Economics and Development - an Insider's View

First Oil in Guyana: Headlong into the Paradox of Plenty?

2016-11-25T18:31:00.001-08:00

Even though the commercial feasibility of the recoverable petroleum resources in the Stabroek Block is yet to be determined, some of the progenitors of a Resource Curse/Dutch Disease phenomenon (the so-called paradox of plenty, in which resource-rich countries fail in their quest for economic transformation) are already apparent in Guyana. It behoves me therefore to urge greater transparency about the commitments being made on behalf of the Guyanese people in the quest to develop an oil and gas sector here; and greater integrity in the management of information issued about the imminence of oil. The two things are related: By giving the impression that Guyana will very soon become an oil producer, the parties to the negotiations are feeding speculation that, in a global oil market characterised by a glut and potentially chronic oversupply in the short to medium terms, the Government might be making commitments that are extremely and disproportionately favourable to Exxon Mobil and its partners. Read more here.

The CCJ's Decision in Rudisa Beverages of Suriname vs. the State of Guyana: Much to Worry About

2016-04-30T17:37:00.002-07:00

1. Introduction

The decision of the Caribbean Court of Justice (CCJ) in the matter of Rudisa Beverages & Juices NV, Caribbean International Distributors, Inc., vs. The State of Guyana has been in the press again. Judgement having been given against Guyana, other beverage companies are now queuing up at the CCJ to be reimbursed for the "environmental taxes" paid to the Guyana Revenue Authority. The CCJ found that the environmental tax, a flat tax of GUY$10/each imported beverage packaged in non-returnable containers, violated the Revised Treaty of Chaguaramas that established the Caribbean Single Market and Economy (CSME) because it was levied only on beverages imported from Rudisa, a Surinamese company, and not on local beverage companies. Among other things, the CCJ ordered that Guyana repay the full value of the environmental taxes paid by Rudisa/CIDI. This amounted to US$6M.

In presenting its defense, Guyana argued that Rudisa/CIDI "must have passed on" the tax to consumers, implying that Rudisa/CIDI did not pay any or all of the US$6M, whose entire reimbursement was ordered by the CCJ. In its judgement, the CCJ contended that:

"Guyana has presented no evidence to show that the Claimants have in fact passed on the environmental tax to their customers. The mere assertion that the Claimants are motivated by profit and that the tax must have been passed on is not enough. Moreover, the Claimants adduced cogent evidence to the contrary on this precise issue. Both Mr. Rotsburg and Mr. Gajadhar testified on behalf of the Claimants that the latter devised an accounting system to enable CIDI to retain a competitive price and not pass the GUY$10 increase per unit onto their customers. They both explained that Rudisa Beverages would invoice goods to CIDI at FOB Suriname prices with Rudisa Beverages bearing the insurance and freight charges. In this way, the increased cost price occasioned by the
imposition of the environmental tax would not be reflected in the price which CIDI charged its customers (p. 15, para 1)."

The CCJ's judgement raises some fundamental problems, one of which suggests that the learned judges did not consider the real incidence of those taxes. The learned judges also overlooked the possibility that Rudisa/CIDI knowingly entered the market, using transfer pricing mechanisms to penetrate the Guyanese market to the extent that it now enjoys a 50% market share, only to now claim reimbursement of a tax that existed prior to its entry into the Guyanese market.

The other problem with the CCJ's judgement is that it displayed little appreciation for the way Pigouvian taxes work.

These two problems will be discussed in Sections 1 & 2, respectively.

2. Tax incidence: Who bears the burden of a tax? Who really pays the tax?

Imagine for a moment that Rudisa & CIDI were not different companies. This is not only relevant for the economic analysis of whether the consumer paid any part of the environmental tax, but it is, financially speaking, exactly the case of a group of companies seeking to maximise group profits. According to the CCJ judgement, Rudisa and CIDI "are part of a group of corporate entities known as the Rudisa Group of Companies (“Rudisa”). The companies have a single shareholder, Mr Dilipkoemar Sardjoe (pp. 3-4, para 5)." To note that Rudisa absorbed the tax paid by CIDI is therefore wholly irrelevant to the positive economic analysis of the tax, as that was an internal arrangement. Whether Rudisa absorbed it or not, the group paid the environmental tax. For now, we shall assume further that both Rudisa and CIDI operate in the same tax jurisdiction. In the next section, where we discuss the claim that Rudisa absorbed the tax in Suriname, we shall relax this assumption.

The first point to note is that the legal incidence of a tax and the economic incidence are not the same; i.e., the person who has the legal liability for remitting or paying a tax is not necessarily the person who bears the burden of the tax. Most courts in the developed world understand this principle, and take it seriously when it matters, as in case in which the remedy involves reimbursing people for taxes paid. It would be harsh to suggest that the CCJ is unaware of this distinction, and one can only surmise that the learned judges had determined that the distinction was unimportant. I respectfully disagree, as I now explain.

Consider the following Demand and Supply diagram, amended to allow us to examine the effects of the environmental tax:

1. The beverage market in Guyana is very competitive, as conceded in the CCJ judgement. Moreover Rudisa/CCJ knew that it was entering into a very competitive market, with several well established incumbents such assuch as Banks DIH Ltd, Demerara Distillers Ltd, Wieting & Ritcher Ltd, Essential Supplies INC and R&P Enterprise (p. 4, para. 6 of the CCJ judgement). This feature of the market is reflected in the diagram by a relatively elastic supply curve, i.e., the supply curve is "flatter" than the demand curve.

2. Without the environmental tax, the equilibrium or market clearing price is the one indicated as P* on the y-axis; and the quantity traded (bought and sold) would be Q* on the x-axis. The key take away here is that both the consumer pays P* for each unit of the product, and the supplier receives the same P* as payment.

