Archive for May, 2007

Do Capital flows help?

May 22, 2007

I happened to read another excellent survey last week. This time it was on Financial Globalization and it covers all the studies that have been done so far to understand whether capital flows have resulted in economic growth. I had posted on the same topic earlier as well.

It has been done by a very influential team of Economists – Ken Rogoff, Eswar Prasad etc and is aptly titled Financial Globalization: A reappraisal This paper is interesting in many aspects:

1. Effects on Growth: It says the evidence so far has been mixed as some papers have used de jure (as per the law) measures of financial openness and some have used de facto (as per practice) measures. Here is a summary:

“By both measures, advanced economies have become substantially integrated into global financial markets. For emerging market economies, average de jure openness has not changed much based on the IMF measure, but de facto integration has increased sharply over the last two decades. For other developing economies, de jure openness on average rose sharply over the last decade, to a level higher than that for emerging market economies, but the de facto measure has stayed flat over this period.

Further, the paper has a very interesting table which summarises most of the research on the subject so far and just a rough counting tells me out of 26 cited studies 18 show mixed evidence.

2. Effects on Volatility: The paper suggests more research in this area and says “there is little empirical evidence to support the view that capital account liberalization by itself increases vulnerability to crises. Indeed, the literature on the effects of financial integration on volatility (and crises) is much sparser than the literature on its growth effects. Further research is warranted in this area.”

3.Composition of Capital Flows: This is the most interesting part of the paper. The basic idea is that it is not right to dump all kinds of flows (i.e. equity vs debt, Portfolio investment vs FDI) as one and analyse the impact. Here are some major findings:

a) Impact of FDI on growth: The usual belief is that FDI is beneficial for growth as it has a positive impact on productivity through transfers of technology and managerial expertise. It has also been argued that FDI is less volatile than other inflows, making countries less vulnerable to sudden stops or reversals of these flows.

But empirical evidence does not show the effect. Out of 11 studies in the paper 10 show mixed effect where FDI alone could not be held responsible for growth.

Even empirical evidence on horizontal spillovers ( i.e. from a foreign company to another company in the same sector) is inconclusive, however, in case of vertical spillovers ( i.e. from the foreign company to its suppliers etc) we have some positive evidence.

 b) Impact of Portfolio Equity flows on growth: Most papers cited show that evidence is positive i.e. equity flows lead to growth.

c) Impact of Debt flows on growth: Well, this is an interesting finding. The paper says that debt flows are the riskier variety-

The procyclical and highly volatile nature of these flows, especially short-term bank loans, can magnify the adverse impact of negative shocks on economic growth. Debt flows lack the positive attributes of equity-like flows. They do not solve certain agency problems, can lead to inefficient capital allocation if domestic banks are poorly supervised, and generate moral hazard as debt is implicitly guaranteed by the government (in the case of corporate debt) and/or international financial institutions (both corporate and sovereign debt).The empirical literature on financial globalization is decisive that debt flows generate the greatest risks from financial openness. In particular, there is a systematic empirical link between exposure to short-term debt and the likelihood (and severity) of financial crises.”

This also explains why RBI has put a cap on the amount Foreign investors can invest in government and corporate bonds. To argue whether the limit should be increased is another issue,

4. The paper further discusses a new framework to understand the impact of capital flows.

 

“A key component of our argument is that it is not just the capital inflows themselves, but what comes along with the capital inflows, that drives the benefits of financial globalization for developing countries.

The paper says that there are many indirect benefits of financial integration which they call “collateral benefits” -development of the domestic financial sector, improvements in institutions, better macroeconomic policies etc. These collateral benefits then result in higher growth, usually through gains in allocative efficiency.

Overall, it is an excellent summary of the work done on the subject so far. A Must read!

 

Assorted Links

May 21, 2007

It is great to be back to the blogging world after a week’s break.  But again, it is really tough to summarise what the bloggers are upto. Here are a few interesting links:

1. Rodrik ( have to begin with his superb blog) says temporary workers make good economic sense. He says he is not as enthusiastic for trade librealization but is all for labor mobility.

2. An excellent write-up on why just focussing on single index for inflation deos not make sense at all.

3. Another thumbs-up from The Economist. It says “If China sharply revalued the yuan, as American politicians are demanding, it could actually hurt the United States and help China.”

