The Politics of Rice 15

This news strikes me. The Jakarta Police has launched a probe into the House of Representatives due to PKS and PDI-P's opposition against the government's decision to import rice. This is ridiculous. Yes, the parties' call for import ban was silly. But that doesn't give a right to the Police to investigate them.

If the Police wants to play cop, they should probe into another office. Think about it.

The Politics of Rice 14

So the government finally admits that Bulog is ineffective. Unfortunately, the solution is worse. Instead of doing something about Bulog, it blames the market. Says Minister of Ag:

"Bulog turns out incapable in driving down the price. Therefore, we need to re-evaluate market operation and rice import". -- my italic.

If only you say "...., we need to re-evaluate the existence of Bulog"... that would make more sense.

Inflation Update

The inflation data for January 2006 is up on BPS’ website. It is 1.36% month-on-month, or 17.03% year-on-year. This is slightly lower than LPEM-FEUI’s estimation of 1.44% and 17.12%. Unless the floods continue to halt paddy harvesting, we expect a deflation in February by 0.17%.

The Statistics Office (BPS) reported that the major driver of the high January inflation was rice price increase. HKTI and DPR, are you happy now? The Bulog’s rice import of 110,000 tons failed to stabilize the price. Again, it is proven that Bulog is ineffective. The solution to this should be straightforward. Don’t rely on Bulog. Just allow everybody to import. (I should’ve titled this post “The Politics of Rice 14”, no?).

In the meantime, people have started to make fuss on the likely increase of electricity rate. However, a 50% increase (already happened in some regions) in rice price is more harmful than 30% increase (popular estimate) in electricity rate, as far as inflation is considered. As we estimate, the former will add 4.3% to the inflation, while the latter 0.89%. But, the second round inflation should also be expected. It seems that the government doesn’t learn from past mistakes. By keeping silent on the exact rate of increase the government is again toying with people’s expectation. Last year inflation was driven more by expectation amid the uncertainty and mixed signals from government officials. Now, they’re doing it again with electricity rate.

There’ve been talks over the January’s inflation figure, that Bank Indonesia might increase its policy rate again next week. I would think it’s premature, even though it's not impossible, considering that the Fed has raised its rate to 4.5% last Tuesday.

BPS also reported that the 2005 export value hit a record high of 19.53%. We shouldn’t be overly happy with this. Note, the number reported is value. That is, price times quantity. Last year export was driven by mining sector, whose world price rose significantly. So it’s not that we exported a lot; only that the price was good. If we are for promoting more export (in quantity, not just relying on international price), we should continue cleaning up the mess in customs and duty clearance procedure.

Rules vs Discretionary

or... Friedman vs Greenspan. I can't let this go unnoticed.

Hat tip to Mark Thoma.

Democracy Bush and Blair Don't Like

The Economist has its right to be skeptical on the current development in the Palestine. It says, under Hamas, things will go worse. Well, that's an editorial judgement, and it's fine.

But it's different when it comes to world "leaders": Bush, Blair and the likes. As the Washington Post reported, Bush was "conciliatory". While Blair worries that Hamas might not practice democracy. Well, if you're concerned with democracy, first of all, you should respect the result of the democratic election. You like it or not, Hamas is winning.

[By the way, allow me for a word about Evo Morales, the new "hero" who just joined the Castro-Chaves Gang. I kinda not like him. But I respect the Bolivian people decision. Bush and his gang should learn to respect that, too].

Update: I just noticed, Posner and Becker are discussing about this, too, with economics. They apply Schelling-way of thinking and both comes to conclude that the world should not worry (too much) about Hamas victory. Says Posner, "Hamas' victory may be the best thing that has happened to Israel in years". While Becker says, "I am more optimistic than Posner and many others about the chances that Hamas' victory will improve rather than worsen relations with Israel."

The Politics of Rice 13

The Jakarta Post's editorial today. It is sensible. While I can't agree more that "[a]rguing that the [rice] import would hurt Indonesian farners is an insult to common sense", there are some points I don't agree with completely. First, that the government requires import at the situation where the quantity of rice falls below 1m tons and the price rises above Rp 3,500. I think when that happens, foreign rice will automatically come in; provided that everybody is free to import. Second, and this always troubles me, the claim that rice is a "strategic and vital" commodity, so that the government should always have some buffer stock. If market can handle that, why bother the stocking?

Barking up the wrong tree (©The Jakarta Post, Jan 24, 2006)

The House of Representatives, already facing a very tight legislative agenda, will simply be wasting its resources if it pushes ahead with its demand to exercise its right of inquiry and investigation into the government's decision to import 110,000 metric tons of rice.

Arguing that the import would hurt Indonesian farmers is an insult to common sense. How could the import, which accounts for a mere 0.003 percent of national consumption, disrupt domestic market prices? Therefore, we cannot help but smell a hidden political subterfuge behind the stubborn opposition to the rice import.

It is indeed the right and duty of the House to oversee government policy. However, in so far as the rice import is concerned the dogged opposition by the majority of the House members is utterly irrational, an insensible subterfuge that would only stupefy the general public.

It would be much better for the House, if it is really concerned about the farmers' income, to scrutinize the implementation of the integrated program to revitalize the agriculture sector, which the government launched last year. There is also an even more important legislative agenda of almost 30 bills that have to be completed by the House during the current session period, which will end in March.

The rationale of the rice import is quite obvious. The government has explained that it would be required if the State Logistics Agency's (Bulog) stocks fall below one million tons and domestic prices rise above the Rp 3,500 (US$0.30) ceiling retail price per kilogram. The government also has assured that imported rice will not be released to the domestic market unless local prices rise far in excess of the ceiling. It would then be in the best interests of the farmers if the House helps the government to install a control mechanism to ensure that the imported rice achieves its objective.

It is strategic and even vital for both political and economic stability that as the world's fourth most populous country with more than 230 million people, the government should always have a buffer stock of at least one million tons to meet urgent needs in emergency situations such as natural disasters or crop failures. It is also worth emphasizing that most rural households are net consumers of rice, and steep rises in rice prices could trigger a social and political crisis because food usually accounts for the bulk of the spending of poor families and weighs heavily in the consumer price index.

It is also a fact, despite the government campaign over the past three decades to diversify the national staple, that food security still means the availability of rice, the main staple, at affordable prices.

The government has not changed its rice policy. It remains the same -- controlling rice prices within a periodically reviewed range of floor and ceiling prices to ensure fairness for both consumers and producers and totally banning rice import to protect the farmers from unfair import competition.

Hence, the import is not a permanent policy, but only a contingency measure, aimed at preempting any shortage before the start of the next harvest in February. Starting preparations for imports only after a major shortage takes place would be calamitous because what may start as an isolated shortage could soon escalate into a crisis as speculators join the fray.

