Is the Chinese debt trap a myth?

It has been suggested that China cajoles less developed countries into taking out multiple loans to build expensive infrastructure that they can’t afford to fund themselves. This then leads to fears of possible takeover of assets by China when the borrowing country defaults on its debt. An example of this is the Sri Lankan port of Hambantota. However, a deeper look shows that accusations of so-called debt trap diplomacy turn out to be unfounded.

Sri Lanka – Hambantota.

It was the Canadian International Development Agency—not China—that financed Canada’s leading engineering and construction firm, SNC-Lavalin, to carry out a feasibility study for the port. The initial phase of the project should allow for the transport of non-containerised cargo—oil, cars, grain—to start bringing in revenue, before expanding the port to be able to handle the traffic and storage of traditional containers.

In 2007 after being turned down by the US and Indian companies, China Harbor won the contract to build the port with China Eximbank agreeing to fund it – $307 million,15-year commercial loan with a 6.3% interest rate. There were 2 phase of the build:

Phase 1 – infrastructure to handle non-containerised cargo – oil, grain, cars etc.
Phase 2 – transforming Hambantota into a container port.

Instead of waiting for Phase 1 to generate income the government went ahead with Phase 2 and borrowed $757 million from China Eximbank at an interest rate of 2%. By 2015 Hambantota was losing money and the Sri Lankan Port Authoroity (SLPA) signed an agreement with China Harbor and China Merchants Group to have them jointly develop and operate the new port for 35 years.

By this time with a change of government and increases in sovereign bond payments the Sri Lankan fiscal position was desperate. They owed more to Japan, the World Bank and the Asian Development Bank than to China. Only 5% of $4.5bn debt servicing was due to Hambantota.

It is important to note that there was never a default – IMF raised money by leasing out the Hambantota Port to an experienced company. Two bids came from China Merchants and China Harbor; Sri Lanka chose China Merchants, making it the majority shareholder with a 99-year lease, and used the $1.12 billion cash infusion to bolster its foreign reserves, not to pay off China Eximbank.

Africa and Chinese infrastructure projects

The video below from ‘Bloomberg Quicktake Originals’ looks at a similar scenario in Africa to that of Sri Lanka. Over the past two decades, China has built large infrastructure projects in almost every country in Africa, making Western powers uncomfortable amid wider concerns about Beijing’s investments across the continent. However, a deeper look shows that accusations of so-called debt trap diplomacy turn out to be unfounded.

Source:

The Chinese ‘Debt Trap’ Is a Myth – The Atlantic 6-2-22

For more on Developing Countries view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

Africa’s resource paradox and market failure

I have blogged a few times on the resource curse that affects some developing countries but it seems that in Africa a lot of resources go unused when they are actually demanded in an economy. There seems to be a lack of planning for supply and demand and build an infrastructure linking the two. The Economist came up with some good examples of this:

  • Ghana – generation vs distribution. The country produces too much electricity as Ghanaian usage per year equates to what someone in the US uses a fortnight. More than 25% of households in Ghana are not connected to the grid and 25% of electricity is lost due to derelict distribution infrastructure and theft. With regard to oil, Ghana spent over $4.7 billion on importing petroleum last year, despite having domestic petroleum refineries which are lying idle – they could produce 30% of its petroleum needs.
  • Uganda – like Ghana supply is greater than demand as capacity if nearly double peak demand. Trucks wait on the side of roads even though traders can’t find vehicles to transport their goods.
  • Ethiopia – largest livestock in Africa and tanneries to turn hides into leather but shoe and glove makers import leather from China. Local tanneries are concerned with how the leather is treated.
  • Nigeria – tomato-processing plant to make tinned paste but closed down due to crop failure caused by a voracious moth

Another issue is the completion of infrastructure projects – according to McKinsey approximately 80% of African infrastructure projects fail in the cost benefit analysis stage whilst fewer that 10% get the stage of acquiring funding. For Africa to further development there has to be some acknowledgement of market failure and a willingness to separate commercial power and political power amongst its government officials.

Source: How market failures are holding Africa back. The Economist 5th May 2022

For more on Market Failure and Development Economics view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

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.

Food and fuel prices impact on Sub Saharan Countries

Just finished completing policies for developing countries with my A2 class and invariably with all my economics classes you cannot get away with not talking about the war in Ukraine and the inflationary problems that the global economy is experiencing. The increase in food and and fuel prices hits the developing world the most and could not have come at a worse time as economies around the world are starting to open up after the COVID pandemic. For the developing world, especially in Sub-Saharan Africa (SSA) there is a significant erosion in living standards and macroeconomic imbalances – see graph below. The IMF has identified 3 main areas that the war is impacting countries:

  • In SSA food accounts for 40% of consumer spending with 85% of wheat supplies being imported. Add to that higher prices for fuel and fertiliser.
  • Higher oil prices mean adds $19bn to the regions imports which worsen the current account balance. However the eight petroleum exporting countries do benefit.
  • SSA countries are not well placed to cope with the need for increased government spending which means using more tax revenue. Increasing oil prices have a direct fiscal cost through fuel subsidies and rising interest rates globally make it more expensive to borrow money to keep the economy ‘above water’ let alone for actual development.

