaps we should use the graduate’s wages. Class size may matter more in poorer countries, where students cannot afford such aids as Cliff’s Notes to cope with monster classes.
Warm bodies, cold statistics
Despite such caveats, one cannot ignore the sheer weight of scores of estimates that have failed to find that class size matters much. Of 112 estimates surveyed by Hanushek in 1986, 89 found no statistically significant effect of class size on student achievement. Only nine were statistically significant and carried the negative sign -- that is, students learned less in larger classes. (In a general comment on Hanushek’s work, econometrician Alan Krueger asserts that drawing several estimates from the same flawed study may give it undue weight in the survey of all studies. This particular survey was of 33 publications.) The idea that large classes stunt learning may merit the Scots’ Verdict – “Not proven.” I am not a specialist, but my impression is that the one durable conclusion from econometric studies of student achievement is that students with richer and more educated parents do better.
In any event, the Ministry wanted KIMEP to cut its student-to-faculty ratio to 8. Unfortunately, the Ministry apparently calculates this ratio in terms of warm bodies. A student who takes one course every year counts just as much as a student who takes 15. Consequently, the ratio may mean virtually anything. Suppose that a school has one professor and eight students. Then the student-faculty ratio is eight if every student takes one course per year. It is also eight if every student takes 15 courses per year. Obviously, the professor can devote more time to a student in a given class in the former scenario. In the latter, he would be overwhelmed by preparations of 15 times as many classes.
The Ministry could get a more accurate picture of the quality of learning at, say, Java College by calculating its ratio in terms of full-time equivalents, which is what experts do. At KIMEP, a fulltime professor teaches eight courses per year, and a fulltime student takes 10 courses. Two students, each taking five courses per year, would count as one fulltime-equivalent student. In our two earlier scenarios, the first has .8 of a fulltime-equivalent student, and the second has 12. If the professor teaches fulltime, then the student-faculty ratio is .8 in the first scenario and 12 in the second. Now it’s clear which school is truly crowded.
As is its wont, the Ministry has neglected the likely consequences of its policy. If only warm bodies matter, then schools will satisfy the student-faculty maximum by hiring the cheapest warm bodies around. Those would be adjuncts, who receive a fraction of the salaries, and none of the benefits, of regular faculty. Since adjuncts often have only a fraction of the learning of regular professors, the Ministry’s policy may torpedo its stated intent of improving education.
Consider an English class of 24 students, taught by a native speaker for $900. To satisfy the Ministry’s mandate, Java College replaces the teacher with three adjuncts, each willing to teach eight students for $300. Now each student can receive thrice as much time from a teacher as before. Unfortunately, his new teacher knows only a few words of English.
Shrinking classes isn’t cheap. The college must either cut back on something else, like teacher quality, or pass on the cost to someone else, namely, the student. The cost may be justified, but in any event it must be considered.
One reason for the continuing controversy over class sizes is that they affect much of what a school does. Reducing class size changes other school traits, which themselves affect learning. When we ask whether class size matters, do we mean just its direct effect on learning? Or also its indirect effects?
“…While class size always affords opportunities for increased investment in each child’s learning, it is not obvious that every school takes up such opportunities,” writes economist Caroline Hoxby. “The actual effect of reducing class size will depend on the incentives a school faces.”
Understating unemployment
The unemployment rate. Most people think that this is the share of potential workers who don’t have jobs. In that light, the rate may approximate one’s chances of going jobless. In reality, the unemployment rate is the share of the labor force that seeks work but can’t find it. (The labor force is the sum of the employed and unemployed.) What if you’re so discouraged that you quit even looking for a job? Does the government count you as unemployed? Nope: It counts you out of the labor force. Consequently, the unemployment rate understates joblessness. This is useful to keep in mind, because Kazakhstan’s government often attributes falls in the rate of unemployment entirely to its own programs to create jobs.
Some governments try to estimate the number of discouraged workers. In the United States, the Bureau of Labor Statistics telephones or personally interviews 60,000 households each month. In August 2010, 1.1 million Americans were too discouraged to look for work -– about one-sixth of the number who still sought jobs although they had been unemployed for at least half a year (“chronic” unemployment). About as many Americans drop out of the labor force in order to go to school, recover from illness, or to look after their families, or for similar reasons, as because they give up on finding jobs.
Employment rates. It’s logical to define the employment rate as 1 minus the unemployment rate. Kazakhstan, with an unemployment rate of 6%, would have an employment rate of 94%; i.e., 94% of the labor force has jobs. However, economists rarely use this statistic, because it adds nothing to what we already know from the unemployment rate.
More interesting is the share of those able to work who have jobs. The employment-to-population ratio is defined in terms of those aged 15 or older. This statistic gives us a sense of whether the economy is operating at full capacity. When the ratio is high, then employers may have trouble finding workers and thus will raise their wage offers. A general increase in wages will force up prices as employers try to pass on their costs to consumers. Hello, inflation.
In Kazakhstan, the employment-to-population ratio is just under two-thirds, according to the World Bank. It is significantly higher for men (roughly 70%) than for women (below 60%).
A way to gauge a nation’s willingness to work is to look at the share of the labor force in the working-age population, called the “labor force participation ratio.” In 2008, this ratio in Kazakhstan was 75% for men and 63.5% for women, according to the United Nations. In the United States, the long-run rate has been about two-thirds and declining (to 65% in August 2010). In August 2010, it was 71.7% for men and 58.6% for women, according to the U. S. Bureau of Labor Statistics. Severe recession has undoubtedly lowered the American rates for August, and they are not seasonally adjusted. Still, one wonders whether Kazakhstanis work harder than Americans.
People sometimes argue that a fall in the unemployment rate -– or, if you will, a rise in the employment rate -– must boost production. That argument confuses the rate of employment with the number employed. An example may clear this up. Suppose that 100 adults comprise the labor force; of them, 50 work and 50 look for work. The unemployment rate is 50%, and so is the employment rate (when defined as 1 minus the unemployment rate). Now, 25 of the unemployed stop searching for jobs; so they drop out of the labor force. Seventy-five remain in the labor force. The new rate of unemployment is 33% (25/75), and the rate of employment is 67% (50/75). The employment rate has risen sharply -- but output remains unchanged, because we still have just 50 on the job.
Labor statistics. Employment and unemployment rates are usually calculated in terms of workers. The government counts you as employed even if you work only one hour per week. You will count as much as does someone who works 60 hours a week.
But the 60-hour worker provides 60 times as much employment as the one-hour worker. Thus employment ratios distort our view of the economy’s performance. In a recession, when firms put workers on a part-time basis, the ratios overestimate the economy’s use of labor. In a strong recovery, when firms pay overtime because they have trouble finding new workers, employment ratios underestimate labor use. Policymakers who rely on these ratios to signal impending inflation may be in for a nasty surprise. Measuring employment in terms of hours worked would correct these faults; the underemployed worker would be recognized as such.
Maybe someday Astana’s chinovikii chefs will consider serving up statistics that are less piquant and more nourishing. -- Leon Taylor, tayloralmaty@gmail.com
Disclaimer: I don’t speak for KIMEP.
Good reading
Angrist, Joshua D. and Victor Lavy. 1999. Using Maimonides’ rule to estimate the effect of class size on scholastic achievement. Quarterly Journal of Economics 114: 2, May, pages 533-575. In the 1100s, the Talmudic scholar Maimonides wrote: “Twenty-five children may be put in charge of one teacher. If the number in the class exceeds 25 but is not more than 40, he should have an assistant to help with the instruction. If there are more than 40, two teachers must be appointed” (page 534). Public schools in Israel still use the rule. This gives researchers an unusually clear chance to study the impact of class size on student performance, because Maimonides’ rule can affect performance only through class size -- not through other factors that are hard to control for. The study finds that making classes smaller will increase test scores for fourth and fifth graders but not for third graders.
Card, David, and Alan Krueger. 1992. School quality and black-white relative earnings: A direct assessment. Quarterly Journal of Economics 107, February, pages 151-200.
Card, David and Alan B. Krueger. 1996. School resources and student outcomes: An overview of the literature and new evidence from North and South Carolina. The Journal of Economic Perspectives 10:4, autumn, pages 31-50. This innovative analysis links smaller classes to greater adult earnings.
Hanushek, Eric A. 1997. Assessing the effects of school resources on student performance: An update. Educational Evaluation and Policy Analysis 19: 2, summer, pages 141-164. “The close to 400 studies of student achievement [in the literature on educational production] demonstrate that there is not a strong or consistent relationship between student performance and school resources, at least after variations in family inputs are taken into account” (page 141).
Hanushek, Eric A. 1996. Measuring investment in education. The Journal of Economic Perspectives 10:4, autumn, pages 9-30. Spending may fail to boost student achievement because of diminishing returns to spending and because of a lack of incentives for teachers like merit pay. (By “diminishing returns,” I mean that spending another dollar does less and less good.)
Hanushek, Eric A. 1986. The economics of schooling: Production and efficiency in public schools. Journal of Economic Literature 24: 3, September, pages 1141-1177. This influential survey of 147 econometric estimates concludes that “differences in [school] quality do not seem to reflect variations in expenditures, class sizes, or other commonly measured attributes of schools and teachers. Instead, they appear to result from differences in teacher ‘skills’ that defy detailed description but that possibly can be observed directly” (page 1142).
Hoxby, Caroline M. 2000. The effects of class size on student achievement: New evidence from population variation. Quarterly Journal of Economics 115: 4, November, pages 1239-1285. This study of 649 elementary schools controls for some factors that determine class size. It finds no statistically significant effect of class size on student achievement. The quote in the text above is from page 1240.
Kazakhstan Today. 2009. Unemployment rate in Kazakhstan to decline. June 8. The government credited its own anti-recession policies with halving the rate of unemployment.
Krueger, Alan B. 2002. Economic considerations and class size. National Bureau of Economic Research Working Paper 8875, April. “…Hanushek’s pessimistic conclusion [in his 1997 survey] about the effectiveness of schooling inputs results from the fact that he inadvertently places a disproportionate share of weight on a small number of studies that frequently used small samples and estimated misspecified models” (page 2). When one gives all studies the same weight, or a weight that increases with the quality of the journal, then class size affects student achievement significantly.
United Nations Statistics Division. Online at data.un.org . International statistics, including economic data for Kazakhstan.
United States Bureau of Labor Statistics. Online at www.bls.gov . Labor data and explanations.
Revised on October 9, 2010.
Thursday, August 19, 2010
A random walk up downtown Almaty
Can you get rich from speculating on stocks in Kazakhstan? Yes! Er, no….
Few markets are actually as competitive as simple economic theory recommends. One may be the stock market. With many buyers and sellers of shares, none is large enough to influence the price of a given stock, much less an index of all stocks.
In theory, then, all agents in the stock market will take the stock price for granted when deciding what to do. When buyers think a stock undervalued, then they will keep buying it until its price rises to the point of reflecting the issuer’s true value. Similarly, they will sell overvalued stocks. Buying and selling shares is simple, so the new information that prompts movements in the stock market will be absorbed by new prices quickly. The market is “efficient.”
This is not quite the usual economic definition of efficiency – i.e., that we maximize the net value of all inputs into production. But it does imply a saving of the most valuable input of all – time. To judge whether oil is becoming more valuable, an observer need not study assiduously the characteristics of the industry, such as the number and locations of oil wells and pipelines, the purity of the crude oil, and the demand of airlines for fuel refined from oil. He need look only at whether the price of oil stocks is rising.
But many are the slips twixt theory and fact. Stock markets may not be as efficient as they seem. Over the Nineties, U.S. stock prices soared for computer firms issuing shares for the first time. The index for NASDAQ, the U.S. stock market that attracted computer start-ups in droves, rose tenfold over the decade. This overvaluation led to the “dot.com crash” of 2000, in which the NASDAQ index would eventually fall by half, noted the financial economist Frederic Mishkin. As paper wealth melted away, American consumers cut back on spending. A mild recession ensued in 2001. Can such market corrections occur fast enough to avoid wild fluctuations in stock prices, wealth and income?
For stock markets in developing countries like Kazakhstan, the question is complicated by doubts about the markets’ basic efficiency. Trading is often thin in these embryonic exchanges. A seller or buyer of stock may find it easy to influence the share price by dominating the volume of trade – that is, by cornering the market.
How can we tell whether a stock market is efficient? If it processes information at the speed of light, then we should observe share prices changing only for unpredictable reasons; all predictable adjustments have already occurred.
Suppose, for example, that the central bank in the United States, the Federal Reserve, announces an apparent slowdown of the national economy. Demand will drop for oil, a primary input. Oil prices will fall as well, pulling down the value of oil extractors. Their share prices will plummet. This reasoning, of course, is almost too obvious to be stated. And that’s the point: Millions of investors will anticipate a fall in oil stock prices and so will cash in their oil shares or sell them short (i.e., sell a borrowed share today and buy a cheaper share tomorrow in order to close the loan). The prophecy will fulfill itself; oil prices will fall immediately. In short, yesterday’s news will affect yesterday’s stock prices. Today’s prices can react only to today’s news – and only the unpredictable news at that.
