In modern parlance the expression Quality of Life refers to the desire for a way of life that is pleasant and sustainable; in other words the expression has come to mean happiness. But if money does not buy happiness as the old saying goes it cannot buy a life of high quality. Thus the need to pose the questions: Is there something we can do that will lead to a life which is both sustainable and of high quality? If yes, how do we recognize that thing and when we do, how do we measure the happiness it is supposed to yield?
Having no answer to these questions, most people hang on to the old notion that the level of income in a household is a good indicator as to the quality of life in it and therefore to its level of happiness. And so they quip that money may not buy happiness but it sure makes life easier and, to most of them, this is the sort of happiness they can live with and one they will seek relentlessly come what may.
While this sort of discussion takes place somewhat tongue-in-cheek among the general public, more serious discussions take place among the planners in many places around the world. And the motivation behind the latter discussions is nothing less than the deep concern that the planners have for the survival of the human race and the need to become better stewards of the planet and its resources.
This preoccupation with the health of the Earth is generated by the demands that modern living makes on the planet’s capacity to provide for a human population that keeps on growing and where everyone strives to take their place at the banquet table. In some sense, the question of how to sustain a livable condition on Earth has replaced the question that the ancient philosophers used to ask: Who are we and why are we here?
And while this is going on among one group of people, another group is debating the fate of Western Civilization where the birthrate is going against the trend and is falling. Since economic strength is viewed as being proportional to the size of the population, this group is alarmed by the prospect of the West being overwhelmed by the other cultures. And while the group does not deny that the resources of the planet are strained, it fears for the future of Western Civilization enough to want its population to grow even if this happens at the expense of the planet.
Abstract notions and potential scenarios are put forward by the various groups to advance arguments on all sides of the issue. But when all is said and done, we are confronted with the reality that we, who live in the West, compete against people who live everywhere else on much less than we do yet seem happier than we are. So the question is asked as to whether or not we can scale down our lifestyle and still function normally if not be happier.
The answers that are advanced begin with the recognition that we are a people to which having more money means being happier than having less. To wit, winning a windfall will change someone’s mood in an instant. But there is a silver lining in this observation because if claiming the winning comes with a condition, the amount won is weighed against the condition. This says that to most of us money is not an end in itself but a means to an end. And this leads to the hopeful question: Is there another way to get to that end?
To answer the question we look at the example of two households having the same annual income of 60,000 dollars. The first household is occupied by two parents and one child for a total of 3 people; the second is occupied by two parents and four children for a total of 6 people. The numbers are so chosen as to make one household twice the size of the other.
Given that the per capita income in the first household is 20,000 dollars and the second is 10,000 dollars, we ask: Can it be inferred that the individuals in the first household are happier than those in the second? If yes, are they twice as happy?
Not many people will make that inference but when the debate begins, a number of interesting arguments are generated on both sides of the issue. On close examination, the ideas expressed can be separated into two groups, the financial type and the social type.
In the financial realm, it is said that because the people in the first household earn 20,000 dollars each, they have the option to spend 10,000 dollars and stop here or they can go on and spend more if they so wish. Thus, they can be as happy as the folks who are limited to the 10,000 level or they can buy misery if this is what spending more money will get them…but it will be their choice to make. And having this choice is in itself a form of happiness. The conclusion is that 3 people earning 60,000 dollars between them are happier than 6 people earning the same amount between them.
The opposite argument says that while the above logic seems flawless on the surface, it does not reflect the full reality of the situation. This is because there are two components to the expenses of a household; there are the fixed expenses which are obligatory and common to both households and there are the discretionary purchases which are paid for with what remains to each individual.
To see how this plays out we do an experiment. We limit the allowable expenses in each household to 10,000 dollars per individual. If now we set the fixed expenses such as paying the mortgage, taxes, insurance, hydro, water, telephone, cable, furniture, appliances and so on at 18,000 dollars a year, the 3 people in the small household will each have to contribute 6,000 dollars for the fixed expenses and thus be left with 4,000 for the expenses called discretionary.
By contrast, the 6 people in the larger household will each contribute 3,000 dollars for the fixed expenses and be left with 7,000 dollars for all the other expenses. The conclusion is that they will be better off than their counterparts in the smaller household because they will enjoy the same comfort yet have more money to spend on the discretionary items.
And the fact is that in order for the people in the smaller household to have 7,000 dollars each to spend on discretionary items and still have the 6,000 dollars to contribute toward the fixed expenses and buy the level of comfort to which they have grown accustomed, they will have to earn 13,000 dollars each, not 10,000.
The folks on the other side of the argument reject this presentation because it assumes that the fixed expenses are unaffected by the size of the household. Instead, they assert that more money is required to pay for the fixed expenses when you have to raise four children in a large household than is required when you raise one child in a small household.
Yes, respond their counterparts but having three extra children in the house does not double the fixed expenses. To be sure the extra children require a little more expenses but they do not double them. For example, you may need a larger refrigerator but not two of them. Also, one oven, one washing machine and one dryer serve the large household just as well as the smaller one. In fact, aside from the refrigerator that runs all the time, these appliances sit idle 90% of the time.
In short, having children in a household does not raise the fixed expenses in proportion to their numbers. The people who argue this side of the question offer the opinion that this fact alone contributes a great deal as to the reason why people in the developing countries live on a smaller income without diminishing their level of comfort. We may have more appliances, furniture and home entertainment units per person but when the numbers are compared on a per household basis, they do not look so lopsided.
The financial arguments thus flushed out, the social arguments begin with the question as to whether or not having children in the house brings happiness. Different people have different views on this subject but they all agree that the money spent on leisure and entertainment varies greatly between the households and thus the types of happiness and their levels will vary from household to household.
And then, a view is advanced to the effect that perhaps the people in the developing countries are happier because they have each other to rely on for support, companionship and amusement. Perhaps, it is said, they feel they are blessed having this style of life more than they would be if each had a car, a refrigerator, a washing machine and a dryer all to themselves with no one to share it with.
Can we, here in the West, adopt this lifestyle and help save the planet?
Sunday, May 18, 2008
Wednesday, May 14, 2008
An Industrial Strategy For Ontario
Being an industrial province, Ontario is suffering from the effects of Globalization that have come to it in the form of competition from the developing countries. Ontario is not alone in this regard but is, in fact, a microcosm of what is happening throughout the industrialized world. Thus, the insight that is generated by discussing this Canadian province may apply to the other places as well.
Ontario has a diversified portfolio of high end industries operating side by side with the mining and logging industries which, by contrast, add little value to the raw material they extract. Thus, what is missing in Ontario’s industrial portfolio are the mid-range value-added industries such as textile, leather, furniture, home entertainment and appliances, and these happen to be the industries where competition from the developing world is fiercest. The auto industry is being challenged at the edges at this time and may soon join the list of the endangered industries.
