The Emerging Economist

Prisoners of pollution: A game theory explanation to why we pollute

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Wed, 02 Nov 2011 19:20:00 +0000

Most people came to know John Nash after the 2001 release of the award-wining movie "A beautiful mind", however, his game theory work has helped economists and people around the world by providing insight into the forces that govern chance and events inside complex systems in daily life.

Arguably his most important work up to date, was the development of the so-called "Nash Equilibrium", which provides a solution to the strategic interaction of non-cooperative decision scenarios. The underlying idea behind this concept is that we cannot predict the outcome of the choices of multiple decision makers if we analyze those decisions in isolation. Instead, we must ask what each participant would do, taking into account the decision-making of the others. The equilibrium is reached when no player has anything to gain by changing only his own strategy unilaterally.

A classic example of the application of John Nash's theory is the famous "Prisoner's dilemma" (see "Investopedia Prisoner's dilemma explanation" for detailed information) where even though there is a globally optimal strategy, this strategy is unstable; so each prisoner ends up betraying the other and finding equilibrium in a sub-optimal outcome.

For most people, these exercises might sound as "boring theories", however the conclusions can be applied to almost any decision-making scenario.

The objective of this article is to use game theory in order to explain why is it so difficult to get people to stop polluting, even though we all agree that the society would be better off if nobody pollutes our planet?.

Assumptions: For simplification purposes let's assume the following:

There are two participants in the pollution game: You, and everybody else.
The benefit of a world without pollution can be quantified as a benefit of "5 points".
The cost or opportunity cost (either money, time or work) of stopping to pollute is of "-2 points".
As "everybody else" actually represents lots of people (right now about 7 billion citizens), is logic to assume that their potential effect on the environment is greater than yours, so even if you pollute, if everybody else stops doing it, the world will be a cleaner place anyway (you get the 5 points benefit).

As it is impossible to talk with "everybody else" this qualifies as a non-cooperation game, this is, you don't know what the others' decision will be.

Scenarios:

Solution:

Even though the outcome number 3 is the "globally optimal outcome", this outcome is not in equilibrium, because you would be better off by polluting and letting everybody else undertake the costs of "cleaning the world" (5 points vs 3 points).

Finally, as each individual of the "everybody else" group will come to your same conclusion, everybody else will pollute, and leave the rest with the cost of cleaning. This would mean that in the end everybody will pollute, leading the society as a whole to a final equilibrium outcome, the solution number 2.

Conclusion:

Even though John Forbes Nash published his equilibrium theory more than 60 years ago, his work and conclusion remain as relevant as ever, as they can be applied to many situations in daily life.

This example might be seen as an oversimplified explanation of a complex issue, however, the behavioral forces that work in this simple example are the same ones that lead our society to a contaminated world, giving an explanation to the commonly formulated question of "Why our society doesn't do what we all know is right?."

The not so rare Chinese strategy with "rare earths".

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Mon, 02 May 2011 07:38:00 +0000

In times like these, when finding assets and investments with the potential of yielding interesting returns is a difficult task, when the stock market is starting to be overvalued, and the fixed income is not a great place to be, international investors are starting to expand their horizons when it comes to find appropriate investments. In these times, alternative investments like the "rare earths" are starting to seem like a viable and interesting option.

The elements commonly known as "rare earths" are a set of seventeen chemical elements of the periodic table, which despite being plentiful in the Earth's crust, are typically dispersed and not often found in concentrated and economically exploitable forms known as rare earth minerals.

Rare earth metals and alloys that contain them are used in many electronic devices that people use on a daily basis such as: computer memory, DVD's, rechargeable batteries, cell phones, magnets, fluorescent lighting and much more. During the past twenty years there has been an explosion in demand for many items that require rare earth metals, both for the technology and defense industries, which, in addition to the growing concern that the world may soon face a shortage of the rare earths, is staring to give a considerable geopolitical importance to the production of these elements.

Not surprisingly, about 97% of the world's rare earth production comes from China, and most of the world's rare earth exploitable reserves are located within the Asian continent. So again we have China taking almost total control of an increasingly important economic resource. Any resemblance to Star Wars' "Galactic Empire" is just a coincidence...

