By Ajay Shah, on January 19th, 2012
I was shocked by Lant Pritchett’s note on the appalling performance of India’s best two states on the international PISA assessment. Actually, I was not really shocked; I didn’t expect anything else as I’ve been listening to Lant for years now. By the same token, I agree with Jishnu Das that we really don’t know much about what works in education (other than that good teaching makes a difference) and that our bean-counting of inputs into education may be completely wrong headed. From conversations with him (also over years) I surmise that the only thing we really know about what leads to more learning is that it is correlated with how many years children stay in school. What that suggests, though, is that attention be directed towards the choice of parents and students to stay in school.
In my opinion people choose to do things if it is worth it to them. This is a common assumption for economists. While challengeable in some circumstances, does it make any sense to think that people send their children to school if they don’t think it’s worth it? If it is
compulsory: sure. With compulsion, attention of policy makers and carefully watchful observers such as Pratham should be to make sure school is worth the year of children’s attendance since people would not be able to decide for themselves. Until we see compulsory schooling enforced, though, years of education remain a family’s choice and we have to understand how and why people make that choice.
Unless we think parents are utterly clueless about the value of education and totally incapable of telling if teachers are doing anything or their children are learning anything, the effectiveness of teaching and the amount of knowledge imparted must be a major factor in their decision as to whether school is worth it. Don’t get me wrong, I’ve met dozens of educators and education officials in India who believe parents are, indeed, clueless and such decisions should be out of their hands. But they are the very people who gave us the PISA ratings and are indeed throwbacks to the License Raj where only bureaucrats were assumed to know anything. Further, with the explosion of private schools, even in rural areas, it is laughable to think that there are so many parents who value education so little. They are willing to forego free public education in order to pay for something more worthwhile.
Which brings us to accountability.
What could parents be looking at, that makes them think school is worth it? It must be based on performance: parents don’t really see
the inputs, they mostly just see their children learn. Or not learn as is the case. So how can they translate their concern for learning into actual learning? They have to be free to pick the educational context that they see is working for them or their neighbors. That’s where accountability comes in.
A provider of any good or service is likely to be most accountable when their livelihood depends upon attracting customers. If what they provide is worth it, people will take the service, and the provider can make a living. If not, parents won’t pay and teachers won’t get paid. As of now, there is no mechanism to allow families to make that choice. There is no such compulsion for teachers to provide a service worth paying for. No doubt there are many teachers (probably most) who are doing the best they can regardless of how they are paid. But with over 24% absenteeism, large numbers of teachers observed to be doing anything but teaching, and many sub-contracting their position to under-qualified replacements at a fraction of government salaries, there is substantial room for improvement.
Further, if we are going to get more students (and, hence, teachers) into classrooms, the dedicated teachers may be the ones who are already on the job. People induced to enter the profession may not be as dedicated and, hence, need some other way to hold them accountable than internally felt professional ethics.I am an educator (of sorts) but have no opinion about what the bottleneck in children’s learning really is. Jishnu says the most successful headmasters all say different things (after good teachers – but then, don’t we judge the goodness of teachers by whether their students actually learn? It’s an output based judgment, too.) I know little of pedagogical theory. But I know just as little about the inner workings of most complex things I use — computers and the Internet, water systems, bicycles. I can tell when they work and when they don’t, though. Similarly, I know that my sons learned to read and
write, become responsible citizens and to develop and exercise critical intellectual capacities (sometimes way too critical for my
taste) even though I have no idea how they learned them. I did know that their teachers were in school almost every day and doing things that sounded like teaching to me. I did not have to be an expert on pedagogy to hold the schools completely accountable for my children’s education.
I was also fortunate enough to be able to take (or threaten to take) them out of government schools if I thought otherwise. Funding
for government schools (in the U.S.) follows enrollment, if not so directly and obviously as for private schools. So my threats about
shifting my children out of government school directly mattered to their teachers.
There is no reason why Indian parents can’t do the same. They, on average, may not have my education but after talking to hundreds of families in rural areas, tribal villages, urban slums and SC hamlets, I hear no less concern for their children’s future than I have for
mine and no less ability to tell if a teacher appears to be doing his job. They may be more capable than me since they are more likely to see the teachers themselves — I needed to ask my children.
In many rich countries, the issue of vouchers to pay for schools is emotionally charged. Historically, free compulsory public education was a result of fights between church and State (even in Japan where `church’ doesn’t quite fit — but religion and State does). Children were already attending school in high percentages and there was a fight for their hearts and minds. In rich countries currently, suggestions to provide vouchers instead of State-run schools re-kindle this old antagonism against religious instruction.
India never had this fight nor this evolution of public provision. Our view of schooling here in India was imposed based on the final result of universal free education seen in rich countries without the history from which that final result evolved.
India needn’t go through the phase of fighting over who gets to teach students who are already highly motivated to learn and have seen learning take place. If India wants to see all children educated, she can certainly pay for the cost of education (in fact, the job can be done for much less per student is presently spent) so that families don’t have to. But the government doesn’t have to provide it directly (though government schools should be free to compete for this money if it can). The fight is the State against society (families), not against the church.
What the State can do is make as much information known to parents as possible. What should children know after how many years of school?
How do you know if your child is keeping up? How do you know what you’re paying for is worth it? As of now, this information is
certainly not given to parents. Maybe State run schools don’t want parents to know (and, unfortunately, most Indian parents will not know about PISA). And as of now, there is nothing parents (particularly poor parents) can do about it anyway.
By Ajay Shah, on December 12th, 2011
There is a lot of gloom in India today about the broad-based failure of the UPA strategy of combining left-of-centre populism, fiscal profligacy, theft, and a lack of interest in the foundations of India’s growth. We learn from history that we learn nothing from history; India has clearly learned very little from its escape from the Hindu rate of growth. The moment we got a little bit of growth, the old style socialism and theft reared up again. In one of the many pessimistic articles of this theme, Shekhar Gupta in the Indian Express says:
What is the Hindu Rate of Growth two decades after reform? It certainly can’t be the 2-3 per cent of India’s socialist Brezhnev decades. The new Hindu Rate of Growth is 6 per cent, and on all evidence, from macroeconomic data to the empty billboards of Mumbai, we are headed there next year.
