Monday, June 23, 2008
THE QUALITY OF BUSINESS LOCATION: THE CASE OF SWISS CANTONS
Credit Suisse recently published a research paper (link) where it's been shown that Swiss cantons with lower tax burden and improved regulatory environment are therefore more attractive as locations for doing business (link). Cantons Zug, Zurich and Obwalden got the highest score. Although tax rate structure in Zurich is not among the lowest in entire Switzerland, Zurich's high score can be explained by the fact that there's a high-quality access to demand linkages that certainly boosts the quality of Zurich as business location despite relatively high personal and corporate tax rates. In more distant cantons, tax competition certainly plays a bigger role since creating a business environment friendly oriented towards incentives to work, save and invest is a primary tool that boosts the locational quality of the region regarding economic outlook and the quality of the particular environment for doing business.
Thursday, June 19, 2008
KENNEDY TAX CUTS IN 1960s
Here is how JFK explained the benefits of tax reductions that he implemented in 1960s.
TAX RATE REDUCTION IN GIBRALTAR
Tax-news.com recently reported that Gibraltar's government eventually decided to slash the corporate tax rate from 33 percent to 12 percent by the beginning of 2010 (link).
ARGENTINA'S PUBLIC DEBT SHOT UP TO 56 PERCENT OF THE GDP
From FT:
"Argentina’s debt levels are now higher than they were when it crashed into the biggest sovereign debt default in history in 2001, and a worsening crisis of confidence in the government has brought the spectre of a new default closer, a report to be published next week says. Despite a radical restructuring just three years ago, public debt has reached $114.7bn (€74.4bn, £59bn), or 56 per cent of gross domestic product, compared with $144.2bn, or 54 per cent of GDP, in 2001 – at a time when Argentina’s economy was much larger – according to the paper. Martín Krause and Aldo Abram, directors of the Argentine Institutions and Markets Research Centre at Eseade business school and the report’s authors, also found that if the amount owed to bondholders who did not accept the 2005 restructuring and are suing to recover their money is included, Argentina’s overall debt rises to $170bn, or 67 per cent of GDP. “We’re not teetering on the brink of default but if we continue down this path, with this level of [social] conflict, we could get there,” Mr Abram told the FT. Many developed countries, including Italy and Japan, have higher ratios of debt to GDP but Argentina’s higher borrowing costs and rocky institutional record make it harder to secure credit. “The worry is not the amount, it’s that we won’t have access to credit,” Mr Abram said. The six-month-old government of Cristina Fernández, the president, has been struggling to resolve a conflict with farmers after it imposed a sliding scale of export tariffs on key agricultural exports in March. The unrest has spread to truck drivers, who have mounted roadblocks to demand an end to the farm dispute, which has disrupted grains transportation. Their action has caused fuel shortages and will put further pressure on inflation, which the government is widely accused of trying to conceal with doctored data. Meanwhile, the government must this year find $14.6bn for debt servicing, plus $11.8bn next year and $10.5bn in 2010. However, the threat of legal action by bond holdouts bars Argentina from international capital markets whilst it remains in default with the Paris Club of creditor nations, to which it owes $6.6bn. Argentina has increasingly turned to Hugo Chávez, the Venezuelan president, who has bought $6.4bn in bonds in the past three years. But its international financial isolation is costly – Buenos Aires has had to pay Venezuela interest rates of up to 13 per cent, yet it cancelled its low-cost International Monetary Fund debt and the Paris Club debt only costs 5.3 per cent, Mr Krause said. By contrast Brazil, which had a far worse debt profile than Argentina in 2001, recently achieved investment grade and sold a 10-year bond at 5.3 per cent."
