Category Archives: Development Economics

The Paradox of Aid – dumping in developing countries.

Although a few years old now the video below is a good example of dumping – where the exporting country is able to lower its prices below that of the domestic price in the market it is selling into. Useful to show when teaching barriers to trade.

The U.S. spends approximately $37 billion dollars a year on foreign aid – just under 1% of our federal budget. “The Foreign Aid Paradox” zeroes in on food aid to Haiti and how it affects American farming and shipping interests as well as Haiti’s own agricultural markets. The fact that the US dump rice exports on the Haitian market below the equilibrium price severely affects the revenue of local farmers. Should there be a trade-not-aid strategy for developing countries? Below is a very good video from wetheeconomy

The trade-not-aid strategy is based on the idea that if developing countries were able to trade more freely with wealthy countries, they would have more reliable incomes and they would be much less dependent on external aid to carry out development projects. International trade would raise incomes and living standards as poor countries would be able to export their way to economic development by selling their products to rich countries eager to buy their goods.

Source: http://www.globalization101.org/trade-not-aid/

Global remittances take a hit with Covid-19

Emerging economies have been affected in numerous ways by Covid-19. The following are just some:

  • Limited movement of their population
  • loss of export earnings
  • drop in foreign direct investment
  • fall in remittances.

Regarding the last one – the World Bank have estimated that global remittances will decline by 20% in 2020 – more than US$100bn – due to the Covid-19 pandemic and shutdown. There are expected to fall across the regions – see graph below:

In 2019 remittances reached a record US$554 billion but are estimated to be US$445bn in 2020. With the fall in foreign direct investment they have become even more important to low and middle income countries (LMIC). In 2019 remittances were greater than foreign direct investment and were the biggest source of capital in LMIC – 8.9% of GDP. This is especially prevalent when you consider that FDI is expected to plunge by more than 35% to LMIC in 2020.

The importance of remittances is also significant when pooling a poverty figures – it is estimated that a 10% increase in remittances reduces poverty by 3%.

A fall in remittances means:

  • less spending the economy as a whole
  • more people below the poverty line
  • more people unable to afford food, healthcare and basic needs

The World Bank estimate that in 2019 there were 272m international migrants of which 26m were refugees. As well there were in 700m migrants within a country providing financial support elsewhere. However with a downturn in the economy due to Covid-19 it is the foreign workers who are first to lose their job. 2021 might see a slight recovery with remittances set to rise by 5.6% to US$470bn but many things can eventuate over the next year.

Why do developing countries like a strong currency?

In the majority of economics textbooks a depreciation of the exchange is beneficial to an economy especially those like developing countries which depend a lot on export revenue.

A fall in the value of the exchange rate will make exports cheaper and so acts as an implicit subsidy to firms that sell abroad. Exposure to world markets also helps companies in the developing world learn and improve.Finished imported products that are still purchased will be more expensive and some of these will count in the country’s consumer price index. Costs of production will be pushed up because the cost of imported raw materials will rise. Domestic firms may also feel less competitive pressure to keep costs and prices low.

A rise in the value of exchange rate will make exports more expensive in terms of foreign currencies, and imports cheaper in terms of the domestic currency. Such a change is likely to result in a fall in demand for domestic products. A higher exchange rate may also reduce inflationary pressure by shifting the aggregate supply curve to the right because of lower costs of imported raw materials. The price of imported finished products would also fall and there would be increased competitive pressure on domestic firms to restrict price rises in order to try to maintain their sales at home and abroad.

It has been traditional for developing countries to try and engineer a weaker currency to make their exports more competitive especially as this revenue is one way in which their economies can start to grow. China and other South East Asian economies adopted this strategy as they went through industrialising their economy. Empirical studies suggest that an undervalued currency boosts growth more in developing rather than developed economies.

