SIMES Newsletter
‘‘TOO BIG TO FAIL?’’ A REVIEW by Kang Yong Kia
April 2012
Transforming Health BY Edwin Wan
THE GENIUS Sun Shuao
Guan Zhong www.simeconomicsociety.org
EARLY ECONOMIC THINKERS OF
Understanding the foundations for modern economic thought
For internal circulation only
CONTENTS
CONTENTS
SIMES Newsletter April 2012
SIMES NEWSLETTER FEATURES
DEPARTMENT
COVER STORY
4 Editor’s Note
8 Ancient Chinese Wisdoms, A History
5 ANote From Sruti Pegatraju
HEALTHCARE
11
SIMES
A Chief Editor’s journey.
10
Transforming Health
A critical approach to connect GDP with health.
BOOK REVIEWS
15 “Too Big To Fail”,
6 Song’s Perspective
Collateral Damage Unavoidable. A review of the Seminar on Global Economy by Song Seng Wun, Regional Economist at CIMB Research.
BiBLiOGRAPHY
A Review
Is the US truly Infallible?
23 Research References and Photo Sources
DEBATES
20 Are We Rational Or IRRATIONAL?
The future of Rational Economics in an irrational world.
SIMES Newsletter April 2012
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EDITOR’S NOTE
SIMES
SIMES Newsletter April 2012
EDITOR’S NOTE
I think we all agree that in every time and place, there exist some heroes. Some are pretty obvious, some are unsung. Then there are those, the in-betweens. They, who seem to be in plain sight, yet lack familiarity and recognition. Precisely because of this halfness, most people have weak desires to find out exactly what contributions they have made.
It is proven time and time again that further commitments and school can coexist.
Special Thanks to Sruti
Here, I would like to remind everyone of our exEditor-in-Chief, Sruti Pegatraju, whose brilliance and hard work have driven us thus far. In her past year as the Editor-in-Chief, her style has penetrated every article in the quarterly SIMES Newsletters. It is quite true that many made the newsletter happen, but they often are pieces of a puzzle. The countless hours required to piece the puzzle cannot be ignored anyhow. Editing is a long and arduous journey.
Congratulations to Marzuki
I would like to congratulate our previous Editor-in-Chief Al Marzuki Anuar on his success in clinching a First Class in his examinations. This position is not for the faint-hearted. Hours and hours of hard work and dedication are inevitable. Some sacrifices have to be made. It is needless to say which. In this tug-of-war between the love of writing and actual preparation for exams, many have chosen the latter. To be able to balance the recipe of such disutility despite passion, and to excel in both speak well of one’s capability. Marzuki, you have done us proud. We send you our well wishes towards your future endeavours. You know you will continue to shine.
Therefore, for all her importance and astounding work, I would like you all to take a step backwards and honour her in the right respect. Our heroine, Sruti Pegatraju. To read more of Sruti’s experiences, see A Note From Sruti Pegatraju(Page 5).
On Healthcare Singapore has come a long way. With improved technology and standard of living, it is no wonder that people are living longer. According to the Department of Statistics Singapore, the life expectancy at birth for the population as of 2010 is 81.8 years. Hence, it is quite clear that we are facing a demographic shift today; an ageing population with which all should be concerned. Our economy is transforming because of this shift, and more importantly, our lives. Edwin Wan, in Transforming Health, seeks to explain the link between income and health. It highlights this demographic transition, among other consequences, which will deepen the much-needed understanding of the reasons behind this shift.
To read more of Edwin Wan, see Transforming Health(Pages 11-14).
Liu CaiJun Disclaimer: All the views and opinions reflected in the articles are the authors’ own. Neither SIMES nor SIM are to be held accountable for the authors’ views. Access our SIMES website by reading our QR code (displayed at the back of this issue) with your smartphone. Download the QR code reader at your App Store.
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SIMES Newsletter April 2012
A NOTE FROM SRUTI
SIMES
SIMES Newsletter April 2012
A Note From
Sruti Pegatraju...
I JOINED the SIM Economics Society as an Exco member in my first September at SIM. I discovered the club in the conventional way, by strolling through the stalls of all student-run clubs during the first few weeks of the UOL semester. After attending the first SIMES Exco meeting and getting acquainted with the friendly committee and members, I decided to get involved in the organization. I helped out during the Economics Week of 2010, and later moved on to becoming Editor-In-Chief of the society’s quarterly newsletters. Being able to contribute to SIM Economics Society as the Chief Editor for the term May 2011 to March 2012 was indeed quite a learning experience. My leadership skills were certainly polished through the organization of various forums, editorial meetings and publishing processes. Involvement in the SIM Economics Week of October 2011 was especially important in shaping key management skills of mine. Tasks involving the allocation of research duties to committee members, liaising with school management and printing houses, and somehow finding a way of getting everything on track with our self-imposed deadlines were daunting at times. They really challenged my timemanagement capabilities. Being in charge of the editorial department, it was my responsibility to equip myself with reasonable knowledge on current economic affairs so I could guide fellow students through their research. With a theme as vast as ‘Global Economic Prospects and Risks’, my personal research on various regions’ economic conditions had expanded beyond what I read in the daily headlines. I became to better appreciate the context of the economic woes in various economies, be it the Eurozone, USA or our Asian counterparts.
SIMES Newsletter April 2012
Apart from our mega event—the Economics Week—undertaking my general responsibilities as editor with Newsletter publications and assisting in our Economic Forum events were indeed a pleasurable experience. It was through those avenues that I was able to meet like-minded peers with an interest in discussing and learning about economic issues. I was highly appreciative of the energy in the student writers during editorial meetings when the writers were collectively bouncing article pitches off each other or even during my individual meetings with writers on article feedback. Everybody had a keen interest in diving deeper into economic events, questioning arguments to formulate their own opinions through their work. In many ways, this was an inspiring environment to be in. Being the Editor of SIMES has been a pleasurable journey, with its fair share of challenges, but a learning experience nonetheless. I grew as a leader, a writer, and as an economist thanks to my involvement in the society’s diverse range of activities. My team of writers and fellow Exco members were wonderful to work with and were the key players to making this whole experience enjoyable. This society is one that aims to provide a platform for students in our university to express and develop their economic thought, thinking beyond what is taught in the classroom. I am confident that the new committee will carry forward this message for the coming year and bring this society to greater heights.
