Friday, February 27, 2009

Is There Correlation Between Savings Ratio & Current Account Deficit?

Household savings ratio: Defined as percentage of disposable income that is saved. For instance if one’s disposable income is RM 3000 & that person spends RM 2400 per month on average, he left RM 600 for himself. In percentage we say his savings ratio is 20% (considered high for a Malaysian)

Current account balance: Defined as the sum of 4 separate balances which include net trade in goods, net trade in services, net investment income & profits from oversea assets & net transfers

Source: tutor2u

Source: tutor2u

Is there likely any positive correlation between the household savings ratio & current account balance?


Source: BBC (Interest rates in US earlier on)

Source: BBC (Interest rates in UK earlier on)
It is very obvious that savings ratio in both US & UK have been steadily declining since early 1990s. Well, this is not surprising given that both economies pursue consumption-led growth. The component of household spending itself actually makes up about 70% of both US & UK’s GDP. It became more apparent somewhere around 2001-2005, when MPC slashed interest rates from 6% high & since then rates were low, lingering around 4%-4.5%. This had encouraged more consumer spending. The same goes for US, when the Fed continuously cut interest rates from 6.5% high in 2001 & since then base rates were standing at only 1%-1.5% until 2005. Furthermore the people in both places have high marginal propensity to import. What this means is, any increase in disposable income will led to large proportion of that income spent onto foreign goods & services

Contrast, 80% of the world trade surpluses come from Germany especially, China, Japan & oil rich gulf nations. Germany for instance, had savings ratio around 11% compared to UK 3%. High level of savings, lower personal debt & lower appetite for imported goods & services can be few of the reasons to explain the success of Germany in maintaining such a high current account surpluses

Not really (evaluations)

While savings ratio can be a good barometer to indicate the positioning of current account, it is considered insufficient. Let’s consider Japan. Despite a sharp fall in savings ratio over the years, still it is able to yield high current account surpluses

What are the possible reasons for this?

(1) Comparative advantage in manufactured goods. The Japanese knew that they can produce cars, electrical appliances & high quality electronic goods at a lower opportunity cost than many other countries. Large investment onto capital goods earlier on results in higher productivity & lower costs per unit of goods. The impact is magnified with large pool of skilled workers. Furthermore, they have successfully captured the world market share in terms of exports, giving them superb advantages in EOS. Over the years, Japan also receives large amount of FDI. Increasing number of foreign production plants also boost their exports. Having all these, no wonder Japan pursue export-led growth

(2) Undervalued exchange rates. Due to the long depression in its economy since 1990s, the Japanese monetary authority had decided to introduce 0% interest rate at March 2001. It was kept at this level until July 2006. In that period many wealthy foreigners, asset management companies, financial institutions etc had withdrawn their savings from Japan in search of other countries which provide higher interest rates. This caused yen to depreciate. Falling yen benefits its manufacturing sector as Japanese goods will be cheap. Simultaneously, desire for imported goods will fall due to falling purchasing power of yen. Rising exports with falling imports will widen the surplus in current account

(3) Increase in investment income & profits. This is strongly tied with 0% interest rate policy. Theoretically, one may argue that savers are still better off since in period of deflation in Japan (falling price level), real interest rates will increase. Consider this, 0% - (-2%) = 2%. However, not all savers were able to see things that way. As such, many rich Japanese withdrew from their country & parked their monies in Australia, US, UK & Europe that time hoping to gain from the differential in interest rates. This phenomenon is called yen carry trade. In couple of years, it had contributed significant surplus in investment income & profits for the Japan’s current account

(4) Strong economic growth in US & Euro-land. In early 2000s economic growth in US, UK & other European economies were robust, generating a large appetite for Japanese goods such as LCD TVs, cameras, cars etc which are classified as luxury goods. In other word, having YED > 1. This is because an increase in income, will generate a larger than proportionate increase in demand for such goods. This further boosts its exports. Having said so, there is not much of an increase after all in its value as % of GDP. Probably the rise in China as another manufacturing hub, had more or less eroded its comparative advantage

Is It Possible To Have Both Low Unemployment & Low Inflation At The Same Time?

The answer to above question is YES. Indeed, in early 1990s UK did witness a period of both low inflation & low unemployment. How could that have happened? Isn’t it there suppose to be a trade off between unemployment & inflation? In other word, we can’t have both at the same time. Policymakers will have to choose either to adopt low inflation or low unemployment economy

The Phillips curve is in recognition of A.W Phillips, a New Zealand economist who did a research using data from 1861-1957 for UK. The 96 years data confirmed that there was indeed a trade off between the 2. For policymakers, the relation seemed to be stable & as such they could choose which macroeconomics objective to fulfill. They could use expansionary monetary policy (cut interest rates) & fiscal policy (increase public spending & cut tax) to raise the real GDP & as such absorbing those unemployed. The price to pay is higher inflation!

Source: plusmath

Soon not long after he proposed this, the so called stable relationship between unemployment & inflation broke down in 1960s. Economists managed to gather more data that contradicts the relation. Unemployment & inflation is creeping up at the same time. So what went wrong?

Source: tutor2u
Later, economists by the name of Edmund Phelps (Nobel Prize Winner in 2006) became the center of attention when he successfully explained this relation.
Source: bized

Assume the economy begins from U where inflation rate is 0%. Say, the government wants to reduce unemployment rate. So it conducted expansionary fiscal policy e.g. building schools, hospitals, repairing roads & bridges etc to absorb more unemployed people. But in order to attract workers, wages must be increased. Unemployed people which made up of frictionally or structural will take up the job. Now unemployment is lower at the expense of higher inflation, 5%

Here those workers took up the job since they expect future inflation to be at 0%. In other word they supply their labour since they thought that their real wages had increased. This phenomenon is called money illusion. Once workers realised that they are not better off, they withdrew their labour service & become unemployed again. The economy moves from point V to point W. Unemployment backs to U again but inflation stays where it is since money wages do not fall back to its original level. Now the economy is on another SRPC with expected inflation to be at 5%

If the government intends to reduce unemployment once again, the cycle will repeat itself & the economy will land at higher price level each time. Unemployment at U consists of all those people who are voluntarily becoming unemployed. Frictionally unemployed could get a job any time but they are just taking their sweet time to look for the best job, with better benefits & higher pay. Structurally unemployed while their skills are becoming more irrelevant can actually move on e.g. North to South or learning new skills etc

Source: tutor2u

Possible reasons for low unemployment & low inflation in UK:

(1) High value of pound.
It had strengthened against many major currencies like dollar since 1996 (it became more volatile when the credit crunch started). Rising pound means any imported goods will become much cheaper for Britons, while at the same time causing UK manufactured goods to be relatively more expensive. This will reduce net exports which mean falling AD & therefore falling inflationary pressure. Also since oil price is quoted in dollar, strong pound had kept oil prices relatively low in UK thus avoiding the risk of stagflation (falling real GDP & rising price level)

(2) Independence of MPC. MPC (Monetary Policy Committee) has gained independence since May 1997. The main intention is to alleviate government intervention when it comes to interest rates decision which is often associated to inefficiency & implementation lags. Also MPC is given the task of maintaining inflation rate within the narrow band of CPI 2% +/- 1% (previously RPIX 2.5% +/- 1%). This shows how committed is UK government is combating inflation. These have physiological effect onto the market. If workers trusted MPC & believe that inflation is stable say, 2% they will not persistently demand for higher nominal wages. Also BOE can adjust for lower interest rates to stimulate the economy. This has helped to unemployment low

(3) Effectiveness of supply side policies. It is said that Margaret Thatcher’s policies begin to bear fruit after some lags. During her era, trade union was weakened & no longer demand for absurd high wages which puts much pressure onto the economy. Also many government entities were privatised during her time. With higher level of competition, firms will strive to become more cost efficient & this is reflected in lower prices. The present Labour government has also introduced New Deal in 1999 which provides training for those unemployed. As a result, millions of workers have managed to secure a job up to date with their newly acquired skills

Monday, February 23, 2009

Is Another Great Depression Inevitable For Japan?