4. Superb Speeches by Bernanke on Sub-Prime Market and by Krozner on International Capital Flows

5. Why China changes its interest rates by 27 bps?

6. What are Mutual Funds? It says “The popularity of mutual funds may be relatively new but not their origin which dates back to 18th century. Holland saw the origination of mutual funds in 1774 as investment trusts before spreading to Anglo-Saxon countries in its current form by 1868.”

Thanks to New Economist for 3, Greg Mankiw for 5, and Finance Professor for 6.

What happens if US economy slows down?

May 11, 2007

I am going to my hometown, Firozabad for a week. I am not sure if I would be blogging from there. Anyways, here is some food for thought:

1. I was reading the World Economic Outlook, April 2007 (for the uninitiated IMF takes out a bi-annual report on World Economy. It is by far one of the most intriguing analysis). Most of the analysis is usual self — how much economies would grow, the factors which could produce higher growth and factors which could reduce growth. Summary is US would slow down but nothing to be really threatened about. The IMF people have lowered down GDP growth estimates to 2.2% for 2007 which is 0.7% lower than the last WEO in Sep, 2006.

The question is why only comment about USA alone? Well the answer is in Chapter 4 which talks about the spillover effects in the World Economy due to slowdowns/recessions elsewhere basically in US, Euro Area and Japan. The chapter tells me that US GDP is about 22% of World GDP, Imports about 20% of World Imports and has 45% of World Market Cap nad hence we need to look more into USA than any other region.

The chapter has some excellent event studies and has analysed the impact on World Economy in the previous 5 recessions and 2 mid-cycle slowdowns (some technical term which means not a recession just a slowdown). The summary is recessions are many types. There have been instances when recession in US is basically due to home factors like in 1991 when there was Savings & Loan crisis and in 2001 when there was a global slowdown. So obviously the effect is most felt in 2001 than 1991.

The net summary is:

1. Recent slowdown in US is mainly because of problems in US economy hence we do not see much impact of US slowdown on world economy.
2. The phrase that “if US sneezes rest catch cold” is true as the world does slow down but the spillover effects are not as big as stated in the media and elsewhere.
3. Moreover, spillovers have been increasing with time.
4. More than global factors, it is regional factors that are more important.

Read on.

A discussion on Financial Globalization

May 10, 2007

IMF conduced a conference on Financial Globalization on April 26-27, 2007. The conference was tiltled New Perspectives on Financial Globalization. A wide variety of papers were discussed and you can find all of them here

What caught my eye was the discussion which took place after the conference. The transcript is available here

The discussants were:
GUILLERMO A. CALVO, Columbia University
JEFFREY A. FRANKEL, Harvard University
KENNETH S. ROGOFF, Harvard University

I couldnt understand much what Calvo said but the discussion by Frankel and Rogoff was excellent and by Frankel in particular.

Frankel puts forward few quotes to the audience and asks them to guess who said the same. Here are a few:

“When financial markets swing more like a wrecking ball than a pendulum, knocking over one economy after another.” — Soros

“Liberalization of foreign financial flows is not regarded as a high priority.” — John Williamson (the guy who was responsible for the Washignton Consensus)

“While there is no proof in the data that financial globalization has benefited growth, there is evidence that some countries may have experienced greater volatility as a result.” — Ken Rogoff, Eswar Prasad etc.

He gives advantages and disadvantages of financial globalization. I loved in particular his theory that “all important generalizations about emerging market crises can be phrased in terms of the car crash analogy” He has ten such cases to explain. Sample this:

“One, sudden stops. It is not the speed that kills, it is the sudden stops that I attribute to Dornbush and Calvo. Second, superhighways. Modern financial markets get you where you want to go fast, so we are better off with them. That is an important conclusion. But when accidents happen they are bigger, and so more care is required. I think this is Bob Merton…..”

The second (in car crash analogy) one was then corrected by Rogoff and he said it was Larry Summers who said the same. Rogoff in turn also summarises a lot of good research on the subject.

Super Stuff!!

Assorted Links

May 10, 2007

1. Indian Rupee : Level vs Volatility? A nice article

2. Germany plans regulation for Hedge Funds

3. Expect Sarkozy to usher reforrms in French Economy? Not really

4. A Wedding at a Funeral Home?

Thanks to Ajay Shah for 1.

