Category Archives: Development Economics

How do deal with a resource curse – Venezuela and Norway

I have been doing exchange rates with my AS class and we talked about the problems some countries have when they are blessed with natural resources – the resource curse. Africa may have enormous natural reserves of oil, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from oil. This refers to the fact that once countries start to export oil their exchange rate – sometimes know as a petrocurrency – appreciates making other exports uncompetitive and imports cheaper. At the same time there is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports. Economists also refer to this as the Dutch Disease which makes reference to Holland and the discovery of vast quantities of natural gas during the 1960s in that country’s portion of the North Sea. The subsequent years saw the Dutch manufacturing sector decline as the gas industry developed. The major problem with the reliance on oil is that if the natural resource begins to run out or if there is a downturn in prices, once competitive manufacturing industries find it extremely difficult to return to an environment of profitability.

A future resource curse in Indonesia: The political economy of natural resources, conflict and development.

Venezuela could learn off the Norwegians
Venezuela is home to the world’s largest oil reserves, and its economy has been tied to the ups and downs of the international price of oil for decades — oil constitutes about 25% of the country’s GDP and 95% of its exports. But the country’s oil production reached its lowest point since 2003 this year, when production went from 1.2 million barrels per day in the beginning of 2019 to an average of 830,000 barrels per day. The energy sector is only producing a fraction of the 4 million barrels of oil a day it could be producing.

Norway, the world’s third largest oil exporter behind Saudi Arabia and Russia, puts away a large share of its wealth in a national pension fund, now worth more than $300 billion. The problem here is that Norway is a small, homogeneous country of about five million people that was relatively advanced when its oil started to flow. It already had the sorts of public institutions that enabled it to cautiously manage its newly found wealth.
In 1969 the discovery of oil off the coast of Norway transformed its economy with it being one of the largest exporters of oil. A lot of countries in similar positions have succumbed to the ‘resource curse’ in which countries tend to focus on a natural resource like oil. The curse comes in two forms:

  1. With high revenues from the sale of a resource, governments try and seek to control the assets and use the money to maintain a political monopoly. This is where you find that from the sale of your important natural resource there is greater demand for your currency which in turn pushes up its value. This makes other exports less competitive so that when the natural resource runs out the economy has no other good/service to fall back on.
  2. However it is the fall in commodity prices that is now hitting these countries that have, in the past, been plagued by the resource curse. As a lot of commodities tend to be inelastic in demand so a drop in price means a fall in total revenue since the the proportionate drop in price is greater than the proportionate increase in quantity demanded.

Norway – has a different approach.
In Norway hydrocarbons account for half of its exports and 19% of GDP and with further oil fields coming on tap Norway could earn an estimated $100bn over the next 50 years. Nevertheless there is a need to wean the economy off oil and avoid not only the resource curse that has plagued some countries – Venezuela is a good example as approximately 90% of government spending was dependent on oil revenue – but also the impact on climate change. Norwegians have been smart in that the revenue made from oil has been put into a sovereign wealth fund Its value on 31 December reached 10.9tn kroner, or US$1,311bn – equal to assets worth US$241,000 for each of Norway’s 5.39 million inhabitants. This ensures that they have the means to prepare for life after oil.

Policies for Developing Economies

Finishing ‘Developing Economies’ with my A2 class and doing some last minute revision before they have an assessment on it. There is usually an essay question on this topic in the A2 CIE Paper 4. Below is a useful mindmap which has been sourced from Susan Grant’s CIE Revision Guide outlining Economic Development.

Policies for Developing Economies.

The solution is shown in the figure below, where foreign help, in the form of official development assistance (ODA), helps to jump-start the process of capital accumulation, economic growth, and rising household incomes. The foreign aid feeds into three channels. A little bit goes directly to households, mainly for humanitarian emergencies such as food aid in the midst of a drought. Much more goes directly to the budget to finance public investments, and some is also directed toward private businesses (for example, farmers) through microfinance programs and other schemes in which external assistance directly finances private small businesses and farm improvements. If the foreign assistance is substantial enough, and lasts long enough, the capital stock rises sufficiently to lift households above subsistence. At that point, the poverty trap is broken, and the figure comes into its own. Growth becomes self-sustaining through household savings and public investments supported by taxation of households. In this sense, foreign assistance is not a welfare handout, but is actually an investment that breaks the poverty trap once and for all. Adapted from Jeff Sachs – The End of Poverty.

The Role of ODA in Breaking the Poverty Trap

Minimal monetised societies and happiness

For less developed countries economic growth is often assumed to improve the happiness of the population although this relationship has come under a lot of scrutiny in recent times. A new study shows that people in societies where money plays a minimal role can have a level of happiness comparable to those living in Scandinavian countries which typically rate highest in the world. An interview with Eric Galbraith (McGill University, Canada) on Radio New Zealand’s ‘Sunday’ programme caught my attention in which he discusses the research undertaken in the Solomon Islands and Bangladesh. The paper is entitled:

Happy without money: Minimally monetized societies can exhibit high subjective well-being

Public policy that has focused on GDP growth fails to capture other aspects such as income inequality, the depletion of natural resources, environmental concerns etc. However subjective well-being (SWB) is an indicator that is more associated with the variables that matter to people. Galbraith et al question the role of money in determining SWB and reference the Easterlin Paradox (see below) which found that people don’t tend to get happier when their income goes up – see graph below.

