Do Or Die For Chrysler

Chrysler has filed a survival plan, as they face a life-threatening time in their life-cycle.
Yesterday, on March 30th 2009, the plan was rejected, being considered as insufficient by President Obama.
The White House has imposed an April 30th 2009 deadline on Chrysler, to come up with a working business plan. Chrysler announced it had the framework of an alliance with Italy’s Fiat SpA. President Obama is convinced that the company can no longer stand on its own and requires that Chrysler engages in an alliance with a partner, in order to receive another multibillion-dollar loan from the government to escape from bankruptcy.

Requirements:

• Chrysler must restructure its balance sheet so that it has a sustainable debt burden in the next 30 days.
• Chrysler, Fiat and the UAW need to reach an agreement that entails greater concessions than those outlined in the existing loan agreements.
• Chrysler and Fiat need to detail an operating plan that is viable, that can generate cash flow and demonstrate taxpayer loans will be repaid on a timely basis.
• A final plan agreed to by Chrysler, Fiat and their stakeholders must not require more than $6 billion in loans from the U.S. Treasury.
• Chrysler must have an adequately capitalized mechanism to finance the purchase of Chrysler cars by its dealers and customers. (Source: The White House)

The basic idea behind the alliance is for Chrysler to take existing small cars, car platforms, and engines from Fiat to produce Chrysler vehicles and for Fiat to utilize Chrysler’s excess manufacturing capacity and dealer network to sell Fiats and Alpha Romeos.

There are several arguments to support the alliance.

Looking at Volkswagen and Toyota sharing platforms or the Audi TT and the VW Golf coming from the same Volkswagen A-platform, a few alliances have been successful in the past.
Eventually Fiat and Chrysler will build both companies’ models together on assembly lines in the United States and Europe, allowing economies of scale.

A piece-by-piece sale of Chrysler after they file for bankruptcy would also represent high opportunity costs, including all future profits of the no longer existing company. Economically, this reflects a decreased supply, taking a producer out of the market.

According to Fiat’s chief executive Marchionne, taking the risk of an alliance with this critical partner, Fiat would help Chrysler come back to life, strengthen its financial position, and be more competitive in the American small car market against Japanese producers. It would also help preserve American jobs and accelerate Chrysler’s efforts to produce fuel efficient cars.

It could also be helpful that President Obama is working on a new program with the Congress to provide consumers with incentives to trade in old and fuel-inefficient cars with newer and environmentally “cleaner vehicles”. Regardless if it is ethically correct or not, Germany has already proved, that a scrap premium can work, increasing its car sales by 21%. For Chrysler, this policy could also mean an increase in car sales, especially when the company can manage to produce more fuel-efficient cars with the help of Fiat.

By strengthening Chrysler and expanding in the American market, Fiat could itself generate value to its stakeholders.

While Fiat would receive access to the American market, Chrysler would gain a distribution network outside of North America.

Theoretically, it might be a good idea for both companies to engage in this alliance. In reality however, the partnership between Chrysler and Fiat faces many problems that might threaten the alliance's success.

First of all, a deadline of one month is only little time to fulfill the requirements and to come up with a new detailed business plan with the partner firm. It is important for both firms to carefully work out a common concept for their future business. Finding a proper solution in 30 days could be a difficult task for Chrysler.

It is also questionable, that a company like Fiat, in bad shape itself four years ago, would be able to save a big company like Chrysler. With a rating of only BB+, Fiat has only limited access to capital and therefore limited financial latitude.
Sharing platforms cannot be realized right away and it would take an estimated two years before Fiat cars could be remade into Chrysler models. Before that, a deal has to be struck.

One cannot forget that Chrysler’s last alliance with the German car manufacturer Mercedes-Benz failed, too. The merger between the two companies in 1998 was made “to set new standards in earning power, profitable growth and social responsibility.” But as the U.S. partner turned out to be critically ill, 30,000 jobs had to be slashed and six plants closed or sold off. Today, consultants use DaimlerChrysler as a model case study to illustrate everything that can go wrong when two companies from different continents and corporate cultures merge.

Even though Daimler CEO Schrempp proclaimed that Chrysler and Mercedes-Benz would mesh perfectly because their strengths lied in different vehicle classes, the two fundamentally different companies were hardly able to do much for each other.
Chrysler had little use for Mercedes- Benz' expensive technology because U.S. customers were not willing to pay for it. Conversely, Mercedes-Benz could not use Chrysler's cheap plastic parts; its clientele was more demanding.

As the DaimlerChrysler example shows, alliances face more or less unpredictable problems in reality. Even though the quality of the parts is more comparable between Chrysler and Fiat as it was between Chrysler and Mercedes-Benz, it will still be a crucial aspect for both companies to work out, integrate, and implement a consistent business plan despite great differences.

The English mentality differs completely from the Italian. Since the corporate cultures, visions, and the companies’ policies derive from the domestic mentality, the alliance could face even more difficulties.

Other contrary arguments of experts are that Chrysler could lose even more potential sales because consumers are worried about warranty cost coverage, whether dealers would be around to repair the cars, and if their car might be of less worth if the brand or model is discontinued. For example, the sales of Saturns, Saabs and Hummers are decreasing already.

Critics also state that small-car profits are difficult to achieve in the U.S. because labor costs are the same as they are on larger vehicles even though the prices are lower.

Another option for Chrysler would be to file for bankruptcy in order to split into “good” and “bad” segments.
As president Obama explained, Chapter 11 bankruptcy does not necessarily mean a company has to close their doors; rather it provides them with the option of cost cuts and restructuring of debt with help from the federal court.
The other side of the coin is that consumers could be afraid to purchase cars from a critically ill company.
Chrysler could also be sold piece-by-piece.

In my opinion, since they are under high pressure at the moment, Chrysler will engage in the alliance with Fiat, because it sees no other way out. Hasty decisions and business plans, and the companies merging from two different continents with completely different car classes and corporate cultures, might lead to another failure in the next few years.

As far as Fiat goes, it is highly important to analyze their potential partner, which is critically ill, their risks, and their potential opportunities. Daimler’s experiences with Chrysler, for example, illustrate that size is no guarantee for corporate survival.
As Porsche CEO Wendelin Wiedeking has persistently mocked: “If volume were everything, dinosaurs would still be roaming the earth today.”