In thinking about GDP growth, it’s always useful to think about both growth and fluctuations. Growth is about the underlying trend growth rate. In the olden days, this was all you needed to worry about. The economy trundled along at roughly the trend growth rate (the Hindu rate of growth of 3.5 per cent), being kicked up or down by good or bad monsoons. In that period, macroeconomics in India required thinking in completely different ways, when compared with standard Western textbooks.
But from the early 1990s onwards, India changed. The market-oriented reforms, which began with the Janata Party in 1977 and gathered momentum in the 1980s, had started creating a market economy. And every market economy in the world experiences business cycle fluctuations. So, in addition to the trend, we got a cycle about the trend. There were good periods and bad periods, and the story running in there was much like that found in mainstream Western textbooks, with a prominent role being played by profitability, inventories and investment by firms.
From this viewpoint, it’s useful to decompose two elements of what we are seeing after 2009. On one hand, trend growth has been influenced by decisions of the UPA. Any perceptive observer also tends to rage at the lost opportunities, of policy decisions that should have been taken, which would have accelerated trend growth. But the second big story is that of fluctuations. Corporate investment is a major driver of business cycle fluctuations in India, and there has been a certain deceleration in this. This may have set off a downturn.
The bulk of the drama that we’re now seeing, and what will play out in 2012, is business cycle fluctuations. This is about fluctuations, not the trend. When trend growth is 7 per cent, the fluctuations make GDP growth range from 4 per cent to 10 per cent. Even if trend growth does not change by even a bit, business cycle fluctuations can take us from a high of 10 per cent to a low of 4 per cent, which is a huge swing of 6 percentage points.
Many elements of economic policy are pro-cyclical: when times are good, they make things better and when times are bad, they make things worse. The financial system tends to suffer from pro-cyclicality: when times are good, bankers lend exuberantly (thus expanding the boom) and when times are bad, bankers tend to be cautious (thus accentuating the bust). It is important to look for a framework for stabilisation, of tools that will counteract business cycle fluctuations. India has crossed one major milestone, in getting to a floating exchange rate. The floating exchange rate is stabilising, in and of itself. In addition, it opens up the possibility of stabilising monetary policy.
As of today, by and large, I think of both fiscal policy and monetary policy as being part of the problem and not part of the solution. While floating the exchange rate (decisions from 2007 to 2009) opened up the possibility of sound monetary policy, the logical next step did not materialise. As of yet, we do not have a sound monetary policy regime. We’re going to require far-reaching surgery to laws and institutions, in order to craft frameworks for fiscal policy and monetary policy that do stabilisation. Until these changes are made, Indian GDP growth will have the high volatility that is characteristically found in countries with weak institutions.
A lot of our work in the Macro/Finance group at NIPFP is rooted in this conceptual framework. In particular, you might like to see two relatively non-technical articles: New issues in macroeconomic policy and Stabilising the Indian business cycle.  
By Simon Grey, on December 5th, 2011
From Bryan Caplan:
Many educators sooth their consciences by insisting that “I teach my students how to think, not what to think.” But this platitude goes against a hundred years of educational psychology. Education is very narrow; students learn the material you specifically teach them… if you’re lucky.
Other educators claim they’re teaching good work habits. But especially at the college level, this doesn’t pass the laugh test. How many jobs tolerate a 50% attendance rate – or let you skate by with twelve hours of work a week? School probably builds character relative to playing videogames. But it’s hard to see how school could build character relative to a full-time job in the Real World.
At this point, you may be thinking: If professors don’t teach a lot of job skills, don’t teach their students how to think, and don’t instill constructive work habits, why do employers so heavily reward educational success? The best answer comes straight out of the ivory tower itself. It’s called the signaling model of education – the subject of my book in progress, The Case Against Education.
According to the signaling model, employers reward educational success because of what it shows (”signals”) about the student. Good students tend to be smart, hard-working, and conformist – three crucial traits for almost any job. When a student excels in school, then, employers correctly infer that he’s likely to be a good worker. What precisely did he study? What did he learn how to do? Mere details. As long as you were a good student, employers surmise that you’ll quickly learn what you need to know on the job.
In the signaling story, what matters is how much education you have compared to competing workers. When education levels rise, employers respond with higher standards; when education levels fall, employers respond with lower standards. We’re on a treadmill. If voters took this idea seriously, my close friends and I could easily lose our jobs. As a professor, it is in my interest for the public to continue to believe in the magic of education: To imagine that the ivory tower transforms student lead into worker gold.
What makes the college bubble so problematic is that it is essentially inflationary. College degrees can be considered a form of currency in the labor market, wherein one purchases a salary with not only one’s labor but one’s college education as well. Obviously, this mechanism is not as direct as, say, buying milk at a grocery store, but the effect is similar.
The labor market, then, relies on college degrees to indicate a prospective employee’s fitness for the salary being offered. Certain types of degrees generally pay better than others, certain colleges’ degrees pay better than others, certain grade point averages are worth more than others, etc. Someone who receives an MBA from Harvard while maintaining a GPA of 4.0 will generally earn more than someone who receives an Associate’s degree from ITT Tech while maintaining a 2.0 GPA. This should make sense, as the quality of student varies by institution, degree, and grade, and there are ways to sort this. The college bubble, then, serves as a form of inflation because it distorts the signal that a college has in the labor market.
Basically, as is well known, the college bubble is the result of massive governmental interference in the post-secondary education market. The federal government offers direct subsidies of education costs (e.g. the Pell Grant), and also makes college loans a very enticing offer to lenders by guaranteeing the loans. With direct subsidies and easy credit, prospective students have a very strong incentive to go to college. Furthermore, with this much money on the line, colleges have a very strong incentive to accept more students.
The effects of this bubble, as noted before, are seen primarily in signal distortion. This occurs because employers now have a larger labor from which to select workers. This generally seems like a good thing, since employers can now offer lower wages, but this is not always the case because some potential workers are perhaps not as well-qualified for their position as others. The problem with using college degrees as a qualification is that, at this point, there isn’t enough data to sort the good from the bad. When there were a limited number of college-educated labor candidates, the quality was considerably better since colleges had an incentive to maintain quality control. This is no longer the case because the federal government is paying colleges, indirectly, to simply pass out degrees to young adults with no regards for their qualification.
