Is trade diversion bad? (2)

Now we relax our first assumption. Suppose consumption on hat is closely (but not perfectly) substituted by clothing. Notice the difference in the utility curve. In the graph 2 now we have a curly utility curve because of our assumption: both goods are closely substituted.

The story is the same as before-NJ signs FTA with WJ and utility level of North Jakarta under FTA, U_NJ^FTA, is lower than utility level under free trade, U_NJ^FT. But look at carefully, U_NJ^FTA curve crosses blue dash line T** (situation where NJ imposes tariff to both WJ and Tangerang). What does it mean? It clearly shows that bundle consumption in B gives the same utility level as bundle consumption in C. In other word, utility level under FTA is as good as utility level under tariff-to-all system.

From these two graphs, i conclude that: it is true FTA may create trade diversion. But is trade diversion really bad in terms of welfare? My answer is not necessarily. Trade diversion is not necessarily bad for the welfare of North Jakarta if West Jakarta efficiency in producing hat is quite close to Tangerang efficiency.

Some of you may argue, why I don’t draw blue dash line crossing point A which is the same as the graph 1. Well, I can do that but as in this case the individual preference is different from the one on the graph 1, the blue dash line crossing point A means nothing (why?).

What happen next if we, once again, take both assumptions off (there are substitution goods and more than one factor production). The result strongly proposes that trade diversion is not necessarily bad for welfare.

If so, does it mean that FTA is the best deal? The answer is surely no. This simple example only justifies the welfare of home country due to FTA where its partner’s efficiency in FTA is pretty close to other countries out of FTA. More importantly, in this case I assume that the cost of doing and cost of FTA itself are close to zero-which is in many cases unrealistic.

Is trade diversion bad? 1

I was involved in a debate with Pasha on Free Trade Agreement (FTA). At any rate, we share the same idea that free trade is worth advocating for. Unilateral-by reducing tariffs regardless what other countries do is the best way; multilateral-based on reciprocity principle is the most economic sensible way.

Yet, the very question here is how we go there. From here, I think, we make a different route :D. Perhaps Pasha may propose something here.


Without any disagreement between us, I suppose, FTA (or Preferential Trade Agreement you may say) is discriminatory. Moreover, we are also concerned that FTA may end in trade creation or trade diversion. Unfortunately, studies on the last issue (trade creation vs trade diversion) are still inconclusive (not only empirical but theoretical as well).


Yet, posting here interests me. My point here : “is trade diversion bad for welfare?” I’ll use an example from this posting, hopefully café’s manager and the author do not mind with this :D. For background story, please see the posting.


Suppose North Jakarta signs free trade agreement with West Jakarta and leaves Tangerang out of deal. It would be true that free trade agreement in hat bad for North-Jakarta people only and if only: first North-Jakarta people have a unique preference (there is no substitution in consuming hat) and second, hat production requires only one factor of production (which is true in this context where hat is produced only by labor).


This may look too technical. But hopefully the graphs may help us understanding the concept of trade diversion.


Look at the graph 1, red line curves are combinations of consumption bundle consisting of clothing and hat which give the same utility for North Jakarta people. U_NJ^FT means utility level of North Jakarta in free trade condition, while U_NJ^FTA is utility level under Free Trade Agreement (FTA). Green line, NJ-T, is trade pattern between NJ and Tangerang under free trade (or in technical term we may call as production possibility frontier) while dark line is pattern between NJ and West Jakarta (WJ).


In this case, only Tangerang and WJ are the only hat producers and NJ is the only clothing producer ( I assume this). Under free trade, NJ will import hat from Tangerang since Tangerang is more efficient than WJ (from the graph we can see that Tangerang produces more hats than WJ).


Now, North Jakarta and West Jakarta agree on FTA but NJ still imposes tariff on hat from Tangerang. What happens then, North Jakarta is likely to import hat from West Jakarta, even though West Jakarta is not an efficient producer. Tariff on Tangerang shifts trade pattern between Tangerang and NJ, hence the NJ-T green line shifts and becomes NJ-T* blue dash line (means that tariff reduces demand for hat from Tangerang ).


