Green garble

Would pollution permits cripple Kazakhstan’s economy?

Kazakhstan plans to control carbon emissions, which create global warning, by issuing pollution permits that can be bought and sold.  To reduce emissions, the government can just issue fewer permits.  Carbon polluters – such as power plants that burn coal in order to generate electricity – protest that the permits cost too much.  That, to put it charitably, is a misunderstanding.

Under reasonable conditions, marketable pollution permits minimize the cost of controlling emissions.  I don’t mean the price paid by the power plant for the permit; its emissions do real damage, so it should pay for the privilege.  I mean the cost to society of pollution control.  For example, some plants may reduce carbon emissions by switching to natural gas or nuclear power.  The cost of this transition may force a plant to layoff workers.  This loss of jobs entails a true cost to society.  We may want to cut carbon emissions, by the given amount, with the smallest possible loss of jobs (or, more generally, with the smallest possible loss of human welfare).  Marketable pollution permits can do this.

To see why, let’s look at how governments usually reduce pollution – “Command and Control”, which orders all polluters to cut emissions by a given percentage (say, 50%).  Consider two power plants that each emit 2 million tons of carbon.  Plant A has equipment designed solely to burn coal.  To halve emissions, it must buy equipment suitable for natural gas.  Reducing carbon emissions by a million tons will cost it $3 million.  Plant B already has equipment for burning either coal or gas, and it can switch to the latter fuel easily.  It can halve emissions for only $1 million.  Under Command and Control, each plant would have to reduce emissions by 1 million tons, at a total cost of $4 million ($3 million for plant A, $1 million for plant B).  It would be cheaper to have plant B cut back by the full 2 million tons, since this would cost only $2 million.  Marketable permits can make this happen.

How?  Suppose that each permit would let its holder emit one carbon ton.  Plant A would want to pay as much as $3 for the permit, since otherwise it would have to pay $3 to avoid emitting the ton.  Plant B would be willing to sell a permit for as little as $1, since it can abate the ton by spending a dollar.  Thus each plant would gain $1 by trading the permit for $2 (B would sell to A).

The gains to polluters are not the issue.  The point is that the exchange enables society to abate the carbon ton as cheaply as possible – for $1, or, more precisely, for a dollar’s worth of physical capital and labor.  Under command and control, the abatement would have cost two dollars’ worth of resources.  The marketable permit frees up a dollar’s worth of resources for producing other things of value, such as research into global warming.

Inflating the facts

A permit system isn’t essential.  The government can achieve the same cost-minimizing outcome by taxing each polluter $2 for emitting a carbon ton.  Plant A will pay the tax and Plant B will abate instead.  But under the tax system, firms can pollute as much as they wish, as long as they pay up.  True, the government can cut pollution by raising the tax rate, but finding the best tax may take several years; meanwhile, the environment may suffer.  Since we are not sure of the damages that global warming may incur, other than that they may be catastrophic, we may prefer permits to taxes, since the government can reduce emissions by a precise amount simply by issuing fewer permits.  That is, the permit system enables the government to control the amount of pollution more precisely than the tax system would.     

Eurasianet.org reports that Kazakhstani business leaders, “including KazEnergy, a powerful alliance of energy producers, is opposing the (permits) plan, arguing that it would stifle economic growth and decrease Kazakh global competitiveness.”  Hogwash.   By saving resources, the permit plan will stimulate growth and competitiveness, when compared to Command and Control. Moreover, the permit system encourages innovations that cut the cost of pollution control, since these increase the innovator’s profit from selling a permit.  If, for example, Plant B can reduce the cost of abating a carbon ton from $1 to $.75, then its profit from selling a permit for $2 increases by $.25.  Command and Control may not induce such innovation, because regulators usually require all polluters to adopt the best available technology.  The innovator will lose his invention to his rivals, so he is less likely to attempt expensive innovation in the first place.    What is costly for Kazakhstan is not the permit scheme but the original decision to reduce emissions.  Given that decision, the permit system is the cheapest way to go.

Eurasianet.org also reports “fears that the (Emission Trading System, i.e.,. permits) can prompt businesses to pass along higher costs to end users, spurring inflation and generating discontent in many communities.”  This argument is confused.  In the past, Kazakhstan exported pollution costs (in the form of global warming) to the rest of the world by permitting its power plants to emit carbon.  Requiring emitters to cut back merely recognizes that firms should pay for the input called pollution.  Undoubtedly a polluter will try to pass on this cost to customers; but since they have enjoyed the benefits of carbon emissions – such as abundant electricity – it seems fair to require them to pay the associated costs.  Anyway, users can avoid these costs by conserving. 

