22/5/15: Expresso: E agora, Cameron?

Portuguese Expresso on UK elections impact on the economy, quoting myself on the subject:

Click on the image to enlarge

22/5/15: You are What (and Where) You Eat

For a half-decent Italian, food is a part of defining both the value and the meaning of existence. For other cultures, food is at the very least definitive of our connection to culture, family, history, land and so on.

Gabriela Farfan, Maria Eugenia Genoni and Renos Vakis of the World Bank looked the the consumption of food away from home across the developing world. And instead of positing aesthetic or value questions relating to food, they look at the impact that ready-to-eat food purchases have on poverty statistics in one developing country for which such data is available: Peru.

Per authors, "…Peru is a relevant context, with the average Peruvian household spending 28 percent of their food budget on food away from home by 2010."

So to the findings, then:

1. "…accounting for food away from home results in extreme poverty rates that are 18 percent higher and moderate poverty rates that are 16 percent lower. These results are also consistent, in fact more pronounced, with poverty gap and severity measures." Why? Because factoring in food consumed away from home boosts overall consumption of those above extreme poverty levels, making extreme poverty look worse in relative terms. However, for the poor who are not extremely poor, adding food away from home recognises more accurately their relative well-being.
2. "…consumption inequality measured by the Gini coefficient decreases by 1.3 points when food away from home is included, a significant reduction." Which is to say, systemic inequality falls. Why? Because the improved scores for middle, low-middle and working poor classes more than offset worsening poverty measurements for the extremely poor.
3. "Finally, inclusion of food away from home results in a reclassification of households from poor to non-poor status and vice versa: 20 percent of the poor are different when the analysis includes consumption of food away from home. 

Full paper: Farfan, Gabriela and Genoni, Maria Eugenia and Vakis, Renos, "You are What (and Where) You Eat: Capturing Food Away from Home in Welfare Measures" (May 5, 2015, World Bank Policy Research Working Paper No. 7257: http://ssrn.com/abstract=2603040).

21/5/15: IMF to Russia: Do What You've Been Doing, Because We Say So

So the IMF released the summary statement on its Article IV 'consultations' for Russia. The stuff reads like something generated by a pre-historic algo with insight of a first order non-stochastic linear equation.

"The Russian economy is in a recession due to lower oil prices and sanctions. In addition, long-term growth remains low given structural bottlenecks." You have to laugh. IMF knows that sanctions are tertiary to Russian recession. Oil prices are primary and structural slowdown that started in late 2012 is secondary.

"The authorities’ macroeconomic policies have helped stabilize the situation, but there remain significant uncertainties regarding oil prices and geopolitical risks. Given these risks, the macroeconomic policy stance must be prudent." In IMF-speak this means that the Russian authorities did an excellent job so far managing the crisis, but they have done it without using IMF 'advice' or 'tool kit'. Which means that, to IMF, they haven't done it as well as the IMF could have done it. Obviously. Really.

So the bad Russkies better deploy the fabled IMF's 'structural reforms' pack:

• Stay low budget deficits (on which they really have no choice and are so far planning to do the same without the IMF 'advice'); 
• Lower central bank rates (which they are already doing without the IMF 'advice'), 
• Provide "limited stimulus" from the fiscal policy side (which, again, they are doing as much as they can). On Central Bank rates: to remind you, on 30 April, the CBR cut its key rate by 150bp to 12.5%. Without IMF's 'help'. I suspect the CBR will move rates below 10% by the end of 2015, unless there is a major reversal in ruble position, or if inflation reverses its (for now very fragile) moderating dynamics (inflation declined from16.9% y/y in March to 16.4% in April)... and… hold it… 
• "Finally, re-invigorating the structural reform agenda and avoiding de-integration from the world economy remain crucial to lift potential growth." Ah, there, IMF said it… 'structural reforms'. 

In other words, IMF is clamouring for some credit in the above. Ex-post the start of Russian adjustments, IMF recommends exactly the same adjustments, so when anyone asks what did IMF do when Russia was clawing its way out of the crisis, the IMF can say: we recommended them.

