The week in numbers

  1. QVNZ three monthly house price growth continued to accelerate, reaching 12.7%pa in July
  2. Retail sales growth was up 7.2%pa in the June quarter, and 4.8%pa in the June month.
  3. The exchange rate is crazy, falling to $0.67US at one point, currently around $0.69.

Robust house price growth and reasonable sales growth are not the sort of news that usually leads to a plunge in the exchange rate. However, with credit tight people are pulling out of NZ to try and get hold of some liquidity.

Product diversity and development

Tim Harford’s latest Undercover Economist column covers some interesting research on industrial development. The paper examines the type of products that countries produce, and the way that a country’s ‘manufacturing portfolio’ changes over time. The key finding is that countries tend to develop by producing similar products to those that they already produce.

This makes intuitive sense: if a country already has infrastructure suited to the manufacture of a particular product then it will be less costly to develop similar products than to develop radically different ones. The problem arises when a poor country with limited production diversity approaches the limits of its current manufacturing processes. It is very difficult and costly to make the transition to producing a new, unrelated product type. The paper’s data confirms that this rarely happens. Notably, the authors find that:

Rich countries have larger, more diversified economies, and so produce lots of products […]. East Asian economies look very different, with a big cluster around textiles and another around electronics manufacturing […]. African countries tend to produce a few products with no great similarity to any others.

If poor countries are to make the step to producing new products then some intervention in the development process may be required. This points to a role for some government industrial policy at a national level, or structural intervention at an international level. It could mean a new justification for infant industry protection in developing countries. It also, perhaps, points to a different way of making effective use of the limited aid money available to organisations such as the IMF and World Bank.

Marital Economics

The Economist Blog pointed out the following blog article. In this article Michael Munger points out how a marriage is like a firm, in the way that it internalizes all the transaction costs associated with purchasing ‘relationship’ goods (this is an application of the Coase theory of the firm). Although the Economist Blog agrees with this underlying way of looking at a relationship the two authors disagree on whether a two person relationship is optimal.

The Economist does have a point in that, a relationship with three or four people could hypothetically work, hell they do occur in real life. The way to analyse whether it would work is to look at the margin. Ultimately, the relationship should be willing to accept one more person if the marginal benefit of getting them in-house is greater than the marginal cost. In most monogamous relationships, the benefits of having another partner (Partnership, sex, love) are less than the costs associated with that partner (Putting up with another person all day, cost for deviating from social norms, costs of co-ordination 😉 ), as a result it is often optimal to stay in a two-person relationship.

Ultimately the optimal size of the firm/marriage depends on the preferences of the individuals involved, and the market of available suitors. Isn’t it beautiful to hear economists talk about love 😉 .

Let the healthcare debate continue…

There are plenty of worthwhile discussions amongst economists and policy-makers about the best way to fund health care. A debate that goes on largely outside the policy-makers’ domain, however, is whether increased health care spending actually improves health care at all. There is a sizable body of research which suggests that increased health care spending doesn’t improve outcomes one iota! If this is true then it makes the whole health care funding debate largely irrelevant.

The real problem with these rather counter-intuitive results is endogeneity bias: often large spending in a particular geographical area indicates that people with serious health problems live in the region. If this is the case then the cross-sectional sample is not randomly selected and the results will be biased. Thankfully, some brainy econometricians came up with a way to instrument for the endogeneity problem and they find that health care spending IS positively correlated with health care outcomes. So now we can all get back to arguing over our entrenched, ideological positions on health funding again. Phew!

New Zealand Currency in Free Fall

So the NZ currency is currently at $0.705US, implying that it has fallen $0.105US in two weeks. What the hell is going on?

As far as I can tell, investors in the US are nervous about some perceived economic contagion from the troubles in the sub-prime mortgage market. As a result of this economic uncertainty in the US, everyone has become significantly more risk averse in their investment behaviour, and in currency markets a ‘flight to quality’ has begun. The quality in this case is US dollars and the Yen.

So the economic situation in the US looks weak, and their dollar has appreciated against ours, messed up aye. Still, for that very reason I don’t think that this is sustainable. The fundamentals that drove our currency to $0.81US still remain in place, robust economic growth, strong world growth, awesome soft commodity prices, and comparatively high interest rates. I’m certain we will hit $0.76US again in the near future, and I wouldn’t be surprised if we hit $0.78US before September. $0.81US was a bit ridiculous, but I think we have fallen a bit past fair value.

Update: Now we are slipping under $0.69US, this reminds me of a famous Keynes quote “The market can stay irrational longer than you can stay solvent”. Damn those animal spirits.

Fair pay for the military?

This blog is all about the times that the market should give way to government intervention; however, I liked Stephen Levitt’s comment on military conscription too much not to post it up. It’s a great example of a case where an area traditionally managed by the government might be improved if we let the market have greater freedom. It’s also a classic Levitt-ism: where he applies economic reasoning to fields not usually studied by economists.

His idea is that, if military service was a job like any other, then soldiers would be paid commensurate to the dangers and hardships they endure. They would also be free to quit at anytime if they felt that they were not being paid a sufficient sum to compensate them for the risks they faced. This, in turn, would force the government to bear the true cost of waging a war: in war-time the troops wages would skyrocket along with the dangers they faced. In economic terms this must be considered far more efficient than the current situation.

The existence of mercenary troops and private security forces in Iraq is testimony to the fact that people are willing to work in that sort of environment if the wage is high enough. Of course, Levitt isn’t suggesting a privatised army, simply an army who can truly be called volunteers in wartime as well as in peacetime. Is that really as traitorous as the comments on his blog suggest?