I have snapped the picture above in one of Tbilisi’s main streets. To the economist’s eye, however, this picture should be disturbing. While the general observer will see clean and wide sidewalks, beautiful classical style buildings, and a single pedestrian in this early hour of the day, one also sees two adjacent currency exchange booths (Lombardi, as they are called here). The nearer sign shows that they buy $100 for 165.2 GEL, and sell $100 for 165.6 GEL—ignore the listed Euro exchange rate for the sake of this illustration. The farther sign shows respective figures of 165.0 and 165.7.
To start with, the second booth should not exist: if I have $1000 I can buy GELs from the first vendor and get 1652 GEL (rather than going to the second booth and getting 1650 only). On the other hand, if I want to buy $1000 I would buy them from the first booth for 1656 GEL rather than paying 1657 GEL to the second, for the very same amount of dollars. Consequently, whether you are buying or selling dollars you will prefer the first vendor. In other words, the second vendor should have been out of business. Now, assuming that he exists (which he does) we can open a third booth between them, with a buying price above what he offers (above 165.0) and a selling price below his (below 165.7). Once again, this will attract all his customers, crowding him out of business.
Notice that one cannot simply make a profit by buying dollars in the first booth and selling to the second—this may happen only if the buying-selling spreads of the two vendors are disjoint, that is, only if the selling price of one booth is lower than the buying price of the other. What can happen here to extract the potential profit (aka “arbitrage” which is about extracting profits by utilizing price differences between different markets; in other words, a zero-cost profit making), however, is to beat the (superior) first booth, by setting up a third booth with a buying price higher than his (say 165.3) and a selling price lower than his (say 165.5). This will crowd the (currently superior) first booth out of business and extract all the remaining profit (between the buying and selling prices). Another entrepreneur will be attracted by the potential arbitrage and set up an additional booth with narrower spread, extracting all existing profits. This process would continue until we get a booth with buying and selling prices which are both identical to the official exchange rate announced by the National Bank of Georgia.
Now, this is not happening in Tbilisi. There are plenty of exchange booths in all big cities of Georgia, and these are always just meters away, but all with different spreads that clearly call for entrepreneurs to collect the potential cost-free profit. To this end, I have no clue why this is not happening here. It can be the case that people (customers) simply cannot understand the difference (i.e., someone with $100 to exchange would be indifferent between going to the first or the second booth mentioned above), or just because the difference in prices is too small for the simple customer to care. It might also be the case that potential entrepreneurs do not see the calling opportunity. To me, however, both explanations seem unlikely, leaving us with an inexplicably perplexing reality. One might also think that all these exchange booths belong to a single owner—so that, no matter where you exchange your money, the profits eventually go to the same place. This means the exchange business is a monopoly disguised as “infinitely many free-market sellers.” In other words, what would have broken this chain—i.e., setting up booths with narrower spreads—might not be allowed (i.e., no “free entry”), either by prohibitive bureaucratic procedures, or by the intervention of powerful characters and stakeholders in this business.
Comments
It is a good evidence.
I think one explanation could be that sometimes, when these (second type) firms after some transactions have a lack of cash they are bidding this "non-profitable" prices for some time (till they raise cash)...
I think the main reason why the third actor is not coming in the business with narrower spread is that this new spread will not be enough to cover all the rent and other costs related to functioning on the market. So it will not be profitable any more. To say economically, economic profit of the first guy could be near to zero already. However, the existence of the second "Lombardi" with wider spread is really "turning Smith in the grave" and is just a result of the stupidity of Georgian customer if we exclude that this market is not monopoly.
One explanation could be that lazy owner had not yet opened his booth that early morning
What we usually observe is that if you are a buyer, you would prefer buying the currency from the one booth and if you are a seller you would exchange in another. And this indeed feels like a collusion.