Following a monopolistic strategy, China has reportedly announced its intention to reduce its export quota to 35,000 tons per year in 2010–2015, with the excuse of its need to conserve scarce resources and protect the environment. However, this move have caused a significant rise on the price of rare earths exports, as demand has recently strained supply. As The Economist recently stated on one of their articles, "Slashing their exports of rare-earth metals...is all about moving Chinese manufacturers up the supply chain, so they can sell valuable finished goods to the world rather than lowly raw materials.", China is trying to redefine the way rare earths are sold, so not only will they control the raw material source but also manage the final product business.

This is another evidence of China's ever increasing importance in the world's raw materials and manufacturing trading businesses, the Chinese way of the world's economic colonization.

Tsunami "Merkel"

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Sun, 20 Mar 2011 15:18:00 +0000

Ten days after a massive earthquake shook Japan, the economic impact of this natural disaster over the japanese and world's economy remains to be accurately estimated.

However, demographic shock aside, some japanese and american investment banks are starting to estimate the economic cost of the natural disaster for the japanese economy at around 4% of the GDP.

While I'm very optimistic about the japanese ability to overcome the disaster and reconstruct the country and its economy in a short amount of time, I remain worried about the economical and cultural impact of the nuclear crisis that is starting to develop.

If you take a look at the financial markets during the first two days after the natural disasters took place, you will notice that while the earthquake and subsequent tsunami had an important effect over the japanese markets, in the rest of developed markets, reinsurance companies aside, this effect was not as strong as you'd have imagined.

This is easy to understand after analysing the implications of the disaster over the world's economy. On the local side, there will be a siginificant impact over the japanese economic output in the short term, however in the mid term, the reconstruction of the infraestucture will probably lead to a significant jump in the japanese GDP.On the global side, except for reinsurance and industrial companies with high dependency ratios with the japanese economy, it's difficult to find other industries and sectors abroad that would be strongly affected by this, and if something, the findings would lead to companies that would benefit from the disaster.

So why there's been significant declines in the world's financial markets in the last couple of days?. A possible answer... the Tsunami "Merkel".

Nuclear power accounts for more than 30% of the electricity production of Europe, and more than 19% of USA electricity generation capacity, so it is undeniable that nuclear energy is one of the most sensitive industries in the developed world.

Nuclear energy is not only cleaner and more environmentaly friendly than fossil fuel energy, it is also significantly cheaper. This means that if the world's governments decide to start phasing out nuclear plants around the developed world, this measure would have a significant impact in terms of cost of living and in terms of carbon emissions, as we can verify in the following chart:

While I acknowledge that there has been a long and complex debate about the benefits and deficiencies of nuclear energy as an alternative for electricity production, I also think that we all agree that this is a matter that can't be taken lightly and therefore needs to be discussed at all levels of the society before taking a resolution.

When Angela Merkel announces that Germany not only will put a halt on several nuclear projects across the country, but will start to discuss about the possibility of phasing out Germany's nuclear power capacity over the next years, she is sending out a message to the world's financial markets with deeper implications than a tsunami, something that can be proved by the fact that the world's market reacted worse to Merkel's announcement than they did after Japan's earthquake news.

The implications could be huge: raging inflation, higher costs for industrial companies, lower economic output, higher CO2 emissions...so I cant't help but think that Merkel is just looking ahead to the incoming presidential elections in Germany, and that she is just following her old populist recipe, to always say what the public wants to hear.

This Egypt is not the same of the Pharaohs

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Sat, 05 Feb 2011 22:09:00 +0000

After 17 years of a convulsing rule, where he impulsed a religious revolution that ended up changing the main gods of Egypt, moving the capital city, and destroying half of Egypt existing patrimony, Akhenaten died in the year 1336 BC. Unlike most pharaohs, Akhenaten presented himself in a way that would lead to controversy and would shock the world and its culture.

More than 3300 years later, Egypt is again the center of attention, its outraged citizens are taking the streets one more time, and a political change seems inevitable at this point.

Hosni Mubarak, in a similar fashion of Akhenaten during his rule, is an authoritarian dictator who has been throwing political rivals in jail for decades, with the ability to grow healthy foreign relationships and take care of diplomacy in order to secure himself more than 29 years of rule, as Akhenaton, known as the "diplomatic Pharaoh", did during his time.

