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Black markets

admin — Wed, 03 Nov 2010 18:42:48 +0000

When price controls are imposed, exchanges at prices outside of the range set by the government are illegal. Governments may also make it entirely illegal to buy and sell certain products. This is the case with drugs like marijuana and cocaine in the United States. Similarly, prostitution is illegal in all states except Nevada. However, controlling prices and making a good or service illegal doesn’t eliminate market forces. When demand is strong and gains from trade can be had, markets will develop and exchanges will occur in spite of the restrictions. People will also engage in illegal exchanges in order to evade taxes. For example, the $3.39 per-pack cigarette tax in New York City has made cigarette smuggling in that city a thriving business.
Markets that operate outside the legal system are called black markets. How do black markets work? Can markets function without the protection of the law? As in other markets, supply and demand will determine prices in black markets, too. However, because black markets operate outside the official legal structure, enforcement of contracts and the dependability of quality will be less certain. Furthermore, participation in black markets involves greater risk, particularly for suppliers. Prices in these markets will have to be higher than they otherwise would be to compensate suppliers for the risks they are taking – the threat of arrest, possibility of a fine or prison sentence, and so on. Perhaps most important, in black markets there are no legal channels for the peaceful settlement of disputes. When a buyer or seller fails to deliver, it is the other party who must try to enforce the agreement, usually through the use or threat of physical force.
Compared to normal markets, black markets are characterized by a higher incidence of defective products, higher profit rates C for those who do not get caught), and more violence. The incidence of phony tickets purchased from street dealers selling them at illegal prices, and deaths caused by toxic, illicit drugs, are a reflection of the high presence of defective goods in these markets. Certainly the expensive clothes and automobiles of many drug dealers suggest that monetary profits are high in black-markets. Evidence of violence as a means of settling disputes arising from black market transactions is widespread. Crime statistics in urban areas show that a high percentage of the violent crimes, including murder, are associated with illegal trades gone bad and competition among dealers in the illegal drug market.
The prohibition of alcohol in the United States from 1920 to 1933 vividly illustrates how violence, deception, and fraud plague markets that operate outside the law. When the production and sale of alcohol was illegal during the Prohibition era, gangsters dominated the alcohol trade, and the murder rate soared to record highs. There were also problems with product quality (tainted or highly toxic mixtures, for example) similar to the ones present in modern-day illegal-drug markets. When Prohibition was repealed and the market for alcoholic beverages began operating once again within the legal framework, these harmful secondary effects disappeared.
The operation of black markets highlights a point often taken for granted: a legal system that provides for secure private-property rights, contract enforcement, and access to an unbiased court system for settling disputes is vitally important for the smooth operation of markets. Markets will exist in any environment, but they can be counted on to function efficiently only when property rights are secure and contracts are enforced in an evenhanded manner.
The analysis of black markets also provides insights into the economies of Russia, Ukraine, and other parts of the former Soviet Union. Following the collapse of communism, the legal systems in these areas reflected the prior socialist nature of these economies. Both the protection of private property and the enforcement of contracts between private parties were highly uncertain. People with political connections were of- ten able to escape their contractual responsibilities and obtain favorable rulings from legal and regulatory authorities. As a result, markets in these countries operated much like black markets. Fraud and deception were commonplace, and the incidence of violence related to business dealings was widespread. A market economy – like any other – does not work well in such an environment. Many foreign businesspeople who were initially attracted to markets in these countries soon began packing their bags and returning home. Financial capital fled, investment shrank, and these economies performed poorly. During the last few years, there has been some improvement in the legal environment, but the enforcement of contracts and conduct of business activities in the former Soviet Union still involve considerable risk. Without sound legal systems, these countries will be unable to reap the full benefits of a market economy.