Sruti Pegatraju
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SONG SENG WUN
SIMES
SIMES Newsletter April 2012
Song’s Perspective
COLLATERAL DAMAGE
UNAVOIDABLE BY SONG SENG WUN
Regional Economist at CIMB Research
“2011 was another turbulent year.” Mr Song opened his semi- sustainable job creation remains problematic. So is the US
nar with a very succinct conclusion of 2011. Only last year, the world was dazzled by a whirlwind of bittersweet events. US and the Eurozone both lost the AAA-rating. The Arab Spring was a series of popular rebellion in its own right. Tyrant Gaddafi was murdered. The people finally spoke in tumultuous times. Number One terrorist Osama bin Laden also succumbed to his supposed fate. Steve Jobs, the man who revolutionised Apple passed on. The tsunami in Japan affected the global supply chain, and more importantly, destroyed homes and lives. Systems were challenged. Fates were challenged. He was quite right. He also gave a short summary of recent major events in Singapore. The General Elections, Inaugural Youth Olympics, the abolishment of TV and Radio licencing, MRT disruptions, stubbornly high inflation rates(crossing the 5% mark) are some of those. According to Mr Song, growth has rebounded in the US. He thinks we must prepare for a wobbly ride as the Americans deleverage to normalcy. The withdrawal of fiscal support, alongside with the issue of unemployment and the lost of the manufacturing sector are most dire for the US; with the manufacturing sector having the capacity to transforming the structure of the US economy. Now, the Americans should focus on the service sector to lead the future. Also, the problem with unemployment seems to be slowly alleviated. Job numbers are on the rise. All are signs of a healthy labour market. However, Mr Song feels that
6
on wobbly foundations?
On the contrary, the situation for Europe is unique. The Eurozone is still deep in crisis. The bail-out plans are extremely costly and sovereigns in the region are showing signs of fatigue. Moreover, the risk of sovereign rating cuts keeps the financial markets on edge. Ridiculously high unemployment rates of 10.8% in February 2012 merely aggravated the situation. However, the big question remains whether Europe can handle the sovereign debts that will be maturing in the February to April period of 2012. Locally, Mr Song predicts that the technology sector will hit the bottom before recovering. The overall manufacturing or exporting industry might still be constrained by weak global economy. Hence, Singapore’s performance is likely to remain volatile. Thus, the estimated growth for this year should be nearing 2.5% as opposed to the original expectation of 5%. However, we must beware that these data are sending mixed signals as the pharmaceutical industry alone can distort growth values. We must note that the data are only approximations. Yet despite all these negativity, one positivity is that the Singapore Budget 2012 cushions the pain from global weakness. What about China? China is riddled with its own problems. With messy, unorthodox lending and food safety issues, China has been on a bumpy ride. The Eurozone crisis basically increased its instability due to strong trade linkages with Europe. To soften the impact, several efforts have been made by the Chinese: Fiscal and monetary policies have been implemented; more targeted measures for consumption to safeguard domestic consumption; aiming to keep prices generally stable. Also with sacrificed GDP to lower inflation, we can indeed assume a soft landing for China. We can also expect new directions and promises as it eases into the 12th Five-Year Plan. Mr Song concludes that globally: The risk of recession has not diminished. China can still expand at a
SIMES Newsletter April 2012
SONG SENG WUN
SIMES
SIMES Newsletter April 2012
Economic indicators and proxies: Unofficial/Independent Statistics: Auto sales market is an example of excellent proxies for economic indicators. It is an area which captures all economic activity (tourist arrivals, cargo traffic etc). Temporary Hiring Market: Lower figures mean more permanent hiring and increased business confidence.
modest rate of 8 to 9%. Growth has rebounded in the US and the labour market seems to be stabilising. The Eurozone, on the other hand, is expected to plunge again in the fourth quarter.
Back to Singapore, the advice is to stay defensive as we may be sensing more shocks than earnings in 2012, and to focus on fine-tuning the economy and tackling with the productivity and foreign labour trade-off in the longerterm.