I think the observation is interesting, still inconclusive. First, the presumption about monopoly could be eliminated if we had the information about the owners of the two competing facilities, since to my knowledge, they are required to exhibit the public registry extract for everyone to see. Second, if these facilities are indeed what we call "Lombardi", or pawn shops, not just currency exchange booths, exchange service might not be their primary business, which would explain the reason they could stay on market. Also to my knowledge, currency exchange booths are no longer required a license, but the national bank prohibits them from engaging in any kind of business activity rather than currency exchange service. And third, national bank does not regulate how the currency exchange booths determine the exchange rate, thus the evidence above says nothing about the long-term situation and no one gets pushed out of market based on one day's performance.
Very nice and refreshing post! The monopoly explanation could make sense if the monopolist tries to corner the market and/or if the second booths just sets a certain exchange rate as a reference price, thus making the first booth's rates look more attractive. It doesn't sound very very compelling though, so maybe only money laundering or poor management are left as explanations
Explanation for existance of the second booth is that sometimes booths have liquidity shortages in some currencies and they prefer to avoid quey of people for reasons. Also another explanation is that there are booths that have extra charge for currency exchange (one i have seen on Pekini str. with more affordable rates but with fix extra charge, If you convert small amount you should prefer to convert it in the booth with ordinary rates, because of that charge). The third explanation is that the major profile of Lombardis is provisiion of short term loans guaranteed by either movable or real property, but not currency exhchange.
I liked the Nino version about the lazy owner. Yet another explanation is that the second owner specializes in stupid customers - so he might get less clients, but make a bigger profit from the few clients he gets. Less work, more profit. It is similar to the taxi drivers who are standing at the Rustaveli McDonald's and charging much higher rates than the ones passing by.
Once I even encountered a case when the buying price of dollars in one booth was less then selling price in another one on Rustaveli. I entered and as Giorgi Balakhashvili wrote there was a few percent charge for the exchange - so, basically, the prices were almost the same (unfortunately).
This is not unique to Tbilisi and happens in every corner of the world, including very center of Manhattan. It may seem so, but currency exchange is not standard service; one shop may offer better quality banknotes, free return, comfortable service, have excellent track record in terms of reliability for local community, no hidden costs, lies closer to junction, gives a hot coffee instead of change and so on. Bank have higher spread, but they make the biggest transactions. If a customer decides to pay more, most probably gets a good with higher value. There are around 3000 currency exchanger and it’s hard to argue the existence monopoly or any bureaucratic burden.
Demand of currency is inelastic and other things equal for any quote your client base is limited; thus, if you lower spread with the same costs, you may end up losing money. Plus, business always needs to compensate for risks and profits.
This is the same as any market in the world, one believes the exchange rate will rise and is willing to pay more to get dollars in and the other thinks the exchange rate will fall and does feel the same demand and dollars will be of less value soon. If could also be that. It may also be like a local pair of gas stations in America, one was quite high and the other, less than a mile away was lower and had a long line of people who believed they were getting a bargain. One man owned both stations and if you went 3 miles further that general market price was even lower. It is all perceived value.
First, I thank you all, so much, for stopping by and reading this post and for your great comments. I learned much from these.
to those of the second.]
Let me just briefly relate to some of your comments:
1- I like the "Lazy" second guy comment, this who didn't get up early to update his prices. While it's a funny comment, I don't think it's the case, because always (in all hours of the day, for the last 4 years of my living in Tbilisi) the second guy has the wrong numbers (which are moving up and down but always wrong compared to his neighbor).
2- I am not sure about the example of Manhattan. Living there for 6 years, I have never had a chance to see such a thing, or even a public exchange booth. The phenomenon of really many exchange booths (and all crowded mostly in just two neighborhoods Vaki/Sabortalo) is special to this city. A similar to this I have seen in Istanbul (with a room for arbitrage, that is). However, I didn't live there long enough to have the same observation (I just was visiting for a week or so. Not enough to judge.)
3- Gas stations example of the US is perfectly true. I've experienced this first hand. This does NOT make the arbitrage phenomenon described above any more rational. That's why, for gas stations in the US cities, there is a web site watching the prices of gas very closely, and one can utilize it to minimize the costs. I lived in upstate NY, in a place which is pretty much in the center of a circle surrounded by many gas stations, all same distance from my place. Using that website I was checking the gas prices in all these stations, and only then decide where to go (and save a fortune). That the stations are in the US (the greatest country in the world) does NOT mean they are not irrational (or in simple English, stupid). Or all belong to a monopoly.
