Co(r)n Law

This essay is among my few amateurish attempts to argue in the realm of normative judgements. To be fair to readers I ought to point out that my political view is that of a moderate liberal. This essay is also written in inspiration from a spiritual-economics post from Mr Wise, a former Grade 12 English teacher of mine whose virtue and honesty as a good, pious Christian taught me a lot about life. I am not knowledgable in religion or well, anything at all, but I hope this adds weight to your concern with a perspective of Economics, a subject that I am at most moderately capable of articulating.

Co(r)n Law

In the 19th Century much debate raged about the Corn Laws, a tariff designed to shield local producers of corn in England from cheaper imports. The acrimonious debate was ostensibly about the inefficiency the law entailed and the burden it encumbered on the poor, but in all sense it was a proxy war regarding the distribution of wealth among the then prevalent social classes in England – the capitalists, the landowners and the workers. It took superhuman analytical skills and very lucid arguments, chiefly in the contributions of David Ricardo and his penetrating analysis to repeal the Corn Law. Along with its repeal, went also the inefficiency of merchantalism as a great empire rose in the surfeit of its disproportionately distributed “wealth of nation” brought about by free trade.

Fast forward to the 21st Century, the social classes of old is non-existent. The humble diner owner down the street where I live is a capitalist in all sense; but a neurosergeon, a “worker”, makes more money now than he does. So now that social classes cannot be delineated by job functions alone, the social class war is now a war between the rich and poor, the right and the left. And just like how the social class was had never truly extinguished but merely changed in its appearance, so had the Corn Law. It’s successor is of course, the Con Laws.

(Here’s a review of what constitutes an economic rent. In economics, an economic rent is the excesses beyond the minimum required to prevent something from being directed to an alternative use. If a factor is compensated at the minimum of what its owner is willing to receive to prevent it from being used in an alternative method, then it is paid at its transfer earnings. Economic rent = Excesses + Transfer Earnings. The following example illustrating the concept assumes that there are no non-monetary advantages.
Keat Yang is a soccer player making $5 million per year. If his pay is reduced to just less than $2 million per year he would decide to become a model for Adidas instead. The money paid to me to prevent me from leaving the soccer club and model for Adidas is thus $2 million, my transfer earning. The economic rent I get is $3 million, what is paid in excess of the transfer earning. An important caveat of course is that what constitutes an economic rent or a transfer payment varies across individuals/firms. For the whole professional soccer player association as a whole, the $3 million from my $5 million wage is an economic rent because if I were to be payed any lower I’d still choose to be a soccer player anyway if I am paid anything above the minimum of $2 million that is my transfer earning. To my soccer club, say Arsenal, that $5 million is a transfer earning because if they do not pay me that much, a small club called Real Madrid might walk in with an offer an hijack me away).

The principle problem with the Con Laws is that they are an institutionalised mechanism meant to extract economic rent at the expense of the greater good. I admit this argument will probably rile up my Conservative counterparts, especially honest ones who think that people should not have what they rightfully earn taken away. I must say this is a belief I share with conservatives. I do not object to Russel Peters, Fernando Torres or Steve Jobs making their millions, because society clearly benefit from their work efforts. Wealth distribution is among the chief causes of idealogical faction between the left and the right, and a pertinent argument is to what degree is government involvement required to distribute wealth in an “equitable manner.” I do not have the moral authority to decide how much of wealth have to be taken away from Bill Gates to be given to the poor homeless person on the street, because I cannot make the poor person better off without making Bill Gates worst off.

Yet it would be an overarching argument to say that all the wealth of the rich are well-earned. My major concern is that when the system is tweaked to institutionalise economic-rent seeking behaviour for dubious, overinflated “contributions” to the world of certain people that spreading the wealth around would be desirable. Take the financial sector as an example. A lot of start-ups that benefited mankind like Google were made possible in part because of bankers and the financial market. However, some quarters in the financial sector, the derivatives market for instance, are manipulating the system (New York Time coverage) to guarantee to themselves the economic rent at the expense of potential competitors and to the potential “Googles” hoping to have cheaper accessibility to the derivative markets. It is in this that a standard approach in positive economics can be used to illustrate the inefficiencies caused by such Con Laws, as David Ricardo did to help repeal the Corn Laws. Using a standard Welfare Economics Analysis, we have a strong case that such “cartelisation” empowered by such Con Laws had essentially guaranteed economic welfare inefficiency. The market price for derivatives can be reduced with the addition of more suppliers in the trading house. As the gap between what consumers would be willing to pay and how much they actually have to pay increases; the gap between what suppliers would like to receive and what they actually receive increases, we have an increase in social welfare up to the point of equilibrium. Even when the size of the gap between what consumers would be willing to pay, and what suppliers are willing to receive, and what they actually pay and receive remains the same as it was, an electronic trading system would reduce industrial cost and hence we also have a strong case for productive efficiency.