Building the stocks from the domestic market now when most rice farmers have sold their surplus output would benefit only traders. Procuring such a big volume in one transaction within such a short period of time also could disrupt the market and trigger excessive price rises.

The government, nevertheless, should also be blamed for the unnecessary furor over the rice import. It does not seem to have taken a lesson from the controversy over the fuel price increases last March and October.

The rice import, like fuel price hikes, is quite rational, making a lot of economic and political sense and is for the good of the people. However, both measures will always be politically controversial if the public opinion environment is not conducive.

The government cannot simply launch a policy and sit back and relax, hoping that all things will run smoothly. The government should still go all out to sell its policies to the public.

However, the policy cannot be sold in a vacuum, meaning that the environment should be made favorable to the policy. The government needs to change Bulog's notorious reputation. The logistics agency has been known as a corruption-infested institution, a cash cow for rent-seekers and vested interest groups, who profited the most from the trading of such controlled commodities as fuel, rice and sugar.

A high degree of transparency early on regarding the real condition of the national rice stock, the process of imports, which parties are involved and how the imported rice will be controlled could have helped precondition the public opinion climate for the contingency measure.

The Politics of Rice 12

Once again, my position with regards to the rice furor is: 1) Rice import is good, 2) Giving an exclusive right to Bulog is not good. It seems to me that people think that the fact that I support rice import automatically means I also support the role of Bulog. No. In fact, whenever the right to import is given only to one entity, my suspicion arises. The effect of such practice on the economy is just similar to the effect of quota. And it's bad.

Readers should not, however, confuse between rice import issue and Bulog's role issue. They are two different things, to be addressed separately, even though the policy implication would be heavily related. I have raised both issues simultaneously many times to avoid misunderstanding that my supporting rice import meaning I am supporting the import mechanism as it is now. Which is fallacious.

The press have quoted me in the way that might lead such misunderstanding about my position. Read here or here, for example. In the latter, they misinterpreted my table. I presented a simple calculation to show that Bulog's claim that they can stabilize rice price is not well founded. I compared two periods, namely the period when Bulog was given the sole right to import rice, and the period when the rice market was liberalized. The coefficient of variation of rice retail prices in Indonesian regions were all higher in the first period than in the latter. Meaning, under Bulog's authority, prices were more unstable. So, the claim was false.

Today, The Jakarta Post has an opinion written by Peter Milne. As I'm writing this, the online version isn't available yet. Milne argues, correctly, that importing rice is pro-poor. Please find and read it.

2006 Outlook

We just released our 2006 outlook yesterday. Here's a press coverage by Bisnis Indonesia (non-permanent link). Keypoints:

1. The economy is to slow down up to the 1st half of 2006, then rebound in the third quarter.
2. The government should focus on effective fiscal policy (especially in the first two quarters), while maintaining tight monetary policy.
3. The effectiveness of government bureaucary is still an obstacle in promoting better investment climate.
4. Reducing high cost economy, ensuring labor market flexibility, and improving the effectiveness of decentralization are keys.
5. Further liberalization is needed to foster growth.

The Politics of Rice 11

Finally, a newspaper editorial on the rice furor that makes sense (Over at the Cafe Salemba, Ape has pointed out the other sensible editorial, also by the same newspaper). The Jakarta Post has another good editorial today about what it calls, "The Politics of Rice" -- sounds familiar? (The problem with the Jakarta Post's web version, it doesn't provide permanent links, so don't be surprised if you click the link tomorrow and you are brought to another piece of article. To avoid you missing this important piece, I copy paste it in its entirety below -- I hope JP doesn't mind).

The politics of rice (© The Jakarta Post, Jan 12, 2006)

The current furor over rice imports flared up when late last year the trade minister gave clearance to the State Logistics Agency (Bulog) to import over 70,000 tons of rice to supplement its buffer stock. The agriculture minister protested, saying the country's stocks were sufficient, and that importing rice would depress domestic prices, penalizing rice growers, most of whom are subsistence farmers.

After several meetings, the agriculture minister backed down and agreed the country needed to import rice to fortify Bulog's stocks. Earlier this week, the government announced it would allow Bulog to import another 110,000 tons of rice from Vietnam through the end of January.

From this, it may be safe to assume the country does need additional rice supplies to keep prices from rising out of control. Higher rice prices are bad for inflation, as rice plays a major role in the calculation of the consumer price index. At the same time, there are people who are making huge profits importing the rice. Well, that's the politics of rice.

It is necessary to take a more rational look at the issue of rice imports. Seen from the interests of the nation, i.e. keeping rice available and affordable for most people, importing rice is not bad, and is also a way to contain inflation.

But we need to take a look at the bigger picture of the role rice plays in Indonesia. As the most important staple food for a large portion of the population, rice is not just another commodity. It is both a market and a political commodity, and any government that failed to ensure the availability of rice at affordable prices would face serious problems.

But just how far should the government go in controlling the rice trade, and who should the government favor in its rice policy -- the growers or the consumers?

By keeping rice prices low, the government sides more with consumers than growers, while at the same time keeping inflation in check. By allowing prices to go up, the government helps farmers and penalizes consumers.

So a balance must be reached. But even such a balance would not be a true balance, as one group would benefit over the other. The easiest and least politically risky decision would be to keep rice prices low. It is rarely beneficial for a politician to favor the interests of rice farmers, who are largely uninterested in politics. Which is why most politicians would rather come down on the side of consumers, especially urban residents who want low rice prices, are politically active and make campaign contributions.

Keeping rice prices low also benefits farmers, who normally become consumers between harvests. So, consumers outnumber growers, making siding with consumers more morally defensible.

Given all of this, the best rice policy would be to keep prices affordable to most people, while importing rice is the best remedy when domestic prices begin to creep up. Imports should also serve as a way to improve the efficiency of our rice growers, so they can eventually become more competitive.

As long as the domestic market remains protected, importing rice will remain attractive for anyone eager to make a big profit. Putting domestic prices on a par with prices in the international market should be the ultimate objective for the country, which would protect farmers from rice imports.

Rice imports are not a problem, but a solution. The problem lies in the process of importing rice. When done by cronies of government officials and Bulog executives, through dubious tenders, the people have a right to raise questions. The government must make the process more transparent. Then no one will raise questions, and the people will have all the affordable rice they can eat.

I hope to see many of this.

The Politics of Rice 10

Kompas reports today, a House member from PAN says that the recent rise of rice price is due to increase in production costs, not to a decrease in supply. The other factor, he adds, is the supply holding by rice speculators to take advantage of price differentials. This is a partial, incomplete way of looking at the problem. Cost of production, supply, and arbitrage are not unrelated. When costs increase, the price would respond upward (or else, the profit margin will be pressed down). And there would be a slowing down in the supply growth, until the adjustment is complete. In the meantime, some economic agents will do arbitrage until the price differential vanishes (taking into account any distortion).

