Uber Pricing

                     Comments due by Oct. 18, 2014

NEW competitors always ruffle a few feathers. The unique thing about Uber, a new taxi-market player, is that it seems to have annoyed some of its customers as much as the incumbent cabbies it threatens. The problem is its “surge pricing”, which can make the cost of Uber rides jump to many times the normal fare at weekends and on holidays. Gouging customers like this, critics reckon, will eventually make them flee, denting Uber’s business. Microeconomics suggests that although Uber’s model does have a flaw, its dynamic pricing should be welcomed.

Taxi markets have long needed a shake-up. In theory, entry should be easy—all that is needed is a car and a driving licence—with new drivers keeping cab fares close to costs. Yet in many cities, cabs are far from that competitive ideal. Decades of regulation conspire to keep entrants out. In New York a pair of taxi medallions sold at a 2013 auction for $2.5m; many other cities have similar schemes. In London “the knowledge”, a test of familiarity with the city’s streets which GPS has made redundant but drivers still have to pass, can take four years to complete. Taxi markets often end up suspiciously clubby, with cabs in short supply and fat profits for the vehicle owners. Antitrust concerns have been raised in Australia, Ireland and Bulgaria among others.

Uber aims to change all this. Launched in San Francisco in 2010 it lets passengers hail drivers from their smartphones—a move requiring even less effort than extending your arm. Some vehicles are not so much taxis as private cars that Uber has vetted. The convenience of hailing a cab from the comfort of a sofa or bar stool has given the service a loyal fan-base, but it comes at a cost. Most of Uber’s prices are slightly cheaper than a street-hailed cab. But when demand spikes, the surge prices kick in: rates during the busiest times, such as New Year’s Eve, can be seven times normal levels, and minimum fares of up to $175 apply.

Critics of Uber’s pricing are treading a well-worn path: setting tailored prices for the same good—price discrimination—often causes howls from consumer groups. It seems unfair when the charges for drugs vary across countries, the price of train tickets varies with the buyer’s age, or, as in Uber’s case, the price varies depending on the time that the journey is booked.

But price discrimination is not necessarily a bad thing, as a 2006 paper by Mark Armstrong of Oxford University explained. A firm offering a single price to all customers faces a trade-off: lowering prices raises sales but means offering a cut to customers prepared to pay more. Maximising profits can often mean lowering supply: goods are not provided to cheapskate shoppers so that more can be made from high-rollers. Customers who value the good at more than it costs to produce might miss out in a one-price-fits-all system—as many punters who have tried to find a regular cab on New Year’s Eve will know.

Uber’s price surge aims to solve this. Like many technology companies Uber is a middleman. It links independent cab drivers with customers wanting a ride in the same way that Google links searchers and advertisers or eBay links sellers and bidders. The business model only works when successful matches are made. Because price spikes raise the pay Uber’s drivers receive (they get 80% of any fare, if they drive their own car) more cars are tempted onto the roads at times of high demand. Prices are high at 2am at the weekend not just because punters are willing to pay more, but also because drivers don’t want to work then.

This strategy is common for firms that operate platforms or “two-sided” markets which link buyers and sellers, according to a 2006 paper by Jean-Charles Rochet and Jean Tirole of Toulouse University. Firms often tilt the market to give one side a particularly sweet deal: nightclubs let women in free to justify charging men a hefty fee, telephone directories are given away to create a readership which advertisers pay to access. The theory predicts each side’s deal depends on two things: price sensitivity and how well-stocked each side of the market is. Uber’s price surge fits perfectly: Friday-night revellers are hit by a double whammy since they are willing to pay up precisely when the pool of cabs is low.

The real pricing problem

There is some evidence Uber’s surge pricing is improving taxi markets. The firm says drivers are sensitive to price, so that the temptation to earn more is getting more Uber drivers onto the roads at antisocial hours. In San Francisco the number of private cars for hire has shot up, Uber says. This suggests surge pricing has encouraged the number of taxis to vary with demand, with the market getting bigger during peak hours.

