25 December 2007

Merry Christmas and Happy New Year!

Economics International Open Forum would like to wish you Merry Christmas and Happy New Year! We hope that you are now enjoying your time with families and friends. This year was a great success for Economics International: 373 visits, 208 visitors in only a couple of months after the Inaugauration in October (Source: official Google Analytics Data). The Economics International team is now working on restructuring the blog so that it is more interesting and entartaining. We are also working on making it more popular. We can assure you that on January the 1st you will see the first changes!

With kind regards,
Economics International

10 December 2007

Dark Future for the World Economy?

Ernst & Young issued a report entitled: "Top 10 Risks for Business in 2008".

You may be thinking that credit crunch is the biggest risk... Unfortunately, you are grossly mistaken. Ernst & Young sees regulatory and compliance risk as the greatest danger:

As the greatest strategic challenge facing leading global businesses in 2008, the industry analysts we polled selected regulatory and compliance risk. This is being driven by an escalating regulatory burden in many markets, as well as numerous compliance challenges as companies extend their value chains well beyond Europe, North America, and the BRICs (Brazil, Russia, India and China). The possibility of regulatory intervention in sectors such as pharma, biotech, insurance, telecoms and utilities, is further elevating this risk. Such intervention could shape the competitive environment and drive fundamental change in business models.

But credit crunch is surely there - it is the second most important risk:

Our analysts acknowledged that few sectors would escape the impact of major global financial shocks. Biotech and utilities firms, for example, would have trouble raising capital; banking, asset management, and insurance companies would be likely to suffer direct losses from market movements; and after making high-cost exploration investments – oil & gas companies might suddenly find themselves facing low prices if the global economy moves into sudden recession.

Risk No.3 is aging workforce and consumers:

An increasing strategic risk for the majority of industries is the threat posed by workforce and consumer aging. Sectors such as asset management and insurance are experiencing dramatic shifts in demand and competitive battles are being fought for savings products that will appeal to the growing group of older consumers. Other firms, for example, those in the auto sector, are facing severe competitive challenges as a result of their aging workforces.

The whole report is available here.

07 December 2007

“S” for Labor Supply

Our moderator, Jan Jablonski, seems to say: assumptions, stupid!

In international economics there is always a moment when we go into a murky waters of international comparison. There are several traps that we should be aware of. One of the greatest sins of an economist is to uncritically employ the analytical apparatus which was previously invented. In other words, there is a high probability of a mistake of some sort if one uncritically uses analytical tools developed for the US and applies them to i.e. Cambodia. What is the most fragile part? As usual it is assumptions. One needs to check if they hold to a reasonable extent. The problem seems to be vital especially in the field of international comparison, given the tremendous variety between economies around the world. This brings us to the actual topic of this short text which is the differences in labor supply among countries that find themselves in different stages of development.

Why labor supply? It is the area in which making a mistake in a simple copying market model with its usual parameters might bring a serious mistake. Usually labor market is assumed to work as any other market. A negative slope of a demand function does not need a particular explanation. Positive slope of a labour supply has its nice explanation. When wage raises the cost of not working also rises and substitution effect (being stronger than income effect) guarantees that the amount of hours of labour supplied rises. Alternatively, when wage falls there is less incentive to work (you don’t work if they pay you hardly anything) and labor supply falls. Thus we have a usual supply and demand cross on a diagram. There is a nuance often put in microeconomic textbooks, namely the backward sloping supply curve. From some high level of wage on, the income effect dominates the substitution effect and the amount of hours supplied to the market actually drops when wage rises. The story behind it is that if you are already rich (high wage) the additional increase in wage will remind you about the beautiful world outside your working place and you’ll decide to spend more time on leisure still enjoying a high wage.

On an aggregated level the labor supply curve often boils down to positively sloped straight line as only few people actually are “too rich for work”. This might well be good approximation for western economies in general. What happens if we travel with this framework to some developing country? Will it still be reasonable?

Let’s go down the wage axis and think what happens to the labor supply. If you earn only a little, let’s say enough to meet the subsistence level and suddenly your wage falls, there is a high chance you wish to continue your existence, so you supply more labor. By doing so you restore your income back to the subsistence level. Why wasn’t it a case in a previous setup? Well, the (usually implicit) assumption was that non-labor income guarantees subsistence level. It is a reasonable assumption in developed countries where non-labor income consists mainly of capital income, but also unemployment and other social benefits. It might be simply a mistake to assume the same for a developing country. Fristly, because of the low level of capital accumulation the capital income might be too low to guarantee a subsistence level. Secondly, a developing country might be simply too poor to maintain an extensive social security system.

What happens to our supply curve if we remove the assumption about the sufficient level of non labor income? Obviously it is getting a negative slope – lowering the hourly wage results in more labour supplied to the market. In this case the negative income effect dominates the substitution effect. What is important is that additional assumption might be very handy. If you have both supply and demand curves with a negative slope you might start worrying about stability of such model. It would be most embarrassing if, in the case of the excess of labour supply, the downward pressure on wages would bring even higher excess of labour supply. You need to assume that when wage falls, the amount of hours of labor demanded rises faster than the amount of hours of labor supplied to the market. In other words you need a slope of the supply curve to be higher (in absolute terms, as they are both negative) than the slope of a demand curve or alternatively: the supply curve needs to be steeper than a demand curve.

Interestingly the cases discussed previously are not exclusive. Putting all the pieces together we get a labor supply curve (Ls on the graph) which has something like an S-shape. The part between point A and B on a graph is a standard representation of a labor supply curve. The part above the point B represents the discouraging effects of a rising wage on hours of labor supplied. The part below point A would represent the increase in hours of labor supplied due to decrease in income below the subsistence level. Which part of the supply curve is applicable to a particular case is a matter of assumptions you can allow.

A real life example often brought forward is the case of female labor force participation. The data investigation for Mexico confirmed a negative relationship between wages and labor supply for this group on low levels of income. The relationship turns positive when the income rises.

What might be the general conclusion? It is trivial, but also crucial: to be aware of assumptions that are required in order to proceed with the analysis. Otherwise one might arrive with conclusions very far from reality.

Author: Jan Jablonski


Licona Gonzalo Hernández Reshaping the Labor Supply Curve for the Poor, LACEA Annual Meeting, Rio de Janeiro, Brazil, 2000, lacea.org.

Krueger Anne O., The Implications of a Backward Bending Labor Supply Curve, The Review of Economic Studies, Vol. 29, No. 4. (Oct., 1962), pp. 327-328.

Dessing Maryke, Labor supply, the family and poverty: the S-shaped labor supply curve, Journal of Economic Behavior & Organization, Vol. 49 (2002) 433–458.

24 November 2007

Paying Taxes

PricewaterhouseCoopers and World Bank have just published a new report on corporate taxation, "Paying Taxes 2008":

"Paying Taxes 2008" offers data on total tax rates, payment frequency, and the time needed to comply with tax regulations in 178 economies. This year's report finds that business taxation goes well beyond corporate income taxes. It identifies five types of taxes that firms pay: profit, social, property, turnover, and other taxes, such as municipal fees and fuel taxes. The number of steps, time requirements, and various cost indicators are used to determine the overall burden of paying taxes.

You are probably wondering who is No. 1? Ireland? Honkkong? Or
maybe some Central - Eastern European country, e.g. Estonia? No.

One more surprise: it is Maldives.

21 November 2007

RIO'S VOICE: Growth and development styles?

From the WSJ "Brazil Says ‘Não Obrigado’ to China-Style Growth Rates":

At the International Monetary Fund meetings, most ministers points to the 10% growth rate of China with a mixture of envy and awe. But Brazil’s finance minister Guido Mantega says 5% will do just fine. “I don’t know if it’s desirable to grow more than 5%,” he said in an interview. “We prefer to grow at a medium rate.”

My first reaction was to wonder who could possibly believe that. I couldn't, and I'm Brazilian! If Mr. Mantega's claim were true, we would be willing to forego half of the income per period we could have if growth rates were equivalent to Chinese ones. Keeping the pace, Chinese will double their GDP in 7 to 8 years, while it will take us around 15 years to double ours. Everything else equal, that roughly translates into twice as much time to double our standards of living, and why would anyone go for that?

According to the WSJ article, it seems as if Mr. Mantega is concerned about inflation, which is easier to keep under control when growing moderately because of lower demand pressures, and about being able to lower interest rates:

At mid-level growth rates, he said, it was easier to keep inflation under control – and provide additional incentive for Brazil’s central bank to lower the country’s sky high interest rates. The Brazilian benchmark Selic is now 11.25%, down from 19.75% in Sept. 2005.

“The conditions are there so that interest rates can head toward levels in civilized nations,” said Mr. Guido, by which he said he meant a nominal rate of 7% to 8%

But wouldn’t that ignite inflation?

I'll ignore the contradiction this time. Important to note now, however, is that China's 10-year high inflation is well within Brazil's target of 4.5% ± 2 p.p. It is possible to grow fast while maintaining prices under control, as long as the economy is not growing beyond it's potential rate. [For those thinking of accelerating inflation in China, remember growth was also accelerating past 10% a year.]

Funny enough, the other day I ran into China Daily's op-ed "China is on the right path to development". From what I wrote above, one could think I would agree with it, and that was my impression at first too, however the title of the article is rather misleading. Instead of focusing on the policies and institutions allowing for Chinese growth, the author in fact discusses the responsibilities that come along with the country's rise.

