From Krugman's Blog -- For Wonkish Professionals

June 21, 2008, 12:31 pm
Vertical specialization and the impact of oil prices on trade
Wonkish post for the professionals, mostly.
I’ve written before about the CIBC study (pdf — second item) suggesting that high oil prices, by making shipping much more expensive, may reverse a significant amount of globalization.
A new NBER working paper by Koopman et al provides some numbers for a thought I’ve had about this: that the effects of higher transport costs may be especially large because so much of world trade these days involves vertical specialization.
What the authors find is that on average, half the value of Chinese manufactured exports consists of imported inputs; in the higher-tech areas, the number is often more than 80%.
Here’s my thought: in such cases, you want to think of transport costs in terms of a sort of effective rate of protection calculation, similar to the ones often used to show that third-world industries are much more protected than the nominal tariff rates might suggest.
Suppose that China engages in some export activity, but half the value is imported inputs. And suppose for the sake of argument that the price China can get for the final good in the export market is fixed by price of import-competing producers. Let the initial price be 100.
Now add transport costs that raise the price of anything shipped back and forth by 10%. This means that China has to cut its fob price to 91, so as to keep the cif price at 100. It also means that those imported inputs now cost 55, instead of 50.
And the result is that the value added China is able to collect falls from 50 — 100 minus 50 — to 36 — 91 minus 55. That 10 percent rise in transport costs in effect reduces the payoff to China from producing the good by almost 30 percent.
OK, you can question some of this: a lot of the inputs into Chinese production come from other Asian countries, so the transport cost won’t be as big a deal as shipping to the US. But the double squeeze, both on export prices and input costs, is real: CIBC mentions Chinese steel, which is suffering from higher cost of acquiring Australian iron ore as well as higher costs of shipping to the US.
If high oil prices persist, we could be seeing a large drop in world trade.
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June 21, 2008, 9:02 am
Calvo on commodities
Guillermo Calvo is one of my favorite economists. But — you know there had to be a but — I just don’t buy his latest missive. Still, it’s important that we have this debate: something awesome is happening to oil and other commodities, and figuring out what it means is crucial.
So, a couple of points.
First, Calvo dismisses the argument that the absence of physical hoarding is evidence against a speculation/liquidity source of high commodity prices. “Suppose, for the sake of the argument, that the demand for commodities for current consumption or production is completely inelastic …” Well, that’s assuming your conclusion.
When I think about speculation, I always start from Paul Samuelson’s classic analysis in terms of intertemporal price equilibrium (a 1957 paper — and not available, as far as I can tell, online. Why isn’t Weltwirtschaftliches Archiv on JSTOR?). Speculation can affect spot prices because it takes physical stuff off the market. Argue, if you like, that the inventory data are unreliable, or that stuff is being held in the ground; but don’t tell me that physical quantities are irrelevant.
Second, Calvo argues that inflation risks stem mainly from excess liquidity. He’s in good company there, but I won’t join in that chorus. In general, I don’t trust hydraulic metaphors for monetary economics. And we are in a world where central banks target interest rates, not monetary aggregates; the risk of inflation, if there is one, would come from Bernanke and Trichet keeping rates too low too long, not on what’s happening to M2 or some broader M-something.
On a happier note, it’s great to see top-flight economists weighing in on the crucial issues of the day. It’s kind of like the Asian financial crisis of 1997-1998, which was bad for the world but a sort of golden age for policy-relevant theory.
Update: Some correspondents have asked me what I think about the Congressional testimony of Michael Masters, who told a Senate subcommittee that “index speculators” — institutions that buy commodity futures as an investment — are responsible for the price surge.
The short answer is that I think his testimony is just stupid. Here’s what he says:
Index Speculators’ trading strategies amount to virtual hoarding via the commodities futures markets. Institutional Investors are buying up essential items that exist in limited quantities for the sole purpose of reaping speculative profits.
That quote pretty much epitomizes what’s wrong with a lot of what people say about speculation. Buying a futures contract for oil does not reduce the quantity of oil available for consumption; there’s no such thing as “virtual hoarding”.
And Masters really is confused about the difference between paper contracts and physical stuff. He compares the growth in the futures market with increased consumption from China, and says
The increase in demand from Index Speculators is almost equal to the increase in demand from China!
Again, the fact that someone bought a futures contract (which means that someone else sold one) doesn’t reduce the amount of oil available to consume.
I’m willing to listen to serious arguments about how speculation might be affecting the price, but you do see a lot of dumb stuff. And this is really, really dumb.
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June 20, 2008, 5:06 pm
FISA
My biggest concern about an Obama administration is that, in the end, he won’t make universal health care a priority. My second biggest concern is that “Unity” means never having to say you’re sorry: that in the name of putting past partisanship behind us, the next administration will sweep the abuses of the past 8 years under the rug, the same way Bill Clinton did in 1993; the result of that decision was that the very same people responsible for Iran-Contra showed up subverting our democracy all over again.