China Seeks More Involvement--And More Clout

Last month, I insinuated that China may be considering expanding its global influence more aggressively, in preparation for its baby-boomer generation to retire and leave the workforce. It seems that I may be right in thinking that: Today, the Wall Street Journal reported that the International Monetary Fund has been begging China for additional funds, on the order of around $50 billion (the actual amount was not stated in the article, but IMF's goal is a $250 billion dollar increase and has recieved $100 billion from Japan and $100 billion from the European Union). China is now under negotiations to grant the additional money in exchange for more votes in the IMF, which, though it comes at the expense of already-overrepresented smaller European countries, also aims to wrest policy control out of the hands of the US. This is a clear reversal of the traditional roles between the IMF and China because China has normally kept a low profile and has had a "sometimes rocky relationship" with the IMF. This change is possibly because the IMF itself has been adapting: the IMF has often been considered a last-resort option for developing countries. In light of current economic trends, however, the IMF has been changing alot of policies, such as loosening the conditions it places on the country in order to recieve the loan. The IMF has gone so far as to consider changing its name, or at least not using its name on its loans. In basic economic terms, there is a large demand for loans at the moment but--despite a sufficiently large supply--not for an IMF loan. Voila! The perfect opportunity for a large economic profit in an almost monopolistic market, if only the Chinese can convince the begging countries that the IMF is different now. And with China a key player, it almost undoubtably will be different.

Lions and Tigers and... Public Health Insurance?

President Obama believes that “healthcare is a right, not a privilege.” So, as promised, he is currently working on a plan to make healthcare affordable for everyone. President Obama wants to create a government-run health insurance plan that would operate beside the private sector of health insurance already in place. The details have yet to be nailed down, but both support and opposition have already raised their voices.

The issue of a public health insurance plan deals with the basic economic concept of competition, and the not-so-basic concept of profit maximization. The article’s author, Reed Abelson, offers almost none of his own explanation or conclusions, but rather offers input from both sides.

Support for a public health insurance plan argues that such a plan would not only make health insurance available for at least most of the 50 million Americans who cannot afford it, but it would also bring more competition into the market. They contend that more competition would result in more fair prices for health insurance, and healthcare effectively.

Those opposed to the plan argue that the government is an “unfair competitor.” Their contention is that the government would have lower costs than private insurance companies.
“It would have a much lower overhead than private plans, with no need to make a profit or spend money on marketing or brokers’ commissions.”

Both sides agree that if the government went through with the plan, the price of private health insurance would have to fall to compete with the government plan. The opposition continues by saying that prices would fall so much that the private sector would be driven out of business altogether. Even if a private firm offered insurance plans at the point where marginal cost was equal to marginal revenue, the generally recognized point of profit maximization, the market price would eventually fall so low that shutting down altogether would be the least costly choice.

Neither side is totally wrong. Economists generally do not regard competition as a bad thing. But the opposition’s analysis is not out of tune with economic analysis—this particular style of competition could potentially cause serious harm to the health insurance industry. The fact is, not enough details are set for anyone to make a complete analysis. Only time will tell.

Uganda Discovers Coca Cola

Though Edris Kisambria, in an article describing the enormous gains a Coca Cola bottler in Uganda experienced, uses the word 'market' quite eloquently to describe the story, one might doubt he truly understands its full implications. In fact, an economist would argue that Edris' use of the word isn't economic at all, for his explanations of what happened in the 'market' for bottled beverages in Uganda entirely escape obvious, fundamental microeconomic principles. Further, microeconomic models capture so much more detail of the enviroment Ugandan suppliers faced in making their decisions than the author's un-informed speculation. Edris' article goes to show how passing by basic axioms of economic reasoning, as such a little mistake, can cause so much of the true picture to be lost.

"The extra capacity that CBL has built up has enabled the company to supply the Rwanda market with Pepsi Cola products. But the thing that is pushing CBL to break new ground really is the new products they are brining to the Uganda market" (Kisambria).

Is this analysis a correct assumption? Was indeed the advent of new bottled beverages the sole cause of CBL's (Crown Beverages Limited) increase in profit, market share and number of beverages they supply to Ugandans? A look into the story Kisambria recapitulates will show that his logic falls short of not only the actual economic cause of CBL's success, but misses the real story entirely.

According to the article, CLB, a Coca Cola bottler in Uganda, "invested heavily" in new capital and more labor to expand their output of Mountain Dew, and other one liter bottled beverages in response to a mighty surge in demand which "outsripped" their output significantly. The supply response granted them a huge increase in profit. This is the true story as told by economics, but Kisambria describes it as the company "growing significantly" and increased their soda production by "22 million bottles a year." His words do accurately describe, very generally, the choices CBL, as an individual supplier made in response to a change in their economic environment- the surge in demand for soda. But his description only gets the general idea.

The story microeconomics would tell reveals a lot more crucial details and insight into the indvidual behaviour of Ugandans, and throws out Kisabria's assumption to the cause of CBL's wealth quoted above. The economic story offers a much better explanation.

Economist's model of perfect competition shows a large shift in the market demand for soda. For some reason, perhaps that the introduction of a bottled beverages market at all caused consumers to substitute Mountain Dew for other bevarages dramatically, marginalizing other beverages as substitutes, or that the price for other availible substitutes went up, Ugandan soda drinkers increased their demand by four times more than what the company had planned for (as quoted in the article by CBL's Cheif Executive Officer) (On the consumer choice model, each consumer's demand curve would've been relatively flat with Mountain dew on the horizontal axis, implying their demand for mountain dew with respect to price was elastic). Then, as the CEO says, CBL attempts to make up for this and pursue the prospect of profit from the increase in price by investing in new captial and more labor to increase their output by 80%.n (To note, it can be assumed that CBL operates in a perfectly competitive market because the article and CEO's words imply that they had no monopoly power to keep price above marginal cost; they took the price as given as it increased and confered a supply response to meet a new competitive equilibrium) Because the firm adheres to profit maximizing behaviour, the notion of higher profits from the increase in demand completely drove their the decision to increase output. Also, because the increase in output was so dramatic, an economist can assume that their supply curve was also relatively elastic with respect to price. All of these events cause equilibrium price and quantity in the market for Ugandan bottled beverages to increase drastically. CBL experiences higher profit from high prices and more output.