Minimum wage

admin — Tue, 26 Oct 2010 18:39:45 +0000

In 1938 Congress passed the Fair Labor Standards Act, which mandated a national minimum wage of 25 cents per hour. During the past 65 years, the minimum wage has been increased many times. The current federal minimum wage is $5.15 per hour, although some states have their own higher minimum-wage rates ranging up to just over $7 per hour. A minimum wage is a price floor. Because most employees in the United States earn wages in excess of the minimum, their employment opportunities are largely unaffected by the minimum wage law. However, low-skilled and inexperienced workers whose equilibrium wage rates are lower than the minimum wage will be affected. Without a minimum wage, the supply of and demand for these low-skilled workers would be in balance at a wage rate of $4.00. Because the minimum wage makes low- skilled labor more expensive, employers will substitute machines and more highly skilled workers for the now more expensive low-skilled employees. Fewer low-skilled workers will be hired when the minimum wage pushes their wages up. The result will be a reduction in employment of low-skilled workers from E, to E,.
On the supply side of the market, as the wages of low-skilled workers are pushed above equilibrium, there will be more unskilled workers looking for jobs. At the $5.15 wage rate, the quantity of workers searching for jobs will exceed the quantity of jobs available, causing excess supply. Economists generally use the term unemployment when referring to excess supply in a labor market.
In summary, economic analysis indicates that minimum-wage legislation increases the rate of unemployment among low-skilled workers. The exceedingly high unemployment rate of teenagers in the United States (one of the groups most affected by the minimum wage) is consistent with this analysis. In the United States, the unemployment rate for teenagers is more than three times the average for all workers, and the unemployment rate for black youth has generally exceeded 30 percent in recent years.
It is important to remember that the market price- the wage rate- is only one dimension of the transaction. When a price floor pushes the wage rate above equilibrium, employers will have less of an incentive to offer nonwage benefits to employees because they will have no trouble hiring low-skilled workers. Predictably, a higher minimum wage will lead to a deterioration of the nonwage qualities of minimum-wage jobs, and so workers in these jobs will experience less convenient working hours, fewer training opportunities, and less continuous employment.
The adverse impact of the minimum wage on the opportunity of youthful workers to acquire work experience and on-the-job training is a particularly important unintended consequence of minimum-wage laws. Low-paying forcing people to take out no fax payday loans, entry-level jobs can provide workers with experience that will help them move up the job ladder to higher-paying positions. Employment experience obtained at an early age, even on menial tasks, can help a person acquire self-confidence, good work habits, and skills that make them more valuable to future employers. The minimum wage makes this more difficult. Not only does the minimum wage make it harder for low-skilled workers to find jobs, it also reduces their on-the-job training opportunities. In order to pay the higher wage rate required by the law, employers will have to find other ways to cut employment costs, like reducing the amount of job training. Not surprisingly, most minimum-wage jobs are dead-end positions with little opportunity for future advancement.
Workers who are able to maintain their employment at the higher minimum-wage most likely the better qualified among those with low skill levels
- rate
- a minimum wage. But other low-skilled workers are harmed by the minimum wage,
particularly those with the lowest skill levels, who will find it more difficult to get jobs. How many fewer low-skilled workers are hired because of the minimum wage? Studies indicate that a 10 percent increase in the minimum wage reduces the employment of low-skilled workers by 1 to 3 percent. Minimum-wage supporters argue that the higher wages for low-skilled workers are worth this reduction in employment and job-training opportunities. Critics argue, however, that the reduced job opportunities for the lowest-skilled workers are reason enough to eliminate the minimum wage. Does the minimum wage help the poor? Most minimum-wage workers belong to families with an income substantially above the poverty line. In fact, about 40 percent of minimum-wage workers are members of a family with an income in the top half of the income distribution. The typical minimum-wage worker is a spouse or a teenage member of a household with an income well above the poverty level. Therefore, even if the effects of a higher minimum wage on employment and non wage forms of compensation were small, a higher minimum wage does little to help the poor, making it a much less attractive antipoverty program than other alternatives.

Long-term renters will benefit at the expense of newcomers

admin — Tue, 12 Oct 2010 18:35:12 +0000

People who stay for lengthy periods of time in the same apartment often pay rents substantially below market value, while newcomers are faced with exorbitant prices for units sublet from other tenants. Distortions and inequities result. A book on housing and the homeless by William Tucker reports several examples: Actress Ann Turkel spends only two months each year in
New York. Turkel pays $2,350 per month for a seven-room, four-and-a-half bathroom duplex she has rented for many years. Identical apartments in Turkel’s building sublet for $6,500 per month. Former mayor Edward Koch pays $441.49 a month for a large one- bedroom apartment that would probably rent for $1,200 in the absence of rent controls.
Koch kept the apartment the entire twelve years he lived in Gracie Mansion (the official mayor’s residence) because had he given up the apartment, it would have been extremely difficult to find another one.
Imposing rent control laws may sound like a simple way to deal with high housing prices. However, the secondary effects are so damaging that many cities have begun repealing them. In the words of Swedish economist Assar Lindbeck: “In many cases, rent control appears to be the most efficient technique presently known to destroy a city – except for bombing. Though this may overstate the case, Lindbeck definitely has a valid point.

