The KASE of the missing trades

Is the Kazakhstan Stock Exchange getting any better?

Though it bills itself as the second-largest in the Commonwealth of Independent States, the Kazakhstan Stock Exchange (KASE) suffers from thin trading. While the volume of trade doubled in the stock market over 2011, other KASE markets were less fortunate. The trade in the two largest – for foreign exchange and overnight loans (“repos”) – barely grew. The market for government securities shrank by a fourth. Overall, trade at KASE grew by less than 3% in the first nine months of 2011, less than half the rate of growth of the national economy.

The stock market at KASE illustrates its main problem. Stock purchases are large, few and far between. Consequently, prices are volatile. On August 19 alone, the KASE Index fell by nearly 5%. In a press statement, the Exchange blamed turbulence in global markets. The share price of copper mining alone fell more than 10% that day.

Such tailspins scare off risk-averse investors: Thin trading gets thinner. The volatility may also hinder the national economy. A sudden fall in stock prices reduces wealth and thus national spending. A steep rise may mislead stockholders into thinking that they are rich. Conceivably, they may try to buy more goods than producers can provide. Prices will rise throughout the economy. Hello, inflation.

KASE may seem too small to damage the macroeconomy. In terms of capitalization (the value of stock shares offered), the New York Stock Exchange is 325 times larger. But the volume of trade at KASE in 2011 exceeded the value of Kazakhstani production that year (gross domestic product). While fewer than 10,000 Kazakhstanis may trade at KASE, they include rich citizens who hold a disproportionate share of national private wealth.

Although its listings have been declining since 2009, KASE is in better shape now than in the late 1990s, when it had to suspend trading for a year or longer in government securities and currency futures (essentially bets upon the value of currency on a given date). One of its new rules, however, may handicap it. A firm that wants to list on KASE must offer at least a fifth of its shares there before going to foreign exchanges. This restriction cuts the rate of return to offering stocks. It may lead firms to prefer debt to equity more strongly than before, or perhaps to sell all shares on foreign exchanges rather than mess around with KASE. The Exchange’s trading may diminish again.



Brisk risk



Another reform may have ambivalent effects on KASE. Originally, KASE granted one vote for each share owned by the Exchange’s shareholders. When KASE went commercial in 2007, its general meeting decided to give each shareholder one vote regardless of his number of shares. Indeed, no shareholder can hold more than a fifth of KASE shares, reported Wikipedia. Had these rules not taken effect, a few large shareholders – like the pension funds – could have dominated KASE policy. Now a diverse group may influence what the Exchange does, but most of the decision-makers have too little at stake in KASE to want to gather much information about it. In effect, the new rules empower the management.

More auspicious for KASE is the People’s IPO (initial public offering), in which the government is selling off portions – ranging from 5% to 15% -- of its enterprises. Air Astana and KazTransOil may go public this year. The government estimates that Kazakhstani citizens may demand $100 million to $200 million of state-held shares. Kazakhstani pension funds, already major players in KASE, may snap up $200 million to $300 million of shares.

Now all we need is a People’s Exchange. KASE is caught in an infernal loop: Its lack of investors leads to price volatility, which in turn discourages potential investors. To attract them, KASE needs some relatively safe products, despite their small payoffs. The economic justification for this is the widely-accepted idea that an additional dollar of spending adds less satisfaction than did the dollar before it. A dollar means more to a pauper than to a millionaire because he needs it to survive. Given this assumption, an investor will turn down a “fair bet” – say, a financial investment with a 50% chance of gaining $1,000 and a 50% chance of losing $1,000 – because he likes the gain less than he dislikes the equivalent loss. A major stock that drops 10% in a day does not exactly commend itself to the risk-averse investor. – Leon Taylor, tayloralmaty@gmail.com





Good reading

Michael Quinn. Is the Kazakhstan Stock Exchange efficient? MBA thesis, KIMEP University, 2012.



References

Interfax-Kazakhstan. JSC Kazakhstan Stock Exchange President Kadyrzhan Damitov: New defaults possible. July 2011. Online. Yet another cheerleader interview with KASE’s president, retold in mangled English.

Wikipedia. Kazakhstan Stock Exchange. Online.

World Finance Review. Kazakhstan Stock Exchange: Better years ahead. December 2011. Online. Full of softball questions and grammatical gaffes.