Japan, being the world second largest economy was previously seen as the most stable one among G7 nations in the current turbulence. Economists based this statement upon its level of exposure to bad loans which is very minimal, benchmarked against US & Europe. But, I argue that the claim is baseless considering Japanese economy which is very globalise & therefore susceptible to any external forces. Yes, it may not have direct exposure to subprime loans, but don’t forget it is still connected to the world out there through trade relations

Earlier, economists predicted that Japan will probably see no growth this year, which many thought of being too optimistic. To me, I see it as a sign of another inevitable depression. By definition, its economy is already in a recession (after 2 successive quarters of negative economic growth). To be classified as depression, its output will have to contract by more than 10%. Given the current indicators in US & Europe at large, the global economy is unlikely to turn around, not until early 2010.

Please refer to the following slide presentation to get better understanding as my explanations are solely based on the diagrams in that slides (couldn't upload for you guys due to different file format)

Why depression is imminent?

(1) Real GDP is fast contracting indicating that there is a severe fall in output. Lack of demand, domestically & internationally are the major driver. On the broader scale, falling real GDP also shows falling income on per capita basis

(2) CPI shows that prices of goods & services are still increasing but at a slower pace. Probably in couple of months, the growth rate will be negative. By then, deflation will took hold Japan once again. While inflation is bad, deflation is probably worse. In the period of falling price, consumers will tend to delay the purchase of cars, houses, cameras & others goods as they anticipate that price will further fall. However, by doing so means that there will be nobody spending into the economy. Fall in consumption, will cause AD to shift leftward. Real GDP will further contract followed by lower price level. The cycle continues

(3) Negative changes means that prices of land & most notably property is falling. This resembles a fall in asset wealth, which may trigger a crisis in consumer confidence & therefore spending. However, it is worth to take note that the negative changes are getting smaller by 2007 which may indicate that prices of property had likely to reach its low & stabilise. Unfortunately, the economic crisis seems to trigger the property price deflation once again

(4) Both exports & imports are collapsing. Demand for Japanese goods especially electrical & electronic goods collapse. Fall in the demand for cars is even worse due to its nature of being luxury goods (having YED > 1). For instance, sales of Mitsubishi fell by 77%, Mazda dropped 72% & Nissan by 62%. Overall, on an annual basis between January 2008 to January 2009, exports fell by 46%. Although, yen had strengthened against major currencies like US dollar, import still fell due to falling confidence, falling overall income & falling industrial activity which lead to lower import of raw materials & capital goods

(5) Yen is strengthening against the greenback due to the unwinding of yen carry trade activities. This heightened the scale of fall in exports. Demand for Japanese goods already fell due to slower economy in US & Euro-land & is exacerbated by the strength of yen which means Japanese goods are more expensive now. I’m not particularly sure if Bank of Japan does intervene actively to stabilise the exchange rate. But one thing for sure, it’s not healthy for an export-oriented economy like Japan. Fall in exports will cause a fall in AD, which also leads to contraction of real GDP. Through the negative multiplier effect, Japanese economy will contract further & at the faster pace. That’s why we see recently there are so many Japanese people being jobless & endless number of companies is desperate of shedding surplus of workers

(6) Of all the macroeconomic variables, I argue that rising unemployment in Japan will be the ‘graviest’ (actually there is no such word) concern for policy makers. Increasing unemployment is often associated with lost of confidence, falling consumer spending & the paradox of thrift which largely explains for the price deflation in Japan. Also it leads to other problems like failures of policy. I have mentioned much earlier that if people lost their confidence, no matter what the government does will not yield any desirable effect. For instance, its 0% interest rate (2001-2006) fails to jumpstart spending. Quantitative easing didn’t work too. On the other hand, excessive public spending which leads to ballooning national debt of 194% yields effect, but by a minor fraction

On top of that, falling birth rate coupled with rising number of elderly people mean lower tax receipts in future which will surely put more pressure onto government finances e.g. increasing demand for healthcare. Interest on debt repayment will worsen the situation

Falling capacity utilisation in manufacturing sector means more spare capacity in the economy. Machineries & other capital goods will not be used to their maximum capacity

Sunday, February 22, 2009

Malaysia: Is Teaching Maths & Science In English A Pro Or Anti-Supply Side Agents?

Reasons Math & Science must be taught in English:

(1) English is the language of knowledge. All the information on the latest issues & coverage whether it’s academic or non-academic are available only in English, whether one like it or not. Failure in its mastery will hinder one from acquiring more knowledge. For instance, during my university years some of my peers face extreme difficulty when it comes to Economics research work as everything learned earlier is in national language but information referred to is in English. Also they are unable to identify those terms such as price elasticity of demand (PED) as we in Malaysia learn it as keanjalan permintaan harga. Some others like terms of trade is called kadar syarat perdagangan (which is long winded), Gross Domestic Product (GDP) called Keluaran Dalam Negara Kasar (KDNK). This is only considering for Economics & not other subjects or broader issues

(2) Spoken language for international business. I don’t have to explain much on this. We hardly use any other language besides English. If I have a business partner based in UK, you can’t expect me to negotiate deals with him in Bahasa or Mandarin. Even between the Malaysian Chinese & Chinese in China, there is an increasing usage of English as medium of communication. Probably it has become a culture. Also, what is the language used in international forum or conference?

(3) To increase employability. One of the main reasons, why unemployment persists among Malaysian graduates is because of inability to converse in English. Even if someone is very outspoken in his mother tongue, but if he can’t communicate his idea in English when it comes to a job interview it will be futile. Also in Malaysia, employers nowadays have the tendency to give written assessment to job applicants as part of screening before the real interview

Reasons why some go against:

(1) Language conservatism. Some quarters just do not seem to understand the intention of Malaysia’s former premier, Tun. Dr Mahathir who wants to produce better quality of human capital through the mastery of English. While it is assured that our national language, Bahasa will remain as the main language & is protected under the constitution, some conservative people are just so worried about the degradation of Bahasa usage in daily life

(2) Japanese people do not learn Science & Math in English. While I do agree that the Japanese are so much forwarded than any other society from the globe without English, their learning culture, technology, civilisation etc have started much earlier than us. In a globalise world, where things change rapidly, failure to keep up with advancement in information will just put us behind others. Wondering why these people don’t compare Malaysia to Singapore?

(3) Rural people are left behind. It is said that rural kids have the lowest level of command in English. As such, putting Math & Science in English will further discourage them from learning. Besides, their parents mostly who do not receive any formal education will be unable to assist their child in subjects like Math & Science. While I do agree, again I feel that to achieve a more developed society this is an inevitable process. Either those rural school children will have to work themselves up or be left far behind

Overall, I do hope that the Ministry of Education will continue the policy of teaching Math & Science in English. From economics point of view, since it increases the marketability of an employee & enables one to acquire more knowledge in the long term, this policy will influence aggregate supply (AS). When AS shifts rightward, higher real output can be attained in Malaysian economy. Productivity of a more knowledgeable worker will definitely be higher than one who is not (refer above)

Saturday, February 21, 2009

Fixed Exchange Rate & Its Macroeconomic Impact

Fixed exchange rate is also known as pegged exchange rate. Under this exchange rate regime, a country’s currency is tied to the value of another single currency e.g. dollar or a basket of currencies e.g. euro or to gold

How it works?

