Is There A Brewing Bubble In The Philippine Education System?

The Philippine educational system seems to be in a bubble. By bubble, this means that the current setup is unsustainable. As famed economist Herb Stein once puts it, if something cannot go on forever it will stop.

The cost of private education has been exploding, as exemplified by the estimated 7 year annual fee increases by PIDS on architecture and engineering courses from 1994-2001 (left window). This has been way beyond the rate of inflation (tradingeconomics.com-right window).

Yet it would be misleading to claim that competition among private schools doesn’t exist.

Most school participants of the major sports tournaments as the UAAP and NCAA demonstrate not only competition for sports superiority, but likewise “competition” for privately funded education.

And competition ought to have brought down tuition fees to market (affordable) levels. But this hasn’t been happening. So what’s wrong? Is this a case of market failure?

Competition Is In The Real Resources

Table from the Department of Education

Even as public schools dominate the education market in the primary/elementary (37,607 for school years 2008-2009) and secondary/high school (5,359) relative to the private sector (primary/elementary 7,084 and secondary/high school 4,707) based on the DepEd report, the relationship between the private sector and the public sector is incomparable or can’t be discerned as either “monopoly” or “market based competition” in the traditional sense, because both cater to distinct constituents, particularly to the underprivileged for public schools and to privately funded education.

However, where factual competition is going on is in the real resources department. Both the private sector and the public sector basically compete to consume the same materials, such as pencils, papers, food and etc... And this includes manpower (e.g. teachers).

Yet the fundamental difference will be on how the consumption patterns are being carried out, i.e. the private sector is sensitive to price mechanism via profit and loss discipline, whereas the public sector is politically determined.

A good example of how this competition for resources is being waged is in the subsidies provided by the Philippine government to private school students.

This from the Inquirer.net, (bold highlights mine)

Monsignor Gerardo Santos, national president of the Catholic Educational Association of the Philippines (CEAP), said private schools needed more subsidies from the government because their lowly-paid teachers were transferring to the public schools.

“That’s not just okay with us. We are advocating it [subsidies]. We are fighting for it,” Santos said in a recent media briefing.

“We want it increased. I hope the government hears us. We really need more,” he said.

The Department of Education estimated that almost half of the country’s 1.3-million private high school students are subsidized by public funds though the Government Assistance to Students and Teachers in Private Education (GASTPE). The program provides a P10,000-subsidy to first- and second-year high school beneficiaries in Metro Manila.

Junior and senior high school beneficiaries in the metropolis get P5,000 while all the beneficiaries in the provinces also receive the same amount.

The government allotted P3.59 billion for the GASTPE program this year.

We learn of several things from the article;

1. There is a mandate for private schools to accept or accommodate welfare constituents via tax funded subsidies.

2. Since government subsidies are considered as deficient, then the private schools shoulders the additional load of expenses (resource consumption) incurred by the welfare students.

3. Operating similar to the mechanics of the senior citizen’s discount cards, the subsidy gap contracted will have to borne, not by the school owners (through profit or earnings), but by passing these costs to the paying consumers, in this case, the paying students.

The last thing that anyone would do is to apply the onus of the cost of government compliance to their own income or earnings. Instead, it would be intuitive for them to just pass it to consumers. This means that any subsidy that comes out of the pocket of the owners suggests that market pricing limits have been reached and that consumers can bear no more. Alternatively, this means lots of marginal providers will go kaput upon reaching this level.

Hence, the exploding costs of private education partly reflect on the subsidies covered by private students on welfare recipients.

And perchance, the high cost of education has significantly diminished the rate of college enrolment from 2001-2005 (tradingeconomics.com).

4. Since government has extensive controls over private schools at almost every aspects, from welfare accommodation to curriculum mandates, enough to designate private schools as extensions of the public school system, then the operating ‘competitive’ environment may not be seen as genuine market based competition but a semblance of cartel-like pseudo-competition.

Thus the first pin to the bubble is when these indirect costs of private sector subsidies become too onerous to bear.

Of course, this resource competition represents only a symptom to a much a larger disease-the education welfare state.

The Original Sin-Welfare Education

For the public ingrained with state paternalism, it would seem like blasphemy to talk about the ills of welfarist education. The deeply entrenched popular opinion is that the state is the only dutiful and rightful provider of education and thus must supply, and if not regulate, almost every activity associated educational development.

Hardly anyone ever realizes that throughout world history, schools or the educational system have been frequently used as the primary conduit by the state to inculcate or impress upon political or religious agendas to commandeer society’s acceptance or what is known as theory of passive obedience.

Murray N. Rothbard in Education: Free and Compulsory wrote,

``It is inevitable that the State would impose uniformity on the teaching of charges. Not only is uniformity more congenial to the bureaucratic temper and easier to enforce; this would be almost inevitable where collectivism has supplanted individualism. With collective State ownership of the children replacing individual ownership and rights, it is clear that the collective principle would be enforced in teaching as well. Above all, what would be taught is the doctrine of obedience to the State itself. For tyranny is not really congenial to the spirit of man, who requires freedom for his full development. Therefore, techniques of inculcating reverence for despotism and other types of "thought control" are bound to emerge. Instead of spontaneity, diversity, and independent men, there would emerge a race of passive, sheep-like followers of the State. Since they would be only incompletely developed, they would be only half-alive.” (emphasis added)

And all these ‘romance with the state’ through education has clearly been visible on budgetary allotment of Philippine government as shown from the above table from National Statistics Coordination Board.

