A visit from the Russian mafia

Kato writes*

The collapse of the Soviet Union was followed by major economic transformations in the dawn of 1990s Russia. Rapid privatisation of the market and liberalization of economic policies gave rise to many private businesses. Since the collapse of SU left many soldiers, and Soviet team sportsmen unemployed, they came together to form racketeering groups specializing in exploiting the profits the private sector made. Extorting, or “appropriating someone’s property under threat of violence or damage to that subject’s prop­erty” (Volkov, Vadim. Violent Entrepreneurs : The Use of Force in the Making of Russian Capitalism, p.3) was their business model, and given the lack of rule of law, this model proved to be a major success. Since this period coincided with the gradual restoration of Russian central authority, structure of all formal institutions of Russia came came to be shaped by gangsters. Now, in such conditions, paying a bribe was a given, and an economy characterized with corruption started to grow and influence its neighbouring country: Ukraine.

Everything was up for grabs, and therefore ‘Aluminium Wars’ took off. Aluminium Wars were waged by gangsters for the influence on Russian Aluminium production. Violence soared, and those who came out as winners, formed into the network of oligarchs, who practiced huge control over Russian resources. Why these above-mentioned processes had a great impact on Ukrainian economics has an origin in a great political and economic proximity of the two countries.

It has to be noted that Russian ethnic population in Ukraine is substantial, amounting to 17%; therefore, so is proportion of the pro-Russian electorate [pdf, p.5.] In addition to that, Ukraine is dependent on most of its oil and gas from Russia, and this dependency is exacerbated given Ukraine has special discounted prices for these resources [ibid, p.7]. Another indicator to the dependency of Ukraine on Russia is how over time, Russia has always been a significant market for Ukrainian exports. For instance, looking at Ukrainian exports of 1996, 38.7% of total exports is owed to Russia [ibid, p.8]. Lastly, Ukraine is, and was in the 90s, a major receiver of Russia FDI, that’s why in the resource sector “out of the six Ukrainian oil-refining plants (ORPs), four are owned by Russian companies.” [ibid, p.10].

Given the above mentioned, it is reasonable to conclude that the economic phenomenon present in Russia had a great potential of impacting that of Ukraine. Importantly, the clear link is to be made between the roaming banditry and Russian economics at first, before discussing its implications on Ukrainian economy.

The interconnectedness of gangsters and economics ran deep. Russian entrepreneurship was based on engaging in criminal activity such as extortion, bribery, and even murder – “During that time, murder was a depressingly common way of resolving business disputes.” Violent entrepreneurship soared with the increased availability of valuable natural resources. According to CNN, out of the Russian oil, gas, timber and aluminum industries, rose a small number of individuals, and among those small group of people, were not only Russian, but also Ukrainian individuals.

Bottom Line: Russia’s and Ukraine’s strong economic interconnectedness is essentially predisposed by their geographic and cultural proximity. Therefore, Ukrainian economics was greatly influenced by the violent entrepreneurship that took off in post-soviet Russia.

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

Redefining economic success

Hanna writes*

The current linear economy measures success in terms of growth. This definition of success fails to include many environmental and social factors that are important for the wellbeing of society and the natural environment.

This one-minded economic system is increasingly being challenged. For long, thinkers and entrepreneurs have tried to come up with alterations to the current system to reduce its negative impacts. Others have even gone as far as proposing alternatives. Two such alternatives to the linear economy aim to step away from the wasteful take–make–dispose flow and redefine the values of the economic system.

The circular economy, as its name states, aims to transform the linear economy into a circular one. Meaning, that, as defined by the Ellen Macarthur Foundation (EMF) [pdf], it is “restorative and regenerative by design and aims to keep products, components, and materials at their highest utility and value at all times.” In practice this translates to shifting ever increasing intensity of production to product quality and towards reuse and upcycling. Making it “restorative and regenerative by design.” Here a distinction between a technological and biological cycle is made. This distinction is made to maximize the use of the product by diversifying its application and ensuring its safe return to a natural state (e.g. decomposition). The circular economy is further said to be economically beneficial and a source for employment creation. As estimated by the EMF, the European Union could increase its net benefits by €0.9 trillion by embracing the circular economy by 2030.

