The Dutch Disease

September 25, 2009

Riches get their value from the mind of the possessor; they are blessings to those who know how to use them, and curses to those who do not.
~Terence

I am going to analise two important phenomenas that affect a country development: The Dutch Disease and The Democracy Effect in Economy. I will start with the former and analyse the later in my next post.

Dutch disease is named after the effect that the discovery of natural gas had in Holland in the 1960s. It is also called the Resource Trap but it can originate not only in natural resources discovery, but in any development in that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment.

Imagine first a country like Japan in the 1950s, with not natural resources. Japanese people want to buy imports, but they can only do so with hard currency, so they need to produce exports to get it. Exports (tradable goods) would sell in hard currency and sell it to importers who will use it to buy imports and sell them in Japan. Exports in such cases are manufactured products and some services (and some natural resources in a limited fashion), so the country start producing in order to import goods that lacks, making the national industry important and competitive. The local non-tradable good and services (like restaurants) get some of the money since people increase their standard of living, elevating the price of these non-tradable goods and services, and attracting some labour

Imagine then a country that discovers oil or gas or diamonds. This natural resource is sold in the international markets, creating a surge in the inflow of hard currency to the country. Since the price of tradeable goods is set internationally, the laws of supply and demand make rise the exchange rate of the country in question, hence making the rest of the exports in the country less competitive. Additionally, the extra revenue make non-tradeable goods and service more expensive in the country since there is more money to be spent and demand for new items.

Example, in the 1970s, Nigeria exported peanuts and cacao, then the oil revenues started to build up, and the Nigerian currency gain value, making their peanuts and cacao too expensive. Both industries collapsed. When prices eventually went down, the growth and standard of living of Nigerians was halved.

So the ill effect comes when the resource runs out or when the price goes down. The manufacturing industry has been badly damaged and cannot compete in international markets. All the foreign investment went towards the natural resource, and nothing to the traditional manufacturing sector. The country then stops development and spiral down.

Foreign Aid has the same effect that a natural resource discovery: It brings unearned hard currency to a country, making his own currency more expensive and killing its exports.

Hence, a sudden surge in the foreign currency inflows to a country make this country uncompetitive in the global markets, killing his tradable sector, making his non-tradable sector more expensive, and slowing the growth in the long run.

Now with pictures: In a normal economy without lots of natural resources, the manufacture sector is big (blue), some people and employ in services (green), and very few are in the natural resources sector (red) and, with hope, very few are unemployed (grey)

Country without resources

Country without resources

Then oil is discovered and a boom starts. The booming sector attracts all the labour force and foreign investment, while the traditional sector lags behind and gets reduced. The non-tradeable sector grows a little since there is a new demand for its goods and products, and draws some of the capital and labour, making these goods and services more expensive and in further detriment of the traditional sector. The excesive exports of the natural resource make the currency so expensive that further damages the traditional tradeable industry.

The economy in a natural resource boom

The economy in a natural resource boom

After some years or decades, the natural resources either ran out or the international prices plumbed. The former boom sectors shrinks, laying out people, the demand for non-tradable good and services shrinks too, laying out people, and the traditional manufactures are now too small to accommmodate the excess of labour. No further investment is done, and unemployment rises.

Dutch Disease effects

Dutch Disease effects


Bill Day

August 28, 2009

It is easy to dodge our responsibilities, but we cannot dodge the consequences of dodging our responsibilities
~Josiah Charles Stamp

I discovered one of the best children rights advocates in the world. He is a cartoonist called Bill Day.

This is his cartoon from today. And there are still termagants who think their body is only theirs.

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New Comic

July 31, 2009

The most erroneous stories are those we think we know best – and therefore never scrutinize or question.
~Stephen Jay Gould

I decided to go all the way and create a comic strip about sustainability. Since my favourite characters are the neohippies, I would like you to introduce Wann Abe and Hippe Te. He is a PhD student from UBC, she is a rich, alternative artist, and both live, where else? in Vancouver.

More Characters coming soon! Click on the image to go to Socialist!

socialist090731

Any resemblance to any real character is pure vengeance.


