The continued increases in gas prices has sparked a considerate amount of political talk because of its widespread impact on almost every single American. This article by Nelson Schwartz from the NY times looks at reasons why the oil prices continue to hit record highs.
Schwartz believes that the basics of demand and supply cannot account for the steady climbing of prices by citing adequate supply of oil available. He finds that the answer lies in the falling dollar. The depreciation of the dollar is causing investors and traders to move their investments into crude commodities such as oil to hedge their portfolio risks. Since the oil market is a global market that is not being affected by domestic currency devaluation, investments in these goods are more stable in comparison to the dollar. The same story goes for gold prices. Since the dollar depreciation, gold prices have continued to raise, also hitting record highs. The institutional shifts of investments, by large investment institutions, into oil has caused informal investors and less informed traders to also move in this commodity. This signaling has only exacerbated the problem of inflated gas prices.
The blame for this exacerbation has been placed on these informal "speculative" traders. Therefore, the potential political response to these bad traders is to raise margin requirements for these trades. Higher requirements would force traders to take less risk because they would be forced to back up their positions with more equity. Schwartz doesn't seem convinced that these traders are the fundamental reasons why prices are so high; however, he believes that it is still worth trying.
Personally, I don't believe that speculative trading is the core reason for the price hikes in oil prices. It does, however, provide a convincing scrape goat and a easy solution. Seeing how politicians are more adverse to inaction than to actual efficacy, this seems that this policy response is adequate to keep them happy - even if it doesn't actually solve the problem. Yet, I remain skeptical that there is even a pricing mismatch problem in the case of oil as Schwartz outlines.
My gut feeling is that current oil prices are anticipating higher costs in the future due to more regulation on carbon emission. The internalization of these externalities is necessary and universally understood in economics as the best way to move towards better efficiency. However, no one said it would be an easy, painless process. These high prices will be born by everyone in the economy and are just the beginning of what is necessary to move the nation, and eventually the world, to a more efficient frontier.
Quick solutions now might cause politicians and their constituents to feel better about themselves. But, in the end, I believe that higher prices of goods are just what we should expect in the horizon because we are in the painful process of internalization of previously unaccounted externalities.
Saturday, May 17, 2008
Friday, May 16, 2008
Obama's iPod Government
Initially, hearing the term "iPod Government" you might think it's just another of Obama's catch-phrase ploys, another cheesy attempt to lock-in young voters. In reality, however, it's an intriguing approach to the political challenge of balancing government-knows-best mandates with leave-it-up-to-the-consumer free choice.
Under Obama's iPod Government system, consumers would make their own choices, but the government would clearly lay those choices out. Rather than simply give us options, Obama would give us options we can understand. This approach would change the presentation of several essential consumer decisions, from Medicare prescription drug plans to mortgage terms.
While the feasibility of this plan is questionable--can such complex decisions really be pared down to a version palatable to the every-day decision-maker without bias or oversimplification?--the benefit is pretty clear. Economic theory would argue that making options clearer will necessarily benefit the consumer, as they will be more educated and face less certainty as a result.
Other aspects of Obama's proposal are more controversial, however. Take for instance his plan to shift the default for many programs from opting in to opting out. The most significant manifestation of this plan, should it come to pass, would be the automatic enrollment of all workers in employer-based savings plans. While today workers must actively enroll in such programs, under Obama's plan they would have to (but easily could) actively drop out. Even if the savings plans themselves were no different than today's, the impact would still be remarkable.
In proposing this over-arching approach to decision-making, Obama has relied heavily on his economic advisors. Abandoning one of the most frustrating assumptions of undergraduate economics--that people are rational actors--Obama's team instead pays significant attention to the field of behavioral economics. In this case, their position is based on the empirically-supported "status quo bias" which suggests that people are likely to stick with the default option, whatever that may be. In other words, if people are automatically enrolled in a savings program, they are significantly more likely to stay in it than if they are automatically not. Regardless of the specifics of the options, the consumer's choice is heavily biased towards the default one.