Macroeconomic Developments in India

May 9, 2007

I posted sometime back about useful reports from RBI on Indian Economy and had said would try and summarise the findings. I have so far read only one chapter on Real Economy (which perhaps is the most important one) and here it goes:

Summary

1. The primary concern is the slowdown in agriculture sector. The growth in 2006-07 is expected at 2.7% lower than 6.0% seen in 2005-06. Whereas, both Indsutrial Sector and Services sector have grown at faster levels in 2006-07 compared to 2005-06. Industrial grew at 10.2% higher than 8.0% and services at 11.0% higher than 10.3%.

2. Overall the growth in economy at 9.2% in 2006-07 slightly higher than 9.0% clocked in 2005-06.

3. Share of services in GDP has been increasing consistently. It was 60.2% in 2004-05, 60.9% in 2005-06 and is at 61.9% 2006-07. Share in agri has fallen from 20.2 in 2004-05 to 18.5% in 2006-07. Share of Industrial Sector is consistent around 19.4% – 19.6%

4.The Industrial Sector is divided into 3 sub-sectors: Mining & Quarrying, Manufacturing and Electricty. All three have grown over 2005-06 with mfg growing at 11.3% compared to 9.1% seen in 2005-06.

5. In Services, Construction has slowed from 14.2% to 9.4% whereas hotels etc have increased by 13.0% in 2006-07 from 10.4% in 2005-06. Reasons for latter growing comes from 2 statistics: a) passangers handled at domestic terminals which increased from 22.9% in 2005-06 to 36.4% in 2006-07 and b) Tourist Arrivals increased by 12.1% in 2005-06 and by 14.4% in 2006-07.

Agriculture
The reason for agriculture is primarily monsoons (what is new?). For the uninitiated (which included me till now) we have 2 monsoons here which help in two crop season.
a) South-west Monsoon (which is June-Sep of which all Mumbaikars are scared of) helps in Kharif crop- rice, oilseed,cotton, sugarcane etc. Coarse cereals are Bajra, Jowar, Maize.
b) North-East Monsoon (which is Oct-Dec)- helps in rabi crop- wheat, rice etc. Bajra, Sugarcane and cotton are not produced in this season.

Rice is produced in both the seasons but majorly in kharif. Cotton and Sugarcane are produced only in kharif. Rabi season is very crucial as wheat is produced in this season.

In 2006 South-West Monsoon was normal but North-East monsoon was almost 21% below expectations. So what would you expect? Rabi crops to do badly isnt it? Which is exactly the case.

Infact, if you look into the numbers a bit in detail, in most of the crops the targets for 2006-07 have been missed and in some by big margins- Coarse cereals by 10%, Pulses by 7%, and oilseeds by a whopping 21%. The missing figure for wheat and rice is 2%. Only in Sugarcane and Cotton the actuals are much higher than targets.

Looking at acreage for a crop:The acreage has fallen for oilseeds, rice and coarse cereals so we can undersatnd the fall in production of the same.
Acreage has increased in wheat, pulses, sugarcane and cotton. We see an increase in sugarcane and cotton as rains have been in normal in south-west monsoon but as rains have not been good in north-east monsoon, we see a fall in wheat despite the increase in acreage. But in Pulses, the fall has come maximum in kharif season when the rainfall was normal. So, Pulses as a group has failed to perform.

So, it is not difficult to see why prices of food and related items have been rising and may continue to rise. It is basics iof economics.

Industry
Industrial Growth is reported via Index of Indstrial Production which comes every month with a lag of 2 months. Now as I explained it is divided in 3 sub-sectors:
1. Mining and Quarrying
2. Manufacturing (which is further sub-divided into 14 groups like Chemicals, leather etc.)
3. Electricity, Gas and Water Supply

Further the data is also divided on the basis of usage i.e.:
1. Basic Goods- iron, coke, diesel etc.
2. Intermediate Goods- bolts and nuts, gearboxes, furnace oil etc
3. Capital Goods- Boilers, machinery etc
4. Consumer Durables- typewriters, wristwatches, cars, bikes etc.
5. Consumer Non-Durables- biscuits, toothpaste etc.

