Escape the income trap, live well

Kaattje writes*

As with many Latin American countries, Ecuador has failed to progress after reaching middle-income status decades ago. Low productivity growth and a failure to move up the “value chain” are typical features of the ‘middle-income-trap’. As with other countries with natural resources, Ecuador’s growth-strategy relies on extracting and exporting raw materials (mainly petroleum but also bananas and coffee) rather than on diversifying production. GDP-growth depends on high prices for primary commodities, leaving the economy vulnerable to price-volatility. The norm of low-skilled and low-value added activities limits job creation and overall labour-productivity.

Escaping the middle-income trap requires structural change. Resources and labour must be reallocated in ways that diversify the productive matrix and upgrade production. Plummeting petroleum-demand in recent years, falling commodity-prices, as well as Ecuador’s sub-soil reserves being inherently finite increase the pressure to diversify the economy. The government’s current industrial policy, however, continues to focus on extractive practices, expanding oil-extraction and investing in large-scale mining. This view does not contribute to development and conflicts with the state’s constitutional commitment to ‘Buen Vivir’, or striving for social  well-being while preserving nature and harmony among citizens who are treated equally. Such conceptualizations, originating in indigenous communities, create a demand for escaping the middle-income trap without causing substantial environmental damage.

Sustainable tourism has emerged as an alternative to extractive activities. Eco-tourism can contribute to Ecuador’s economic diversification while respecting its ‘Buen Vivir’ goals. Ecuador is home to 17 different ecosystems and the most diverse biological hotspot of the western hemisphere.

The eco-tourism experience depends on the degree of environmental protection, as future revenue depends on avoiding natural depletion. One challenge is the subjective understanding of ‘green’ tourism, which leads to self-regulated notions of environmental stewardship and raises questions on “greenwashed” experiences.

Three objectives must be balanced to minimize tourism’s potential costs to sustainable welfare: nature conservation, local participation, and economic feasibility. Past experiences in Latin America have shown the importance of using ecotourism revenues to maintain the natural resource base and the importance of host-community empowerment. Local definition and management of eco-tourism allows communities to turn their natural and cultural heritage into an economic asset while also ensuring its protection. Costa Rica‘s experience is helpful: the country advanced to one of the leading eco-tourism destinations worldwide on its way out of the middle-income trap, coming from an export-profile similar to Ecuador’s. Past eco-tourism stories also highlight how the effective advancement of sustainable well-being means balancing among (sometimes competing) economic, environmental and social interests.

Bottom Line: After being stuck in the middle-income-trap for over 60 years, it is time for Ecuador to move past its dependency on resource-extraction, to focus on sustainable development under ‘Buen Vivir.’

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Dutch education, debt & sustainability

Haydar writes*

In the Netherlands, the government subsidizes education. Historically, students had to pay fees, but they were much lower than actual costs. In addition, students at university received a stipend to make sure that everyone, especially students from lower income families, could participate. In 2012, this system changed. Stipends were replaced by loans, which can scare potential students away.

The choice of participating in higher education depends on financial pressure, future earnings, educational demands, value placed on higher education and personal characteristics (Metcalf, 2005). Metcalf shows that higher fees mean more debt and longer enrollment, both of which reduce students’ satisfaction with higher education.

The 2012 reform had one element aimed at a particular group. The previous policy gave an additional grant to students from low-income families, and the reform increased that supplement, thereby increasing in the difference between students with and without the supplement. Students not living with their parents received €14.000 less while students living with their parents received an extra €1.500, leading to a total difference of €15.500 (Bolhaar, Kuijpers, Zumbuehl, 2020).

The 2012 reform led to more debt for Dutch students (see figure) due to an increase in the price of education but also changes in student behavior. Some students borrowed more money and worked less. Other students worked the same but borrowed more. Why this happened is not clear, but the effects of this loan system can be devastating as students graduate with more debt. For students who will earn more, extra debt may not be a problem, but that debt will be a burden on those whose earnings do not rise as fast as their debt (Bolhaar, Kuijpers, Zumbuehl, 2020; Scheer, Visser, 2020) .

