rumblings II ( innovation and social usefulness)

So taking the story forward in the last post- what will happen if the innovation by the third person in business activity is not weaving clothes but say brewing alcohol. The third person finds out a way to produce alcohol from food produced by the other two person. The alcohol is liked by all the thriee persons and hence GDP increases which comprises of three portions of food and three portions of alcohol.

So how this situations stands vis a vis the earlier situation of three portions of food and three portions of clothes. In terms of GDP, this will depend on what is the utility value of clothes vs alcohol to people. How does one calculate utility? Well it will be the value/happiness that one will get out of consumption of alcohol/cloth? Both alcohol and cloth can keep you warm in winter but clothes can do extra in making one fashionable.

From a GDP growth perspective, does it matter? Well in short term no. In long term may be. If usage of clothes lead to better processes of weaving of clothes and people discover another profession like fashion consultant which is of higher utility, while on the other hand , usage of alcohol may lead to finding its usage in medicine and someone start producing them. So in the long term, GDP may grow differently depending on the productivity growth and the future innovation of goods.

The next question is what is socially useful. Well for that we need to get a definition of social usefulness which doesn't exist or change depending on the person that you talk to.

Lets take the social usefulness as factors that affect social structures like family, legal system etc which in long term will negatively affect the economy. On this criteria, if say alcohol consumption makes people violent and more prone to fighting , this will make it socially harmful. So clothes innovation is better than alcohol on this scale.

The other criteria is a more philosophical one. What type of society do we want. Do we want to develop a society where clothes symbolizing comfort takes precedence over alcohol symbolizing leisure or vice versa. Or to take a better example whether we shall spend money/innovate profession in finding medicine for AIDS or on space exploration. In the short term, it doesn't matter. In the longer term the results may vary.

What matters here is who are "we". Could there be political leader or social evangelist deciding what we want or is it the choice arising from trials and errors of utility functions of people, the other name of this is entrepreneurship.

This also explains the charm of planned economy vs market economy. In planned economy, the planners by their supposed "super- intelligence" decide what type of goods/profession/path that the economy shall take. So in this case, through their calculations and social judgments, the planner will decide what is beneficial and hence choose the path. This will be done through quotas on goods production in private arena and capital investment by government. Also since the goods are already planned, there is no waste in form of entrepreneurship since no experimentation on utility function of people is required.

And there lies the fallacy that someone or a group of people can know what is beneficial for others in the economy and hence make a judgment on the utility functions which is impossible to perceive for a single individual leave aside the whole country.

The "socially useful" advocates also makes implicit assumption on long term utility functions of individual while deciding on what set of professions need to take precedence. Deciding on expenditure on AIDS drugs over space exploration does have the assumption that people would have larger utility of AIDS drugs as there is fear of epidemic rising in future. What may happen that in future, space exploration may lead to discovery of alien race that has already discovered drugs for AIDS.

Financial innovations can also be thought in this framework but that will be the subject of another post.

rumblings - I

so i was thinking of some basic economics and thought to put down in a basic form so as to improve my understanding.

So how will be new jobs created in a economy? Let take an example comprising of three people where all of them are involved in food gathering and they work for 12 hours every day to gather enough food(3 portion) to satisfy hunger for each of the three. In this case, each of the person has wages equal to 1 portion of food. All have 12 hours of leisure everyday.

Now lets think of situation that by trial and error and working in 2 hours of leisure, they figure out a way of producing food out of land which is agriculture. By this method, they can produce enough food using only 24 manhours per day so as to satisfy hunger of three people. Now in this case, there are two choices.

First choice is that all three now work 8 hours a day, produce three portion of food which they divide among themselves. But each of them will have 16 hours of leisure in this case. The economy remains the same and in the way we calculate GDP, the GDP has stagnated. This is socialism at its best.

The second choice is that two of them decide to continue working 12 hours a day to produce three portions of food. And the third one becomes unemployed because he doesn't know the technique of agriculture. So what will happen now.