Malaysian government used to peg RM3.80- $1 during the Asian financial crisis. Say, value of RM falls becoming RM4 per $1, the government will enter into foreign exchange market & buy RM using dollar. Increase in the demand for RM, will push its value up. This is main reason why governments must have reserves of foreign currency. In case if RM strengthens against dollar say RM3.50-$ 1, then Malaysian government will increase the supply of RM & buy dollar

Advantages of having fixed exchange rate:

(1) Stability in trade. Countries which do not adopt fixed exchange rate may at times see their currency appreciates too much against its trading partners. Japan is a good example. In period of global recession, the unwinding of yen carry trade has caused yen to appreciate significantly against dollar & euro. This has caused demand for Japanese goods to fall significantly. In case of depreciation, falling purchasing power will increase costs of imports for firms. As such profitability may be lower

(2) Create certainty. Fixed rates provide greater certainty for exporters as the trend of demand for their goods will be more apparent. This will help them to plan production systematically. Also there will be greater incentive to invest by buying capital goods, expand operation etc. This is because costs & profits are more certain. Critics mention that should UK have adopted euro currency, the inward investment will be larger as instability between euro & sterling will be eliminated. Also the Asian financial crisis was improved when China pegged its renminbi & Malaysia pegged its ringgit to US dollar

Disadvantages of adopting fixed exchange rate

(1) Unable to correct BOP deficit. Imbalance in trade can only be corrected when a country adopts flexible exchange rate. When a trade deficit occurs, there will be an increase in the demand for foreign currency. As such, its value will appreciate against local currency. That in turn, means now foreign goods are more expensive for local market. Consumption on imported goods will fall (M falls). Meanwhile, weakening of home currency will serve to boost exports (X increases). This will over the time, narrow the deficit in current account

(2) Certainty may also cause currency attack. It is undeniable that fixed exchange rate provide greater certainty & stability. However, it also depends on how high a country pegs its currency relative to another. If it is peg at an unsustainable rate, it will attract speculations that the rate cannot be maintained. UK & the ERM (Exchange Rate Mechanism) is a good example. The Lawson boom in late 1980s had caused UK to join ERM in order to reduce inflationary pressure at the rate of DM2.95 to the pound. At that period, high inflation had reduced economic activity & causing pound to lose its value rapidly. As it fell below the ERM limit, the government intervened in the exchange market by using foreign reserves to buy sterling. Also interest rates were raised at the same time, hoping that it will attract hot money

Somehow, high interest rates further slow down economic activities. Those with mortgages were unable to repay their loans. Default rates increase. House prices suffered a large freefall. UK economy went into deeper recession. Speculators like George Soros (the same person on Asian financial crisis) predicted that sterling will collapse too. So he (largest speculator) & others continuously sell the pound. Large increase in supply caused its value to fall. UK government no longer able to intervene to support its value. £27 billion of foreign reserves had been spent & was still unable to match trillions of pound traded in the market. The last measure adopted was to increase interest rates from 12% to 15%, but still the pound kept devaluing as investors knew it was unsustainable. UK government had no choice but to leave the ERM

(3) May cause other economic problems. As mentioned above, continuous intervention into the currency market will just inflict drainage of foreign reserves. Better option will be to increase interest rates to increase the value of the home currency as in this way it may attract hot money flows. Somehow, higher interest rates will slowdown economic activities. People & firms will be discouraged from spending. Unemployment will increase

How Does It Feel Living In One Of Those Urban Slums

This is a video clip regarding shanty towns/ urban slums which took place in Sau Paulo, the largest city in Brasil. The local people have a unique name for it, the favelas.

Some issues worth to consider:

Reasons for the existence of urban slum:

(a) Rural migrants whose skills are ill-suited to the modern manufacturing & service sector in urban

(b) Although the urban does provide employments, somehow it is unable to absorb the large influx of migrant workers

(c) Manufacturing sector is increasingly replacing manual labour with machineries as part of long term cost saving

Implications of growing favelas:

(a) A disgust to the beautiful sight of the city

(b) Increase in crime rates in the city. Robbery will probably be the most common one since people there have insufficient income or no income to support themselves

(c) Rising income inequality

(d) Spreading diseases as garbage are all over the street

Thursday, February 19, 2009

Ridiculous Euro Stability Pact

The Stability & Growth Pact (SGP) is an agreement by EU member states related to their conduct of fiscal policy. Under SGP, country members are not allowed to incur budget deficit of greater than 3% of their GDP

However due to the tough restrictions imposed, many economists & politicians from EU has criticised & called it as ‘stupidity pact’. Among the earliest that stirred controversies is non other than Romano Prodi, the President of the European Commission from 1999-2004. On 21st October 2002 he mentioned:

“Enforcing the Pact inflexibly and dogmatically, regardless of changing circumstances... is what I called - and still call – stupid”

Well, I do agree with him on several issues:

(1) Narrowly defined. First, the clause of not having a deficit between public spending & tax revenues over than 3% is somewhat vague. There is no detailed explanation regarding the composition of spending. In other word, it does not distinguish between incurrence of current spending like paying unemployment benefits, pensions, servicing debts etc which ‘does not add much value’ to the economy compared to investments on schools, hospitals, upgrade infrastructures etc which influence the AD in short run & AS in long run. In UK, all these are well addressed since Gordon Brown introduced himself a restriction called Golden Rule & Sustainable Investment Rule

Source: BBC

(2) Absurd restriction in period of recession. Many argued that the restriction should be increased e.g. 5% deficit of GDP. It makes much sense especially in the period like now where all those largest economies of Euro-land such as Germany, France, Italy etc has fallen into deep recession. In such period, the deficit will be magnified as government spending will automatically increase & yet there is shortfall in tax receipts. Also since unemployment picks up, real economy will shrink. France & Italy are among those which have already incurred large deficit. Forcing these economies to run balanced budget now will condemn any recovery efforts. Also it is one of the most solid reasons to explain for slow economic growth in major EU economies even before the mortgage crisis as government can’t spend

(3) Biasness towards larger government. Earlier in 2001, Portugal, France, Germany & Italy admitted that the deficit had breached the ceiling of 3% & ask for leniency e.g. longer duration to balance the deficit This infuriated Spain, Netherlands & other smaller member states which are close to balance. They argued that it is unfair for member countries that have to be frugal in spending

(4) Force some countries to under report the figure.
Tight restrictions had forced some countries to under report the deficit. Italy, Portugal & Spain are accused of doing so

Wednesday, February 18, 2009

Pro & Cons For UK When Adopting Euro

Benefits for UK if adopting euro:

(1) No transaction costs. This is the most obvious advantage. UK people will no longer need to incur transaction costs in exchanging currency when they go for a holiday in Euro-land. For businesses the advantage is considered bigger, as they no longer need to incur higher transaction costs which include the costs of hedging against huge currency swings

(2) Price transparency. Since everything will be quoted in euro, UK consumers will find it easier when comparing prices of goods & services. Also this ensures that local firms will always price their goods competitively. This results in increase in consumers’ welfare. For firms, they can also take this opportunity to source their raw materials from the cheapest suppliers thus minimising their production costs

(3) Eliminate exchange rate volatility. Manufacturers in UK will have greater incentive to invest e.g. expanding operation into Euro-land, import capital goods from German etc when exchange rate is certain. Also they can plan their production of output systematically, as the trend of demand for UK goods will be more apparent. This is very important considering UK has more than 50% of trading share with Euro-zone. Ability to explore the wider market also means greater EOS (economies of scale)

(4) Attract investors from outside. It is said that UK could have attracted more investors if it adopts euro earlier. According to critics, no doubt UK has its own advantage such as pool of productive workforce, flexibility in labour market, independence of the monetary committee etc which largely explains for the influx of foreign investment all this while. However with single currency, the attraction is larger as it helps investors to further minimise their costs of production as accrued to the first 3 reasons as above

