4: global shocks: oil prices 0. overview global shocks and responses oil price world economic growth...
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Overview
Global shocks and responsesOil priceWorld economic growthReal interest rates
Indonesia’s “other” D.D.Philippine currency crisis
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The resource wealth paradox“Since the second world war it has become quite clear
that rapid economic growth is available to those countries with adequate natural resources which make the effort to achieve it.” W.A. Lewis 1968, Some Aspects of Economic Development: ix
“Incentives to create wealth sometimes get blunted by the ability to extract wealth from the soil or the sea. Rich parents sometimes spoil their kids; Mother Nature is no exception.” J. Sachs and A. Warner 2001: “The curse of natural
resources”, Eur. Econ. Rev.
“You can’t build ships by selling fish” B.J. Habibie, Indonesian minister for science & technology (1997)
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The resource curse hypothesis Sachs and Warner: countries with abundant natural
resource wealth grow more slowlyDutch disease: non-resource tradable sectors don’t grow
as fastNR-rich econs don’t invest in renewable assets (capital,
education) Returns to human capital investments are likely to be low
E.g. Thailand’s low secondary enrollment ratesResource wealth may promote inefficiency and corruptionCommodity price instability may reduce investment
efficiencyPuzzle: why are major SE Asian countries exceptions to
the Sachs-Warner story?
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Model: resource exports and Dutch Disease
Traded (T) and non-traded (N) goods in a ‘small’ economyAssume traded goods enter domestic market at (given) world price
Global demand (exports) or supply (imports) infinitely elasticNon-traded goods: domestic market clears; price is endogenous
Assume 3 sectors: T = Traditional exports and import-competing sectors N = non-traded services; demand is highly income-elastic
Labor is mobile among all sectors
Real exchange rate RER = pN/pT
= pN/EpT* , where pT
* are world prices (in $) and E = Rp/$
Ex. 1: nominal exch rate appreciation (fewer Rp per $) real appreciation, or a rise in RER.
Ex. 2: Rise in pN also real appreciation
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Traded goods
Nontraded (services)
RER
A
• All traded goods aggregated on vertical axis • All non-traded goods on horizontal axis • Cannot trade N goods, so eq’m at A: production = consumption • RER = pN/pT that clears domestic markets and trade
u(T, N)
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Traded goods
Nontraded (services)
RER0
A
B
• Resource boom moves PPF out in direction of T only • Assume (for now) that demand for N remains constant at N0 • At initial prices (RER0), move to B: but excess demand for N • Adjustment requires a real appreciation to RER1 , i.e. pN/pT rises
RER1
C
N1 N0
T1
T0
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Traded goods
Nontraded (services)
RER0
A
B
• The boom generates new income for consumers• Assume demand for N is income-elastic (grows along inc. exp. path) • At initial prices (RER0), move to D, but excess demand for N • Adjustment requires another real appreciation toward RER2
C
Income exp. pathfor RER0
RER2
D
N1 N0 N2
Summary: the story so farThe ‘boom’ in one tradable sector (say, oil) has supply and
demand side effects on the rest of the economySupply side: resources (e.g. labor) pulled in from other
sectors, incl. non-tradables To sustain N production equal to demand, their price must
riseDemand side: boom creates new income, and some (all) is
spent back into economy. Spending on N raises their price
Two sources of real exchange rate appreciationWhat do these price changes, and associated reallocation of
productive resources, mean for the rest of the economy? Implications for growth, econ. structure, income dist?
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LN0LT
0
0N L0 LM0 0T
w0
LM
LN1
LT1
w1
w2
• Measure N sector employment from 0N, T sector emp. from 0T
• Initial labor market equilibrium at (L0, w0) = full employment• Resource boom increases jobs in resource sector, moves LT to LT
1
and wage to w1 • Spending effect increases jobs in N to LN
1, raises wage to w2. ? What happens to M sector employment (and thus output)?
a
c
d
Resource boom and Dutch disease In an economy producing resources, manufactures and
services, a ‘boom’ (discovery of new resources):Raises output of resource sector and reduces output of
both other sectors through competition for labor, which raises wages …
… and leads to excess demand for services, which produces a real appreciation …
… which diminishes output gain in resources sector and further reduces jobs and output in manufacturing.
The spending of new income created by the boom:Raises demand for all goods, including services, which
leads to a further real appreciation and wage rise … … which once again reduces jobs and output in
manufacturing13
More on resource booms
Sector described as ‘manufacturing’ could instead be traded agriculture (hence ‘deagriculturalization’), or both
Technical progress such as green revolution can also be a source of a ‘boom’
‘Enclave’ sectors (e.g. oil) may have little or no factor market impact -- but income (spending) effect may be very large
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The OPEC oil price boomsOPEC oil price rises (1973 and 1978-80)
raised Indonesia’s terms of trade with rest of world.
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Indonesia’s “other” Dutch diseaseBig structural change effects… but a puzzle too
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* Why did manufacturing output not decline as predicted?
How Indonesia avoided Dutch disease
• Increased protection for industry • Nominal devaluations to offset inflationary effects of
real appreciation: 1978, 1983, 1986• Support for other tradable sectors, especially
agriculture:– Infrastructure investments -- irrigation, roads, market facilities– Capital market investments -- rural credit– Human capital investments in rural areas (health & nutrition,
education)– Agricultural R&D investments-- new rice research– Land colonization (transmigration programs) to maintain labor
productivity
* These measures also reduced poverty and rural-urban inequality-- and so built political support for Suharto regime
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Indonesia: Central government expenditures
0.00
10.00
20.00
30.00
40.00
50.00
60.00
1970197119721973197419751976197719781979198019811982198319841985Source: Woo et al Table A12
(Development exp as % of total exp, total exp. in $US
Percent
0.00
5.00
10.00
15.00
20.00
25.00
Total exp ($US bn)
Development exp
Total exp (US Bn)
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Indonesia: Components of gov't spending by sector
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
1970197119721973197419751976197719781979198019811982198319841985
Source: Woo et al Table A12
$US bn
Industry subsidies
Education
Other agr & irrigation exp
Fertilizer subsidy
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Poverty in Indonesia During the Oil Booms
0
10
20
30
40
50
60
1976 1978 1980 1984 1987
(1): Biro Pusat Statistik (2): V.V.H. Rao, APEL
Percent of reference group population
Urban (1)
Urban (2)
Rural (1)
Rural (2)
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Per capita household expenditure in developing oil exporters (1974 = 100)
0
50
100
150
200
250
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990
Source: WDI
Algeria
Indonesia
Venezuela
Policy implications of Dutch diseaseIf the ‘boom’ is permanent, change in economic
structure should not present a policy dilemmaBut for a temporary change, possible problems:
If structural change is costly (transactions costs) If some sectors or industries suffer irreversible changes (e.g. go
out of existence) Moreover, deindustrialization could be a problem:
If industry sectors exhibit positive externalities, e.g. from increasing returns to scale, or learning by doing, or inter-industry productivity spillovers
Foreign exchange windfalls can be ‘sterilized’ by saving them as foreign assets rather than spending them in domestic economy But political costs of this strategy
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