3. The environmental tax has the effect of shifting the supply curve upwards, from the "bold" supply curve to the "dotted" one. The vertical distance between these two lines, measured in monetary units of course, is G$10. Quantity traded now falls to Q'. The total tax revenue paid is the monetary value shown as the sum of the blue and red rectangles. P⁺is the price paid by buyers, and it is G$10 more than P^- or the price the sellers receive. This difference is simply the G$10 collected by the supplier is remitted to the revenue authority. Whereas the market price was a unitary one, the tax has driven a wedge between the price paid by the buyer and the price received by the seller.

4. What is more, the diagram makes it clear that the seller does not usually pay all the tax; i.e., that the seller does not usually bear the entire burden of the tax. Indeed, as made clear in the diagram, in a very competitive market with many suppliers it is the consumers that bear the greater burden of the tax, by far. This is the represented by the blue rectangle. The cost of the tax to the supplier is the much smaller red rectangle. In what sense does the consumer bear part of the burden of the tax? It is clear that because of the tax, buyers now have to pay a higher price than P*, and in response to this higher price quantity demanded falls, from Q* to Q'. To the extent that consumers are driven to consume less than the preferred amount, the tax is imposing a burden on them.

Whether the tax was paid by CIDI or effectively by Rudisa, the highly competitive nature of the beverage market in Guyana guarantees that consumers would have borne the "lion's share" of the environmental tax. Moreover, the economic analysis would suggest that the CCJ's implicit assumption of an inelastic supply curve as the basis for ignoring the distinction between the legal and economic incidence of the tax runs into trouble precisely because the market was, by its own admission, competitive. (The CCJ could not have been assuming that the demand was inelastic - another way of dismissing the distinction between legal and economic incidence - because that would have meant that the consumers bore the entire tax).

The Claim that Rudisa Absorbed (or Paid) the Environmental Tax

Let us now relax the assumption that Rudisa and CIDI operated in the same tax jurisdiction. Rudisa is in fact the parent company registered in Suriname and CIDI is a wholly owned subsidiary of Rudisa, operating in Guyana. So the "absorption" argument is that consumers did not pay any part of the tax; that Rudisa/CIDI did not pass on the tax. The CCJ agreed that the taxes levied by the GRA (on beverages sold by CIDI) were absorbed entirely by Rudisa before the beverages were sold in Guyana. When CIDI - a subsidiary of Rudisa - imported beverages from Rudisa, it paid only the "cost price," not the insurance and freight. This, according to the CCJ, allowed CIDI to pay the environmental tax in Guyana, but still keep price low enough for it to "retain its 50% market share (p. 15, para 32)."

In evaluating this argument, two things will prove to be significant:

The environmental tax was in place in 1995, prior to the decision by Rudisa/CIDI to enter the Guyana beverage market in 2005-2006;
Rudisa/CIDI now enjoys a 50% market share in a very competitive industry.

One may only assume that the duty of the CCJ was to prescribe a remedy that would attempt to retrieve a "no-environmental tax" state for all concerned, or at least for Rudisa/CIDI, the claimants in the proceedings. What would have constituted such a "no-tax" state? The following discussion makes it clear that such a state would not be retreived simply by reimbursing Rudisa/CIDI the US$6M that was paid to the Guyana Revenue Authority.

Three distinct scenarios ought to have been considered by the CCJ in determining the amount of the reimbursement: That the purported absorption was equal, greater than, or less than the environmental tax; or assuming that the freight and insurance per bottle measured in G$ is (f + i), that (f + i) = G$10, (f + i) > G$10, or (f + i) < G$10.

1. (f + i) = G$10. In this case it could indeed be said that Rudisa absorbed the environmental tax. The key question is however, how much would Rudisa/CIDI been able to sell, and at what price, had the environmental tax not been levied on it? The diagram above makes it clear that full absorption would imply that CIDI was selling at P^-, which is below the market price P*.

This is easier to see in the diagram below. The gain in market share would have been larger (and more visible in the diagram) if we assumed that the demand for beverages was more elastic. This is a realistic assumption, and is the only thing that is different from the earlier analysis:

This diagram makes it clear that:

Retrieving the no-tax state would have only involved absorbing the "blue triangle" or the burden borne by consumers. With the proper information, one can calculate this but clearly, the amount of the tax borne by consumers is much less than the total tax burden, and will be even smaller as demand is more elastic. But let us allow that Rudisa/CIDI was justified in absorbing this amount of the tax.
Rudisa/CIDI may argue that beyond this, a remedy was required for the amount of the tax that was borne by the company (the red area). This too is all well and good, if it can be proven that the selling price for Rudisa/CIDA products was P* and not P^-.
And what if Rudisa/CIDI did not sell at P*? By choosing to absorb all of the environmental tax, i.e., both the blue and the red areas, Rudisa not only made it possible for CIDI to sell at the below-market price of P^- but also to gain market share. At this price, Rudisa/CIDI could sell not only Q*, but as much as Q". The appropriate remedy in this case would be the "red area" minus the value of the increase in market share. That Rudisa/CIDI incurred a loss over and beyond the red area to increase its market share is of absolutely no concern to the CCJ, as the decision to sell at price below the market price was not imposed on Rudisa/CIDI by anyone.

2. (f + i) > G$10. In this case Rudisa/CIDI was doing more than absorbing the environmental tax. Rudisa/CIDI could sell beverages in Guyana at prices even lower than P^-. The points raised above would apply a fortiori, and the remedy provided by the CCJ would be even less justifiable.

3. If on the other hand, (f + i) < G$10, then Rudisa could not have absorbed the cost, and simple arithmetic would imply that it was likely that Guyanese consumers did indeed bear part of the burden of the tax. Were this the case, the amount of the remedy ought to have been reduced by the amount borne by consumers. Note that Rudisa/CIDI did not lose any market share however, so there would have been no reason to compensate them for lost market share. Clearly even if it was the case that (f + i) < G$10, Rudisa/CIDI would have priced below P*.

Does it matter that Rudisa/CIDI entered the market in July 2007?

