How to create income like magic

Why are government statistics in Kazakhstan truly incredible?

Great news!  Despite anti-Russian sanctions and anemic global prices for oil, average income in Kazakhstan is rising 14% per year.  That would make it one of the world’s fastest-growing economies…if you could believe the government.

Unfortunately, you probably can’t.  I’ll explain.

Nominal income per person, measured in tenge, is not the best measure of prosperity, since it can rise because of growth in either output or prices.  Real income subtracts price increases, reflecting only growth in output. It measures purchasing power and thus prosperity.

As a simple example, consider an economy that produces only bottled water.  The price is 100 tenge per liter.  If average nominal income is 200 tenge, then a typical person can buy two liters of water, which is real income.  If nominal income doubles to 400 tenge, and if the price also doubles, to 200 tenge per liter, then the person can still buy only two liters.  Although nominal income has risen by 100%, real income has not changed.

Now suppose that nominal income doubles to 400 tenge but that the price remains at 100 tenge per liter.  Then your new income can buy four liters rather than just two.  Real income has increased by 100%.

In short, the growth rate in real income roughly equals the growth rate in nominal income minus the growth rate in prices.  If nominal income rises by 8%, and prices rise by 6%, then real income rises by about 2%.

Now we can discuss the news.  A few days ago, quoting the government’s statistical committee, the business newspaper Panorama said nominal income per person was rising 8.4% per year.  Inflation – the average rate of increase in prices for all products – was something like 5% or 6% per year.  One should conclude that real income per person is rising in the neighborhood of 2% or 3% per year, depending on the precise rate of inflation, which was not reported.

However, according to the weekly newspaper, real income per capita is rising 14%.  Evidently, someone calculated growth in real income by adding the inflation rate to the growth rate of nominal income.   

In principle, either Panorama or Kazakhstan’s statistical committee could have pulled this boner.   But given that Panorama, like most newspapers in Kazakhstan, intones government press releases as if they were the Word of God, the error probably came from Astana.

So don’t plan your Mediterranean vacation just yet.  You may not be as rich as the government thinks.  –Leon Taylor tayloralmaty@gmail.com

       

References

Panorama.  Tovarooborot Kazakhstana so stranamy TS v 2014 godu pashul na snyzheni.  (Kazakhstani trade with the other countries of the customs union in 2014 tends towards decline.)  September 19, 2014.

Money on the move

How quickly do we spend?

The West today worries that prices will fall unexpectedly, discouraging production.  But deflation is no problem for Kazakhstan, which benefits by the bane of the West, expensive oil.  In Kazakhstan, prices on average have been rising about 6% to 8% per year since its recovery from the financial crash of 2008-9.  At times, monthly “headline” inflation has exceeded 20%, often due to food prices in the short run.  The resulting uncertainty is not good for business.

The central bank, the National Bank of Kazakhstan, periodically avers that it will contain inflation.  Indeed inflation here has been lower than in Russia, for whatever that’s worth.  But an inflation rate of 8% is about four times higher than the one often recommended by economists.  Can the National Bank reduce inflation?

Conservative economists note that the higher the money supply, the higher the prices.  Suppose that Kazakhstan’s economy produces only one product, a pint of kefir each year.  Then increasing the money supply from 200 to 400 tenge will double the beverage’s price. 

The inflation in this example is temporary, since the price will stabilize at 400 tenge.  But monetarists point out that continual increases in the tenge supply may sustain inflation if they exceed the rate of increase in production.  To avoid long-run inflation, the money doctors prescribe a diet for the National Bank:  Cut back on those high-fat tenge. 

In Kazakhstan, the annual rate of growth in “broad” money – cash, checking and savings accounts, called “M2” – has thankfully fallen since the bubble days of 2006, when it was 78%. But it remained at 13% and 15% in 2010 and 2011, according to the International Monetary Fund.  These rates were roughly double the output growth rates in those two years. 

This “tough love” argument is alluring, but it assumes a simple link between the tenge supply and the price level (which is the price of a typical bundle of products).  If money supply rises by 16% and output by 6%, then the price level will rise by 10%.  So cut back the increase in tenge to something like 6%.  But this assumes that we can forecast output.  If production actually rises by 16%, then no inflation will occur.

Safe at any speed?

More unsettling is an assumption that central banks rarely discuss with the public.  It concerns the rate, or “velocity,” at which people spend a tenge.  Suppose that the money supply is 1 trillion tenge.  If velocity is 3, then each tenge is spent 3 times per year.  Annual spending is 3 trillion tenge.  If velocity suddenly rises to 6, then spending will double and may well push up prices.  To calculate the money supply that will avoid inflation, the central bank must forecast velocity as well as output.

At one time, it was fashionable to assume a constant velocity.  People will always spend a typical tenge three times per year, so we need not worry that an unexpected change in velocity will gum up the forecast.  This supposition was common shortly after the American economist Irving Fisher had popularized velocity in 1911.  Alfred Marshall, an English economist (and teacher of Keynes), explained in 1923 that velocity was stable because spending habits are slow to change.

