## Thursday, May 23, 2013

### Ford closes... along with common sense

Now that Ford has finally closed its assembly plant we have a reason for the economics crowd to reveal the biases in their ‘model thinking’.

Take Possum Comitatus, aka Scott Steel, who seems to think that if Australia had a few more people we would make more stuff (is that more per capita Poss?).

Which is a bit of nonsense really.

A Twitter argument broke out between Possum, Nicholas Gruen, and our own The Prince.

Nick - Nonsense, we’ll always make things in Australia, just less than some other countries.

Prince - Sorry, that’s BS. Switzerland, Norway, Finland. All manufacturing giants but minnows in population. It’s how you structure econ.

Possum - That utilise the EU population as a local population with common consumption demands. Ahem.

Possum - The Australian market isn’t large enough to sustain many goods specifically customised for Australia. Cars are the perfect example

Possum - Volume matters for stuff like this

Nick - So we’d export - like Volvo. Alas we woke up to that issue too late and too lethargically

Possum - We’d export to where? What other country in the world, using cars as an example - has a similar spectrum of conditions?

Prince - Population is not a cure for structural imbalances - makes house prices higher.. is that the real goal here?

Possum - Go and stick Finland, Switzerland and Norway in the middle of the Indian ocean. Reckon they’d be a manufacturing base?

Possum - Population is scale. Want cheaper house prices, build more houses.

Sorry Possum. Population is population. Scale is scale. The conflation of domestic population and industry scale, and therefore competitiveness, is one that regularly occurs. It is number two on my population myths list.

That large scale manufacturing is shifting to low cost countries is a product of globalisation - the multi-decade process of reducing barriers to international trade. It is a sign of our wealth relative wealth, but also a product of the management of our foreign account balances.

Switzerland protected its local trade-exposed industries by protecting its currency. German manufacturers are benefiting from the weak Euro, while Japan’s attempts at stimulating economy activity revolve around containing the value of the Yen.

Richard Tsukamasa Green actually has a very nice reply, outlining how in a situation of protected local markets being opened up to international trade.  He deserves quoting at length
In short, companies that produce for a market in their own country have an advantage when exporting. If we have increasing returns to scale, that is it keeps getting cheaper to produce more once you’re already producing, then the efficient, cheap producers are those who are already producing.
...
If so, then when it comes to trade, the countries who were producing widgets for their own market are those that provide it cheapest to everyone else. The home market has become part of the country’s comparative advantage.
...
Most importantly there aren’t too many cases I can think of where this advantage has been maintained without government props. Other elements of comparative advantage, like wages levels or training, seem to outweigh lingering home market effects – the massive amounts of computer hardware out of South East Asia isn’t due to their love of PCs, nor do Chinese consumers exhibit a love for…everything manufactured. The most valuable thing seems to be know how, and that is the most mobile of production factors.
The other is hat it makes the most sense when countries have been operating as autarchies and then BAM, international trade. That possibly made sense in the world of 1985 following five odd decades of global protectionism, but not now. Any developing industry will start with many countries as potential locations, regardless of where the consumer lies. The home market effect would only hold if transport costs are high so manufacturing close to customers is cheaper, but then that the lowering of costs once things get going are so great they more than offset the cost of transport.
I fully concur that this myth persists because in the period of reducing trade barriers larger domestic markets did provide a 'home market' advantage.  But this is not the world of 2013.

Let me respond to Possum point by point.

[Finland, Norway, Switzerland] “utilise the EU population as a local population with common consumption demands.”

I’m not sure what to make of this. Is he saying that foreign populations that demand the same goods generate a larger potential market? If so, that is my argument.

The Australian market isn’t large enough to sustain many goods specifically customised for Australia. Cars are the perfect example

Which is an astounding fact considering the number of different cars available from Japanese, European and US manufacturers. There must be at least 20 major brands in the Australian market, and over a hundred different models of car available. Whatever customisation they require seems a simple enough task.

After all, if Japan, Germany and Sweden can export a completed car suitably customised to Australian conditions to us, why can’t we do the same in reverse?

We’d export to where? What other country in the world, using cars as an example - has a similar spectrum of conditions?

I have no idea what ‘spectrum of conditions’ means, but the answer to the first part is easy - anywhere. If we are going to be an exporter we manufacture to the conditions of the destination countries regardless of whether they are identical to our own.

I find it funny because in Melbourne we have Boeing’s largest manufacturing base outside of North America. We assemble Volvo trucks. In fact over at Manufacturer’s Monthly there is a whole list of the companies ‘making stuff’ in Australia. It seems we can make stuff after all.