The environmental tax was in place since 1995, and Rudisa/CIDI produced evidence to show that it was aware that Guyana had resisted, from May 2001 to January 2006, efforts by CARICOM to remove the environmental tax from beverages and other products imported from CARICOM companies. In other words, when it entered the Guyana market in 2007, it took a calculated risk that Guyana would extend community treatment to it after incorporating the Revised Treaty of Chagauramas into domestic law in 2006.

What is more, there is good reason to believe that the "accounting system" discussed above was in fact designed to keep price below market price in order to penetrate the Guyana market. It is difficult to imagine how it could have been otherwise, considering that Rusisa/CIDI was able to achieve a 50% share of a very competitive market!

Many cases are in fact determined on the basis of the timing of action, and on motive. That Rudisa/CIDI was taking a calculated risk, and that that risk was based on a market penetration strategy, would have been sufficient for a competent court to dismiss its claims for reimbursement of the environmental tax.

3. The Environmental Tax as a Pigouvian Tax to "Internalise Externalities"

Most of Guyana's 750,000 people live on the coastal plain, which is below sea level, and is sandwiched between the Atlantic Ocean on the north and the country's highland region on the south. When it rains heavily in the in the southern regions of the country, huge amounts of water rush down from the mountains and highland regions to the coast, and fill the man-made East Demerara Water Conservancy, which is a man-made catchment area for the water. Life on the coast is precarious, and depends heavily on the proper functioning of a dense network of drainage and irrigation canals to mange water. As pointed out in project documents for the rehabilitation of the "Cunha Canal,"

"Drainage during rainfall events has been managed through the use of a gravity-based system augmented with pumps. This system is under increasing stress, suffering from the impacts of sea level rise and from the age of the coastal drainage and irrigation system which was initially constructed 150 years ago."

Source: Guyana Floods: Geotechnical and Hydraulic Assessment of the East Demerara Water Conservancy

With the introduction of the Economic Recovery Programme in 1989, incomes started to rise and so did imports, just climate change began to be experienced as sea level rise in the Atlantic Ocean. All this made it very important for Guyana to control the extent to which plastic bottles and other containers entered the coastal space.

The environmental tax was one instrument at the disposal of the State to help it to achieve this objective. To proceed with the analysis in the particular case being discussed, it is important to note first of all that the environmental tax was a tax on the containers, and not a tax on the beverages that were imported by CIDI from Rudisa. In particular, it was an attempt to impose a Pigouvian Tax to get CIDI to internalise the external cost or negative externality that is associated with the clogging up of canals with containers used for bottling Rudisa beverages.

Externalities

The purchase and sale of Rudisa/CIDI beverages occur within a well defined market - the market for beverages. Unfortunately, this is not a perfect market in the sense that when the containers and packaging in which the beverages are disposed of, third parties are affected by a transaction in which they were not involved. When the containers and beverages enter the network of drainage canals, flooding occurs or at any rate the probability of flooding is increased. The costs associated with this flooding are external to the beverage market, but they are very real and significant costs. The social costs or the real economic cost of consuming and producing beverages necessarily includes the costs imposed on third parties.

Though externalities occur outside markets, it is usual to depict them in the demand and supply framework, as in the diagram below, as a “shift” in one or the other, or both, curves. Externalities can be represented by ‘virtual’ demand and supply curves that are distinct from the demand and supply curves of the private transactors in any one market. A negative externality is illustrated in the diagram below as inward shift in the supply or Marginal Private Cost (MPC) curve:

The negative externality renders Marginal Social Costs (MSC) greater than the Marginal Private Costs (MPC) by the Marginal External Cost (MEC) the costs due to non-returnable containers and packaging entering the network of drainage canals. The profit maximising producer (Rudisa/CIDI) is only conscious of the marginal private costs, so that the supply curve is the MPC curve. Had all costs been considered by the producer, the supply curve would have actually coincided with the Marginal Social Cost curve.

The "Pareto Optimum" or the proper economic optimum secured by a perfect market system actually has the property that Marginal Social Benefits equal Marginal Social Costs at the equilibrium in each market. This is consistent with private utility and profit maximising behaviour because social benefits and costs are coincident with private benefits and costs and is the ideal case of a one-to-one correspondence between private and social net benefits. The problem posed by externalities is precisely that this correspondence breaks down on account of the externality.

In the above diagram, the net loss to society of producing at the privately rational, profit maximising, equilibrium (Q₀, P₀) is given by the area abc. To see this, consider the case of reducing output and sales to the socially optimal level Q* instead. By reducing output to Q*, total social costs fall by Q*abQ₀, the area under the "true" supply curve in the output range Q*Q₀. The reduction in output also leads to fall in total social benefits, by the amount Q*acQ₀, the area under the demand curve in the given output range Q*Q₀. Clearly, the fall in total social costs is greater than the fall in total social benefits by the amount abc. In other words, society will gain abc by reducing output from Q₀ to Q*, or alternatively, society loses abc when say Rudisa/CIDI puts Q₀ instead of Q* on the market.

The Environmental Tax as a Pigouvian tax

One of the standard solutions to this problem of exernalities is for the government to impose a tax exactly equal to the external cost on the producer/supplier. This is known as the Pigouvian solution to the problem of externalities, and the tax that is set exactly equal to the MEC is known as a Pigouvian Tax. As was shown in the earlier discusison of the incidence of a tax, such a Pigouvian tax has the effect of shifting the supply curve up by exactly the amount of the tax. Remarkably then, with a Pigouvian tax, producers are made to operate on the Marginal Social Cost curve, and their own privately rational, profit maximising, choice would be to produce Q*, the socially optimal amount! The tax raises the cost of production, in this case by G$10 per unit of beverages, so that it is now rational to produce the socially optimal output level.