Danger – insurance ahead

Does deposit insurance really insure against trouble?


Even before 2008, banking crises were common around the globe. One study reports 160 calamities in more than 150 countries over two decades. The currency crash of 1997 cost Thailand and South Korea nearly a third of their GDP – and Indonesia, almost half -- thanks to tottering banks.

Small wonder, then, that depositors demand insurance. In 1974, only 12 countries offered deposit insurance; by 1999, 71 did, according to Asli Demirgüc-Kunt and Edward Kane. Kazakhstan has offered deposit insurance since 1999, through the Kazakhstan Deposit Insurance Fund. It’s owned by the National Bank of Kazakhstan, which initially kicked in a billion tenge for the till. The Fund said it had enough to pay for the failures of two mid-sized banks, or 7 billion tenge. That was before 2008-9, when two of the nation’s largest banks collapsed. A deposit had been insured for up to 400,000 tenge ($2,700 at today’s exchange rate). In 2008, the Fund increased coverage to 5 million tenge ($33,800).

Yet insurance may increase the chances of a bank collapse. After all, a fully-insured depositor no longer has reason to monitor the care that the bank takes in lending. The insurance may also make the banks careless about their loans, because they know that most of their depositors can get their money back, regardless of whether the borrower pays back. In the United States, most banks paid no premiums for their deposit insurance, even though the risk of failure was not zero, reported Fred Furlong and Simon Kwan in 2002.

By making the banks careless, the insurance creates a “moral hazard” – that is, a change in behavior, arising from a contract, that hurts one of the signers. For example, in the Eighties, savings and loan associations in the U.S. – which offered home mortgages -- often had little net worth, so they literally bet the bank on risky loans. They figured that if the loans paid off, then they would profit handsomely, because they could charge a high interest rate for risk. And if the loans went bad? No problem: The federal government would pay off the depositors, and the thrifts weren’t worth much, anyway. In 1989 alone, 327 thrifts failed, according to Antoine Martin. The banks were also more likely to take risks in the Eighties when their charter value fell. Less efficient banks took on more risk, more loans per dollar of assets, concluded Thomas Siems in 2002.

In this light, Kazakhstan’s exemption of bank executives and top shareholders from insurance in bank failures seemed to address a special moral hazard. (The Kazakhstan Deposit Insurance Fund didn’t insure deposits of top executives and of shareholders who owned more than 5 percent of the bank’s voting shares. Neither did it insure the so-called VIP deposits – time deposits that exceeded 7 million tenge.) If the bank executive didn’t even have his own money at stake, then why should he object to risky lending that may indirectly push up his salary?

Ironically, the U.S. government offered deposit insurance to try to save the banks, during the Great Depression of the 1930s. If depositors knew that the government would reimburse them, then they might not have reason to run on the bank, all of them demanding their money at once. During the Depression, deposit insurance seemed to work: The number of bank failures fell from 4,000 in 1933 to just over 50 banks a year from 1934 to 1941, wrote Martin.


Branching for safety


Today, as developing countries with undercapitalized banks adopt deposit insurance, the moral hazards are more evident. Statistical studies suggest that banking crises are more likely in countries with extensive deposit insurance, particularly if its institutions are weak – for example, if the government is prone to corruption. You would think that the government of a developing country could stave off a banking crisis by guaranteeing to repay the depositors. But if the government is poor, then its promise is not credible.

We need not insure deposits in order to protect them. The bank could instead diversify its risk by offering branches. For example, YourBank may have a branch in Almaty and another in Astana. When education turns down, due to a booming national economy that attracts potential students into jobs, then the Almaty branch may do relatively poorly; but the Astana branch will be swimming in cash, and this will protect depositors in Almaty. During the 1920s in the United States, banks with branches were less likely to fail than banks without branches, according to economic historians Jeremy Atack and Peter Passell. Even before 2008, the number of bank branches in Kazakhstan was declining, according to First Initiative.

If the depositors will monitor the bank, then it will lend with care. One way to ensure that the depositors keep an eye on their institution is to make them co-pay for deposit losses, suggested Demirgüç-Kunt and Kane.

Otherwise, the government could motivate the bank to exercise caution by charging rates for deposit insurance that rise with risk; that rise, in particular, with the percentage of loans that are bad, since it is hard for the regulator to know exactly which loans are risky. Maybe the bank will promise to extend only safe loans, in order to procure the low premiums, but then lend to risky enterprises, in order to earn high rates of return, suggested Edward Simpson Prescott.

