Thursday, July 31, 2008

Martin Feldstein and the NBER

David Warsh has a nice article on Martin Feldstein and his contributions to the profession at Economic Principals.

TNK-BP Part Two

My previous entry discussed the basics of the TNK-BP affair and the opinions of the competing sides. AAR believes the joint venture is ill-run, BP thinks that AAR wants to force them out so they can sell the company to a third party (Gazprom?). Many observers think AAR is really acting on behalf of Putin so that the state can take over the company.

Here is my take. When the partnership was formed both sides brought valuable assets to the table. BP brought technology and marketing skills. The former allowed the company to recover oil economically than previously was considered too costly -- reserves were greatly enhanced. And the marketing skills helped with distribution. This was important because when the partnership was created oil prices were much lower and the cost of Russian oil is relatively high.

What did the AAR partners bring to the table? Of course the Tyumen Oil Company (TNK). But that is not all, or even the most important part -- they could have just sold the company to BP if that was what mattered. What AAR brought was relational capital. This is key asset for any company operating in Russia. It is the insurance that prevents expropriation and the trust that makes contracts operate (see here and here for a discussion of relational capital). AAR had high relational capital due to the investments of its leaders. BP could not buy this. It had to partner with them. The important point is that western companies cannot invest in relational capital because many of the payments are made informally, and adherence to even minimal international accounting standards prevents such payments.

Now return to 2008. Oil prices are much higher. So the profits of TNK-BP are much higher. So the payments the joint venture has to make to maintain its relational capital are higher. But only the Russian partners pay these insurance premiums. So the value of their contribution to the partnership is rising, while with higher oil prices the contribution of BP is less important. Moreover, as this article in the Financial Times discusses, oil services companies like Schlumberger make it easier to tap deposits without the expertise of the oil majors. The conditions have thus changed dramatically since the bargain was formed. Is is odd that AAR wants to revise the contract?

What about Putin? Let's think of this in the simplest way possible using the notion of resource rent distribution that Gaddy and I have outlined in our work (see here). At today's vastly higher oil prices, companies like TNK-BP earn more resource rent, and Putin wants Russia to get its share. Of course the budget is automatically getting more revenue from the oil sector as the oil price rises. But that is only the formal side of the story. Much of the payment of the rent takes place informally. We call this "informal taxation" - payments that range from the innocuous (social spending, philanthropy) to the outright illegal (bribes, kickbacks), with a large grey zone between (so-called "voluntary" contributions to politicians' off-budget funds, and so on). You could call it a "protection racket." As Cliff noted in this article:

Another term for what is going on is “protection racket.” In a protection racket, there is a threat against which someone offers to protect you. The catch is that the threat emanates from the protector himself. Here, the threat is the loss of property rights. Sharing rents locally is one way to pay the protection money. There is also a national version of the protection racket, designed primarily for the very largest companies...Companies are expected, for instance, to pursue certain policies in their foreign activity that further the geopolitical interests of the Russian state, even if they sometimes don’t quite make sense from a strict business perspective...In sum, companies...are expected to do three things: (1) pay their formal taxes; (2) pay their informal taxes (share locally); and (3) serve the foreign policy agenda and promote other strategic interests of the state. It is very important to recognize the informal rent sharing. This is the part of the iceberg that lies below the surface. That’s the part that is hidden, and the part that tends to be larger. It’s the part that can cause
Yukos and Mikhail Khodorkovsky were victims of the hidden iceberg. We have used this picture to illustrate the iceberg phenomenon and the distribution of the rent.

To the extent that TNK-BP adheres to international accounting standards, it is highly constrained in paying these kinds of informal taxes. And even if it were able and willing to compensate by paying more formal taxes, there are reasons why that would not be acceptable to Putin. The ability to collect and redistribute informal taxes is at the heart of Putin's system of management of "Russia, Inc." It is their opaqueness that is key. Thus, from Putin's standpoint, formal taxes are less efficient than informal taxes. So I would expect that he would not be displeased if AAR wins this battle.

Addendum: A Tyumen court just ruled against BP in a dispute over the Board of the joint holding.

Wednesday, July 30, 2008

Behind the TNK-BP Affair

There has been much recent discussion about the contest over TNK-BP, Russia's third largest oil company. Some of the background is available in this Washington Post article. The dispute pits powerful Russian oligarchs, Mikhail Fridman, Viktor Vekselberg, and Len Blavatnik (actually American, but of Russian origin) against the mighty oil giant, BP. The Russian partners, known as AAR after their respective holding companies, accuse the management of the joint venture of running the company in BP's interest. For example, here is Mikhail Fridman (also see his comment in the Financial Times):

"The conflict between AAR and BP is about control of TNK-BP. We want the company to be managed as an independent oil company in the interest of all shareholders, including the 5% minority shareholders. BP wants to operate our joint venture like a BP subsidiary and it wants to control all aspects of its business. If the company is to compete against the best and to have a successful future as a leading international oil business, this state of affairs must change."

BP claims that the Russians want to force BP out so they can cash in. BP's chair, Peter Sutherland, (quoted here in the New York Times) blames the Russian oligarchs for engaging in corporate raiding, and wonders why the Russian government does not stop it:

“This is just a return to the corporate raiding activities that were prevalent in Russia in the 1990s,” Mr. Sutherland said at a conference in Stockholm. “The leaders of the country seem unwilling or unable to step in and stop them. This is bad for us, bad for the company and, of course, very bad for Russia.”
Many argue that AAR is just acting on behalf of the Kremlin, though BP strictly avoids making this claim.