Another strong example of the Con Laws (Or in nerd-speak you can call it Corn Law V2.0) we have the lobbying group and lobbying firm employed by farmers for agricultural subsidy. Part of the food crisis we are facing now can be attributed to such subsidy scheme, which essentially yet in a twisted manner serve the same function as the Corn Law in Ricardo’s era. An unjustifiable subsidy to inefficient producers distorts the price signal for the planning of crop cultivation and raises the relative price of imports that would have been “cheaper” were it not for such artificial impositions. The result is of course and badly-coordinated argricultural sector that brought along with it a food crisis.

Given what we understand from Public Choice Theory and the Impossibility Theorem, I understand that people plead apathetic to political and economic issues. Why incur the cost of examining these issues when its marginal effect on each individual is so small? Yet we continue to fume over our social class war of the rich versus the poor. The poor would see a conservative party in the mould of the Sheriff of Nottingham, the manifestation of a political power to stymie the efforts of their Robin Hood. The Rich would see a liberal party as a mould of the dreaded Robin Hood, a manifestation of political power to rob from the not-evil Rich to give to the poor.

Arguing in such a vacuum is a futile exercise with no physical reality. Conservatives or Liberals, Democrats or Republicans, a common threat to us all are the Con Laws.

PS: Tea-Partyers and fanatical Conservatives, I don’t really understand your economics. Congressman and Senators who bend on over to secure economic rent for vested interests, I admire your ability to say what you will do “for our children” in camera only to enact laws that makes me and my future generations starving and dying. For people who are gaming the system, I wish they give me an Inception-style dream device and I can recreate Dante’s Inferno for you.

Advertisements

Velk on QE2

Tom Velk from McGill’s North American studies observed that the market is not responding to the Federal Reserve’s QE2 programme. In the same commentary Velk also provided the underlying principles of the financial market as we understand it and argued that because prospects of growth are anticipated to be grim and that the counter-recession programmes have hampered the perceived solvency of most countries, the markets simply won’t budge.

(For readers with no economics background, Quantitative Easing is (typically) the purchasing of government securities to lower the interests they pay by using money printed by the central bank, as empowered in the law of its creation. The purpose is to create additional supply of money so that commercial banks will lend them out and hopefully, spur growth to bring a country out of a recession. There are a few psychological factors that should in theory, spur investments and spending in an economy.
1. When short-term interest rates are low and firms are not responding, lowering the yield of long-term interest rates by purchasing government securities (or other financial instruments) will create more money in the economy so that no one has the incentive to hoard it as a store of value.
2. If the economy expects that there are prospects for growth, borrowing when it is cheap right now might pay off in the future when the economy recovers.
3. A slightly more “evil” twist to see this is that when investors think that inflation(rise in price of goods) that is about to accompany growth when the economy recovers will decrease the value of their assets, they will be be more inclined to invest in assets; or in the case of firms, instead of holding the money they have as part of their capital, will invest it instead. Either way, because of the fear that their assets might lose value, these individuals or firms will spend right now, thus collectively veering the economy to recovery.)
For a take on QE in combating a liquidity trap that mired us in this depression, I recommend Paul Krugman’s Return of Depression Economics. Alternatively you can read this post from some lousy wannabe.
An important caveat: The success of any round of QE is contingent of the Federal Reserve and by extension, the government’s ability to persuade the market that the recession is but a glitch and prospects for future growth is solid. Velk’s commentary is arguing that as of now, the Fed and the government has not succeeded in doing this thus far).

Instead of piling their faith on the government programmes and the central bank, as Velk argued, investors are flocking to a more “tangible” store of value in commodities like oil, gold etc. The gold-bug camp argues that because investors are jitterish about the run-away inflation that seems plausible when the economy recovers and that the Federal Reserve might not be able to rein-in the excess of supply of money, the price of gold is skyrocketing.(For non-economics readers again, what we mean by this is that investors are worried that the excess supply of money will make their money worthless because inflation caused by the rise of the price of goods will take away the value of their money. Think about the stories your parents told you about how Char Mee Hoon used to cost 5 cents.An illustration can be found here, linked from Greg Mankiw’s blog). In this I share the view of  economists who disagreed. Scott Sumner for instance, argued that the increasing price of gold is not due to the fear of inflation afflicting North America, but rather the increase in demand for gold from China, where the people are hedging against the inflation in an overheated market. (Scott Sumner’s post was made accessible from Hisham’s blog).

It is in this that I think using the soaring price of gold to argue that investors are spooked by inflation overstates the case against QE2. I admit however, the credibility of governments and central banks are under siege. What we need right now is not the fear of inflation, but rather inflation to hurtle us out of this mess. The key in achieving that while assuring the market that it will be placed under control would require the satisfaction of these conditions:
a) That policy makers explicitly target an inflation rate.
b) To provide a stable macro-economic conditions for investors.
c) Enact policies (tax cuts, government spending etc) to boost real income and create a feedback loop of recovery.