The government can also make clear that the healthy banks must repay the deposits at failed banks. This will give the healthy banks an incentive to monitor its ailing brethren. Finally, the government can close weak banks before they go under. Under a 1991 law in the U.S., the feds could close any bank with a capital-to-asset ratio below 2 percent. That is, if the bank’s net worth is less than 2 percent of its assets, which are mainly loans, then the government can shut it down. This, at the least, avoids the expense of reimbursing the depositors in the event of a bank failure, noted Martin. Canada has a provision like this. As a consequence, when Canada introduced deposit insurance, the banks did not take many more risks. – Leon Taylor, tayloralmaty@gmail.com





Good reading


Charles Calomiris. Is deposit insurance necessary: A historical perspective. Journal of Economic History 50. Pp. 283-296. 1990.

Fred Furlong and Simon Kwan. Deposit insurance reform – when half a loaf is better. Federal Reserve Bank of San Francisco Economic Letter. May 10, 2002. Online.

Asli Demirgüc-Kunt and Edward J. Kane. Deposit insurance around the globe: Where does it work? Journal of Economic Perspectives 16:2, summer 2002, pp. 175-195. Online.

Antoine Martin. A guide to deposit insurance reform. Federal Reserve Bank of Kansas City Economic Review. First quarter 2003. Online.

Thomas F. Siems. Survival and the hump in the CAMELS. Federal Reserve Bank of Dallas Expand Your Insight. October 2, 2002. Online.

Edward Simpson Prescott. Can risk-based deposit insurance premiums control moral hazard? Federal Reserve Bank of Richmond Economic Quarterly. Pp. 87-100. Spring 2002. Online.

Jeremy Atack and Peter Passell. A new economic view of American history. New York: W.W. Norton. Second edition. 1994.

Eugene Nelson White. State-sponsored insurance of bank deposit in the United States, 1907-1929. Journal of Economic History 41. Pp. 537-58. 1987.



References


First Initiative. www.firstinitiative.org

International Association of Deposit Insurers. Member profile: Kazakhstan Deposit Insurance Fund. www.iadi.org

Kazakhstan Deposit Insurance Fund. Otveti na chasto zadavaemie voprosi (FAQ). The Fund does not offer a FAQ for depositors in English. www.kdif.kz

A plight to remember

Has London anything to teach Almaty?



Amid economic growth, prices have remained volatile in Central Asia since the turn of the century. A measure of dispersion, the standard deviation, was twice as volatile for prices in the region as for those in the United States from 2000 through 2009. Even Kazakhstan, which has the strongest economy in Central Asia, has suffered more inflation over the period than has the U.S., according to World Bank data.

Fluctuating rates of inflation induce buyers and sellers to err, because they cannot be sure whether the price changes they observe for some product are due to changes in its supply and demand or to inflation that has yet to affect other products. Such errors retard economic growth. Since long-run inflation usually occurs because of excess money in the economy, is it time for the National Bank of Kazakhstan to stabilize money supply rather than the exchange rate?

A similar debate in England almost two centuries ago may shed light on the National Bank’s predicament. In the early 1800s, the price of a typical bundle of goods in England -- the “price level” -- fell about as sharply as it rose, resembling a roller-coaster. The most influential critics of the Bank of England, called the “Currency School”, demanded that the central bank stabilize the money supply, which at that time comprised gold and silver as well as paper money. Led by Lord Overstone, the critics argued that the Bank’s fine-tuning of money had undermined its credibility. In a recession, speculators could anticipate that the bank would issue more paper money, effectively to try to stimulate spending. But because the new money was not backed by a commensurate increase in gold, a pound sterling would lose value. Speculators knew this, so they would try to profit in advance by selling pounds to banks in exchange for gold. The loss of gold reserves left the banks vulnerable to panicked withdrawals of yet more gold. Sooner or later, the banks would collapse. Rather than risk this scenario, the Bank of England should commit to a given level of money supply -- no matter what the commercial banks demanded -- in order to preserve confidence in banking. A few commercial banks would fail, because the Bank would not lend to them in emergencies; but this was better than losing the system of banks.