Of course, another bit that fills one with wonder in the IMF statement is how can Russia 'avoid de-integration from the world economy' any differently than it has been doing to-date?

To recap last 12 months or even last 12 years: Russia initiated a huge whirlwind of 'global integration' projects and activities in Asia Pacific, the Central Asia, India and Latin America. May be these are not quite 'global' enough for the IMF? Or should Russia somehow magic up 're-integration' with the EU? Actually it is trying to do so on a bilateral basis (proposing trade sanctions relaxation with a handful of countries) and tried - unsuccessfully so far - with the EU itself. Did Russia 'de-integrate' itself out of South Stream? Did Russia de-integrate itself from joint energy projects in the Arctic? Did Russia 'de-integrate' itself from the debt and investment markets in Europe? Nope, not them - that was the EU de-integrating Russia. But Russia did continue to de-de-integrate itself in nuclear energy sector, for example, in Hungary and Finland and Turkey and elsewhere...

IMF's generalities aside, the Fund updates some of its point estimates for the Russian economy.

A month ago in its April World Economic Outlook update, IMF forecast Russian economy to shrink 3.83% y/y in 2015 and 1.096% in 2016. Now, one month later, the forecast is for the economy to shrink 3.4% in 2015 (a 0.4 percentage points improvement in one month) and post a "mild recovery" (as in positive growth) in 2016. The Fund 2015-2020 projection in April was for an average rate of growth of 0.096% and 2016-2020 average of 0.9%. This time around, the Fund is expecting a medium-term growth to be 1.5% per annum. Seems like at least someone in the Fund is starting to look at the real dynamics in the economy.

Here's more of what the Fund does get right: "Persistently low oil prices or an increase in geopolitical tensions could further weaken the economic outlook... However, in the near-term, sizeable buffers, including high international reserves, low public debt, and a positive net international investment position should help safeguard external sustainability." Yes, the risks are there. But, the idea that Russia is just going to run out of reserves by the end of this year - often repeated by numerous analysts, including some who should know better - is bonkers, unless something really massively negative happens. Which may happen. Or may not. IMF is of little help on this point estimate.

One interesting bit: "The re-pricing of the FX liquidity facilities was adequate. The central bank could consider limiting further the FX allotments to ensure that the facilities remain sufficient for emergency purposes. The announced program of FX purchases to build precautionary buffers is welcome."

Did you hear that? Yes, Russia is again building up its forex reserves. Not the stuff you normally read in the Western press. Things are short-term, for now, but Russian FX reserves bottomed out in the week of April 17th at USD350.5 billion. Last week, they were at USD362.3 billion. Again, things might change and these increases can be reversed, but when was the last time that you read in the mainstream media that the CBR is now buying dollars and euros rather than selling them?

Russia will need higher reserves. Its economy is being held back by the severe impairment to its companies access to capital markets - reaching well beyond the intended targets of the sanctions. The West, which imposed these sanctions under the explicit stipulation that they were not supposed to hurt ordinary businesses and households, is doing absolutely nothing to rectify the problem.

Meanwhile, gross fixed investment continues contracting: in March down for the 15th consecutive month at -5.3% y/y. Net capital inflows in the non-banking sector totalled USD18 billion in 1Q 2015, second weakest in 12 months period, while total net capital inflows were USD32.6 billion - second highest year-to-date. The IMF is forecasting Russian aggregate investment to drop from 21.6% of GDP in 2013 and 19.9% of GDP in 2014 to 17.6% in 2015, before recovering slightly to 17.9% in 2016. This clearly puts strong emphasis on the need to support investment activity in the economy.