The bright side of this reform is that the university enrolment did not change but is the extra debt sustainable?

Bottom Line: The 2012 reform has led to more debt for more Dutch students. Students do not seem to mind this system, but their increasing debt may not sustainable. Should the reform remain as it is or is a “reform to the reform” necessary?

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Germany’s stubborn coal industry

Paula writes*

It was with relief and a good dose of surprise that the news was heard in January: Germany will achieve its targeted emission limits for 2020. Although this previously seemed out of reach, the COVID-19 pandemic allowed emissions to be reduced by 42.3%. But this is not enough. It has been long known that coal must be phased out to mitigate climate change and meet the 2015 Paris promise of keeping global warming below 2 degrees.

Germany is the largest producer of coal in Europe (see image). The energy sector constituted the largest share of CO2 emissions in 2018, with 34% of energy gained through coal in 2017. In 2020, the government announced the coal phase-out by 2038. It will be driven by increasing CO2 prices and state-ordered shutdowns of coal-fired powerplants.

Moreover, it has recently become obvious that even from a purely economic point of view, the coal industry is ceasing to be profitable. This is mostly due to negative externalities caused by extensive greenhouse gas emissions. As CO2 emissions have been quantified and monetized by the EU’s Emission Trade System (ETS), production costs of coal energy will steadily increase. Additionally, the increasing competitiveness of renewable energies has resulted in lower electricity prices and hence decreasing market share for coal. Lignite mining will be economically unprofitable by 2030.

To compensate for possible financial losses of the industry, the government will pay more than 4 billion euros to two of the biggest energy firms, RWE and LEAG. However, this amount appears to be €1.9 billion more than the firms realistically need to finance the transition. Moreover, despite the grim outlooks for the industry, RWE – the biggest producer of CO2 in Europe – is still deforesting areas and relocating villages to expand coal powerplants. This brings up the question of the role and interests of big energy firms in the coal-phase out.

According to economic theory, inefficient firms should be eliminated under perfect competition as new firms enter the market and compete for profits in the long run. Thereby, resources are allocated to the most efficient producers. This theory does not hold in Germany, where the energy market has an oligopolistic structure, allowing big firms to keep producing despite cost disadvantages. One source of such imperfect competition can be lobbying and bribe-paying. A major lobbyist against the coal phase-out has been the “Wirtschaftsrat” (an association representing the interests of 12.000 businesses) – known for its proximity to the CDU, which is in the ruling coalition. More specifically, RWE’s close relationship to CDU politicians has given the company significant political influence, such as in the commission on energy-policy.

The interests of big energy firms run against the public interest when it comes to Germany’s coal phase-out. Firms want to avoid losses and stranded assets by producing as long as possible. The “public interest” does not automatically mean pursuing sustainability goals, but it does mean allocating resources (including labor) to future-proof industries, reducing emissions, promoting ‘clean’ energies, and facilitating job transitions.

Bottom Line: The market power of Germany’s big energy firms allows them to sustain inefficient production against the public interest.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Corruption in crisis management

Laura writes*

In 2015, Nepal was struck by a 7.8 magnitude earthquake followed by a 7.3 magnitude aftershock, resulting in over 9,000 casualties and almost 22,000 injured people (BBC, 2015). Entire villages were decimated, 2.8 million people were displaced, and 4.2 million people were in urgent need of medical assistance (WHO, 2015).

Source: BBC, 2015

The international community responded immediately by sending in rescue teams, necessary materials, and various forms of humanitarian and financial aid (MSF, 2015). Although this aid helped the Nepali community tremendously, not all resources reached the intended target groups. Why?

Primarily because of corruption.