The steady state economy goes one step further and calls for downsizing and degrowth of the current economy to a size that can be sustained by the planet. Firmly decoupling the economy from growth and focusing it on limiting environmental degradation and improving the quality of human capital and consumer goods. In other words, there is an upper threshold or limit to the steady state economy. This threshold calls for a sustainable and consistent population size (births+immigrants = deaths+emigrants) and capital stock production. Fair distribution of wealth and the efficient allocation of goods and services are said to be easier to achieve in a steady state economy with a stable population.

To achieve either model, behavioural patterns and institutions supporting “growth and accumulation” as measures for success would have to be challenged and altered. This poses a significant challenge to society and will surely not be accomplished overnight. However, first efforts to implement the circular economy are on their way. Other trends within the business sector are evolving, implementing more sustainable practices and slowly reshaping ‘business as usual.’

Bottom Line: Current definitions of success being equal to constant growth must be altered to include environmental and social factors that contribute to wellbeing. This can be done by altering the current linear economic model and moving away from the throwaway society to one that is more restorative by nature. This shift is already in process but still has a long way to go.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice 🙂

Peru’s poverty of riches

Daniela writes*

“Peru is a beggar seated in a golden bench.” This famous phrase by Italian scientist Antonio Raimondi is especially relevant to describe the socio-economic reality of the Peruvian mining industry. While it is perceived to be thriving in terms of contribution to GDP and hence output, there is a different story to be told in terms of development for neighbouring mining communities which are responsible for natural resource extraction. Most surprisingly, it is not a new story, but one that has persisted over the centuries.

Probably unbeknownst to the reader, Peru is the second largest exporter in the world of copper, silver and zinc and the fourth largest exporter of gold in the world. The industry accounted for 62% of total exports in 2017, constituted 10% of GDP and 5% of employment generation in the same year.

Even though mining projects by 2021 are valued at almost $70 billion dollars, it is mostly benefitting large multinational companies and local giants. On the other hand, the miners, responsible for the manual labour, will probably not reap the most gains. Today, 50% of the population in these mining communities is living under the poverty line, 15% remain illiterate and overall, the communities count with a disheartening human development score of less than 0.5, while the country counts with an average of 0.75 out of 1.

History seems to repeat itself, as these regions continue to be the poorest in the country, 500 years after the institutionalization of the Spanish mita, used to colonize the native population. Miners, similar to other poor communities in Peru, face a significant obstacle to development: they remain at a historical disadvantage in obtaining their rights against a persistent pattern of extractive institutions and exploitation. In the present, miners stand powerless against giant corporations which do not have it in their agenda to contribute to the progress of these communities but rather to generate enormous profits.

In addition, informal mining and conflict-ridden communities neighbouring major mining projects are two crucial phenomena to consider in terms of limited progress for Peru.

Although the Ministry of Mines and Energy (MINEM) has predicted to formalize almost 10,000 miners this year, informal miners constitute at least 750,000 of the mining community, while those directly formally employed lag behind at 190,000. This means that at least 75% of all miners in Peru are waiting for their rights to be recognized by the state. If the efforts by MINEM are successful, formalized miners will have rights to extract resources over a certain area through concessions, which most miners are unable to do so at the moment.

Informality, alongside environmental concerns and poor living conditions, has sparked conflicts in mining communities and deterred potential investment. It is estimated that $12 billion dollars in investment could go forward if conflicts in the South of the country would be resolved. Mining conflicts are most prevalent in this region given that this is where most mining activity takes place. These conflicts are mostly caused by environmental concerns, dissatisfaction of the miners with the role of the State and direct confrontations with major enterprises. While these are mostly protests, some have scaled up to pose a risk to human life, most notably in Tia Maria and Conga.

While the government is making significant strides to try to overcome conflict and informality, there remains the question whether the reforms will achieve meaningful progress and institutional change.