Obama’s support for the FISA bill intensifies my second worry. He did say some of the right things, promising to work to get rid of telecom immunity and hold people accountable. But caving on this bill is nonetheless not a good sign.
I’m with Greg, dday, and Atrios: this is a downer.
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June 20, 2008, 12:18 pm
Global news
Atrios asks why the dateline on this financial story is Bangalore.
Because Reuters now covers U.S. financial markets from India.
Fun stuff.
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June 20, 2008, 12:08 pm
Conservatives and evil speculators
The most startling passage in John McCain’s energy speech was his denunciation of speculators:
A futures contract assures importers that they can sell the oil at a profit.
That’s the theory, anyway. But we all know that some people on Wall Street are not above gaming the system. When you have enough speculators betting on the rising price of oil, that itself can cause oil prices to keep on rising. And while a few reckless speculators are counting their paper profits, most Americans are coming up on the short end — using more and more of their hard-earned paychecks to buy gas for the truck, tractor, or family car.
Investigation is underway to root out this kind of reckless wagering, unrelated to any kind of productive commerce, because it can distort the market, drive prices beyond rational limits, and put the investments and pensions of millions of Americans at risk. Where we find such abuses, they need to be swiftly punished.
Aren’t conservatives supposed to believe in efficient markets, where competition is good for everyone?
But McCain is following the likes of Steve Forbes and many articles in places like the National Review, all claiming that oil prices are a bubble, soon to disappear — a claim they’ve been making for at least three years.
What’s going on?
I think that conservative belief that the market is always right is colliding with another, even more deeply held belief — that there are no limits, except for those imposed by tree-huggers.The idea that oil might really be getting hard to find, in spite of the magic of capitalism, is just unacceptable; so they insist that it’s all craziness in the futures markets.
It’s not just conservatives who are into blame-the-speculators mode, of course; but they’re the loudest voices. It’s really weird.
Consider this an open thread for today’s column. (Sorry about the late posting: I’m very under the weather.)
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June 18, 2008, 1:40 pm
Concrete evidence of China’s importance
Cementing its place in the world economy
From The Oil Drum.
Update: A commenter sent me this link — but by the time I saw the comment, I had already posted it!
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June 18, 2008, 12:48 pm
Don’t worry, be happy?
Via Tyler Cowen, I learn that there’s a paper, regressions and all, evaluating how happy economists look. Yes, I’m in there — and I cry foul.
I mean, the photo they used is of me in a suit, posing for a book jacket — a combination guaranteed to make me self-conscious and, um, unhappy. Here’s a more characteristic photo (at the Bilderbuch cafe in Berlin, with my wife.)
Breakfast at the Bilderbuch
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June 18, 2008, 10:40 am
No sex please, we’re bananas
Good piece by Dan Koeppel. I highly recommend his book.
One interesting thing about the Great Banana Plague is that it’s a striking confirmation of the Red Queen explanation for why we have sexual reproduction: sex lets us reshuffle our genes, keeping one step ahead of parasites. The trouble with bananas is that they’re all clones, so that once a disease take hold, none of them have any resistance.
Of course, you might want to be cautious about following this line of argument. After all, the theory of evolution is responsible for fascism, or something.
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June 18, 2008, 9:23 am
Baselines, shmaselines
Wise words from the Tax Policy Center:
There is an easy way to cut through this palaver. Forget the baseline. Just think about three numbers: How much would either candidate collect in taxes as a share of the Gross Domestic Product? How much is government likely to spend? And, how much would they have to cut that spending to keep the national debt from ballooning.
TPC estimates that in 2013, Obama would collect revenues of 18.2 percent of GDP. McCain would bring in about 17.8 percent. Spending that year would be about 19.5 percent, according to the Congressional Budget Office, assuming the Iraq war will be winding down.
The key point, again: because of all those middle-class tax cuts in the Obama plan, he collects only 0.4% of GDP more in taxes than McCain. The tax collection comes from different people: lower and middle-income Americans would be substantially better off under the Obama plan. But where is the money for health care reform?
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June 17, 2008, 10:02 pm
Nothing has been learned
OK, I’m close to despair. If there’s one thing I hoped reporters had learned from the last 8 years, it was to NEVER, NEVER trust politicians’ statements about proposed tax changes. Year after year we’ve seen the Bush administration play childish games with the numbers; my favorite was the claim that cutting the tax rate on dividends was a gift to senior citizens, because the benefits would go disproportionately to people over 65. The reason, of course, is that most very rich people are also old.
So John McCain makes a typically Bush-like conflation: there are 21 million small business owners; there are small business owners in the top two tax brackets; therefore, Barack Obama plans to raise taxes on 21 million small businesses. It was nonsense, of course. (Most living things are microbes; men are living things; therefore, most men are microbes.) But sure enough, McCain’s claim is being reported as a fact.
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June 17, 2008, 10:08 am
The world gets bigger
Many people have noticed that higher fuel prices are putting the brakes on globalization: if it costs more to ship stuff, there will be less shipping.