4- Comments speaking about "different conditions, the type of service, location, etc..."
Mostly this is NOT the case. The picture above proves it: these guys are in THE SAME PLACE, LITERALLY. So no one is "at the junction" or "close to coffee shop" or whatever. They are 1 meter away, so they are in the same place. As to their service: both give you GELs for your Dollars and Dollars for your GELs. There is no more "beautiful" Dollars and less "ugly" GELs. They are all legal notes, no counterfeits, and all work (buy you stuff). Both guys do NOT charge additional commissions or fees. And both do not offer coffee or treat: only a cold (machine-like) face (no smiles, no talks), takes your currency and gives you the other one.
5- All arguments about "profits, and if they have narrower spreads they lose money...etc..." That is exactly the crux of the argument:
A- If the first booth gets a positive profit, the second booth SHOULD BE out of business. [Identical product, but more expensive, why shall he survive? It is NOT a Nestle chocolate and Barambo chocolate: if these have different prices (and they do) then I understand that. But the GELs of the first guy really have the same function and look similar
B- If the first booth gets a positive profit (say 1000), then THERE IS A ROOM for a third booth to open next to him, with narrower spread--and thus less profit (say 900). It is wrong to state "...if somebody opens with narrower spread he will LOSE money.." this is wrong. He will "get LESS profit" and not lose money. Now a fourth guy comes, with a narrower spread, and gets a profit of 800, and more and more come to open places until the profit goes to zero. (The zero-profit, however, does NOT mean a zero-spread--i.e., a buying price equal to selling price--but means the narrowest spread that makes enough money to cover the salary of the worker and the rent/other costs of the place. So there is a minimum spread that every exchange booth should arrive at, at any moment in the day. Ideally this is the zero-spread (e.g. the NBG exchange rate), but this cannot happen if there are any costs of operating such a place--unless the NBG itself opens a booth with identical selling/buying price equal to the official exchange rate: that will eliminate the WHOLE business of currency exchange totally (even from commercial banks): nobody will be able to compete with that.)
That is perfect competition, and that's what should happen UNLESS:
1- people are not smart enough to make the difference between the two booths. And/or
2- there is something wrong about the "perfect competition" assumption of these exchange booths. Monopoly (or the underground) was just a guess.
Finally, having "3000 exchange booths in Tbilisi" does NOT prove it is not a monopoly business. You know, Microsoft has more than 50,000 employees and thousands of branches in the world: but it is a classical monopoly. Believe me, a monopoly can distribute its "arms" (exchange booths, gas stations, etc...) in any way it likes to maximize profits (some of which, as Dace said above, come from Stupid Customers. Point A above)
Muhammad, thanks for a great post!
Is the first sign visible (assuming it is two-sided) when you walk from the other direction?
Thank you Eric!
, it is a one-way street so one cannot see the other side. I guess--if the electronic sign is two-sided, which is mostly the case--both signs are equally visible from the other side, for pedestrians.
A good observation! For cars (i.e., for me
This famous joke can also be an explanation:
Two beggars are sitting side by side on a street in Rome.
One has a cross in front of him; the other one the Star of David. Many people go by and look at both beggars, but only put money into the hat of the beggar sitting behind the cross.
A priest comes by, stops and watches throngs of people giving money to the beggar behind the cross, but none give to the beggar behind the Star of David.
Finally, the priest goes over to the beggar behind the Star of David and says, "My poor fellow, don't you understand? This is a Catholic country; this city is the seat of Catholicism. People aren't going to give you money if you sit there with a Star of David in front of you, especially when you're sitting beside a beggar who has a cross. In fact, they would probably give to him just out of spite."
The beggar behind the Star of David listened to the priest, turned to the other beggar with the cross and said: "Moishe, look who's trying to teach the Goldstein brothers about marketing."
Wow, Lasha, you are right on target!