The friends of the Bank, called the "Banking School", thought the Currency medicine too harsh to swallow. The Bank should simply lend to anyone who was creditworthy, they argued. Because such people borrowed money only to increase output, the resulting economic growth would justify expansion of the money supply. (To buy more goods, we need more money.) The best way to stabilize the economy was to ensure that people could always get gold from banks in exchange for paper money (or near-money, like bills of exchange). Secure in that knowledge, they would not run on banks.


Taking chances


In 1844, Parliament bought the Currency argument. It compelled the Bank to back its paper money 100% with reserves of precious metals. To issue additional notes, the Bank would need additional gold. The Bank also had to separate its two main functions – managing the money supply and supporting commercial banks.

In a few years, the Bank was back in a jam. When English harvests failed, grain imports and prices rose. So did the demands for liquidity from commercial banks.  Before 1844, banks might have been able to make good on the withdrawals by drawing upon the reserves that they kept at the Bank of England. But the Bank’s Issue and Banking departments had been separated; the Issue department had plenty of gold in reserve, but the Banking department didn’t. So it balked at issuing notes.  In the liquidity crisis that followed, the government suspended the 1844 law and authorized the Bank to lend freely at an unusually high rate of interest (8%), noted an economic historian, John Wood.


Unfortunately, such largesse may bring on the crises that it was meant to prevent. Suppose that speculators anticipate that a crop failure will lead the Bank eventually to lend notes freely. They realize that this increase in money supply may lower the value of a note (in terms of the products that it can purchase). So, as soon as the crops fail, they will exchange their notes for gold while these are still worth something. Gold reserves at the banks will fall, stirring doubts about the value of the notes and paving the way to a panic.

The National Bank of Kazakhstan faces a similar conundrum today. Countries today are no longer on a gold standard, but the U.S. dollar plays a similar role, since it exchanges easily for most currencies. Should the National Bank maintain large reserves of dollars, in order to avoid lapses of public confidence in Kazakhstan’s currency? Or should it use the dollars to bail out troubled banks? Should it announce that it will permit the money supply to increase at only the rate of economic growth, no matter what the immediate demands for money may happen to be? Suddenly, London is no longer so distant from Almaty. – Leon Taylor, tayloralmaty@gmail.com


Good reading

Walter Bagehot. Lombard Street. Various publishers. 1873. A classic tract of monetary economics by the editor of The Economist.

Anna J. Schwartz. Banking School, Currency School, Free Banking School. In John Eatwell, Murray Milgate and Peter Newman, editors, New Palgrave Dictionary of Economics: Money. Norton. 1987.

John H. Wood. A history of central banking in Great Britain and the United States. Cambridge University Press. 2005. Lively and informative.


References

World Bank.  World Development Indicators.  http://www.worldbank.org/

A grain of truth

Are grain farmers in Kazakhstan acting on bad information?


The grain market in Kazakhstan may be headed for the economic version of a train wreck. According to the business weekly Kursiv’, experts expect an increase in Chinese demand for Kazakhstani grain this year, accompanied by a shortage of grain carriers and granaries in the country as well as by a reduction in the harvest since last year’s record yield.

All of these factors presage an increase in grain prices here. But what is most striking about the market is its volatility. The grain yield in 2011 was more than twice that of 2010, which in turn was 40% below the yield in 2009, according to Kursiv’.

Cobweb, anyone?

The term refers to a market in which output and prices fluctuate because producers act upon mistaken expectations. Suppose that wheat prices are unusually low in Year 1. Farmers planning for next season’s market may assume that prices will remain anemic; and so they will sow little. As a result, the harvest will be small. This scarcity of wheat will send its prices soaring in Year 2. Now farmers, anticipating a bonanza, will sow a bumper crop…which will pull prices back down in Year 3. Economists call this predicament a “cobweb” because of the ever-growing oscillations of price and quantity when plotted on a market graph. Its vital feature is that the farmer always presumes that this year’s price will also be next year’s.

The grain market in Kazakhstan may be particularly vulnerable to cobwebs because nearly 90% of the country’s yield goes into the domestic market -- partly because of the lack of export facilities, although the country is a leading exporter of wheat and flour. In the domestic market, sharp changes in output may lead to sharp changes in prices.  On the other hand, wheat farmers in northern Kazakhstan may sow regardless of the expected price because they have few other uses for the land, suggest researchers at the United States Department of Agriculture


Cobwebs in the brain


A cobweb market has two causes. First, producers assume that current conditions will hold in the coming season. The government can address this misunderstanding by publicizing more sophisticated forecasts – or by developing the futures market, which rewards accurate forecasting.

