Category: Economics

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Economics

[2555] What is the best banking system for high-skilled service industry?

During the launch of IMF Regional Outlook a few months ago, Anoop Singh, the IMF director for the Asia-Pacific Region mentioned how the financial system is not ready for high-skilled service industry.

As his argument goes, banks usually demand collateral before providing any loans to businesses (or, mostly, anybody for that matter). This is perfectly fine for capital-intensive businesses but it becomes an issue when it comes to labor-intensive businesses. With little capital, there is little to function as meaningful concrete collateral. There are other things that can replace collateral like personal guarantee but such guarantee has to be credible and eventually means the businessowner’s personal assets. You still require some concrete assets in the end.

But what if you are nobody but you have a great idea that is labor-intensive?

Here, labor-intensive means just you and your partners maybe sitting down writing codes or running some weird but amazing business that, in the extreme for illustrative purpose, is one of pure brainpower, negligible capital requirement and no muscle, manned by individuals of limited wealth.

There are venture capitalists and that is usually the solution to the problem. But imagine a widespread proliferation of such industry that it becomes the dominant industry in an economy. Venture capital setup will be woefully inadequate as a source of funding.

The virtue of a bank (commercial bank) is its capability to pool large capital through aggregation of savings and to redistribute it elsewhere pretty painlessly. Venture capitalists are decidedly not as good as a traditional commercial bank at pooling resources.

This leads to a question, what is the solution?

I am unclear about that.

The banking system is inadequate as Mr. Singh points out but I am unsure if banks should evolve to not require concrete collateral to accommodate for the so-called new service industry if ever we come to that fork. Identifying a problem, while helpful, is very different from formulating a solution.

And an evolved banking system designed to not require collateral sounds like recipe for a banking crisis. A large percentage of businesses fail and without collateral, the banking system of such evolved banks would quickly be brought down to their knees. And a banking crisis, in the modern economy, will quickly turn into a widespread, horrible, economic crisis.

What about the government?

The problem of business failures will still be relevant but at least it addresses the banking system concern by socializing losses. I doubt the taxpayers will be happy with that.

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Economics

[2554] Is the real interest rate too high?

Those whom keep a close eye on monetary policy will realize that the real interest rate at the moment is positive. My data suggests it is above 1% mark right now given how the Overnight Policy Rate is at 3% and inflation is hovering around 2% with core inflation being slightly lower than headline inflation.

Despite an abstraction and not directly observed like the everyday nominal interest rate, it is the real interest rate that is crucial in determining decision between consumption and saving/investment in most cases. This is not to say the nominal interest rate is not an abstraction. It still is but real interest rate is not immediately understood or observed by laypersons as nominal interest rate.

The reason I am bringing up the issue about real interest rate is that I think there is a worry of a slowdown in the domestic economy, especially with European and Chinese economies showing signs of stress. And I am always not keen of shoring up the economy with fiscal policy in the traditional way as long as monetary policy can do the jobs well. I also think that monetary policy has done an excellent job in the past few years amid serious unprecedented crisis despite Keynesian’s liquidity trap theory, which appears to be irrelevant: as market monetarists have successfully argued, the fixation on interest rate is overrated in zero-interest rate situation. Market monetarists, the successor to the monetarism of the 1970s, of course, argue more about monetary policy but let us leave that aside for now because I know they would not like my fixation with interest rate here.

With more than 1% real interest rate, this creates the incentive to save more than to spend in the economy. Or to invest less. The bottom line is that it has a negative impact on economic growth.

One also has to remember that the OPR is the base rate. There are other rates based on the OPR and they are priced higher. This means the relevant real interest rate are higher than 1% for consumers and businesses.

Furthermore, in the free (or rather, maybe, just efficient?) market, I would assume the optimal real interest rate is 0%. This suggests that even under free market environment, the real interest rate is too high.

There are other considerations in the settings of the rate. One big consideration is the management of inflation. But with demand-pull inflation coming down and with downside risk as far as growth is concerned, I think there is room to make the real interest rate more accommodative to economic growth without scaring the hawks away.

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Economics

[2553] The lesson of Europe for Southeast Asia

Indonesian President Susilo Bambang Yudhoyono warned of the danger of a common currency in an interview with the Wall Street Journal. It is a reminder that needs not a resounding. The horror of Europe is enough to make one thinks twice of a currency union. The talks of Greek exit can potential become the end of the European dream.

The European crisis is a challenge to me partly because I am supportive of a currency union for Southeast Asia. Sometimes in the past, I contended to be associated with the term Aseanist.

More importantly, I am supportive of a currency union because of my free trade tendency: a union boosts trade because it reduces trade barrier significantly.

