Been Busy: Gov't Spending is No Free Lunch

I haven't been posting for a long time ever since I left Singapore. Time isn't really on my side and I have been busy with work and studies. There is, however, one interesting article that I think it's worth a read. For the macronians, quoted entirely from WSJ written by Robert J. Barro:

Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called "multiplier" effect of government spending on economic output is greater than one -- Team Obama is reportedly using a number around 1.5.

To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy's total output expands by enough to create the airplane or bridge without requiring a cut in anyone's consumption or investment.

The explanation for this magic is that idle resources -- unemployed labor and capital -- are put to work to produce the added goods and services.

If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment. In this scenario, the added government spending is a good idea even if the bridge goes to nowhere, or if public employees are just filling useless holes. Of course, if this mechanism is genuine, one might ask why the government should stop with only $1 trillion of added purchases.

What's the flaw? The theory (a simple Keynesian macroeconomic model) implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.

John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall. So, something deeper must be involved -- but economists have not come up with explanations, such as incomplete information, for multipliers above one.

A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP -- consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one.

This approach is the one usually applied to cost-benefit analyses of public projects. In particular, the value of the project (counting, say, the whole flow of future benefits from a bridge or a road) has to justify the social cost. I think this perspective, not the supposed macroeconomic benefits from fiscal stimulus, is the right one to apply to the many new and expanded government programs that we are likely to see this year and next.

What do the data show about multipliers? Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II. The usual Keynesian view is that the World War II fiscal expansion provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists.

I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports -- personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses -- there was a dampener, rather than a multiplier.

We can consider similarly three other U.S. wartime experiences -- World War I, the Korean War, and the Vietnam War -- although the magnitudes of the added defense expenditures were much smaller in comparison to GDP. Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 -- the same value as before. (These estimates were published last year in my book, "Macroeconomics, a Modern Approach.")

There are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases. For one thing, people would expect the added wartime outlays to be partly temporary (so that consumer demand would not fall a lot). Second, the use of the military draft in wartime has a direct, coercive effect on total employment. Finally, the U.S. economy was already growing rapidly after 1933 (aside from the 1938 recession), and it is probably unfair to ascribe all of the rapid GDP growth from 1941 to 1945 to the added military outlays. In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.

As we all know, we are in the middle of what will likely be the worst U.S. economic contraction since the 1930s. In this context and from the history of the Great Depression, I can understand various attempts to prop up the financial system. These efforts, akin to avoiding bank runs in prior periods, recognize that the social consequences of credit-market decisions extend well beyond the individuals and businesses making the decisions.

But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory of Employment, Interest and Money." The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936.

Much more focus should be on incentives for people and businesses to invest, produce and work. On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.

Mr. Barro is an economics professor at Harvard University and a senior fellow at Stanford University's Hoover Institution.

Principles of Economics simplified, and what it really means

I can't help it, this video is hilarious. And for some 'shocking' facts, check it out.

Are foreign workers any good?

No, I do not really want to debate on the merits and/or pits and falls of having foreign workers in the country. No doubt, they have their merits, although it's hard to educate the man on the street to understand the economics behind this. But I do think that the the social cost, which are mostly intangible especially in the initial stage, have to be considered.

In terms of tangibility, the area of the foreign workers' dorms along Old Tampines road is always filled with rubbish especially on certain hill slopes, and pictures of foreign workers relaxing and partying on the slope after work form in my mind. Whatever happen to green and clean Singapore? Ok, probably this is a sweeping statement and the new generation of Singaporeans aren't too particular about keeping the environment clean. But if you are to ply along the dorms of foreign workers, more likely than not you will see the same scenario. The psychological impact on locals is also evident, and I believe I do not have to talk about it too much.

The government allocates 20% of local university places for foreign students and if you belong to the engineering school or faculty of sciences, that would be most apparent. While I do not object to welcoming foreign talents with open arms since having them around increase competiton and raise the overall quality of the university, 20% is a bit too much in my own honest opinion. The ministers gave the reason of locals not wanting to study these important majors with most opting for business and arts. Well, one can't blame the young 18 year olds from having such preference given the much glamor and $$$ associated especially with the heated marketing campaign and competition among SMU, NUS Business School/ FASS and NTU Business School/ School of Humanities and Social Sciences. On the other hand, no marketing effort to spruce up the dull and boring image of engineering and science was done.

Technology is associated with being hip, world-changing, full of impact, and highly lucrative in universities such as MIT, Stanford (ok, having Silicon Valley next door is a marketing ploy in itself) and also universities in Japan and Taiwan where technology is the main catalyst of economic growth. Electrical Engineering, one of the most 'common' engine majors where NUS/NTU students do not view it with much pride, is actually one of the most competitive course to get in alongside traditional competitive courses like medicine and law in the National Taiwan University. But Singapore isn't doing so bad, with 80% of the global market share in microchip processors and a vibrant life science research center, the Biopolis.