The problem of course is that the relative size of our natural resource production. Coal, iron ore and gold make up 40% of our exports. We then have education, tourism, and a whole bunch of other primary resources (gas, wheat, alumina, copper ore, beef).

The big long term economic questions that the Ford decision reminds us about are
1. Do we value diversity of economic production?
2. How do we want to manage our external position given the volatility of the resources cycle?

## Wednesday, May 15, 2013

### Government debt hysteria

It’s budget time.  That means it’s time to switch off from the mainstream business news for a couple of weeks.  To help get you through I have a couple of notes about the ridiculous government debt hysteria that has broken out in this country in the past decade, and in many troubled nations (save Japan) since the financial crisis.

1. Nonsensical comparisons
First cab off the rank, debt to GDP. GDP is a measure of the volume of all transactions in the economy.  How is it related to the debt held by an institution that forms a minor fraction of the economy.  Why not compare BHP debt to Australia GDP?  The very fact that this nonsense ratio is considered important by macroeconomists as a determinant of anything is quite bizarre.

In any case, Australia is a world leader in low government debt.

￼Source: Wikipedia

Moreover, shouldn’t we consider the assets of an entity when considering its debts? Mmm.  What would the assets of the the Australian government be worth? This is a trick question.   There is basically no way of estimating the value of the nation’s shared public assets despite some valiant attempts.  These attempts put Australia’s wealth at over $6 trillion in 2008. That’s around$300,000 per person.

But isn’t a better measure of the ‘sustainability of debt’ the interest cost to government revenue ratio? For example, here is a nice comparison of interest expense as a percentage of central government revenue.  Australia barely makes a showing.

Should we not also consider that the same entity, in effect, sets the interest rate on those debts. As Dean Baker points out, this power really negates the ‘future burden’ of debt that the ‘household view’ of government budgets suggest.

And with all this focus on the crazy debt to GDP ratio, somehow the debts of the private sector are ignored.

2. Money is a human creation
Humans made every rule there is, and every rule can be changed. Keep this in mind.

But we also need to think about what interest payments actually are.  They are transfers from the debtor to creditors.  So when government pays interest on its debt, it is simply creating a transfer payment from taxpayers to holders of government bonds.  In many cases, these will be the same people or entities. Sometimes the owners of bonds will be foreign, but they only get paid interest in Australia dollars, which need to be spent within Australia, circulating through the economy.

Furthermore, the government can allow inflation to reduce the real size of the transfer involved with servicing its debt, and it can set the interest rate it pays.

We also need to fully comprehend Paul Krugman’s analysis of the Capitol HIll Babysitting Co-op Crisis. Put simple, the baby-sitting co-op created their own monetary system which fell into recession for lack of money.  Those who were running low on ‘baby sitting money’ because they had redeemed their vouchers over short period were worried about their shortage of remaining vouchers and stopped going out.  Those who had accumulated vouchers were worried about being unable to earn back their wealth should they start spending.

Notice that the money issued actually facilitated wealth inequality in the co-op.  Some families had very few vouchers left while the others were accumulating voucher wealth. We shouldn’t be surprised about this relationship between widening wealth gaps and business cycles.  And we shouldn’t be surprised that ancient remedies involved resetting debt periodically though jubilees - which would have worked perfectly well in the babysitting coop.

Ultimately we make the rules and can deal with the social and economics outcomes that arise from our economic system however we choose.  Fundamentally these choices are moral ones.

3. Equilibrium analysis does not apply
Most detractors of government debt seem to have a model of the economy in mind where the economy is in its magical equilibrium.  Then the government spends money, and since the model is always in equilibrium, the extra spending crowds out other spending exactly.  You might think I’m simplifying the argument.  I’m not.  There is not even money in the model at all.

The scope for adjustment to monetary policy, tax policy, inflation, all of which can reduce the debt interest size over time, are never discussed.

Remember debt and money are human inventions. Look at Japan to see what is possible and why we need considered analysis based on a proper understanding of money.

I hope, given the horrid state of quantitative macro that the RBA’s conference at the end of this year attracts some more robust analysis.

## Thursday, May 9, 2013

### Why Mathematica for economics?

Readers would have noticed that some of my previous posts containing interactive graphs that require Mathematica CDF Player to view. Which might leave you wondering why I choose to use Mathematica as my computational tool for ‘doing economics’.

So I thought I might outline here why I do.

And the answer is, mostly, because it was easy to learn

1. The documentation in Mathematica is very comprehensive and delivered in a notebook format (Mathematica’s ‘front end’ interface), so you can modify the examples and test what your modification does to the output.

Many useful functions are built in, and even better, functions are typically named by their real mathematical name.

