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Crossing the chasm: Economics and economic policy

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Contemporary economists the world over are trained in textbooks that are overwhelmingly American in thought and methods.

The conclusions of standard textbooks are straightforward; the market must be free in order to achieve resource allocation efficiency, the political economy must be anchored in privatization, liberalization, globalization and the smaller the government the better.

And it’s almost a cardinal sin for any advocacy for state planning, state owned enterprises, industrial policy, regional development, export development, and foreign direct investment (FDI) development programming, etc.

And if these state interventions are not eliminated and free market institutions installed or restored, the economies involved will run the risk of collapsing under the weight of state intervention and inefficiency. If China has not collapsed yet then it is collapsing soon – just ask Gordon Chang! (He made the prediction in 2001 and has since been changing his expected timing of the coming collapse of China!)

These are the same advice that orthodox economists have doled out to countries in Africa, Latin America and China for that matter. Absence of adherence to these policy prescriptions, the economies involved are predicted to be leading to underdevelopment, or even if by chance economic development does take hold, the end results would still be the same: rampant corruption, inequality of income distribution, environmental degradation, and unhealthy economic speculations and bubbles of all sorts especially in real estates.

By this line of argument, it appears that liberal political economy is the cause that determines economic prosperity. In other words, if Western, or to be more precise, American style political economy is made to prevail then economic development will take off. But there is no evidence for that. In fact, the reverse is more likely. All present day developed countries have gone through periods of corruption, primitive socio-economic inequality, environmental degradation, unproductive speculations, protectionism and/or colonizing others in the case of European powers, on their path to sustainable economic development. Evidence for this latter hypothesis has been convincingly presented in two books by two distinguished economists; Brad DeLong of UC Berkeley in Concrete Economics and Ha-Joon Chang of the University of Cambridge in 23 Things They Don’t Tell You about Capitalism.

China is a classic case in point. The country is a one-party state and obviously not a liberal democracy, the government is heavily involved in the economy, state owned enterprises (SOE) account for about 30% to 40% of the country’s GDP and 20% of total employment, party cells are embedded in SOE’s and many institutions, and Marxism is still being promoted at least nominally. All these, from a Western liberal perspective, point to a scenario of the worst of all worlds as far as economic development is concerned.

But is it true?

Take the case of the Philippines, it was a colony of the US and has taken much heavier doses of liberal economic policy remedies longer than China, the same goes for many Latin American countries. And Ukraine and Russia both pursued liberalization of their economies way more thoroughly than China. But what happened to these economies compared to China is beyond dispute! In fact, the two most populous countries on earth – China and India – unlike others, have leveraged state economic planning for their mixed economies for economic growth with significant achievements. In the case of India,  state owned enterprises account for 45% of the manufacturing sector, followed by services (35%), energy (12%), and mining (8%).

I started this paper by questioning the conclusions of standard economics textbooks on economic development. But my argument in this essay is not to promote state owned enterprises either. I simply use the cases of China, India and others to highlight my main argument that economic development policy must be based on real life economics and not on ideological beliefs; be it left or right. Here’s what I think economic policy should be based on.

First of all, market does not dictate resource allocations but company management does. Corporations when faced with challenges and opportunities make their choices of what to avoid and what to pursue. This is the essence of the Nobel Laureate Ronald Coase’s well known “The Nature of the Firm” argument that if market is so efficient why you would need companies.

Economic theory concerns itself with modelling the relationship between inputs and outputs but has nothing to say about how inputs get grinded into outputs.This explains why the public sector has been the driving force in China’s early economic reforms. Because after a long period of absence from private enterprise operations (from 1949 to early 1980’s), the public sector was the only place where management talents could be found. Deng Xiaoping’s gradualism in market and ownership reforms colloquially termed “touching the stones to cross the river” in Chinese was the right call for China.

Secondly, “market” does not exist in a vacuum. Contrary to conventional wisdom, “market” is more a public good than a private good. An above-ground market exists because of government acting as the enforcer of rules and regulations. Similarly, an underground market exists because one or a group of gangsters acting as enforcers of underground rules and regulations.

