Category: Economics

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Economics Environment Science & technology

[1840] Of missed chance for fuel efficiency improvement?

It has been said that necessity is the mother of all inventions. That is certainly true with regards to the introduction of fuel-efficient vehicles in the 1970s. There are several factors that ushered in an era of engines with greater fuel efficiency but one of the most important was the then record-breaking crude oil prices caused by events in the Middle East.

By the 1980s in contrast, there was an oil glut but improvements gained in the previous decade stayed in spite of the downward trend in global crude oil prices. The same trend was again seen in the 2000s. Crude oil prices went up and then down but I fear that we might have missed the wave for fuel efficiency improvement, no thanks in part to intervention by the state in many parts of the world.

In one way or another, many economists have never really doubted that global crude oil prices would come down even when oil prices were going through the roof not too long ago. The rationale behind the idea is closely related to the mainstream growth model which stresses the importance of technology in improving output based on the same input in a status quo scenario. In other words, when prices increase sufficiently high, there is an incentive to look for new and better ways to solve old problems.

The availability of substitutes further strengthens the idea as consumers switch from consuming crude oil to other resources.

And then there is the gospel of economics. With all else being equal, quantity demanded goes down given higher prices.

Therefore, the fall of crude oil prices was never a question of if; there was only a question of when. Some people laughed at this, just as the executives at Shell in the early 1980s laughed. They probably did not even smile when the oil glut set in soon and lasted for about two decades.

In 1980, the famed Simon-Ehrlich wager was entered between entomologist Paul Ehrlich and economist Julian Simon. The wager was made to settle a dispute on whether commodities prices would on average be higher in the future while discounting for inflation.

Ehrlich hypothesized that humanity would face a severe shortage of resources in the long run. Simon believed otherwise. With prices as a signal of scarcity, Ehrlich bet the prices of five commodities would increase in 10 years’ time; Simon bet in the other direction. It was a battle between Malthusian and mainstream economic ideas.

Ehrlich’s hypothesis is not at all insensible but prices of commodities are hardly the best indicators to prove his case. Technology improved in those 10 years. Lesser materials were required for the same activities. Moreover, the availability of substitutes moderated and even prevented the predicted prices increase. In the end, Ehrlich lost the bet.

We are witnessing the same trend at the moment. Global prices of crude oil as well as various commodities have gone up and down. However, the factors which played a part in bringing the prices down may differ from the previous 1970s episode. Instead of technological improvement, based on various newspaper reports, lesser economic activities seem to be the culprit.

Prices of crude oil began the relentless upward march around 2003 only to fall dramatically in the middle of year 2008. People did respond to the situation while prices were high. There is proof that people were switching to smaller vehicles. In Malaysia in September 2008, for instance, sales of compact cars experienced an increase amid dearer retail fuel prices. Electric vehicles meanwhile saw themselves being moved from the fringes of society to almost mainstream in developed economies such as the United States

Despite all that, there is not enough convincing evidence which asserts there is an overall widespread improvement in fuel efficiency. In many ways, these changes are merely transient in nature unlike technological improvements. These changes are transient because they probably would revert once prices go down again. These are cyclical rather than structural changes.

Structural changes unlike cyclical ones have lasting effects. Within the context of fuel efficiency, the changes come in the form of technological improvements which cut across the board.

Because of this, global crude oil prices may return to record-breaking levels once the economy recovers from its flu.

The period of expensive crude oil was an opportunity to improve fuel efficiency of vehicles but unfortunately, the creative destruction associated with free market did not happen as widespread as it had in the 1970s. Then, the introduction of more fuel-efficient Japanese vehicles in the US almost brought the Big Three — General Motors, Chrysler and Ford — to their knees. Vehicles with bad fuel economy were made obsolete and rejected. While the Detroit-based manufacturers are again in trouble, it is not very clear if the main cause is the creative destruction we saw in the 1970s.

The structural changes probably failed to occur due to the fact that almost half of the world population enjoyed fuel subsidies until only recently. The subsidies shielded the consumers from the effect of high global crude oil prices. The disconnection between individuals and the free market prices effectively removed the demand for greater fuel efficiency and conservation in general.

Just as high crude oil prices forced countries to reduce or abandon subsidies, the economic downturn set in to bring fuel prices down. Even when we finally got the chance to meet reality, the impetus for structural improvement in the economy was robbed from us in the nick of time.

The quest for greater fuel efficiency can be grounded on many reasons but for me, the greater reason revolves around the need to reduce carbon emissions in order to mitigate the effects of climate change. Climate change is perhaps the largest tragedy of the commons we have ever seen. It is not at all comforting that a lot of these emissions occur in developing countries with fuel subsidies.