So why aren't the students here viewing technology as an attractive option? Some, or rather, most said engineering/science subjects are too boring. So are they? Or is it the way it was being taught? Business/arts subjects are relatively easier to be perceived to be more interesting since it is mostly qualitative and can be related to real life easily, while the poor engine student struggles to make sense how knowing digital signal processing or linear predictive coding or symbol synchronization can make a difference to his life. This is one of the Singapore Economy-Education Paradox (ok, there's no such term, i coined it myself), where the economy's star industry is not reflected in the education system despite the close connection between the labor force and education. Another example would be while Singapore has one of the best ports in the world, no one seems to be very interested in logistics and port management. In fact, there is no such specialized bachelor degree offered in the 3 local universities. The closest one can find is the Bachelor of Engineering (Industrial & Systems Engineering) offered by NUS and till recently, the Bachelor of Science in Maritime Studies (with Business Major option) offered by NTU, as well as the 3 local business school bachelor degree with concentration in Operations Management.

And then the controversial issue of too many MOE scholarships being given out to foreign students especially those from India and China. With their home countries coming up as super-powers, which student in their right mind, in all logic and patriotism, would choose to settle in tiny limited opportunities Singapore? The resources spent on each undergraduate MOE scholar are immense, estimated at a conservative S$125,000! And that is no small figure. For those unfortunate Singaporeans who didn't get to be admitted into the local universities end up having to spend a fortune on private institutions such as SIM or MDIS, and also most commonly opt to go over to Australia and UK.

For the uninformed, one can get a very good undergraduate/ masters education in countries such as Germany, France, Sweden and Switzerland at a bargain. Look beyond the normal destinations. Sure, there may be some language barriers but there are also some english programmes. Education in Germany is in fact free! And there's Lund University and Stockholm School of Economics, both free as well (although there are plans to charge international students now) Or take the University of St. Gallen, which is one of the more renowned university in Switzerland. Total annual tuition fees is only 1170 Swiss Francs or in today's exchange rate, around S$1480. Take in the estimated living expenses of 2000 Swiss Francs per month, the annual education in Switzerland would cost around S$ 31,000. Almost equivalent to (just) the annual tuition fees at aussie universities. And I believe Europe would be a nicer and enriching place to receive your education than Australia.

Cost of Living

This is kinda random. I was reading through Bloomberg when this heading attracted me.

Cost of Living in U.S. Probably Dropped by the Most in Almost Sixty Years - "Prices May Have Tumbled as Economy Sank: U.S. Economy Preview "

Well, with the USD strengthening so much against the SGD, I was pretty devastated. I can still vividly remember the rate is 1.43 in May. And now it's 1.52 and going on strong.....And apparently the rental fees I am inquiring will be increased 2-5%....

Classical or Keynesian prevails?

I would love to post many of my thoughts especially after the turbulent October month but work load is not granting me the luxury of time. Facing this trade-off, to maximize my utility, this post would be 'pretty' summarized.

"Poor economic data exacerbates financial market" - But OF COURSE!! People reacted to bad news and now many companies are firing. The top catalyst has to be Lehman's bankruptcy. With uncertainty in the market, of course people will consume less and bad news such as increased unemployment, slowing sales in X company and declining profits in Y company would follow. What else do you expect? So it sets off a string of 'bad news on bad news' and what we see today is a lot of over-reaction and subsequent moral hazards playing out. I won't be surprised if after Hong Kong, more countries such as Japan (wait, has it ever really recover from the asset bubble a decade ago? lolz), Taiwan, Malaysia, Indonesia etc goes into technical recession.

10,000 miles away from U.S., DBS fired 900 staff and still have the cheek to say, "We are fundamentally strong, but is now prudent for us to realign ourselves to the challenging economic outlook." I would believe it's to raise enough capital for the payout of the Lehman minibonds which had angered the public. What's an easier way to ensure you have enough money for the payout in the very short term? Just fire off some, or rather, lotsa people in your company especially middle/ top management since they are the most expensive to retain!

While I may sympathize with some (some, mind you) that seemed to have been 'conned' into buying those risky products, somehow I would very much believe there are those who understands such risk, took the plunge and are now trying their luck at getting back some monies. See, moral hazard increased.

Switching back to the States, GM starts to approach the Fed for help citing that the cost of the company's collapse will cost the country more than to save it. GM sells cars. So if they can't sell their cars, it's obviously their own problem and why should the citizens pick up the tab for that? This happens in the mist of unprecedented government bailouts and companies seem to be taking advantage of this 'goodwill'. Moral Hazard is at play again. If GM can't sell their cars, so be it. Let it collapse. The law of the urban jungle cites only the fittest survive. No point spending to maintain a 'unrealized loss' akin to throwing money into a black hole.

How long more can the Fed continue to rescue the frail economy? As mass amount of assets lost value, money supply could shrink--recipe for a deflationary economy. But U.S. is lucky as it is the only country in the world where it can print more money and countries around the world are willing to buy them. But then, there is still a limit to how long more the world can and are willing to sustain the world's largest economy.

Then we have Alan Greenspan admitting the laissez-faire form of economics theory is flawed. Well, that is itself a centuries old debating topic. While the classical form of economics seemed to have failed in the current context, some may yet remember how the Keynesian way was rebutted as out of fashion during the economic boom of U.S. just 8-10 years ago (or even longer) where classical theory showed economic superiority.

