Just completing the Unit 6 of the A2 course and updating my notes on the current issue of debt hangover from the Global Financial Crisis. The FT recently reported that there are worrying signs of private sector credit in emerging economies.
Turkey Brazil Russia – private sector credit in year to April 2012 up 20%.
China – private sector credit in year to April 2012 up 15%.
Poland – private sector credit to GDP 49%
This is seen as inevitable if an economy is going to grow but there needs to be investment in capital which will ultimately increase a country’s productive capacity and long-term development. However a lot of this borrowing has gone into consumer goods rather than capital infrastructure projects. This is especially worrying in Brazil as the transport system needs a major overhaul if it is going to cope with the demands of the Olympic Games in 2016. According to the FT misdirected credit can produce two damaging consequences:
1. When too much money is directed into the housing market bubbles can occur – subprime for instance and more recently China.
2. Poor credit allocation can harm economic growth, both in the short and in the long term.
Although China and Brazil has loosened monetary policy this needs to be accompanied by a process that ensures it is directed to where it is most needed. Jeffrey Sachs in his book “End of Poverty” talked about how a country needs six major kinds of capital:
1. Human capital: health, nutrition, and skills needed for each person to be economically productive
2. Business capital: the machinery, facilities, motorized transport used in agriculture, industry, and services
3. Infrastructure: roads, power, water and sanitation, airports and seaports, and telecommunications systems, that are critical in-puts into business productivity
4. Natural capital: arable land, healthy soils, biodiversity, and well-functioning ecosystems that provide the environmental services needed by human society
5. Public institutional capital: the commercial law, judicial systems, government services and policing that underpin the peaceful and prosperous division of labor
6. Knowledge capital: the scientific and technological know-how that raises productivity in business output and the promotion of physical and natural capital
Figure 1 shows the basic mechanics of saving, capital accumulation, and growth. We start on the left-hand side with a typical household. The household divides its income into consumption, taxation, and household savings. The government, in turn, divides its tax revenues into current spending and government investment. The economy’s capital stock is raised by both household savings and by government investment. A higher capital stock leads to economic growth, which in turn raises household income through the feedback arrow from growth to income. We show in the figure that population growth and depreciation also negatively affect the accumulation of capital. In a “normal” economy, things proceed smoothly toward rising incomes, as household savings and government investments are able to keep ahead of depreciation and population growth.
Source: The End of Poverty: How we can make it happen in our lifetime by Jeffrey Sachs (2005).