Deemed "libertarian paternalism", this policy simultaneously allows for consumer choice and pushes that choice in the direction Obama prefers. In my opinion, it's a sound policy. Any way you look at it, some option has to take the default place. And, as discussed in class, the option of non-participation is no less neutral than the automatic enrollment one. So, why shouldn't the default option be the one that experts like Obama and his economic advisers recommend? Sure, in some ways this means the government will be making the decision for some consumers (i.e., those who just stick with the default, regardless of what it may be). But economic theory would likely fall apart with them anyways--if they aren't rational, informed consumers, they are unlikely to independently make the optimal choice regardless.
So maybe this is the best of both worlds: let the people who care make their own well-informed decisions and help those that don't by guiding them in the direction you (and your team of economists and experts) think best.
Under Obama's iPod Government system, consumers would make their own choices, but the government would clearly lay those choices out. Rather than simply give us options, Obama would give us options we can understand. This approach would change the presentation of several essential consumer decisions, from Medicare prescription drug plans to mortgage terms.
While the feasibility of this plan is questionable--can such complex decisions really be pared down to a version palatable to the every-day decision-maker without bias or oversimplification?--the benefit is pretty clear. Economic theory would argue that making options clearer will necessarily benefit the consumer, as they will be more educated and face less certainty as a result.
Other aspects of Obama's proposal are more controversial, however. Take for instance his plan to shift the default for many programs from opting in to opting out. The most significant manifestation of this plan, should it come to pass, would be the automatic enrollment of all workers in employer-based savings plans. While today workers must actively enroll in such programs, under Obama's plan they would have to (but easily could) actively drop out. Even if the savings plans themselves were no different than today's, the impact would still be remarkable.
In proposing this over-arching approach to decision-making, Obama has relied heavily on his economic advisors. Abandoning one of the most frustrating assumptions of undergraduate economics--that people are rational actors--Obama's team instead pays significant attention to the field of behavioral economics. In this case, their position is based on the empirically-supported "status quo bias" which suggests that people are likely to stick with the default option, whatever that may be. In other words, if people are automatically enrolled in a savings program, they are significantly more likely to stay in it than if they are automatically not. Regardless of the specifics of the options, the consumer's choice is heavily biased towards the default one.
Deemed "libertarian paternalism", this policy simultaneously allows for consumer choice and pushes that choice in the direction Obama prefers. In my opinion, it's a sound policy. Any way you look at it, some option has to take the default place. And, as discussed in class, the option of non-participation is no less neutral than the automatic enrollment one. So, why shouldn't the default option be the one that experts like Obama and his economic advisers recommend? Sure, in some ways this means the government will be making the decision for some consumers (i.e., those who just stick with the default, regardless of what it may be). But economic theory would likely fall apart with them anyways--if they aren't rational, informed consumers, they are unlikely to independently make the optimal choice regardless.
So maybe this is the best of both worlds: let the people who care make their own well-informed decisions and help those that don't by guiding them in the direction you (and your team of economists and experts) think best.
Thursday, May 15, 2008
"Paying" Farmers for Votes
Even though no politician would actually endorse this tag-line, it is essentially what increased subsidies to farmers means. The new Farm Bill that is being finalized in congress now aims to do just that.
Both Democratic candidates support this bill in light of its inherent economic problems. Government subsidies would only distort efficient pricing of goods by deflating costs of production. However, the cost of production doesn't magically disappear. It would be financed by the government and, in turn, the American public. Essentially, domestic consumers are still paying higher costs for farm goods. Why not let the American public directly face the higher costs? The indirect nature of this policy takes away the consumer's ability to correctly maximize consumption choices because they are given incorrect prices.
Letting the market resolve the underpricing of farm goods would be the most efficient way of shaping up our highly pampered farming sector. This would allow the best farms to continue while trimming the fat of bad farms. A subsidies program would hinder this "survival of the fittest" idea of efficiency for the dynamic future because farms would have little incentive to change and improve. Basically, the burden of sustaining inefficient farmers is carried by the public when a subsidy is in place.
