Monday, 31 May 2010

A good question

Why is it
[...] when BP screws up we make sure they pay every dime in damages, but if a bank screws up we bail them out with taxpayer money.
So asks Captain Capitalism

Red tape is your (very expensive) friend?

This from the Wall Street Journal,
AirSea's odyssey illustrates one of the key problems preventing Greece from generating the economic growth it needs to pay off its heavy debts: Critics say a sprawling civil service has tried to secure its own survival through an opaque patchwork of fees, taxes and red tape. The European Commission estimates the administrative burden of Greece's bureaucracy—the value of work devoted to dealing with government-imposed administration—is equivalent to 7% of gross domestic product, twice the EU average.
You have to ask what effect such costs have on entrepreneurship within Greece and its effect on foreign investors. It has to be deterring economic growth increasing activities by both groups.

The article goes on to say
Tourism is Greece's top money earner. But despite the country's magnificent coastlines and ancient monuments, many visitors are young people traveling on a shoestring. Operators trying to attract higher-end tourists say ham-handed government moves have driven business away.

This past August, for example, Athens imposed a new tax on yachts in an effort to close its budget gap. A 43-foot craft under a foreign flag was levied $5,265 a year if it had spent more than 40 days a year in Greek waters since March 2009. For a 98-foot boat, the charge was about $27,000.

The new tax "was a squeeze-the-rich measure, so they just left," withdrawing a much-needed source of crew salaries, port fees, fuel taxes and onshore spending, says Peter Custer, marketing and sales manager at Privatsea Yachting, a yacht-services firm in Athens. (Emphases added)
People respond to incentives, by and large if you tax something you get less of it, and that can mean less economic actvity just at the time you need it most, as Greece now does.

Sunday, 30 May 2010

China and India: awakening giants, feet of clay

From comes this audio in which Pranab Bardhan of the University of California, Berkeley, talks to Romesh Vaitilingam about his new book "Awakening Giants, Feet of Clay: Assessing the Economic Rise of China and India". He argues that significant poverty reduction in both countries is mainly due to domestic factors – not global integration, as most would believe.

Privatisation: problems

In the comments to a previous post PaulL asked
During your research for this, were there any counter-studies that you haven't mentioned here, or would you say this is a reasonable sample of the literature?
I think it is an reasonable quick look at the evidence but obviously there have been a number of privatisations that have not worked out. The question is Why?

When discussing privatisation in Latin America, Alberto Chong and Florencio Lopez-de-Silanes write,
Overall, the empirical record shows that privatization leads not only to higher profitability but also to large output and productivity growth, fiscal benefits, and even quality improvements and better access for the poor. Instances of failure exist, but in light of the overwhelming evidence, these failures should not be turned into an argument to stop privatization. The analysis in this chapter suggests that privatization failures can be understood in a political economy framework. Their roots can be traced to substantial state participation in opaque processes, poor contract design, inadequate reregulation, and insufficient deregulation and corporate governance reform that increase the cost of capital and limit firm restructuring in a competitive environment. (Chong and Lopez-de-Silanes 2005: 2)
The basic points they make are true of a wider range of privatisation programmes. A badly formulated and run programme will give bad results.

An major example of these problems is given by the early privatisation programme in Chile. Ronald Fischer, Rodrigo Gutierrez and Pablo Serra explain:
Most financial firms, as well as several banks that had been privatized from 1975 to 1979, were taken over by the state during the economic crisis of 1981-83. Beginning in 1981 several banks became effectively insolvent because they could not recover loans from troubled companies, many of them related firms, which were either bankrupt or had suffered severe losses. The government took over four banks in November 1981 and two more the following year, all of which were later closed. In January 1983 the government had to take over eight additional banks that had failed to repay international loans (three of these banks were later closed down). Ironically, most of the financial institutions that had been privatized during 1975 and 1976-representing 55 percent of all financial assets-were again being run by the state in the early 1980s (Rosende and Reinstein 1986).

By December 1984 the accumulated losses of the financial sector represented more than 200 percent of the sector's equity and reserves and 18 percent of GDP (Valenzuela 1989). To continue to have access to international credit markets, the government had to guarantee all foreign loans of the banks that it had taken over while rescuing local depositors. The government also took over many nonfinancial companies, as well as the private pension funds (Administradoras de Fondos de Pensiones [AFPs]) that were linked to the troubled banks, either because they had unpaid loans from the banks or because they were owned by the same economic conglomerates (Rosende and Reinstein 1986). Between 40 and 90 firms were taken over by the state, giving rise to the so-called a'rea ram ("gray sector"). Hence in the 1982 crisis, the state once more became the controller of many previously privatized firms. This new period of state control was fairly short-lived, and firms were not considered to be truly state-owned.

The trigger of the crisis may have been international in origin (a large rise in the prime lending rate in 1981 plus a moderate fall in the terms of trade), but the impact was amplified by mistakes in economic policy, some of which were related to the privatization process. The Chilean financial system was sufficiently fragile that the rise in interest rates, coupled with the stoppage in capital inflows, weakened the new conglomerates, most of which had high debt-to-asset ratios. The mechanisms used for privatization in the 1970s led to concentrated property holdings and gave rise to conglomerates that were highly leveraged (Sanfuentes 1984). In many cases, the buyers of banks used bank deposits to pay the loans incurred in acquiring the banks. When nonfinancial firms were privatized in 1976-77, the new owners of banks also used their clients' deposits or loans from other financial institutions to buy the firms. As mentioned, the buyers were required to put up collateral for 150 percent of the loan used to buy state-owned firms, but shares in the firm could be used as collateral. In this way, large and highly indebted conglomerates were formed.

