Something to Be Thankful for....

I don't know how many of you have been using the "sub-prime" story in your class. I've always been a believer in using headlines to add interest and draw attention to principles when teaching economics and personal finance. And this story certainly has provided a lot of fodder.

But given the impact it has had on markets over the past couple of months, I think you and your students need to keep one thing in mind as you discuss this. Take a look at this link (link no longer operative). The whole sub-prime sector is a very, very small portion of the world's financial market. And while a large number to consider (.7 trillion), even if the whole market was "marked to zero" or written off, it actually would be less than the stock market can lose in a single day's trading in the major stock exchanges.

Now, I don't mean to minimize the issue. There are significant human costs when people lose their homes. But many of the people in this market continue to make their mortgage payments, and the market is not likely to be written off in total. So what's to be thankful for? This could be much bigger than it is. And while substantial, the damage may be less than we fear when we read, watch or listen to the news.

Thanks and a HT to Felix Salmon at Market Movers and Tyler Cowen at Marginal Revolution.

I look forward to your comments. Have a Happy Thanksgiving.

Some Resources for the Classroom

First, I owe a HT to Greg Mankiw and Mark Perry for these resources. I hope you can put them to good use.

The resource from Dr. Mankiw is a link to a policy simulation to use with your students. It does model a European economy. This may cause students some confusion: things like VAT (value-added taxes) and higher levels of government spending. Additionally, there doesn't seem to be a way to manipulate monetary policy. Finally, the program is a beta version so may have some bugs. But it's a classic exercise.

The resource from Dr. Perry is a link to a YouTube video-clip of the Milton Friedman Choir, singing about the responsibility of corporations. It's interesting and fun, and a great way to introduce a discussion with the students.

Let me know how these work out for you, and if you've run across anything else that you use effectively.

Bringing Things Together

One of a number of hot topics on many economics blogs right now is health-care. Specifically, there has been a very good and informative back-and-forth between Paul Krugman and Greg Mankiw. To bring both of these economists together, along with some good discussion starters, visit the Aplia Econ Blog. It's a good place to start in the discussion.

Please share your thoughts.

Steel, China and Other Delights

Yesterday's (11/12/07) issue of The Wall Street Journal provided a cornucopia of articles that can be used in the classroom. That publication is a favorite of mine for finding things like this, and everyday is pretty profitable)high marginal benefit to cost), but yesterday was great. This post focuses on three of the articles and will provide some ideas for their use.

The first two articles, "Big Steel is Dealt Weak Bargaining Hand", (subscription required) and "West's Mining Deals Put China in a Bind" (subscription required), are about the potential merger of two of the world's largest mining concerns, BHP Billiton and Rio Tinto. Because these two are big players in iron ore mining, the combination could have significant repercussions for steel producers around the globe. But the problem could be especially significant in China.

The impact is less significant for a number of U.S. steel producers as can be found out in the third article, "U.S. Steelmakers Draw Fire" (subscription required). But it has another twist. The reason the combination is not as large a problem in the U.S. is that many domestic steelmakers own their own sources of ore - an example of "vertical integration." But the twist comes from the fact that U.S. steel is heavily subsidized to protect it from foreign competition. The subsidies are considerable. And one gathers from the third article, that even with the combination of BHP Billiton and Rio Tinto, the potential price rise will still not make U.S. steel producers competitive, and willing to give up their subsidies.

These articles can be used in so many ways. You can discuss of market structure (combinations and how some natural resource firms handle production and pricing), interdependence (impact of ore prices on steel and then on consumer prices), international trade (the role of multi-nationals, comparative advantage, or why nations trade), the role of government and fiscal policy (subsidies are part of fiscal policy) and the impact of trade barriers on consumer prices and competition.

I encourage any economics teacher to look at these articles. Try the links, but if they get disabled, look for old copies of The Wall Street Journal in your school or public libraries. To borrow from the theme of the articles, there's a rich vein of resources to be mined here.

I look forward to your comments and any further suggestions you may have.

Classroom Discussion Starter - 10 Minute Lesson

Several quotes in The Wealth and Poverty of Nations struck me as good introductions for classroom discussion, either to start off a lesson or to wrap it up if you found that you have a few unused minutes because your plan worked better than you expected. Let me give them to you and offer some ideas to guide discussion.

"Is inflation a kind of impersonal lie?"
This is great way to start or end your discussions of inflation and/or monetary policy. Consumers, investors and businesses plan for the future - some farther than others, but we'll pass on that for the moment. In their planning they anticipate costs, usually in terms of price. To what extent does inflation complicate planning? Does allowed inflation constitute a willful misleading by policy makers of those trying to plan future activity? How does low or zero inflation help the economy?