Subsidies are the fast-food equivalents of solving the problem of the farm industry - instant gratification that hides its long term harms. Obviously, the government does not have the finances to extend subsidies forever. Then, why are politicians so keen on these irresponsible policies that would negatively distort long run stability by rewarding a lack of innovation for improvements? So, how will the fundamental problems of the farm industries be solved?
Perhaps our political system is to blame for this lack of long sight. The short terms of office incentivize politicians to solve short-run problems with slapdash solutions without given much thought to long-run stability.
Still worse, a big chunk of this Farm Bill, "around two-thirds of the bill's cost, would pay for food stamps and other nutrition programs." This coupling of a bad subsidies policy with a stronger social welfare project seems like it is a strictly political move to boost support. These instances cause me to be very disillusioned with our political system and its penchant for confusing the general public. It's essentially equivalent to tagging a "baby protection act" to a bill that allows human torture. To me, it is disgustingly outrageous. However, this blog is to discuss economic issues, not problems of our political system.
I'm interested to see what will happen to bill when it is placed up for vote.
Both Democratic candidates support this bill in light of its inherent economic problems. Government subsidies would only distort efficient pricing of goods by deflating costs of production. However, the cost of production doesn't magically disappear. It would be financed by the government and, in turn, the American public. Essentially, domestic consumers are still paying higher costs for farm goods. Why not let the American public directly face the higher costs? The indirect nature of this policy takes away the consumer's ability to correctly maximize consumption choices because they are given incorrect prices.
Letting the market resolve the underpricing of farm goods would be the most efficient way of shaping up our highly pampered farming sector. This would allow the best farms to continue while trimming the fat of bad farms. A subsidies program would hinder this "survival of the fittest" idea of efficiency for the dynamic future because farms would have little incentive to change and improve. Basically, the burden of sustaining inefficient farmers is carried by the public when a subsidy is in place.
Subsidies are the fast-food equivalents of solving the problem of the farm industry - instant gratification that hides its long term harms. Obviously, the government does not have the finances to extend subsidies forever. Then, why are politicians so keen on these irresponsible policies that would negatively distort long run stability by rewarding a lack of innovation for improvements? So, how will the fundamental problems of the farm industries be solved?
Perhaps our political system is to blame for this lack of long sight. The short terms of office incentivize politicians to solve short-run problems with slapdash solutions without given much thought to long-run stability.
Still worse, a big chunk of this Farm Bill, "around two-thirds of the bill's cost, would pay for food stamps and other nutrition programs." This coupling of a bad subsidies policy with a stronger social welfare project seems like it is a strictly political move to boost support. These instances cause me to be very disillusioned with our political system and its penchant for confusing the general public. It's essentially equivalent to tagging a "baby protection act" to a bill that allows human torture. To me, it is disgustingly outrageous. However, this blog is to discuss economic issues, not problems of our political system.
I'm interested to see what will happen to bill when it is placed up for vote.
My Obama Dream
I want so badly to support Barack Obama. I agree with him on many sundry political issues, and I love his powerhouse economic advising team. But when I look at his spelled-out economic policy beliefs, I am confronted with a deep philosophical dilemma. How can I support a candidate with such stupid ideas?
There are a million reasons, economic and moral, that I don't like unions. They inflate costs by extorting above-market wages, hurting businesses and consumers, and they prevent improvement through their absurdly restrictive policies, their tangled bureaucracy, their rampant corruption, and their general sloth-like nature.
Many of my objections to unions are summarized in this video.
It disturbs me that Obama supports pro-union policies. Of course I understand that he needs to say things he might not mean to get elected, and maybe he is doing so here. But how many times can I give him the benefit of the doubt? I've already tried to ignore his NAFTA-bashing, his "outsourcing" tirades, and his Hillary Clinton-esque corporation slandering. At the end of the day I am left with two competing visions of Obama: either he is a classic liberal (read: socialist) when it comes to economic policy, or he's a devious politician who has concocted a vast, overarching network of lies to cover up his true beliefs. If he's the former, I don't want him as my president, and if he's the latter, then I'm downright scared of him.