Last but not least, market and government are not mutually exclusive and they affect and influence each other. Market does not come into being naturally. Market is created. The existence of market depends on political stability, societal trust and the availability and refinement of social and physical infrastructures. This latter point has been particularly documented in Mariana Mazzucato’s research that reveals that “every technology that makes the iPhone so ‘smart’ was government funded: the Internet, GPS, its touch-screen display and the voice-activated Siri.”

Academic economists enjoy the beauty of economic theories the same way that mathematicians enjoy the beauty of mathematics, or philosophers enjoy the beauty of logical arguments in their quest for “truth”. These are worthwhile pursuits because they are beautiful in and of themselves.

But we should not get carried away by extending too far economic theories into economic practice.

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Economy

Transitioning from least developed country status: Are countries better off?

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The Least Developed Countries (LDCs) are an internationally defined group of highly vulnerable and structurally constrained economies with extreme levels of poverty. Since the category was created in 1971, on the basis of selected vulnerability indicators, only five countries have graduated and the number of LDCs has doubled.  One would intuitively have thought that graduation from LDC status would be something that all LDCs would want to achieve since it seems to suggest that transitioning countries are likely to benefit from increased economic growth, improved human development and reduced susceptibility to natural disasters and trade shocks.

However, when countries graduate they lose international support measures (ISMs) provided by the international community. There is no established institutional mechanism for the phasing out of LDC country-specific benefits. As a result, entities such as the World Bank and the International Monetary Fund may not always be able to support a country’s smooth transition process.

Currently, 14 out of 53 members of the Commonwealth are classified as LDCs and the number is likely to reduce as Bangladesh, Solomon Islands and Vanuatu transition from LDC status by 2021. The three criteria used to assess LDC transition are: Economic Vulnerability Index (EVI), Human Assets Index (HAI) and Gross National Income per capita (GNI).  Many of the forthcoming LDC graduates will transition based only on their GNI.  This GNI level is normally set at US $ 1,230 but if the GNI reaches twice this level at US $ 2,460 a country can graduate.

So what’s the issue?  A recent Commonwealth – Trade Hot Topic publication confirms that most countries graduate only on the basis of their GNI, some of which have not attained significant improvements in human development (HAI) and even more of which fall below the graduation threshold for economic development due to persistent vulnerabilities (EVI).  This latter aspect raises the question as to whether transitioning countries will, actually, be better off after they graduate.

Given the loss of ISMs and the persistent economic vulnerabilities of many LDCs, it is no surprise that some countries are actually seeking to delay graduation, Kiribati and Tuvalu being two such Commonwealth countries despite easily surpassing twice the GNI threshold for graduation.

How is it possible that a country can achieve economic growth but not have appreciable improvements in resilience to economic vulnerability?  Based on a statistical analysis discussed in the Trade Hot Topic paper, a regression model, based on all forty-seven LDCs, was produced.  The model revealed that there was no statistically significant relationship between economic vulnerability and gross national income per capita.  The analysis was repeated just for Commonwealth countries and similar results were obtained.

Most importantly, analysis revealed that there was a positive relationship between GNI and EVI. In other words, increases in wealth (using GNI as a proxy) is likely to result in an increase in economic vulnerability.  This latter result is counterintuitive since one would expect more wealth to result in less economic vulnerability.

So what’s the take away?

The statistical results do not necessarily imply that improving the factors affecting economic vulnerability cannot result in improvements to economic prosperity.  It does suggest, however, that either insufficient efforts have gone into effecting such improvements or that there are natural limits to the extent to which such improvements can be effected.

One thing is clear, the multilateral lending agencies should revisit the removal of measures supporting climate change or other vulnerabilities for LDCs on graduation, since the empirical evidence suggests that countries could fall back into LDC status or stagnate and be unable to achieve sustainable development. Whilst transitioning from LDC status should be desirable, it should not be an end in itself. Rather than to transition and remain extremely vulnerable, countries should be resistant to such change or continue to receive more targeted support until vulnerabilities are reduced to more acceptable levels.

What are your thoughts?