However, the inflexibility of Uber’s matchmaking fee, a fixed 20% of the fare, means that it may fail to optimise the matching of demand and supply. In quiet times, when fares are low, it may work well. Suppose it links lots of potential passengers willing to pay $20 for a journey with drivers happy to travel for $15. A 20% ($4) fee leaves both sides content. But now imagine a Friday night, with punters willing to pay $100 for a ride, and drivers happy to take $90: there should be scope for a deal, but Uber’s $20 fee means such journeys won’t happen.

Despite the revenues a matchmaking fee generates, it may not be Uber’s best strategy. A fixed membership charge is often firms’ best option in two-sided markets. By charging drivers a flat monthly fee Uber would generate revenue without creating a price wedge that gets in the way of matches. Since stumping up cash might put infrequent divers off, they could be offered a cheaper category of membership. Uber should keep its surge pricing in place. But to make the market as big as possible, and really revolutionise taxi travel, it might need to retune its fees. 

The Rise of the Robots

                                                    (C0mments due by Oct.11, 2014)
For decades, people have been predicting how the rise of advanced computing and robotic technologies will affect our lives. On one side, there are warnings that robots will displace humans in the economy, destroying livelihoods, especially for low-skill workers. Others look forward to the vast economic opportunities that robots will present, claiming, for example, that they will improve productivity or take on undesirable jobs. The venture capitalist Peter Thiel, who recently joined the debate, falls into the latter camp, asserting that robots will save us from a future of high prices and low wages.

Figuring out which side is right requires, first and foremost, an understanding of the six ways that humans have historically created value: through our legs, our fingers, our mouths, our brains, our smiles, and our minds. Our legs and other large muscles move things to where we need them to be, so our fingers can rearrange them into useful patterns. Our brains regulate routine activities, keeping the leg- and finger-work on track. Our mouths – indeed, our words, whether spoken or written – enable us to inform and entertain one another. Our smiles help us to connect with others, ensuring that we pull roughly in the same direction. Finally, our minds – our curiosity and creativity – identify and resolve important and interesting challenges.

Thiel, for his part, refutes the argument – often made by robot doomsayers – that the impact of artificial intelligence and advanced robotics on the labor force will mirror globalization’s impact on advanced-country workers. Globalization hurt lower-skill workers in places like the United States, as it enabled people from faraway countries to compete for the leg-and-finger positions in the global division of labor. Given that these new competitors demanded lower wages, they were the obvious choice for many companies.

According to Thiel, the key difference between this phenomenon and the rise of robots lies in consumption. Developing-country workers took advantage of the bargaining power that globalization afforded them to gain resources for their own consumption. Computers and robots, by contrast, do not consume anything except electricity, even as they complete leg, finger, and even brain activities faster and more efficiently than humans would.

Here, Thiel offers an example from his experience as CEO of PayPal. Instead of having humans scrutinize every item in every batch of 1,000,000 transactions for indications of fraud, PayPal’s computers can approve the obviously legitimate transactions, and pass on the 1,000 or so that could be fraudulent for thoughtful consideration by a human. One worker and a computer system can thus do what PayPal would have had to hire 1,000 workers to do a generation ago. Given that the computer system does not need things like food, that thousand-fold increase in productivity will redound entirely to the benefit of the middle class.

Put another way, globalization lowered the wages of low-skill advanced-country workers because others would perform their jobs more cheaply, and then consume the value that they had created. Computers mean that higher-skill workers – and the lower-skill workers who remain to oversee the large robotic factories and warehouses – can spend their time on more valuable activities, assisted by computers that demand little.

Thiel’s argument may be correct. But it is far from airtight.

In fact, Thiel seems to be running into the old diamonds-and-water paradox – water is essential, but costs nothing, whereas diamonds are virtually useless, but extremely expensive – albeit in a sophisticated and subtle way. The paradox exists because, in a market economy, the value of water is set not by the total usefulness of water (infinite) or by the average usefulness of water (very large), but by the marginal value of the last drop of water consumed (very low).