Why then is it that some African countries still want to maintain a strong currency? Primary sector exports and overseas aid raises the demand for local currencies making them appreciate. Governments are concerned about a weaker currency as

  • Some are dependent on capital imports to finance infrastructure projects
  • It forces them to spend more income to pay back foreign debts.
  • Pushes up the cost of imported goods, including food, medicine and fuel – mainly impacts the city population who are more likely to complain to politicians.
  • Some companies in developing countries import a lot of their machinery and raw materials – additional cost to their production.
  • A weaker currency does make exports cheaper but this can be nullified by more expensive imports.

However all of this has been overshadowed by COVID-19. The pandemic is increasingly a concern for developing countries which rely heavily on imports to meet their needs of medical supplies essential to combat the virus.

Developing countries green policies and investment

Here are some FT journalists answering questions around the impact of green policies on the growth of developing countries. The main points are:

  • Under the Paris climate agreement there is currently no obligation for developing countries to implement green policies.
  • It is unfair for developed economies to ask developing countries to stop their oil and gas industry when they themselves has accrued the benefits of energy extraction.
  • China has invested hugely in solar energy – this is seen as the next industrial revolution
  • Over last decade China has committed over $780bn to wind and solar energy
  • In 2019 29 countries spent $1bn or more on renewable energy – indicative of it becoming cheaper.

Developing countries bigger spenders than Developed countries

Developed countries were the first to embrace non- hydro renewables, back in the last decade, offering subsidies to encourage deployment. However, the sharpest increases in electricity demand, by far, are taking place in developing countries. The figure below shows that up to 2014, the majority of renewable energy capacity investment was in the developed world, but that every year since then, emerging economies have been dominant. In 2018, developed economies invested $125.8 billion, some 10% more than in the previous year, while developing countries committed $147.1 billion, down 24%. However, the different shades of green in the chart reveal that the latter change was entirely due to China and India. Investment in those two giants, taken together, fell 36% to $99.6 billion, while that in “other developing economies” rose 22% to a record $47.5 billion.

Developed vs Developing Countries – Investment in renewable energy 2004-2018 $bn

Source: Frankfurt School – UNEP Collaborating Centre for Climate & Sustainable Energy Finance. Global Trends in Renewable Energy Investment 2019

Developing economies growth 2010 – 2019

Below is a graph from the FT site that shows growth rates in leading developing countries and it makes a good comparison with the Eurozone and the World. Some emerging economies have, nevertheless, achieved high economic growth rates in recent years. China has witnessed particularly rapid economic growth and has become the second largest economy in the world behind the US. China’s increase in output has been driven by increases in investment and exports. This has been helped by a fall in the renminbi which makes Chinese exports cheaper. India’s growth rates has also been significant because of an increase in the labour force and advances in IT. Remember that ‘economic development’ is the process of improving people’s economic well-being and quality of life whilst economic growth is an increase in an economy’s output and the economic growth rate is the annual percentage change in output.

Ghana and Ivory Coast cocoa supply chain – Opec to Copec

Ghana and Ivory Coast produce nearly 2/3 of the global supply of cocoa. Most of the 2m cocoa farmers in west Africa are smallholders and therefore have little influence on the world price. Why is it so difficult for poor countries to command higher prices for cocoa and controlling more valuable areas of the supply chain?

Ghana – supplies 20% of all cocoa beans – earns $2bn a year which is less than 2% of the value of chocolate that is manufactured, branded and sold. It seems that cocoa producers are in a colonial style relationship with chocolate manufacturers.

Chocolate – $100bn industry and Ghana and Ivory Coast who produce 65% of the raw material only earn $6bn – see image below. But why couldn’t these two countries have earned more money by processing the cocoa into liquor, cocoa butter or chocolate. One reason is the electricity costs and the industry likes to keep most of the added value near the western markets that it serves.