In order to address this issue, the government is currently working on the establishment of three main types of funds. This includes a macroeconomic stabiliser “Fund of Fiscal Stabilization“, eight regional social funds, and the most recently set “Fund of Social Advancement”  set to begin its operations in 2019. While the latter two intend to contribute to the provision of basic public goods and services in mining communities – including water, sanitation, infrastructure and education – the former is a sovereign wealth fund intended as a risk stabilizer if a catastrophe were to happen in the economy. The Fund of Social Advancement seems to be the most promising, given that it intends to merge the efforts of the regional funds into a centralized mechanism, for which $15.1 million dollars have already been destined.

Nevertheless, a significant weakness of these funds is that, while they seem specialized in the provision of essential public goods, they do not intend to tackle the long-term challenge of breaking the barriers of path dependency. Essentially, a potential solution could be to centralize efforts into a macro-encompassing fund which guarantees security and the development of future generations. For instance, Peru could mimic the Norwegian Sovereign Wealth Fund model by guaranteeing that a significant share of the profits of natural resource extraction are destined to the sustainable development of the mining industry and the communities involved.

Bottom line: Even though the mining industry in Peru is perceived as thriving by dollar counts, there is a different story to be told in terms of the development of neighbouring mining communities to major projects.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice 🙂

Singapore: ethnicity & progress

Sharaiz writes*

Together with Hong Kong, Taiwan, and South Korea, Singapore is considered one of the Four Asian Tigers: countries in (South-) East Asia that industrialized and grew from poverty in the 1960s into  high-incomes today. According to Tan, the founding of modern Singapore started in 1819 with the arrival of Sir Thomas Raffles, who recognized the island as an exceptional location to build a new port. This started an era of British colonization of Singapore that lasted until 1965, when the colony officially became independent with Lee Kuan Yew, the People’s Action Party (PAP) leader, becoming the nation’s first prime minister. Two years before they gained their independence, the PAP decided to merge Singapore with Malaysia as they thought it would benefit Singapore’s economy. While the Malay already formed a sizeable proportion of the Singaporean population before the merge, this move led to increased racial tensions between the Chinese-Singaporeans and Malay-Singaporeans, and eventually even resulted in race riots. Both groups felt that there were certain policies that benefitted one over the other. This was one of the reasons why the union of Singapore and Malaysia was eventually reversed.

Another factor that has historically added to the ethnic diversity in Singapore is migration from India that started during the colonial era when both countries were British colonies. Over time, the size of the Indian community grew, and Singapore became a nation of mixed ethnic groups.

The government has sought to foster peaceful coexistence. The CMIO-system (Chinese-Malay-Indian-Others) is used to racially categorize all of the citizens, and it is common for people to keep to their own racial group. This ethnoracialization is institutionalized at an official level, as illustrated by the state funded self-help organizations, which are differentiated by racial identities (pdf). These organizations exist to target ethnic-linked socio-economic problems of each racial group and also to address issues that are specific to each group. The government professes a policy of meritocracy — the idea that anyone with skills can progress socio-economically, regardless of their race.

Despite all of these efforts, there remains a high level of inequality between the different ethnic groups (pdf). Chinese, Malay, and Indian households have a median monthly income per household of S$5,100, S$3,840, and S$5,370 respectively, which suggests an unfair distribution of income. Additionally, if we look at the highest educational qualification attained, we see significant differences in the percentage of university graduates per ethnic group:

Other reports (pdf) suggest that Chinese-Singaporeans have an unfair advantage in academic and professional settings due to their race. It seems that while Singapore has indeed experienced tremendous economic growth, the same cannot necessarily be said for the development of all of its citizens as seemingly ethnicity-based inequality continues to plague the nation.

Bottom line: Despite the government’s focus on multiculturalism and meritocracy, Singapore’s different racial groups seem to experience significant inequality problems in multiple areas, like income, educational attainment, and opportunities.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice 🙂

China’s investment trap

Douwe writes*

The rapid growth of the Chinese economy in the wake of Mao’s death inspired both awe and envy across the world. From the 1980s onwards, the Chinese Communist Party (CCP) under Deng Xiaoping increased opportunities for private entrepreneurship leading to the so-called “Chinese Miracle.”