But there's another disturbing statement in the same article. Some analysts say that the recent rice import approval by the government is just a way to get political support from ... urban middle class! I'm no political scientist but isn't it stupid to try getting support from minority, not majority when you want to keep your political position? In fact, if vote getting is of concern, then this person might be more likely to win the majority. And somehow that explains... Or not?

The Politics of Rice 9

Minister of Agriculture, HKTI chairpersons, House members, politicians, rentseekers, sorry activists, flipflop economists, misled journalists should read this.

Then why don't you tell the "tukang becak"s (rickshaw drivers) and "buruh angkut"s (those who help carry heavy stuff for a small payment -- what's the English?): "Sorry, guys, we don't care about you all. We only want to protect "farmers". You're not in the equation. Rice price should be high".

SHAME ON YOU. (I shouldn't be that impolite)

The Politics of Rice 8

The government has decided to lift import ban as reported in Kompas today, as the main headline. Good. The next good thing would be to let importation be done by anybody who wants. Or, create another institution to compete with Bulog. And another, and another, and another.

Meanwhile, opposition keeps arising. To which, I would address the following:

Some say the government does not stand for farmers' interest. They want the price high so as to protect farmers' income. I have stated so many times that the farmers they want to protect are actually net consumers, not producers, who will be happy with lower price. But, even if I was wrong; that is, if all farmers -- and most importantly, the majority, or the poorest of the poor -- are net producers, I would like to ask this question to the opponents of rice import: Suppose the rice price increases (as they like), do they not think that would also trigger increase in other prices? Most Indonesians eat rice. Higher price means higher spending. Marginal consumers will cut on other spending, and marginal consumers who produce will pass the burden on to other consumers through increase in the price of whatever they produce. And it will snowball. This is what the opponents of rice import fail to see (or choose not to see). They think rice lives in its own and has nothing to do with other prices that would impact on them.

The Politics of Rice 7

I'm tired of doing this. But I have to, 'cause too many people are misled by politicians and rent-seekers. (This one is not cross-posted at Cafe Salemba anymore -- I don't want to spoil the party there with too much of my "political" view).

Read this article from Kompas. Also, this editorial and this opinion in the same newspaper. Among all, it is reported that:

• Farmers refuse to sell rice to Bulog, "not due to shortage, but the price is not good".
• Even though the price is high, West Jave governor refuses importation.
• South Sumatra governor says, the price in his region is abnormally high, because the region is a surplus area (I hear you laughing).

Other newspapers have the same non-sensical accounts (not to mention confusing statements from the government, especially Minister of Agriculture).

Honestly, I never thought that lack of understanding of the role of price can have this big of impact on the way people think.

It's obvious. If you are free to import, do you want to do that for a loss? If you are about to sell, do you want lower price? If you are buyer, do you like higher price? You say, this is political. Nothing is political about the nature of price -- it's common sense.

It's also obvious. The government created Bulog to "help" the farmers. The farmers don't want to sell to Bulog. This is just another way of saying that Bulog is useless. Dissolve it.

Deflation?

Unofficially I was told, December inflation is negative. Let's see tomorrow in the newspapers. My hunch is, the media won't make a big deal out of this, the way they did when two months ago inflation soared, due to the BBM price hike.

"Stagflation" worriers, what's up?

The Politics of Rice 6

(Crossposted at Cafe Salemba)

Again, another misleading headlines (here's the other). Kompas writes (in Bahasa): "Rice Stock Sufficient -- Prices Skyrocketting in Some Regions". What a contradiction. But let's play no more semantics. (But oh, I can't help it: the way I read it is, rice stock is enough, but there's shortage in the market, because the price has been wronged and it frees itself in some regions).

Instead, let's look at the content. Business association now worries that some people might abuse the import. Well, it's no surprise. Researcher from Kadin says "the number of 'deficit farmers' outweights the number of 'surplus farmers'". Be not confused by those terms. It's only another way of saying "in aggregate, our farmers are consumers" As a consequence, lower price is good.

This passage says it all (liberally translated):

A number of farmers in Kecamatan Adipala and Maos, Kabupaten Cilacap, complain the increasing price of rice.

Why is it so difficult to understand this?

Remove import ban. Allow everybody to import. Don't take peasants' rights to buy cheap rice.

The Politics of Rice 5

[Crossposted at CafeSalemba]

Kompas today has a report with a subheader: "It's a like a rat dying in a rice warehouse". This is an old saying Indonesians use to express the irony of someone's inability to make use of generous opportunity; or when someone is prevented to do what's best for him/her.

The saying applies to Indonesian peasants. The article reports that majority of the recipients of "raskin" ("rice for the poor" -- a government program that gives rice to poor families at price significantly lower than the market price). Why the irony? Because those peasants produces rice. Yet they have to buy rice. This is just another way to say that the poor peasants are net consumers.

Question: 1) For net consumers, which is better: higher or lower price? 2) Does import increase or decrease domestic price? 3) Is it good to give import license to only ONE company?

If you read my previous posts you surely know what my answers would be. Yes, higher price might stimulate increase in employment. But see my previous post citing a study by Warr. Yes, it's good to remove import ban. But giving a sole authority to Bulog is not. Allow everybody to import. If only Bulog can import, the effect is the same with quota. Every economics student knows that's bad.

"Reshuffle"

Finally, the undecisive president announced his cabinet reshuffle an hour ago. He has appointed Budiono as the new Coordinating Minister for Economic Affairs and Sri Mulyani Indrawati as the Finance Minister. The rest of the speech was a joke.

Slow... what?

One thing that I like from this country is, we love to create terms. No matter how foolish it is, as long as you say it first, you'll be known forever and get credits from the press. And here comes, the ... SLOWFLATION... Oh my God...

Not long ago, the President himself "invented" his own toy word: BIGBANG. Well, it's not like, he's the one who invented the word. Physicists did, long long time ago. But, our beloved president, SBY is the one who thinks he can use the term to refer to, well, persons!

And here's the best part: everybody starts using the terms! ("everybody" being the operative word. Meaning, google up yourself -- it's everywhere).

I remember, once upon a time, some Indonesian started using the term "QUO VADIS ----?" in his article. And then, kaboom, hundreds and hundreds of articles use that term, no matter how unnecessary it is.

Ever heard this term: LATAH?