For emphasis, note that the environmental tax of G$10 is not being imposed on the beverages. Rather it has been imposed on the non-returnable containers used by Rudisa/CIDI to sell their beverages to Guyanese consumers. What is more, had Rudisa/CIDI not chosen, as has been purported, to absorb the tax, then this Pigouvian tax would have been borne by both the consumers and Rudisa/CIDI.

By choosing the "absorb" the tax, Rudisa/CIDI was thus able to impose the external cost on Guyanese at large (third parties) by contributing to the clogging of the network of drainage canals on which we depend so heavily to avoid flooding. It did not internalise the external cost of its activities in the Guyana beverage market.

One final point on this matter of the environmental tax as a Pigouvian tax is whether is was discriminatory and violated the community treatment requirements of the RCT. In this regard, it is worth recalling Ronald Coase's point that externalities have a reciprocal character, i.e., that they can be avoided if the "victims" were to move away from the area in which the externality occurred, so to speak. This was the basis of his powerful argument that it may be possible for polluters to pay third parties as long as it this cost is less than the cost of reducing production of paying a tax. The point is that producers in Guyana, beverage producers included, have to bear increased costs when there is flooding, and so they are already bearing the costs associated with the use of non-returnable containers. Unlike a Surinamese company, Guyanese companies pay for the use of non-returnable containers by having to bear increased costs to deal with flooding. In this sense, the tax on Rudisa/CIDI is not even discriminatory.

Two questions must therefore be answered: why did it not internalise the external cost, and what could it have done instead?

Why didn't Rudisa/CIDI internalise the external cost, and what could it have done instead?

The answer to both these questions involves market share. Rudisa/CIDI chose not to internalise the external cost by using non-returnable containers because it was more interested in gaining market share than it was in being a responsible corporate citizen. As shown above in the discussion of the incidence of the environmental tax, by choosing to absorb all of the environmental tax - (f + i) = G$10 - it nonetheless was able to set price below the pre-tax equilibrium price, contributing to even more of an externality than had it operated at the pre-tax price. Clearly the case is stronger against Rudisa/CIDI if it were the case that it absorbed more than the environmental tax. Rudisa/CIDI chose to allow market share considerations to trump the wider social concern about flooding in Guyana.

But what could it have done to avoid the tax? Pigouvian taxes are designed to give producers an opportunity to avoid having to pay the tax by changing their production process, changing the inputs used in the production process, or reducing output. In the last case, Rudisa/CIDI would have had to reduce output/sales to zero to avoid the tax, so this was not an option.

Considering that the environmental tax was a tax on the containers, the packaging, and the disposal of those containers,and not a tax on the beverages themselves, the option open to Rudisa/CIDI was to open depots across Guyana that would allow consumers to return the containers in which they purchased Rudisa/CIDI beverages; or to change the containers from non-returnable containers to returnable containers, or both. The companies lawyers would have advised on the definition of "returnable" versus "non-returnable" containers. True, this might have raised the cost of sales for the company, but only to take get it to internalise the external cost that was being imposed on third parties. That Rudisa/CIDI chose to continue selling beverages on the local market in non-returnable containers shows that it was actually profitable for it to do so, the increased cost notwithstanding! Had it chosen instead to use returnable containers, it may have had to charge a higher price, and to have lost market share. It was not prepared to do this, and as argued throughtout this review, it even went farther and absorbed more of the tax that was required, in order to charge prices lower than the pre-tax price.

4. Conclusion

Contrary to what the CCJ judgement implied, the distinction between the legal and the economic incidence is not immaterial to the matter of reimbursement of the environmental tax. The highly competitive nature of the industry, the presence of substitutes for Rudisa/CIDI products, and the increase in market share despite the environmental tax all attest to this. Additionally, the tax is a tax on the use of non-returnable containers by foreign beverage companies and not a tax on the beverage itself, and it could have been avoided had Rudisa/CIDI changed its policy of using non-returnable containers.

To the extent that the cost of freight and insurance for beverages imported by CIDI was absorbed by Rudisa, there is strong a priori reason to believe that consumers would have borne part of the burden of the environmental tax. In fact, it is only if the selling price for CIDI beverages was equal to or less than "equilibrium" price in a no-environmental-tax world for the entire period of its operations in Guyana, that consumers would not have borne part of the tax. It price was less than this equilibrium price however, then CIDI would have been able to increase its market share. This could have happened even if the cost of freight and insurance was less than the cost of the environmental tax.

As long as the cost of the freight and insurance absorbed by Rudisa was equal to or greater than the environmental tax, CIDI would have doubtless charged low enough prices to increase their market share significantly relative to the no-environmental-tax world. It certainly would have had the capacity, the opportunity and the incentive to do so. As long as this was the case, the remedy granted ought to have been adjusted downwards by the value of this increase in market share.

The argument that Rudisa incurred a loss either to maintain the no-environmental-tax market share or to extend it is rendered less efficacious with the recognition that the company took a calculated risk to enter the Guyana market, knowing full well that Guyana persisted in levying the environmental tax on imports from Caricom companies, despite several attempts by CARICOM to get Guyana to comply with the Revised Treaty of Chagauramas (RCT). The timing of its entry into the Guyana market suggests further that Rudisa/CIDI had developed a carefully thought out strategy to keep price low in Guyana. The strategy may be dubbed "a back-door penetration of the Guyana market that involved invoking the RTC."

The other major point of contention is that the environmental tax was a Pigouvian tax on the use of non-returnable containers. This Pigouvian tax was intended to get Rudisa/CIDI to bear the external cost of its activity on the local beverage market. It was not discriminatory because Guyanese producers bear the cost of flooding in increased production costs, but a Surinamese company does not have to bear these costs. If anything, the environmental Pigouvian tax was was probably too low to make the company get the company to use returnable containers.