For several decades, however, these were the industries that thrived in Ontario and throughout the developed countries. But then the poor countries began to industrialize and they supplanted their rich counterparts as suppliers of those products to the world. And that world included the developed countries which came to the conclusion that they have no choice but to leave the field and did so gradually as if dying a slow death.
This outcome was predicted twenty or thirty years ago, and the prophecy was fulfilled exactly as imagined. But did it have to be this way? Could something else have been imagined that would have led to a different outcome? In other words, was this outcome inevitable or was it the result of an ill-advised judgment made by the collective intelligentsia in the developed countries?
If the answer is to the effect that the outcome was not preordained, then there must have been another possible outcome which we missed out on. But what would it have been? Surprisingly enough we don’t have to go too far looking for the answer because the textile industries in the United States have taken steps to adapt to the new economic environment, and they provide some clues as to what the alternative might have looked like.
What these industries do now is buy the raw material locally or from abroad, produce the fabric in the United States inside factories that are capital intensive, and ship the textile to the emerging countries where it is made into garments inside factories that are labor intensive. The garments are then shipped back to the United States and elsewhere around the world where they are sold at competitive prices.
This is an approach that all industries in Ontario and the developed countries could have taken a generation ago but never did. The captains of these industries wasted valuable time because they relied on the predictions which said America and the West will no longer need to produce goods at the low end of the manufacturing industries.
Those who made such predictions believed that everyone who wants to work in the future will find a job at the high end of manufacturing and make tons of money. They thought this was going to happen because the workers in the developing countries will toil in sweat shops to supply the world with the fruits of the loom at the low end of manufacturing, and that they will not develop ambitions beyond this level for a long time.
Well, the predictions proved to be wrong when it was discovered that you still need someone to flip hamburgers in the developed countries and that a number of people flipped over to fill these positions. Young people and a few older ones were hired for the purpose but a number of them quickly got tired of the dead end jobs and flocked to the manufacturing positions in the lowly industries. In fact, some of the factories in America and in Ontario received as many as 50 applications for every job opening they advertised.
Seeing that the world had not turned upside down as predicted, the textile industries breathed a sigh of relief and responded by reinventing themselves upon which they found a good supply of workers in America willing to join their team. Textile returned to the country looking not as it did before but more in tune with the new economic realities.
We must recognize this turn of the events as representing Globalization at its best but we must also view it as being the beginning of a process. Similar approaches can and must be taken with regard to the other industries, and there is no doubt that the private sector will try do so where it can. However, many of these industries have been wiped out already in places like Ontario, and the question is whether or not there is a role for government to play both with regard to reviving those that died and to shoring up those that face a similar fate.
The short answer is that there is a role for government to play. But before we get into this, we should understand that at the basis of our thinking must be the search for strategies that will respond appropriately to the strategies adopted by the developing countries. The aim will be to work with those countries harmoniously so as to complement each other and not try to supplant one another.
What the American textiles did was to identify those parts of the process that were best suited to be handled locally and those that were suited to be handled in the developing countries, and they shared the work. Until we find a better model to work with, this example must be the one to follow because it was tested and has proved to work.
The government of Ontario should now pave the way for similar processes to happen reasonably quickly and not wait for them to evolve because it may take a generation or two for this to happen. The private sector will muddle along as it always does but the government can help in two ways. First, it can provide incentives via the tax code for sharing the work with the developing countries; second, it can coordinate the efforts with foreign governments based of the following principles:
The development of the countries that were left behind need not take place under conditions that look like a wrestling match, a combat or a war between two worlds. Rather, the exercise should look like a wedding between the two groups and be that in practice. What must be understood is that the aim of the developing countries is to industrialize as quickly as possible and become like the developed countries. It must also be understood that the latter want the developing countries to succeed and they are willing to help.
Thus, instead of working at cross purposes, each side doing something that may be detrimental to the interest of the other, let the two sides coordinate their efforts so that the development of the lagging countries progresses in a way that is beneficial to both sides. To this end, the work in every industry should be dissected into parts, those that are capital intensive and those that are labor intensive. At first, the developing countries will do the labor intensive parts while the developed countries do the capital intensive parts.
But as the developing countries progress, they will gradually get more of the capital intensive parts of the job while the developed countries get more of the labor intensive parts. Eventually there will come a time when the two sides will have the same mix of jobs, and the goal of achieving industrial equality between the nations will have been reached.
As an incentive for the developing countries to go along with this plan, the advanced countries will agree to come to the negotiating table as soon as a developing country feels it is ready for the transfer of technology. The two sides will negotiate the manner and sequence in which this will be done and then explore how the developing country may reciprocate.
One way to reciprocate that is beneficial to both sides, for example, will be for the developing countries to open their markets ever wider for more goods, services and investments to flow from the developed world.
Ontario has a diversified portfolio of high end industries operating side by side with the mining and logging industries which, by contrast, add little value to the raw material they extract. Thus, what is missing in Ontario’s industrial portfolio are the mid-range value-added industries such as textile, leather, furniture, home entertainment and appliances, and these happen to be the industries where competition from the developing world is fiercest. The auto industry is being challenged at the edges at this time and may soon join the list of the endangered industries.
For several decades, however, these were the industries that thrived in Ontario and throughout the developed countries. But then the poor countries began to industrialize and they supplanted their rich counterparts as suppliers of those products to the world. And that world included the developed countries which came to the conclusion that they have no choice but to leave the field and did so gradually as if dying a slow death.
This outcome was predicted twenty or thirty years ago, and the prophecy was fulfilled exactly as imagined. But did it have to be this way? Could something else have been imagined that would have led to a different outcome? In other words, was this outcome inevitable or was it the result of an ill-advised judgment made by the collective intelligentsia in the developed countries?
If the answer is to the effect that the outcome was not preordained, then there must have been another possible outcome which we missed out on. But what would it have been? Surprisingly enough we don’t have to go too far looking for the answer because the textile industries in the United States have taken steps to adapt to the new economic environment, and they provide some clues as to what the alternative might have looked like.
What these industries do now is buy the raw material locally or from abroad, produce the fabric in the United States inside factories that are capital intensive, and ship the textile to the emerging countries where it is made into garments inside factories that are labor intensive. The garments are then shipped back to the United States and elsewhere around the world where they are sold at competitive prices.
This is an approach that all industries in Ontario and the developed countries could have taken a generation ago but never did. The captains of these industries wasted valuable time because they relied on the predictions which said America and the West will no longer need to produce goods at the low end of the manufacturing industries.