The lack of regulation in the banking system made it easy for the banks to lend money to related firms, and even when restrictions were imposed on related lending, they were easily eluded. In the case of the two main banks, 71 nprcent and 50 Dercent of all loans went to conglomerate members. Bank regulators did not keep track of the quality of the loan portfolios, Ideology played its part in the lack of regulation, since government economists argued that if the banks were receiving deposits, private investors must have decided that the projects to which the banks were loaning money were profitable, and regulation was unnecessary. However, the regulators failed to realize the effect of implicit deposit insurance on their assumptions. In 1976 depositors in a failing newly privatized bank had been protected from losses, which created the perception among depositors of the existence of implicit state insurance. Moreover, investors in the conglomerates believed that they were too large to fail (Vergara 1996). Regulatory changes to monitor the quality and supervise the concentration of bank loans were put in place only in 1982; a stringent new banking law was not introduced until 1986.

In addition to the financial resources from their affiliated banks, the two largest conglomerates managed mutual funds (82 percent), insurance companies (53 percent), and pension funds (68 percent) that granted them even more control over the economy (Sanfuentes 1984). These institutions bought shares of firms in the conglomerate, thus raising share prices. The indebtedness of the conglomerates resulted in part from the level of real interest rates in the 1975-81 period, which was high because of the excessive demands for credit from the conglomerates to buy even more privatized firms. The high real rates were compensated by capital gains in the stock market. In 1981 the government allowed banks to contract loans abroad, which led to a rapid increase in indebtedness. Firms that had access to international loans obtained credit at much lower rates than could smaller firms with no access. In less than two years foreign debt doubled, with the two largest groups holding 52 percent of the debt.

Starting in 1985 the banks that had been taken over began to be privatized once again. Preferred shares representing 70 percent of equity were sold to new buyers. The banks sold their bad loans to the central bank and were recapitalized. In return, the central bank became a claimant on future profits of the banksg When selling the two major banks, the government strove to create a broad-based class of shareholders for two reasons: to provide stability and to make it more difficult to reverse the privatization process. The mechanism was so-called "popular capitalism": buyers were required to put only 5 percent down, while CORFO gave them a 15-year loan for the remainder. There was a 1-year grace period at a zero real interest rate, a 30 percent discount for timely repayment of the loan, and generous tax benefits. The number of shares per buyer was limited (and limits were enforced). Three additional banks were sold to groups of investors.

The two main conglomerates had been the owners of the larger AFPs (Provida, Santa Maria, San Cristbbal, and Alameda), which held 68 percent of workers' pension funds. The two largest (Provida and Santa Maria) were sold under the popular capitalism scheme (without the tax benefits). Aetna, which owned 49 percent of AFP Santa Maria, bought enough shares to get control, while the rest went to small buyers. Banker's Trust bought 40 percent of the shares in Provida, with the remaining shares going to small buyers. The other two AFPs were merged and auctioned under the name of AFP Union.

After their recapitalization, the government also auctioned the other firms it had taken over. In most cases, a controlling package was auctioned, but in contrast to the procedures of the 1970s, the government required that payment be up-front. Local conglomerates in association with foreign investors bought the major companies. To make the auctions more attractive to foreigners, they were allowed to pay with Chilean bonds that were selling in the market at 60 percent of par value. Unfortunately, little information is available about the details of the transactions of that period, as there seem to be no clear records. (Fischer, Gutierrez and Serra 2005: 207-10)
So as argued above if you implement a privatisation programme badly you are most likely to bad results, just like any other policy programme.
  • Alberto Chong and Florencio Lopez-de-Silanes (2005). 'The Truth about Privatization in Latin America'. In Alberto Chong and Florencio Lopez-de-Silanes (eds.) "Privatization in Latin America: Myths and Reality", Washington: World Bank.
  • Ronald Fischer, Rodrigo Gutierrez and Pablo Serra (2005). 'The Effects of Privatization on Firms: The Chilean Case'. In Alberto Chong and Florencio Lopez-de-Silanes (eds.) "Privatization in Latin America: Myths and Reality", Washington: World Bank.

Friday, 28 May 2010

Privatisation: the "facts"

Let us now take a look at a few of Marty G 's "facts" about privatisation.
Fact 1) We - the ‘mums and dads’, the brothers and sisters, even the aunts and uncles - already own Kiwibank and other public assets.
Actually no we don't. The government does. The government has the residual control rights over these assets and thus they own them.
Fact 2) ‘Mums and dads’ don’t end up owning privatised assets.
They may not but why should we worry? The idea of the sale of any asset is to get it in the hand of whoever values the asset most highly. That may or may not be "Mum and Dads".
Fact 3) Privatisation harms markets.
I'm not sure that even make sense. I'm not sure how getting more firms into a market can "harm the market" - whatever that means. The evidence tells us that privatisation increases competition in markets and I can't see how that "harms the market".
Fact 4) Privatisation leads to asset-stripping.
It may or may not. In some cases that is exactly what should happen. In a number of cases, eg NZ Rail, the business as sold wasn't viable and thus needed reorganisation. Privatisation is a good way of doing this.
Fact 5) We also get a bad deal on SOE sales.
How can we tell? If this means we don't get the highest price possible for an asset then why worry? The idea idea for asset sales isn't to sell at the highest price, if it was then the government should make all SOE's into monopolises before selling them as monopolises command a higher price than competitive firms. Even Marty G should be able to see the problem with that!!!!
Fact 6) Kiwibank doesn’t need to be partially sold to get money for expansion. The cheapest source of capital is the government
If this is true for Kiwibank then it is also true for all other firms and thus the government should supply the capital for all firms. To get capital allocated rationally you need the price of capital to be the market price so that it reflects the true opportunity cost of that capital.