What does the economic story suffice to say about Kisambria's idea that the quality of the beverages CBL produced solely acted to increase their profits? As microeconomic analysis as above points out, the quality of CBL's product had absolutely no effect on the firm's decision to supply more or their benefit of higher profit. It was supply and demand acting together in the market place as Alfred Marshal wrote, that brought them to that point. Kisambria's assumption completely leaves out the demand side of the market, and misses the fact that the only reason CBL behaved as they did was because they are profit maximizers and responded to the increase in demand on the sole incentive for higher profits. The conditions they faced completely dictated their behaviour. Though the quality of their beverages might count if the firm were in competition with few other firms in monopolistic competition or oligopoly to keep customers, and does count to prevent consumers from substituting other beverages, it economically impacts the supply decision in no sort of way. Microeconomics captures the important details about indivdual decisions.

Kisambria's error should serve to show the conclusions one can come to when they overlook the basics of economic thought in analyzing an everday day instance of scarcity like Uganda.

Redbox Rocking DVD Industry?

This article looks at the effect of Redbox kiosks on DVD sales nationwide, accusing the establishment of these machines of hindering movie sales and cutting into profits at rental stores like Blockbuster. It cites the availability, and price, of Redbox rentals as a leading force in a decrease in demand for DVD purchases. While Redbox is contributing to the reduction in DVD purchases, that is not the main impact of these dollar-per-night rentals. In fact, it could be argued that rentals in general are driving down the demand for DVDs, as consumers are more likely to simply rent a film for any amount of time as opposed to spending $20 to own it. This is because renting a movie and owning it are, in terms of comparing goods, substitutes. And since renting is cheaper accross the board, a higher demand will exist for them.

The real effect of Redbox, and other cheap rental providers, is felt at places like Blockbuster and Hollywood Video. These places are competing amongst one another in the rental market alone, and so have more direct stake in rental prices. Again, movies from Blockbuster and movies from Redbox are considered substitutes for one another, and the determining factor in demand for these movies is price. Redbox charges $1 per every 24 hours that the movie is away from the kiosk, while Blockbuster charges a few dollars, depending on if the movie is a new release, for five days. Depending on how long a consumer intends to hold onto the movie, either venue could be much cheaper than the other.

The article has a lot of bells and whistles worrying about how Blockbuster is in danger and Redbox is sweeping the market. As it stands, however, the firms are equally able to survive, as each has a unique consumer base. Besides, many Blockbuster stores are introducing $1 per night rentals in order to more directly compete with Redbox sales. Movie rental stores are going to stick around for a while, until online streaming plans like Netflix end up driving prices too low for the firms to continue to support themselves. In which case Blockbuster will still have streaming movies to compete on that front as well.

When will they learn?

                The idea of the Treasury Secretary controlling all the wages of the workers in the companies the government contributes to just sounds like a bad idea.  The problem with this article is that they avoid the economic impacts.  It’s like minimum wage, except it’s maximum wage?  I understand that all these companies messed up and the government wants to watch their money, but it might be better to have someone act more like a supervisor than someone simply controlling it all.

                If the government begins to put a maximum level on their wages, what’s the incentive to work harder?  They’re saying that they will be fair wages and such, but really?  When people lose that incentive to work harder then companies don’t improve themselves as quickly.  The workers don’t work harder and faster, they just work. 

                It also takes away from the workers market.  The higher the skill the higher the pay, so the company can chose between the more skilled workers who can get things done faster, or two workers who aren’t as skilled and together get as much done in the same period of time as the one worker.  If the more skilled workers think that they can make more by working for a company not controlled by the government they will.  Those that don’t and are getting these likely lesser wages are distorting the market saying that a company can get more highly skilled workers for less than they’re actually worth.  When those wages change the input prices change so it my (eventually) look like those companies are making a positive economic profit inviting firms to enter the market and if the government backs out at the wrong time and the workers demand the pay they actually deserve, then input prices will quickly rise, and we will be back to the point where some of these companies will be failing.  On top of that, what’s the point in being skilled if you can make the same money if you’re not a highly skilled worker?  So there will be less skilled workers in the workforce all together. 

Oh the government should just stay out of these things.  Distorting markets is not the way to fix them.

Housing: Wealth

This article says that the value of housing has been decreasing rapidly for quite some time, but is now becoming more desirable as the price has decreased, and the housing market, therefore, is near the end of its slump. This is a study taking place over 20 major U.S. cities.

As housing is typically the largest asset ownable by a person, the cost of that housing also represents the ability of the owner to pay it and therefore the average housing cost is a good indicator for the average American's wealth and the strength of the economy. This assumes that lendees are not sub-prime and that people will upgrade their housing as they are able to do so.

The proposed reason for the fall in housing prices is that people stopped buying new houses as they were unable to afford the change from their current house to a new and presumably better one. This is most carefully attached to demand loss according to foreclosures. This represents a decrease in demand, which, in this case, was compounded over 4 consecutive years of near-constant decreases.

This article proposes that the last two months of this year saw increased selling and buying of new and old houses, and that this means that the housing slump that grew over the last 4 years is supposed to be getting near its end.

Along with the falling price of housing, the cost of loans decreased. This is an increase in demand as it becomes easier to take out a loan to buy a house that costs less. This agrees with the evidence that housing sales have begun to increase again, and will do so until the prices are back up on both loans and houses.

Yay!