“Inflation” is a rise in prices throughout the national economy.  Technically, it’s the rate of increase in the “price level”.  A onetime increase in energy costs may push up the price level, but not forever.  So, the impact on inflation would be temporary.

Permits enjoy a political advantage over taxes.  Since the government must collect the tax revenues, it may be accused of adopting pollution taxes for financial rather than environmental reasons.  But it need not collect anything under a permits scheme:  It can allocate the permits for free and let their sellers keep the revenues.  Given Astana’s reputation for pecuniary cunning, this advantage is not rhetorical.         

--Leon Taylor, tayloralmaty@yahoo.com

Good reading

Larry E. Ruff.  The economic common sense of pollution.  The Public Interest.  Spring 1970.

Tom Tietenberg.  Environmental and natural resource economics.  Addison-Wesley.  Sixth edition.  2003. 

References

Khamidov, Alisher.  Carbon trade scheme fuels divisions in Kazakhstan.  Eurasianet.org.  July 9, 2013.

152

Why does the tenge weaken?

Since February 2009, the National Bank of Kazakhstan has held the daily exchange rate close to or below 150 tenge per United States dollar, with little difficulty – until now.  In the past two weeks, for the first time since early 2000, the currency has weakened to 152 tenge per dollar.   

In principle, the National Bank should be able to strengthen the tenge by exchanging dollars for it.  But recent shrinkage of the Bank’s reserves of foreign currency suggests that it may have some trouble defending its target rate.  Net international reserves fell by 8.06%, the largest monthly decline since June 2012, according to Bank data.  By comparison, these reserves fell 8.1% in January 2009, just before the Bank devalued the tenge by 25%.  They were $18.2 billion at that time and $25.6 billion last month (roughly $19 billion,  adjusting for inflation in Kazakhstan).   Moreover, gold reserves this June declined by 13.75%, the largest monthly fall since January 1994, in the wild woolly days of Kazakhstan’s transition to markets.  The main reason is probably the steep fall of 12% in late June in gold prices, which are now recovering.  Even so, the overall pattern of growing weakness in the tenge and in reserves is troubling.  What gives?

An eventual depreciation was probably inevitable, due to expectations of rising prices (i.e., inflation).  The unemployment rate in Kazakhstan has been falling steadily ever since 2000, indicating that the economy is using up its excess capacity.  When it reaches full capacity, deploying all of the workers and machines that it comfortably can, then additional demand for its products will drive up prices rather than output.  This would make its exports more expensive for foreigners to buy – and imports cheaper for Kazakhstanis to buy.  Since the country relies on net exports (the value of what it sells to foreigners, minus what it buys from them) for economic growth, the National Bank would surely have let the exchange rate rise above 150 someday, in order to make exports cheaper.  (If a buck can buy 165 tenge, rather than just 150, then the dollar price of Kazakhstani exports will fall by a tenth.)  And, in fact, the tenge has been depreciating fairly steadily since early 2011, when it was just above 145, according to Bank data.  The foreign exchange market in the Kazakhstan Stock Exchange has not been unusually active, but the average exchange rate for the tenge has been rising steadily since 2011 at least.  Which brings us back to the $64 question: Why is the tenge depreciating to above 152, a record level, now?  At the moment, the rate of inflation in Kazakhstan is falling.  The annual inflation rate in consumer prices is 5.9%, the lowest since November.

The depreciation is particularly mysterious because it may put the Bank on dangerous ground.  If the Bank cannot hold the exchange rate below 152, which is something of a bright line, then it may have to announce a new target – say, 153 or 155.  If speculators anticipate this, then they will sell tenge now while they’re still worth something.  This would raise the exchange rate on the street (i.e., the tenge would weaken), forcing the Bank to act sooner than it would like.  In short, the Bank may face a speculative attack.  To avoid volatility, it should make its intentions clear.

Who yearns for the yen?

Some reasons for the tenge’s depreciation are obvious enough.  The world oil market has been anemic this year, and the quantity of crude sold may surpass that of 2012 by less than 4%, reports a business weekly, Panorama.  (The ischemia may be temporary: Futures prices for crude have been rising since April.)  Also, all things are relative: The tenge may be depreciating in terms of the dollar because the latter is strengthening.  The Federal Reserve has now made clear that it may weaken its stimulus of the U.S. economy someday, although it is in no hurry to pull back.  This hint is enough to convince speculators that growth in the supply of dollars may slow down. The dollar would become scarcer, so its expected value, in terms of foreign currencies, would rise.  With respect to the euro and the yen, the buck is strengthening at the moment -- albeit in the latter case partly because the Bank of Japan is doubling its money supply in a campaign to escape deflation.