There are a million reasons, economic and moral, that I don't like unions. They inflate costs by extorting above-market wages, hurting businesses and consumers, and they prevent improvement through their absurdly restrictive policies, their tangled bureaucracy, their rampant corruption, and their general sloth-like nature.
Many of my objections to unions are summarized in this video.
It disturbs me that Obama supports pro-union policies. Of course I understand that he needs to say things he might not mean to get elected, and maybe he is doing so here. But how many times can I give him the benefit of the doubt? I've already tried to ignore his NAFTA-bashing, his "outsourcing" tirades, and his Hillary Clinton-esque corporation slandering. At the end of the day I am left with two competing visions of Obama: either he is a classic liberal (read: socialist) when it comes to economic policy, or he's a devious politician who has concocted a vast, overarching network of lies to cover up his true beliefs. If he's the former, I don't want him as my president, and if he's the latter, then I'm downright scared of him.
Wednesday, May 14, 2008
Democratic Candidates: Trade Policy on NAFTA
In the last two months, Democratic Presidential candidates Hilary Clinton and Barak Obama fought over Ohio and Pennsylvania, states that suffer from manufacturing job losses. Both candidates resorted to trade-bashing tactics, which is “a time-honored tactic in Democratic race” because the Democratic Party relies heavily on labor unions for donations and votes. [1]
Clinton and Obama have made the following pledges: 1) renegotiate the North American Free Trade Agreements (NAFTA) incorporating more strict labor and environmental standards, 2) oppose pending FTA deals with Columbia and South Korea, and 3) punish China for intervening to artificially devalue their .
While it is well-known that there is a large gap between what a candidate promises during the race, and what the candidate actually does once elected into the Office, to me it seems like as the preliminary race intensifies, each candidate is taking the toughest stance possible against trade, making pledges from which he or she will find difficult to get away once elected. [2]
“Both have given themselves less wiggle room and boxed themselves in,'' said Claude Barfield, a trade expert at the American Enterprise Institute in Washington. “There are all kinds of ways when you're president to get out of campaign promises, but it's going to be tougher this time.” [1]
Both candidates have been trying best to walk the tight rope between free trade and protectionism. While there is no consensus on the net benefit of free trade, in general, economists agree that trade results in a social benefit for the society. Taking this positive view on trade, I take the opportunity to briefly explore the long-term implications of, in particular, a renegotiation of the NAFTA.
In my opinion, the renegotiation will be terribly inefficient, and bring about a significant economic loss because for one, counterparties will also want to reach renegotiate for better terms. The U.S. might end up compromising on its priority access to Canadian oil. Also, Mexico may end up winning more provisions on work visa. [1]
Another problem is tied with political economics. The renegotiation of the NAFTA would allow a small but better organized group in the population to exert influences on the trade policy. The resulting changes would benefit the workers, but most likely reduce the net social gains from the trade.
Lastly, if anything, exports will be hurt and trade balance will worsen. And a further increase in trade deficit is not the best thing the U.S. needs at this time of financial crisis. According to Robert Lawrence, a professor of international trade at Harvard University:
Our economy is being held up by export growth,'' Lawrence said. ``If ever there was a bad time to delay trade negotiations and market-opening measures, it's now.” [1]
[1] Matthew Benjamin and Mark Drajem, “Obama, Clinton Promises May Undo Bill Clinton's Trade Legacy,” http://www.bloomberg.com/apps/news?pid=20601087&sid=anqjPdbTszNk&refer=home
[2] Helene Cooper, “Democrats’ Third Rail: Free Trade,” http://www.nytimes.com/2007/08/12/weekinreview/12cooper.html?fta=y
Monday, May 12, 2008
Anti-Capitalism at its best..
"The other day the oil companies recorded the highest profits in the history of the world. I want to take those profits"- Hillary Clinton
If this statement by Hillary Clinton doesn't scare you, I'm not sure what will.
