All true but largely beside the point.

Thanks to the weather (an ice storm), I woke today to find that that I had a bit of extra time. So I sat with a cup of coffee and yesterday's NYT (December 10th 2007) and saw on the front page Lydia Polgreen's "Congo Republic Awash in Oil and Poverty". I readily admit that I expect to see certain things in any article on Africa. Ms. Polgreen's article did not in any way, shape, or form surprise me. In it (1) I found a naive notion that mineral wealth, overall wealth, and income are synonymous and found no mention of environmental issues, (2) I found too much focus on corruption, and (3) I found a careless use of numbers. One walks away from a piece such as Polgreen's confident that if they were given a month or two to run the show all would be well. Implicit in this is the ugly attitude that the people actually involved are so inherently bad, stupid or both that they cannot manage their own affairs. (1) RESOURCES: After having described the deplorable conditions at Brazzaville's main teaching hospital, Polgreen poses the following question "... why is the hospital, like so much of the Congo Republic, so tattered when the country sells billions of dollars of oil each year?" The answer is actually simple. Oil and willing workers it may have but the Congo Republic lacks human capital, tools and machinery and natural resources. The skilled labor to fix plumbing, repair light fixtures and electrical connections is in short supply. Also the capital it needs, real capital, both public (roads, well developed harbors, airports) and private (tools and machinery) is scarce in the Congo Republic. Finally, as green and lush as it may appear the Congo Republic's environment is very fragile indeed. As population has increased and farmers have been forced to change from traditional slash and burn techniques to more settled agricultural techniques, nutrient mining (the depletion of minerals in the soil and hence fertility) has been very high (1). This coupled with the Congo river (an annual river which goes from a trickle to rapids and back again) means that overall the country's natural resource base is quite poor. Nobody who takes a moment to consider how important natural resources, physical capital, and skilled labor to economic development will be at all surprised that the Congo Republic is so poor. Perhaps a better question would be how well those of us from economically richer areas -used to the advantages we enjoy-would cope with the obstacles found in the Congo Republic. _________________________________________________________ Of course, the preceding raises the question as to why the stock of skilled labor, tools and machinery and infrastructure is so poorly developed. Consider investment in public capital or infrastructural investment first. The Congo like most of SubSaharan Africa is sparsely settled. Therefore the cost of building and maintaining infrastructure is spread over relatively fewer people and people who are poor. As a result, the cost per person is by definition far higher than it would be in a more densely settled area. There is therefore in turn a lower chance that individual benefits will outweigh the costs. Because of this, as Ester Boserup argued a long time ago, poor and sparsely settled areas are caught in a trap that is difficult to escape. The publicly provided capital, the infrastructure, that the country needs to carry out economic activity such a producing and then transporting new light fixtures, paint, and plumbing fixtures to fix hospitals is far from developed to the degree that it should be. Without a great deal of extra effort this is unlikely to change. And low levels of investment in education, training, or in business is a chicken and egg problem. Take for example education. The benefits from the investment in education are contingent on what we expect others to do. If somehow a poor family could afford to give up the income that their children help to provide them*(see * below), it would all be worth it if that child in turn could find work that would make use of this education. However, this will only be true if the structure of the economy changes and this the family has no direct control over. Stuck at the bottom of a very deep hole individuals trying to climb up to the top on their own are unlikely to make it. Only if they were to cooperate, standing on one another's shoulders, might it be possible to escape. And this is not possible without a great deal of trust. While life at the bottom of the deep hole may not be too pleasant you know what you must face and know you can cope. What if a family helps others climb out only to find that when they have reached the top they have forgotten their obligation to help the rest escape? What of the risks of injury if this human ladder collapses means? It perhaps is better to leave well enough alone. Poor laborers, farmers, and business people are -because of their poverty-risk averse. (2) CORRUPTION: Even if one had the most dedicated and well-financed government in the world it is difficult to overcome these obstacles, especially when the environment is such that it lacks skilled labor and capital and the country's coastline has few natural harbors, its rivers are not navigable, rainfall is highly variable, and soil is poor. In short, when the hole is especially deep and the edges particularly slippery it will require far more effort and far more help than the help those in shallower holes required. Corruption does not help make it any easier for a poor country to climb out of the hole it is in. However, for every twenty pieces written on the political and economic obstacles African countries face that focus on corruption there may be one that mentions the problems of poor natural resources, low private investment and poorly developed infrastructure. A change in political culture will not make the Congo River more navigable. It will not change the speed with which the costs of increased population and density emerge (urban overcrowding, nutrient mining, and so on) versus the speed at which the benefits appear (a wider base to spread infrastructural investment over only works if the level of real per capita income remains constant or increases.) It can of course alter the payoffs from private investment in such a way that it lessens the risks to any one family or business taking the first steps to educate, train, or invest in their own business or farm. However, a less corrupt government does not alter the contingent nature of these investments. What I referred to as the chicken and egg problem remains. Blessed with natural harbors, timber, coal, iron ore, fertile land, labor (first brought in chains and the driven here by poverty) the U.S. has prospered despite Tammany Hall, McCarthyism, Watergate, or Enron. Although India's shining is more an example of how all that glitters is not gold (see Mira Nair's Planet India for example) its growth is high despite widespread corruption. To blame poor performance on corruption is cruel when no matter how well run things might be or how selfless public servants could be, the hole is so deep and so hard as to be almost impossible to climb out of. (3) PROPORTION: My last criticism of Polgreen's piece involves simply taking the numbers she had reported and asking a few relatively straightforward questions. For example, Polgreen states that the Congo Republic churns out 250,000 barrels of oil a day. At $90 a barrel this means that that the Congo would earn $22,500,000 a day or $8,212,500,000 a year. This sounds like an awful lot of money. However even with a population of only 3.8 million people this then represents only $2,161.18 a year available per person. Say that actually only half of this (about $1100 per person) could be turned back over to development because the rest is needed to cover costs of production and that none of this money was wasted. It is without a doubt true that a great deal could be done with this in such a poor country as the Congo. It is equally true that the average American would need to pay only about $14 a year and that the burden would be even less (far far less than what the average American family spends eating out or on entertainment each year, about $5,000 per family) if all the economically more developed parts of the world were to ask its citizens to put money into what might be called something like a Help Africa Compensate for Corruption Fund. In sum, we could help those most in need if we were to actually go out and buy a ladder rather than standing at the edge of this deep hole criticizing the behavior of the leaders on the bottom. The money wasted by government officials on travel, lobbying, and such is not confined to just countries like the Congo Republic. *(See above) Stephan Thernstrom in _Poverty and Progress_ wrote eloquently of the problem that the families of unskilled workers in Newburyport, Massachusetts faced. "The relentless pressure of poverty -stemming from the depressed wage level for common labor and from sharp seasonal fluctuations in employment opportunities -forced the children of Newburyport's laborers into the job market at an early age. Sometimes a laborer went several weeks without earning a cent; then the four dollars a week that his twelve year-old son earned as a bobbin boy was the family's sole source of support. Opportunities for formal education past the age of eleven or twelve were effectively nil for working class children" (Thernstrom, 1971, pp. 22-23) For more on geography as a barrier to trade see Hummels "Time to Trade"

