Interesting debate between Krugman and Taylor

Watch Paul Krugman and John Taylor argue about fiscal stimulus, debt, inflation, interest rates, healthcare and more…

Indonesia: Economic crisis and the developmental state

Degol Hailu argues that policy responses to the economic crisis is turning Indonesia into a developmental state. I think the same can be said about pretty much every country that initiated some trade restrictions and implemented fiscal stimulus in the past two years. We are becoming more Keynesian than ever!

In the first quarter of 2009, rubber exports fell by 32 per cent. Farmers have suffered most. In some provinces tapping has completely ceased. The policy response was to cut shipments of rubber exports by 700,000 tons, a cartelist measure that was taken in concert with Thailand and Malaysia. The hope is to keep prices high and maintain constant income levels, just as the Organisation of Petroleum Exporting Countries (OPEC) does.

The price of tin, another major Indonesian export, fell from US$23,595 per ton in July 2008 to US$12,355 in April 2009. The government suspended the quota system that set minimum limits on tin exports. When prices were high, provinces such as Bangka Belitung and the Riau Islands were required to export at least 90,000 and 15,000 tons of tin, respectively. By suspending the minimum quota, the government is encouraging producer to cut their output and keep prices stable in the face of slow global demand. As a result, tin production fell from an average of 120,000 tons between 2005 and 2007 to 80,000 tons in 2008.

The target for the footwear and textile industry is to switch the above percentages: 60 per cent for domestic consumption and 40 percent for exports. As part of its stimulus package, the government is providing direct subsidies for the purchase of machinery under the Machinery Revitalisation Programme.

Rcently, the footwear industry received a cash subsidy of US$5.17 illion, and US$22.1 billion was provided to the textile industry. The government stepped in and launched a scheme to increase cotton output to 48,000 tons in the next few years, and to double the area under cultivation to 40,000 hectares. The provision of subsidised seeds and farm inputs has already started in Gunung Kidul, Yogyakarta, Pati, Kudus, Blora, East Java, and South Sulawesi provinces.

The government’s response to the crisis has also included macroeconomic policy changes. The interest rate was cut to 7.8 per cent in 2009 from 9.5 per cent in 2008. A fiscal stimulus of US$7 billion, or 1.4 per cent of GDP, has also been announced. The stimulus comes in the form of tax cuts (76.5 per cent of it), infrastructure expenditure (16.8 per cent) and direct subsidies (6.7 per cent). Fortunately, 2009 started with a fiscal deficit of 1.2 per cent of GDP, which gave the government room for deficit financing.

Agriculture subsidy working in Malawi

A carefully designed state-led agriculture subsidy program successful in Malawi:

The farmers’ success is not a coincidence: After facing a famine four years ago that threatened one-third of the country’s 13 million people, around half of whom live in poverty, tiny Malawi has utilized a $60 million policy of state subsidies for agriculture to become a net grain exporter. Malawi has transformed itself from a ward of the international community into one of the most successful agricultural economies in southern Africa: The landlocked, geographically diverse country, covered in green rolling hills and dotted with freshwater lakes, now exports thousands of pounds of corn to neighboring, starving Zimbabwe, a nation once known as the breadbasket of the region.

State agriculture subsidies are hardly what the doctor–or, in this case, the international aid community and the World Food Program–ordered. But Malawi triumphed precisely by ignoring the world’s leading pro-privatization agricultural experts. In fact, the "Malawi model" could turn out to be one of the only African success stories in recent years.

[…] Starting in 2004, it launched the nationwide Agricultural Inputs Subsidy Program, in which roughly half of Malawi’s small farmers were given coupons to buy fertilizer and seed at a rate far below the market price. Critically, the government focused the program not on the most destitute, but on the poor farmers who at least had some land and the ability to work the plots, thus guaranteeing a return on their investment in the form of more efficient grain output. At the same time, the government invested in training programs, helping farmers learn about new types of irrigation and management to improve their yields. And once the farmers produced, the Malawian government created funds designed to buy a percentage of the maize crop and store it for future emergencies. In this way, the state hoped to ensure that it would never be caught in a famine having to rely upon private traders to supply staple crops.

And, the danger of getting overly obsessed with “invisible hand” (liberalization and privatization) in vulnerable sectors, i.e. sectors whose performance would have a direct bearing on the very survival of poor people!

In many poor countries, when governments stopped handing out seeds and fertilizer, or providing warehouses to store farmers’ grain, the meager private sector was not equipped to fill the void. Unlike in the developed world, home to giant agribusinesses, in Africa the small private grain sellers and buyers have little capital or ability to raise money. And with little financing, it is nearly impossible for the private sector to develop large stocks of seed and fertilizer, or to build large warehouses necessary to store significant quantities of staple foods. Forced to rely upon the private sector, farmers in turn could not buy large quantities of seed, or store grain between harvests; and even if the resources were available, farmers often could not afford to buy fertilizer and seed. In many nations that had liberalized agriculture, crops simply rotted.