Those who made such predictions believed that everyone who wants to work in the future will find a job at the high end of manufacturing and make tons of money. They thought this was going to happen because the workers in the developing countries will toil in sweat shops to supply the world with the fruits of the loom at the low end of manufacturing, and that they will not develop ambitions beyond this level for a long time.
Well, the predictions proved to be wrong when it was discovered that you still need someone to flip hamburgers in the developed countries and that a number of people flipped over to fill these positions. Young people and a few older ones were hired for the purpose but a number of them quickly got tired of the dead end jobs and flocked to the manufacturing positions in the lowly industries. In fact, some of the factories in America and in Ontario received as many as 50 applications for every job opening they advertised.
Seeing that the world had not turned upside down as predicted, the textile industries breathed a sigh of relief and responded by reinventing themselves upon which they found a good supply of workers in America willing to join their team. Textile returned to the country looking not as it did before but more in tune with the new economic realities.
We must recognize this turn of the events as representing Globalization at its best but we must also view it as being the beginning of a process. Similar approaches can and must be taken with regard to the other industries, and there is no doubt that the private sector will try do so where it can. However, many of these industries have been wiped out already in places like Ontario, and the question is whether or not there is a role for government to play both with regard to reviving those that died and to shoring up those that face a similar fate.
The short answer is that there is a role for government to play. But before we get into this, we should understand that at the basis of our thinking must be the search for strategies that will respond appropriately to the strategies adopted by the developing countries. The aim will be to work with those countries harmoniously so as to complement each other and not try to supplant one another.
What the American textiles did was to identify those parts of the process that were best suited to be handled locally and those that were suited to be handled in the developing countries, and they shared the work. Until we find a better model to work with, this example must be the one to follow because it was tested and has proved to work.
The government of Ontario should now pave the way for similar processes to happen reasonably quickly and not wait for them to evolve because it may take a generation or two for this to happen. The private sector will muddle along as it always does but the government can help in two ways. First, it can provide incentives via the tax code for sharing the work with the developing countries; second, it can coordinate the efforts with foreign governments based of the following principles:
The development of the countries that were left behind need not take place under conditions that look like a wrestling match, a combat or a war between two worlds. Rather, the exercise should look like a wedding between the two groups and be that in practice. What must be understood is that the aim of the developing countries is to industrialize as quickly as possible and become like the developed countries. It must also be understood that the latter want the developing countries to succeed and they are willing to help.
Thus, instead of working at cross purposes, each side doing something that may be detrimental to the interest of the other, let the two sides coordinate their efforts so that the development of the lagging countries progresses in a way that is beneficial to both sides. To this end, the work in every industry should be dissected into parts, those that are capital intensive and those that are labor intensive. At first, the developing countries will do the labor intensive parts while the developed countries do the capital intensive parts.
But as the developing countries progress, they will gradually get more of the capital intensive parts of the job while the developed countries get more of the labor intensive parts. Eventually there will come a time when the two sides will have the same mix of jobs, and the goal of achieving industrial equality between the nations will have been reached.
As an incentive for the developing countries to go along with this plan, the advanced countries will agree to come to the negotiating table as soon as a developing country feels it is ready for the transfer of technology. The two sides will negotiate the manner and sequence in which this will be done and then explore how the developing country may reciprocate.
One way to reciprocate that is beneficial to both sides, for example, will be for the developing countries to open their markets ever wider for more goods, services and investments to flow from the developed world.
Sunday, May 11, 2008
The Double Faced Economy
People in the developed countries read and hear stories about societies where some individuals live on less than one US dollar a day and wonder how this can be. They say they can understand how a society of primitives who never came into contact with civilization could live like this in the jungle but not the urban poor in a developing country that has skyscrapers and highways, cellular telephones and air travel.
This puzzlement is understandable given that the mythology is propagated by people of distinction who should know better than to write in prestigious publications or get on radio and television where they repeat nonsense they hear from someone else but are unsure what it means. They are people who do the public a great disservice and must therefore be educated along with their editors and publishers who allow this sort of shoddy work to go unchecked.
As for myself, when asked a question on the subject I respond by telling the questioner that I am not aware the country they talk about has adopted the US dollar as their currency. Oh no, say the questioner, the country has its own currency. So I reply, in this case tell me how much of their currency those individuals earn and how much it costs to live where they reside but do not tell me how many US dollars they do not make because it is irrelevant to them as it is to me and to the discussion. But if you do not have such information, consider what else you know to be trash and stop repeating it. And here is the reason why it is trash:
All economies are double faced as they have been since the first time a border was drawn between two societies. And all economies shall remain double faced for a long time to come because economies follow one set of rules to control their internal commerce and another set to control their external commerce.
To a large extent this dual character determines how economies work but this fact is often overlooked in the public discourses. And the time has come to give the matter a high profile because there is insight to be gained in doing so and because the insight can illuminate as well as answer many of the often asked questions.
What may change a situation that has been the norm since the beginning of time is the emergence of an economy whose citizens are allowed to trade with the other countries free of any restriction. However, if this were to happen to one country, the act itself will not produce a complete reversal of the situation because the citizens of the country will still have to obey the rules of the foreign countries they trade with.
A complete reversal of the situation will come only when two or more countries drop all the rules governing the commerce between them and adopt an identical set of rules at home to govern their internal commerce. When this happens the countries will behave like one market and thus create the single faced economy.
In the meantime, the obligatory prerequisite that two or more countries must achieve before shooting for the single faced economy is to adopt one and the same currency for all. Members of the European Union did this, and Europe is on its way to realizing the dream. When the work is completed, Europe’s achievement will have surpassed that of Canada where it is more difficult to trade between the provinces than with a foreign country even though all the provinces use the same currency.
But what is it that feeds the mythology of people living on less than a dollar a day? The following example provides the answer: Imagine a fictitious scenario unfolding between two countries: America which is developed and Vietnam which is developing. America wants to have unrestricted free trade between the two countries thus requiring the removal of all the rules regulating trade between them. Vietnam, on the other hand, wants to see some rules in place.
To the American way of thinking, Vietnam is a place that is full of untapped natural resources and a population that is yearning to improve its lot. Consequently, American businesses should be allowed to go into Vietnam, extract the resources there and manufacture them either locally, in America or anywhere else depending on the needs of business.
Not so fast, say the Vietnamese, because when you carry on in this manner the few Vietnamese individuals who will be hired to work for the American companies will be paid a lot more than their compatriots. This will boost the rate of inflation to a considerable height and cause the rich to get fabulously richer and the poor to get exceedingly poorer. And the seeds will have been planted for two Vietnams to emerge and be locked in class warfare.