Taking stock of financial markets and the FED

Before mid September when the FED shaved off 50 bp from its fed funds target the DOW stood at 13404.42 (9/17/2007). After its September meeting, and as one would expect, stock prices began to climb. They in fact rose quite rapidly, reaching a peak in early October when the DOW hit 14164.53 (10/9/2007). The situation just as quickly changed however. Between the 9th and the 19th some 85% of the 5.7% climb in stock prices was lost. In short, on the 19th the DOW was only a fraction of a percentage point above where it had been prior to September 18th. The only thing that changed this was the growing anticipation of the .25% rate cut in the fed funds rate. As a result of this we have seen a healthy increase in stock prices in the last few weeks. (To see what has happened to the DOW over the last six months click here and choose zoom 6m) However, with the actual announcement on Wednesday that this was indeed what the FED was going to do we see a drop in prices rather than the sort of dramatic increase in stock prices that took place between September 18th and October 9th. Two questions immediately present themselves: (1) what accounts for the very different reaction to Fed rate cuts and (2) what can or should the Fed do about it? As the late John Kenneth Galbraith in his book the Great Crash "Of all the weapons in the Federal Reserve Arsenal, words were the most unpredicatable in their consequences" (JKG, The Great Crash, p. 38). Along with their announced cut the Fed pointedly noted that they now regarded the risks of inflation to be as important as the risks of recession. One interpretation of this, don't expect further rate cuts any time soon. One might charitably think that this was a more than reasonable statement to make, especially in light of what the figures for real income growth (the real GDP stats) for the third quarter of 2007 indicated. They showed a very robust economy, despite weakness in the housing sector with the demand for our exports growing at a much faster clip in the third quarter than in the second (16.2% versus 7.5), federal government spending growing at a slightly faster rate, investment in equipment and software continuing to grow, consumer spending growing at over twice the rate that it had in the second quarter and so on. However the weakness in housing is very real, with residential fixed investment falling 20.1% after already having dropped by 11.9% in the second quarter. Perhaps more significant is that nonresidential fixed investment grew at a slower pace than it had in the second quarter. Also over a third of a percentage point in the 3.9% growth in real income and production last quarter was due to a substantial build up in inventories. Part of this build up must be in anticipation of growing demand. As a result, continued growth in demand is a necessity if this build up of inventories is to be justified. Of course, another part of the build up could be due (and probably is due) to the weakness in housing and the softening of nonresidential fixed investment. In hindsight, it might have been better if the Fed had reported that it was still more concerned about economic weakness than inflation because as Galbraith suggested what the Fed says has very unpredicatable effects. All it took were the words that it was as concerned about inflation as it was about recession to short-circuit what arguably was one of its chief reason for cutting interest rates, to soothe financial investors' fears. Whether you believe that the Fed will have any reason to raise rates some time in the near future does not mean that you will continue to hold stock. The fundamentals matter far less than what you believe others -rightly or wrongly- think and how they will react. If you think a sufficiently large number of your fellow traders are likely to be bears then you have no choice but to follow suit (unless you can wait things out a bit) It did not help matters at all that the price of oil went higher as buyers in the oil market factored in growth in overall demand in the U.S. market. (They of course failed to factor in the impact in turn of significant oil price increases on that growth.) This undoubtedly added fuel to the speculation that either the Fed would indeed refrain from further rate cuts (and possibly in fact raise rates) or at least to an increasing belief that others trading stocks felt this way. Others then would be less inclined to hold stock, penalize those who failed to follow suit, and thus depressed the market still further What has been encouraging and characteristic of the fed funds futures market is that until this morning's jobs report traders were still betting strongly on another quarter percentage point rate cut in December and more than even odds of yet another cut of .25% in the targeted rate in January. However with the jobs report, an unemployment rate still at 4.7% but growth in payroll double the consensus estimate, these estimates have changed, especially in the case of another 25 bp cut in December. The probability of a .25% cut in the targeted rate implied by the price of these contracts has fallen from a 84% probability to only a 68% chance. (for more on this market click here.) Still I think the point to emphasize is that as of now it remains true that the majority in this market still believe that it is more than likely the Fed is going to be cutting another .25% off the fed funds target by mid December and still more than even odds that it will target still lower rates in January. This is regardless of what the Fed might have wished to suggest on Wednesday The added liquidity to help struggling banks that recklessly overextended themselves is there but the Fed must also take the reaction of financial markets into account. The simple fact is that if banks fail or capital markets seize up then the final quarter of 2007 and the first quarter of 2008 will not be as strong as they could be, whatever strengths we saw in the U.S. economy during the third quarter. One might argue that the credibility of the Fed -having suggested that further rate cuts should not be expected- is in danger if it does indeed cut rates further. The Fed did not however categorically state that it was not going to further cut rates. Also, it is fortunate that most involved are wise enough to realize that even if the Fed had made such a foolish and categorical statement at the end of October concerning its plans a month and half later that this is subject to change.

Inequality Rises in the U.S.

This report (click her) ran a while back on NPR's Morning Edition. (For the numbers the report was based on click here.) The bounty going to the top 1% of Americans has pushed past that of even the 1990s. What was offered as an explanation was the simplistic notion that the demand for services of highly skilled labor was rising faster than the economy overall was growing. However with even a basic background in economic theory it should be apparent that higher returns in a competitive market invites entry. (In point of fact, one definition of competitive market is that free and easy entry into a market is possible) All else equal, as suppliers exit the market with lower returns and enter the market with higher returns the value of the former should rise and the latter should fall. Persistent inequality is a sign of failure of the market system rather than the price to be paid for all the very real benefits markets provide. Skills mean in essence education and so the issue of persistent inequality begs the question of why access to quality education is so inequitably distributed. To focus on the competition that unskilled labor faces from technological change or from abroad diverts our attention from this much more awkward question. The poor cannot afford to live in areas where the property tax base is high enough to support good public schools. It is even less likely that the poor can afford to send their children to private schools. And most importantly, despite whatever unrealized potential a given student might ultimately have, the poor cannot hope to leverage this potential into the sorts of loans that would fund that child's education and lift that child and her family out of poverty. Given the imperfections that exist in credit markets this is out of the question. Add to these financial constraints families at the top end of the income distribution have accumulated many advantages over the years . These advantages include the skills required to negotiate the educational system to our childrens' advantage and you have a fairly complete explanation of why inequality is so persistent in America. (See Annette Lareau's Unequal Childhoods or her earlier book Home Advantage) It is important to note that despite the very real problem that persistent inequality presents, the IRS numbers overstate the degree of inequality. Many students and other young adults from middle class and wealthier families file returns. The adjusted gross income of a graduate student with a tuition fee waiver and a monthly salary for working as a teaching assistant or research assistant or, more importantly, the college student who works part time as kitchen help or as janitor will be pitifully small. However, their poverty is only temporary and not very real. As they go to school or work part time and try to find some direction in their lives they live comfortably and securely.

on market falure, game theory, and government policy

Markets are efficient when they are able to communicate information at the lowest cost possible. Therefore one way of characterizing market failure is to describe it as a situation in which markets do not or cannot communicate information effectively. When markets fail there is possibly some benefit to government intervention. However, to the degree that markets communicate information, one should be leery of government intervention. Goverment intervention may disturb the delicate process of communicating information between buyers and sellers. There is also the very real potential of policy makers acting in their own self-interest rather than working for the general good. Communication failures 1: Unable to communicate, negative externalities. In the case of negative externalities, such as pollution, markets fail because prices do not convey full information of the costs of their activities to buyers and sellers. Polluters and their customers consider only the costs they have to bear. Why do they fail to take into account the total cost of their actions ? The principle reason is that other parties cannot accurately express what share of the resources harmed by pollution are theirs. And it is often too costly for individuals hurt by pollution to form a block that could effectively communicate to the polluting company the total costs of its activities. (For more on these problems click here.) Government steps in to supply this information to polluters, most commonly through emissions taxes. Communication Failures 2: Unable to communicate, missing information. There are many instances where markets not only do not communicate information efficiently but in which they cannot. The facts are simply not there to be uncovered. What happens as a result of one’s own actions are contingent on what everyone else does. In turn, what others plan is contingent on their expectations of what still others will do. There is absolute ignorance of what the future will bring. The future is not something to be uncovered through careful study but rather it is something we create. From an individual perspective, this lack of information means that often it is far better to wait than to act. Economists have experimented with all sorts of terms to capture this: for example, linkages (Hirschman), circular and cumulative causation (Myrdal), and most recently, complementarities (development economist), reciprocal externalities (public choice theorists), and network externalities where you capture benefits being part of the same group or network; investing businesses, educated workers, and so on (economists working in the field of industrial organization).

Why better safe than sorry rather than nothing ventured nothing gained? There are of course many transactions which are small and routine and the potential costs of mistakes are therefore small. Here one can experiment. One needn't rely on trust or extensive experience. Say that I spend $1 to buy new brand of cola rather than Coke. I discover that I don’t like it nearly as much as I do Coke. The next opportunity I have I will simply remember to buy Coke rather than the new brand and my loss, the cost of my mistake, is at most the $1 spent. However, there are many transactions that are infrequent and that are far from routine. Basically whenever it is the case that a transaction is large (large from the perspective of the individual involved) and, at least at first, the transaction is far from routine the costs of making a mistake are quite high. We see people hesitate for this reason. Whether a given choice has been a wise or a foolish choice hinges crucially on what others do. Your assessment of the wisdom or folly of a particular decision then hinges crucially on what you think others will do. Before deciding to reenter the bond and stock market (and to therefore begin to take greater risks again) in the wake of a bear market, a financial investor must be confident that others will soon begin to feel bullish as well . In an economy where, even with education, jobs opportunities are scarce, a poor family sending their children to school (and in the process foregoing the income they would otherwise help bring in depends on) hinges on being confident that jobs will be there. Residents living in the vast slum of Dharavi in Mumbai agreeing to move into smaller living spaces, doing their handicraft work in the centralized location promised, hinges crucially on their being confident that the promised work space will materialize. In all of these cases resistance to change is far from irrational. The costs of mistakes are so great and the decision to heavily invest in bonds, to take years out of one’s earning life for education , or to agree to move if markets remain bearish, job opportunities scarce, or promises are not kept impose costs too great to absorb. Game theory. Game theory focuses on such situations.* In the classic prisoner’s dilemma criminals face potentially tremendous costs. To minimize the damage that might occur to them individually they confess rather than stay quiet. A socially efficient decision (from the standpoint of this society of two criminals at least) would be to keep quiet. However not knowing what the other prisoner is doing to do, the equilibrium solution is to confess. Both do so and both are far worse off than they would have been if they had just kept quiet. The reason they don’t is in part because they do not know what the other will do. However, the choice made is more importantly due to the fact that they make this decision only once, and that the costs of mistakes are very high indeed. Contrary to the typical examples of market efficiency in a prisoner's dilemma rational self-interest leads to socially poor results. If you keep the same fundamental structure of a prisoner’s dilemma (choices/decisions are not small routine ones and where mistakes are relatively expensive and are not quickly or easily corrected) but alter the payoffs in such a way that the actions of decision makers (players of the game) are complementary you move from a prisoner’s dilemma to what are called coordination games.** To say that the payoffs are complementary means that they are very much contingent on what others do. Good or bad, decisions reinforce one another. If we are able and willing to take risks and are fairly confident that others will act in such a way that their choices positively reinforce our actions then we will go ahead. If we are not confident of this, it is better to wait.