He declares that "the current international economic order and rules, which were mostly formulated by Western powers to reflect their interests, do not work well for the realization of China's long-term and strategic interests", and goes on to essentially state that China ought to abide by its own commitments, but shouldn't give in to "ceaseless demands from Western powers for further opening and reform".

Unfortunately reality is not so easy to deal with. Policies that benefit a country at the expense of its trading partners will certainly lead to retaliation, as history has shown over and over. The US Congress has already indicated it will pass a bill raising tariffs if the Chinese don't revalue the Yuan, recent events also indicate China's beggar-thy-neighbor policies are irritating the Europeans. Soon, Brazil and other nations will follow. The China Daily's article seems to ignore how others interested parties react to China, and it would be wise to remember these words from the World Economic Outlook of April 2006:

Even as linkages between economies grow, far too many governments are putting the slightest domestic constraint above any international interest. Others are reviving beggar-thy-neighbor policies, except they are now on the capital account—shielding large swathes of their own economy from corporate takeovers while encouraging their own companies to take advantage of the continued openness of others.

This is dangerous, short-sighted and sub-optimal. As Raghuram Rajan (Economic Counsellor and Director, Research Department, IMF), "I hope good sense will prevail".

And what about Brazil? Well, one can debate all day which development style to use. The most serious problem with our minister's statement is that we cannot talk about a style of growth when there is no growth to begin with! I have a feeling we will come back to this some time soon...

17 November 2007

CITIZEN OF EUROPE: F-16 Planes, the Euroarea and Falling Dollar

What do F-16 fighter planes, joining the Euroarea and the falling dollar have in common?

It seems that they do have a lot.

As Gazeta Wyborcza (a large Polish centre-of-the-left newspaper, with very good econ articles) wrote, the Polish government decided to increase the number of F-16s Fighting received this year from 4 to 6 (Poland bought 48 planes to be received in the coming years and is thinking of joining the JSF programme)

There are two connections between this purchase, joining the Euroarea and the falling dollar..

The connection No. 1 is simple: the cheaper dollar is, the less you have to pay for the planes.

But there is something more to it that meets the eye.

Poland wants to join the Euroarea around 2011-2012. So far it has met all monetary requirements (inflation, interest rates etc). Nevertheless, the situation with fiscal requirements is not that good: budget deficit is still more than 3% (the Euroarea reguirements are here).

At the moment, the economy is booming - the growth is around 6%. Nevertheless, economists predict a mild slowdown next year. That means budget revenues will be smaller and budget deficit may increase.

By paying for two additional F-16s now, the government decreased expenses scheduled for the next year of about 90M USD. The predictions are that, thanks to this, the budget deficit will drop below 3% next year.

As a result, Poland will be able to start negotiations on accession to the Eurozone.

Shrewd, isn't it?

14 November 2007

Indonesia - On International Confidence

Indonesia’s Position and Potential in the International Economy

As an archipelago of 17,508 islands, located at a strategic position on major trade routes and possessing a rich variety of natural resources[1], Indonesia could have great potential in a capitalist world. Still, it is one of the target countries of the UN Development Goals (UNDP). The islands of Indonesia have experienced centuries of Dutch colonization. ‘Have been dominated by’ would perhaps be a better phrasing, because the development of Indonesia has been influenced greatly by the Dutch (Geertz, 1963: 47). One could argue that the current economic state of the country is entirely due to colonization and associated exploitation and violence, but given the efforts that have been made since 1945 to alleviate poverty and boost the economy, this is not a very likely hypothesis. Instead, a significant role should also be attributed to international confidence in the country. An analysis of the post-war national economy of Indonesia shows that growth rates fluctuate with foreign investment.

Starting with a historical introduction to the Indonesian economy, this article contrasts past foreign dominance to the current independent Indonesian economy. It examines in particular the latter’s current perception by international economic parties, mainly foreign investors. Indonesia’s position in the globalizing world economy is a relevant example of how national and international trends influence each other, and together determine the path that the economy of a development country will follow.

Colonization by the Dutch started shortly after 1600. The Dutch settled mainly on Java, where the company chose as its ‘headquarters’ the city of Batavia (the current Jakarta).[2] From this period onwards, Java was to be the center of Indonesian development. Jakarta, currently the capital city of Indonesia, is still the economic center of the country, and deep contrasts exist between the latter and the country side, which is more often than not characterized by extreme poverty.

On other islands, the Dutch initiated cultivation of former rainforest, in order to export goods like nutmeg, coffee, pepper and sugar. Because of Dutch interference, the original trade with continental Asia was paralyzed and villages were no longer self-sustainable. The infrastructural orientation changed profoundly. Village production was taken to the main export centers like Batavia, instead of being exported to continental Asian countries, as was done before the Dutch arrived. In and between these colonial centers (mostly located on Java), ports, road systems and railways were developed. Because of their ‘core’ function (politically and economically), capital accumulation occurred mainly here.

The main export industries were established during the 19th century. There was now more direct involvement of the Dutch in the Indonesian agriculture, including Dutch settlement and exploitation, mainly as resource depletion. This was linked, first, to the Cultivation System[3], which also resulted in more large scale land cultivation and massive migrations to Java, and later to Dutch traders leasing Indonesian land.[4] On the East-coast of Sumatra, plantation economy arose. (Britannica)

The main industrialization took place on Sumatra and Java, due to the relative wealth of, and the amount of Westerners on, these islands. Very influential were the new agricultural technologies that were introduced in this period. This enabled rubber and petroleum production and exports to rise during the early twentieth century (Library of Congress Country Studies, 1992). Mainly on Java and Sumatra, irrigation systems were introduced to flood the rice sawas.

Decolonization started in 1945, when Indonesia declared itself independent. Four years of severe violence followed, which were, of course, far from beneficial to the country’s overall well being.[5] Sumatran exports only recovered in 1965 to pre-war levels (Airries, 1991: 5). In the second half of the twentieth century, heavy population growth occurred and urbanization figures (mainly in Jakarta) exploded (figure 1 and 2).

Figure 1. Urbanization in Indonesia. Adapted from UN World urbanization prospects (2005)

Figure 2. Urbanization: Jakarta. Adapted from UN World urbanization prospects (2005)

Industry and agriculture were somewhat diversified. Garment became a major export category under Sukarno (Antlov. 1997, 1172), further shifting land use and the orientation of labor from agriculture to basic industry. The dominant picture since this period is one of small scale villages exercising handicraft on the countryside, while more and more administrative occupations were located on Java. These developments led to an even more clear-cut division between a ‘core’ region (centred around Java), and a peripheral region.

Globalization and the emergence of the tourist sector were mainly influential in the core, where much more capital was located than in the outer regions, enabling more investment in trade, tourism, industrialization and infrastructure. There is still great inequality between the ‘core’ and ‘peripheral’ regions in infrastructure and economic growth.

Clearly, the legacy of colonization has been far from positive. But what happened after 1945? Why has the economic potential of the fourth largest country in the world still not been realized? The lack of economic growth and the ‘underdevelopment’ of Indonesia are often mentioned as a result of integration in the world economy. As stated by Barro, however, until the Asian crisis of 1997, there was rapid economic growth in Indonesia:

“Before the 1997 financial crisis, the fast-growing economies of East Asia were favorites of economists and international investors. Then Indonesia, Malaysia, South Korea, and Thailand were hit hard with currency devaluations and high interest rates. A 40-year period of sustained rapid growth was replaced in 1998 by sharp economic contractions in these countries, ranging from 7% in South Korea to 15% in Indonesia.” (Barro, 2001: 1)

Also, in the 1970s, plantations’ exports rose from 445,611 tons to 951,985 tons (PBS 1985, 100), a more than 100% growth. Between 1965 and 1990, Indonesia’s rate of economic growth was twice as high as the World Bank figures for the Middle Income group of countries (Hill, 1994: 833). In fact, as can be seen in figure 4, it was the 1997 crisis that changed the economic situation, not only of Indonesia, but of the ASEAN countries in general.

Figure 4. Per capita GDP growth in Indonesia. Adapted from van Leeuwen, 2007.

Of the four countries mentioned by Barro, Indonesia is the slowest to recover from the 1997 crisis. Barro rightly points out that an important factor in this is the current lack of foreign investment (Barro, 2001: 1). He comments that “the failure of investment to recover suggests that businesses do not anticipate returns to the sustained high growth of the past.” Thus, logically, the current investment climate is caused by sharply decreased confidence in the economy, which can also be seen in the stock market.

That the national economy is indeed ready for, and, to be more precise, deserving foreign investment is clear from the flexibility that has assured fast recovery from former economic slumps and from the process of structural reformation of “banking sectors (…), protection (…), state enterprises (…), taxation structures (…).” (Hill, 1994: 834). The Indonesian government tries to stimulate a more positive image of the Indonesian investment climate, mentioning very positive numbers:

“The rupiah has appreciated from a low of 17,000 to the dollar to a steady 8,500. The budget deficit has shrunk from 4.8% of GDP to 1.8%, and government debt from 100% to 67%. Inflation, which peaked at 60% in 1998, is down to 6% and still falling. Buoyed by this parade of encouraging figures, the stock market has recently hit several successive three-year highs.” (Economist, 27 Sept. 2003).