Another factor in the tenge depreciation, if only a remote one, may be that pension reform has compromised Astana’s financial credibility.  The sudden decision this spring to “unify” private pension funds into one controlled by the government suggests that it had earlier underestimated the cost to it of future pensions.  In addition, some analysts contend that the pension nationalization will impede embryonic financial markets in Kazakhstan, reported Panorama.  In that case, the tenge will lose value relative to currencies used in financial markets that flourish. 

In brief, tenge may be weakening for the same reason that I can’t sell my used toothbrushes: No one wants them, particularly in such abundance.   –Leon Taylor, tayloralmaty@gmail.com

References     

NASDAQ.  Gold prices; crude oil futures prices.  www.nasdaq.com

National Bank of Kazakhstan.  Statistics.  www.nationalbank.kz 

Panorama.  Aktyva Natsbanka v zolote sokratylys’ za mesyats na 13.6%.  July 12, 2013.    

Fifty shades of gray dictators

 What motivates authoritarian rulers in Central Asia?

Paul R. Gregory.  The political economy of Stalinism: Evidence from the Soviet secret archives.  Cambridge University Press.  2004.  308 pages.

More than two decades after the massive heart attack of the Soviet Union, scholars debate the reasons for the collapse.  To Austrian economists like Friedrich Hayek, a planned economy cannot induce the information from individuals that generates trade.  Had Steven Jobs not known the prices and quantities bought of personal computers, he might not have been able to gauge the potential profits in a pocket-sized device (assuming that he could have kept them).  Socialist economists blame the men rather than the blueprint.  Planning might have worked had the politically powerful not been intent on pocketing gains.  To use Joseph Berliner’s analogy, did the Soviet economy implode because of the jockey or the horse?  “What we know for certain,” writes Paul Gregory, who has studied Soviet economies and their progeny for four decades, “is that the administrative-command system survived longer than Hayek and [Ludwig von] Mises would have expected and, at its peak in the 1960s and 1970s, it constituted a credible military threat as a world superpower.”

The Austrians failed to anticipate this qualified success because their model was too simple, Gregory argues.  Bureaucrats had incentives to gather information informally, but not necessarily to share it with ostensible superiors.  Brezhnev faced the same problem that torments main shareholders today in the United States – the agent may not do the bidding of the principal.

The two-arm bandit

To explain Stalin, Gregory puts forth four models of a dictator – models that may apply in Central Asia today.  The first and least likely is the “scientific planner”, who merely defines benevolent rules for divvying up resources among the population and leaves the decisions to the technocrats.  In contrast, the “stationary bandit” manages the economy in order to ensure its long-run growth and subsequently the nation’s political stability.  (Gregory attributes this model to the late, great American economist Mancur Olson.)  

Both types of dictators may engender economic growth; but clearly other types proliferate, somewhat in the manner of stinkweeds.  The “selfish dictator” cements his political support by bribing or bullying the powerful.  Finally, the “referee-dictator” presides over the internecine struggles of interest groups in order to make himself indispensable to them.  (Yet another Olsonian concept.) 

With respect to Stalin, we can dispose of the scientific-planner model rather quickly.  Also, his iron grip on the Soviet economy and politics would rule out the referee-dictator model.  Choosing between the two remaining models is complicated by the lack of reliable statistics, Gregory argues.

From specialized studies of output, investment, rubles and other topics, Gregory concludes that the Kremlin horse had thousands of jockeys, some of whom were superiors to others and all of whom were elbowing for position..  “Each superior faces an uncooperative and untruthful subordinate who can only be moved to positive action by force.  One dictator alone could bring little force to bear.  Each dictator requires minidictators under him to coerce action at the next level.”  This inelasticity in the economy reduced output.  “Virtually all economic instructions were based on the principle that this year’s activity would be last year’s plus a minor adjustment.  The massive imbalances were resolved by arbitrary interventions by the thousands of ‘dictators’ empowered to intervene.  There could be no general rules because they would have interfered with the authority of officials to intervene….In effect, the economy was frozen in place as the other world economies progressed.”  Regardless of its motivation, the dictator’s urge to command inhibited economic growth.  Perhaps this principle is not entirely alien to Central Asia.   -- Leon Taylor, tayloralmaty@gmail.com

        

Good reading 

Hayek, F. A.  The use of knowledge in society.  American Economic Review 35.  1945.  Argues that only free markets can collect essential economic information from individuals, through millions of their exchanges.

