« May 2007 | Main | July 2007 »
June 29, 2007
State management of production and the forces of the market (or, what should be the price of gas in Iran anyway?)
On Wednesday, I posted a story on how Iranians are upset about gasoline rationing. A key point which figures into what follows is this quote from the article:
The new rules limit drivers of private cars to 100 liters, or 26 gallons, every month at the subsidized price per liter of 1,000 rials, or 10 cents. Taxicab drivers are limited to 800 liters a month. (Emphasis mine)
So we are to take away from this article that gasoline is offered for sale to Iranian citizens at the price of 10 cents per liter and that this price is the result of a government subsidy. (NOTE: 10 cents per liter would be 38 cents per gallon. However, another article cites it as 42 cents. It depends on how you round your exchange rate and your gallon to liter conversion. I will use 40 cents from this point on.)
One of my frequent commenters, spencer, raises an objection that essentially boils down to this. Is that 40 cents per gallon price really a subsidy if, as a major oil producer, they are able to produce the gasoline for just pennies per gallon? Don't OPEC countries have lower gasoline prices anyway? Is that a subsidy, or just price discrimination (supplying the domestic market at cost before putting the rest of the supply on the world market as an oligopolist)?
First of all, spencer points out that the domestic refining and distribution network in Iran is nationalized. I should have pointed that out, and I am grateful that he reminded us of that fact. So, the question is would they be within their power to produce their domestic supply of gasoline cheaper because they can extract the oil at a cost that is much below the $70/barrel the oil fetches on the world market? Absolutely.
How much cheaper? For that, I refer to this MSNBC analysis piece by Robert Windrem from January with the provocative headline: Are Saudis waging an oil-price war on Iran? The entire article is worth a read, but here's the part that matters for us:
The trader notes that Iran, OPEC’s second largest producer, is “in trouble” both in the short and long term. Iran’s oil reserves, he notes, are declining more rapidly than Saudi Arabia’s and are more difficult to extract. While a barrel of oil costs the Saudis $2-3 to get out of the ground and to market, that same barrel costs Iran as much as $15-18.
“Iran does have some oil that costs them $8-10 but most of it is in that upper range,” he said.
Moreover, Iran has a large domestic market for oil, particularly fuel oil, which Saudi Arabia, with its smaller population and milder climate, does not.
Perhaps more important, because Iran has limited refining capability, it must import more than 40 percent its gasoline, making it the second largest importer of gasoline in the world after the United States, according to the Department of Energy’s Energy Information Agency.
And since Iran sells gasoline at a rate comparable to the rest of the Gulf states — around 33 cents a gallon — it must subsidize the price on a massive scale. In fact, say traders, Iran is paying about $1.50 per gallon to subsidize domestic gasoline consumption — the world market price of gasoline minus the tiny price per gallon — a practice that is costing Iran billions of dollars annually and eating up most of the state-run oil company’s discretionary funds.
Yes. You see, as I said in a follow up comment to spencer on the previous post, Iran imports around half of its gasoline. The world wholesale price for gasoline is in the neighborhood of $2/gallon. Being as charitable as I could to spencer's argument, I allow for the fact that they may be able to negotiate a better deal than the U.S. can. Even so, the half of the gasoline supply that comes from overseas surely must cost them more than 40 cents per gallon. Maybe they're not losing their shirt, but I don't see them breaking even. Today's research on the subject suggests I might not have had to be so charitable. They might be losing their shirt, if Windrem's sources are correct.
So I think we can safely lay to rest the claim that this really isn't a subsidy. If the oil coming out of the ground costs $15/barrel, then the cost of producing a gallon of gasoline probably exceeds 40 cents per gallon. (It is commonly stated that a barrel of oil yields 19.5 gallons of gasoline among other products. If the other products fetch a high enough price, you might break even overall, but I'm not sure this is the case.)