However, the Economist also points out some less positive trends(27 Sept. 2003). Politics are still highly unstable, and it is mainly the IMF, not the Indonesian government, that made the figures the latter is so proud of come into being. The IMF program has ended in 2004, and corruption and bureaucracy persist. “During Indonesia's rainy season, the dirt tracks that connect Javanese villages to their fields often become impassable. According to one estimate, every dollar spent surfacing these roads--with sand, rock and gravel--brings benefits worth $3.30 over the roads' lifetime. (…) Some of the World Bank money allocated to village infrastructure ends up greasing palms, not smoothing gravel.” (Economist, 18 March 2006).

Corruption and political instability are the main reasons for a lack of international confidence. However, corruption has a particular origin in Indonesia. According to King, there were corruption-like practices in the traditional tribal society, already in the 10th century. These were not illegal, but constituted a system of reward: the king could grant a good civilian a position in which the latter was expected to engage in self-enrichment (King, 2000: 605). Later, the Dutch used these mechanisms in the same way (King, 2000: 606). Corruption rose to current numbers under presidents Soekarno and Soeharto, as a consequence of his ignorance and personal benefit to maintain the status quo (King, 2000: 607-609). For many, there was no other way to urn a living. Furthermore, law-enforcement was hardly exercised with respect to corruption, allowing a climate of disregard of the law to emerge. King remarks that during the initial post-war growth, corruption declined profoundly, mainly because of the favorable economic climate, idealism, and effective law-enforcement (King, 2000: 606). Thus, on the long term, there is hope for foreign investors, provided that the government resumes enforcement of the law. However, their contribution is also necessary to establish, via economic growth, more favorable conditions for the people.


  • Airries, C.A. “Global economy and port morphology in Belawan, Indonesia”. Geographical Review, Vol. 81, Issue 2, 1991.
  • Antlov, Hans (Review author). [Kosuke Mizuno. “Rural Industrialization in Indonesia: A Case Study of Community-Based Weaving Industry in West Java”.] The Journal of Asian Studies, Vol. 56, No. 4 (November 1997), pp. 1172-1173.
  • Barro, Robert J. “A 'YANKEE IMPERIALIST' OFFERS ASIA A ROAD MAP”. Business Week, Issue 3736, 2001.
  • Britannica (Indonesia). Date of access: 18 September 2007. http://www.britannica.com/eb/article-22814/Indonesia
  • Countryprofile (Indonesia). Date of access: 18 September 2007. http://www.asianinfo.org/asianinfo/indonesia/pro-history.htm
  • Geertz, Clifford. Agricultural Involution. The Process of Ecological Change in Indonesia. London: University of California Press, 1963. Fourth ed. 1970.
  • Hill, Hal. “ASEAN Economic Development: An Analytical Survey--The State of the Field”. The Journal of Asian Studies, Vol. 53(3), 1994.
  • King, Dwight Y. “Corruption in Indonesia: a Curable Cancer?” Journal of International Affairs, Vol. 53(2), 2000.
  • Leeuwen, van, Bas. (2007). Human Capital and Economic Growth in India, Indonesia, and Japan: A quantitative analysis, 1890-2000. Doctoral thesis Utrecht University.
  • Library of Congress Country Studies (Indonesia). Date of access: 18 September 2007. Contents page: http://lcweb2.loc.gov/frd/cs/idtoc.html . Quotation from: http://lcweb2.loc.gov/cgi-bin/query/r?frd/cstdy:@field%28DOCID+id0021
  • PBS (Pelabuhan Belawan statistik). 1985. Medan: Port of Belawan Statistics Department.
  • UNDP (Indonesia). Date of access: 18 September 2007. http://www.undp.or.id/
  • UN World unrbanization prospects, 2005. (Indonesia). Date of access: 18 September 2007. http://esa.un.org/unup/p2k0data.asp

[1] The resources listed by the CIA Factbook are: “petroleum, tin, natural gas, nickel, timber, bauxite, copper, fertile soils, coal, gold, silver” (CIA Factbook).
[2] Java was an interesting place for the company since it was already developed as a regional trade centre (Tichelman, 1980: 105). Infrastructural changes were, at first, hardly implemented, since these trade centres were located in the Pasisir (i.e. coastal) region of Java.
[3] The Cultivation System held that every village or settlement had to export the crops produced on one fifth of all its cultivatable land to Holland.
[4] There were conditions to prevent too rigorous exploitation. For example, Dutch entrepreneurs could only lease the land if that would not imply that the local inhabitants were enough denied resources to sustain their livelihood.
[5] As is quite usual when large scale violence occurs, there was no money or initiative to start building up an infrastructural network or invest in industrialization.

11 November 2007

Australia’s Current Boom: Boon or Bane?

Melvin Watts looks at an economy rarely mentioned in economic news nowadays.

Australia is booming. Its business cycle yields a continuous upswing, including full employment (with an unemployment rate around 4 percent). The persisting high demand for human capital has enticed the government to recruit migrant labourers. Companies have been vigorously investing. Having benefited from high revenues the government has run a budget surplus since FY 2005/06, which was the first time for more than three decades. In order to further stimulate the already high consumption behaviour of private households, it has initiated a generous tax cut in May 2007. In the face of the stable boom, economists have forecasted a growth of 3.3 percent for 2008.

One of Australia’s core businesses pertains to mining and commodity production, which form about 6 percent of the national income. The service sector however, which generates 80 percent of the national income, is closely geared with the former: Those benefiting from the booming exports of raw materials encompass subcontractors of both mining firms and building enterprises, shipping companies, and architecture firms. The Australian financial market, which provides financial experts for investments in mineral resources, is regarded as a hub of global commodity trade. Mining giants such as BHP Billiton and Rio Tinto invest several million to develop new ore, gold, or nickel deposits.

Economists regard Australia’s ongoing performance not only as a result of the booming commodity trade but also as a result of far-reaching economic reforms that were implemented since the 1980s, transforming the country to a liberal national economy. According to these reforms, the government deregulated the financial market and lowered the customs tariff, leading to currency import and a stimulation of foreign trade. Besides, roads and highways, as well as airports and power suppliers were privatised and the value added tax was adopted at coeval abatement of the income tax. Government influence was reduced, while individual responsibility was stipulated. Previous year the government disempowered the labour unions; collective labour agreements were substituted by workplace agreements according to which the employers negotiate with their employees individually. Also, the dismissal protection for firms with up until 100 employees was abolished. After initial protests against these new rules people finally accepted the more flexible labour market in the face of low unemployment. Job advertisements have increased by 36 percent compared to previous year.

Despite the boom however, Australia has other worries to cope with: the increasing indebtedness of both, private households and firms. More and more Australians buy now and pay later. On average, every holder of a credit card has debited his account with 3000 Australian dollars. At the same time, the cost pressure increases, considering the privatised educational and health care system, as well as child care, or tolls for highways and tunnels. Apparently, the whole country is on the nod. For decades, imports used to exceed exports, leading to a high deficit of the trade balance. Since the financial market was opened, Australia increasingly borrowed more money from abroad than it earned by itself, while firms strongly financed themselves by more favourable foreign debt. Economists fear now that either a possible shock in the form of economic slump occurring in either of its important trade partners, China and Japan, or a recurrence of an international financial crisis could make Australia abruptly run short of liquidity. Moreover, the country is highly dependent on Asia’s excessive demand for raw materials. The agriculture is sagging after six years of drought; also, the manufacturing industry hardly contributes to economic growth. The trade balance is expected to improve this year only due to the increasing exports of commodities. Therefore, some Australians already talk about a commodity curse.

--Melvin Watts


Downwonder. (March 29, 2007). The Economist. Retrieved on: 18 October 2007 on http://www.economist.com/

Sprothen, V. (August 28, 2007). Boom auf Pump. Wirtschaftswoche, pp.36-38)

08 November 2007

Investment Banks

Two days ago, I was at workshops organised by one of the leading investment banks. Apart from some ibk case solving and currency trading exercise, there was a speach of one of the managing directors. The guy talked on why it is worthy to work for this investment bank and not another one.

And believe me: for most of the speach the guy tried to convince us that the subprime crisis is not a big issue for his company...

Look at an article from the Economist.

25 October 2007

CITIZEN OF EUROPE: Is EU really so socialist?

A couple of weeks ago, we wrote that the EU is going to regulate financial markets more tightly and make them more transparent...

Nothing new on that topic, but something definitely interesting is happening in EU international financial markets...

The new EU legal act MiFID (the Markets in Financial Instruments Directive) is due to be introduced soon.

For people not knowing the EU law: a directive is not a set of directions - it is a fully binding legal act that needs to be, nevertheless, transposed into national legal systems by member states parliaments before a set deadline.

I am now doing my homework on the EU institutional law and what's more the MiFID is not new to me: while working in corporate banking this summer, I heard many discussions on MiFID... And I must admit that he EU directive is surely a very interesting piece of legislation. As the Economist writes:

"Big Bang” or not, expect dramatic changes. The new rules end the monopoly (albeit a waning one) of national stock exchanges over share trading and throw open the field to newer electronic exchanges and even the big investment banks. Until now, some countries (such as Poland, the Czech Republic and Hungary) still required trading to take place over the national exchange. Others, such as Britain, have long been more liberal.

Handed an effective monopoly like the utility companies of yore, the protected exchanges took full advantage, charging everything from fat fees on membership to hefty tariffs on each trade. Even in more liberal regimes, over-the-counter trades have had to be reported to the exchanges. The exchanges charge members for the privilege of doing so and then, to add insult to injury, levy members again for access to those data in “real time”.

