HowTo: Catch-up

The principle of “Catch-up” in economic theory is a macroeconomic principle that says countries with lower initial levels of GDP will experience higher levels of GDP growth – i.e. they will catch up.

From the famous Hubbard and O’Brien:

The countries along the red arrow – the “line of convergence” – are the ones meeting this principle (this is where the class segues into economic policies that secure sustainable long-run economic growth).

From the even more famous real life:

…investors say emerging markets are just as stable as the U.S., Europe and Japan, and deserve a premium because their economies are growing three times as fast. Stocks in developing nations traded this month at 15.2 times estimated profit versus 14.9 times for equities in industrialized countries, data compiled by Bloomberg show. In 2005, the ratios were 8.45 and 17.3, respectively.

“Investors say” must the financial news equivalent of “some people say … that you hate America because you support civil unions for gay couples.” Thank you, Fox News, for your fine contribution to conventional journalistic integrity. Or what we have now that used to be journalistic integrity, when it used to have integrity. Too harsh? Too bad.

They’re also, perhaps, the same investors that are sending all our financial markets to utter shit, using the same bloody computer models to escalate volatility in trading. Honestly, even when computers take over, it turns out we all get fucked by the herd mentality of speculation at the trading desks.

Anyway.

“Emerging countries, by and large, are stockpiling either trade dollars or petrodollars, in such a degree that they’ve taken the financial risk way down,” said James Swanson, who helps oversee $200 billion as chief investment strategist at MFS Investment Management in Boston.

China, Russia and India will account for half of the world’s economic growth this year, the IMF said last month. Developing countries are forecast to expand 8 percent this year, compared with 2.6 percent for advanced economies, the IMF said in July.

The Washington-based fund boosted its 2007 growth forecast for China the most of any country, raising it 1.2 percentage point to 11.2 percent. The Russian economy is also beating forecasts and is set to grow 7 percent this year, more than the 6.4 percent predicted in April. For the U.S., the IMF trimmed its 2007 growth forecast to 2 percent from 2.2 percent.

…

On the basis of estimated earnings for the next year, emerging markets traded at a 1.6 percent premium to developed countries this month. That would mark the first time emerging markets are more expensive than developed nations since March 2000, if analysts’ earnings estimates prove correct.

So that’s catch-up. Kind of. At the moment we’re observing in certain countries according to their reserves of commodities (ore, gas or petroleum) or reserves of cheap labour (i.e. ability to manufucture cheap shit, cheaply, for the rich countries). Our economies are slowing down, meanwhile – we’ve tapped most of the growth potential available for our current level of technology.

We aren’t necessarily observing the economic principle of convergence: poor and relatively resourceless countries aren’t experiencing all-too-rapid growth (so far) in exchange for their good policies. With the credit crunch the way it is, attracting foreign capital is probably becoming rather more difficult, and the technological gains of our countries are getting further out of reach of poor ones. I suspect that the poverty trap (all those green dots near the origin, in the graph) just became a little bigger, and a lot stronger.

The trouble is, there isn’t much of a niche for those countries. Some countries ‘do’ finance (the US, Germany, the UK, etc.), some have commodities, some have labour. Countries that don’t have any of those have a hard time even getting in the global economy, forget about catching up.

HowTo: Moral Hazard

I don’t recall whether or not I mentioned this specifically, but economists everywhere will have considered the moral hazard of central banks bailing out financial markets.

Moral Hazard on Wall Street

Moral Hazard is usually considered within the context of insurance (health insurance, more specifically). It basically says that, if you have health insurance, the consequences of you taking risks (not making effort to prevent ill-health, participating in “extreme sports”, and so forth) are much less – you won’t have to pay the entire cost of that 6 weeks in traction, so you worry about it less (okay, bad example). This means people take more risk than they would if made to be personally liable, and more health care ends up needing to be consumed as a result.

So where do central banks fit in? Just like the Wall Street Journal (and any other economist) says:

If investors believe the Fed will rescue them from their excesses, people will take greater risks and, ultimately, suffer greater consequences. Some grumble that the Fed created problems this way in 1998, 1999 and 2003.

If the Fed were to cut rates now, it certainly could help with the current market crisis. The cheaper money would reduce pressure on stock and bond markets by making it easier to buy beaten-down stocks, bonds and other securities world-wide. Wall Street is a powerful lobby in Washington, and its bleating for help can be hard to resist for politicians, whose campaigns often depend on financial contributions from Wall Street figures.