In classic examples of market efficiency, no one need think strategically at all and the environment is truly a competitive one in which the gains of some are offset by the losses of others. We do not have to think strategically because the costs of mistakes are so small. In a prisoner’s dilemma we think strategically at first but ultimately decide that regardless of what others might do it is best for us to protect ourselves whatever might be the long-run costs to society and to ourselves. In a coordination game , we think strategically throughout and must trust others to act in a certain way before we are willing to move in a positive direction. Unless confident of what others may do, their actions materially altering the payoffs of our taking on greater risks, we are better safe than sorry. Nothing ventured nothing gained is too dangerous a philosophy for us to follow. Understanding the obstacles to forward movement government can act as a catalyst to decisions taken by private citizens and businesses and can improve on market outcomes. In the process the payoffs change in such a way that sellers’ costs, the prices buyers must pay, the uncertainty of markets materializing and the contingency of individual decisions are reduced. President Clinton’s Aids/HIV initiative can be viewed in this light. With private donations and government grants he provided a guarantee to drug companies that if they were to ramp up production and, in so doing, realize large enough economies of scale to lower costs demand would be sufficient to absorb the added production. The guaranteed demand was made possible though the Clinton foundation support that supplemented recipient countries’ funding. By guaranteeing a market President Clinton broke the deadlock that otherwise would have gone on for far longer. *The late British economist G.L.S. Shackle wrote of "crucial experiments" which by their very nature are nonroutine and potentially very costly if they fail. Although I am not aware of anyone doing so, one might draw a direct link between Shackle's crucial experiments and nonrepeated games. Also, in mainstream economic theory, there is Christina Romer's irreversibility hypothesis -that decision makers confronted with uncertain situations rationally will delay committing to making any decision and spending when such commitments are costly to reverse. (see " Irreversibility, Uncertainty, and Investment" Pindyck,Robert S., Journal of Economic Literature, 1991, 29, 3, 1110-1148 and "Uncertainty as a Propagating Force in The Great Depression" Ferderer,J.Peter; Zalewski,David A., The Journal of Economic History, 1994, 54, 4, 825-849) For more on coordination games see "Coordination" by C. Monica Capra and Charles A. Holt Southern Economic Journal, Vol. 65, No. 3 (Jan., 1999), pp. 630-636 or Debraj Ray, Development Economics, Princeton University Press.

sanitation in india

For anyone travelling to India the question of public sanitation naturally arises. Garbage collects on the streets alongside animal waste. Men stop on the side of the road to relieve themselves. Toddlers squat right out in the open to defecate. The extremely naive notion is that it is culture that explains why Indians of all walks of life accept this . (India of course is far from alone in the developing world in struggling with these issues. Click here for more.) A historical perspective. In _Conditions of the Working Class in England_ Engels describes 19th century urban England. It matches what one sees in urban India today: Every great city has one or more slums, where the working-class is crowded together. True, poverty often dwells in hidden alleys close to the palaces of the rich; but, in general, a separate territory has been assigned to it, where, removed from the sight of the happier classes, it may struggle along as it can. These slums are pretty equally arranged in all the great towns of England, the worst houses in the worst quarters of the towns; usually one- or two-storied cottages in long rows, perhaps with cellars used as dwellings, almost always irregularly built. These houses of three or four rooms and a kitchens form, throughout England, some parts of London excepted, the general dwellings of the working-class. The streets are generally unpaved, rough, dirty, filled with vegetable and animal refuse, without sewers or gutters, but supplied with foul, stagnant pools instead. Moreover, ventilation is impeded by the bad, confused method of building of the whole quarter, and since many human beings here live crowded into a small space, the atmosphere that prevails in these working-men's quarters may readily be imagined. Further, the streets serve as drying grounds in fine weather; lines are stretched across from house to house, and hung with wet clothing. (For reference click here.) Stuart Blumin in his book _The Emergence of the American Middle Class_ describes the same transition taking place between late 18th century urban America and the post-bellum period. Urban America moved from "street-alley segregation" of classes to "areal" segregation. Street-alley segregation meant wealthier families lived on the broader, better maintained streets while poorer families lived nearby, down narrower and more crowded alleys. Areal segregation means different social classes living in distinct neighborhoods. Advances in transportation made it possible for more affluent city dwellers to in one way or another to remove themselves from direct contact with what Engels describes above. And something similar is happening today in modern India. Slums are being cleared and slum families relocated. In the place of slums multi-storied apartments are built for the middle class and wealthier families. Those able to separate themselves from the less fortunate do so. It means that the illnesses and the other problems of the poor become less and less of an immediate threat to their own family's well-being. With this, the more affluent need worry far less about the poor's welfare. The poor continue to live their lives, removed from the sight of the "happier" classes . No Other Choice: Enduring open sewers and refuse of all kinds is not a cultural choice. Access to running water and toilets is obscenely small in India. With considerable variation state by state, according to the 2001 census fewer than 30% of homes in India have toilets (with a sizeable percentage of these being pit latrines or pit toilets. For a break down I've compiled state by state click here). This begs the question as to why investment in water and sewer systems are not given priority, especially given the seriousness of the diseases caued by improper sanitation.

Two important differences between modern India and urban 19th century America and western Europe:

The provision of clean water and sewer connections was not remarkably fast in the now indistrialized world (see for example, Martin Melosi's _The Sanitary City_) There are two things that make India's current situation different from western Europe or America's in the 19th century however that have made progress even slower in India and in other economically developing countries. The first has to do with the medical advances that have taken place between the 19th century and now. The second is the sheer size of the problem India faces now now versus what America and western Europe had to deal with a century and a half ago.

Modern medicine has made it possible for economically privileged families to protect themselves without having to worry as much about the poor and their situation. In contrast to 19th century America and western Europe, middle class and wealthier families can insulate themselves fairly effectively against diseases such as cholera and dysentary. Abram De Swaan in his book _In the Care of the State_ details how even as more properous families located in suburban areas with new construction and water and sewer lines they could not completely protect themselves from diseases spread from the poorer sections of 19th century America and Europe. Also with greater numbers of poor people crowded into urban areas it was more and more likely that dieseases such as cholera would break out and spread from poorer areas to wealthier ones. Before antibiotics, other advances in medical care, and insecticides weighing the threat of diseases spreading to wealthier neighborhoods against the added costs of extending water and sewer lines to poor neighborhoods, the calculus of enlightened self-interest tipped the scales in favor of the poor (see Abram De Swaan, pp. 137-142). In modern India the costs and the benefits have changed radically. Poor areas are incredibly congested and therefore very difficult (i.e. costly) to connect to existing water and sewer lines. At the same time and more importantly, the direct benefits to wealthier families of such measures are far less thanks to modern medicine which better protects them against the threat of diseases originating in poorer areas.* *Susan Chaplin in her article "Cities, Sewers and Poverty: India's Politics of Sanitation" (environment and Urbanization, 1999, pp. 145-158) clearly notes this "...the very developlements in modern medicine and civil engineering that contributed to the success of sanitation/ public health in nineteenth century Britain have enabled the middle class to largely ignore environmental problems and the resulting diseases. The use of antibiotics and insecticides have generally contained potential epidemics in slum areas, and hence have not generated a mutual awareness amoung the middle-class that it would be in the interests of society as a whole if the poor were provided with decent living conditions" (Chaplin, p. 151) The congestion and the resultant costs of dealing with sanitation issues are in part a function of much higher rates of increase in numbers and therefore a much larger scale problem to be dealt with. Mira Kamdar in _Planet India_ notes that urban India grows by 10 million people a year. and in Calcutta, The Living City, volume 2 it is noted that Mumbai saw its population increase by 1000 people per day through migration. (Although these numbers are out of date one can imagine the problem is even worse today). America and western Europe had much smaller numbers to deal with during their periods of substantial urban growth. Other factors: A great degree of India's failure to conquer the problems of sanitation and clean water are therefore arguably due to the these two factors. Other factors of course are at play as well. There is the fear on the part of municipal authorities that if in they take measures to improve the living conditions of the poor that this will simply attract more poor migrants to them. There is a Harris-Todaro like argument implicit in this that therefore improvements will be short-lived. As conditions in city A improve a larger fraction of those migrants who might have moved to city B will move instead to A, overtaxing its capacity to serve them and pushing living conditions back to where they were before. The initially cleaner city is ultimately no better off than it was before. One conclusion to be drawn from this is that piecemeal efforts to effect change are far less likely to achieve success than coordinated concerted effort on at least a regional if not national front. There is also the fact that many slum areas are occupied by squatters. The fear is that extending proper water and sanitation will legitimize squatters' claims to these lands. Often large slums are located in what are considered areas of prime real estate (currently Dharavi in Mumbai and the Salt Lake area in Kolkata years ago as well.). As an area becomes more and more settled real estate developers must realize that it will be far more difficult for the state to remove and relocate slum dwellers from these areas on their behalf. (see pages 14-15 of Burra, Patel and Kerr, "Community Designed, built and Managed Toilet Blocks in Indian Cities" Environment and Urbanization, 2003, pp. 11-32) The great predicament is that if the Alliance (SPARC, the National Slum Dwellers Federation, and Mahila Milan) estimates are correct and a 10 seat toilet block will serve 500 people in an area are realtively low cost ($800 U.S. to build a well-designed 10 seat toilet block with pour-flush systems) the fact remains that to tackle this problem requires massive expenditures. For example, in Mumbai almost 2000 such blocks would need to be built to cover slum dwellers who, as of now, haven't access to proper facilities at all. Using the official exchange rate, the total costs would therefore be over one and a half million dollars U.S. (and in terms of purchasing power parity almost $8 million U.S.). Regardless of the cost, management of various charities and NGOs of 2000 such projects along with the competition for money as these organizations work independently of one another implies a high degree of inefficiency. Yet along with the decided apathy that exists due to government focusing mostly on the interests of the well-to-do and the powerful there is the issue of government inefficiency. Burra, Patel, and Kerr make a strong case for being more than a bit skeptical about the ability of municipal governments being at all efficient. One Alliance study cited in their article shows that contractors have routinely built substandard toilet blocks.** Inadequate water supplies in particular mean that often in as little as three months latrines become so blocked and dirty that they become unusable. This couple with builders asking community members for more money as toilet blocks are being built in their neighborhoods and the city charging unrealistically high fees for access (Rs150 for a family of five would allow each family member to use the facilities once a day) suggests that perhaps community based initiatives, given political realities, are on balance a better alternative. ** See Robert Wade_Governing the Market_ pages 288-289. Contrasting corruption in Taiwan to corruption in India he notes that in East Asia: "Most rumored or reported corruption takes place at the local and provincial government levels where nothing major for the national development effort is at stake ... In all these ways corruption contrasts with corruption in many other countries in South and Southeast Asia. Corruption on public works projects, for example, occurs mainly through overcharging for correctly built structures. In India it occurs mainly by substandard construction of correctly priced structures, which are much more likely to wash out in the next monsoon. Taiwan's mode is probably less damaging to economic development than India's".

