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Why dearer oil impacts developing economies more.

It wasn’t long ago that $100 for a barrel of oil was the norm but with the advent of the shale market the production increased which depressed prices. It was felt that the flexibility of large scale shale production from the USA could act as a stabiliser to global oil prices.

Oil shocks – supply or demand?

Oil shocks are not all the same. They tend to be associated with supply issues caused by conflict or OPEC reducing daily production targets. In the case of an increase in global growth there is the demand side for oil which increases the price. However this doesn’t have a great effect as in such cases the rising cost of imported oil is offset by the increasing export revenue. However today’s increase has a bit of both:

Demand – global consumption has increased as the advanced economies recover after the GFC especially China
Supply – supply constraints in Venezuela from the economic crisis. Also tighter American sanctions on Iran and OPEC producers are not increasing supply with the higher price.

Higher oil prices do squeeze household budgets and therefore reduce demand. Lower prices are expected to act as a stimulus to consumer spending but it can also have negative effects on the petroleum industries.

Emerging economies the impact of higher oil prices

Oil importing emerging economies are badly impacted by higher oil prices:

  • Terms of trade deteriorate as the price of their imports rise relative to their exports
  • Exports pay for fewer imports = importers’ current-account deficits widen.
  • Normally this leads to a depreciation a a country’s currency which makes exports cheaper and imports more expensive.

However this is not the case today. World trade is slowing and with it manufacturing orders therefore higher oil prices make the current account worse which in turn depreciates the exchange rate. For emerging economies who have borrowed from other countries or organisations a weaker exchange rate intensifies the burden of dollar-denominated debt. Companies in emerging economies have borrowed large amounts of money being spurred on by very low interest rates but they earn income in the domestic currency but owe in dollars – a weaker exchange rate means they have to spend more of their local currency to pay off their debt. Therefore indebted borrowers feel the financial squeeze and may reduce investment and layoff workers.

Another problem for emerging economies, as well as higher oil prices, is that central banks are looking to tighten monetary policy (interest rates) with the chance of higher inflation.

Source: The Economist – Crude Awaking – September 29th 2018

Global poverty rates down but challenges still remain

The world attained the first Millennium Development Goal target—to cut the 1990 poverty rate in half by 2015—five years ahead of schedule, in 2010. Despite the progress made in reducing poverty, the number of people living in extreme poverty globally remains unacceptably high. And given global growth forecasts, poverty reduction may not be fast enough to reach the target of ending extreme poverty by 2030.

According to the most recent estimates:

  • 1990 – 36% of the world’s population lived on less than US$1.90 a day
  • 2013 – 11 % of the world’s population lived on less than US$1.90 a day
  • 2015 – 10 % of the world’s population lived on less than US$1.90 a day

Nearly 1.1 billion fewer people are living in extreme poverty than in 1990. In 2015, 736 million people lived on less than $1.90 a day, down from 1.85 billion in 1990.

While poverty rates have declined in all regions, progress has been uneven:

  • East Asia and Pacific (47 million extreme poor)
  • Europe and Central Asia (7 million) have reduced extreme poverty to below 3 percent, achieving the 2030 target.
  • More than half of the extreme poor live in Sub-Saharan Africa. In fact, the number of poor in the region increased by 9 million, with 413 million people living on less than US$1.90 a day in 2015, more than all the other regions combined. If the trend continues, by 2030, nearly 9 out of 10 extreme poor will be in Sub-Saharan Africa.
  • The majority of the global poor live in rural areas, are poorly educated, employed in the agricultural sector, and under 18 years of age.

Challenges

One of the main challenges is that it is becoming very difficult too reach those that are in extreme poverty as they often live in countries that are remote or have internal strife amongst its population. Furthermore access to good schools, health care, electricity, safe water, and other critical services remains elusive for many people, often determined by socioeconomic status, gender, ethnicity, and geography.

Even those that seem to be able to move out of poverty can only do it for a certain period of time as economic shocks, food insecurity and climate change can be their undoing and revert them back into poverty.

Policies

The book ‘The End of Poverty: How we can make it happen in our lifetime’ by Jeffrey Sachs (2005) looks policies to overcome poverty. Although it is an old publication it does have some valid points. However what is imperative is that a one-size fits all policy doesn’t work as all countries have some unique variables that requires a customised approach.