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on inflation. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

Difference between the IMF and the World Bank

Teaching external debt and the role of IMF and World Bank which is part of Unit 4 of CIE A2 syllabus. This is area where students get confused as to the role of each organisation.

The International Monetary Fund (IMF) (http://www.imf.org) promotes international financial stability of the world’s monetary system. Lends to countries with balance of payments problems and aims to promote development by restoring short run stability and by supporting long term adjustment and reform

The World Bank (http://www.worldbank.org) promotes institutional, structural and social development by providing low interest loans and technical assistance for domestic investment projects. It’s goal is to reduce poverty by offering assistance to middle-income and low-income countries. It aims to help countries meet the UN Millennium Development Goals.

Below is a useful video from CNBC on the differences.

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on developing economies and the IMF/World Bank. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

Surge in food prices hits developing countries

With the war in Ukraine there have been serious concerns about global food supply especially when you look at the graph below. Main points to consider:

  • Russia and Ukraine are both major grain and sunflower oil exporters
  • Spring planting near impossible for farmers in battle zones
  • Sanctions on Russia agricultural goods
Source: Thoughts from the Front Line – Another Strange Recession By John Mauldin | March 12, 2022

How will it impact developing countries.
The staple diet of many developing countries relies on imports of wheat and sunflower oil – for instance Egypt imports 85% of its wheat and 73% of its sunflower oil from the Ukraine and Russia. Countries in these circumstances have no choice but to not put sanctions on food imports. The Food and Agricultural Organisation of the UN Food Price Index – meat, dairy, cereals, oils, and sugar – rose 24.1% in February compared to a year ago. This price shock will impact developing countries as food takes up a greater percentage of a person’s income in the developing world. In the developed world food costs 17% of consumer spending in contrast to those in poorer countries where it takes up 40% of income.

IMF Blog

Many developing countries subsidise food prices to maintain law and order and avoid its population from starving but with higher food prices how are they going to afford subsidies? There is also the problem of repaying debt as feeding the population will the priority rather than servicing foreign debt. Furthermore there is an opportunity cost – money won’t be spent on eduction, healthcare, infrastructure etc which it was originally intended for.

In getting out a recession consumers and producers make adjustments sufficient to reinstate growth. I can’t see that happening soon. The entire world order is experiencing a shock adjustment — economically, geopolitically, and otherwise. John Mauldin

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

Chinese lending and underreported debt.

Most people will be aware of China’s presence in global trade but its growing influence in international finance seems to be relatively unknown mainly due to a lack of transparency and data. The vast majority of lending to Low Middle Income Countries (LMIC) is focused on infrastructure projects but China’s lending policy is obscure for a variety of reasons.

  • There is no published report of the China’s lending activity
  • As China is not a member of the Paris Club that shares bilateral lending and trade credit flows

The Paris Club is a group of 22 major creditor countries who try to find sustainable solutions to the payment difficulties experienced by debtor countries.

Features of Chinese loans

China by far the world’s largest official creditor, with outstanding claims in 2017 surpassing the loan books of the IMF, World Bank and of all other 22 Paris Club governments combined.  see graph.

Features of Chinese loans:

  • China lends at commercial rates – approx 4% – which is four times than that of a loan from the World Bank or an individual country.
  • China’s repayment period is generally shorter – less than 10 years which compares to approx 28 years for other lenders’ loans to LMIC.
  • China’s state-owned lenders require borrowers to maintain an offshore account which they have access to as security. This saves China having to go through the judicial process to recover funds.
  • Some countries are fast accumulating debt to China and for a lot of them the amount of debt owed has increased from less than 1% of debtor country GDP in 2005 to more than 15% in 2017. A dozen of these countries now owe debt of at least 20% of their nominal GDP to China.

Is China setting up debt traps?
There are mixed views on whether China keeps lending money to countries that can’t afford the repayment. This can result in China gaining part ownership of foreign assets as compensation for non-payment of a loan. Sri Lanka has been cited as an example of this in which there was considerable Chinese investment in a port project. However using loans and contractors from China proved contentious and Sri Lanka was left with growing debts. In 2017 consensus was reached which gave state-owned China Merchants a controlling 70% stake in the port on a 99-year lease in return for further Chinese investment.