Carbon emissions is one of the reasons why I oppose fuel subsidies. In addressing the tragedy of the commons, technological improvements in fuel efficiency or even downright new sources of energy are crucial. We had the chance to undergo a period of creative destruction but that opportunity has come and gone, for now.

The next time the opportunity knocks on our doors, we must seize it.

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.

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Economics

[1839] Of Taylor advocates better economic policy

Economist John Taylor suggests that a good fiscal stimulus contains three factors:

– Permanent. The most obvious lesson learned from the first stimulus is that temporary is not a principle to follow if you want to get the economy moving again. Rather than one- or two-year packages, we should be looking for permanent fiscal changes that turn the economy around in a lasting way.

– Pervasive. One argument in favor of “targeting” the first stimulus package was that, by focusing on people who might consume more, the impact would be larger. But the stimulus was ineffective with such targeting. Moreover, targeting implied that increased tax rates, as currently scheduled, will not be a drag on the economy as long as increased payments to the targeted groups are larger than the higher taxes paid by others. But increasing tax rates on businesses or on investments in the current weak economy would increase unemployment and further weaken the economy. Better to seek an across-the-board approach where both employers and employees benefit.

– Predictable. While timeliness is an admirable attribute, it is only one property of good fiscal policy. More important is that policy should be clear and understandable — that is, predictable — so that individuals and firms know what to expect. [Why Permanent Tax Cuts Are the Best Stimulus. John B. Taylor. Wall Street Journal. November 25 2008]

This is written to oppose fiscal stimulus based on temporary tax cuts. Recent experience on temporary tax cut provides empirical evidence why temporary tax cuts do not positively significantly affect the economy.

He further wrote:

The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market. [Why Permanent Tax Cuts Are the Best Stimulus. John B. Taylor. Wall Street Journal. November 25 2008]

Categories
Economics Liberty

[1835] Of freedom to err and to learn

Failure is simply part of life. A world without failure is a fanciful dream incapable of withstanding reality. No matter how much failure hurts, it teaches us valuable lessons for future endeavors. Do it enough while learning from it, and a pot of gold awaits the daring at the end of the rainbow.

Success and failure are just the result of competition for the best answers to questions that beset humanity. Who is the fastest runner in the world? Who blew the biggest balloon ever? Who is the smartest kid in the class? Mirror, mirror on the wall, who is the prettiest among them all?

In search for the best, somebody must lose. Somebody must be in second place, or last. Not all can take the No. 1 position.

How do we cross the ocean? How do we get to the moon? How do we conquer the final frontier? Failures greeted us along the way before we successfully answered the questions. Remember the tragedy of the Apollo 1 and the Space Shuttle Challenger. Their failure led us to learn more about ourselves, our capabilities and our mistakes. It is because we learned that they did not die in vain.

The glorious discovery of scientific methods which played no small part in aiding the relentless progress of humanity itself stands firm as a witness to the importance of failure: observe, hypothesize, predict and test.

If the prediction is successful in verifying the hypothesis in the first try, then congratulations. If no, then hypothesize sensibly anew. Each time we hypothesize and fail, we are one step closer to the answer for we now know yet one more path we should not take, cutting down the odds in our favor. It is simply so because failure eliminates the wrong paths.

We learn from failure by marking the false doors and knocking tirelessly on unopened ones. The whole process, to generalize it crudely, is an exercise in trial and error. Needless to say, repeated trial and error involves failures and successes.

Evolution, for one, is the great trial and error game. Since time immemorial, nature has constantly tried countless combinations to find the building block of life and reach where the whole earthly living world finds itself today. It is through evolution that nature finds the perfect fit for all. It systematically tries everything in its mind and systematically purges failed combinations in favor of the successful results from many trials.

Evolution is a competition of designs, as Eric Beinhocker writes in ”The Origin of Wealth” as he tries to promote complexity in economics to challenge the neoclassical models. Evolution is a contest to look for the best design and eliminate the failed ones. The inherent Darwinism is harsh but trust the evolutionary processes to produce greatness by exercising the liberty to err and the liberty to learn.

The parallel is seen in the free market system. Through the creation of free competition enabled by the free market system, various ideas compete against each other to satisfy our needs, our demands and our questions. The best ideas and decisions will be rewarded while the worst will be punished, as judged by participants of the market. In other words, the free market mechanism simply adheres to the concept that failures eliminate the wrong paths. The free market is evolution.

This is exactly what we have witnessed for the longest time. An economic downturn occurs for a reason and each time it happens it is because of the mistakes which we commit. The irrational exuberance of the 1990s, for instance, saw massive investment into businesses with weak models. When these models failed as the market finally turned around to revolt against our acts of foolishness, so too those who invested in it. We then adjust our expectation to a more reasonable level.