This is what trade diversion means. FTA alters consumption from the more efficient producer to less efficient one. And it reduces possibility of producing more good. At the same time we can see clearly that utility level of North Jakarta is lower now under FTA compared to free trade (just rule of thumb, as utility curve is close to origin, it means that utility level decreases-that’s why I draw line crossing the origin) Then, we compare situation between FTA and condition when North Jakarta imposes tariff to both West Jakarta and Tangerang. How can we analyze this? When NJ levies tariff from both WJ and Tangerang, NJ still imports hat from Tangerang because, even there is tariff, Tangerang is still the most efficient producer of hats.

Look at blue dash line in T** (without any loss generality, I don’t draw a new line for WJ). It is trade pattern between NJ and Tangerang when NJ imposes tariff to both countries. Under T**, Tangerang produces more hat than condition under T* (under FTA) why? because WJ’s hat is also imposed tariff by NJ. Yet remember, under T**, Tangerang produces less than under free trade, namely, T.


Under tariff for both WJ and Tangerang, NJ imports hat from Tangerang (because Tangerang is still more efficient producer than WJ). Therefore utility level exists in intersection between blue dash line T** (tariff) and green line T (free trade). In other word, utility level under tariff coincides with utility level under free trade. You may surprise why utility level under tariff is the same as utility level under free trade. This may happen if tariff revenue is returned to this kind consumer by lump-sum method. What if tariff revenue is not returned to the consumer? Then utility level under tariff lies between free trade condition and FTA. Yet the point is still the same, utility level under FTA is lower than under tariff-to-all system (Most Favored Nations tariff) and absolutely far lower than free trade.

Some Mathematical Proof

Economist John Siegfried wrote an interesting piece for students who never took econometrics or planning to take their first econometrics class. Here's the link.

Robert Mundell on David Letterman

I found this on youtube. Nobel Laureate Robert Mundell appeared in the Late Show with David Letterman. It truly shows that economists are a unique bunch. Enjoy.

Not So Dismal After All

Here's an interesting news. Here's a quote:

"In 2006, in the first ever national assessment of economics, 79 percent
of 12th-graders nationwide performed at or above the Basic achievement
level. Forty-two percent performed at the Proficient level or higher.
On average, male students scored higher than female students, and
White and Asian/Pacific Islander students scored higher than other
racial/ethnic groups. Students from schools in large cities had lower
average scores than students from schools in other locations. Students
from families with higher levels of parental education scored higher, on
average, than their peers from families with lower levels of parental
education. Most 12th-graders reported some exposure to economics
content during high school."

Mickey Mouse Once Tried to Commit Suicide

Here's something way off the mark. As a fan of sequential art, I always find something interesting about the history of long established characters such as superman, batman, or spiderman. This time it's Mickey Mouse. During the 1930's, to capitalize on the success of the character in the cartoon movie, Walt Disney decided to also put the character in a comic strip. The strip was drawn and written by Floyd Gottfredson. One of the strip tells the story where Mickey was upset with his relationship with Minnie and decided to commit suicide, although in a comical way. You can read the whole strip right here. It goes to show how sense of humor evolves over time. Mickey Mouse used to be very funny.

Why A Chapter in Game Theory is So Important, Particularly for Partygoer Students

One day, two procrastinating economics students decided to go for a party in a campus instead of studying for exam. They knew that the next Monday is Microeconomics Analysis 1 exam (let’s say so). But it's so worthy not to be missed. This party would be getting crazy and hang out (a bit hang-over) with ladies in the next campus could be a lot of fun. A party which must be put on not-to-be missed party list. Besides, they should not worry about exam anyway. The party is on Saturday and there is a plenty of time for reviewing the materials. Since they thought they are smart students and, of course, good party goers, 6 hours on Sunday for refreshing the course is enough.

Then they went to the party. They’re right. At least the party got crazy and many were unconscious-including them. Getting hang-over….back home and oh sleeping the whole day on Sunday. After all, Shit!..no time for covering the whole materials. They just reviewed Social Welfare I and II and no much time for studying A chapter on Game-Theory. In a very decisive time, one of them realized, raised a brilliant idea and thought that they could use special consideration for delaying exam.

They would tell the Prof that they attended a seminar (or workshop…or whatever academic things) in Econ program at the neighbour university. And when they were on the way back home, there was something wrong with one of the wheels. The wheel was broken and it took a whole day for fixing it. “Mmmm it sounds reasonable….” replied another smart but artful student. They did and they were allowed to take the exam in the next week after.