Inefficient use of housing space will result.

admin — Tue, 05 Oct 2010 18:34:46 +0000

The tenant in a rent-controlled apartment will think twice before moving. Why? Even though the tenant might want a larger or smaller space or an apartment closer to work, he or she will be less likely to move because it will be much more difficult to find a unit that’s vacant. Turnover will be lower, and many people will find themselves in locations and in apartments not well suited to their needs. In a college town, students who live in the local area will have an advantage over newcomers. Local students and their parents will be more likely to have connections with apartment owners in the area. Many students from farther away, including those who value the apartments more highly, will find it extremely difficult to locate a place to rent.

How will these global current-account imbalances correct: gradual adjustment or sudden shock?

admin — Mon, 29 Mar 2010 13:52:10 +0000

High levels of current-account surpluses in those countries which are manufacturing exports and producing resources and correspondingly high levels of current-account deficits in the consumer-driven importing economies cannot be sustained indefinitely. Borrowing such a high proportion of income must eventually be curtailed. But there has been considerable room for difference of opinion on how and when this would happen and whether the correction, when it eventually came, would be a gradual and relatively smooth adjustment of incomes and patterns of trade or a jarringly painful forced contraction of expenditure.
To explain what is involved, it is worth recounting the views of some leading economists in 2006, before the financial crisis erupted (for me, as a card-carrying economist holding a London School of Economics Ph.D. this is a natural reference point). The media characterizes economists as being unable to agree about anything. Disagreement on economic issues among professionals is as natural as it is among non-specialists. When policy advice depends on forecasts – which are always uncertain – and on different political standpoints and judgements, then economists do indeed express a wide range of views.
What is striking about this issue is that back in 2006 leading economists, from a wide range of different standpoints, were expressing very much the same views about the world current-account imbalances. They all agreed that the level of savings by exporters of resources and manufactures and correspondingly large borrowing by the importing countries, could not be sustained indefinitely. The reason is simple arithmetic. A country, even a large and great country like the United States, is in the same position as an individual; it cannot keep borrowing 5 per cent of its income forever, spending $105 for every $100 it actually earns.
There were arguments about the statistics. Some, for example, believed that there is hidden income on US overseas assets and that when this is included the deficit looks a little smaller. But almost no one disputed that eventually income and expenditure in the United States and other deficit countries would have to adjust, through some combination of reduced spending on imported goods and services and higher domestic production, to bring total expenditure more into line with total income.
Where there were disagreements was on how this adjustment would come about and how quickly, and on what policy measures might be needed to deal with it. Some were pessimistic about this adjustment process, anticipating what was commonly labelled as a ‘hard landing’. To take one example, Paul Krugman, Professor of Economics at Princeton University and an op-ed writer for the New York Times, wrote on several occasions about the possibility of an abrupt slowdown in US consumption and house prices and a potentially sharp dislocation in exchange and interest rates.2 He was concerned about both the sustainability of consumption and the role of international investors. Household consumption – which accounts for around 70 per cent of all US expenditure – might slow sharply, triggering a sharp decline in national output. There could also be a collapse of confidence by overseas investors, leading them to switch out of dollars into other currencies, and triggering a massive correction to the dollar exchange rate, far more than was required for adjustment of the external deficit, and leading to rising inflation and a major reduction in business confidence and private-sector investment.
Other commentators stressed the ability of the market to self-correct, arguing that households and taxpayers are not entirely short-sighted and would recognize when they, or government on their behalf, are spending beyond their incomes, and then gradually take steps either to reduce expenditures or to increase incomes. Savings, in other words, can be expected to rise gradually to bridge the gap. Market prices will also adjust to encourage this correction, so that we can expect to see a lower dollar exchange rate, at least against the Chinese renminbi and the Japanese yen. These will lead to higher US savings and to greater export growth, and to a slowdown in consumer borrowing and the growth of imports.
Many economists held these views. One elegant statement is to be found in a 2006 paper by the respected economists Guillermo Calvo and Ernesto Talvi.3 They contest Krugman’s argument that reduced investment in the United States by the Chinese government would lead to a sharp fall in US economic activity, arguing instead that the export of savings by surplus economies is unlikely to come to a sudden sharp halt; but they do acknowledge the possibility that a sharp correction in US housing markets could lead to a slowdown in US consumer spending.
It is now clear that the adjustment of the world’s structural currentaccount imbalances is clearly not going to be smooth. But the shock is not one of those identified by Krugman or indeed by any other economic commentator before early 2007. We have not so far seen a complete collapse in household consumption in the deficit countries. Nor have we seen an uncontrolled collapse of exchange rates and withdrawal of foreign capital from the United States, the United Kingdom and other borrowing countries. What has instead happened is an entirely unanticipated major and long-lasting dislocation to credit markets and bank funding.
As a result, far from a gradual adjustment of the world’s current-account balances, we now seem to be heading towards a much sharper correction through a massive contraction of credit, leading to falling household and business expenditure. If this happens it will create a cumulative downward spiral in world economic activity.