The fact is that Iran is facing a lack of refinery capacity. Welcome to the club. The question is how will they deal with this. If this was more of a competitive market situation, the answer would be that prices would rise, refinery profits would increase, capacity would be added and price would head back down towards marginal cost.
Yeah, that's textbook theory. It doesn't work literally here in the U.S. because there are a lot of frictions caused by imperfect competition, regulation, externalities, etc. It certainly won't happen in a state controlled monopoly situation as Iran has. But are they immune to the forces of the market. Absolutely not.
So spencer writes, "First, refining is a public sector industry so the economics are secondary."
I'd prefer "non-market".
He continues, "Second, Iran has budgeted a doubling of refining capacity."
So they are responding then? In fact, that seems like a no-brainer. Of course, if domestic demand is building, oil extraction costs are going up, and you're losing your shirt paying for imports because your nationalized firm can't satisfy your domestic consumers, then yeah, I'd say it's time to think about expanding that line in the budget.
But this is not going to be easy for them. If you are a company that builds refineries, is Iran a place where you want to be building them right now? If you are the government of Iran, where is the money going to come from? This is what I meant when, in the first post, I said:
...I would suppose that more comprehensive solutions will be politically difficult.
So in the end, I have to take issue with spencer's final comment,
But what it comes down to is standard economic theory has little to do with the issue and refinery profitability is not really an issue.
That's true only if you think that standard economic theory begins and ends with the perfectly competitive model. In that model, profitability is the main issue. The market fixes imbalances by sending signals to expand or contract and to enter or exit.
However, governments can and do contravene the operation of the market. They do this for good or for evil, but regardless of the reason behind it, the effect is to obscure the signals. Nevertheless, the forces are still there, and they ignore them at their peril. In setting a fixed market price for gasoline, Iran has committed the resources of the state to supply its citizens with the gasoline they demand at that price, even if that means the state's resources will be drained away from other uses. This they can do because profitability is not the main issue. Political economy is. However, there are still no free lunches, even for nationalized firms. Now, both market and non-market forces outside of Iran have combined to increase the drain on its treasury caused by its commitment of resources.
They must now make a choice. They could allow it to continue and supply at a price that is below cost. (A private firm that did so would soon find itself bankrupt.) They could make a long term investment in capital to lower the marginal cost of supplying the product to bring it in line with the price. (Just as a private firm might invest in the ability to perform a task "in-house" rather than pay a high market price.) But as I pointed out, this may be easier said than done.
Of course, they could just raise the price--doing by committee what the markets usually do. If they get it right, bravo. If they get it wrong, well...
Or they could renege on their commitment to their citizens and reveal that the gasoline is too expensive to obtain and supply to them at the established price, so they will not be able to have as much as they want at that price. This has been known to make people violently angry.
I know that spencer and probably some of my other readers think that I've never seen a problem that the market can't fix. That's simply not true. I tend to favor market solutions, but readily admit that government intervention is sometimes necessary. I'm not even suggesting that a move to a free market is desirable or even possible for Iran without a lot of other considerations.
No, my message here is simpler. You can obscure the signals of the price system with the stroke of a pen. But escaping the forces of the market is more difficult by orders of magnitude. The rigidity of Iran's price controls have allowed this problem to "slow-cook" for a long time in a way that doesn't happen in a free market. They must now deal with the consequences of their choices.
Posted by William Polley at 02:33 PM | Comments (5) | TrackBack
June 28, 2007
Quo vadis?
Once again the FOMC decided to keep the fed funds rate unchanged at 5 1/4 percent. (Read the statement) There were some minor changes in the wording compared to the May statement. For example, in the second paragraph it is said that economic growth appears to have been moderate "despite the ongoing adjustment in the housing sector." Previously it had said that "adjustment in the housing sector is ongoing." Today's statement strikes me as conveying a somewhat more positive spin than before. No doubt many will think that is not warranted at this time.
The more important change seems to have been in the next paragraph. Here's the new language:
Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.