More public support for higher education

A story on Congressman Jim Webb's proposal to more completely fund veterans college education ran this morning on NPR's Morning Edition. More specifics on Congressman Webb's proposal is to found here on his website. Another related story ran on Marketplace Morning Report. On October 1st a new law comes into effect that changes how students loans are distributed and the rates of interest charged. For more on this click here. The impetus for this new law comes from the Campaign for America's Future .

The G.I. Bill

One way of describing what college professors do is to say that we perpetuate middle class privilege. We could also say that we help to protect the economic gains many families and the American economy overall enjoyed as a result of the G.I. Bill. For more on the G.I. Bill and its impact on American society click here.

socioeconomic standing and access to higher education

Over the last several days I have been struggling with some numbers I had seen reported. These numbers are statistics on minority enrollments and the persistence of enrollment gaps between African-Americans, Hispanic Americans, Non-Hispanic White Americans and Asian Americans. A study by Carnavale and Fry for ETS "Crossing the Great Divide: Can we Achieve Equity When Generation Y Goes to College?" notes that, although the total number of minority students (African-American and Hispanic American) enrolled in college is projected to rise as is the percentage of total enrollments, a significant gap between the share of 18-24 year olds in these groups and the number of African American and Hispanic American 18-24 year olds enrolled as students will grow. (By 2015, 550,000 fewer young Hispanic-Americans enrolled than one would expect given projected population and over 200,000 fewer young African-Americans.) This is a very funny number. The projected population totals are based sensibly on current trends in the growth of different groups (presumably it is based firstly on the number of children born between 1991 and 1997 and then with adjustments made for complicating factors such as immigration, deaths, and so on). However, the appendix to "Crossing" explains that projected enrollments are based on the assumption that current enrollment rates (obscenely lower for African-American and Hispanic Americans 18-24 year olds) will continue. (see Projection Methodology p. 55 of "Crossing"). So numbers such as those for Fall 2005 from the Census Bureau were used. These numbers show that while 40% of non-Hispanic White Americans 18-24 years old were enrolled full time or part time in four year colleges and 50% of Asian Americans only 29% of African Americans 18-24 years old were enrolled part time or full time in four year colleges and only 24% of Hispanic Americans of this age group were. Given the age range reported (18 year olds to 24 year olds) one would expect to see a fraction of 18-24 year olds who have completed their undergraduate degrees. And indeed you do see this. According to the Census Bureau the numbers were 4% for White-Americans, 3.5% for African Americans, only 1.82% for Hispanic Americans, and almost 9% for Asian Americans in October 2005. More importantly and my main reason for looking at these numbers are that regardless of ethnicity there are significant differences in enrollment rates -in either two year or four year colleges or in four year colleges- according to SES (socioeconomic standing). Haveman and Smeeding( "The Role of Higher Education in Social Mobility", The Future of Children, vol. 16, no. 2., Fall 2006, pp. 125-150) note that 90% percent of students from families with incomes in the top quartile of earnings were enrolled in college twenty months after graduation (73% in four year colleges) only 60% of students from the bottom quartile were enrolled in college twenty months after graduation (with fewer than half enrolled in four year colleges, 37% in two year colleges, and 17% enrolled in vocational/technical schools.) To assume that low enrollment rates will persist -as Carnavale and Fry implicitly do- is not very helpful. Similarly, while racial discrimination is in part the cause of lower SES, it is much more important to focus attention on social class as an obstacle to higher education and success. To focus on race seems to invite substantive versus formalist interpretations of the achievment gap. In other words, that the differences in achievment are in large part due to cultural factors. However, controlling for race, there is a strong statistically significant relationship between family income levels and enrollment in college (in either two or four year schools or in four year schools). Using data for October 2005, I find that enrollment rates were about 23% points higher for 18-24 year olds students from families with incomes in the $100,000 to $150,000 range than they were for 18-24 year olds whose families earned between $30,000-$40,000 for example. (These numbers are derived from regression I have run using Census Bureau data on fall enrollments for Fall of 2005.) I am incredibly impressed with a paper entitled "Reducing Inequality in Higher Education: Where Do We Go From Here?" by Cornell University's Ronald Ehrenberg . I am impressed first because of its focus on SES and the inequalities that are perpetuated by both the differences in access to higher education as well as differences in levels of success after a student enters colleges. I am also impressed because of its focus on an analysis of what possibly can be done -in terms of financial aid, education policy at the primary and secondary levels, and within college itself- to assist students from economically disadvantaged backgrounds . For good measure there is a thoughtful discussion of the direct and indirect financial pressures colleges and universities face and how these pressures have led them to worry far less about their role in perpetuating inequality. The paper was presented at the Conference on Economic Inequality and Higher Education: Access, Persistence, and Success, Syracuse University, September 23-24, 2005). Ehrenberg's main points are (1) that little advance has been made in enrollments of students from low income families since the 1970s, (2) that states have increasingly faced tight budgets and, as a result, have kept state spending per student at more or less constant levels since the 1970s, (3) that increased spending per student has therefore been funded largely by tuition increases, (4) that , perversely, as the private returns to college have grown and the gap in earnings between the college educated and those without college degrees has increased, the tuition increases have been more or less tolerated by middle class families. The increases are regarded as the price to be paid for protecting their position. (5) that the increase in tution at four year colleges has shifted proportionately more and more low income students into two year colleges, (6) that given the difficulty of transitioning from two year to four year colleges, especially to those schools where transfers from two year colleges are relatively rare -persistence- the ability of transfer students to complete their undergraduate degrees has fallen.

He outlines several very recent programs at flagship public universities such as UVA, the University of Texas, and UNC-Chapel Hill to increase enrollment of students from low-income families as well as very recent efforts by Princeton (1998), Harvard (2005), and Yale (2006) to increase enrollment rates and graduation rates of students from low-income families. Very selective schools by definition admit and graduate mostly students from wealthier families. Hill, Winston, and Boyd ("Affordability: Family Incomes and Net Prices at Highly Selective Private Colleges and Universities" Journal of Human Resources, 40 (fall 2005)) note that 108,721 students earned undergraduate degrees at the 28 highly selective private colleges and universities in their study. This implies that well under 10% of all the students earning bachelor's degrees in spring of 2002 received their degrees from such schools. Given the cost of attending such institutions, one can safely assume that families of relatively modest means were receiving some sort of financial aid. Assuming that all middle class and low-income families attending these schools received some kind of aid, students from families earning less than $51,000 a year represented only 17% of students graduating from such schools.

To make these very exclusive schools more inclusive is fine. However, students from wealthy families are disproportionately represented in these schools and always will be. Besides this, as noted above only a small percent of college graduates in a given year earn their degrees from such institutions. Therefore changes here cannot be expected to create more than a ripple overall. What is needed are similar programs at the colleges and universities where the majority of students pursue their education. However as Ehrenberg points out there is a danger in such institutions being more inclusive because these "lesser" colleges and universities face even more risk -both financially and politically- if they follow suit.

The financial resources of such schools are far more limited. As Hill,Winston, and Boyd (in the study of highly selective private colleges and universities already mentioned above) note there is a statistically significant inverse relationship between the net price students from low-income families are asked to pay for their schooling and the size of the endowment per student a particular school has. In the case of schools with much lower endowments per student Ehrenberg notes that they "...do not have the large flow of annual giving and the large endowments that the University of Virginia or the University of Chapel Hill have and thus it will be more difficult for them to develop the resources necessary to support programs such as Access UVA or the Carolina Covenant."

He goes on to point out that "If these flagship institutions are successful in diversifying their student bodies along racial/ethnic and socioeconomic lines, they run the risk of alienating the traditional supporters of their institutions; the upper and middle class families whose children attend high school that have been large feeders schools for them. This may translate into political pressure to reverse policies that led to the diversification, or a further loss of financial support for the public institutions." (Ehrenberg, p. 14). Other schools face the same political problem if students from the families that have typically supported these schools have a more difficult time being admitted into these schools because equally or more deserving students from poorer families have taken their place.