"Argentina’s debt levels are now higher than they were when it crashed into the biggest sovereign debt default in history in 2001, and a worsening crisis of confidence in the government has brought the spectre of a new default closer, a report to be published next week says. Despite a radical restructuring just three years ago, public debt has reached $114.7bn (€74.4bn, £59bn), or 56 per cent of gross domestic product, compared with $144.2bn, or 54 per cent of GDP, in 2001 – at a time when Argentina’s economy was much larger – according to the paper. Martín Krause and Aldo Abram, directors of the Argentine Institutions and Markets Research Centre at Eseade business school and the report’s authors, also found that if the amount owed to bondholders who did not accept the 2005 restructuring and are suing to recover their money is included, Argentina’s overall debt rises to $170bn, or 67 per cent of GDP. “We’re not teetering on the brink of default but if we continue down this path, with this level of [social] conflict, we could get there,” Mr Abram told the FT. Many developed countries, including Italy and Japan, have higher ratios of debt to GDP but Argentina’s higher borrowing costs and rocky institutional record make it harder to secure credit. “The worry is not the amount, it’s that we won’t have access to credit,” Mr Abram said. The six-month-old government of Cristina Fernández, the president, has been struggling to resolve a conflict with farmers after it imposed a sliding scale of export tariffs on key agricultural exports in March. The unrest has spread to truck drivers, who have mounted roadblocks to demand an end to the farm dispute, which has disrupted grains transportation. Their action has caused fuel shortages and will put further pressure on inflation, which the government is widely accused of trying to conceal with doctored data. Meanwhile, the government must this year find $14.6bn for debt servicing, plus $11.8bn next year and $10.5bn in 2010. However, the threat of legal action by bond holdouts bars Argentina from international capital markets whilst it remains in default with the Paris Club of creditor nations, to which it owes $6.6bn. Argentina has increasingly turned to Hugo Chávez, the Venezuelan president, who has bought $6.4bn in bonds in the past three years. But its international financial isolation is costly – Buenos Aires has had to pay Venezuela interest rates of up to 13 per cent, yet it cancelled its low-cost International Monetary Fund debt and the Paris Club debt only costs 5.3 per cent, Mr Krause said. By contrast Brazil, which had a far worse debt profile than Argentina in 2001, recently achieved investment grade and sold a 10-year bond at 5.3 per cent."
PRICE CONTROLS DON'T SOLVE RELATIVE SCARCITY: THE CASE OF MEXICO
Financial Times reports that Mexican government decided to impose food price controls in response to an increase in food prices. It will be interesting to see the situation when the laws of supply and demand take place.
INFLATION IN ASIAN ECONOMIES
Financial Times has a brilliant analysis regarding inflationary pressures and the surgence of macroeconomic instability in Asian export-driven economies (here).
Wednesday, June 11, 2008
REGULATION AND ENTREPRENEURSHIP
Kevin Hassett of the American Enterprise Institute recently published in article (link) in which he explained why there is a negative correlation between high regulation of entry and entrepreneurship. Two economists, Silvia Ardagna and Annamaria Lusardi examined survey data collected from 150,000 individuals in 37 different countries and showed that the amount of opportunity entrepreneurs is the highest in countries where there is less regulation of entry. For example, the United States has the highest share (8 percent) of opportunity enterpreneurs and the fewest regulatory entry barriers, after Canada and Denmark. On the other side, Spain, France, Belgium and Slovenia have the lowest share of opportunity enterpreneurs and unsurprisingly many regulatory barriers of entry.
Thursday, June 05, 2008
Wednesday, June 04, 2008
AUSTRALIA'S ECONOMY GROWS FAST
In the latest quarter, Australia's economy grew 0,6 percent - twice as fast as the economists forecasted - continuing 17 years of rapid economic expansion. Economy's growth records may force the central bank to raise interest rate to curb inflationary pressures (link).
HOW WOULD EMERGING MARKETS SURVIVE MACROECONOMIC CRISIS
Bloomberg discusses how emerging markets would survive an economic crisis (link).
AGEING POPULATION IN JAPAN
From WSJ's Real Time Economics (link):
"Japan’s finance minister, Fukushiro Nukaga, suggested a way to alleviate the country’s strained finances as its population ages rapidly: Work till you’re 70. Japan is already the world’s oldest big nation, and between 2005 and 2020, the number of Japanese aged over 65 is forecast to rise to about 36 million from 26 million. Meanwhile, the number of working age Japanese will shrink to 74 million from 84 million. That is already hurting economic growth, and is expected to have an even greater effect in the future. Japan’s productivity — a measure of how much each worker produces — will rise a healthy 2.2% a year between 2009 and 2013, according to a forecast by the Organization for Economic Cooperation and Development. But the shrinking workforce will strip 0.7 percentage point from that, leaving the country with just 1.5% annual growth. “We are at a historic turning point,” Mr. Nukaga told a news conference Wednesday. While output growth is slowed, more people are living off pensions. Japan over recent years has already introduced some changes designed to make its pension system workable. Between 2000 and 2025, the age at which men can receive their full pension is being raised from 60 to 65. (The changes affect women five years later.) Pension premiums paid by workers are rising. This still isn’t enough however. Other ways to alleviate the problem, he said, could include allowing a greater number of foreign workers in Japan, which has traditionally not allowed large-scale immigration."
