Separating the micro from the macro

Dani Rodrik's blog has become a must-read for those interested in economic development. Recently, he's been writting quite a bit on the merits of industrial policy. Contrary to most orthodox economists, he argues that extensive market failures do justify intervention, at least in some cases (see here).

Now, industrial policy models come in many flavors. There's the East Asian development model, based on exports, and the old import substitution model (ISI)followed in Latin America and in India from the 1950's to the 1980's. Results were, obviously, very different.

But, as Rodrik points out, industrial policy falls within the realm of the micro. While it does have macro repercussions, it's absurd to blame it for events such as the Latin American debt crisis of the 1980's. After all, some countries with open economies, such as Chile, experienced severe crises at that time, while ISI-followers such as Colombia and India did not.

That makes The Economist's economics blog's screed against import substitution so bizarre. One can debate ISI's merits, but arguing that ISI caused the debt crisis because it hampered the recovery that came after (which is obvious) makes no sense.

This doesn't mean the two are completely separate. An argument can be made that by the 1970's the ISI model had run against diminishing returns, lowering growth. Facing acute political and social pressures, many Latin American governments worked to raise growth by massively (and recklessly) increasing public spending. This was possible because of the abundant liquidity in the 1970's, which enabled governments go get abundant, low-cost foreign currency loans. If Latin American nations had opened their economy earlier or developed more efficient ways to combat unrest, things may have turned out very differently.

Brangelina kills Bat Boy

Sad, but true. Supermarket cashier lines will be a duller, sadder place after Weekly World News recently ceased publication, although it retains a web site. Those furtive glances (it took rare courage to actually grab a copy) always brought a smile. Now, we're left only with humorless, unimaginative gossip and soap opera rags.

I did enjoy this, perhaps unintentionally poignant, op-ed by one of its contributors.

I was, at first, confused about whether I was supposed to write true offbeat news, general satire or complete fabrication. So I asked. The response was loud and clear: "complete fabrication." (In case this wasn't clear, the paper started running a disclaimer in 2004: "The reader should suspend disbelief for the sake of enjoyment.")

Yet each piece was written as if completely real. So when, for example, Bigfoot got married, launched his acting career and became involved with Kabbalah, each story got a dateline, quotes from "sources" and "experts" and followed a typical Associated Press structure. In fact, much of the original staff came from mainstream newspapers. The standard? It had to seem true.

"Half the readers realize the stories are tongue-in-cheek; the other half believe they're all true," my editor explained. "You have to write the stories to satisfy both groups."

Without such whimsy, the world is a little bit diminished.

Cemex or why geographic diversification helps

Mexico-based Cemex, the world's leading construction materials firm, certainly qualifies as a victim of the U.S. housing collapse. The U.S. market represents a quarter of its sales and in the second quarter its sales fell 16% year-on-year, following a similar drop in volume. Spain, another big market facing housing woes, also saw a more modest volume contraction.

Yet, Cemex managed to squeeze out a 6% rise in sales during the second quarter. How? Well, a strong euro (the RMC acquisition gave it a strong presence in Europe) and booming emerging market sales, including Mexico, managed to compensate its troubles in the U.S.

So, its vaunted diversification is finally proving its worth. But curiously, Cemex is not the Mexican cement firm you want to be invested in. That honor belongs to Grupo Cementos Chihuahua, a much smaller produccer that has also entered the U.S. market in a big --and much more succesful--way. Just compare the performance of their stocks.

Nokia's blowout

It's not every day that a company with a market cap of $100 billion plus sees its stock price jump 8% in one session. Today Nokia did just that after reporting its 2Q results.

Were its numbers that good? Yes, despite the fact that one of its four engines is not working (its network equipment division, Nokia Siemens), a strong euro and so so performance in its biggest division (mobile phones).

Leaving aside the network division numbers, which are not comparable to previous periods due to the Siemens merger, sales jumped 13% over the year-ago period. But what's extraordinary is that they rose nearly 14% compared to the first quarter. That's 40%+ annual growth going forward. It was driven by strong growth in multimedia devices (fancy 3G phones and PDA's) and enterprise solutions.

I have no idea whether they can keep up this growth rate. And it's certainly a feast and famine industry, with long stretches of little or no growth (2002-2004). Yet, at 21 times earnings, while no bargain, it's certainly not too expensive to cash in on one of the world's leading growth markets.

After all, worldwide cell phone penetration standas at 40%, according to the ITU, with Asia at 30%. So there's still a lot of room for growth.

