Categories
Economics

[1874] Of expropriation is not necessarily cheaper than status quo

MP Tony Pua made a statement that expropriating the LDP highway is cheaper than maintaining status quo.[1] This is not necessarily true. As typical in the realm of economics, the answer is it depends.

What exactly does it depend on?

The biggest assumption lies in the discount rate. The discount rate is required to incorporate the time value of money in any calculation. In a calculation that spans for a very long time, the slightest change in the discount rate could imply a very different solution to a particular fork. In our case, the time length is 20 years because the contract between the government and the operator of LDP only ends in 2028.

Before we inspect Mr. Pua’s comparison which leads him to call for expropriation, a brief introduction to theory of time value of money is most appropriate.

Time value of money says that rational individuals prefer to have money now rather than later. An ice-cream, for instance, is worth more today than tomorrow with all else being equal. The discount rate acts, as the name suggests, to discount the value of the ice-cream as we progress along a certain timeline.

Next, two crucial variables will need clarification.

The first is the cost of expropriation which is RM1.327 billion. This is the cost the government will have to pay if it ever plans to exercise its rights in eminent domain. The cost in my calculation is assumed to be paid in one lump sum as soon as possible.

The second cost is the cost of compensation which the cost at 0.00% discount rate is RM1.929 billion. The compensation is presumably, as it should, paid in the year that the compensation is required. After all, the compensation is really a subsidy of RM0.50 the government gives to the operator in order for the operator to reduce the toll from RM2.10 to RM1.60. While I have not read the agreement relating to the Highway, it seems that the arrangement is more or less a pay-as-you-go.

For expropriation to be desirable, the expropriation cost must be cheaper than the compensation cost.

With that out of our way, let us get down to business.

If the discount rate is 0.00%, Mr. Pua would be right. At 0.00% discount rate, the cost of expropriation does not exceed the cost of compensation. Under this scenario, it makes sense to expropriate the highway from an economic point of view.

As the rate goes higher, however, the narrative veers to the direction of the other side as the differential between the two costs shrinks; the time value of money reduces the cost of compensation. This is so because all future compensations are redefined in present terms.

At approximately 3.89%, the difference becomes zero. This is where the philosophically agnostics celebrate their existence on this fair planet of ours.

Anything above 3.89%, with all else being equal, empirically leads to the logical conclusion to oppose expropriation. This is where libertarians hold wild party with contrabands filling the cocktail table.

For Mr. Pua to be right, he needs to pray that the government’s discount rate is less than 3.89%.

The following table illustrates how various discount rate affects the compensation rate and the case for expropriation.

Finally, caveat.

Mr. Pua places total compensation as RM2.2 billion with 0.00% as the discount rate while I estimate it to be only RM2.0 billion at the same rate. Why is the difference?

First of all, Pua includes a 2008 sunk cost of RM0.6 billion. Sunk cost however is irrelevant in this comparison. We are interested at projecting the future and our decisions cannot change the past, unless we decide to cook the books. To include the extra RM0.6 billion is to commit logical fallacy. A fair comparison must align the stream of payments together and only then an apple to apple comparison is possible. Regardless, Mr. Pua has been careful with that and has added the necessary qualification with respect to the RM0.6 billion. Therefore, this is hardly an issue.

Secondly, Mr. Pua mentioned that the toll is scheduled to increase to RM3.10 from RM2.10 in 2016. Yet, he did not include that in his calculation. In effort to paint a more accurate picture, I incorporate that increase into the compensation calculation while holding the fraction of subsidy (approximately 23.81% with a RM0.50 subsidy over total toll of RM2.10) constant from 2009 to 2028.

The effect of the exclusion and the inclusion of the two factors lead to the difference of RM0.2 billion.

There are several other assumptions made but I think those caveats are insignificant unless the wonks come out of their caves with their arrows and spears. In any case, the calculation is available here for public consumption.

Finally, the consideration for the time value of money is not the only indicator we should concern ourselves with if we want to expropriate the LDP. Even if the time value of money proves that it is cheaper to expropriate it, several questions remain. One of them is: can the government operate the highway more cheaply than the current operator?

It is possible that even if the expropriation cost is lower than status quo, the operation of the highway by the government may actually impose greater overall cost on the government where everybody, including those who do not use the highway. All taxpayers of which a majority do not use the highway would have to support a small group of taxpayers who use the highway.