“Our recent engagement with the union has been conducted in a constructive and open atmosphere, and I look forward to this continuing”- Henry Ford

While a bit misleading-Henry Ford adamantly opposed unions stating the UAW would organize “Over my dead body,” I bet Ford never imagined that unions would contribute so profoundly in the deteriorating and dismal state of his beloved company today. In an article by the AP and recently updated on MSNBC, President Obama’s pledged to aid the ailing Big Three automobile companies (Ford, Chrysler, GM) given a viable plan. Previously, former President Bush provided the Big Three with a loan of some $40 billion dollars (distributed for the most part between GM and Chrysler). “Obama, responding to a question… said the current was unsustainable and the Big Three would need to change their ways.” Restructuring to cut costs in order “preserve” the “symbol” of what is supposed to be Americana. In many Americans eyes this symbol represents an inability to compete, and a reliance on welfare to avoid Chapter 11. In accordance with the terms of the Bush loan the UAW (United Auto Workers) has adopted “work rule changes and reducing total hourly labor costs to be comparable to those at Japanese automakers with U.S. factories.” Well that’s a start , but it fails to address the fundamental problem and doesn‘t factor the comfortable retirement and benefits of UAW employees. While the Obama administration may suggest restructuring these companies it de-emphasizes one of the biggest proponents on why these companies are failing to compete-- the UAW. The article states that Obama “stressed the large number of jobs connected to the companies and suppliers.” Inevitably this argument is incessantly brought up somehow validating why the government should throw the lifeline to these companies, that their presence fuels X amount of secondary jobs. Arguments, include: are these jobs worth the $40+ billion dollars were loaning these companies, should we reward these incompetent, myopic firms? If people aren’t buying the cars to remain profitable then why should we, as the proverbial saying goes- catch the falling knife? (Recall the 1979 bailout of Chrysler, they sold a large part of their business, Chrysler Defense, to repay the government loan but still resulted in wide spread job loss) Researching the topic further the seemingly straightforward problem evolved in complexity and while I will not assess the history of business/union relations in America or pass judgment I will state the numbers. An explanation for the current domestic automobile situation and the pitfalls of simply eliminating the union is needed. In terms of competition , the once dominant Big Three held a vice grip around the US automobile market and could be characterized as an oligopoly. With an increase in domestic competition, the market changed to one of monopolistic competition. It is here, where the problem to remain profitable castrated the Big Three. Like many unions, industrial unions primary objective is to try to unite all workers in the same industry, to create enough leverage to be taken seriously in their demands (wage increases, benefits, etc.). This market environment while not the most efficient, still provided the U.S. automobile companies to be profitable till an influx of foreign rivals (which possessed the luxury of a non union workforce). With the U.S. governments implementation of VER (voluntary export restraints) on Japanese automobiles, foreign companies started producing cars in the U.S. While I can’t measure the qualitative nature of U.S. cars to Japanese cars during the same period I can tell you since late 2007 foreign automakers held over 50% of U.S. automobile market and is still growing. Assumptions could indicate a change in consumer preference due in part to the lack of quality amongst the Big Three. The once nationalistic cry to “buy American” has been replaced by buying quality (to be perfectly honest I’ve always had a fondness for Ford’s F-series trucks). Even that slogan has been diluted some since those same foreign automobile companies are in fact produced in factories in America (for the most part). Some facts gathered off the internet highlighting the impact of UAW compared to non-unionized Toyota.

• Increased costs due to UAW benefits-$1,600 every vehicle of GM
• Average GM worker-$70 an hour in wages and benefits
• Average Toyota worker- $35 per hour (still making $100,000 in wages, benefits)

(James Sherk of The Heritage Foundation)

From this information we can safely conclude that the increased labor cost has negatively effected the business model of all three companies. Money that could be allocated efficiently for perhaps research and development has been siphoned to provide the demands of the union. The Big Three are at such a disadvantage concerning their labor force that their products are not cost effective in comparison to Toyota or Honda. The large dichotomy, means larger revenue streams for non unionized firms towards the betterment of their companies. The Big Three have little leeway in the matter of eliminating the UAW, the UAW could threaten to strike, rendering the companies futile in a competitive marketplace. Currently, the UAW has placed itself in a position where the companies can not act without it. While the UAW is not the sole reason for the failure of the Big Three it is becoming increasingly apparent that it is a large contributor. Perhaps, the lack of adapting to consumer preferences is amongst the reasons why the Big Three have found themselves in this situation, but we can not ignore the effect of the UAW. With a consumer base increasingly geared towards more fuel efficient cars the Big Three have been slow to react in a competitive manner. While unions protect workers, the unintended consequence is that they could be responsible for the loss of the thousands of jobs they sought to protect. GM, Ford and Chrysler are expected to heed Obama’s advice and cut thousands of jobs.

AIG Reaction

In this article Douglas McIntyre discusses the ramifications of the AIG bailout. The bailout was meant to help AIG help the middle class citizens, which could have potentially stimulated our suffering economy. Essentially, the government was trying to help out our banks so they could help our middle class. However, the bailout money was not used for what it was intended. It was used for bonuses given to the head honchos of the company when it should have been used to cover the increasing costs AIG was experiencing. Now, the government wants to take some of that money back by taxing the payouts at a rate of 90% because they felt the money was misappropriated. McIntyre explains that even though the ‘goal’ of ‘big government’ is to bring a sense of calm during a time of crisis it did not take peoples survival instincts into consideration. During stressful times, like a recession, playing into a persons worry can cause them to take advantage of the help for their own benefit. They are going to put themselves ahead of all others.
So, AIG took advantage of the bailout. There is no point in dwelling on the past or in placing blame. The focus should be on either fixing the problem or on enacting plan B. The government thinks they have the problem solved by taxing the payouts at a high rate. I’m not entirely convinced this is a good idea. The whole point of the bailout was to stimulate the economy. Taking the money back does not stimulate a thing. Even though the money was used differently then expected, it is still in circulation and it will still be spent, thus aiding the economy. Look at it this way. The people who received bonuses increased their budgets, which makes them more likely to spend money on things they would not have before. This increases their utility while putting money back into the economy. If you tax that excess money their budget and utility both decrease and they spend less money. Yes, the money was supposed to directly help the middle class citizen, but stimulating the economy helps them too. It is just a more indirect approach.

A gasoline tax to.... reduce prices???