What a brilliant idea. Then they would have a plenty of time for studying lovely microeconomics. The exam time was coming. They sat separately (of course this is an exam and not a study group). Both were surprised since there were only two questions.

The first question was about consumer theory which account for only 10 % of total grade. Even, there was no question about game-theory. The second question was only one sentence but significant and account for 90 % of total grade. The question is like this: “which wheel was broken?”

Well the Prof just applied one important part of a chapter in game theory, namely, Prisoner’s Dilemma. Yeah..they once again missed that part.

*Note: this is a common joke and ,of course, not a real story :D

A New Look and Blabbing...guh..Babbling

As you can see we got a new look for our blog. What do you think? By the way, did any of you ever read this blog? No? Or just skimming? No? Just looking at the pretty pictures? What pretty pictures?? Pictures that someday we might put in this blog. WHAT?? Sure, someday people won't have to write or read blogs anymore, they look at pretty pictures. Didn't the porn industry already done that?? Riiiiiiiight. Nevermind, here's Calvin and Hobbes taking a shot at economics (just click the comic for a bigger picture).

Something to Laugh About

Given my previous post, apparently Jorge and I were thinking of the same thing, but with a different twist. So much for this one.

So...What Have You Been Up To Lately?

I ran into a friend the other day, we went to the same school by the way. As usual, when you ran into someone you know in the summer, you'll be asked the "what are you doing this summer?" type of question. Thus, I was asked that philosophical question. A typical graduate student answer would be "Oh, I'm doing an intership at this blablabla..." or "Well, I'm doing my research on bla...". Ok, I'm a graduate student but I'm not doing any internship this summer. I kind of doing research but not quite sure yet due to some administration problem. Trust me, it's complicated. "So what do I have to say as an answer?", I thought to myself.

Let's see, I finished reading this, which is quite interesting. I also read this, which kept me up for three days (once you start reading the first sentence, it's hard to put it down). Not only that, this and this just arrived from Amazon which will keep me busy for the rest of the summer. I'm in the first few chapters of this. I also enjoyed reading this, I was quite taken by its surprise ending. In all my years as a reader and collector of this, it was the first time in a long while I felt excited reading page after page (Well done Geoff!).

Aside from reading I saw this, which was not as good as the second one. The filmakers tried to tell too many things in just under three hours which convoluted the story. A few days after that I moved into a new apartment. Not only that, I also help some of my friends move out from their apartment, which is a good exercise for the summer. It builds your upper and lower body, not to mention you get free lunch...well not exactly free...rather you're compensated for being a goood samaritan. I highly recommend it. Then, two weeks ago I went in the movie theater and spend $9 to see this, which was not the best $9 I've ever spent. Thank you Michael Bay for ruining my childhood heroes. To me, this version is better, despite that it's corny and he died in it. But at least he died fighting and not that lame fighting sequence in the new movie. Him killed by him, come on. The franchise is about robots not humans! Fortunately, I still have this and this to fall back to every evening. To enhance my cultural experience, I went to this concert which was very entertaining, But mostly I'm preparing myself for this. And right now I'm pondering whether or not I should enter this contest.

Given all this. I come up with one perfect answer, "Not much".

Gaming for Economics

Here's an interesting development. The University of North Carolina at Greensboro (UNCG) has created an online course for introductory level economics. You're probably wondering, "So what? There's a gazillion online courses anyway on the net". Well, to make it interesting, the course is in the form of an online game, where the students play an alien race that crash landed on Earth. In the game, students have to make decisions to ensure the survival of the alien race. This is a very interesting way to introduce the basic concepts of the economics to students, such as opportunity cost.

To play the game you have to enroll in the course in the fall semester, which is open to those who are interested. Will this method of teaching catch on? We'll just have to wait and see. Besides, you don't really have to play this game to learn basics economics. If you're a game fanatic, playing games such as civillization IV or the now classic sim city, or any other strategy based game already taught you economics without you even realizing it.

Growth Theory and the Wealth of Nations (2)

Here's Ap with his second part of the article:

So, once again, why a country can be rich, and the other poor?

Most of research on growth empirics are trying to look how far do these variables explain the cross-country per-capita income differences: investment, human capital, population growth, or trade. Such analysis will be subject to the usual problems of empirical analysis: correlation does not mean causality!

True, the higher the country's investment, or schooling rate, or trade volume, and the lower the population growth rate, the higher is the GDP per capita. But can we say that education (or investment or trade) that makes a country rich, or vice versa? Or, perhaps, there are other unobservable things that affect both education and GDP per capita simultaneously.