Therefore the current efforts that are being made to make access to higher education more equitable are likely to have less impact than one would hope for or what is needed to really change the way opportunity is distributed. A few cards in the deck are being moved around and most of the aces are still at the top. The entire deck needs to be reshuffled.

Housing prices and news coverage of the subprime crisis.

In an interview with Newsweek's Daniel Gross last week, one of the hosts of NPR's All Things Considered, Robert Siegel, described a hypothetical family that had their home appraised at $300,000 last year. He went on to ask Gross to explain the effect of the value of this family's home falling to $250,000 , rather than rising to $350,000 as they might have expected. Mr. Siegel's line of questioning is typical. We accept the notion that across the country housing prices are falling and falling sharply. Given this, we conclude that consumer spending will weaken in the months ahead, perhaps significantly enough to push the economy into recession. The current situation is serious. On the one end of the spectrum you have poorer families - only recently becoming homeowners- who are now losing their homes. In the face of higher interest rates they are unable to make payments. Banks have either abandoned the subprime market entirely or have tightened their lending standards. Either way, other families who might buy these homes cannot raise the money needed. The two forces combined have led to an increase in foreclosures and a glut of inexpensive homes for sale. Not coincidentally, at the other end of the spectrum, there have been increased requirements for those borrowing to fund the purchase of homes with values well in excess of $400,000. What subprime mortgages and jumbos have in common is that Freddie Mac and Fannie Mae refuse to touch them. Borrowers taking out "jumbo mortgages" have typically been asked to pay a minimum of 5% as a downpayment and a premium in interest over what conventional conforming mortgages charged. It is because luxury homes are less liquid (because they are hard to sell quickly without a fairly substantial cut in price) and because of a general desire to limit risk until a clearer picture emerges that lending standards on these sorts of loans have tightened as well. (See "Subprime Mortgage Woes Spreading : Subprime Mortgage Crisis Spreading to High-End Housing Market" AP Wednesday August 29). Therefore the trouble is at the two extremes of the market, where the supply of homes on the market has increased while at the same time, and for the same reasons, the demand for such homes has been depressed. Many banks, formerly in the business of originating these mortgages and then selling them, have seen demand plummet. Where does this leave Mr. Siegel's middle class family with a very nice, fairly new home? They are probably okay. Rather than a home that was worth $300,000 last year selling for only $250,000 today, it would more than likely sell for $308,000-$310,000. (See OFHEO's website) The present crisis as serious as it is, is largely confined to the two extremes of the mortgage market already mentioned. to banks originating such mortgages, and to institutions such as Countrywide that have become more heavily involved in both extremes of the mortgage market. It is an old story, one reminiscent of the junk bond market, where tempted by the higher yields on riskier investments investors convince themselves and others that the market's assessment of risks have been too high. In short, the impact on the consumer spending of middle class America should not be as great as one might imagine. There are if you will several leaks in the roof and serious repairs are needed but the roof is still basically sound and if we patch the roof it should be okay. Pick a different housing price index and you will get a very different number: Estimates of what has happened to housing prices vary enormously. It is indeed confusing. The NAR (National Association of Realtors) suggests that in the second quarter of this year housing prices declined (in fact, NAR sugggests that it is the fourth successive quarter of such declines ). The decline in housing prices according to the NAR number was not as severe as the drop year-over-year in the fourth quarter of 2006 when prices fell by their reckoning 2.7% but still in the second quarter of 2007 they were 1.5% lower than a year earlier. According to the Case-Shiller index however in the second quarter of 2007 there was a "record fall" in housing prices in the second quarter of 2007 with prices falling on average by 3.2% between April-June of this year. Finally, the numbers I used to adjust Mr. Siegel's example are based on the housing price index (HPI) reported by the Office of Federal Housing Enterprise Oversight (OFHEO) which indicated that housing prices rose between 2.6% to 3.2 % over this same period of time. The reason for these discrepancies is, of course, due to the fact that each statistic reported includes or excludes different numbers. (For more detail see "Consider the Source" by Lasalle Bank Associate Economist Adolfo Laurenti) Out of the three just mentioned, the Case-Shiller and OFHEO HPI are far more reliable. Both are to be considered to be so because they are paired-sales statistics. This means that it is the price of particular properties that are tracked over time. Other indices, such as the figure given by the NAR are not paired and as a result are sensitive to not only what is happening to the price of homes themselves but to the types of homes being sold. A drop in the NAR statistic could just as readily mean that proportionately more modestly priced homes are being sold than that the price of houses in general are going down. Say that previously 50% of homes being sold over a three month period were sold for $50,000 and 50% for $200,000. If the proportion of homes being sold in the $50,000 range rises it would not take much to generate a huge decline in the average price of homes being sold (a shift to from a 50% to 60% share would cause the average to fall by 12%!). Nonetheless while OFHEO's HPI indicated an increase in hokme prices, Case-Shiller indicated a decline. The difference between Case-Shiller and the OFHEO's HPI can be explained by the fact that the HPI only considers what is happening to the price of homes being purchased with conventional conforming mortgages while Case-Shiller includes jumbo mortgages. In short, the clearest picture we get nationally for the great middle section of the housing market is not a decline. Rather what is happening to the value of many middle class families' homes is that they are still increasing, albeit at a much slower rate (3.2%) than they had over the last five years overall (an annual rate of about 8.5%) So Why Does This Matter? There is first and foremost the impact of of all of this on poorer families that is going largely unreported. (See however the dicussion of turning properties that would otherwise go into foreclosure into rental properties on Marketplace Morning Report September 6th, 2007. Click here ) There is also the fact that the recent crisis has increased the number of individual financial investors who wish to sit on the sidelines with their cash and wait to see if a clearer picture emerges . This flight into liquidity has inadvertently dampened the demand for commerial paper as well as restricting poorer families' access to credit [(1.) For the significance of commercial paper see "Commercial paper market still shrinking: Asset-backed securities fall 15.6% in past three weeks" by Rex Nutting for MarketWatch Aug 30, 2007. (2) For the reasons behind this shift away from commercial paper see "Subprime `Tsunami' Hits Asset-Backed Commercial Paper Market" by Mark Pittman and Elizabeth Stanton for Bloomberg.com August 8, 2007]. What the Fed has done and promises to do is,simply put, a move to provide the extra cash to satisfy an increased desire for liquidity and therefore quite necessary. And President Bush's promise to assist families caught up in the subprime crisis, if sincere, is also a move in the right direction. However, it is debatable in the extreme that the majority of middle class families have anything immediately to fear in terms of falling home prices and higher mortgage interest. In point of fact, Countrywide and other mortgage brokers are trying to redeem themselves financially. They clearly intend to do this by sharply limiting their investments in mortgages that Fannie Mae and Freddie Mac will not purchase: subprime and jumbo mortgages. Middle income households represent the salvation of mortgage lenders as they turn their backs of higher risk, poorer borrowers. (for more click here.) To focus on falling home prices and the possible impact on middle-class consumers diverts our attention away from the real issues involved. For a previous blog on related issues click here.