How should we think about this conflict? In the next post, I offer an explanation based on the work I have been doing with Clifford Gaddy.

Tuesday, July 29, 2008

Gravity and Real Estate Prices

This article in today's NYTimes gets to the heart of one key aspect of the housing crisis. Here is the key quote:
But behind the political pyrotechnics is a simple truth: Executives at IndyMac, like many people on both Wall Street and Main Street, apparently never dreamed that home prices might fall. To the contrary, IndyMac made many loans on terms that implicitly assumed prices would keep rising.

This presumption forgets the truism that what goes up must come down. This is at least true when the prices of assets rise faster than rents. Apparently, many lenders forgot this, despite the fact that at least in recent years we have some good data. Robert Shiller produced this graphic, for example, in his book Irrational Exuberance, and the graph was published in the New York Times in 2005.
It is pretty apparent that real housing prices fluctuated between 100 and 125, aside from the Great Depression, for about 100 years. The recent period clearly looks like a bubble. Looking at this graph would you believe that prices never come down?

This is more apparent still when we look at house prices compared with rents. Shiller provides this in a recent working paper (gated).

Housing prices clearly grew faster than rents since 2000, and this is the hallmark of a bubble. But bubbles eventually burst. If financial institutions lend while ignoring this basic fact they can burst too.

Friday, July 25, 2008

Investors Know Who Runs Russia

An article in today's NYTimes notes the impact on the stock price of a Russian steel producer, Mechel, that was criticized by Prime Minister Putin. Putin gave a speech that was critical of the steel producer for charging higher domestic prices for steel than for its exports. The shares of Mechel are traded on the NYSE via American Depositary Receipts. The article notes that the market value of the companies shares which closed Wednesday at $36.61 in New York, tumbled $13.77 on Thursday to close at $22.84, wiping out $6 billion in value. Or, as the article notes, about $1.2 billion per sentence of Putin's speech.

What is interesting is that this points out that western investors believe that Putin is still in control in Russia. I have not checked what happened to the price of Mechel shares in Russia, but this belief is also widespread there of course.

Thursday, July 24, 2008

Irony and Loyalty

The New York Times has an article about William Browders' troubles in Russia. Browder was one of the most prominent foreign investors in Russia. His fund, Hermitage Capital, had $4 billion under management. He was a champion for minority shareholder rights in Russia. In that capacity he stepped on some important toes. Since 2005 he has been unable to secure a visa to return to Russia.

The irony is that Browder (the grandson of Earl Browder, former head of the US Communist Party) used to be one of Putin's biggest cheerleaders. He argued that Russia needed Putin's strong leadership, and applauded when Mikhail Khodorkovsky was sent to jail in October 2004.

Browder's fate does might seem to reflect a lack of loyalty on Putin's part. But what it really signifies is the risk inherent in challenging the system Putin created for control and distribution of resource rents in Russia (see my article with Cliff Gaddy on Resource Rents and the Russian Economy for a discussion). Browder's calls for transparency challenged the fundamentals of the Putin system. That is why he lost his visa.

Ambulance Chasing Econometrics

A recent post in Slate asks whether IMF loans cause Tuberculosis. The article refers to a recent study published in an on-line journal, apparently peer-reviewed journal. The author of the Slate post, is a physician at Yale, not an economist, so I suppose I should not be too surprised at the lack of skepticism in the article. Still it makes one wonder about the uses physicians make of statistics. If a Yale Professor of Medicine accepts this silliness, I am not sure I want to take his prescriptions for any illness I have.

One should read the published article, International Monetary Fund Programs and Tuberculosis Outcomes in Post-Communist Countries, which is available on-line here.

The basic premise of the study is that IMF programs result in reduced government spending, which leads to reduced spending on health, which leads to more TB. One might expect that the authors had tested this by looking to see if countries with IMF programs reduce spending on TB programs. That is, test the mechanism directly. Instead they regressed changes in mortality (over time across countries) from TB on the length of time a country operates under an IMF program. How hard is it to see the problem with this exercise?

Suppose we ran a regression of mortality from accidents on the amount of time people spend in ambulances. Does anyone doubt that we would find that ambulances cause accidents. This would especially be so since people who never get in an accident never find themselves in an ambulance. Would Dr. Spiesel tell us not to use ambulances to stay healthy? Well, countries that did not experience economic crises do not need to go to the IMF (for example, Slovenia, in the data sample used by the authors).

What the authors of the article and the physician miss is that admission to IMF programs is not a random occurrence. Countries go to the IMF only when things get so bad that accepting the pain from the program seems better than accepting a collapse of the currency or of the State (sometimes both, remember Suharto and Indonesia?). But the factors that have caused the economic crisis may also be causing the health crisis. In that case the correlation with the IMF program is spurious.

One good thing about this paper is that the data they used is available online. One can examine the data and see what is going on. You can see, for example, that countries with stronger state capacity that have joined the EU (e.g., Czech Republic, Hungary) had short IMF programs early in transition and that weak states have had long stays with the IMF.