CIMB’s growth forecast for 2012: Singapore -0.8 to 2.8% China: 8.0% Singapore property market: oscillates, so not too much of a worry. Written By: Kang Yong Kia Liu CaiJun
SIMES Newsletter April 2012
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Cover Story
ANCIENT CHINESE WISDOMS
SIMES Newsletter April 2012
Ancient Chinese Wisdoms Reflecting upon the economic history of China
By Shum Tin Jun Daniel
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SIMES Newsletter April 2012
ANCIENT CHINESE WISDOMS
Cover Story
SIMES Newsletter April 2012
During the early stages... of Chinese civilization, namely the Xia, Shang and Western Zhou dynasties, China was a slave society. Most of its population was made up of slaves who were tied to the land, in bondage to the clans of slave-owners. Its society had yet to evolve into the feudal society which we would see in Imperial China. Trade was then almost non-existent since production was then monopolized by the slave-owners, the aristocrats of the day. The only goods being produced then were those only for the exclusive consumption of the slaveowners. With no competition and being perfectly satiated with exploiting the slave-craftsmen under them for their own pleasure, there was little incentive for them to improve on the prevalent economic system. Technology was very primitive at the time. Human labour was then used to plant crops. All this would change with the collapse of the Chinese slave society in 770BC. The Chinese slave society had always been dominated by a leading clan with many different aristocratic slave-owning clans, both big and small, under their control. As the years went by, tensions within the society built up as aristocrats exploited their slaves more to maintain their increasingly decadent lifestyles. Tensions eventually reached breaking point during the despotic rule of King Li of the Zhou clan, when slaves were under the worst exploitation they had seen for decades. The Chinese slave society would eventually fall apart after King Li was overthrown by a popular rebellion. After the collapse of the Chinese slave society in 770BC, Chinese society began to evolve into the feudal society which we would come to recognize in Imperial China. This could be attributed to the more widespread usage of iron agricultural implements that opened many possibilities for the peasantry. Peasants were now able to cultivate more land and since had started clearing forests to expand their land-holdings. They could also grow enough crops to keep some for themselves. This made them unwilling to work for the slave-owners that continued to use human labour to till their lands, leaving slave-owners with little choice but to change the economic system. Slave-owners now became landlords, renting out their plots of land to former slaves to cultivate, collecting a share of the crops planted in exchange. As this arrangement became increasingly common, China thus evolved into a feudal society. Not only did the collapse of the Chinese slave society bring about massive social changes, it also led to key
SIMES Newsletter April 2012
political changes, thus creating the environment for the implementation of the earliest recorded macroeconomic policies in Chinese history. The collapse of the Chinese slave society brought about great political upheaval, when various aristocratic clans broke away from the dominance of the leading Zhou clan. Each of the clans looked into ways to better exploit the resources under their control, so that they could have the power, wealth and influence to unite all the other clans under their banner. It was under this political climate that the first signs of a more advanced economic system came into being and the first economic policies in China were formulated. Two individuals were part of this early policymaking, Guan Zhong and Sun Shuao, of the Qi and Chu clans respectively, whose policies would have the greatest amount of influence on future generations to come. Guan Zhong had earlier laid the foundations of Imperial China’s feudal society by organizing the people in his clan into 4 social classes, aristocrats, peasants, craftsmen and traders. The traders and craftsmen were two new social classes that emerged from the social turbulence after the collapse of China’s slave society. Despite the fact that the economy of his clan territories was then largely agrarian-based and the trading class was very small, Guan Zhong introduced the first economic policy to aid them in his efforts to develop trade and industry in his clan territories; it was the act of establishing a merchant’s quarter, for the trading class to stay in and conduct their business, the ancient equivalent of our modern business district. Besides fuelling the growth of commerce in the clan territories, the merchant’s quarter also made it possible for the trading class to conduct trade with people from other clans. Sun Shuao, on his part, introduced policies to give the peasants from his clan, access to the rivers and forests. Before this, only the aristocrats and the clan leaders had access to them. This increased the economic resources the clan had at its disposal, thus contributing to a rise in the clan’s productivity. At the same time, he also introduced another policy, which was to let market forces run the clan’s economy. This was founded on his belief that things in society should be left to run their natural course. Despite the rudimentary economic policies these reformers introduced, there would still be some time before the earliest economic theories came into fruition since such said economic policies were guided more by a desire
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Cover Story
ANCIENT CHINESE WISDOMS
SIMES Newsletter April 2012
to solve the social problems afflicting the respective clans the policymakers belonged to rather than a basic understanding of the way the economies of their clans functioned. These theories would later be presented by a group of thinkers, members of a new social group, the scholars, gradually coming into existence at this point of time.
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SIMES SIMESNewsletter Newsletter April April2012 2012
Healthcare
A NOTE FROM SRUTI TRANSFORMING HEALTH
SIMES SIMESNewsletter Newsletter April April2012 2012
On Health: A critical approach. Measuring the effects of INCOME on HEALTH.
TRANSFORMING HEALTH BY EDWIN WAN
SIMES Newsletter April 2012
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Healthcare
TRANSFORMING HEALTH
SINCE TIME immemorial, The manifestation people’s fascination
of
with
the concept of
good health and longevity was shown by an existential debate of a fountain of youth first by Herodotus, among many others. The fountain of youth was a symbol that showed Mankind’s innate desire for a salubrious lifestyle where one’s health would never deteriorate and dwindle. Since the advent of increasing economic growth in countries world-wide, there has been a sharp drop in mortality rates especially in the case of infant mortality rates.
Is
the rise in incomes associated with the increasing standard of health or is it purely coincidental? In this article, the subjects discussed would be the effects of income on populations both on the aggregate level and the individual level in section 1.0. The theories to examine the effects of income on health will be in section 2.0. The conclusion of the article will be articulated in section 3.0. What is health? Health, as defined by the WHO, is “a state of complete physical, mental and social well being and not merely
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SIMES Newsletter April 2012
the absence of infirmity.” Health can be seen as a human capital where investment in it would lead to an increase in production possibilities in the future in terms of increase in productivity due to the reduction of hours compromised by illnesses. One defining quality of health in this article is not discussed as an external factor but rather as a function of several explanatory variables like the lifestyle that individuals adopt or income as discussed later in the article. Yardsticks that would measure health of populations would be criteria like crude death rate or the Human development index (HDI). One way of measuring utility gained from better health would be using the concept of Quality Adjusted Life Years (QALYs). QALYs are benefits received from the consumption of the health-producing good in terms of years whereby the person is in perfect health. One underlying assumption for using QALYs is that the benefits gained is of equal worth to people no matter who they are or what stage of life that the consumer is in. 1.0 The Effects of Income on population health Analysis on the effects of income on health can be categorized on the individual level and on the national or aggregate level. The two discernible effects discussed at the population level would be the demographic transition and the epidemiological transition. Two of the effects that we can talk about at the micro level are the rate of time discount for individuals and access in healthcare facilities. 1.1 Aggregate (national) level
Countries affected by economic development are characterized by Rostow’s stages of development. As the pre-conditions for the “take off “set in, countries will move into the industrial and service sectors while reducing their agricultural industries. This phenomenon will reduce the incidences of infectious diseases found in rural areas like cholera, as in the case of Zimbabwe, due to untreated water. However, the dichotomy between rural and urban areas on the effects of health remains blurred as the people in urban areas face a host of other health problems. Even though urban populations are often classified with a lower
SIMES Newsletter April 2012
Healthcare
TRANSFORMING HEALTH
transportation cost and accessible healthcare, there are problems like overcrowding in hospitals and a host of other stress related illnesses.