The Bourbon statistician
This suggests a simple pattern for stock prices: Today’s price will equal yesterday’s, plus a random change. That’s a “random walk.” In New Orleans, once Party Central for most of the known universe, native statisticians liken a random walk to the path of a drunk on Bourbon Street – one step forward, maybe one step back, as the party pro staggers on a whim.
This summer, a graduate student in KIMEP’s economics program, Assel Prmanova, looked at whether stock prices in Almaty followed a random walk. She gathered daily values of the index for the Kazakhstan Stock Exchange (KASE) for the past decade. She concluded that today’s index value does indeed incorporate yesterday’s.
But the daily change in the index was not random. It followed a negative pattern: Usually the index rose one day and fell on the next. (Econometricians call this “negative serial correlation.”) Evidently, KASE is not completely efficient: The price changes follow a pattern that speculators should exploit but don’t. If we saw the market rising today, then we should sell short in order to cash in on tomorrow’s likely decline. Our short sales would lower today’s prices, eliminating the pattern of rise and fall. In other words, the very presence of a price trend tells us that speculators are not acting on all information available.
There is a golden lining in these statistical clouds. If the stock market is fully efficient, then a speculator cannot hope to grow rich over time; his rivals have already exhausted all visible opportunities for profit. To make money at all, you must be lucky or -- what amounts to the same thing -- quick. (Or well connected.) But KASE does not seem that efficient. So get out your checkbook.
Some technical issues remain. Dana Stevens, KIMEP’s vice president of academic affairs and an economist trained by Stanford, points out that the KASE index changed little from 2000 to 2003. If the index was 100 on one day, it was 100 on the next. This inertia may mislead us into believing that today’s index incorporates yesterday’s more often than it actually does.
The key issue is whether KASE changed fundamentally in 2003. A constant stock price need not connote inefficiency; we would be rational to avoid a market that kept us from taking profits. But if, in fact, KASE took on a new shape in 2003, then we will need a new model to explain it for that year and forward.
Moral: No economic model is ever perfect. That’s why economists are guaranteed long and gainful employment. – Leon Taylor tayloralmaty@gmail.com
Full disclosure: I advised Ms. Prmanova’s thesis, as did Drs. Aleksandr Vashchilko and Eldar Madumarov, economics professors at KIMEP, and Dr. Stevens, a finance professor at KIMEP.
Good reading
Fama, Eugene F. 1970. Efficient capital markets: A review of empirical work. Journal of Finance 25:2, May, pages 833-417. A famous survey of early tests of the Efficient Market Hypothesis, which were generally favorable.
MacKay, Charles. 1996. Extraordinary popular delusions and the madness of crowds. New York: John Wiley. This 19th-century classic on financial hysteria is fun to read.
Malkiel, Burton. 2007. A random walk down Wall Street: The time-tested strategy for successful investing. New York: W. W. Norton. A classy defense of market efficiency, with a few words of advice on how to play the stock exchange. (The main word is: “Don’t.”)
Marsh, Terry A. and Robert C. Merton. 1986. Dividend variability and variance bounds tests for the rationality of stock market prices, American Economic Review 76:3, June, pages 483-498. Takes a tack differing from Shiller’s but also rejects the Efficient Market Hypothesis.
Mishkin, Frederic S. 2007. The economics of money, banking and financial markets. Eighth edition. Boston: Pearson Addison Wesley. Chapter 7, The stock market, the theory of rational expectations, and the Efficient Market Hypothesis. An easy-to-read overview.
Mishkin, Frederic S. 1978. Efficient markets theory: Implications for monetary policy. Brookings Papers on Economic Activity 1978: 3, pages 707-752. This survey is more detailed and sophisticated than Mishkin’s textbook chapter, but it’s still readable.
Prmanova, Assel. 2010. Factors affecting the Kazakhstan Stock Exchange Index. Almaty, Kazakhstan: KIMEP Master’s of Economics thesis.
Shiller, Robert J. 2003. From efficient markets theory to behavioral finance. Journal of Economic Perspectives 17:1, winter, pages 83-104. Develops a novel test that rejects the Efficient Market Hypothesis.
Revised on August 21, 2010
Wednesday, August 11, 2010
Emigrants from Tajikistan: A lesson before you go?
Why don’t Tajikistani workers in Russia speak Russian? Because their schools can’t afford to teach them
Despite an economic growth rate of 60% over a recent six-year period, Tajikistan remains one of the world’s poorest countries. Mainly for that reason, it ranked in 2003 in the lowest third of nations for economic development, reported the United Nations Development Programme. A typical resident earns $1.50 a day, still below his Soviet earnings of two decades ago.
Tajikistan lacks not resources but the means of exploiting them. The country is rich in rivers, but hydropower requires more physical capital than Tajikistanis can easily finance. They are too poor to save.
Traditionally, economists recommend that a developing country raise money for investment by exporting goods. But geography precludes this strategy for Tajikistan. Of the nation’s land, 97% is mountainous, and none of it is accessible to navigable waters. Import buyers around the world can’t afford to transport many Tajikistani goods. Trade in portable services, especially labor, becomes all the more important.
Thanks to the Soviet commitment to educating all – if rote learning qualifies as education -- Tajikistanis are learned compared to other peoples of like income. And their youthfulness -- 67% are younger than 29 – may enable the country to capitalize on its universal education, in the form of literate emigrants.
The importance alone of emigrants to Tajikistan’s economy could justify public investment in them. Civil war in the mid-Nineties propelled the first migrants – skilled non-Tajiks -- from the newly independent country. Since then, the surge has become a flood, with one of every three male workers going abroad to try his luck, noted Abdul-Ghaffar Mughal. Tajikistan’s economy relies more on emigrant workers than does any other. It is among the 20 countries with the largest receipts of remittance, and it has the highest ratio of remittance to gross domestic product (about half, according to the National Bank of Tajikistan). In 2008, remittances were $2.6 billion, much higher than foreign spending on factories and other capital in Tajikistan (i.e., foreign direct investment).
Do the earnings of emigrants help develop the home economy – or hinder it? The answer may depend on how families spend the money. A statistical study by the International Monetary Fund (IMF) in 2009 concluded that emigrant earnings “have contributed little to economic growth in remittance-receiving economies and may have even retarded growth in some extent.” Adolfo Barajas et al. found no example in which remittances had spurred long-run growth of the home economy. Evidently, families spent them on “life’s necessities” rather than lend them indirectly to projects expanding the economy’s capacity to produce. Foreign direct investment may stimulate more economic growth than remittances do.
In Tajikistan, investment in production amounts to only 15% of all spending on the country’s goods and services. Remittances do not boost this share by much, since only 3% are banked in Tajikistan and thus available for business loans. To the contrary, of every additional somoni earned, two thirds are spent on imports – three times as much as export earnings. The emigrants buy imports, too. Of those surveyed a few years ago, 89% said they had gone abroad mainly to earn money for buying food, clothes, and basic goods for the home, reported the International Organization for Migration. Only 5% said they had emigrated in order to finance homes or other durable goods, or to fatten the piggy bank. In 2008, less than a fourth of all remittances were saved – and half of those for less than six months, said the International Labour Organization. Perhaps the government could induce emigrants to save something in an institution like Russia’s SBERbank, the leading bank in the Commonwealth of Independent States and in Eastern Europe.
Russian roulette
Diverting more remittances into savings accounts could help boost the rate of growth of Tajikistan’s economy. But it could also create risk, in the form of larger fluctuations in national income, since most emigrants go to Russia – 85% of those surveyed in 2007. This destination is natural, since it abounds in resources but not in labor, thanks partly to the low fertility rate of Russian women. Russia is unlike Tajikistan, where the annual entry of 120,000 into the labor force far exceeds the number of jobs available. Nevertheless, an economic crisis in Russia – like the ruble crash of 1998 or the financial crisis of 2008-9 – would have magnified effects on Tajikistan.
Ordinarily, a government might blunt such a depression by spending money. The security guard who gets a new job from the government will spend his somoni at the grocery, enabling a cashier there to spend more money, too. But Tajikistan is wide open to the global economy. Very little spending remains within its borders, so it cannot generate many more rounds of spending at home. An expenditure of $100 million by Dushanbe may boost national income by only $103 million in the final reckoning (see the Technical Notes).
Probably the most effective of all policies for the emigrants would be to educate them. In principle, a literate country like Russia could sell human capital to Tajikistanis in exchange for their labor. In reality, emigrants return to Tajikistan with more money than knowledge, in part because they do not understand Russian well enough to learn from their stays. This may help explain why Tajikistanis earn lower wages in Russia than virtually any other group of emigrants.
By subsidizing instruction in Russian, the government in Dushanbe could enable emigrants to earn higher wages in Russia – or to work elsewhere in the post-Soviet bloc. Such diversification of destinations would reduce the risk that emigration generates for Tajikistan’s economy. Instruction in English could widen the emigrants’ net still further. At present, only 2% of Tajikistani teaching is in Russian, and only .03 of a percent in English, wrote Briller.
In addition to language instruction, Dushanbe could facilitate training in sectors that are most likely to weather a downturn in Russia, such as information services and the repair of heavy machines. That strategy applies to other countries, too. This spring, the government agreed to send 1,000 physicians and nurses to Saudi Arabia.
Government spending on education earns a double return: Literacy increases, and emigrants become more productive and thus better paid. A 2000 study in Australia, by Borland et al., found that college graduates earn a wage premium of 65% over their careers, compared to non-graduates. Assuming diminishing returns to education as the level of education increases, the wage premium in Tajikistan may well be higher than 65%; but we will take this as a starting point.
One educational payoff for government is a modest increase in its tax revenues – not enough, however, to justify the expense to it of education. (This consists of the direct cost of schooling as well as the tax revenues foregone because a youth now studies rather than works). Even given a schooling cost of only $2,500 a year for a four-year degree, and given a hefty tax rate of 40% on income, several times higher than other top marginal tax rates in Central Asia, the tax revenues from enhanced income cover only a fourth of Dushanbe’s original outlay for college (see the Technical Notes). This explicit return to education is small because Tajikistani incomes are low to begin with and because wildfire inflation erodes the purchasing power of future tax receipts.
Tajikistani schools get a failing grade
Ironically, Tajikistan’s government has cut back sharply on educational spending, like others in Central Asia. In the last Soviet years, public spending on education was about 8% of gross Tajikistani income. After independence, this share fell to 2% by 1995 and remained there for nearly a decade. As late as 2006, the share was apparently still less than 3%. Merely maintaining the education system might require roughly 7% of GDP, according to Briller, who did not justify the estimate.
The educational system cannot be reformed in a New York minute. More than a third of the schools lack toilets. More than 40% of teachers in Tajikistan have never attended college, and their average salary is about $13 per month, according to Briller’s report for UNESCO. More than a fifth of youths aged 13 to 17 do not attend school, partly because children comprise as much as 40% of the work force picking cotton, the leading legal export of Tajikistan. As happened in the United States in the 1910s, a ban on child labor in Tajikistan would probably boost school attendance, but at some short-run cost to rural farmers.
Education in Tajikistan requires public subsidy for several reasons. In a more general context, Milton Friedman noted the most apparent reason a half-century ago. An educational loan from a bank cannot be secured with the asset that the loan would develop, human capital, without risking slavery. In principle, the family could offer other assets, such as land, for collateral; but in reality, families that cannot afford education cannot afford much of anything else.
In addition, education of emigrants generates spillover benefits. The Russian-speaking emigrant abroad can gain knowledge to be shared with his family and friends in Tajikistan. Since the emigrant cannot collect payments for this shared knowledge, he may discount its value when considering whether to incur the expense of learning Russian. A public subsidy for learning Russian may induce the emigrant to take its full benefits into account.
Some indirect policies may improve education in Tajikistan as sharply as would a direct subsidy. One roadblock to long-run investment in Tajikistan is its central bank. It tolerates annual rates of inflation that are variable and high: About 7% in 2005, 21% in 2008. No lender wants to be paid back in somoni weaker than the ones lent out. So creditors of education will increase their annual interest rates by as much as 20%, making their loans unaffordable for most individual borrowers in Tajikistan. In addition, volatility in the rate of inflation, which tripled in four years, will lead a typical creditor to refuse to lend to students because he fears getting burned by unanticipated inflation. The National Bank of Tajikistan could make the country safer for investment by stabilizing the supply of somoni and thus the rate of inflation.
The government declared 2010 to be the “year of education.” Is it willing to put its money where its mouth is? -- Zafar Davronov and Leon Taylor tayloralmaty@gmail.com
Zafar Davronov graduated from KIMEP with a Master's of Business Adminstration and now is a graduate program officer in the Bang College of Business at KIMEP. A Tajikistani, he often writes about economics and finance in Tajikistan.