Some macroeconomists still assume a constant velocity, at times for reason.  A rate of turnover in bank deposits was fairly constant in Britain from 1920 to 1940, reported J. S. Cramer.  But most economists now recognize that velocity may depend on the interest rate.  When bonds pay off at higher rates, people will buy them more quickly, increasing the rate at which money turns over.  Thus, in reality, velocity is volatile. 

In Kazakhstan, the velocity of cash and checking accounts (“M1” money) has halved since 2002, from 4 to 2, according to one study.  This may relate to a fall in interest rates, or it may express a new reluctance to spend that would not bode well for the country in the event of another global recession.  In any event, fluctuations in velocity over the course of a year have nearly tripled since 2008. 

Forecasting the “right” money supply may be harder for the National Bank than classical monetarists might claim.  Perhaps the Bank should provide a range of forecasts (for example, from 1 to 2 trillion tenge) rather than just one value.  –Leon Taylor, tayloralmaty@gmail.com

Notes

1.  The IMF defines M2 money as “the sum of currency outside banks, demand deposits other than those of the central government, and the time, savings, and foreign currency deposits of resident sectors other than the central government.”  I use end-of-year estimates.

2.  The velocity rate reported by Cramer was measured as the ratio of debts to account balances, excluding money markets.  It ranged from 15 to 20.

         

Good reading

Alfred Marshall.  Money, credit and commerce.  Prometheus Books.  2003. 

Ana Lucia Coronel, Dmitriy Rozhkov, Ali Al-Eyd, and Narayanan Raman.  Republic of Kazakhstan: Selected issues.  IMF.  2011.  Discusses inflation and food prices.   

J. S. Cramer.  Velocity in circulation.  In John Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave: Money.  Norton.  1989.

Irving Fisher, assisted by Harry G. Brown.  The purchasing power of money: Its determination and relation to credit interest and crises. Macmillan.  1911.

References

Murat Alikhanov and Leon Taylor.  An algorithm for estimating the volatility of the velocity of money.  Working paper, Munich RePeC archives.  2013.  The source of the estimates of velocity in Kazakhstan used above.

International Monetary Fund.  International financial statistics.  Online.

Call for papers

The Central Asia Business Journal, published by KIMEP University twice each year, promotes understanding of business issues (broadly defined) in the region.  As we see it, the region includes the post-Soviet “stans” (Kazakhstan, Kyrgyzstan, Tajikistan, Uzbekistan and Turkmenistan) as well as the post-Soviet states of the trans-Caucasus area (including Armenia, Azerbaijan and Georgia).

Central Asia is a fertile area for research.  It prospers from rich natural resources and high commodity prices as well as from its location at the crossroads of East and West.  But its open economy is vulnerable to such external shocks as the global financial crisis of 2008, and its Soviet legacy complicates its transition to markets.

Authors may submit research papers, case studies, and book reviews as either completed works or as abstracts and proposals.  We also invite students’ papers.  All submissions must be in English.  Refereeing is double-blind.

 The journal is open to all methodologies, but it especially welcomes papers that are conceptually and analytically strong and that relate to the real world.  We prefer papers with new findings but also publish surveys.  All papers should discuss applications to Central Asia.

The journal’s interests include:
International accounting standards and taxation
Corporate governance
Financial and capital markets and industries
Market structure and efficiency
Human resources management
Leadership
International business and globalization
Business law
Marketing strategies and effectiveness
Tourism and the hospitality business
Logistics and supply chain management
Management information systems
Business cycles and economic development
Market integration and segmentation
Emerging markets
Institutional economics
Microfinance and development    
Multinational enterprises and business strategy
Natural resources and their internationalization
Nongovernmental organizations and entrepreneurs
Mathematical economics
Statistical economics
Risk and uncertainty
Political economy
Behavioral economics

We also welcome contributions to three sections of the journal:

Perspectives.  This features nontechnical surveys of issues in Central Asian business that would interest scholars.  An example is a survey of theoretical and empirical papers about customs unions.  A typical length is 4,000 to 6,000 words.  You should propose your topic to the managing editor before beginning work.

Book reviews.  Reviews should summarize and evaluate books about Central Asian business or about business issues of interest to the region.  Most reviews will concern recent books, but the journal may also publish a retrospective essay about well-known titles in a particular field.  A typical length for a review is 1,500 to 2,500 words.  Please write the managing editor about the book that you propose to review.

Symposium.  This consists of several commentaries on a recent issue of interest – for example, the February 2014 devaluation of the tenge.  A typical commentary may run 1,500 to 2,500 words.  The commentaries are not refereed.  Usually, the journal commissions commentaries, but you may propose a symposium to the managing editor.



Deadline for completed work for the March 2015 issue: October 15, 2014.  After that date, we will consider submissions for later issues.  We try to give the author a decision in six weeks.

The Journal’s website is www.kimep.kz/CABJ.

For further information and submissions, please write to the Journal at cabj@kimep.kz or to the managing editor, Leon Taylor, at ltaylor@kimep.kz.

Step on it

Can price hikes worsen Kazakhstan’s gasoline shortage?

In the last few months, drivers and observers have suspected gasoline shortages in cities of Kazakhstan, including Almaty.  Shortages may also occur in Kyrgyzstan because of a holdup of petrol supplies from Kazakhstan. 

