Friday, March 30, 2007

Pertamina versus Chevron

No, this is not about fight next big fight for Indonesian oil field.

I recently finished reading a book entitled "Collapes" by Jareed Diamond about how societies choose to fail or to succeed which according to him is is its relationship with nature. As Professor of Geography at UCLA and winner of Pulitzer Prize as well as National Medal of Science he know very well how to combine long historical vew with eye-opening analysis and captivating prose.

In the book, he recorded his visit to Pertamina site in Salawati Island, Papua and Chevron oil field in Kutubu, Papua New Guinea. This is a snipped on the first "From a long distance, the field's location could be recognized by a flame shooting out of a high tower, where natural gas obtained as a by-product of oil extraction was being burned off, there being nothing else to do with it (facilities to liquefy and transport it for sale were lacking). There are numerous oil spill on the ground. I encountered only three species of large fruit pigeons, of which 14 have been recorded elsewhere on Salawati. A Pertanima employee described to me the location of two pigeons breeding colonies, where he said that he hunted them with his shotgon..." (page 442-3).

This is his take on the second, "I look out the airplane windows for some signs of the oil field infrastructure that I expected to see lookin gup. I became increasingly puzzled still to see only uninterrupted expanse of rainforest...On the flight in, firearms or hunting equipment of any sort are forbidden, on the flight out; animals or plants of their feathers or parts that might be smuggled... New Guineas has many birds and mammal species whose presence and abundance are sensitive indicators of human disturbance... I discover to my astonishment that these species are much more numerous inside the Chvron area than enywhere else that I have visited on the island of New Guinea expecet for a few remote uninhabites areas... In effect, the Kutubu oil field functions as by far the largest and most rigourously controlled national park in Papua New Guinea" (page 444-6).

What are the probable explanations? I quoted in full:

"There are several differences between Pertamina's situation as a national oil company in Indonesia in 1986, and Chevron's situation as international company operation in Papua New Guinea in 1998, that may account for the differing outcomes. The Indonesian public, government, and judiciary are less interested in, and expect less from, the behaviour of oil companies than do their European and American counterparts encompassing Chevron's major costumers. Pertamina's Indonesian employees have had less exposure to enviromental concerns than have Chevron's Amrican and Australian employees.

Papua New Guinea is a democracy whose citizen enjoy the freedom to obstruct developmental projects, but Indonesia in 1986 was a military dictatorship whose citizens enjoyed no such freedom. Beyond that, the Indonesian government was dominated by people from its most populous islands (Java), looked on its New Guinea province as a source of income and a place to resettle Java's surplus population, and was less concerned with the opinions of New Guineans than is the government of Papua New Guinea, which owns the eastern hald of the same islands. Pertamina did not face rising environmental standards from Indonesian overnment, such as those that international oil company face. Pertamina is largely a national oil company within Indonesia, competing for fewer overseas contracts than do the big international companies, so that Pertamina does not derive an international competitive advantage from clean enviromental policies." (page 451-2)

Two questions come to my mind. Why Pertamina has not become an international oil company competing for overseas contracts (like say, Petronas Malaysia)? Second, how far have we really improve since 1986?

Sunday, March 25, 2007

EconMethod: Assumptions

by Berly

The post in kaFE depok have been sporadic and on various topics. Not that it is bad; after all there are so many things to analyzed and so little time. But there is nothing wrong with series of posts on a connected topic to dig deeper and understand more. Therefore, I inaugurate the first instalment of our first series.

Economic methodology has not received wide attention in the academic discussion in Indonesia. At most department of economics in Indonesia there will be one class on economic history that implicitly discuss methodology and one class on general research methodology. There are very few, if any, undergrad doing their thesis on economic methodology.

With so many developmental and economic problems in Indonesia it is understandable that our Econ PhD students abroad are more occupied with mastering the use of sophisticated economic and econometrics tools rather than substantiate the arcane technical and philosophical assumptions behind. You know what they say, those who can’t do economics, study methodology.