(5) Improvement in inflation performance. Compared to UK’s Bank of England, the ECB (European Central Bank) is said to have ‘zero-tolerance’ policy against rising inflationary pressure. In UK, CPI is allowed to increase up to 3% but in Euro, its targeted inflation is close, but not more than 2%. Countries that have high inflation could benefit from these

(6) Rising importance of Euro. Euro currency is increasingly becoming more influential in international trade. Some economists argued that it may replace dollar one day as the most sought after currency in period of globalisation. This is because, the size of Euro’s economy is much larger than US alone & this is not considering other potential members which may be joining at later date. The market is large & it is politically stable too. On the other hand, instability of dollar & rising national debt in US has sort of spark fears that the dollar will collapse one day. China is also accused of slowly diverting its dollar holding to euro holding

Costs of adopting euro:

(1) Sensitivity of changes in interest rates. This is the MAIN reasons as to why UK chose to stay out of Euro. House ownership in UK is the highest in any parts of Euro-land & also traditionally Britons store their wealth in property market. As such any changes in interest rates even by 25 basis points or 0.25%, will have a severe effect on UK economy.

For instance, Euro’s interest rates are lower than in UK (much earlier before the mortgage crisis). Upon joining, UK interest rates will be lowered in accordance with ECB rate. This will surefire raise the inflationary pressure in UK as everybody will be taking up loans to buy property. Another classic case, Ireland. Before joining it had 6% of interest rates. After adopting euro, its interest rate was 3%. This largely explains why inflation rate in Ireland is reasonably higher than others

(2) Constraint in government spending. Stability pact signed by member countries makes things worse. It states that members’ annual budget deficit (how much spending exceed tax revenue) cannot exceed 3% of GDP. This will be the biggest stumbling block when it comes to recession. In downturn the figure is easily in excess of 3%. Look at it mathematically. When economy slows down, it makes sense for government to continuously increase public spending. So budget deficit widens (numerator). At same time, GDP is falling (denominator). Of course this will lead to a huge number!

(3) Surrendering of monetary decisions to ECB. Since gaining independence from Labour government in May 1997, UK’s MPC (Monetary Policy Committee) has gained credibility & international recognition. Due to this, it sounds more like an embarrassment if MPC loses control in the monetary decisions by bowing to the ECB. Also the council members in ECB are representative from different countries with varied vested interests. Consensus & interest rate decisions will therefore be less frequent than MPC who will only consider what is best for UK

There are other problems like loss of devaluation as an economic management policy. UK is no longer be able to influence the exchange rate by manipulating interest rates. This could be detrimental to exports

(4) Inflexibility in labour market. Labour market in UK is much more flexible than most of those in Euro. UK has finally reaped all the benefits under the reforms during the era of Margaret Thatcher (1979-1990) after some effect lags. Trade union has been under control thus wage-push inflation is of limited influence. Meanwhile, UK firms are given more autonomy when it comes to employment. As a result, more part time works have been created & this result in lower unemployment. By joining Euro, UK will have to strictly adhere to many new labour rules, many which are created with employees in mind e.g. hiring & firing will be more difficult, more benefits etc. These will ultimately increase production costs & give unions more sense of power which could be harmful in many aspects.

After losing control in monetary tools & fiscal spending, surrendering the flexibility in labour market is the last thing UK should do.

(5) Costs of adjusting currency. Machines & other tools will have to be adjusted. In between firms will be in darkness regarding the proper exchange rate to use. Nevertheless all these are once-off costs

Sunday, February 15, 2009

Why Economics Is Related To The Art Of Balancing?

There must be a sense of balance between macroeconomic variables. In other word, 'too high of something is bad' & 'too low is bad' either. Here are the reasons:

(1a) Inflation too high will cause:
(i) Erode the purchasing power of money
(ii) Cause workers to bargain for higher wages to sustain their current standard of living, which often aggravates inflation
(iii) Leather shoe costs
(iv) Menu costs
(v) Redistribution of income from lenders to borrowers & employees to government
(vi) An early warning that the economy may go bust soon

(1b) Severe deflation will cause
(i) Loss of confidence with the economy
(ii) Further contraction in real economy as everyone postpones spending in expectation of lower price in the future. It is a cycle
(iii) Inevitable depression, which is the worst case scenario
(iv) Massive unemployment
(v) Capital flight
(vi) Weakening of currency as in the period of deflation normally interest rates will be very low

(2a) Very high savings ratio means:
(i) Everyone is thrifty & not spending into the economy. May contract the economy unless is countered by increase in the components of injections (government spending, investment & exports)
(ii) House prices are likely to be low due to lack of demand
(iii) Inflation in the country is likely high & the central bank is controlling it via higher interest rates which attract savers

(2b) Very low savings ratio:
(i) Banks will not have enough money to generate lending & they often resort to borrowing from the money market. One of the main reasons for banking crises in UK
(ii) May face liquidity problem in case large number of depositors would like to withdraw their money

(3a) Widening current account deficit:
(i) Must be able to continuously attract the inflow of foreign capital. Otherwise home currency will depreciate
(ii) Unsustainable economic growth with high inflation
(iii) Exports are growing at a slower rate than imports
(iv) Means home country is fast losing competitiveness
(v) Currency could be too strong

(3b) Widening surplus in current account:
(i) The economy is probably export-driven. Therefore it is very susceptible to global economic climate
(ii) The standard of living could be low & as such the people consume lesser imported goods
(iii) Currency could be too weak & as such may dampen the purchasing power

(4a) Oil price too high:
(i) Unsustainable growth with high inflation
(ii) Probably the availability is getting lower
(iii) Unhealthy speculation in oil futures
(iv) May cause stagflation
(v) More firms making losses especially those which find difficulty in passing on price increase

(4b) Oil price too low
(i) Sign of global recession like now
(ii) Major exporters face severe declining export revenue. As such, they may restrict investment into operations. May lead to lesser discovery of oil fields in future

Saturday, February 14, 2009

Is The Plan Of Protectionism By US Acceptable In Current Global Recession?

The economics jargon ‘protectionism’ is at its peak of popularity lately. The difference with text book is that this time it comes from one of the most developed economies-US rather than LDCs.

The rationale of US to practice protectionism:

(1) Protect local jobs. Unemployment in US is at record high now. Latest data released showed that 3.7 millions people in total have been out of job since December 2007, with more than half of those from the recent 3 months. Obama’s proposal of ‘Buy American’ which is still under negotiations while not exactly like the Smoot-Hawley tariff is actually meant to make local consumers substitute away from imported goods to local goods. Rise in the demand for domestic goods & services will generate jobs for locals & put loss-making firms back to business as usual

(2) Improve trade deficit. US & UK have something in common, the current account deficit. With protectionism such as import tariffs, imported goods will become more expensive & as such spending on imports will fall. Assuming that other countries do not retaliate & US is still able to export as usual, the imbalance will shrink

(3) Provide government with some revenue. Again, in the case of import tariffs US government may earn some revenue. It is calculated by tariffs per unit x no. units imported

Why protectionism is not wise?

(1) Companies become complacent. Operating behind the walls of protection may cause loss-making firms to become slack ‘forever’. Firms will not have the incentive to become productively efficient. There could be little to no improvement in quality of goods. Furthermore, the cost of removing this protection is very high & is politically unpopular

(2) Trade retaliation. The worst case scenario. In fact, protectionism is nothing new in US. It has been practiced way back during the period of Great Depression. US Senator Reed Smoot & Representative Willis Halley thought what they did was right that time. So they raised tariffs to protect American from foreign competition. Some duties of more than 60% were slapped onto 3200 imported goods. This led to retaliation by other country. As a result, demand for US exports had fallen by 69% & unemployment increased once more not only in US but all around the world.