Thus, the lower wages that have resulted from the increased pool of labor applicants can be thought of as a risk premium. Because there are more college-educated people in the labor supply coupled with increased variance of abilities without there being an increase in the sharpness of the signal generally associated with a college education, and because American labor is tightly regulated with regards to discrimination (particularly as it pertains to firing employees), there is consequently more risk associated with hiring someone because the chance that person a company hires turns out to be a bust, as it were, is considerably greater. Given the costs associated with firing incompetent workers, particularly if they are in a union or minority, employers have an increased incentive to mitigate that risk by offering lower wages.
As such, the most problematic aspect of the college bubble is the consequences that come with signal distortion. Because the supply of college educated labor has increased with a matching increase in demand for said labor, and because a college degree isn’t nuanced enough as a single, there will be an increase in the number of people who are overpaid and an increase in the number of people who are underpaid. This happens because the signal sent by a college degree is roughly the same for everyone who has one.*
Some people will be underpaid because their aptitude is such that they would ordinarily deserve more pay than they are currently receiving but, because it is now more difficult to tell who has what levels of aptitude, they must take a pay cut. The reverse is true for those who are overpaid. Basically, the inflation in the number of students undermines meritocracy, thereby distorting the pay scale. Thus, the current bubble has introduced not only distortion, but market failure on a large scale.
The irony of the current college bubble is that its existence is largely predicated on the belief that a college education makes one more intelligent. This claim is laughable on its face because it does not begin to account for the self-selection bias inherent in this sort of activity. Do students learn because they go to college or do they go to college because they like to learn? This is a crucial question because if the answer is the latter, then it seems likely that those who do go to college would become just as knowledgeable if they lived in a library for four years.
At any rate, the college bubble has had the nasty effect of giving diplomas to those who have no desire to learn, and have undermined the meritocracy that once was a college education, thereby depriving those who are truly above average from an income that would properly reflect this fact. This, then, is the lamentable effect of the college bubble: The attempt to make everyone equal in education has only led to a diminution of standards. We are all idiots now.
* Obviously, a Harvard diploma is still more valuable than an ITT Tech diploma. However, if Harvard’s business school doubles the number of graduates, year over year, the value of a Harvard degree will decline assuming that there is not a corresponding increase in demand for Harvard grads.
By Simon Grey, on July 19th, 2011
ASI:
One example he used was of Jonathan’s Coffeehouse, a private club that preceded the London Stock Exchange. In the 18th century, the government refused to enforce stock exchange contracts, seeing them as a form of gambling. Nevertheless, the Coffeehouse became a centre of commerce and contracts were usually upheld voluntarily. If you were a trader, you could rip somebody off once, but would be barred from the club. For people whose livelihoods were based on stock trading, it wasn’t worth it.
The same phenomenon exists today in a whole range of exchanges. When I go to a restaurant and get a bland meal, it’s practically certain that I won’t sue. Does this mean that profit-maximising restaurants will constantly give out bland meals? No – if it serves bad food, I’ll stop going and tell my friends not to go either. Reputational capital, so to speak, is enormously valuable, and losing it can be worse than just losing a court case. As a side-point, the reason that restaurants in touristy areas are usually so bad is down to this fact as well. Tourists typically don’t know anything about the restaurants they go to – could things like TripAdvisor bring an end to tasteless, expensive tourist food?
One complaint about the unfettered free market is that there is no way to “make sure” that people behave ethically and fairly in their business dealings. The unspoken assumption is that only government can provide the final guarantee against fraud, presumably through the use of force. What’s neglected in this fairly shallow analysis is that most people expect to participate in the market over the long term, the market can exert plenty of force, and the government is far from perfect anyway.
Since most people expect to participate in the market over the long term, it would be foolish for them to do things that would cause consumers to distrust them. As was already noted, if someone were to even sell a shoddy product, they would presumably suffer negative consequences. And if they intentionally defrauded customers, they would find that they would go out of business quite quickly.
The reason for this is due to the effect of social pressure, which exists outside of the state. Most people with decent faculties will find that it is in their best interest to “play by the rules” because doing so ensures that will have social acceptance, which in turn ensures that there is some degree of implicit trust which then enables trade. This social pressure ensures that most people conform to social norms, and this is itself a form of force.
Unlike the state, though, the market does not have coercive power, in the sense that conformity can be forced. Anyone can opt out of the society in which they live, if they so choose. Incidentally, if one were to opt out of a given society, the market in that society would improve because those who opted out would no longer participate in that market.
Finally, the coercive force of the government is not always used for good. Even if the market cannot ensure that no one ever gets hurt when engaging in market transactions, it does not follow that the government will. As such, the argument that the government needs to regulate the market for the good of consumers is simply specious.
By Simon Grey, on July 14th, 2011
The quick fix that got both Democrats and Republicans off the hook with a temporary bipartisan tax compromise, several months ago, leaves investors uncertain as to what the tax rate will be when any money they invest today starts bringing in a return in another two or three or ten years. It is known that there will be taxes but nobody knows what the tax rate will be then.
Some investors can send their investment money to foreign countries, where the tax rate is already known, is often lower than the tax rate in the United States and — perhaps even more important — is not some temporary, quick-fix compromise that is going to expire before their investments start earning a return.
Although more foreign investments were coming into the United States, a few years ago, than there were American investments going to foreign countries, today it is just the reverse. American investors are sending more of their money out of the country than foreign investors are sending here.
Since 2009, according to the Wall Street Journal, “the U.S. has lost more than $200 billion in investment capital.” They add: “That is the equivalent of about two million jobs that don’t exist on these shores and are now located in places like China, Germany and India.”
President Obama’s rhetoric deplores such “outsourcing,” but his administration’s policies make outsourcing an ever more attractive alternative to investing in the United States and creating American jobs.
One cannot have free trade, an anti-market domestic trade policy, and a growing domestic economy simultaneously. One might be able to have two of the three, but there is no way to have all three. Unfortunately, Obama is trying to have all three, and it’s just not going to work out.
By Simon Grey, on June 17th, 2011
I’ve been meaning to write this post for nearly a month, but I didn’t feel like getting around to it until I saw this post by OneSTDV: In general, the mainstream Right views corporations as unassailable edifices of the free market. They triumphantly brag about shopping at big chain stores and express indifference towards corporate influence. Yet, the reactionary Right doesn’t quite share this position or at least shares a tempered optimism towards the benefits of corporate dominance. In my opinion, the mainstream’s defiance regarding criticism of big corporations is part of their frustrating adherence to the proposition nation. Instead of espousing a straightforward nationalistic and traditionalist conception of America, mainstream conservatives use proxy indicators, such as guns, religion, libertarianism, and corporatism, to illustrate their right-wing bona fides.