"Japan’s finance minister, Fukushiro Nukaga, suggested a way to alleviate the country’s strained finances as its population ages rapidly: Work till you’re 70. Japan is already the world’s oldest big nation, and between 2005 and 2020, the number of Japanese aged over 65 is forecast to rise to about 36 million from 26 million. Meanwhile, the number of working age Japanese will shrink to 74 million from 84 million. That is already hurting economic growth, and is expected to have an even greater effect in the future. Japan’s productivity — a measure of how much each worker produces — will rise a healthy 2.2% a year between 2009 and 2013, according to a forecast by the Organization for Economic Cooperation and Development. But the shrinking workforce will strip 0.7 percentage point from that, leaving the country with just 1.5% annual growth. “We are at a historic turning point,” Mr. Nukaga told a news conference Wednesday. While output growth is slowed, more people are living off pensions. Japan over recent years has already introduced some changes designed to make its pension system workable. Between 2000 and 2025, the age at which men can receive their full pension is being raised from 60 to 65. (The changes affect women five years later.) Pension premiums paid by workers are rising. This still isn’t enough however. Other ways to alleviate the problem, he said, could include allowing a greater number of foreign workers in Japan, which has traditionally not allowed large-scale immigration."
CUTTING THE CORPORATE TAX BURDEN
Greg Mankiw (link) recently wrote an article (link) published in The New York Times (link) discussing the possibility of a cut in the corporate tax rate as recently proposed by the economic advisers of John McCain. While John McCain has some doubtful and economically questionable proposals, such as the extension of gas-tax holidays, his economic advisers recently proposed a cut in the federal corporate tax rate from 35 percent to 25 percent. While the suggested proposal has been harshly criticized by economists such as Brad DeLong (link), the proposal deserves an open discussion about the consequences of the corporate tax rate.
The most frequent mistake that has been grasped repeatedly by the mainstream media and intellectual elites is that corporate tax is actually paid by the corporation itself. Despite the soundness of the argument, it is false. Corporations are likely to be tax-collectors than taxpayers. Why? For example, if you own equities and securities, than corporations shift the burden to consumers, hired labor and stockholders. An increase in the corporate tax rate potentially reduces capital investment. In turn, a corporation levies the burden by cutting total costs of labor and services. Consequentially, corporate equities and stocks are hampered by a higher relative weight on potential returns. Also, a significant amount of empirical research, including Randolph's 2006 study (Congressional Budget Office), has confirmed that the major share (70 percent) of the corporate tax burden is beared by the labor force. Researchers at Oxford University (Arulampalan, Devereux, Maffini) examined the effect of the corporate tax in 50,000 European companies in nine European countries. They found that, in the long run, a $1 increase in the tax bill reduces the real wage at the median by 92 cents.
The opposition to the cut in corporate tax rate often includes arguments such as the loss of tax revenue and the reduction of real wages. However, none of these arguments is based on empirical observations. In the short run, there are numerous static assumptions claiming that the revenue may fall precisely. However, the reduction in corporate tax burden would result in a stronger and less volatile stock market. In turn, that would boost capital investment respectively which would lead to higher productivity growth. A basic consequence of productivity increase is the increase in real wages and a drop in consumer prices. True, part of rhe revenue loss may be covered by an increase in other taxes such as gasoline taxes. But have there been any confident estimates showing that the revenue may really decline?
An additional and truly important measure to decrease the corporate tax burden is lowering government expenditure, both in absolute in relative terms. According to experience, the net effect of lower government spending is an increase in the growth of real productivity as well as stronger stock market that would boost investment and reduce volatility of the stock market itself. Also, lower government spending would result in higher output growth as well as it would have significantly positive welfare effects on prices, wages and employment.
The most frequent mistake that has been grasped repeatedly by the mainstream media and intellectual elites is that corporate tax is actually paid by the corporation itself. Despite the soundness of the argument, it is false. Corporations are likely to be tax-collectors than taxpayers. Why? For example, if you own equities and securities, than corporations shift the burden to consumers, hired labor and stockholders. An increase in the corporate tax rate potentially reduces capital investment. In turn, a corporation levies the burden by cutting total costs of labor and services. Consequentially, corporate equities and stocks are hampered by a higher relative weight on potential returns. Also, a significant amount of empirical research, including Randolph's 2006 study (Congressional Budget Office), has confirmed that the major share (70 percent) of the corporate tax burden is beared by the labor force. Researchers at Oxford University (Arulampalan, Devereux, Maffini) examined the effect of the corporate tax in 50,000 European companies in nine European countries. They found that, in the long run, a $1 increase in the tax bill reduces the real wage at the median by 92 cents.