Budgetary allocation for education has ballooned to Php 185.5 billion (Philstar) out of the Php 1.541 trillion or accounting for about 12% of the national budget for the year 2010 (Sunstar).

Yet for the many who embrace Sta. Claus economics, nothing is ever enough. There are many who still clamor for more spending as if government is a fountain of endless wealth.

Never has it occurred to them that government’s primary source of revenue is mainly through taxation which means government redistributes rather than creates wealth. And government can only redistribute what is available, or that there are effective limits to redistribution.

The worst part is that by depending on government, welfare recipients have been relieved of their major personal responsibilities such as family planning, by which the ensuing dependency mindset could have contributed to the above world average population growth for the Philippines (Google Public Data). “Why not have more children”, welfare beneficiaries might think, “since government pays for their education anyway”.

The dependency mindset via the welfare state is the most obvious way to manipulate society to create a political constituency that could ensure the preservation or the expansion of power by the political class.

Yet what we aren’t told about is that resources consumed by the public sector, in this case Php 185.5 billion worth from the education department, represents as lost productive opportunity or money that could have been used by the private sector to get invested into productive ventures that could have increased the per capita of the Filipinos, from which would allow them to finance out of their own pockets, a quality education of their choice for their own children.

Besides, private sector charity or philanthropic activities would surely get amplified once the burden of taxation will have been mitigated from the diminished pressures of government expenditures. But all these aren’t likely to happen until the unsustainability of the system will forced upon by economic laws.

The crux of the bubble in welfare state is that the bubble can only last for as long as the taxpaying population is willing to tolerate the costs or comply with government’s redistribution program or the market is open to funding fiscal spending requirements.

For now, this would seem to be the case, as per capita GDP of the Philippines appears to be picking up.

Three Pins To Pop The Bubble

Nevertheless, I see three possible proverbial pins that could implode the education welfare bubble.

One, An Overdose of Welfarism.

As mentioned above, disharmony in the economic system caused by too much subsidies and other interventions could drive up the cost of education to highly restrictive levels. And as consequence, there will be increases in the political demand for more free (lunch policies) education. And instituting more of these welfare policies will push the country’s fiscal conditions into a boiling point where funding from taxation or from market based debt financing won’t be sufficient.

Two, Contagion Effect From Boom Bust Cycles

Since the world operates on boom bust cycles, I don’t see it as a distant possibility for a crisis to happen in Asia or within the Southeast Asian region. And any crisis of this nature is likely to have a severe contagion effect on the Philippines, similar to the Asian crisis of 1997.

Like all cycles, during good times, social programs like education are alluringly on path for expansion. That’s because as the economy expands, political leaders are likely to exhibit more generosity—in order to buy votes or preserve or enhance their popularity ratings—in the expectations that the growth in tax revenue collections will be sustained.

However, once a financial or economic bust should emerge, all these programs will suddenly suffer from a withdrawal or a dearth of funding. It’s not hard to picture a recent noteworthy example of government prodigiousness penalized—Greece.

Three, there is always the transition to the information age to consider.

Acceptability of “affordable” online education seems to be picking up momentum and may displace the overrated industrial age educational system in place.

This from SFGate.com

``Evidence nationwide suggests students could be warm to the idea of online learning.

``The number of college students taking online courses nearly tripled between 2002 and 2008, according to the Sloan Consortium, a nonprofit that encourages online education. Nearly 5 million students took at least one online course in 2008, up from 1.6 million in 2002, Sloan found.

``UC wouldn't be the first university to offer undergraduate degrees online. Among the most successful is the University of Massachusetts' "UMassOnline," which includes graduate degrees. It reported revenue growth of 20 percent since last year, to $56 million, and 14 percent enrollment growth, to 45,815 students.”

And here is how Mises Academy fared with its introductory online course, according to Jeff Tucker at the Mises Blog,

``From our own experience, the success of the Mises Academy has far exceeded anything we imagined. It grows and grows. The venue is super compelling, highly effective, economically rational, and it connects students and professors together again as they were before the rise of the overfunded, unresponsive, heavily bureaucratized brick-and-mortar U. There is no doubt about the future; the only question is who will be making it happen vs. who will be left in the dust.

The major problem for online courses, for now, is that the current business environment has been oriented towards the recognition of credentials via government accreditation procedures or mechanisms. This is actually part of how the state controls our actions.

As Murray Rothbard once wrote,

By enforcing certification for minimum standards, the State effectively, though subtly, dominates the private schools and makes them, in effect, extensions of the public school system. Only removal of compulsory schooling and enforced standards will free the private schools and permit them to function in independence.

But the continued permeation of online education could reach a tipping point where the current credential-accreditation system risks being deconstructed.

And this obviously will pose as another threat to mainstream’s educational platforms, be it on the private sector or on the public schools.

As online education grows expect fireworks (resistance to change) from here.

Matt Ridley: When Ideas Have Sex

Great stuff from Matt Ridley, watch it....

US Unemployment: It’s Partly About Skills-Jobs Mismatch

It isn’t true that unemployment in the US is all about the lack of opportunities.

Instead a big part of this, aside from regulatory uncertainties, is the mismatch of required skills relative to the available jobs.