Technical notes
The government’s rate of return to education. Suppose that the government pays $10,000 per year to finance four years of study for a college student. Also suppose that the graduate commands a wage premium of 65% (relative to a high school graduate) over a 30-year career, or a total wage of $7,100 per year. (For a mean household of 7.1 persons, the annual income would be about $4,300. A 65% markup would increase this to $7,100.) Finally, suppose that his marginal tax rate on income is 40%, four times higher than the top individual tax rate in Kazakhstan, according to the World Bank. (Data on income tax rates in Tajikistan were not readily available.) For now, assume no discounting.
The total cost to the government of the investment is $40,000 (out-of-pocket expenses of education) plus $7,000 (foregone tax revenues on four years of averted work, 4*$4,300*.4), totaling $47,000.
Upon the total investment, annual net tax revenues after graduation are $2,800*.4 = $1,120, or $33,600 over 30 years, only 71% of the cost of capital.
Even this pessimistic calculation overstates the return to government, for two reasons. First, inflation will reduce the purchasing power of the dollars to be received in the future, relative to the dollars paid today for the college education. Second, the agents of government may prefer to receive a dollar now rather than later, if only because of impatience and uncertainty.
One way to crudely measure the impact of these factors is to look at the market interest rate that the government pays in order to borrow a dollar for immediate spending. The interest rate reflects the strength of the government’s preference to spend today. It also reflects the inflation rate expected by the creditor, since he wishes to be paid back later with dollars just as valuable as the ones that he now lends.
In 2008, the rate of inflation in Tajikistan was 20.5%, and the real interest rate -3%. Thus the market rate of interest was about 17%. Factoring this rate of discount yields a present value of $3,450 for the government’s return to education. That is, the government would be indifferent between receiving $3,450 now and receiving $1,260 a year for 30 years. This amount is only 9% of the original cost of capital of $37,570 (where this amount has also been discounted at the annual rate of 17%).
The failure of new tax revenues to cover the original cost of human capital is insensitive to various parameters. If the direct cost is $2,500 a year (not $10,000), then the new tax revenues still cover only 26% of the total cost of capital. If the wage premium is 100% (rather than 65%), the share of expenses recouped is 14% (assuming $10,000 of annual direct costs).
Spreadsheet calculations are available upon request.
Income multipliers. In Keynesian economics, the total impact of an initial round of spending takes into account that a new dollar may be respent indefinitely. Denote the initial round of spending as A and the share spent domestically of a new dollar of income as c, normally between 0 and 1. Then total income generated is Y = A + c*A + c*(c*A) +…. Rewrite this expression as cY = cA + c*c*A + c*c*c*A + …. Then Y – c*Y = (1-c)*Y = A. Solving, Y = A/(1-c) = A/s, where s is the share saved of the new dollar.
In addition to savings, spending on imports and income taxes also divert dollars away from consumption. Denote as t the share of another dollar spent on taxes and as m the share spent on imports. The revised expression for income generated is Y = A + c*(1-t – m)*A + c*(1-t-m)*c(1 – t –m)*A + …. Thus Y – c*(1-t-m)*Y = (1-c*(1-t-m))*Y = A. Solving, Y = A/(1 – c*(1-t-m)), where the denominator simply expresses the modified share in new income of saving.
For Tajikistan, we may take c to be .1; m, .65 (as estimated by the IMF); and t, .1. Calculating, the multiplier is 1/.975 or 1.03.
References
Borland, Jeff, Peter Dawkins, David Johnson and Ross Williams. 2000. Returns to investment in higher education. The Melbourne Economics of Higher
Education Research Program Report No. 1. At http://www.melbourneinstitute.com/research/micro/rihe.pdf
Brajas, Adolfo, Ralph Chami, Connel Fullenkamp, Michael Gapen and Peter Montiel. 2009. Do workers’ remittances promote economic growth? IMF working paper.
Briller, Vladimir. 2008. Tajikistan country case study. Prepared in 2007 for the Education for All Global Monitoring Report 2008: Education for All by 2015: will we make it? At http://unesdoc.unesco.org/images/0015/001555/155515e.pdf
Friedman, Milton. 1982 (1962). Capitalism and freedom. The University of Chicago Press. Second edition. More careful and interesting than Free to choose.
International Labour Organization. 2010. Migrant remittances to Tajikistan: The potential for savings, economic investment and existing financial products to attract remittances. May.
International Monetary Fund (IMF). Country report 2008. Includes estimates of average income in Tajikistan.
Mughal, Abdul-Ghaffar. 2007. Migration, remittances, and living standards in
Tajikistan: A report based on Khatlon Remittances and Living Standards Measurement Survey (KLSS 2005). September. International Organization for Migration Tajikistan.
Kireyev, Alexei. 2006. The macroeconomics of remittances: The case of Tajikistan. IMF working paper WP/06/02. At http://www.untj.org/files/reports/The_Macroeconomics_of_Remittances_the_case_of_Tajikistan.pdf.
Leuchtenburg, William E. The perils of prosperity, 1914-1932. 1958. Second edition (undated). The University of Chicago Press. Pithy.
Taylor, J. Edward. 2006. International migration and economic development. Prepared for the International Symposium on International Migration and Development, Population Division of the Department of Economic and Social Affairs at the United Nations Secretariat, Turin, Italy, June 28-30. UN/POP/MIG/SYMP/2006/09. At http://www.un.org/esa/population/migration/turin/Symposium_Turin_files/P09_SYMP_Taylor.pdf
United Nations Development Programme. Various years. Human development report. Ranks economic development of nations by weighing life expectancy, average income, and the literacy rate.
World Bank. 2010. World development indicators. Online at data.worldbank.org/indicator.
Revised August 19, 2010
Despite an economic growth rate of 60% over a recent six-year period, Tajikistan remains one of the world’s poorest countries. Mainly for that reason, it ranked in 2003 in the lowest third of nations for economic development, reported the United Nations Development Programme. A typical resident earns $1.50 a day, still below his Soviet earnings of two decades ago.
Tajikistan lacks not resources but the means of exploiting them. The country is rich in rivers, but hydropower requires more physical capital than Tajikistanis can easily finance. They are too poor to save.
Traditionally, economists recommend that a developing country raise money for investment by exporting goods. But geography precludes this strategy for Tajikistan. Of the nation’s land, 97% is mountainous, and none of it is accessible to navigable waters. Import buyers around the world can’t afford to transport many Tajikistani goods. Trade in portable services, especially labor, becomes all the more important.
Thanks to the Soviet commitment to educating all – if rote learning qualifies as education -- Tajikistanis are learned compared to other peoples of like income. And their youthfulness -- 67% are younger than 29 – may enable the country to capitalize on its universal education, in the form of literate emigrants.
The importance alone of emigrants to Tajikistan’s economy could justify public investment in them. Civil war in the mid-Nineties propelled the first migrants – skilled non-Tajiks -- from the newly independent country. Since then, the surge has become a flood, with one of every three male workers going abroad to try his luck, noted Abdul-Ghaffar Mughal. Tajikistan’s economy relies more on emigrant workers than does any other. It is among the 20 countries with the largest receipts of remittance, and it has the highest ratio of remittance to gross domestic product (about half, according to the National Bank of Tajikistan). In 2008, remittances were $2.6 billion, much higher than foreign spending on factories and other capital in Tajikistan (i.e., foreign direct investment).
Do the earnings of emigrants help develop the home economy – or hinder it? The answer may depend on how families spend the money. A statistical study by the International Monetary Fund (IMF) in 2009 concluded that emigrant earnings “have contributed little to economic growth in remittance-receiving economies and may have even retarded growth in some extent.” Adolfo Barajas et al. found no example in which remittances had spurred long-run growth of the home economy. Evidently, families spent them on “life’s necessities” rather than lend them indirectly to projects expanding the economy’s capacity to produce. Foreign direct investment may stimulate more economic growth than remittances do.
In Tajikistan, investment in production amounts to only 15% of all spending on the country’s goods and services. Remittances do not boost this share by much, since only 3% are banked in Tajikistan and thus available for business loans. To the contrary, of every additional somoni earned, two thirds are spent on imports – three times as much as export earnings. The emigrants buy imports, too. Of those surveyed a few years ago, 89% said they had gone abroad mainly to earn money for buying food, clothes, and basic goods for the home, reported the International Organization for Migration. Only 5% said they had emigrated in order to finance homes or other durable goods, or to fatten the piggy bank. In 2008, less than a fourth of all remittances were saved – and half of those for less than six months, said the International Labour Organization. Perhaps the government could induce emigrants to save something in an institution like Russia’s SBERbank, the leading bank in the Commonwealth of Independent States and in Eastern Europe.
Russian roulette
Diverting more remittances into savings accounts could help boost the rate of growth of Tajikistan’s economy. But it could also create risk, in the form of larger fluctuations in national income, since most emigrants go to Russia – 85% of those surveyed in 2007. This destination is natural, since it abounds in resources but not in labor, thanks partly to the low fertility rate of Russian women. Russia is unlike Tajikistan, where the annual entry of 120,000 into the labor force far exceeds the number of jobs available. Nevertheless, an economic crisis in Russia – like the ruble crash of 1998 or the financial crisis of 2008-9 – would have magnified effects on Tajikistan.
Ordinarily, a government might blunt such a depression by spending money. The security guard who gets a new job from the government will spend his somoni at the grocery, enabling a cashier there to spend more money, too. But Tajikistan is wide open to the global economy. Very little spending remains within its borders, so it cannot generate many more rounds of spending at home. An expenditure of $100 million by Dushanbe may boost national income by only $103 million in the final reckoning (see the Technical Notes).
Probably the most effective of all policies for the emigrants would be to educate them. In principle, a literate country like Russia could sell human capital to Tajikistanis in exchange for their labor. In reality, emigrants return to Tajikistan with more money than knowledge, in part because they do not understand Russian well enough to learn from their stays. This may help explain why Tajikistanis earn lower wages in Russia than virtually any other group of emigrants.
By subsidizing instruction in Russian, the government in Dushanbe could enable emigrants to earn higher wages in Russia – or to work elsewhere in the post-Soviet bloc. Such diversification of destinations would reduce the risk that emigration generates for Tajikistan’s economy. Instruction in English could widen the emigrants’ net still further. At present, only 2% of Tajikistani teaching is in Russian, and only .03 of a percent in English, wrote Briller.
In addition to language instruction, Dushanbe could facilitate training in sectors that are most likely to weather a downturn in Russia, such as information services and the repair of heavy machines. That strategy applies to other countries, too. This spring, the government agreed to send 1,000 physicians and nurses to Saudi Arabia.
Government spending on education earns a double return: Literacy increases, and emigrants become more productive and thus better paid. A 2000 study in Australia, by Borland et al., found that college graduates earn a wage premium of 65% over their careers, compared to non-graduates. Assuming diminishing returns to education as the level of education increases, the wage premium in Tajikistan may well be higher than 65%; but we will take this as a starting point.
One educational payoff for government is a modest increase in its tax revenues – not enough, however, to justify the expense to it of education. (This consists of the direct cost of schooling as well as the tax revenues foregone because a youth now studies rather than works). Even given a schooling cost of only $2,500 a year for a four-year degree, and given a hefty tax rate of 40% on income, several times higher than other top marginal tax rates in Central Asia, the tax revenues from enhanced income cover only a fourth of Dushanbe’s original outlay for college (see the Technical Notes). This explicit return to education is small because Tajikistani incomes are low to begin with and because wildfire inflation erodes the purchasing power of future tax receipts.
Tajikistani schools get a failing grade
Ironically, Tajikistan’s government has cut back sharply on educational spending, like others in Central Asia. In the last Soviet years, public spending on education was about 8% of gross Tajikistani income. After independence, this share fell to 2% by 1995 and remained there for nearly a decade. As late as 2006, the share was apparently still less than 3%. Merely maintaining the education system might require roughly 7% of GDP, according to Briller, who did not justify the estimate.
The educational system cannot be reformed in a New York minute. More than a third of the schools lack toilets. More than 40% of teachers in Tajikistan have never attended college, and their average salary is about $13 per month, according to Briller’s report for UNESCO. More than a fifth of youths aged 13 to 17 do not attend school, partly because children comprise as much as 40% of the work force picking cotton, the leading legal export of Tajikistan. As happened in the United States in the 1910s, a ban on child labor in Tajikistan would probably boost school attendance, but at some short-run cost to rural farmers.
Education in Tajikistan requires public subsidy for several reasons. In a more general context, Milton Friedman noted the most apparent reason a half-century ago. An educational loan from a bank cannot be secured with the asset that the loan would develop, human capital, without risking slavery. In principle, the family could offer other assets, such as land, for collateral; but in reality, families that cannot afford education cannot afford much of anything else.
In addition, education of emigrants generates spillover benefits. The Russian-speaking emigrant abroad can gain knowledge to be shared with his family and friends in Tajikistan. Since the emigrant cannot collect payments for this shared knowledge, he may discount its value when considering whether to incur the expense of learning Russian. A public subsidy for learning Russian may induce the emigrant to take its full benefits into account.