The IMF does note the serious drag on medium term growth exerted by the structural weaknesses in the economy. In line with what many, including myself, have argued before, the IMF puts forward a set of very general 'directional' reforms needed:

• "Less regulation and a reduction of the government’s role in the economy remain crucial to foster efficiency, confidence and investment". It worth noting that the Fund does suggest more and better regulation in the banking sector.
• "…improving protection of property rights" - a perennial problem that can only be resolved over the long run
• "…enhancing customs administration and reducing trade barriers" - a problem that is unlikely to be sorted because the Russian Government is pursuing medium-term growth strategy based on imports substitution - a strategy that, if executed correctly (a big 'if') can be quite productive
• "…empowering the Federal Antimonopoly Service (FAS) to eliminate entry barriers to several sectors/markets" - really a pipe dream at this stage, unfortunately.
• "…to improve labor force dynamics in the face of negative demographic trends, pension reform should be a priority" - which is something that was well underway prior to 2014 crisis, but got derailed by the extreme demand for dollar liquidity in the system triggered by the 2014 crisis.

Can't wait to see the 70-pages-plus full report. At least it promises colourful charts, if not an incisive insight... 

21/5/15: Global M&A and Economic Fundamentals

Here are some select slides from my presentation at this week's Alltech's Rebelation conference in Lexington, KY.

21/5/2105: The Darker Side of Transparency?

World Bank paper published earlier this month and titled "The Dark Side of Disclosure: Evidence of Government Expropriation from Worldwide Firms" raises some very interesting questions about the relationship between corporate transparency and government incentives.

The paper by Liu, Tingting and Ullah, Barkat and Wei, Zuobao and Xu, Lixin Colin (May 4, 2015, World Bank Policy Research Working Paper No. 7254: http://ssrn.com/abstract=2602586)  looks at "the effects of voluntary accounting information disclosure through auditing on firm access to finance, exposure to corruption, and sales growth." The authors use data for more than 70,000 firms in 121 countries.

The authors find that "…disclosure can be a double-edged sword" with overall effect depending on institutional capital present in a specific country.

"On the one hand, audited firms exhibit a slightly lower level of financial constraints than unaudited firms." This is in line with traditional theory whereby voluntary transparency increases information quality about the firm, but also signals self-selection of better-governed and better-performing firms to the markets.

"On the other hand, audited firms face a significantly higher level of corruption obstacles." Which is really surprising, until you understand the underlying logic.

"The net effects of voluntary information disclosure on firm growth are negative, which can largely be explained by the fact that most of the countries in the sample are developing countries where institutions are weak. The beneficial effect of disclosure increases as a country's property rights protection improves. The qualitative results are robust to considerations of the endogeneity of auditing and to alternative measures of corruption and financial constraints. The findings reveal the dark side of voluntary information disclosure: exposing firms to government expropriation where institutions are weak."

In other words, in more institutionally-advanced economies, voluntary disclosure is a positive factor for the firms, even she we control for self-selection bias. But in countries where institutional capital is weak, the effect is the opposite: in presence of corrupt and accountable governments, disclosing corporate information to the markets can trigger greater effort by the government to expropriate from the reporting firm.

There are serious ramifications for policy and development economics from this study. Traditionally, we tend to push more transparency and more disclosure for the firms operating in institutionally-weak emerging markets. In doing so, we may be aiding the predatory governments who, thus, gain greater ability to corruptly capture firm assets and/or profits over and above legally required taxation. This, in turn, strengthens the corrupt state institutions and government, instead of pushing them toward adopting more rule of law-styled reforms.

Beyond this, the study results suggest that at least in some setting, less transparency and greater ability for the corporates to operate within private information markets can actually be a good thing.

What is interesting is that in public domain, very little attention is paid to this issue. The results of this study, however, are broadly supportive of Acemoglu and Johnson ("Unbundling Institutions", Journal of Political Economy 113(5), 949–92005, 2005) work on the overwhelming importance of constraining government expropriation in facilitating economic development, ex ante other reforms.

On the other hand, transparency is value-additive in the advanced economies setting, where institutions are sufficiently high quality to preempt (or at the very least, diffuse significantly) the emergence of actionable incentives for state expropriation and information-led corruption.

