Cyclopedia Of Economics 3rd edition

7. 
   Money back warranties or guarantees. These are really forms of free content. The consumer is safe in the knowledge that he can always return the already consumed content and get his money back. In other words, it is the consumer who decides whether to transform the content from free to paid by not exercising the money back guarantee.
   

8. 
   Relative pricing. Information available on the Web is assumed to be inherently inferior and consumers expect pricing to reflect this "fact". Free content is perceived to be even more shoddy. The coupling of free ("cheap", "gimcrack") content with paid content serves to enhance the RELATIVE VALUE of the paid content (and the price people are willing to pay for it). It is like pairing a medium height person with a midget - the former would look taller by comparison.
   

9. 
   Price rigidity. Free content reduces the price elasticity of paid content. Normally, the cheaper the content - the more it sells. But the availability of free content alters this simple function. Paid content cannot be too cheap or it will come to resemble the free alternative ("shoddy", "dubious"). But free content is also a substitute (however partial and imperfect) to paid content. Thus, paid content cannot be priced too high - or people will prefer the free alternative. Free content, in other words, limits both the downside and the upside of the price of paid content.
   

This article is, of course, free content...:o))

The experiment of online content is in its infancy. Content creators, providers and aggregators fall into seven categories, though hybrids and permutations abound:

Unrestricted access to the entire body of content available through a central URL or database.

Access to the entire body of content available through a central URL or database conditioned on providing a few personal data and being assigned - or choosing - a user ID and password. But, subject to registration, the content is entirely free, as in (I).

Unrestricted but time-limited access to some content available through a central URL or database. Access to new material is free and unrestricted. Access to archived material requires a subscription.

Unrestricted but time-limited access to some content available through a central URL or database. Access to archived material is free and unrestricted. Access to new material requires a subscription.

Unrestricted but time-limited access to some content available through a central URL or database. Various parts of the Web site (desks, chapters, features, articles, stories, sections, etc.) become accessible at different times. Access is rotated between these sections periodically or thematically or arbitrarily.

Unrestricted - time unlimited or time limited - access to some content (selected articles, headlines only, etc.) available through a central URL or database. Access to the rest of the content requires a subscription.

Access to content subject to paid subscription or payment per item.

Vodka is a crucial component in Russian life. And in Russian death. Alcohol-related accidents and cardiac arrests have already decimated Russian life expectancy by well over a decade during the last decade alone.

Vodka is also big business. The brand "Stolichnaya" sells $2 billion a year worldwide. Hence the interminable and inordinately bitter battle between the Russian ministry of agriculture and SPI Spirits. The latter, still partly owned by the state, is the on and off owner of the haloed brand "Stolichnaya", James Bond's favorite.

SPI's PR firm, Burson-Marsteller, posits this commercial conflict as a classic case of the violation of the property rights of hapless foreign shareholders by the avaricious and ruthless functionaries of an unreformed evil empire. They question Russia's readiness to accede to the WTO and its respect for the law.

SPI's latest press release consists of the detailed history of this harrowing tale. The brand Stolichnaya, as well as 42 others, were privatized in 1992. The firm quotes a document, bearing the official seal of the maligned ministry, which states unambiguously: "VAO Sojuzplodoimport has the right to export Russian vodka to the USA under the following trademarks: Stolichnaya, Stolichnaya Cristall, Pertsovka, Limonnnaya, Privet, Privet Orange (Apelsinovaya), Russian and Okhotnichya."

The privatization was completed in 1997 when the old SPI was sold to the new SPI Spirits. The new SPI claims to have assumed $40 million in debt and invested another $20 million to rebuild the company into "one of the world's leading vodka producers". Yet, the Russian government, as heavy handed as ever, clearly is unhappy with SPI.

It says the privatization deal was dubious and that SPI paid only $300,000 (or maybe as little as $61,000 claim other sources) for the multi-billion dollar brands, including "Stolichnaya", "Moskovskaya", and "Russkaya". The government values the brands at a far more reasonable $400 million. Other appraisers came up with a figure of $1.4 billion.

The government, in a bout of new-found legal rectitude, also insists that the seller of the brands, the defunct (state-owned) SPI, was not their legal owner. It also questions the mysterious shareholders of the new SPI - including a holding company in tax-lenient Delaware. SPI's trademarks portfolio is represented by an Australian law firm, Mallesons Stephen Jaques.

Putin himself set up a committee for the repatriation of these and other consumer brands to the state. He craves the beneficial effects the alcohol sector's tax revenues could have on the federal budget - and on its powers of patronage. A central state-owned brand-holding and distribution company was set up less than two years ago. Ever since then, the alcohol sector has been subjected to relentless state interference. SPI is not the most egregious case either.