To reconcile the two visions, American and Vietnamese teams start to negotiate a trade protocol, each coming to the table with a set of ideas. The Americans negotiate on behalf of the corporations whose agenda is to do what is good for the shareholders. That is, they want the flexibility to open, to close or to relocate any business facility inside or outside the country. And they want the freedom to hire, to fire or to relocate any employee in accordance with the needs of the business.
The Vietnamese on the other hand want to develop their country and render it as advanced as America in the shortest period of time. To this end, they want their workers to earn as high a salary as they will negotiate for them but they do not want all the money to go to the workers lest the inflationary forces be let loose as mentioned before.
Instead, the Vietnamese negotiators want to set up a pay structure whereby the workers will receive a good salary by Vietnamese standard but one that remains competitive with the other emerging economies. In return for the concessions, the negotiators want to see money go into programs that benefit the Vietnamese society as a whole. These programs will be supervised by the Vietnamese government and financed with money collected from the American companies in the form of signing bonuses, royalty payments, taxes et cetera.
The net result is that the Vietnamese will save a large portion of their national income and achieve a high rate of growth which they will sustain year after year as most of the savings will go to improve the infrastructure and perhaps buy a share of the companies that set up in their country. They will also accumulate considerable foreign reserves and show a negligible foreign debt. Consequently, the balance sheet will say that the country is economically comfortable if not wealthy but because consumer spending remains low, the people will look poor. And this is a sign that the country is enduring hard conditions now to build a better future.
The tools that these people use to realize their goal are not mysterious creations but are the familiar exchange rate, tax and interest rates as well as the other economic tools. To understand what the Vietnamese do with these tools, we visualize a fictitious situation whereby two sets of accounting books are set up. Each set mirrors a different economy yet both are meant to reflect the same one.
To see what goes into the first set of books, we imagine transporting the Vietnamese workforce to America and paying the workers American wages and salaries. To this end, I take the most conservative figures available and work out the math. Vietnam has a young population of 80 million people where the participation rate is 30% indicating a workforce of 24 million. The lowest paying job in America being 7 dollars an hour means that, working 2,000 hours a year, the workforce will earn a grand total of 336 billion dollars during the year. I call this the inferred GDP.
This sum represents two thirds of the actual GDP which comes to 504 billion dollars. When it is divided by the population, it yields the per capita income of 6,300 dollars a year or $17.26 a day. And this is a far cry from saying some people in Vietnam live on less than a dollar a day. But there is more to the math because the average wage and salary is in reality at least twice the minimum wage if not more considering the sort of industries they have in Vietnam. So you do the math yourself and figure out what it all means.
So far so good but what is there in the second set of books? Well, this is actually the set that was used before the drive to industrialize had begun. It was a time when a large percentage of the people were subsistence farmers and they spent much of their income to buy the minimum requirement of 2,700 calories of food per day per person.
The country had little that could be exported and there was virtually no demand for its currency. Thus, the amount of Vietnamese money that bought 2,700 calories worth of food on the local market was exchangeable for less than one US dollar even though the same food would have cost 10 dollars or more to buy in America.
But when the country began to industrialize, foreign money was injected into the system and the local currency began to appreciate. Serious distortions resulted in the marketplace and the government intervened to prevent the lucky few from becoming fabulously rich at the expense of the rest who were becoming exceedingly poor. That intervention consisted of separating the internal commerce from the external one, something that necessitated the keeping of two sets of books which in turn gave the economy its two distinct faces.
In taking these measures, the government avoided the emergence of two Vietnams and the inevitable class warfare such as happened in Latin America during the Nineteen Seventies and Eighties. This was a time when a small class of people became fabulously wealthy by aligning themselves with the West against the majority of their compatriots who remained desperately poor. And this was the reason why many in Latin America turned bitter against US values and remained so to this day.
In sum, what goes on with the second set of Vietnamese books is that the internal commerce is treated as if the country had not started to industrialize. Coupled with this is the fact that the government artificially maintains the currency at a worthless level to smooth out the market distortions and maintain social tranquility. It also happens that these measures discourage the imports and encourage the exports, which suits the government just fine.
But the GDP and the per capita income are expressed in terms of the local currency, and those policies make them look small when the currency is converted into dollars. In fact, the conversion says that some people in Vietnam live on less than a dollar a day which we know to be false because the people have the wherewithal to buy more than 2,700 calories a day with half what they earn. Consequently, how do you explain this, ye Vietnamese officials? We don’t explain anything, ye idiotic pundits because your ignorance was never our problem, comes the response.
If anything, this says that when a set up is artificial, the conversion of the currency is a meaningless exercise because it is worse than comparing apples and oranges or comparing one face of the coin with the other face when the two were made differently by design. And this is why a system called Purchasing Power Parity (PPP) was invented to help make a more intelligent comparison between different economies.
There is a way to use that system but the way is not sacrosanct because the system is known to be deficient. Thus, I prefer to use an approach that takes into account the size of the labor force and the kind of industries the country is engaged in. I am convinced this approach paints a better picture of reality than the PPP and hope I succeeded in showing this when calculating the inferred GDP as I did earlier.
In conclusion, it must be resolved that the habit of trying to look smart by being dumb - which is what the mindless repetition of idiotic statements amounts to - shall be abandoned by the writers and the audio-visual talking heads because it screams to the world on behalf of its authors: I am ignorant and so are my editors and publishers.
This puzzlement is understandable given that the mythology is propagated by people of distinction who should know better than to write in prestigious publications or get on radio and television where they repeat nonsense they hear from someone else but are unsure what it means. They are people who do the public a great disservice and must therefore be educated along with their editors and publishers who allow this sort of shoddy work to go unchecked.
As for myself, when asked a question on the subject I respond by telling the questioner that I am not aware the country they talk about has adopted the US dollar as their currency. Oh no, say the questioner, the country has its own currency. So I reply, in this case tell me how much of their currency those individuals earn and how much it costs to live where they reside but do not tell me how many US dollars they do not make because it is irrelevant to them as it is to me and to the discussion. But if you do not have such information, consider what else you know to be trash and stop repeating it. And here is the reason why it is trash:
All economies are double faced as they have been since the first time a border was drawn between two societies. And all economies shall remain double faced for a long time to come because economies follow one set of rules to control their internal commerce and another set to control their external commerce.
To a large extent this dual character determines how economies work but this fact is often overlooked in the public discourses. And the time has come to give the matter a high profile because there is insight to be gained in doing so and because the insight can illuminate as well as answer many of the often asked questions.
What may change a situation that has been the norm since the beginning of time is the emergence of an economy whose citizens are allowed to trade with the other countries free of any restriction. However, if this were to happen to one country, the act itself will not produce a complete reversal of the situation because the citizens of the country will still have to obey the rules of the foreign countries they trade with.