According to the Wall Street Journal,(all bold emphasis mine)

Employers and economists point to several explanations. Extending jobless benefits to 99 weeks gives the unemployed less incentive to search out new work. Millions of homeowners are unable to move for a job because the real-estate collapse leaves them owing more on their homes than they are worth.

The job market itself also has changed. During the crisis, companies slashed millions of middle-skill, middle-wage jobs. That has created a glut of people who can't qualify for highly skilled jobs but have a hard time adjusting to low-pay, unskilled work like the food servers that Pilot Flying J seeks for its truck stops....

Matching people with available jobs is always difficult after a recession as the economy remakes itself. But Labor Department data suggest the disconnect is particularly acute this time around. Since the economy bottomed out in mid-2009, the number of job openings has risen more than twice as fast as actual hires, a gap that didn't appear until much later in the last recovery. The disparity is most notable in manufacturing, which has had among the biggest increases in openings. But it is also appearing in other areas, such as business services, education and health care....

Longer-term trends are at play. For one, the U.S. education system hasn't been producing enough people with the highly specialized skills that many companies, particularly in manufacturing, require to keep driving productivity gains. "There are a lot of people who are unemployed, but those aren't necessarily the people employers are looking for," says David Autor, an economist at the Massachusetts Institute of Technology.

In the transition to the information age, the shape of investment and hiring would pronouncedly be different as it will involve more specialized “local knowledge” skills and deepened division of labor.

Government intervention (stimulus, unemployment benefits, bailouts, obamacare) has kept the labor market from the adjustment process that should have met these “new” realities. Thus, additional government interventions won’t help.

And the recent resignation of the head of the Council of Economic Advisers to President Obama, Mrs. Christina Romer, appear to be a revelation of the failed Keynesian policies of the Obama regime.

How Bro. Armin Luisitro’s 12 Year Basic Education Cycle Will Benefit The Big League Schools

The proposal of De La Salle Bro Armin Luistro, the incumbent education secretary, to extend the basic education cycle into 12 year cycle isn’t likely achieve the purported goals. [Sorry, but I have to part ways with my alma mater, assuming DLSU adheres to Bro. Luistro’s stand].

According to the Inquirer.net,

“The current thinking is if you don’t finish with a college degree, there is something missing. But in basic education, the operative term is basic, and what is basic is that they should be able to live a meaningful life, be prepared to start a family, be productively employed,” Luistro said.”

Will an additional 2 years of education guarantee that students will become productively employed? The answer is NO. Instead, what such policy will guarantee is that schools, particularly the elite schools, will be assured of additional revenues.

Yet, isn’t 10 years enough to instill basics?

Table From Alabama Cooperative Extension: What Are Employability Skills?

Many of the employable skills are actually self-learned from actual occupational experiences than from a classroom setting. This includes high-order thinking skills and personal qualities in that come in relation with people relations management.

Adding practical skills to the curriculum will not likely enhance for the simple reason that the students won’t get the desired experience of real work pressures until they get formally employed. Employers will unlikely put pressure on people whom are not committed to them. For instance, at On the Job Training (OJT) with companies, students will merely be given the least sensitive job, and thus, will hardly imbue so-called required skills.

This would be analogous to teaching people how to swim in the swimming pool (controlled setting) when what is needed is how to survive the open seas (variable conditions).

Another example would be competition, you can’t exhaustively teach competitive skills in the classroom or practical class, but from the rigors of the real world.

In addition, Bro. Luisito isn’t dealing with reality but dabbles instead with statistics.

Again from the Inquirer,

``While a large percentage of families could not afford to send their children to college, the current basic education cycle is inadequate in giving students employable skills, Luistro noted.

``Only 16 percent of the student population finish college while 84 percent leave school at different stages, Luistro noted.

Yet, despite this, the Philippines has one of highest educational attainment in Asia that’s according to the ADB’s 2007 Education and structural change in four Asian countries

“Of the four countries studied in this chapter, India is the least educated. Thais are slightly less educated than Indonesians, and Filipinos are the most highly educated. Three of the four countries have aggressively pursued increases in education levels, especially at the secondary level, during the period under consideration. Around 90% of Thai secondary education is privately provided. The corresponding figure is 20% for the Philippines, down from 32% in the mid-1990s, and roughly 40% for India and Indonesia”

You see, the problem isn’t much about employable skills, but about that the lack of investments that spurs the job creation. In short, it’s the lack of jobs.

Let say Bro Luisito can produce many employable skilled workers alright, but absent jobs these employable skilled workers will remain unemployed.

Importantly, I see Bro Luisito protecting the interests of the elites by introducing anti-competitive provisions,

Again from the same inquirer article,

“While not everyone will end up with a degree that is very, very academic, we recognize now more than ever that for nation-building, our high school program should look at [offering] different tracks to be able to address the many needs and gifts of students,” Luistro said, describing this as a “multi-intelligence” approach.

“For instance, certain high schools could specialize in the arts, partner with the Technical Education and Skills Development Authority for technical-vocational courses, or the Philippine Sports Commission to develop a more sports-oriented curriculum.

The new provisions would effectively mandate affiliations with “specialty partners”, thus schools that don’t meet the criteria would be forced out of the playing field. This means that the school big leaguers would be the major beneficiaries from the new law.

