Economic Doodles

With an estimated 3 million leaving the country and the remaining 90% living below the poverty line, Venezuela, once a prosperous middle-income country in Latin America has found itself in the midst of a humanitarian disaster. Yet, the country sits on some of the largest oil fields in the world – making up 98% of its exports and contributing $3.1 billion in export revenue. How then can a country so rich in oil be in such a calamitous economic and humanitarian situation?  

The economic theory behind this phenomenon is known as the paradox of plenty, dutch disease, or simply the resource curse. It occurs when a resource, such as oil, creates an over-appreciation in the domestic currency. This is caused by an influx of foreign money from trading the resource on the global market. The appreciation creates a structural transition away from other sectors in the economy, such as manufacturing and agriculture, since these industries are no longer globally competitive. For example, a factory owner who exports his goods to the US will suddenly find that his goods have become more expensive to US buyers.  The US buyers spend their dollars elsewhere and the fall in demand causes the factory owner to reduce investment and hire less workers. Hence, labour and capital moves away from manufacturing  to the booming oil business and the industry begins to collapse. This process is expedited by the government also focusing more attention on the resource industry and ignoring others sectors in the economy. 

Now, this may not necessarily be a problem in the short-run. It simply represents a structural shift in the economy and the allocation of resources to a more socially optimal industry. Unemployment could rise as labour intensive industries contract but under good governing institutions the revenue from oil exports could easily support generous unemployment benefits. However, in the long-run the situation could easily deteriorate. The flagging industries often offer the most growth potential through learning-by-doing and positive technological externalities . Thus, as the economy becomes over-reliant on the resource the real engines of growth begin to fail.

Furthermore, the problem can exacerbated greatly by the price volatility of resources. In the graph above you can see the dramatic fall in oil prices which would have significantly reduced oil export revenue in Venezuela. The oil industry, having been mismanaged for years, couldn’t cope with the shock. 

These economic arguments go some way to explaining how a resource rich country can fail. However, political economy and governance  is also critical in understanding the situation.  The quality of institutions matter crucially for resource rich countries as they keep checks and balances on the government – curtailing corrupt despots and the like . Unfortunately, Maduro has had a unchecked grip on power for many years. This seems to be waning though and once the military abandons him then regime change will be possible. However, the economic situation is likely to remain dire for significantly longer.

 

 

 

One of my favourite books last year was “Doughnut Economics” by Kate Raworth. In it she outlined how the economics profession needed to adapt and grow to the challenges of the 21st century. Specifically, she argued that a new model was required; one which could both deliver the economic necessities for the global poor without destroying the very source of all wealth – the environment. Amusingly, this meant we had to reach that sweet spot of a ringed doughnut. 

Chapter 7 of the book was particularly interesting as it brought forward an argument which is rarely talked about in the mainstream – being antagonistic about the pursuit of economic growth.  

A number of questions arise. Is growth a political necessity? Is it desirable? And perhaps most importantly is it achievable within planetary boundaries? 

Let’s, for now, accept that growth is both necessary and desirable in the 21st century (obvious for low-income developing countries but contestable in advanced countries). Then, how can we achieve growth without harming the environment? The answer is a process of de-coupling between GDP and emissions – sort of like an economic version of Gwyneth Paltrow and Chris Martin. 

The above diagram shows the process of de-coupling occurring. For most of the previous 100-150 years growth has been closely followed by emissions. A reversal of this is required in the 21st century if we hope to curtail the degradation of the environment. This is shown by the divergence between the pathways of resource use and GDP growth across time. For example, if from 2019-2022 GDP grew at 3% and emissions grew at 1% then relative de-coupling would have occurred. 

So how are things looking?

A paper last year by IMF economists (see source) found some promising results for the advanced economies of Germany, UK, and France. Their analysis found statistically significant evidence of absolute de-coupling between output growth and emissions growth. However, for many of the other economies only relative de-coupling had been achieved. Nevertheless, it’s encouraging that the UK, France, and Germany have implemented policies to transition away from fossil fuels and these seem to have worked – proving that taking coordinated action can achieve results. 

Yet, relative de-coupling – while a step in the right direction – may not be enough to achieve the climate goals outlined in the Paris climate agreement. Unfortunately, it appears that many economies are still at this stage. Moreover, sufficient absolute de-coupling is required  and we don’t know whether that would require an elasticity between output growth and emissions of -0.5 or -0.9 or even -1.3.  

De-coupling does then seem to be possible. But maybe only for the wealthy vegan pop-stars among us. 

 

As I mentioned briefly in my post before one of the key features of the Chinese mobile market is that consumers place less emphasis on access to Apple’s ecosystem of products. This is because Chinese mobile users can get most of their functionality out of a single app – WeChat. 

Hence, we can say that iPhones and other mobile devices are closer substitutes than they are in Western markets. Using the basic economic theory of cross-price elasticity of demand, we can say that if two goods are close substitutes then demand for one of the goods will be more responsive to changes in the price of the other good. iPhones and Huawei phones will never be perfect substitutes, not least because of the brand loyalty attached to each device. But, if they are closer substitutes in China then we would expect to see a reduction in price of Huawei phones reducing demand for Apple phones in greater magnitudes than in other markets.