In June, the oil and gas minister of Kazakhstan, Uzakbai Karabalin, denied that a gas shortage would occur and vowed to avoid a price hike.  (In Kazakhstan, the government regulates retail fuel prices.)  But in late August, the economy minister authorized gasoline prices to rise 10% to 15%, reported TengriNews.  At present, the liter price of high-grade gasoline is roughly 157 tenge, or 86 cents, estimated globalpetrolprices.com. 

The government may have had to raise prices in order to eliminate excess demand.  Question: How should they rise?

Suppose that the prices of all grades of gas rise by the same amount – say, 20 tenge per liter.  Remarkably, this may increase demand for the highest grade of gas, compared to the demand for a lower grade; and it may not alleviate the shortage of high-grade gas as much as that of low-grade gas.

To see how, check out your apples.

Suppose that the city of apples, Almaty, exports its fruit to Moscow.  Every apple sent out will incur the same transport cost -- say, 5 tenge.  To avoid losing money, exporters must raise their price by 5 tenge per apple.  The demand for apples, or for anything else, depends on the price of apples relative to the price of a substitute, since the buyer must decide which product to buy with his 20 tenge.  This especially applies to good and bad apples.  A good apple sells at a higher price than a bad one – say, 20 tenge rather than 10.  In Almaty, the relative price of a good apple is thus 2 bad apples, or simply 2. 

Now suppose that we export both good and bad apples.  The price of both will rise by 5 tenge, or to 25 tenge and 15 tenge.  The relative price of the good apple exported is 25 / 15, or 1.67.  Yes, the relative price of the good apple falls when it is exported to Moscow rather than sold on Dostyk Boulevard.  Consequently, demand for good apples, relative to demand for bad ones, will be higher in Moscow than in Almaty.  Ceteris paribus, the seller may respond by selling good apples in Moscow and bad ones in our fair city.  Have you checked your yabloky for worm holes lately?

Your slimmed-down wallet

Back to gasoline.  If all octane grades increase in price by the same amount, then the price of high-grade gas, relative to the low-grade price, will fall.  Motorists will respond by substituting some high-grade gas for low-grade gas. 

How much will they substitute?  We don’t yet know.  In the United States, studies indicate that a fall of 1% in the relative price of high-octane gas will increase demand for it, relative to low-octane gas, by less than 1%, even after two or three months.  Drivers may be reluctant to substitute one grade of gas for another because their vehicles are designed for a particular grade.  In any event, if these figures hold roughly for Almaty, then a uniform price increase may not aggravate the shortage of high-grade gas by much.

In addition, increases in gasoline prices reduce the purchasing power of your income, since you can no longer buy as much gasoline as before.  As a result, you may buy fewer liters overall – say, 10 liters per month rather than your usual 20.  The share of high-octane gas in your purchases may rise – say, from 10% to 15%.  But because your overall purchases have fallen, the overall amount of high-octane gas that you buy is likely to fall.    

Still, keep your fingers crossed.  You’ll need some gas in order to drive to Moscow and buy good Alma-ata apples. –Leon Taylor, tayloralmaty@gmail.com

Notes

The drop in the price of a good product, relative to the price of a bad one, occurs because a given increase in any number will raise the total by a smaller percentage for a large initial number than for a small one.  This illustrates what economists call the “third law of demand.”  Alchian and Allen introduced the idea. 

In our example, the initial price of good apples was 20 tenge.  The additional 5 tenge due to transport costs raised the price by 25%.  The initial price of bad apples was 10 tenge, which the additional 5 tenge raised by 50%.

References

R. Morris Coats, Gary M. Pecquet, and Leon Taylor.  The pricing of gasoline grades and

the Third Law of Demand.  KIMEP Social Research Working Paper Series.  2014.

globalpetrolprices.com.  Kazakhstan gasoline prices, liter.  Accessed September 2, 2014.

Gyuzel Kamalova.  Additional gas to be imported from Russia: KazMunaiGas Onimderi.  en.tengrinews.ke  September 1, 2014.

Oksana Kononenko.  V KMGO schytaiot defytsyt benzyna delom ryk camyx AZC.  Panorama.  August 22, 2014.

Assel Satubaldina.  Kyrgyzstan blames Kazakhstan for fuel shortages.  TengriNews.   en.tengrinews.kz.  July 11, 2014.

Sergey Smirnov.  Struggle with gasoline shortage in Azerbaijan and Kazakhstan.  Oilnews.kz.  November 27, 2013.

TengriNews.  No petrol shortages expected in Kazakhstan: Oil Minister.  en.tengrinews.kz .  June 19, 2014.

Gul’zhanat Yxyeva and Ol’ga Kym.  Benzyn na korotkom povodki.  Kursiv’.  August 21, 2014.

Good reading

A. A. Alchian and W. R. Allen. University Economics.  Wadsworth. 1967.

    

T. E. Borcherding and E. Silberberg. Shipping the good apples out: The Alchian and Allen Theorem reconsidered.  Journal of Political Economy, Vol. 86. 1978.