20/5/15: Effects of commuting times on couples’ labour supply

"You’ve come a long way, baby. Effects of commuting times on couples’ labour supply" by Francesca Carta and Marta De Philippis, (Banca d'Italia, number 1003 - March 2015: http://ssrn.com/abstract=2600874) [comments within quotes are mine]"…explores the effects of husbands' commuting time on their wives' labour market participation and on family time allocation. We develop a unitary family model of labour supply, which includes commuting times and household production. In a pure leisure model [model where there is a binary choice: work or leisure; as opposed to work, leisure or work at home] longer commuting time for husbands increases their wives' labour market participation and reduces their own working hours. However, a model that includes household production might determine the exact opposite result."

So far so good for the theory: the paper shows that when the non-principal earner is faced with a choice of either enjoying leisure only or working only, absent household production, the second earner will opt, on average, for work and the principal earner will take less effort in their own work. However, once household production is an option or a requirement (as in the case of, say, a family with children or other dependents), then the secondary earner will more likely opt for staying out of the workforce and devoting their effort to increased household production, while the primary earner will apply more effort in their own work.

That's in theory. But empirical application is a bit less straight forward:  "We then examine the sign of these effects by using data from the German Socio-Economic Panel from 1997 to 2010. Employer-induced changes in home to work distances allow us to deal with endogeneity of commuting times. We find that a 1% increase in a husband's commuting distance reduces his wife's probability of participating in the labour force by 1.7 percentage points, 2% over the mean. Moreover, it increases his working hours by 0.2 hours per week. The average effect masks substantial heterogeneity: lower participation rates are concentrated in couples with children and where the husband has higher levels of education."

17/5/15: ‘High’ Achievers? Cannabis and Academic Performance

For the libertarians around, sorry - one deflationary piece of research… "‘High’ Achievers? Cannabis Access and Academic Performance (CESifo Working Paper No. 5: http://www.iza.org/en/webcontent/publications/papers/viewAbstract?dp_id=8900) looks at "…how legal cannabis access affects student performance."

To deal with a  bunch of pesky econometric issues, the study looks at data generated by "…an exceptional policy introduced in the city of Maastricht which discriminated legal access based on individuals’ nationality." So the authors used a difference-in-difference approach on a panel data set of over 54,000 course grades of local students enrolled at Maastricht University before and during the partial cannabis prohibition.

"We find that the academic performance of students who are no longer legally permitted to buy cannabis increases substantially. Grade improvements are driven by younger students, and the effects are stronger for women and low performers. In line with how THC consumption affects cognitive functioning, we find that performance gains are larger for courses that require more numerical / mathematical skills. We investigate the underlying channels using students’ course evaluations and present suggestive evidence that performance gains are driven by improved understanding of material rather than changes in students’ study effort."

Guess that explains why he wasn't any good in Topology either...

17/5/15: Forbes Opinion Piece on Ukrainian Crisis

An interesting, unorthodox - for Western media - perspective on the Ukrainian crisis and Russian longer term problem: http://www.forbes.com/sites/dougbandow/2015/05/11/ukraine-fight-flares-again-u-s-should-keep-arms-and-troops-at-home/


Note: as usual, my reposting of the material does not qualify as an endorsement of the views presented.

17/5/2015: BlackRock Institute Survey: N. America & W. Europe, April

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe:

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 48% of 56 economists expecting the world economy will get stronger over the next year, compared to 52% from previous report. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy. At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned by the survey to strengthen or stay the same except Canada and Denmark."

Country results 6 months forward compared to current conditions assessment:

Note: (0,0) Corner point denotes Austria, Denmark, Norway, Spain, Sweden and the Netherlands

Country results 12 months forward:

"Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Finland, Greece and Italy to be in a recessionary state, with the even split between contraction or recession for Portugal. Over the next 6 months, the consensus shifts toward expansion for Italy. Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months except Canada where the consensus is split between mid-cycle or late-cycle states."

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

17/5/15: Ukraine's GDP down 17.6% in 1Q

Some pretty bad numbers out of Ukraine this week. 