Commonwealth

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Economy

U.S. policy and the Turkish Economic Crisis: Lessons for Pakistan

M Waqas Jan

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Over the last week, the Turkish Lira has been dominating headlines the world over as the currency continues to plunge against the US dollar. Currently at the dead center of a series of verbal ripostes between Presidents Donald Trump and Recep Tayyip Erdogan, the rapidly depreciating Lira has taken center stage amidst deteriorating US-Turkey relations that are wreaking havoc across international financial markets. Considering Pakistan’s current economic predicament, the events unfolding in Turkey offer important lessons to the dangers of unsustainable and unrealistic economic policies, within a dramatically changing international scenario. This holds particular importance for Pak-US relations within the context of the impending IMF bailout.

In his most recent statements, Mr. Erdogan has attributed his economy’s dire state of affairs as an ‘Economic War’ being waged against it by the United States. President Trump too has made it evident that the latest rounds of US sanctions that have been placed on Turkey are directly linked to its dissatisfaction with Ankara for detaining American Pastor Andrew Brunson. Mr Bruson along with dozens of others has been charged with terrorism and espionage for his purported links to the 2016 attempted coup against President Erdogan and his government.  There is thus a modicum of truth to Mr. Erdogan’s claims that the US sanctions are in fact, being used as leverage against the weakening Lira and the Turkish economy as part of a broader US policy.

However, to say that the latest US sanctions alone are the sole cause of Turkey’s economic woes is a gross understatement. The Lira has for some time remained the worst performing currency in the world; losing half of its value in a year, and dropping by another 20% in just the last week. Just to put the scale of this loss in to perspective, the embattled currency was trading at about 2 Liras to the dollar in mid-2014. The day before yesterday, it was trading at about 7 Liras to the dollar.

While the Pakistani Rupee has also depreciated quite considerably over the last few months, its recent drop (-17% against the dollar over the past 12 months) pales in comparison to the sustained and exponential downfall of the Lira. Yet, both the Turkish and Pakistani economies are at a point where they are experiencing an alarming dearth of foreign exchange reserves that have in turn dramatically increased their international debt obligations.

The ongoing financial crises in both Turkey and Pakistan are similar to the extent that both countries have pursued unsustainable economic policies for the last few years. These have been centered on increased borrowing on the back of overvalued currencies. While this approach had allowed both governments to finance a series of government investments in various projects, the long term implications of this accumulating debt has now caught up with them dramatically. As a result, both countries may soon desperately require IMF assistance; assistance, that in recent times, has become even more overtly conditional on meeting certain US foreign policy requirements.

In the case of Pakistan, these objectives may coincide with recent US pressures to ‘do more’ regarding the Haqqani network; or a deeper examination of the scale and viability of the China- Pakistan Economic Corridor. With regards to the latter, US Secretary of State Mike Pompeo has clearly stated that American Dollars, in the form of IMF funds, to Pakistan should not be used to bailout Chinese investors. The rationale being that a cash-strapped Pakistan is more likely to adversely affect Chinese interests as opposed to US interests in the region at the present. The politics behind the ongoing US-China trade war add even further relevance to this argument.

In the case of Turkey however, which is a major NATO ally, an important emerging market, and a deeply integrated part of the European financial system, there is a lot more at stake in terms of US interests. Turkey’s main lenders comprise largely of Spanish, French and Italian banks whose exposure to the Lira has caused a drastic knock on effect on the Euro. The ensuing uncertainty and volatility that has arisen is likely to prove detrimental to the US’s allies in the EU as well as in key emerging markets across South America, Africa and Asia. This marks the latest example of the US’s departure from maintaining and ensuring the health of the global financial system, as a leading economic power.

Yet, what’s even more unsettling is the fact that while the US is wholly cognizant of these wide-ranging impacts, it remains unfazed in pursuing its unilateral objectives. This is perhaps most evident in the diminishing sanctity of the NATO alliance as a direct outcome of these actions.  After the US, Turkey is the second biggest contributor of troops within the NATO framework. As relations between both members continue to deteriorate, Turkey has been more inclined to gravitate towards expanding Russian influence. In effect, contributing to the very anti-thesis of the NATO alliance. The recent dialogues between Presidents Erdogan and Putin, in the wake of US sanctions point markedly towards this dramatic shift.