And here is what they said in May:
Core inflation remains somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.
The line about "sustained moderation...has yet to be convincingly demonstrated" is a clever way to word it. At the same time, they say that readings on core inflation "have improved modestly in recent months."
Reuters focuses on the first sentence: (Headline: Fed holds rates steady, nods to ease in inflation)
WASHINGTON (Reuters) - The Federal Reserve on Thursday held benchmark U.S. interest rates steady at 5.25 percent for an eighth straight meeting and dropped a description of core inflation as "elevated."
King Banaian focuses on the second sentence: (Blog post title: This'll be icky)
The Federal Reserve held rates steady, but the markets will not like the references to inflation here:
...
The Dow was up 50 when the news broke; I'd bet that won't last.
As of this writing, the Dow is up about 24 points. That's down from earlier, but hardly a sign that this news sent traders running with their tails between their legs. The bond market is another story. The 10 year is down 8/32 at this writing with the yield at 5.11%. King also points out that the WSJ Economics Blog says that tomorrow's release of the May PCE will be closely watched. Indeed.
But I'm of the opinion that nothing in today's statement is truly market moving news. Yes, bond traders are more touchy about this than stock traders perhaps. They may recover some of those 8 ticks today or tomorrow after mulling this over. This statement is not a clear sign that the FOMC intends to get back into a tightening mode. At least the market is not interpreting it as a clear sign, and that's what counts.
However the Fed doesn't want to telegraph its move quite yet. They don't want to be locked in on the off chance that the spillover from housing is worse than imagined, or something like that. That would cost them credibility. On the other hand, you can only sit for so long with core PCE outside your comfort zone without losing some credibility too. Before the end of the year, I think they will have to decide where they are going. If the growth picture looks about the same as it does today, and if core PCE is still on the high side, I think you know which way I would like them to go.
UPDATE: Dave Altig at macroblog links to some of the financial media coverage which was, as one might expect, all over the map. One of the more reasonable comments was from the Wall Street Journal (no link provided) which suggests that this really wasn't much of a substantive change. It's as if they were changing some of the wording (removing the word "elevated") just to keep people from fixating on the language that had been used for a while.
I'd like to think that's the case since it fits with a view that I have had ever since they overused a certain phrase a couple of years ago.
Posted by William Polley at 02:24 PM | Comments (0) | TrackBack
June 27, 2007
The Wall St. Journal is openly hawkish
All indications are that the Fed will keep its 5.25% target fed funds rate today, while perhaps fiddling with its accompanying policy "guidance." We'd feel better, however, if the Governors leaned toward protecting the dollar and curbing any credit excesses built on expectations of future dollar inflation around the world.
They listened to Cassandra.
Posted by William Polley at 11:24 PM | Comments (0) | TrackBack
iPod accounting
In his Economic Scene column, Hal Varian links to this study by researchers at UC-Irvine that does a breakdown of the value added throughout the supply chain for the iPod.
I think I'll assign the article in my principles course this fall.
Posted by William Polley at 11:01 PM | Comments (0) | TrackBack
Isn't it ironic?
Iran, awash with crude oil, is finding itself short on refinery capacity. The results aren't pretty.
TEHRAN: Angry drivers set fire to some gasoline stations here after the government announced that fuel would be rationed beginning Wednesday.
The government first planned to start the rationing a year ago, but put the decision off repeatedly out of fear that it would lead to unrest. The plan was announced only a few hours before it took effect. State television reported Wednesday that "several gas stations and public places had been attacked by vandals."
...
The new rules limit drivers of private cars to 100 liters, or 26 gallons, every month at the subsidized price per liter of 1,000 rials, or 10 cents. Taxicab drivers are limited to 800 liters a month.
And then there's this...
The government is still considering whether to allow drivers to buy additional fuel at higher prices.