Hillary Clinton's policy on oil not only undermines capitalism but seems to have come straight out of the Communist Manifesto. It is true that oil companies are seeing record profits, this is only to be expected due to current record demand. Hillary insists that the price of oil is soaring due to market manipulation and will launch investigations into OPEC for price gauging. People have been trying to proove price gauging/price fixing on OPEC for years and have come up with nothing. I don't think Hillary will find anything past administrations haven't.
It is just scary to think that a potential president of the U.S feels they have the power to "take profits" from certain companies they feel are doing too well. This idea certainly seems to have socialist components. The average net profit margin for the S&P Energy sector, according to figures from Thomson Baseline, is 9.7%. The average for the S&P 500 is 8.5%. Oil companies are not seeing profit margins far and beyond what other companies are making. Google, for example, reported a profit margin of 25% in its most recent quarter. Does Hillary want to implement an online search engine windfall profit tax?
Hillary needs to be taught how gas prices arrive at the pump. The price of gas is derived from the price of crude oil which is set on the crude oil futures market. These prices are affected by supply and demand due to the fact that oil is traded on a global market. It is a fact that much of our oil supply is relatively static but world demand continues to grow. If supply isn't changing, but demand is, the price will obviously rise.
It's a dangerous precedent to set by taking profits from companies that are making legal profits. OPEC is the only organization that has any effect on the price of oil, and there isn't any American politician that can change that. The only solution for breaking out of our independence on oil is to invest in other types of fuel (currently, there is little incentive to invest in this sector).
Instead of stealing oil companies profits, why not tell people there free to plunge their savings into these oil companies stocks, or even buy crude oil on the futures market. That is the joy of our financial markets which Hillary is attempting to undermine.
If this statement by Hillary Clinton doesn't scare you, I'm not sure what will.
Hillary Clinton's policy on oil not only undermines capitalism but seems to have come straight out of the Communist Manifesto. It is true that oil companies are seeing record profits, this is only to be expected due to current record demand. Hillary insists that the price of oil is soaring due to market manipulation and will launch investigations into OPEC for price gauging. People have been trying to proove price gauging/price fixing on OPEC for years and have come up with nothing. I don't think Hillary will find anything past administrations haven't.
It is just scary to think that a potential president of the U.S feels they have the power to "take profits" from certain companies they feel are doing too well. This idea certainly seems to have socialist components. The average net profit margin for the S&P Energy sector, according to figures from Thomson Baseline, is 9.7%. The average for the S&P 500 is 8.5%. Oil companies are not seeing profit margins far and beyond what other companies are making. Google, for example, reported a profit margin of 25% in its most recent quarter. Does Hillary want to implement an online search engine windfall profit tax?
Hillary needs to be taught how gas prices arrive at the pump. The price of gas is derived from the price of crude oil which is set on the crude oil futures market. These prices are affected by supply and demand due to the fact that oil is traded on a global market. It is a fact that much of our oil supply is relatively static but world demand continues to grow. If supply isn't changing, but demand is, the price will obviously rise.
It's a dangerous precedent to set by taking profits from companies that are making legal profits. OPEC is the only organization that has any effect on the price of oil, and there isn't any American politician that can change that. The only solution for breaking out of our independence on oil is to invest in other types of fuel (currently, there is little incentive to invest in this sector).
Instead of stealing oil companies profits, why not tell people there free to plunge their savings into these oil companies stocks, or even buy crude oil on the futures market. That is the joy of our financial markets which Hillary is attempting to undermine.
Cap & Trade: Making Dollars & Sense
In a further attempt to prove that being a Republican is different from being Dubya, John McCain has called for a mandatory limit on greenhouse gas emissions in the United States and embraced the formation of a cap-and-trade system. McCain, Clinton, and Obama all support some form of cap-and-trade scheme in order to reduce carbon emissions.
As economists, we love this. For tree-huggers, sentiments are a little more mixed.