I would not take sides although I am more of a Keynesian. Simply because if humans need laws and constitutions established to ensure law and order in the society, it just makes sense to have some regulation in place in the economy.

So what are you? A classical? Or a Keynesian?

P.S. Somehow I am glad yet grim that I would soon have the chance to assess the greatest financial fallout in the States since the Great Depression.

Comments on Samsung F480

Ok, this is not an economics topic, or anything related to my 'original posts'. I test drive a Samsung HP F480 and part of the condition attached is I have to do a review of the HP in my blog. So here it goes:

Pros:

• Aesthetically appealing (I love the leather cover & the half metal casing looks cool)
• Small and Light (although Ultra edition still trumps.)
• Alternative to Samsung Omnia (which I am currently using)
• 5MP Camera, no more bringing out of digital camera
• Interface considered quite intuitive
  

Cons:

• Screen not very responsive sometimes.
  
• Does not run on Windows mobile = limited applications.
  
• The camera function of Samsung still lose out to Sony Ericsson and Nokia. This applies to the Omnia too. The flash is simply a LED, far inferior to Sony Ericsson's Cyber-shot Xenon flash. The shots becomes very pixeated when using the zoom for photos/ videos recordings. (the digital camera market is still very safe!) This also implies night shots are lousy.
  
• Touch screen is a killer for people with thick fingers. And there is no stylus! I tried to use my Omnia stylus and strangely, it doesn't work! Apparently the screen only works with fingers (some heat detecting technology?).
  
• The small screen of F480 means people will only buy it for the better aesthetic appeal (though it's subjective) and a pain to use especially when sms-ing. Omnia will almost definitely cannibalize the product. LG's Soul looks almost exactly the same as F480 minus the leather design (which gives F480 the edge).
• It's obviously a phone for women. Guys will go for Omnia, since it's more masculine and functional.
  

For some videos on Youtube.

A Personal Comment:
I think the Ultra edition is wonderful. I used the U600 before it spoils (just a couple of months after warranty ends...I hope the same thing don't happen for my Omnia or else I'll suspect Samsung is deliberately causing their products to fail) and out of novelty, I bought the so called 'i-Phone killer' Samsung Omnia. From what I know, Samsung has stopped producing the Ultra edition which to me is a pity. Samsung seems to be rolling out touchscreen phones as the main focus with the Omnia, Innov8 and then this F480 (it's newer than Omnia apparently).

In short, I'll prefer Omnia over F480 any time.

Welcome to Recession

Finally the dreaded word was confirmed. Singapore is technically in recession, although that is jolly well anticipated given the market turmoil happening over at the States. The weakness of an export-driven economy flares up again. So how bad is the economy now? To give a perspective, the US stock market falls 7 days consecutively with the DJIA falling below 9000 points since 2003, the Japanese yen reaching a new high, a slowing economy in the U.S. showing up in the USD-SGD exchange rate now at 1.46 (it was 1.36 when i went China 4 months ago), the quick fire interest rate cut showing up in AUD-SGD E/R at below 1 (bid is 0.98 last check), and the stock of Citigroup is now traded at US$12.93 versus a high of US$48.95 for the last 52 weeks with the news of Wells Fargo trumping Citi's bid for Wachovia wreaking further havoc to the stock.

Why was I so concern? Coz I bought Citi heavily for my portfolio with a bet that Citi will win (damn it!). Luckily it's virtual. Haha. I admit it's pure speculation. But then, given the irrationality in the market, investment analysis no longer makes much sense. Prices just keep going down and down and down. Even with strong fundamentals, most stock prices are still going south. Probably the only consulation is dropping oil price. No amount of measures, be it massive amount of money pumped into the money market or coordinated interest rate cuts seemed to stem the market downturn with everyone adopting a wait and see attitude and the component of trust and confidence in the government and central banks dissipating.

Can the recession in Singapore be entirely blamed on U.S.? Probably, given our export driven economy. One interesting contrast is the low unemployment rate in Singapore although there might be some changes in the near future. Companies are now nervous about spending and banks are not lending to one another. One leads to another and you have a credit crunch that keeps getting worse. I remembered just a year ago the authorities are heaping on the strong economic growth in the country therefore justifying the wage raise for our dear government. Now, I must admit that they are indeed far sighted, to increase their wages at the peak of the economy.

So how will the Singapore authorities pull off this problem? For most countries, the most direct method would be to cut interest rate. But that was not the tool for MAS. Being a small country, we are basically price takers. And the MAS chooses to play around with the SGD exchange rate against a basket of currencies instead. To help propel growth, the variable bandwidth would be lossened to help export and also against inflation. We may also see the government increase public spending to expand the economy at least in the short term. How long the recession is going to last is everyone's guess. Economists put it at 12-15 months. Technically, the U.S. is not in recession yet, although all of us knows it is. The bottoming may not be ending any time soon.

So what's you gonna do now? Stop spending and eat more at home.