In all sense the economy is analogous to a game of music chair. If everyone pretends that the music hasn’t stopped and keeps on passing the parcel, the game goes on. What we need then is to get all these players to continue to pass on the parcels by making them believe that the music is still going on, regardless of what it may be objectively. When the music is played back, we’d all still be trudging along.

On what I think about austerity packages right now, I quote Keynes ” In the long run we’re all dead.”

A Cartel in the Derivatives Market

The New York Time’s latest coverage alleging a cartel formed amongst “big banks” in the oligopolistic derivatives market is an interesting one. In standard Economics textbook it is often said that the stability of a cartel lies on its ability to enforce its ground rules among its members.

In this case it appears that the cartel might actually be strengthened on the legislative side with the support of a Republican-controlled Senate. But then a Judiciary that is interested in interpretting law rather than focusing on upholding the law might thwart that.

As an added twist, if a cartel were to be formed there are incentives for outside firms to stay out of the cartel and then cheat by producing more and selling at the price created by the output restrictions of the firms involved in a cartel. However in this case, since total market power is created by law to be concentrated on the hands of the members of the cartel, only members in the inner circle benefit.

In my humble normative judgement, I think economics should be a focal point of the impending debate. In an utilitarian view point, the cartel should be broken down and transparency is paramount because the benefits accrued to society in greater and cheaper accessibility to derivatives far outweights the cost (profits of “Big Banks”, whatever “Big Banks” mean). On a Just Deserts theory viewpoint, it is hard to make a case that the members involved in his cartel deserve the economic rent (which mean institutionalised guarantee of maximum profits, which may be negative,zero or positive) by virtue of their contribution in providing a valuable service, because the additional value attested by the profits is artificially sustained by forcefully keeping potential competitors out.

Towering Prosperity

To its proponents, towering skyscrapers bustling with economic activities encapsulate the progressive nature of the community.They are grandiose architectural successes etching closer and closer to the sky as communities engage in an arms race to boast that only the sky is the limit. To its staunch opponents, they are but hollow phallic symbols showcasing garish extravagence. Fervent supporters of skyscrapers are quick to point out that major global city centers have one – the Empire State Building in New York; Taipei 101 in Taipei etc. Some would even go as far as arguing that the construction of skyscrapers causes economic growth.I am skeptical of such arguments on the basis that correlation is not causation.

Just because skyscrapers are found in major city centers in the way doesn’t prove that their construction brings economic growth. In an ironic(and iconic) twist, Burj Dubai, the skyscraper that was to be inaugurated as the tallest skyscraper in the world was renamed Burj Khalifa in gratitude to the U.A.E for bailing Dubai out of a property bust. Using skyscrapers to predict economic boom or gloom would yield a prediction no more accurate then say, flipping a coin.

There is always a “construction lag” between the time investment decisions are made and the time a skyscraper is completed. The fact that skyscrapers tend be completed in times of boom doesn’t mean that investment in skyscrapers per se contribute to growth. Rather the macroeconomic conditions were such that investors expected inflation to pose enough justification to invest now in a skyscraper (because their money will be worth much less in the future); or are expecting interest rates to increase as the Reserve Banks try to cool down an overheated market. Either way, the decision to build skyscrapers is an effect of a booming economy rather than the other way around.

Of course, a keen reader might observe that the flip side can also be true. The completion of a skyscraper might also predict a bust. (Hence the Skyscraper Index). If investment decisions are made in a market fuming with irrational exuberance, where nobody entertains the idea that the bubble will burst, then the completion of a skyscraper under such condition is inevitably accompanied with a period of gloom. When the dust settles in the aftermath of the bubble’s burst, what we are left with are a glut of towering buildings appraised with low values that would have seemed preposterous months ago.

By now, how confident can we be with the causal relationship between skyscrapers and economic growth?Skyscrapers can’t even be used reliably to establish a correlational relationship with a boom/bust outcome. And in what sense is a skyscraper beneficial for growth? In thinking of building one we also have to take into account the high cost in maintenance such buildings incur. If the presence of a skyscraper signals to investors on how serious a party is in the development of an area, as an economics student I have to ask, would the same be achieved by building a vast network of infrastructure connecting to the site?

So hopefully you can all see that not only is it dubious to claim that building skyscrapers drives growth, correlating skyscrapers with specific outcomes is equally questionable.

I am not opposed to growth and I am willing to entertain the idea that skyscrapers can contribute to growth if I am presented with strong evidence. What I am unwilling to accept is the junk-economics people try to sell me by cherry-picking data and packaging dubious correlational arguments into undisputed causal ones.