Some indirect policies may improve education in Tajikistan as sharply as would a direct subsidy. One roadblock to long-run investment in Tajikistan is its central bank. It tolerates annual rates of inflation that are variable and high: About 7% in 2005, 21% in 2008. No lender wants to be paid back in somoni weaker than the ones lent out. So creditors of education will increase their annual interest rates by as much as 20%, making their loans unaffordable for most individual borrowers in Tajikistan. In addition, volatility in the rate of inflation, which tripled in four years, will lead a typical creditor to refuse to lend to students because he fears getting burned by unanticipated inflation. The National Bank of Tajikistan could make the country safer for investment by stabilizing the supply of somoni and thus the rate of inflation.
The government declared 2010 to be the “year of education.” Is it willing to put its money where its mouth is? -- Zafar Davronov and Leon Taylor tayloralmaty@gmail.com
Zafar Davronov graduated from KIMEP with a Master's of Business Adminstration and now is a graduate program officer in the Bang College of Business at KIMEP. A Tajikistani, he often writes about economics and finance in Tajikistan.
Technical notes
The government’s rate of return to education. Suppose that the government pays $10,000 per year to finance four years of study for a college student. Also suppose that the graduate commands a wage premium of 65% (relative to a high school graduate) over a 30-year career, or a total wage of $7,100 per year. (For a mean household of 7.1 persons, the annual income would be about $4,300. A 65% markup would increase this to $7,100.) Finally, suppose that his marginal tax rate on income is 40%, four times higher than the top individual tax rate in Kazakhstan, according to the World Bank. (Data on income tax rates in Tajikistan were not readily available.) For now, assume no discounting.
The total cost to the government of the investment is $40,000 (out-of-pocket expenses of education) plus $7,000 (foregone tax revenues on four years of averted work, 4*$4,300*.4), totaling $47,000.
Upon the total investment, annual net tax revenues after graduation are $2,800*.4 = $1,120, or $33,600 over 30 years, only 71% of the cost of capital.
Even this pessimistic calculation overstates the return to government, for two reasons. First, inflation will reduce the purchasing power of the dollars to be received in the future, relative to the dollars paid today for the college education. Second, the agents of government may prefer to receive a dollar now rather than later, if only because of impatience and uncertainty.
One way to crudely measure the impact of these factors is to look at the market interest rate that the government pays in order to borrow a dollar for immediate spending. The interest rate reflects the strength of the government’s preference to spend today. It also reflects the inflation rate expected by the creditor, since he wishes to be paid back later with dollars just as valuable as the ones that he now lends.
In 2008, the rate of inflation in Tajikistan was 20.5%, and the real interest rate -3%. Thus the market rate of interest was about 17%. Factoring this rate of discount yields a present value of $3,450 for the government’s return to education. That is, the government would be indifferent between receiving $3,450 now and receiving $1,260 a year for 30 years. This amount is only 9% of the original cost of capital of $37,570 (where this amount has also been discounted at the annual rate of 17%).
The failure of new tax revenues to cover the original cost of human capital is insensitive to various parameters. If the direct cost is $2,500 a year (not $10,000), then the new tax revenues still cover only 26% of the total cost of capital. If the wage premium is 100% (rather than 65%), the share of expenses recouped is 14% (assuming $10,000 of annual direct costs).
Spreadsheet calculations are available upon request.
Income multipliers. In Keynesian economics, the total impact of an initial round of spending takes into account that a new dollar may be respent indefinitely. Denote the initial round of spending as A and the share spent domestically of a new dollar of income as c, normally between 0 and 1. Then total income generated is Y = A + c*A + c*(c*A) +…. Rewrite this expression as cY = cA + c*c*A + c*c*c*A + …. Then Y – c*Y = (1-c)*Y = A. Solving, Y = A/(1-c) = A/s, where s is the share saved of the new dollar.
In addition to savings, spending on imports and income taxes also divert dollars away from consumption. Denote as t the share of another dollar spent on taxes and as m the share spent on imports. The revised expression for income generated is Y = A + c*(1-t – m)*A + c*(1-t-m)*c(1 – t –m)*A + …. Thus Y – c*(1-t-m)*Y = (1-c*(1-t-m))*Y = A. Solving, Y = A/(1 – c*(1-t-m)), where the denominator simply expresses the modified share in new income of saving.
For Tajikistan, we may take c to be .1; m, .65 (as estimated by the IMF); and t, .1. Calculating, the multiplier is 1/.975 or 1.03.
References
Borland, Jeff, Peter Dawkins, David Johnson and Ross Williams. 2000. Returns to investment in higher education. The Melbourne Economics of Higher
Education Research Program Report No. 1. At http://www.melbourneinstitute.com/research/micro/rihe.pdf
Brajas, Adolfo, Ralph Chami, Connel Fullenkamp, Michael Gapen and Peter Montiel. 2009. Do workers’ remittances promote economic growth? IMF working paper.
Briller, Vladimir. 2008. Tajikistan country case study. Prepared in 2007 for the Education for All Global Monitoring Report 2008: Education for All by 2015: will we make it? At http://unesdoc.unesco.org/images/0015/001555/155515e.pdf
Friedman, Milton. 1982 (1962). Capitalism and freedom. The University of Chicago Press. Second edition. More careful and interesting than Free to choose.
International Labour Organization. 2010. Migrant remittances to Tajikistan: The potential for savings, economic investment and existing financial products to attract remittances. May.
International Monetary Fund (IMF). Country report 2008. Includes estimates of average income in Tajikistan.
Mughal, Abdul-Ghaffar. 2007. Migration, remittances, and living standards in
Tajikistan: A report based on Khatlon Remittances and Living Standards Measurement Survey (KLSS 2005). September. International Organization for Migration Tajikistan.
Kireyev, Alexei. 2006. The macroeconomics of remittances: The case of Tajikistan. IMF working paper WP/06/02. At http://www.untj.org/files/reports/The_Macroeconomics_of_Remittances_the_case_of_Tajikistan.pdf.
Leuchtenburg, William E. The perils of prosperity, 1914-1932. 1958. Second edition (undated). The University of Chicago Press. Pithy.
Taylor, J. Edward. 2006. International migration and economic development. Prepared for the International Symposium on International Migration and Development, Population Division of the Department of Economic and Social Affairs at the United Nations Secretariat, Turin, Italy, June 28-30. UN/POP/MIG/SYMP/2006/09. At http://www.un.org/esa/population/migration/turin/Symposium_Turin_files/P09_SYMP_Taylor.pdf
United Nations Development Programme. Various years. Human development report. Ranks economic development of nations by weighing life expectancy, average income, and the literacy rate.
World Bank. 2010. World development indicators. Online at data.worldbank.org/indicator.
Revised August 19, 2010
Tuesday, July 13, 2010
Just passing through
Weakening the tenge – and paying the piper
The new customs union with Russia (and, depending on the day of the week, with Belarus) will make Kazakhstan an economic appendage of its northern neighbor, since its economy is less than a tenth as large. Trade barriers between the two countries will fall, and Kazakhstan will adopt the same tariffs against the rest of the world as Russia already has. This particular tail won't be wagging the wolfhound.
This may seem like enough integration for the nonce. But policymakers are discussing a further step – a common currency. Kazakhstan would replace the tenge with the ruble.
Unfortunately, the central bank of Kazakhstan would no longer be free to counter economic downturns peculiar to this country. In a small, open economy like ours, the central bank can salubriously stimulate global demand for our goods by weakening the tenge -– say, from 150 tenge to the dollar to 160. This lowers the cost to foreigners of getting their hands on tenge to buy our exports. For example, the 25% devaluation of the tenge in February 2009 might have kept the economic slowdown that year from being much more severe than it was.
But devaluations can drive up prices in general -– that is, they can engender inflation. The world demands more of our goods, forcing Kazakhstanis to compete for them by bidding higher prices. If exporters can sell Caspian oil to China for the new high price of $70 a barrel, then they will demand at least $70 from a Kazakhstani buyer. Also, the increased demand for our goods raises the demand of home producers for workers. Wages will rise, propelling prices anew. Such sudden inflation catches buyers and sellers unawares, causing them to err.
The demerit of a devaluation depends on how quickly and sharply prices will subsequently rise. In principle, a 25% devaluation should lead to a 25% increase in prices. Otherwise, Kazakhstan’s exports will remain cheap compared to those of other nations. This will stimulate demand for our exports, and thus bid up their prices, until our price advantage disappears.
But in fact, prices throughout Kazakhstan have risen only 15% (as an annualized rate) since February 2009 -- despite price spikes, immediately after the devaluation, of 9% throughout the nation and up to 15% in Almaty. Even given last year’s standstill economy, that pace of inflation is surprisingly sedate. What happened?
Rate expectations
Kazakhstanis are not alone in wondering. Around the world, evidence amasses that devaluations often stimulate small, slow adjustments in price. Under what conditions does this occur? Would this be the usual case for Kazakhstan? If it would, then we may think twice about turning over monetary autonomy to the Bank of Russia.
In 2000, John Taylor offered an intriguing explanation for an incomplete “pass-through” of inflation via the exchange rate. Price increases depend on what people think will happen in the economy. If they believe that the central bank will prevent severe, sustained inflation, then they will be less inclined to raise their own prices to ward off such consequences. The owner of a pizzeria in Almaty will shrug off the tenge devaluation, since he is not worried that his workers will demand a sudden pay raise in order to pay higher prices for nan and fermented mare’s milk. In turn, this reluctance to raise prices will help restrain inflation. The prophecy of low inflation happily fulfills itself.
A bit of evidence suggests that this prophecy may hold for Kazakhstan. Since 1994, soon after the tenge was introduced, the pass-through stemming from changes in its exchange rate have seemed modest, concludes a student in the economics graduate program at KIMEP, Meruyert Beisenbayeva. A 1% weakening of the tenge, with respect to either the ruble or the Chinese yuan, leads to an increase in consumer prices in Kazakhstan of a sixth of 1% or less. Perhaps the National Bank of Kazakhstan has convinced people that it won’t tolerate the episodes of rampant inflation that have ravaged other economies in Central Asia.
Perhaps. Another possibility is that producers in Kazakhstan are loathe to raise prices for fear of losing market share to importers. The Chinese, world champs in cutthroat pricing, are rapidly gaining ground in Kazakhstan. They sell us a seventh of our imports -- outstripped only by Russia, which accounts for just under a third of imports. Kazakhstani firms would be prudent to match Chinese pricing -– cutting prices when the Chinese do, and raising them only after the Chinese raise theirs.
Ms. Beisenbayeva finds evidence consistent with such strategizing. A 1% increase in Chinese consumer prices seems to induce a quick rise in ours of more than half of a percent. In contrast, the impact of Russian prices on ours is muted and quite possibly zero. Perhaps Russian exporters to Kazakhstan have become so familiar that our firms no longer worry about losing customers to them.
Ms. Beisenbayeva’s work raises several possibilities. First, the National Bank of Kazakhstan may already have done about all that it can to contain short-term inflation. Any future gains would have to come from an antitrust policy that keeps big Kazakhstani firms from charging the highest prices that the market will bear.
Long-run inflation, of course, remains the responsibility of the central bank. Prices can rise for years only if fueled by new money. The National Bank manages the tenge supply.
Second, adopting the ruble could endow Kazakhstan with unexpected inflation, since Russia’s central bank has trouble keeping the lid on the price level. Inflation rates in Russia double those of Kazakhstan’s (for Russia, 14% in 2008, 12% in 2009). If firms don’t trust the National Bank of Russia, then they may quickly counter ruble devaluations by raising their own prices before their suppliers can. The pass-through value will close in on that predicted by theory, 1. Economic theorists will chortle; Kazakhstani consumers and lenders won’t. – Leon Taylor, tayloralmaty@gmail.com
Full disclosure: I advised the thesis -- along with Aleksandr Vashchilko, Altay Mussurov, and Eldar Madumarov, all economics professors at KIMEP.
References
Beisenbayeva, Meruyert. 2010. The exchange rate pass-through to the CPI in Kazakhstan. Thesis for the master’s of arts in economics. Almaty, Kazakhstan: KIMEP, Department of Economics.
Organisation for Economic Co-Operation and Development. 2010. Source of data on Russian inflation. stats.oecd.org
Mishkin, Frederic S. 2008. Exchange rate pass-through and monetary policy. Speech to the Norges Bank Conference on Monetary Policy in Oslo, Norway. March 7. A readable survey.
National Bank of Kazakhstan. 2010. Source of data for consumer price inflation. www.nationalbank.kz
Taylor, John B. 2000. Low inflation, pass-through, and the pricing power of firms. Working paper. Stanford University. Influential.
The new customs union with Russia (and, depending on the day of the week, with Belarus) will make Kazakhstan an economic appendage of its northern neighbor, since its economy is less than a tenth as large. Trade barriers between the two countries will fall, and Kazakhstan will adopt the same tariffs against the rest of the world as Russia already has. This particular tail won't be wagging the wolfhound.