Second, the farmer when planning his sowing assumes that his harvest will be too small to affect the national output and price. That’s rational, but if every farmer makes that assumption as well as the one of cobweb prices, then the national market may indeed gyrate.

One solution to this problem – organizing the farmers into a cartel that will make sowing decisions for all – is the sort of cure that kills the patient. Unfortunately, with its penchant for industrial planning, the government may choose essentially this treatment. A less intrusive policy would have the government – perhaps via KazAgro -- buy surplus grain in bumper years and release it in years when the harvest comes a cropper.

The cobweb model fails to explain why farmers repeat their errors when there is money on the table. Perhaps the market oscillations arise from rational expectations – which use all available information, not just past prices -- about shocks to the system. For example, a cattleman must decide whether to slaughter and sell his animal now or to breed it. A rise in beef demand that seems temporary may lead to more slaughters for a while. This affects the age distribution of the cattle, the birth and death rates, and ultimately the size of the stock. The cattle cycles generated may resemble cobwebs, but they stem from well-informed decisions.

At the University of Chicago, economists Sherwin Rosen, Kevin Murphy and José Scheinkman found that a rational-expectations model snugly fit the cattle cycles observed over 115 years when adjusted for trends in beef demand. They write: “Shocks to demand and supply have persistent long-term effects on future shocks by changing farmers’ incentives to carry breeding stock and altering the age composition and reproductive capacity of herds.”

Some studies have tried to observe cobweb expectations directly, by running a laboratory experiment. Participants in a simulated market are asked to predict the price in the next period. At the University of Arizona, Charissa Wellford found “little or no indication that cobweb or rational expectations are employed by the sellers.” (A pox on both houses.) Adaptive expectations, in which one forecasts the price partly by extrapolating past prices, “perform somewhat better.” This is not the first time that a cherished notion from economics has failed to find support in the lab. -- Leon Taylor tayloralmaty@gmail.com





Good reading

Mordecai Ezekiel. The cobweb theorem. Quarterly Journal of Economics 52: 255-80. February 1938.

United States Department of Agriculture, Production Estimates and Crop Assessment Division, Foreign Agricultural Service.  Kazakhstan Wheat Production: An Overview.  Online.


References

Sherwin Rosen, Kevin M. Murphy, and José A. Scheinkman. Cattle cycles. Journal of Political Economy 102: 468-92. June 1994.

Bakitzhan Toksharayev. Nazlo recordam. Kursiv’. March 20, 2012.  Page 1.

Charissa P. Wellford. A laboratory analysis of price dynamics and expectations in the cobweb model. University of Arizona Discussion Paper 89-15. 1989. Online.

The saving grace

Does Kazakhstan save enough to ensure future growth?

A student radical once asked the philosopher Sidney Morgenbesser if he agreed with Mao Zedong’s pronouncement that a statement could be both true and false. Morgenbesser replied, “I do and I don’t.”

In the same way, Kazakhstan is poor and it isn’t. Adjusted for prices and exchange rates, its income per person is less than a sixth of that of an American, according to World Bank data. But the nation saves a much larger share of income than does the U.S. (Any income that is not spent or paid in taxes is “savings.”) National savings – deducting the amount needed to replace worn-out capital – have increased steadily in Kazakhstan, from 4% of gross national income in 2000 to 20% and higher after 2006. Mr. Micawber, in Charles Dickens’s David Copperfield, would have approved. “Annual income twenty pounds, annual expenditure nineteen, nineteen six, result happiness,” the clerk intoned. “Annual income twenty pounds, annual expenditure twenty ought and six, result misery.”

Savings pay for expansion of stores and plants, for education, and for other ways to increase the amount that we can produce in the future. Such additions to our means of production are what economists mean by “real investment.” Thus, Apple invests when it builds a factory. When you buy a stock share of Apple for $80, you don’t invest; you save. When Apple spends the $80 on its plant, then it becomes investment.

The way that household savings pay for investment is simple: Kazakhstanis stash their savings into accounts at the bank, which lends them out to businesses (or, for that matter, to college students who borrow in order to pay tuition – yet another form of investment).