The Politics of Rice 4

[This is a cross-posting to Cafe Salemba]

I've been meaning to bring up this issue of rice import in the Cafe, as I did here, here, and here. I'm for removing the rice import ban. But I am against the idea that the government should give an import monopoly rights to Bulog. That's even worse. When we allow importation, why should we allow it only for one single institution? I'll talk more on import monopoly rights next time. Now, I want to elaborate more on the first issue, import ban.

My supporting on import ban removal is based on the fact that majority of Indonesian peasants are net consumers. Therefore the arguments of keeping price high in order to protect peasants (or the poorest farmers) break down.

A moment of reflection, however, might undermine my claim. I failed to consider the employment effect of high rice price. That is, my argument only looked at the consumer price faced by both net producers and net consumers, not their incomes. High price, however, is an incentive for land holders to expand production. As production expands, the demand for landless laborers increases. This would increase employment and real wages of peasants. Therefore, any argument for or against rice import should look at both price effect and income effect.

Fortunately, Peter Warr of Australian National University has recently studied this issue. In his paper, he rightly uses a general equilibrium framework that involves 1,000 individual households. He factors in the distributional effects of rice import restrictions both on households' expenditures and their incomes. He even considers the effect of price increase on the demand for other staple foods, such as corn and wheat flour.

The Warr conclusion is interesting:

[T]he [Indonesia's] rice import ban raises poverty incidence by a little less than one per cent of the population. Poverty rises in both rural and urban areas. Among farmers, only the richest gain.

Therefore:

It is not possible to justify the import ban by claiming that it reduces poverty.

That said, I keep my position: remove rice import ban.

Informal Collection

In a seminar today, I reiterated my concern that the reason our products are not competitive is not merely due to production inefficiency. It is more of something beyond the producers' control. It includes poor infrastructure, illegal collection, and logistic inefficiency.

Negotiation in Politics

At the outset, I should make a disclaimer. I'm not a political scientist and also not a very good observer of politics.

It appears to me, political parties are preparing themselves to grab the opportunity of cabinet "reshuffle". But among all the parties, I think what PKS has been demonstrating is better than any other.

I always think that politics is about bargaining. You support somebody for a return -- or if you don't like that word, change it to "specific, pre-defined objectives". So, it really is not something surprising to read moves like this. (The account tells how PKS clearly stated their demand to the president). And that's what I think what politics should be.

On the contrary, I think this kind of move is strange. Note the statement given by a politician from another party. On the forming of some coalition that excludes PKS, the former ally of that group, he says, "... We exclude PKS, because it has crossed polite political ethics..." By that he means, because PKS has demanded certain positions, explicitly. Now I'm confused. Why demanding a position in return for a support in political arena is called unethical? If it is unethical, what are those other parties aiming for? Let's wait how long can we have these other parties' words. Experience says, don't trust them.

Facts of gasoline

Here, via Mark Thoma. Of course, in Indonesia, the story is way more complicated. The gasoline retail price here is not just about sum total of refining, distributing/marketing, taxes, and crude oil. It is made messier by complicated contract with foreign drillers, Pertamina's obligation to supply the army with special terms, etc. And there's the subsidy... And there's the cost-plus fee... And there's smuggling...

Economist-cum-journalist

Dave Warsh has a very interesting account on economists who happen to be journalists. Or the other way around. My favourite is, of course, the author himself. Krugman is a good economist. But he kind of sucks as journalist.

RIP: Peter F. Drucker

I'm a stranger in the field of management science. But I would be lying if I say I don't know Peter Drucker. So, I agree, his death is a big loss to academia. Here's a nice obituary by a colleague, Hermawan Kertajaya.

Cafe Salemba

A new cafe is opened. Recommended.

Cash Transfer

Here's my take on the current cash transfer program. Unfortunately, The Jakarta Post has edited it in a manner I wouldn't have suggested. To avoid misleading, here is the original, uncut:

A Perspective on the Cash Transfer Program

My main skepticism toward the current cash transfer program (CTP) lies on the failure of the government in identifying who are and who are not eligible. As with most other social safety programs, CTP suffers from adverse selection and moral hazard problems. Evidence for all this are widespread. Pick any local newspaper today, you will find stories about people run amok because they are deemed ineligible. Some old, thin person is pictured with his extremely poor house in the background, looking at the camera with empty eyes. The caption says it all: “Pak Fulan of Desa Bojong earns fifty thousands rupiah ($5) a month from scavenging around. With that, he has to feed his family of five. Yet, he is not on the list”. Or, there are news about how local government officials can manipulate the system by directing the CTP to their relatives and friends who are not eligible.

If the government’s objective is to improve income distribution, however, it deserves some credit. The government knows nothing what a given citizen really needs. It has no information whatsoever whether Family A is in desperate need for rice, or for motorcycle, or for health services at one particular moment. So, giving away cash is preferable than providing in-kind assistance: it gives freedom to the recipient to spend it anywhere he or she wants.

But where does the cash come from? It is from oil subsidy cut. The government claims that the subsidy has been benefiting the rich rather than the poor. It is now time to “give justice to the poor”: transfer the money from the rich to the poor. Some might ask, however: Why should a hardworking person be punished because he earns a lot higher than others? Who is the government to decide that Family B should give his money away to Family A? These questions are valid; but might be missing the point. The CTP now undertaken is financed through reduction in distortionary oil subsidy. People, regardless of income groups, have been enjoying oil subsidy for years. And that is not sustainable; unless everybody agrees to give up other development targets such as good infrastructure, education, and health facility. (Or, if everybody accepts tax increase). The demand for development increases over time. With limited financial resources, the subsidy should be removed gradually and let the “saved” resources be used for other development targets. Surely this is painful. The government is required to provide a pain reliever. Hence the CTP. To put simply, CTP is a means to take back some amount of subsidy from everybody and give it back in cash to the poor, not to the rich (for lack of better dichotomy). This is a form of redistribution. In its ideal, the CTP aims to leave the poor at least as well off as before the change. This is what welfare economists used to call “compensating variation”, measured by the “willingness-to-accept” the change. What about the rich? What is the compensation for them? The government uses statistics: even though everybody enjoyed the subsidy, it is the rich who enjoyed it more. The rich deserves no cash back. Fair enough.

As a side note, however, the compensating variations argument above may be shaky on theoretical ground. John Hicks, who first proposed the compensating variations as a measure of welfare change in 1943 defined it as the minimum amount a person would require as a compensation for welfare loss. We have yet to hear clearly how the government comes up with the Rp 100,000 per month per family. Is it really the minimum amount required? Or is it simply a back-of-the-envelope calculation subject to budget concern, regardless of people’s willingness-to-accept? If the latter is true, we should not claim it as a “compensating variation”. The fact that people stand in long queue to receive cash suggests that they are willing to accept it. However, “willingness-to-accept” – as the name suggests – should be based on voluntary exchange between both parties. In the absence of negotiation the long queue does not reflect the true minimum willingness-to-accept. It is a reflection of involuntary submission – “better than nothing”. In fact, it might be perceived as a pure “bribe”. At least, public bribe can be explained using political economics framework: the government has to cut on subsidy. People will suffer. Bribe them, so they will not react harsly. If “bribe” is too much a bad word, replace it with “compensation” (note the sarcasm).