Olson, Mancur. The logic of collective action: Public goods and the theory of groups.  Harvard University Press.  1971.  Small interest groups may dominate large ones because their benefits per member are larger and their organizational costs smaller.   

Olson, Mancur.  The rise and decline of nations: Economic growth, stagflation, and social rigidities.  Yale University Press.  1982.    

The real trouble in Tehran

 

Should we blame sanctions for Iran’s woeful economy?

The surprisingly strong showing last week of a moderate in Iran’s presidential election, Hassan Rowhani, suggests that the economy perturbs voters more than the regime had realized.  The Iranian on the street may worry most about rising prices.  At the current rate of inflation, prices throughout the economy would double in less than three years.  (And that’s just at the official annual rate, 32%.  Last October, a well-known U.S. economist, Steve Hanke, estimated the actual rate as 196%.) 

To deflect blame from the government, some supporters attribute the inflation to sanctions imposed by the West to discourage the building of nuclear weapons.  Independent analysts have also weighed in.  One at RAND says: “Of course inflation was high before sanctions against the central bank, but there are indications that sanctions have pushed Iran’s inflation much higher.”

This argument may confuse prices with their rate of increase.  I’ll explain.

Every product has its price, of course, but the one that matters most in the national economy is the average price, called the “price level”.  You can think of this as the price of a typical market-basket of goods and services bought by a consumer each year.  Suppose that the basket consists of two kefirs, each priced at 100 tenge, and three CD’s, each priced at 500 tenge.  Then the price level is 2*100 tenge + 3*500 tenge, or 1,700 tenge.  If the price of a CD rises next year to 600 tenge, then the price level will become 2,000.  Over the year, it has increased by about 18%.  That’s the rate of inflation.

Those are the basics.  But in reality, governments measure the current price level in terms of its increase since a base year.  If the base year is 2013, then they will set its price level to 100.  The price level for 2014 is 118, 18% higher than in 2013.

Masters of inflation

By reducing the supply of a wide variety of goods, sanctions cause the price level to rise.  There are fewer goods to go around, so a consumer must bid higher prices to get them.  As prices increase, the demand for goods falls -- and the supply rises, since domestic producers may profit at the higher prices.  At some point, the price level is so high that demand no longer exceeds supply.  The price level will then stop rising, since there is no longer any excess demand to propel it.  When it stabilizes, the rate of inflation becomes zero.

In short, one-time economic sanctions will permanently raise the price level, but they won’t create sustained inflation.  The inflation occurs only while the price level is adjusting to the new scarcity.  Sanctions can create long-term inflation only if they continue to tighten.  The European Union did give the screws another turn last October, but in general the sanctions have not tightened continuously since 2010.

An example may help.  Suppose that sanctions reduce the supply of goods in Iran by 20%.  Then the price level will rise from, say, 100 in 2010 to 120 in 2011.  If the new price level eliminates excess demand, then it will be 120 in 2012, in 2013 and in the years to come.  The rate of inflation from 2010 to 2011 was 20% and then fell to 0% for succeeding years.

The problem for Iran is not that the price level has sometimes spiked but that it has been rising at double-digit rates since 2000 at least and has risen by more than 26% for more than a year, according to the International Monetary Fund (IMF).  (These are consumer prices.)  As a practical matter, such sustained inflation has only one cause – the central bank keeps printing too much money.

Suppose that the central bank raises the money supply by 20%.  With more money chasing the same number of products as before, prices will rise by 20%.  If the bank does not increase the money supply again, then prices will now stabilize.  But if the bank increases the money supply by another 20% every year, then the price level will keep rising by 20% each year.  That’s long-term inflation.

Some nongovernmental organizations contend that the cure for inflation is to print more money.  Here’s the chief executive of United Against Nuclear Iran:  “By manipulating and increasing the printing volume of the rial, the regime can bolster its floundering currency and mask the disastrous impact of its political decisions, economic mismanagement and isolation.”  The NGO urged Western nations to stop printing the rial for Iran.  Tehran may find this a blessing in disguise. 

Or it may not.  Unfortunately for the Islamic Republic, a reduction in the rial supply may have subtle effects.  In general, sanctions have raised input prices in Iran, driving up production costs and output prices and thus reducing income.  The silver lining is that a recession lowers the demand for money, by reducing spending.  An excess supply of rials develops, which causes their exchange rate to depreciate -- that is, to become cheaper in terms of other currencies.  This makes Iranian exports less expensive for those countries that still consent to trade with it.  (If a euro can buy 30,000 rials rather than just 15,000, then Iranian exports become cheaper for Europeans, presuming that they will buy them.)  Eventually, exports will increase, stimulating recovery.