With private traders unable to store crops, governments selling off their warehouses to the private sector, and no one investing in agricultural research, developing nations have been left dangerously short of any food reserves. Yet for years, donor nations ignored the downside to privatization, even as country after country suffered through famines made worse by a lack of food stockpiles–and as rich countries, in a great irony, subsidized their own farmers. As former President Bill Clinton told a United Nations conference on food security last year, referring to wealthy nations’ push for agriculture privatization: "We all blew it."

A simulation of potential trade policy scenarios under the WTO showed that small country like Malawi would emerge as losers of agricultural trade liberalization. So, it does not make sense to argue for complete agriculture trade liberalization. Also, it does not make sense to blindly follow the market principles, though the best system if certain conditions are predetermined, and argue for full privatization, deregulation and liberalization of the agriculture market. Another relevant question here is: Would the developing countries lose or gain from agriculture trade liberalization (includes scrapping agriculture subsidies in the US, the EU, and Japan? Some say the developing countries would be worse off if agriculture subsidy in the West is eliminated. It really depends on if (households) a country is a net exporter or importer, its production and distribution cost structure, and demand of such goods in the global market, among other factors.

Aggregates of global crisis and development impact

This one comes from Duncan Green’s blog post about summary of the development impact of the global crisis:

Unemployment (ILO)

• Gender impact of the economic crisis in terms of unemployment rates is expected to be more detrimental for females than for males in most regions of the world and most clearly in Latin America and the Caribbean (only regions where expected to be less detrimental for women are East Asia, developed economies, and non-EU south-eastern Europe and CIS)
• Global unemployment could rise to 220 million people (6.8 per cent) in 2009, up 39 million on 2007.
• Number of working poor (people unable to earn enough to lift themselves and their families above the poverty line) could rise to 1.3 billion ($2/day), 746m ($1.25/day).
• Under a worse case scenario, global unemployment could be as high as 239 million (7.4 per cent) in 2009.
• Under a worse case scenario, the number of working poor could rise to 1.4 billion ($2/day), 857m ($1.25/day).

Economic Growth (IMF / UN-DESA / World Bank)

• World economic output is expected to contract by 1.3 [2.6] {2.9} per cent in 2009, down from growth of 3.2 [2.1] {1.9} per cent in 2008, and 5.2 {3.8} per cent in 2007 (IMF [UN-DESA] {World Bank}).
• Economic output in emerging and developing economies [{developing economies only}] is expected to grow by 1.6 [1.4] {1.2} per cent in 2009, down from 6.1 [5.4] {5.9} per cent in 2008, and 8.3 {8.1} per cent in 2007 (IMF [UN-DESA] {World Bank}).

Bank Bailouts (IMF / calculation for Oxfam by James Henry)

• As of February 2009 headline support to the financial sector by advanced economies had reached 43 per cent of their GDP, compared with 2 per cent in emerging economies (IMF).
• On a worldwide basis, as of January 2009, banks and other financial service firms have already digested at least $8.7 trillion of state sponsored financing ($903 billion of government capital injections, $661 billion of toxic asset purchases, $1.38 trillion of subsidized loans, $5.76 trillion of debt guarantees). N.B. This is not all upfront cash - guarantees reflect the value of the insured assets (James Henry).

Fiscal Stimuli (ILO)

• Total fiscal stimulus packages are currently (March) 3.16 per cent of global GDP.

Poverty Impacts (UN-DESA)

• Between 73 and 103 million more people will remain poor or fall into extreme poverty in comparison with a situation in which pre-crisis growth would have continued.
• Most of this setback will be felt in East and South Asia, with between 56 and 80 million likely to be affected, of whom about half are in India. The crisis could keep 12 to 16 million more people in poverty in Africa and another 4 million in Latin America and the Caribbean.

Remittances (World Bank)

• Officially recorded remittance flows to developing countries were estimated to be $305 billion in 2008, up 8.8 per cent from $265 billion in 2007; but in real terms, remittances are expected to fall from 2 per cent of GDP in 2007 to 1.9 percent in 2008.
• In 2009, remittances to developing countries are expected to fall by 5.0 per cent to $290 billion – 1.8 per cent of developing countries’ GDP.
• Considering that remittances registered double-digit annual growth in the past few years, an outright fall in the level of remittance flows as projected now will cause hardships in many poor countries.
• The persistence of the migrant stock will contribute to the persistence (or resilience) of remittance flows in the face of the crisis.
• South-South remittances from Russia, South Africa, Malaysia and India are especially vulnerable to the rolling economic crisis. Also the outlook remains uncertain for remittance flows from the GCC (Gulf Cooperation Countries) countries.