Similarly, the wages and salaries of low- and high-skill workers in the robot-computer economy of the future will not be determined by the (very high) productivity of the one lower-skill worker ensuring that all of the robots are in their places or the one high-skill worker reprogramming the software. Instead, compensation will reflect what workers outside the highly productive computer-robot economy are creating and earning.

The newly industrialized city of Manchester, which horrified Friedrich Engels when he worked there in the 1840s, had the highest level of labor productivity the world had ever seen. But the factory workers’ wages were set not by their extraordinary productivity, but by what they would earn if they returned to the potato fields of pre-famine Ireland.

So the question is not whether robots and computers will make human labor in the goods, high-tech services, and information-producing sectors infinitely more productive. They will. What really matters is whether the jobs outside of the robot-computer economy – jobs involving people’s mouths, smiles, and minds – remain valuable and in high demand.

From 1850 to 1970 or so, rapid technological progress first triggered wage increases in line with productivity gains. Then came the protracted process of income-distribution equalization, as machines, installed to substitute for human legs, and fingers created more jobs in machine-minding, which used human brains and mouths, than it destroyed in sectors requiring routine muscle power or dexterity work. And rising real incomes increased leisure time, thereby boosting demand for smiles and the products of minds.

Will the same occur when machines take over routine brainwork? Maybe. But it is far from being a safe bet on which to rest an entire argument, as Thiel has.

Bradford De Long)

Inequality, Unemployment and Technology

                                                     (Comments due by Oct. 5, 2014)

Productivity and profits are growing, but jobs and wages are not, creating an unsustainable economy

If you ever wonder what's fueling America's staggering inequality, ponder Facebook's acquisition of the mobilemessaging company WhatsApp.

Facebook is buying WhatsApp for $19 billion. That's the highest price paid for a startup in history. It's $3 billion more than Facebook raised when it was first listed, and more than twice what Microsoft paid for Skype.

(To be precise, $12 billion of the $19 billion will be in the form of shares in Facebook, $4 billion will be in cash, and $3 billion in restricted stock to WhatsApp staff, which will vest in four years.)

Given that gargantuan amount, you might think WhatsApp is a big company. You'd be wrong. It has 55 employees, including its two founders, Jan Koum and Brian Acton.

WhatsApp's value doesn't come from making anything. It doesn't need a large organization to distribute its services or implement its strategy. It doesn't require lots of people to assemble anything or sell anything or transport anything.

Its value comes instead from two other things that need only a handful of people. First is its technology -- a simple butpowerful app that allows users to send and receive text, image, audio and video messages through the Internet. Second is its network effect: The more that people use it, the more other people want and need to use it in order to be connected. To that extent, it's like Facebook -- driven by connectivity.

WhatsApp's worldwide usage has more than doubled in the past nine months, to 450 million people -- and it's growing by around a million users every day. On December 31, 2013, it handled 54 billion messages (making its service more popular than Twitter, now valued at about $30 billion.)

How does it make money? The first year of usage is free. After that, customers pay a small fee. At the scale it's already achieved, even a small fee generates big bucks. And if it gets into advertising, it could reach more eyeballs than any other medium in history. It already has a database that could be mined in ways that reveal huge amounts of information about a significant percentage of the world's population.

The winners here are truly big winners. WhatsApp's 55 employees are now enormously rich. Its two founders are now billionaires. And the partners of the venture capital firm that financed it have also reaped a fortune.

And the rest of us? We're winners in the sense that we have an even more efficient way to connect with each other.

But we're not getting more jobs, and our wages are stuck.

In the emerging economy, there's no longer any correlation between the size of a customer base and the number of employees necessary to serve them.

In fact, the combination of digital technologies with huge network effects is pushing the ratio of employees to customers to new lows. (WhatsApp 55 employees are all what its 55 million customers need).

Robert Reich

Can GM produce a real Luxury car

Can GM produce a competitive luxury car or are the American consumers wedded to German made vehicles? The record at GM has been mixed so far. Cadillac has produced two worthy competitors in the CTS and ATS models but has not done an admirable job on the 6000 pound Escalade. The market will get a chance to pass a verdict in the next 6-9 months.