Remember that 1Q 2015 Russian GDP shrunk 1.9% y/y in real terms and the forecasts for 2015 full year decline range between 3% (official forecast) to north of 7% (some Western banks analysts), with the consensus at around 3.8-4.0%.

Now, Ukraine's economy is in the IMF programme and the Fund latest forecast for 2015 full year growth was -5.548%. That is the base on which the so-called debt sustainability analysis is based. Even the World Bank - which forecast -7.5% real GDP decline for 2015 - was contrarian to the IMF optimism.

However, this week official data shows real GDP decline of 17.6% in 1Q 2015 y/y and down 6.5% on 4Q 2014. Exports to the EU are down 1/3rd, exports to Russia down 61% and industrial output is down more than 20%. With inflation at around 60% y/y in April, retail sales are down 31% at the end of 1Q 2015 y/y. 

Good news is - it is likely that 2H 2015 will see some improvement in Ukrainian growth dynamics, just as the same is likely in Russia. But I fear that we are going to see a much sharper contraction for the full year overall, compared to the IMF forecasts. If that turns out to be the case, Ukraine can require restructuring of its IMF 'assistance' package, although much of that risk also hinges on the progress on haircuts negotiations with the private sector creditors. These negotiations have not been progressing too well, so far, but there may be a turnaround in the works. 

In short, Ukraine's 'debt sustainability' charade the IMF has put up is now firmly in crosshairs of two risks - the haircut slippage and economy collapse. And both risks are rising, not falling so far…

17/5/15: Public Debt, Private Debt… Someone Thinks There Might Be Consequences

Remember last year vigorous debate about whether debt (in particular real economic debt - as I call it, or non-financial debt - as officialdom calls it) matters when it comes to growth? Well, the debate hasn't die out… at least not yet. And some heavy hitters are getting into the fight. Òscar Jordà, Moritz HP. Schularick and Alan M. Taylor paper, "Sovereigns versus Banks: Credit, Crises and Consequences", Working Paper No. 3: http://ssrn.com/abstract=2585696

Ok, so some key preliminaries: "Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies." The problem is that the two 'narratives' "…may interact in important and understudied ways", most notably via debt and debt overhangs.

The authors examine "the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt."

Time for Krugmanites to pop some champagne? Err, not too fast: "However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression."

Wait, what? A state indebted to the point of losing its shirt (or rather default on pay awards to trade unionised workers and retirees) imposes cost on private sector that can be detrimental during private sector own deleveraging? Yeah, you betcha. It is called power of taxation. Just as during the current crisis the Governments world wide gave no damn as to whether you and I can pay kids schools fees, health insurance and mortgages, so it was thus before.

"We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870:

1. in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; 
2. the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and 
3. the path of recovery is worse still when a credit-fuelled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now."

Now, take a more in-depth tour of the changes in fiscal and private non-financial debt across 17 advanced economies since 1870s:

Oh, yeah… 1950s and 1960s public deleveraging was done by leveraging up the real economy. And it didn't stop there. It got much much worse… instead of deleveraging one side of the economy, both public and private sides continued to binge on debt. Through the present crisis.

So "what does the long-run historical evidence say about the prevalence and effects of private and public debt booms and overhangs? Do high levels of public debt affect business cycle dynamics, as the public debt overhang literature argues? Are the effects of either variety of debt overhang more pronounced after financial crisis recessions?"

So here are the results:

So the results provide "…a first look at over 100 years of the inter-relationships of private credit and sovereign debt. We end with five main conclusions":