Since the recent fall of Tunisia's longstanding president and the current revolution in Egypt, some people are starting to worry about a possible "splash effect", arguing that these events are just the tip of the iceberg that will inevitably shock several emerging markets. Some analysts are even starting to predict that this splash effect will have important consequences on the performance of emerging markets stock indexes, and therefore are recommending to flee from these stock markets for the time being.

However, thanks to the global diversification offered by the Emerging Markets indexes, when we look at their country concentrations, we find that Egypt makes up a very small part of the model portfolio, representing about just 0.6% of the MSCI Emerging Markets Index, to name one example.

This fact leads me to believe that the current events in Egypt do not pose a significant risk to investors in diversified emerging-markets funds, specially if you, like me, consider that the possible departure of Egyptian President Hosni Mubarak, could actually be good for markets. In my specific case, I like to believe that given Mubarak's track record, it is at least as plausible that a successor will be good not only for Egypt's economy, but for its investors and ultimately its suppressed citizens.

While Akhenaten was able to change the gods, construct a new capital city and shock the world with a religious revolution, I don't think that anybody outside Egypt will lose their sleep if Mubarak is overthrown.

Not hydrogen...not ethanol...not biomass...The fuel for the future is Entrepreneurship.

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Sun, 09 Jan 2011 14:46:00 +0000

If we give a look to the Global Entrepreneurship Monitor Report for 2009, we can extract several interesting conclusions about how the entrepreneurial philosophy of a country is related with the economic performance of its economy as a whole.

The report classified a total of 54 countries among three well differentiated groups: 1. Factor Driven Economies, 2. Efficiency Driven Economies and, 3. Innovation Driven Economies. Among the innovation driven economies we can find almost all of the high-developed economies of the world, while the efficiency driven economies are countries that are on the way of transitioning into developed stages of the entrepreneurial activity, and the factor driven economies, are mostly countries characterized by having "resource extractive" economies.

After giving a detailed look to the analysis, we can see that among the industrialized countries, those who have the biggest fear of failure and the lower growth in entreprenuerial iniciatives are, Spain, Greece, Japan and France. Is not a coincidence that these countries are among the ones that are suffering the most in the current economic crisis.

Some other interesting findings are that while less than 3 percent of adults 18 to 64 years of age are involved in entrepreneurial endeavors in Japan, Russia and Belgium, more than 18 percent are so engaged in India and Thailand. The level of entrepreneurial activity was lowest in the developed Asian countries (Japan, Hong Kong, Taiwan and Singapore) and Central Europe (Russia, Croatia, Poland, Slovenia and Hungary), slightly higher in EU Europe plus Israel, substantially higher in the former British Empire Anglo countries (Australia, Canada, New Zealand, South Africa, and the United States), higher still in Latin America (Argentina, Brazil, Chile and Mexico), and highest in the developing Asian countries (China, Korea, India, and Thailand).

You could say that even though there is still a long way to go in terms of entrepreneurial activity and specially entrepreneurial success between the developed economies and the emerging economies, this gap, as it also happens with the economies as a whole, is starting to reduce at a fast pace.

There is a close relationship between the entrepreneurial strenght of the citizens of a country, the flexibility and adaptative capacity of its society, and the economic growth and resilience of its economy. It was the american entrepreneurship that allowed the US to become the biggest economy of the world, surpassing all European powers during the beggining of the century, and don't be surprise if entrepreneurship will also be what leads some emerging economies into a main position in the world economic and political stages.

Thai recovery: Tom Yam Goong is just a soup again.

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Wed, 29 Dec 2010 20:07:00 +0000

It is a fact that almost every single tourist, out of the 14 million that visit Thailand every year, has tasted or at least seen the famous Tom Yam Goong soup during his stay in the paradisiac country. Tom Yam Goong, a savoury soup made with prawns, chicken, lemon grass, among other ingredients, is one of the culinary simbols of Thailand.

However, this name is also known, by economists and finance related people around the world, as the name given to the severe financial crisis that affected much of Asia on 1997, and eventually raised fears of a worldwide economic meltdown due to the possibility of a financial contagion. This crisis was to be known as the Tom Yam Goong in allusion to the fact that everything started in Thailand, where the financial meltdown led the country to bankruptcy.