These days everyone wants to be an economist. With the U.S. economy "falling off a cliff" it seems that more and more people know just what to do to fix all our problems. CNN is on this list of so-called economic experts. Their specialty today: Gasoline prices. The CNN article, by Steve Hargreaves, states that there is some evidence (although he does not cite or reference any of these findings) that shows people are not using the decline in gas prices to buy food or health care, but in fact, to drive more. This in turn will force demand up and increase the price of gas all over again. Wow, this must be shocking to many Americans who had no idea they affected the market in such a negative way. Good thing Steve is here to tell us what to do... Impose a gasoline tax to decrease demand and stabilize the price. It seems only obvious!

Goodness. Does CNN actually require its economy journalists to actually have taken an economics class? Apparently not. Although there may be evidence to support the basic claim that people are driving more due to a decrease in gas prices, there is another reason why Steve here wants to impose a tax on gasoline; Global warming. Where global warming issues may see this tax as a big win, American's wallets will not. This article shamelessly tries to bring about an economic reason in which it would be "smart" economically to impose a tax, in a horrible attempt to sway public opinion. Steve explains that "While it [a gasoline tax] is likely to raise prices immediately, the tax would also simultaneously act to reduce consumption, so the market price for gas would likely fall. That would mean less money for OPEC or Exxon Mobil." Can you hear the public cheering yet?

But let us look at what a gasoline tax would actually do, although it pains me to be so obvious. In the short run supply will decrease, and yes OPEC and Exxon Mobil will produce less and profit will decrease, however at a higher price to the consumer. This will knock the market off equilibrium and people who cannot afford the tax (the poor) will not be able to buy it. If they loose their jobs because they cannot get to work... oh well. Ride the bus. In the mean time the rich, who can afford to drive more, still will. Global warming? Well, maybe there emissions will be offset by the poor who can no longer drive. Gosh Steve, this plan is really working out! The first part of this analysis checks out. Gas prices will rise, and consumption will fall. Let us look at the second part: due to the fall in consumption market prices will 'likely' fall as well and we will all be happy.

In the short run, part of this tax will be shifted to the consumer and the other part to the sellers. However, the multi-billion dollar oil industry is likely to adapt faster than average citizen. Thus, we move into the long run. If we assume a constant cost industry, in the long run, long run average costs and marginal costs will have shifted up by the amount of the tax. Will this increase lead to a fall in prices as Steve has predicted??? No. In fact, it will lead to the full amount of the tax being shifted to the consumer, aka an increase in price. Mmmmmmm. So when exactly will the consumer be better off? Well you might just have to ask Steve.

Hospital Oligopoly

In a NY Times article, How do Hospitals get Paid?, author, Princeton Professor, Reinhardt, speaks candidly about the different associated fees that hospitals charge.

1st fee- Is that of Medicare where the government pays based on the condition of the elderly under a flat fee- which can change through levels of persuasion from hospital administration about how much of a percentage of risky (expensive hip replacements) patients that come in with Medicare(especially if based on govt. payments per dollars a day).

2ND fee- Fees that accrue from private insurers which Reinhardt assures readers that "On average these payments exceed the hospital’s cost of providing the underlying services and that these profits cover the losses hospitals book on serving Medicare and Medicaid patients, who are billed high prices but often do not pay their bills in full".

Through these different fees each hospital has a different range of fees and therefore each has its own unique charge master. Strangely, the author points out three discoveries: that these varying cost of medical services have nothing to do with the quality that one receives at their hospital, Medicare is considered a price setter and that charge masters are not visable for the public.

Why are medical services so expensive? Well according to those that believe in free market rather than government help, who do you think?

Correct me if I'm wrong...
Hospitals aren't really a monopoly in this case, but are being given monopoly power through funding of medicare & medicaid fees. The ammount of funding comes from the approach of persuasion that the hospital has when government & hospital staff negotiate. The thing is negotiation power for govt. funding may be considered a weak argument f hospitals incur more costs with these elderly programs and assistance to lower income than they would without them. Perhaps its the regulations that government puts toward private insurers such as the required ammounts that insurers must pay to certain hospitals. So it may still be negotiation power, but from this article that suggests higher profits from private insurers perhaps the most profitable negotiation is cohersion of a third party.To clarify( hopefully), I just mean that insurers are the ones that fund more money towards hospitals because hospital negiators lobby for more government regulations to increase their profit margin and that because ( I wonder if price discrimination applies here) government is using force in this situation rather than finding funds through taxpayer revenues private insurers are increasing their costs as well to transfer some of their revenues to hospitals at inflated prices.

The last point that Reinhardt introduces in this article is that the charge masters are not visable to the public. This I would say would be more speculative than my own take on this situation b/c its so generalized but what is a blog for I guess. Perhaps because if people did see the prices perhaps there would be government blame for medicare and medicaid than what exists presently since prices seem to change much more rapidly or perhaps the fear of removing this oligopoly power for the various hospitals' sake.

http://economix.blogs.nytimes.com/2009/01/23/how-do-hospitals-get-paid-a-primer/?scp=2&sq=hospital%20monopoly&st=cse

Nationalizing Our Banks?

Nationalizing our banking system is a scary thought. The key to nationalization is that the government actually owns and runs the banking institution, but so far that is not what they are doing, getting close but not quite yet. Our government has pumped billions of dollars into banks that are “too big to fail” in a plan they call TARP. This Troubled Asset Relief Program (TARP) is designed by the government to insure the bank’s most toxic assets, but has been extremely unregulated and left large banks with no accountability or decree for the usage of the funds. The government truly does not want to own the banks; the original goal of TARP was to protect the common shareholders giving the company incentive to raise the necessary capital through the market. First of all why have we allowed banks to get too big to fail, leaving a gigantic burden on taxpayers? Maybe we should limit the size of banks so they can be more manageable and not as risky. Smaller banks that have failed have been taken over by the FDIC and no depositors within the monetary limit have lost their funds. There was a great report on 60 Minutes that revealed that exact process, it was extremely enlightening and interesting. http://www.cbsnews.com/stories/2009/03/06/60minutes/main4848047.shtml
So why, as taxpayers, are we accountable for the intense risk of these “government-guaranteed securities” for big banks, when smaller banks simply get bought out or closed down? Does this behavior not send a message that taking unhealthy large risks towards rapid growth is a good thing simply because the hardworking people of this country will back you if you fail? We have a huge mess and no uncomplicated way to clean it up. Nationalizing banks is not a cleanup tactic I condone.