But I would argue that it is impossible to do proper economics without understanding sufficient economic methodology (which also includes history of methodology and how they developed) and applicability to Indonesia. All-out liberalization would not worked as well in Indonesia as in US/EU since they already have strong legal protection at place (and taken as granted). Studying unemployment in Indonesia will need modified analysis of self selection bias since Heckman estimation was developed with unemployment insurance in mind. Poverty analysis in Indonesia could not use only income as indicators since many Indonesian farmers consumed what they produce. The list can go on.

Now a bit on qualifications. Aside from long time interest since undergrad time, I took courses on Economic History and Methodology at University of Amsterdam (UvA) at master level. Courses? Yeap, not only one course. And also not two courses. But three courses. One of them was taught by a John Davis that held two PhDs (in Economics and Philosophy) and the editor of Journal of Economic Methodology.

Occasionally, Indonesian economists quoted Milton Friedman paper entitled “The Methodology of Positive Economics” in defending unreal assumptions in economics. I don’t know if they have read Friedman’s entire paper, but I know I did. I was assigned to it and presented my analysis in the class.

Here is the infamous quote, “Truly important and significant hypothesis will be found to have assumptions that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory the more unrealistic the assumptions…To be important, therefore, a hypothesis must be descriptively false in its assumptions…”

Friedman stressed that the validity of economics is not in the assumption but on prediction. A billiard player may not be know the of law of physics but he played as if he knows it since that is the only way to put the balls out and win the game. A person may not be totally selfish and materialistic but economist can predict the action by assuming as if he is.

There have been numerous critiques to this position. Alan Musgrave, a philosophy professor, said that Friedman over-generalized on assumption (assuming too much about assumption?). There are three kinds of assumption according to him and mixing them up is a mistake.

The neglibility assumptions are factors that only affect the analytical result in very minor ways thus can be assumed away. Example in physics includes air friction in a calm day that only slightly affects speed of falling item. The domain assumption put boundaries where theories are valid inside it but not outside. The celebrated example are the search for Theory of Everything since quantum mechanics and relativity, each valid in their domain, propose radically different descriptions of the universe. Heuristic assumption is use at early stage of theory presentation to be drop later.

The example in economics is as follow. Micro economics textbook usually start with an economy without government. Does it mean that whether government exist or not will have no detectable differences to phenomena investigated? No, so it is not neglibility assumption. Does it mean that the theory only valid when there is no government intervention? Domain assumption may play a role here. But mostly it is used as heuristic assumption which will be relaxed shortly.

Stiglitz (1994) has a stronger word, “I have shown that slight perturbations in the standard information assumptions drastically change all the major results of standard neoclassical economics. The theory was simply not robust at all.” I think he is referring to domain assumption meaning most of the neo classical theory that preceded recognition of asymmetric information problem was only valid if there were none.

The other strong argument against Friedman’s over-simplication is the heart of his argument. The model with self interest, super-rational and time-consistent agent don't always predict well, in some case it way off the fact. Yes, the neo classical model can explain some of the action, but the accuracy sure can be improve.

Aside from knowing the direction of action we also need to know the magnitude of the effect. Recent development in behavioral economics and experimental method prove to better predict (and explain) human behavior by incorporating additional (and more realistic) assumption that human also care (and willing to incur cost in taking action that benefit) on other people not only self, process not only result, non-material instead of only material (more in the next installment).

Please keep the above argument in mind next time an economist used Friedman’s line as shield.

Thursday, March 22, 2007

Review of Economics Studies European Tour

A couple of months ago, cafe salemba posted an article on the most promising young economist (young guns) in US (link).