SIMES Newsletter April 2012
Based on the graph of Singapore’s TFR:
Regardless of the possible health problems living in an urban environment, higher income could allow an increase in the consumption of health producing goods and engage in services that are preventive or curative in nature. An increase in the consumption of services like prenatal care or preventive measures like family planning service; for instance educating the use of contraceptives and birth control that would reduce the chances of stillbirth, reducing infant mortality. This could lead to a decrease in infant mortality rates.
This shows Singapore’s declining fertility rate from the 1950’s to 2010 which could be attributed to the increasing economic growth that led to a rise in income. One very compelling reason for the sharp decline from the 1950’s to the 1970’s would be the government population polices that was implemented during the 1960’s. Campaigns like the “Stop at 2” and measures like the legalization of abortion and sterilization would probably have accounted for the sharp decline in the TFR for Singapore. In the 1980’s, incentives were given to mothers to procreate. (Yap,2003 pg 654) and setting up departments like the Work-life unit to advocate family friendly work practices to aid procreation efforts for couples. In the case of Singapore, Singapore went through rapid economic growth and development from the 1960s to the 1980s due to strategies like engaging in industries that substitute imports and encouraging foreign direct investment. From the graph, there is a sharp decline in infant mortality rates from 1950s to the 1960s.This could be due to having the ability to purchase higher quality of preventive healthcare like ultrasound scans. The declining infant mortality rates show the generally positive relationship of income on population health. This positive relationship that income has on population has 2 effects; the demographic transition effect and the epidemiological transition effect. The demographic transition effect arose from the fact that when populations are healthier, life expectancies will increase. As the mortality rates decrease, the net addition to population will increase, ceteris paribus. Due to individuals becoming healthier, people will live longer; this would lead to an increasing proportion of elderly. Coupled with declining fertility rates, this would lead to a demographic shift.
SIMES Newsletter April 2012
Despite the incentives given, there is still a fall in the TFR . Under the assumption that one reason for bearing children is for their use as a productive resource, the falling child mortality rate would show that lesser kids are needed to sustain the level of income security. A positive improvement in income would lead to a general improvement of health, thus girding the effect of the demographic transition. Another effect of income on health would be the change in the disease affecting population health when there is economic development. This can be broken into two effects; as a rise in income due to economic development causes health improving technologies to become relatively affordable. This would lead to a better control of diseases due to better vector control and health prolonging technologies. As some diseases declined due to improvement of control and combat, some other diseases will rise relatively in importance. This will lead to a change in the composition of diseases that the population faces. Another factor affecting the epidemiological transition is due to the generally positive relationship between income and health. An increase in lifespan as a result of improved health will
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TRANSFORMING HEALTH
Healthcare
bring about a host of age related diseases. These two factors bring about the epidemiological transition of population.
SIMES Newsletter April 2012
In the figure showing the Preston Curve:
1.2 Individual (Micro) level At the individual level, there are two factors that influence on the health of the individuals in lieu of rising income due to the economic development and growth. The first factor that affects the individual pursuit of health would be the ‘time preference’ (Fuchs, 1998, 169-170). Time preference refers to the how much would an individual give up the future consumption in return for present consumption. Individuals with high rates of time preference will tend to devote lesser resources to increase future consumption and place more importance on present consumption. A person with high rates of time preference will have worse health, lower income due to the lack of investment in future consumption. (Fuchs, 1998, 169-170). In a perfect capital market, people with low rates of time preference will loan money to people with high rates of time preference to the point where the rate of time discount is at equilibrium. However, this theory of a perfect capital market is far from reality. Individuals with low incomes who want to borrow large sums of money would find that difficult without collateral as banks would view these as risky investments. Many decisions regarding health do not require money which would render the capital market dysfunctional for allocating resources. Another determinant affecting health of the individual in the face of rising income would be the access of the individual to health care. As the incomes of individuals rise, they would have better access to preventive and curative healthcare, thus increasing the health of the population as a whole. 2.0 Preston curve The Preston curve was created in Samuel .H Preston’s groundbreaking work, “The Changing Relation Between Mortality and Level of Economic Development” in 1975. This work was one of the foundations for population health polices and studies. (Leon, 2007) The Preston curve explores the positive relationship between life expectancies and income level for poorer countries and the relationship would be non-linear for the more affluent countries. (Bloom& Canning,2007 ). Preston did an analysis on three decades: 1900s, 1930sand 1960s, which showed the relationship between life expectancy and income.
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There is generally a positive relationship between the life expectancy and income based on the curve Preston curve in 2000. The lower income tier is more responsive to the change in income as compared to the richer countries like Japan or US. 3.0 Conclusion There are many factors to consider when considering the effect of income on population health which sometimes is uncertain or indeterminable due to the lack of empirical evidence. There is still much to be explored and explained in the realm of population study and health economics.
SIMES Newsletter April 2012
TOO BIG TO FAIL
Book Reviews
IS THE US TRULY
SIMES Newsletter April 2012
INFALLIBLE?
INSIGHTS INTO TOO BIG TO FAIL BY KANG YONG KIA
SIMES Newsletter April 2012
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TOO BIG TO FAIL
Book Reviews
SIMES Newsletter April 2012
In the aftermath of the credit crisis, it is probably
a good time to take a backseat and examine exactly what went wrong. On hindsight,
America’s leaders would probably lament the lack of efficiency in decision-making, as well as the prolonged time it took to curb the problem. Too Big To Fail: Inside the Battle to Save Wall Street, penned by Andrew Ross Sorkin, provides detailed insights into the true causes of the crisis. Sorkin often takes the first-person’s point of view in his writings, weaving suspense and drama not unlike the standard Hollywood affair; it is to the extent that the reader can almost feel the immense pressure that must have been felt in the company boardroom during those anxious moments. Upon completion of the book, the reader can expect to have a good grasp of the events leading up to the crisis and better appreciate the intricacies involved in the decision-making process at the US Treasury Department.