This may seem like enough integration for the nonce. But policymakers are discussing a further step – a common currency. Kazakhstan would replace the tenge with the ruble.
Unfortunately, the central bank of Kazakhstan would no longer be free to counter economic downturns peculiar to this country. In a small, open economy like ours, the central bank can salubriously stimulate global demand for our goods by weakening the tenge -– say, from 150 tenge to the dollar to 160. This lowers the cost to foreigners of getting their hands on tenge to buy our exports. For example, the 25% devaluation of the tenge in February 2009 might have kept the economic slowdown that year from being much more severe than it was.
But devaluations can drive up prices in general -– that is, they can engender inflation. The world demands more of our goods, forcing Kazakhstanis to compete for them by bidding higher prices. If exporters can sell Caspian oil to China for the new high price of $70 a barrel, then they will demand at least $70 from a Kazakhstani buyer. Also, the increased demand for our goods raises the demand of home producers for workers. Wages will rise, propelling prices anew. Such sudden inflation catches buyers and sellers unawares, causing them to err.
The demerit of a devaluation depends on how quickly and sharply prices will subsequently rise. In principle, a 25% devaluation should lead to a 25% increase in prices. Otherwise, Kazakhstan’s exports will remain cheap compared to those of other nations. This will stimulate demand for our exports, and thus bid up their prices, until our price advantage disappears.
But in fact, prices throughout Kazakhstan have risen only 15% (as an annualized rate) since February 2009 -- despite price spikes, immediately after the devaluation, of 9% throughout the nation and up to 15% in Almaty. Even given last year’s standstill economy, that pace of inflation is surprisingly sedate. What happened?
Rate expectations
Kazakhstanis are not alone in wondering. Around the world, evidence amasses that devaluations often stimulate small, slow adjustments in price. Under what conditions does this occur? Would this be the usual case for Kazakhstan? If it would, then we may think twice about turning over monetary autonomy to the Bank of Russia.
In 2000, John Taylor offered an intriguing explanation for an incomplete “pass-through” of inflation via the exchange rate. Price increases depend on what people think will happen in the economy. If they believe that the central bank will prevent severe, sustained inflation, then they will be less inclined to raise their own prices to ward off such consequences. The owner of a pizzeria in Almaty will shrug off the tenge devaluation, since he is not worried that his workers will demand a sudden pay raise in order to pay higher prices for nan and fermented mare’s milk. In turn, this reluctance to raise prices will help restrain inflation. The prophecy of low inflation happily fulfills itself.
A bit of evidence suggests that this prophecy may hold for Kazakhstan. Since 1994, soon after the tenge was introduced, the pass-through stemming from changes in its exchange rate have seemed modest, concludes a student in the economics graduate program at KIMEP, Meruyert Beisenbayeva. A 1% weakening of the tenge, with respect to either the ruble or the Chinese yuan, leads to an increase in consumer prices in Kazakhstan of a sixth of 1% or less. Perhaps the National Bank of Kazakhstan has convinced people that it won’t tolerate the episodes of rampant inflation that have ravaged other economies in Central Asia.
Perhaps. Another possibility is that producers in Kazakhstan are loathe to raise prices for fear of losing market share to importers. The Chinese, world champs in cutthroat pricing, are rapidly gaining ground in Kazakhstan. They sell us a seventh of our imports -- outstripped only by Russia, which accounts for just under a third of imports. Kazakhstani firms would be prudent to match Chinese pricing -– cutting prices when the Chinese do, and raising them only after the Chinese raise theirs.
Ms. Beisenbayeva finds evidence consistent with such strategizing. A 1% increase in Chinese consumer prices seems to induce a quick rise in ours of more than half of a percent. In contrast, the impact of Russian prices on ours is muted and quite possibly zero. Perhaps Russian exporters to Kazakhstan have become so familiar that our firms no longer worry about losing customers to them.
Ms. Beisenbayeva’s work raises several possibilities. First, the National Bank of Kazakhstan may already have done about all that it can to contain short-term inflation. Any future gains would have to come from an antitrust policy that keeps big Kazakhstani firms from charging the highest prices that the market will bear.
Long-run inflation, of course, remains the responsibility of the central bank. Prices can rise for years only if fueled by new money. The National Bank manages the tenge supply.
Second, adopting the ruble could endow Kazakhstan with unexpected inflation, since Russia’s central bank has trouble keeping the lid on the price level. Inflation rates in Russia double those of Kazakhstan’s (for Russia, 14% in 2008, 12% in 2009). If firms don’t trust the National Bank of Russia, then they may quickly counter ruble devaluations by raising their own prices before their suppliers can. The pass-through value will close in on that predicted by theory, 1. Economic theorists will chortle; Kazakhstani consumers and lenders won’t. – Leon Taylor, tayloralmaty@gmail.com
Full disclosure: I advised the thesis -- along with Aleksandr Vashchilko, Altay Mussurov, and Eldar Madumarov, all economics professors at KIMEP.
References
Beisenbayeva, Meruyert. 2010. The exchange rate pass-through to the CPI in Kazakhstan. Thesis for the master’s of arts in economics. Almaty, Kazakhstan: KIMEP, Department of Economics.
Organisation for Economic Co-Operation and Development. 2010. Source of data on Russian inflation. stats.oecd.org
Mishkin, Frederic S. 2008. Exchange rate pass-through and monetary policy. Speech to the Norges Bank Conference on Monetary Policy in Oslo, Norway. March 7. A readable survey.
National Bank of Kazakhstan. 2010. Source of data for consumer price inflation. www.nationalbank.kz
Taylor, John B. 2000. Low inflation, pass-through, and the pricing power of firms. Working paper. Stanford University. Influential.
Saturday, July 3, 2010
Arkonomics
Does economics endanger species?
To economists, “sustainability” means leaving no generation worse off than ours. This may conduce us to preserve unique species. Kazakhstanis think of the snow leopard, endangered partly by poaching for pelts and for bones prized in Chinese folk medicine.
Species preservation may be getting harder. The number of species becoming extinct each year may be 10 to 1,000 times higher than in past eons. In Kazakhstan, sturgeon are in dangerous decline, partly due to poaching. Catches in 2003 were but half of the quota, although the fishing season was a month longer than usual. Most sturgeon caught in scientific studies of the Caspian Sea are juveniles, so maybe the fish old enough to reproduce have dwindled dangerously. Of 835 vertebrates in Kazakhstan, the government lists 15% as endangered, including falcons, eagles and vultures.
It’s tempting to try to save all species. This goal is enshrined in the Endangered Species Act, probably the most extreme of United States environmental laws. “It is clear from the Act’s legislative history,” wrote the Supreme Court, “that Congress intended to halt and reverse the trend toward species extinction -– whatever the cost.” The federal government banned a firm from cutting timber on a site because a pair of northern spotted owls had appeared on public land 1.6 miles away.
In reality, not all species can be preserved. In the distant past, five episodes of mass extinction claimed up to 84 percent of the genera in existence. Which species should we try hardest to preserve? How?
"What is biodiversity? In what units is it to be measured?” write two economists, Andrew Metrick and Martin Weitzman. “…At the end of the day, all the brave talk about ‘win-win’ situations, which simultaneously produce sustainable development and conserve biodiversity, will not help us to sort out how many children’s hospitals should be sacrificed in the name of preserving natural habitats.”
Metrick and Weitzman seek a way to preserve biodiversity cheaply, so that we can build more hospitals with the saved money. Of course, we should spend another tenge on biodiversity, and another, as long as the benefit of doing so exceeds a tenge. But what is the benefit?
It’s information. A species is like a library, with genes for books. A library generates direct value, from the building itself; and indirect value, from the diversity of shelf books. As aesthetes, we might like diversity in novels (science fiction, stream-of-consciousness), just as in the colors of a painting. As pragmatists, we might like diversity in print for creating ideas about new medicines and foods.
Here’s our goal, as Metrick and Weitzman see it: Maximize the degree of diversity (plus direct value), given our limited budget. Noah’s special case was an ark in which to save species from an impending flood. The Book of Genesis saith the ark was just 450,000 cubed cubits large (77,000 cubic yards or 101,000 cubic meters). How should Noah choose species to save?
First, measure the direct and indirect value of each species, encompassing commercial, recreational and emotional values. Then rank each species by its expected increase in direct value per cubed cubit in the Ark.
To measure diversity, consider three cases for each species:
1. For each “library” (species), acquire books by sampling an infinite number of them. Each species is isolated, so gene pools don’t mix. Genes evolve on their own.
2. Create a library by photocopying all books of the main branch. Again, each book is isolated from others.
3. Close a library. If we lose a species, we will lose all of its genes.
What is a species’ contribution to “diversity,” its distinctiveness from other species? To find out, measure its distance from its “neighbor,” a species with similar genes (a library with books like ours). In terms of an evolutionary tree, measure the species’ addition to diversity by the length of its branch from the trunk. When a species becomes extinct, this length measures the loss of diversity, as if the branch had snapped off.
In short, the total value of a species sums its direct utility and its contribution to diversity.
Finally, Noah must determine how much his attempts to save a species will increase its chances for survival. Can a giraffe endure the stormy voyage?
Now, to rank every species, multiply the change in the probability of its survival by its total value. Divide these expected gains of boarding the species on the Ark by the boarding cost. This is the expected gain per dollar spent.
The costs of any preservation project include the value of foregone development. Recently, entrepreneurs spent $1 billion in western Ukraine to build a ski resort with 26 lifts and 75 miles of trails. One cost of converting the area to a natural preserve instead would be the foregone value of skiing.
Noah, master bureaucrat
Noah’s formula captures four factors that should affect conservation plans: Utility, diversity, increase in survivability, and the cost of that increase. Do governments actually weigh these factors? Metrick and Weitzman look at how the U.S government ranks species.
To characterize the public decision, they consider: The number of public comments favoring a proposal to save an endangered species; the government’s decision of whether to list the species as endangered (yes or no); and the amount spent by the government to recover the species.
Now consider the variables that, according to Noah, should influence the decision to preserve. To gauge direct utility, categorize each species as mammal, bird, reptile, amphibian or fish. Presumably, people prefer large mammals. To measure diversity, note whether the species is the sole representative of its genus; and, if not, whether it is actually a subspecies. Finally, to measure the species’ prospects for survival, use a ranking, from 1 to 5, of the degree of endangerment of each vertebrate species. The ranking comes from a private conservation group.
Metrick and Weitzman find that large mammals and birds are especially likely to be listed as endangered. (Amphibians need not apply.) The government spends more to save larger animals -– but less, curiously, to save the most endangered species. Evidently, Noah is not running the U.S. Fish and Wildlife Service. -– Leon Taylor, tayloralmaty@gmail.com.
References
Bo, Wen. Undated. Illegal trade in snow leopards in China: An overview. http://www.snowleopardnetwork.org/bibliography/bwit02.pdf .
Brown, Jr., Gardner M., and Jason F. Shogren. 1998. Economics of the Endangered Species Act. Journal of Economic Perspectives 12(3): pages 3-20 (summer). Reprinted in Robert N. Stavins, editor, Economics of the environment: Selected readings, New York: W.W. Norton, fifth edition, 2005, pages 514-532. The source of the Supreme Court quote.
Caveat Emptor. 2003. Letter to the U.S. Fish and Wildlife Service on whether to list the beluga sturgeon as endangered under the Endangered Species Act, September 2, Caviar Emptor project, http://www.caviaremptor.org/sep03_letter.html. Data on sturgeon catches.
Metrick, Andrew, and Martin L. Weitzman. 1998. Conflicts and choices in biodiversity preservation, Journal of Economic Perspectives, 12(3): pages 21-34, summer. Reprinted in Economics of the environment: Selected readings, fifth edition, pages 533-546.
Pohl, Otto. 2006. Ukraine sees bright future on ski slope. The New York Times, March 6.
United Nations Environment Programme. 2005. http://enrin.grida.no/htmls/kazahst/soe/soee/nav/biodiv/typediv.htm. Data on endangered species in Kazakhstan.
To economists, “sustainability” means leaving no generation worse off than ours. This may conduce us to preserve unique species. Kazakhstanis think of the snow leopard, endangered partly by poaching for pelts and for bones prized in Chinese folk medicine.
Species preservation may be getting harder. The number of species becoming extinct each year may be 10 to 1,000 times higher than in past eons. In Kazakhstan, sturgeon are in dangerous decline, partly due to poaching. Catches in 2003 were but half of the quota, although the fishing season was a month longer than usual. Most sturgeon caught in scientific studies of the Caspian Sea are juveniles, so maybe the fish old enough to reproduce have dwindled dangerously. Of 835 vertebrates in Kazakhstan, the government lists 15% as endangered, including falcons, eagles and vultures.
It’s tempting to try to save all species. This goal is enshrined in the Endangered Species Act, probably the most extreme of United States environmental laws. “It is clear from the Act’s legislative history,” wrote the Supreme Court, “that Congress intended to halt and reverse the trend toward species extinction -– whatever the cost.” The federal government banned a firm from cutting timber on a site because a pair of northern spotted owls had appeared on public land 1.6 miles away.