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General Motors’ struggling Cadillac division is hoping that bigger is better.

While luxury competitors have been scaling down their offerings, Cadillac announced on Friday that it would add a new, larger sedan to its lineup next year, which it hopes will lure wealthy trendsetters.

G.M. did not release specifics of the yet-unnamed flagship sedan, but the automaker described it as a “top end, high technology” car intended to compete with the best from German rivals.

“The objective for this upcoming model is to lift the Cadillac range by entering the elite class of top-level luxury cars,” Cadillac’s president, Johan de Nysschen, said in a statement.

The new car will take aim at the BMW 7 Series, Audi’s A8 and the Mercedes S-Class — the top of each competitor’s lineup. Those sedans carry price tags starting in the $75,000 range and can exceed $100,000 for the most feature-laden configurations.

But while the luxury auto market has been surging this year, Cadillac has been left behind.

Through August, Cadillac’s overall sales were down 5 percent this year compared with a year ago, and the company’s sedans have fared even worse, down a combined 15 percent through August. The entry-level ATS sedan, though widely praised, has not taken off with buyers. Its sales were down 20 percent; the larger CTS sedan was down 6 percent.

The entire market for luxury vehicles in the United States has risen 14 percent over the same period, according to the auto research firm AutoData. Audi sales are up 15 percent, BMW up 12 percent and Mercedes-Benz up 9 percent this year through August.

“Cadillac still suffers from more of an older demographic,” said Jessica Caldwell, senior analyst with Edmunds.com.

Cadillac has also suffered from a seemingly endless cast of executives rotating through its top positions. In July, the company looked to the outside, hiring Mr. de Nysschen from Nissan’s Infinity division in an attempt to bring fresh ideas and long-term stability to Cadillac’s leadership.

Mr. de Nysschen is best known for his work at Volkswagen. He played an important role in transforming Audi into a true luxury competitor. Cadillac wants to be seen similarly as among the best luxury brands in the world.

One bright spot for Cadillac is China, where it sold more than 50,000 vehicles last year. The new sedan aims to capitalize on that market, said Xavier Mosquet, head of the Boston Consulting Group’s automotive practice.

Mr. Mosquet said that the European market had no appetite for large cars, and while Americans did, the number willing to buy an ultraluxury Cadillac was not large enough to justify the investment in the new model. Chinese buyers, on the other hand, are not only snapping up larger, more luxurious vehicles, but are also open to switching from one auto brand to another.

“Many in China are now first-car owners,” he said. “People are now about to make new choices, and many of them want to upgrade.”

Mr. Mosquet said that even though only the elite in China were likely to be able to afford the new flagship Cadillac, the aspirational effect for lower-tier buyers would be important. With so much of the Chinese market up for grabs, and no long-ingrained loyalties to weigh down buyers’ decisions, Cadillac has a chance to establish a reputation in China that matches that of the Germans.Production of the new Cadillac will begin next year in the fourth quarter. It will be assembled at G.M.’s Detroit-Hamtramck plant, which currently builds the Chevy Volt, Impala, Malibu and Cadillac ELR. The company plans to unveil the new model in the first half of 2015.

(NYT)

Gender Gap: Wages

Debates over the supposed differences between men and women are a staple of pop culture. But two new books offer an economic look at the evidence, giving support to both pessimistic and optimistic perspectives on the direction of gender relations and the prospects for more fairness and equality.

The first book, “Why Gender Matters in Economics” (Princeton University Press, 2014) by Mukesh Eswaran, an economics professor at the University of British Columbia, draws on data from past economic studies conducted under laboratory conditions to show how gender influences financial actions and relationships.

In one set of these experiments, called the dictator game, women were found to be more generous than men. Players were given $10 and allowed but not required to hand out some of it to a hidden and anonymous partner.Women, on average, gave away $1.61 of the $10, whereas men gave away only 82 cents.