During the years before 1997, Thailand, along with other Asian economies, had been able to achieve incredible rates of growth, a phenomenon called the "Asian economic miracle", thank to the ever increasing capital inflow destined during those years to the emerging markets and particularly Southeast Asia. This inflow of capital allowed asset prices to increase dramatically, fueling a growth model that was not sustained by productivity growth, creating a huge economic unbalance in these economies. This unbalance impulsed the need for the government to defend the value of the Thai Baht— which by the time was fixed or pegged to the US dollar and was experiencing a very strong depreciative pressure—, by having to buy any excess domestic currency at the fixed exchange rate with foreign reserves, up until the point that the government was forced to let the currency float and therefore create a mega-devaluation of the currency and the stock market.

The effects of this financial crisis were so dramatic, that economies like the Indonesian were still smaller in 2005 than they had been in 1997, suggesting an impact on those countries similar to that of the Great Depression.

Over the last five years, and despite the double blow of a collapse in global trade and domestic political disturbances, Thailand’s economy has staged a remarkable comeback. In its annual assessment of the Thai economy the IMF says the country—which has one of the world’s most open economies—has since overcome these events, with the economy roaring ahead to an estimated growth of 7,5% during 2010 and 4% for 2011.

Some people might argue that probably this could be a sign that some of the problems of the past may arise, specially after foreign capital continue to flow into the country.

In my specific case I can say that after having travelled to Thailand this summer—where not only I visited some Thai-owned industrial factories and institutions like the Bangkok Port, but also experienced the open-business mentality of Thai people and of course tried the famous soup— I am pretty confident that the only Tom Yam Goong we will hear or see in the near future will be just a red shrimp soup.

Mexicans are waking up...in their own manufactured beds

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Sun, 19 Dec 2010 13:18:00 +0000

After experiencing a year 2009 that probably most mexicans would like to forget, the future prospects for the mexican economy are starting to brighten, as international companies are landing in the country for its competitive advantages in the manufacturing industry.

We all agree that 2008 and 2009 proved to be a challenging period for most of the countries' economies, however, the situation was specially hard in Mexico, where external factors like the swine flu, or long existing conditions like the drug cartel violence, took an additional toll over the economic development of the Aztec country. It was inevitable for everyone to remember and draw comparisons with the so called "Tequila crisis" of 1994, specially after not only the mexican economy contracted in 6,5% during 2009 (one of the world's hardest hit countries), but the violence generated by the drug business rose considerably, impulsed by the government crackdown on the major drug cartels.

Despite this scenario, the backbone of the mexican economy was in better shape than during the 1994 "Tequila crisis", thanks for the most part to Calderon's government effectiveness in keeping the budget deficit in only 2,3 percent of the GDP, and therefore protecting the value of the peso against other currencies. This characteristics, -- plus the fact that in comparison with other emerging markets, Mexico can be qualified as having a relatively stable political situation, that also has signed free trade and economic agreements with most of the developed countries--, allow Mexico to be in a great position to ride the recovery of the american economy.

As it was widely expected, chinese labor costs are starting to rise as more and more people are joining the middle classes in China, a situation that has some international companies starting to look towards Eastern Europe and Central America, as viable alternatives for the location of their manufacturing centers. Even though annual wages are still higher in Mexico than in China, this gap is starting to reduce, and when american companies add the shipping costs into the equation -- its not the same to ship a container through the sea from China to Chicago in one month, than to ship a truck container from Monterrey to Chicago in just 5 days--, Mexico is looking more than ever as a cheap place to manufacture.

This --and the better gastronomy-- is why companies like Ford, Research in Motion, Cessna, General Motors, General Electric or Whirlpool among others, are continuing to invest in Mexico and locating their manufacturing centers there and not on China, taking advantage of Mexico's skilled manufacturing labor and the lack of conflicts and strikes; not only allowing mexican factories to create jobs, but returning the country into the economic growth path for 2010 and beyond.

Iraqi mines or Venezuelan Chavez ?