In its judgement, the CCJ was careful to point out that it did have jurisdiction to hear the claims made by the litigants. It then assumed that the establishment and clarification of its jurisdiction (to hear the claims of a person against a state other than its own) was sufficient basis for it to prescribe a remedy, the correctness of which can no longer be taken for granted, on a sovereign state. Unless the so-called Westphalian principle that each nation state has sovereignty over its territory and domestic affairs has been surrendered by member states that have also ceded their sovereignty to the CCJ, there is much to worry about in this decision and judgement.

The Economics of Pope Francis' Laudato Si'

2016-04-27T08:04:00.001-07:00

On Thursday, April 21, 2016, I attended on behalf of the Transparency Institute of Guyana, a lively and insightful panel discussion on the last Papal Encyclical, Laudato Si' at Marian Academy. In the audience was, as indicated by the Global Catholic Climate Moverment, the highest-ranking Vatican official ever to visit Guyana, Cardinal Claudio Hummes from Brazil. Cardinal Hummes is a former archbishop of Sao Paulo and is currently the president of the Commission for Amazonia of the National Conference of Bishops of Brazil. The main purpose of the Cardinal’s visit to Guyana was to present the vision of REPAM, which is the Pan-Amazonic Church Network formed in 2014. This also includes discussing the relevance of Pope Francis’ recent encyclical Laudato Si (Praise Be To You) to conserving the Amazon and helping the poor in the area.

The panelists were Mauricio Lopez Oropeza, Executive Secretary of REPAM, Paul Graham Atkinson (from Moruka, an Amerindian Villiage), and Maj. Gen. Rtd. Joseph Singh, who has extensive knowledge of environment and natural resource matters in Guyana. The first panelist spoke about the message, motivation and challenges presented in Laudato Si' (especially for the Amazonian countries); Paul Atkinson spoke about the attributes and traditions of indigenous people - integrity, honesty, trustworthiness, respect for others and for their natural environment, a willingness to cooperate with each other, a strong sense of identity with nature, and inclusive collective decision-making that reflected the deep communitarianism of indigenous peoples' societies - that have helped to preserve the environment in the Amazon rainforest; and Joe Singh spoke about the encyclical itself, emphasising its contrast between 'anthropocentrism' and 'eco-centrism,' and suggesting ways in which the church and civil society can respond to the encyclical.

The Economics of Luadato Si' and the Panelists

Economists interested in climate change issues might know of the strong criticism by William Nordhaus and Robert Stavins, two highly influential environmental economists, of the encyclical's statement that "The strategy of buying and selling “carbon credits” can lead to a new form of speculation which would not help reduce the emission of polluting gases worldwide (para. 171)." Nordhaus' The Pope and the Market and Stavins' The Papal Encyclical and Climate Change Policy both made the point that the problem of climate change is properly understood as an "externality," and that a "cap-and-trade" mechanism involving the trading of carbon credits is indeed a viable approach to getting economic agents to internalise that externality. (Carbon taxes would be another, but the two are regarded as the obvious market approaches). The articles are very well written, so I shall not attempt to outline the argument, but will add that I too am persuaded that these are obvious policies to consider. There are also technological solutions such as carbon capture and storage and political economy approaches such as REDD and REDD+, that would contribute to the removal and reduction of carbon emissions from the atmosphere, but the economic or market based approaches to which Pope Francis refers are the only ones that will get the main polluters - e.g. those who use fossil fuels - to bear the cost of their activities, but will do so in a cost-effective manner.

Neither referring to the market-based solutions nor rejecting them, the panelists expressed views that were strongly in favour of the solution suggested by Pope Francis: To change our way of life from one that is driven by consumerism and the quest for profits, and to embrace a different, more other-regarding, ethic; or in the language preferred by Mauricio (the first panelist), to experience a "metanoia" or radical conversion of the heart and mind. Pope Francis emphasised the "ethical and spiritual roots of environmental problems, which require that we look for solutions not only in technology but a change of humanity (para. 9)" that recognises our environment as "our common home." In particular, the climate, according to Pope Francis, is "a common good, belonging to all and meant for all (para. 23)," but further held that such an understanding could only come by cultural revolution (para. 114), or some sort of community metanoia - though admittedly, there was some lack of clarity about whether metanoia is better suited to describe an individual or a community level experience.

Laudato Si' goes further to suggest that it would be irrational not to work together to reverse the current climate trend, noting that "It is remarkable how weak international political responses have been. The failure of global summits on the environment make it plain that our politics are subject to technology and finance. There are too many special interests, and economic interests easily end up trumping the common good and manipulating information so that their own plans will not be affected. The Aparecida Document urges that 'the interests of economic groups which irrationally [my emphasis] demolish sources of life should not prevail in dealing with natural resources (para. 54)."

In other words, the encyclical seems to be saying that any attempt to meaningfully address climate change would require us to change our lifestyles; that, as onerous as this metanioa might be, it is rational to undertake it urgently; and that what is needed is an "enforceable international agreement .. on the systems of governance for the whole range of so-called 'global commons' (para. 173 & 175)." It does so against the backdrop of skepticism of what the market can achieve in mitigating and adapting to climate change, but it also recognises that the problem is actually not "economics" itself as it consumerism, the emphasis on immediate profits regardless of the costs imposed on third parties, and the use of technology in pursuit of unbridled utility and profits. According to Pope Francis, "businesses profit by calculating and paying only a fraction of the costs involved. Yet only when 'the economic and social costs of using up shared environmental resources are recognized with transparency and fully borne by those who incur them, not by other peoples or future generations,[can those actions be considered ethical (para 195)." This is precisely what economists like Robert Stavins and William Nordhaus contend. The Pontiff even suggests that climate action might be consistent with profit-maximisation if the producers are made to consider all costs and if they have a longer time horizon: "Efforts to promote a sustainable use of natural resources are not a waste of money, but rather an investment capable of providing other economic benefits in the medium term. If we look at the larger picture, we can see that more diversified and innovative forms of production which impact less on the environment can prove very profitable (para 191).