Political Stress on Economics

In a NY Times article, Obama Offers Broad Plan to Revamp Health Care, writes about the cut in federal payments to hospital and insurance companies, while funding those that do not have health insurance.



Even though this initiative, as the title states, is a vague plan for altering health care, the uninformed reasoning is still there. Obama may be more concerned about those in congress and the public in creating actions rather than the actual economic effects.



Some of these problems that Obama seems to dismiss is the breakdown of his suggestions in improving health care that this news article has presented. First, the article mentions Obama's theory of raising Medicare beneficiaries premiums. With the assumption that these Medicare beneficiaries are the middle class ,is contradictory to supporting the existence of the middle class. Obama seems to be transferring costs with those that cannot afford health insurance and those that can. The main flaw in this intiative is that instead of leaving those that have the ability to afford health insurance alone, Obama's goal will restrict those that can afford health insurance. Second, Obama is requiring that drug companies should supply generic drugs at a lower price for people to afford these cheaper alternatives. The problem yet again with this change is the idea of demand and supply. How will drug companies afford to lower their prices without being in the red? If a firm's goal is to maximize profits with increased costs because of the government wouldn't the firm increase the cost of drugs that aren't generic and choose to eliminate the avaliability of generic drugs so that it wouldn't have these regulations?

Beijing Reserves Could Fuel Natural Resources Deals

I am in awe every time I think about China’s market structure. In a country teeming with human life (over 1 billion more than the third largest country in the world) and not nearly as much developed infrastructure, not to mention a government-operated market system….well, the sheer logistics must be staggering.
The Chinese in recent years, have been rising up to the challenge, though. Partly through a mercantilist mindset, they have been hoarding up—and, incidentally, investing in US treasury bonds—in order to lower prices and remain competitive on the world market.
As China’s population begins aging, however, they have started running into the same issue that we here in the US face: how to pay for social security and medical care for the elderly? A big part of the answer in the past has been to trust in US t-bills, and still is, to some degree. However, a recent article in the Wall Street journals seems to indicate a change in policy.
With the turmoil in many world industries, the Chinese seem to realize that this would be an excellent time to invest while prices are temporarily lowered. Mr. Fang (a top Chinese official in the Chinese investment corp.) is quoted as saying, “China’s reserves are largely invested in safe government bonds like U.S Treasurys [sic], but they can be used to pay for imports or for foreign investment.” As Chinese foreign exchange reserves near $2 trillion, they have the potential to tip the scales in their favor all across the world.
Incidentally, these investments, so far have been in the arena of natural resources: Oil and steel being the biggest. I won’t pretend to understand why their focus has shifted to natural resources, but I could, in one word, take a guess: production. In a modern economy, though, the major factors of production are labor (which they have in spades) and capital (which they are working on feverishly), as opposed to “the bounties of the Earth” (especially if one is not overly concerned about pollution and the squandering of resources). I wonder if there might be another, ulterior motive there as well. Could China be hoarding more than simply wealth in anticipation of some crisis? Only time will tell, I suppose.

Scrap Logic

The car scrap premium proposal of Frank-Walter Steinmeier, Germany’s foreign minister, was approved by the Federal Government, but yet the question is, does it make sense?
To stimulate the automotive industry by increasing sales of new cars, people receive a $3.000 payment to scrap their car, that is 9 years or older, in order to buy a new car (that fulfils the new emission standard Euro-4).

John Maynard Keynes ironically stated, that in times of recession, the government should “fill old bottles with bank notes, bury them at suitable depths in disused coal mines which are then filled up with town rubbish, and leave them to private enterprise on the well-tried principles of laissez faire to dig them up again.” This could have the same effect as the new scrap premium.

In order to be effective, it has to encourage enough people to make an impact.
It is questionable, if the premium actually encourages people, to destroy their car and buy a new one.
On the one hand, it would help the decision of car drivers who have already thought about purchasing a new car. I would consider this number of people as relatively low.
On the other hand, in times of the financial crisis, it is unlikely that a car owner is willing to buy a new one. Other reasons could be that he cannot afford a new car, does not want to buy one because of its relatively high opportunity costs, or still likes his car that is 9 years or older. An additional $3.000 increases the budget of the individual, but the purchase of a new car might still be beyond this new budget line.
A new car has a fast depreciation in value, especially in its first year. This is why there is a tendency to buy used cars. Buying a new car also faces higher opportunity costs because it binds the capital and fewer interest can be realized.

Therefore the base of new car consumers may be smaller than needed and the scrap premium would only have little impact for the automotive industry.

Another aspect of a policy’s intension should be the generation of value, while the car scrap premium reflects a destruction of value.
In my opinion, it is a shame to destroy cars, just because they are nine years or older, in order to get the premium, even though they are still in proper running condition.
The premium causes an economic damage of the rest value of the car plus the costs of search to find a new one.
Would it not be the same to blast houses in order to stimulate the building industry?

The reduction of CO2-emission represents another argument for the scrap premium.
By replacing old cars for newer, more fuel efficient ones, the premium is supposed to contribute to the reduction of CO2-emission and therefore to the protection of the environment.
However, I do not consider the solution using a premium as very effective and do not think it could result in a multiplier effect.
To achieve an ongoing effect, it is necessary to put incentives on the people’s behavior. By charging car drivers with a CO2-emission price that is integrated in the petroleum tax, the individual can choose how much he is willing to pay more for the additional pollution.
Without negotiating with all other continents, I do not see a significant effect of reducing the CO2-emission with the premium. There is no local solution for a global problem like this.

Maybe this is not quite the area of responsibility for a foreign minister, and the government should consider theories of specialists of a more effective investment to stimulate the automotive industry and to protect the environment.

http://www.dw-world.de/dw/article/0,,3996710,00.html
http://www.tagesschau.de/wirtschaft/konjunkturfoerderung100.html

Uganda's food scramble

According to reporter Sylvia Juuko, rising prices of food in Uganda are causing consumers to eithr cut their habits of eating lunch out entirely, or significantly reduce them. She's entirely right in her analysis, giving decent logical reasons for consumer's radical change in eating habits in response to a dry season for growing foods eaten regurlarly in their diets. However, Sylvia's article could benefit from a whole plenty of information contained behind the scenes.