Economic historian Angus Madison once show that the world has been unequal since even before the industrial revolution (see his graph here). That means, world's inequality is not just a recent issue. The question is, of course, what makes the world unequal? Some studies try to go further to find 'deeper' explanations. To do so, we must find an exogenous factor; something that affects countries' per-capita income differences, but not affected by per-capita income.

One possible explanation is geography. If we look at the distribution of countries by income per capita, almost all of the poorest countries are close to the equator, and most of the richest ones are in the temperate zone. Maybe it was not just a coincidence. Maybe something with the temperate climate that affects productivity (lower energy intake required to do a similar thing). Maybe being in the tropical zone has something to do with germs and contagious disease (virus and germs are less aggressive in cold weather; this is what Jeffrey Sachs keeps arguing).

Geographical position is also important in the sense isolation. If a region is isolated from the rest of the world by hills or mountains, lacking of access to the sea or navigable river, then the society won't be able to benefit from trade, technology and knowledge diffusion.

Another theory related to geography is what Jared Diamond proposed in his seminal Guns, Germs and Steel. He wrote that world inequality started as early as 13,000 years ago, when human invented the agriculture system and switched from hunting-gathering to food producing. Development of food production has enabled society to generate food surplus and live a sedentary lifestyle. Food surplus and sedentary lifestyle then led to division of labor and more complex political structure. Such lifestyle then paved the way for important inventions (wheel, alphabet) and technology.

The thing is, the earth has been exogenously unfair, meaning not all societies were lucky enough to get close to available domesticated plants and animals. That explains why Europeans, who were close to the Fertile Crescent, and China, had a head start than the Americas, Africa, Australia and New Guineas. That explains why it was the Europeans who sailed to the New World, not vice versa.

While geography hypothesis is interesting, it seems to be too deterministic. It also fails to explain why some big ancient civilizations (like Egypt, Aztec) failed to sustain, while the current rich were far behind those (read my account on this similar issue here).

If we see the history of modern economic growth, two main drivers are: i) commercial activities, and ii) the advance of knowledge, technology and innovations (the variable A in Solow's model). In both cases, there are some pre-requisites:

1. Individual freedom and autonomy, be it from the ruler or the church.
2. Incentives to pursue trade and innovations.

Both (1) and (2) were enabled by, among other things, the inventions of property rights. But property rights alone is not enough. One needs to find an agreeable mechanism on how to: i) acquire it, ii) prove it, iii) protect it, and iv) enforce (iii). All of those conditions require good and strong institutional setting (see Douglass North's 1990 book for more discussion).

To make the story short, the institutional hypothesis argues that the disparity of today's world income per capita is the product of the variations of institutional quality: rule of law, bureaucracy, governance regulatory quality, corruption, risk of property expropriation, even democracy.

One tricky question. How can we be sure that it is institution that affects economic performance? Can it be that when a country gets richer, it can afford to have better institution, better governance, lower corruption or better democracy?

This problem was answered by a paper by Acemoglu, Johnson and Robinson (2001). The authors argue that the quality of a country's institution today is shaped by the institutional setting brought by the colonial power. The decision to build different types of institution in the colonies were determined by the colonists' strategy, which range from 'extractive state' at one extreme (Congo, Latin America to a lesser extent) to 'New Europe' at the other extreme (USA, Canada, Australia, New Zealand).

What then determined different strategy? The challenges faced by the colonists. If the colonists faced hostile environment like tropical disease or resistance from indigenous people, they don't find an incentive to build settlements, and end up pursuing extractive state strategy. On the other hand, the Europeans in North America or Australia did not find hostile environment, and the indigenous population was relatively easy to defeat. In this circumstances, it was possible to build a New Europe, copying the same type of institution that they have had in the Old Europe.

There are other theories. For example, David Landes in his 2001 book explained that it was culture that matters. Culture, he argued, especially scientific and secular culture of the Europeans explained why it was Europe, not China nor the Islamic world who dominated the world. Other theory points to the ethnic, language or religious fractionalization of a country.

At the end, the question 'why a country can be rich, and the other poor' remains a mystery. But we don't have to find a single explanation, because it will be impossible. More important is the process on how do we get the answer.