The economy was propelled forward through agricultural reform, export and huge infrastructure investments serving as engines of growth.

However, the characteristics of China’s transformation towards a middle-income economy presents lasting obstacles for growth and development in the long term. While China can be viewed as embracing capitalism, the private sector still occupies a minority share within the economy, with State Owned Enterprises (SOEs) still dominating the market. While these are responsible for a large share of the economic growth, their relative output often pales in comparison with their private sector counterparts.

Additionally, SOEs have been able to stay afloat through the financial repression policies of the Chinese state, with massive injections of cheap credit being available within a giant investment boom as shown by Figure 1. These SOEs are able to access cheap credit because they are favored by the state-owned banks and seen as insured by the state. This has led to crowding out of the private sector, while simultaneously disincentivizing SOEs from innovation and increasing efficiency, causing many to become bloated and uncompetitive. This is due to the reluctance of the state and the banks to write off non-performing loans and restructure the SOEs due to entrenched opposition to reforms and fears of social unrest.

Source [pdf].

This lack of credit has led companies within the private sector to turn to shadow banking or seek external financing by becoming hybrid companies that can benefit from Foreign Direct Investment or access foreign capital markets by listing in Hong Kong.

Even though this system until now has served the CCP well in promoting growth, in recent years the economy seems to be slowing down, as diminishing returns on investment and uncompetitive companies have decreased growth figures.

Slow growth is especially problematic in state-supported sectors like green energy, where government-subsidized overcapacity resulted in dumping on foreign markets, and a lack of competition to incentivize efficiency and innovation. This is especially relevant in relation to the CCP’s “Made in China 2025” policy [pdf], which is aimed at creating internationally competitive firms in technology sectors. This plan can be impaired, as the industrial policy and especially investment allocation provided by the government suffers from information asymmetries and bias towards SOEs in both the government and the banking system.

Interestingly, a partial solution might be presented by China’s trade war with the United States, as President Trump’s drive against unfair competition threatens to close markets for Chinese industrial overcapacity. The lack of buyers for such goods could make the state’s current policies completely unsustainable and possibly force the state to change them.

With the lack of competition threatening further innovative growth, a possible middle-income trap looms. Unable to achieve technological upgrading and compete with the developed economies, the Chinese rapid economic engine could grind to a halt. Aside from the problem of diminishing growth figures, the CCP is simultaneously presented with demands for development concerning inequality, an ageing population, and environmental damage. Therefore, it might need to alter the way it sustains its political coalition, from economic growth towards addressing the countries other societal needs, all without getting cold feet.

Bottom line: It is time for China to deal with SOEs and non-performing loans, quit overinvestment, and put the country on a path of sustainable growth and development.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice :))

Leaving the European market

Henry writes*

Yes, Brexit poses some serious threats to the UK’s economy. Yet while the media only likes to portray the future of the UK’s economy in constant doom and gloom, there exists many advantages and positive signs from the UK’s perspective. Brexit’s economic challenges can be overcome, and although it may take a while for the UK’s economy to adjust, if there is one country in Europe capable enough of growing and sustaining its economy independently, it is the United Kingdom. Not a believer? – The UK accounts for just under a fifth of total EU GDP and is the second largest EU economy behind Germany (Eurostat). On top of this, we remain one of only two countries within the EU to have kept its own currency, which should be pointed out is stronger than the Euro. One of the best economic decisions we made in the past was to choose to exempt ourselves from adopting the Euro, so before you say we are making another mistake, let’s wait and see how this all unfolds before jumping to any conclusions.