I used to defend corporations as the cornerstone of the free market until I was introduced to the reality of corporations by the Austrian school of economics. Wikipedia provides an excellent summary of why corporations are ill-equipped to serve as the bastions of the free market: A corporation is a legal entity that is created under the laws of a state designed to establish the entity as a separate legal entity having its own privileges and liabilities distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter (i.e. by an ad hoc act passed by a parliament or legislature). Most jurisdictions now allow the creation of new corporations through registration.
An important (but not universal) contemporary feature of a corporation is limited liability. If a corporation fails, shareholders normally only stand to lose their investment and employees will lose their jobs, but neither will be further liable for debts that remain owing to the corporation’s creditors.
The important thing to take away from this is that corporations are government-defined entities. The only reason corporations exist is because businessmen decided to cozy up to the government, which is not exactly the free market in action. As such, corporations serve as a market distortion in a variety of ways.
In the first place, the existence of the corporation shifts moral hazard from business owners to consumers, which effectively means that consumers bear the market risk that rightly belongs to corporations. This can be seen in the area of business contracts, most notably sales contracts. Without going into highly technical details, English common law dictated that consumers have the right to expect explicit and implicit guarantees of performance and safety for whatever product they bought. If a consumer buys a product that doesn’t perform, or a product that causes injury during intended use, the producer would be liable to the consumer for failure to perform or for incurring damage. If a producer made an incredibly shoddy product, he could go completely bankrupt.
The possibility of personal bankruptcy helped to ensure that producers manufactured products that met a basic level of quality. The formation of the corporation limited this incentive in that business owners no longer bore unlimited liability for their products. This shift, then, meant that business owners could make products that were “riskier,” in the sense that they could manufacture products that were more dangerous or liable to underperform without having to face the risk of personal bankruptcy. As such, the invention of the corporation has had the effect of shifting moral hazard from businesses to consumers, which is effectively a type of subsidy and a virtual tax.
A second effect of the abstract legal entity of the corporation is that it created a paradigm wherein people began to think that corporations pay taxes. In fact, there has never been a point in history where abstract legal entities have paid taxes. Only people can pay taxes, but there are some who think that corporations can pay taxes simply because those in the legal system have at one point argued that a corporation is a type of person. This has led to incredibly muddled tax policy, which has been discussed in detail prior on this blog.
In the third place, corporations require increasing government intervention into the market. This is due to the inherent subsidy of corporate status. All subsidies impose some sort of negative externality, which leads to negative market distortions. In this case, the status of corporation does not discourage risky production as much as it should, which leads to corporations making either shoddier or more dangerous products.
Consumers demand, quite legitimately, that the government fix this problem. Since governments are generally allergic to owning their mistakes, and are generally desirous of increasing their power, they seize this opportunity to regulate businesses in order to ensure that they meet production quality and safety standards.
Incidentally, the worker side of the equation deserves discussion as well. Not only does corporate status limit a producer’s liability to consumers, it also limits its liability to workers as well. Corporations can, to a limited extent, ignore the safety of their workers because they do not bear personal liability for whatever harm befalls them in the course of normal work. The poor working conditions of the industrial revolution can therefore, to a very limited extent, be blamed on the corporate status of businesses.
Anyway, the history of the corporate entity has shown that the original distortion has led to many, many more distortions, always in the name of correcting some “market” flaw.
Finally, note that corporations have had the effect of transferring power and wealth to those who are already wealthy. There is no debating the fact that many corporations suckle at the government’s teat. This should not be surprising, given that the only reason corporations exist is because businessmen went to the government to ask for special market privileges. As such, those who own corporations have been seeking, since day one, to use the government to make them wealthier, and to help them beat the market.
At this point, then, it should be obvious that corporations are not, and indeed have never been, the free market’s friend. In fact, corporations are as free market as the government that grants and defines their continued existence. Corporations are an inherent market distortion, and should be recognized as such.
By The Gold Report, on June 14th, 2011
 The Emerging Trends Report is 18 months into a planned 4-year circumnavigation of Australia, investigating specialty metal projects and recommending ASX-listed companies to clients. In this exclusive interview with The Critical Metals Report, we caught up with ETR Managing Editor Richard Karn shortly after he delivered the keynote address to the 2011 Energy and Resource Symposium for an update on the specialty metals market down under.
The Critical Metals Report: Let’s start with the basics. In general terms, what exactly are “specialty” metals?
Richard Karn: We use the term “specialty metals” to refer to metals and elements that are neither base metals (iron, copper, nickel, lead and zinc)—which oxidize, tarnish or corrode easily, nor energy metals (uranium and thorium). We find the nomenclature the market uses to refer to these metals not only confusing but also conflicting and misleading: Precious, industrial, clean, rare, military, green, critical, minor, technology and strategic.
Most of these metals have a wide range of applications that resist such simple categorization. For instance, so-called minor or industrial metals, such as antimony, manganese, tungsten, molybdenum, vanadium or magnesium are largely leveraged to the base metals they are commonly alloyed with and are clearly critical or strategic in that you cannot make steel or myriad alloys without them, yet all of them are increasingly finding use in so-called “clean” or “green” applications. Precious metals—gold, silver and the platinum group metals (PGMs)—also are in widespread use in technology, green, military and industrial applications. We’re also discovering that rare earth elements (REEs) are in a surprisingly wide variety of applications and devices that make modern life possible.
In essence, what we are trying to do with the term “specialty metals” is simplify the language in hopes of making a lucrative but demanding investment trend more accessible to the broad market.
TCMR: In broad strokes, please outline the investment case for specialty metals.
RK: Essentially, the West, which we loosely label “free marketeers,” allowed the East, which we label “neomercantilists,” to gradually take market share in the production of the vast majority of specialty metals.
Free marketeers were so focused on short-term profits, and often the executive compensation attendant to making the number each quarter, that they lost control of the long-term supply of the specialty metals critical to their businesses. Novel business models like just-in-time supply chains are starting to break down as a result.
