Rent seeking behavior and the economics of commodities

I am taking a small break from writing about Singapore to draw attention to a major story that appeared in the NY Times over the past few days. It appears that Goldman Sachs has been operating Metro International, an aluminum warehousing operation in a manner that inflates the price of the commodity in a classic illustration of "rent seeking". The activities described if accurate, account for high profit and low value added activity, shifting costs to customers and consumers.

In Microeconomics, we teach students that there is no profit in the long run. We make this counterintuitive claim because profit is different in an economic sense than it is in an accounting sense. In accounting profit is the net of revenues and costs, But in economics we are concerned not just about those costs but also the opportunity cost. This is the cost of forgoing the next best opportunity. Meaning that if the accepted rate of return in the economy is 5%, then anything below that is a loss. In the long run we assume that firms can't exceed that rate of return because if there are opportunities for higher than normal profits then firms will enter the market and drive down returns (given a lack of barriers to entry, meaning free entry and exit). There is an incentive then for firms to try to create profit by manipulating markets or government to capture higher than normal profits, economic rent.

In the Goldman Sachs example, the Federal Reserve gave permission for banking institutions to speculate in the commodities market in 2003. Goldman subsequently purchased Metro International which offers warehousing services for aluminum. According to sources cited by the Times, Metro has significantly slowed deliveries of the commodity, at the same time they make money charging rent to customers for warehousing space. The amount of material under the control of Metro has skyrocketed from 850,000 tons in 2010 to over 1.5 Million tons today (it was less than 100,000 tons in 2008).

This is rent seeking writ large. The Federal Reserve has to decide over this next year whether it will continue to allow the banks to control commodities. It is obvious that Goldman does not need aluminum for its operations (nor do the banks like JP Morgan Chase which is trying to do the same for copper), yet they have identified a way to capture profit by simple financialization. There is no value added to the customers, there has been no operational or technological improvement by their ownership just more money flowing to the pockets of execs at the banks at the expense of other businesses and consumers. They manipulate markets and regulators to allow them to capture above normal profits, rent seeking.

Multicultural environment of Singapore

Those who know Singapore know it is a relatively small city-state at the tip of a Malaysian peninsula. Singapore won its independence from Malaysia 48 years ago (after previously getting independence from the UK). It is a relatively new country with new cultural, political and economic foundations. You do not have to spend much time here to see the richness of the multicultural environment.

The Asian influence is strong with a Chinese, Malay, Indonesian and Indian components. I have a Japanese friend here and I am certain there are representatives of other Asian ethnicities here as we'll. There is a Chinatown, Little India and an Arab Street. 

There is the great central mosque, the Sultan Mosque. It anchors the Arab Street area (which is really a quarter). In honor of Ramadan there are special food and shop activities in the latter part of the day near the mosque. Yesterday we met with officials from the Singapore Management University which attracts students from around the world and the director of the institute we visited was an Indian national who has lived here for over 30 years.

And it works. While the political elite is largely of Chinese descent there are significant contributions across the ethnicities. Why does this multiculturalism work? Since Singapore is a small place; 287 square miles and 5.4 million people there is a rational basis for the need to make sure everyone has the capability to make a contribution. Since the birth rate is relatively low, there is a big emphasis on immigration. For example, foreign students are invited into Singaporean universities with subsidized tuitions if they are willing to spend three years working for a Singapore registered company. With this policy they combine the support for human capital development and that of openness to people's from other countries. Typical of many policy choices here, it is rational, there is an incentive, so they do it.

By the way there are many Caucasian visitors and residents here.

Infrastructure in Singapore

One of the interesting features of Singapore is the intense capital investment in infrastructure. Everywhere you go there are good roads, access to public transit and sidewalks. This facilitates life in a densely populated area. Not surprisingly, given the market orientation of the system here, there are incentives and disincentives to lessen traffic and consume public transport. To own a car here is quite expensive.

In fact, car ownership requires payment of a fee that is in excess of the open market value of the car. So cars which are expensive to import become even more expensive to operate as you are paying the price of the car again as a one time excise. On the upside they offer lower (basically free) prices for the subway during  early morning hours. The subway system is comprehensive and efficient. It is convenient and comes frequently. Clean and comfortable it is one of the best transit systems I have ever experienced.

The nation invested significant funds in its deep water ports to capitalize on its strategic sea lane position. I had an amazing view of the shipping lanes on my ride in from the airport and I have never seen so many big ships off a coast. All said the smart investments have contributed to Singapore's high rate of economic growth and high quality of life. 

Initial thoughts on Singapore

I have been here all of almost two days so not by any means an expert but it is a very interesting place. Doing serious research on economic performance here and their focus on human capital for talks later this week. My first takeaway is that I will never complain about the humidity in Boston again. Wow, dripping here constantly. Never felt humidity like this before and that is saying something as I spent my entire life in the Mid-Atlantic and New England regions where humidity is the norm.

The urban environment is quite green in that there are trees and grass everywhere. This photo is of Marina Bay and the three towers of the casino/hotel there. The top is a a park. This is a common site in Singapore as they have rooftop gardens on some buildings including one across the street from my hotel. Singapore is not green in the recycling sense as there is no sign of any efforts. Not sure where all   the garbage goes however.

The people are friendly and cafe life is similar to Europe in that nobody bothers you and service is no speedy. But just relax and take it in and enjoy. At least that has been my philosophy so far. Favorite coffee place is Symmetry which is near the Arab Street area and the great Mosque. Best mocha ever and the food is tasty.

Basketball Blogger

Took some time from politics and economics and wrote about basketball. You can find me at The Casual Hoya

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Cyprus Monday March 18

http://nyti.ms/1317mHM The decision of the ECB and Euro Zone leaders to "tax" deposits in Cypriot banks is a phenomenally bad decision that must cause a giant run on their banks and weaken the entire Euro Zone. Part of the problem that places like Cyprus struggle with are constant capital outflows from current account deficits. Those out flows are made for with inflows from Russians and other convinced of Cypriot stability. So much for that. It is inconceivable that this haircut of depositors could work. Should have just nationalized the banks.

Relationship Stock market and Oil prichttp://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=DCOILWTICO,DJIA&scale=Left,Left&range=Max,Custom&cosd=1986-01-02,1986-01-02&coed=2013-01-29,2013-02-01&line_color=%230000ff,%23ff0000&link_values=false,false&line_style=Solid,Solid&mark_type=NONE,NONE&mw=4,4&lw=1,1&ost=-99999,-99999&oet=99999,99999&mma=0,0&fml=a,a&fq=Daily,Daily&fam=avg,avg&fgst=lin,lin&transformation=nbd,nbd&vintage_date=2013-02-04,2013-02-04&revision_date=2013-02-04,2013-02-04&nd=2007-12-01,2007-12-01

As someone who watches the markets for equities and commodities fairly closely I have been interested in the incidence of relationship between increases in oil prices and the increase in the value of stock market indices like the Dow. Here is a chart of the changes over a period from 1986 until today.