Random thoughts of an economist

It is education! STUPID!

Posted in China, Economic growth, Economics, Parenting, teaching by kafuwong on March 24, 2014

Nobody said it better about the Taiwanese protest about a trade pact with mainland China than one of my friends who teaches Economics in Taiwan.

Rule no. 1 of free trade: comparative advantage.

All students who have taken Economics should know this principle. The major source of gains from trade is from the specialization in the tasks that we are relatively good at – at least in the short run.

Under free trade, refusing to specialize in tasks that we have comparative in will result in lower income and living conditions. In a sense, the competition that comes with free trade will crush us.

So, how can I survive the wave of free trade? The key is in understanding our own comparative advantage.

What determines our comparative advantage in performing different tasks? At the individual level, comparative advantage is determined by our inborn talent and temper (genes?), education, training and experience. Inborn talent and temper cannot be changed. However, education, training and experience can be adjusted to change our comparative advantage. For instance, an exchange experience at a German university might improve our comparative advantage in the trading business between Hong Kong and Germany. A bachelor degree in Economics will give us a comparative advantage in working in banks.

That is, we still can choose things we like to do but we have to invest enough so that we will have comparative advantage in the things we like to do!

In the longer run, competition will force us to invest in tasks that we want to have comparative in. You invest. I invest. Then, the productivity will eventually improve. We have a better world with higher productivity and more goods to consume.
What if you are the laid-back type who has no intention to invest and improve, or change career to specialize in things you have comparative advantage in? Then, you are doom to suffer once the competition (due to free trade) arrives.

In short, if you can ride on the wave of free trade, you win. If not, you will lose.

One way or the other, Taiwan has to open itself to the rest of the world. Keeping Taiwan close is not an option. Mainland China is the best example. Much of its growth has been due to the openness to the rest of world since 1978. Ride the wave earlier, you gain more. Ride the wave later, you lose (or gain less).

Students, go back to your classrooms. Study very very hard! Make sure you will have comparative advantage in the things you like to do.

P.S.: I am more sympathetic with those older people who would have difficulty in making their adjustment. To them, government should give a helping hand.

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A consistent bias in the Hong Kong’s budget surplus forecast

Posted in Economic growth, Economics, Forecasting by kafuwong on March 11, 2012

A plot is worth a thousand words. Why has there been a consistent bias in the government forecast of budget surplus? Why has the government been consistently pessimistic about the economy?

A forecast of labor shortage in Hong Kong

Posted in Economic growth, Economics, Forecasting, Population by kafuwong on March 11, 2012

Recently, the Hong Kong government released a forecast of manpower supply and demand to 2018. February 09, 2012 (http://www.legco.gov.hk/yr11-12/english/panels/mp/papers/mp0216cb2-1010-1-e.pdf). Some key findings were summarized below.

• The overall manpower supply is projected to be 14,000 people short of the overall manpower requirement in 2018 due to the ageing population.

• Releasing its preliminary key findings today on the manpower projection to 2018, the Labour & Welfare Bureau forecast manpower supply in 2018 to be 3,582,400, while the manpower requirement will be 3,596,400. The manpower requirement is forecast to grow at an average annual rate of 1.1%.

• It said the shortfall is due to slower growth in supply, mainly attributable to the ageing population.

• The manpower requirements of the four pillar industries are projected to increase, with tourism being the highest industry at 2.9% and financial services at 2.5%.

• The three economic sectors expected to grow fastest are financial services, at an average annual rate of 2.5%; and, construction, information and communications, which will grow at 1.9%.

• The Government will continue to upgrade the competitiveness and employability of low-skilled workers through training and retraining, the bureau said.

How do we understand such projection?

First, we have to understand that from economic perspective, without regulations, markets tend to clear by adjusting prices and quantities. Shortage cannot happen if prices are allowed to adjust freely. If one predicts a shortage of manpower, one must have assumed that the prices are not allowed to change. In fact, in economics, a shortage results whenever the price is regulated at a level below the equilibrium wage. That is, a more correct statement is “If wage is now regulated or kept at the current level, the change in supply and demand condition will result in a shortage of manpower of x  number of workers.” The corollary is that “If wage is allowed to adjust to clear the market, the change in supply and demand condition will result in an increase in wage by y  percent.”

We need to read similar reports with a grain of salt. Have we seen any manpower report that forecast a surplus of manpower? Of course not. Why not? Such report is meant to accomplish something. Let’s think about it. If you tell me you forecast a labor shortage, I will probably follow you logic that the labor shortage will hinder economic growth and thus a relaxation of immigration policy is justified. My problem is: Why don’t you describe your forecast as that the wage is going to increase. Is an increase in wage bad news? It is bad news to capitalist who would like to enjoy low-cost labor. However, it is in fact good news for workers! In short, we should understand the conclusion of a labor shortage (instead of an increase in wage) helps the capitalists. Why should we help the capitalists?