However some reports suggest that the deal was driven by local political motivations, and China never took formal ownership of the port. In fact there are no instances of China seizing a major asset in the event of a loan default – AidData.

Why is there underreported debt? According to the China Africa Research Initiative there are five main reasons why countries have not reported debts to the World Bank.

  • World Bank rules on debt reporting only apply to countries actually borrowing from the World Bank. For instance when President Hugo Chavez of Venezuela pulled out of the World Bank after paying off loans, China then lent Venezuela US$90bn (21.1% of its GDP) which Venezuela was not required to disclose to the World Bank
  • Geopolitics also influences a country’s decision to disclose its debt. As well as Venezuela, Russia doesn’t report fully to the World Bank. For instance sanctions against a country will limit its ability to borrow from the World Bank.
  • Weak government capacities – if a country is afflicted by civil war they are often unable to report their borrowing. Sudan – overrun by conflict – stopped reporting loan commitments by China after 2010.
  • Deliberate hiding of foreign borrowing – loans to a country’s SOE’s may not be reported to the World Bank as domestic accounting systems keep SOE debt distinct from central government public debt. Mozambique has deliberately hidden loans from Swiss and Russian banks.
  • Chinese loan contracts – confidentiality clauses in them prevent borrower governments revealing the terms or even the existence of debt. Although more evidence is needed to prove this claim.

Why does underreported debt matter?
For policymakers in LMIC’s underreported debt is worthy of attention for the following reasons:

  • It can displace other public spending priorities that were planned and budgeted.
  • If a central government has a high level of debt exposure and this is underreported it will continue to borrow from lenders who are unaware of the risks. This can lead to an unsustainable accumulation of public debt.
  • It becomes very hard for for countries to resolve their debt crisis when they have such high underreported debt exposure. Creditors are likely to be less sympathetic to country’s who have underreported their debt exposure leading to litigation.

Sources

What is the Real Story of China’s “Hidden Debt”? by Deborah Brautigam and Yufan Huang. China Africa Research Initiative No. 6 2021.

China: Is it burdening poor countries with unsustainable debt? by Kai Wang – BBC Reality Check January 2022

Banking on the Belt and Road: Insights from a new global dataset of 13,427 Chinese development projects. Sep 29, 2021. Aid Data

Externalities of Food

Informative video from the FT that looks at the externalities of food covering – environmental cost, health costs and social costs. It focuses on the ‘True Cost Accounting’ and uses the example of coffee where a 1 kilo bag from Brazil costs $2 but the real cost is around $5.17 when you include that farmers are underpaid, there is unsustainable water use, air pollution, climate changing energy supplies and land degradation.

To encourage greater sustainability Rabobank introduced ‘The Rabo Impact Loan’ which is a low-interest business loan created especially for farmers that have a high sustainability performance. Good introduction to market failure.

Africa’s resource curse lingers on.

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. It is estimated that for every extra dollar in foreign currency earned from exporting resources reduces non-resource exports by $0.74 – Torfinn Harding of the NHH Norwegian School of Economics and Anthony Venables of Oxford University.

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.

According to the UN a country is dependent on commodities if they are more than 60% of its physical exports – in Africa that makes up 83% of countries. One of the major concerns for resource rich countries is the wild fluctuations in commodity prices which can lead to over investment – Sierra Leone created two new iron-ore mines in 2012 only for them to close in 2015 as prices collapsed. However the amount of jobs created in the mineral extraction industry is limited – across Sierra-Leone of 8m people, about 8,000 work in commercial mines. A major problem in these countries is that when there is money made from resources it tends to go on government salaries rather than investing in education. infrastructure and healthcare etc.

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 which is now worth $1.1trn – equates to $200,000 for every citizen. This ensures that they have the means to prepare for life after oil.

Source: The Economist – ‘When you are in a hole…’ January 8th 2022

BRICS – 20 years on

‘Counting the Cost’ from Al Jazeera looks at the BRICS countries – Brazil, Russia, India and China (and South Africa, which was added later). According to Jim O’Neill of Goldman Sachs ,who came up came up with the acronym, these countries would, over time, come to dominate the rankings of the world’s richest economies. Apart from China the other countries have been a disappointment and the programme looks into the reasons why they have failed to live up to expectations. Useful for the developing economies topic as it shows how different each economy is and what they are dependent on for economic growth.