The rhetoric aside - and there is a fair dose of liberal rhetoric in Laudato Si' - the Encyclical has essentially opted for climate action that requires cooperation to achieve the socially optimal outcome of an urgent and significant reduction in GHG emissions. Pope Francis also explicitly recognised that action is required at different levels, including the global, regional, national, community and individual levels. He did express skepticism about cap-and-trade solutions and in particular the use of carbon credits, but was clear about the weakness: Because the appeal and success of cap-and-trade approaches rest on the behavioural assumption of profit seeking, these approaches are themselves subject to manipulation by unscrupulous speculators.

Indeed, reading Laudato Si' causes one to think time and again about the work of economics Nobel Laureate Elinor Ostrom. While the Nobel was awarded for Ostrom's extensive work on the management of the local commons, she extended her thinking to climate change. In a background paper to the World Bank's 2010 World Development Report on Climate Change titled A Polycentric Approach to Coping with Climate Change, Ostrom argued that "To solve climate change in the long run, the day-to-day activities of individuals, families, firms, communities, and governments at multiple levels - particularly those in the more developed world - will need to change substantially (p. 4)."

Conclusion
While Elinor Ostrom won the economics Nobel Prize, Pope Francis' Encyclical has been castigated by two leading economists for saying things that are quite consistent with her work on the management of the commons. True, what Elinor Ostrom was saying was indeed revolutionary. She was contending that the tragedy of the commons, according to which the rational pursuit of private individual self interest can compromise the commons for everyone, does not require government intervention; it is usually solved by users of the commons themselves who decide collectively to monitor each person's use of the commons so that no one would be able to over-exploit the resource. Voluntary collective action and cooperation can obviate the need for government intervention even when there is a basic market failure.

Pope Francis perhaps sounded too much like Garret Hardin, the biologist who in 1968 wrote the classic paper, The Tragedy of the Commons, the abstract to which said quite simply that "The population problem has no technical solution; it requires a fundamental extension in morality [my emphasis]." Economists, with much assistance from game theory, responded to him by pointing out how rational behaviour - not crass self interest, but "enlightened" self-interest - could indeed avert the tragedy of the commons.

Those of us who remember that Adam Smith also authored a book called Theory of Moral Sentiments, which was essentially a statement about our capacity for enlightened self interest and empathy, would now appreciate the importance of a discussion on the behavioural and institutional economics of climate change policy. That will be the subject on another post.

2015-09-18T02:27:00.000-07:00

Price and Tariff Determination and Regulation in the Telecommunications Bill 2011

This is a big and complicated bill and no attempt will be made to review it in its entirety. Rather, this article takes a brief look at provisions in the Bill that have to do with the determination of prices and tariffs. The review begins with a bird’s eye view of the Bill in Section 2 to determine its ethos, the legislative intent behind it, by trying to asses just how serious is the intention to liberalise the telecoms sector. Section 3 outlines the key issues in price and tariff determination and regulation, and in particular compares rate of return and price cap regulation. The specific price regulation provisions of the Bill are reviewed in Section 4. Section 5 concludes with a quick look at some omissions and missed opportunities in the Bill.

2015-09-16T08:07:00.000-07:00

Costs, Risks and Institutional Arrangements inthe Rice Sector

This article takes a brief look at the costs rice cultivation, some common institutional arrangements that occur in the rice sector and their implied risks. It discusses the costs and financing of rice cultivation and the distribution of the risks, noting that the institutional arrangements favour the miller and place the burden of financing on small farmers, exposing them to a disproportionate share of the various risks that confront the sector. Invoking the language and development paradigm of Nobel Laureate Amartya Sen, these institutional arrangements fundamentally limit the capabilities and freedoms of small farmers, depriving them of the agency and entitlements required for development. Read more ....

2014-05-31T14:49:00.002-07:00

What's morality got to do with it?!

Though churches, temples, mosques and NGOs abound, we think little about matters of morality in Guyana. Even those who are strategically positioned to restore a just, well-ordered society in Guyana, themselves find good reason to justify unethical decisions and opinions, relentlessly reminding us of the proverb “the fish rots from the head down.”

But really, what does morality have to do with it? Amidst the obvious moral bankruptcy apparent in domestic and other forms of violence; torture by policemen; crime, which includes executions and homicide; hit-and-run killings on the road and alcohol- and/or speeding-induced road accidents more generally; human- and narco-trafficking; corruption, graft and rent-seeking; child neglect and abuse; institutional and individual connivance at wrong doing (usually to avoid risking losing some cherished benefit); the side-lining, in spaces we control, of opinions that are contrary to ours; racism, including the racism that hides as ethnocentrism; and the unethical political correctness that parades as professionalism – amidst the palpable moral barrenness in our nation that manifests itself in suicide and net migration rates that are respectively at 4^th and 9^th in the world,[1] there is the less obvious type of immorality that causes us to behave in a crassly self-interested manner especially in social dilemmas such as pollution, in which individual and collective interests are in perpetual tension. In 2013 my thoughts were directed to precisely this issue in a presentation titled “National Unity in Perspective: 750K People, Many Nations, and No Destiny?” There, I had made the point that violence, child abuse, racism and indeed all the problems mentioned above had become widespread and very much a part of our culture, giving them the character of social dilemmas that required a solution in the public interest. The key to that solution was, I suggested, national unity, interpreted specifically as an ethic of cooperation in our society.

As question-begging as it was, the suggestion of an ethic of cooperation in our society was attempting to say that the problems noted above were, on account of their pervasiveness, indicative not just of private ethical lapses but of an ethically bankrupt culture. One year after, at Independence 2014, I feel a deep hollowness as I contemplate the ‘why’ and the ‘whither’ of our national indifference to a moral compass, with many of our leaders themselves lacking awareness of the ethical implications of their actions and public statements; and who knows, an immoral State as a partner in our 48 year old social contract.