If we were start from scratch to produce a similar forecast report, we would have to think about how we can forecast labor shortage using different approaches. Can we produce forecast of labor shortage using historical shortage? In a free-market economy like Hong Kong, manpower shortage is theoretically zero at any given point in time. Thus, if we want to use the historical shortage to forecast future shortage, the best forecast is zero shortage. That is, we will not get anything that is nonzero.

The alternative is to forecast the labor supply and labor demand separately. Labor supply can broadly be estimated as the population between 15 to 65. In a close economy, we can produce a pretty accurate forecast based on population pyramid, taking into account the mortality rate and birth rate. The forecast can become slightly more complicated when immigration and emigration are taken into account. Immigration and emigration depends on the economic opportunities of Hong Kong relative to the rest of the world. When Hong Kong offers better opportunities than the United States, then some Americans will come to Hong Kong. Similarly for the flow between Hong Kong and mainland China. Of course, mainland China will be the major inflow. The flow from mainland has been driven by differences in economic opportunities, welfare, freedom, and re-union (cross-border marriages). To forecast this flow, we need to forecast the difference in economic performance of Hong Kong relative to many other countries. This task is daunting but we can always focus on a handful of countries from which we have more flow of people (both in and out). If we can produce a labor supply forecast, we definitely want to have a forecast by age group and education background. To do this kind of forecast, one will need to do extensive research. The easier alternative is to sit in an armchair and guess some reasonable numbers.

Labor demand is complicated. If we want to forecast labor demand using historical demand, we only have one data point at each given month. That data point is in fact the equilibrium quantity of labor, the result of an interaction of labor supply and demand. Thus, unlikely this quantity will be useful to forecast labor demand. One possibility is to do a survey and ask firms how many more workers they will hire in the coming 10 years — at the current wage rate. How many firms will be able to tell us such number? Unlikely any. Thus, one boils down to sitting in an armchair and trying to make some “reasonable” assumption of labor demand growth by sectors. How do we get those numbers? Likely by gut feelings. Sometimes, we will make an assumption of 2% growth in a sector, and let the computer to simulate what happen after many years.

In fact, what we are doing here is called scenario analysis. There is a popular way to do similar scenario analysis — computable general equilibrium (CGE) models. Here is an excerpt from wikipedia, http://en.wikipedia.org/wiki/Computable_general_equilibrium

Computable general equilibrium (CGE) models are a class of economic models that use actual economic data to estimate how an economy might react to changes in policy, technology or other external factors.

Given all this armchair forecast, how accurate will this forecast be? Highly inaccurate. It could be the case that when we adjust an assumption slightly, we can get a forecast of labor surplus. Will we report the labor surplus when we forecast one? Of course not! We are given the task to write a report that serves the hidden agenda. Only a forecast of a big labor shortage will cut it!

If I were going to do similar work (very time-consuming) with adequate freedom, I would want to report the set of parameters and models from which a given forecasted labor shortage will result. At least, it gives the readers a sense how reasonable (or unreasonable) my underlying assumptions are. I would also put my codes on the web so that other researchers could replicate my work, change the assumptions and produce new set of forecast.

Finally, we must note that an increase in wage in Hong Kong (i.e., better opportunities) will attract inflows of people from other countries. Even if there is an increase in demand for labor, it is likely filled by inflow from the other countries. That is, nothing to worry about. Let the market guide us. Do not use the highly inaccurate forecast that is led by a hidden agenda to help the capitalists.

Earthquake at Qinghai, China

Posted in Economic growth, Economics, Natural disasters, Research by kafuwong on April 15, 2010

Sad to read the news about the earthquake at Qinghai, China (http://www.guardian.co.uk/world/2010/apr/14/china-earthquake-death-toll-yushu).   At magnitude 7.1 and in a poorly developed province of China, the causalty can easily exceed 1000.  Indeed, in January 2010, an earthquake of magnitude 7.0 at Haiti killed more than 200,000.   So, a natural question is:  How is the causalties related to the level of economic development and the population density in the cities or countries?   What is the likely causalty at Qinghai?

It turns out that United States Geological Survey’s (USGS) Earthquake Hazards Program  (http://earthquake.usgs.gov/earthquakes/world/world_deaths.php) keeps data about earthquakes in the US and around the world.  One can easily obtain data bout GDP (a measure of economic development) and the population density of different countries.  With the collected information, a multiple linear regression of the causalties on the magnitude of earthquake, a time trend, the GDP and the population density should provide a reasonable answer to the question posted.  It turns out that a similar research has been conducted — “Economic development and the impacts of natural disasters” by Hideki Toya and Mark Skidmore (Economics Letters 94 (2007) pp.20-25). 

Of course, we might be interested in the alternative question: How does the frequency of earthquakes (or natural disasters) affect the economic development of a country?  I will leave that to you to tell me the relevant research papers on this question.