Who gets what in the cocoa supply chain – Breakdown of costs for wholesale cocoa (%)

Opec to Copec

From October 2020 Ghana and Ivory Coast will have a fixed premium of $400 a tonne over the benchmark futures price. Opec controls 30-40% of global oil supply and have a significant role in influencing prices. Ghana’s vice-president Mahamudu Bawumia refers to this in the cocoa industry as Copec. The premium known as the ‘living income differential’ (LID) is intended to increase farm-gate prices so that farmers can have a much higher standard of living than they presently have. However unlike oil wells, cocoa trees cannot simply be turned off to reduce supply. Even if prices go up, say traders, that will encourage farmers to grow more which will increase supply and reduce the price.

Being a bigger part of the supply chain. As well as seeking higher cocoa prices, Ghana wants to add value to its product and give tax breaks to chocolate manufacturers to grind cocoa beans domestically. However there are issues:

  • mechanised factories employ few people so tax breaks have a low return
  • Ghana has a small dairy industry forcing manufacturers to import
  • Electricity prices are high
  • The climate requires greater refrigeration which means costs go up

Costs are always going to be more in Ghana than in Europe – also manufacturers are closer to their market in Europe. If consumers want to help poor farmers trading houses and big companies need to be cut out of the loop. At the moment there is a monopsony market.

Source: The African farmers taking on big chocolate – FT – 16-12-19

Mozambique’s monopsony market goes nuts

The primary sector is seen as integral to assisting developing countries grow and raise their standard of living. For the Mozambican economy the cashew industry is an example of this – more than 40% of Mozambican farmers grow and sell cashew, and the processing sector provides formal employment to more than 8,000 individuals. Mozambique is currently the second largest producer in East and Southern Africa and has links with premium export markets, including the United States and Europe.

In the 1960’s the cashew nut industry in Mozambique was in good shape supplying over 50% of global supply and processed most of these domestically and thereby adding employment. However, with a civil war and the instruction from the World Bank in the 1990’s to remove controls and cut taxes on the exports of raw nuts, trading firms shipped out cashews and processed them overseas with significant job losses. But an about turn by the government in 2001 has seen:

  • an export tax of 18-22% for raw nuts
  • a 0% tax for processed kernels.
  • a ban on exports during the first few months of the harvest

16 factories employing 17,000 people, which process about half the cashews sold.

However by having less competition amongst processors – a little like a monopsony market – farmers selling raw cashew nuts are finding that the price of their crop is being reduced by the smaller number of processors. Most cashew nut farmers are smallholders and the government seems to be oblivious to the 1.3m families for the sake of protecting processing jobs.

Monopsony – one buyer many sellers – other examples include:
– large supermarkets, who can dictate terms to smaller suppliers.
– buyers of labour in the labour market.

There is a dilemma for developing countries as when a primary industry starts to expand into the secondary stage of processing, government protection can hurt nut-growers. Just like the coffee industry farmers are at the mercy of a small number of middlemen in this case the processors monopsony power.

Source: Mozambique’s nut factories have made a cracking comeback –
The Economist 12th September 2019

Climate change = higher interest rates for developing countries

A significant number of developing countries are located in and around the equator which also means that they are more exposed to the extremes of climate change. As the world gets hotter these countries will suffer the most which makes their ability to advance their standard of living even harder. Temperatures in tropical climates will become far more variable and soil near the equator will dry up reducing its ability to dampen temperature swings e.g. Amazon rainforest, Congo, Indonesia etc.

The additional cost to poor countries in avoiding the damage caused by climate change is estimated to be between US$140bn – US$300bn each year on measures such as costal defences, strengthening buildings etc. This is according to the UN Environment Programme which assumes that global temperatures will be only 2°C above pre-industrial levels by the end of the century – unlikely according to The Economist. Not only are these countries suffering from climate change‑related drought, which will lead to a consequent drop in agricultural production and rise in food insecurity, but it also means higher interest payments than similar countries that are less exposed to climate change.