The impact of price floors

admin — Mon, 19 Oct 2009 18:37:37 +0000

A price floor establishes a minimum price that can legally be charged. The government imposes price floors on some agricultural products, for example, in an effort to artificially increase the prices that farmers receive. When a price floor is imposed above the current market equilibrium price, it will alter the market’s operation. A surplus (Qs – Q,) of the good will result, as the quantity supplied by producers exceeds the quantity demanded by consumers at the new controlled price. Just like a price ceiling, a price floor reduces the quantity of the good exchanged, and reduces the gains from trade.
As in the case of the price ceiling, nonprice factors will play a larger role in the rationing process. But because there is a surplus rather than a shortage, this time buyers will be in a position to be more selective. Buyers will purchase from sellers willing to offer them nonprice favors- better service, discounts on other products, or easier credit terms, for example. When it’s difficult to alter the product’s quality- in this case, improve it to make it more attractive for the price that must be charged- some producers will be unable to sell it.
It is important to note that a surplus doesn’t mean the good is no longer scarce. People still want more of the good than is freely available from nature, even though they want less of it at the controlled price than sellers want to bring to the market. A decline in price would eliminate the surplus, but the item will be scarce in either case.

Nonprice methods of rationing will become more important

admin — Sun, 27 Sep 2009 18:32:49 +0000

Because price no longer rations rental housing, other forms of competition will develop. Landlords will rely more heavily on nonmonetary discriminating devices. They will favor friends, people of influence, and those whose lifestyles resemble their own. In contrast, applicants with many children or unconventional lifestyles, and perhaps racial minorities, will find fewer landlords who will rent to them. Since the cost to landlords of discriminating against those they do not like is lower, discrimination will become more prevalent in the rationing process. In New York City, where rent controls are in force, a magazine article suggested that “joining a church or synagogue” could help people make the connections they need to get an apartment. Can you imagine having to devote this amount of effort to finding an apartment? If your city enacts rent controls, you just might have to.

Short Selling

admin — Sat, 26 Sep 2009 13:41:02 +0000

Shorting a stock involves selling a stock that an investor does not hold in the expectation that it can be bought back at a later date at a lower price. This provides a way to make absolute returns when stock prices are falling. Custodian banks act as facilitators to this process. Custodian banks approach their fund management clients to make stock lending agreements. Stock lending provides a means for fund managers to enhance returns, they lend the stock to the short seller, but retain all of their rights to the stock (dividends, rights issues etc.). In return the short seller pays a fee for this facility.
The custodian bank is exposed to counterparty risk and will also require a margin deposit from the short seller. The short seller sells the borrowed stock into the market. The proceeds from the sale cover the margin requirement and fees and leave a balance that can be invested elsewhere, usually in the money market.
Closing a short position requires a reversal of these flows. The short seller withdraws their money market deposit, buys back the borrowed stock in the market, returns the stock to the custodian bank and receives back its margin deposit.