In reality, not all species can be preserved. In the distant past, five episodes of mass extinction claimed up to 84 percent of the genera in existence. Which species should we try hardest to preserve? How?
"What is biodiversity? In what units is it to be measured?” write two economists, Andrew Metrick and Martin Weitzman. “…At the end of the day, all the brave talk about ‘win-win’ situations, which simultaneously produce sustainable development and conserve biodiversity, will not help us to sort out how many children’s hospitals should be sacrificed in the name of preserving natural habitats.”
Metrick and Weitzman seek a way to preserve biodiversity cheaply, so that we can build more hospitals with the saved money. Of course, we should spend another tenge on biodiversity, and another, as long as the benefit of doing so exceeds a tenge. But what is the benefit?
It’s information. A species is like a library, with genes for books. A library generates direct value, from the building itself; and indirect value, from the diversity of shelf books. As aesthetes, we might like diversity in novels (science fiction, stream-of-consciousness), just as in the colors of a painting. As pragmatists, we might like diversity in print for creating ideas about new medicines and foods.
Here’s our goal, as Metrick and Weitzman see it: Maximize the degree of diversity (plus direct value), given our limited budget. Noah’s special case was an ark in which to save species from an impending flood. The Book of Genesis saith the ark was just 450,000 cubed cubits large (77,000 cubic yards or 101,000 cubic meters). How should Noah choose species to save?
First, measure the direct and indirect value of each species, encompassing commercial, recreational and emotional values. Then rank each species by its expected increase in direct value per cubed cubit in the Ark.
To measure diversity, consider three cases for each species:
1. For each “library” (species), acquire books by sampling an infinite number of them. Each species is isolated, so gene pools don’t mix. Genes evolve on their own.
2. Create a library by photocopying all books of the main branch. Again, each book is isolated from others.
3. Close a library. If we lose a species, we will lose all of its genes.
What is a species’ contribution to “diversity,” its distinctiveness from other species? To find out, measure its distance from its “neighbor,” a species with similar genes (a library with books like ours). In terms of an evolutionary tree, measure the species’ addition to diversity by the length of its branch from the trunk. When a species becomes extinct, this length measures the loss of diversity, as if the branch had snapped off.
In short, the total value of a species sums its direct utility and its contribution to diversity.
Finally, Noah must determine how much his attempts to save a species will increase its chances for survival. Can a giraffe endure the stormy voyage?
Now, to rank every species, multiply the change in the probability of its survival by its total value. Divide these expected gains of boarding the species on the Ark by the boarding cost. This is the expected gain per dollar spent.
The costs of any preservation project include the value of foregone development. Recently, entrepreneurs spent $1 billion in western Ukraine to build a ski resort with 26 lifts and 75 miles of trails. One cost of converting the area to a natural preserve instead would be the foregone value of skiing.
Noah, master bureaucrat
Noah’s formula captures four factors that should affect conservation plans: Utility, diversity, increase in survivability, and the cost of that increase. Do governments actually weigh these factors? Metrick and Weitzman look at how the U.S government ranks species.
To characterize the public decision, they consider: The number of public comments favoring a proposal to save an endangered species; the government’s decision of whether to list the species as endangered (yes or no); and the amount spent by the government to recover the species.
Now consider the variables that, according to Noah, should influence the decision to preserve. To gauge direct utility, categorize each species as mammal, bird, reptile, amphibian or fish. Presumably, people prefer large mammals. To measure diversity, note whether the species is the sole representative of its genus; and, if not, whether it is actually a subspecies. Finally, to measure the species’ prospects for survival, use a ranking, from 1 to 5, of the degree of endangerment of each vertebrate species. The ranking comes from a private conservation group.
Metrick and Weitzman find that large mammals and birds are especially likely to be listed as endangered. (Amphibians need not apply.) The government spends more to save larger animals -– but less, curiously, to save the most endangered species. Evidently, Noah is not running the U.S. Fish and Wildlife Service. -– Leon Taylor, tayloralmaty@gmail.com.
References
Bo, Wen. Undated. Illegal trade in snow leopards in China: An overview. http://www.snowleopardnetwork.org/bibliography/bwit02.pdf .
Brown, Jr., Gardner M., and Jason F. Shogren. 1998. Economics of the Endangered Species Act. Journal of Economic Perspectives 12(3): pages 3-20 (summer). Reprinted in Robert N. Stavins, editor, Economics of the environment: Selected readings, New York: W.W. Norton, fifth edition, 2005, pages 514-532. The source of the Supreme Court quote.
Caveat Emptor. 2003. Letter to the U.S. Fish and Wildlife Service on whether to list the beluga sturgeon as endangered under the Endangered Species Act, September 2, Caviar Emptor project, http://www.caviaremptor.org/sep03_letter.html. Data on sturgeon catches.
Metrick, Andrew, and Martin L. Weitzman. 1998. Conflicts and choices in biodiversity preservation, Journal of Economic Perspectives, 12(3): pages 21-34, summer. Reprinted in Economics of the environment: Selected readings, fifth edition, pages 533-546.
Pohl, Otto. 2006. Ukraine sees bright future on ski slope. The New York Times, March 6.
United Nations Environment Programme. 2005. http://enrin.grida.no/htmls/kazahst/soe/soee/nav/biodiv/typediv.htm. Data on endangered species in Kazakhstan.
Monday, June 21, 2010
Kazakhstan's economy: Twists and turns in the road ahead
Will it rain on our parade?
Kazakhstan’s economy has two vital determinants: The global price of oil, and financial activity. The government’s recent forecast of 7% growth in real GDP this year seems based on the expectation that oil prices, which have risen about three-fourths from trough-to-peak since early 2009, will always keep the economy afloat.
As a long-run expectation, this may seem reasonable: Oil prices have risen 600% since the late 1990s. But a short-run forecast – say, for six to nine months – must allow for price volatility. Rising oil prices fueled 7% growth in GDP for the first quarter of 2010, compared to the same period in 2009; but oil prices often fall as rapidly as they rise. In 2009, daily futures for light crude oil on the New York markets varied from $50 to $80 per barrel; and even in 2010, a relatively sedate year, they have ranged from $70 to $85. In addition, buyers will eventually substitute cheaper fuels or conservation for expensive oil.
Finally, the government’s forecast is weakened by the fact that it may be based on only one or two months of good performance (March and possibly April).
Astana’s forecasts have ignored the ill health of the financial industry. This month, the World Bank and the International Monetary Fund warned that bad loans were still rising as a share of all loans in Kazakhstan – to one fourth as of May. After visiting Kazakhstan, the IMF staff said the economy should recover “but remains constrained by banking sector difficulties…. Credit expansion is subdued despite ample bank liquidity, and activity in key sectors, such as construction and real estate, remains sluggish.” With “large international reserves and low debt,” the government can spend more to revive the economy, if need be. (In fact, the government has stepped up spending on school construction.) But it should try to strengthen the economy for the years to come, by regulating the finance industry and by avoiding recurrent public expenses such as pay hikes for bureaucrats. Overall, the IMF forecasts 4% growth this year. If all goes well, then the economy may grow 6% annually over the next five years.
The willingness of a family to finance a four- or five-year investment, like a college education, depends partly on its expectations of economic growth, since this determines much of a family’s income. One way to gauge these expectations is to look at leading and lagging indicators of economic activity. Not only are they inputs into expectations; some of them – such as real investment -- are based on expectations themselves.
For leading indicators, let’s look at real investment; for lagging indicators, wages and employment.
Leading indicators
Real investment. Investment in durable goods – especially fixed capital such as office buildings and heavy equipment – discloses primarily the expectations of companies for the national economy for the next few years. In a transition economy like Kazakhstan, few firms have built up enough in retained earnings to see through an investment that will pay off only after many years. They will invest only if they believe that the economy will grow rapidly enough to enable them to recoup investment costs in a few years.
By this indicator, companies in Kazakhstan in 2009 did not seem to expect a strong economic recovery in 2010 or 2011. Adjusting for inflation, total investment in fixed capital for January through August 2009 was down 5% from the same period for 2008. The picture is no brighter for 2010: Nominal fixed investment in the first three months of the year was 622 billion tenge ($4.1 billion), 2.7% below the same period of 2009 and only .3% above the same period for 2008. Adjusting for inflation, which the government estimates (optimistically) at 7% a year, fixed investment was nearly a tenth below that of the same quarter in 2009, although this period had been weakened by recession.
As in 2009, this stagnation is mainly due to pessimism in the city of Almaty, where fixed investment is a seventh below that for the same period of 2009. At least half of fixed investment in the first quarter of 2010 was in the Caspian region, especially in Atyrau, due to rising oil prices. These are continuing trends; for January through September 2009, fixed investment in the city of Almaty was a third below that of the same period of 2008.
Construction. As in 2009, pessimism pervades construction as much as it does fixed-capital investment in general. In nominal terms, home construction in the first quarter of 2010 was only two fifths of 2008. Construction in early 2008 may still have reflected the housing bubble; but even when compared to the first quarter of 2009, when the bubble had disappeared, nominal construction was down by a tenth. The value of home construction in Almaty in the first quarter of 2010 was down 40% from the same period of 2009. Contracted construction work in Almaty was down by nearly half.
Home construction in 2009 had all but collapsed. For January through August, the value of such building was only half of that in the same period for 2008. Data for the first quarter of 2010 indicate no recovery from the collapse. In 2009, decline disproportionately affected Astana, as well as the city and oblast of Almaty, because these areas accounted for three-fourths of home construction in Kazakhstan. Adjusted for inflation, home construction in Astana fell by three fourths; in the city of Almaty, by half.
In physical terms, the discouraging trends in construction of 2009 seem to continue, judging from the performance in the first quarter. In square meters, residential starts in Kazakhstan were down 6% as compared to the first quarter of 2009. The city of Almaty suffered a 15% fall. In terms of apartments, starts in Kazakhstan were holding steady at 12,000 for the first quarter of 2010; but the city of Almaty saw a fall of nearly a fifth from the first quarter of 2009, when the city had performed much better than in 2008. Perhaps apartments had been oversupplied in 2009. In early 2010, the hot spots in the nation for residential starts were Akmola and Pavlodar.
Adjusting for inflation, construction in Kazakhstan for January through August of 2009 was down by a fifth from the same period of 2008. In the three areas that accounted for almost half of all construction – the oblast of Atyrau and the cities of Astana and Almaty – building was down significantly. In Astana, it had decreased by almost half. The hot spots in 2009 for fixed capital, and for construction in particular, were Zhambyl and South Kazakhstan. These accounted for only minor shares of the nation’s stock of fixed capital.
Lagging indicators
Wages. These indicators usually lag the business cycle, since they are often fixed by contract.
Average real wages in Kazakhstan for the first quarter of 2010 were only 1.1% higher than in the same period for 2009, suggesting a glacial recovery. Some industries important to Almaty saw real wages decline: Finance and insurance, down 1.5%; hotel and food services, down 6.2%; education, down 3.1%. Despite the housing crash, wages rose 6.4% in real estate and 7.4% in construction. But in general, workers may have perceived too much excess capacity in the economy to permit them to demand substantial pay raises.
Employment. The employment rate, generally a lagging indicator of recovery, responds more quickly than the wage rate. The unemployment rate in Kazakhstan is seasonal, generally peaking in the first quarter of each year, probably due to weather. Since 2003, it has fallen steadily. The decline continued in the first quarter of 2010, relative to the same period of 2009. The fall in the unemployment rate for youths was twice as steep as that for workers in general. These trends are due to new jobs, not to the withdrawal of discouraged job-seekers. In fact, the number of inactive workers might have fallen slightly in the first quarter of 2010.
The bottom line -- and the silver lining
Kazakhstan is recovering slowly from the global recession that reduced oil demand and deflated real estate values. Its long-term prospects remain strong: Exports rose 70% in the first four months of 2010, relative to the same period in 2009, mainly on the strength of rising oil prices. But this income accrues mainly to the Caspian region. Almaty will benefit mainly from the secondary spending, which generally lags primary spending by a year or so. The silver lining in this thundercloud is that 2011 should be a strong year for Almaty. – Leon Taylor, tayloralmaty@gmail.com
All Kazakhstani data are from the Statistical Agency of Kazakhstan unless otherwise attributed.
Revised on June 22, 2010
Kazakhstan’s economy has two vital determinants: The global price of oil, and financial activity. The government’s recent forecast of 7% growth in real GDP this year seems based on the expectation that oil prices, which have risen about three-fourths from trough-to-peak since early 2009, will always keep the economy afloat.
As a long-run expectation, this may seem reasonable: Oil prices have risen 600% since the late 1990s. But a short-run forecast – say, for six to nine months – must allow for price volatility. Rising oil prices fueled 7% growth in GDP for the first quarter of 2010, compared to the same period in 2009; but oil prices often fall as rapidly as they rise. In 2009, daily futures for light crude oil on the New York markets varied from $50 to $80 per barrel; and even in 2010, a relatively sedate year, they have ranged from $70 to $85. In addition, buyers will eventually substitute cheaper fuels or conservation for expensive oil.