1. "…while public debt has grown in most countries in recent decades, the extraordinary growth of private sector debt (bank loans) is chiefly responsible for the strong increase of total liabilities in Western economies. About two thirds of the increase in total economy debt originated in the private sector. ...Sovereign and bank debts have generally been inversely correlated over the long run, but have increased jointly since the 1970s. In modern times, the Bretton-Woods period stands out as the only period of sustained public debt reduction, both in expansions and recessions."
2. "…in advanced economies financial stability risks originate primarily in the private sector rather than in the public sector. To understand the driving forces of financial crises one has to study private borrowing and its problems. In the very long run, if we run a horse race between the impact of changes or run-ups in private credit (bank loans) and sovereign debt as a predictor of financial crisis and its associated distress, private credit is the more significant predictor; sovereign debt adds little predictive information. This fits with the events of 2008 well: with the exception of fiscal malfeasance in Greece most other advanced countries did not have obvious public debt problems ex ante. Of course, ex post, the fierce financial crisis recession would wreak havoc on public finances via crashing revenues and rising cyclical expenditures."
3. "…with a broader and longer sample we confirm that private debt overhangs are a regular feature of the modern business cycle. We find that once a country does enter a recession, whether it is an ordinary type or a financial-crisis type of recession, if it carries the legacy of a large private credit boom then the post-recession output path of the economy is typically adversely affected with slower growth."
4. "…our new data also allow us to see the distinct contribution of public debt overhangs. We find evidence that high levels of public debt matter for the path of economies out of recessions, confirming the results of Reinhart et al. (2012). But the negative effects of high public debt on the performance of the economy arise specifically after financial crises and in particular when private borrowing also ran high. While high levels of public debt make little difference in normal times, entering a financial crisis recession with an elevated level of public debt exacerbates the effects of private sector deleveraging and typically leads to a prolonged period of sub-par economic performance." In other words, not too fast on that champagne, Krugmanites… 
5. "…from a macroeconomic policy standpoint these findings could inform ongoing efforts to devise better guides to monetary, fiscal, and financial policies going forward…" blah… blah… blah… we can stop here.

Funny how no one can get the right idea, though - the reason public debt matters is because the state always has a first call on all resources. As the result, the state faces a choice at any point of deleveraging cycle:

• (A) leverage up the State to allow deleveraging of the real economy; or
• (B) tax there real economy to deleverage the State.

In the US, the choice has been (A) in 2008-2014. In Europe, it has been (B). The thing is: both Europe and US are soon going to face another set of fine choices:

• (Y) reduce profligacy in the long run to deleverage the State; or
• (Z) get the feeding trough of pork barrel politics rocking again.

No prizes for guessing which one they both will make… after all, they did so from 1970s on, and there are elections to win and seats to occupy...

17/5/15: Two Asias and the U.S. European Incentives

If you want to see the context to the ongoing geopolitical re-distribution of power that is threatening the world order, do not look at the margins of the European realm, like Ukraine. Look at Asia.

Here is an excellent discourse that supports the thesis of the emergence of two Asia:

• Asia dominated (already) economically by China; and
• Asia dominated (for now) military-wise and geopolitically by the U.S.

Read the full text here: http://belfercenter.ksg.harvard.edu/files/Summary%20Report%20US-China%2021.pdf and a summary here: http://www.businessinsider.com/major-change-in-world-order-china-us-economy-2015-5.

Europe has already decoupled with the U.S. on the issue of Chinese-led Asian Infrastructure Investment Bank, while BRICS have decoupled from the U.S. on a vast range of initiatives. But European signals of willingness to engage with the new Asia are going to continue being half-hearted, principally because of the second bullet point above - economic cooperation will not resolve the growing tension on geopolitical stage. Sooner or later, the U.S. dominance in Asia Pacific will be weakened to the point of the Western block playing a second (albeit not insignificant, by any means) role.

There are two levers for retaining direct and active links to the Asia Pacific centre of power that are currently available to Europe: India and Russia. Alas, both are lost to Europeans for now, one for the reason of perpetual neglect and the other for the reason of perpetual antagonisation.

Oh, and one last piece of 'food for thought' breakfast: as the U.S. is being squeezed in Asia Pacific, is it more or less likely that the U.S. will need to amplify cohesion of its allies around the Atlantic? And if you think the answer to this question is 'more likely' (as I do), what other means can the U.S. find to doing so other than by playing centuries old angsts across EU's Eastern borders?