Speaking of bribe leads us squarely to the issue of corruption. And this is where again my skepticism builds upon. Implicit in the first paragraph above, a smooth transmission mechanism is a necessary condition to ensure the effectiveness of any wealth transfer. But the coast is far from clear for a smooth landing. We have read evidence where aid does not work well in countries with severe corruption. Jeffrey Sach’s humanitarian effort for Africa will not work if all the aid he mobilized end up in the pocket of corrupt government officials. Nick Kristof writes in the New York Times (Oct 18, 2005) how Nigerians are starved by red tapes, not just by malaria and measles. In a more academic-oriented paper using cross country comparisons, Easterly (2005) finds support for democratic institutions and economic freedom as determinant of growth – while aid is less effective, especially in a corrupt environment. Cash transfer program works in similar mechanism as foreign aid. It is supposed to transfer some wealth from rich to poor. It is fair to say, therefore, that failure factors in aid programs might as well be existent in cash transfer programs.

Alas, we too live in a corrupt country. Many studies, including those by LPEM-FEUI, have found evidence of severe corruption in Indonesian economy. For example, in 2000, a typical business in Indonesia has to pay extortion as high as 10 percent of its total production costs (LPEM-FEUI, 2001). In 2003, the average size of bribes per annual production costs is 4 percent (LPEM-FEUI, 2003). Finally, the logistics inefficiency in export industries is almost 6 percent of total production costs (LPEM-FEUI, 2005), due mostly to poor infrastructure conditions and bad government regulations. Having listed just a few of them, it might be a better idea to use the resources from subsidy cut to combat the “high cost economy”. This includes establishing a solid set of rules of law. Robin Hood policy might look good in a very short run. But it is near useless if economic sustainability is of concern. With regards to the current problem, however, I have a slightly different position with some fellow economists. They believe that the subsidy cut should have been cancelled. There are ways around the budget problem other than cutting the subsidy. That includes, combating rent-seeking activities in oil and gas industry, mobilizing other sources of fund (e.g. tax reformation), and debt restructuring. I think we should do them all (including the subsidy cut). The domestic fuel artificial price has been the root of evils: it creates “triple-distortions”: between domestic prices and international prices, between industry price and household price, and between products (e.g. gasoline vs. kerosene). The world responds to the increasing oil price by investing on oil drilling and expanding refining capacity (supply side); and developing alternative energy resources and good public transportation (demand side). Both forces are likely to hold crude price well below $100/barrel. Unfortunately, such responses are not evident in Indonesia – the incentives are blocked by the artificial prices.

One might ask, if the saved resources are for building schools, roads, hospitals, etc., what is then the “compensation” for the poor who have to face higher prices? The better schools, the better roads, the better hospitals, the better rules of law, are it. This sounds cliché, true. But it is the government job to convince the people.

I should say, I am not claiming that cash transfer program can not be successful at all. A program called “PROCAMPO” (Program for Direct Assistance in Agriculture) in Mexico aimed to provide compensation for anticipated price effects of trade liberalization on basic crops is found to create multiplier effects when the farmer recipients put the money to work so as to generate further incomes (Sadoulet et al, 2001). It is hard to imagine that this can be done in Indonesia with the current CTP: the Rp 100,000 would simply vanish as consumption in a matter of days. The PROCAMPO transfers cash of $300 per year per family, or roughly Rp 250,000 per month. The program is relatively well-managed: eligible farmers have to show that they have planted at least one of the listed nine staple crops. In addition, the PROCAMPO card can be used as collateral in borrowing from commercial banks. The Mozambique’s Cash Transfer Program (“GAPVU”) is also successful, thanks to a well-designed program that succeeds in reaching household targets, using decentralized health and community administrative structures, and “strong political and institutional backing” (Schubert, 1995). GAPVU transfers cash of “only” $2.5 per month per capita, or roughly Rp 125,000 per month per family of five. Note, however, that GAPVU has nothing to do with compensation. It is merely a welfare program with clear targets: poor households with severely undernourished children or severely undernourished pregnant woman, elderly persons living alone, severely disabled persons living alone, and female-headed households with at least 5 family members. The eligibility is reviewed annually. Finally, the Social Safety Net Program (“RPS”) in Nicaragua uses conditional cash transfer system (Maluccio and Flores, 2004). Selected poor households should maintain their eligibility by sending their children to schools and visiting preventive health-care providers. They are eligible for a cash transfer of $357 per year per family, or roughly Rp 300,000 per month.

In conclusion, the current CTP might end up wasted, if not managed well. The government has two options: leave it and use the money for other development targets; or, make it better. As usual, either way is costly. And both needs better PR skill that has been lacking from the government.

New Euphemism

I learned from Mahalanobis, we now have a new euphemism: "constrained discretion". It is taken from Ben Bernanke's statement, and it means "a state where you have no idea what you're doing" -- my rephrasing Mahalanobis.

Speaking of euphemism, here's another one: "My priors shifted". Meaning: "I changed my mind". (via Arnold Kling).

A Glance on 2006

The following is the list of key macroeconomic assumptions for the budget year 2006, as agreed by the government and the parliament, last Friday. In parentheses are the government’s initial assumptions, before the discussion with the House.

• Economic growth 6.2% (6.2%)
• Inflation 8.0% (7.0%)
• IDR/USD 9,900 (9,400)
• 3-month SBI 9.5% (8.0%)
• World oil price USD 57/barrel (40)
• Domestic oil lifting 1.050 mbpd (1.075)
• GDP IDR 3,041 trillion (2,996)

Some notes are in order. If this year’s growth is 5.6% and the projected 2006’s is correct, then there is no reason to worry about stagnation. Furthermore, this year’s inflation will likely to be 13-14% (I initially thought it would be 12% -- due to BBM price hike; but then BI printed money). In other words, next year’s inflation rate will be lower. These two indicators are sufficient not to expect a stagflation (yes, unemployment might increase a little above 10% -- but it alone is not enough to qualify for a stagflation).

However, it is fair to say, that the lower inflation rate assumption would be easier to settle if the government refrains a little on spending. It has proposed a 1.1% deficit. The House, on the other hand, is more prudent with 0.6%. They agreed on 0.7%. If this is credible, I wouldn’t be surprised if the next year’s growth is 6.0%, not 6.2%. But that’s good, since it will hold down inflation rate a little below 8.0%. This year’s inflation is too high already that BI should probably set its BI rate at 13-14% (currently it’s 11%). Meaning, commercial banks’ borrowing rate might end up at 20-21%. That’s too much for the real sector. Some degree of prudence next year might then be a good idea. And by “prudence”, I also mean not talking too much.