Thursday, 27 May 2010

Privatisation: the facts

Over at the (low) Standard Marty G is proving once again that he doesn't know much about economics. He gives us Privatisation: The facts. Read them if you must. As a public service let me give some actual facts about privatisation.

As to the evidence on the subject the following comes from the summary of chapter 4, 'Empirical Evidence on Privatization's Effectiveness in Nontransition Economies', from William L. Megginson's book "The Financial Economics of Privatization", New York: Oxford University Press, 2005,
The 87 studies from nontransition economies discussed in this chapter offer at least limited support for the proposition that privatization is associated with improvements in the operating and financial performance of divested firms. Most of these studies offer strong support for this proposition, and only a handful document outright performance declines after privatization. Almost all studies that examine post-privatization changes in output, efficiency, profitability, capital investment spending, and leverage document significant increases in the first four measures and significant declines in leverage.

The studies examined here are far less unanimous regarding the impact of privatization on employment levels in privatized firms. All governments fear that privatization will cause former SOEs to shed workers, and the key question in virtually every case is whether the divested firm's sales will increase enough after privatization to offset the dramatically higher levels of per-worker productivity. Three studies document significant increases in employment [Galal, Jones, Tandon, and Vogelsang (1992); Megginson, Nash, and van Randenborgh (1994); and Boubakri and Cosset (1998)], but most of the remaining studies document significant-sometimes massive- employment declines. These conflicting results could be due to differences in methodology, sample size and make-up, or omitted factors.

However, it is more likely that the studies reflect real differences in post-privatization employment changes between countries and between industries. In other words, there is no "standard" outcome regarding employment changes.

Perhaps the safest conclusion we can assert is that privatization does not automatically mean employment reductions in divested firms, though this will likely occur unless sales can increase fast enough after divestiture to offset very large productivity gains. Since the empirical studies discussed in this chapter generally document performance improvements after privatization, a natural follow-up question is to ask why performance improves. For utilities, the need to introduce competition and an effective regulatory regime emerges as key, but there is no "silver bullet" answer for what makes privatization successful for firms in competitive industries. As we will discuss in the next chapter, a key determinant of performance improvement in transition economies is bringing in new managers after privatization. No study explicitly documents systematic evidence of this occurring in nontransition economies, but Wolfram (1998) and Cragg and Dyck (1999a,b) show that the compensation and pay-performance sensitivity of managers of privatized U.K. firms increases significantly after divestment. Studies that explicitly address the sources of post-privatization performance improvement using data from multiple nontransition economies tend to find stronger efficiency gains for firms in developing countries, in regulated industries, in firms that restructure operations after privatization, and in countries providing greater amounts of shareholder protection.
Sunita Kikeri and John Nellis write in their article, An Assessment of Privatization, "The World Bank Research Observer", vol. 19, no. 1 (Spring 2004)
This article takes stock of the empirical evidence and shows that in competitive sectors privatization has been a resounding success in improving firm performance. In infrastructure sectors, privatization improves welfare, a broader and crucial objective, when it is accompanied by proper policy and regulatory frameworks.
Mary M. Shirley and Patrick Walsh write in Public versus Private Ownership: The Current State of the Debate, Working Paper, The World Bank,
Our review found greater ambiguity about ownership in theory than in the empirical literature. In the debate over the effects of competition, theory suggests that ownership may matter and if so, that private firms will outperform SOEs. The empirical studies squarely favor private ownership in competitive markets. Theory’s ambiguity about ownership in monopoly markets seems better justified, since the empirical literature is also less conclusive about the effects of ownership in such markets. Theories that assume a welfare maximizing government suggest that SOEs can correct market failures. In contrast, public choice theories are skeptical of the benevolent government model. Corporate governance theories suggest that even well intentioned governments may not be able to assure that SOE managers do their bidding. The empirical literature favors those skeptical of SOEs as a tool to address market failures. In studies of industrialized countries, where we might expect more developed political markets to motivate greater government concern with welfare maximization or better information and incentives to overcome corporate governance problems, private firms still have an advantage. The private advantage is more pronounced in developing countries, where market failures are more likely.
As to the New Zealand experience let me deal with one obvious recent example: Kiwirail.

In the July 2009 issue of Competition and Regulation Times put out by the New Zealand Institute for the Study of Competition and Regulation (ISCR) the question is asked, Kiwirail: strategic asset or strategic blunder? The article summaries an ISCR research paper "The history and future of rail in New Zealand" by Dave Heatley.

My view has, for awhile, been nearer the blunder end of the scale than the asset end. The Times article and the research paper argue along similar lines. Heatley opens his Times article by noting that back in 1999 one of the first projects undertaken by the ISCR was a study of the long-term economic performance of New Zealand railways.
Public rail ownership was characterised by declining performance, beginning in the 1920s and culminating in a very poor prognosis in the 1990s. There were signs that since 1993, privatisation had led to improved productivity and profitability; however, the business was still far from achieving financial sustainability. The ISCR report predicted that private-sector ownership would result in better incentives for productivity-enhancing decision making, but in the long run it was unlikely that in its current form the business would be able to generate returns sufficient to cover the costs of the very large sums of capital employed. Given these facts, a rational private owner would likely rationalise services and reduce the scale of the network to the point where it constituted a sustainable long-run business. Revenues freed up from repeated cycles of historic government-funded capital injections and operating subsidies could then be applied to more productive uses, to the wider benefit of the New Zealand economy.
Given that rail is again in the hands of the government it is timely to re-examine the assumption that government ownership will result in superior long-term outcomes for the long suffering taxpayer owners. Heatley writes,
The 2009 analysis reveals little evidence to suggest that overall the economic outlook for rail has improved since 1999. Despite gains in operational productivity, rail's share of the land freight task has declined over the period examined. Profitability has remained poor, suggesting an ongoing lack of competitiveness vis-a-vis other freight modes.
and continues
Rail networks offer benefits from economies of density (increasing use of existing tracks), but not necessarily from economies of size (increasing size of the network).' In a rail network with uneven patterns of use, such as New Zealand's, the economics of density means that the closure of lightly used lines will, in general, improve the overall economic performance of the network.
Importantly Heatley notes that
It proved difficult for private owners to rationalise the size of the network efficiently, due to poorly aligned incentives and political intervention in operational decisions such as exiting from the provision of certain long-distance passenger services.