The new law dismantles each one of those monopolies at a stroke. "'

What is even more important:

"Under MiFID, these off-exchange markets will in effect become more regulated, because they will have to disclose more pricing information. They will also be freer to tempt business away from the traditional exchanges. This should encourage the traditional marketplaces to lower fees and increase the speed of transactions to become more attractive, which could make for leaner markets and larger trading volumes. On the other hand, it could “balkanise” trading; one of the tests of the new law's effectiveness will be whether it adds to overall liquidity or channels it in so many directions that it evaporates."

So as we can see: a new EU legislation piece means more markets and more transparency.

This is largely in contrast to what many of my Polish libertarian friends think of the EU. It's strange, but for some guys in my country, the EU is first and foremost a 'socialist federation', stiffling markets and spreading statism... Just look at the picture (scroll down, to the very bottom)

Bizarre... At least to some extent.

Not that I am a lover of Brussels, but still: a partially pro-market character of the EU cannot be denied...

17 October 2007

Carry Trade

Kasia Burzynska explains how to print money on your own. Kids, don't do it at home...

Printing money is not that difficult. Global traders have been doing it over the past few years thanks to the magical machine called carry trade. It all comes to the strategy in which an investor borrows a low-yielding currency and uses the funds to buy a higher-yielding one. Yen carry trade is the best example.

When the Japanese economy faced the crisis in the 1990s, the Bank of Japan decided to maintain for a very long time zero interest rates policy. Till today the rates are kept very low – at the moment it is 0.5 percent. On the other hand, the benchmark rate in Euroland is currently 4 percent, in the United States 4.75 percent and in New Zealand as much as 8.25 percent.

The traders have been eagerly taking advantage of this yield gap. They could borrow 10 000 yen from a Japanese bank, convert the funds into New Zealand’s kiwi and re-loan it out. The spread of 7.75 percent (i.e. 8.25 percent - 0.5 percent) makes up profit. And it can be even bigger when we take leverage, that is popular method of increasing profit by using borrowed money, into consideration. Common leverage factor of 10:1 boosts profit to 77.5 percent.

But carry would not be that interesting without risk. And carry trade can be a risky business. First of all the interest rates can change. The investors got used to very low interest rates in Japan and take it for granted. But after nearly 6 years of zero interest rates policy, Japan’s central bank raised rates to 0.25 percent in July 2006, then to 0.5 percent in February 2007. As the economic situation in Japan seems to be gradually improving, the Bank of Japan is likely to continue the hikes (Chavez-Dreyfuss, 2007) and the narrowing of the interest rate gap makes carry trade less attractive. Secondly the cross-currency carry trade involves the risk of moves in the exchange rate. If the lower-interest rate currency rapidly rises, the cost of debt relative to assets increases and at the same time the value of assets relative to borrowing decreases. That is why any strengthening of the yen worries traders. They can lose a lot in no time without a warning.

The investors must mind the risk from other sides too. Very often the money from borrowing the yen is invested in places like emerging markets, which are more unpredictable and riskier. When the economic slowdown comes, the risky assets will lose in value, which will lead to the situation in which traders will want to receive their money back to repay the debts in yen. This may make the yen rise and even more traders will have to go back to the yen, deepening the trend.

What is even more interesting, no one really knows how much capital in carry trade is involved. Its total size is estimated to as high as $ 1 trillion (Lenzner, 2007). But theoretically it should not even exist or at least not for long. The carry trade is against economic theory that says the high-yield currency compensates investors for the risk of depreciation. Similarly the low-yield currency should have the tendency to appreciate. Nevertheless, yen remains weak. The very actions of traders can be a good explanation of why it happens. They sell yen and buy other currencies. The more investors enter into carry trade the more they strengthen the tendency for the yen to fall and other currencies like the kiwi or won to rise.

Carry trade has been used by the Japanese households to get higher returns by shifting the money from their bank accounts to relatively secure but higher–interest-rate assets like New Zealand, American or Australian bonds. International investors, like hedge funds, have found carry trade applicable also for more speculative, leveraged trades.

All these flows of cheap money cannot stay without impact on global economy. The Economist’s Big Mac index from July 2007 suggests that the yen is undervalued against the dollar by 33 percent. The weak yen favours the Japanese exporters. And the high-yielding currencies are getting stronger. As O'Brien and McIntyre (2007) report Australia's dollar has gained 18 percent versus the yen in the past 12 months and the New Zealand dollar strengthened 12 percent. The same tendency is seen in the value of the won – it has been rising against the dollar and meanwhile the yen has dropped against the dollar as well as the won. That is why South Korean Finance Minister Kwon Okyu says the low value of the yen is “deepening global imbalances” and sees carry trade as “a potential threat to the international financial markets”. Carry trade hurts a lot of exporters in South Korea or New Zealand too, first of all worsening the competitiveness of small and medium-sized businesses.

Latest report from UN Conference on Trade and Development (2007) draws attention to the danger of unwinding of carry trade. It can be a threat especially for developing countries. “The web of different funding and lending currencies of otherwise unrelated economies causes the countries involved to become interdependent and subject to reversals of perceptions and to contagion effects”. Unexpected changes in exchange rates can trigger “a large unwinding of investments and this can spill over to emerging market economies”.

Carry trade is a major source of financial liquidity in global markets. It causes asset prices to rise worldwide. Unwinding of carry trade and thus drying up of this source can create market volatility. When the traders suddenly begin to sell the assets in order to raise cash to pay back their short-yen currency positions, the yen will jump accelerating further selling. And so the declines will deepen, which can lead to global crisis.

For the time being, yen carry trade still exists and still works. But it becomes even riskier. Former Federal Reserve Chairman Alan Greenspan said: “at some point it's got to turn”.

Author: Kasia Burzynska


Adam, S., Batchelor V. (2007), “APEC Says Flexible Currencies Will Reduce Imbalances”. Bloomberg.com.

Arnold, W. (2007), “Yen carry trade falling from favor”. International Herald Tribune.

“Carry on living dangerously” (2007). The Economist.
“Carry on speculating” (2007). The Economist.

Chavez-Dreyfuss, G. (2007), “Japan inflation shock could fuel carry unwind”. Reuters.

Chen, S.-C. J. (2007), “A Yen For Currency Trading”. Forbes.com.

Chen, S.-C. J. (2007), “Yen Carry Trade Unraveling Faster”. Forbes.com.

Da Costa, P. N., Kadoya T. (2007), “Greenspan says carry trade has limited room to run”. Reuters.

Lenzner, B. (2007), “A Meltdown From The Yen-Carry Trade?”. Forbes.com.

O’Brian, E., McIntyre E. (2007), “Australian and N.Z. Dollars Gain on Demand for Nations' Bonds”. Bloomberg.com.

Pesek, Jr. W. (2006), “Japan's Boom May Explode Yen-Carry Trade”. Bloomberg.com.

Smith, P., Pilling D. (2007), “Japan faces carry trade scrutiny”. Financial Times.

“What keeps bankers awake at night?” (2007). The Economist.

Young, A. (2007), “Eye on the Carry Trade”. Business Week.

16 October 2007

Investment high-flyers...

Imagine that you are a CEO of huge multinational and you are looking for a suitable location of a foreign direct investment (e.g. opening a factory, a chain of shops or aquiring such entities abroad). Where would you go?

China? Slovakia? Estonia? Chile? Brazil?

None of these countries...

According to Investment Performance Index for prepared by the Irish National Bank, the top three FDI high flyers are:

1. India
2. Poland
3. Thailand.

(for an article on the index click here)

15 October 2007

Nobel Prize in Economics goes to...

Speculations of who will get this year's Prize were pretty intense, but finally the verdict is there:

Leonid Hurwicz, Eric S. Maskin, and Roger B. Myerson.

(click for bios; for the rationale of why the Prize went to these three American economist, go here)

Many of you may be probably wondering what the mechanism design theory is and, more importantly, since Noble Prize winners should make a contribution to humanity, what practical relevance it has for us. Well, it had an impact on the development of game theory, allowing economists to analyse the sources of market failure. It seems to me that Guardian is offering a pretty good explanation of what this economic animal is.


Talking about the game theory, I have seen recently an interesting BBC three-part documentary: "The Trap. What Happened to Our Freedom".  

It touches upon game theory and modern economics, putting them in a wider social perspective.

Do I personally recommend watching it? Yes, if you like uncovering fallacies and sophistry (which is something economists are good at and do like...)


Coming back to international economics, let me present you the article headlines for this week. On Wednesday, we should have a brilliant piece on carry trade by Kasia Burzynska of Gdansk University (Poland) and later (on Saturday) a research article on how Indonesia adapts to changing conditions in international economics by Barbara Kits of University College Utrecht (The Netherlands).

10 October 2007

CITIZEN OF EUROPE: Between Scylla and Charybdis...

The first consequences of the financial crisis are clearly visible... The EU has plans of regulating financial markets more tightly, i.e. introducing more transparency, but also standardising and limiting the complexity of financial instruments...

Most of the readers would say that this is a definitely appropriate move... And I agree, but only to a certain extent.

As usually, there is something that some economic tiggers like the best...

I have no research on the topic at hand, but my intuition is that public choice theory may be relevant here - the number of lobbyists in Brussels is overwhelming and some of the new regulation may be detrimental to market players and the general population...