A complete reversal of the situation will come only when two or more countries drop all the rules governing the commerce between them and adopt an identical set of rules at home to govern their internal commerce. When this happens the countries will behave like one market and thus create the single faced economy.
In the meantime, the obligatory prerequisite that two or more countries must achieve before shooting for the single faced economy is to adopt one and the same currency for all. Members of the European Union did this, and Europe is on its way to realizing the dream. When the work is completed, Europe’s achievement will have surpassed that of Canada where it is more difficult to trade between the provinces than with a foreign country even though all the provinces use the same currency.
But what is it that feeds the mythology of people living on less than a dollar a day? The following example provides the answer: Imagine a fictitious scenario unfolding between two countries: America which is developed and Vietnam which is developing. America wants to have unrestricted free trade between the two countries thus requiring the removal of all the rules regulating trade between them. Vietnam, on the other hand, wants to see some rules in place.
To the American way of thinking, Vietnam is a place that is full of untapped natural resources and a population that is yearning to improve its lot. Consequently, American businesses should be allowed to go into Vietnam, extract the resources there and manufacture them either locally, in America or anywhere else depending on the needs of business.
Not so fast, say the Vietnamese, because when you carry on in this manner the few Vietnamese individuals who will be hired to work for the American companies will be paid a lot more than their compatriots. This will boost the rate of inflation to a considerable height and cause the rich to get fabulously richer and the poor to get exceedingly poorer. And the seeds will have been planted for two Vietnams to emerge and be locked in class warfare.
To reconcile the two visions, American and Vietnamese teams start to negotiate a trade protocol, each coming to the table with a set of ideas. The Americans negotiate on behalf of the corporations whose agenda is to do what is good for the shareholders. That is, they want the flexibility to open, to close or to relocate any business facility inside or outside the country. And they want the freedom to hire, to fire or to relocate any employee in accordance with the needs of the business.
The Vietnamese on the other hand want to develop their country and render it as advanced as America in the shortest period of time. To this end, they want their workers to earn as high a salary as they will negotiate for them but they do not want all the money to go to the workers lest the inflationary forces be let loose as mentioned before.
Instead, the Vietnamese negotiators want to set up a pay structure whereby the workers will receive a good salary by Vietnamese standard but one that remains competitive with the other emerging economies. In return for the concessions, the negotiators want to see money go into programs that benefit the Vietnamese society as a whole. These programs will be supervised by the Vietnamese government and financed with money collected from the American companies in the form of signing bonuses, royalty payments, taxes et cetera.
The net result is that the Vietnamese will save a large portion of their national income and achieve a high rate of growth which they will sustain year after year as most of the savings will go to improve the infrastructure and perhaps buy a share of the companies that set up in their country. They will also accumulate considerable foreign reserves and show a negligible foreign debt. Consequently, the balance sheet will say that the country is economically comfortable if not wealthy but because consumer spending remains low, the people will look poor. And this is a sign that the country is enduring hard conditions now to build a better future.
The tools that these people use to realize their goal are not mysterious creations but are the familiar exchange rate, tax and interest rates as well as the other economic tools. To understand what the Vietnamese do with these tools, we visualize a fictitious situation whereby two sets of accounting books are set up. Each set mirrors a different economy yet both are meant to reflect the same one.
To see what goes into the first set of books, we imagine transporting the Vietnamese workforce to America and paying the workers American wages and salaries. To this end, I take the most conservative figures available and work out the math. Vietnam has a young population of 80 million people where the participation rate is 30% indicating a workforce of 24 million. The lowest paying job in America being 7 dollars an hour means that, working 2,000 hours a year, the workforce will earn a grand total of 336 billion dollars during the year. I call this the inferred GDP.
This sum represents two thirds of the actual GDP which comes to 504 billion dollars. When it is divided by the population, it yields the per capita income of 6,300 dollars a year or $17.26 a day. And this is a far cry from saying some people in Vietnam live on less than a dollar a day. But there is more to the math because the average wage and salary is in reality at least twice the minimum wage if not more considering the sort of industries they have in Vietnam. So you do the math yourself and figure out what it all means.
So far so good but what is there in the second set of books? Well, this is actually the set that was used before the drive to industrialize had begun. It was a time when a large percentage of the people were subsistence farmers and they spent much of their income to buy the minimum requirement of 2,700 calories of food per day per person.
The country had little that could be exported and there was virtually no demand for its currency. Thus, the amount of Vietnamese money that bought 2,700 calories worth of food on the local market was exchangeable for less than one US dollar even though the same food would have cost 10 dollars or more to buy in America.
But when the country began to industrialize, foreign money was injected into the system and the local currency began to appreciate. Serious distortions resulted in the marketplace and the government intervened to prevent the lucky few from becoming fabulously rich at the expense of the rest who were becoming exceedingly poor. That intervention consisted of separating the internal commerce from the external one, something that necessitated the keeping of two sets of books which in turn gave the economy its two distinct faces.
In taking these measures, the government avoided the emergence of two Vietnams and the inevitable class warfare such as happened in Latin America during the Nineteen Seventies and Eighties. This was a time when a small class of people became fabulously wealthy by aligning themselves with the West against the majority of their compatriots who remained desperately poor. And this was the reason why many in Latin America turned bitter against US values and remained so to this day.
In sum, what goes on with the second set of Vietnamese books is that the internal commerce is treated as if the country had not started to industrialize. Coupled with this is the fact that the government artificially maintains the currency at a worthless level to smooth out the market distortions and maintain social tranquility. It also happens that these measures discourage the imports and encourage the exports, which suits the government just fine.
But the GDP and the per capita income are expressed in terms of the local currency, and those policies make them look small when the currency is converted into dollars. In fact, the conversion says that some people in Vietnam live on less than a dollar a day which we know to be false because the people have the wherewithal to buy more than 2,700 calories a day with half what they earn. Consequently, how do you explain this, ye Vietnamese officials? We don’t explain anything, ye idiotic pundits because your ignorance was never our problem, comes the response.
If anything, this says that when a set up is artificial, the conversion of the currency is a meaningless exercise because it is worse than comparing apples and oranges or comparing one face of the coin with the other face when the two were made differently by design. And this is why a system called Purchasing Power Parity (PPP) was invented to help make a more intelligent comparison between different economies.
There is a way to use that system but the way is not sacrosanct because the system is known to be deficient. Thus, I prefer to use an approach that takes into account the size of the labor force and the kind of industries the country is engaged in. I am convinced this approach paints a better picture of reality than the PPP and hope I succeeded in showing this when calculating the inferred GDP as I did earlier.