The opposition to the cut in corporate tax rate often includes arguments such as the loss of tax revenue and the reduction of real wages. However, none of these arguments is based on empirical observations. In the short run, there are numerous static assumptions claiming that the revenue may fall precisely. However, the reduction in corporate tax burden would result in a stronger and less volatile stock market. In turn, that would boost capital investment respectively which would lead to higher productivity growth. A basic consequence of productivity increase is the increase in real wages and a drop in consumer prices. True, part of rhe revenue loss may be covered by an increase in other taxes such as gasoline taxes. But have there been any confident estimates showing that the revenue may really decline?
An additional and truly important measure to decrease the corporate tax burden is lowering government expenditure, both in absolute in relative terms. According to experience, the net effect of lower government spending is an increase in the growth of real productivity as well as stronger stock market that would boost investment and reduce volatility of the stock market itself. Also, lower government spending would result in higher output growth as well as it would have significantly positive welfare effects on prices, wages and employment.
Wednesday, May 28, 2008
HOUSING BUBBLE SPREADS ACROSS EUROPE
This article was written by Martin Rojko, a real estate analyst and frequent guest writer at Capitalism & Freedom.
According to indicators used for measuring a housing price bubble, residential property values were inflated last year in many european countries. Morgan Stanley´s and Global Property Guide´s data indicate, that market distortion is in Spain, Ireland, Baltic states, Netherlands, Denmark, Czech republic, Great Britain. As these data were gathered in 2006, it´s more than probable more markets join now a bubbled group including Slovakia.
According to TREND calculations the price of mostly selling apartment (one-bedroom, 60 m2 livable area) were equaled to eight-year disposable household income in Bratislava area. Although numbers (not only) such these should be counted carefully, sticking out income and price is a matter of fact. Also another indicator of rental property yields signals the bubble. While a few years ago an owner in Bratislava could make 10% or more from an apartment, now it is approximately 5% (less than mortgage interest in banks). It is the result of doubling apartment prices and stabilising rents.
A long history of western developed markets suggests a normal yield of around 10 – 12%. Property gets cheap when yields approach 15 – 20%. Numbers lower than 6-8% mean overvaluation. According to ECB note house prices in euro zone are overvalued by 15 to 25% by this indicator from their historical averages.
The second indicator, price-to-income ratio, tells how many years of pretax annual earnings are necessary for a household to purchase a house. The historical rule of thumb is that one annual income indicates undervalued properties, two and three annual incomes normal valuation, and four and more annual incomes overvaluation and bubble territory.
This situation has clear solution. To bring the ratio of prices to rents and incomes back to fair value, both must rise sharply or prices must fall. Housing prices now fall in Ireland, Latvia, Estonia, Spain and Great Britain.
We can often hear some experts said that european countries haven´t so crazy lending standards as in the USA and that´s why there´s no danger to afraid of a bubble. It´s a clear misunderstanding. Subprime mortgages don´t create a bubble although it can boost it. Look at Great Britain, Ireland or Spain. There haven´t been much relaxed bank´s lending conditions (especially comparing to the USA), so why the current turmoil? Because home prices are not justified by fundamentals – income, and rents. The bubble is reality.
Now the question stands whether it will burst and harm the whole economy or slowly blowing-out. Considering three mentioned countries I see the greatest danger in Spain. First, there is a huge home supply at prices which people simply can´t afford to pay. Currently cca 650 000 unsold units. Developers will be forced to decrease price maybe 30% down to sell them. But in the meantime many firms get to financial problems and go bankrupt. Second, Spain has the highest construction sector share on GDP in Europe (nearly 18 %). When developer, building firms have troubles, banks and whole economy have also. Of course, government interferes and pumps subsidy package to the economy, but this step only postpones clearing of the market.
There´s another (empirical) point we must be aware of. It is a tight correlation between US and euro area housing prices. The latter following the former with a lag of about two years. US started to decline in 2006, so maybe this year eurozone is in order.
But what about emerging euro countries? Well, as mentioned above the bubble exists in many of them. One thing is clear. Prices are rising slower than in previous years, in some markets (Estonia) they are heading downward with mild heavy impact on a part of mortgaged buyers. They have stabilized in polish Warsaw (been for 9 months cca on the same level) and start to stabilize in Bratislava. While up to day growth was driven in most part by foreign investors, they are now (also due to so called “mortgage crisis”) away. Developers thus hope domestic buyers will continue, but prices are too high for middle classed society (as largest pool of potential clients), because they are set-up still for wealthy and investors.