Besides where he claims that the new law will “address the many needs and gifts of students” is in contrary to his earlier statement saying that the law will “conform with global standards”. How does uniformity (global standards) harmonize with individuality (many needs and gifts) [unless our children will get transformed into automatons]?

Finally, Bro. Luisito claims that there won’t be added financial burdens.

Of course, he saying this, because he isn’t paying for it. To paraphrase Warren Buffett, this would be like asking a barber if you need a haircut.

Again from the inquirer,

“Luistro dismissed fears that the expanded elementary and high school period in the only country with a 10-year basic education cycle would be a financial burden to parents.”

I have NO direct figures to make a comparison of the inflation of the private primary and secondary school levels.

Table From PIDS: College Fee Structure and Fee Inflation

Nevertheless, the table above from PIDS, gives us some insights on why there have been huge college drop-out rate, as well as, the rate of inflation that encompass private college courses.

Bottom line: in contrast to Bro. Luisitro’s claim, there will be material financial burden to families, be it directly (as above) or indirectly (as below). This will particularly onerous to low income levels.

Graph From The ADB’s Hyun Son Has Inflation Hurt the Poor?

In other words, this would mean additional load for families to sustain the burden of carrying children through additional 2 years of the 12 year basic cycle, which doesn’t guarantee anything but huge revenues for the big league schools.

The other way to say it, is that expect more tuition fee increases for schools to meet such mandates!

Is this the change we’ve been looking for-more politicization of education for the benefit of a few?

Why Capital Is Never Homogeneous

What is Capital?

1. It is a function of savings.

Capital goods come into existence by saving. A part of the goods produced is withheld from immediate consumption and employed for processes the fruits of which will only mature at a later date. All material civilization is based upon this "capitalistic" approach to the problems of production. "Roundabout methods of production," as Böhm-Bawerk called them, are chosen because they generate a higher output per unit of input. (Mises)

2. It is the “fundamental concept of economic calculation” (Mises)

Capital is an applicable concept only for market economies.

3. Capital is everything that goes into the entrepreneurial process that produces a final output.

Capital is the sum of the money equivalent of all assets minus the sum of the money equivalent of all liabilities as dedicated at a definite date to the conduct of the operations of a definite business unit. It does not matter in what these assets may consist, whether they are pieces of land, buildings, equipment, tools, goods of any kind and order, claims, receivables, cash, or whatever. (Mises)

4. It is specific and limited usage.

For instance, materials that go into a pencil production won’t be the same as those in car or semi-conductor production.

5. It is complimentary.

Example, a semi-conductor chip fits into the motherboard. A carburetor enhances the engine.

6. It has opportunity costs.

A doctor may know how to do the work of the secretary but opts not to. That’s because he is more efficient in being a doctor and instead hires a secretary. The opportunity cost here is the division of labor.

So is capital homogeneous? Never!

Therefore, any models predicated from the assumption that capital is homogeneous should automatically be thrown to the garbage bin and should not be wasted a second of precious time.

Graphic: Recalculation Theory

Jessica Hagy calls her splendid and evocative piece of graphic as “Somebody has to do something!”

Whereas my interpretation of this is Professor Arnold Kling’s Recalculation Theory.

This excerpt From Professor Kling,

``if the old patterns of specialization and trade are not sustainable, the economy faces the Recalculation Problem. New patterns of specialization and trade need to be created. While the economy is creating new patterns even in good times, when it faces a Recalculation Problem it cannot create new patterns rapidly enough to prevent widespread unemployment.” (emphasis original)

In the transition to the information age, the new pattern of specialization and trade is the discovery process called as the “seed of the start up”!

The Brain Drain Nonsense

In reading media, it’s just amazing how incurably specious their treatment of social issues are.

Take for example the recent issue on supposed “brain drain”. It’s been emphasized that the Philippines appears to be helpless in the exodus of manpower as a result of demand from abroad.

This from the Inquirer.net,

Scientists, engineers, doctors, IT specialists, accountants and even teachers are among the English-speaking talent heading to foreign lands, leaving the government and private companies scrambling to find replacements.

"There is a skills haemorrhage. We are losing workers in the highly professional and skilled categories," Vicente Leogardo, director-general of the Employers' Confederation of the Philippines, told Agence France-Presse.

While they (government and business groups) don’t exactly say it (as this would construed as politically incorrect since OFWs are now an important political force!), the undertone suggests that these should be stopped. How? By Fiat!

I may be wrong but the following seems to be a clue.

More from the same article, (emphasis mine)

The government has been seeking ways to upgrade salaries and benefits, according to Myrna Asuncion, assistant director of the government's economic planning department.

"But local salaries can only go up by so much before they start hurting the competitiveness of local industries," Asuncion told AFP.

"We want to provide employment opportunities in the Philippines but there are some sectors that say salaries are already too high," she said.

You see the problem?

On the supply side, these anecdotes only reveal that the government and Filipino companies are “afraid” or "reluctant" to engage in market competition by paying market rates for these skills. With foreign companies willing to pay local skilled workers enough to tilt the latter’s (cost benefit tradeoffs) choice, thus, they decry the “brain drain”.

In short, this is simply demand and supply or Economics 101 at work.

Of course, media, politicians and their coterie (business interest groups, politically blind academicians and experts) loathe demand and supply. They believe in Santa Claus or free lunch economics.