Trade Flows (Bloomberg / IMF / World Bank)

• The Baltic Dry Index (a benchmark indicator of shipping costs, which serves as a proxy for world trade flows):
• Is 58 per cent lower than its one year high in June 2008
• Has recovered from its one year low in Dec 2008 (93% below June ’08 peak)
• IMF expects world trade volumes to contract this year, falling by 11.0 per cent
• World Bank expects world trade volumes to contract this year, falling by 9.7 per cent

Foreign Direct Investment (Institute of International Finance / World Bank)

• Volume of net private capital flows to emerging markets is likely to decline dramatically to $141 billion in 2009, after an estimated $392 billion in 2008, and a record volume of $888 billion in 2007 (IIF).
• A modest revival of flows is now starting to become evident and the IIF projects that the 2010 volume will reach $373 billion (IIF).
• Net private capital inflows to developing countries fell to $707 billion in 2008, a sharp drop from a peak of $1.2 trillion in 2007. International capital flows are projected to fall further in 2009, to $363 billion (World Bank).

Vulnerable Countries (World Bank / IMF / Economist)

• According to the World Bank, 43 developing countries are highly exposed to the poverty effects of the crisis (with both declining growth rates and high poverty levels).
• The IMF identifies 26 highly vulnerable low income countries.
• The Economist identifies 17 vulnerable emerging-market economies on the basis of current account, short-term debt, and banks’ loan/deposit ratio.

Food and Oil Prices (FAO)

• Are now on the rise again after bottoming out in Jan/Feb.

No lowering of interest rates in Nepal

A piece about Nepal’s banking sector on Bloomberg. The governor makes sense here--

Kshetry said he can’t lower interest rates to support economic expansion because of high inflation. Nepal’s inflation rate climbed to 11.9 percent in March from 9 percent a year earlier because of a shortage of food and fuel, Kshetry said.

The central bank raised the cash reserve ratio to 5.5 percent from 5 percent and the key bank rate to 6.5 percent from 6.25 percent in October 2008. It has kept policy rates unchanged since, Kshetry said.

Troubled banks in Nepal

A day after liquidating Nepal Development Bank (NDB), of which I argued for immediate liquidation, it has been know that another bank (I suspect there are many such low performing banks who play with balance sheet) is in trouble. World Merchant Banking and Finance Limited, after a year in operation, loaned Rs 9 million to a contracting company without properly assessing the loan-seeker’s ability to pay back the loan. Being unable to recover loans and to avert a negative balance sheet, it created a fictitious story-- that it recovered loan from the company and lent it to someone else.

When all this happened, the central bank was completely kept in dark by the incompetent management of the bank. Okay, it is partly the central bank’s fault to not tap on this shady practice for over five years.

This illegal practice of transferring the ´troubled´ loan into a new person´s name continued for five years till 2007, when borrowers started asking the finance company to release some of the land held as collateral by the finance company. "To coax the management the borrowers paid back Rs 700,000 of the loan amount. But we did not agree," said the source. Then subsequently, the borrowers started claiming they did not owe any money to the finance company and it had failed to deduct the installment amount that borrowers had paid over the years, which, the finance company calls a "total lie." "We challenge the borrowers to show cash receipt if they had truly repaid the loan amount," said the source.

Then the matter went to the police and in January 2008, it asked the finance company to submit all the documents involved in the loan transaction. Then the central bank became wary of malpractices going in the financial institution and in April 2008 it warned World Merchant to discontinue the illegal practice of transferring liability of loan amount to new persons.

And, a persistent problem of moral hazard because of the institutionally (and human resource wise) deficient and inefficient central bank.

On June 14 this year, Binit Mani Upadhyaya, CEO of the finance company, was arrested after borrowers lodged a complaint at the Commission for the Investigation of Abuse of Authority. Since then depositors have withdrawn around Rs 400 million from the finance company. "But we are not facing cash crunch as the central bank is indirectly pumping money into the financial institution," the source said.

M2 is going up and so is inflation, despite a deflation in India. If this continues, then the Nepalese financial market will be hit by a terrible storm!

Roads, connectivity and markets

The importance of roads in establishing a link between production site and market:

As recently as 5 years ago, farmers in Belanting had to pay Rp15,000 ($1.26) to take 100 kilos of rice to the market, a fee that significantly cut into their already narrow profit margins. Today, Mr. Maca says he only pays Rp1,000-less than 10% of what he previously did- and profits from his farm have more than doubled.

That’s from a project funded by ADB in Philippines.