(3) Harmful to consumers. Depends very much on the nature of trade restriction. If US erects higher administrative barriers such as requiring imported goods to meet certain safety standards, many goods will not be able enter US. This results in lesser choice for consumers. On the other hand, if US impose import tariffs probably consumers can still exercise their options but at the expense of higher price. Either way, consumers’ welfare will still be lower

(4) Worsen poverty in LDCs. It is a well known fact that these countries mostly specialised in the production of agriculture goods. Under the existing CAP (Common Agriculture Policy), farmers from the poorest continent are often depress as EU impose high import quotas & practice dumping of cheap surpluses. If they were to retaliate & practice ‘Buy Euro’ only, then the windows of opportunities for poor countries to export themselves out of poverty will be shut. The vicious cycle of poverty will take place. The efforts drawn in the UNDP will be meaningless as they will have to start all over again

Anyway, I do hope that the world’s biggest economy shouldn’t start any protective measures. While it is understood that Mr. President is trying to save the local industries & employment, nevertheless the price to pay for it is hefty. Hope Obama had taken his history lesson!

Friday, February 13, 2009

Snapshots Of Global Economies

Snapshot of European economy, source BBC

(1) US economy

There is not much time left & yet policymakers have nearly exhausted all ammos. Interest rates have been maintained between 0 - 0.25% & yet it fails to jump start the economy. The proposed quantitative easing also fails to provide visible results simply because banks are still reluctant to lend & people dare not to take up any large financial commitment at the moments. Critics rifled that it will be another classic case of failure, just like what we have in Japan. Tax cut has been saved rather than spent. Our only option? More public spending into the economy, by building more schools, hospitals, repair roads & bridges etc. This is meant to absorb more unemployed

However, I’m afraid that Obama’s political rhetoric to create 4 million jobs will meet failure. Current jobless toll is 3.7million people. By next month, through negative multiplier effect probably we already have more than 4 million jobless people before even a million is created. I hold my view that the US economy will not recover, not until early next year

(2) UK economy

UK’s economy is the worst affected among developed nations with its GDP contract by 3%. UK’s economy is largely hit by the housing market woes due to the high proportion of people who store their wealth in property market. Marked fall in house prices means falling wealth which had severely crippled consumers confidence. There are just too many problems. Like America, most policies do not seem to work at the moment. Interest rates have been adjusted downward from 5.75% in September 2007 to 1% January 2009. National debt as a % of GDP has increased to 47% due to the massive bailout of Northern Rock, RBS, Bradford & Bingley and HBOS & this has overshot Gordon’s own sustainable investment rule. However it is argued that this is an insignificant figure if we compared to US which exceeds 70%, France & Germany around 64% and Japan 194% of its GDP

However, there is a fear over UK services export sector. Tertiary sector has very high income elasticity of demand. This means a slight fall in income will create a larger than proportionate fall in demand for UK services. This will definitely hurt employment in this sector which makes up of majority workforce in UK economy

(3) Eurozone

(a) Germany’s economy shrunk 0.4% in 2nd quarter & 0.5% in 3rd quarter. By definition, Germany has entered into a recession. To strengthen this, its economy contract even further by 2.1% in 4th quarter. It comes under surprise. Unlike UK economy, there is no housing market boom & bust, no over-borrowing, high level of savings just like Japan & China & yet recession took place. This is because Germany’s economy is export-driven & it forms a large component of GDP. So a fall in exports will drive AD down. For UK, it is consumption-driven & it makes up nearly 70% of her GDP. So in UK’s experience, is contract in personal expenditure. Demand for Germany’s manufactured good will continue to fall in near term due to the appreciation of euro. Also its practice of responsible-borrowing in recession, will actually hurt more of its economy due to fall in G

(b) France as the top 3 largest economy in Euro is not spared too. One problem that persist in its economy until now is high rate of unemployment which is about 8%, above the EU average. In recession this figure will definitely higher. I won’t be surprised with this. In EU, France is very well known for its strong labour union which often fight for unreasonable high salary. Also there are lots of regulations which are not in favour of companies e.g. high corporation tax of 33.3%, maximum 35-hours working week, increased difficulty of firing etc. All these increase the operation costs. Furthermore, with limitations like limit of spending not exceeding 3% of GDP & lost of control over monetary policy, France economy is set to decrease further

(c) Meanwhile Iceland economy had collapsed, that economists cynically cited that even Zimbabwean’s economy will perform better than Iceland. Its economy is said to suffer from Great Depression-style of fall in output by 10% next year. Nevertheless, it is sort of embarrassing to see one of the richest nations in the world to turn to IMF for financial assistance
(4) China

The latest report stated that China’s export had plunged 17.5% & this is the worst figure since 1997-1998. At the moment of writing, import is falling at a quicker rate than export, suggesting how the growing number of middle-classes in China is affected. Also it is a sign of lesser investment & falling import for intermediate goods. Since Chinese economy is export-driven due to its comparative advantage of cheap labour, we will witness large scale of retrenchment in manufacturing sectors which are labour-intensive. Economy of Guangdong & Shenzhen will be the worst affected since they become the house to many factories. The revaluation of renminbi will actually worsen the situation. Despite this, Chinese economy will continue to grow, but at a slower pace at around 6-7% in 2009

(5) Japan
Japan had undergone the ‘long lost decade’ in 1990s to early 2000s due to housing market bust. Many efforts were done, including maintaining interest rates at 0% for many years but it failed to revive the economy. Related to the concept propounded by Keynes- paradox of thrift. Also quantitative easing being used does not provide any significant results. Government debt on the other hand had been piling up to 194% of GDP. Only somewhere around 2005, its economy began to show some recovery, thanks to the export sector. Price level began to increase for the first time, prompting officials to raise interest rate to 0.5%. Alas, the success is not long before the Japanese economy was slapped by another bitterness. Demand for Japan’s good particularly electronic fell sharply due to major US & major EU economy are in recession

(6) Sub-Saharan African
The poorest countries in the world, majority which originates from SSA will be the worst affected. IMF & World Bank already in the progress of cutting financial aid to these countries in the period when they needed it most. Development economists regret that those efforts all this while to pull the poor Africans out from the cycle poverty is washed away with the global credit crisis, putting more people back into absolute poverty. In fact these poor people should bot bear the brunt of crisis that originated from America

Thursday, February 12, 2009

Flowers On Valentine's Day As Luxury Goods

Flowers as luxury goods

I came across an interesting news in The Star, Malaysian local newspaper & thought I would like to share with all readers. Again it really amaze me how simple economics concept can be applied just everywhere even onto roses & chocolates which are very popular with Valentine’s Day.

Click on this link:

These are the 3 quotes:

“Global financial crisis seems to have taken its toll on Valentine’s Day romance here with people spending less on flowers and chocolates to show their love”

“Although customers are still willing to spend on flowers, it will just be between RM100 and RM200”

“Previously, the highest amount was RM600 for a bouquet and the number of RM100 bouquets sold was definitely more”

From the above statements, I conclude that roses & chocolates are best viewed as luxury goods. Recall the concept of income elasticity of demand (YED). It measures the responsiveness of quantity demanded for a good to a change in income

Or we can write it mathematically:

YED = (% of change in quantity demanded) / (% of change in income)

Again there 3 types of YED:

(1) YED less than 0 (inferior). Inferior goods are goods that we consume less in the period of rising income. Say YED = -0.6. This means as our income increases by 10%, the quantity demanded for that good will fall by 6% & vice versa. I don't think flowers for lovers are inferior goods, otherwise we couldn't have bought it in the first place!