Microfinance

An example of a microloan (a little does quite a lot): A young man named Abhijit lives in Kolkata. He has saved up Rs 400 to buy small area rugs to sell on the streets. The wholesaler's warehouse is one hour by bus from the place this young man has found to sell these rugs. The cost of the trip one way is Rs10. He figures, correctly as it turns out, that he can sell an average of 10 such rugs an hour. He sells them from about 12 noon until about 8 in the evening. Each day but Sunday Abhijit leaves home at 10:00, reaches the supplier's warehouse at about 11:00. He then quickly buys his day's supply of rugs and hurries back to start selling by noon. The rugs cost him Rs5 apiece and he is able to sell his rugs for an average of Rs5.5. At the end of the day he has sold 80 rugs at Rs5.5 a rug and so has earned Rs440 total or about$55 U.S. This leaves him with Rs400 to buy a fresh supply of rugs tomorrow and Rs20 to cover his bus fare round trip. In the end , he makes about Rs20 a day or about the equivalent of $2.50 U.S. The week's net income, if all goes well, is therefore Rs20*6 or RS120 (about $15). If Abhijit could stock up and buy three days' worth of inventory at one go he could manage to save 8 hours of the time lost to travel each week. This would require however a total of Rs1400 that he does not have. Although the equivalent of about $175 U.S. with an uncertain weekly income of $15 (Rs120) this is far beyond Abhijit's resources. The supplier, better off than Abhijit, is far from wealthy enough to risk three days worth of inventory and hesitates extending this sort of trade credit to Abhijit out of fear that others will ask for the same. Abhijit is trapped in this situation, limited by his own meagre financial resources . He learns of a MFI (microfinance institution) and is contacted by one of their representatives. He discusses with this representative his idea of buying a three day supply of rugs. He thinks that he has the capacity to twice a week carry the 280 rugs on the bus that 3 day's inventory represents and to safely store the ones he hasn't sold . The total cost of Rs1400 is lent to him at a rate of 100% interest. No longer having to travel each day to pick up his inventory, over the course of 30 days or so (from Monday July 30th to Saturday September 1st) he saves a tremendous amount of time and money; 40 hours of travel time or Rs400. The average saving of Rs80 a week means Rs4160 saved over the course of the entire year. The total payments made on this one year loan, even at 100%, are "only" Rs2268. Abhijit's annual net income as a result is Rs1892 higher than the RS6240 it otherwise would have been (i.e. 30% higher). (For a similar real world versions of this story click here and here.) The beauty of microfinance is found in examples like this one. Several questions naturally arise: (1) Although the present example illustrates that even at exceedingly high rates of interest microfinance loans are profitable, why do the rates charged on micro loans tend to be so high? (2) where do the funds to finance such loans come from? (3) would financial resources channelled into microloans be better used improving woefully substandard infrastructure and funding education? High rates of interest. Microloans typically are short term and the track record of the majority of borrowers is very good. Therefore microloans carry little interest rate risk or default risk. The principle reason rates are so high is that the adminstrative expenses are enormous. These expenses include first the costs of identifying and assessing the creditworthiness of clients. With little or no collateral and little or no established credit history this is a very time consuming -and therefore expensive- part of microfinance. This is followed by the costs of processing a loan. These costs will tend to be the same regardless of the size of the loan. That is to say, whether it is a $100 loan or a $1 million loan the amount paperwork involved will be very much the same. After these two already substantial expenses comes the process of first turning over the funds being lent to the borrower and then collecting payment. One study estimated that in India each personal contact with a borrower, such as meeting them to collect payment, costs $0.25. This may not seem like much but consider $1 million lent $100 at a time. This means loans to 10,000 borrowers who must be contacted monthly to collect payment. Over the year, at $0.25 a visit, this adds up to $30,000. (For more details on the pricing in microloans click here, here , or here.) The last component of adminstrative expenses may be considerable even if ultimately the default rate is low. This cost is the added cost of following up with those borrowers who are late making payments on their loans. Disappointing sales, illness, or interuption of supply all may hamper a particular borrower's ability to pay on time in a give month. The MFI's representative may have to return a few more times to collect payment and to offer advice. Anyone with firsthand experience of the difficulties that often are encountered when trying to contact someone or trying to travel in an economically poorer country will understand another very concrete reason why payments may be delayed. If the borrower is not facing difficulty but simply isn't there when the first visit is made means that follow-up visits will be necessary. Say that these five elements represents $3 each in administrative expenses on a $100 loan. The borrower must then pay $15 just to cover these costs. Now add on to this a nominal rate of 10% for the funds raised and a 1% premium to cover the risk of default and the rate to be charged is already at 26%. How successful a microloan is depends on a variety of factors including how small the amount to be borrowed is. A corrolary of the idea that borrowers are not especially senstive to the interest rate charged on microloans is that beyond the initial loans made it is hard to identify further investments unless the interest rates charged are significantly lower. For example, while it might be more efficient for Abhijit to buy and cary home the entire week's inventory even at 26% this would not be feasible. He would sell Rs440 worth of rugs the first day followed by Rs3,300 over the following five days. This would require a loan of of Rs3400 (the cost of goods sold= 8 hours day 1 times sales of ten an hour times the cost per rug of Rs5 plus 10 hours days 2 to 6 times sales of ten rugs an hour times costs per rug of Rs5) . With cost savings of only Rs100 a month and a loan of Rs3400 at 26% annual interest, Abhijit faces monthly payments of Rs324.80 (or about Rs135 more in added debt payments each month). The added costs per month of servicing his debt clearly would wipe out the benefits of this added debt (the reduction in travel expenses). In short, while initially the gross marginal returns on small investments might be high enough that the loans to fund them might be profitable for both borrowers and lenders alike, the marginal returns fall off quite quickly for many borrowers. Abhijit's investment demand schedule, while initially quite interest inelastic, very quickly becomes interest elastic. However it is safe to assume that there are many more potential borrowers like Abhijit who if offered credit, even at fairly high rates of interest, will be more than ready to borrow. Therefore the sharp kink in individual investment demand curves emerges much more slowly in the aggregate. To the degree that MFIs have an increasingly easier time identifying and orginating microcredit and the pool of potential borrowers remains large the overall costs of providing microcredit should be kept in check. In the case of a nonrenewable resource overall costs are made up of exploration costs and extraction costs. The former with experience have declined over time while the latter, extraction costs, as more and more coal or oil is pulled out of the ground, have risen over time. What has kept costs of coal and oil from rising has been the fact that when certain areas have been completed mined or pumped dry it has been relatively easy to open up new areas. With MFIs even if the additional benefits to an individual borrower are quickly reached there are many more borrowers to move on to who have as yet not been touched. Alternatives to microloans: This leads to the question of priorities and the relative benefits of microloans for poor merchants such as Abhijit compared to the same financial resources being used elsewhere. For example, the funds could have been channeled into Kolkata's transportation system, into its utilities or into its public schools. Improvements in Kolkata's transportation infrasctructure might cut the travel time from Abhijit's market to his supplier and back again by half an hour and reduced fares by Rs2 for each trip. This would result in a cost savings each week of Rs48 or over the five weeks from July 30th to September 1st a reduction in Rs240. All this without Abhijit's degree of combined leverage (the sensitivity of his net profits to changes in sales) worsening as it would with a fixed commitment to pay Rs189 a month servicing debt. Of course, the two in combination or, better still, microfinance loans and infrastructural investment combined with more resources invested in education would be even more desirable. The latter would mean that while Abhijit toils away in the market each day his children are acquiring the skills that would increase their options once they enter the labor force. Whatever the details, the point is that the small investments made possible through microloans should not be considered a substitute for other, more major investments. Microloans should be considered as highly complementary to these other investments. And if financial resources are scarce, there is a very real question of whether the highest returns, long-term, come from micro loans. Financial resources are far from scarce: Potential funding is available to do much more than currently is being done. Unitus estimates that 80% of the world's most desperately poor families living on $2 or less a day (2.4 billion souls and, assuming an average family size of six people, 400 milion families) have limited or no access to microcredit. Without access to microcredit, the vast majority of the world's poor families are therefore forced to rely on their own resources, if they have any to speak of, or what can be borrowed from moneylenders. Unitus and other organizations promote the idea that private capital markets need to be tapped to rapidly expand the funds available. This is one avenue of funding certainly worth pursuing. However, one could also note that if the U.S. federal government were to divert only .5% of our nation's total earnings to funding MFIs this would provide about $55 billion or about $137.5 per family in this cohort of 400 million that Unitus estimates do not have access to microcredit at present These families could then make the sorts of relatively small and simple changes that Abhijit did in our earlier example. (for Unitus's webpage click here .) (see also the Basic Facts About Microfinance.) Could such a sacrifice be made? When the economic standard of living was considerably lower than it is now the U.S. lent the U.K. a similar amount (when adjusted for inflation) for an entire 60 year period at 2% interest. (click here and here). Not that I advocate this particular method of raising the $55 billion but it could be raised by increasing federal corporate income taxes by 16% over what they were last year or increasing federal individual income taxes by a little over 5%. Although it is politically naive to consider either one as likely, my point is that the sacrifice is not so great that it couldn't be done. And indeed, through growth in the U.S. economy federal tax revenues grew by $353 billion between 2003 and 2006 . Simply skimming off 16% or so of the increase in payments (or well under the increase in revenues for just one of these years) would accomplish the goal of making over $100 a year available to families throughout the world currently without access to microcredit. (click here for more details on recent federal income tax revenue collection.) Private capital markets are there as an alternative to bridge the gap between what we are truly capable of doing and what we are willing to do. However, even if half of the 57 million households who in 2006 earned above median family income were to invest $1,500 a year in MFIs the total amount of funding available for microloans would fall far short of the $55 billion needed to provide the $100 + per family that currently does not have access to microcredit. If one quarter of wealthier American households were to invest $800 a year then each of these 14.25 million households could provide some funding to 82.94 million more families than are being served right now The binding constraints are economic as opposed to financial resources:Even this more modest goal may not be too practical in that there are 10,000 MFIs with an average of $700,000 per MFI in loans outstanding. For the average MFI to take in and effectively lend $1.14 million more over and above the current $700,000 in loans they are originating now may be asking for far too much in the short run. Even Kiva, a remarkable organization that has helped to originate $9-10 million in loans with what appears to be a fulltime staff of 20 is -because of the way that it is structured- uniquely positioned to directly absorb such funds. But it would face difficulties. For example, if one-tenth of the money we are thinking about here were to go to Kiva and even if Kiva lent unusually large sums of money to individual borrowers of $1,000 each this would still mean originating over 150 loans a day each day per staff member! In short, the current size of the pipe appears to be too small to absorb significant increases in a short amount of time. Much more would need to be done if we were to accomplish a net decrease of even about 25% in the number of families currently without access to microcredit. In the preceding, I have not considered what governments, business, and individuals in Japan, the newly industrialized countries, the European Union, Canada, New Zealand, and Australia could contribute which would make some of this seem less daunting. At the same time, I have assumed quite unrealistically that the number of families living in dire economic poverty does not grow. Just because the job is enormous and microcredit is not "THE" answer to ending much poverty as quickly as we can (of course, unfortunately nothing is "THE" answer to this) I hasten to note that not only have MFIs done a great deal to help millions of economically poorer families the potential is great to still more, especially if we are aware of the obstacles in the way. Other references: Blondeau, Nicholas "Microfinance An Instrument of Sustainable Development"? "Microfinance Interest Rates as a Function of Transaction Costs" Guinnane, Timothy "A Failed Institutional Transplant: Raiffeisens' Credit Cooperative in Ireland, 1894-1914" Hollis, Aidin "Microcredit in Prefamine Ireland" World Development, forthcoming Aidin Hollis and Arthur Sweetman, "Microfinance and Famine: The Irish Loan Funds during the Great Famine", World Development, forthcoming. Morduch,Jonathan, "The Microfinance Promise", Journal of Economic Literature, 1999, 37, 4, 1569-1614. Wikipedia on microfinance, microcredit and the early history of microcredit in what is now Bangladesh