"The Observer" mentions that SPI currently runs most of its business from inscrutable Cyprus, a favorite destination for Russian money launderers, tycoon tax evaders, and mobsters. SPI's German distributor, Plodimex, is increasingly less active - as three new off shore distribution entities (in Cyprus, the Dutch Antilles, and Gibraltar) are increasingly more so.

The FSB ordered Kaliningrad customs to prohibit bulk exports of Stolichnaya. Cases of the drink are routinely confiscated. Criminal charges were brought against directors and managers in the firm. The Deputy Minister of Agriculture is discrediting SPI in meetings with its distributors and business partners abroad. He is also accused by the firm of obstructing the court-mandated registration of its trademarks.

The courts have lately been good to SPI, coming out with a spate of decisions against the government's conduct in this convoluted affair. But on February 1, the firm suffered a setback, when a Moscow court ruled against it and ordered 43 of its brands, the prized Stolichnaya included, returned to the government (i.e., re-nationalized).

SPI is doing its best to placate the authorities. It is rumored to have offered last month to use its ample funds to supplement the federal budget. It has indicated last September that it is on the prowl for additional acquisitions in Russia - a bizarre statement for a firm claiming to have been victimized. "The Moscow Times" reported that it is planning to sign a $500,000 sponsorship agreement with the Russian Olympic Committee.

Summit Communications, a country image specialist, placed this on its Web site in November last year:

"One example of a savvy Russian company that has managed to do well in the West by finding the right partner is the Soyuzplodimport company (see also p. 14). Soyuzplodimport, or SPI, has the exclusive rights to export Stolichnaya, which vodka lovers in the U.S. fondly refer to as 'Stoli'. Some 50% of the company's export turnover comes from the United States, thanks mostly to its strategic alliance with Allied-Domecq for U.S. distribution.

'I'm not sure that all Americans know where Russia is on the map, but most of them know what Stolichnaya is,' muses Andrey Skurikhin, general director of SPI. 'I want the quality of Stolichnaya in America to create an image of Russia that is pure, strong and honest, just like the vodka. At SPI, we feel that we are like ambassadors and we will try to do everything to create a more objective and positive image of Russia in the U.S.'"

SPI's troubles may prove to be contagious. Allied Domecq, its British distributor in America and Mexico, now faces competition from Kryshtal International, a subsidiary of the troubled Kristal distillery, 51% owned by Rosspirtprom, a government agency. Kryshtal signed distribution contracts for "Stolichnaya" with distilleries backed by the Russian ministry of agriculture.

Allied and Miller Brewing have announced a $50 million investment in product launch and marketing campaigns only two years ago. "Stolichnaya" (nicknamed "Stoli" in the States) sells 1 million 12-bottle cases a year in the USA (compared to Absolut's 3 million cases).

The trouble started almost immediately with the first foreign investments in SPI. As early as 1991, Vneshposyltorg, a government foreign trade agency,  tried to export Stolichnaya in Greece. This led to court action by the Greeks. Vodka wars also erupted between the newly-registered Russian firm "Smirnov" and Grand Metropolitan over the brand "Smirnoff".

The vodka wars are sad reminders of the long way ahead of Russia. Its legal system is rickety - different courts upheld government decisions and SPI's position almost simultaneously. Russia's bureaucrats - even when right - are abusive, venal, and obstructive. Russia's "entrepreneurs" are a penumbral lot, more enamored with off-shore tax havens than with proper management. The rule of law and private property rights are still fantasies. The WTO - and the respectability it lends - are as far as ever.

In October 2005, Parliamentary Assembly of Europe members tabled a draft resolution castigating the human rights situation in the province of Vojvodina. As EU accession looms larger for Serbia and Montenegro, such resolutions are bound to proliferate. Vojvodina is widely regarded as a test case and the touchstone of Serbia's post-Milosevic reforms.

Milosevic is still a hate figure in Vojvodina. Until he abolished it in 1989, the northern region, bordering on Hungary, enjoyed an autonomy granted by Tito's successive constitutions. Vojislav Kostunica, the current prime minister of erstwhile rump Yugoslavia and a one time winner of the first round of elections for the presidency of Serbia has replaced the deposed autocrat as chief villain. His opponent, the reform-minded Miroljub Labus, won convincingly only in Vojvodina and southwestern Serbia in the self-same elections.

Exactly four years ago, the provincial assembly of Vojvodina sacked the region's deputy prime minister, a Kostunica crony, and upgraded the status of Novi Sad to "capital city". The assembly's speaker stormed into the building of Novi Sad's TV and radio to protest a Belgrade appointment.