The Western plan to stop printing so many rials reverses these effects.  It creates an excess demand for rials.  The exchange rate will appreciate – becoming more expensive in terms of foreign currencies – discouraging exports.  The Iranian economy may take longer to recover.  

The Tehran tango

Thanks partly to these entangling effects, the central bank of Iran is losing its grip on monetary policy, a grip that has never been particularly strong.  According to the World Bank, M2 money in Iran – cash, checking accounts, and small savings accounts -- rose by more than 23% in each year from 2003 to 2009 (except for 2008, when the growth rate was 7.5%).  It then fell radically in 2010 and 2011, at the respective rates of -41.8% and -33.3%.  Such wild gyrations in the money supply cause prices to go haywire, creating uncertainty throughout the economy. Because the central bank no longer has credibility, it will have trouble eliminating expectations of inflation, even though money supply is falling.  The roller-coaster ride that is the Iranian economy will continue.   

Iranian voters have the right instincts.  They sense that the government is to blame for long-run inflation, and they are almost certainly correct.  A decade ago, the central bank should have resisted the temptation of creating an illusion of easy wealth by printing rials.  It should have stabilized prices, by holding down the long-run rate of change in money to the long-run rate of change in output (which the IMF projects at -1.3% for 2013).  Instead, the bank chose go-go monetary policy.  As a consequence, today in Tehran, anything goes.  –Leon Taylor, tayloralmaty@gmail.com

Notes


"Money demand” may seem a strange expression. Don’t we all demand an infinite amount of money?

In economics, the term refers to the demand to hold money rather than other assets like stocks and bonds. We don’t want to hold an infinite amount of money, because we could exchange it for an asset that earns interest.

Good reading

Krugman, Paul, and Maurice Obstfeld.  International economics: Theory and practice.  Boston: Addison Wesley.  2009.  Discusses macroeconomic adjustments in product and asset markets.

   

      

References

Gladstone, Rick.  Double-digit inflation worsens in Iran.  The New York Times.  April 1, 2013.  The source of the RAND quote.

Gladstone, Rick.  Iran cites I.M.F. data to prove sanctions aren’t working.  The New York Times.  October 9, 2012.  The source of the Hanke estimate.

Gladstone, Rick.  Iran sanctions may cut supply of currency.  The New York Times.  October 16, 2012.

International Monetary Fund.  World economic outlook.  Online.

Kanter, James, and Thomas Erdbrink.  With new sanctions, European Union tightens screws on Iran over nuclear work.  The New York Times.  October 15, 2012.

Gross Domestic Unhappiness

Is national income good for the soul?

In Central Asia, when political leaders want to brag, they usually spout statistics about gross domestic product – the value, when sold on the market, of goods and services produced by the nation in a year.   One can hardly blame them.  Double-digit rates of growth in GDP have been common in the region since the turn of the century.

There are other ways to judge our performance.  We may measure how well that our national economy is doing, per person, in terms of wealth or income.  “Wealth” is the accumulation of savings, which in turn is unspent income.  Suppose that you made $6,000 in your part-time job this year.  Of that amount, you put $2,000 in your savings account; bought $2,000 of KazKommerzbank stock shares; and spent $2,000 on food and clothes.  Then your savings are $4,000.  The stock doesn’t count as consumption, because you can’t enjoy it in the same way as a cone of ice cream; it’s just a parking lot for your money.  If you also saved $10,000 from past years, then your wealth is $14,000.  This figure indicates the lifestyle that you can support in the future.  The $6,000 of wages is your annual income, indicating how well that you can live this year without dipping into your wealth.  Income is a yearly inflow into your accounts; wealth is a stock, the value of your assets at a given time.

  

Before The wealth of nations appeared in 1776, scholars had thought that the nation’s wealth depended on its gold or silver.  Spain was rich because it had hauled tons of the precious metals from the New World.

We owe our modern notion of national wealth to Adam Smith, who attributed it to labor productivity – the amount that a typical worker can produce.  If she can figure out how to produce shirts more cheaply, then we can buy more shirts with given savings.  Wealth  increases in terms of what it can buy. 