The current economic crisis is characterized by failure to see the mistakes in time. Mistakes of encouraging home ownership with disregard to creditworthiness; mistakes of loose monetary policies to solve the previous economic downturn; mistakes from leveraging too highly while failing to manage risk; mistake of bad regulations. When the mistakes converged as the fruits ripened too much to turn sugar to poison, the time for punishment at long last arrived.

There is no doubt failure is painful but we are only likely to learn something when it is painful. The fear of pain will encourage us to not to repeat the same mistake. We know fire is hot only after we have burned ourselves.

While we learn, we must remember that we are only humans and we are not perfect. Some will learn and some will forget. Some will learn to adapt and others will fail to do so. For those who failed, the system will keep reminding them why they failed.

What we are witnessing at the moment is the free market taking its course to correct the paths we have mistakenly taken. The system now demands that we learn from our mistakes. For those who have learned something from the past, they will not be affected as badly as those who commit the same mistakes again out of ignorance or arrogance.

Regardless of that, failure is part of the free market system because failure is one of the manifestations of free will. Mahatma Gandhi once said that freedom is not worth having if it does not connote freedom to err. Without failure, the free market cannot function on paper or in practice.

Without failure, the best cannot be found. Without failure, there is an implicit assumption of the equality of results where everybody lives as miserably as the other in a dull monotony: at its center is the equality of poverty. We have seen how such systems failed to incorporate the very basic economic lesson — that individuals respond to incentive. We have seen how that has failed and how the human spirit revolted against it. That failure too is merely a function of evolution embraced by the free market philosophy.

While keeping this in mind, one should be mindful of missing the woods for the trees.

The series of failure across the Pacific and its subsequent ripples spreading globally are not a failure of free market capitalism. It is not a failure of liberty. On the contrary, the series of failure is an automatic reaction against our mistakes. The system is responding because we respond to events around us and that alone shows that the idea of economic liberty with its carrot and stick model works.

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.

Categories
Economics

[1831] Of the quicksand of Keynesianism

Over 70 years after The General Theory on Employment, Interest and Money was published, Keynesianism now holds sways over macroeconomic thinking. Neo-liberalism almost made Keynesianism as obsolete as communism but the tradition of The General Theory proved to be resilient. Resilient as it may be, there are dangers in following the track of Keynesianism and it is certainly not the only option available out there when it comes to facing economic downturns.

Keynesianism, despite its wide explanation of the economy, is best known as the idea which advocates the state taking an active role in managing the economy. In times of uncertainty, the idea that the government needs to spend to pick up the slack in the economy has again regained currency. The Abdullah administration recently introduced an economic stimulus plan worth RM7 billion, announced by the new Finance Minister Najib Razak, to do just that. The DAP proposed an even bolder move involving spending about 6 folds larger than the planned stimulus.

This happens at a time when the country is expected to experience its 12th consecutive fiscal deficit in year 2009.

During the first tabling of the 2009 Budget, the government projected a deficit of 3.6 per cent of the country’s gross domestic product. With lower energy prices as well as increased expenditure, the deficit can go only higher.

When Keynesians espouse deficit spending, they really mean a counter-cyclical fiscal policy in which the government increases its activities in the economy in times of crisis and cuts down the frictions it causes in the economy in good times. However, too many advocates of the policy, especially politicians, conveniently forget or even do not know what the Keynesian countercyclical fiscal policy is all about.

Not that I am advocating the true form of the Keynesian policy but clearly, many politicians subscribe to the narrative of countercyclical fiscal policy only in times of hardship. In better times, none of the action proposed by Keynesian economics is implemented. The continuous fiscal deficit is a proof to that. In all likelihood, the continuous deficit would merely impose a higher cost of borrowing on the country, forcing future generations to bear the burden of past mistakes.

It is true that fiscal deficit and debt in general is not necessarily bad. If borrowing today offers an opportunity for profits tomorrow, that borrowing might be a good idea. The problem with this country is that the government, instead of truly investing in public goods with more convincing multiplier effects like education, is more interested in investing in white elephants, or in the stock market, as evident in the RM5 billion injection into ValueCap through borrowing. It is things like this that make it imperative for us to be suspicious of politicians who seemingly adhere to the Keynesian school of thought.

It has to be noted that when Keynes wrote The General Theory, he was trying to save capitalism. On the contrary, politicians who inconsistently advocate for Keynesianism are not trying to save capitalism. In times of economic crisis, the political environment could be very dynamic and it is Keynesianism, out of several others, which has the potential of calming the electric atmosphere.