(2) YED between 0 & 1 (necessities). Normal goods are those which we will consume more in the period of rising income, but the increase in its demand is less than proportionate of income. Say when average income increases by 10%, the quantity demanded for that good will increase also but less than proportionate say 8%. So when we substitute into formula we will get 0.8. Well, I don't think it's a necessity either. Do you buy these flowers everyday?

(3) YED> 1 (luxuries). Here I will explain why chocolates & flowers are viewed as luxury. For luxury goods any small increase in income say 10%, will trigger a larger than proportionate demand for it say 15% & vice versa. Hence we get YED = 1.5. The article mentioned that in the previous, there were even people taking up flowers worth RM 600 per bouquet, with RM 100 - 200 selling like hot cakes. Now it seems like the willingness of customers to pay had fallen as none of them are willing to offer anything more than RM 200

Friday, February 6, 2009

Will Obama's Fiscal Stimulus Plan Work On Time To Prevent Onslaught Of Unemployment?

I’m sort of uneasy with these 2 quotes recently. Both were from BBC, 6th Feb:

“The US unemployment rate rose to 7.6% in January, up from 7.2% in December, the highest level since 1992”

“In total, the US economy has lost 3.7 million jobs since the recession began in December 2007, with nearly half of those jobs shed coming in the past 3 months”

Economic interpretation:

The first quote shows that unemployment has been rising at an increasing rate due to the reasons which I will discuss later. Highest since 1992 means we have never seen such rate since that period

I’m more interested with the second quote. The moment I read, I tried to perform some rough & simple arithmetic on it. Half of the jobs lost were reported in the recent 3 months? Wow! That means we have 1.8 million Americans being jobless just within November to January, with an average of 600, 000 ‘casualty’ per month. Meanwhile another 1.8 million job losses since December 2007, brought about 150, 000 ‘casualty’ on average per month. How did this happen? The answer is of course through negative multiplier effect. By the way, if we are going to plot all this on a graph, I believe it will look somewhat exponential. This further support my first statement, saying that the unemployment rate will be increasing at an increasing rate

Why unemployment will be higher over time?

(1) Politicians fault.
I’m not talking only about US, but generally politicians all over the world including my home country, Malaysia. I’m somehow amazed & at the same time feeling amuse as how politicians care more for themselves than the public at large. They seem to politicise every single thing tabled, hoping to gain popularity even in the period of recession

For instance, while I understand that ballooning fiscal deficit in US is unhealthy due to continuous spending by Federal Government, somehow it is necessary to jump start the economy. Think about this. How many options are left? Slashing interest rates did not work. Cut in rates were not passed on. People continue to be thrifty & this caused US economy to contract further. Quantitative easing by far has not proven any visible results. Lending activities continue to weaken as banks are seizing the opportunity to refurnish their balance sheet, causing property market to be in worse state. Tax cut I believe will be save for paying debt. The only tool left is to reverse the onslaught-that is creating employment for those unemployed. At least it will revive some confidence into the economy

However not to forget 2 thing the implementation lags & effect lags. Legal procedures even in the present state may take weeks if not months to execute. Secondly, even after implementation we may not be able to see those 4 million jobs created with immediate effect as publicised by Obama. Presently, the unemployment toll in US is 3.7 million. I was thinking, even before Obama has created 4 million jobs, by next month the unemployment would surefire exceed that amount!

(2) Negative multiplier effect. In general, it means an initial fall in AD will cause a substantial larger fall in AD later. I will talk about consumption, since US economy just like UK economy is consumption-driven. Here, more than 70% of US economy is made up of C. Hence ballooning unemployment will trigger a spending crisis. As people are out of job, they will automatically cut their spending into the economy. Firms on high street begin to shed jobs since there is no point hiring so many workers, when the demand for their output is so low. This leads us to second round of unemployment. Now, with even more people out of job, contraction in consumer spending will be magnified Companies make even larger losses this round (depends also on nature of business & number of workers they have) & in return retrench more of their workers

This cycle will repeat itself. But don’t forget, there could be many other sectors of the economy that rely on it. For e.g. if the Big 3 really go under administration, various spare part suppliers will suffer. Suppliers of raw materials e.g. steel, rubbers etc are not spared too. Banks will then lose of their biggest & yet most loyal customers that contribute to their profit every year. The list goes on. These explain why unemployment may increase according to geometric progression

(3) Paradox of thrift. In recession, the best thing one can do is save more money for rainy days. However, in the end this could bring more harm than benefit to the economy & that person itself. The reason is simple. If everyone begins to save, there will be no active spending into the economy. Leakage is said to have taken place. Private spending being the most important component of American economy will slow down & then shrink into negative territory. Economy will also move at slower pace before moving into recession. By then companies will make losses & the era of retrenchment will take place. It will be enlarge by the multiplier effect as explained above

In short, I seriously don’t think Obama’s plan will work on time to slowdown the rising unemployment rate based on the economic principle discussed. Somehow, I argue that the key to economic revival lies in the hand of financial institutions. As long as they are not willing to start lending, we will remain (or worse) in current state as where we are. If only we can make them lend

Thursday, February 5, 2009

Is Presence Of Multinationals Desirable In LDCs?

Multinationals: companies that operate in more than one country

Economic reasons to go multinational:

(1) The local market has become saturated & possibly there is not much space for further growth

(2) To make larger supernormal profit by basing in developing countries which have increasing number of middle income households such as China & India

(3) To exploit economies of scale when they produce in larger volume

(4) To take advantage of ease in obtaining natural resources in developing economies

(5) Producitvity of labour is increasing & yet they are able to endure long working hours. Also they hardly ask for higher pay

(6) Easy to press local government to pass on laws that favour MNCs e.g. extension period of tax holidays, investment allowances & cheap provision of factory sites

(7) Avoiding legal compliance in developed world which actually increase their production costs e.g. health & safety standards

Benefits of multinational in LDCs

(1) Filling the savings gap. According to Harrod-Domar, savings which are later channeled to investment is the main driver of economic growth. With greater investment spending, there will be more capital goods & human capital produced, thus increasing the productive capacity of economy. This then enables output & income to grow, which in turn generates larger saving & then larger investment. The system will be self-sustained. Somehow in many LDCs especially African regions, unemployment is high, those employed have decent wages & many that do not trust their financial institution. As such it is very difficult to kick start any investment due to lack of funds

Therefore inflow of foreign capital may help to patch the savings gap & enable a country to achieve targeted level of investment spending

(2) Filling the foreign exchange gap. Many LDCs are facing the problem of current account deficit. To pay, they will need lots of foreign currency such as dollar, euro or pound. But the problem is, LDCs which are mainly primary sector driven suffer all these years from the fall in world commodity prices & the worsening of Terms of Trade (ToT). These attribute to lower foreign exchange earnings

With large influx of foreign capital, LDCs will have more foreign currency in their reserves. Also once established, goods produced & exported will help to minimise the current account deficit

(3) Tax revenue. LDC government may also expect to be able to collect tax revenues from both MNC in the form of corporation tax & income tax that resulted from employment created. As such there will be more available funds to meet development projects. There will be more schools, hospitals, upgrading of roads, setting up proper communication system etc that can increase the standard of living of its people

(4) Employment & skills to local. Remember under the Lewis model, large scale rural-urban migration has caused industries unable to absorb surplus of labour force. As such increasing number of multinationals in LDC is invaluable in solving problems like urban poverty resulted from unemployment. Also there will be transfer of skills, knowledge about technology & management experience that can be gained through training & the process of learning by doing. MNCs can educate local managers on how to establish contacts with oversea banks, locate alternative source of supply & become flair with international marketing practices

In time there may be positive externalities. As workers become more marketable, they may leave MNCs to work in local companies, or use their knowledge to start their own businesses