The retention of land ownership by the Crown at the time of privatisation muted private incentives to rationalise the network as the private operator was unable to access the potential land-sale benefits from closing unprofitable lines. Private-sector owners have been incentivised to persevere with a strategy (originating under public ownership) of retaining otherwise uneconomic lines for their current income-generating potential, but refraining from investing in replacement infrastructure such as sleepers, tracks and bridges.

A return to integrated land, infrastructure and operational ownership resolves the incentive misalignment, enabling its new owners to rationalise network infrastructure efficiently. Yet perversely, extensive recapitalisation has followed re-nationalisation. The government has invested $2.9 billion in rail since 2002, and has committed a further $0.9 billion through to 2013. It is unlikely that the government will earn a reasonable financial return on this investment, as the strong incentives of private owners for ongoing productivity improvements will likely be muted under government ownership, and the scope for political intervention in strategic and operational activities has increased.

The consequences of political intervention are evidenced in the targets set for a modal shift from road to rail freight in the New Zealand Transport Strategy. Any increases in rail freight's share must ultimately come from substitution at the margins away from competing transport modes. Extensive competition from both road and sea freight restrains the ability of rail to set prices. Rail exhibits few apparent cost advantages, even with subsidies from the written-off opportunity cost of capital. So modal shift can only be driven by increasing the level of subsidies in order to lower prices artificially and therefore induce movement of marginal freight away from more efficient road and sea freight. Such shifts will be to the detriment of the overall economic performance of the transport sector and the wider New Zealand economy.

There is little evidence that the real costs of the current government ownership and investment strategy have been adequately assessed in terms of foregone benefits in other taxpayer-funded areas, such as health and education.
After this, an obvious question to ask is, Is there light at the end of the tunnel? Heatley comments,
The 2009 analysis confirms that the issues identified in 1999 still remain, and are unlikely to be addressed by recent changes in governance, ownership and policy direction. Yet rail still remains a viable transport medium for those segments to which it is intrinsically well-suited - long-haul carriage of heavy, bulky freight (coal, logs, manufactured goods, etc.) and high volume urban commuter services. The challenge for rail's new owners is to find a viable subset of the current rail network. Given current and projected freight and passenger types and volumes, it appears a viable subset exists at around 1500-2000 kilometres in length - less than half the present size. Line closures and land sales could fund upgrading of the core network to 21st-century standards.
So, rail makes sense for a small portion of the current network. However I can't see the changes in government policy and public perceptions need for rationalisation of the network coming to pass any time soon. So the taxpayer gets stuck with yet another white elephant

As to a general argument on the value of privatisation we can ask when is government control and production preferable? As a general guide, Hart, Shleifer and Vishny ("The Proper Scope of Government: Theory and an Application to Prisons", Quarterly Journal of Economics, 112(4): 1127-61, November 1997) argue that the case for government provision of goods or services is generally stronger when non-contractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant and when corruption in government procurement is a severe problem. It has been argued that the case for government production is strong in such services as the conduct of foreign policy, police and armed forces. The case can also be made reasonably persuasively for the case of prisons. The case for private sector provision is stronger when quality reducing cost reduction can be controlled through contract or competition, when quality innovations are important and when patronage and powerful unions are a severe problem inside the government.

Its not clear that the government's interventions have been in areas where the Hart, Shleifer and Vishny arguments would suggest the government should be involved. Banking, for example, is not a area where cost reduction come at the expense of quality, where innovation is unimportant or where there are any problem with government procurement. So why have the government owning a bank? Also government involvement in Air New Zealand is hard to justify on these grounds. As noted above, the case for private sector provision is stronger when quality reducing cost reduction can be controlled through competition, and the airline industry is very competitive, when quality innovations are important, and we want a high quality and innovative airline industry, and when patronage and powerful unions are a severe problem inside the government, which are things we wish to avoid with an airline. Here private provision makes sense.

There is also the issue of mixed ownership. This seems to be in the government's mind for assets like Kiwbank. The kinds of problems that mixed ownership can bring can been seen from the New Zealand experience with the SOEs. While many are not in actual mixed ownership, the pressures that such ownership can bring about can, nevertheless, be seen in our recent history with the SOEs.

The SOE Act states that SOEs, basically, have to be run like normal non-government owned firms. In effect this requirement is the same as you could get if private owners have a stake in a firm. The private owners would, we assume, wish to maximise profits, but the government may not. And you see this with SOEs. The government often wishes to intervene in the running of SOEs to get them to carry out not profit maximising activities, just as it would if it had a partial stake in a mixed ownership firm. This problem of having SOEs (or mixed ownership firms) trying to serve two masters was noted more than 10 years ago by Spicer, Emanuel and Powell in their book "Transforming Government Enterprises: Managing Radical Organisational Change in Deregulated Environments" (The Centre for Independent Studies, 1996). They warned that there are two pressures on SOE's: the first being towards privatisation since the productivity and efficiency gains achieved by SOE are in danger of being eroded over time. Privatisation is a way of both cementing in the commercial orientation of enterprises and wringing out further gains resulting from the high powered incentive and control mechanisms which can be bought to bear in privately owned and publicly traded companies. The second pressure on SOEs is towards being pulled back into the public sector where social and political objectives can be more readily be meet. What we saw under the Clark government was the second of these pressures being very strong. But not for socially useful reasons. Most interventions seem to be more politically motivated.