Growth theory and the wealth of nations (1)

Our friend Ap from cafe salemba, and frequent visitor of "ruang 413" (literally...in the real world) is starting his stint as guess blogger this month. So, without futher ado, here's what Ap has written for our enjoyment...

Growth theory and the wealth of nations

Judging from his posts here, here and here, Yudo seems to be in the 'fascinated' stage with the (neoclassical) growth theory. Indeed, since Robert Solow's 1956 paper, the field of economic growth has become a very interesting subject. The paper provided a scientific framework to analyze what makes a country grow faster while the other don't.

Then, thanks to the availability of both empirical data on cross-country national income, and the advance of statistical tools, starting in the 1980s-1990s economists were able to do empirical analysis on economic growth. Some people have even devoted their life and career on doing such regression, like Harvard's Robert Barro.

The basic, fundamental question for doing cross-country growth analysis is: why some countries are rich and some other poor? Moreover: why some countries have successfully become rich while some others failed?

The irony is, the more we try to explain it, the more likely we fail to do so. The reason became the mechanism of economic growth is very complex to fit into a single model. Consider Solow's famous model. As explained by Yudo, the model predicts that a country's income per worker will grow faster if: i) it can accumulate physical capital ('investment') faster than the rate of its population growth and depreciation ('net depreciation'), ii) its capital-per-worker stock is relatively low.

By way of corollary, Solow model than provides the basic for the famous 'convergence' analysis: at a given rate of investment and net depreciation, poorer countries would grow faster in terms of income per worker, and soon they will catch up the richer ones, who are growing only at the 'steady-state' rate.

In the context of economic development, Solow model suggests that:

1. Level of physical capital should explain cross-country income differential.
2. Investment should affect only the short-run economic growth.
3. In the long-run, economic growth would be determined by the growth rate of something exogenous. Solow labeled it A for technology. What is A, and what affects it, we don't know (he didn't provide any explanations). It is something like the 'manna from heaven.'

When people did the empirical testing for Solow model, (1) and (2) are generally confirmed, but unsatisfactorily. For example, Mankiw (1995) found that variation of physical capital only explains about a third of cross-country income per capita differences in the 1990s. He suggested the term 'capital' should be re-formulated by including 'human' capital. Using secondary school enrollment rate as the proxy for human capital, Mankiw showed that the combination could explain around 80% of income differences.

But still the puzzle still remains. Does secondary enrollment make a good proxy for education in general? Does it mean that poor countries should invest more in schooling? One may tempted to say 'yes.' But other empirical analysis show that Africa remains poor despite heavy investment in education (in terms of school enrollment), as mentioned by William Easterly in his 2001 book. (A chapter in the book discussed how the idea of controlling population growth also did not work well).

There are even bigger puzzles. First, the fact that rich countries are able to sustain, even increase, their growth rates for a very long period. This suggests that the exogenous variable A is more important that just a residual. Perhaps it is not even exogenous; it may be endogenous .

Second, the model has little to say about historical path of economic development. Some today's poor countries were not poor some hundreds and thousands years ago, while the rich group only recently – in the human civilization history scale – became rich. What explains this reversal of fortune? It is very likely that the current per-capita income differences that we observe now have a long and deep historical determinants.

Therefore, the basic, fundamental questions I raised earlier still unanswered by the existing growth models.

Does blogging make you addict?

This is a simple proof. Moreover if you want to know what a non-economist says about economics idea behind blogging, this is a good example. He also gives you a link to know how worth your blog is.

Why perfect political market is not always good (part 2 of 2)

We continue our discussion. Suppose the coalition form is like the table. The first term in the bracket is number of seat in parliament (gain for president) and the second one is gain for each political party. Zero in the first term means that the president is not supported by a party.

From here we know that Policy A is supported by Golkar, PKB, and PD; Policy B is supported by PDIP, PKS, PD and Party Y; Policy C is supported by Golkar, PKS, PD and Party Y. Total support (237) means the number of member in parliament supporting the president's policy and this is more than half of the total seats in our hypothetical matrix. The coalition is formed according to the preference of political parties (for example in Policy A, Golkar, PKB and PD form a coalition to support the president). In this situation, the president is indifferent as the number of support is equal in each policy (just to make our analysis simple).