But if the Fed were to ride to the rescue, the skeptics worry, it would encourage people to speculate even more, creating an even bigger bubble later.

The stock market cannot be made into a one-way street. We can’t have the likes of Jim Cramer insisting job losses are a boon when they’re elsewhere, and then going crazy as a bloody March hare, screaming for Wall Street Welfare, when it’s his turn. Financial markets are in this mess because they made it. They thought they were making hay while the Sun shone, not noticing it was actually a bonfire.

The same is true, sadly, of sub-prime and Adjustable-Rate mortgages. Having central banks bail out households who cannot afford their mortgages is temporary – it only encourages re-financing and the false belief that these households can in fact afford their mortgages after all.

So: Moral Hazard. The more that Bernanke earns his nickname of Helicopter Ben, the more risks Wall Street (and bond makers, traders, hedge funds and private equity the world over) will take – with your pension fund – and the more they’ll lose when shit like this happens. Which it will. Again, and again, and again (with apologies to the Highwaymen).

Electric cars: the weirdest two-part tariff I’ve ever seen

Late to posting today – I was travelling out to (and back from) the office. But I lined up three posts over breakfast!

First: the Financial Times is carrying a great story about an electric car. After killing their last one, General Motors is getting back in the business.

General Motors may allow buyers of its Chevy Volt electric car to rent the vehicle’s battery as a way of pricing the vehicle at a comparable level to a traditional, petrol-driven family saloon.

The Volt is emerging as one of the most crucial vehicles in GM’s history. Failure would be a deep embarrassment after the fanfare surrounding its development. But success could propel GM past Toyota as a pioneer in alternative energy vehicles. GM has assigned 150 engineers to the project.

The Detroit carmaker aims to launch the Volt by 2010. The battery would give a range of 40 miles and maintain full performance for at least 10 years. It would be recharged either by the car’s small combustion engine or from a normal electrical point.

Battery rentals would help fulfil GM’s goal of giving the Volt a wider appeal than the petrol-electric hybrid vehicles now on the road. Noting that the Volt will be marketed under GM’s global, mass-market Chevrolet brand, Frank Weber, the carmaker’s chief engineer, said that it “needs to be affordable to the buyer of a normal mid-sized car”.

I gave up hyperlinking brands and companies half-way through. Also that typo is not mine, but I hate the use of “(sic)”.

Two-part Tariffs

Two-part tariffs are a form of price discrimination, when the ‘good’ being sold is divided up – part is sold for a fixed amount, the other part sold per-unit. Razors are good example of this (thanks, Dave!). We buy the handle, first:

And then we pay for the razor itself:

The handle purchases our access to the usage of the razor as a whole (i.e. the ‘good’). GM is going for the same thing: purchase the car for a lump sum, then rent the battery as you actually use the car. Technically it is not a perfect example, unless the batteries (or, say, battery size/capacity) are bundled in a manner than extracts more Consumer Surplus than an ordinary market for batteries (such as purchasing them and charging them yourself).

What doesn’t follow, exactly, is the idea of making the car more affordable by employing this approach. It’s a hybrid, but more an electric car than petrol – it ought to be poor without the battery, right? So you buy the car, and you give GM the power to tap into your Consumer Surplus as time goes on. You buy a car that is immediately held hostage by GM. Rationally, we should accept that, if buying a house is supposed to make more sense than renting, in the long run, shouldn’t buying a car do so, also? Particularly given that the car itself is supposed to be priced to match others:

GM’s goal is to price the Volt, excluding battery, at about the same level as its Chevrolet Malibu saloon.

Mr Weber estimates that an average Volt owner would spend about $25 a month on petrol, against $145 for a traditional Malibu. The difference could be used on battery rental payments, giving a similar total cost.

Meaning that, as petrol prices increase, you can expect to see your rental prices increase. On the other hand, it could also confer to batteries (the key ingredient of a power in an electric car) the same advantage one gets from leasing an entire car – you get to upgrade, as upgrades come along. This way you might get to keep the same car, but get progressively more power/fuel efficiency as the technology improves.

It might turn out great for the environment (I’d take it)! I’m just saying, I don’t see you making money off GM, along the way.