The UK’s shift away from the EU market can all start with the vital trade deals it makes with other countries, allowing them to strike further exporting partnerships into markets outside of Europe. Having said that, the European market is currently the UK’s largest trade market (Office for National Statistics GB). Brexit will bring new barriers to trade and break supply chains and deals with EU businesses. This will undoubtedly affect the UK’s flow of trade and, consequently, revenue into the country. However, what we have not been told is that the percentage of UK exports to the EU has been steadily declining over the past few years (Lynn 2019). In fact trade statistics have shown that this percentage has continued to decline even into 2018 as results from the last year were recorded (ibid.). This might be implying that the importance of the EU as an export market is declining. The rest of the world’s economies, for the most part, are growing at much faster rates while Europe’s economies are stagnating (ibid.). Consequently, trade is service based and follows where the most of the demand is, and with the UK’s shift away from European markets, Brexit may only speed up this trend away from European markets. To highlight this trend, last year UK export sales to countries outside of the EU went up by a notable 7.3% (ibid.). This comes in addition to the near 10% decline in exports to EU over the past fifteen years (ibid.).

In light of these statistics, it is important to consider that trade relationships and markets are built over years rather than the short term. No shift away from the EU market will happen so quickly. Therefore in the meantime it is still vital that the UK secures some sort of trade deal with the EU, despite this greater trend of exporting to markets outside of the EU. What I am trying to point out is that some positive signs of trade do exist going into our departure from the European Union. For example, UK export sales to China increased by 25% over the last year (ibid.). Going into Brexit, with a deal or not, the trade statistics do make one thing clear. The UK’s economy has already been separating itself from European markets for some time now and this trend isn’t going to stop. With Brexit you could almost say that the political side of things are only just catching up with the economic reality.

Bottom line: Brexit began even before the vote to depart the EU. While the political situation is currently a mess, I would argue that with time, a UK economy free of the EU’s regulations can thrive despite the uncertainty surrounding the UK’s future. I’ll take it that the UK’s economy may suffer for the first few periods after Brexit. But come back to me in ten years time, see where our economy is standing in comparison to the EU, for good or for worse, and then let’s talk about Brexit.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice 🙂

Insurance on the FDI frontier

Jelmer writes*

If one were to ask a group of economists, policymakers, and other public intellectuals how to solve The Great Issue™ of stark global inequalities in wealth and development, they may very well yell “Foreign Direct Investment!” This is exactly what the World Bank has been preaching for the past thirty or so years. After all, neoclassical economics dictate that the private market should find these massive stocks of human capital, natural resources, and an untapped market to boot too good to pass up on. Considering the globalization of the economy at large it would be suboptimal at best and un-capitalist at worst not to jump on the opportunity these resources offer. Of course, it never was this easy. Resource allocation is a game we play, and when the rules and outcomes are unclear costs potentially outweigh benefits. This is often the case in poor countries; therefore, private parties keen on profits get cold feet and back out. They are wary of expropriations and (government) parties defaulting on payments. In other cases, social unrest, terrorism or even war may destroy a company’s operations abroad. Political Risk Insurance (PRI) encompasses a range of products designed to ameliorate the costs associated with these risks.

As stated by Iftinchi and Hurduzeu [pdf], PRI is offered by two main groups; public and private insurers. Public insurers are often linked to, or are an immediate part of, a development bank or government initiative. They tend to be in the market for relatively long-term investments and are less flexible due to their alignment with governments’ foreign policy or sustainability goals. Private parties, on the other hand, insure short- and medium-term projects at highly variable premiums and often with little regard for the (socio-economic) environment. As can be seen in the graph, the main public player is the World Bank’s Multilateral Investment Guarantee Agency (MIGA), with significant market share in countries with the highest risk rating (BB and worse). Zurich Group is the largest private party, insuring PRI across the board and outperforming MIGA in the, quite relevant from an international development standpoint, ‘CCC and lower’ rated market.

Source: miga.org

At its very core, the public provision of PRI is supposed to improve global resource allocation. It allows firms to engage in markets which they previously may not have considered. This very idea was central to the initiation of MIGA by the World Bank [pdf]: “sustainable economic growth in many developing and transitional countries would require stimulation of private enterprise and foreign direct investment.” Albeit easy to get behind, there are definite questions to be raised about the World Bank’s interference in this market. As market shares show, private insurers do not necessarily have a problem with fulfilling the demand in place. This issue was already being raised at the very establishment of MIGA; Stefan Sinn dealt with it extensively in his 1986 “Second Thoughts on MIGA” [pdf] paper. Furthermore, he raises fundamental concerns about the role of insurance provision in resource allocation. As with any type of insurance, risks such as moral hazard may, in fact, worsen allocation. Yes, there are obvious benefits to FDI; its size potential in comparison to other forms of development aid [pdf] says as much. And yes, its flow may very well be improved by PRI products. However, the fundamental questions raised by Sinn remain unanswered some 30 years later.