Gains for the President and Political Parties[1]

Party	Policy A	Policy B	Policy C
Golkar	(128,100)	(0,-100)	(128,50)
PDI-P	(0,-100)	(109,100)	(0,-100)
PKB	(52,100)	(0,-100)	(0,-100)
PKS	(0,-100)	(45,100)	(45,50)
PD	(57,100)	(57,100)	(57,100)
Party X	(0,-100)	(0,-100)	(7,100)
Party Y	(0,-100)	(26,100)	(0,-100)
Total support	237	237	237

To simplify the problem, the president tends to choose policy which get strong signal and support from the political parties. We should only notice three parties supporting more than one policy: Golkar, PKS and Partai Demokrat (PD). We drop PD from our analysis since it is less relevant (it supports every president’s policy).

Each political party does not cooperate. Each signals strong support for the most favorite policy and strong opposition for the least favorite policy. In this case, Golkar strongly support policy A while strongly reject policy B. PKS strongly support policy B while strongly reject policy A.

Then some brilliant politicians from both suggest “Why do not we cooperate and signal our second preferred policy as strong as the most preferred policy, so the president will choose policy C?”. It happens, the president chooses policy C, but would this cooperation be lasting? Maybe not. Golkar is tempted to defect the coalition and signal the most favorite policy (policy A) but PKS also does the same thing (policy B). Then, is there any outcome which is stable and certain? The answer is perhaps no.

This very simple situation shows how uncertain and unstable the multiparty and presidential system. Let’s put more complicated things. It surely does not make sense to assume that only one or two political parties doing portfolio of policies like what Golkar and PKS do. Imagine when there are many policies, many portfolios, the spreading support of political parties for every policy and the president is not indifferent over his policies. To narrow down many possibilities, president only pursue policies which get strong support. Since the coalition changes over time which means that support also changes, the president’s policies will lose coherency. Therefore, it is very possible that a policy chosen by the president contradicts to what he campaigned in the election.

What happen to other interest groups? Well they have to “bribe” more than one political party and also the president (since the president may come not from major political party, like SBY) to influence their favorite policies. This increases the cost of lobby.

The soaring cost of lobby and uncertainty may endanger our democracy. It is very clear that we should restructure our political institution. There are two systems which may bring good political outcome, parliamentary system or oligopoly political party-presidential system. These systems, i think, reduce uncertainty and the cost of lobby among interest groups. The first one reduces the cost of lobby and uncertainty in the relationship among interest groups, parliament and prime-minister. The second one narrow down policy options supported by political party and finally it eliminates uncertainty and push the cost of lobby for interest groups.

My colleague argues that presidential system is desirable particularly in divided society since the winners do not take all and it also trim down potential conflicts among groups (ethnic or religion). But looking what these guys find, stable and certain outcome are more important than “representation of all”. Regarding current political situation, I favor parliamentary system.

Lastly, it is completely wrong to blame democracy as the cause of our chaotic political situation. What has happened is that our political system within democratic regime does not produce efficient political outcome. The worst thing is that our politicians endanger the future of our democracy.

---

[1] The first number in the bracket is the real seats in parliament. The second one is hypothetical gain for a political party. Party X and Y are hypothetical parties. This matrix is a very simplified (variant) menu-auction game since it is pretty difficult to cover each player strategies (the president and political parties) in a plain way within this short posting. You may come up with more illuminating model.

Why perfect political market is not always good ( part 1 of 2)

Could I find someone who really loves our politicians? You may reply “what a stupid question”. Surely, it is too naïve, to think that politicians advocate the interest of the people. I do believe there are good politicians but I do not trust, for sure, the devils in their hearts.

Recalling our politicians’ behaviors, I very often find myself so peevish. Recently several former candidates for the 2004 presidency election has been found involved in accepting non-budgetary fund from Ministry of Fisheries. In the last year, the members of parliament agreed to increase their salary. A couple months before, they endorsed a budget for laptop-project. What irritating the most is what they have gotten do not match with what they have done.

My friend indicates that this problem may come up due to high transaction cost and inefficiency in political market. To eliminate the cost and increase efficiency, it is necessary to bring competitive political market into the political system. Only by competitive means, our political system may produce an efficient political outcome.

It is true that current political institution is not efficient, particularly regarding the impact of the political outcome on the welfare of the people. However, calling for competitive political market does not seem to be the answer. What has happened actually is that our political system is too competitive. Multi-party system in parliament illustrates this situation and this is when our problem begins.