Case one is that he dies of hunger. Since there is no one to consume 3 portions of food, they will start producing 2 portions of food and start spending more leisure time. The GDP will reduce but per capita GDP remains the same. This is capitalism at its worst if one has even a slight bit of humanitarianism in his soul.

Case two is that the third person innovates and create a product which is useful for all three. Say that he learns to weave clothes for which the two farmers are ready to provide one portion of food to him for his survival. This situation increases the economy and GDP grows to three portion of food and three portion of clothes. The per capita GDP also increases. This is capitalism at its best.

too big to fail

Its not about preventing "too big to fail", it is about preventing "too connected to fail". Breaking up Too big financial institutions make sense for political reasons since these lead to legislation favoring banks and which are detrimental to general public welfare. But that is a phony arguments since that is true for all private enterprises and that brings into question of determining what is meant by "too big".

The concern over future bailouts come from "too connected to fail". That is the reason why credit market freezed after Lehman collapsed and there were billion dollars bailout even though Lehman by its size is quite small compared to overall size of financial institutions. The same thing can be seen in earlier crisis of 1930s where it was the failure of many small banks but inter-connected bringing the whole of US economy to ground.

Hence in future, one can't be sure that when banks start failing , one may not have option of not bailing it out if it is too inter-connected and hence endangering the system. Inter-connectedness can't be determined apriori since that will depend on the general situation of economy and the environment of fear, cynicism present in such situations.

tech voyeurism

http://www.nytimes.com/2010/04/23/technology/23share.html?ref=technology

list of startups which are catching up the idea of voyeurism and naked self-promotion from facebook to the next level. The mindset is changing and we have now the technology to drive it.
will this work? Yes. From my recent increase in activity on facebook, I have come to realized some points about this craze of letting other people know what you are doing. The real analysis of underlying emotion is best left to some social scientists but on a crude level this is self promotion and voyeuristic nature coming to the front.

Inflation (rumblings)..

Well let me start by saying what Freidman said "Inflation is always a monetary phenomena". Due to excess liquidity available global as a result of low interest rates in all countries, the stage could be set for inflation worldwide which is not a case currently. US is still experiencing sub-normal inflation and the same is case for European countries.

The argument that if the world prices are high, one cant cut down on domestic inflation is basically proxy for the argument that the whole world is a giant connected market with free flow of capital and trade. Hence even if domestic interest rates are increased, there will be large influx of capital. This will either (lead to appreciating the currency, hurting exports and hence GDP) or (increase in forex reserves -> high inflation) . This is a major concern currently as even though there are inflation concerns in Brazil and Australia and they have raised rates, but some country like Brazil had to impose capital controls in order to control appreciation of the currency.

But after saying that, the Indian Market is not so integrated with world capital markets that the rise in interest rates in India will have no effect on underlying domestic inflation. We in India and China to some extent are facing a much higher inflation compared to US, Europe which would not have been the case if the world has been flat.

The other aspect of monetary policy which I guess have become a big issue now whether there is broad based or sector specific inflation. This is taking the same logic from international to sectors. Due to sector specific distortions like government taxes, incentive etc, infrastructure etc, there could be inflation in specific sectors or specific geographies. One would like the central bank NOT to play the role of stocks speculator and decide whether some specific sector is inflated or not because that is complicated, impossible to do and would lead them to favor one over another. It is expected that they look at broad inflation numbers and do a good job in managing growth along with maintaining a growth target. This aspect is currently being questioned though in light of housing crisis. Whether the central bank has the duty to identify the inflation/bubble and prick it or it is too difficult task and hence they shall not intervene. My view is that they shall not do it but I guess one can differ. It is about accepting small positive changes or large changes with variation on both sides.

Now coming back to current changes by RBI, this certainly is not geographic specific inflation. Is this a sector specific inflation? Well I am not so sure about it. I will see if I can dig some data for this.

interesting piece of social rule

http://economix.blogs.nytimes.com/2010/04/20/a-tale-of-many-cities/

This has explanation of Zipf law according to which "the population of town is inversely proportional to its rank among cities. So the largest city has twice the population of second ranked,thrice the population of third ranked and so on."