Popes and Marxists

Productivity shapes income as well as wealth.  A Nobel-laureate economist, Robert Solow, pointed out that you could produce more cheaply if you had more capital to work with.  (“Capital” is anything man-made used in production: Machine tools, office towers, knowledge of accounting.)  Nations with more capital per worker can sustain higher levels of income per person.  Ethiopia is poor partly because its workers have few machines. 

Human capital – such as education and training – are particularly important to growth, noted the Nobel laureate Robert Lucas. Although this sounds obvious now, it was revolutionary.  The classical world didn’t appreciate knowledge about production and offered no means by which you could profit by it, wrote Ronald Wirtz.  In contrast, Americans have accumulated human capital rapidly in part because their universities compete for students.  The strength of private universities in the U.S. is virtually unique in the world, according to economists Claudia Goldin and Lawrence Katz.

These perspectives presume that wealth or income per capita is the most reliable measure of human well-being because they are material.  A 19^th-century pope dissented.  In countering Marxists of the 1890s, who threatened to revolutionize Europe, Leo XIII defended property rights but added:

"...[I]n the case of the worker, there are many things which the power of the state should protect; and, first of all, the goods of his soul. For however good and desirable mortal life be, yet it is not the ultimate goal for which we are born, but a road only and a means for perfecting, through knowledge of truth and love of good, the life of the soul."

In the Sixties, Pope Paul VI reinforced the point: "Increased possession is not the ultimate goal of nations nor of individuals. All growth is ambivalent."  Income per capita is merely a means to a spiritual end.

Income per capita is a limited measure of human well-being because it fails to account for leisure, notes Robert Forrestal.  Over the past few decades, the entry of women into the labor market has increased.  In Kazakhstan, the number of women in the labor force rose 12.7% in seven years.  Even over the period of financial crisis, 2008 to 2010, the number rose 1.5%.  Such a surge into the labor market may raise income per capita, but at the loss of leisure (see the Notes).  “Economists simply cannot tell whether society is better off or worse off in this case.”  But women choose to work, so on average they surely must gain.

Bhutan’s way

The larger point – that income per capita does not fully measure well-being – is well-taken.  The United Nations measures human welfare with the Human Development Index, which reflects life expectancy, educational standards and individual purchasing power.  For example, Costa Rica has ranked much higher in its human development score than in its total output per capita. In the early 2000s, Costa Rica placed 76th by total output per capita but 42nd by human development. The discrepancy occurred because the average Costa Rican lived longer, learned more, and drank cleaner water than did residents of other nations with similar average incomes.  In 2004, the United States placed only eighth among all nations, in terms of the index.  Norway and Sweden led the list, reported the Financial Times..

One Nobel laureate economist uses death rates to analyze economic performance.  To Amartya Sen, the way that nations handle famine, health care, sexual and racial inequality, and poverty may reflect economic progress more truly than does income.

Skeptical of income estimates, some nations have adopted alternative measures of well-being.  The tiny nation of Bhutan judges its economy annually by a measure of Gross National Happiness.  One of its indicators is environmental quality, reported The Economist.  Conventional measures of gross domestic product do not subtract environmental damages; in fact, a rise in pollution will boost GDP, by increasing demand for health care.  To the contrary, Bhutan regards forests – which cover nearly three-fourths of its land -- as contributing to its Gross National Happiness.  But another indicator of its Happiness, the preservation of culture, may measure xenophobia.  Bhutan discourages Hindu immigrants from Nepal. 

To measure national income, economists sum up payments to input owners: Wages and salaries, profits, interest payments and rent.  Another approach is to sum all spending on production, since a tenge of spending is a tenge of income to someone.  Total spending is gross domestic product.  In developing countries, estimates of national income may fall short of GDP when people don’t report all of their income to the tax agency.  The difference measures the underground economy.  In Nigeria, Egypt, and Thailand, the underground economy has accounted for nearly three of every four dollars spent, noted economist John McMillan. –Leon Taylor, tayloralmaty@yahoo.com

Notes

Denote the number of adults in the labor force as LF, the number not in the labor force as NLF, total wage income as WI, and total nonwage income as NWI.  Then income per adult is a weighted sum of the sources of income, where the weights are the labor force share of all adults and 1 minus that share:

YPC = [LF/(LF + NLF)](WI/LF) +  [NLF/(LF + NLF)](NWI/NLF).

Denote the average labor wage as w, a decreasing function of LF, and the average nonlabor wage as nw, assumed constant.  Then, by definition,  

YPC = [wLF + nwNLF]/[LF + NLF]

Assume that NLF is a constant.  Then

dYPC/dLF = [1/(LF + NLF)][w + (dw/dLF)LF – (wLF + nwNLF)/(LF + NLF)].