Infact there has been unprecendented growth rates in Basic goods, Capital goods and consumer goods sector. The growth levels have been higher every year compared to previous year since 2001-02 in each of these sectors and hence we have seen robust growth in overall indstrial sector year after year.
Only in intermediate goods (IG), the growth has been topsy turvy. But in 2006-07, IG is also showing a double digit growth.

In 2006-07, the trend is similar and we have higher grwoth rates in basic and capital goods sector. However, there is a slight slowdown in consumer goods sector.

In a nutshell, Industrial sector looks quite good as of now.

Services
I have already summarised above.

In a nutshell
So you get the whole picture? Agriculture forms the main input for many industries and former has not been performing well. Hence, we would see pressure on industry as well as input costs would increase and this raises costs.

With high competition, it is not easy to pass on the prices to the consumers unless all or most of the players in the industry agree to pass on the prices. But as we have been seeing prices in most products have been increasing and hence we have inflationary pressures which we have been seeing for quite sometime.

So, overall things look good but with such an unprecedented growth for so many years it seems the pressure to catchup with previous growth is showing and we should expect a slight cooling in the economy.

Comments are welcome.

Financial Markets: If they are important, why don’t they develop?

May 8, 2007

Most of the research on financial markets focuses on capital structure, asset pricing, volatility etc. I used to like this research for some point of time but after understanding that most of the research depends on the time period taken to study and on some fancy model (which mostly doesn’t work when applied) my interests have moved onto something more basic which is financial systems. I have posted about some work on the subject here and here .

I came across this another superb paper from the deadly combo – Rajan and Zingales. It is titled The Great Reversals: The Politics of Financial Development in the 20th Century.

In their typical style they go on and give a very different theory of financial development. The paper is old and was written in 2001 but is very interesting and relevant. The abstract:

“We show that the development of the financial sector does not change monotonically over time. In particular, we find that by most measures, countries were more financially developed in 1913 than in 1980 and only recently have they surpassed their 1913 levels. This pattern is inconsistent with most recent theories of why cross-country differences in financial development do not track differences in economic development, since these theories are based upon time-invariant factors, such as a country’s legal origin. We propose instead an ‘interest group’ theory of financial development. Incumbents oppose financial development because it breeds competition. The theory predicts that incumbents’ opposition will be weaker when an economy allows both cross-border trade and capital flows. This theory can go some way in accounting for the cross-country differences and the time series variation of financial development.”

To understand why the paper is different, we need to understand the papers so far on financial development. The reason attributed initially to financial markets development was common law vs civil law. The countries having former were considered to have better financial systems as they offered better investor protection rights.

The paper which popularised this approach was developed by Shleifer et al and the model was popularly called LLSV (after the first alphabet of the 4 authors’ surname). The paper can be read here

R & Z offer a different explanation. Their idea is that in 1913 Fin Markets in France were more developed than in US. And France had a civil law system, then how come it had a better financial system? Also why it took so long to reach the 1913 levels?

R & Z say it is because people who are already well-off (established indsutrialists etc) do not want reforms as it would lead to competition and eroding of their market shares. Further they say:

“Incumbent interests are least able to co-ordinate to obstruct or reverse financial development when a country is open to both trade and capital flows. When a country is open to neither, they are likely to be able to coordinate to keep finance under heel. Matters are unlikely to be much better when a country is open only to capital flows or only to trade. In the former case, incumbent industrial interests may hold back financial development, fearful of the domestic competition that might be financed, while in the latter case, both industrial and financial incumbents may want to strengthen existing financial relationships to combat the foreign threat. Free access and transparency are likely to get short shrift at such times.”

Well the analysis offers a very realistic explanation of financial sector development. Most papers exclude politics while talking of development and moreso when talking of developments in finance but this paper includes it in a very interesting manner.

The paper clearly forms the basis of their book “Saving Capitalism from the Capitalists” .

The paper also forms the basis for their food for thought paper I reviewed in my previous post. In that paper the idea is different i.e. underdevelopment is due to initital factor endowments but approach is same that people may not be interested in development as it does not help them.

A must read for finance professionals.

Assorted Links

May 8, 2007

1. Dani Rodrik posts another thought on why trade does not necessarily lead to growth (reduction in poverty etc). This time he goes a step further and presents available literature (read papers) done by him and others saying the benefits of trade are not as large as people as they are made out to be.