the insanity of college rankings

The very best book to read on the subject is Paul Boyer's College Rankings Exposed. It should be available right next to copies of U.S. News and World Reports annual College Rankings issue (what those at USNWR refer to as their swimsuit issue.) In a recent AP piece (Colleges Struggle to Quit the Rankings Habit) Brian Kelly, editor of USNWR, is quoted as saying that its annual rankings of colleges and universities simply provide "consumers" -hungry for hard data- with the same sort of rankings offered for cars, refrigerators, and the like. This is very telling. Are the families who enroll their students in college really consumers? There is a great deal of data on marriage and the sort of characteristics that contribute to a man becoming a good marriage partner. Weddings are, like college, a major expense. USNWR could rank cities across the U.S. according to the quality of its me. Part of these rankings could be based on what thsoe performing marriage ceremonies in other cities have heard about men in a particular city. In the case of some cities they might have direct knowledge -current or not-while in others they may have little or no information at all. We could then place a great deal of weight on these scores regardless. Families with these rankings in hand could make a much more informed decision about what city is the best one to go to if you wish to locate a husband. Einstein is quoted as saying that "everything that can be counted does not necessarily count; everything that counts cannot necessarily be counted". And this is at root the point. Just as there is not one universally valid criteria for selecting someone with whom you will share your life with there is not a universally valid criteria for selecting a college or university. While we can all agree on a fairly limited list of factors that make one big screen TV better than another or, similarly, one set of tires better than another how on Earth can it be argued that there is a relatively finite list of factors that determine waht constututes a good school? Consider also that when it comes to rankings that the most elite schools are so because they serve, as they always have, the elite. Socioeconomic status is a powerful deteminant of academic achievement. Highly ranked schools are largely populated by students from "highly ranked families"; the well-to-do and the powerful. Wealthy alumni can afford to make large contributions. Large contributions together with tuition revenues mean that such schools are able to recruit and retain faculty at relatively high salaries. It also allows them to ask faculty to carry light enough teaching loads that permits success in both teaching and research. Finally having already completed their primary and secondary education at exceedingly good schools, students come far readier for the rigors of higher education. To have completed one's undergraduate career at a highly ranked college or university is more often than not symptomatic of an exceedingly advantaged background rather than having achieved some thing spectacular through hard work, perseverence or exceptional intellectual gifts. For "lesser" institutions to climb the summit means drawing students from such backgrounds. The likelihood of their being able to attract a critical mass of students from such advantaged backgrounds to materially change their fortunes is small at best. Especially for small liberal arts colleges -modelled after top liberal arts colleges from the east coast- founded over a hundred years ago by immigrant communities throughout the U.S. the chances are small. The alternative is to encourage their faculties to develop a more national profile (and, via slick marketing to make these acheivements known to a wider national audience.) in the hopes of raising the heavily weighted peer review in thge USNWR rankings. The fact is that the top ranked schools, thriving in a very different environment, are unlikely to pay much attention. (Check out this story from NPR's Morning Edition September 15 2006, "Marketing Higher Education Gets Sophisticated" ) And as the following illustrates, deans and presidents of competing institutions are unlikely to be swayed by suchinformation no matter how impressive it might actually be. Say that you have two Deans of two colleges, A and B, who are asked by USNWR to rank one another. A can given B a rank of one (a low ranking), a five (a high ranking) or give B a rank of three. B has the same set of choices as far as A is concerned. The deans of colleges A and B may dismiss out of hand the notion of giving their competitor a rank of one. Both Dean reconginize that truly miraculous things are happening at the other college and so briefly consider giving the other college a ranking of 5. What stops either from doing so is the following. Consider college A. If its Dean gives B the ranking it deserves and B does not reciprocate but instead gives A a ranking of 3 (the rank it received in last year's USNWR) then A will drop relative to B in the rankings. Of course if B gives A a rank of 5 then, relative to B, A's position is unchanged. A family whose student is considering both colleges A and B will note that A and B are both highly ranked if the latter happens and that A has a much lower rank if the former happens. Regardless of what B does then, the worst thing that can happen to A if its Dean gives B a ranking of 3 is that its relative ranking will remain unchanged. However , if A's Dean gives college B the ranking that she feels it truly deserves and B does not return the favor the worst thing that can happen is for college A's relative position to fall 2 points. Now, a student who might have considered college A or B will see a ranking of 3 for A and of 5 for B and choose B. It follows from this that both Deans will choose to award a rank of 3 to the other college. In fact, if you look at peer rankings for liberal arts colleges in last year's USNWR -outside the top fifty schools- peer rankings do indeed cluster around three. The end result is a tremendous amount of effort and time are expended to change a situation that look at the problem strategically is unlikely to change. And the peer ranking is important. It is given a great deal of weight in USNWR's overall ranking. In frustration, colleges respond by putting more resources into encouraging students and faculty to perform specatacular feats as well as trying to tweak other numbers that would also help push the overall rankings higher. The most infamous such strategy has been the practice of sending rejection letters to students who appear to have included a given school as a back-up school. (See "Glass Floor: Colleges Reject Top Applicants,Accepting Only the Students Likely to Enroll" by Daniel Golden, WALL STREET JOURNAL, May 29, 2001.) When students either failed to make the cut at their preferred school but were also turned down by the "lesser" school or worse still, they were accepted at their preferred school but turned down by the "lesser" school it became readily apparent that admissions policy was in part being driven by the desire to lower that college's acceptance rate, and, to a degree, bolster its USNWR rankings. Passing over students with perhaps greater potential but with lower ACT/SAT scores (fn1), putting money into campaigns to boost alumni contributions and failing to accept students probably heading elsewhere anyway all have been done in an effort to boost rankings. Silly as these things are, it is quite impossible for a college to unilaterally opt out. To do so would be suicidal. That is what is so heartening about the agreement reached earlier this summer by the Annapolis group. As with all such agreements the risk of defection is high. However, the only way out of such a bad situation is through such a cooperative agreement. While I am sympathetic to the notion that families and their students need help in making the decision about where they are going to go to school. It is not an easy choice. What Vasaar College's President Catherine Bond Hill suggest as an alternative to USNWR's rankings is an online database where students and families would have access to data and could construct school rankings whose value would be based on weights that they choose (see "A Better Way to Rank Colleges" .) One of the key things one should understand to their maerrow after graduating from any institution of higher learning that is worth its salt is that there is seldom one universally valid answer to important questions. Perhaps that lesson should start with the college selection process itself. fn1: See "Paving a Path for Poor Students' College Dreams" where reporter Wendy Kaufman notes that tuition has continued to rise and financial aid and scholarship money has not even more schools seeeling to boost rankings "...are emphasizing schoalrships based on high grades and test scores, not financial need")

personal savings, consumer debt and subprime mortgages

I have been trying over the last several days to come to grips with the current subprime mortgage "crisis". We Americans are exceedingly fond of beating ourselves up for not saving enough, for carrying excessive amounts of debt, and for taking too many risks. The numbers, as they are reported, seem to confirm these things. Consumer debt is at record levels, our personal savings rate is negative, and there are a number of families who, having bought homes over the last few years, cannot make payments on their mortgages (a , b,c,d). Some very fundamental questions present themselves. Is it really the case that Americans spend too much and save too little? Do we really carry too much debt? Are we too willing to take risks? (Of course there are too many of us and we consumer far too much of the planet's resources than we have any right to but that is another matter. Environmental concerns be damned in what follows and let's focus on the question of savings, debt, and what can be refered to as "financial fragility". ) The personal savings rate. Imagine a young couple who last year earned good salaries and, after paying their taxes, paid all of the interest due on their student loans, credit card debt, and car loans. With the balance they paid rent, bought food, paid for entertainment, bought electronics, and paid for a variety of services. They will have not saved a dime by the reckoning of the BEA (the Bureau of Economic Analysis, the agency that reports the personal savings rate each month.) This despite the fact that they have given up spending on goods and services now to pay the interest they owe on the their financial obligations. Imagine a family that has a home that has gone up in value by quite a lot. Their 18 year old daughter is off to her first year of college. They refinance their mortgage at a lower rate of interest and take cash out of their home. The cash taken out of their home and the money freed up by lower mortgage payments are used to help fund their daughter's first year in college and to make improvements in their home. Despite the fact that they are spending money on their daughter's education and are protecting the investment already made in their home the personal savings rate will decline as a result of what they have done. Imagine someone who bought shares of stock last year for $10,000 and then sells them this year for $40,000. The net capital gain let's say is $20,000 and they spend it. The $10,000 they pay in taxes and the $20,000 they spend will be counted as $30,000 pulled out of past savings and reduce personal savings by $30,000. Despite the fact that what has happened is qualitatively quite different from having put $30,000 in the bank last year and then drawing on those savings this year it will be treated in exactly the same way. All statistics are flawed but the personal savings rate has several. (See also a). When stocks are being sold to realize capital gains and the money from this is spent personal savings decline. When mortgages are being refinanced and cash is taken out to do the sorts of things described in the above example personal savings fall. When families take a sizeable portion of their earnings and use it to pay interest on debt, if it is not interest paid on mortgages, personal savings drop. In short, any economy in which financial values are rising and in which the value of new and existing homes are rising, interest rates are falling and refinancing is common you should expect to see this number fall. While we responsibly pay for the privilege of enjoying goods and services sooner rather than later by making car loan payments and payments on out credit cards, as we put money into our children's education and our homes and as we enjoy the good fortune of having made financial investments that have gone up in value we are told that we are spendthrifts. Taking the personal savings rate at face value, we fell as guilty as someone who takes the family's meagre paycheck and spends it all at the corner bar on drink and betting. The investment ratio: A considerably more meaningful figure can be calculated from statistics reported quarterly by the BEA, the investment ratio. The investment ratio is the ratio of gross private domestic investment to total production. It measures how much of total production in a quarter has been devoted to maintaining or expanding our stock of physical capital. Indirectly, it measures how much of the resources we choose to employ that are used to produce machines, tools, build buildings, spend on computer software and hardware and so on. It is the nature of the beast that this number fluctuates quite a bit. Not surprisingly the lowest it has been was during the Great Depression of the 1930s (1932 the investment ratio was under 2%). Even with the extremely low figures for the 1930s included we have devoted an average of over 11% of our productive efforts each year to investment. Last year in 2006 it was 17%. If we broaden our focus to include not only private investment but include as well investment carried out by state and local governments and the federal government the share of production devoted to maintaining or expanding our stock of physical capital was a little under 19% last year (with an average since January-March of 1988 to the second quarter of this year of 17.52%) . Therefore as a nation, last year we devoted a little under one-fifth of our efforts to providing for our future. This is not at all bad. And this number does not include the share of our produtive energies devoted to educating ourselves, keeping ourselves healthy, and keeping ourselves safe.