These pressures would also be there for a mixed ownership firms and help explain why they don't do as well as fully privately owned firms. For example, Aidan Vinning and Anthony Boardman in "Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises", Journal of Law and Economics vol. XXXII (April 1989) conclude 'The results provide evidence that after controlling for a wide variety of factors, large industrial MEs [mixed enterprises] and SOEs perform substantially worse than similar PCs [private corporations].' The basic problem is that partial government ownership politicises the firm. We just have to hope we don't see a move in this direction in New Zealand.

As to the performance of state-owned banks Marcio I,. Nakane and Daniela B.Weintraub and look at Bank privatization and productivity : evidence for Brazil. Their abstract reads:
Over the past decade, the Brazilian banking industry has undergone major and deep transformations with several privatizations of state-owned banks, mergers and acquisitions, closing down of troubled banks, entry by foreign banks, and so on. The purpose of this paper is to evaluate the impacts of these changes in banking on total factor productivity. The authors first obtain measures of bank level productivity by employing the techniques due to Levinsohn and Petrin (2003). They then relate such measures to a set of bank characteristics. Their main results indicate that state-owned banks are less productive than their private peers, and that privatization has increased productivity.
Rafael La Porta, Florencio Lopezde-Silanes and Andrei Shleifer also look at the Government Ownership of Banks. They write
In this paper, we investigate a neglected aspect of financial systems of many countries around the world: government ownership of banks. We assemble data which establish four findings. First, government ownership of banks is large and pervasive around the world. Second, such ownership is particularly significant in countries with low levels of per capita income, underdeveloped financial systems, interventionist and inefficient governments, and poor protection of property rights. Third, government ownership of banks is associated with slower subsequent financial development. Finally, government ownership of banks is associated with lower subsequent growth of per capita income, and in particular with lower growth of productivity rather than slower factor accumulation. This evidence is inconsistent with the optimistic development' theories of government ownership of banks common in the 1960s, but supports the more recent political' theories of the effects of government ownership of firms.
This however has to be the coolest paper ever on the trying to workout if there is a difference between the performance of government-organised production versus privately organised production. Jonathan M. Karpoff, "Public versus Private Initiative in Arctic Exploration: The Effects of Incentives and Organizational Structure", Journal of Political Economy, February 2001, v. 109, iss. 1, pp. 38-78.

Karpoff's paper exploits a very interesting and unique natural experiment to compare the performance of government-organised versus privately organised production. Karpoff studies a comprehensive sample of 35 government-funded expeditions and 57 privately funded expeditions to the Arctic from 1818 to 1909 seeking to locate and navigate a Northwest Passage, discover the North Pole, and make other discoveries in arctic regions. I guess these are the cold hard facts!

He finds that the private expeditions performed better using several measure of performance. Karpoff shows that most major arctic discoveries were made by private expeditions, while most tragedies - in terms of lost ships and lives - were on publicly funded expeditions. Karpoff notes that the public expeditions might have had greater losses because they took greater risks, but then the public expeditions would have had a greater share of discoveries, which did not occur.

Karpoff also estimates regressions explaining outcomes in several ways-crew deaths, ships lost, tonnage of ships lost, incidence of scurvy, level of expedition accomplishment - controlling for exploratory objectives sought, country of origin, the leader's previous arctic experience, or the decade in which the expedition occurred. In essentially every regression, the dummy variable for private expedition is significant, with a sign indicating that the private expedition performed better. Karpoff concludes that the incentives were better aligned in the private expeditions, leading to systematic differences in the ways public and private expeditions were organised. While the uniqueness of the sample limits its generality, Karpoff provides an interesting illustration of the impact of ownership on the performance of an organisation.

While it is true that the effect of changes in ownership on the performance of firms is still debated in some quarters. Most of the evidence suggests that firm performance improves when SOEs are privatised, see above. A question that remains is, What happens to firm performance if a firm is re-nationalised? A paper, Privatisation, State Ownership and Productivity: Evidence from China, from the International Journal of the Economics of Business looks at these privatisation/nationalisation issues, for the case of China.

The paper examines the relationship between the transfer of ownership between the public and private sectors of Chinese industry, and its impacts on performance. They link ownership changes to productivity growth, and demonstrate that privatisation contributes significantly. An interesting extension that the authors deal with is that they look at firms that are taken back into state ownership, and evaluating the productivity growth effects of this.

The paper offers several contributions to the analysis of ownership change and productivity. Their results confirm that privatisation in China is important for generating productivity growth. They find a degree of cherry picking by foreign investors when acquiring a stake of SOEs, but not when investing in private firms. Interestingly, foreign investors also have the effect of generating further productivity growth among hitherto SOEs. This highlights another contribution of this paper, which is to distinguish between different types of ownership change in a manner that had not been done previously for China, and seldom at all. The results indicate that the transfer of SOEs to the private sector is important for productivity growth, and there is a consistent ranking of the productivity growth effects of privatisation. Changing to foreign (foreign includes Hong Kong, Macau, Taiwan, as well as other foreign counties) ownership generates the greatest productivity-enhancing effect among SOEs, followed by the transfer to domestic private individual enterprises (domestic private individual enterprises include four types of private firms: solely private funded enterprises, private cooperative enterprises, private limited liability corporations, and private share-holding corporation limited), then to domestic private company (domestic private companies include the rest of the private enterprises, mainly share-holding corporation limited and other limited companies.), and finally to collectively owned enterprises (COEs are economic units such that the assets are owned by collectives. The collective here means the community in the city or rural area), which is still significant. Finally, the paper's results question the wisdom of taking firms back into public ownership, as this appears to be associated with lower productivity, both in terms of level and growth.