Now the question is whether incomes will rise so quickly that homes will sell at this level or prices should go down. I think second alternative is the most probable (and not because of I´m not living in my own). And the sooner sellers realize this, the lesser will be impact of bursting bubble in later times. The opposite side of a coin is firms are misguided by monetary policy of central banks, which manipulate interest rate according to their needs, while a real value of the money (or better said the means of payment) can be much higher (see US). And another question here arises (when not talking of abolition), whether one central bank for many differently phased markets is the best way to cope with problems.
Martin Rojko, author is a reporter in TRENDreality.sk (real estate server of business weekly TREND) and runs a blog vlastnictvo.blogspot.com
Monday, May 26, 2008
WHAT IS BEHIND THE INFLATION IN EMERGING MARKETS?
Gary Becker (link) and The Economist (link) recently discussed the surge in commodity prices and inflation that has driven inflation rates in emerging markets as well as in high-income economies to historic highs. For example, China's official rate of consumer price inflation is at 12-year high of 8,5 percent. Unofficial estimates have shown that Argentina's inflation rate has peaked 23 percent in 2008. Also, inflation rate in Russia has trimmed up to 14,5 percent, up from 8 percent annually. Central banks in emerging markets have repeatedly faced significant inflationary pressures. In world market, the price of oil barrel has climbed over $120 USD which gave speculators a boost in inflating the expectations that the world price of oil barrel will reach $200 percent and more.
Using the data and some basic tools of economic analysis, it is easily shown that the real price of oil per barrel in relative terms, cannot reach $200 USD unless terrorists attack or a sudden attack on oil fields in the Middle East impairs production abilities of oil producers in that part of the world. Commodity market analysts repeatedly analyze the spillover effects of the regulation of production in oil-exporting economies that generates upward changes in the world price of oil. One reason is that OPEC is a cartel of countries whose profit-making point rests on the real assumption that price elasticity of oil demand is very low which means that there's an inelastic demand for oil. In that case, producers choose to allocate relatively scarce resources by rationing the production of oil and thus increasing the price of oil which, in real conditions of imperfect competition, yields oil producers gains since inelastic consumer demand and quantity control of the production return higher profits when the price per unit of oil is increased. One of the classical solutions to avoid higher price increases and mark-ups is to shift towards the consumption of green energy that will make the demand for commodities, such as oil, more elastic and that would immediately eliminate the monopoly power of OPEC. But the shifts towards "greener energy" is a time-taking process that involves significant consumer expenditures as the price of products that are not linked to oil as production ingredient, is high. That is because, developing "green" products demands huge company expenditures in R&D, supply chains and knowledge-intensive services. Over time, the dependency on oil is expected to decline which implies that cartel stability of OPEC which controls the quantity and price of oil in the world market will decline gradually.
Among economic analysts, the surge in commodity prices is assumed as the engine of current inflationary pressures. But world supply and demand cannot solely explain the surge in commodity product prices. Impeding price controls and export subsidies have vastly contributed to a recent surge in commodity prices. Using price controls causes disparities in quantitiy demanded and supplied which leads to quantity shortages and price accomodation in underground markets. Also, various export bans, subsidies and price controls cause significant micro-inefficiencies that raise the rigidity and potentially reduce the elasticity of demand and supply.
Another important aspect of the surge in inflation in emerging markets is macroeconomic policy pursued by central banks and fiscal policymakers. For example, China responded to inflation surge by putting up more price controls and export bans. India has suspended futures trading in particular commodity markets. In the short run, such measures can cap the official inflation but in the long run, such measures do not lead to price adjustment after the endogenous and/or exogenous shocks tranquil. One of the reasons for an obviously higher inflation rate is that households in emerging markets have higher food expenditure from their budgets which places a heavy weight on food demand, making it more inelastic. Another reason is that central banks in emerging markets such as Russia, China, India and Brasil, pursued an expansionary monetary policy in recent years. Money supply, for example, has grown tremendously. In Russia, for instance, money supply has grown by a swelling 42 percent and central bank's target interest rate (6,5 percent) is far below the official inflation rate (15 percent).