How Biofuels Could Starve the Poor

July 18, 2007

The world’s poorest people already spend 50 to 80 percent of their total household income on food
~C. Ford Runge and Benjamin Senauer

I wrote some time ago about how the increasing use of ethanol was damaging the economy of the poor in Latin America, with little benefit for the environment. The rise of corn prices, driven by the excessive demand, increased the price of corn and other staple foods, and make them harder to afford for the more vulnerable citizens. C. Ford Runge and Benjamin Senauer just published an article in the May/June issue of foreign affairs that expand on this problem.

There were 110 ethanol refineries in operation in the United States at the end of 2006. Many were being expanded, and another 73 were under construction. When these projects are completed, by the end of 2008, the United States’ ethanol production capacity will reach an estimated 11.4 billion gallons per year. President George W. Bush called on the country to produce 35 billion gallons of renewable fuel a year by 2017, nearly five times the level currently mandated.

The push for ethanol and other biofuels has spawned an industry that depends on billions of dollars of taxpayer subsidies, and not only in the United States. In 2005, global ethanol production was 9.66 billion gallons, of which Brazil produced 45.2 percent (from sugar cane) and the United States 44.5 percent (from corn). Global production of biodiesel (most of it in Europe), made from oilseeds, was almost one billion gallons.

Of course this growth in the demand means that more and more of the corn production is used to produce ethanol, and this is affecting the food system. It is binding the prices of a staple food with oil, third world countries are double whammed with oil and food prices going up:

Filling the 25-gallon tank of an SUV with pure ethanol requires over 450 pounds of corn -which contains enough calories to feed one person for a year. By putting pressure on global supplies of edible crops, the surge in ethanol production will translate into higher prices for both processed and staple foods around the world. Biofuels have tied oil and food prices together in ways that could profoundly upset the relationships between food producers, consumers, and nations in the years ahead, with potentially devastating implications for both global poverty and food security.

Worse, this is not an economically driven phenomena, but a political one:

In the United States and other large economies, the ethanol industry is artificially buoyed by government subsidies, minimum production levels, and tax credits. High oil prices over the past few years have made ethanol naturally competitive, but the U.S. government continues to heavily subsidize corn farmers and ethanol producers. Direct corn subsidies equaled $8.9 billion in 2005.

Two additional effects are: the high price of yellow corn, the current source of ethanol and used to feed cows, will drive white corn -used for human consumption- and other staples foods’ prices higher, and more surface will be deforested to harvest corn:

With the price of raw materials at such highs, the biofuel craze would place significant stress on other parts of the agricultural sector. In fact, it already does. In the United States, the growth of the biofuel industry has triggered increases not only in the prices of corn, oilseeds, and other grains but also in the prices of seemingly unrelated crops and products. The use of land to grow corn to feed the ethanol maw is reducing the acreage devoted to other crops. Food processors who use crops such as peas and sweet corn have been forced to pay higher prices to keep their supplies secure — costs that will eventually be passed on to consumers. Rising feed prices are also hitting the livestock and poultry industries. According to Vernon Eidman, a professor emeritus of agribusiness management at the University of Minnesota, higher feed costs have caused returns to fall sharply, especially in the poultry and swine sectors. If returns continue to drop, production will decline, and the prices for chicken, turkey, pork, milk, and eggs will rise. A number of Iowa’s pork producers could go out of business in the next few years as they are forced to compete with ethanol plants for corn supplies.