For simplicity, set nw = 0.  With manipulations, dYPC/dLF is positive if

(w/LF)[NLF/(LF + NLF)] > dw/dLF.

An increase in the labor force raises income per adult if the magnitude of the wage response is less than the ratio of the wage to the labor force, weighted by 1 minus the labor force share of adults.  This is most likely when the wage is high and the labor force share of adults is small – conditions that may describe a resource-intensive developing economy.

Good reading

The Economist.  The pursuit of happiness.  December 18, 2004.

Goldin, Claudia, and Lawrence Katz.  The shaping of higher education in the United States and New England.  Regional Review.  Federal Reserve Bank of Boston.  Q4 2001.  On line.

Forrestal, Robert.  Economic development for the 21^st century: New measures of well-being.  The region.  Federal Reserve Bank of Atlanta.  June 1994.  The source of the papal quotes. 

Lucas, Robert.  Lectures on economic growth.  Harvard University Press.  2004.

McMillan, John.  Reinventing the bazaar.   Norton.  2002.

Sen, Amartya.  Development as freedom.  Anchor.  2000.

Solow, Robert.  Growth theory: An exposition.  Oxford University Press.  2000.

Williams, Frances.  Diversity “must be embraced” to ensure stability in globalizing world.  Financial Times. July 16, 2004.

Wirtz, Ronald A.  The new (and improved) economy.  The Region.  Federal Reserve Bank of Minneapolis.  June 2000.  On line.

References

The statistical agency of Kazakhstan.  Labor indicators by gender 2003-2010.  Online. 

Taking it back

Can transition economies handle inflation?

 

Around the world, governments balk at spending more for fear of racking up debts that they cannot easily repay.  They leave it up to the central bank – which manages the nation’s money supply -- to stimulate the economy, effectively by printing money.  The Federal Reserve in the United States and the European Central Bank have pledged to provide enough dollars and euros to keep low the interest rate, which is the price of holding money (since this is what you forego by holding rather than lending).  The Bank of Japan is doubling the supply of yen -- although, unusually for a central bank these days, especially for Japan’s, this is to accommodate the government’s largesse.  In Kazakhstan, M2 money -- which includes cash, checking accounts and small savings accounts -- has tripled since the beginning of the banking crisis in 2007.

As a rule, new money eventually raises prices, since people use it to bid more for products.  When the economy operates at full capacity, it cannot create more goods and services, so increased demand for them merely drives up their prices.  At the moment, the world economy is well below capacity, so inflation is not a problem.  But the day will come when that may change.  Are central bankers ready?

They usually argue that they can easily soak up excess money, by exchanging securities for them.  By selling a public bond (basically an IOU issued by the government) for $50,000, the bank can withdraw that many dollars from the economy.

This may work in Western countries, which have well-developed financial markets.  In the U.S., the market for overnight loans, called “repos”, has run into trillions of dollars and is quite sensitive to changes in demand and supply.  The Federal Reserve can quickly withdraw from it a precise amount of money by selling loans.

But in transition economies, financial markets are embryonic.  Their central banks cannot rely on exchanges of securities for money (“open market operations”) to manage the money supply.  They must fall back upon cruder tools.

The folly of ’37

One is to raise the interest rate that the central bank charges on loans to commercial banks.  (In Kazakhstan, this is the “refinancing rate”).  These banks will respond by borrowing less money, which reduces the amount that they can provide to people to spend.  Unfortunately, bank demand for loans depends not only on the interest rate but also on such factors as the banks’ expectations of economic growth, since they will re-lend the money only if they expect to get paid back.  In a recession, impoverished borrowers may default rather than pay interest.  Since expectations are hard to measure in times of uncertainty, the central bank may misjudge the response to a given increase in interest rates.

Another tool for central banks in transitional economies is to reduce the share of deposits that commercial banks can legally lend out.  (This is the “required reserve ratio”).  Again, it’s hard to anticipate precisely how this tool will affect the money supply; it depends on the behavior of banks, depositors and borrowers – behavior that we don’t understand well.  When the Fed doubled the ratio in 1937, the U.S. economy plunged back into depression, recovering only when World War II boosted government spending.

Even central banks in transitional economies that use open market operations may face hurdles.  In some countries of the Commonwealth of Independent States, the central bank has sought (or was required) to discourage the government from borrowing, by refusing to buy many of its securities.  When the day comes, those banks may not have enough securities on hand to sell in order to reduce the money supply sharply.