Rodrik then looks at one of the papers by Bradford, Grieco, and Hufbauer (subscription needed) that show trade is beneficial and says the models are not robust enough and more so have used wrong numbers which have been picked up from study. Sample this-

The paper also calculates benefits from regional trade agreement and for this it takes a formula from another paper as (exp(1.17)-1»)222%. But BGH use the figure as 118%.

On reading the comments on the pots I came across this fact:
(exp(1.17)-1) ~=222% but a simple misreading could result in
exp(1.17 – 1) ~=118% !!

So we have a classic problem of measurement here. Rodrik begins the article like this:

“Many many years ago when I was a recently minted assistant professor, I heard Gary Hufbauer tell an anecdote at a conference on international trade. A government economist is called in by his superior, who tells him “Look, I have to make a case for this policy in front of Congress, and I need a number real bad.” The economist responds, “well, I haven’t done a proper analysis, so I can give you a real bad number.” Perhaps it was a true story based on Gary’s own government experience. “

This clearly summarises the state of problems.

2. Buffet says index funds are better!

3. Jeremy Siegel’s view on stocks.

4. Josh Lerner’s view on Reverse LBOs

5. Much of the widening gap in incomes reflects the rising payoff for a college education and other skills. Becker and Murphy argue that it is beneficial and desirable.

I don’t really agree to the view point though. It may be ok for a developed/rich economy but may not be the same in a developing economy. As the article is on US, I would like to see how can emerging economies benefit, particularly India and China with huge populations.

6. Crony Capitalism is alive and kicking in India. On one hand we talk about MIFC and on the other we witness this

“Records investigated by The Sunday Express show that the Government has crammed at least 33 of the 37 positions for independent directors (called “non-official” directors, in banking parlance) with men and women known for their allegiance to the Congress party: at least five secretaries of the All India Congress Committee (AICC), a vice-president and a secretary of the All India Mahila Congress (AIMC) and the Sewa Dal — politicians who have lost elections or loyalists to whom the party wishes to dole out a favour. “

Read some reviews here and here

Thanks to Ajay Shah for 6, Finance Professor for 2, Greg Mankiw for 3 and Economist.com for 5.

Mumbai as an International Finance Centre…you must be joking?

May 7, 2007

It is actually amusing that people of high calibre keep coming out with such fascinating, visionary and fancy reports (pun intended). But this one on Mumbai as an International Finance Centre is the outright winner. Initially the report could only be bought, but now it is available for a free download. Number of articles on the same is maintained by Ajay Shah (a consultant to the report)

MIFC report is clealry a fancy idea. I think Mumbai first needs to be made a better city to live before it can be made into an international (whatever..) centre. It has too many challenges in terms of basic infrastructure. It is one thing to stay in South Mumbai (read Nariman Point, Malabar Hill, Napean Sea Road etc) and travel to work in the same nearby areas and it is a different thing to travel from a suburb in Mumbai (Western, Central, Harbour etc) to work anywhere in Mumbai (except for the suburb they stay in).

Navi Mumbai which used to be a relatively neat and clean place just 2 years back ( the time I came to Mumbai) seems to be becoming a pain to live in. All roads are extremely crowded and the place is full of cars, 2 wheelers etc. (Some people call this development, I really do not think so). I was reading the other day that

Navi Mumbai was suppossed to take the pressure away from Mumbai and it was expected that many people staying in Mumbai and coming to Mumbai would relocate/stay in Navi Mumbai. It currently has a population of something like 14 lakhs and it should have been 20 lakhs some few years ago.

I cant even imagine what will happen if the population was 20 lakhs with the current state of roads and infrastructure.

I would guess for Mumbai to become an IFC, it is important that the best talent (trained in financial markets) comes to Mumbai to work. As long as the advocates of the IFC can provide accomodation to the talent in and around South Mumbai (where most of the fiancial industry is housed), it is fine otherwise it just remains an idea.