Very interesting piece. Such elegant piece of rule in such a complicated real world scenario. Is this random or God playing its hand? Or there is a sincere explanation for this.

The network effect of aggregation of population can be understood but will this lead to such a clean relationship, that is difficult to explain.

Exchange rate

I came across a very interesting piece about exchange rates in the book "Lords of finance". Setting Exchange rate rather than being a technical exercise is more of a political one where decision has to be made on which group has to be favored. Normally it is exporter vs importers which comes down to producer vs consumer. The producers being small in number and organized does lead to moving the rate in their favor. Another decision has to be made is on the amount of inflation invariably linked to exchange rate. A high inflation transfers wealth from savers to debtors while protecting the people who own means of production while deflation does favor the other way around.

After the first world war, all the three European countries Britain, Germany and France were riddled with large monetary expansion and foreign debt. The value of exchange rates would determine the inflation and total national debt.

Britain chose the conservative approach to get the exchange rate back to its pre-war level thus protecting the creditors and savers but causing a recession and later stagnation due to required deflation. Germany took the opposite path leading to a period of hyper-inflation and hence destroying the wealth of savers in this case the whole middle class. France took the medium path and in short term was the most successful economy, growing at a good rate.

Setting the exchange rate is always a political decision.

Next step: Look at the political economy behind China's current exchange rate dilemma.

Blankfein's take on Goldman being accused of fraud

Lifted from Simon Johnson blog

"http://baselinescenario.com/2010/04/19/discount-rate-mismatch/#more-7226" ..
The facts may not be right but is downright funny..



You want the truth? You can’t handle the truth. Son, we live in a country with an investment gap. And that gap needs to be filled by men with money. Who’s gonna do it? You? You, Middle Class Consumer? Goldman Sachs has a greater responsibility than you can possibly fathom. You weep for Lehman and you curse derivatives. You have that luxury. You have the luxury of not knowing what we know: that Lehman’s death, while tragic, probably saved the financial system. And that Goldman’s existence, while grotesque and incomprehensible to you, saves pension funds. You don’t want the truth. Because deep down, in places you don’t talk about at parties, you want us to fill that investment gap. You need us to fill that gap.



“We use words like credit default swaps, collateralized debt obligation, and securitization… We use these words as the backbone of a life spent investing in something. You use ‘em as a punchline. We have neither the time nor the inclination to explain ourselves to a commoner who rises and sleeps under the blanket of the very credit we provide, and then questions the manner in which we provide it! We’d rather you just said thank you and paid your taxes on time. Otherwise, we suggest you get an account and start trading. Either way, we don’t give a damn what you think you’re entitled to

financial reform ..

http://krugman.blogs.nytimes.com/2010/04/18/six-doctrines-in-search-of-a-policy-regime/#more-8819
Krugman at his best in being lucid and descriptive about financial crisis. what is surprising is how close are economists on the left and right (centre-right) are in their views about fianancial reform are and how far the politicians are in terms of slogans like "too big to fail" and "cut payments to banks"

is this the only way one can make money?

so in the recent crisis, there were some people who didnt lose much money and in made some cases made real good money.. Paulson Hedge fund, george soros and goldman sachs were few of those who bucked the trend and made profit. And this was supposedly because they were the smartest guys in the room and knew that this was coming . I remember that in goldman sachs presentation, one of the gentelman said that one of the reason that they did better was their risk management and they used long term investments rather than repo to fund the investments..

The recent SEC investigation is a bad publicity to this . Being smart has been always respected at least in US but defrauding and your investors is a big no-no at least with respect to reputation if not in terms of legality.

But from news report, the evidence doesnt look cohnvincing enough. Anyhow given the credibility and past history of SEC, I suspect that this case will go nowhere. Politically though this is a bomb shell. Everyone gets a whipping boy of its own. The finance reform bill will get a lift. Making derivative trades transparent has to be part of any reform bill and this incidence will make sure that such a provision is added if not present.