Based on the above, it has become increasingly evident that US actions have come to stand in direct contrast to the Post-Cold War status quo, which it had itself help set up and maintain over the last three decades. It is rather, the US’s unilateral interests that have now taken increasing precedence over its commitments and leadership of major multilateral frameworks such as the NATO, and the Bretton Woods institutions. This approach while allowing greater flexibility to the US has however come at the cost of ceding space to a fast rising China and an increasingly assertive Russia. The acceleration of both Pak-China and Russo-Turkish cooperation present poignant examples of these developments.

However, while it remains unclear as to how much international influence US policy-makers are willing to cede to the likes of China and Russia over the long-term, their actions have made it clear that US policy and the pursuit of its unilateral objectives would no longer be made hostage to the Geo-Politics of key regions. These include key states at the cross-roads of the world’s potential flash-points such as Turkey and Pakistan.

Therefore, both Turkey and Pakistan would be well advised to factor in these reasons behind the US’s disinterest in their economic and financial predicaments. Especially since both Russia and China are still quite a way from being able to completely supplant the US’s financial and military influence across the world; perhaps a greater modicum of self-sufficiency and sustainability is in order to weather through these shifting dynamics.

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Social Mobility and Stronger Private Sector Role are Keys to Growth in the Arab World

MD Staff

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In spite of unprecedented improvements in technological readiness, the Arab World continues to struggle to innovate and create broad-based opportunities for its youth. Government-led investment alone will not suffice to channel the energies of society toward more private sector initiative, better education and ultimately more productive jobs and increased social mobility. The Arab World Competitiveness Report 2018 published by the World Economic Forum and the World Bank Group outlines recommendations for the Arab countries to prepare for a new economic context.

The gap between the competitiveness of the Gulf Cooperation Council (GCC) and of the other economies of the region, especially the ones affected by conflict and violence, has further increased over the last decade. However, similarities exist as the drop in oil prices of the past few years has forced even the most affluent countries in the region to question their existing social and economic models. Across the entire region, education is currently not rewarded with better opportunities to the point where the more educated the Arab youth is, the more likely they are to remain unemployed. Financial resources, while available through banks, are rarely distributed out of a small circle of large and established companies; and a complex legal system limits access to resources locked in place and distorts private initiative.

At the same time, a number of countries in the region are trying out new solutions to previously existing barriers to competitiveness.

  • In ten years, Morocco has nearly halved its average import tariff from 18.9 to 10.5 percent, facilitated trade and investment and benefited from sustained growth.
  • The United Arab Emirates has increased equity investment in technology firms from 100 million to 1.7 billion USD in just two years.
  • Bahrain is piloting a new flexi-permit for foreign workers to go beyond the usual sponsorship system that has segmented and created inefficiencies in the labour market of most GCC countries.
  • Saudi Arabia has committed to significant changes to its economy and society as part of its Vision 2030 reform plan, and Algeria has tripled internet access among its population in just five years.

“We hope that the 2018 Arab World Competitiveness Report will stimulate discussions resulting in government reforms that could unlock the entrepreneurial potential of the region and its youth,” said Philippe Le Houérou, IFC’s CEO. “We must accelerate progress toward an innovation-driven economic model that creates productive jobs and widespread opportunities.”

“The world is adapting to unprecedented technological changes, shifts in income distribution and the need for more sustainable pathways to economic growth, “added Mirek Dusek, Deputy Head of Geopolitical and Regional Affairs at the World Economic Forum. “Diversification and entrepreneurship are important in generating opportunities for the Arab youth and preparing their countries for the Fourth Industrial Revolution.”

With a few exceptions, such as Jordan, Tunisia and Lebanon, most Arab countries have much less diversified economies than countries in other regions with a similar level of income. For all of them, the way toward less oil-dependent economies is through robust macroeconomic policies that facilitate investment and trade, promotion of exports, improvements in education and initiatives to increase innovation and technological adoption among firms.

Entrepreneurship and broad-based private sector initiative must be a key ingredient to any diversification recipe.

The Arab Competitiveness Report 2018 also features country profiles, available here: Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, United Arab Emirates.

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