The European economy in a nutshell

(HT: Greg Mankiw)

The IMF on the multiplier

Matt Nolan has been talking about Fiscal policy camps over at TVHE. Given this discussion let me add this from John Taylor's blog Economics One:
In a soon to be published paper, several economists at the International Monetary Fund report estimates of government spending multipliers which are much smaller than those previously reported by the U.S. Administration. In order to obtain the estimates the IMF economists use a very large complex model called the Global Integrated Monetary and Fiscal (GIMF) Model developed by Douglas Laxton and his colleagues at the IMF . The paper is quite technical, but the bottom line summary is that a one percent increase in government purchases (as a share of GDP) increases GDP by a maximum of 0.7 percent and then fades out rapidly. This means that government spending crowds out other components of GDP (investment, consumption, net exports) immediately and by a large amount.
This doesn't make government spending look good or all that useful. Something that supporters of increased government spending in face of the financial crises will have trouble explaining. After all their whole argument was based on a large government multiplier.

Wednesday, 26 May 2010

The recession and crime

According to the New York Times:
WASHINGTON — Despite turmoil in the economy and high unemployment, crime rates fell significantly across the United States in 2009, according to a report released by the Federal Bureau of Investigation on Monday.

Compared with 2008, violent crimes declined by 5.5 percent last year, and property crimes decreased 4.9 percent, according to the F.B.I.’s preliminary annual crime report. There was an overall decline in reported crimes for the third straight year; the last increase was in 2006.
So if the relationship between unemployment and crime is positive, Why do we see these kinds of results? It is often argued that poverty is the root cause of lawlessness but if the trends evident in the above data continue this argument will look less likely to be true.

EconTalk this week

Gary Belsky, Editor-in-Chief at ESPN The Magazine, talks with EconTalk host Russ Roberts about his career path in journalism and the day-to-day life of editing a major American magazine. Belsky discusses some of the lessons of his early career as a business journalist. The discussion then turns to the magazine, its creativity and the perks and challenges of editing the magazine, managing the staff, and chatting up Serena Williams. The conversation closes with a discussion of Belsky's theory of trivia and some of his favorite trivia questions.

Friday, 21 May 2010

Do people understand inflation?

Over at the Standard I see that Eddie is quoting as saying David Cunliffe as saying,
The government says that most people would be better off after taking into account the GST rise and the income tax cuts. Their calculator uses the estimate of 2.02 percent inflation arising from GST alone.
This seem odd since an increase in GST has no effect on inflation at all. The GST increase will increase the price level but will do so instantaneously which, by definition, isn't inflation. I would have thought that someone, like David Cunliffe or Eddie, claiming to be an expert on the economy would have known this econ 101 type point and corrected such an error.

Tuesday, 18 May 2010

Klein on "The Capitalist and the Entrepreneur"

Peter Klein, of Organizations and Markets fame, has a new book out: The Capitalist and the Entrepreneur: Essays on Organizations and Markets. In the introduction he writes,
Austrian economics, I am convinced, has important implications for the theory of the firm, including firm boundaries, diversification, corporate governance, and entrepreneurship, the areas in which I have done most of my academic work. Austrian economists have not, however, devoted substantial attention to the theory of the firm, preferring to focus on business-cycle theory, welfare economics, political economy, comparative economic systems, and other areas. Until recently, the theory of the firm was an almost completely neglected area in Austrian economics, but over the last decade, a small Austrian literature on the firm has emerged. While these works cover a wide variety of theoretical and applied topics, their authors share the view that Austrian insights have something to offer students of firm organization.
This point that there is little in the way of a truly Austrian theory of the firm has always puzzled me. They have written extensively on the market (and the entrepreneur) but haven't devoted much energy to exploring what underlies either side of the market: demand (households) or supply (firms). What determines the boundaries of a firm? How are the internal structures of the firm determined? In what organisational framework does the entrepreneur carryout his activities? Or in short, Does the entrepreneur need a firm?

There seems to be obvious, but as yet unexplored, overlaps between the Austrian approach to microeconomics, mainly to do with the market, and other institutions or organizations, such as the firm. Why such inactivity on the part of Austrian economists on the question of these other institutions? It seems to be a shortcoming in current Austrian thinking.

The train set gets even more money. why? (updated)

Over at Kiwiblog David Farrar writes,
Steven Joyce has announced:
The Government’s commitment to invest $250 million to support the KiwiRail Turnaround Plan will help increase New Zealand’s economic productivity and put us on the path to faster growth, Transport Minister Steven Joyce says.

The Budget 2010 appropriation is the first round of Government support for the objectives of the $4.6 billion Turnaround Plan.

The Government has committed in principle to a total package of $750 million over the next three years, with final decisions on funding subject to individual business cases.

“The KiwiRail Turnaround Plan is designed to see the rail freight business become sustainable within a decade by getting it to a point where it funds its costs solely from customer revenue,” says Mr Joyce.

“In fact, the lion’s share of the $4.6 billion will come from the business itself.
The Government really has little choice. One can’t sell Dr Cullen’s train set. No one would buy it.
David I fear you have missed the point of your own statement. If no one will buy it, should it exist? If you are right there is an important message in the point you make. May be the train set should be thrown out in the rubbish.

To be honest I would guess that some parts of the set would be bought, just not the whole package. So what the government should do is put it up for sale and let bidders chosen which bit they really want. The rest can be thrown out.