Serb radicals demanded full self-government, the large Hungarian minority - one eighth of Vojvodina's two million strong populace - petitioned for self-rule in locales with a Magyar majority, moderates urged Belgrade to start negotiating soon. Hungary, under the previous prime minister, Viktor Orban, agitated aggressively on behalf of its ethnic kin. It looked as though Vojvodina is about to join the ranks of independence-prone Kosovo and Montenegro. Many Vojvodina Serbs still regard it as central European, having been part of the Habsburg empire until 1918.

Vojvodina's denizens - pro-Western, highly educated, intellectuals, members of the free professions, and globe-trotting businessmen - were horrified by the barbarity of Yugoslavia's tortured demise. They now act as the self-appointed conscience of Serbia and Montenegro.

In June 2002, Nenad Canak, the head of the provincial parliament, demanded the prosecution of journalists who contributed to "warmongering" during Milosevic's reign. As reported by Radio B92, the organizers in Novi Sad in August 2002 of "Blood and Honey", an exhibition of photo-journalist's Ron Haviv's work in the Balkan in the 1990's, wrote in a letter addressed to Kostunica, among others:

"Why do you keep silent regarding nationalistic and chauvinistic behavior? Why is this problem being ignored? This is obviously not an isolated incident, but an organized, planned and financed action. Does this mean that you are turning a blind eye to the truth? The [truth] is simple - wars happened and crimes were committed in them, crimes that we will have to face, sooner or later."

Even their dismay at NATO's surgical demolition during the 1999 Kosovo campaign of their three economically-critical bridges over the Danube and their only oil refinery did not turn them into anti-Western xenophobes.

Finally, in January-February 2001 and again in January-February 2002, the Serbian parliament restored some of the territory's previous powers and privileges - over its finances, agriculture, health care, justice, education, tourism, sports, the media, and social services. Mile Icakov, a triumphant parliamentarian, from the late Djindjic's DOS umbrella grouping of reformist parties, quoted by Radio Free Europe/Radio Liberty, uttered this veiled admonition:

"That's something we had and that's something that belonged to us and nobody has to grant it to us, but to return back what was taken away against the law and against the constitution... Everyone in Serbia has already agreed on the largest-possible autonomy for Kosovo. Nothing will change if they do the same for Vojvodina. It would be fair to give Vojvodina the [same rights]. It's not fair that the bad kid gets everything he asks for and the good kid gets nothing."

Yet, the omission to tackle Vojvodina's grievances - or even to consult it - in the March 14, 2002 EU-sponsored Agreement on Restructuring Relations between Serbia and Montenegro irritated the disgruntled province. Vojvodina is not only Yugoslavia's bread basket, it also harbors its nascent oil industry, and many of its blue-chips.

As a result, it is a net contributor to the federal budget and subsidizes the other parts of the rump Yugoslavia. It produces two firth of Serbia and Montenegro's dwindling GDP and attracts two thirds of its foreign direct investment - with only one fifth of its population.

In January 2002, the French multinational Lafarge bought a majority stake in the Beocin cement factory near Novi Sad. It paid $51 million of which Vojvodina is likely to see very little. Five loss making sugar factories were next in line. Serbia's privatization minister pledged to plough back one quarter of all future privatization receipts into the local economy.

Then Serbian Minister of Agriculture, Forestry and Water Management, Dragan Veselinov, offered to subsidize sugar beet, soybean, and sunflower crops and to buy 280,000 tons of wheat in 2003. But these belated pre-election bribes did not soothe jangled nerves.

During the 1990's Vojvodina was reluctantly flooded with Serb refugees from Bosnia, Croatia, and Kosovo. The "invasion" altered its character. The erstwhile bastion of tolerant Austro-Hungarian culture has been Balkanized and rendered discernibly more nationalistic, corruption-ridden, and fractious. Neo-fascist, anti-Semitic, revisionist, racist, pro-Greater Serbia, and skinhead organizations proliferate.

The two pillars of the movement for self-governance are, therefore, nostalgia and money. It is a belated reaction to the convulsive and blood-spattered disintegration of the federation. But it is also a rejection of Vojvodina's exploitation by the other provinces.

Like Scotland and Flanders, northern Italy and Quebec, and the Shiite and Kurd regions of Iraq, Vojvodina would like to retain a larger share of its resources for local consumption and investment. In a "Europe of regions" and a world of disintegrating nation-states, this was to be expected. In August 2002, the Committee for International Cooperation and Relations with Euroregions of the Vojvodina parliament voted to join the Assembly of European Regions (AER).