The Irresistible Force and the Moveable Object

admin — Sat, 04 Jul 2009 17:55:56 +0000

As the capital account surplus is reduced while the current account deficit remains high, the pressure through the balance of payments is expressed through rising local interest rates and increasing downward pressure on the local currency. In order to maintain the peg, the central bank again intervenes, this time buying local currency (when capital was flowing in, it was forced to sell its own currency) and selling the base currency. In order to do so, it has to sell its foreign exchange reserves, which are denominated in that base currency. As local currency is bought from the market so supply is reduced and the interest rates attached to that local currency forced higher. The central bank has the unpalatable choice of sterilizing this effect by injecting liquidity back into the money market and thus effectively nullifying the effect of its foreign exchange intervention or allowing interest rates to rise and hurting the economy and asset markets in turn. As interest rates rise, so asset markets fall, forcing those investors who have stayed to cut their losses — and their positions — thus putting yet more pressure and so on and so forth. A vicious cycle develops, the length of which is decided only by the ability or the willingness of the central bank to expend its foreign exchange reserves. Eventually, one of two things happen, either the central bank runs out of reserves or the economic and financial cost of maintaining the currency peg becomes too great and the central bank scraps the peg and allows the currency to “float” (i.e. free-fall).

Capital Infows and Real Exchange Rate Appreciation – practice

admin — Fri, 03 Jul 2009 17:54:44 +0000

Asian countries pegged their currencies to the US dollar in order to provide a foundation for economic stability, while they got on with the job of growing their economies. In a sense these dollar pegs did their job too well. With Asian currencies pegged to the US dollar, it appeared that the idea of currency risk had been all but eliminated. Asia in the 1980s and early 1990s had been growing strongly in any case. Thus the Asian currency pegs together with strong domestic growth rates provided the platform for a veritable tidal wave of capital inflows to the region, both of the portfolio and foreign direct investment kind. The lack of currency volatility lulled investors into a false sense of security — though that false sense of security in some cases lasted for more than a decade.
Many Asian countries had relatively high inflation rates, higher than the US whose currency they were pegged to. Ordinarily, this should mean that a currency depreciates to offset its higher inflation rate, however in the case of Asia the sheer weight of massive capital inflows, combined with the currency pegs, meant that Asian currencies appreciated on a real (inflation- adjusted) basis, which was greatly exacerbated by the 35% devaluation of the Chinese yuan in 1994 and the depreciation of the Japanese yen from 1995. The result was widening Asian trade and current account deficits. Put simply, Asian countries were slowly but surely losing export competitiveness. High inflation and currency pegs meant high interest rates, despite the fact that most Asian countries ran healthy fiscal surpluses. This was not a problem for Asian governments since most were not seeking to expand domestic borrowing, but it was a problem for the private sector. Those currency pegs provided the illusion of exchange rate stability, encouraging corporations to borrow offshore at lower interest rates and swap back to domestic currency. As a result, significant external debt burdens were built up. Unlike in Latin America in the 1980s, this was private not public debt and went largely unnoticed in the more transparent public accounts. Thus, Asian corporate and bank balance sheets became increasingly exposed to external, US dollar-priced debt. While Asian currencies could not move, this was not an issue. Implicitly however, it meant if Asian currencies were ever allowed to depreciate, the capital base of those same corporate and banking sectors would be severely depleted if not eliminated. Asian currency devaluation would mean the cost of repaying that external debt would be multiplied by the extent of that devaluation.
By late 1996, real exchange rate appreciation had resulted in significant trade and current account balance deterioration. Thailand was running a current account deficit of some 8% of GDP. Assuming the balance of payments must indeed balance, the other side of a current account deficit must be a capital account surplus. This is indeed what happened in Asia. Massive capital inflows helped cause real currency appreciation, which in turn led to a rising current account deficit. To fund its widening current account deficit, Thailand had to attract an ever increasing amount of capital inflows. It did not get them. Instead, “fundamental” investors became increasingly wary and started if anything to reduce their exposure to Thailand in early 1997 due to a combination of increasing political and economic concerns and diminishing returns on their investments. As that capital fled — selling Thai baht in order to do so — so Thai domestic interest rates edged higher while the Thai baht itself came under increasing downward pressure.