Over the next few weeks, I will further research the growing market of PRI, and the role of public provision specifically. To stay updated and receive the final report, please contact me by e-mail.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice 🙂

The BRI in Malaysia

Yeseong writes*

China’s influence on other countries is hard to grasp so this post focuses on President Xi’s biggest and most ambitious foreign policy: The Belt and Road Initiative, or BRI. The BRI is an effort to link some 70 countries through a trillion dollars of investment in roads, ports, pipelines, roads, and other infrastructure. Xi claims that this initiative will work magic like the ancient silk routes, opening “windows of friendly engagement among nations, adding a splendid chapter to the history of human progress.”

Malaysia supported BRI under the rule of the former Prime Minister Najib Razak. Malaysia signed deals for infrastructure to be funded by the Chinese state-owned and commercial banks. The people of Malaysia supported these deals as they had nothing to lose from more jobs, and better infrastructure. They believed the BRI would help the economy and raise their quality of life.

Yet, the new government, led by PM Mahathir Mohamad, did not feel this way. The former government was corrupt, and Mahathir believed that Najib began unnecessary ventures the country could not sustain, which led to the cancellation of $22 billion of BRI projects for rail links and gas pipelines. As a cautionary tale, consider that Pakistan borrowed from Chinese commercial banks until it needed an IMF bailout.

There are clear opportunities and risks involved with the Chinese effort to bring countries together. A successful BRI would improve Eurasian trade connectivity, boost the economies of developing countries, and raise living standards for millions of people. On the other hand, trade processes might be hindered by cumbersome policies; large infrastructure projects may be ineffective due to many reasons including corruption (which is the case of Malaysia under Najib Razak); and accumulating debts in developing participants may be on an unsustainable level. Some also worry that the BRI is an excuse “to establish a comprehensive system to shape the world according to China’s interests.

Bottom Line: China’s BRI promises investments to link numerous countries. It would be wonderful if the BRI’s promises materialized, but the reality is different. Thus, countries need to be careful of BRI risk, as Malaysia discovered with corruption and excessive debts from unnecessary projects.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice 🙂

Microfinance: Is it a trap?

Jeroen writes*

Microfinance (MF) was invented in the 1970’s as a means of uplifting the poor. Since then, it has been widely pursued by NGO’s and even international organizations such as the World Bank. Its inventor, Muhammad Yunus, even earned a Nobel Prize for it. But does microfinance really deliver on its promise? Or are there adverse effects that outweigh its benefits? This post will examine microfinance’s effect on entrepreneurs’ prosperity. In the blog’s one-handed tradition, I will be fairly biased, in that I zoom in on a drawback of microfinance: displacement effects.

Displacement refers to when microloan entrepreneurs crowd other business out of the market, as Milford Batesman argues in his book Why Doesn’t Microfinance Work? Displacement occurs when microfinance entrepreneurs compete with other small businesses over limited jobs for self-employed workers in developing nations. Exceptions to this rule exist, such as in newly formed Bosnia-Herzegovina, where many unemployed were highly educated and could therefore perform a wider variety of tasks. However, in many developing countries, such as Bangladesh, MF workers stick to jobs like farming, craftmanship or keeping a small shop.

This competition has two adverse effects for workers in the sector. First, it pushes prices down. For example, more barber shops open, but the demand for haircuts hasn’t necessarily changed. Thus, as illustrated in the figure below, the supply curve moves outward and prices drop. Second, the new barber shops steal away customers from the old barber shops. Even though the quantity demanded of haircuts rises slightly, that quantity has to be shared among more workers. The result of both these mechanisms, is profits decrease, as Honohan discusses.