For me, public policy is always walking between Scylla and Charybdis. Scylla of market failure and Charybdis of government failure...

04 October 2007

China, Japan and Baltic Tigers...

The Economist has a brilliant article on the China's economy. The article describes and analyses all possible threats to the Chinese economy at the moment, except one: a currency crisis.

As I wrote earlier (backed by research by more authoritative authors, e.g. Eichengreen or Allen), a currency or twin crisis is a viable threat in China and it is strange that the Economist does not take it into account. I bet that if hedge fund use all of their resources, the famous Chinese reserves may not be sufficient...


My column collegue, André, is a big "fan" of inflation... In my favourite financial newspaper, I found a peculiarity that may be of interest to him.

Lowering inflation due to globalisation or other factors has usually been seen as a positive development, making the work of central bankers easier. Nevertheless, this is not the case in Japan:

A price war aimed at Japan’s 100m mobile phone users could have a significant impact on the core consumer price index, potentially prolonging the country’s brush with deflation, economists warned on Wednesday.'

This may not be a development stemming from international environment, but FT also writes that earlier there were fears that the Japanese fragile inflation may be lowered by a drastic plunge in prices of flat-screen TVs, which I do think may be due to China. I am just wondering whether Japanese alterglobalists will adopt it as an argument against globalisation... I am also wondering how alterglobalists, in general, respond to the argument that globalisation moderates inflation. Low inflation is, as we know from textbooks, less changeable, which means stability for employers and consumers and, thus, higher economic growth and lower unemployment. I guess that they could argue that low inflation is based on low wages in Third World countries. This is to some extent true, but you need to remember that costs of living in Third World countries are smaller than in the West, of which alterglobalists usually tend to forget...


As a prelude to my article on the Baltic Tigers, please take a look at an interesting piece from FT. It seems that making appropriate (?) reforms is not always enough to create conditions for the long-term macroeconomic stability. In a week, we will delve more deeply into the topic and try to see whether the Baltic Tigers will be able to join the Euroarea soon...

01 October 2007

Mishkin is pop, people are irrational and other news

I was going through our blog yesterday and a very interesting headline was showing up in our news section: "Fed's Mishkin downplays globalization as a factor in low inflation". In an earlier post on the theme, I defend that globalization can impact inflation through imports prices as well as through policy incentives and other mechanisms. Forbes reports:

Mishkin did say globalization may have helped in 'subtle' ways, such as by spreading a 'common culture that stresses the benefits of achieving price stability.'

[H]e said that while it is 'plausible' to hold the theory that lower priced imports from China and other countries are lowering inflation, research suggests that the importance of this factor 'should not be exaggerated.'


The Fed governor seems to be particularly under the spotlight ever since the media have called attention to his clues about the 50 basis points cut during last open market committee meeting. The Wall Street Journal blog had a very good piece about this. One passage above all others caught my attention:

There’s only one problem. Most of those four speeches came on nights or weekends. The March inflation speech was on a Friday night. The Jackson Hole paper was presented on a Saturday and last week’s “important”-downside-risks speech was given at 7:30 p.m. EDT, which might as well be midnight for Wall Street.

It is clear to me investors were not using all available information, which brings us to a question about the efficient market hypothesis and rational expectations theory, which claims "expectations will be identical to optimal forecasts [...] using all available information"[1]. It does not explain why the relevant and available information above would be ignored, perhaps because it doesn't address costs and benefits of gathering information.

But even if we account for that, wouldn't it be rational to assume that the expected benefits of gathering information about a Fed governor's public speeches outweigh costs?


Back to international economics, Brian Caplan points out 4 other irrational beliefs people have in The 4 Boneheaded Biases of Stupid Voters. Check out the "Anti-Foreign Bias".


Finally, Greg Mankiw points out The Rationality of Harry Markowitz and attends a seminar in Behavioral Macroeconomics.

[1] MISHKIN, Frederic, "The Economics of Money, Banking, and Financial Markets", 8th edition, p. 157.

27 September 2007

Bringing old ghosts back in

Amidst speeches praising the rescue of national sovereignty, the presidents of Bolivia, Evo Morales, and Venezuela, Hugo Chávez publicly announced, on August 10th, the creation of an oil company owned by both states: the Petroandina. Initial projections from both governments predict that the company will invest USD 600 million within the first year. This is intended for a further exploration into the oil and gas fields recently found just north of La Paz, the capital of Bolivia. The announcement is one step further down the road of a sui generis process of regional integration that has been developing in South America.

According to textbooks, regional integration processes usually lead to the formation of common markets, including lowered tariffs and trade barriers that ease the national firms’ ability to compete in their neighboring markets. Nonetheless, what is taking place in part of South America now is not an integration of markets but an integration of transportation and energy infrastructure led by common state-owned enterprises.

Despite the clear consolidation of market-oriented economies such as in Chile, Brazil and Colombia, newly elected governments are bringing the national States back into to business. After almost two decades of market-oriented reforms promoted since the debt crisis of 1980’s, countries such as Venezuela, Bolivia, and in a lesser degree Ecuador and Argentina, their respective national governments are reclaiming the right to manage main sectors of their domestic economies, in particular the oil and natural gas industries. What has changed in a continent that for decades was the stage of market-oriented reforms sponsored by international agencies such as the IMF and the World Bank?

In this short article we will try to answer this question and show the nature of that integration project sponsored by the President of Venezuela, Hugo Chávez.

New and Old Lefts

Crucial to this process is the already mentioned election of new state-oriented governments in many countries of the region. The wave of new left-leaning governments gaining power throughout the continent in the beginning of the decade can be interpreted as a desire for policies that would extend further than the stabilization programs of the 1990’s, as well for more effective social policies in a region fraught with social and economical inequality. It’s not a coincidence that the word “redistribution” was the catch-phrase of of the newly elected presidents’ campaign speeches (Panizza, 2005).

Nonetheless, as Castañeda (2006) suggests, the diversity within this freshly emergent left has to be taken into consideration.

The new governments can be divided in two different types. The first one is the “new” left which recognizes the importance of a market economy, low fiscal deficits and low inflation and which battles inequalities through social policies. The second type of left, though, could be seen an heir to the populist tradition of Latin America: fiscally irresponsible, nationalistic and prone to authoritarian decision-making. The latter left, elected in Venezuela and Bolivia, is the force responsible for bringing the state back in. According to Castaneda (2006), South America is far from being completely free of this ghost.

The Oil Effect

But the election of “old” left governments does not provide sufficient basis for understanding the whole process. One evident reason for the emergence of more responsible economic policies in South America since the 1980’s debt crisis was the well-documented shortage of credit in the international financial markets at that time. With the disappearance of easy sources of loans, there were few other alternatives than adopting sound fiscal and monetary policies, privatization and regulatory reforms in order to either attract international investments, or to generate surpluses that could be used in public investments. In this context, the pursuit of old-fashioned populist policies would be a prelude to a prolonged recession or hyperinflation, as experienced by several countries in the region.

So what could allow new governments to take this old path again? The answer can be found in the case of Venezuela and the country’s abundant oil reserves. With oil prices sky-rocketing, President of Venezuela Hugo Chávez is able to spend his country’s vast oil fields – it is the world’s fifth largest oil producer – to finance his “Bolivarian Revolution”. With this apparently infinite gold mine, President Chávez is increasingly taking back the control of privatized firms, threatening investors and firms that do not want to submit to his pricing regulation, and steadily increasing public spending through heavy subsidies (the price of a liter of gas around 4 cents of a US dollar) and generous social programs. The public appeal of these policies is evident in the terrible defeat by the opposition in the last election, as well as in the public support for the not-quite-democratic constitutional reforms, proposed by Mr. Chávez in the last years. In Venezuela, the State is definitely back in and fueled by a lot of gas (Shifter, 2006).

Just a Little Help to My Friends

The situation in Venezuela has resulted in more than domestic effects. President Chávez goal to export his 21st century oil-based socialism to his regional neighbours has produced a change in the regional balance of power and created favorable conditions for other governments in the region to implement new state-led economic policies. In addition to the controversial support for a presidential candidate during the last Peruvian election, and the disputes with Brazil for the regional leadership, Chávez is using the oil revenues to create conditions where friendly governments can adopt economic policies that diverge from the legacy of market-oriented reforms of 1980’s and 1990’s. The countries where this influence is more visible are Bolivia and Argentina.

In Bolivia the nationalization of natural gas refineries in 2006 led by Bolivian president, Evo Morales, was publicly supported by Chávez, and by the promise of investments by Petróleos de Venezuela S.A. (PDVSA), the Venezuelan state-owned oil company, to increase production. Consequently, Morales could send foreign oil firms – including the Brazilian state-owned oil firm Petrobras – home because he was backed by the petro-dollars of PDVSA (Oil and Energy Trends, 2006). It is reasonable to wonder if Mr. Morales project could be this radical without the Venezuelan support, especially when considering that the country is one of the smallest economies in the region, with a GDP in 2006 of only USD 22 billion. To reject all foreign investors under such conditions, without a Plan B, would be an unwise move even for the logic of more radical nationalism.