Finally, the government’s forecast is weakened by the fact that it may be based on only one or two months of good performance (March and possibly April).
Astana’s forecasts have ignored the ill health of the financial industry. This month, the World Bank and the International Monetary Fund warned that bad loans were still rising as a share of all loans in Kazakhstan – to one fourth as of May. After visiting Kazakhstan, the IMF staff said the economy should recover “but remains constrained by banking sector difficulties…. Credit expansion is subdued despite ample bank liquidity, and activity in key sectors, such as construction and real estate, remains sluggish.” With “large international reserves and low debt,” the government can spend more to revive the economy, if need be. (In fact, the government has stepped up spending on school construction.) But it should try to strengthen the economy for the years to come, by regulating the finance industry and by avoiding recurrent public expenses such as pay hikes for bureaucrats. Overall, the IMF forecasts 4% growth this year. If all goes well, then the economy may grow 6% annually over the next five years.
The willingness of a family to finance a four- or five-year investment, like a college education, depends partly on its expectations of economic growth, since this determines much of a family’s income. One way to gauge these expectations is to look at leading and lagging indicators of economic activity. Not only are they inputs into expectations; some of them – such as real investment -- are based on expectations themselves.
For leading indicators, let’s look at real investment; for lagging indicators, wages and employment.
Leading indicators
Real investment. Investment in durable goods – especially fixed capital such as office buildings and heavy equipment – discloses primarily the expectations of companies for the national economy for the next few years. In a transition economy like Kazakhstan, few firms have built up enough in retained earnings to see through an investment that will pay off only after many years. They will invest only if they believe that the economy will grow rapidly enough to enable them to recoup investment costs in a few years.
By this indicator, companies in Kazakhstan in 2009 did not seem to expect a strong economic recovery in 2010 or 2011. Adjusting for inflation, total investment in fixed capital for January through August 2009 was down 5% from the same period for 2008. The picture is no brighter for 2010: Nominal fixed investment in the first three months of the year was 622 billion tenge ($4.1 billion), 2.7% below the same period of 2009 and only .3% above the same period for 2008. Adjusting for inflation, which the government estimates (optimistically) at 7% a year, fixed investment was nearly a tenth below that of the same quarter in 2009, although this period had been weakened by recession.
As in 2009, this stagnation is mainly due to pessimism in the city of Almaty, where fixed investment is a seventh below that for the same period of 2009. At least half of fixed investment in the first quarter of 2010 was in the Caspian region, especially in Atyrau, due to rising oil prices. These are continuing trends; for January through September 2009, fixed investment in the city of Almaty was a third below that of the same period of 2008.
Construction. As in 2009, pessimism pervades construction as much as it does fixed-capital investment in general. In nominal terms, home construction in the first quarter of 2010 was only two fifths of 2008. Construction in early 2008 may still have reflected the housing bubble; but even when compared to the first quarter of 2009, when the bubble had disappeared, nominal construction was down by a tenth. The value of home construction in Almaty in the first quarter of 2010 was down 40% from the same period of 2009. Contracted construction work in Almaty was down by nearly half.
Home construction in 2009 had all but collapsed. For January through August, the value of such building was only half of that in the same period for 2008. Data for the first quarter of 2010 indicate no recovery from the collapse. In 2009, decline disproportionately affected Astana, as well as the city and oblast of Almaty, because these areas accounted for three-fourths of home construction in Kazakhstan. Adjusted for inflation, home construction in Astana fell by three fourths; in the city of Almaty, by half.
In physical terms, the discouraging trends in construction of 2009 seem to continue, judging from the performance in the first quarter. In square meters, residential starts in Kazakhstan were down 6% as compared to the first quarter of 2009. The city of Almaty suffered a 15% fall. In terms of apartments, starts in Kazakhstan were holding steady at 12,000 for the first quarter of 2010; but the city of Almaty saw a fall of nearly a fifth from the first quarter of 2009, when the city had performed much better than in 2008. Perhaps apartments had been oversupplied in 2009. In early 2010, the hot spots in the nation for residential starts were Akmola and Pavlodar.
Adjusting for inflation, construction in Kazakhstan for January through August of 2009 was down by a fifth from the same period of 2008. In the three areas that accounted for almost half of all construction – the oblast of Atyrau and the cities of Astana and Almaty – building was down significantly. In Astana, it had decreased by almost half. The hot spots in 2009 for fixed capital, and for construction in particular, were Zhambyl and South Kazakhstan. These accounted for only minor shares of the nation’s stock of fixed capital.
Lagging indicators
Wages. These indicators usually lag the business cycle, since they are often fixed by contract.
Average real wages in Kazakhstan for the first quarter of 2010 were only 1.1% higher than in the same period for 2009, suggesting a glacial recovery. Some industries important to Almaty saw real wages decline: Finance and insurance, down 1.5%; hotel and food services, down 6.2%; education, down 3.1%. Despite the housing crash, wages rose 6.4% in real estate and 7.4% in construction. But in general, workers may have perceived too much excess capacity in the economy to permit them to demand substantial pay raises.
Employment. The employment rate, generally a lagging indicator of recovery, responds more quickly than the wage rate. The unemployment rate in Kazakhstan is seasonal, generally peaking in the first quarter of each year, probably due to weather. Since 2003, it has fallen steadily. The decline continued in the first quarter of 2010, relative to the same period of 2009. The fall in the unemployment rate for youths was twice as steep as that for workers in general. These trends are due to new jobs, not to the withdrawal of discouraged job-seekers. In fact, the number of inactive workers might have fallen slightly in the first quarter of 2010.
The bottom line -- and the silver lining
Kazakhstan is recovering slowly from the global recession that reduced oil demand and deflated real estate values. Its long-term prospects remain strong: Exports rose 70% in the first four months of 2010, relative to the same period in 2009, mainly on the strength of rising oil prices. But this income accrues mainly to the Caspian region. Almaty will benefit mainly from the secondary spending, which generally lags primary spending by a year or so. The silver lining in this thundercloud is that 2011 should be a strong year for Almaty. – Leon Taylor, tayloralmaty@gmail.com
All Kazakhstani data are from the Statistical Agency of Kazakhstan unless otherwise attributed.
Revised on June 22, 2010
Tuesday, June 15, 2010
Tempting targets
Should Tajikistan fix its exchange rate or its volume of currency? Zafar Davronov points out the pitfalls
You know the apocryphal Chinese curse: May you live in interesting times. Last week adumbrated an interesting trend in the exchange rate of the tenge for the dollar: After strengthening for most of the year, in line with rising oil prices, the tenge has been falling steadily this month, roughly from 146.7 tenge per dollar to 147.3T. The most evident reason is that the International Monetary Fund (IMF) released a forecast of Kazakhstan’s economy that was less giddy than the government’s. Astana projects 7% real growth in gross domestic product (GDP) this year; the IMF, 4%. The tenge fell most steeply after June 8, when the IMF report appeared. For most of 2010, the central bank of Kazakhstan has let foreign exchange markets set the value of the tenge, but it must have been tempted to check its fall toward 148T per dollar.
This is one episode in a larger drama: When, if ever, should the central bank fix the exchange rate in a transition economy? This February, the National Bank of Kazakhstan put the exchange rate for the tenge in a corridor from 127.5T to 165T, or 15% and 10% variations respectively from the target of 150T. You could drive a freight train down a corridor that wide. Why doesn’t the Bank save itself all this trouble and just announce that it will let the market determine the exchange rate? With a 25% leeway, that's effectively what it's doing.
As it happens, another central bank in the region has wrestled with this question. Tajikistan, saddled with one of the weakest economies in a weakened global economy, embarked last year on a radical experiment: Flexible exchange rates amid the turmoil of global finance. The plight of the National Bank of Tajikistan may shed light on that of Kazakhstan’s.
Tajikistan consigned its somoni to foreign exchange markets when collapsing national income, and devaluations by major trading partners, made it hard for the central bank to defend its currency. In 2009, the somoni lost a fourth of its value relative to the United States dollar. Half of that loss occurred in May, when it fell to 3.79 somoni to the dollar. It weakened sharply again in May 2010, to 4.57 somoni. Since then, it has held steadily at 4.38 somoni.
When the world economy catches a cold, Tajikistan gets double pneumonia. Repatriated earnings by its emigrant workers, which normally account for half of national income, shrank by nearly a third in 2009 as Tajikistanis in Russia lost their jobs in the regional recession. The relative demand for legal exports from this small once-open economy has been shriveling for years. The GDP share of merchandise exports fell from virtually 100% in 2000 to less than 20% in 2008, according to the World Bank. Despite this trend, national income had grown steadily since 2000, with an average annual gain of about 2.5 billion current international dollars, due partly to migrant earnings in a regional boom. Suddenly, in 2009, Tajikistanis had to tighten their belts. Their rate of income growth halved, according to the National Bank.
The loss of funds put Tajikistani banks in double jeopardy: Households and firms withdrew their money from the banks just as foreign creditors to the banks were demanding payment. Like banks in Kazakhstan, those in Tajikistan had relied heavily on foreign currencies. In 2007, these comprised four fifths of the banks’ deposits and two thirds of their loans.
The central bank’s sudden return to a flexible exchange rate added to bankers’ woes. In a free currency-market, the somoni was heading into a free fall. This would eviscerate the dollar value of bank assets expressed in somoni. And unhedged domestic borrowers of dollars and euros would have trouble repaying bank loans, since their wealth was in somoni, too. Bank defaults would become more likely. Since commercial banks were the key creditors in Tajikistan, firms would shelve expansion plans. Without this spending, the recession would deepen.
Collateral damage
In using the exchange rate as a policy tool, the central bank faces a trade-off. Both fixed and flexible exchange rates are risky. Which is the least risky?
To answer such questions, an American economist, Martin Weitzman at Harvard University developed a general analysis that tries to minimize the damages that uncertainty can wreak. An example from the news may help convey his approach.
To generate electricity, most power plants burn oil or coal, emitting residual carbon to the atmosphere. The accumulating carbon seals in terrestrial heat, threatening to create severe weather. To avert this threat, nations seek ways to reduce carbon emissions. One proposal is to compel any polluter to pay a tax per carbon ton emitted. The other proposal would compel him to buy a permit for each carbon ton emitted.
The two proposals may strike you as essentially the same, but they differ in the uncertainty that attaches to each. The carbon tax limits the environmental costs that a polluter would have to incur. But it doesn’t limit the volume of carbon emissions, since in principle the polluter can emit all that he wants, as long as he pays the tax. On the other hand, the scheme of carbon permits limits the volume of carbon emissions, since governments could agree to print no more than, say, 100 million permits. But the permit policy doesn’t limit the costs that a polluter would have to incur. If he must have a permit in order to operate, then he will be willing to pay any amount for it, up to his total expected profits.
In short, targeting the “price” of the right to pollute (that’s the tax) limits compliance costs. But it doesn’t mandate a given amount of compliance, so we may not get as much cooperation as we had expected. Targeting instead the volume of pollution (that’s the permit scheme) limits environmental damages. But it doesn’t limit how much that firms would have to pay for the right to wreak these damages, so we may find that containing global warming will cost us more jobs than we had expected.
Your choice between the permit and the tax will depend on what you worry most about – unexpectedly high environmental damages or unexpectedly high compliance costs. Since people seem to worry most about the former – melting ice caps, a flooded London, an Amsterdam in shambles – the permit scheme has won the most political support.
Now let’s return to our conversation about money. The same choice – between a price target and a volume target – faces the central bank of Tajikistan as faced environmental policymakers. In principle, the market for somoni determines the price of the currency (i.e., the exchange rate) as well as its quantity (the number of somoni in the world). If the central bank fixes either the price or the quantity of the somoni, then it must leave free the other variable for the market to determine, or no market can exist. (Yes, the bank can try to fix both price and supply. But it cannot predict changes in demand and supply perfectly, so its adjustments will sometimes err. In other words, the bank must live with some sort of market for somoni, whether it wants to or not. It can’t control speculators around the world.) Which variable should the bank fix? That depends on the type of uncertainty that worries it the most – uncertainty in the demand for somoni, or in their supply, suggest Chang and Velasco.
Suppose, for example, that the central bank worries mostly that the demand for somoni will collapse, perhaps because of a world depression. Then the bank may prefer to fix the exchange rate. Fixing the supply of somoni instead may prove to be a costly error, since the exchange rate may have to fall drastically in order to clear the market after an unexpectedly severe decline in demand.
On the other hand, suppose that the central bank is more vexed by the prospect that the commercial banks will call in loans of somoni, reducing their supply in circulation. Then the central bank may prefer to fix the supply of currency, perhaps by creating somoni to replace those that the private banks retire from circulation. The exchange rate would be left free to change until it clears the market. If the bank fixes this rate rather than supply, then it may have to live with disquieting changes in supply, thanks to arbitrage, until the market’s rate of exchange equaled the bank’s.