Price falls as microloan entrepeneurs enter the market. Source: Batesman

The shrinking of profits due to displacement has two implications. First, it is a key limitation to many studies examining MF’s economic benefits, as Honohan points out. Second, it means that capital accumulation for the poor becomes much harder.  Microfinance advocates themselves admit that capital accumulation is key to poverty alleviation. They use anecdotes of entrepreneurs that put their profits into their children’s education, or the expansion of their business. Displacement undermines this ability.

The story of rent reduction seems to be one of collective-action failure. Microfinance benefits individuals who take a microloan and start a business. However, it hurts all workers in that business by pushing their profits down.

One might object to the displacement argument, that microloans can also be used to make investments that boost productivity, thereby boosting the profits made by businesses. Honohan provides an example of this: a trader buying a bike, making him faster (and more efficient) than other traders on foot. Here, the bikeless trader is outcompeted and replaced by a more efficient service (i.e. creative destruction). There is no literature about how these productivity loans compare to the loss of profits for entrepreneurs. However, I would argue these examples are less frequent. Micro-finance loans tend very small, typically around $27. This is often enough to buy the basic supplies for a business, but not to make additional investments. Thus, entrepeneurs might use microcredit to improve on the margins (i.e. buying a bike), but it is uncertain whether this will create enough value to compensate for profits lost due to displacement.

Bottom line: Microfinance can reduce entrepeneurial profits and thus slow the poor’s rise out of poverty. From this perspective, Microfinance looks more like a trap than an escape.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, etc. (Or you can just say something nice 🙂

Brazil’s new direction: Bolsanaro

Tom writes*

Brazil experienced high growth from 2000 until 2014, when the country was suddenly in an unprecedented recession. Although the country’s GDP showed some recovery in 2017, Brazil elected far-right politician Jair Bolsonaro as president in a response to “rising crime and two years of political and economic turmoil”. As what follows will suggest, the election of Bolsonaro is not so much a result of the stagnation of economic growth, as it was rooted in the lack of development following the past decades’ growth.

To assess economic development, Sen and Nussbaum’s capabilities approach will be used as a definition to measure economic development in Brazil. Two of his most important political promises that explain why Bolsonaro gained so much support are his plans to fight corruption and reduce crime rates. The former deals with capability 10A, the political aspect of control over one’s environment, whereas the latter aims at tackling violations of capability 3, bodily integrity, and capability 10B, the material component of control over one’s environment. One might argue that a tougher policy on crime even relates to the first capability, life, in a country where homicide rates are among the highest in the world. The lack of economic development is also visible in the extreme income inequality and the over 23.3 million Brazilians, over 10 percent of the population, living below the poverty line, which inhibits almost all aspects of human development. This also explains why many people from minorities, such as people of colour and women, voted for him, despite his countless insults; they are overrepresented in the poorest groups of Brazilian society. It is important to note here, though, that many of Bolsonaro’s plans will probably not enhance human development as defined by Sen and Nussbaum, the argument is rather that the reason why people voted for him, are the obviously lacking aspects of development that he addresses.

What gave to rise Bolsonaro, however, started five years before his presidential election, in 2013, when all across Brazil, people took to the streets “with a range of demands from affordable public transportation to fixes to the government bureaucracy”. These demands are rather aimed at enhancement of quality of life than at quantity and seem to have more to do with development than growth. Popular discontent in Brazil was mainly centred around issues of development, but many of them are related to economic growth issues, such as stagnation and a drop in inflation that threatens the position of the middle class.

At the same time that development is lacking, the prospects for economic growth in the next years are also critical, especially since Bolsonaro, in an attempt to recover Brazil’s economy, wants to break most economic ties with China, while trade with China grew with 4000% between 2000 and 2013, largely contributing to Brazil’s economic growth. The irony is that at the same time that the ‘Trump of the Tropes’ wishes to copy Trump’s strong anti-China economic policy, it was exactly this American trade war with Beijing that has boosted Brazilian exports to China.

Bottom line: The rise of Bolsonaro as Brazil’s new president is rather a response of human development falling behind for years than just a response to the lack of economic growth between 2014 and 2016.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, data sources, etc. (Or you can just say something nice 🙂