Vojvodina still faces the outcomes of a decade of Western economic sanctions and NATO military action. Sanctions-busting smuggling operations during Milosevic's rule criminalized some parts of the economy. Novi Sad's water, natural gas, the railway to Budapest, river cargo transport, and telecommunications infrastructure were rendered idle by the decimation of its bridges.

The reconstruction of the first, largest bridge, "Sloboda" (or Liberty) was completed in 2004 and cost 34 million euro in EU funds, according to "Balkan Times". Two temporary crossovers cater to the needs of Novi Sad's population - but they are poor substitutes. Rail links to the rest of Europe, for instance, have yet to be restored. The expensive and intricate clearing of the Danube of unexploded ordnance has been completed only recently.

Vojvodina strives to become a regional commercial hub. HINA, the Croat news agency, reports that the Serb province and the neighboring Vukovar-Srijem county in Croatia have agreed to rebuild bridges, in both the literal and the figurative senses. Vojvodina vowed to help Vukovar secure the return of art expropriated by the Serbs during the internecine war, demine its environs, and find the whereabouts of missing Croat soldiers and civilians.

Vojvodina's parties are members of the ruling, Western-orientated, formerly Djindjic-led, coalition in Belgrade. The Vojvodina Reformists, who backed Kostunica in the recent bout of elections, once have teamed with a DOS breakaway faction to form a new, left of center, political force. Vojvodina plays a crucial role in Serb politics.

Even the leader of the Alliance of Vojvodina Hungarians, Jozsef Kasza, admitted to the Yugoslav daily "Dnevnik", that the status of the Hungarian minority is improving "step by step", though "Hungarians are still not adequately represented in the judiciary, prosecutions, in leading positions in the economy."

He elaborated: "During the Milosevic era they wouldn't let us have our schools, media, they banned the official use of the language. The situation has now improved, the Law on national communities has been passed which needs to continue its implementation more and more."

In an inversion of the traditional roles, the Beta news agency reported that Vojvodina's then secretary for culture and education, Zoltan Bunjik, announced a series of assistance programs targeted at the Serb minority in Hungary, including a Serb history and culture curriculum.

Volatility

Volatility is considered the most accurate measure of risk and, by extension, of return, its flip side. The higher the volatility, the higher the risk - and the reward. That volatility increases in the transition from bull to bear markets seems to support this pet theory. But how to account for surging volatility in plummeting bourses? At the depths of the bear phase, volatility and risk increase while returns evaporate - even taking short-selling into account.

"The Economist" has recently proposed yet another dimension of risk:

"The Chicago Board Options Exchange's VIX index, a measure of traders' expectations of share price gyrations, in July reached levels not seen since the 1987 crash, and shot up again (two weeks ago)... Over the past five years, volatility spikes have become ever more frequent, from the Asian crisis in 1997 right up to the World Trade Centre attacks. Moreover, it is not just price gyrations that have increased, but the volatility of volatility itself. The markets, it seems, now have an added dimension of risk."

Call-writing has soared as punters, fund managers, and institutional investors try to eke an extra return out of the wild ride and to protect their dwindling equity portfolios. Naked strategies - selling options contracts or buying them in the absence of an investment portfolio of underlying assets - translate into the trading of volatility itself and, hence, of risk. Short-selling and spread-betting funds join single stock futures in profiting from the downside.

Market - also known as beta or systematic - risk and volatility reflect underlying problems with the economy as a whole and with corporate governance: lack of transparency, bad loans, default rates, uncertainty, illiquidity, external shocks, and other negative externalities. The behavior of a specific security reveals additional, idiosyncratic, risks, known as alpha.

Quantifying volatility has yielded an equal number of Nobel prizes and controversies. The vacillation of security prices is often measured by a coefficient of variation within the Black-Scholes formula published in 1973. Volatility is implicitly defined as the standard deviation of the yield of an asset. The value of an option increases with volatility. The higher the volatility the greater the option's chance during its life to be "in the money" - convertible to the underlying asset at a handsome profit.

Without delving too deeply into the model, this mathematical expression works well during trends and fails miserably when the markets change sign. There is disagreement among scholars and traders whether one should better use historical data or current market prices - which include expectations - to estimate volatility and to price options correctly.

From "The Econometrics of Financial Markets" by John Campbell, Andrew Lo, and Craig MacKinlay, Princeton University Press, 1997:

"Consider the argument that implied volatilities are better forecasts of future volatility because changing market conditions cause volatilities (to) vary through time stochastically, and historical volatilities cannot adjust to changing market conditions as rapidly. The folly of this argument lies in the fact that stochastic volatility contradicts the assumption required by the B-S model - if volatilities do change stochastically through time, the Black-Scholes formula is no longer the correct pricing formula and an implied volatility derived from the Black-Scholes formula provides no new information."