Addendum: This is shocking. Just an hour ago a collegue told me that October's inflation is ... 8.7% m-o-m! I couldn't believe it. But his source is an official from the Statistics Office (BPS). How can this happen? Moreover, the y-o-y inflation rate is 17.89% and y-t-d is 15.65%. Well, if all this is true, the arguments above break down... But I'm still having hardtime to understand the official figures. I hate to suspect (or blame it on) the politics.

Addendum's addendum: It is confirmed. The October's inflation is 8.7%. The biggest contributors are BBM (3.47%) and transportation (2.08%). BI has raised its BI rate to 12.5%. This means, the prime rate will be around 19.5%! (higher yet for concumption credit). This is saddening. BPS also informs that the open unemployment increases to 11.6 million (10.8% of the labor force), 0.4 million of which is "due to BBM price hike". I hope November and December inflation rates are well below that of October -- and there are reasons for that hope.

Marxian call for, well, market

CafeHayek, in a Marxian tone calls us:

Economists of the world, unite! Help the world understand the role of prices.

I'm in.

President should buy ... helicopter

Surely this kind of news shocks everybody. First, it shows how uncoordinated the administration is. Second, the timing is bad. In this account (in Bahasa), it is explained that the budget increase is for buying the president a private airplane.

I think, instead, the president should buy ... a helicopter! I hate it when the government officials are transported. It always creates traffic jams. That costs me time.

What? It's not Ben?

I don't know if this means official already. But CafeHayek tells us that Bush has chosen the new Fed chairman. And it's not Ben Bernanke. I don't know much about Robert McCleskey. What I know from the candidates list, Ben is quite the best replacement for Greenspan. I'm not alone.

Update: It's Ben.

Keynes is more than that, my friends

Recently, I gather that critics of Keynes usually don’t understand Keynes very well. They believe, Keynes is all about Big Government, and that is bad; full stop. So, they find it strange that a person like me, who loves how the market works through price mechanism and hates big government still has belief in Keynes. Worse yet, when I argue for liberalizing the market, they think I am a convert. Strangely enough, they are the ones who come up with policy recommendation such as cash transfer as a compensation for oil subsidy removal, that economic downturn is caused by investment shortage, that herd instinct is more desirable than hoard instinct in stimulating growth, that monetary policy “might have its limits”, that deficit spending is sometimes -- many times -- needed. And they say Keynes should be despised? In fact, they even call for bastardized Keynesianism: that the government should create jobs; that the government should lead growth. These two, even me have reservation.

Schelling gets the award

The 2005 Economics Nobel Prize is shared by Bob Aumann and Tom Schelling. I am not too good in explaining who they are. In fact I think it would be tough to explain their works to students in undergraduate level, especially Aumann's contrbution. As for Schelling, his works are (or, could be made) less complex, yet are powerful building blocks of evolutionary game theory. So, how would I explain them to my students? I will go:

Both Aumann and Schelling are top notch game theorists. Aumann's papers are tough. By contrast, Schelling has written some non-technical books. Go find them, especially The Strategy of Conflict.

Somehow I know what to answer the next time my wife complains to me why I don't like too many open options offered to me. ("You're strange. I thought economics is an art of choice. Why do you complain when I tell you that to go to Building X you can choose either way 1 or way 2 or way 3 or... so forth. You always want less options"). Now I know the answer. Schelling has taught us! It's the focal point that interests me. Too many similar options can blur my focal point. Yes, it's the... Schelling's Point.

BBM price hike and a credit for the govt

I was attending a meeting in Thailand when the news broke out (yes, another one was the Bali bombings -- I am too sad to talk about this). It said, the government of Indonesia cut the fuel subsidy and accordingly raised the price. I was admittedly a little surprised with the magnitude, having seen all the resistance while the policy was underway. For premium gasoline, for example, I was hoping a full subsidy removal, but expecting somewhere between 50 and 80%. It was 87.5%. As for kerosene, I wasn't that surprised (it was a 187% hike) -- knowing that its former price had been the root cause of illegal mixing with premium gasoline.

But, I applaud the decisiveness. After all, this was a brave, unpopular call. And it was inevitable. It was really a matter of time. Some people argue that the timing is bad. I think it's not. In fact, there should be a dampening effect with the seasonal Ramadhan shopping spree, as opposed to that if the price adjustment took place before or after the Ramadhan. In addition, experience has told us that such price hike will on average have only 3 months of effective impact. Therefore, while we should submit to a double digit inflation this year (probably 11-12%), next year should be better.

Having said that, I am not hesitant to give a credit to the government. I even raised a discourse among fellow critics that cabinet reshuffle might not be the most important issue anymore (I think the demand for reshuffle is a function of the success of dealing with the oil problem). The recently launched "October 1, 2005 Package" provides another justification for that position. The October Policy includes, among all:

• Reduction of sugar import tariff.
• Removal of industry raw material import tariff.
• Removal of converter kits import tariff.
• Reduction of container handling charge and installment of a 50% cap on surcharge.
• Closure of 73 truck inspection stations ("jembatan timbang").

This might be hard for some people. But that's the bitter pill for the better will.

Aceh

Gave a small talk in Aceh yesterday, regarding the "reconstruction and rehabilitation". My remarks are as follows:

• It is the right momentum to redevelop Aceh. Almost all needed sources are there. The exception, however, should be taken more seriously. It includes: accountable aid management, soft infrastructure, property rights system, and the balance between regulation and rooms for the locals to decide what's good and what's bad for them.
• That said, I tried to encourage the community not to rely completely on Jakarta. ("Acehneses knows themselves way better than anybody else").
• We're in the search for good property rights system. And that does not have to be dictated by central govt -- some systems might even have been existent already. Basically, the central government (or, local government for that matter) is needed only for their role in advocacy. ("We don't need to kick out big corporations. We need to use them. But in order to level the negotiation field, we might need advocacy -- that can come from the government or NGOs).
  
• Do not get trapped in the "poverty trap" assertion. The naive "Big Push" era in Rosenstein-Rodan's sense is over (as opposed to Murphy-Shleifer-Vishny's "big push" interpretation that look more on the institutional dimension). No matter how much money you get to boost up investment, if soft infrastructure is not ready, it all goes to consumption. (By "soft infratructure" I mean institution: political system and the people running it as well as the legal framework, and of course ability to adopt technology).