And here are very important factors which they don’t say:

From TradingEconomics.com

First of all, they don’t tell you that the lowered standards of living have been the result of past collective policies that has resulted to inflation or the loss of purchasing power of the Peso.

Over the years, this has significantly contributed to the reduction of competitiveness. Think capital flight.

Chart from the BSP

Next, they don’t tell you that a lower Peso (falling from an exchange rate against the US dollar at 2 in the 1960s to 55 in 2005) doesn’t necessarily fuel an export-industry boom.

So policy manipulations (such as welfarism) to diminish the Peso’s worth only sustains distortions in the economic system, via protectionism -which favors select political groups (think cronyism). And these exacerbate the outflows of labor force.

In other words, protectionism is mostly a zero sum game and hardly contributes to goods-services value formation.

Chart from the OECD

Another, from the demand side, the demographic imbalances or falling fertility rates in developed economies will sustain the need for labor manpower from emerging markets. And the Philippines given the current political economic setting is likely to be a major participant for a long time.

Importantly, with increasing technology based globalization, skilled jobs will be a major contribution to the “labor” aspect of globalization.

Chart from the TradingEconomics.com

Essentially the so-called “brain drain” is a symptom of an underlying disorder.

And one of the primary variable is lack of desire to compete.

So even at relatively low wages (compared to OECD), the market’s response to price signals set by the downtrodden Peso have been undercut by the regulatory, bureaucratic, legal, (property rights) and tax environment.

According to Trading Economics, ``The Ease of doing business index (1=most business-friendly regulations) in Philippines was reported at 141.00 in 2008, according to the World Bank. In 2009, the Philippines Ease of doing business index (1=most business-friendly regulations) was 144.00. Ease of doing business index ranks economies from 1 to 181, with first place being the best. A high ranking means that the regulatory environment is conducive to business operation.”

The Philippines is shown as one of the world’s least business friendly environments in the world, thus, resonating the signs of refusal to adjust to the global market climate. Instead, these interest groups seek political cover—which doesn’t change the nature of economics.

Finally, it’s equally nonsense to imply that brain drain will suck out the heck out of our skilled workers. This will only be true if you think the Philippines is immune to the basic laws of economics.

Why?

Because price signals say supply will adjust to demand!

Chart from TradingEconomics.com

Exploding remittances and net migration trend reveals how these dynamic would unfold.

The fertile population of the Philippines should “naturally” respond to these dynamic by having more Filipino youth take on more specialized courses that would meet global demand. Hence restrictions on these adjustments should be avoided.

Unless Filipinos are daft, which I don’t think we are, except in the eyes of politicians and media, I trust that the law of economics would prompt “brain drain” to result to a net positive benefit for the Philippine society, because it is a purposeful choice made by millions of individuals (our countrymen) in response to the current environment.

If we truly want to reverse “brain drain”, then we need to build capital.

And how do we that?

By sloughing off protectionism, cronyism, paternalism and embracing competition, free trade and economic freedom.

As Ludwig von Mises once wrote,

Under a system of completely free trade, capital and labor would be employed wherever conditions are most favorable for production. Other locations would be used as long as it was still possible to produce anywhere under more favorable conditions. To the extent to which, as a result of the development of the means of transportation, improvements in technology, and more thorough exploration of countries newly opened to commerce, it is discovered that there are sites more favorable for production than those currently being used, production shifts to these localities. Capital and labor tend to move from areas where conditions are less favorable for production to those in which they are more favorable.

That’s what media and the mainstream won’t likely tell you.

Update:

Outside business administration the major growth area in Philippine education is practically where the skilled exports has been taking place (red arrows)--namely, Medical Sciences (strongest), Math and computers sciences and engineering (growing but variable), that's from NSCB data (see below)

Bottom line: The law of economics works!

Why Mainstream Economists Are Mostly Wrong

How could economists/experts get it (forecasting, policy prescriptions) so wrong?

This from Janus Lim of the World Bank (hat tip: Prof Antony Mueller) [bold emphasis mine, italics his]

It would seem that the current crop of modern macro models are not only ill-suited for prime-time policymaking in the developed world, they are also inadequate for the developing-country context. At some level, this is ironic. Developed economies are typically far more complex, with larger and more sophisticated product, financial, and labor markets. If anything, the relatively simple structure of DSGE models should be attractive to developing countries, since they are more likely to be successful in capturing the primary features of these economies.

Of course, it may well be the case that developing country policymakers are not quite ready for such sophisticated, state-of-the-art macro modeling tools. Perhaps so, but this seems to me to be a red herring. While ease of use is certainly relevant for capacity-constrained LDCs, the more important question to ask is whether such models can answer the questions foremost on the minds of developing country policymakers. If they can't, it matters much less that the developing world is not ready for them. It would be more that these models are not ready for the developing world.

For simplicity sake, the answer is because they substitute models for human action.

Prof Richard Ebeling writes,

The inability of the economics profession to grasp the mainsprings of human action has resulted from the adoption of economic models totally outside of reality. In the models put forth as explanations of market phenomena, equilibrium — that point at which all market activities come to rest and all market participants possess perfect knowledge with unchanging tastes and preferences — has become the cornerstone of most economic theory.