Black-Scholes is thought deficient on other issues as well. The implied volatilities of different options on the same stock tend to vary, defying the formula's postulate that a single stock can be associated with only one value of implied volatility. The model assumes a certain - geometric Brownian - distribution of stock prices that has been shown to not apply to US markets, among others.

Studies have exposed serious departures from the price process fundamental to Black-Scholes: skewness, excess kurtosis (i.e., concentration of prices around the mean), serial correlation, and time varying volatilities. Black-Scholes tackles stochastic volatility poorly. The formula also unrealistically assumes that the market dickers continuously, ignoring transaction costs and institutional constraints. No wonder that traders use Black-Scholes as a heuristic rather than a price-setting formula.

Volatility also decreases in administered markets and over different spans of time. As opposed to the received wisdom of the random walk model, most investment vehicles sport different volatilities over different time horizons. Volatility is especially high when both supply and demand are inelastic and liable to large, random shocks. This is why the prices of industrial goods are less volatile than the prices of shares, or commodities.

But why are stocks and exchange rates volatile to start with? Why don't they follow a smooth evolutionary path in line, say, with inflation, or interest rates, or productivity, or net earnings?

To start with, because economic fundamentals fluctuate - sometimes as wildly as shares. The Fed has cut interest rates 11 times in the past 12 months down to 1.75 percent - the lowest level in 40 years. Inflation gyrated from double digits to a single digit in the space of two decades. This uncertainty is, inevitably, incorporated in the price signal.

Moreover, because of time lags in the dissemination of data and its assimilation in the prevailing operational model of the economy - prices tend to overshoot both ways. The economist Rudiger Dornbusch, who died last month, studied in his seminal paper, "Expectations and Exchange Rate Dynamics", published in 1975, the apparently irrational ebb and flow of floating currencies.

His conclusion was that markets overshoot in response to surprising changes in economic variables. A sudden increase in the money supply, for instance, axes interest rates and causes the currency to depreciate. The rational outcome should have been a panic sale of obligations denominated in the collapsing currency. But the devaluation is so excessive that people reasonably expect a rebound - i.e., an appreciation of the currency - and purchase bonds rather than dispose of them.

Yet, even Dornbusch ignored the fact that some price twirls have nothing to do with economic policies or realities, or with the emergence of new information - and a lot to do with mass psychology. How else can we account for the crash of October 1987? This goes to the heart of the undecided debate between technical and fundamental analysts.

As Robert Shiller has demonstrated in his tomes "Market Volatility" and "Irrational Exuberance", the volatility of stock prices exceeds the predictions yielded by any efficient market hypothesis, or by discounted streams of future dividends, or earnings. Yet, this finding is hotly disputed.

Some scholarly studies of researchers such as Stephen LeRoy and Richard Porter offer support - other, no less weighty, scholarship by the likes of Eugene Fama, Kenneth French, James Poterba, Allan Kleidon, and William Schwert negate it - mainly by attacking Shiller's underlying assumptions and simplifications. Everyone - opponents and proponents alike - admit that stock returns do change with time, though for different reasons.

Volatility is a form of market inefficiency. It is a reaction to incomplete information (i.e., uncertainty). Excessive volatility is irrational. The confluence of mass greed, mass fears, and mass disagreement as to the preferred mode of reaction to public and private information - yields price fluctuations.

Changes in volatility - as manifested in options and futures premiums - are good predictors of shifts in sentiment and the inception of new trends. Some traders are contrarians. When the VIX or the NASDAQ Volatility indices are high - signifying an oversold market - they buy and when the indices are low, they sell.

Chaikin's Volatility Indicator, a popular timing tool, seems to couple market tops with increased indecisiveness and nervousness, i.e., with enhanced volatility. Market bottoms - boring, cyclical, affairs - usually suppress volatility. Interestingly, Chaikin himself disputes this interpretation. He believes that volatility increases near the bottom, reflecting panic selling - and decreases near the top, when investors are in full accord as to market direction.

But most market players follow the trend. They sell when the VIX is high and, thus, portends a declining market. A bullish consensus is indicated by low volatility. Thus, low VIX readings signal the time to buy. Whether this is more than superstition or a mere gut reaction remains to be seen.

It is the work of theoreticians of finance. Alas, they are consumed by mutual rubbishing and dogmatic thinking. The few that wander out of the ivory tower and actually bother to ask economic players what they think and do - and why - are much derided. It is a dismal scene, devoid of volatile creativity.