(1) Harm domestic firms. Local companies may not be able to compete directly with multinationals that possess everything e.g. management skills, tendency to be more productive efficiency (producing at lower part of LRAC), marketing strategies etc. As such, they could be out of business & this may result in bankruptcies which surface along with unemployment. Also local suppliers of raw materials, capital goods etc may be worse off if these MNCs decide to buy them from overseas

(2) Crowing out effect. Although MNCs provide capital, large numbers of them do raise financial needs domestically. In LDCs, available funds for investment are already limited. With the presence of MNCs, competition for limited amount of fund will eventually bid up interest rates, thus crowd out local investment & private consumption. From macroeconomic perspective, although AD in theory is said to increase due to investment by foreign firms, somehow it is offset by the fall in both local investment & consumption. AD & therefore economic growth may not increase that much after all

(3) Worsen both current account & financial account. Although the initial impact of MNC investment is to improve the foreign exchange position of recipient nation, its long run impact may reduce foreign exchange earnings on both current & capital accounts. The current account may deteriorate as a result of substantial import of intermediate products & capital goods. Meanwhile, capital account may worsen because of the repatriation of profits & other funds back to their home country

(4) Contribute little to tax. Although MNCs do contribute to public revenue in the form of corporation tax, their contribution is considerably less than it should be due to liberal tax concessions, excessive investment allowances & practice of transfer pricing. Transfer pricing is a situation where MNCs inflate the price it pays for intermediate goods bought from overseas affiliates. In this case, overseas affiliate will register higher profits while that MNC will register lower profits. This is because that MNC could be operating in a high-tax LDC & while its affiliate operating in a low tax LDC. As such it’s like some sort of ‘profit-transferring’

(5) Unemployment not solved. Since most MNCs originate in more-developed countries, they tend to use technology that suits the conditions with which they are familiar. In many cases, these will tend to be relatively capital-intensive, which may not be wholly appropriate for LDC factor endowments e.g. large pool of labours. As such employment may not be created or perhaps limited to relatively low-skilled jobs

(6) Limited spillover effects. Those MNCs may make use of local unskilled labour but hire expatriate skilled workers & managers. As such there could be of minimal spillover effects to local economy. Another possibility is that, MNC may pay wages that are higher than necessary to maintain good public image & to attract best local talents. This is fine for workers lucky enough to land on such job, but it can cause great difficulties to local companies to maintain their best workers. Yes, they could increase the wages but at the expense of increase in production costs

(7) Worsen rural-urban migration. MNCs tend to locate in urban areas, usually the capital city of LDCs, unless they are purely resource seeking in which the case they may be forced to locate near the supply of natural resources they are seeking. Locating in urban areas may aggravate the rate of migration. This will potentially cause 2 major problems. First, if the job expansion cannot keep up with the high migration rate, we will witness urban unemployment which leads to other problems like shanty towns. Secondly, higher incomes earn in urban may result in the widening of income inequality between urban-rural areas

There are other problems as well. Powerful MNCs may exert their power so as the government bows to their need e.g. more favourable tax rate, greater investment allowances etc. Also MNCs may produce growing number of higher income groups with high propensity to buy imports & low propensity to save domestically

Implications of Low Life Expectancy In Developing Countries

Implications of low life expectancy:

(1) Loss of productive workforce. In many parts of African continent, life expectancy continued to decrease. For instance, Botswana people use to live up to 60 years old but now averaging at 40 years of age. South Africa which is relatively the performer among African peers, does not do so well too. Life expectancy has come down from 60 years of age to 45 years. If fundamental problems, e.g. lack of access to healthcare, acute shortage of clean water, AIDS awareness campaign are not properly address, this will stem human crisis capital

It is worth to note, that 40-45 years of age are the time where workers are most productive. Even while the sick workers are still in workforce, their medical condition means more days will be taken off as sick leave which means loss of output. From macroeconomic argument, this shows a fall in the productive capacity of the economy. AS curve shifts left. Firms will not want to hire new workers considering those new one are very young e.g. 15 years old & inexperience. Also they need to consider costs of retraining

(2) Crisis in education sector. This is like a ‘multiplier’ argument. Loss of productive workforce covers every sector including education. Some countries like Zimbabwe have witnessed the collapse in primary & secondary school enrolment rate. With even much lesser teachers in school, the problems are waiting to be worsened. Soon the students to teachers ratio increase, classrooms overcrowded, they may institute law that limits number of students per school etc. As such, illiteracy rate will widespread. These people will not know how to operate machineries, understanding complex instructions, or even perform simple primary arithmetic

(3) Loss of tax revenue. There is already very little incentive for private enterprise to operate in the ‘dying’ Africa both local & international. As such corporation tax will not be much. Now, the picture is worsened with bulk of workforce that is relatively young. Young workforce generally earns lower income than those older workers. Secondly, low life expectancy may tend to reduce the existing base of workforce. These 2 factors contribute to lower income tax

(4) Foreign investors lost interest.
Productivity of workforce is one of the major considerations by multinationals when deciding whether to invest in a country or not. Of course there are other factors such as political landscape, potential market, ease of obtaining natural resources etc. Why productivity?

Productive workforce can work better & faster resulting in lowering per unit cost of labour. The primary reason for MNCs mainly from US, UK & Eurozone looking for market outside their country is because they would like to avoid legal compliance which actually increases their LRAC (long run average costs). Also, many developing countries excluding SSA, literacy rate is rising & yet they are willing to work at meager wages

(5) High dependency ratio. As parents die in young age, they will probably leave behind their kin under the care of nearest relatives. This will actually increase the dependency ratio. In short, the ratio of youngs (0-15 years) to the working population will increase. These people may have to face opportunity cost of loss income as lesser time is spent on working & more time in watching the kids. This probably explains best why it is so difficult to break the vicious cycle of poverty

(6) Forced to work at young age. Some whose parents have died & without relatives will be forced to work at young age, when in fact they should spend their time in school. Normally most of them will be absorbed into farming. Wages paid could be far below the market as rich landlords may want to exploit them due to their situation. Sadly, this young generation will also enter into the cycle of poverty

(7) Government spending more on healthcare. For government there is an opportunity cost too. To address the problem of low life expectancy, necessary it means more hospitals must be built, surgery equipments must be upgraded, more doctors & nurses must be trained or brought in from outside etc. The result is not instantaneous & it may take decades. Meantime, as more finances are drained to healthcare sector, other sectors such as education, transportation & communication may be victim of ignorance

(8) Worsening international debt. To fulfill other development projects, the African governments will refer to IMF & World Bank for financial aid. This directly means greater burden of debt which include debt servicing. Major South American economies like Argentina & Mexico had once collapsed due to this. Other than that, they are also subjected to SAP (Structural Adjustment Program) which is ill-suit to local economy. Among measures are like, fiscal austerity, interest rates raised to strengthen currency, privatisation, & deregulation of banking & international trade. Some economists argued that this is the modern way of colonisation by world superpowers

Tuesday, February 3, 2009

Reasons For Low Life Expectancy In Sub-Saharan African Countries

While social indicators slowly but progressively have improved all the years in many of African countries, the statistic of life expectancy at birth still by today shows a large disappointment. In fact, the top 10 countries with lowest life expectancy all originate from African continent.

These countries are like Swaziland, Sierra Leone, Zimbabwe, Zambia, Namibia & Botswana, where on average none of the male or female live beyond 45 years. This is a far cry compared to some countries like Japan with 85 years of age

Check ranking of countries in terms of life expectancy:

Possible arguments for low life expectancy

(1) Famine. According to Malthus, there is a strong imbalance in terms population growth rate against the growth rate of food. While population grows geometrically, food supply grows arithmetically. Although argued by Western economists for undermining technology, his theories make very much concrete presence in African countries. Famine is everywhere since there is acute shortage of fertile land for growing crops. To worsen the situation, there is even lack of raindrops in many parts of Africa causing droughts & existing water supply is insufficient for irrigation.