How Free Trade Saved The World From Depression

This from the Economist, (all bold highlights mine)

DURING the Great Depression, America’s protectionist Smoot-Hawley Act of 1930 raised tariffs on more than 900 goods. A series of retaliatory actions by other countries followed. The effect on global commerce was devastating. In the three years to June 1932, the volume of world trade shrank by over a quarter. No wonder, then, that the spectre of the worst recession since the Depression led many to fear another descent into protectionism and a similar decline in trade.

At first, the recession did hit trade hard. Global GDP fell by 0.6% in 2009 while the volume of world exports dropped by 12.2%. But whereas the Depression saw trade decline for at least four years, this time the rebound has been quick, and sharp. By May this year, emerging-economy members of the G20 were importing and exporting around 10% more than their pre-crisis peaks (see chart). Rich-world trade has recovered from the trough too, though it has not yet made up all the ground lost since the credit crunch began.

Trade has not been devastated by the raft of protectionist actions taken during the downturn. According to the World Bank, the rise in tariffs and anti-dumping duties explains less than one-fiftieth of the collapse in world trade during the recession. For the most part, the fall in trade reflected a drop in demand.

There is even some evidence that activity has rebalanced from the lopsided trade pattern that existed just before the crisis. Then, the share of emerging-world imports that came from rich countries had been on a steadily declining path. But now demand from emerging economies is helping to prop up rich-world exports to a larger degree than is commonly realised. According to IMF figures, of nine emerging markets in the G20, seven got a higher share of their imports from rich countries in 2009 than they did a year earlier. Just 59% of China’s imports came from rich countries in 2008, but this rose sharply to 66% in 2009. India obtained 42% of its imports from rich countries in 2008, but last year this rose to 47%.

That mutually beneficial pattern points to the importance of both rich and poor countries keeping their markets open, so that growth in one part of the world can help stimulate a recovery elsewhere.

Some observations:

People have learned from history (perhaps heeded George Santayana’s admonitions?)

Having sentiently benefited from the experience of trade, most of the world appear to embrace free-trade globalization as means of generating wealth. And as shown above, this is noteworthy especially in the emerging markets.

The proof of the pudding is in the eating. The best test of the conceptual assimilation of free trade is through a crisis, and free trade seems to have passed with flying colors.

The Economist doesn’t mention it, but the world’s growing acceptance of free trade, in my opinion, is largely aided by the shift to the information age. This seismic transition allows for real time communication, thereby reduce the instances of conflicts by open dialogue.

Like always, mercantilists have it wrong anew.

And with this we quote Mr. Ludwig von Mises in Liberalism,

To this question Ricardo's doctrine provided the answer. The branches of production distribute themselves among the individual countries in such a way that each country devotes its resources to those industries in which it possesses the greatest superiority over other countries. The mercantilists had feared that a country with unfavorable conditions for production would import more than it would export, so that it would ultimately find itself without any money; and they demanded that protective tariffs and prohibitions on imports be decreed in time to prevent such a deplorable situation from arising. The classical doctrine shows that these mercantilist fears were groundless. For even a country in which the conditions of production in every branch of industry are less favorable than they are in other countries need not fear that it will export less than it will import. The classical doctrine demonstrated, in a brilliant and incontrovertible way that has never been contested by anybody, that even countries with relatively favorable conditions of production must find it advantageous to import from countries with comparatively unfavorable conditions of production those commodities that they would, to be sure, be better fitted to produce, but not so much better fitted as they are to produce other commodities in whose production they then specialize.

Breakfast Inflation

We’ve been repeatedly told by experts that inflation has been non-existent and is less of a threat compared to deflation which is seen as the major scourge.

This from the Economist,

SEVERE drought and wildfires in Russia, the world’s fourth largest wheat producer, have destroyed a fifth of the country’s crop and sent prices soaring. Since the end of June wheat prices have more than doubled. On Wednesday August 4th, the UN’s Food and Agriculture Organization cut its forecast for 2010 global wheat production by 5m tonnes, to 651m tonnes. Kazakhstan and Ukraine, both big wheat producers, have also been hit with dry weather. In Canada the problem is the reverse: unusually wet weather has prevented seeding and destroyed crops. But wheat is not alone. The price of orange juice has also risen recently, probably thanks to bets placed on the likelihood of tropical storms. Coffee prices, which hit a 13-year high, are a result of poor harvests. Taken together, the raw ingredients for breakfast in much of the rich world have increased in price by 25% since the beginning of June.

Some observations:

Inflation on your breakfast table poses only as short term quirk.

Inflation is beginning to pick up and your breakfast is first among the many diffusing signs.

Let me guess, mainstream analysis which see money has having a neutral effect is wrong.

What Exploding IPOs In Asia Means

There has been an explosion of IPOs in emerging markets, particularly in Asia.

According to Globe and Mail (graph included)

Globally, July IPOs totalled $30.5-billion (U.S.), according to Thomson Reuters, the highest value since November, 2007. The Asia-Pacific region benefited most from the boom, buoyed by Agricultural Bank of China Ltd.’s $20.8-billion IPO. Not only did AgBank garner strong demand, the offering was ultimately upsized.

Since January, the Asia-Pacific region, excluding Japan, has raised almost $136-billion (U.S.) in IPOs and follow-on offerings, according to Thomson Reuters, while the United States has raised $67-billion. Investors can only wonder why North America has been so tepid while Asia is so hot.