Since the slowdown of the global economy in 2008-9, however, real investment has stagnated in Kazakhstan. In Almaty, investment in fixed capital – immobile assets such as office towers -- in the first half of 2011 was 2% below that of early 2010. One problem is that household income in Kazakhstan remains too modest to provide huge savings.

Treasure chests of tenge

Another way to pay for investment is through businesses themselves. Firms save by hanging on to profits rather than paying them out as dividends to shareholders. In the U.S. before the Great Recession, these retained earnings came to a trillion dollars a year and were the country’s largest source of funds for investment. In Kazakhstan, retained earnings are anemic, partly because our market economy is only two decades old – not enough time for firms to build up their coffers of profit.

A sort of hybrid of the household and the firm is the venture capitalist. She lends savings to the entrepreneur directly, as a general partner who owns part of the funded project. Once the project sells its shares to the public, he sells his own shares for a profit. Only one project of every ten ever gets that far, but they include Microsoft, Apple Computer, Intel and Federal Express, note two American researchers, Edgar Parker and Phillip Todd Parker. Venture capital is less visible in Kazakhstan than in the U.S.

Aside from households and firms, who else can provide savings to finance investment in Kazakhstan? The remaining possibilities are the government and foreigners. We can quickly rule out the latter. To accumulate savings, foreigners must sell more products to Kazakhstan than they purchase from it. But the reality is the opposite. Kazakhstan has long had a trade surplus; its exports exceed its imports. (On the other hand, foreigners do invest in Kazakhstan. As a share of Kazakhstan’s economy -- measured by the market value of Kazakhstan’s annual production, called “gross domestic product” -- the net inflow of foreign direct investment increased 24-fold after 1992 to 12% in 2008, according to World Bank data.)

That leaves the government. Its National Fund of oil export taxes holds $45 billion, the rough equivalent of a third of Kazakhstan’s income. It is the obvious potential source for financing investment in health and education. – Leon Taylor, tayloralmaty@gmail.com


Good reading


Jagdish Bhagwati. Don’t cry for Cancún. Foreign Affairs. January/February 2004. The source of the story about Mao Zedong. Online.

Edgar Parker and Phillip Todd Parker. Venture capital investment: Emerging force in the Southeast.  Economic Review. Federal Reserve Bank of Atlanta.  Fourth quarter 1998.  Pp. 36-47. Online.


References

World Bank. World Development Indicators. Online.

Bank shot

Does Lombard Street have any news for the National Bank of Kazakhstan?


Who calls the shots at a central bank – and why?

The historical answer of economists has been that the bank’s governor makes the key decisions in order to benefit the public. “…We ought to be able to assume that the Central Bank will be at least as intelligent as a Member Bank and more to be relied on to act in the general interest,” wrote John Maynard Keynes in 1930, in A treatise on money. The Bank of England was “the conductor of the orchestra [which] sets the tempo.”

Unlike Keynes, Walter Bagehot -- editor of the London newspaper The Economist -- viewed the structure of the Bank of England as an exercise in politics. In the 1870s, the Bank’s board of directors consisted mainly of merchants. They, quite naturally, sought profit: So they instructed the Bank to minimize its reserves, since money in the vault earns no interest. This kept the Bank from managing economic panics. Hefty reserves of gold would have pacified people who worried that paper money would lose its value, since the Bank was prepared to exchange gold for cash. Without the gold, the Bank could not assure the public that it could always maintain the going exchange rate for cash; and so people would dump their money anywhere that would give them a little gold. The exchange rate for cash would collapse. Those left holding the money-bags would realize their worst fears.

Bagehot proposed that the Bank maintain an announced minimum of reserves that was high enough to mollify people in panics. To enforce this rule, the Bank should appoint a sort of managing director who handled day-to-day matters. To protect him from political pressure, this director could hold his position for life. At the time, the two top officers of the Bank were political appointees on two-year terms, with the deputy governor automatically relieving the governor at the end of each term.

Bagehot’s reforms would have required a new vision of the central bank. “…The distinct teaching of our highest authorities has often been that no public duty of any kind is imposed on the Banking Department of the Bank [of England],” wrote Bagehot in Lombard street, “that, for banking purposes, it is only a joint stock bank like any other bank; that its managers should look only to the interest of the proprietors and their dividend; that they are to manage as the London and Westminster Bank or the Union Bank manages.”



Buy low, sell high



Would the structures of central banks in Central Asia satisfy Bagehot?