On the offset, rigid labor markets and inflexible wage determination lead to price-wage spiral. An evidence has been observed in Russia where wages are growing 30 percent annually, more than 3 times more than the growth of productivity. A combination of rigid and inflexible market mechanism and expansionary macroeconomic policy as well as supply shocks contributed to the rise in the inflation rate. Even though sound growth forecast, predict a fairly stable output growth rate in the medium term, central banks in emerging markets will have to face the fact that expansionary fiscal policy must be neutralized by a rise in the interest rates and a decrease in the growth of money supply as a neccessary measure to bring the inflation under control. Continued rapid growth in emerging markets means that relative-price shock will be temporary and the food prices will remain high. Also, exchange rate flexibility is needed to avoid intended currency depreciation which sets an important pressure on inflation expectations. Thus, without tighter monetary policy and flexibile labor markets, central banks may soon repeat the mistakes which caused the great inflation in 1970s.
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Using the data and some basic tools of economic analysis, it is easily shown that the real price of oil per barrel in relative terms, cannot reach $200 USD unless terrorists attack or a sudden attack on oil fields in the Middle East impairs production abilities of oil producers in that part of the world. Commodity market analysts repeatedly analyze the spillover effects of the regulation of production in oil-exporting economies that generates upward changes in the world price of oil. One reason is that OPEC is a cartel of countries whose profit-making point rests on the real assumption that price elasticity of oil demand is very low which means that there's an inelastic demand for oil. In that case, producers choose to allocate relatively scarce resources by rationing the production of oil and thus increasing the price of oil which, in real conditions of imperfect competition, yields oil producers gains since inelastic consumer demand and quantity control of the production return higher profits when the price per unit of oil is increased. One of the classical solutions to avoid higher price increases and mark-ups is to shift towards the consumption of green energy that will make the demand for commodities, such as oil, more elastic and that would immediately eliminate the monopoly power of OPEC. But the shifts towards "greener energy" is a time-taking process that involves significant consumer expenditures as the price of products that are not linked to oil as production ingredient, is high. That is because, developing "green" products demands huge company expenditures in R&D, supply chains and knowledge-intensive services. Over time, the dependency on oil is expected to decline which implies that cartel stability of OPEC which controls the quantity and price of oil in the world market will decline gradually.
Among economic analysts, the surge in commodity prices is assumed as the engine of current inflationary pressures. But world supply and demand cannot solely explain the surge in commodity product prices. Impeding price controls and export subsidies have vastly contributed to a recent surge in commodity prices. Using price controls causes disparities in quantitiy demanded and supplied which leads to quantity shortages and price accomodation in underground markets. Also, various export bans, subsidies and price controls cause significant micro-inefficiencies that raise the rigidity and potentially reduce the elasticity of demand and supply.
Another important aspect of the surge in inflation in emerging markets is macroeconomic policy pursued by central banks and fiscal policymakers. For example, China responded to inflation surge by putting up more price controls and export bans. India has suspended futures trading in particular commodity markets. In the short run, such measures can cap the official inflation but in the long run, such measures do not lead to price adjustment after the endogenous and/or exogenous shocks tranquil. One of the reasons for an obviously higher inflation rate is that households in emerging markets have higher food expenditure from their budgets which places a heavy weight on food demand, making it more inelastic. Another reason is that central banks in emerging markets such as Russia, China, India and Brasil, pursued an expansionary monetary policy in recent years. Money supply, for example, has grown tremendously. In Russia, for instance, money supply has grown by a swelling 42 percent and central bank's target interest rate (6,5 percent) is far below the official inflation rate (15 percent).
On the offset, rigid labor markets and inflexible wage determination lead to price-wage spiral. An evidence has been observed in Russia where wages are growing 30 percent annually, more than 3 times more than the growth of productivity. A combination of rigid and inflexible market mechanism and expansionary macroeconomic policy as well as supply shocks contributed to the rise in the inflation rate. Even though sound growth forecast, predict a fairly stable output growth rate in the medium term, central banks in emerging markets will have to face the fact that expansionary fiscal policy must be neutralized by a rise in the interest rates and a decrease in the growth of money supply as a neccessary measure to bring the inflation under control. Continued rapid growth in emerging markets means that relative-price shock will be temporary and the food prices will remain high. Also, exchange rate flexibility is needed to avoid intended currency depreciation which sets an important pressure on inflation expectations. Thus, without tighter monetary policy and flexibile labor markets, central banks may soon repeat the mistakes which caused the great inflation in 1970s.
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Monday, May 19, 2008
FRENCH WELFARENOMICS
Here (link) is an interesting story from The Economist which discusses huge price disparities between French and German retailers. For example, a basket of almost identical durable goods costs 30 percent more in France than in Germany.