Exploding IPOs, for me, are symptoms of brewing euphoria, which are mostly in response to policies. The rate of increases provides significant clues to the transitioning phases of a bubble cycle. See earlier discussion What Agricultural Bank of China’s IPO Should Imply For Asian Financial Markets

The issue of concern here isn’t a liquidity drain. For every buyer there will always be a seller. Thus, liquidity (money) is transferred from buyer to seller.

The issue is here is euphoria, artificially bolstered demand from policy impetus that forces the public to (decrease savings) increase risk appetite and chase yields, thereby distorting relative price levels of financial securities, the fostering malinvestments (in the real economy) and the attendant speculative orgies.

The primary reasons why Asia outperforms or has gained significant traction from such policies as earlier stated here has been because of huge savings, less systemic leverage, and a largely unimpaired banking system.

Of course, many real economic reasons provide for the other “rationalization”. Think regionalization, urbanization, wealth transfer etc... But they are secondary forces.

Importantly, in a world of globalization, global funds tend to seek out the best performers, which is emblematic of the ‘bandwagon effect’, as Templeton’s Mark Mobius writes,

In general, institutional pension funds’ exposure to the emerging markets asset class averages around 3% to 8% of their portfolios. From a pure market capitalization perspective I think that they are severely underweight in the asset class, as emerging markets stocks account for more than 30% of the world’s total market capitalization. We anticipate seeing some shift of institutional allocations to this asset class. Consequently, we believe institutional investors could fuel further demand for emerging markets equities.

...and that there would be numerous carry trade or arbitrage opportunities, from the fast emerging divergent monetary policies which could be channelled from currencies to bonds and could find its way to these IPOs and fuel more of this bubble like phenomenon.

I don’t think that Asia’s IPOs has reached a scale of bubble proportions to the point of implosion. Not yet anyway. Perhaps we could still be far off. But these constitute one of the many signs that we are headed in that direction.

P.S. As per the Philippines an IPO boom has yet to materialize.

Revocation Of Midnight Appointments: It’s About Who YOU know

Perhaps you’ve heard the axiom “It’s not about what you know but WHO you know.”

In a market economy, this would be less relevant because consumers are reckoned as the empowered political-economic force.

But in a statist economy, where economic opportunities are mostly distributed according to whims or priorities of politicians then this becomes a very influential factor.

And it appears that the second executive order issued by the President Aquino is emblematic of the latter.

This from the Inquirer.net,

President Benigno Aquino III has issued Executive Order No. 2, revoking the “midnight appointments” former President Gloria Macapagal-Arroyo made on or after March 10, Malacañang has announced...

De Mesa said Malacañang found 977 instances wherein the previous administration violated the constitutional ban on appointments two months before the presidential elections and 90 days before the end of Mrs. Arroyo’s term last June 30.

My comment:

1. After the Wang Wang, now political retribution. President Aquino’s thrust seems very much directed at populist politics, obviously aimed at sustaining his high popularity ratings.

Since former President GMA has been intensely unpopular, then piggybacking on vindictive sentiments seems the most apparent way to meet his personal goals (popularity ratings).

However, as we earlier wrote, ``Political gimmickry can only have a short term impact, thus he would need a bagful of other tricks to keep people entertained.”

2. Like any other politician, the President’s action reveals that political loyalty and affiliation have been the primary mechanism to effect ‘changes’.

This implies that preservation of power translates to rewarding supporters and will use such occasion (PGMAs unpopularity) to his advantage.

Hence, the vacated posts will most likely be used for election payback.

Yet, if President Aquino truly desires to seek the betterment of the Philippine society, then he should use this opportunity to trim the bureaucracy. But the latter option is wishful thinking on our part and isn’t likely the course of action.

3. While one may argue that midnight appointments are illegal, they could, technically speaking.

But these types of laws can be arbitrarily interpreted to the convenience of the powers-that-be.

Laws can be perverted to unjustly impose powers over certain groups or to the society for the attainment self-interested political agenda by political leaders.

As Frederic Bastiat wrote in the Law, “they turn to the law for this despotism, this absolutism, this omnipotence.”

And as we’ve been saying all along, we are seeing more and more proof of “the more things change the more they stay the same”.

Elusive dreams will remain ever elusive.

Rahn Curve: Defining The Optimum Level Of Societal Benefits From Government Spending

There is a limit to everything. And this applies to government spending as well.

Cato's Daniel Mitchell, in another great educational video, explores to identify the optimum state point of government spending [up to what level of government spending benefits a society?] via the Rahn Curve.

Demographic Nightmares 2

George Magnus writes,

``capitalism rewards scarcity, and as labour supply fades relative to the availability of capital, returns will shift towards the former...

Huh?

If capitalism rewards scarcity then why at all risk precious capital to invest in order to produce?

What could Mr. Magnus be smoking?

Capitalism is an economic or resource distribution system which operates on the platform of property rights, voluntary exchange, and the profit and loss system in a world of scarcity. And the reason capitalism exist is to satisfy the unease or the pain of consumers from scarcity, hence the incentive to invest to produce.

I am reminded that once we argue using false premises then the conclusion would obviously wrong.

Mr. Magnus is apparently anxious about the world’s demographic trends echoing Pimco’s Bill Gross [see William Gross’ Demographic Nightmare]

His concern is that a smaller labor force would result to reduced corporate earnings and a lower economic growth. Hence, he recommends numerous “policy levers” or interventions to solve these predicaments.