In line with that article, review of economics studies already picked seven most promising job market candidate in the world to present the paper in several universities in Europe.

here are a quote from RES website (here)
"The Review of Economic Studies European Meetings have been held annually in May since 1989. Every year, in line with the Review's tradition of encouraging the work of young economists, seven of the most promising graduating doctoral students in economics and finance in the world are selected to present their research to audiences in Europe. The meetings take place at the economics departments or institutes of three or four major universities across Europe. Standard seminar presentations are given over two days to audiences invited by the local hosts and which include members of the journal’s editorial board. "

This year's "very" young guns are:

Although, they are still in the gradute school (mostly will be graduated on July 2007), most of them already published in top economics journal (AER, JPE, etc, ).

Congratulation for them....

Saturday, March 10, 2007

The Price of Airline Safety

by Berly

We at kaFE depok rarely post on actual events. Maybe since most of us are students so we are more exposed to methodological and theoretical aspects of economics while the daily experience are more in contact with European livelihood.

But the recent Garuda accident in Jogja definitely worth a mention. It took away the sense of security in domestic flying. Almost as if we found out that some of Blue Bird drivers are criminals. Previous accidents are all occurred at private and budget airline, thus critics pointed out for a supposed link between low ticket price and flight safety.

Not anymore. Garuda is definitely not selling the cheapest ticket for Jakarta-Jogja route. So finally people (hopefully) can disentangle price from safety.

Is it really cost that much to apply safety measure? In the short run it will cost more but with low reputation of safety then there will be less people buying the ticket meaning less revenue. The first question is within subject, mean one company applying two different treatments. The second question is more tricky, will airline with better safety have higher ticket price?

The answer is not necessarily. Ryain air is the top budget airline in Europe with the chepest price that could range below 10 euro (before airport tax) if you ordered one month or more before the flight. Yet, it obtained high profit (329 million euros in second half 2006) and very high passenger (more than 750 flights a day) with no recent history of accident. The safety record of other main budget airlne (EasyJet, AirBerlin, TransAvia) are also very good.

An efficient airline can deliver high safety and low ticket price. Many cost items can be cut. Food on the plane? just unbundled and sale to those willing to pay. Flight entertainment and free goodies? Forget it. Personnel? Make those pretty air steward served double duty at ticket counter in the airport before take off. Revenue? Institute a dynamic ticket pricing where those that buy ticket earlier (thus having lower opportunity cost of time and value flexibility less) to get it at lower price. Today Ryanair even charge if we check-in luggage in additional to cabin luggage.

So should we all sit down, calculate the expected probability accident and risk premium we are willing to pay for safety? You could, but the complexity of the calculation, technicality of safety procedure and the possibility of death certainly raise some difficulties.

This situation resemble asymmetric information problem where the customer know less about a product than the sellers. Since the effectivity of setting up a mechanism design and incentive compability constraint is in doubt, the remedy would be to increase information flow.

EU has an agency that empowered to conduct random safety check of airline and then rank them accordingly. Those with unacceptable lowest will be ban from Europe sky, meaning huge loss of revenue while the low-but-still-acceptable airline is given warning. More important, the ranking are post online and quoted by major newspaper (to read more click here, here, and here). The concept has many similar with rating agency such as Moody or S&P. Thus, the low rank should provide premium (lower ticket price or more perk) to be selected. Equipped with the information; customers are free to choose among airlines.

So what we need is an Asean-wide agency, staffed with prffesional from all over Asean with similar responsibility as in EU. A national agency would be more susceptible to political pressure and bribe and high safety country would raise the standard due to reputation confern. Of course, there should be sufficient salary for the inspector, monetary incentive if they found security flaw and severe punishment for bribery. There is already Asia Pacific branch of International Civil Aviation Organization that can serve or assist the embryo of such agency. Who said economist always dislike regulation and against government role?

*** update:
The article has been published in Paras Indonesia with minor modifications (to read click here)

Wednesday, March 07, 2007

Queing in Japan

by Berly

I recently returned from a presenting paper in conference at
Japan, as I has read many things about Japan (the second biggest economy in the world, centre of innovation and reverse engineering, etc) I am a bit disappointed to found few skyscraper in Tokyo and Osaka (turn out that taller building more susceptible to earthquake) and little sign of affluence.