"...the rich [countries] see the peril -- at least some do -- and their wealth permits them to spend on clean-up and dump their waste elsewhere. They also abound in good ecological advice to the new industrializers. These in turn are quick to point to the pollution perpetrated by today's rich countries in their growth period. Why should today's latecomers have to be careful? Besides, most developing countries are ready to pay the environmental price: wages and riches now; disease and death down the road ... Meanwhile who can confine pollution and disease? The rich are frightened, even if the poor are not. The rich have more to lose."
If you discuss economics and the environment, this is a good quote. It summerizes much of the current focus on environmental issues as it applies to developing nations. At the same time, it shows that there is a cost for short-term vs. long-term thinking. One of the best lessons of economics is that the costs of our decisions lay in the future. Is it foolhardy to count on/hope for a technology that will allow us to reverse environmental problems? This can also be used in tandem with discussions about the problems arising with the Three Rivers Dam project in China, or land-clearing by burning in places like Brazil.

I look forward to your comments.

What I'm Reading

I recently finished The Wealth and Poverty of Nations: Why Some Are So Rich and Some Are So Poor by David Landes. The book is almost 10 years old, having been originally published in 1998 and had languished on my "to read" pile for a while. Nevertheless, I'm glad I picked it up for a two reasons - the first being I enjoyed it.

Let me start by pointing out some aspects of the book that are controversial. Landes' critics focus primarily on two of his points: a Eurocentric focus, and a cultural bias. As to the Euro-centrism, that perhaps is too broad. I will point out that he frequently cites shortcomings among many European nations. He particularly points to the experiences of Spain and Portugal as early leaders in the Renaissance followed by disappointing participation in the era of the Industrial Revolution. He seems less harsh on Italy, France and the Netherlands. However, one could make a case for an Anglo-centric view in some parts of the book, as he does hold up Great Britain as having achieved a higher level of economic development, at least until the post-WWII era.

The second criticism, of cultural bias, many feel is almost racist. I certainly did not pick that up. And I would actually dismiss this charge, if only because of the nature of the book. Landes is addressing that area of economics many of us would label "institutional." Institutional economics deals with the rules (formal and informal) and organizations that economic, political and social systems put in place to help direct decisions. From laws and cultural traditions, to political, commercial and informal groups; societies erect barriers and doors to help direct our choices about resource use, whether it be money, time, talents, or even emotional attachments. It is these institutions, as much as the Industrial Revolution, that Landes points out as playing key roles in economic development across the world. Indeed, if one were to look at one of the key historians of the twentieth century, Fernand Braudel, much of what he brought to the historical profession was a greater understanding of the importance of institutions.

Now, this is not meant to discount the way 18th and 19th-century colonial powers used, abused and misused resources (natural, human, and capital) across the world. However, that indictment should not be used to provide a blanket excuse for the state of subject economies, and their respective rates of progress since achieving independence.

Indeed, the institutional approach was one of the aspects of the book I did enjoy (I also enjoy Braudel). I believe that when discussing comparative economics, or economic development - or even when attempting to make policy, institutional factors are frequently overlooked. There is a tendency to prescribe as if all economies or societies arrived at decisions in the same way. While the processes may be similar, the constraints on the process imposed by institutions (especially informal ones) create subtle nuances that take to time to work through or even change.

I found that Landes does an excellent job placing the economics in a historical context. His talents as a historian are exemplary. He tells a story that is understandable, provides explanation as well as anecdote. And his argument is potent, even if it does ruffle a few feathers. I will not and can not say that it provides the sole explanation for differences in economic development. But I think it does provide a good base for discussing how nations develop; including resource endowments (geographical influences) as well as institutional considerations. For ultimately, the story Landes tells is one of the importance of human capital. The systems and institutions that encouraged (or at the very least did not discourage) new knowledge and its application to practical use, were those that surpassed others. By creating an environment where new ideas could not only develop, but be borrowed and find practical use; certain countries encouraged risk, risk brought change, and change brought growth. To borrow from Landes, "...if the gains from trade in commodities are substantial, they are small compared to trade in ideas."

Now for the second reason I'm glad I picked up the book, and I hope it is an opportunity you will take advantage of. Part of my responsibilities call for me to teach a course in "Globalization" as an economics elective. I am not fond of the texts that have been used in the past, and I'm looking for another text or texts. Given the size of Landes' book, it would probably be the sole text; in which case it would be augmented by other articles.