Climate Change = Higher risk of default = Higher Interest Payments

The V20 countries
The Vulnerable Twenty (V20) Group of Ministers of Finance of the Climate Vulnerable Forum is a dedicated cooperation initiative of economies systemically vulnerable to climate change. The call to create the V20 originated from the Climate Vulnerable Forum’s Costa Rica Action Plan (2013-2015) in a major effort to strengthen economic and financial responses to climate change. Originally 20 countries it has now expanded to 48 and the membership is mostly from poor countries that make up less than 5% of global GDP. They include the following:

Afghanistan, Bangladesh, Barbados, Bhutan, Burkina Faso, Cambodia, Colombia, Comoros, Costa Rica, Democratic Republic of the Congo, Dominican Republic, Ethiopia, Fiji, The Gambia, Ghana, Grenada, Guatemala, Haïti, Honduras, Kenya, Kiribati, Lebanon, Madagascar, Malawi, Maldives, Marshall Islands, Mongolia, Morocco, Nepal, Niger, Palau, Palestine, Papua New Guinea, Philippines, Rwanda, Saint Lucia, Samoa, Senegal, South Sudan, Sri Lanka, Sudan, Tanzania, Timor-Leste, Tunisia, Tuvalu, Vanuatu, Viet Nam and Yemen.

Research has estimated that V20 countries pay 1.2% higher than comparable countries which raises the V20’s borrowing costs by about 10% which is equivalent to an extra US$4bn each year in interest payments. It has also been estimated that of corporate debt a significant amount is held by countries who are the most at risk of climate change. This equates to 3% of total debt in more than 60,000 firms in 80 countries. These high risk countries were charged 0.83% higher interest on loans which equates to roughly a 10% premium. Therefore credit rating agencies are including climate change in their risk models and what makes it worse for developing countries is that they tend to be primary based economies which are the most susceptible to climate change. Moody’s, the credit rating agency, has suggested that of the 37 countries that are most vulnerable, farming accounts for 44% of employment on average.

For developing countries to counter the impacts of climate change sovereign parametric insurance has been prevalent. This insurance is pooled amongst countries in close proximity and makes the premium more affordable. This insurance relies on risk modeling rather than on-the-ground damage assessments to estimate the cost of disasters. Parametric insurance policies pay out automatically when certain pre-agreed conditions, such as wind speed, rainfall or modeled economic losses, meet or exceed a given threshold. Examples of areas where countries have pooled insurance are:

  • Caribbean Catastrophe Risk Insurance Facility
  • African Risk Capacity
  • Pacific Catastrophe Risk Insurance Company
  • Southeast Asia Disaster Risk Insurance Facility – under development

Like any insurance although it might be under used it does mean that countries can access money to recover and rebuild their economies – ideally with greater resilience.

Source: The Economist – ‘Costing the earth’ – 17th August 2019

Ethics and Profits – what about the coffee growers?

No business, however great or strong or wealthy it may be at present, can exist on unethical means, or in total disregards to its social concern, for very long. Resorting to unethical behaviour or disregarding social welfare is like calling for its own doom. Thus business needs, in its own interest, to remain ethical and socially responsible. As V.B. Dys in “The Social Relevance of Business ” had stated-

“As a Statement of purpose, maximising of profit is not only unsatisfying, it is not even accurate. A more realistic statement has to be more complicated. The corporation is a creation of society whose purpose is the production and distribution of needed if the whole is to be accurate: you cannot drop one element without doing violence to facts.”

Business needs to remain ethical for its own good. Unethical actions and decisions may yield results only in the very short run. For the long existence and sustained profitability of the firm, business is required to conduct itself ethically and to run activities on ethical lines. Doing so would lay a strong foundation for the business for continued and sustained existence. All over the world, again and again, it has been demonstrated that it is only ethical organisations that have continued to survive and grow, whereas unethical ones have shown results only as flash in the pan, quickly growing and even more quickly dying and forgotten.