Sylvia begins her article by telling readers about how the dry season in Uganda led to a rise in the price of food. Mostly covering all of her bases, she resons that this rise in the cost of food caused restaraunts, specfically popular spots for lunch out during a typical work day, to either increase the cost of their meals or decrease the amount of food they serve to customers. In response, she says, business men and women have radically economized on eating out- packing lunches or going to the supermarket down the street. Basically, Sylvia does a great job of telling readers about how supply and demand interacted in the market for lunch out, but she doesn't give any premises or reasons to justify her logic. Deeper economic analysis, or a look at an economic model would've provided her with just the reasons she needed to support her arguments.

In the article, Sylvia justifies her reasoning with quotes from Ugandan business men and women who were forced to economize on eating lunch out during a busy day at work, and those restaraunt and grocery story owners who feel like they've gotten a raw deal from both the rising costs of food and a huge drop off in business. These words of course, logically perfectly justify what happened; obviously if someone testifies to it, that must be great evidence for it happening, right? But, little does the writer know, the words from Ugandans actually points us in the direction of microeconomics at work. In effect, Sylvia has failed to tell us why Ugandans responded the way they did to the market.

The dry season would've indeed caused the price for food to restaruant owers to increase. Food distrubuters, to make up for their losses from the season must increase the price they charge for food to restaruants. In response to being charged more for food, restaruants, to make up for the lost profit, carry that price over to their customers. None of this should seem terribly surprising, and worked in exactly the way Sylvia described, mostly. Models tell economists that the dry season caused supply to decrease, shifting the supply curves in the market for prep food and restaruant food upwards. What this says that Sylvia doesn't tell us is that resturaunt owers must also have decreased the amount of food they prepare- the increase in costs of production reflects this. Things get interesting when we examine more closely the radical response consumers held to an increase in the price of eating out. Sylvia gives quotes from extremely disenchanted Ugandan consumers. They complain that they've had to economize enormously on eating out. Some decided to bring lunches to work and stop eating out entirely. Others went to the supermarket to find cheaper prices. Some consumers traded eating out on some days and bringing lunch on others. What does all of this tell us about consumer's preferences? Their demand for lunch out must've been extremely elastic, with an elasticity far below -1, maybe even far enough to halt consumption completely. Those consumers that did halt completely probably had perfectly elastic curves. An easy accsess to cheaper substitutes also caused them to find cheaper food. The increase in cost of eating out was just perfecltly too much for businessmen and women, with their heavy schedules, high dollar value for time and the existence of cheap super markets down the street. What Sylvia didn't capture in her analysis was this detail- income and substitution effects working in the same, negative direction to have a huge impact on consumption. Consumers ate out less and made their own food more. Plus, their budgets just couldn't handle a price change of that degree; consumption of luch out decreased even more. The author's analysis could've been enriched with this look behind the scenes.

Lastly, what Slyvia didn't focus on was the postive impact that had to have occured on supermarkets and other marginal food sellers from the increase in price. Since consumers substituted so much of their own food for food ate out, supermarkets and cheap fast food would had to have experienced an increase in profits, even with the higher cost of prep food. In the end, its the marginal foodsellers who truely get the good deal.

Although Sylvia's logic was sound and her examples supported it well, we can see that so much more happened behind the scenes in Uganda. Radical changes in individual preferences and higher food prices all worked to explain the events she describes.

(Untitled)

We’ve all heard about the current state of the U.S. economy—unemployment is way up, businesses are shutting down, the government is bailing out companies left and right, consumer spending has plummeted, the sky is falling, the sky is falling… This article discusses how Saks, a retailer that sells luxury clothing and accessories, is dealing with it all.

Saks has taken the obvious avenue of reducing prices in their attempt to stay alive in a market that has been experiencing drastically decreasing demand. This measure is in total compliance with the Law of Demand; however, Saks faces an unusual problem.

Many Saks’ fashion-forward customers are not your typical consumers—they defy some of the basic characteristics on which economic consumer theory is based. Such consumers receive more utility from relatively expensive goods because they assume a lower price means lower quality (not to mention their lowered egos when they wear lower-priced merchandise). Since they are put off by lower prices, those consumers may turn to other high-end retailers like Nordstrom or Neiman Marcus to quell their expensive taste. Saks risks losing an important part of their target market, and their image along with it.

The discounted prices on merchandise have helped Saks sell their inventory (at a loss) to consumers who perhaps otherwise would not have shopped there at all. In reference to the steep discounts taken, the article quotes Stephen Sadove, the company’s CEO: “Some actions were taken that you’ll probably never see again.” Maybe that will appease Saks’ traditional epicurean customers. In an effort to keep their new, more price-sensitive customers coming back, the article also mentioned that Saks plans to start carrying lines of “exclusive but more affordable merchandise.”

Saks is doing their best to carry goods that will provide a greater amount of utility to consumers with a wider range of budget constraints than they have in the past. If their plan is successful and more consumers start to spend their money there, the effect could be similar to that of an increase in income—an increase in demand. Best of luck to them.

Mr. Market

Given the U.S. financial markets volatility and somewhat slow regression the last couple of months, I found it appropriate to briefly and simplistically analyze speculative trading and its effects on the investment of commodities in the last year or so. To start, I remember a time when Goldman Sachs analysts predicted that oil could reach $200 and while wrong, the prediction highlighted the amount of fear in the market when the logistics never warranted it. The only explanation for the behavior of investors was trade speculation into oil, hedging against a supply shock that never occurred. Hard commodities like oil, have been subject to rampant fluctuations in market price, often resulting in extreme devaluation and economic instability. Some background. In case you’ve been in a hole the last one and a half years and haven’t received the news, the worlds financial markets experienced tremendous highs and devastating lows. While the S&P 500 has dropped roughly 50% Russia’s RTSI has dropped 80% since its highs in the middle of 2008. An explanation: roughly 8o% of Russia’s exports (U.S.- 30% commodities) are natural resources (oil, natural gas, timber) and the RTSI’s businesses are reflective of this. Interpreted in dollars, we are talking about losses in trillions of dollars worldwide.