At the most basic level, the key to ending extreme poverty is to enable the poorest of the poor to get their foot on the ladder of development. The development ladder hovers overhead, and the poorest of the poor are stuck beneath it. They lack the minimum amount of capital necessary to get a foothold, and therefore need a boost up to the first rung. The extreme poor lack six major kinds of capital:

  • Human capital: health, nutrition, and skills needed for each person to be economically productive
  • Business capital: the machinery, facilities, motorized transport used in agriculture, industry, and services
  • Infrastructure: roads, power, water and sanitation, airports and seaports, and telecommunications systems, that are critical in-puts into business productivity
  • Natural capital: arable land, healthy soils, biodiversity, and well-functioning ecosystems that provide the environmental services needed by human society
  • Public institutional capital: the commercial law, judicial systems, government services and policing that underpin the peaceful and prosperous division of labor
  • Knowledge capital: the scientific and technological know-how that raises productivity in business output and the promotion of physical and natural capital

Source: The Economist – Espresso

Free access to elearnEconomics

Below is a link to free access to elearnEconomics website. It includes notes, video lessons and multiple-choice questions with worked answers. It covers all aspects of IB, NCEA (NZ curriculum), Cambridge International Exams (CIE)  A levels and most university introductory courses.

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OECD – GDP per capita – New Zealand falls to 22nd.

New Zealand has enjoyed a high standard of living and solid economic growth in recent years. However, during this period New Zealand has also exhibited a comparatively low level of productivity growth relative to our OECD peers. Broad-based evidence of this can be seen in New Zealand’s Gross Domestic Product (“GDP”) per capita. This metric measures output per New Zealander and is standardised into US Dollars for all countries. On this metric, New Zealand has consistently trailed the United States, Australia, Canada, Great Britain, France, Japan and the OECD average.

In 2017, New Zealand was ranked 22 of 48 countries surveyed by the OECD, compared with 9th place in 1970 and 20th in 1993. Over the last 50 years the world has seen much stronger growth in exports of manufactured products and slower growth in exports of primary products. And New Zealand’s competitive advantage is still in primary products. We are now on the brink of a technological revolution that will alter the way we live and work. The fourth industrial revolution is all about embracing the digital revolution. Our low productivity levels are a bit of a conundrum and the reasons for this are varied and subjective. Source – ANZ Bank

OECD GDP PER CAPITA (2017)

Source: Organisation for Economic Co-operation and Development (“OECD”)

AS Economics – Hyperinflation causes and ends

Starting with a definition. In 1956 Phillip Cagan, an economist working at America’s National Bureau of Economic Research, published a seminal study of hyperinflation, which he defined as a period in which prices rise by more than 50% a month.

There seems to be common patterns when hyperinflation occurs in an economy. These include:

  1. Fiscal pressure – cost of funding a war, increased social welfare payments, corrupt officials taking money from the budget.
  2. Dependence of a particular resource – the resource curse. Some economies rely on exports of oil, iron ore or other resources to fund its spending. This has the effect of increasing the value of the currency and although this will make imports cheaper once the resource runs out or global prices start to drop the overvalued currency falls causing a large increase in imported prices. Furthermore governments come to depend on revenue from oil and a sudden drop in prices saw a massive drop in tax revenue – 90% of Venezuela’s revenue came from oil.
  3. Printing money – like Bolivia in the 1980’s, Venezuela overcame their shortfall in income by printing more money. The increase in the supply of money pushes up inflation. But what makes it worse is, as the inflation rate impacts the real value of government revenue, they continue to print money to finance the budget deficit which in turn exacerbates the problem – bigger budget deficit and further inflation.
  4. Exchange rate – at some stage the exchange rate will collapse as people lose confidence in the currency. Imports become ever increasingly expensive and feed into the inflation calculation.
  5. Inflationary expectations – In recent years more attention has been paid to the psychological effects which rising prices have on people’s behaviour. The various groups which make up the economy, acting in their own self-interest, will actually cause inflation to rise faster than otherwise would be the case if they believe rising prices are set to continue. This is evident in Venezuela as people become accustomed to higher prices and expect them to continue which makes inflation likely to continue.Workers, who have tended to get wage rises to ‘catch up’ with previous price increases, will attempt to gain a little extra compensate them for the expected further inflation, especially if they cannot negotiate wage increases for another year. Consumers, in belief that prices will keep rising, buy now to beat the price rises, but this extra buying adds to demand pressures on prices. In a country such as New Zealand’s before the 1990’s, with the absence of competition in many sectors of the economy, this behaviour reinforces inflationary pressures. ‘Breaking the inflationary cycle’ is an important part of permanently reducing inflation. If people believe prices will remain stable, they won’t, for example, buy land and property as a speculation to protect themselves.