A highly recommended and compelling read, this is business journalism at its best. Below is the list of key figures involved in the US debt crisis, followed by a review of the book. I have included the alma mater of the individuals to possibly highlight the fact that an impressive CV does not insulate a person against failure.
LIST OF KEY FIGURES ASSOCIATED WITH THE DEBT CRISIS Richard S. Fuld, Jr.
name “Gorilla”.
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Former Chairman and CEO of Lehman Brothers. Received BA from University of Colorado in 1969, MBA from New York University’s Stern School of Business in 1973. Joined Lehman in 1969 as a commercial paper trader and earned a reputation running the firm’s fixed income business. His short fuse earned him the nick-
Joseph J. Cassano Dubbed “the man who crashed the world”. Former CEO of AIG and head of London-based AIG Financial Products. Studied Political Science at Brooklyn University. Known for his organisational skills, not his acumen in finance. Spearheaded the search for safe-haven investments after the 1997 Asian flu pandemic and the crash of the Thai currency, both of which set off a financial chain reaction. Together with bankers from JPMorgan, pitched the newfound derivative Credit Default Swaps (BISTRO). Even as the bubble inflated, Cassano remained unalarmed.
SIMES Newsletter April 2012
Book Reviews
TOO BIG TO FAIL
SIMES Newsletter April 2012
LIST OF KEY FIGURES ASSOCIATED WITH THE DEBT CRISIS Ben S. Bernanke Current and 14th Chairman of the US Federal Reserve. Graduated summa cum laude from Harvard University in 1975 with BA in Economics, received Phd from MIT in 1979. Scored a near-perfect score of 1590 out of a possible 1600 in the SAT. Taught at the Stanford Graduate School of Business from 1979 until 1985, was a visiting professor at New York University and went on to become a tenured professor at Princeton University in the Department of Economics. Appointed by then US President George W. Bush to be Chairman of the United States Federal Reserve on February 1, 2006. Confirmed for a second term as Chairman on January 28, 2010, after being nominated by President Barack Obama.
Henry M. Paulson Jr. 74th US Secretary of the Treasury (2006 – 2009). Received BA from Dartmouth College in 1968 majoring in English Literature, MBA from Harvard Business School in 1970. Former CEO of Goldman Sachs (1999 – 2006). Was central to most of the decision-making process throughout the crisis, orchestrating the rescue plans for Wall Street’s top banks. Succeeded by Geithner. Suspicions were raised due to the close ties he maintained with the senior personnel of the bailout beneficiaries, in particular, Goldman Sachs.
THE REVIEW
IN this era of heightened competition between the two superpowers that have emerged over the last two decades—the US and China—the US debt crisis does indeed put a dent on the reliability of the once-thought infallible American model of free enterprise and capital markets. In the most recent years running up to the credit crisis, the United States was ushering in an unprecedented generation of wealth. The finance industry boasted $53 billion in total compensation in 2007, with Goldman Sachs accounting for $20 billion of the total, all of which worked out to $661,000 per employee. Goldman Sachs CEO Blankfein alone reaped in an impressive $68 million. However, the story quickly unfolds in a parable-like way reminiscent of an Aesop’s fable, when it became evident that the cri-
SIMES Newsletter April 2012
sis could not be contained. In the words of Sorkin, “This drama is a human one, a tale about the fallibility of people who thought they themselves were too big to fail.” Fuld, former chairman and CEO of Lehman Brothers, has been widely criticised for his dubious decisions. He turned down offers to settle on a capital injection or a merger to save the firm before the crisis, which eventually led to the collapse of Lehman. Fuld had pitched his company’s stocks to investment guru Warren Buffett, but after the latter had perused Lehman’s annual publication 10-K, Buffett uncovered too many discrepancies and rejected Fuld’s ambitious offer. Fuld also took a gamble with potential buyer Korea Development Bank, holding out for
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Book Reviews
TOO BIG TO FAIL
LIST OF KEY FIGURES ASSOCIATED WITH THE DEBT CRISIS Timothy F. Geithner 9th President of the New York Federal Reserve and 75th US Secretary of the Treasury. Received BA in government and Asian studies from Dartmouth College in 1983, MA in international economics and East Asian studies from Johns Hopkins University's School of Advanced International Studies in 1985. Served as an attaché at the Embassy of the United States in Tokyo. Played a large role in allocating funds from the Troubled Asset Relief Program. Criticised by economists for using the funds from the TARP to create “bad banks”.