Another question of does the market clears in terms of reputation? Even if Goldman Sachs is not punished, shall this act as a reduced revenues for them since other investors shall be wary now. I would love to say yes but I am not sure looking at the evidences in current crisis. The investors at other funds are also playing with others money and they can come back and invest . What probably they will do is to use a consultant advice to protect their asses if this thing unravel.

There are sometimes a thin line between having enough freedom for taking risks for the good of business and esentially defrauding the shareholders. Doesn't it come back to corporate responsibility , a special sarben-oaxley for financial institutions!!

Nation under debt

With the whole debate on national debt, I come across this interesting piece of history while reading the book "The Lord of finance".

After the first world war, all the european countries (england, france and italy) had amassed huge debts mostly from the US governments. Since the war was the main reason for this large debt, the European countries started clamoring for reducing the debt. Mostly being linked to a war and since US was the biggest debtor, the debts were renegotiated.

Keynes famously announced that in these cases it is the debtor who has the upper hand and asked England to hold out.

England possibly out of its civility gave in first and 80 cents to dollar, France got its debt reduced to 40 cents and Italy negotiated a settlement of 24 cents to dollar holding out till very end and negotiating finally in 1926.

A similar example was when Argentina threatened to default in 2001 and got a deal by which 76% of the defaulted bonds were exchanged by others, of a much lower nominal value (25–35% of the original) and at longer terms.

Key lesson: the countries typically being sovereign and under the false modicum of international law where penalty is non-existent can easily threaten to default and negotiate its debts. This can be key lesson for the bonds of European countries under crisis now.

though it will be interesting to see whether such instances of default, debt restructuring by sovereigns lead to building a higher risk rate in the long term treasury bonds of those countries.
One of the reason for low long term interest rates for US has been the instances of US government always acceding to pay its debt particulatry after the civil war. The free market voices in US will never allow a sovereign default by US.

But if comes to shove, u don't know where the public opinion will turn to.

ebook and ecommerce

If e-books become the order of the day, would Amazon or any aggregator will be able to charge a high sales commission (right now 30%) ? In that scenario, the aggregator would be delivering search service for which commission would be very low. Hence ecommerce would move to
a) Diversifying to other goods where physical delivery is required. There supply chain efficiencies, good customer service will justify the presence of aggregator.
b) New tie-in business model like Amazon and Apple are doing. Sell hardware to which you can tie-in your e-book sales.
I think the spectre of future where Amazon and apple would lose its functionality as aggregator of music is playing a big role in forcing these companies in adopting model (b) and not trying to act just as a platform.

The same logic applies for music(mp3). Movies are a different story. There one can have a third business model of being a platform through which movies are sold by content creator (Hulu.com, Netflix).

free market..

"The free market is a successful motivator of people because it does not rely upon the altruism of its participants."

Altruism is individual dependent and can't be built in a model for developing a robust process of economic exchange. Hence free market systems shall work better as a process in a large system while planned system can work in a small organization where altruism can be determined using personal interactions.

But selfishness taken to its extreme level , doesn't it cause the system to die from its own weight?
Well the thing is to have the right systems in place. All externalities are taken care of and a person is penalized for his extravagance. Is it easy to put the system in place?

No certainly not . There are lot of thin lines to be taken care of . The question is whether this line of thinking has been well accepted truth or still there needs to be debate around it.

rachel getting married

just saw the movie. was blown away by the strong emotions present in the movies. the movie was replete with strong characters which were greyish. i think the most fascinating aspect of movie making or story writing for that matter is to create such interesting unique characters and tell their story, bring our their emotions. And this movie is a live example of it . story of a family with their complex emotions on display bound by circumstances no one can wish away .

and what was icing on the cake was anne hathway's acting. she never appeared to be any good in all the movies I have seen earlier but in this, she was brilliant. this does show that with good direction and script , bad actors can also bring in an impressive performance . kudos to her. and deservingly she own an oscar nomination.

climate economics

http://www.nytimes.com/2010/04/11/magazine/11Economy-t.html?pagewanted=1

a nice matter of fact, easy to read view on climate economics in US