At 10 cents per liter, I can understand why they have issues with low refinery capacity. Even if the crude oil was free, the cost of running the refinery would make it a rather dicey proposition. Since the government subsidizes gasoline to keep the prices low, one would have to expect that only government subsidies will rectify the refinery capacity issue. Meanwhile the economy continues to grow and demand increases. Something has to give.
Allowing additional purchases at a higher price might be warranted as a stop-gap measure. I would suppose that more comprehensive solutions will be politically difficult.
Posted by William Polley at 04:36 PM | Comments (6) | TrackBack
June 26, 2007
Hans Rosling at TED 2007
If you liked this one, you'll enjoy the sequel.
Hat tip to Felix Salmon.
Posted by William Polley at 03:42 PM | Comments (0) | TrackBack
Dynamic price discrimination
So you want to be first on your block with an iPhone? It'll cost you.
NEW YORK (Reuters) - Apple Inc. said on Tuesday its hotly anticipated iPhone could cost as much as $3,000 with a required two-year service contract, and a handful of eager buyers started lining up to spend their money.
They don't go on sale until Friday. And to be clear, that is $3000 over the life of the two year contract, as the article later explains...
Apple and AT&T on Tuesday outlined three iPhone rate plans that will be available, from $60 per month for the most basic to just under $100 per month for more talk time. AT&T said iPhone customers could also choose other AT&T service plans listed on its Web site.
While that is consistent with other AT&T wireless plans, it adds $1,400 to $2,400 to the cost of what many say is already a steeply priced $500-to-$600 gadget.
Of course, many people already pay $60 for their wireless plan, so using the economist's favorite concept of opportunity cost, it's the $500-$600 for the iPhone itself that is of interest. Still, that is several times what I paid for our family's two phones combined. (Our monthly rate is comparable to theirs, but again, that's for two phones.)
The story wouldn't be complete without this...
Not only Apple and AT&T are hoping to profit on the iPhone phenomenon. Advertisements on the New York and San Francisco online message boards at Craigslist.org solicited payment for waiting on line to buy an iPhone.
One listing from a self-professed "professional waiter" offered to stand on line for a fee of $100 per eight hours wait. The person will throw in delivery for an extra $50.
One wonders just how high Apple could have pushed up the price for this initial release. There is one certainty however. In a few months, there will be a better model that will be released at about the same price and this one will be sold at a discount. For tech products like this, there is most certainly a dynamic form of price discrimination partly due to the nature of quality improvement and innovation over time and partly due to calculated profit maximizing behavior. The effect is to segment the market into the patient and the impatient.
UPDATE: Felix Salmon thinks they are cheap. Yes, I think they could have gone higher. But on the other hand, as they come out with better models, they may be intending to stick with the $500-$600 price for the top shelf model for some time which will capture a moderate amount of consumer's surplus at each stage of product evolution rather than try to squeeze out too much in the first round. Just a thought.
Oh, and via Wired, we read that the iPhone will be sold in a box just like the iPod and you'll set it all up through iTunes.
Customers will choose their AT&T voice and data plans through iTunes, while iTunes is transferring songs and video files to the iPhone (and iSync or Outlook is copying contacts and calendars). The phone will be activated remotely over the cell network.
"It will go much, much faster than the normal process of buying a cell phone," Allen said. "Apple has a reputation for streamlining the customer experience. I'm sure there's not going to be any box opening in the store. That's such an important part of the process of getting an Apple product."
Because Apple won't be opening boxes in the stores, Allen said buying an iPhone on Friday -- when big crowds are expected -- might be faster at Apple stores than at AT&T stores.
Posted by William Polley at 02:56 PM | Comments (0) | TrackBack
Our graduates are in public service worldwide
I learned today that one of our alumni is now Deputy Minister of Finance for Economy and Integration in Paraguay. One of my thesis students from this past year is in the Ministry of Finance in Mozambique. He and I are working on a paper together.