a higher sell price, but in the end the deal fell through because of Fuld’s obstinacy. As early as 2006, Paulson had warned President Bush that the economy was due for a crisis, likening it to “tinder awaiting to be lit”. Paulson recognised that business cycles typically renew themselves every 6 to 10 years, and it was evident from statistics that a crisis was looming. The stability of businesses on Wall Street relies very much on the confidence of other investorsand it could waver at the slightest hint of a problem. Due to his previous appointment as CEO of Goldman Sachs, Paulson had to frequently defend his actions before Congress. To date, the close friendships he maintains with the higher echelons of
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SIMES Newsletter April 2012
Goldman Sachs shrouds his actions with suspicion and a big question mark still hovers over the effectiveness of his bailout plans. Geithner had also warned of systemic risk (risk of collapse of an entire financial system or entire market), and warned that “this is not theoretical risk, it is not something the market can solve on its own.” Geithner cautioned for years that credit derivatives would ultimately cause banks and the US economy to become more vulnerable, because of the domino effect of defaults. However, no one outside the financial world would listen; the general public was instead serenaded by the words of Greenspan and Bernanke. As Geithner had witnessed firsthand the crushing inflation and deflation of Japan’s bubble economy, he was especially troubled by the lack of attention to the US economy, that the US could very well go down the path of Japan. However, critics disagreed with his decision to create one or more “bad banks” to buy and hold toxic assets, using a mix of taxpayers’ and private money. Furthermore, the blatant lack of oversight and careful planning prior to the implementation of the TARP left the program open to fraud and collusion between participants. A scholar of the Great Depression and having written a PhD thesis on it, Bernanke shared Greenspan’s (his predecessor) views on the importance of the free market, but also attributed the fall of the economy in the summer of 2007 to Greenspan’s short-sightedness. Bernanke instead, advanced the views of Milton Friedman and Anna Schwartz; both co-wrote the paper A Monetary History of the United States, 1867-1960. Bernanke argued that at the time of the Great Depression, the Fed had inadvertently worsened the crisis by not immediately flushing the system with cheap cash to stimulate the economy. Then Fed chairman Herbert Hoover did the exact opposite: tightening the money supply, which choked off the economy. However, it was also clear that Bernanke had failed to gauge the severity of the situation when he declared in his speech that “at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system.” At that time, the subprime market had mushroomed to $2 trillion, but it was still only a fraction of the overall $14 trillion US mortgage market.
Before the financial-sector meltdown, few people had ever heard of Credit-Default Swaps (CDS). They are insurance contracts — or, if you prefer, wagers — which insure that a company will pay its debt. As a founding member of AIG’s financial-products unit, Cassano, who ran the group until he stepped down in early 2008, knew
SIMES Newsletter April 2012
Book Reviews
TOO BIG TO FAIL
SIMES Newsletter April 2012
them quite well. In good times, AIG’s massive CDS-issuance business minted money for the insurer’s other companies. Unfortunately, those same contracts turned out to be at the heart of AIG’s downfall and its subsequent taxpayer rescue. So far, the U.S. government has invested and lent $150 billion to keep AIG afloat. At this point, it is important to note that socialism is taboo in the US; most people believe in “the invisible hand”, that widely held Neoclassical Economics notion that government intervention is at best, a last resort. It is no surprise then, that most people in government thought everyone on Wall Street was greedy and overpaid, and bailing them out was as popular a notion as raising taxes. For most of the interrogation by the banking committee, representatives from the Fed and Treasury stood their ground and explained that the bailout plan was a once-in-a-lifetime act of extreme desperation, elaborating that the demise of one bank could disrupt the entire financial system. Eventually, the US government decided to inject liquidity in banks, in the hope that banks would continue lending, but hopefully not in the irresponsible way that started the crisis in the first place. However, the primary argument against such a policy was that even if the plan worked, it would inadvertently create moral hazard. Interested readers should note that Too Big To Fail goes to great lengths to explore every nook and cranny of the crisis. The author has turned more than 500 hours of interviews and documentary evidence ranging from e-mails to call logs into a bird’s-eye-view account of the credit fiasco. Inside the book the reader will find a detailed description of the whos, hows and whys associated with the crisis; it delves deep into the recesses of Fuld’s brain, exploring the reasons for his actions, which ultimately led to the collapse of Lehman Brothers—one of the top 5 banks on Wall Street— before the onset of the crisis. Concepts such as naked shorting, BISTRO, the Bernanke Doctrine, “Break the Glass” plan, the Uptick Rule, and Repo 105 are also discussed in the book. So if you are keen to learn more about the Merrill Lynch acquisition, the conservatorship of Fannie Mae/Freddie Mac, or the Berkshire Hathaway bailout of Goldman Sachs, this book is for you.
SIMES Newsletter April 2012
A 19
ARE WE RATIONAL OR IRRATIONAL
Debates
SIMES Newsletter April 2012
ARE WE RATIONAL OR
IRRATIONAL? The Future of Rational Economics In An Irrational World BY LIU CAIJUN
THE CONCEPT OF RATIONALITY has been
quite instrumental in shaping mainstream economic analysis, which is deeply
embedded in the traditions of Hobbesian-Lockean political philosophy. That is, taking the concept of rationality as the unequivocal starting point of analysis. However, recent increasing amounts of empirical evidence suggest otherwise. They have contradicted the fundamental assumption of rationality. The seeming inconsistency of human behaviour proves evidential of irrational behaviour. The global economic crisis is one such excellent example. Why did the rational decision-makers of Wall Street fail us? This forces many to raise questions about the far-reaching standards of Homo Economicus(Economic
man: rational and self-interested). Is it an illusion or is it reality? Therefore in a world very much consumed by irrational behaviour, it is wise to understand why some economists still choose to defend rational economics and why others have “quite rationally� chosen to avert from this ideological path.
WHAT IS RATIONALITY?
In economics, a rational decision-maker optimises his goals which have to be reducible to the direct consumption of material goods and services. A rational human being is naturally-constituted and independent. Unfortunately, This concept of full, substantive rationality seems to only function under the conditions of a fully attained competitive equilibrium, without which, would crumble.