The article reports that in many places in France there are local retail monopolies protected against domestic and foreign competition. There is also no free negotiation with suppliers, the sale of non-prescription drugs is prohibited, and the consumers do not support the new law that would deregulate the retail market to liberalize entry conditions and enforce competitive mechanism.
There is a well-known fact from microeconomic theory that consumer demand curve for monopoly firm equals average revenue of the monopoly firm and that monopoly firm will never like rigid or completely elastic demand but the elasticity of demand that will be equal to 1, given the point of the maximum profit taken by the monopoly firm. Hence, the price charged by the monopolist is P = MC/1+(1/Ex,px) which means that greater monopoly power leads to higher mark-ups. And also, the allocative inefficiency of the monopoly means that firm will set the price at the point where marginal revenue and marginal cost are crossed. Hence, higher prices and quantity regulation maximize the profit of the monopoly firm but consumers face a significant welfare loss.
In France, however, only 42 percent of the respondents favored more competitive retail market while 85 percent favored sales tax cuts and 72 percent prefered the rise in the minimum wage. Competitive market is always the only way to break the rigidity and monopoly position of the firm inparticular markets. For example, if there would be sales tax cut, that would not change the structure of the market but it would have an effect on the price elasticity of demand and since a local monopoly firm would face changes in the composition of the local demand, a tax cut would ease the prices but would still give local monopoly firms incentives to impose the mark-up. A rise in the minimum wage is a fallacy that, empirically, results in the rise of the unemployment and further labor market rigidity that hinders the growth of real productivity, decreases job growth and does not stimulate the real increase in purchasing power parity since higher prices, charged by firms to cover-up the loss from minimum wage, discourage the increase in purchasing power that is not linked to real productivity growth.
The article reports that in many places in France there are local retail monopolies protected against domestic and foreign competition. There is also no free negotiation with suppliers, the sale of non-prescription drugs is prohibited, and the consumers do not support the new law that would deregulate the retail market to liberalize entry conditions and enforce competitive mechanism.
There is a well-known fact from microeconomic theory that consumer demand curve for monopoly firm equals average revenue of the monopoly firm and that monopoly firm will never like rigid or completely elastic demand but the elasticity of demand that will be equal to 1, given the point of the maximum profit taken by the monopoly firm. Hence, the price charged by the monopolist is P = MC/1+(1/Ex,px) which means that greater monopoly power leads to higher mark-ups. And also, the allocative inefficiency of the monopoly means that firm will set the price at the point where marginal revenue and marginal cost are crossed. Hence, higher prices and quantity regulation maximize the profit of the monopoly firm but consumers face a significant welfare loss.
In France, however, only 42 percent of the respondents favored more competitive retail market while 85 percent favored sales tax cuts and 72 percent prefered the rise in the minimum wage. Competitive market is always the only way to break the rigidity and monopoly position of the firm inparticular markets. For example, if there would be sales tax cut, that would not change the structure of the market but it would have an effect on the price elasticity of demand and since a local monopoly firm would face changes in the composition of the local demand, a tax cut would ease the prices but would still give local monopoly firms incentives to impose the mark-up. A rise in the minimum wage is a fallacy that, empirically, results in the rise of the unemployment and further labor market rigidity that hinders the growth of real productivity, decreases job growth and does not stimulate the real increase in purchasing power parity since higher prices, charged by firms to cover-up the loss from minimum wage, discourage the increase in purchasing power that is not linked to real productivity growth.
Wednesday, May 14, 2008
Tuesday, May 13, 2008
RETHINKING ARGENTINA'S ECONOMIC CRISIS
BrinkLindsey of the Cato Institute wrote a piece on the origins and causes of Argentina's economic crisis. The article can be read here.