For me, I need a tool that can handle analysis of graphs and networks, can do symbolic manipulation, produce charts, handle diverse file types, analyse textual data (for matching names and other strings in large data sets). I have scraped data from websites using Mathematica, analysed social networks, and more.

Now, Mathematica is surely not the only tool for these jobs. Many like the open source R, others like Matlab, and for basic regressions Stata is a common tool. I don’t want to start a debate about which tool is better for which job - ultimately it is a user choice about investing their time to learn one or the other, and about the ongoing usability.

2. I like the integration of different functionality. There are real and electronic books written completely in Mathematica. It has built-in slide show options to have live and interactive calculations and charts in presentations. Easy interactive tools and web deployment (but viewers do need the free CDF player).

3. One thing that Mathematica users seem to emphasise is functional programming. Rather than writing loops to build up calculations, you simply write the function and it can automatically map across lists and various other data structures. Once you get used to this, you won’t want to write out loops again. This also means it is easy to get quite complex calculations coded up quickly.

4. A very helpful user group, especially at StackExchange

Lastly the RBA produces their charts and does a lot of analysis with Mathematica (although using custom packages). Some useful Mathematica tips from the RBA’s Luci Ellis are here, and here is a useful blog on how the dynamic graphing capabilities make good teaching tools.

## Sunday, May 5, 2013

### Life of an economics student?

Having studied the fundamental post-graduate economic courses last year I feel I can comment on this quite scary YouTube clip. Basically, the public perception of what economists do and the tools they use to understand the economic is completely out of whack with what most really do.

Yes, there are research frontiers in many areas that factor in the political and social realities we read about, but should it not be the case that all economists are equipped to understand these realities?

Teaching of economics really needs to get out of the 1980s and embrace all the knowledge the field has attained in the past couple of decades into their core curriculum.

Enjoy.

## Friday, May 3, 2013

### More housing market signals

My recent post about timing the Australian property cycle concluded that, all things considered, the period over the next 2-3 years will probably the best time to buy since the late 1990s.

My message, if it wasn’t clear, is that if you have been holding off purchasing a home because of the risk of capital losses, then these risks are probably lower now than at any time in the past decade.  Maybe prices will be a couple of percent lower at the end of next year, but I have a hard time wrapping my mind around downward price movement more severe than a couple more years of the slow melt, or around 3% in nominal terms.  The chances of price gains is also now much higher.

described in the past how each Australian city has its own cycle, and that aggregate data is may need to be assessed against local indicators. Sydney will probably be the first to start the next price cycle.

Now don't take this as a thumbs up from me for housing price growth.  High asset prices are not a particularly desirable feature of an economy.  However my strongly held view is that asset prices should not form part of the debate over housing affordability.  It is like having a debate over the affordability if steel by looking at the price of BHP shares.  No, the asset price will be subject to the whims of financial markets, and the affordability of steel can only be observed by looking at the price of steel.  In housing markets, land prices are asset price, and rental prices are the actual market price for housing.

Whether we also desire for social reasons broad access to the housing asset market, then we may consider severe changes to policy in this arena.

Further, I am merely observing the features of previous cycles.  This is a slightly better approach than just extrapolating recent trends, but there is no particularly strong theoretical reason why the next cycle should be identical to the last.  Though I do expect common features.

So what sort of indicators are crucial in observing the bottom of the cycle?

Dwelling turnover
What we are looking for in this indicator is a slight uptick. We have bobbed along the bottom for three years now.  Can this go on, or are we due for a correction?  Will those reluctant landlords cash in once prices have stabilised?  Once turnover starts to noticeably increase, perhaps break through 5% toward 6%, I will have more confidence that it is a relatively advantageous time to buy.

Turning point of mortgage payments to income ratio
We should see bottoming out of mortgage payments to household incomes at the bottom of the cycle.  With further interest rate cuts expected this year, this indicator should fall quickly below 8% in the next two years.

Turning point in housing credit
Housing credit growth has been on the decline since the end of the national boom in 2003. However the short periods of increasing rates of growth also produced price gains.  It’s now been ten years since the peak, and a modest turn around looks imminent, especially considering the pattern of the second derivative of housing credit which is surging towards positive territory.

Falling rents
It may seem like an odd indicator, but falling rents (in terms of rent to income ratios) is a signature of increasing prices.  The last 5 years have seen rents tighten in relation to income.  This might be over for now and if we see this indicator start to fall I will have even more confidence about where we are in the cycle.

Of course, I noted earlier that the next housing price cycle will be far less severe than the last.  This is not a prediction of a huge nominal gains, but of relative returns from entering housing in 2014-2015 compared to the last 6 years.  For those interested in getting into the market it is time to start paying close attention to the market in your area.