Corruption – the ‘abuse of public office for private gain’ (Schleifer & Vishny, 2003) – is a notorious problem in development aid and affects resource allocation greatly. According to Ban Ki-Moon, the former Secretary General of the United Nations, corruption absorbs a baffling 30% of all development assistance that never makes it to its final destination (UN News, 2012), and there is increasing evidence of a strong statistical correlation between corruption and a loss of life in earthquakes (Messick, 2015).

In Nepal, corruption hampered post-earthquake aid allocation in a number of ways, which are important to examine to avoid the further loss of resources. First, corruption diverted aid away from target groups into private pockets. This is a principal-agent problem, as is exemplified by volunteer staff who reported that Nepali government officials required bribes and a share of the resources to allow the inflow of earthquake resources from India (Francis, 2015) . In addition, the Nepali government tried to “wrest control of relief” by demanding that all aid allocation should flow through the Prime Minister’s Disaster Relief Fund, which centralized aid funds and made it easier for bribes to be extracted (Francis, 2015).

Second, the presence of corruption disincentivized international donors from providing humanitarian or financial aid in future crises (Francis, 2015). For example, Britain’s International Development Committee announced large budget cuts to their development program to combat corruption in Nepal and in other earthquake-stricken countries to penalize the governments for it (Griffin, 2021). Consequently, it not only hampers short-term allocation of aid, but long-term trust in the government to allocate the aid.

Although the international community knows that corruption takes place and that it hinders development aid from reaching those in need, it still has long ways to go in identifying where and how it inhibits aid allocation. This is a strong reason to conduct case studies of corruption in post-crisis management, such as in Nepal.

Bottom Line: Corruption disrupts development aid from reaching those in need. To avoid a further loss of resources, the international community needs a better understanding of the origins and mechanisms of corruption.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Less chicken, more beans in every pot

Noor writes*

In 1928, the Republican slogan “A chicken in every pot. And a car in every backyard, to boot.” was born. The aim was to raise prosperity by making privilege available to the wider public by raising the living standard at an affordable cost. Meat is seen as the food for the wealthy, and meat producers are more than happy to play in to that image. Meat has been scarce, thus a treat, for the better part of human history, rendering it to be desired by those who couldn’t have it. We feel that meat will make us strong, it is macho, and makes us feel prosperous, whilst in fact heavy consumption of meats weakens health and the environment.

The association of meat with prosperity has led to widespread government subsidies for the agricultural industry, even though many developed countries now advertise reduced meat consumption because of its environmental and health repercussions. Though these subsidies the retail price of meat is kept low, but consumers pay it indirectly through tax money, environmental degradation, and health risks.

Animal products are the third-largest sources of global Green House Gas (GHG) emissions, stemming from the fuels needed to grow the feed, transportation, and their methane gas emission. Furthermore, animal products are high in water consumption and animal agriculture occupies one-third of the earths’ landmass for grazing or growing feed, making it the main driver of deforestation.

The demand for meat is expected to reach 570 million tons in 2050, double the consumption of 2008. If western consumption patterns remain unchanged, this would mean insufficient food to feed the 10 billion people population, as almost half of the world’s harvest is fed to animals. The global meat consumption rises due to growing population and increasing wealth bringing about higher demand for meat, as can be seen in the figure. China for example, is now the world’s largest meat producer and Asia produces more meat than any other region in the world.

Though there is a growing trend of plant-based living in developed countries, this will not be enough to counter the rise expected from developing countries. The solution to the issue at hand seems simple: less meat must be consumed to avoid running out of food, water, or a planet. However, for many the consumption of meat holds an aspirational or cultural value, rather than a nutritious one. Even if this was possible, is it fair for developed nations, who have enjoyed meat, to deny developing countries the same privilege? For many the answer is no, yet decreasing our own consumption is more difficult than anticipated: how do you willingly degrow?