Updated: Liberty Scott also wonders about the usefulness of the railways.

EconTalk this week

Russ Roberts, host of EconTalk, discusses his paper, "Gambling with Other People's Money: How Perverted Incentives Created the Financial Crisis." Roberts reflects on the past eighteen months of podcasts on the crisis, and then turns to his own take, a narrative that emphasizes the role of government rescues of creditors and the incentives this created for imprudent lending. He also discusses U.S. housing policy, particularly the Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac and how the government's implicit guarantee of lenders to the GSE's interacted with housing policy to increase housing prices. This in turn, Roberts argues, helped create the subprime market, created mainly by private investors. The episode closes with some of Roberts's doubts about his narrative.

Sunday, 16 May 2010

Kocherlakota on macro

An essay on the state of modern macroeconomics by Narayana R. Kocherlakota - President of the Minneapolis Fed. Kocherlakota writes
This essay describes the current state of macroeconomic modeling and its relationship to the world of policymaking. Modern macro models can be traced back to a revolution that began in the 1980s in response to a powerful critique authored by Robert Lucas (1976). The revolution has led to the use of models that share five key features:

a. They specify budget constraints for households, technologies for firms, and resource constraints for the overall economy.
b. They specify household preferences and firm objectives.
c. They assume forward-looking behavior for firms and households.
d. They include the shocks that firms and households face.
e.They are models of the entire macroeconomy.

The original modern macro models developed in the 1980s implied that there was little role for government stabilization. However, since then, there have been enormous innovations in the availability of household-level and firm-level data, in computing technology, and in theoretical reasoning. These advances mean that current models can have features that had to be excluded in the 1980s. It is common now, for example, to use models in which firms can only adjust their prices and wages infrequently. In other widely used models, firms or households are unable to fully insure against shocks, such as loss of market share or employment, and face restrictions on their abilities to borrow. Unlike the models of the 1980s, these newer models do imply that government stabilization policy can be useful. However, as I will show, the desired policies are very different from those implied by the models of the 1960s or 1970s.

As noted above, despite advances in macroeconomics, there is much left to accomplish. I highlight three particular weaknesses of current macro models. First, few, if any, models treat financial, pricing, and labor market frictions jointly. Second, even in macro models that contain financial market frictions, the treatment of banks and other financial institutions is quite crude. Finally, and most troubling, macro models are driven by patently unrealistic shocks. These deficiencies were largely—and probably rightly—ignored during the “Great Moderation” period of 1982–2007, when there were only two small recessions in the United States. The weaknesses need to be addressed in the wake of more recent events.

Finally, I turn to the policy world. The evolution of macroeconomic models had relatively little effect on policymaking until the middle part of this decade.1 At that point, many central banks began to use modern macroeconomic models with price rigidities for forecasting and policy evaluation. This step is a highly desirable one. However, as far as I am aware, no central bank is using a model in which heterogeneity among agents or firms plays a prominent role. I discuss why this omission strikes me as important.
Make of it what you will.

Finance, growth and development

In this audio from Thorsten Beck of Tilburg University talks to Viv Davies about his current research in the areas of finance, growth and development - and the policy lessons for developing countries.

EconTalk last week

Ed Leamer of UCLA talks with EconTalk host Russ Roberts about the state of econometrics. He discusses his 1983 article, "Let's Take the 'Con' Out of Econometrics" and the recent interest in natural experiments as a way to improve empirical work. He also discusses the problems with the "fishing expedition" approach to empirical work. The conversation closes with Leamer's views on macroeconomics, housing, and the business cycle and how they have been received by the profession.

Sunday, 9 May 2010

Unemployment solved !!!

Don Boudreaux has written an open letter to Ezra Klein of the Washington Post on the topic of productivity and employment:
Dear Mr. Klein:

You allege that when unemployment is high, a slowing of productivity growth is “good news” for the economy (“When bad economic news is good news,” May 6). The reason, according to you, is that the greater the number of workers required to produce a given amount of output – everything from a Starbucks’ latte to a Boeing 747 – the higher is the is the demand for workers.

The relationship between productivity and demand for workers isn’t this simple. (If your employer, the Washington Post, suddenly lost access to the Internet and found itself stuck with vintage 1890 printing presses, are you sure that the Post would hire more workers to compensate for its drop in productivity?) But assuming your premise to be true, why rely only upon unguided forces to reduce worker productivity? Shouldn’t government help this beneficial process along – say, by requiring that each employee drink three martinis before reporting to work?

Not only are drunk workers less productive than are sober ones, they’re also more likely to damage equipment. So mandating employee intoxication promises a helpful double-whammy during these recessionary times: employers would hire more workers to produce any given amount of output, and employers would hire more workers to repair damaged equipment. Presto! Unemployment problem solved!

Shall we drink to this proposal, Mr. Klein?

Donald J. Boudreaux
I wonder why we didn't just outlaw all mechanical devices and computers. Surely this would drive down productivity and increase the need for workers. The unemployment problem would be solved in an instant. Then all we would have to do is solve the standard of living problem.

I guess we should be pleased to learn that its not just New Zealand newspapers that have crap economics written in them.

Happy birthday Friedrich Hayek

Yesterday was the birthday of Friedrich A. Hayek: born May 8, 1899.
Hayek at the London School of Economics in 1948.

Philip Booth writes in the Telegraph on why the Financial crisis shows why we should admire Freidrich Hayek.

Peter Klein at Organizations and Markets gives this set of readings for Hayek's birthday:

Friday, 7 May 2010

International trade doesn't affect the number of jobs: 1903 version

In an earlier posting I made the point that importing the new trains for Auckland from overseas would not affect the number of jobs in New Zealand. Now I find I am more than a hundred years late in making this point!