In Argentina, the help of Chávez has been less direct but not less effective. Since the Argentinean default of 2001, the country hasn’t tried to sell any new bonds on international financial markets, which puts less pressure on the government to implement more acute market-oriented reforms, or adopt more austere fiscal and monetary policies. With President Nestor Kirchner, the Argentinean government has implemented economic policies of nationalization, price-controls, systematically undervalued currency and plans to create a development bank to boost investments (Grugel & Riggirozzi, 2007). However, the sustained independence from the international financial markets has only been possible because the Venezuelan government has bought USD 2,7 billion in Argentinean bonds since 2004. In other words, the isolationist strategy of the Kirchner administration has been possible because Chávez has been financing the Argentinean debt. Besides the “little” help received from the Venezuelan government, both countries also benefit from the recent general increase in commodities prices, such as in natural gas, for Bolivia, and in wheat, for Argentina. With revenues from exports also going up, they are able to increase the scope of the State intervention in the economy and the range of social programs (Santana & Kasahara, 2007).

Infra-structure Integration and What Else?

The integration project financed by President Chávez is apparently bi-dimensional, based on the idea of a common infra-structure of roads, oil and gas pipe-lines, and a shared ideology of strong interventionist States and state-owned firms. But it is hard to figure out what else we could integrate since domestic markets tend to be protected from any kind of competition according to this logic. The idea of opening up the market for labor and goods, for instance, would represent a potential loss of domestic jobs, as well as making it difficult to justify state subsidies to domestic firms. The creation of common monetary institutions doesn’t seem very plausible either, considering that controlling the currency is a fundamental strategy of his economic model, a strategy that has also been adopted by Morales and Kirchner (Kellog, 2007). Because of that, it is not surprising that the Brazilian President, Lula da Silva, is not pushing his Congress harder to approve Venezuela’s membership in Mercosul – the regional free-trade agreement that includes Brazil, Argentina, Uruguay and Paraguay (Camargo, 2006). As representative of a more moderate left and president of the biggest economy in the region, Mr. Lula has good reason to be suspicious of Venezuela’s growing influence over the sub-continent.

Another interesting question is what we can expect of such integration in terms of stability. What would happen if Morales, his partner, lose the next election? Or what would happen if the oil prices fall? What will Chávez do if the inflation starts to rise again (it was already around 12% in 2006)? The answers are troubling. Even though the oil prices don’t show any signs of falling in the near future, it will end, and it will end faster if the production increases in order to finance Chávez’s many projects. And Bolivia’s and Argentina’s dependency on these revenues is do not bode well for their economic development.

An even more serious concern is the fact that, although legitimately elected, Mr. Chávez has been giving serious signs that he wants to stay in power longer than the constitution presently allows. His movement toward a constitutional reform that would change the Venezuelan rules in concordance with his desire to stay in power is a serious threat to a region that is experiencing its first taste of democracy after decades of military rule. And, although it might not be a real possibility, it will be even more dangerous if Chávez‘s controversial methods are adopted by his friends. In the worst case scenario, the result of this integration process, besides bringing back the ghost of economic mismanagement could be the return of the authoritarian ghost as well. Let’s hope that one is forever exorcized.

Yuri Kasahara


  • BUXTON, Julia (2005). “Venezuela’s Contemporary Political Crisis in Historical Context”. Bulletin of Latin America Research, 24 (3).
  • CAMARGO, Sônia de (2006). “Mercosul: Crise de Crescimento ou Crise Terminal?”. Revista Lua Nova, 68, 57-90.
  • CASTAÑEDA, Jorge (2006). “Latin America’s Left Turn”. Foreign Affairs, May/June.
  • GRUGEL, Jean & RIGGIROZZI, Maria (2007). “The Return of the State in Argentina”. International Affairs, 83 (1).
  • KELLOG, Paul (2007). “Regional Integration in Latin America: Dawn of an Alternative to Neoliberalism?” New Political Science, 29 (2), 187-209.
  • OIL AND ENERGY TRENDS (2006). “Latin America Ponders Nationalist Energy Policies”, 31 (6), 13-14.
  • PANIZZA, Francisco (2005). “Unarmed Utopia Revisited: The Resurgence of Left-of-Centre Politics in Latin America”. Latin America Politic Studies, 53 (4), 716-734.
  • ROCK, David (2002). “Racking Argentina”. New Left Review, 17, Sept/Oct.
  • SANTANA, Carlos Henrique & KASAHARA, Yuri (2007). “Algo de Novo no Front? O Retorno do Estado e seus Impactos sobre a Integração Sul-Americana”. Observador On-Line, 2 (4), April.
  • http://observatorio.iuperj.br/pdfs/17_observador_topico_Observador_v_2_n_4.pdf
  • SCHAMIS, Hector (1999). “Distributional Coalitions and the Politics of Economic Reform in Latin America”. World Politics, 51, January.
  • SHIFTER, Michael (2006). “In Search of Hugo Chávez”. Foreign Affairs, May/June.

23 September 2007

The Miraculous Asian Tiger

Olga Muravjova looks at how Hong Kong came to power in the international economic arena.
"If you approach Hong Kong from the sea, you will sail through a narrow channel between the island on the south and the mainland to the north, thus coming into the great harbor from which the island-colony gets its name. For Hong Kong (pronounced in Cantonese Heung Gong) means “Fragman Harbour” (Hague, 1959, p.7).

Sea and harbour are important for Hong Kong not only as determinants of its geographical position. The sea and the harbour may be seen as the symbols of trade and openness. And these two elements together with appropriate policy measures (and a dose of geographical luck) actually constitute the essence of Hong Kong's success.
In this article, I would like to show that the development of Hong Kong was due to policies that adopted the city-state's economy to changes and fluctuations in the post-war world economy. I also try to show how the development of Hong Kong affected the development of the Pearl River Delta in the People's Republic of China.

Tiger is Born: 1940s-1970s

The role of Hong Kong as an “entrepot” changed with the establishment of the People’s Republic of China in 1949 and the outbreak of the Korean War. As a consequence of the war the United Nations put an embargo on China in 1951 (Chan, 1996). This resulted in great waves of refugees, entrepreneurs and manual labor from China to Hong Kong, bringing along with them managerial and entrepreneurial skills, capital, market knowledge as well as an abundant labor force to the territory, and setting the foundation for the first phase of industrial development of Hong Kong (Chan, 1998).

From the mid 1950s, labor intensive industries directed by export oriented strategies developed, taking advantage of Hong Kong’s geographical and economic positions. Also, as Yulong and Hamnett (2002) say, other favorable conditions at that time, such as the freer economic policy, the emergence of the New International Division of Labor (NIDL) as well as integration with the world capitalist system, (especially in the “regulations governing the operation of economy and trading”) brought new opportunities for Hong Kong to improve its industrial structure and also had an influence on rapid development of the city.

Badcock (2002) says that the economic success of Hong Kong in the 1970s was due to its ability to “mass produce” consumer goods at lower prices than its main competitors in other places. The production of different electronic devices and toys was common among the industries. These goods were usually produced by small and medium enterprises, and this led to the economic paradox of mass production, since usually big companies experiencing economies of scale carried out mass production, as the Fordist model explains. However, Augustin-Jean (2005) says that Hong Kong had never been an example of the Fordist paradigm, and the small and medium enterprises managed to benefit from their ability to produce “differentiated products in small quantities and in a short period of time” using simple technologies. This gave the possibility for entrepreneurs to quickly adjust their production to changes in demand, to modify their products several times a year in order to satisfy their most demanding overseas customers and when orders were too large, companies subcontracted parts of the production. Indeed, as Badcock (2002) mentions, Hong Kong’s industries had adopted flexible production characteristic for post-Fordist manufactories. However, the development of Hong Kong depended on its external relations, the importance of its port, its free port status as well as its existence as a specific economic entity.

Since Hong Kong’s beginning in 1841, the city was declared a free port, which fitted the laissez-faire ideology of the time, specifically that of a supporter of the “free economy”, which British Government was. At that time, the “British Government decided that…British taxpayers should not subsidize the running of the colony”, and therefore there were no taxes on products (Augustin-Jean, 2005).

But that was not all. Industries in Hong Kong received benefits from government actions in the 1970s. In response to rising world trade protectionism and competitive pressures from its Asian counterparts and lower wage developing countries, Hong Kong’s government “embarked on a series of laissez-faire financial policies”, such as the introduction of low taxes, abolition of exchange controls, and the accessibility of an extensive range of financial and technical services (Yulong & Hamnett, 2002). This started a shift in its economic development strategy which entailed a move to a “diversified economic structure particularly focused on the financial and service sector”.

Furthermore, Hong Kong’s location on China’s doorstep, as well as near the sea, is another factor that has greatly benefited Hong Kong’s economic expansion. Since the middle of the 20th century, Hong Kong has been the major link for China’s relations with the outside world. Furthermore, Hong Kong’s industries received huge benefits from the waves of migrants from the Mainland, since the effect of that was the great supply of labor. Additionally, China had supplied Hong Kong with basic daily necessities including fresh food and drinking water, even during the “Cultural Revolution” (Yulong & Hamnett, 2002). The importance of the connection with China and Hong Kong’s location rose especially after the “Open Door” policy was implemented, which I will discuss later.