In conclusion, it must be resolved that the habit of trying to look smart by being dumb - which is what the mindless repetition of idiotic statements amounts to - shall be abandoned by the writers and the audio-visual talking heads because it screams to the world on behalf of its authors: I am ignorant and so are my editors and publishers.
Wednesday, May 7, 2008
The Socio-Industrial Strategy For Development
A number of countries in Asia, North Africa and the Middle East have developed and are still developing at a pace that is unprecedented in human history. Understandably this change has stirred up a great deal of emotions ranging from high excitement to bitter consternation both in those countries and in the rest of the World.
Some people in the developing countries are happy for the progress they are making but others are fearful of losing the familiar lifestyle they grew up with. As for the rest of the World, some people see expanded opportunity for trade and commerce while others see a potentially damaging competition rising to challenge them. And the question now is this: How do these countries do it anyway?
Much has been written about the bolts and nuts of the industrial plan that each country has adopted but little was said about the social impact that the phenomenon of rapid industrialization is having on the ordinary people. Even less was said about the three-way interplay between the society, the government and the phenomenon. I try to touch on some aspects of that interplay in this discussion.
When a program of industrialization is adopted in a country and the economy begins to improve, a well documented trend is seen to develop; infant mortality drops, people live longer and all this leads to families becoming larger. Although these are welcome vital signs, the phenomenon itself hurts the economy in two ways. First, it eats up the savings of the family and thus reduces the level of investment. Second, it swells the population of the country and thus keeps the per capita income from rising as high as it can.
Sooner or later the government realizes that the economy has the potential to grow at an annual rate of 10% or more but that the high rate of birth is moderating the growth; and the idea of initiating a program of family planning is studied seriously. This happens when the big wigs in the government are forced to come to grips with the tough choices they have to make.
They see that they could enact a one child policy like it was done in China or they could encourage the practice of vasectomy like it was done in India. However, both of these methods are intrusive measures that quickly became unpopular in those two countries, and they were too difficult to police anyway. Not many big wigs dwelt on these ideas for long.
And because measures such as these are unthinkable in most other countries, especially in the Middle East and North Africa, an alternative crept into the system almost imperceptibly. Here, the economic factor became a method of family planning. All indications are that this alternative did not come by design but came by a process of natural evolution made inevitable by the force of necessity.
The economic factor came out of the notion that when young men and women turn optimistic about the future, they tend to get married and have children early in life. What materialized in response to this trend was a disincentive that reversed the trend. It did so by encouraging the young to put off marriage to a later date. Thus, the young were encouraged to do something against their grain not because the law of the land nudged them to do so but because the law of economics nudged them to do it.
Governments contributed to the achievement of that goal by preventing the wages and salaries from growing fast enough even when the economy improved considerably. Thus, most of the growth in the economy that would have gone toward consumption was collected as taxes and the money utilized to improve the infrastructure of the country.
These measures were relatively easy to implement because they only involved the local scene. But since those emerging economies are not isolated from the rest of the World, other measures were taken with regard to foreign trade. To this end the governments wanted to keep the exchange rate stable and the value of the currency relatively low for as long as possible given that it was inevitable the currency will be taken on a rollercoaster ride.
This movement of the currency happens because when a country begins to export, the currency firms up. But as the middle class begins to form and the people gain confidence that the good times are here to stay, they want to consume some of the goods they do not yet make locally. They import such goods from abroad and when this is added to the demand for machinery and for raw materials, it causes the local currency to drop.
Eventually a point is reached when the country exports more than it imports and the situation is reversed causing the currency to appreciate again. But when this is seen to crimp the export capabilities of the country, the government intervenes to keep the value of the currency low so as to encourage export.
Eventually a set of regulations is put in place to control the situation but the government also takes into account what happens on another front. It is that when the local people become savvy enough to set up businesses that can trade with the rest of the World, the government wants to protect them from competition. But as the businesses grow strong enough to hold their own, the government eases up the support to let foreign competition force an improvement in local productivity and the quality of the products.
In view of all that, the question is this: What does the mix of policies look like that accomplishes those goals? Of course, every country is different from the other and every phase in each country’s development is different from the previous. Thus, there will be variations on the policies that are adopted at various times and various places but they will all have a few things in common as discussed below.
First, whereas the compensation package for labor in the developed countries reaches two thirds of the national income, it scarcely surpasses a quarter of the national income in the developing countries. The difference between the two levels is the sum of money that is utilized to build the infrastructure of the country and to launch the big projects.
Here, the word infrastructure stands for two sets of things. It is the hard structure such as the roads, bridges, hydro and telephone lines, even new cities, and it is the soft structure such as the training of teachers, business managers, engineers and the like. Many of these people are sent abroad to get trained on the most up to date methods of doing things, and many more are trained at home by local teachers and by foreigners who are invited into the country for the job.
Second, the setting up of industries that have the tendency to foster consumerism is at first discouraged in favor of producing the parts and components for such industries. The most notable candidate in this category is the auto industry. The developing countries avoid it at the beginning because cars use too much raw material when they are made and too much energy after they are made.
But the auto industry is so large worldwide that you cannot avoid getting into it if you want to prosper as a nation. Therefore, those countries get into the business of producing parts and components for the industry to use as spare parts locally and to export the rest. This allows the countries to be part of the industry while putting off the assembly of cars until such time they are ready to let the economy grow more by internal consumption than by export.
Third, except for the mortgage lending institutions whose establishment is encouraged especially in the countries where the resources for building material are plentiful, the consumer lending institutions are discouraged from setting up shop. The net effect is that towns which look every bit like an industrial town in the developed World are inhabited by people who must save all the money they will need to buy a big ticket item.
Also, any sense of a foreign insurance company setting up shop in those countries is strongly resisted by the governments because insurance is seen as making money off the fears and misery of the people without contributing one iota to the industrial development of the country.
But when these countries evolve far enough to want an indigenous insurance industry that stands on sound modern practices, they allow a select number of foreign insurance companies to set up shop on their territory. The purpose here is to give their own people the opportunity to acquire hands on experience in the field, something they will use at a later date to expand their nascent industry.
Only then does the capacity of the insurance companies to provide the marketplace with liquidity for investment and for the expansion of the economy is recognized. In the meantime, however, the people go without the protection that a vibrant insurance industry can provide and remain content with whatever protection the government can provide if any.
Fourth, as the economy develops and its requirements evolve in terms of the machinery it needs to continue developing, the country gets into the production of these machines or parts thereof. The government does it by negotiating with the foreign suppliers a deal whereby the technology is transferred and the licenses are granted to the developing country so as to enable it to participate in the production of what it consumes. The same sort of deal is also negotiated where large quantities of consumer items are used by the citizens of the developing country.