I would suggest they should look at basics first. Have most of the committee members experienced what it is like to search for a apartment in Mumbai? Not just the rents are sky-high, but one cannot get anything without a broker’s help. And then you need to pay the broker 2 months of rent as his fee. With just a 11 month agreement you end up doing the same job every year. With local trains the only way one can commute, most need a house near the railway station. So you see, the basic need which is a house is itself so complex. Why can’t we have a better system of renting apartments in Mumbai?

The same concerns are even mentioned in Ajay Shah’s blog to which he answers: “Mumbai becoming unlivable: Could it be that some other city in India could become a financial centre? I am really confused by this approach, You want to make Mumbai an IFC just because no other city in India can become one?

Assorted Links

May 7, 2007

1. Dani Rodrik continues to impress me by his ideas on benefits of trade. I agree completely to his viewpoint that trade theorists assume many things while advocating benefits of trade.

The theory is all fine but when the implementation of the same comes it has not really worked. Like for instance the theory says opening up trade in developing countries benefits consumers as we get better products.  But is that all? What about the labour that works in those industries. To assume they would relocate to other productive industries is too much of a blond notion.  In developing countries, the labour is generally not very well trained to do other jobs and only know the work related to the industry they have been working on. Plus, most of them have learnt the skills not at some school but from parents/relatives etc. So, it is all the more difficult for them to move to the other industry as mostly stated in textbook economics.

This is not to undermine the theory at all, but to point out the fact that reality is quite different.

Read Alan Blinder’s negative view on Off-shoring. His take is 30 million to 40 million U.S. jobs are potentially offshorable which could have serious consequences for the economy as transition is going to be difficult. His arguments are not really convincing ( and I need to read more on this) but if someone can talk of transition becoming difficult for American workers imagine the plight in developing economies.

2. Take the Rodrik poverty quiz. Very interesting…

3. Longest Bull Run in 80 years!

4. Check out the all new website of Economic and Political Weekly ( a leading journal on Socio-Politico-Economic issues in India). It has become much better and would also feature a blog discussing the top 4 issues in every issue.  

Assorted Links

May 4, 2007

1. A very good article on Investments by Hal Varian (He used to be my one of the favorite economist at one point of time). The summary is: “No point in timing the market, just buy and hold.”

An investor who bought a value-weighted portfolio of stocks in the New York Stock Exchange and American Stock Exchange in 1926 and held them until 2002 would have earned an average annual return of about 10 percent. By contrast, an individual who bought in 1926 but moved his dollars in and out of the market in the same pattern as the average dollar invested in the market would have earned a return of only 8.6 percent a year.

For Nasdaq, the difference between buy-and-hold and dollar-weighted returns is even larger. An investor who bought the Nasdaq index in 1973 and sold in 2002 would have earned an average yearly return of 9.6 percent. But the typical investor in Nasdaq earned only 4.3 percent over this period. This is true not just in the United States — the same thing occurred in 18 of 19 international markets that Mr. Dichev examined.

The article aslo provides with some useful recent research in capital markets.

2. I like blogs as it allows people like me to read up on what the top minds in my chosen subject of interest are thinking about. Most of them share their views openly and allow others to participate via comments.

I posted some days ago about the debate most economists (who are blogging that is) had on benefits of trade.

In carrying on with the discussion spirit, Marginal Revolution asks Rodrik a question to which latter replies. This is what blogging is all about.

Assorted Links

May 3, 2007

It is good to be back after a 2 day break. However, it is painful preparing the assorted list. Here it goes:

1. An excellent speech by Bernanke on Trade
2. Read this Ken Rogoff take on Wolfowitz. Really Funny.
3. Racism in NBA Basketball. Read the review here. This is the most discussed paper in blogosphere. The summary of the study is:

The authors find that during the 13 NBA seasons from 1991 through 2004, white referees called fouls at a greater rate against black players than against white players. However, they find a corresponding bias in which black officials called fouls more frequently against white players, though that tendency was not as strong. They went on to claim that the different rates at which fouls are called “is large enough that the probability of a team winning is noticeably affected by the racial composition of the refereeing crew assigned to the game.”

This is mind-blowing stuff.

4. Jagdish Bhagwati and Alan Blinder had a debate on Outsourcing in Harvard yesterday. Read Rodrik’s comments. I am still waiting for some transctript on the same.

5. What is Crowdsourcing?

Thanks to Mankiw for 2 & 3. Thanks to my colleague Varsha for 5


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