Below is a video from the FT that I showed my A2 class this morning. The significance of it is the Australian dollar and how its value is strongly linked to iron ore prices. Recent growth in China has exceeded expectations and this has led to a rebound in commodity prices especially iron ore. The belief is the AUS$ is higher than the equilibrium level suggests and that this rate will not be sustainable. There are two reasons for this:
- Commodity prices have accelerated which has led to more demand for AUS$ which might not be sustained.
- Higher relative interest rates has made the AUS$ strong as ‘hot money’ has been attracted in the country. The Reserve Bank of Australia (central bank) has recently cut the cash rate (interest rates) to 1.75% and there is talk of a further cut this year.
With the fall in the price of oil to under US$30 a barrel, two oil exporting economies in particular have been adversely affected – Nigeria and Russia.
- Oil accounts for 10% of GDP but 70% of government revenue and almost all of Nigeria’s foreign earnings.
- Government revenue has fallen by 30% from this time last year
- Foreign reserves are down by $9 billion in 18 months
- Growth rate for 2015 was 3% which was down from 6% in 2014
- Nigerian bank loans are exposed to ups and downs of the oil market. At present about 24% of Nigerian bank loans are to oil and gas producers and struggling power companies. This exposure could lead to a banking crisis in Nigeria.
How is Nigeria tackling the problem?
The Economist outlined 3 responses to the crisis of which the first is the only realistic measure:
- An expansionary fiscal policy to stimulate aggregate demand
- Protect its hard currency reserves by blocking imports
- Try to crack down on inflation by keeping the naira pegged at 197-199 to the US$.
Nigeria is fortunate to have low levels of public debt – 19% GDP – but it is not helped by high interest rates but high interest rates means that 35% of government revenue is taken up by servicing its debt. Lower oil prices would be the catalyst to a serious debt problem.
Russia’s exports and government revenue are heavily dependent on the price of oil. Since the oil peak in June 2014 GDP has shrunk by approximately by 4%. The Russian budget assumes an average oil price of $50 a barrel, which was to have produced a deficit of 3% of GDP. However the budget deficit rises by roughly 1% of GDP for every $5 drop in the oil price and with the current oil price around $30 a barrel the deficit would probably rise to 7% of GDP.
If the economy does start to run out of cash the option of printing money may be tempting. But with inflation at around 13% this would further fuel inflation and also mean a further weakening of the rouble which wold make Russian imports more expensive for firms and households. Russian economic data does not look healthy:
- real wages fell by 9% in 2015 and 4% in 2014
- GDP per person was $8,000 in 2015 in contrast to $15,000 in 2013
- 2 million fell into poverty on 2015
- the share of families that lack funds for food and clothing rose from 22% to 39%
- retail sales have dropped by 13% last year
The 25% fall in the inflation adjusted exchange rate in the past year brought with the opportunity to diverse away from oil. The weaker double makes exports more competitive and now that labour is cheaper in Russia than in China there is great opportunity. However, it is not going to come from foreign investors as foreign investment has fallen from $40 billion in early 2013 to $3 billion in June quarter of 2015.
The December 2015 edition of the New Internationalist discussed 10 Economic Myths that need to be addressed especially after the GFC. Below is the list and the NI goes through each in detail – click here to go to the NI website.
Myth 1: Austerity will lead to ‘jobs and growth – ‘
It’s wrong to sell austerity as a cure for economic woes
Myth 2: Deficit reduction is the only way out of a slump
- Don’t rely on those who caused the crash to resolve it
Myth 3: Taxing the rich scares off investors and stalls economic performance
– Taxation creates prosperity just as much as private enterprise
Myth 4: Economic migrants are a drain on rich world economies
– Migration follows a demand for labour and benefits the receiving country
Myth 5: The private sector is more efficient than the public sector
– There is no evidence of greater efficiency
Myth 6: Fossil fuels are more economically viable than renewables
– Not if you look at the environmental costs
Myth 7: Financial regulation will destroy a profitable banking sector
– Why should financial markets be accountable only to themselves?
Myth 8: Organized labour is regressive –
It can be argued that the opposite is actually true.
Myth 9: Everyone has to pay their debts
– We need debt management not reduction
Myth 10: Growth is the only way
– why we need to find another way, fast.
Although it is repetitive in places especially when they talk of debt and austerity it does provide some valid arguments. I think that the last myth ‘Growth is the only way’ is of particular importance in that GDP growth at all costs has led to wasteful resource use, particularly by the wealthier countries, on an unparalleled scale and without a backward glance. It is often noted that the economy is a subset of the ecological system, but equally there seems to be a belief that nature can cope with anything we throw at it. However, an assessment by the Global Footprint Network indicates we are running a dangerous ecological debt. Currently the global use of resources and amounts of waste generated per year would require one and a half planet Earths to be sustainable (see graph below). The price to be paid for this overshoot is ecological crises (think forests, fisheries, freshwater and the climatic system), a price that is again paid disproportionately by the poor.
Although Norway is a capitalist country, it is state-owned enterprises that seem to be most prevalent in business circles. Oil revenues have been at the forefront of Norway’s development and it is, behind Luxembourg, the richest country in Europe. Ultimately the economic welfare of the country is heavily influenced by the price of oil and the peak of $150 a barrel in 2008 had huge benefits for the government purse. Oil and gas now account for about 25% of Norway’s GDP and almost 50% of its exports. However with the recent fall in oil prices to below $50 a barrel, oil companies have had to lay off workers – estimated to be 30%. According to The Economist the falling oil price has exposed two weaknesses in the Norwegian economy.
- Bureaucracy is a problem in Norway with the government owning about 40% of the stockmarket. Furthermore, as the vast majority of the country’s top executives attend the Norwegian School of Economics there is an unhealthy cultural uniformity which is not a catalyst to change.
- The welfare state has been too generous. The public sector employs 33% of the workforce (compared to 19% for the OECD countries) and as people enjoy a 37 hour week and sometimes a 3 day weekend there is a concern that the state is undermining the work ethic. In 2011 Norway spent 3.9% of GDP on incapacity benefits and early retirement, compared with an OECD average of 2.2%.
However, the government has been very prudent with its saving in that it now has the biggest sovereign-wealth fund in the world at $873 billion. The country also has a fish industry which is worth $10 billion a year.
Where to from here?
Are we seeing a classic resource curse where an economy has become reliant on a particular resource? Does Norway have a real alternative to oil to generate revenue for its economy?
Norway needs to allow the entrepreneurial spirit more room to grow and also apply some free market reforms to the welfare state. Shrinking the role of the state will help as the private sector cold start to be more involved in the running of schools, hospitals, and surgeries. So far the country’s reaction to the oil price drop is to be become even more left wing especially in the cities of Bergen and Oslo.
Source: The Economist – Norwegian Blues – October 10th 2015
Here is another very good video from wetheeconomy. Are natural resources vital to the economy?
Why should nature be taken into account when looking at the economy as a whole? A Bee’s Invoice uncovers and incorporates the hidden value of natural capital in the measurement of our economy. Natural capital in this instance is productive – bees are responsible for over 8% of the total agricultural output in the US which equates to over US$190bn. However it is not recognized as an important part of the economy as nature is not priced and we don’t account for the hidden value that nature contributes to an economy.