Most central banks today probably should not withdraw much money from circulation.  Unemployment still matters more than inflation.  But accommodation has long-run consequences.  Central banks in the CIS may prepare by developing securities markets; ensuring that they have enough securities to buy back lots of money;  and by researching effects of monetary policy.  Central banks can take the money back – without taking it on the chin. –Leon Taylor, tayloralmaty@gmail.com   


Good reading


Cole, Harold L., and Lee E. Ohanian. The Great Depression in the United States from a neoclassical perspective. Federal Reserve Bank of Minneapolis Quarterly Review. Winter 1999. The source of the story about Fed policy in 1937.

Friedman, Milton, and Anna Schwartz. A monetary history of the United States, 1867-1960. Princeton. 1963.

References

Ewing, Jack.  A rate cut in Europe, and a hint of limits.  The New York Times.  May 2, 2013.

National Bank of Kazakhstan.  Monetary aggregates.  www.nationalbank.kz

Tabuchi, Hiroko. Japan initiates bold bid to end years of tumbling prices.  The New York Times.  April 4, 2013.

   

Golden years

Does pension reform benefit workers?

Kazakhstan’s proposal to raise the retirement age for women, from 58 to 63, has resulted in a culinary event, reported Silk Road Intelligencer.  A week or two ago, a protester pelted the labor minister, Serik Abdenov, with rotten eggs as he tried to explain the reform.  Will it endow the nation’s economy with rot as well?

One point of the proposal, of course, is to cut government spending, thus averting a later tax increase.  Kazakhstan restructured its pension program in 1998, but the reform won’t take full effect until perhaps 2038.  Meanwhile, lingering features of the old program are costing the government.

Here are details.  Before 1998, Kazakhstan had the traditional pay-as-you-go program for retirees, in which current workers effectively paid for current pensions through taxes.  (Ostensibly, employers financed pensions via a payroll tax of 30%, Lim notes.  But they were likely to pass on much of this expense to workers in the form of lower wages.)   As the population continued to age, the number of retirees per worker would continue to rise, increasing the tax burden on labor.  To avoid this political catastrophe, the government notionally replaced the pay-as-you-go structure with one in which each worker would save for his own retirement.

At the time, Kazakhstan was hailed as a pioneer in pension reform (which it had adapted from Chile).  Overlooked was the fact that the reform couldn’t take full effect immediately, since workers who would retire soon had not yet saved enough money to provide themselves with much of a pension.  Instead, Kazakhstan would implement the reform gradually, continuing to pay pensions but at a diminishing rate over time.  For example, a worker retiring in 2018 will receive half of his pension from the pay-as-you-go plan and half from his own pension account, since he will have worked for half of his career (assuming a 40-year career) since 1998.  A worker retiring in 2038 will have worked his full career since 1998, when the reform was announced, so he will be expected to pay for his entire pension himself.  At that point, the pay-as-you-go plan will cease to exist.  But until then, the government must continue to pay some part of the pensions, since it must finance shortfalls in private payments.

To save or to slave

Saving the government money is not the only purpose of the pension reform.  Another is to encourage people to save.  Under the pay-as-you-go program, a worker’s pension would not depend on his own savings, since future workers would pay for him; so he might not save.  Under the new program, the worker must save for his own pension.  He would put his savings in a bank that subsequently could lend the funds (until he needed them) to firms for expanding their capacity to produce.  Thus the pension reform could engender economic growth.  That, at least, was the idea.

There is another possibility.  Perhaps people don’t save for retirement; instead, they save in order to pay future tax increases.  The reform avoids an increase in payroll taxes by shifting the burden of the pension from current workers and to the future pensioner.  Since taxes wouldn’t increase, the worker wouldn’t have to save more for them.  In this case, the household savings rate (the share of after-tax household income that is not spent) would fall.

A final possibility is that people save for both retirement and taxes.  In that event, the pension reform would have no net impact on the personal savings rate.  One would save $1,000 more for the pension but $1,000 less for tax increases.          

But set these complications aside.  The immediate problem for the government is to explain intelligibly one of its most significant reforms to the people who would benefit by it.  The penalty for failure is a short order of flying eggs.  --Leon Taylor, tayloralmaty@gmail.com

Good reading

Jiunjen Lim.  Pension reform in Russia and Kazakhstan.  2005.  Online.  An overview.

References

Silk Road Intelligencer.  Women’s retirement age.  April 29, 2013.  www.silkroadintelligencer.com

World Bank.  Paying pensions in Kazakhstan.  web.worldbank.org