What is the Easterlin Paradox?

Easterlin Paradox
  1. Within a society, rich people tend to be much happier than poor people.
  2. But, rich societies tend not to be happier than poor societies (or not by much).
  3. As countries get richer, they do not get happier. Easterlin argued that life satisfaction does rise with average incomes but only up to a point. One of Easterlin’s conclusions was that relative income can weigh heavily on people’s minds.

It is generally believed that people in less developed countries that have minimally-monetised economies have low that SWB. However the fact that happiness has a universal feeling suggest that income may be just a substitute for other sources of happiness, an assumption that is easier to notice in settings where money has little or no use. They used three independent measures to assess complementary but distinct psychological dimensions of SWB.

  1. Cognitive life evaluation – this asks about a person’s satisfaction with life and questions are phrased in a few different forms.
  2. Affect balance – asks what emotions they had experienced throughout the previous day, and calculated as the difference between positive and negative emotions.
  3. Momentary affect – data was obtained by querying subjects by telephone at random times about their emotional state.

Researchers selected four sites in two countries:

Solomon Islands – round 80% of the population live in rural subsistence communities and it has a Human Development Index (HDI) of 0.546 (rank 152 in the world). The sites were Roviana Lagoon (rural site) and Gizo (urban site)

Bangladesh – 35.9% of it being urban, and has an HDI of 0.608 (world rank 136). The sites were Nijhum Dwip (rural) and Chittagong (urban).

Results
The graph below shows that the 4 sites, although are minimally monetised societies,
do experience high levels of SWB which challenge the prevailing view that economic growth is a reliable pathway to increase subjective well-being. While the data presented here were collected only in two countries and four sites this is the first study to that systematically compares standardised SWB measures in minimally monetised, very low-income societies.

Credit rating agencies polices could impact developing countries recovery.

The world’s three major private credit-rating agencies (CRA) Standard & Poor’s, Moody’s and Fitch are using their power to prevent low-income countries from restructuring their debts and stimulating their economies. Credit rating agencies realise that developing economies who engage with private creditors, which is part of the G20 Common Framework for Debt Treatments, run the risk that those creditors will incur losses and therefore CRA downgrade the developing country’s credit rating. The Common Framework is supposed to help debt-ridden countries and are the best chance for developing countries to reduce their liabilities but a ratings downgrading damage their prospects.

Standard & Poor’s, Moody’s and Fitch control more than 94% of outstanding credit ratings. They are basically an oligopoly influencing financial portfolio investments, the pricing of debt and the cost of capital. Their authority is also enhanced by the SEC (Security and Exchange Commission) who see them as the official CRA. Below are the ratings that each company uses.

We’ve been here before – conflict of Interest and the sub-prime crisis of 2008
Rating agencies are paid by the people whose products they grade and they are competing against other rating agencies for the business. Subsequently the rating agencies were being played-off against each other by the bankers in this market and this led to a systemic decline in standards and willingness not to check the underlying information as thoroughly as possible for fear of losing the deal. Even the rating agencies themselves admit mistakes were made is assessing sub-prime debt and that there were issues to do with data quality from their sources of research. However one has to consider whether the world have been better off if credit rating agencies had not existed as pension funds, bond funds, insurance companies etc would have had to do a lot more of their own research on what they were buying.

Remember before the credit crisis AAA investments mushroomed between 2000-2006 see graph below.

But consider the following:
Bear Stearns
– rated A2 a month before it went bankrupt
Lehman Brothers – rated A2 just days before it collapsed
AIG – rated AA within days of being bailed out
Fannie Mae & Freddie Mac – AAA rating before being bailed out by the government
Citigroup – A2 before receiving a bail out package from the Government
Merrill Lynch – A2 before being sold to Bank of America

A2 is considered a good investment grade

Source: Credit-Rating Agencies Could Derail Economic Recovery – Project Syndicate

Economic growth becoming a malignancy – Dr Mike Ryan WHO

Most economics courses will include the topic of limitations of Gross Domestic Product as an indicator of standard of living. US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile. I was very taken by Dr Mike Ryan’s (WHO) recent speech about how Covid 19 is a wake up call to how we live our lives. A lot of references to the fact that we can’t keep just focusing on economic growth. Well worth a look.

China looking to domestic sector to maintain growth.

Neoliberal policies of the last 30 years have seen income inequality grow and the collapse of consumer spending (C) the main driver of any domestic economy. There has been an increase in the proportion of income accruing to assets which worsens inequality in many countries. While China’s economy is synonymous with exports, private consumption has been the largest component of Chinese GDP growth since 2014. With household spending at 39% of GDP in 2018, compared with nearer 70% for more developed economies such as the U.S. and the U.K., it also has considerable potential for further growth. Remember that Aggregate Demand = C+I+G+(X-M).