And for what? Are we really helping the environment with corn based ethanol? Ford and Senauer do not agree:

Ethanol and biodiesel are often viewed as environmentally friendly because they are plant-based rather than petroleum-based. In fact, even if the entire corn crop in the United States were used to make ethanol, that fuel would replace only 12 percent of current U.S. gasoline use. Soybeans and especially corn are row crops that contribute to soil erosion and water pollution and require large amounts of fertilizer, pesticides, and fuel to grow, harvest, and dry. They are the major cause of nitrogen runoff. Nor is corn-based ethanol very fuel efficient. Debates over the “net energy balance” of biofuels and gasoline have raged for decades. Corn-based ethanol appears to be favored over gasoline, and biodiesel over petroleum diesel — but not by much. Scientists at the Argonne National Laboratory and the National Renewable Energy Laboratory have calculated that the net energy ratio of gasoline is 0.81, a result that implies an input larger than the output. Corn-based ethanol has a ratio that ranges between 1.25 and 1.35, which is better than breaking even. Petroleum diesel has an energy ratio of 0.83, compared with that of biodiesel made from soybean oil, which ranges from 1.93 to 3.21. (Biodiesel produced from other fats and oils, such as restaurant grease, may be more energy efficient.) Similar results emerge when biofuels are compared with gasoline using other indices of environmental impact, such as greenhouse gas emissions. The full cycle of the production and use of corn-based ethanol releases less greenhouse gases than does that of gasoline, but only by 12 to 26 percent. The production and use of biodiesel emits 41 to 78 percent less such gases than do the production and use of petroleum-based diesel fuels.

Using gasoline blends with 10 percent corn-based ethanol instead of pure gasoline lowers emissions by 2 percent. Likewise, diesel containing 2 percent biodiesel emits 1.6 percent less greenhouse gases than does petroleum diesel. On the other hand, biodiesel can increase emissions of nitrogen oxide, which contributes to air pollution. In short, the “green” virtues of ethanol and biodiesel are modest when these fuels are made from corn and soybeans, which are energy-intensive, highly polluting row crops.

One root of the problem is that the biofuel industry has long been dominated not by market forces but by politics and the interests of a few large companies. Corn has become the prime raw material even though biofuels could be made efficiently from a variety of other sources, such as grasses and wood chips.

The World Bank suggests that caloric consumption among the poor declines by about half of one percent whenever the average prices of all major food staples increase by one percent. When one staple becomes more expensive, people try to replace it with a cheaper one, but if the prices of nearly all staples go up, they are left with no alternative.

If the prices of staple foods increased because of demand for biofuels, the number of hungry people in the world would rise by over 16 million for every percentage increase in the real prices of staple foods. That means that 1.2 billion people could be chronically hungry by 2025. The world’s poorest people already spend 50 to 80 percent of their total household income on food.


Is Gasoline a Comodity?

June 22, 2007

If you’re not confused, you’re not paying attention.
~Tom Peters

Gasoline, petrol, essence, call it the way you want, we need it and we need it a lot. notwithstanding the widely known fact that I’m biking to work now, I still need the refined dinosaur bones to get to day care, supermarkets, and being summer, the beach. Every day we can see the price on the pumps going up and down, synchronized, in all the city of Toronto, and they have explain to us that no, that the four major gas retailers are not in concubinage to fleece us up, and that the high prices are just a reflect of demand, supply, crude oil prices, and of course, the overwhelming threat of terrorism since *sigh* 9/11.

Since the only threat I consider real is that aimed to my wallet, first I though nah! they are fleecing us up, then I realize that I cannot make an asseveration like that since everybody in the oil industry and in the government is telling us that high oil prices, problems in the supply chain, refinery cost, and *sigh* threat of terrorism since 9/11 are pushing this commodity’s price up and that the retailers are just as victims as us.

So I went to torontogasprices.com and made a small graph to see the correlation between oil and gas prices during the last six years.

Toronto, Gas and oil prices

I do not have the numeric data, so I cannot make a proper correlation, but, with the proper scale used (the increments in both Y-axis are similar), we can see that the price of gasoline is being every time a minor percentage of the oil price.

When in 2001 the Oil barrel was at 21 dlls, the litre of gas was at 60 cents, that is, given that the oil barrel has got 159 litres, a relation oil-litre/gas-litre of 13:60 or 21.66%, so for each dollar spent on gas, 21 cents went to paid for the oil. In 2007, we have got a price of 67 dlls per barrel (42 cts/lt) and 104 cts/lt of gas, so, the relation is now 42:104 or 40.38%, meaning that now, for every dollar of gas, we pay 40 cents of oil. So, the relation between oil and gas prices is a little foggy.