I argue that multi-party and presidential system is likely to increase the cost of lobby and uncertainty. Presidential system puts strong power on president to govern. However multi-party disperses the power on parliament. Power to govern, in the end, should be supported by voters which are represented by the parliament.

Here, the president will pursue policies which bring maximum gains (support from many parties) meanwhile parties put their support on some range of policies which the magnitude of supports varies in each policy.

Some say that the president Susilo Bambang Yudhoyono seems to be pigheaded by doing coalition when many political observers told him that he does not need to form a coalition. Why is he still doing coalition? Perhaps, by doing coalition, he thinks he can reduce uncertainty in the relationship between him and the parliament. Yet since the political parties avoid the risk of getting nothing, they spread out political support over available policies. Then no wonder does a political party stand in more than one side and a coalitional form in the parliament changes over time. This seems what SBY has missed

Summer Reading

Recently a friend of mine, who is non-economics major, asked me to provide him a list of economic books that are non technical and interesting to read during the summer. Here’s what I come up with, in no particular order:

1. The Armchair Economist, Steven Landsburg.
2. More Sex is Safer Sex: The Unconventional Wisdom of Economics, Steven Landsburg.
3. Freakonomics, Steven Levitt and Stephen Dubner.
4. The Undercover Economist, Tim Harford.
5. The Truth About Markets: Why Some Nations are Rich but Most Remain Poor, John Kay.
6. The Elusive Quest for Growth, William Easterly.
7. The White Man’s Burden, William Easterly.

If any of you have some other interesting titles that you have read or just dying to read, let me know. Enjoy the summer!

Between Politics and Business

This shows why state-owned banks are vulnerable to political concession. Worst, they may risk macroeconomic stability which has been achieved so far. I suspect (it seems very clear anyway) that PT Bosowa Trading International is part of Bosowa group-a business group of vice-president Jusuf Kalla.

Democrats vs. Republicans

This is a clip that depicts Democrats (Hillary, Obama, Gore, etc) againts the current administration (Bush, Cheney, etc). What made it funny is that it shows them fighting each other with a kind of "Super Friends" cartoonish flavor attached to it. Enjoy...



Here's a list of the character bios shown in the clip if you're interested. Oh, in case you don't know or forgot what "Super Friends" is, it's a cartoon show that ran from the 70's to the early 80's (guess how old am I?:D) that showed Superman, Batman, Wonder Woman and other super heroes fighting againts supervillains such as Lex Luthot, the Joker, etc. Here in the US, with the presidential primaries nearing, I guess this type of things always come up. I'm betting the guy who made this is a liberal:D

An Evidence on Growth Theory

I found that this posting may add our empirical evidence about growth theory-there is a strong tendency that economies among countries converge. However, we should note that this graph does not take into account population growth-the graph only depicts adjusted GDP with purchasing power parity (PPP).


As i argued before, taking account population makes us sure that one country produces more output than that of other countries. If we found that population growth among these countries move in the same pace-and i guess they don't, we could say that the graph is completely correct. Yet, if we take into account population growth, the whole story doesn't change anyway- economies still converge. what may change is time in which economies converge.

On Growth Theory (Part 1)

In this posting, I pursue my colleagues’ spirit at Café Salemba on spreading economics ideas to general reader. Here, I try to keep the ideas as plain as possible. But putting economics ideas by words is not always simpler than writing by math expressions. However, let’s try.

Some central questions to macroeconomics theory are; why do economic growth rates differ across countries? Why does a country produce more while the others do not? Some countries that were poor grow faster (e.g. East Asian countries) while some countries that were pretty rich in the past grow slower (e.g. Latin America countries). Some seem to end in doom (e.g. Sub Saharan Africa). Why are the economies of some likely to converge to the same pattern (e.g. rich countries and East Asian countries)? How long does one country need to double its output and why does it take so long? Does capital gap explain the differences of growth rates among countries?

Below are some facts

Source: Charles I Jones, Introduction to Economic Growth 2002

Take Zimbabwe as a case. Its average growth rate from 1960-97 is around 0.4 percent. Hence it takes 192 years for Zimbabwe to double its output. It takes only 12 years for South Korea to double its output while the USA needs 50 years to double its output.