Role of Government: Urban Planning Strategies

Yet, not everything was according to laissez-faire lines in Hong Kong. Despite their laissez-faire attitude, and a policy of minimal intervention, the colonial authorities had become increasingly involved in the management of land and public housing. After the World War II, there was a rapid economic development as well as a huge inflow of immigrants. The Hong Kong Government quickly understood that some planning actions were needed. A famous urban planner, Sir Abercrombie, came from England to Hong Kong in 1947, however, due to the liberation attitude of the time, there was little done during that period. Nonetheless, after a tragic event, when a gigantic fire completely destroyed a slum area in New Kowloon and left about 50,000 people without shelter, “one of the most ambitious public housing programs on Earth” had been started (Augustin-Jean, 2005). Simultaneously, in order to try to reduce the inevitable disturbance (noise and pollution) caused by industries to the residential districts, local government put into practice a relocation program for small and medium enterprises (SMEs) and encouraged the creation of industrial zones. The local authorities presented their program as a part of their mission to help the poor and I definitely can state that local economy benefited from the government intervention in the housing market. The system was very simple, did not involve much transfer of public funds, and was economically beneficial. Therefore, as Augustin-Jean (2005) says, it was not considered as a “contravening mechanism” of an ideology of a “free economy”.

International Environment and Roots of Economic Development from 1979s

Gar On-Yeh (1997) says that the most significant economic restructuring in Hong Kong occurred in the late 1980s after the adoption of economic reform and open door policy of China in 1978. The catch phrase of the Open Economy Policy was “to open to the outside world and to revive the economy of the island” (Chan, 1998). Hong Kong transformed from an industrial to an information society; the major international centre was founded not only on trade, shipping, banking, investment and finance, but also on property, tourism and entertainment. The laissez-faire financial policies of the beginning of the 70s appeared to be victorious, and by the beginning of the 1980s, Hong Kong became the fourth largest financial market in the world after New York, Tokyo and London (Yulong & Hamnett, 2002). In the meantime, this resulted in a market decline in the industrial and manufacturing sectors. The Hong Kong economy survived the oil crises of the 1970s, but the growing land prices and increasing labor wages have deteriorated its industrial production advantages. A significant amount of manufacturing production moved to cities and towns in southern China (Chan, 1996). Moreover, the competitiveness of the United States and Europe in the world market improved, after they started using flexible production systems. However, these developments did not frighten Hong Kong, and because of the economic reforms occurring in China at that time, Hong Kong did not have to take extreme measures to remain a competitive actor in the world market (Augustin-Jean, 2005). Therefore, it is important to examine economic developments in the People’s Republic of China in order to evaluate the economic restructuring of Hong Kong.

Hong Kong and China

China's economic reforms since the late 1970s and 1980s have had a far reaching effect on the economic restructuring of Hong Kong's economy. Guangdong Province is the first province in China which benefited from the Open Door Policy. The reason for this is that three out of four SEZs and two out of the 14 coastal open cities are located there. The province is believed to move “one step ahead” of the other provinces in the People’s Republic of China. This is also the province to have the largest impact on trade between China and Hong Kong. As Chan and Kam mention, Hong Kong and China are currently the largest trading partners (Chan, 1996; Kam, 1999). For example, trade amounted to 395 billion Hong Kong dollars in 1990, and it has been described that Hong Kong’s role vis-à-vis China as being a “trading partner”, “financier”, a “facilitator” and “middleman” (Chan, 1996). These definitions are especially correct with respect to the Pearl River Delta, a composite delta in Guangdong Province of south China, developed into one of the leading growth regions in the People’s Republic, and where most of the wealth is situated.

Hong Kong and the Pearl River Delta Region

The Pearl River Delta was fundamentally an agricultural region, however, since the 1980s its economic profile had experienced significant transformation, changing from an agricultural to a manufacturing area, dominated by “textile, food processing, footwear and electronic assembly enterprises”. More recently, some cities have focused on expanding commercial and service sectors (Chan, 1998). After China adopted the “Open Door Policy”, the industrial and manufacturing sectors have been decreasing. As Chan (1996) mentions, there was a relocation of the local industries and factories from Hong Kong to Shenzhen and other parts of the Pearl River Delta region. Hong Kong industrialists used these regions as a “backyard”, since while administrative operations stayed in Hong Kong, the production lines gradually moved to Guangdong and were decentralized. Such complementarity of the factors of production gives us a significant explanation of the success story of Hong Kong. “China can provide cheap land and labor; Hong Kong has the capital surplus and know-how” (Augustin-Jean, 2005). The migration from rural areas provided the labor supply. The government strictly controlled rural-urban migration on the Mainland until the establishment of the rural responsibility system, which consisted of a set of reforms aimed on giving the individual peasant households bigger responsibility of managing their own economic matters. As a result, the Pearl River Delta region has experienced massive migration of farmers traveling to township enterprises. Since the adoption of the “Open Door Policy”, the portion of the delta in Guangdong Province has become one of the largest economic regions and a massive manufacturing centre of mainland China, and there is an increasing integration between Hong Kong and the Delta. Chinese government hopes that the manufacturing in Guangdong, in a combination with the financial and service economy in Hong Kong will create an economic gateway attracting foreign capital throughout mainland China (Rohlen, 2000). The closeness of the Pearl River Delta region to Hong Kong attracts the overseas investors, which consequently stimulates the economy of both Hong Kong and the Delta region.

Urban Planning after 1979

The control of urban planning after the introduction of the “Open Door Policy” was significantly higher than before the reforms occurred in China. However, the economic restructuring that has occurred since the mid-1980s has created new challenges for urban planning in Hong Kong. New measures had to be developed to deal with the increasing cross-border traffic and to accommodate the changing needs of economy. Thus, a Territorial Development Strategy appeared in the early 1980s to coordinate land use and transport development in order to be able to provide a better living and working environment as well as to sustain economic development (Gar-On Yeh, 1997).

After the establishment of People’s Republic of China, and after the Korean War, the industrial sector of Hong Kong was rapidly increasing because of the great labor supply, caused by the huge inflow of migrants from the Mainland to Hong Kong. Also, the flexibility of Hong Kong’s industries, and the ability to response quickly to demands, created big advantages. Hong Kong’s industries were either small or medium in size and also had simple and very flexible production systems. Other parts of the world would experience such flexible and post-Fordist way of production only decades later. Moreover, “free economy” (free port status and other laissez-faire policies) gave profits to local industries. Regarding the urban planning in Hong Kong, there was a significant intervention from the government, to a degree of paternalistic reasons.

The “Open Door Policy” influenced Hong Kong’s development in a major way, transforming the city from industrial to an information based society. Industrial and manufacturing activities moved to the Mainland, especially to the Pearl River Delta region. By that time, Hong Kong had become a major financial centre. The increase in the connection between Hong Kong and the Peal River Delta was economically beneficial. The connection with China on another hand made Hong Kong even more attractive for foreign investors. In the 1980s, the introduction of the Territorial Development Strategy in order to improve lives of people by sustaining economic growth was a major change.


Hong Kong had undergone many development phases before it achieved the status of developed city. Its geographical advantages, successful planning and openness to changing economic situations in the rest of the world, helped Hong Kong to become one of the most important cities and the fourth largest financial market in the world. Hong Kong may be a good example of how openness, free trade and, last but not least, appropriate government policies lead to economic prosperity. In this sense, Hong Kong is to a certain extent the child of an ongoing process of globalization.


Asian Info – Hong Kong. 3 May 2007.

Augustin-Jean, L., “Urban Planning in Hong Kong and Integration with the Pearl River Delta: A Historical Account of Local Development”, GeoJournal, Vol. 62, Issue: 1, pp. 1-13. 2005

Badcock, Blair. Making Sense of Cities – A Geographical Survey. London, Arnold. 2002

Bureau of East Asian and Pacific Affairs. “Hong Kong”. 2007. 2 May 2007.

Chan, R.C.K., “Cross-border regional development in Southern China, GeoJournal, Vol. 44, Issue: 3, pp. 225-237. 1998

Chan, R.C.K., “Urban Development Strategy in an Era of Global Competition: The Case of South China”, Habitat international, Vol. 20, Issue: 4, pp. 509-523. 1996

Hague Eric. In the Shadow of Nine Dragons. Hong Kong Sketches. London. 1959

Gar-On Yeh, A., “Economic restructuring and land use planning in Hong Kong”, Land Use Policy, Vol. 14, No. 1, pp. 25-39. 1997

Kam Ng, M., “Political economy and urban planning: a comparative study of Hong Kong, Singapore and Taiwan”, Progress in planning, Vol. 51, Issue: 1, pp. 1-90. 1999

Rohlen, P. Thomas. “Hong Kong and the Pearl River Delta: “One Country, Two Systems” in the Emerging Metropolitan Context”. 2002

The World Fact Book. “Hong Kong”. 2007. 1 May 2007.

Yulong, S., Hammett, C., “The potential and prospect for global cities in China: in the context of the world system”, Geoforum 33, pp. 121-135. 2002

19 September 2007

Global public goods

A new approach to development or a fashionable speculation to revitalize aid-fatigued donor countries?

In these years, development institutions' capacity of delivering results to poorest countries has been questioned a lot. World Bank's mission creep – that can be summarized as starting from basic infrastructure building in the 1940s and arriving to the "working for a world free of poverty" motto – has lead to serious accountability and effectiveness problems, up to the point that today's Bank's mission has become so complex that seem hardly manageable. The IMF is in deep water as well. The words "structural adjustment" had become a catch-all phrase for the pain inflicted on the poor in developing countries by faceless austere bureaucrats in Washington, and the new implementations do not seem to satisfy all: the debate about IMF and WB reforms is still open.