Then, let’s see about those problems in refinery and the supply chain. We can compare the prices between Canada and USA

Gas Prices, USA and Canada

They dance together! We do not need r ~ 1 to see that the prices are co-related. If we have refinery and distribution issues, are those affecting the entire continent? Both USA and Canada are heavy oil producers, so, the refinery and distribution within North America should affect only some areas, not the entire sub continent. Just for fun, let’s compare two oil producing cities in USA versus Toronto, a non-producer from Canada.

Dallas, Anchorage, Toronto gas prices

Looks like the relation is not that clear now. Looks like the price of gas not depend only on distribution or oil prices, since, although the price is mainly lower in the oil producing cities than Toronto, is not really always the case, and the price variation is less in Anchorage and Dallas than in Toronto.When we compare Toronto versus Calgary, another heavy producer, but in Canada, the difference is less, with Calgary having some times a higher price than Toronto.

Toronto, Calgary gas prices

What do we make of all these graphics? It is certain that there is not an issue about supply chain and distribution, and that the relation between oil and gas prices, while obviously existent, is not that strong as you may think between a raw material and a finished product, what makes sense, since the refinery process adds a lot of value.

The final explanation of why gas prices are so high would be demand and supply. The oil companies and the government keep telling us that a commodity is subject to full free market forces. Let’s see then how can we define a commodity:

1) A commodity is easily interchangeable, you can buy it from any supplier and the result is the same. This is partial true for gas, because we can buy it from any supplier, but there are not substitute products that we can use instead of gasoline.

2) A commodity is subject to free market rules. This is false in the case of gas, first, because we have a limit number of suppliers. In Canada we have Esso and Shell dominating the market, with Sunoco and Petro Canada filling up the gaps. This is not truly a perfect competition scenario. Second, no commodity is as regulated and taxed as gas, with federal and provincial taxes building up about 50% of the final price.

So we can conclude that gas price is not a commodity, that there is not apparent chain supply problem, and that, while the oil price is going up, the relation is not strong, giving also the fact that a lot of the value of the gasoline is added during refinery and do not come from its raw material.

In other words, they are fleecing us up.


Protection Barriers; The Canadian Experience

May 15, 2007

You cannot protect something by building a fence around it and thinking that this will help it survive.
~Wim Wenders

People advocate for trade barriers when they feel that:

1) Local industry needs protection from abroad

2) Industry from abroad is playing dirty tricks (i.e. dumping, protecting their own industry, sending lower quality products)

3) The industry is of strategic importance (i.e. banking, communications, farming)

What are the cost of proteccionism? Let’s analise the Canadian Experience. In 1878, Sir John A. MacDonald’s conservative government introduced the National Policy. The idea was to encourage investment and economic growth within Canada, as well as build an east-west flow of goods to tie the country economically. The policy had two simple components: high tariff on manufactured goods and open market for foreign investment.

The tariff were imposed to encourage the growth of central Canada’s manufacturing industries, hoping that they would reach a scale to compete internationally. Some machinery was exempt, like those needed by the natural-resource industries. The Canadian companies will sell more to other Canadians, increasing the east-west commerce and hence helping to build the very needed TransCanada Railway.

The open-investment policy was intended to attract foreign capital, since locals had not got enough resources. The first invertors were British lending money first to other British, then to Canadians. During the 1900s however, Americans replaced British as the main capital source, and this was not in the form of debt, but equity. The reason is clear in retrospect, the Americans couldn’t sell in Canada due to the tariff, but they were able to open Canadian subsidiaries, which, being Canadian, could benefit from the protection.

The consequences are still affecting us, 130 years after. The Canadian manufacturing sector became a branch plants with no incentive to compete internationally, since they will compete against their parent companies.