To be fair to myself, I support a union across similar economies and not wholly across the diverse Southeast Asia economies from the financially sophisticated Singapore to the tiny backwater East Timor.

Really, the lesson of Europe is not that monetary union does not work. The lesson is that monetary union works best for similar economies: the economic cycles mostly coincide, the structures are about the same, the culture of societies in it are not so different, etc.

I think I have made the case for a currency union for Malaysia, Singapore and Brunei for a start. In fact, Singapore and Brunei are already on a currency board, which effectively means de facto currency union. Malaysia is the natural extension of the Brunei-Singapore union because of its proximity and the massive interlinking between the three economies.

Then, there is perhaps historical hangover on my part, given how the original Malaysian proposal was a 15-state federation, with both Brunei and Singapore in it. Indeed, prior to 1973, all three currencies were interchangeable freely. Even before that between 1953 and 1967, all three countries used the same currency.

One issue with the Malaysia-Singapore-Brunei currency union is that the Singaporean economy tends to be more volatile than Malaysia. Nevertheless, I think in many ways, the direction of both economies are more or less the same. In that sense, the challenge of a monetary authority is to be more flexible and responsive to a more dynamic economy.

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Economics

[2550] Labor shortage in the palm oil industry

I do not typically post news articles these days, but I think this news article is particularly relevant on one issue that I raised earlier.

MALAYSIA is losing billions of ringgit in palm oil exports because there is not enough foreign workers to harvest fruit bunches in the oil palm fields.

The Malaysian Palm Oil Board (MPOB) estimates that the industry need to hire another 40,000 foreign workers to harvest the riped fruit bunches in order to achieve the 19.3 million tonnes of oil output target.

[…]

“The trees are fruiting, but there’s acute shortage of harvesters and this is affecting the country’s palm oil export earnings,” he told reporters on the sidelines of MPOB seminar titled “Labour – Key Driver For Continued Sustainability of the Oil Palm Industry” held here yesterday.

“If the government approves of another 40,000 foreign workers, we can reduce wastage and surpass the 19.3 million tonne output target easily,” Lee said.

It is estimated that millions of tonnes of fruit bunches rot in the fields because planters are not able to hire enough foreign workers to harvest them. [Labour shortage hits palm oil export earnings. New Straits Times. May 15 2012]

This is the difference between debating from market knowledge with context and theorizing by reading one line in a news article.

Categories
Economics

[2548] One way which minimum wage increases unemployment rate

One impact of minimum wage is the general increase in labor supply in the market. Let us be clear and not talk too generally or loosely. Precision is key. I think if you cannot be clear, then it is very likely that you do not understand or have not thought of the issue well enough. And I think I understand it very well.

And I apologize if this appears to use a lot of jargons. I try to explain each jargon but I believe you will be able to overcome the jargons if you are really interested in the issue; if you really interested in the issue of minimum wage and not merely interested in the ideological battle, then you have to understand the mechanics. There is no short cut. Besides, the jargons are really self-descriptive.

And this is not a moral argument but rather it is the mechanics; just as explaining why the sky is blue does not make any moral argument, so is this.

So, here is the precise simplified mechanism: labor supply will increase if the newly instated minimum wage is higher than most of the prevailing wages. Higher wages attract workers into the labor market thus increasing the labor force/supply.

At the same time, minimum wage puts a limit on total jobs growth. Walter Williams has explained how that is so. Williams explains it in a specific context, but the logic can be generalized beyond the competitive context that Williams describes.

Now, combine the two effects related to labor supply and total jobs growth.

If you understand how unemployment rate is calculated, then you will realize how this will increase unemployment rate. For the uninitiated, the unemployment rate is calculated by taking the ratio of total unemployed individuals to the total labor force.

This is of course is not the general effect between minimum wage and unemployment rate, but part of that effect is explained by this particular interaction between variables.

This is how minimum wage, jobs and labor supply interact.

If total filled jobs grow faster than labor force, then unemployment rate will decrease.

If total filled jobs grow slower than the labor force, then unemployment rate will increase.

With minimum wage, there will likely be a shock to both total jobs and labor force growth. Since minimum wage puts a cap on total jobs growth and at the same time encourage more individual to join the labor force, there is a strong case to expect total jobs growth will be slower than labor force growth at the time when minimum wage is in force.

That will cause the unemployment rate to jump up. That elevated unemployment rate will remain at its new high level, discounting for other effects, until further development happens.

These other effects may increase or lower the unemployment rate on the balance. One factor that may blunt the effect of minimum wage on unemployment is inflation.