But first: why cap-and-trade makes economic sense. Because different firms face different marginal costs of abatement, requiring all firms to cut emissions by a given amount will not have the same costs across the board. However, if firms are allowed to trade permits, those facing the lowest costs of abatement will reduce emissions the most, while those facing higher costs will pay them to do so (see figure below).
Note: MBemissions = MCabatement
Type I firms face higher marginal costs of emissions abatement than Type II firms. Assuming an equal number of both types, each type would be required to reduce emissions to E/N if they did not trade permits. With trade, Type I firms would be willing to pay up to a for an additional permit. Likewise, Type II firms would be willing to sell a permit at a price of b. Trades will therefore take place as long as the marginal abatement costs to Type I firms exceed those faced by Type II firms, establishing the equilibrium price Ppermits.
Both types of firms benefit from trading permits—Type I firms pay area D for permits, but save areas C+D in avoided abatement. Type II firms must pay area B in extra abatement costs, but receive A+B for the permits they sell. Therefore, A+C is the net social gain resulting from tradable emissions permits.
A tradable permit scheme therefore minimizes efficiency losses associated with the uncertainty of marginal benefit, but it also ensures that the government does not see large windfalls from rent associated with auctioning, that market forces determine where the allocations end up, and, most importantly, that emissions are reduced to a certain targeted value. The aggregate amount of emissions remains fixed at E*, which is a plus for tree-huggers.
However, because cap-and-trade only puts a limit on total emissions, concerns arise relating to localized pollution. As a result of trading permits, it is possible that certain areas will become more concentrated in terms of emissions. This can impose significant negative externalities on residents in these areas, and the local environment.
In addition, there is the larger issue concerning linkages between money and the environment: can we really put a price on pollution? Can we really grant the right to pollute?
I can't answer those questions, but from an economic standpoint, adopting a national cap-and-trade policy not only maximizes efficiency for firms facing different marginal costs of abatement, but also offers reduction in greenhouse gas emissions that we so desperately need.
As economists, we love this. For tree-huggers, sentiments are a little more mixed.
But first: why cap-and-trade makes economic sense. Because different firms face different marginal costs of abatement, requiring all firms to cut emissions by a given amount will not have the same costs across the board. However, if firms are allowed to trade permits, those facing the lowest costs of abatement will reduce emissions the most, while those facing higher costs will pay them to do so (see figure below).
Note: MBemissions = MCabatementType I firms face higher marginal costs of emissions abatement than Type II firms. Assuming an equal number of both types, each type would be required to reduce emissions to E/N if they did not trade permits. With trade, Type I firms would be willing to pay up to a for an additional permit. Likewise, Type II firms would be willing to sell a permit at a price of b. Trades will therefore take place as long as the marginal abatement costs to Type I firms exceed those faced by Type II firms, establishing the equilibrium price Ppermits.
Both types of firms benefit from trading permits—Type I firms pay area D for permits, but save areas C+D in avoided abatement. Type II firms must pay area B in extra abatement costs, but receive A+B for the permits they sell. Therefore, A+C is the net social gain resulting from tradable emissions permits.
A tradable permit scheme therefore minimizes efficiency losses associated with the uncertainty of marginal benefit, but it also ensures that the government does not see large windfalls from rent associated with auctioning, that market forces determine where the allocations end up, and, most importantly, that emissions are reduced to a certain targeted value. The aggregate amount of emissions remains fixed at E*, which is a plus for tree-huggers.
However, because cap-and-trade only puts a limit on total emissions, concerns arise relating to localized pollution. As a result of trading permits, it is possible that certain areas will become more concentrated in terms of emissions. This can impose significant negative externalities on residents in these areas, and the local environment.
In addition, there is the larger issue concerning linkages between money and the environment: can we really put a price on pollution? Can we really grant the right to pollute?
I can't answer those questions, but from an economic standpoint, adopting a national cap-and-trade policy not only maximizes efficiency for firms facing different marginal costs of abatement, but also offers reduction in greenhouse gas emissions that we so desperately need.
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