Today, free marketeers are in denial about what they have wrought; so, they are clinging to slogans like, “Market Forces Will Prevail,” while they scramble to secure supplies of these metals. On the other hand, the neomercantilists have arrived at the happy situation wherein they have near-monopolistic control of a whole range of metals—not just REEs—and they are openly pressing their advantage. We were somewhat surprised last year by the market’s reaction to China’s announcement that it would severely curtail the availability of REEs. The country had been incrementally reducing production, making regular cuts to export volumes and increasing export taxes for years. But in the whimsical ways of the market, none of that mattered at all until it suddenly became paramount. We actually had been expecting such an announcement pertaining to antimony, tungsten, graphite, indium or germanium rather than REEs—all of which are, incidentally, also largely controlled by China and ended up being included in its strategic reserve.
That’s the Reader’s Digest, condensed version of how we arrived at our current situation.
What we consider the largest single demand driver of the trend in specialty metals today is simply our endless pursuit of higher-quality, ever-more efficient devices at ever-lower prices. It’s difficult for many people to grasp the extent to which the combination of advances in computer-processing power, analytical and modeling software and data storage—all of which were attended by plunging prices—has enabled an explosion in material science and metallurgical R&D.
Literally, the more these scientists look, the more new and exciting uses they find for these specialty metals. The unique performance characteristics of these metals limit substitution and such trace amounts are used, that the metals are price inelastic. Many of these metals, such as tellurium, which is actually scarcer than platinum, are sourced only as a byproduct of other metal production, which render them supply inelastic. Add in the fact that many experience dissipative uses, but lack recycling protocols, and the enormity of the supply problems begin to come into focus. Add sovereign risk and resource protectionism to the mix, and it becomes equally apparent that these supply problems are entrenched, structural and without quick remedy—regardless of how fervently the free marketeers chant, “Market Forces Will Prevail.”
Keep in mind that rapid technological advance shrinks a device’s operational lifespan (everyone wants the latest, greatest version) and that, to a large degree, the specialty metal demand trajectory is discovery-driven rather than correlated directly with GDP, as is the case with oil, base metals, lumber, etc. An example of this can be seen with the mobile phone market—while the global financial crisis (GFC) crimped demand for high-end phones, unit sales of low-end models actually increased as demand from so-called “emerging markets” continued unabated.
TCMR: There are some commonly held misconceptions about the specialty metals market. Could you please clear those up or dispel those myths for our readers?
RK: The biggest myth is the aforementioned, “Market Forces Will Prevail.” You simply cannot fix structural problems quickly that took decades to develop by throwing money at the problem. Specialty metal projects are difficult to find, and financing more difficult to arrange, because the majority of these metals are unhedgeable—that is, they trade off exchange—which makes banks nervous.
The market is just starting to become aware of the difficulty involved with processing these metals, which, in many cases, more closely resemble sophisticated industrial chemistry than traditional onsite brute processing. Putting flow sheets together that process these metals and elements economically is no mean feat. And the neomercantilists are increasingly acting like cartels, in that they are actively taking steps to protect their controlling positions.
Another myth is the extent to which substitutions for these metals can be found. It’s true that often you can substitute certain metals or elements with those in the same group, such as with PGMs or REEs, but that frequently results in the price of the substitute increasing as well. Finding substitutes outside the group tends to require more of the substituted material and usually results in a bulkier device with poorer performance characteristics. Researchers worldwide are scrambling to find alternatives, but I wouldn’t use that as a rationale upon which to base an investment decision.
The same applies to recycling. We are huge fans of recycling, especially of specialty metals, because we live in an increasingly resource-constrained world and metals are effectively infinitely recyclable, which makes them a truly sustainable resource. But only a small percentage of the specialty metals found in computers, mobile phones and consumer electronics are recycled. All too often, the same people protesting new mine development, or clamoring for a bigger piece of the resource pie, think nothing of discarding the devices containing these precious resources. We can’t have it both ways. If we had the political wherewithal to mandate recycling, perhaps by adding a metal-value surcharge to the price of a device that could be redeemed at recycling centers, we could significantly increase our resource base and preserve it for future generations.
As it stands, recycling is a for-profit business. Until the prices of these metals get high enough to warrant the time and energy to develop recycling technologies, many of which resemble sophisticated chemistry rather than crushing and baling, recyclers will focus primarily on the easily recoverable, high-value metals. I read recently that more than 90% of the contained value in computers is found in just four metals: Gold, silver, palladium and copper—in mobile phones, it was 95%. That means literally dozens of other specialty metals are simply being thrown away.
Even Japan, which is very good at such things, is having problems recycling the REEs used in a variety of devices. This does not bode well for prices. Think about it—a number of these electronics manufacturers are recycling their own products, which means they have access to the exact metallurgy involved in their products’ alloys, yet they are having problems recovering them.
One last myth that keeps popping up is that these metals represent but a few billion dollars of value in a $50 trillion global economy; so, why do they really matter? As China is making abundantly clear—it’s what these metals mean, in terms of value-added products that count. And that certainly runs to the trillions of dollars.
TCMR: One problem with investing in specialty metals is the lack of transparency. Most base metals are traded on the London Metals Exchange (LME), which means just about anyone can visit the LME website, see the prices for and inventory of those metals. Do you expect to see a similar bourse develop for specialty metals? If not, how will transparency find its way into this rapidly growing sector?
RK: China just announced plans for a rare earth element exchange—not a futures exchange, but rather a vehicle to determine (some would say dictate) the spot price. We are leery of China’s motivations these days. In fact, a groundswell is gathering momentum that could result in China being brought before the WTO for a number of its practices. We wouldn’t be surprised if the country’s response is, shall we say, unsettling.
Some metals are legitimate candidates for exchanges, others are far more problematic because they are byproducts sold forward at a discount to meet financing demands or are produced in such small quantities that it would not be practical. Others are sold on a highly confidential basis between producer and user, with the latter developing and maintaining a competitive advantage over its rivals via these negotiations.
So, no, we don’t see most of these metals ever trading on exchanges and, judging from some of the questionable practices being allowed on the gold and silver futures exchanges, that might not be a bad thing.
TCMR: Richard, you say the price of critical metals is “discovery driven” and not tied to GDP growth, as is the case with commodities like oil and base metals. What are some examples of discoveries that really drove up the prices of specialty metals?