That is not fair.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — I have blogged earlier that after reviewing the agreement of several toll concessions, including Lebuhraya Damansara-Puchong (LDP), Cheras Grand Saga Highway, KESAS and Butterworth Outer Ring Road (BORR), the Government is able to ‘expropriate’ these highways by giving between 3 to 6 months’ notice at ‘reasonable’ prices. [Cheaper to expropriate LDP. Philosophy Politics Economics. January 7 2009]

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

A version of this article was first published in The Malaysian Insider on January 9 2009.

Categories
Economics Humor

[1872] Of save those porn jobs!

Ah, hell. They’ve already bailed out the financial and the automotive sectors. What is the point of resisting anyway. Let us add another sector into the list in the name of saving jobs.

WASHINGTON (CNN) — Another major American industry is asking for assistance as the global financial crisis continues: Hustler publisher Larry Flynt and Girls Gone Wild CEO Joe Francis said Wednesday they will request that Congress allocate $5 billion for a bailout of the adult entertainment industry.

”The take here is that everyone and their mother want to be bailed out from the banks to the big three,” said Owen Moogan, spokesman for Larry Flynt. ”The porn industry has been hurt by the downturn like everyone else and they are going to ask for the $5 billion. Is it the most serious thing in the world? Is it going to make the lives of Americans better if it happens? It is not for them to determine.” [Porn industry seeks federal bailout. Rebecca Sinderbrand. Mark Preston. CCN Political Ticker. January 7 2008]

Yeah. We do not want to miss those big boobs and the ooh and the aah. No sir. Only socialism could save us all from those lonely nights.

Categories
Economics

[1865] Of Malaysia should capitalize on others’ spending

President-elect Barack Obama promises greater government spending to ward off the ongoing economic crisis in the United States. More than 1,000 miles to the southwest of the Aleutian Islands, the Japanese government proposes its largest ever budget. In it, Prime Minister Taro Aro incorporates record breaking government spending to ease the faltering Japanese economy. On the Asian mainland, China prepares to spend close to US$600 billion on public works to prevent its economy from cooling too fast.

These countries are important export destinations for Malaysian goods. In 2007, the US, Japan and China were the first, third and fourth most important export partners of Malaysia respectively. Combined, approximately 35.1% of Malaysian goods went directly to these three countries. This does not include items which find its way to third-party countries before reaching the three countries.

In discussing the global economic downturn, it is fashionable to cite the interconnectedness of the world where recession is contagious. Reduced economic activities in some foreign countries, especially in these three countries, adversely affects demand for Malaysian goods. In fact, Malaysian exports have been negatively impacted. As the cliché goes, when the US sneezes, the world catches cold. Malaysia, as proven, is no exception.

Less discussed is the reverse relationship, which is also true. Improved economic conditions of the major consumers of Malaysian goods will encourage exports. This realization is yet another important argument against greater government spending as fiscal stimulus in Malaysia.

It is important because the slowdown of the Malaysian economy is likely principally caused by the softening of external demand. The Malaysian economy only began to take a hit when the health of our trading partners went down south. With exports contributing to almost half of our gross domestic product, it is hard to imagine how the Malaysian economy could escape unscathed. Nevertheless, our internal demand remains resilient, as proven by the local retail and the automotive sector. Therefore, the problem plaguing our economy as with many export-oriented countries revolves around external factors and not domestic demand.

As much as I hate to say this, government spending may help in cushioning the impact of reduced exports in Malaysia. Given the current condition of the Malaysian fiscal deficit as well as the inherent policy lag of government spending as fiscal stimulus though, it may not be the best path to tread on. I continue to prefer long term tax cuts and tweaking the monetary policy as the way forward over government spending. The effects from these two policies could be felt relatively quicker than increased government spending. More importantly, it avoids the long term repercussions of Keynesianism, or, in all likelihoods, half-hearted countercyclical policies.

The Malaysian context notwithstanding, government spending may help the economy of China, Japan and the US. While these countries would suffer the side-effects of government spending as fiscal stimulus, they could experience shallower downturn and quicker recovery. This could prove to be beneficial to Malaysia.