Greenpeace lays out a plan [pdf] to half the meat and dairy consumption by 2050 to reduce GHG emissions, fight climate change, fight deforestation, preserve water quality, remain within the planetary boundaries, and battle global obesity. People will however need to be motivated to make this change at an individual level. The subsidies for meat need to be cut, bringing its price closer to the actual costs instead of supporting an unsustainable industry. More importantly, the narrative around meat needs to be changed: meat will need to become a privilege again, not just be framed as one. Perhaps most effectively, taking into account that prices and not intrinsic motivation are the best driver of behavioral change, the price will need to reflect the externalities of meat production, as well as the urgency of the climate crisis.

Bottom Line: Increasing population and income levels will lead to a significant rise in meat consumption that the planet cannot sustain. Meat consumption poses threat to the climate through its contribution to GHG emissions, heavy use of water, land use, and inefficiency. Thus, changes in consumption patterns are needed sooner rather than later, and the most effective solution seems to be price incentives.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Feeding off the locals

Amber writes*

Gas extraction in the north of the Netherlands been highly beneficial for the government and economy. Gas revenues accounted for 3% of annual GDP and a total of nearly 417 billion euros. However, the local population of Groningen, the province where gas extraction takes place, bear the costs. Their houses suffer severe damages from earthquakes caused by gas extraction, costing them large sums of money. Moreover, Groningers sleep with one eye open as they do not feel safe in their houses. The government has made minimal effort to compensate Groningers, deliberately delaying action by starting new and long investigations. Since the first heavy earthquake in 2012, the government kept extracting gas above the annual cap.

One of the many houses with severe damages to foundations resulting from the earthquakes

Why the delays? One reason might be the government’s significant role in gas extraction. Of the 4 companies involved, 2.5 are state-owned: EBN (Energie Beheer Nederland) and Gasunie are fully state-owned, and the state owns half of GasTerra. Moreover, the other two actors (Shell and ExxonMobil) are actually one company: NAM (Nederlandse Aardolie Maatschappij), which is in charge of all gas extraction. The government receives royalties, dividends and taxes from NAM that add up to 70% of NAM’s profits.

Although it might make sense that the government compensate Groningers out of its own revenues, it does the opposite when it fails to act. Groningers have been fighting NAM and the state in the courts for nearly a decade without much progress. But the last two years have offered some hope.

A secret contract from 1963 (containing the original division of benefits and costs between actors) was released three years ago. It showed that the role of the Dutch state was much larger than originally thought. The document was used in court in 2018 and although the court ruled the state is not directly liable for damages, it did rule that EBN is. After another case, where a couple sued all actors involved (including the state), the Dutch High Court ruled in July 2019 the Dutch state can be considered accountable from 2005 onwards, as the state would by then have received ample signals of what was going on. Thus, the state is liable.

Unfortunately, even though the state is proven to be responsible, it is not taking this responsibility. Proof is still lacking on whether the state did do enough to prevent damages or whether it deliberately chose not to. A parliamentary inquiry has been set up only recently (February 2021) and it will finish only in 2023. Thus, it will take almost three more years to find out who is legally accountable. By then gas extraction in Groningen will have already been finished and the houses already repaired (though these procedures are long and unfair). As a final disappointment, the judge ruled there was no criminal intent of NAM endangering livelihoods. Hence, it is highly questionable whether the judge will rule against the state and in favour of the Groningers.

Bottom Line: Part of the Dutch state’s profits from gas extraction are at the expense of Groningers, who are unlikely to be compensated. This example shows that trade-offs between national economic growth and (local) human development are still relevant in wealthy countries with rule of law and democratic institutions.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Achilles Heel: Capital Flight

Theodor writes*

An historical free trade agreement (FTA) came into effect on January 1 2021. With 54 member states, it is the largest FTA in the world. The United Nations Economic Commission for Africa believes the African Continental Free Trade Area (ACFTA) will grow the share of intra-African trade from the current average of 12% to 15-25% by 2040.