While I lament each time Keynesian economics takes centre stage, its effectiveness in smoothing the downside of capitalism is undeniable. There are side effects however.

The government is expected to finance the deficit and the fiscal stimulus through borrowings. The Finance Minister has indicated that the government will mostly obtain the funds from local sources. This effectively means that private enterprises will have to compete against the government in sourcing for precious capital. With the financial crisis well under way internationally, it is likely that the opportunity for local private entities, especially smaller ones, to borrow from abroad is small, leaving local sources as the only options.

This competition for capital only increases the lending rate as demand increases vis-à-vis supply of loanable funds. This has the potential of crowding out private investment. As a result, the private sector may miss out opportunities in times of a downturn and be unable to be as dynamic as it should during recovery times and during yet another era of exuberance.

Deficit spending may also defeat the purpose of the economic stimulus. With higher interest rates, it makes more sense for individuals to save rather than invest in various value-creation initiatives, with all else being equal.

This, in a way, makes countercyclical fiscal policy unhelpful. At least one paper — by Gordon and Leeper — highlights that. The paper states that “countercyclical policies may create a business cycle when there would be no cycle in the absence of countercyclical policies”.

Furthermore, if Keynesians are interested in fighting business cycles so selflessly, why do they not simply eliminate business cycles altogether?

Instead of trying to smooth out cycles after it happened, the Austrian school of economics seeks to inherently smooth business cycles by instilling discipline in monetary policy. While there is not much data to compare the effectiveness of the two schools, the Austrian theory, if business cycles are of concern, sounds far more superior to the Keynesian countercyclical action.

Finally, despite the level of comfort far too many people have when they confidently say that government spending is the only option available in facing an economic downturn, that statement is absolutely false.

One of them involves private rather than public spending. Malaysians — and East Asians in general — have a tremendous amount of private savings. A report states that the level of savings by Malaysians is well above 30 per cent of income. Policymakers could design a policy which takes advantage of that fact. Indeed, the reduction of worker’s contribution to EPF from 11 per cent to 8 per cent is one policy which takes this path.

Others include permanent tax cuts to encourage businesses and enhance disposable income or even simply let the market eliminate unprofitable ventures made unwisely to give other promising ventures a shot.

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.

Categories
Economics

[1829] Of libertarian paternalism in EPF?

One aspect of the stimulus package announced by the Finance Minister earlier was smart enough in its execution that it needs a mention. While the 3% return of money to workers is optional, the return is done automatically unless the workers request not to.[1]

This is similar to the thinking of libertarian paternalism. Despite the term libertarian in it, do not be fooled by it because libertarian paternalism is not libertarian at all. In it the idea of the state knows best, “nudging” — as they call it; there is a controversial book called Nudge which had the libertarian world went on frenzy mode — individual to the option which the state thinks is the best or more often than not, prefers, with no coercion.

The idea of this particular implementation is to spend existing savings. With a high saving rate of over 30%, resources for spending to give the economy a little jolt is there. It is never a question whether the Malaysian government has any resources to stimulate the economy — that is, if it needs stimulation — but rather how does the government ensure that there is spending rather than a simple cash transfer which only ends up as savings again and therefore blunting the stimulus package.

Researches cited by libertarian paternalism indicate that individuals to large extent suffer from status quo bias. It means individuals are comfortable with current settings even if new settings are more efficient than the existing ones. The automatic EPF return takes note of this pattern.

If there was no automatic return, it is likely that the money would not be spent or distributed more widely in the economy, due to status quo bias. Many people would probably leave it in the EPF.

By having automatic return, individuals suddenly hold more disposable income with all else being constant. Thus, greater capacity for spending.

Opposition against the automatic return has been expressed[2], seemingly opposing libertarian paternalism. How many is unclear but there are those with low discount rate who would like to keep those 3% in EPF and the execution plan by the EPF only forces them to do more work than necessary. Groups, including those with the capability to fight instant gratification have demanded for the process to be reversed: return needs to be requested. That, indeed, the way it must be done.

In any case, in the end of the day, I am just glad that I will get some of my money back. In fact, to hell with paternalism as a whole. I want all of my money back and I want to decide how I want to spend or save the money.

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

[1] — Following up on the announcement, the EPF had instructed that those employees who did not wish to reduce their statutory contribution from 11 per cent to eight per cent a month would have to state that in writing by filling up a form. [EPF procedure to carry out 3pc cut ‘not practical’. New Straits Times. November 8 2008]

[2] — Various parties have voiced concern about the procedure for workers to reduce their contribution to the Employees Provident Fund (EPF) by three per cent for two years, which the government has proposed. [EPF procedure to carry out 3pc cut ‘not practical’. New Straits Times. November 8 2008]