Both came here on a Fulbright Fellowship. Over the years, WIU has attracted many Fulbright students from around the world. They add to the intellectual vitality of the department, and it is rewarding to see them do well.
Posted by William Polley at 02:24 PM | Comments (0) | TrackBack
Globalization backlash
I'm teaching a course in international economic relations that is primarily for MBA students. Tonight their reading assignment was Dani Rodrik's "The Global Governance of Trade as if Development Really Mattered". For Wednesday, they will read, among other things, Rodrik's "Trading in Illusions". So I've been doing quite a bit of reading on trade and development, the collapse of the Doha round, etc. As you would expect, it has had me thinking a lot about public sentiment toward globalization.
So when I saw the New Economist's post tonight on the changing opinions toward globalization, I immediately sent the link to my class. It fits perfectly with what we've been discussing.
This article from the Wall St. Journal does as well.
A paper commissioned by the Financial Services Forum sets out several policy options aimed at cushioning the blow from job losses and other dislocations caused by global trade, in a bid to defuse protectionist sentiment in the U.S. and promote free-trade agreements.
The banking, investment and other CEOs who belong to the group have consistently cited protectionism as the leading threat to continued U.S. and global economic growth.
The effort marks one of the first times top business leaders have sought to weigh in collectively in the globalization debate. The paper acknowledges that trade can have ill effects on some groups of workers -- such as stagnant personal earnings and job losses -- and recommends ways to reduce, or at least redistribute, the pain.
Incidentally, one of the authors of the paper was Matthew Slaughter, who also co-wrote this article with Kenneth Scheve cited by the New Economist.
This has been building for some time, and isn't going away any time soon.
Posted by William Polley at 01:10 AM | Comments (0) | TrackBack
June 13, 2007
Three items relating to the Fed
So I was checking my Reuters news feed and these three caught my eye.
Fed mulling ban on some mortgage lending: Kroszner
"We will also seriously consider whether there are mortgage lending practices that should be prohibited," Kroszner said in prepared remarks at a U.S. House of Representatives Financial Services Committee discussion on consumer protection.
Kroszner said the Fed was specifically eyeing 'stated-income' loan applications and prepayment penalties, as well as considering whether lenders should require monthly payments of annual fees like taxes.
...
"We must be careful, however, not to curtail responsible subprime lending or beneficial financing options for consumers," Kroszner said.
Meanwhile, south of the border, the former Fed chair gets the newswires buzzing...
Greenspan: Disinflationary process may be reversing
MEXICO CITY (Reuters) - Former Federal Reserve Chairman Alan Greenspan on Wednesday said a rise in the cost of Chinese goods imported into the United States may be a signal a long disinflationary trend may be reversing.
"That is the first sign that I have seen that disinflationary pressure ... may be turning around finally," the former U.S. central bank chief said, referring to U.S. data released earlier on Wednesday.
His comments came after the U.S. Labor Department on Wednesday released data showing that U.S. import prices for goods from China rose 0.3 percent in May, the largest monthly gain since this measure was first published in January 2004.
Speaking to a business exposition via videoconference, Greenspan said it was inevitable that at some point the downward pressure on inflation stemming from the opening of emerging economies would come to an end.
Back in Washington, the Beige Book was released.
Fed's Beige Book: Economy expanded through May
WASHINGTON (Reuters) - Economic activity expanded from mid-April through May, with a number of areas reporting stronger growth, the Federal Reserve said on Wednesday.
Seven Fed districts described growth as modest or moderate, while others reported growth as moderately strong, edging up, or somewhat faster than in recent months, according to the Fed's Beige Book summary of anecdotal economic conditions.
The Fed said overall wage pressures had not increased, but added that there were "significant" price increases for energy-related products.
However, districts generally did not indicate an increase in overall price pressures, the U.S. central bank said.