What could hamper this huge trade potential? Capital exports.

Global Justice Now estimates that African countries exported $41 billion in 2015. The main driver of capital outflows are Illicit Financial Outflows (IFOs). As of 2017, IFOs were 1.2 times larger than all aid, FDI, and private sector loans, combined.

What do IFOs look like? In 2017, there were $68 billion of IFOs, of which $48 billion exited via trade misinvoicing, i.e., intentionally misreporting the value of goods or services on invoices submitted to customs. Other tools enabling IFOs include tax havens and goods-based money laundering.

What factors drive capital flight? The capital flight literature highlights external debts, aid, and risk-corrected investing, but the most important factors relevant to the ACFTA are trade in natural resources (NR) and the political environment. In both cases, the government holds extensive responsibility. Evidence has shown that the trade of NR has been used to enable IFOs, mostly through various forms of trade misinvoicing.

While it is very difficult to promote good governance of NR, resource-endowed governments are losing tax revenue needed to finance the implementation of the ACFTA. NR being one of Africa’s main exports, needs to be one of the main IFO channels to be actively confronted, as it will take time to reduce the continent’s economic reliance as its main export good. Political stability on the other hand is addressed in the ACFTA agreements and remains one of the main concerns of the African Union and the literature on the ACFTA. Therefore, managing political stability will not only have a positive effect in ensuring a good political environment but will also reduce IFOs and therefore grow the tax revenue of African governments.

What is then the relation between IFOs and the ACFTA? IFOs account for most African capital flight. African governments will have to invest heavily to make the ACFTA a successful project. Costs include the crucially needed expansion of infrastructure to enable intra-African trade, the costs of financing the headquarters and administration (to be built in Nigeria or Ethiopia), and compensating larger members for trade losses.

Bottom Line: If African countries do not tackle IFOs, then inadequate tax revenues risk undermining the ACFTA.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Definitions of capital

Appendix E

§1. Definitions are not always clear or agreed upon. Capital goods (e.g., machines) are not the same as trade capital (e.g., funds used to buy inventory). Machines owned and used by a business are not the same as a hobbyist’s machines (or are they?)

§2. Capital contributes to production over time, as it’s not “used up” immediately. As such it represents “stored value” from prior work (this idea leads Marxists to claim that capital is merely “stored labor” but that ignores the many other components that go into making goods, such as managerial skill, innovation, market making, etc.)

§3. There are many definitions, but I can’t be bothered to split those hairs 😉

This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics from institutional induction to mathematical deduction.

The reserve army of urban refugees

Hanadi writes*

Most people think the refugee crisis looks like the photo below, but almost half of the world’s 10.5 million refugees reside in cities and towns, compared to a third who live in camps.  In the Middle East specifically, the vast majority of refugees reside outside of camps in either urban or rural areas.

Rapid urbanization is one the most significant ‘mega-trends’ confronting our planet today. It is a multifaceted phenomenon affecting other global developments, such as environmental degradation, volatile commodity prices, and climate change. Notably, another effect of urbanisation is its impact on the refugee crisis, and the absence of work.

What differentiates urban refugees is that they are faced with a range of legal, financial, and cultural barriers in maintaining sustainable livelihoods. In most cases, they resort to joining the informal economy, where they compete with a large number of poor people for hazardous and badly paid work. Informal firms are extremely unproductive, and they are unlikely to benefit much from becoming formal. As a result, La Porta and Shleifer argued that the remedy for informality is economic growth.

It is common to hear the win-win refrain of turning the Syrian refugee crisis into a development opportunity, i.e., a solution that simultaneously alleviates refugees’ economic troubles and reinvigorate host states’ economies.

There are numerous challenges to integrating refugees into the formal economy, and non-enforcement of labor regulations is a big one. Such non-enforcement means informal workers lack permits to work or work outside their expertise. Such non-regulation allows displaced migrants into the country but only partly formalizes their status. Employers, as a result, offer lower wages.