But I found people, lot of them. More than 66% of the 127 million Japan populations are living in urban area. With mountains and forest still filling most of Japan landscape, there are more than 50 % of population lives on 2 % of land. With population density of 1,523 persons per square kilometer for habitable land, Japan society is certainly a crowd.

I remember reading (please tell me the author if you happened to know) the supposed correlation between population density and social order. In highly dense population, society is compelled to developed norms where people tolerate other more, being nicer to other or both. It quite makes sense since a shoot-from–the-hip cowboy character would find many reasons to be angry with more people swooshing around (just try to get in Tokyo subway in rush hour).

Combine the high population density with justice system during pre-Meiji era where death is almost the single punishment. That should weed out most of energetic and rebellious gene that did not become samurai. The social system in pre-Meiji era also organized in a mini cell (10 household) where mistakes will result in punishment for all. Thus, the Meiji reform and introduction of western knowledge is imposed on a discipline and responsive-to-direction from-the-top society that said to inspire Borg race in Star Trek series.

I am especially fascinated by the queue for metro/subway in busy station. Instead of standing in random and start queue when the metro arrive, the Japanese just walk to designated place where the door will be, start queuing in neat two lines and wait there until it arrive. Inside the bus and metro, if you hear any ring-tone then you can be sure that the phone is own by a non-Japanese, and of course there are no graffity or bubble gum stain in the public transport. There is unexceptionally high regards for public good.

I have lived in Holland and visited both UK and Germany, all three with long history of population density, structured society and industrialization (even if with less severe justice system compare to Japan). Can’t start wondering if there is any correlation between civic duty (queuing habit, strict law enforcement, norms of saying sorry & thank you, etc) has strong correlation with industrialization and economic growth.

What do you think?

Thursday, March 01, 2007

Children and watching TV

There are many ways how an economist come out with a certain topic. Amongst them are the personal experience.

Motivated by experience handling his autism son (now permanently cured due to policy to bandon TV for his child) , a cornel economist , M Waldman, and his other two fellows S Nicholson (cornell), N Adilov (purdue) did a research on autism and watching TV (read here). They found that watching TV could cause autism. In their research, they used rain prescription (thus the wheater report) as the instrument variable.

This results then become the heated debate among economist and geneticist. The geneticist argue that the research needs an experiment in a controlled/steriled area. Otherwise there would be a misconclusion (inconsistency in econometrics terms). (read wsj). Pat Levitt, geneticist from Vanderbilt University, gives some possible misconclusions. He argue that there are possible several factors such as the quility of the house, the cleaness of the house, the area where the house is located and the air quality inside the house, that affect the autism rather than watching TV (read time).

In economics terms, Levitt argue that the instrument variable used by Waldman et al is not valid (the rain prescription is still not orthogonal with the error term on the main regression). Thus, the regression would be inconsistent. (Since from the variables he proposed -the quility of the house, the cleaness of the house, the are where the house is located and the air quality inside the house -, at least one of them can not be observed by econometrician, thus will be included in the error term of the first regression. Since these variable could have some correlation with the rain prescription in one area, thus the instrument variable is correlated with the error term of the first regresssion)

However, despite the debate on the inconsistency, there is one thing that could be learnt. Before further results and decision from the referee in academic journal (this paper is not published yet. So it could receive many comment from referees thus need to be revised), TV could be not good for children. Why do you take a risk, if you could avoid them. Parents should be risk averse after all (regarding the decision related to their children)

In Indonesia, we are all still remember the "smack down" case.(for debate about this, you can read cafe salemba). Taking into account the results of Waldman et al, now there is one additional reason for parents to limit the time of their children to watch TV.

Now, after all this possible bad effect of TV, will you still let your children watch too much TV?