If you've read the book, I would be interested in your thoughts and recommendation.

Oil Prices, Economic Growth and the Global Economy

I've frequently posted on how oil prices can be used in the economics classroom - frequently suggesting that they are good for demonstrating the effect of prices on supply and demand - usually as primary effects.

On the front page of today's (11/1/07) Wall Street Journal (subscription required), is a different opportunity. It still uses oil, but now it provides links to issues related to economic growth and development, foreign exchange and secondary effects. It's worth your time.

The article addresses the connection between the rising oil prices of the past year and growing demand in Asia. It does a very good job of explaining how industrializing countries in Asia have been able to push prices higher. But what it does that usually is lost in the classroom discussion is address the price subsidies many Asian nations have provided on consumer purchases of oil - a classic example of a binding price ceiling as illustrated here.

Now, if graphs freak you out, you should try to ignore all the shaded areas and just focus on a couple things. First, look at the intersection of the supply curve (upward sloping) and demand curve (downward sloping) that is labeled "free market equilibrium". That shows you the price at which the quantity of a good supplied and the quantity of a good demanded are equal. In this case, we are talking about the market price of gasoline.

Second, look at the horizontal line below the equilibrium price. That represents a binding price ceiling, or in the examples used in the article, the subsidized price to consumers that has been set by various governments. Please notice difference between the point this line crosses the supply curve, and the point where it crosses the demand curve. The difference is labeled as "excess demand." This tells us that at the lower, artificially set price, people (or businesses) will use (demand) more fuel, than producers are willint to provide (supply). At this price, some firms would go out of business or customers would find themselves unable to get fuel. But government can choose to make up the shortfall (subsidy). But this means government must find the revenues to cover the expense of doing so.

As we learn in the article, various Asian governments have been providing this. But the cost of subsidizing retail fuel is getting higher, largely because demand in many of those countries has not been provided the proper signals that come with market prices. Consequently, people who use gasoline have continued to demand more, because they are not directly paying the price. Remember, prices serve as signals: what to produce, how much to produce, and for whom. In this last respect, it is also a rationing mechanism. If the price is incorrect, the product (gasoline) is not allocated properly or efficiently. Likewise, the producers are not receiving the market price, and they are receiving signals to produce an insufficient amount to meet demand. They have no incentive to produce more or to bring more productive resources on-line.

The article also points out how many Asian nations have used this subsidy to energy to help drive rapid growth. This is logical. As industries and countries move up the industrialization ladder, they use more energy to produce goods, generally higher value goods. But if the price does not reflect true resource cost, the energy may be used inefficiently, or even in a way that is harmful to the environment.

But, what was most interesting to me about the article was the authors' example on how the decision to reduce (or maybe even end in some cases?) subsidies will impact on other aspects of the economy. The use of fuel to transport food, could potentially impact a nation with a significant income distribution problem that is also facing rising food costs. Furthermore, since oil prices are quoted in dollars, the recent decision by the Fed could further complicate things. Generally, as our interest rates are lowered, the value of the dollar in foreign exchange markets also slips. This means that it takes more dollars to buy the currency of other nations, and foreign currencies will purchase more dollars. As the value of the dollar falls, the price of oil is also likely to rise.

Nations that need dollars to purchase oil have a couple of alternatives. First, they could increase exports of products to the U.S. to sell for dollars, increasing the amount of foreign goods we import. Or they could offer to buy dollars, using their currency or other reserve currencies (euros, yen) in payment. Some questions for your students on these last points are these:

1) What would an increase in imports do to economic growth? (You may have to revisit the GDP equation to help them see the effect.)
2) What would increasing demand on the dollar do to the value of the dollar in foreign exchange markets? (And consequently would that help/hinder inflation pressures and, again, the balance of trade?)
3) As fuel prices rise within the Asian economies, what does that do to the "real income" of citizens? Does that have an impact on their ability to buy domestic goods in their own economy? Goods imported from the U.S.?
4) If fuel prices rise, is there an potential impact on the environment as nations have incentives to use fuel more efficiently?
5) Is it possible that the subsidized price of fuel had an impact on the price of goods/services produced by these nations for export? What trade advantage would that give, if any and what would that mean for their trading position?

I'm sure there are a lot of other aspects that I am overlooking, but these are the questions that popped into my head as I read the article. I welcome your discussion, and any other teaching ideas you might have using this article.