Hyperinflation tends to end in two ways.

  1. The paper currency becomes so utterly worthless that it is supplanted by a hard currency. This is what happened in Zimbabwe at the end of 2008, when the American dollar took over, in effect. Prices will stabilise, but other problems emerge. The country loses control of its banking system and its industry may lose competitiveness.
  2. The second, hyperinflation ends through a reform programme. This was very much the case in Bolivia in the 1980’s – Government spending was slashed. Price controls were scrapped. Import tariffs were cut. Government budgets were balanced. Therefore this typically involves a commitment to control the budget, a new issue of banknotes and a stabilisation of the exchange rate—ideally all backed with confidence-inspiring foreign loans. Without such reform, Venezuela’s leaders, though scornful of America, may find that its people are forced eventually to adopt its dollar anyway.

Sources:

  • The Economist “The half-life of a currency” September 15th 2018
  • The Economist “The roots of hyperinflation” February 12th 2018

New Zealand’s Terms of Trade – Milk Powder v Oil

The recent history of New Zealand’s terms of trade has been largely linked to dairy product export prices although in a longer-term context the price of imported oil has been paramount. Today we can see that the price of powdered milk (export) and the price of brent crude oil (import) are heading in the wrong directions. Powdered milk prices are falling and brent crude oil prices are rising which makes for an unfavourable terms of trade – see graph. This is not a good sign for the terms of trade which reached its peak in March this year.

What is the Terms of Trade.
The terms of trade index measures the value of a unit of exports in terms of the number of imports it can buy, or the purchasing power of our exports. This is similar to comparing the number of sheep exports that will buy a typical imported family car, from one time to another. The formula is:
Formula: Terms of Trade (TOT) =

Export Price Index (Px)           x   1000 (base year)
Import Price Index (Pm)

  • An increase in the TOT (e.g. from 1050 to 1200) is called “favourable”
  • A decrease in the TOT (e.g. from 1050 to 970) is called “unfavourable”

A “favourable” (increase) in the TOT may come about because the average:

– export price rose and import price stayed the same
– export prices rose faster than import prices
– export prices stayed the same and import prices fell
– export prices fell but import prices fell faster

The index number that results tells us whether merchandise export price movements have been favourable relative to import price movements. An increase in the terms of trade from 1000 to 1100 represents an increase in the purchasing power of our exports of 10% which means, other things being equal, we would be able to buy 10% more from overseas. As a country we would be wealthier. A decline in the terms of trade would result in the opposite situation.

Limitations of the Terms of Trade

Terms of trade calculations do not tell us about the volume of the countries’ exports, only relative changes between countries. To understand how a country’s social utility changes, it is necessary to consider changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows.

The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price. An example of this is the high export price suffered by New Zealand exporters since mid-2000 as a result of the historical mandate given to the Reserve Bank of New Zealand to control inflation.

In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.

Evaluation

  • A decline in the terms of trade is not necessarily a bad thing. For example, a decline in the terms of trade may occur due to a devaluation in the exchange rate. This devaluation may enable a country to regain competitiveness and increase the quantity of exports.
  • The impact of a decline in the terms of trade will depend on the elasticity of demand. If demand is elastic, the lower price of exports will cause a bigger % increase in demand.
  • Some Less Developed Countries (LDCs) have seen an improvement in terms of trade because of rising price of commodities and food post 2008. It is not always LDCs who see a decline in the terms of trade.
  • It is important to distinguish between a short term decline in terms of trade and a long term decline. A long term decline is more serious for reflecting a fall in living standards.