A second legacy of the National Policy was the concentration of the wealth on very few hands. the National Policy make Canada a very comfortable place to compete; once established, they were protected by the tariff, and the incentive to be productive was limited. For the Canadian Companies, the profits were huge and resulted in very concentrated industries for each sector: Beer is dominated by Molson and Labatt, retail was dominated first by Eaton’s and Simpsons, then by The Bay and Sears. We only have five banks. You can count one or two large companies concentrating the national production for each sector.

Foreign ownership is not a matter of national pride, but economic sense: The typical organization have a profit of 10% of the revenue, but the lion’s share of the expenses is that 90% used on research, salaries, production, marketing campaigns… and, being branch plants, all those process take place on the main headquarters, outside Canada, so Canada is not only losing the 10% of the revenue, but an important component both of economic and strategic value. While there are exceptions, like companies doing an entire process in their Canadian branch (Pratt and Whitney, ICI explosives), this rule applies to the oil producers, the automotive manufacturers and so on.

The three final consequences of the National Policy enacted in 1878 are, that in 2007:

1) Canada has a very concentrated industry, so the free market rules, where supply and demand set the price, are not valid here, because when one or two companies dominate the market, they are price setters, no price takers. That is why is cheaper driving to Buffalo and buying your stuff there, that going to Eaton Centre or Yorkville and being fleeced up.

2) Canada’s wealth is concentrated within a handful, where 100 individuals or families have got a collective net worth of $141.6 billion

3) Canadian companies are not producing the world’s leading technology. We haven’t got any Microsoft, Hewlett Packard, or Intel. I don’t really now how much Research in Motion is licensing technology or really creating new one, so I cannot comment in this one, but the general rule is new technology being developed somewhere else and then being copy or license here.

So, protectionism has resulted harmful in the long way for Canada. We will measure some other trade barriers soon.


Equilibrium, Disequilibrium and Sticky Prices

February 5, 2007

If economists were good at business, they would be rich men instead of advisers to rich men.
Kirk Kerkonian

In order to better understand the market’s forces, we need to handle three concepts which are very simple but also very powerful. You may want to go back to our little supply and demand post before moving on. If you know it already, let’s then move on.

When supply equals demand, we say that the market is in equilibrium. This means that all the goods and services produced are accommodated at a given price and no demand is left unattended. This is also called a clear market.
Supply and Demand

Equilibrium is a characteristic of free markets. When market imperfections exist, the market may take some time to clear. An example: when guarantee prices for commodities exist. Let’s say wheat’s producers are guaranteed a minimun price for metric ton. If the wheat demand goes down, the price of wheat won’t, because the price that they receive is guaranteed, the farmers are encouraged to keep their previous levels of production. The result is excess demand:

Excess Market

Pg is the guaranteed price, which produces Q1. When the demand curve moves downwards, Q2 becomes the new quantity which the market demands, thus the new price should be Pr, but because producers are still receiving Pg, they continue to produce Q1. The market only accommodates Q2, so the difference is now an excess.

In the agricultural sector, the excess is often bough by the government and then either sold with a loss, or pour into the ocean. Haven’t seen those Braziliean cargo ships pouring coffee into the Atlantic?

In the labour market, this would be manifested throught unemployment. Salaries can’t go down, and the market can only accommodate Q1 at the current wages, so, the excess is people either fired or not being able to find a job.

Price flexibility is crucial for continuous equilibrium in markets. If prices are flexible they adjust quickly to changes in supply or demand, so market equilibrium is restored. When a price takes to long to adjust downwards, is called a sticky price. Sticky prices have a considerable practical significance. At the onset of a economic recession, a slowdown in growth triggers cuts in production and drop in demand for goods and services. Unemployment rises; both labour income and business profits fall. The negative effect is worse if prices cannot adjust fast enough.

The most perfect market, the one that clears fastest, is the Capital Market. The price of money is the interest rate; the slightest adjust and capitals fly all over the world. The sticker price is labour, which due to regulations usually never moves downwards directly.

These apparent boring subjects will be very useful when we’ll examine Fair Trade price scheme. As reward for bearing with me during all this economic jargon, which I know may be pretty hard, here is THE funniest video:
http://www.youtube.com/watch?v=rfP90uJ12eQ