Business needs to function as responsible corporate citizens of the country. It is that organ of the society that creates wealth for the country. Hence, business can play a very significant role in the modernisation and development of the country, if it chooses to do so. But this will first require it to come out from its narrow mentality and even narrower goals and motives. However behavioural economists have found that many business people don’t behave in this type of profit-maximising manner in times of crisis – e.g a water shortage means businesses could charge more. If they do, consumers remember and retaliate down the road.

Ethical Consumers

As consumers start to develop a preference for ethical brands, e.g.. Fair Trade Coffee, create a market for such coffee. Firms are therefore pressured to shift toward supplying what consumers want. This is even the case if the firm’s management don’t care how or where the coffee is sourced. Changing consumer preferences force firms to change their ways. Even at higher prices consumers are often willing to pay a premium for ‘ethical’ products or the products of socially responsible firms. Being more expensive doesn’t necessarily mean the company will go out of business if consumers have a preference for ethical products. Higher-priced ethical firms remain highly successful under these circumstances. Instead of being protected by tariffs or subsidies, they’re protected by the preference of consumers.

Coffee supply chain.
However a recent article in the FT outlined the desperate state for coffee growers. The price of high quality arabica beans is trading just above $1 in the New York Commodity Exchange – this is half the value it was 5 years ago. This was due to Brazilian producers flooding the market. Although coffee prices in the cafes have increased the farmers are not the ones to benefit. The image below shows that the grower only gets 1p from the $2.50 and the coffee itself only accounts 10p.

There is a supply chain that takes ‘clips the ticket’ on the way through (see image) but the majority of the cost is associated with rent, wages and tax. The video Black Gold (a bit old now but has some good economics) looks at the growing industry in Ethiopia where they have some of the finest coffee beans in the world. Farmers there have been ripping up coffee plants and replacing it with ‘chat’ – a drug which is banned in the West – which fetches a much higher price.

Globalisation for Africa

By end of the century 40% of the world’s population is projected to be living in Africa and still globalisation seems to have a limited impact on its people. In order to make Africa more inclusive policies will have to focus on accelerating regional integration, bridging gaps in labor skills and digital infrastructure, and creating a mechanism to own and regulate Africa’s digital data. Although the first industrial revolution resulted in a significant increase in international trade Africa has been a poor benefactor and this has led to the “great divergence” in income levels between the Global North and South. In the 1980s, the Brandt Line was developed as a way of showing the how the world was geographically split into relatively richer and poorer nations. According to this model:

  • Richer countries are almost all located in the Northern Hemisphere, with the exception of Australia and New Zealand.
  • Poorer countries are mostly located in tropical regions and in the Southern Hemisphere.

With the advances in technology over the last two decades Asian countries like China, Taiwan and South Korea have been able to narrow the gap with developed nations mainly because of the emergence of complex global value chains. However although Africa might have benefitted from the commodities market developed economies can now produce goods more cheaply and African countries have found it difficult to develop local industries that create jobs.

Unsurprisingly the economic disparity between Africa and richer countries has widened in recent decades, with the ratio of African incomes to those in advanced economies falling from 12% in the early 1980s to 8% today. In order to reverse this trend and enable Africa to benefit more from globalisation, the region’s policymakers should accelerate their efforts in three areas.

Policies to promote growth in Africa:

  1. Governments should promote further regional integration to make Africa economically stronger and more effective at advancing its agenda internationally. Progress so far is very encouraging.
  2. Africa must improve its digital infrastructure and technology-related skills to avoid being further marginalised. Moreover, the low-cost, low-skill labour on which Africa has traditionally relied is becoming less of a competitive advantage, given the advent of the Fourth Industrial Revolution
  3. Africa must create a system for owning and regulating its digital data. In the modern era, capital has displaced land as the most important asset and determinant of wealth.

By 2030, the continent will be home to almost 90% of the world’s poorest people. Unless globalisation works better for Africa than it has in the past, its promise of shared prosperity will remain unfulfilled.

Source: Project Syndicate – Making Globalization Work for Africa May 30, 2019 Ngozi Okonjo-Iweala , Brahima Coulibaly