The discussion was good. In fact I enjoyed talking with the Aceh people. They're very open-minded. (Frankly, I was sort of expecting typical NGO-like resistance to economic solution -- as it turned out, this was way better).

Note: Just found out that the latest Economists' Voice contains two articles related to city redevelopment -- in this case New Orleans vs Katrina (one by env-economist Bob Hahn and the other by the ever-smart Ed Glaeser). Check them out (subscription required).

Be supportive, exers!

Some days ago I came across this news about ex presidents, ex vice presidents, and some other ex high profiles sat together and called for cancellation of BBM price increase. And they went on pointing out the current administration's weaknesses. As if, they were good at their time. They were not. Some of them were even worse. And look closely. Those presidents increased BBM price, too. Look more closely, there's an ex-con in the gang!

It seems to me, these people just love to act (or over-react for that matter) in front of cameras and appear as the never-wrong people.

The Politics of Rice 3

Many people asked me about my posts on rice. I think I should reiterate my position: I am for removing rice import ban (the way I support removing some export bans). One thing that I am obviously against with is if the import license is given to one single firm. And that firm, as we're not surprised, is Bulog. And as days go by, the politics reveal itself. We've been having rice at price higher than those in other countries. Pro-protectinists also argue that this is what we want: to protect farmers. I say, not completely. In fact, it may end up hurting the entire economy, as studies have shown that our farmers are net-consumers peasants who buy rice at the marketplace. In that regard, I agree with removing the import ban. Rice will flow in, adding to the domestic supply and eventually pressing down the price a little bit - and hence the inflation, for rice is a big weigh in the CPI basket.

But now the problem kicks in. The government thinks they can do this supplying business better than anyone else. So they give import license to none but this Bulog -- widely known for its corrupt behavior back in the New Order. So, what can you expect? Nothing but rent-seeking. And days go by: we now knew that in fact, the imported bulks of rice are priced higher than the domestic price! Note that my support for import is based on total welfare concern (which admittedly consumer-biased). But if we in fact import at higher price -- not lower price, this line of argument breaks down. The only explanation left is the belief that stock is really inadequate. But again isn't this the same story as that in BBM fiasco? Only that, this is sort of the beginning.

Moreover, the import has been set without legal auction. Something is really fishy here. Who's there in Thailand smiling wide now?

Votes

Received the paper ballot for AEA 2006 Officers election. Of course I don't bother sending it back. But I would have voted for Chris Sims as the Vice President. (Tom Sargent is surely the next President).

As for the upcoming Nobel Prize in Economics, my guess is for Bhagwati.

Finally, for this far-from-representative list of "world's top intellectuals", I voted for al-Qaradahawy, Toer, Becker, Bhagwati, and Posner. (Yes, there is a Friedman in the list -- but not THE Friedman).

Sachs the Prophet 2

I guess I'm not the only one puzzled by the new Sachs. (See my post yesterday).

The Politics of Rice 2

I knew it! (No, you need not to click it; just scroll down -- it's only two posts down the way). The government will import rice. And it's not hard at all to guess who gets the sole licence: Bulog (State Logistics Agency). In case you missed it, Bulog general manager had just claimed that Indonesia should not import rice. Cheap trick!

Sachs the Prophet

Enough is enough. Now Jeff Sachs declares himself a "prophet"? I'm having hard time to get it. Oh, maybe because he is indeed one of the best economist-speakers? For that matter he deserves the trophy.

(I have to confess. I have not read that guy's book, End of Poverty -- something like that. I just happened to watch the G8 parties endorsing his idea of spoiling the poor. At the time he came to Jakarta, I had two choices: attending his presentation, or watching a movie. The latter it was).

But not for his misleading populism. I can't elaborate my disagreement with his approach now. (The point is, I just don't think the mechanism will work out well -- as in my skepticism toward Indonesian compensation plan, see below). But of course Bill Easterly says it all.

And somehow this leads us to our own government plan to distribute lumpsum money to the poor families every month as a form of compensation after raising the oil and gas prices. If Sachs were indeed a prophet, he seemed to be a successful prophet in Indonesia.

[Via Mahalanobis].

The Politics of Rice 1

In a national newspaper today, the general director of Bulog -- Indonesian state-owned enterprise responsible for rice stock and distribution -- warns not to remove rice import ban. (By this he actually means: don't let anybody but Bulog to import rice. Yes, the law actually assigns Bulog as the only entity allowed to make import). His argument is typical: to protect farmers' income.

He is wrong.

Most of Indonesian paddy "farmers" are actually working peasants who don't own even slightest peace of paddy land. They are pure labors. But they eat rice. In other words, in general, Indonesian farmers are net consumers. Guess who gets hurt when rice price is artificially higher than market equlibrium price? Consumers.

In fact, the same general director says that Bulog is pessimistic that it can meet domestic demand for rice. They don't have enough stock after end of this year. Here comes the silliest part: he blames the shortage on smuggling out. Somebody should explain to this guy, what causes smuggling in the first place.

Policy Package That Isn't

The President announced yesterday an "economic policy package" to deal with the "likely economic crises". (It is so strange: I can't find any online news covering the package in its entirety!). To me, this package is not a package. It's a sermon -- a bad sermon. There's nothing specific in it. Nothing verifiable. In short, it's nothing. The President shouldn't waste his time and ours waiting for such crap announced.

Had SBY been more responsive, he should have announced instead:
1. When exactly he would eliminate the fuel subsidy, and what is the magnitude (numbers, please!). That is, what are the prices he would set for fuel and other derivatives.
2. When exactly he would fire his underperforming ministers.

About fuel price. I would suggest no more administered prices. Let the market decides. Invite competition from abroad. That will release the burden on the budget. Yes, there will be social resistance. Face it. It will be inflationary, yes -- for shorter run than worried, for smaller degree than imagined. The inflationary spiral will go first to rice price. Yes, but it can be curbed by removing the import restriction.

As for the number two, I tolerate some gestation period, as long as there's a definite date when the decision will be announced. A note however, all this complain about "businessmen should not be in the politics" is ridiculous. Why shouldn't businessmen have the same rights as other citizens? My problem is more on whether or not the businessmen who are now in the administration are the right businessmen. I think they are not. Fire them.

Approaching his one year in the administration, SBY so far has been extremely undecisive. It's time now to do something real. Even though I'm not too pessimistic (as in "we're having crisis"), a strong determination from number one leader is a must to calm the market.

Semester Kickoff

New semester has just started. I am teaching Microeconomics for undergraduate and graduate levels. And the hard work continues. This time I have lowered my expectation. Even though I'm assigned to teach advance microeconomics, I'll be taking the liberty (or lack thereof) to drill the basics once more. What's the point of forcing advance analytical tools while the basics are lacking? Why the need? Because in these past two semesters teaching environmental economics, I came to realize, most students simply have no idea what the key principles are. Central of the problems is the vague understanding of price. So, we'll labor a lot on that issue.