This is where government spending of the three countries, the importance of the three countries to Malaysian exports and the cause of weakening Malaysian economic growth converge to petition against greater government spending as fiscal stimulus in Malaysia.

Malaysia could and should capitalize from increased government spending of its major exports trading partners while refraining from doing the same thing. It allows Malaysia to enjoy the benefits of the policy while evading the cost associated with the expensive solution. It circumvents the question of trade-off associated with greater government spending altogether.

Admittedly, this proposal is slightly guilty of free riding on others’ policies. Being a small economy compared to the three however, it is unlikely how a Malaysian policy to free ride would affect their policies. How can a matchbox toy car significantly affect a speeding prime mover is beyond the imagination of the sane. It is unlikely for these countries to complain about a Malaysian policy based on refrain and prudence.

The World Bank probably would not like this after issuing a statement to encourage governments all around the world to spend and spend till they drop. Ever since Paul Krugman won the Nobel Prize in economics not too long ago, almost everybody is a Keynesian nowadays.

Well, Keynesians love to flaunt the multiplier effect of government spending. What better time to test the magnitude of the multiplier effects other than right now? What better way to test the multiplier effect other than free riding?

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

This article was first published in The Malaysian Insider.

Categories
Economics

[1864] Of time to invest in junk bonds

The Economic Council is contemplating the establishment of an entity to guarantee bonds with low ratings.

The Economic Council, a high-level advisory body chaired by the Prime Minister, has proposed to set up an entity to guarantee bond issues with lower ratings.

Economic advisers to the government said the entity can help bolster the domestic bond market, which is expected to shrink 10 per cent to RM25 billion next year from an estimated RM28 billion this year.

It can also eventually help stimulate the local economy by guaranteeing debts raised by companies in key sectors like infrastructure and services to finance viable projects. [Bond guarantee plan. Zuraimi Abdullah. Business Times. December 25 2008]

Suppose that the plan goes through and lowly rated bonds are now guaranteed.

Consider the fact that lowly rated bonds — it could be junk bonds for all we know — offer high yield rates to compensate the inherent default risk any purchaser of the bonds face. Therefore, the issuers’ cost of borrowing is high.

Consider the fact that highly rated bonds offer low yield rates due to high repayment certainty it offers. The cost of borrow for highly rated issuers are low.

Now, if the junk bonds are guaranteed, which between the lowly rated bonds and the AAA-type would you choose, with all else being equal?

It should be the junk bonds. You get higher yield compared to the AAA while enjoying the guarantee, assuming the yield does not incorporate the guarantee.

Yup. It would turn the world upside-down.

The bonds with high default risk become the safest bonds in the local market by virtue of sovereign guarantee. With sovereign backing, the risk of default is practically zero, making badly rated bonds to be better than the AAA-type. The AAA then would have to seriously compete with the junk bonds for funds despite the obvious difference in risk profile.

Worse, the AAA would have an incentive to lower their ratings to qualify for the guarantee so that people buy their bonds. In fact, the AAA would have to offer higher yield rates to compete with the junks which are supposed to be crawling at the bottom of the table.

In other words, the guarantee would punish those with good records while rewarding those with bad or unproven standings.

If the yields are adjusted to incorporate the guarantee, risk-adverse purchasers would still prefer badly rated bonds to goods ones by the virtue that it is safer than the better rated ones. Meanwhile, the cost of borrowing for the highly rated ones become more expensive than that of the junks’.

Either case, eventually, it would open encourage many to undertaken risky investments because the state would reward bad behavior and punish good behavior.

Blow up the bubble, please. And when it finally burst to cause untold damage, please blame it on free market philosophy.

And yes, do it with our retirement funds collected by forced saving too:

Shareholders of the proposed entity could include Bank Negara Malaysia and large institutional investors like the Employees Provident Fund, he said. [Bond guarantee plan. Zuraimi Abdullah. Business Times. December 25 2008]

Categories
Economics Science & technology

[1862] Of orangutans understand money

Really!

Orangutans can help each other get food by trading tokens, scientists have discovered – but only if the help goes in both directions.

Researchers from the University of St Andrews found orangutans could learn the value of tokens and trade them, helping each other win bananas. [Orangutans learn to trade favours. BBC. December 24 2008]

How cool is that?