RK: One example is ruthenium, the minor PGM that was instrumental in facilitating the jump from longitudinal-bit stacking to perpendicular-bit stacking and the higher magnetism used in our multiterabyte hard disk drives today. Others include the use of gallium and tellurium in competing types of solar panels, rhenium in the superalloys used in jet turbines, indium in flat panel displays, graphite in lithium-ion batteries, carbon nanotubes, graphene, and grafoil, or antimony in flame retardants in everything from the plastics used in consumer electronics to children’s clothing and upholstery.
Once you start looking at these metals and their uses, it’s actually quite fascinating. The advances we have seen especially in consumer electronics over the last decade and a half have not been driven by lone inventors or college kids tinkering in their parents’ garages, but rather by very large, well-equipped and well-staffed research arms of powerful corporations. The stakes are high and if a certain metal is critical in an application, they will buy it regardless of the price.
TCMR: Going back to your discovery-driven investment thesis, wouldn’t an economic slowdown result in less money flowing into R&D budgets, ultimately leading to fewer new discoveries and, thus, lower demand for critical metals?
RK: More than half the world’s population is doing its damnedest to secure the standard of living that we take for granted. They were largely unaffected by the global credit crisis because they live in a largely cash-and-carry world. So, barring an abject collapse, I doubt we will see a significant demand decrease.
TCMR: In your research, you say the price of rare earth elements is up 1,700% over the previous 10 years. Likewise, the price of antimony is up 1,600%; zirconium and magnesium—both up 950%; tungsten up 750%; and manganese up 700%. Are there four or five metals that you expect similar rises for over the next decade?
RK: We can easily see the majority of the 50 metals (including gold) we cover experiencing similar price increases, though we would caution readers to be careful what they wish for. We have long maintained that the monetary inflation being visited upon the world by a plague of bureaucrats—and it is a global phenomenon not limited to the U.S.—eventually will produce elevated commodity prices. You can only use perpetually devaluing paper currency to purchase real hard assets for so long before commodity producers’ start demanding significantly more paper for their products, or their projects become uneconomic and fold up entirely.
We would also add that, at some point, the U.S. and the EU are going to wake up to the fact that they have neglected their infrastructure for the better part of 30 years and simply can no longer afford to continue the neglect if they wish to maintain any pretense of being globally competitive. In the case of the U.S., whether it is QE3 or QE33, at some point, the administration will stumble across the idea that putting people to work repairing, replacing and expanding our infrastructure is what is needed to put America back on track.
So, we expect specialty metal prices to remain volatile but with a decided upward bias, because we simply do not believe there are sufficient specialty metal projects coming onstream to meet demand. Once the U.S. and EU start their infrastructure-refurbishment program, things will get very interesting indeed.
TCMR: You claim that no less than 50 specialty metals (including gold) are subject to supply threats. Moreover, you report that 40 of those metals can be found in Australia and will be mined there inside three years. In fact, you’re a big proponent of investing down under. Why are you so bullish on Australia?
RK: Allow me to give you a little background on the 50 specialty metals we consider to be under supply threat. First, we consider there to be essentially five forms of supply threat: 1) Sovereign risk; 2) Scarcity; 3) No substitute for the metal in a primary use; 4) Byproduct sourcing; and 5) Dissipative use in a primary application. In order to qualify, for our list, a metal must experience at least two forms of threat—the average is three.
Of these five threats, only two are really under any semblance of investor control: 1) Sovereign risk; and 2) Dissipative use—assuming that at some point we wake up and mandate recycling.
We have been concerned, and writing, about sovereign risk since early 2007, at which point we began limiting our investment universe to North America and Australia. In the aftermath of the GFC, resource protectionism, nationalization and corruption are on the rise—as is consistent with more than 150 years of economic history. We see no reason to tolerate any sovereign risk.
Successive Prime Ministers Rudd and Gillard notwithstanding, we consider Australia about as politically secure as can be found today. Australians honor their agreements, contractual or otherwise.
Australian geology is also unique. As the most tectonically stable continent on the planet, its considerable mineral endowment has benefited from eons of exposure to water, wind and sun concentrating what it has. And Australia has at least 40 of the 50 metals we track; for example, though slightly off topic, BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) and Rio Tinto (NYSE:RIO; ASX:RIO) are mining ore in the hell-and-gone of the Pilbara region, which is nearly 60% iron and requires no processing whatsoever before being loaded on trains and shipped to the coast for export. In fact, were it not for this natural processing, or concentrating, a case can be made that a number of their projects would not be economic.
I can talk about this all day long because, for me, it is a perpetually unfurling tableau of wonder; but to put things in perspective, think about this—you can go down in Karijini Gorge in Western Australia and put your hands on rocks that are at least 2.5 billion years old—literally from the basement of time.
TCMR: You note that the clash between free marketeers and neomercantilists has created investing opportunities in Australia. Tell us about that ongoing battle and what it could mean to investors.
RK: When the neomercantilists were taking market share by undercutting the world’s for-profit mines on price, a significant number of those closed were located in Australia—not least due to the high wages Australia pays and the fact that it’s a difficult, arid geography in which to operate. A lot of Australian mines were closed not for lack of ore but because they were undercut on price. Today, metal prices have rebounded and many are reaching new highs, which certainly renders these mines economic again. Many still have functional infrastructure and a few of the operators of such mines have had the foresight to keep their mining licenses current.
The same applies to a number of very promising specialty metal deposits that cannot arrange financing in the aftermath of the GFC because the metals in question are not hedgeable. This is presenting a range of opportunities for private equity money, and we believe many of these projects will do quite well following their eventual IPOs.
Further, over the last year or 18 months, the large caps and the micro caps in Australia have outperformed the mid caps significantly. This usually results in significant M&A activity as the large caps use their richly valued shares to pick up comparatively undervalued mid caps. This process has just begun, and we expect it to accelerate from here.
TCMR: Some of those 40 metals that will be mined in Australia will be REEs. Are there some companies operating in Australia that you believe have exciting opportunities for growth in the coming years?
RK: We wrote up Alkane Resources Ltd. (ASX:ALK) as our first investment report in early April 2010. We not only liked its suite of REEs but also that it would be producing a variety of zirconium compounds, as well as niobium and tantalum concentrates. In other words, this was a company flying under the world’s radar, for the most part, that was set to produce 19 of our 50 metals in one go. It had been working in conjunction with the Australian government in a public-private initiative to develop and demonstrate its flow sheet, which put it well ahead of the majority of REE projects. Throw in what I consider stellar management, a very long-life asset and a clear plan to throw off dividends for a long time once in production, and we thought it made a brilliant inaugural report.