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Mon, 13 Dec 2010 16:58:00 +0000

After being on power for more than 11 years now, becoming one of the most known political leaders of the world, and hitting the news worldwide on a daily basis with his already boring and out of fashion political speech, it would seem impossible for anyone to keep gaining the attention of citizens around the world, specially in these times, where even established institutions like the Catholic Church are struggling to keep attracting followers.

Against all odds Hugo Chavez have not only been capable of achieving that, but continues to generate a strong influence around the world on everything he is related to, from pissing off King Juan Carlos of Spain to affecting the markets' assessment of the Venezuelan economy.

Some days ago I did the exercise of comparing the yields (the effective interest rate that an issuer pays the investor as a remuneration for lending them money) of several high-risk considered countries. So I had Iraq, Iceland, Argentina, Greece and Venezuela compared against each other in terms of yields for similar bonds issues. Even though this is not a new thing, I continue to be perplexed by the fact that Venezuela -- an oil-exporting country with a steady source of cash-flow, an historically positive trade balance, and a lower debt/gdp ratio than most of the developed countries -- has to pay more for attracting investors that a country engaged on armed conflicts and with almost no government like Irak, or a country like Argentina, which not so long ago not only froze all private bank accounts in order to stop a bank run, but also defaulted for most of its debt.

I want to make clear that I am not insinuating that the Venezuelan economy is in great shape, because it does carry lots of negative forecasts for the future, like an ailing oil production output, an increasing pressure on consumer prices, reduction of external reserves, and pressure for a further currency devaluation, among others; what I am trying to expose is that the economic reasons are not responsible for the level of risk (one of the world's highest) that the markets are currently attributing the country, because the main reasons are, in my opinion, mainly political.

It's funny to think that Chavez's tv programme "Alo Presidente" could possibly have a stronger influence in the world financial markets, than Jim Cramer on "Mad Money" and Pimm Fox on "Taking Stock" together, but is also interesting to know that this market fear of Chavez, could actually open good opportunities for investing in Venezuela's and PDVSA debt, specially if you, like me, think that countries like Iraq or Iceland -- where even the families are indebted for more than four times the GDP of the country -- are probably riskier alternatives, even if yields say the contrary.

Disclaimer: The objective of this article is purely informative, the article does not constitute an advice for buying or selling securities.

The hidden importance of holding debt..."negotiation power".

noreply@blogger.com (Víctor Hugo Gómez Zerpa) — Wed, 08 Dec 2010 19:23:00 +0000

Over the last days, most of the economic news around the world have been somehow concentrated (with a lot of good reasons) over the debt problems of the peripheral european countries (I decided not to use the terms PIGS or GIPSIS because we are starting to run out of letters).

After several weeks of uncertainty in the financial markets around the world, with lots of news going around about the who and when of the financial rescue of the Irish government, the origin of the funds neccesary to rescue Ireland was shortlisted to a small list of candidates: Germany --I'm sorry, I meant Europe--, the IMF, and any fool in the corner.

It's quite understandable that Germany promptly showed reluctance to the idea of having its taxpayers rescuing another irresponsible country (citing german citizens words), so in the end it will probably be an IMF-EU joint effort that will take place to rescue the embattered country. However, even before this news came out, there was already speculation about the next country to fall, with the main candidates being Portugal and Spain, two countries with similar problems to those of Greece and Ireland, a surmounting public debt, a real estate bubble, low productivity, and decreasing economic output.

The economic consequences of the bankruptcy of a country like Spain to the world's economy are known by everyone, so I won't even go deep about it, however, there is an additional consequence and its not economic, its political. The IMF is not enough capitalized to face the rescue of an economy the size of the Spanish one, so in this case we would run out of "usual suspects" able to rescue a country like Spain.

Here is where China comes into play, with reserves of more than USD 2,6 trillions, China could play its cards and offer themself to capitalize the IMF. This kind of move could allow China not only to become the largest shareholder in the IMF, but to vault into a leading global role by moving the IMF headquarters from Washington to Beijing.

Of course that right now these are just speculations, but.. does anybody wonder why China has been able to keep its currency devalued, even though half the world have been gently asking them to let the Yuan strenghten for the last couple of years?. I don't know you but for me that's some negotiation power!.