Consumer credit:

Isn't it still true that the average American family carries massive amounts of debt? Without question we do. Looking at figures from 1953 to the present the ratio of household liabilities to personal income has grown significantly. But this simply means that we spend now and save later. Our savings take the form of interest payments and payment of principal on the funds we have already borrowed. We save ex post (after the fact) not ex ante (before the fact). This debt is part of the price we pay for enjoying goods and services sooner rather than later and it does carry with it certain risks. Our ability to retire this debt is senstive to the rate of interest charged, the total amount we have borrowed, and what happens to our earnings. If I use my credit card to make major purchases, the more I charge to this card, the higher the interest rate attached to this credit and the lower my income is as I pay back this debt, the larger the share of my earnings I must commit to paying interest and the original amount charged if I am to retire this debt any time soon. The temptation to delay this final day of reckoning and the almost inevitable need to so as unexpected expenses come up means that for many individual families the burden can grow to be considerable. We may in fact long for the mythical days when to buy something one had to build up cash reserves over time. In this case, in the event of a broken windshield and $100 deductible to cover or hundreds of dollars in plumbing bills, one could draw on these balances and simply delay further the major purchase originally planned.

The moral virtues of delayed graitifaction aside, the real advantage of "saving-up" for something then is the flexibility is provides. The temptation of simply putting off payment, the risk of rising rate being charged on balances you still owe and the financially precarious position one faces having amassed such debt if their earnings decline are the real reaons to be concerned about consumer credit. The personal advanatges of controlling spending and using this money to make extra payments on the mortgage, on car loans, and on credit cards are very real. And a shift from the buy now/pay later mentality that easy access to consumer credit makes possible would provide the sort of freedom of manouevre already discussed. However, these actions will weaken the financial position of businesses accustomed to the trade of such familes. As their revenues fall, given costs, profits and cash flow will decline. It is this a very fundamental fallacy to reason from the individual advantages of higher savings that it will be socially advantageous. Reduced spending will free resources that could be used for more investment. However, since saving in the aggregate will not increase -increased personal saving leads to reduced business saving- the rate of interest will not fall. And the degree to which these businesses rely on cash flow to honr their debts, any belt tightening by households will simply push the burden on to the business sector. At any rate, although we obviously save today so that we will have the power to spend sometime in the future we have only the vaguest ideas of what form exactly this spending will takeor when it will take place. As a result, assuming they could somehow raise the funds to employ investible resources, businesses contemplating investment are left to themselves to decide what fraction of the resources available they should employ and in what direction they should employ them. Subprime mortgages: It is interesting to go back to comments made by Greenspan in 2004 regarding what we now refer to as the subprime market. He pointed to advances in computer technology that made it easier to identify good credit risks out of the pool of low income borrowers. In particular he was referring to the automated underwriting systems such as Freddie Mac's Loan Prospector (see a, b, c, d). These systems promised to make it possible to extend credit to many who otherwise might be denied mortgage credit under traditional underwriting. With automatic underwriting systems to screen applicants (and separate the wheat from the chaff high credit risk borrowers from lower risk ones) Freddie Mac claimed in 1996 to have reduced such costs by on average $350 to $600 per loan (a) (For claims made more recently that it is has been reduced by over $900 see b). As a result of such technologies, lenders- anxious to mine a previously untapped vein of borrowers and to tap a market where the rates charged typically were 2% points higher than a prime mortgage for the same amount would be- aggressively begain issuing mortgages to economically poorer families with less of an estiablished credit history in more depressed areas. Banks increasingly originated variable rate mortgages to low income families to purchase modest homes. According to one source, last year in 2006 20% of all mortgages granted were to subprime borrowers. The social benefits of subprime lending are that home ownership rates have risen from 65% of the population to 69% with 12 million new homeowners and approximaltely half from racial minorities (see a and b) Greater competition among banks for the business of higher income families with proven credit histories and buying expensive homes meant that potentially greater returns could be obtained by those moving into the subprime market. The securitization of such mortgages meant that there was money to be made through fees paid to the banks that originated these mortgages and the pooling of such loans into firms specializing in subprime mortgages meant that the risks could be spread out among a large number of investors. Lending to lower income families at variable rates of interest is one thing when jobs are relatively plentiful and market interest rates are low. It is quite another matter when higher interest rates are targetted and weakness in the overall economy (or specific sectors such as construction and the automobile industry) and the housing market caused in part by higher interest rates are coupled with competition from abroad, immigrant labor and computerization reduce employment opportunities and growth in earnings. Also, unlike prime mortgages, subprime mortgages more often than not carry substantial prepayment penaltie. Typically they were set up in such a way that they were more than viable in an economy with low interest rates, easy refinancing, and rising house prices but carried, as we can now see, a considerable amount of downside risk. Were lenders who originated these mortgages, the companies that bought them, and the borrowers blind to these risks? Probably in the case of many borrowers yes. Less financially savvy, eager to buy their own home, and trusting the authority of bankers and mortgage brokers they have workers with, they focused on the initial terms of the mortgage and were reassured that later on they had little to worry about. What is chilling is how little attention is being paid to 1 million plus families who are expected to go into default this year and therefore who will face foreclosure. Equally chilling is that the many families who were misled, given the complexities and layering of these securitized mortgages, have a far more daunting task if they wish to complain of consumer fraud than if this were a more traditional mortgage both issued and held by the bank that set up the mortgage(See Kiff and Mills). In the case of the bankers, mortgage brokers, and investors who provided the demand for subprime mortgages, rather than being blind to these downside risks they have rightly assumed that downside risks would be shared and, if lucky, the lion's share of the burden would be borne by others. Many involved in the formerly lucrative business of originating subprime mortgages are leaving both the families they lent money to and the investors who bought these mortgages from them to twist in the wind. That the focus has been on the latter group and the much more economically and financially significant repercussion of their difficulties is shameful. The real victims are those who have lost their homes and suffered the embarassment of default. Should the Fed and other central banks intervened as they have? Consider what the root causes of this crisis are. Many subprime mortgages start with the first two, three, or five years at low fixed rates and then change over to variable rate loans. The rates charged on variable rate loans may be a high as a full five percent over LIBOR. In addition to income and a borrower's debt service ratio, the feasibility of refinancing will depend on the ratio of the amount of money that must be borrowed to retire the old debt and convert it into a new mortgage relative to the value of the home. With prepayment penalities and stagnant or falling home prices the amount to be borrowed climbs as well as the loan to value ratio rises. First lax regulation by the Fed and other regulatory bodies allowed banks to become increasingly cavalier about credit risk. Second, Fed policy since 2004 has been to tighten credit and push interest rates higher. The fed funds rate stands over 4% points higher than it was in June 2004. Fed monetary restraint, whatever the intention, in turn has contributed to the fall in the U.S. housing market. All of this has made payment of existing mortgages or refinancing difficult if not impossible for subprime borrowers. This crisis, like the foreign/Latin American debt crisis of the 1980s or the Dot.com bust of the late 1990s, is therefore due to no small degree to shifts in Fed policy. Since the current crisis is in part the Fed's doing, it is only right therefore that the Fed do something. I am little concerned that specualtors will come to expect the Fed to bail out markets when they falter significantly and therefore become more reckless still. It seems few involved with Fed policy understand how often in recent years they are simply being forced to offset the harmful effects of the sort of stop/go cycle that constitutes modern monetary policy. If Fed officials fail to discern this pattern why should one expect private investors, with a much narrower and a shorter time horizon, to see one? Since Hyman Minksy, inspired by Irving Fisher and Michal Kalecki, wrote about these issues in the 1960s and 1970s we have understood that the price we pay for a robust growing economy is the sort of excesses that we are seeing now. The Fed has again shown its incredible knack for tapping on the brakes just as we are starting to climb up a very steep hill. What is regrettable is how little attention is given to the low income homeowners being crushed under the wheels of our economic machine as it rolls backwards.