Although there is food aid, very much of it falls into the hand of dirty politicians who disproportionately distribute it to their cronies or sell it in black market which undercut local prices. Lack of food & malnutrition seems to be one of the major factors contributing to low life expectancy

(2) Governments too poor to spend. Many of the African countries are said to be poor. There are just so many of them which are classified as HIPC (Highly Indebted Poor Countries) where they owe huge sum of money to IMF & World Bank. As such most of the tax receipts & other revenues are spent of just to repay these international organisations, leaving not much for them to develop local economy. Besides, they are also under the SAP (Structural Adjustment Programs), which required recipient countries to undergo fiscal austerity so that they have monies to pay back those debts.

As such, there will not be large allocation on hospital building. Therefore access to healthcare remains a great difficulty e.g. too far away, cannot afford medical bills. Even if hospitals are available, machineries & surgery equipments are often obsolete, break down & small in numbers. This explains why life expectancy is low

(3) Corrupt government officials. Some of the financial aid given does not reach those most needing. Bulk of it were siphoned to individual accounts, to be misused for pursuing political agendas & campaign etc when in fact those monies can be used to spend on building hospitals, upgrading hospital equipments, increase number of hospital beds, invest on R&D, buy medical drugs etc. In some places like Zimbabwe, hospitals were built only in the surrounding of capital city like Harare, which is benefiting those few rich ministers including Mugabe himself. If these hospitals are located in rural areas, many of those poor & ill people could have benefit from it

(4) Low level of education. There is a strong correlation between level of education & healthcare. People who are more educated, tend to have higher awareness regarding their personal & surrounding hygiene. Unfortunately, enrolment rate to even primary schools have dropped in many parts of Africa. As parents are not educated, so as their children

(5) Availability of clean water. As high as 45% of the people in Sub Saharan Africa had no access to clean water supply. As there is no alternative source, many of the poor collect drinking water from rivers, streams & canals polluted with human excreta & chemicals. The health & economic costs associated with waters are enormous. Millions of cases of diarrheal diseases, cholera, typhoid & hookworm are reported every year & in most cases are answered by death due to low accessibility to healthcare

(6) Widespread of AIDS. African regions are very synonym with AIDS. In some places the rate is very high, where one out of every 5 adults is infected by the deadly disease. There is no cure for this & the trend is worrying as number of new cases reported has increased dramatically over the years. In other word, we will be expecting more death in near future. Zimbabwe, Namibia & Zambia are few of the good examples I can cite. It is also closely tied to low level of awareness among the adults, which clearly can come only if one has pursued sufficient level education. The practice of unsafe sex & being force into prostitution due to poverty were the 2 largest contributors

Sunday, February 1, 2009

Economics Of Aid From The Perspective Of Developing Countries

Aid: economic assistance given by one country to another, usually from the developed to the less developed economies

Types of aid

(1) Tied aid. Aid which is given upon the condition that the recipient country must use the funds to purchase goods & services from donor country

(2) Bilateral aid. Aid given by the government of one country directly to another

(3) Multilateral aid. Aid given by the government of a country to an international agency such as World Bank, IMF & European Development Fund before channeled to different countries

Arguments for aid

(1) To promote investment climate. Poor countries particularly from Sub Saharan African regions badly need an international aid. In some places like Zimbabwe, primary school enrolment rate has declined steeply over the 10 years. This stemmed from some fundamental problems like lack of schools to accommodate ever growing number of children. Besides, access to basic healthcare is very limited. There is not much increase in number of hospitals. Even if there is, machineries, surgery equipments etc are often obsolete & do not function well. This could stem a human capital crisis in near future

On the other hand, government can also channel the money to upgrade roads, railways, bridges, airports & ports. Improvement in these will have rewarding supply-side effects. Having all these basics e.g. productive & knowledgeable workforce, efficient transportation system is vital to attract foreign & local investment

(2) Sense of ‘responsibility’. Communities within the less developed countries (LDC) feel that the developed economies have the responsibility to reshape the economic mess faced by them. This could be due to humanitarian reason that the colonial power such as UK has occupied many of these countries & have largely exploited their natural resources. For instance, British colonial have largely exploit resources from East Africa & Asia for their own benefits like fast development. In the process, they only favour & upgrade areas that are resource-rich while ignoring others. This largely explains for the large imbalances faced by many African regions

(3) Savings & foreign exchange gap. Inflow of foreign exchange is viewed as precious source to fill in the savings gap. Very often, domestic savings in LDCs are at very low rate particularly due to majority of households are very low wage-earners & distrust over local financial institutions. As such it is one of the biggest barriers for domestic investment to take place. Providing aid & other form of development assistance can help to finance projects. Also, many LDCs face the problem of acute shortage in foreign exchange due to falling commodity prices which leads to the worsening terms of trade & also due to debt servicing. The hard fact is, many of the currencies of poor LDCs are weak & therefore not accepted on foreign exchange market. To enable them to import, they must therefore have hard currencies such as dollar, euro or pound

(4) Political purposes. In some cases, foreign aid such as military goods could be view as source to maintain existing government in power. The ending of Cold War between NATO & the Soviet Union has contributed to the fall in Official Development Assistance (ODA) to African continent, while countries like Israel remain as the major recipient of ODA

Arguments against aid

(1) Sense of dependency. The record of Western aid to Africa is one the worst failure in history. Throughout 1960 to 1997 more than $500 billion had been pumped into their economy & yet the results produced are at dismal. In fact their standard of living has fallen even more as measured by the real GDP per capita. Unemployment rises everyday, famine is everywhere, increasing number of people are out of school & die everyday due to contagious disease like AIDS, BOP deficit worsen etc. Despite difficulties, I argue that African leaders should seriously adopt free-market. Although it will be more curse than cure in short term, it is necessary to have a more establish economic system in the long run. Many countries like Europe, Japan, Hong Kong, Singapore & Taiwan are economically successful without relying on any aid

(2) Problems of debt repayment. Many LDCs are facing ballooning debts in the 1980s. It had become so serious due to factors like global recession which led to falling exports, falling commodity prices which reduce their foreign exchange earnings, delay in loans which lead to higher interest rate repayments etc. To some countries like Argentina, the value of debt once stood at one-fourth of their GDP & 3 times their export earnings. This explains why it comes to default by 2001. IMF & World Bank can share the blame too. They knew that the amount of debt is unsustainable, but why continue lending?

(3) Aid is often conditional. IMF & World Bank often impose painful SAPs (Structural Adjustment Programs). Measures propose are like increasing interest rates to strengthen local currency, fiscal austerity which include raising tax & reduce government spending to correct for deficit, privatisation to increase efficiencies, deregulation on the operating of banks & capital flows. Although it is understood that these may stabilise the micro & macroeconomic conditions, somehow it may be ill-suited to local environment

(4) Aid is not evenly distributed. Aid is more often than not, fall into the hands of corrupt officials who may siphon it for their own benefits e.g. to pursue political campaign or agenda. Also these recipients could affect the projects that are chosen to be financed. For instance, the aid could be used to construct state-of-the-art school or hospital only in the capital city, which clearly benefits those few rich ministers. If the equivalent amount were spent in rural areas including the purchase of generic drugs, more people could have benefited it

(5) Serves donor’s objectives. Donors often have their own agenda. Aid is given but upon the condition that it will be used to purchase the goods from donor countries. In other word, normally these countries pursue export-led growth. Seeing the demand for their exports to collapse is the last thing they wanted to do! For e.g. Japan has been well known for disproportionately distributing aid to neighbouring Asian countries, which clearly shows that it has commercial interests