Consider the National Bank of Kazakhstan. The enabling legislation says the Bank is “accountable” to the president of Kazakhstan, who appoints (and removes) the governor and four deputy governors to six-year terms, with the consent of the ever-obliging Senate. The Bank’s 10-member board includes an assistant to the president as well as the ministers of finance and of economic development and trade.

A few real-world details may bring the picture into focus. In 2007, the National Bank of Kazakhstan had set its exchange rate at 120 tenge to a United States dollar. In the global slowdown of the following year, demand weakened for Kazakhstani products; so, demand for the tenge weakened as well. Since the official value of the tenge was now above its market value, speculators could profit by purchasing tenge cheaply on the street and essentially selling them back to the central bank at the high official value, in exchange for dollars. (On the street, buy 150 tenge for a dollar, then sell the tenge to the Bank for $1.25. Repeat until rich.) As a result, dollars began to drain out of official reserves. The National.Bank faced the prospect of soon having too few dollars with which to defend the official exchange rate.

At this point, the president of Kazakhstan, Nursultan Nazarbayev, stepped in. He appointed a new governor of the Bank, Grigoriy Aleksandrovich Marchenko, who quickly devalued the currency to 150 tenge per $1. That gutted any speculative attack on the official dollar reserves.

Devaluation was probably the correct decision, but that is not my point here. My point is that the decision was basically political. It had not been made by a civil-service director of the Bank, which is what Bagehot had in mind. It had been made by politicians.

Bagehot would ask: What would prevent Astana in the future from appointing a Bank governor who acted in the interests of politicians -- say, by inflating the money supply in order to create spending and jobs just before an election, regardless of eventual inflation? Granted, the legislation states that the Bank’s prime aim is price stability; but what would happen if stable prices would jeopardize the re-election of an incumbent president? Bagehot would probably propose a Bank charter that mandated longer-term appointments on the basis of merit, not of politics. -- Leon Taylor, tayloralmaty@gmail.com


Good reading

Walter Bagehot. Lombard Street. Various publishers. 1873.

Nariman Gizitdinov. Kazakh central bank devalues tenge 18%, ends support. Bloomberg News. February 4, 2009. www.bloomberg.com

Silk Road Intelligencer. Marchenko’s appointment clears path to devaluation. January 26, 2009. www.silkroadintelligencer.com


References

John Maynard Keynes. A treatise on money. London: Macmillan. 1930.

Doctor’s disorders

If Kazakhstanis are nearly affluent, why can’t they afford good health?


Kazakhstan recovered from the troubled transition to markets in the 1990s more successfully than any other nation in post-Soviet Central Asia. Since 2000, when it had finally recovered from the Russian ruble crash of 1998, its economy has galloped at a pace that would double the income of the average resident every decade. In Almaty, shopping malls offer Italian boots and plasma televisions with larger-than-life flat screens.

Yet….

I have an acquaintance who cleans floors for a reputable employer in Almaty. A recent accident of hers required knee surgery. The bill was $6,000.

In the West, her predicament would have posed no problem. Health insurance from the government or the employer could easily have covered $6,000 – and kept her out of a wheelchair.

But this is Kazakhstan. The middle-aged woman’s health insurance through her employer did no more than pay 5,000 tenge ($34) for medication. The employer would not lend her money for the operation, although her paycheck could have served as collateral. The government offers no health insurance worthy of the name. So she had to scrounge among family and friends for $6,000 in cash (dollars, pazhalsta).

Her dilemma is not unique. In Kazakhstan, stories are rife of physicians demanding a payment under the table for emergency surgery.


Under the green knife


This may help explain why the country’s rapid economic growth has barely affected the most important indicator of economic development -- life expectancy at birth. By 2009, the average span of life had stalled at 64 years for males and 74 years for females, virtually the same as the expectancies of 64 years and 73 years, respectively, that prevailed in the Soviet 1980s, according to data from the World Bank and the World Health Organization. The short life spans are due in large part to Kazakhstan’s high rate of infant mortality – 29 deaths in every 1,000 live births in 2010, although the rate has been dropping, according to the World Bank. Rates of roughly 5 deaths or fewer per 1,000 births are common in the West.


One reason for these disparities may be the lack of comprehensive health insurance here. A statistical study by John Ayanian and coauthors suggests that, in the United States, the insured are more likely to buy preventive care – such as a normal checkup in the past two years -- and thus to avoid some hospitalization.