Then, when China made its REE announcement last June, we issued a bulletin to our sponsors to buy more ALK, as well as Arafura Resources Ltd. (ASX:ARU), Lynas Corporation (ASX:LYC) and Molycorp Inc. (NYSE:MCP), for which the IPO was slated in August, but which went off in late July. All have performed well, and we expect this to continue to be the case.
A related specialty metal we are particularly taken with is scandium—a fascinating metal that stands to significantly improve the performance and economics of both the aviation and fuel cell industries. It is literally a case of significant demand awaiting reliable supply to give birth to a new metal market. As is the case with REEs, with which scandium is usually grouped, economic deposits are very rare and processing is difficult.
We actually were onsite in Greenvale in northern Queensland with the geologist who found the bonanza grades when Metallica Resources Inc. made its announcement about the scope of the scandium deposits on its Lucknow and Kokomo tenements. To the best of our knowledge, there are currently only three deposits in the world that are deemed economic—all three are in Australia, and MLM controls two. The third is a joint venture (JV) at Nyngan, New South Wales that EMC Metals Corp. (TSX:EMC) is farming into; so, we issued a Buy on both companies. One way or the other, we wanted a piece of those deposits because the metal is too important not to have economic deposits get developed.
By way of disclosure, not only do we own shares in both companies, but also, subsequent to the release of that report, I have personally become involved with a private equity group that is in discussions with MLM to form a JV company to put part of the Lucknow tenement into production.
TCMR: And how have your recommendations performed?
RK: On June 1, 2011, our sponsors were up 137% since April of 2010, and our annual subscribers were up 94%.
TCMR: What are some rules of thumb that investors should adhere to when investing in specialty metals?
RK: Do your homework—this is not the market for the lazy or uninformed. But by the same token, you really do not need to be a specialist either. We’re generalists, but developments over the five years we’ve been following the specialty metal sector have provided us with insights borne of experience. Heck, I’m not a geologist, metallurgist or process engineer—I’m a retired university professor—of American Literature.
TCMR: This has been very informative, Richard. Thank you so much for speaking with us today.
Richard Karn, managing editor of The Emerging Trends Report, has a broad, multidisciplinary background, industry contacts and a working knowledge of precious and specialty metals, as well as considerable research, analytical and writing experience. He has written for publications ranging from Barron’s, Kitco and Fullermoney to Financial Sense online.
By Winton Bates, on March 31st, 2011
In his book, ‘The Upside of Irrationality’, Dan Ariely claims to have identified a market failure in the online introductions market. He refers to a survey indicating that people participating in that market spent on average 5.2 hours per week searching profiles and 6.7 hours per week emailing potential partners for a payoff of 1.8 hours actually meeting them.
He comments:
‘Talk about market failures. A ratio of 6:1 speaks for itself. Imagine driving six hours in order to spend one hour at the beach with a friend (or even worse, with someone you don’t know and are not sure you will like)’.
When I read that my first thought was that it would not be particularly uncommon in Australia for young people to drive three hours to spend an hour with a friend and then drive for another three hours back to where they came from.
I think the term market failure is thrown around too loosely. The situation described clearly involves high transactions costs, but that doesn’t mean the market has failed. The existence of high transactions costs in a market should not be viewed as a symptom of market failure unless we can point to some reason why the market cannot function efficiently.
In this instance the market seems to be working well because evidence relating to the existence of high transactions costs has induced some enterprising people to consider what innovations might be introduced to reduce those transactions costs. The fact that the innovators were a university professor and his associates suggests to me that university staff may be becoming more entrepreneurial.
I think Dan Ariely has done a good job of demonstrating the potential for behavioural economics to help entrepreneurs to design innovations that may reduce transactions costs. He considers survey and experimental evidence which suggests that the high transactions costs associated with online introductions stem from the attempt to reduce humans to a set of searchable attributes. The problem is that the searchable attributes convey little information about what it might be like to spend some time with particular individuals.
Ariely and his associates developed a virtual online dating site that enabled participants to engage anonymously in instant message conversation about various images e.g. movie clips and abstract art. They found that participants were about twice as likely to be interested in a real date after meeting in person following the virtual date than following a conventional online introduction. It seems that when we experience something with another person we gain much more information about compatibility than when we just look at searchable attributes. He has discussed his research here.
It is too soon to know whether Dan Ariely and his associates have prompted a market innovation that will help large numbers of people to live happier lives. However, I think Ariely has demonstrated that behavioural economics may be able to help markets work better. As he points out, there is potential for firms to do a better job of satisfying consumer demand by conveying to consumers what it might actually be like to have the experience of using their products. I think that means, among other things, that if retail stores didn’t exist already they would probably need to be invented to give consumers the opportunity to experience goods before they buy them.
Coming back to market failure, does the fact that some consumers buy goods cheaply online after visiting a retail outlet constitute a market failure? I don’t think so, even though such behaviour is evidence of positive spillovers associated with retailing. Manufacturers will work out before long that retailers provide them with a useful service by enabling consumers to experience their products in real life and think up some way to encourage ongoing provision of that service.
By Winton Bates, on December 13th, 2010
There are some fairly obvious reasons why societies characterized by low levels of inter-personal trust tend to be highly regulated. In a society where people tend not to trust each other there is likely to be less adherence to social conventions and there is likely to be more political pressure for the use of government regulation to deter anti-social behaviour. Causation can also be expected to work in the other direction. In a society where it is impossible to conduct market transactions without breaching some regulation it is only to be expected that many people will wonder whether those with whom they are dealing can be trusted not to dob them in to the authorities. Regulation promotes low trust.
So, what is likely to happen to levels of inter-personal trust following substantial deregulation in a highly regulated, low-trust society. As a general rule I think it would be reasonable to expect that greater reliance on market disciplines would generally promote more trustworthy behaviour. Individuals and firms would find that it pays to develop a reputation for trustworthiness and this would result in higher levels of inter-personal trust. Such attitudes could be expected to be associated with public support for deregulation policies.