In another test, called the ultimatum game, one player received $10 and then decided how much of it to offer to a partner. (Let’s say the first player suggests, “$8 for me, $2 for you.” If the respondent accepts the offer, that’s what each gets. If the respondent is offended by the unequal division or dislikes it for any other reason, he or she may refuse, and then no one gets anything.)

Photo

CreditMinh Uong/The New York Times

The depressing news was this: Both men and women made lower offers, on average, when the responder was female. Male proposers offered an average of $4.73 to male respondents, but only $4.43 to women. More painful yet was the behavior of female proposers, who, on average, offered $5.13 to men but only $4.31 to women. It seems that women were seen as softies who were willing to settle for less — and the discrimination was worse coming from the women themselves.

Another economic test involved a game in which players would fare best collectively if they cooperated, and yet individuals had an incentive to act more opportunistically for a higher payoff. The laboratory result was that women were more likely to start off by cooperating, but then would learn through bitter experience that they’d be taken advantage of if they continued to do so. By the time this game was played over multiple rounds, the initially cooperative behavior of the women converged into the more opportunistic behavior of the men, but women’s initial reluctance to use cutthroat strategies still brought them losses.

In another setting, women seemed quite willing to compete against other women but much less willing to compete against men. And in yet another study, women negotiated harder when they were working on behalf of others rather than for themselves, which implied a reluctance to push their own interests.

In sum, these research results suggest that women are perceived as easier to take advantage of in a variety of economic settings. That’s the bad news, and it comes from measuring a difference in gender behavior at a specific point in time.

There is greater cause for optimism, however, when we study changes over time. We find the more positive evidence in another new book, “The Silent Sex: Gender, Deliberation and Institutions” (Princeton University Press, 2014) by Christopher F. Karpowitz, professor of political science at Brigham Young University, and Tali Mendelberg, professor of politics at Princeton.

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Continue reading the main story

Drawing upon data from politics, business meetings and behavior in the corporate boardroom, they portray a society where women participate less in many public settings, especially those in which real power is exercised. This links up with the experimental results described in Mr. Eswaran’s book, because an underparticipating group that doesn’t resist discrimination is more likely to suffer.

Continue reading the main stor

This sounds gloomy so far. But the authors show that once women achieve a critical mass in a particular area, their participation grows rapidly, at least after basic norms of inclusion have been established.

In fact, the general method of economics provides foundations for some feminist views. First, economics emphasizes that incentives matter and that incentives can be changed. These are common themes underlying feminist thought, which stresses how a fairer social environment can give people greater reason to choose better behavior.

Second, the long-term response to a change in incentives is often much greater and more important than the short-term response. For instance, Mr. Karpowitz and Ms. Mendelberg show that, over time, men behave in a less stereotypically male way when more women are participating in an organization or an activity.

As a former chess player, I am struck by the growing achievements of women in this great game — one in which men were once said to have an overwhelming intrinsic advantage. (Among the unproven contentions was that men were better at pattern recognition.) Although women were never barred from touching the chess pieces, strong female players were few in number.

These days, many more women play very well, and the gap between the top men and women in the game is narrowing. The main driver of the changeappears to be that more and more women are playing chess, creating a cycle of positive reinforcement that encourages ever more women to excel. We’ve seen a similar dynamic in the workplace, as more women have made great strides in the areas of law, medicine and academia. And this process may spread to other sectors of the economy as well, such as technology industries.

This longer-term, optimistic perspective has deep roots in economics, and was articulated eloquently in “The Subjection of Women,” John Stuart Mill’s 19th-century essay. Mill said men and women were indeed different, but he saw the achievements of women as dependent on incentives and the work environment, which he thought could be improved beyond what most people in his day — and perhaps ours, too — could easily imagine. For all the sexist behavior we economists measure in the lab, the research around the bigger picture is supporting Mill’s optimism about a better world to come.

Tyler Cowen is professor of economics at George Mason University. Follow him on Twitter at @tylercowen.

Do we need a new economics?