You might think that Kazakhstan’s privatization of much of the health sector over the past 15 years would automatically create profitable opportunities for insurers. Governments in Kazakhstan, which in the late 1990s dedicated one-seventh of their budgets to health care, spent only 11% that way in 2007, according to the World Bank. Since the early 2000s, the burden of paying for health care has been shifting to individuals, who provided two of every five dollars spent on health in 2009, according to World Bank data. The need for private insurance, in a country where the typical hospital visit can cost as much as two months’ worth of individual income, would seem clear.

Nevertheless, private insurance for major illnesses is not available to most Kazakhstanis today. The probable reason is that private health insurance plans are subject to an odd market failure. To make a profit, the insurer must set the premium above the expected cost per policyholder of claims. But this premium will drive away policyholders who have lower-than-average costs of claims. While the insurer thus loses healthy policyholders to cheaper plans (such as self-insurance), it retains the sickest of its old policyholders, since they expect their claims to exceed the premiums that they pay. Since the insurer retains only the sickest, its expected cost of claims per policyholder will rise. To cover this cost, the insurer must raise its premiums -- scaring away the few healthy policyholders that it still has. Eventually, this process of "adverse selection" will bankrupt the insurer.

As a result, few private comprehensive health insurance plans around the world make money.  No such plan seems to exist in Kazakhstan. But the government can resolve the problem by uniformly taxing the populace to finance public insurance. This requirement forces healthy Kazakhstanis to subsidize health care for sick Kazakhstanis, thus avoiding adverse selection. Public insurance also spreads health costs over a large pool of insurees, reducing fluctuations in the income of sick families (since such families pay low premiums in exchange for an annual income that remains stable despite sickness).


Is insurance out of style?


In 1996, the government launched exactly this insurance plan, financed by a 3% tax on payroll. It killed the plan two years later, when firms refused to provide the tax revenues at a time when Kazakhstan was suffering a slowdown. Perhaps Astana can afford public health insurance now, since the National Fund of oil tax revenues has a net international reserve of $33 billion, about $2,000 per Kazakhstani, according to data from the National Bank of Kazakhstan.

Public health insurance here would not be out of step with the West. The only industrialized countries that lack public comprehensive health insurance today are the United States and Turkey – and the former has taken steps in the past two years toward such a policy.

Comprehensive health insurance is no panacea. Because insurance rewards the policyholder for detrimental outcomes, it weakens his incentive to avoid them. The buyer of home insurance, which will fully compensate him for damages due to a house fire, no longer has reason not to smoke in bed. The buyer of health insurance covering the costs of lung cancer may now light up a celebratory cigarette. In fact, the incidence of lung cancer is rising in Kazakhstan, where a pack of Western-style cigarettes costs as little as 30 cents. In the West, “sin” taxes have raised the price of a pack in places such as Manhattan to more than $11.

This source of inefficiency notwithstanding, public comprehensive health insurance could shield families from catastrophic reductions in income. And it may provide needed money to health care providers – especially in rural areas, where midwives (feldsheri) must often go without weight scales and even syringes; and, more generally, throughout a country where the average doctor literally has made less money than the average worker.

In 2009, total spending on health care in Kazakhstan comprised 4.5% of gross domestic product, less than half the proportion that prevails in Europe, according to the World Bank and the World Health Organization. Perhaps Kazakhstanis die young largely because they spend too little on the most critical stock of human capital of all – health. The government has the power to correct this deficiency. – Leon Taylor, tayloralmaty@gmail.com


Good reading


David M. Cutler. Equality, efficiency and market fundamentals: The dynamics of international medical care reform. Journal of Economic Literature 40:3. Pages 881-906. September 2002.

Rexford E. Santerre and Stephen P. Neun. Health economics: Theories, insights and industry studies. Fourth edition. Mason, Ohio: Thomson Higher Education. 2007.


References


John Z. Ayanian, Joel S. Weissman, Eric C. Schneider, Jack A. Ginsburg, and Alan M. Zaslavsky. Unmet health needs of uninsured adults in the United States. Journal of the American Medical Association 284: 16. 2061-9. October 25, 2000.

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

World Bank. World Development Indicators. www.worldbank.org

World Health Organization. World health report. Various years. http://www.who.int/

A version of this article appeared in the Caspian Business Digest in 2007.