How big is this effect? We know that the volume of trade between any two countries falls a lot with distance; this indicates that trade is quite sensitive to transport costs. This study gives a number:
[D]oubling transport costs from their median value … reduces trade volumes by 45%. Moving from the median value of transport costs to the 75th percentile … cuts trade volumes by two-thirds.
Now, the fuel price increase doesn’t have that large an effect — at least not yet. But a very back-of-the envelope calculation using CIBC estimates of the fuel cost effect gives me a 17 percent contraction in trade if oil prices stay at current levels for a long time.
Business travel will also be affected. Via Felix Salmon, airlines are starting to cut long-distance nonstops. Why? Because a nonstop from, say, NY to Singapore is kind of like a rocket ship: a lot of the fuel it carries is being burned to carry additional fuel, which makes overall fuel efficiency lower than a journey with refueling stops along the way. Of course, those non-nonstop trips take longer, so the world in effect gets bigger.
Interesting stuff. Fortunately, I no longer have to do a lot of flying to SE Asia and South America to keep tabs on the world financial crisis; I can get there on New Jersey Transit.
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June 16, 2008, 5:47 pm
On not knowing Who
NOT a phone booth
Shame on my employers. From the Times story on Russell Davies, describing Doctor Who:
The show followed the adventures of a time-traveling character whose spaceship was cunningly disguised as an old-fashioned telephone booth …
No, no, no! The TARDIS looks like a police box.
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June 16, 2008, 4:30 pm
Mundus vult decipi, ergo decipiatur
I saw this phrase in Alan Furst’s new book The Spies of Warsaw; it means “The world wants to be deceived, so let it be deceived.” A good slogan for the Bush years - but not only in reference to Bush.
I just read Naomi Klein:
Barack Obama waited just three days after Hillary Clinton pulled out of the race to declare, on CNBC, “Look. I am a pro-growth, free-market guy. I love the market.”
followed by a rant against Jason Furman.
Look, Obama didn’t pose as a Nation-type progressive, then turn on his allies after the race was won. Throughout the campaign he was slightly less progressive than Hillary Clinton on domestic issues — and more than slightly on health care. If people like Ms. Klein are shocked, shocked that he isn’t the candidate of their fantasies, they have nobody but themselves to blame.
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June 16, 2008, 12:56 pm
Campaign coverage puzzle
OK, I don’t get it. Barack Obama’s new Social Security proposal, love it or hate it, is huge news; it would push tax rates on some high-income Americans back to the levels of the 1970s.
Yet the proposal has received minimal media coverage — certainly as compared with the candidate’s Father’s Day speech, which was beautiful but didn’t have major policy implications.
If a candidate announces a major policy initiative but nobody hears about it, did it really happen?
Instant update: I went over to the Tax Policy Center’s blog, and discovered that the Obama campaign is itself downplaying the initiative:
The campaign clarified that the threshold would be $250,000, but Senator Obama has not specified what the rate would be, when it would take effect, whether it would apply to employers, employees, or both, or what the tax base would be.
Um, if the Obama campaign hasn’t figured out what this policy is, perhaps it would be best not to speak about it?
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June 16, 2008, 11:44 am
Tax policy puzzles
The Tax Policy Center comparison of the candidates’ tax plans is here. Anyone who cares at all about the issues should read it.
There’s nothing surprising in there about the McCain plan: it’s tax cuts and more tax cuts, all hugely tilted toward the top 1 percent of the income distribution.
The surprise about the Obama plan is how much in the way of tax breaks it contains, and how much that cuts into the revenue available for other things, especially health care. And there are two pieces that really puzzle me.
First is the income tax exemption for seniors with incomes under 50K. The Tax Policy Center explains:
Under current law, most senior citizens do not pay income tax because only a portion of Social Security benefits are subject to tax, and only for taxpayers with incomes above a threshold. In addition, senior citizens may claim an additional standard deduction. Nobody age 65 and over whose income comes entirely or almost entirely from Social Security is subject to income tax. The proposal would actually exempt comparatively well off, though not affluent, senior citizens from tax and give them a benefit not generally available to working Americans.
And I have to say, I really don’t like the idea that certain demographic groups get exempted from taxation. Why, exactly, is this part of the plan?
The other is Making Work Pay, a tax credit of up to $500 a year for workers; given the formula, the great majority of workers would in fact receive a flat $500. The thing about this proposal is that it’s very, very expensive: $700 billion over 10 years, or close to half typical estimates of the cost of the subsidies needed to achieve universal health care.
What I don’t get about this proposal is that we already have a program to help lower-income workers, the Earned Income Tax Credit. If raising wages at the bottom is a priority, why not just make the EITC a lot bigger? As it is, the Making Work Pay proposal would give most of its benefits to relatively well off workers — again, at a huge cost, large enough to pose real problems for other initiatives. What’s that about?
Consider this an open thread for today’s column.