You can read the entire Beige Book at the Fed's website. With the exception of residential real estate, it's a fairly good report. Only Richmond reported a decline in manufacturing, and more than half the districts reported increased commercial real estate leasing activity. Price pressures are still clouded by higher energy prices nationwide and higher materials prices in some areas. Nothing in the report changes my assessment of where the Fed is heading for the rest of this year.
Posted by William Polley at 02:41 PM | Comments (0) | TrackBack
Don Herbert, Mr. Wizard: 1917-2007
From the NY Times,
Don Herbert, who unlocked the wonders of science for youngsters of the 1950s and ’60s as television’s Mr. Wizard, died yesterday at his home in the Bell Canyon section of Los Angeles. He was 89.
The cause was bone cancer, his son-in-law Tom Nikosey told The Associated Press in confirming the death.
Mr. Herbert held no advanced degree in science, he used household items in his TV lab, and his assistants were boys and girls. But he became an influential showman-science teacher on his half-hour “Watch Mr. Wizard” programs, which ran on NBC from 1951 to 1965.
And the LA Times recounts this story. (Hat tip to Betsy's Page for the article.)
Not every Mr. Wizard experiment went according to plan.
In "Saturday Morning TV," a 1981 book by Gary H. Grossman, Herbert recalled pouring two colorless solutions into one glass and then announced that the solution would turn black before he counted to nine.
"I got up to 20 and decided I'd better stop," he recalled. "I explained that apparently other factors like temperature and acidity had interfered with the experiment."
But as he finished his explanation, the liquid changed color.
"It was embarrassing, certainly, but I discovered the answer," he said. "We hadn't used a fresh solution, so the reaction was slower than expected."
I am not old enough to remember the original NBC series, but I have seen some of those episodes shown on The Science Channel. By the time he revived the concept for the Nickelodeon network in the 1980s, I was a little older than his target demographic, but I still was fascinated by it. I remember thinking, "Why isn't there more stuff like this on TV?" Today we have The Science Channel, Bill Nye, and of course, the Mythbusters; but Mr. Wizard started it all and no one has done it quite like he did.
And he did it with class. No big budget effects. No gimmicks. You could try it at home.
A lot of us did. Thanks, Mr. Wizard.
The official Mr. Wizard website.
UPDATE: Wired News interviewed Herbert last month. It doesn't surprise me at all that he liked the Science Channel too.
WN: Are there any current science shows that you find particularly educational or entertaining?
Herbert: The Discovery Science Channel.
WN: Do you think that you were an inspiration for the science programming that has become very popular on the Discovery Channel?
Herbert: Maybe.
Go read the rest of the interview.
Posted by William Polley at 11:22 AM | Comments (0) | TrackBack
June 04, 2007
Hard to see a rate cut anytime soon
Reuters headline: Wall St. backs off calls for Fed rate cuts
NEW YORK (Reuters) - Renewed signs of strength in the U.S. economy have forced a number of Wall Street firms to back away from forecasts for interest rate cuts this year.
Merrill Lynch's shift was the most drastic. It went from predicting the Federal Reserve would lower rates by a full percentage point to not seeing any reductions at all.
"The Fed is not going to be cutting rates at any time this year," said David Rosenberg, chief economist for North America at Merrill Lynch.
Back on December 7, I wrote:
The part of me that wants to give a prediction that is right is turning to the view that there will be at least one rate cut in 2007.
The Cassandra in me is having a tough time with that.
A couple months later, I looked back on that call:
Thank goodness for my inner Cassandra for keeping me from jumping all the way on that bandwagon.
In recent weeks it seemed that the pendulum was swinging back in favor of looking for a rate cut, but I'm still not on that bandwagon. Not yet anyway. Listen to Cassandra.
Of course the lackluster first quarter GDP is one factor keeping me from going all out and predicting an increase in the fed funds rate right now. However, there are reasons for guarded optimism. There are also good reasons to be cautious.
When it is time for them to move, in either direction, it will probably come without much warning.
Posted by William Polley at 04:05 PM | Comments (0) | TrackBack