Here is a fact of rich countries' economies

Source: Charles I Jones, Introduction to Economic Growth 2002

The graph strongly illustrates that rich countries’ economies converge to the same pattern. Turkey, Mexico and South Korea experience the same thing. Then, another fact is

Source: Charles I Jones, Introduction to Economic Growth 2002

Some countries grow faster but some do not (see African countries). Finally, we also find that growth rates in many countries are persistent.

Source: Angus Maddison: The World Economy. A Millennium Perspective (OECD,2001)

These figures give us good clues. From this posting, we learn that economies grow gradually and stable over period, I mean there is no such “jump” up in economy. Moreover, we also find that growth rates in many countries are persistent. So far, we have four important clues: growth rates are persistent, varied across countries, they converge and grow gradually (relatively stable over periods).

Economists realize that output and factors of production (inputs such as capital and labor) may grow in a different direction. Percent of growth per se does not give us strong information about economic situation as the population also grows. Another problem: this information cannot tell for sure whether the economy of country A produces more output than that of the economy of country B.

Just pick any number, suppose Indonesia economy grows 5 % while Singapore grows 4 %. Looking these numbers and saying that Indonesia produces more than that of Singapore is not sensible. In fact, the Indonesian population increases by 3 % while the Singapore is almost zero. Here, Indonesians enjoy only 2 % additional income while Singaporeans keep 4 %.

As our fact suggests that economies converge, there must be law that both output and inputs (factor productions) move in the same direction. Well, we find the law by such a very simple way. Assuming that the population growth is not influenced by economy (we call it as exogenous since it is an external factor of our economy) and transforming all variables into per capita term make our life simpler. That is the law, "per capita variables"

Now we are ready to framing economy. Just for introduction, let us start from very simple growth model. This model assumes that an economy produces only one good; no government; no technical change; no unemployment; there are only two inputs, namely, capital and labor; saving rates, depreciation and population growth are constant (however after the model is established, we can do such some experiments on what happen if these three are no longer constant).

It is, moreover, common to think of this model as unrealistic. However I cannot agree more to David Romer’s, professor economics of UC Berkeley, suggestion[1].

I try to avoid using too much technical procedures in building our model. Let me begin from the first ‘equation’. An economy consists of capital and labor. Then, the output of economy is divided between investment and consumption. The fraction of output allocated to investment (or simply say saving rate) is assumed constant.

Since capital depreciates, capital stock (or an additional capital) must be equal to the fraction of current output allocated for investment minus the depreciation of existing capital. This is the second equation of our model.

Remember, we need that both output and inputs move in the same direction and we are interested in per capita income rather than unadjusted income. So we transform all variables into per capita terms. Since our model assumes that there is no unemployment, the terms “per capita” means “per labor”. Just for convention, later I’ll use “per labor” concept instead of per capita. But both are the same concept.

The next step is just doing simple exercise. By doing some technical manipulation[2], finally I end up with very important equation, the third equation. Then we call it as capital stock per capita.

The equation above tells that capital stock per labor should be equal to actual investment per labor (sŷ) minus break-even investment ( (n+δ)k ), where n is labor growth and δ is depreciation rate and k is capital per labor.

What is break-even investment? Intuitively, we know that capital is depreciating and population is growing. Therefore, to maintain capital per labor from depreciation and the growth of labor, we need some amount of investment which is exactly equal to (n+δ)k.

Graphically, the third equation can be drawn like this

Suppose our economy stays at K₀/L, then gap BC is the amount of consumption per labor (per capita). DA is the amount of break-even investment and the rest, CD, is the amount of actual investment per labor (per capita).

Would this graph fit with empirical evidences? What does this graph tell us in reality? For a while let these things stay in our mind. I’ll continue to discuss what the graph means and implies, and we’ll find out why, according to our simple model, this statement might be true.

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[1] David Romer says “The purpose of a model is not to be realistic. After all, we already possess a model that completely realistic-the world itself. The problem with that “model” is that it is too complicated to understand. A model’s purpose is to provide insights about particular features of the world. If a simplifying assumption causes a model to give incorrect answers to the questions it is being used to address, then the lack of realism may be a defect…if the simplification does not cause the model to provide incorrect answers to the question it is being used to address, however, then the lack of realism is a virtue”. Romer, David. Advanced Macroeconomics 2006

[2] The third equation comes up by differentiating the first equation with respect to time. Then dividing the second equation with capital (K) we find the growth rate of capital stock. Substituting this into the first equation, arranging them, we would find capital stock per capita