Malthusian nonsense never goes away

Over the nearly 200 years since the good Rev. Malthus published his famous hypothesis that food supply can't keep up with population growth, the facts have shown, over and over again, that he got it wrong. Yet, every time food prices rise, neo-Malthusians rise up and say that this time it'll be different.

Well, today's Malthusian Chicken Little is none other than celebrity Harvard professor Niall Ferguson (see here, hat tip to Economist's View). Sure, food prices have risen over 20% as he states. And yes, per capita grain production has not kept up with world population growth over the last two decades. So, is he right that food will be increasingly scarce and expensive in the future?

Nonsense. The IMF's commodity food price index has risen 23% over the last 24 months. (Not all atributable to ethhanol, weather and oil prices have also played their part). But they're only 7.7% above their level in 1980. So even if we assume a modest world inflation rate of 2% a year on average over the last 27 years, in real terms food prices are actually 37% below the 1980 level.

How about the grain supply? According to the FAO, world grain production rose 32.5% between 1979-1981 and 1999-2001, while the world's population rose 45% over the same period. Yet, during this time, meat production jumped 72% and fruit/vegetable production rose 91.7%. Folks, this is a sign of greater affluence and better nutrition.

While there's no denying that climate change will pose challenges, I have no doubt the world will be able to feed itself in the future, as yields rise in many emerging economies and the genetics revolution spreads. And I'm just as sure that uninformed doomsayers like Dr. Ferguson will keep appearing every time food prices rise.

Emerging markets have arrived

Last week, developed world stock markets fell 5%, according to MSCI. Traditionally, emerging markets would fall twice as much on your average market panic (like this year's China scare or 2006's big May sell-off). But last week the MSCI EM index fell just 5.7%.

While I would be reluctant to declare the end of emerging market crises, this certainly shows just how much their risk levels have fallen due to fundamental improvements and, just as important, that developed nation investors have come to know and recognize this fact. As a veteran of nearly 30 years of economic upheavals in the developing world, this is as welcome as it was unexpected a decade ago.

How inept can a ruler be?

No, I'm not thinking of George W. Bush right now. Guess which long-standing national leader uttered this infamous phrase recently:

"Where money for projects has not been found, we will print it," xxx was quoted as saying.

The answer is: Robert Mugabe of Zimbabwe. Not surprisingly, inflation in that country, currently over 4,500% a year, is going to infinity and beyond. If I were a betting man, I'd wager Mugabe's regime will collapse in less than a year.

If you're interested in why Zimbabwe technically got into this mess, check out this paper.

Economic tortoise, financial hare

Other than in soccer, Latin America has (mostly) lagged behind (east) Asia in nearly all indicators, specially in terms of economic growth. But, as BCA Research recently noted, Latin American stocks have outperformed their Asian peers by a wide margin over the last 20 years. Capital Spectator looks at some explanations, but finds no clear answer.

Actually, there's a pretty simple explanation.

In the 1980's, Latin America was stuck in a huge economic and financial crisis after many nations defaulted on their foreign debt and commodity prices plunged. At the same time, the Asian Tigers were roaring along quite nicely. Hence, Latin American stocks at that time had very high risk premiums incorporated into their valuations. Those risk premiums have fallen dramatically as LA has put its finances in order during this time frame. Thus, starting from a lower base, the region's stocks have outperformed.

One could aslo add that the LA sector is dominated by a few fantastically profitable monopolies/oligopolies and that Asian markets were and are much more liquid, so that a falling liquidity premium might be helping LA stocks.

Contagion in the credit markets?

The markets were once again singin' the ol' sup-prime mortgage blues today. However, I believe that fears of a meltdown in the credit markets are way overblown. For one, corporate balance sheets are pretty healthy after years of record-high profits and modest leverage. In fact, spreads between BAA corporates and Treasuries have stayed pretty stable (however, I don't have data for the past couple of days).



The real problem lies with consumers and certain financial firms, where leverage has grown strongly, as this graph shows.



Outside the financial sector, my one big worry is what impact falling home prices will have on consumers. So far, American consumers have, as always, withstood the storm. But for how long? Only time will tell, but in the meantime I'd avoid stocks exposed to U.S. consumer demand.

A bubble in emerging market stocks?

This graph says yes. It compares the evolution of the Nasdaq Composite between June 1994 and June 1999 and the MSCI Emerging Markets index between June 2002 and June 2007.




We know how the Nasdaq story played out after a few more months of spectacular rises. But appearances can deceive. The main difference between these two? The Nasdaq's P/E was well north of 100x at its peak, while the P/E for emerging markets as a whole is around 15x today.

Of course, this doesn't guarantee that emerging market stocks are a good investment opportunity today, but at least they're not obviously overvalued.