However, evidence presented in a paper by Philippe Aghion et al, entitled ‘Regulation and Distrust’, suggests that an opposite tendency was more common in countries undergoing transitions away from socialism in the 1990s. Data from the World Values survey indicates that levels of inter-personal distrust increased in most of these countries during that period. There were also substantial increases in distrust of civil servants, justice systems and business. Most households perceived that corruption had increased. The surveys suggested that there was also an increase in tolerance of corruption (bribe taking) and a reduction in the proportion of the populations who considered tolerance and unselfishness to be important attributes to teach children. Not surprisingly, there was also an increase in the proportion of the populations who disliked competition and private ownership of firms.
The authors suggest that those findings are a consequence of low levels of social trust prior to transition. Their model predicts that in a low trust society entrepreneurs will tend to be less civic-minded (because they need to pay bribes in order to enter the business) so liberalization of entrepreneurial activity will tend to result in an increase in negative externalities (e.g. pollution) and an increase in corruption. They conclude: ‘Liberalization of entrepreneurial activity starting from a low level of social capital has increased corruption, invited a demand for greater state control of economic activity, and reduced trust’. At the end of their paper the authors suggest that public education might provide a way forward for transition economies by leading the way toward greater ‘civicness’, lower regulation and higher productivity.
One of the merits of the model put forward by Aghion et al is that it is capable of explaining why many people in countries with bad governments may want more government intervention. The benefits of liberalization of entrepreneurial activity are perceived to be outweighed by the costs.
I am not convinced, however, that the poor outcomes of reforms in transitional economies should be attributed to low levels of social trust prior to transition. An alternative explanation is that the reform process was poorly managed so that instead of a transition from socialism to competitive markets – permitting mutually beneficial exchange that had previously been prevented – these countries underwent a transition from socialism to crony capitalism following the collapse of communist governments. The evolution of attitudes to business may reflect the rent-seeking entrepreneurship to which people were exposed. Under the prevailing circumstance it may not have been possible for the reform process to have been better managed in the transitional economies, but this means that their experience may not be of much relevance to other low trust, high regulation countries.
Rather than focusing on the transitional economies as a group it might be interesting to consider whether different reform strategies adopted in different countries (including other countries such as China and India in the analysis) have had different effects on levels of social trust.
By Winton Bates, on October 7th, 2010
I am sometimes asked questions like: What is so wonderful about the free market? My answer is that the free market is about choice. You choose what you want to buy. The choices you make send signals through the market to huge numbers of people involved in retailing, manufacturing and production of raw materials. A lot of these people live in different parts of the world. They don’t even know each other – they are just responding to market opportunities. It is inspiring to think that this whole system responds to individual choice.
However, some people argue that free choice is just an illusion. These people include some famous economists, such a J K Galbraith, who wrote ‘The Affluent Society’ in the 1950s. He argued that your choices are manipulated by advertisers, who sell you things that you may not really need. Others argue that modern economies are geared to selling things that are bad for us – food full of fat and sugar; fuel guzzling cars; new fashions in clothes that serve no obvious purpose – often funded with credit that consumers have difficulty repaying.
How has the economics profession responded to this challenge? Over most of the last 50 or so years I think it is fair to say that the profession has largely ignored the challenge. That was easy to do because there was never any serious suggestion that advertising should be banned. Advertising of some addictive products that are harmful to health has been restricted and there has been some regulation to shield children from exposure. Everyone agrees, however, that it would be silly to discourage informational advertising about store locations, products sold and prices. As for more subtle forms of advertising, it is difficult to define activities that should be discouraged without infringing the rights of individuals to engage in persuasive communication with each other.
Much of the economic research that has been undertaken on the effects of advertising has suggested that they are small and do not last long. However, such findings raise more questions than they have answered. Why would firms spend large amounts on advertising if it has little effect on sales?
The findings of some recent studies on the evolution of brand preferences are consistent with Israel Kirzner’s view that it is the entrepreneur’s function not only to make the product available, but also to ensure that the consumer’s attention is attracted to the opportunities that the product provides (‘Perception, Opportunity and Profit’, 1983, p 10). These studies have shown that:
• brand loyalty tends to be a very important factor – many people prefer to buy a leading brand product, even though a less expensive product is indistinguishable when packaging is not visible;
• the first brand that becomes established in a market tends to maintain a substantial advantage over those that come later; and
• this advantage is greatest for products that are heavily advertised.
(For example, see “The marmite effect’, ‘The Economist’, Sept. 23 2010 and Bart Bronnenburg, Jean-Pierre Dubé and Matthew Gentzkow, ‘The evolution of brand preferences’, NBER Working Paper 16267.)
Marketing experts have a great deal to say about how brand loyalty is established. Conventional branding models assume that the purpose of advertising is to influence consumer perceptions about the brand (e.g., associations tied to quality, benefits, personality, and aspirational user imagery). In cultural branding, however, advertisers seek to establish a story about the kind of people who buy the product they are selling and how it fits into their lives. The product is simply a conduit through which customers can experience the stories that the brand tells. (see: Douglas Holt, ‘How Brands Become Icons’, chapter 2). Some people identify strongly with the brand’s story, some may see it as saying something relevant to themselves, others see it as irrelevant.
One of the most interesting marketing exercises in Australia is the advertising of Victoria Bitter. For a long time the story was about ‘Vic’ as a reward for a hard days work – the ‘hard-earned thirst’. It was the working man’s beer. Over the last couple of years the advertising has moved up market. Last year, the story suggested that VB was every man’s beer. The most recent advertising seems to be aimed at young me who sees themselves as a ‘authentic Aussie blokes’. (The latest ad is here). If you buy the story, you buy the product and you make a statement about how you see yourself and how you want to be seen by others.
How can an understanding of marketing be incorporated into economics? There is a relatively new brand of economics developed by George Akerlof and Rachel Kranton  that is helpful. Identity economics recognizes that people gain satisfaction from acting in accordance with their identity – how they perceive themselves – as well from the goods and services they consume. This explains why some people would prefer to buy the branded product they usually buy rather another product that is a lot cheaper and is indistinguishable in all respects when taken out of its packaging. They get satisfaction from being the kinds of people who use that brand. The satisfaction they get from acting in accordance with their identity – the story associated with the brand – may exceed the satisfaction they would get from paying a lower price. Summing up then, advertising does not make consumer choice an illusion. Advertisers are often trying to sell you a story. If you don’t identify with the story they are telling, you don’t buy their product. It’s your choice.
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