To fight this lack of effectiveness a new rhetoric about developing institutions has arisen, starting with the Millennium Development Goals and UN declarations, which advertised human development, pace, equity, justice, gender equality, environmental safeguard as the new performance benchmarks for development institutions.

Surfing this wave, a new concept has been forged to provide theoretical strength for a broad approach to development and to revitalize "aid-fatigued" donor countries with new appealing evidence: the concept of global public goods. An increasing literature (Kaul et al., 1999, Agerskov, 2005 among others) recommends focusing on global public goods for boosting growth in poor countries.

In Prague, 2000, the World Bank and IMF Development Committee identified five priority areas for GPG intervention, recognizing the need for the Bank to define more precise targets. These areas are communicable diseases; environmental commons; development information and knowledge; trade and economic integration; international financial architecture (which is an IMF specific role). Actually, the architecture for Bank involvement in global programs seems to be increasing. In fiscal year 2004, 64% of the Bank's trust fund monies ($7.1 billion), went to global and regional programs, compared to 57% in 2003 (source: OED 2004). The share of single country operations, however, is still much higher, and multi-country operations among small groups of countries remain low.
The UN has also identified in 2004 six clusters of global challenges: war between states; violence within states; poverty, infectious diseases and environmental degradation; nuclear, radiological, chemical and biological weapons; terrorism; transnational organized crime.

What are global public goods exactly? What are the insights on development that this approach provides? Can this concept be a reference point for development programs? Let's try to find an answer to these questions.

The term "public goods" was first mentioned by David Hume, the Scottish philosopher and economist, and later properly introduced in the economic field in 1954 by Paul Samuelson (Economic Nobel Prize Winner in 1970). Samuelson defined public goods as a commodity or an activity with the characteristics of "non-rivalry" and "non-excludability" in consumption, i.e. where any one's person consumption of the good doesn't affect the available amount for others, and where it's hard to exclude anyone from accessing the good. Public goods' nature making this class of goods undersupplied by the market, the need to supply public goods besides market allocations traditionally justifies government involvement in the economy.

The concept of "global public goods" (GPGs), counterposed to national public goods, became widespread in the literature with the UNDP publication Global Public Goods (Kaul et al, 1999). A global – or international, the terms are almost interchangeable – public good is one where the elements in question are nations, rather than individuals. Thus, the joint and non-excludable benefits apply among nations, in a globalized environment.

While the subsequent broad literature accord on the main definition of GPGs, there are great semantic variations and different classifications among the authors. Let's quote some of the main views: Agerskov (2005) provides a very theoretical division among demand-related variations or supply-related variations on the general "public goods" concept. Focusing on spillovers, Kanbur et al (1999) distinguish three types of spillovers - national, regional and global; Sandler (2001) further analyze the geographical range to which the benefits apply: he divides local, national, regional, international and global benefits, in ascending climax. Morrissey (2002), analyzing the spatial range from a different point of view, considers three kinds of benefits that GPGs give rise to - risk reduction, enhancing capacity, and direct provision of utility – and classifies the national or international level of a public good according to benefits.
The broadest and most general attempt of classifying and analyze GPGs can be found, however, in Kaul et al. (1999). With less stress on precise economically-supported distinctions, they simply divide their book in six case studies, each of them analyzing one or two closely-related GPGs: equity and justice, market efficiency, environment and cultural heritage, health, knowledge and information, peace and security.

As these many classifications prove, the concept of "global public good" has become wide, multifaceted and increasingly unclear. So large is the basket of GPGs that the only definition of GPG that may "contain" all the examples and study cases provided in the literature is the definition given by Morrissey (2002), "a benefit providing utility that is in principle available to everybody (let's say many) through the globe". Yet it's not a very stimulating or sharp insight. The main question in defining GPG – the same question that is involved in many economical concepts – is whether we want a theoretical or an operative concept.

The theoretical, idealistic concept of GPGs, which includes values as equity, justice and peace (I'll discuss later the advisability of such classification even in a wide contest), mainly focuses on the "underprovision" and "benefit-all" aspects of GPGs. This focus has the clear aim to revitalize with new incentives the "aid fatigued" donor countries, to give them a new boost for financial intervention. However, as Kanbur (2002) smartly points out, two concerns arise. First, the "there's something in it for us" argument used to stimulate the Northern public has less solid moral basis than assistance based on humanity and empathy. Second, and more economic related, the supposed unilateral positive spillover of aid from rich to poor countries is hardly sustainable; the empirical evidence on the efficacy of IMF's and World Bank's aid for promoting development is, at least, mixed.

The operative approach, on the other hand, moves from the definition of non-excludability and non-rivalry in consumption, and from the positive spillovers among countries, to underline the practical implication of GPGs for economic development, therefore to provide a new agenda focused on global and regional programs for international organizations, World Bank in primis, with new importance on effective cooperation among the recipient countries.

If our goal is to identify the reasons of the failure of unilateral aid approach, and to provide poor countries with new bases for development, an operative, narrower approach to public goods may be useful.

Let's analyze first the definition and the division provided by Kaul et al., to show their weaknesses and to underline the necessity of a narrower approach for development.

The authors, in the first chapter, traditionally define GPGs as something that "must meet two criteria. The first is that their benefits have strong qualities of publiciness (sic) – that is, they are marked by non-rivalry in consumption and non-excludability. […] The second criterion is that their benefits are quasi universal in terms of countries, […] people […] and generations […]. This property makes humanity as a whole the publicum." Taken literally, this definition can be either very broad, if we consider any kind of abstract concepts, or very narrow, if we consider "goods" as tangible goods. The former one seems to be the pattern followed by the authors. Later on, in fact, they explicitly further divide GPGs in final global public goods, which are "outcomes rather than goods in the standard sense", and which can be tangible (environment, common heritage of mankind), or intangible (peace, international stability), and in intermediate global public goods, which "contribute to the provision of final GPGs" (international regimes, economic growth).

Even considering "goods" not just in a strict sense, it's very hard to see how international regimes can really benefit the whole humanity (even organizations as UN and IMF face huge problems of representation and are not able to account for small countries), how economic growth can be non-excludable toward the whole humanity (just recognizing positive externalities doesn't mean that growth per se benefit all the globe, unfortunately), or how heritage of a culture can benefit everyone (how archaeological sites in Peru can benefit all the citizens of Russia, for example).

The standard definition applies neither to the equity nor justice nor peace, other GPGs mentioned in the book. Can we really define them as GPGs? Aren't them values to pursue and to be inspired by rather than "goods" to provide? How can equity concretely be part of a specific development program?

Regarding knowledge, it's at least curios to classify it as a GPG, after a whole branch of philosophy (epistemology and gnoseology) has been studying for centuries what knowledge is and how is provided. If we want to talk about externalities, we may consider public-made, shared knowledge rather than knowledge itself. And still, the implications are quite problematic: first, nothing assures that all "kinds" of knowledge will be shared to a global public and will become easily available; second, even when shared through printed documents, internet or mass-media (thus becoming "information"), strong prerequisites are necessary to access it – such as information technologies to physically access, education to fully take advantage of it. Thus, knowledge and information are everything but non-rivalry and non-excludable in consumption.

As for financial stability, market efficiency and security, they are classified as global public goods because they prevent global public "bads", i.e. financial crises, market failures and wars. Besides the appealing pun, the definition is again unclear: global public bads seem to be just negative externalities, and they do not really fall into the categories of non-rivalry and non-excludability. That does not mean that international institutions such as the IMF or NATO do not have to promote financial stability and security. It just means that not everything that is important for global growth can be labeled as GPGs.

Environment is maybe one of the few pure cases of GPGs: the stratospheric ozone layer and the stability of the climate affect the whole world, they are non-rivalry and non-excludable, and similarly reduction in the use of ozone-depleting chemicals and in the emission of greenhouse gases benefits the whole humanity. Moreover, they have practical connotations: the levels of emissions are scientifically measurable, and it's not hard to think about concrete project to enhance environmental protection. However, environmental problems usually have regional, not global, implications: water pollution, acid rain, biodiversity and resource conservation are examples of region-related problems.

As well as environment, health is a GPG that can have both a global and a regional connotation. Diseases such as AIDS, malaria and avian influenza may have worldwide spread, but they are mostly concentrated in specific regions (Africa, Asia).

Environment and health thus lead us to a question: are GPGs really global in a pure sense, or are they mostly regional? In the second case, does a "global approach" really make sense, and can it be operational and useful? Even if recent literature have mostly focused on the appealing concept of global public goods – so easy to link to the fashionable concept of globalization – besides few examples international public goods have more often regional rather than global implications. Consequently, a closer focus on narrower concepts such as regional public goods can be more useful for understanding public goods' potential for development.


* Addressing the challenges of globalization, World Bank Operations Evaluation Department, 2004

* Agerskov, A. H., Global Public Goods and Development – A guide for policy makers, in Global Development Challenges Facing Humanity, World Bank Seminar, May 2005

* Kanbur et al., The future of development assistance: common pools and international public goods, ODC, 1999

* Kanbur, R., International financial institutions and international public goods: operational implications for the World Bank, G-24 discussion paper series, December 2002

* Kaul et al., Global public goods, Oxford University Press, 1999

* Morrissey et al., Defining international public goods: conceptual issues, Overseas Development

* Sandler, T., Comment on "The growing importance of regional public goods by Marco Ferroni", February 2002