What now?
What should the central bank of Tajikistan worry about? A small economy that relies heavily on world trade, like Tajikistan’s, would benefit the most from a fixed exchange rate, since it may be buffeted by large and hard-to-predict changes in global demand for its exports, noted Kettell. The lack of diversity in Tajikistan’s exports strengthens the case for fixing the exchange rate, since this sameness magnifies potential changes in the demand for somoni. With respect to legal goods and materials, Tajikistan exports mainly cotton and aluminum, the export revenues of which have declined by 60 to 70 percent since last year. The undeveloped, inflexible nature of Tajikistan’s financial sector also intensifies the potential impact of changes in somoni demand, since few local opportunities for hedges exist. In sum, the central bank should not fix the supply of somoni, because it can’t be sure that people will want them.
Nevertheless, the central bank in 2009 adopted a flexible exchange rate. Why? Because it was running out of dollars with which to defend the somoni. The central bank would have needed to spend $234 million per month to defend the somoni’s high old rate of exchange, said the bank chairman, Sharif Rahimzoda. The country's total reserve of foreign currency was only $198 million in January 2009; it had almost halved in one year. At that rate, defending the somoni for little more than three weeks would have wiped out the entire reserve.
Also, two major trading partners of Tajikistan -- Russia and Kazakhstan -- had already devalued their currencies. Since this increased the relative cost of Tajikistani products, the National Bank was pressured to devalue as well.
In a sense, Tajikistan had to balance economic stability and autonomy. A fixed exchange rate – say, in terms of the U.S. dollar – would have turned over Tajikistan’s monetary policy to the Federal Reserve. That might have satisfied international investors, if not Tajikistanis. Given Tajikistan’s dire straits, a flexible exchange rate was more of an economic gamble. At some point, Tajikistan might have had to appeal to the International Monetary Fund for another stopgap loan; the IMF approved $116 million in April 2009. In exchange, the IMF might require the government to do more to balance its books – and the central bank to be more accurate in its reports.
Thanks to oil, Kazakhstan is not in the same predicament as Tajikistan, but it faces the same dilemma. How much autonomy is the government prepared to give up in order to placate international creditors? Interesting times, indeed. – Zafar Davronov and Leon Taylor
Zafar Davronov is a student in KIMEP’s MBA program. His interests include Central Asian economics and finance.
References
William J. Baumol and Wallace E. Oates. 1988. The theory of environmental policy. Second edition. Cambridge University Press. Applies Weitzman's principle to pollution taxes and permits.
Francesco Caramazza and Jahangir Aziz. 1998. Fixed or flexible? Getting the exchange rate right in the 1990s. International Monetary Fund Economic Issues, number 13.
Roberto Chang and Andres Velasco. 2000. Exchange-rate policy for developing countries. The American Economic Review 90: 2, pages 71-75.
International Monetary Fund. 2008. Republic of Tajikistan: Financial system stability assessment.
Brian Kettell. 2000. What drives currency markets: The signals you need to stay ahead of the game. Financial Times/Prentice Hall.
Martin Weitzman. 1974. Prices vs. quantities. Review of Economic Studies 41:4, October, pages 477-491.
Revised on September 23, 2010.
You know the apocryphal Chinese curse: May you live in interesting times. Last week adumbrated an interesting trend in the exchange rate of the tenge for the dollar: After strengthening for most of the year, in line with rising oil prices, the tenge has been falling steadily this month, roughly from 146.7 tenge per dollar to 147.3T. The most evident reason is that the International Monetary Fund (IMF) released a forecast of Kazakhstan’s economy that was less giddy than the government’s. Astana projects 7% real growth in gross domestic product (GDP) this year; the IMF, 4%. The tenge fell most steeply after June 8, when the IMF report appeared. For most of 2010, the central bank of Kazakhstan has let foreign exchange markets set the value of the tenge, but it must have been tempted to check its fall toward 148T per dollar.
This is one episode in a larger drama: When, if ever, should the central bank fix the exchange rate in a transition economy? This February, the National Bank of Kazakhstan put the exchange rate for the tenge in a corridor from 127.5T to 165T, or 15% and 10% variations respectively from the target of 150T. You could drive a freight train down a corridor that wide. Why doesn’t the Bank save itself all this trouble and just announce that it will let the market determine the exchange rate? With a 25% leeway, that's effectively what it's doing.
As it happens, another central bank in the region has wrestled with this question. Tajikistan, saddled with one of the weakest economies in a weakened global economy, embarked last year on a radical experiment: Flexible exchange rates amid the turmoil of global finance. The plight of the National Bank of Tajikistan may shed light on that of Kazakhstan’s.
Tajikistan consigned its somoni to foreign exchange markets when collapsing national income, and devaluations by major trading partners, made it hard for the central bank to defend its currency. In 2009, the somoni lost a fourth of its value relative to the United States dollar. Half of that loss occurred in May, when it fell to 3.79 somoni to the dollar. It weakened sharply again in May 2010, to 4.57 somoni. Since then, it has held steadily at 4.38 somoni.
When the world economy catches a cold, Tajikistan gets double pneumonia. Repatriated earnings by its emigrant workers, which normally account for half of national income, shrank by nearly a third in 2009 as Tajikistanis in Russia lost their jobs in the regional recession. The relative demand for legal exports from this small once-open economy has been shriveling for years. The GDP share of merchandise exports fell from virtually 100% in 2000 to less than 20% in 2008, according to the World Bank. Despite this trend, national income had grown steadily since 2000, with an average annual gain of about 2.5 billion current international dollars, due partly to migrant earnings in a regional boom. Suddenly, in 2009, Tajikistanis had to tighten their belts. Their rate of income growth halved, according to the National Bank.
The loss of funds put Tajikistani banks in double jeopardy: Households and firms withdrew their money from the banks just as foreign creditors to the banks were demanding payment. Like banks in Kazakhstan, those in Tajikistan had relied heavily on foreign currencies. In 2007, these comprised four fifths of the banks’ deposits and two thirds of their loans.
The central bank’s sudden return to a flexible exchange rate added to bankers’ woes. In a free currency-market, the somoni was heading into a free fall. This would eviscerate the dollar value of bank assets expressed in somoni. And unhedged domestic borrowers of dollars and euros would have trouble repaying bank loans, since their wealth was in somoni, too. Bank defaults would become more likely. Since commercial banks were the key creditors in Tajikistan, firms would shelve expansion plans. Without this spending, the recession would deepen.
Collateral damage
In using the exchange rate as a policy tool, the central bank faces a trade-off. Both fixed and flexible exchange rates are risky. Which is the least risky?
To answer such questions, an American economist, Martin Weitzman at Harvard University developed a general analysis that tries to minimize the damages that uncertainty can wreak. An example from the news may help convey his approach.
To generate electricity, most power plants burn oil or coal, emitting residual carbon to the atmosphere. The accumulating carbon seals in terrestrial heat, threatening to create severe weather. To avert this threat, nations seek ways to reduce carbon emissions. One proposal is to compel any polluter to pay a tax per carbon ton emitted. The other proposal would compel him to buy a permit for each carbon ton emitted.
The two proposals may strike you as essentially the same, but they differ in the uncertainty that attaches to each. The carbon tax limits the environmental costs that a polluter would have to incur. But it doesn’t limit the volume of carbon emissions, since in principle the polluter can emit all that he wants, as long as he pays the tax. On the other hand, the scheme of carbon permits limits the volume of carbon emissions, since governments could agree to print no more than, say, 100 million permits. But the permit policy doesn’t limit the costs that a polluter would have to incur. If he must have a permit in order to operate, then he will be willing to pay any amount for it, up to his total expected profits.
In short, targeting the “price” of the right to pollute (that’s the tax) limits compliance costs. But it doesn’t mandate a given amount of compliance, so we may not get as much cooperation as we had expected. Targeting instead the volume of pollution (that’s the permit scheme) limits environmental damages. But it doesn’t limit how much that firms would have to pay for the right to wreak these damages, so we may find that containing global warming will cost us more jobs than we had expected.
Your choice between the permit and the tax will depend on what you worry most about – unexpectedly high environmental damages or unexpectedly high compliance costs. Since people seem to worry most about the former – melting ice caps, a flooded London, an Amsterdam in shambles – the permit scheme has won the most political support.
Now let’s return to our conversation about money. The same choice – between a price target and a volume target – faces the central bank of Tajikistan as faced environmental policymakers. In principle, the market for somoni determines the price of the currency (i.e., the exchange rate) as well as its quantity (the number of somoni in the world). If the central bank fixes either the price or the quantity of the somoni, then it must leave free the other variable for the market to determine, or no market can exist. (Yes, the bank can try to fix both price and supply. But it cannot predict changes in demand and supply perfectly, so its adjustments will sometimes err. In other words, the bank must live with some sort of market for somoni, whether it wants to or not. It can’t control speculators around the world.) Which variable should the bank fix? That depends on the type of uncertainty that worries it the most – uncertainty in the demand for somoni, or in their supply, suggest Chang and Velasco.
Suppose, for example, that the central bank worries mostly that the demand for somoni will collapse, perhaps because of a world depression. Then the bank may prefer to fix the exchange rate. Fixing the supply of somoni instead may prove to be a costly error, since the exchange rate may have to fall drastically in order to clear the market after an unexpectedly severe decline in demand.
On the other hand, suppose that the central bank is more vexed by the prospect that the commercial banks will call in loans of somoni, reducing their supply in circulation. Then the central bank may prefer to fix the supply of currency, perhaps by creating somoni to replace those that the private banks retire from circulation. The exchange rate would be left free to change until it clears the market. If the bank fixes this rate rather than supply, then it may have to live with disquieting changes in supply, thanks to arbitrage, until the market’s rate of exchange equaled the bank’s.
What now?
What should the central bank of Tajikistan worry about? A small economy that relies heavily on world trade, like Tajikistan’s, would benefit the most from a fixed exchange rate, since it may be buffeted by large and hard-to-predict changes in global demand for its exports, noted Kettell. The lack of diversity in Tajikistan’s exports strengthens the case for fixing the exchange rate, since this sameness magnifies potential changes in the demand for somoni. With respect to legal goods and materials, Tajikistan exports mainly cotton and aluminum, the export revenues of which have declined by 60 to 70 percent since last year. The undeveloped, inflexible nature of Tajikistan’s financial sector also intensifies the potential impact of changes in somoni demand, since few local opportunities for hedges exist. In sum, the central bank should not fix the supply of somoni, because it can’t be sure that people will want them.
Nevertheless, the central bank in 2009 adopted a flexible exchange rate. Why? Because it was running out of dollars with which to defend the somoni. The central bank would have needed to spend $234 million per month to defend the somoni’s high old rate of exchange, said the bank chairman, Sharif Rahimzoda. The country's total reserve of foreign currency was only $198 million in January 2009; it had almost halved in one year. At that rate, defending the somoni for little more than three weeks would have wiped out the entire reserve.
Also, two major trading partners of Tajikistan -- Russia and Kazakhstan -- had already devalued their currencies. Since this increased the relative cost of Tajikistani products, the National Bank was pressured to devalue as well.
In a sense, Tajikistan had to balance economic stability and autonomy. A fixed exchange rate – say, in terms of the U.S. dollar – would have turned over Tajikistan’s monetary policy to the Federal Reserve. That might have satisfied international investors, if not Tajikistanis. Given Tajikistan’s dire straits, a flexible exchange rate was more of an economic gamble. At some point, Tajikistan might have had to appeal to the International Monetary Fund for another stopgap loan; the IMF approved $116 million in April 2009. In exchange, the IMF might require the government to do more to balance its books – and the central bank to be more accurate in its reports.
Thanks to oil, Kazakhstan is not in the same predicament as Tajikistan, but it faces the same dilemma. How much autonomy is the government prepared to give up in order to placate international creditors? Interesting times, indeed. – Zafar Davronov and Leon Taylor
Zafar Davronov is a student in KIMEP’s MBA program. His interests include Central Asian economics and finance.
References
William J. Baumol and Wallace E. Oates. 1988. The theory of environmental policy. Second edition. Cambridge University Press. Applies Weitzman's principle to pollution taxes and permits.
Francesco Caramazza and Jahangir Aziz. 1998. Fixed or flexible? Getting the exchange rate right in the 1990s. International Monetary Fund Economic Issues, number 13.
Roberto Chang and Andres Velasco. 2000. Exchange-rate policy for developing countries. The American Economic Review 90: 2, pages 71-75.
International Monetary Fund. 2008. Republic of Tajikistan: Financial system stability assessment.
Brian Kettell. 2000. What drives currency markets: The signals you need to stay ahead of the game. Financial Times/Prentice Hall.
Martin Weitzman. 1974. Prices vs. quantities. Review of Economic Studies 41:4, October, pages 477-491.
Revised on September 23, 2010.
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