In sum, what took the developed countries two centuries to accomplish, the developing countries aim to accomplish in a quarter of the time. A number of them have had such brilliant successes already that no doubt exists the other countries will do as well. And the best thing we can do in the West apart from learning a thing or two from them is to behave in such a way as to be invited to the party when they celebrate.
Some people in the developing countries are happy for the progress they are making but others are fearful of losing the familiar lifestyle they grew up with. As for the rest of the World, some people see expanded opportunity for trade and commerce while others see a potentially damaging competition rising to challenge them. And the question now is this: How do these countries do it anyway?
Much has been written about the bolts and nuts of the industrial plan that each country has adopted but little was said about the social impact that the phenomenon of rapid industrialization is having on the ordinary people. Even less was said about the three-way interplay between the society, the government and the phenomenon. I try to touch on some aspects of that interplay in this discussion.
When a program of industrialization is adopted in a country and the economy begins to improve, a well documented trend is seen to develop; infant mortality drops, people live longer and all this leads to families becoming larger. Although these are welcome vital signs, the phenomenon itself hurts the economy in two ways. First, it eats up the savings of the family and thus reduces the level of investment. Second, it swells the population of the country and thus keeps the per capita income from rising as high as it can.
Sooner or later the government realizes that the economy has the potential to grow at an annual rate of 10% or more but that the high rate of birth is moderating the growth; and the idea of initiating a program of family planning is studied seriously. This happens when the big wigs in the government are forced to come to grips with the tough choices they have to make.
They see that they could enact a one child policy like it was done in China or they could encourage the practice of vasectomy like it was done in India. However, both of these methods are intrusive measures that quickly became unpopular in those two countries, and they were too difficult to police anyway. Not many big wigs dwelt on these ideas for long.
And because measures such as these are unthinkable in most other countries, especially in the Middle East and North Africa, an alternative crept into the system almost imperceptibly. Here, the economic factor became a method of family planning. All indications are that this alternative did not come by design but came by a process of natural evolution made inevitable by the force of necessity.
The economic factor came out of the notion that when young men and women turn optimistic about the future, they tend to get married and have children early in life. What materialized in response to this trend was a disincentive that reversed the trend. It did so by encouraging the young to put off marriage to a later date. Thus, the young were encouraged to do something against their grain not because the law of the land nudged them to do so but because the law of economics nudged them to do it.
Governments contributed to the achievement of that goal by preventing the wages and salaries from growing fast enough even when the economy improved considerably. Thus, most of the growth in the economy that would have gone toward consumption was collected as taxes and the money utilized to improve the infrastructure of the country.
These measures were relatively easy to implement because they only involved the local scene. But since those emerging economies are not isolated from the rest of the World, other measures were taken with regard to foreign trade. To this end the governments wanted to keep the exchange rate stable and the value of the currency relatively low for as long as possible given that it was inevitable the currency will be taken on a rollercoaster ride.
This movement of the currency happens because when a country begins to export, the currency firms up. But as the middle class begins to form and the people gain confidence that the good times are here to stay, they want to consume some of the goods they do not yet make locally. They import such goods from abroad and when this is added to the demand for machinery and for raw materials, it causes the local currency to drop.
Eventually a point is reached when the country exports more than it imports and the situation is reversed causing the currency to appreciate again. But when this is seen to crimp the export capabilities of the country, the government intervenes to keep the value of the currency low so as to encourage export.
Eventually a set of regulations is put in place to control the situation but the government also takes into account what happens on another front. It is that when the local people become savvy enough to set up businesses that can trade with the rest of the World, the government wants to protect them from competition. But as the businesses grow strong enough to hold their own, the government eases up the support to let foreign competition force an improvement in local productivity and the quality of the products.
In view of all that, the question is this: What does the mix of policies look like that accomplishes those goals? Of course, every country is different from the other and every phase in each country’s development is different from the previous. Thus, there will be variations on the policies that are adopted at various times and various places but they will all have a few things in common as discussed below.
First, whereas the compensation package for labor in the developed countries reaches two thirds of the national income, it scarcely surpasses a quarter of the national income in the developing countries. The difference between the two levels is the sum of money that is utilized to build the infrastructure of the country and to launch the big projects.
Here, the word infrastructure stands for two sets of things. It is the hard structure such as the roads, bridges, hydro and telephone lines, even new cities, and it is the soft structure such as the training of teachers, business managers, engineers and the like. Many of these people are sent abroad to get trained on the most up to date methods of doing things, and many more are trained at home by local teachers and by foreigners who are invited into the country for the job.
Second, the setting up of industries that have the tendency to foster consumerism is at first discouraged in favor of producing the parts and components for such industries. The most notable candidate in this category is the auto industry. The developing countries avoid it at the beginning because cars use too much raw material when they are made and too much energy after they are made.
But the auto industry is so large worldwide that you cannot avoid getting into it if you want to prosper as a nation. Therefore, those countries get into the business of producing parts and components for the industry to use as spare parts locally and to export the rest. This allows the countries to be part of the industry while putting off the assembly of cars until such time they are ready to let the economy grow more by internal consumption than by export.
Third, except for the mortgage lending institutions whose establishment is encouraged especially in the countries where the resources for building material are plentiful, the consumer lending institutions are discouraged from setting up shop. The net effect is that towns which look every bit like an industrial town in the developed World are inhabited by people who must save all the money they will need to buy a big ticket item.
Also, any sense of a foreign insurance company setting up shop in those countries is strongly resisted by the governments because insurance is seen as making money off the fears and misery of the people without contributing one iota to the industrial development of the country.
But when these countries evolve far enough to want an indigenous insurance industry that stands on sound modern practices, they allow a select number of foreign insurance companies to set up shop on their territory. The purpose here is to give their own people the opportunity to acquire hands on experience in the field, something they will use at a later date to expand their nascent industry.
Only then does the capacity of the insurance companies to provide the marketplace with liquidity for investment and for the expansion of the economy is recognized. In the meantime, however, the people go without the protection that a vibrant insurance industry can provide and remain content with whatever protection the government can provide if any.
Fourth, as the economy develops and its requirements evolve in terms of the machinery it needs to continue developing, the country gets into the production of these machines or parts thereof. The government does it by negotiating with the foreign suppliers a deal whereby the technology is transferred and the licenses are granted to the developing country so as to enable it to participate in the production of what it consumes. The same sort of deal is also negotiated where large quantities of consumer items are used by the citizens of the developing country.
In sum, what took the developed countries two centuries to accomplish, the developing countries aim to accomplish in a quarter of the time. A number of them have had such brilliant successes already that no doubt exists the other countries will do as well. And the best thing we can do in the West apart from learning a thing or two from them is to behave in such a way as to be invited to the party when they celebrate.