Since the 2008 financial crash, our country has been reeling without getting its economic policy right. What we needed then, and need now, is a new kind of macroeconomics; one that aims for investment-led growth, not consumption-led growth. But investment-led growth can't be achieved by a temporary stimulus. It requires a very different kind of strategy and policy. Investment-led recovery requires a clear identification of our society's longer-term needs, needs that can be filled through complementary investments by the public and private sectors. Think of railroads and farms in the late 19th century; highways, cars, and suburbs in the 1950s; and information technology, smart grids, and low-carbon energy for our time. And it requires a set of public policies to spur those investments, in part by using smart public investments to help leverage a private-sector investment boom.

Therefore, it is very frustrating to read Paul Krugman again today write about our current stagnation with so little reflection on his part that his own preferred stimulus policies can't solve the problem. It's of course even worse to hear this from Larry Summers, who Krugman quotes favorably today. Summers was the architect of Obama's economic policies during the first term, and now he tells us that the administration's policies haven't worked.

Both Summers and Krugman subscribed to Keynesianism, the idea that larger budget deficits and short-term stimulus after 2008 would revive the economy. Neither of them reflected on how the macroeconomic policies after 2008 should respond to the causes of the crisis. If they had, they might have recommended a very different strategy. And the debt-to-GDP ratio might not have doubled in the meantime as a result of the reliance on Keynesian stimulus policies.

When the financial crisis broke out in the fall of 2008, I warned against the Keynesian approach to recovery. In 2009, I had this to say about the administration's economic plans:

The White House and Congress are attempting in every way they can -- through tax cuts, rebates on home buying, and cash for clunkers -- to boost total spending. The cash-for-clunkers epitomizes the shortsightedness of it all. We paid billions of dollars for individuals to trash their existing cars and buy new ones. In general, the neo-Keynesians think about "stimulus" -- that is, aggregate demand -- without thinking much about the various needs and uses of public and private spending, or about the longer-term consequences of budget policies... Yet none of this will work. The U.S. economy, and the world economy, cannot recover sustainably by propping up consumers for yet another binge.

Consumption-led recovery was the wrong way to go then and it still is now. The entire crisis of 2008 began with a debt-financed consumption and housing binge that went wrong. By 2009, consumers were broke and exhausted. Wages of median workers had not risen for decades (!). Did the administration and Krugman really believe that a two-year temporary demand stimulus would truly do the job? They sure acted that way. Krugman wanted an even larger stimulus, which would have caused an even greater surge in the debt-to-GDP ratio than we've had. But it would again have been at best a temporary salve, and most likely done little to spur a permanent recovery.

Keynesians like to say that there is a savings glut (an excess of saving over investment). They try to remedy it by spurring consumption. This is a mistake. There is an investment shortfall, because the financial, regulatory, and policy barriers to high-return investments have not been addressed. America urgently needs investments in modernized infrastructure, advanced science and technology, and job skills appropriate for the 21st century. We are sitting on top of an information revolution and nanotechnology revolution that could positively reshape healthcare, education, transportation, low-carbon energy systems, green buildings, water conservation, and environmental safety.

What are we doing about it? Very little, alas. Just look at the paucity of actual investments being made. There is so little dynamism. The wondrous IT revolution, with its potential to remake our economy as a world leader in efficiency and quality of services, needs to be much more than new apps for smartphones and new ways to sell online advertising through social media.

Obama's political advisors were woefully shortsighted in 2009, and the president himself was badly misled by the simplicity of Keynesian stimulus, to the point of believing that "shovel-ready" projects would surge with just a little fiscal pump priming. How sad. What a lost opportunity. There were no such shovel-ready projects, as the president later acknowledged.

Large-scale investments remain impeded because the U.S. lacks basic strategies in all key sectors. We have no national energy strategy other than fracking; no modern transportation strategy; no coastal protection strategy; no jobs-training strategy. The list of "no strategies" goes on. The result is that we have little investment dynamism where we need it, and continue to hope for spending in the old standard-bearers: housing, cars, and consumption goods. In the meantime, competitors like China are shaping their economies for the technological advances of the 21st century.