COP26 – a summary

Another good video from CNBC looking at the recent COP26 meeting. COP26 – Conference of the Parties – is the specific name of the annual United Nations Climate Change Conference in its 26th year. The first meeting was in Berlin in 1995. Main points from the video are:

  • 2015 Paris Climate Agreement – committed countries to limit global warming to no more than 2°C above pre-industrial levels with an aim for 1.5°C
  • Global warming is 1.1°C – on track for 2.4°C increase by end of the century
  • Rather than phasing out coal they would phase down – opposition from China and India
  • USA, EU and others stated that they would cut global methane levels by 30% by 2030
  • India to cut its emissions to net zero by 2070
  • Richer nations need to help finance emerging economies to cope with climate change
  • Present policies will see the temperature rise by 2.7°C.
  • If National Determined Contributions (NDC) targets are implemented then by 2030 temperature rise will be approximately 2.4°C.
  • If all targets are fulfilled the best case scenario is 1.8°C
  • GFANZ – Glasgow Financial Alliance for Net Zero – hope to raise $130 trillion from private capital to fight climate change.

AS Revision – Tariffs and Protectionism

Just completed a 3 day CIE AS Revision Course.  I talked about Tariffs and Protectionism which is in Unit 4 of the AS course and how it can be a popular ‘Discuss’ question in the essay paper (Paper 2). However you will be expected to know this at A2 level also. Remember the following reasons for barriers to trade:

Why Protectionism?
a) Safeguard home country employment
b) Correct balance of payments disequilibria
c) Prevent labour exploitation in developing countries (or other political – not economic – goals)
d) Prevent Dumping
e) Safeguard infant industries

Below is useful mindmap that I use for revision of the topic.

Source: CIE A Level Revision – Susan Grant

New Zealand Subnational Human development index (SHDI)

Most macro economics courses cover development economics and the human development index (HDI). The HDI is the average of three indices based on three different variables and it sets a minimum and a maximum value for each dimension and then shows where each country stands in relation to these values, expressed as a number between 0 and 1. The higher a country’s HDI score, the higher its level of human development (and vice versa).:

The 3 indices in the HDI are:

Life expectancy: Life expectancy at birth and is:
1 when Life expectancy at birth = 85
0 when Life expe
ctancy at birth = 20.

Education:
Mean years of schooling – a country whose citizens all attained 15 years of education by the age of 25, would have an MYS index of 1.0.
Expected years of schooling – if every student in a country enrolled in a master’s degree that country’s EYS index would be 1.0

Standard of living: GNI per capita (PPP US$)
1 = $75,000 / annum
0 = $100 / annum

The new Subnational Human Development Index (SHDI)is a simple cross-nationally comparable index. While at the national level it coincides with the official HDI constructed by the UNDP, its subnational values reflect – in a globally comparable way – the variation in human development among geographic regions within countries. See graph below for New Zealand. Note that Wellington and Auckland have the highest SHDI score whllst Gisborne and Northland the lowest.

IMF: SDR’s and poor countries

When teaching development economics most courses reference special drawing rights (SDR) from the IMF to assist both developing and developed countries. SDR was created in the 1960’s and is a part currency consisting of reserve assets such as dollars and gold. They are valued against a basket of several major currencies and can be swapped for those currencies. Unlike a lot of loans there are no conditions with SDR’s and the interest rate is only 0.05% with no payment deadline.

Since COVID-19 the IMF has assisted countries as follows:

  • extended loans worth about $130bn to 85 countries
  • provided debt-service relief to some poor economies
  • created $650bn in new foreign-exchange reserves

The important aspect about this is that the availability of these reserves should lift market confidence and put less pressure on a country’s foreign currency reserves. The IMF estimates that the global economy will be short of reserve assets of 1.1 to 1.9 trillion.

Why are SDR’s useful for countries

Assuming there is a recovery in the USA this will lead to higher interest rates and money will leave predominately poorer countries to take advantage of the higher return. This will weaken those domestic currencies which in turn make imports more expensive. The new allocation of SDRs will give governments the finance to import essentials like food and vaccines – see graphic.

The more you give the more you get.

The new distribution of SDR’s equates to the proportion of funding that a country provides to the IMF which means that more developed countries will receive more than half the quota. Low income countries get 3.2% or $21bn of the total which seems to be insufficient to cope with public health issues caused by COVID-19 as well as climate change and an economic recovery. Furthermore, more developed countries have greater ability to borrow on global markets than those less developed. However, richer countries are looking at ways of donating some of their new SDRs to poorer nations with contributions of about $15bn in existing SDR holdings have already helped expand an IMF facility offering no-interest loans to poor countries over the past year.

Source: The Economist -Every little helps – 17th July 2021

Economics of Coffee

Below is a very good graphic from Visual Capitalist about how coffee prices are broken down. One of the most popular commodities, coffee is supported by a massive $200+ billion industry. You can enlarge the image by clicking on it. However it is the developing countries who lose out and is some instances grow things like ‘chat’ (narcotic) instead of coffee beans. This has been especially prevalent in Ethiopia

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