INFLATIONARY PRESSURES IN GULF COUNTRIES
From FT (link):
"Inflation has replaced unemployment as the most pressing short-term problem facing the oil-rich Gulf economies, which are reaping the benefits of record oil revenues but do not have the tools available to cap rising prices, the International Monetary Fund warned on Monday. Creating jobs for the region’s growing youth population continued to be the main longer-term challenge for Middle Eastern oil exporters, said Mohsin Khan, the IMF’s regional director, but rising prices, already a concern in Qatar and the United Arab Emirates, had now extended across the Gulf Co-operation Council members to traditionally low-inflation countries such as Saudi Arabia, where inflation is approaching 10 per cent... The IMF predicts the Arab Gulf states’ consumer price index will average 7.1 per cent this year, up from 6.1 per cent in 2007 – while the broader Middle East and north Africa region will reach 10.4 per cent this year. With many regional economies pegged to the dollar, central banks lack any monetary policy tools to tackle inflation, leaving fiscal spending, rent caps and price subsidies as the only policy tools available to policymakers. In November last year, for example, rumours of a revaluation in the UAE sparked speculative inflows of $45bn (€29bn, £23bn) in one month, almost a third of the UAE’s gross domestic product... The Middle East and central Asia, which has been largely insulated from global economic uncertainty, was set to continue its strong performance, with oil-exporting countries seeing growth pick up to 6.25 per cent, the IMF said in its biannual regional economic outlook report. The region’s oil and gas exports will amount to $940bn this year, almost $200bn more than last year, as an almost fivefold increase in the price of oil fills the GCC’s coffers. The IMF estimates that the GCC’s combined GDP will reach more than $1,000bn this year, up from $805bn in 2007. The oil exporter’s growing external current account surplus, which is expected to grow to $1,400bn for 2004-2008, signals a continuing ability to invest abroad, while coping with increasing imports and investment into their domestic economies. The GCC’s current account surplus is expected to rise to $332bn from $227bn in 2007, with the UAE’s surplus rising 58 per cent and Qatar’s almost doubling. Official reserves of oil exporters had reached $800bn by the end of 2007. Foreign direct investment into the region reached $80bn in 2007, four times as high as 2002, 55 per cent of which flowed into Egypt, Saudi Arabia and the UAE."
"Inflation has replaced unemployment as the most pressing short-term problem facing the oil-rich Gulf economies, which are reaping the benefits of record oil revenues but do not have the tools available to cap rising prices, the International Monetary Fund warned on Monday. Creating jobs for the region’s growing youth population continued to be the main longer-term challenge for Middle Eastern oil exporters, said Mohsin Khan, the IMF’s regional director, but rising prices, already a concern in Qatar and the United Arab Emirates, had now extended across the Gulf Co-operation Council members to traditionally low-inflation countries such as Saudi Arabia, where inflation is approaching 10 per cent... The IMF predicts the Arab Gulf states’ consumer price index will average 7.1 per cent this year, up from 6.1 per cent in 2007 – while the broader Middle East and north Africa region will reach 10.4 per cent this year. With many regional economies pegged to the dollar, central banks lack any monetary policy tools to tackle inflation, leaving fiscal spending, rent caps and price subsidies as the only policy tools available to policymakers. In November last year, for example, rumours of a revaluation in the UAE sparked speculative inflows of $45bn (€29bn, £23bn) in one month, almost a third of the UAE’s gross domestic product... The Middle East and central Asia, which has been largely insulated from global economic uncertainty, was set to continue its strong performance, with oil-exporting countries seeing growth pick up to 6.25 per cent, the IMF said in its biannual regional economic outlook report. The region’s oil and gas exports will amount to $940bn this year, almost $200bn more than last year, as an almost fivefold increase in the price of oil fills the GCC’s coffers. The IMF estimates that the GCC’s combined GDP will reach more than $1,000bn this year, up from $805bn in 2007. The oil exporter’s growing external current account surplus, which is expected to grow to $1,400bn for 2004-2008, signals a continuing ability to invest abroad, while coping with increasing imports and investment into their domestic economies. The GCC’s current account surplus is expected to rise to $332bn from $227bn in 2007, with the UAE’s surplus rising 58 per cent and Qatar’s almost doubling. Official reserves of oil exporters had reached $800bn by the end of 2007. Foreign direct investment into the region reached $80bn in 2007, four times as high as 2002, 55 per cent of which flowed into Egypt, Saudi Arabia and the UAE."
Sunday, May 11, 2008
THE REAL FACE OF PUTINOMICS
Aleh Tsvynski and Sergei Guriev wrote a brief article on Russia's state of the economy and political stability. Here's a slice of the article:
"The other major barrier to growth is corruption. In another World Bank-EBRD survey, 40% of firms in Russia reported making frequent unofficial payments, and roughly the same percentage indicated that corruption is a serious problem in doing business. Unlike in other emerging markets, corruption has not declined with economic growth; it remains as high as in countries with one-quarter the per capita income of Russia."
"The other major barrier to growth is corruption. In another World Bank-EBRD survey, 40% of firms in Russia reported making frequent unofficial payments, and roughly the same percentage indicated that corruption is a serious problem in doing business. Unlike in other emerging markets, corruption has not declined with economic growth; it remains as high as in countries with one-quarter the per capita income of Russia."
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