The non-enforcement of labor market regulations has largely benefitted employers, who tend to be locals, and not the labor force, which is vulnerable to exploitation and denied rights. Refugees as a reserve army of labour mean employers have access to a flexible labour force whose weak rights make it easier to profit through systematic discrimination.

Many job sectors are further formally closed to non-nationals even though migrant workers may informally work in these sectors. Palestinians in Lebanon are unable to work in the public sector or in professions such as medicine, law or engineering, where membership of syndicates is compulsory. Such restrictions protect a domestic constituency and contribute to the perception of ‘too many’ (unemployed) refugees.

Labor regulations can be designed to prevent abusive, monopsonistic hiring practices. Labor inspections can improve workers’ rights and enhance firms’ competitiveness. A national minimum wage in Costa Rica produced higher compliance with minimum wages without reducing employment.

Stronger regulations can also encourage employers to offer training and invest in productivity enhancing measures. Minimum wages can prevent extreme poverty among workers and address inefficiencies that arise from non-competitive labor markets.

Bottom Line: Attempts to increase refugees’ formal labor market participation do not account for non-enforcement of labor regulations. We must rid ourselves of the misconception that most refugees reside in camps and integrate informal workers into the formal economy by enforcing labor regulations and opening closed sectors to qualified workers. The real win-win will come from more jobs, higher productivity, and less burden on humanitarian agencies.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Pricy wine pays for equal health

Stella writes*

After living in the Netherlands for two years, returning to Sweden and its steep alcohol prices sure feels unappealing – but how would a Sweden without a State monopoly on alcohol look like really? Systembolaget (the state’s monopoly seller) says things would get worse, with 29,000 more cases of reported abuse, 8,000 more cases of drunk driving, and 1,400 other alcohol-related deaths each year. Stockwell et al. estimated there would be substantial increases in alcohol-related harms, crimes and deaths if Sweden were to privatize its alcohol monopoly. Additionally, alcohol-related harm is unequally distributed amongst the population based on factors such as socioeconomic status, education level, sex, ethnicity, and place of residence. Inequalities that would only be exacerbated by disbanding the monopoly.

Systembolaget Opening Hours by Geir Olsen 

But would the market really change as drastically as these numbers suggest? The idea behind the alcohol monopoly is to remove private profits from the alcohol market. Profit and competition incentivize private companies to increase their sales. This is desirable for most goods as it ensures market efficiency i.e. the market does not supply more than is demanded and this is reflected in the price of the goods. However, for alcohol, privatization, in any form, would increase competition between firms pushing the price down leading to increased accessibility – factors that contribute to elevated drinking and thus also alcohol-related harm. In fact, Systembolaget estimates that if people could buy alcohol in regular grocery stores the number of available points of sales would increase by 1500% and opening hours would extend by 68%. The WHO confirms that increased accessibility could have detrimental effects on consumption. Above all, however, dismantling Systembolaget would significantly affect the pricing systems and the way that alcohol is marketed and sold.

The removal of profit interest is evident in every Systembolaget retail point, no products are placed near the checkout, no products are on sale, no products can be bought on promotional offers, and there is no product discrimination – no beer is stored refrigerated because then they would have to store all comparable products refrigerated. All these marketing tricks and pricing systems contribute to Swedish citizens not buying more than they initially planned and will reasonably consume. In addition to this, not-for-profit monopoly retailers are more effective in enforcing legal purchasing ages because profits cannot rise. Restricted access to alcohol also helps individuals whose socioeconomic situations make them more vulnerable to alcohol and reduces impacts on bystanders.

Bottom Line: Sweden’s monopoly on alcohol is not a fabrication just to keep prices artificially high but indeed has a significant effect on the well-being of the Swedish population. Introducing a private licensing system in its place would cause a marked increase in consumption and thus alcohol-related harm. I happily pay more to keep this system going.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).