Welcome, unctuous expressions. I hope we can learn something. And have fun.

Repatriation?

[At the outset, let me state my position: I'm not that pessimistic considering our recent economic dowturn. The whole thing has root on the hiking oil and gas prices. The key problem is that, the country has no access to benefit from this incentive. The price movements are simply blocked. We see here and there some positive development, though: people are talking about alternative sources of energy, about the need of better technology, and of course about efficiency. Even officials (and yes, some legislatives) have started to welcome the elimination of subsidy; gradually, but that's ok for now, considering the likely social and political resistance.]

(Having said that) I'm not too excited with this whole idea about export repatriation.

Think about your home. What happens if you close the door? You can't go out, and .... neither one can come in. How to close the door effectively? Use the best lock. Otherwise, hire the best guard in town. My point is, repatriation will lead to reciprocity. And besides, monitoring costs are high.

Reshuffle?

Somebody asked my opinion on the possibility and feasibility of SBY's cabinet reshuffling due to poor performance. The media widely covers this issue of firing the President's economic team. My take is, reshuffle will send a good signal of strong determination by the President. In markets, signal is key. And the market has yet to see an decisive president since the last election: that's not good. However, recent circumstances provide justification (see my next post, above), not to do the reshuffle until at least, the general business cycle shows a more predictable direction. I would say, give them one more year. When the time comes, fire the coordinating minister for the economy, central bank governor, and minister of finance. Dissolve the national development planning agency and assign its current chief to a new post, that is the coordinating minister for the economy. in the meantime, the minister of trade should continue her work on reducing trade price distortions.

Hey, you asked me to opine.

Thank you, high oil price!

Nobody explains it better than Jay Hancock why we should thank hiking oil and gas prices. (The link brings you to Baltimore Sun website and it might ask you for free regsitration. But the points are):

The very high oil and gas prices have led to:

1. Billions of dollars invested in petroleum production. Supply will increase.
2. Chevron, Marathon, and many others are opening millions acres for drilling.
3. Oil and gas explorations create jobs in Rusia, Angola, China, Algeria, Britain, India, Canada, Azerbaijan, Nigeria, Poland, Malaysia, New Zealand, and Trinidad-Tobago.
   
4. The number of exploratory rigs around the world hit record high level since 1986.
5. Companies in South Korea, China, Singapore, and the US are building new hardaware to address drilling-rig shortage.
6. Chevron is expanding its refinery in Mississippi by 25 percent.
7. Kinder Morgan and Sempra are going to spend $3b on pipeline delivering natural gas from the Rockies to the Midwest and East.
8. Valero and ConocoPhillips are improving their ability to process sour crude that is cheaper than sweet crude.
9. Thai Oil is spending $1b on new ouput capacity.
10. Brazil in planning to increase processing capacity by 20 percent.
11. Florida is building 750MW-worth of wind-powered electricity generation.
12. China and India have doubled their refining capacity.
13. Everywhere people reduce unnecessary driving and encouraging fuel efficient cars and public transportation.
14. Sales are soaring for hybrid vehicles.

In short, incentives are all out there now for efficiency and better technology. We, too, can benefit from this situation, only as long as we free the prices.

Wife Attack!

I have heard many economists are frustrated in delivering their messages. Not that people can not follow the logic, but because economists are bad explainers. I usually tell my collegueas: "Don't blame those who don't understand you. Blame yourself who fail to explain". That advice applies to ... me, too.

And this one case is special. My very own wife is "attacking" me. To avoid endless debate -- see, I am a bad explainer -- I suggests her instead to read my regular columns in this magazine.

Economic Principals is no blog -- it should not

Dave Warsh says it all. We all have benefitted from the blog revolution. But as a regular EP reader, I don't want it to follow the euphoria. Warsh's column is special and no blog can beat it: professional journalism as well as well-researched arguments. Warsh doesn't hold an Econ Ph.D., but that does not bar him from being better than Krugman sometimes -- many times -- in economic analysis.

Keep up the good work, Dave!

Unfair Diplomas

Different?

I recently raised a concern to some collegues. On examining two master's thesis defense, I was surprised by the huge gap of quality between the two. Yet, both passed. Why so? I was told, because one student was from "regular" program, while the other one from "executive" program. "So the executive program should not be as tough as the regular program". Fine. But I was curious: would they hold identical certificate? To my surprise, the answer was: yes.

I usually don't care with how people gets their jobs. If two persons with different quality end up in the same workplace, do the same thing, and get paid the same amount, I say: none of my business.

But this one is a slightly different problem. It involves maintaing the standard quality of our graduates. I would feel bad to let students leave unprepared for job market. In addition, I don't want the market to perceive that we produce graduates with low quality.

It's happening, unfortunately. I hope this is not simply because we desperately need to raise money and have to sacrifice quality.

Thinking about it a little further, this situation is not only harmful to the department/university itself, but also to the students, and to the employers. A prospective student of the regular program would think twice: why should I work harder than some other students, if we would all get exactly the same labels? Below is a brief explanation of the effect to the hiring company (see graph above):

Think about a company seeking for two employees with master’s degree in economics. Assume that two of our graduates fill in the application. The company doesn’t want graduates from other university. Our two graduates hold the same diploma. But their quality differs. Graduate L has low probability (P) of failing his assignment, while H has high probability. Both alumnae’s utility curves are shown accordingly. Note that C is “coverage”, or think about wage; and d is “premium” or, for that matter, effort required from the employee. Don’t over-interpret “effort”. It simply means, “If you are not good enough, then you should work harder to be in par with the other – if you demand equal wage”.

The company system goes like this: the more likely you are to fail your task, the more effort you should undertake, and we will pay you accordingly. Obviously from employee’s point of view, less d and more C is preferable – hence the shape and the direction of the utility curves.

If the company can clearly separate between the “low-risk” and “high-risk” employees, it can require different effort levels. For a given wage level, therefore, the equilibrium is A for the good graduate and B for the worse graduate. However, many times, companies fail to identify which one is which – especially when their diplomas are identical. So, since both types prefer A to B, the former will be chosen by both. In this case, the company will make zero "profit" with L-type and negative profit with H-type. If the company wish to prevent any H-type (whichever graduate it turns out) to move to point A, and therefore implements a single rate (d*L_H), it will make profit at the cost of low-risk employees.

On the other hand, the good graduate is surely disadvantaged by the situation. With the same effort level with the worse graduate, but with higher quality, he is underpaid (or put differently, the worse graduate is overpaid).

In plain words: moral hazard is at play. And maybe adverse selection as well.