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SIMES Newsletter April 2012
ARE WE RATIONAL OR IRRATIONAL
SIMES Debates
SIMES Newsletter April 2012
The Case
FOR
Rational Economics The observable violations of standard economic notions of rationality are indisputable. It is difficult to assume that people can have complete, reflexive, continuous and transitive preferences. Even economists seeking to preserve rationality have begun to recognise the behavorial biases and limited cognition in humans which lead to non-standard behaviour. To explain the non-standard behaviours, the neoclassicalists have come up with two methods: Price-theoretic treatments and axiomatic treatments. Price-theoretic treatments focus on the role of incentives and market discipline in shaping non-standard behaviour whereas the axiomatic treatments involve weakening the assumptions of underlying utility theory (Santos and Chen 2008). One good example of the price-theoretic treatments might be Becker and Murphy(1988) analysis on substance addiction. Although substance addiction is widely recognised to be an “irrational behaviour�, Becker and Murphy grounded their analysis on the belief that such behaviour might arise from underlying stable preferences in which consuming an additive today is indeed a complement, as opposed to a substitute, in consuming one tomorrow. In their opinion, this behaviour is completely rational. According to Santos and Chen, modern behavioural economics seeks behavioural biases in fields like social psychology and sociology. However, Santos and Chen have a deeper analysis in terms of behavioural biases. They conducted experiments on Capuchins, a species that branched out from the primate line approximately 35 million years ago, and found out that Capuchins exhibit the same behavioural biases as human. Human behaviourial biases might result not from species-unique market experiences or cultural learning; instead, such biases are more likely to be far more basic, perhaps even evoled strategies present long ago in our common ancestors (Santos and Chen).
SIMES Newsletter April 2012
Alternative approaches for modeling behaviour as opposed to the standard neo-classical behavioural modeling look at the psychological motivating factors behind decision-making (Opaluch and Segerson 1989). Examples of alternatives are captured by the regret theory, prospect theory and decision making under ambivalence. The fundamental assumption in regret theory is that final utility depends not only on what you get, but also on what you could have gotten had you chosen an alternative action which might avoid a catastrophe. In other words, realised outcomes are judged relatively rather than absolutely (Opaluch and Segerson 1989). Under prospect theory which is a theory of choice under uncertainty by Kahneman and Tversky(1979), decision makers naturally frame their decisions as gains and losses to a particular reference point (Santos and Chen 2008). The need for decision making under ambivalence is when the individual strongly repels and avoid making a decision. This would affect the resultant choice sets in making the decision. This is commonly found in cases where social moral values are challenged and there is no precise trade-offs that are socially acceptable. For instance, the choice between money and death. There is no direct measure of utility in this case and even if the numerical utility is the same, it cannot be simply considered as indifference as the choice of death would be directly filtered. Despite the alternatives provided by Opaluch and Segerson, they emphasise that this does not mean that rational economics has become obsolete. Such alternatives seek to complement and extend neoclassical rational economics in hope to strengthen our very understanding of rationality in human behaviour.
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ARE WE RATIONAL OR IRRATIONAL
Debates
SIMES Newsletter April 2012
The Case
AGAINST
Rational Economics The above mentioned fully attained competitive equilibrium is purely theoretical. It is simply not realistic. Yet, at the same time, it is not satisfactory, even acceptable, to modify the conditions of competitive equilibrium as it would ultimately introduce strategic behaviour which is not under competitive equilibrium (Economic man is generally assumed to interact with each other in a way that is almost frictionless, which will yield equilibrium behaviour). Also, the idea of the competitive equilibrium is an ambiguous one. There is no detailed explanation of the dynamics involved in attaining equilibrium prices. The static nature does not provide us with adequate information for our resolve. Observed behaviour has shown inconsistencies with full substantive rationality, humans basically seem to be incapacitated in making transitive choices and exhibiting error-free cognition as they are assumed to be endowed with. Hence, the rational-actor programme just cannot explain most social occurrence. The hopefuls who attempted to rationalize the problem of inconsistency of the rational-actor theory, had resorted to “prevaricate strategies”, such as the F-twist by Milton Friedman and the “as-if ” statements (Foley 2003). However, such defences seem to weaken the credibility of the theory rather than to reinforce it. One good example of defence might be again the Becker and Murphy (1988) analysis on substance addiction. The idea of rationalising the seeming irrationality is quite futile.
Recognising the unrealistic nature of full rationality, economists have sought ways to weaken the assumptions for rationality. “Bounded rationality” by Herbert Simon and “procedural rationality” by Simon and James Buchanan are some of such examples. Bounded rationality involves accepting sub-optimal behaviour to achieve similar goals as in the case of full rationality. Procedural rationality involves following the rationally devised procedures and accepting the outcomes without working out substantive consequences (Foley 2003). However, the possible variations of full rationality are countless. This only contributes to the non-unification of ideas which will degrade the language from being a normative one (explanatory framework) to a descriptive one. Some behavioural economists provide critiques of rational economics from another approach. According to behavioural economist Dan Ariely, behavioural economics is “founded on the premise that human beings are fundamentally irrational and motivated by unconscious cognitive biases”, as opposed to the neutrality of Santos and Chen. In his article “The End of Rational Economics”, he highlights the importance of psychological basis in understanding irrationality. He mentions the vengeful spirit in humans and that it overrides and overpowers rationality. In the Swiss “trust game with revenge” by Ernst Fehr, the subjects exacted revenge on their anonymous counterparts when betrayed, even if it called for higher price to be paid. The interesting part is that the irrational behaviour of exacting revenge under anonymous conditions generated an increased utility. Well, does this mean that humans have biological roots of being irrational? It remains rather polemical.
Conclusion We have seen ways economists try to keep rational economics alive, such as the rational roots of irrational behaviour and even perhaps the origins of rationality. We have also seen ways in which economists have departed from rational economics, from the structural disagreement to the psychological founding. So what is your take?