The topic of the effects of trade speculation was brought to my attention by the recent article in the Financial Times “Chinese copper entrepreneurs flee.” China’s government has spearheaded an effort to support private investments in Africa to secure natural resources. A result of the growth seen from China and other emerging markets gave credence to the belief that the hard commodities needed for the rapid expansion of infrastructure and essentially modernization would equate to greater demand in these goods. Well, the consensus now is that slow global growth outweighs the demand. The article brought in light the abandonment of Chinese smelters in the Katanga region of the Congo. With the cost of copper soaring to $9000 a ton the cost provided enough incentive for Chinese miners to move into the Katanga province and mine at a lucrative $5500 dollar profit. But as the cliché goes, good things never last and investors sold off their positions in commodities, marking the end of the commodity boom. As a result forty Chinese smelters left Katanga and as the author states “luxury house building projects and freshly imported Jeeps vanished and replaced with crime and unemployment.” The reason? Copper plummeted to nearly $3200 a ton and the incentive to mine in Katanga was not lucrative enough given the operating costs. We can deduce that speculation in copper created an unstable and inefficient market. In the case of Katanga, the investment brought in from the Chinese provided an economic expansion and influx of wealth. Speculation in copper (increasing prices) over the years created enough of a catalyst for the expansion of supply and investment but after the deflated price it left it no better than before. With a conditioned reluctance for foreign institutions the future is uncertain for Katanga. Adding the cherry to the top of the “screw you” sundae the Chinese owners failed to pay taxes and compensate workers. Moise Katumbi, was asked if copper price were to rebound would he allow the Chinese to come back, saying “No. no no. Not as long as I am governor.”

An argument for the recession attributing to the price of copper is valid and obvious, while some state that the value of copper is pragmatic, since its wide use in homes, pennies, etc. and consequently not subject to speculation. In my mind it ceases to explain the 320% increase in copper from March 2004 to February of 2006, and its subsequent drop to 2004 March price levels in December 2008, in a matter of months. I am in no way denouncing speculation in the commodity market, I realize that in order for markets to work, individuals willing to risk their capital for a high reward is a cornerstone of any market, but some (politicians) wish to control speculation on the basis of possible collusion, my humble opinion is that Mr. Market is just being Mr. Market.

Legalizing Marijuana: The end of all our economic problems?

California is trying desperately to push through a bill that would allow people age 21 and up the legal right to smoke marijuana. The Board of Equalization estimates that it will bring in 1.3 billion dollars every year and help California out of a huge pile of debt. If only our government could learn how to spend our money more wisely, then maybe they would not need to continue taxing everything they can get their hands on… even illegal substances.

However, this is very unlikely, so we are stuck analyzing the economical implications/rewards of legalizing pot. First of all, an increase in tax revenue will most likely not bring the state out of debt, no matter how much revenue is made. A basic concept in economics lies behind the demand of a market. When people have more money they tend to demand more goods and services, thus maximizing their utlilty. This is proven true also by our government’s reckless spending that only increases with tax hikes. For instance, part of the revenue brought in my legalizing marijuana will be spent on rehabilitating the drug addicts that it is predicted to create. Whereas, the people might benefit from the government injecting these tax dollars into the economy, in all actuality, California will likely remain in debt.

Still, people in many ways will be better off, which is after all the underlying point of economics. Potentially, many jobs will be created, prisons and the courts will be less crowded, and the government will be able to inject money back into the economy. Health risks are, for the most part, pointless to debate, since hundreds of thousands will smoke marijuana whether it is legal or not. Violent crimes could possibly be lowered due to a fall in dangerous black market dealings as well. Although the argument will probably made that this is the ruin of moral society as we know it, I see it as just one more thing the government can no longer tell the people not to do, which is ironic, since people are smoking without their consent anyways.

There is one other point made on the new legislation that needs examining. The bill puts a $50.00 fee on the sale of marijuana per ounce. Where this arbitrary number came from is not clear, but the negative implications could be endless. Since it is ridiculous to believe that all the drug dealers operating on the black market will shut down shop and instead allow the family owned gas station down the street to take all their business, there is still going to be a black market for weed. Especially if the $50.00 imposed fee turns out to be a price ceiling or a price floor. My guess is that this price is going to be a floor, since the government is interested in maximizing profits, they will set this as the minimum amount allowed to be charged to buyers. Selling below this price will be illegal. This will allow the black market to continue selling cheaper marijuana, undermining the government’s prices. If the $50.00 price is above the equilibrium price of the market for marijuana, then there will be a surplus of the quantity supplied by the government. If people can get cheaper marijuana illegally they probably will since they have been all this time anyway. This will reinforce the black market instead of weakening it. Either way, an imposed legal price disrupts the rationing ability of the free market. If the government really wants to maximize their profits, they should stay out of the markets way.

California's Bailout

This article from the San Francisco Chronicle looks at the bill introduced by Tom Ammiano in order for California to become the first state to legalize marijuana. As the state of California’s economy declines, Ammiano proposes the idea that taxing marijuana in ways that alcohol and cigarettes are, the state can generate the extra revenue to be put back in to the state. Aside from taxes, Ammiano also reveals that the street value can be dropped by over 50 percent, with increase users of 40 percent, generating more profit for the state. With police making countless arrests each day for possession of marijuana, the legalization of this drug would enable law enforcement to focus on more dangerous issues. He also stresses the strong regulations and expensive licenses people would have to abide by.

I believe the legalization of Marijuana can benefit California’s economy in many ways. The taxation of alcohol and cigarettes has already proven to generate mass amounts of revenue for the government. Adding another regulated substance such as marijuana will only increase this revenue. As for the street value dropping by nearing 50 percent I believe that with the legalization of marijuana and the decreased price would strongly influence more consumers. The more consumers, the higher the demand, the more demand the more revenue California can produce. With lower prices, more consumers, and the government collecting on the tax to better the state, it’s a no brainer.