Yet how valid is this?

True, the global rate of population growth has been falling as shown above, but it is still mostly positive (ex- Japan).

However, what is not seen is that the crucial reason why the rate growth has been falling is due to the relatively high nominal levels of world population which has already reached 6.697 billion (!), in 2008, according to the World Bank.

Another important variable in the present global demographic trends is that while population growth rate has slowed in developed economies, the bulk of the growth now comes from emerging markets.

Chart from Oppenheimer Funds

The implication is that this puts to risk the cumbersome welfare system of developed economies, aside from crimping “aggregate demand” (we dealt with this earlier).

Although I would be agreeable to one of Mr. Magnus’ suggestion that changes be made in the welfare system, I’d take a more radical approach.

Since it is to my opinion that welfare systems signify as unsustainable political PONZI programs that had been designed to buy votes of the population and to keep people dependent on politicians, welfare systems should be phased out or trimmed to the essentials.

The reduction or elimination of which would entail diminished financial burdens for the future generations, which should allow our children more room to deploy resources to their interest or pleasure, thereby reduce the barriers to investments.

This should also instill the culture of savings and personal responsibility and importantly advance the cause of personal liberty—where lesser redistribution translates to more efficiency of resource allocation and freedom of choice.

And there is another possible solution which could compliment this: ease immigration barriers to allow for free movement of people or enhance social mobility.

So globalization shouldn’t be limited to trade and finance, but also to migration flows, which at present constitutes only an estimated 3.1% of the global population, according to the International Organization For Migration (IOM).

These two structural reforms will greatly ease the concerns over reduced economic and corporate earnings growth, thus, needing less government activist (boom-bust) policies which would only worsen whatever demographic nightmare envisaged by interventionists.

Quote Of The Day: No Scientific Understanding Of Human Society

From James Manzi, (hat tip Prof Arnold Kling)

``At the moment, it is certain that we do not have anything remotely approaching a scientific understanding of human society. And the methods of experimental social science are not close to providing one within the foreseeable future. Science may someday allow us to predict human behavior comprehensively and reliably. Until then, we need to keep stumbling forward with trial-and-error learning as best we can.”

My comment: Anyone audaciously claiming that they can use science or math or econometric models to influence changes in society signify no less than a huckster, a false messiah or a fraud.

China’s State Driven Bubble

Who is responsible for inflating China’s Bubble?

Her Government.

This from the New York Times, (bold emphasis mine)

All around the nation, giant state-owned oil, chemical, military, telecom and highway groups are bidding up prices on sprawling plots of land for big real estate projects unrelated to their core businesses.

“These are the ones that have the money to buy the land,” says Prof. Deng Yongheng at the National University in Singapore. “Because in China, it’s the government that controls the money supply and the spending.”

By driving up property prices, the state-owned companies, which are ultimately controlled by the national government, are working at cross-purposes with the central government’s effort to keep China’s real estate boom from becoming a debt-driven speculative bubble — like the one that devastated Western financial markets when it burst two years ago.

Land records show that 82 percent of land auctions in Beijing this year have been won by big state-owned companies outbidding private developers — up from 59 percent in 2008.

This is looking very much like the transitioning phases of the Austrian Business Cycle...

(all charts from World Bank China’s Quarterly report and IMF’s People’s Republic of China: 2010 Article IV Consultation)

From the rapid expansion of circulation credit….

to exploding money supply growth…

mostly directed at future oriented capital structure in this case, real estate.

Frothy real estate markets…

….the deepening exposure by the banking system to the property-real estate sector.

Add that to the Chinese government’s crowding out of the private sector by her state owned enterprises bidding up on land, which worsens the bubble conditions and fosters systemic malinvestments.

And most importantly, artificially suppressed interest rates have been crucial to these dynamic.

Well, since bubbles come in phases, muted inflation hasn’t YET been much of a factor in pressuring interest rates higher.

So perhaps the bubble will persist.

This reminds me of Ludwig von Mises who once wrote, (emphasis added)

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

In fullness of time, China’s policies of turning stone into bread (philosophers' stone) will end in tears.

For now, party on!

Inflation’s Sweetspot: Jitters Over Debt Crisis Subside

At the start of the year, financial markets, particularly in developed economies, had been jittery over the contagion effects of the debt crisis in the PIIGS area led by Greece.

Now, such concerns appears to have reversed, as highlighted by the table below from Bespoke Invest, which covers 5- year CDS swap prices and includes the ‘four problematic’ US states.

According to Bespoke,

European countries rank first through fifth in terms of decline since July 2nd. Belgium has seen default risk decline the most at 30.1%. Belgium is followed closely by Spain (-29.1%), Italy (-27.3%), and France (-26.2%). The four US states highlighted are Illinois, California, New York, and New Jersey. All four states declined roughly 20%, with California decline the most (-22.3%) and New Jersey declining the least (-18.6%).

In terms of default risk levels, Venezuela ranks highest, followed by Argentina, Greece, and Dubai. The four US states highlighted aren't too far from the top of the list and have higher default risk than countries like Spain and Italy. The US, Germany, Australia, the UK, and France currently have the lowest default risk.

Ah, behold the seductive ephemeral wonders of inflationism!