A Common Christian Identity - and the Glory of God in Us

2013-05-17T03:27:00.001-07:00

The title of this post was the title of my message on May 12, 2013 (Mothers' Day), delivered at Burns' Memorial Presbyterian Church. It actually invoked some of the new insights in economics about group norms and collective choice. For me it is absolutely fascinating that the Gospel is in fact chock-full of the insights that modern economics is now coming to grips with. I post my message 'for what it is worth;' and also because I believe that faith is integral to hope, and without hope the poor will always be poor and defeated. Click here for "A Common Christian Identity - and the Glory of God in Us.

It might surprise you that this is also the position adopted by Esther Duflo, the brilliant MIT economist who co-authored Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty. In her 2012 Tanner Lectures, Duflo explains why hope is necessary for the poor, if they are to get out of poverty: "the existence of a step that is too high to climb creates a rational temptation to hold back, to avoid trying too hard. Having not tried, individuals may never discover what they are capable of. This worsens the poverty trap, or in some cases creates one where there was not one in the first place (p. 41)." She concludes later, "A little bit of hope and some reassurance that an individual's objectives are within reach can act as a powerful incentive. On the contrary, hopelessness, pessimism, and stress put tremendous pressure both on the will to try something, and on the resources available to do so."

The Ridiculous Losses of the Guyana Gold Board: More on Institutional Failure in Guyana

2013-05-02T02:48:00.000-07:00

As you consider this post, please remember that I'm not a macroeconomist:

According the the Guyana Gold Board (GGB) Act, Cap 66:01, the GGB is authorised to buy (all the) gold in Guyana and sell it locally and abroad. It is also required to keep an adequate supply of gold, clearly to satisfy jewelers' demand and that sort of thing.

The GGB is also allowed to invest in securities; but unless one is being very generous, gold is not a security. In other words, the GGB buys gold to sell gold. Specifically, it is only the Bank of Guyana, to the best of my knowledge, which is authorised to hold gold reserves on behalf of Guyana.

There is good reason for effectively requiring the GGB to sell the gold it buys, rather than to hold gold stocks for speculative purposes. Consider what would happen if the GGB did indeed have a large stock of gold, and perceiving that the price would fall, it sells a large amount. Then there would immediately be upward pressure on the Guyana dollar, and the BoG would, if it is to pursue its (unwritten) policy of exchange rate stabilisation, have to increase its foreign currency reserves and at the same time to issue treasury bills (increasing the domestic public debt). In other words, speculation by the GGB would have monetary and macro economic implications; and these should be taken into explicit account.

What for example could happen is the setting up a special reserve fund to do what the GGB has apparently been doing (holding gold reserves), contrary to the provisions of the GGB Act. Other resource abundant countries who maintain special funds and resource stocks understand the macroeconomic implications of operating such a fund, and have explicit regulations about the management of those funds and stocks. Moreover such funds are usually managed so that they contribute to the welfare of future generations - sort of like funding the NIS from the real return from some special fund that is managed for that purpose.

In Guyana however, there is little thought of the salience of people's agency and static welfare concerns; and even less of the welfare of future generations. Think of what has happened. The GGB bought gold when the prices were high, paying high prices to producers, and instead of selling when the prices were as high as they would likely get (everyone knew this), held on to the gold until the prices fell. The producers were not in any way exposed to market/price risk. The people of Guyana are now going to pick up the tab - while the NIS, sugar, rice and all that are in a spot of trouble.

No one seems to be asking, but I do wonder how large the GGB stocks were when the price fell. What are the implied losses for the GGB, and for Guyana? And a word to those who would want to wait for the price to rebound, perhaps to its dizzying heights, to eliminate those losses - it won't happen. Trust me.

High Taxes are Good for You - the (Economics) Gospel According to Guyana's Finance Minister!

2012-12-11T02:04:00.002-08:00

When he said recently that cutting taxes (and raising social sector spending) would make economy unstable, and therefore would not be high on the government’s agenda for the next budget, the Minister of Finance was saying quite a mouthful.

In the first instance, he was saying that internal instability might exist, but his interest is more particularly in external stability. He was also saying that the biggest threat to external stability is an increase in the fiscal deficit, and more specifically, that external imbalance is driven by the fiscal deficit in Guyana, empirical evidence to the contrary about the Caribbean in general notwithstanding. And finally, the Minister of Finance was affirming that his Ministry is the agency that conducts monetary policy and exchange rate policy in Guyana. Thus, through its banker (the Bank of Guyana), the Ministry of Finance issues new debt over and above what is needed to finance the modest fiscal deficits. Indeed, the Minister’s overriding interest in external stability and in keeping fiscal deficits low, have virtually obviated the need for debt financing of the latter.

Or to put it another way, the Minister of Finance was saying it was his job, and that of the Commissioner General of the GRA, to defend the integrity of the international payments system and to look after the interests of Guyana’s ‘real’ private sector.

At any rate, the growth rate of real GDP has been creditable, and though this has in large measure been driven by high and sustained government spending, almost fully financed by the people of Guyana (i.e., their taxes), such a policy framework is a better bet than relying on the traditional private sector to get its act together to increase investment, create jobs, increase value added and output, and all that jazz. Besides, the private sector is getting lots of contracts from government, so government is doing its bit to keep unemployment from being even higher than it now is, and to buoy spending.

In fact, this is a brilliant macro-policy framework. It keeps the private sector savings-investment gap small, so that the high cost of credit to the private sector is in fact an equilibrium; and Mr. Sattaur always delivers the goods, so that the fiscal profligacy of the socialist era doesn’t again threaten the current account of our Balance of Payments. Critics might point out other threats to our international competitiveness and external stability – Guysuco’s poor performance, high electricity costs, high shipping costs, high crime (that just might hamper our export of tourism services in particular), inordinate red-tape and its attendant corruption, high taxes – what have you. But come to think about it, these are not real threats because we are not doing much by way of traditional exports anyway. What matters for our current account is that non-traditional exports, including gold and other very high-valued (use your imagination!) exports, have been rising. The ‘real’ private sector in Guyana is a booming one already, and it doesn’t carp about high taxes. It even thrives in the environment created by the new-age fiscal profligacy.