We need, in short, a new macroeconomics that moves us beyond the tired debates over public debts and short-term stimulus. Here's what I wrote about such a new framework back in 2009:

Macroeconomists trained in the past 30 years believe that demand increases depend mainly on interest rates and deficit or tax levels. Yet increased spending on renewable or nuclear power plants, a robust power grid, carbon-capture and sequestration, wastewater treatment facilities, fast inter-city rail, higher education, urban co-generation of electricity and heat, green buildings, and countless other new sustainable technologies, will depend on establishing a policy framework that harmonizes regulations, land use, public financing, and private investment. Large-scale stimulus, in other words, requires the nitty-gritty of public-private planning, technology assessments, demonstration projects, and complex project financing.

The new tools of macroeconomics, therefore, are quite different from the existing tools. The new tools begin with a medium-term (say, ten-year) budget framework, so that tax policies are not pulled out of thin air or campaign rhetoric, but reflect the calculated needs for public outlays; a medium-term set of income distributional goals and strategies, especially to break the back of child-poverty, rising school drop-out rates, and training for low-skilled workers; structural objectives regarding the rebuilding of infrastructure and the transition to a low-carbon economy; and a new set of institutions to carry out these policies. The new institutions might include a National Infrastructure Bank, as Obama mentioned during the campaign, to help finance public-private partnerships in energy, water, and transport. The Energy Department might be reconstituted as the Department of Energy and Climate Change, to bring the requisite expertise and financing for the low-carbon economy under one roof.

Many progressives will no doubt say that I'm being unfair to the Keynesians, and that they too would favor an investment strategy if the Republicans didn't block them. I hope that's true. Yet Keynesian stimulus repeatedly takes our eyes off the long term. We need a new approach to growth, not another quick fix. And if the time is not right politically for an investment-led approach, it will become right the more we prepare and advocate for it.

Follow Jeffrey Sachs on Twitter: www.twitter.com/JeffDSachs

Can the Russian Economy withstand the Sanctions?

Signs of Russia’s growing economic distress became even clearer today, as the central bank unexpectedly raised interest rates for the second time since March, while Standard & Poor’s cut the country’s debt rating to one notch above junk.

In lifting the benchmark borrowing rate from 7 percent to 7.5 percent, the bank said it was acting to cool inflation that’s now running above 7 percent. But, says economist Tim Ash of Standard Bank in London, “it has nothing to do with inflation. It’s all about signaling that the central bank is shoring up its defenses” to strengthen the ruble and stem the flight of capital from the country.

Whether the bank can achieve those goals looks doubtful. The ruble, the second-worst-performing currency among developing countries this year, continued to lose ground today, trading above 36.01 against the dollar. And, as S&P noted in its downgrade announcement, the standoff over Ukraine could spur capital outflows, which already exceeded $50 billion during the first three months of the year. Ash predicts the total could reach as much as $200 billion by yearend.

With Russian companies and consumers facing higher borrowing costs, the rate hike will depress an economy that’s already in danger of tipping into recession. And continuing political uncertainty over Ukraine means that foreign companies “will not invest in Russia’s real economy, they’ll just stall their investment,” Ash says.

Moreover, “inflation is likely to remain relatively high,” above 7 percent this year, emerging-markets economist Liza Ermolenko of Capital Economics in London wrote in a note to clients. “This is the result of Russia’s deep-seated economic problems—in particular, the fact that wages have been growing well ahead of productivity.”

All this while the West is still mulling tougher economic sanctions on Russia. President Obama, traveling in Asia, is planning a conference call with European leaders to discuss whether to expand the limited sanctions now in place. Secretary of State John Kerry warned in Washington on April 24 that Russia was running out of time to avoid sanctions. “If Russia continues in this direction, it will not just be a grave mistake, it will be an expensive mistake,” he said.

“What we’re seeing now is a pretty permanent exodus from Russia, and it will be very difficult for the Russian central bank to fight it,” Lars Christensen, chief emerging-markets analyst at Danske Bank in Copenhagen, tells Bloomberg News. “The central bank is very much between a rock and a hard place. They frankly seem quite desperate in their actions.”

(Bloomberg Businessweek)