S&P Global

At the annual planning meeting last month China decided to focus on expanding domestic demand and achieving a major breakthroughs in core technologies. President Xi Jinping’s administration is looking at being self-sufficient in a range of technologies that have in the past been dominated by US firms. An obvious reason for the switch to domestic consumers is that with COVID-19 there is increasing instability and uncertainty around the international environment. A temporarily suspended trade war with the US has emphasised the importance of ending its dependence on foreign technology supplies. President Xi Jinping outlined a new dual circulation economic strategy which came about with the potential decoupling with the US and deglobalisation which would negatively impact the demand for Chinese exports. The dual circulation economic strategy consists of:

  • The importance of strengthening domestic demand
  • Technological innovation over closer integration with the outside world

Growth targets
China has set targets for economic growth in its 5 year plans – this is its 14th 5 year plan. It is expected that annual average growth to be around 5% down from previous years where it was expected to be 6.5% – 7.5%.

Final thought
China needs a lot more domestic consumption as newly produced goods will just become surplus to requirements. This will also mean increased levels of corporate debt.

Hernando de Soto – Property Rights 20 years on.

I have blogged quite a bit on this topic using the work of Peruvian economist Hernando de Soto and his book ‘The Mystery of Capital’. There was also some great footage from the Commanding Heights Series which showed de Soto traveling in Peru and talking about what he sees as the main obstacle to the development of markets and capitalism within developing countries – property rights.

Without a title to a property nobody knows who owns what or where, who is accountable for the performance of obligations, who is responsible for losses and fraud, or what mechanisms are available to enforce payment for services and goods delivered. Consequently, most potential assets in these countries have not been identified or realised; there is little accessible capital, and the exchange economy is constrained and sluggish. However in the West, where property rights and other legal documentation exist, assets take on a role of securing loans and credit for a variety of purposes – building capital with capital.

De Soto estimated that about 85% of urban parcels in Third World and former communist nations, and between 40 and 53 % of rural parcels, are held in such a way that they cannot be used to create capital. The total value of the real estate held but not legally owned by the poor of these countries is at least $9.3 trillion – $13.5trn in today’s money. Studies suggest that titling has boosted agricultural productivity, especially in Asia and Latin America. The World Bank wants 70% of people to have secure property rights by 2030. Despite all these efforts, only 30% of the world’s people have formal titles today. In rural sub-Saharan Africa a dismal 10% do. Just 22% of countries, including only 4% of African ones, have mapped and registered the private land in their capital cities.

PRINDEX is an organisation that measures global perceptions of land and property rights – see video below.

In July 2020 they published an informative report on tenure security – “Comparative Report – A global assessment of perceived tenure security from 140 countries”. Some of the findings from the report:

  • Nearly 1 billion people around the world consider it likely or very likely that they will be evicted from their land or property in the next five years. This represents nearly 1 in 5 adults in the 140 countries surveyed.
  • Levels of perceived insecurity vary by region. While the greatest number of people who are insecure live South Asia (22% of people), sub-Saharan Africa (26%) and the Middle East and North Africa (28%) each have higher proportions of insecurity.
  • People living in cities experience higher levels of insecurity than those living in rural areas (18% vs. 16%).
  • The possession of formal land and property rights documentation tends to be associated with greater confidence of perceived tenure security compared to owners and renters who have no formal documentation at all (80% vs. 63%)
  • Nearly half of all women in sub-Saharan Africa (48%) feel insecure about their land and property rights when faced with the prospect of widowhood or divorce.
  • Tenure insecurity is strongly linked to age. Overall, 24% of young people aged 18-25 felt insecure compared to just 11% of people aged over 65.
  • Tenure insecurity is associated with economic factors in regions that are highly developed, such as North America, Europe, Australasia and parts of Asia.
  • Perceived tenure insecurity is closely correlated with other economic, human development, and governance indicators, including gross domestic product (GDP), World Governance Indicators (WGI), the Multidimensional Poverty Index, and the Human Development Index. There is a particularly strong correlation between tenure insecurity and the Corruption Perceptions Index (CPI).

Below is a graph from the report:

Perceived tenure insecurity as measured across all properties and plots of land that a respondent has rights to access or use, not just their ‘main’ property.

Concerns

In the developing world having the authority to allocate land has great benefits.

  • Politicians use land as a way of rewarding supporters and themselves
  • Politicians / Chiefs use their powers to sell the land to mining companies / developers without the consent of their people
  • Some seize the land because it is deemed to be in the “public interest”

A crucial lesson of the past few decades, however, is that if land reform is treated purely as a top-down technical task, it will not work well. It is not enough simply to map and register a property, as several high-profile efforts show. Land is an emotive issue, especially where memories of colonial expropriation still linger. As Mr de Soto argued, capitalism should be for the many, not just the few. The Economist – September 12th 2020

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.