What is the new-age fiscal profligacy? Government is as profligate as it has been all along (plus ça change, plus c'est la même chose!). Public sector spending is now about 65% of GDP. What’s new however is that government doesn’t have to borrow (much) to finance its clearly very high level of expenditure. While the budget deficit averaged about 40% of GDP in the pre- and early post-1989 periods, it now averages about 5% - 6% of GDP.

But why has the national debt, and in particular the domestic debt, been increasing if the fiscal deficit has been so carefully managed? The Minister would no doubt carefully, if impatiently, explain to us the fundamental difference between the old-styled monetising of the deficit and the new-age policy of sterilising liquidity. The former involved the purchase of new debt by the Bank of Guyana; the latter involves the purchase of new debt by the public, though it’s also about the need to stabilise the exchange rate.

Were taxes to be cut in the next budget, and if spending were to increase to boot, then clearly the budget deficit would rise again to its old heights. The current account of the Balance of Payments would worsen, and as we don’t seem to be able to attract foreign investment, our international reserves that have been accumulated over the last few years would suddenly evaporate.

It’s no doubt easy for the traditional private sector to see that high taxes, constrained consumer spending, rising domestic debt and the sterilisation programme are all different dimensions of the same policy framework. For real GDP growth to continue with lower taxes, private sector investment and productivity will have to increase. For investment to increase the cost of credit will have to go down and this might require the government to reduce its issue of new debt to sterilise the liquidity created by its ‘stable exchange rate’ policy. The Bank of Guyana will also then have to reduce its accumulation of international reserves, the stock of foreign exchange in the economy would be higher and the Guyana dollar would appreciate. To regain international competitiveness, we’d have to lower electricity costs, shipping costs, the crime rate, red-tape, corruption, and all that jazz. We might even have to do something about Guysuco. Then there is the small matter of increasing productivity. Come to think of it, we might also have to figure out how to lower the rate of emigration from Guyana.

Oh yes, there is actually one more thing. With a decrease in taxes, government spending will have to decrease not only to avoid compromising the international payments system, but also because a failure to do so might cause the economy to overheat badly if a booming traditional private is allowed to develop alongside the (definitely booming) ‘real’ private sector. And it’s unthinkable to thwart the growth and development of the latter.

Read my mouthful, says the Minister of Finance: For the sake of the economy and the world, taxes will remain (very) high in the 2013 budget!

Infrastructure and Development

2012-06-19T12:58:00.000-07:00

As I mentioned in my last post, the interviewer asked me for recommendations to get economic growth growing, and I had promptly responded by saying that in recent times economists have been talking about 'institutions,' but that this had not produced the expected results. Because of the 'limits of the law' and in particular (1) because new laws that sanction undesirable behaviour as a means of inducing desirable behaviour create a windfall of potential rents for law-enforcers and ajudicators, thereby increasing the opportunities for bribes to be demanded and offered and (2) because of the huge costs of enforcement implied by these new opportunities for rent-seeking behaviour, given the problem of 'infinite regression' of

The first thing I said was that even though there has been a recent emphasis on the salience of institutions for economic growth, reforming and strengthening institutions to secure property rights and to ensure better and more efficient economic and political governance would not be enough to get growth started.

Infrastructure and Development (or the Fantastic IIRSA!)

2011-10-05T01:19:00.000-07:00

In the interview I referred to in my last post I suggested that new (formal) institutions - laws and regulations in particular - that attempt to secure 'good' behaviour by sanctioning 'bad' behaviour create huge potential rents for law-enforcers and ajudicators and that they therefore

Institutions and the Limits of the Law

2011-09-19T10:10:00.000-07:00

The interviewer asked me for recommendations to get economic growth growing. I promptly responded by saying that in recent times economists have been talking about 'institutions,' but that this had not produced the expected results.

That was not good of course because I was being interviewed for a job with The Inter-American Development Bank (IADB), which has recently been investing heavily in instituional strengthening and reform projects! Institutions - the “humanly devised constraints that structure political, economic and social interactions” are known to have important effects on economic outcomes (see Douglass North's fantastic research), so investing in institutions makes good sense.

What I did mean, but I said it most ineffectively, was that an emphasis on formal institutions such as constitutions, laws and regulations were necessary for economic development but that economic development would not occur simply by putting good institutions in place. This is so because laws and regulations have to be enforced, but who is to say that the laws and regulations would be enforced? Poorly paid enforcers might use the very existence laws as an opportunity to solicit or even demand bribes - a phenomenon known as rent seeking. Hence enforcers will be needed to ensure that the proximate officers enforce the law, but people being people, there will be need for prior enforcers of the enforcers of the proximate enforcers, and so on.

Enforcement failures happen routinely because of this problem of infinite regression. Thus if a country were to rely only on formal institutions it would almost certainly end up being a land of lawlessness!

Sounds familiar? And what can we do about this?

2011-09-15T05:35:00.000-07:00

Guyana is a violent society. Indeed, there is a culture of violence in Guyana. As a response to this reality, I did a presentation sometime ago called "In a Life Without Values, Life Has No Value" that combines my thinking as an Economist and as a Christian. In it I suggested that:

Life in Guyana is lived in a palpable shadow of violence
Violence is the "state of nature" for us given the social anomie and lawlessness that exist here
More "law" might not be the solution because of the limits of the law due to the rents that can be derived from its discretionary enforcement; and because violence is itself an equilibrium
The ethics of Jesus known as the Golden Rule - or "doing unto others as we'd have them do unto us" - would result in a state in which there is social cooperation instead of violence
Moving to this new equilibrium would require a tipping mechanism, which I further suggest is the prophetic "remnant" of the Church.

I believe that there is good economics in this view, and also good theology, if I might say so myself!