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SIMES Newsletter April 2012
Bibliography SIMES
REFERENCES AND PHOTO SOURCES
SIMES Newsletter April 2012
bibliography REFERENCES
PHOTO SOURCES (Or Figures) SIMES logo, courtesy of www.simeconomicsociety.org Sun Shuao, [春秋]第一循吏良臣 孙叔 敖, http://news.hbtv.com.cn/zt/hubeiren/ content/2011-03/19/content_1833534.htm Guan Zhong, 【春秋·管仲】先 有商业经济的鼻祖，后有春秋 第一相, http://wenhua.eco.gov. cn/3/1/6/2/2009/0703/135824.html Chinese market economy, 山东古代 著名的经济都会, http://zx.sd.3158. cn/2011111127/n196711884.html Too big to fail, http://economicoutlier. wordpress.com/2011/05/19/book-reviewtoo-big-to-fail/; http://www.ifc.com/ fix/2011/05/andrew-ross-sorkins-too-bigto; http://www.telegraph.co.uk/finance/ newsbysector/banksandfinance/8387028/ US-hasnt-solved-Wall-Streets-too-big-tofail-problem.html
COVER PAGE
healthcare, http://visualarchive. sg/?cat=130, http://nadeco.org/5-healthytips/, http://www.doctors.com.sg/ health-screening-singapore.html, http:// doctorkem.com/healthy-living/freehealthy-lifestyle-guide rationality, http://www.larsonallen. com/EffectNew.aspx?id=11443, http:// visualrevenue.com/blog/2010/07, http:// rationallyspeaking.blogspot.com/2011/11/ difference-between-rationality-and.html The SDP National Healthcare Plan, SDP to unveil healthcare plan for the nation, http://theonlinecitizen.com/2012/03/sdpto-unveil-healthcare-plan-for-the-nation/
CONTENTS
EDITOR’S NOTE
Too Big To Fail, http://www.moviegoods. com/movie_poster/too_big_to_fail_2011. htm
Singapore population statistics, http:// www.singstat.gov.sg/stats/keyind.html Sruti Pegatraju, courtesy of Sruti Pegatraju
A NOTE FROM SRUTI PEGATRAJU Unemployment in the eurozone hit 10.8%, 23.6% in Spain, http://www.spainreview. net/index.php/2012/04/03/unemployment-in-the-eurozone-hit-10-8-23-6-inspain/
SONG’S PERSPECTIVE
Song Seng Wun, http://www.unisim.edu. sg/microsites/forum/Speaker3.html
Key targets of China’s 12th five-year plan, http://news.xinhuanet.com/english2010/ china/2011-03/05/c_13762230.htm Greece’s bail-out Rescue fatigue, http:// www.economist.com/node/21548251 Seminar by Mr Song Seng Wun
SIMES Newsletter April 2012
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SIMES Bibliography
REFERENCES EDITOR’S ANDNOTE PHOTO SOURCES
SIMES Newsletter April 2012
bibliography
ANCIENT CHINESE WISDOMS
REFERENCES
PHOTO SOURCES (Or Figures)
赵靖主编，《中国经济思想通史》 ，北京大学出版社 2002年修订本 [Zhao Jing, History of Chinese Economic Theory, Beijing University Press (2002)]
Spring and Autumn Period (722 BC – 403 BC), http://history.cultural-china.com/ en/183History6968.html
Bloom, D. E. (2007). Commentary: The Preston Curve 30 years on. International Journal of Epidemiology , 498-499.
Graph on Singapore Infant Mortality Rate, courtesy of Edwin Wan
Jack, W. (1999). Principles of Health Economics for Developing Countries. Washington,D.C: World Bank Institute.
TRANSFORMING HEALTH
Kerwin, J. (2012, 04 9). Globalhealth.hub . Retrieved 4 9, 2012, from Globalhealth. hub . Leon, D. A. (2007). Commentary: Preston and mortality trends. International Journal of Epidemiology , 500-501. R.Fuchs, V. (1998). Who Shall live ? Health,Economics,and Social choice . Singapore: World Scientific publishing .
Graph on Singapore Total Fertility Rate, courtesy of Edwin Wan How will healthcare evolve in future urban cities?, http://www.edb.gov.sg/ future_ready/singapore_sessions/sessions/ healthcare.html Healthcare in Singapore, http://www. gvpedia.com/Singapore/Top-HealthcareFacilities.aspx Health care in 2012: Extension Of Palliative Care In Hospitals, http://www.c3a. org.sg/learning/health-care-in-2012-extension-of-palliative-care-in-hospitals
WHO. (n.d.). Retrieved 04 9, 2012, from WHO: http://www.who.int/publications/ en/ “Too Big to Fail’’, Andrew Ross Sorkin, Penguin Group (USA)”. Us.penguingroup. com. Retrieved 2010-05-22.. ISBN 978-0670-02125-3
Richard S. Fuld, Jr., Bollyn.com Joseph J. Cassano, Zimbio.com Ben S. Bernanke, GlobalPost.com Henry M. Paulson Jr., NYpost.com
TOO BIG TO FAIL
Timothy F. Geithner, articles.NYdailynews. com Too Big To Fail Book Review, http://bookgalaxo.com/2009/12/07/too-big-to-failbook-review/ Foley, D.K., 2003. Rationality and Ideology in Economics. World, 71(2), p.1-10. Available at: http://homepage.newschool. edu/~foleyd/ratid.pdf. Ariely, Dan. “The End of Rational Economics.” Harvard Business Review 87.August 2009 (2008) : 78-85.
ARE WE RATIONAL OR IRRATIONAL
The Myth of Rational Thinking, http:// www.google.com.sg/imgres?um=1&hl=e n&biw=1280&bih=653&tbm=isch&tbni d=HagiLFJYXUsxlM:&imgrefurl=http:// www.woodka.com/2009/07/02/rational /&docid=6FkKWrA82meJWM&imgurl =http://www.woodka.com/wp-content/ uploads/berns_rational_t
Santos, Laurie R, and M Keith Chen. “The Evolution of Rational and Irrational Economic Behavior : Evidence and Insight from a Non-human Primate.” Ed. P W Glimcher et al. Brain (2008) : 81-94. Opaluch, J J, and K Segerson. “Rational Roots of Irrational Behavior, New Theories of Economic Decision-Making.” Northeastern Journal of Agricultural and Resource Economics 18.2 (1989) : 81-95.
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SIMES logo, courtesy of www.simeconomicsociety.org
SIMES SIMESNewsletter Newsletter April April2012 2012