In the latest issue of Econ Journal Watch they reprint a anti-protectionism letter to the The Times (of London), and other papers, which appeared on 15 August 1903. The letter was signed by C.F. Bastable, A.L. Bowley, Edwin Cannan, Leonard Courtney, F.Y. Edgeworth, E.C.K. Gonner, Alfred Marshall, J.S. Nicholson, L.R. Phelps, A. Pigou, C.P. Sanger, W.R. Scott, W. Smart, and Armitage Smith, and supported after the fact by S.J. Chapman and J.H. Chapman. Now that is a serious list of heavy hitting British economists at this time.

What I find interesting is the following section of the letter:
Our convictions on this subject are opposed to certain popular opinions, with respect to which we offer the following observations:-
1. It is not true that an increase of imports involves the diminished employment of workmen in the importing country. The statement is universally rejected by those who have thought about the subject, and is completely refuted by experience.
Perhaps those at The Standard need to read a little more history.

Wednesday, 5 May 2010

International trade doesn't affect the number of jobs

Over at the (low) Standard a number of posters are getting very upset about the fact that Kiwirail will not, most likely, tender for local assembly of the new trains for Auckland. In particular they seem to think that buying these unit overseas will mean less jobs in New Zealand. They point out that BERL has claimed that 1200 jobs would result from building the units here. But the point to keep in mind is that trade has little effect on the total number of jobs in the economy. What it does is move jobs around, away from areas in which we don't have a comparative advantage into areas where we do. As Paul Krugman, of all people, has said
It should be possible to emphasize [...] that the level of employment is a macroeconomic issue, depending in the short run on aggregate demand and depending in the long run on the natural rate of unemployment, with microeconomic policies like tariffs having little net effect. Trade policy should be debated in terms of its impact on efficiency, not in terms of phony numbers about jobs created or lost.
and as another trade economist Douglas Irwin has put it
The claim that trade should be limited because imports destroy jobs has been around at least since the sixteenth century. And imports do indeed destroy jobs in certain industries: [...]

But just because imports destroy some jobs does not mean that trade reduces overall employment or harms the economy. [...]

Since trade both creates and destroys jobs, a frequently asked question is whether trade has any effect on overall employment. Unfortunately, attempts to quantify the overall employment effect of trade are I exercises in futility. This is because the impact of trade on the total number of jobs in an economy is best approximated as zero.
But perhaps Laura LaHaye puts it best
Of the false tenants of mercantilism that remain today, the most pernicious is the idea that imports reduce domestic employment. This argument is most often made by American automobile manufacturers in their claim for protection against Japanese imports. But the revenue that the exporter receives must be ultimately spent on American exports, either immediately or subsequently when American investments are liquidated.
Thus if the The Standard is really worried about unemployment, there are much more important issues to deal with than imports of trains, or the imports of anything else for that matter.

A talk from Esther Duflo

Here is Esther Duflo, this year's John Bates Clark medal winner, giving an overview of her work on using randomized trials to evaluate development policies.
(HT: Marginal Revolution)

EconTalk this week

Nassim Taleb, author of The Black Swan and Fooled by Randomness, talks with EconTalk host Russ Roberts about his latest thoughts on robustness, fragility, debt, insurance, uncertainty, exercise, moral hazard, knowledge, and the challenges of fame and fortune.

Sunday, 2 May 2010

Robert Higgs debates James Galbraith on Obamanomics

From the Independent Institute comes this audio in which Independent Institute Senior Fellow Robert Higgs debates James Galbraith (Professor of Economics, University of Texas; son of infamous, “liberal”, Keynesian economist John Kenneth Galbraith) on Antiwar Radio regarding the folly of government bailouts for insolvent banks, creation of the Glass-Steagall Act as a means to prevent FDIC insured banks from taking excessive risks, benefits and detriments of public and private regulation and oversight, problems of regulatory capture and revolving door politics, divergent opinions on the causes of the Great Depression and efficacy of the New Deal and the arguments for and against government spending on public infrastructure.

Tax freedom day

From the New Zeland Business Roundtable comes the news that Tax Freedom Day this year is again 11 May, at least as far as the central government tax burden is concerned. Tax Freedom Day represents the notional day in the year when the average New Zealander stops working for the government and starts working for themselves. So the average New Zealander effectively spends more than one third of the year working for central government. Aren't we lucky?!!

In the UK Tax Freedom Day 2010 is May 30, so we are doing a little better than them. In the US it is April 9, a month before us.

Latest data continue to show little impact of government stimulus on GDP

John Taylor writes on his blog Economics One that
The 3.2 percent growth rate of real GDP in the first quarter (released by BEA yesterday) confirms that the recovery is looking more U-shaped than V-shaped. But it also provides further evidence that the stimulus package of 2009 has had a small contribution to the recovery. Most of the recovery has been due to investment—including inventory investment, which was positive in the first quarter after declining for all of last year—and has little to do with discretionary stimulus packages.
So thus far the stimulus package seems to be having little effect on recovery. Taylor gives two charts that show the percentage contribution of investment and government purchases to real GDP growth in the first quarter and in the preceding quarters since 2007. The charts clearly indicate that the changes in real GDP growth have been mostly due to changes in investment and little to changes in government purchases. This makes New Zealand's not doing much response to the crisis look more like a good policy.

Saturday, 1 May 2010

US monetary and fiscal policy in the 1930s – and now

In this audio from Price Fishback of the University of Arizona talks to Romesh Vaitilingam about whether the current US economic situation is really comparable to the Great Depression. He argues that today’s monetary policy response is heavily and positively influenced by the failures of the past – but that today’s fiscal stimulus is far stronger than in the 1930s and out of proportion to the problem.