Unemployment – a ‘luxury good’ in the developing world

Image result for unemployment in developing countriesFollowing from my last post about the welfare state, the lack of jobless benefits in developing countries has led to very low unemployment levels as workers simply cannot afford not to work. In order for them to survive they need to be prepared to do any sort of job. Even if unemployment benefits are available a lot of the time they are not worth the effort. In Thailand, for example, payments last six months and range from 1,650 baht per month ($52) to 15,000. To be eligible, a Thai worker must register with the social-security office. But only one in three does so.

Therefore if they have lost their job what do they do? A laid-off factory worker might lend a hand on the family farm, become a casual day labourer, or sell trinkets on the street. When Annan Chanthan left his job as a graphic designer in Bangkok five years ago, he thought about collecting unemployment benefits, but never bothered. He now earns more money selling lottery tickets next to Hua Lamphong railway station than he did in his former profession.

But the situation can be complicated in developing countries, with their large informal sectors, which offer a relatively easy way for unemployed people to pick up some income — undetected by the government — while they continue to receive jobless benefits. However the level of the unemployment benefit influence the duration of the period of unemployment, but it doesn’t really help workers find better jobs (such as those that pay a higher wage). However, the level of the benefit does seem to improve wages somewhat, although not the unemployment duration.

In poor countries, unemployment is paradoxically concentrated among the better off and better educated. They can afford to wait a bit for a job that matches their aspirations and qualifications. Their behaviour may also explain unemployment’s curious stability but when times are bad, they may settle for a worse job or stop looking, rather than wait longer, which would add to the rate of unemployment.

Source: The Economist June 9th 2018 – The luxury of unemployment

 

 

AS Revision – Income Elasticity of Demand graph

Currently taking CIE revision classes this holiday and was working through Unit 2 and income elasticity of demand. Quite a few of the class had never come across this graph which is popular in multiple-choice questions. It is important that you read the axis.

Usefulness of Income Elasticity of Demand

Knowledge of income elasticity of demand for different products helps firms predict the effect of a business cycle on sales. All countries experience a business cycle where actual GDP moves up and down in a regular pattern causing booms and slowdowns or perhaps a recession. The business cycle means incomes rise and fall.

Luxury products with high income elasticity see greater sales volatility over the business cycle than necessities where demand from consumers is less sensitive to changes in the economic cycle

The NZ economy has enjoyed a period of economic growth over the last few years. So average real incomes have increased, but because of differences in income elasticity of demand, consumer demand for products will have varied greatly over this period.

Over time we expect to see our real incomes rise. And as we become better off, we can afford to increase our spending on different goods and services. Clearly what is happening to the relative prices of these products will play a key role in shaping our consumption decisions. But the income elasticity of demand will also affect the pattern of demand over time. For normal luxury goods, whose income elasticity of demand exceeds +1, as incomes rise, the proportion of a consumer’s income spent on that product will go up. For normal necessities (income elasticity of demand is positive but less than 1) and for inferior goods (where the income elasticity of demand is negative) – then as income rises, the share or proportion of their budget on these products will fall. See table below for a summary of values.

A2 Revision – Economies of Scale Mind Map

With the A2 exam not far away here is something on Economies of Scale – also a mind map which I have edited from Susan Grant’s book.

When the average cost curve slopes downwards it means that average costs are decreasing as output increases. Whenever this happens the firm is experiencing economies of scale . If on the other hand the average costs are increasing as output increases the firm is experiencing diseconomies of scale . Why do firms experience economies of scale?

Technical Economies: large firms can take advantage of increased capacity machinery. For example, a double-decker bus can carry twice as many passengers as a single decker bus. But without the purchase costs and the running costs are not doubled.

Managerial Economies: In a small firm the manager may perform the role of cost accountant, foreman, salesman, personnel officer, stock controller etc. However, as a firm increases in size it can take advantage of specialisation of labour.

Commercial Economies: The large firm can buy it raw materials in bulk at favourable rates.

Financial Economies: the larger firm can negotiate loans from banks and related institutions     easily and at favourable rates.

Risk-Bearing Economies: All firms are subject to risk at sometime or other. However, the larger firm has distinct advantages in this area as small changes in supply and demand can often ruin a small company and larger firms can cover itself by producing a variety of products for a variety of markets.