Sunday, May 4, 2008
What We Can Do For Africa
Some people say that the developed countries should give in cash the equivalent of 0.7% of their GDP to the underdeveloped countries. Doing the math for the share of the United States whose GDP approaches 14 trillion dollars, the amount comes to 98 billion dollars. If you add to that the share of the other countries in the developed World, the amount comes close to a quarter of a trillion dollars. And guess what, this is the price of all the food at the farm level that is produced in North America, Europe and Australia put together.
But what else can we do with all that money, anyway? Well, it all depends on what the question means. If you mean to ask what good can we do for the poor people of the World, the answer is nothing because nothing good can come out of a scheme like this. Most of the money will go to the White charlatans who will stand between the treasurers of the donor nations and the Colored charlatans in the recipient nations, and the rest of the money will go to the colored charlatans themselves.
If you are serious about helping sub-Saharan Africa and wish to see it to develop and become like East Asia or North Africa, there is a much better way to approach the task. Tell those countries to come up with a long term plan for development by looking at the plans that were successfully implemented elsewhere, and by adapting them to their own situation. If need be, assist them to draw up the plans or tell them to seek assistance from the United Nations or elsewhere. Plenty of good people around the World will do this sort of work for the sheer pleasure of doing it. It is a creative sort of work and it yields a tremendous amount of satisfaction.
At the same time, form a consortium of the donor countries and assess the capabilities of each country to help in the implementation of those plans. Create a kind of Clearing House whose task will be to match up each project in Africa with a company or an institution in the donor countries that is best suited to carry out the project. And then let it all happen; it is a simple as that.
When China began the drive to industrialize three decades ago, 500 million people participated in the move and the ride has been breathtaking. The other 800 million waited until now to participate and their move, when it comes, will not be less breathtaking. Well, there are 500 million people in sub-Saharan Africa who could benefit from a similar move down there. And if you liked doing business with China, you will love doing business with Africa not for any sentimental reason but for many practical reasons.
First of all, Africa has a lot more natural resources than China; you will not have to run around looking for these resources and bring them to Africa. Second, you will participate directly in the implementation of the projects without having to wait for the Chinese bureaucracy to issue a permit or give the green light or whatever. Third, the money that will be invested to carry out the projects in Africa will be mostly invested in the donor countries, especially during the out years. At the beginning, some cash will go to Africa to launch the process but the little that will go there will do a lot of good because it will pay the local simple folks who will work on the projects.
This is a much better approach than spending nearly 250 billion dollars a year every year for an indefinite period on something that has not worked in the past and will not work in the future because it is a plan that was designed to fail. In fact, nobody who comes up with a plan like this has altruistic motives; these people only work for themselves.
They are people whose hearts bleed for their own bank accounts and whose props are images of the suffering that goes on anywhere. They want to see the suffering continue because replenishing their bank accounts continues to be their only mission. They rip off the World on account of every suffering in the same way that they ripped off the American treasury on account of the Katrina tragedy. If they can do it to their own people and congratulate themselves for being so smart at being so heartless and get away with it, they will do it to anyone anywhere in the World and congratulate themselves no less.
And if they must, these people will use some of the money they rip off their victims to foster unrest, foment revolutions, and start civil and cross-border wars so as to keep the misery going and the cash flowing into their wallets.
My submission, therefore, is to the effect that if you start with Africa on the right footing, there will be no need to help that Continent until it becomes like Dubai. All you need to do is start the process of development, educate enough local people to take over the work as soon as possible and then see your creation sustain itself from that point on. Thus, instead of spending 250 billion dollars every year going nowhere, you will spend 25 billion a year for 10 years and score a brilliant success that will be permanent and become a monument to your generosity.
And that is all it will take to pull sub-Saharan Africa out of its eternal slump. Just consider this, when a country is as poor as these countries are, you can create a super excellent job by local standard with only 5,000 dollars. Thus, in the first year of operation 25 billion dollars will create 5 million jobs that will sustain 5 million families at a level they could not dream of before. This is almost 6% of the total population and almost 15% of the desperately poor in those countries.
These people will work on the infrastructure and on the development of the agricultural and mineral resources that will pay their wages and salaries the following years as they move into the next phase which will be their industrial development. That phase will consist of the installation and the starting up of the industries which will export goods and services made in Africa for payments from the rest of the World not in response to a request for aid but in response to a commercial invoice.
All the work and the raw materials to establish those industries will be supplied by and from local sources but the machinery will be donated by the donor countries. Year after year more sophisticated industries will be established; and after ten years of this sort of effort, most of the countries in sub-Saharan Africa will have reached the point when they will no longer need any assistant.
But the work will not be finished because the sky is still the limit. It is only that the limit will now be one that the Africans themselves will aim for by the power of their imagination and the sweat of their forehead.
But what else can we do with all that money, anyway? Well, it all depends on what the question means. If you mean to ask what good can we do for the poor people of the World, the answer is nothing because nothing good can come out of a scheme like this. Most of the money will go to the White charlatans who will stand between the treasurers of the donor nations and the Colored charlatans in the recipient nations, and the rest of the money will go to the colored charlatans themselves.
If you are serious about helping sub-Saharan Africa and wish to see it to develop and become like East Asia or North Africa, there is a much better way to approach the task. Tell those countries to come up with a long term plan for development by looking at the plans that were successfully implemented elsewhere, and by adapting them to their own situation. If need be, assist them to draw up the plans or tell them to seek assistance from the United Nations or elsewhere. Plenty of good people around the World will do this sort of work for the sheer pleasure of doing it. It is a creative sort of work and it yields a tremendous amount of satisfaction.
At the same time, form a consortium of the donor countries and assess the capabilities of each country to help in the implementation of those plans. Create a kind of Clearing House whose task will be to match up each project in Africa with a company or an institution in the donor countries that is best suited to carry out the project. And then let it all happen; it is a simple as that.
When China began the drive to industrialize three decades ago, 500 million people participated in the move and the ride has been breathtaking. The other 800 million waited until now to participate and their move, when it comes, will not be less breathtaking. Well, there are 500 million people in sub-Saharan Africa who could benefit from a similar move down there. And if you liked doing business with China, you will love doing business with Africa not for any sentimental reason but for many practical reasons.
First of all, Africa has a lot more natural resources than China; you will not have to run around looking for these resources and bring them to Africa. Second, you will participate directly in the implementation of the projects without having to wait for the Chinese bureaucracy to issue a permit or give the green light or whatever. Third, the money that will be invested to carry out the projects in Africa will be mostly invested in the donor countries, especially during the out years. At the beginning, some cash will go to Africa to launch the process but the little that will go there will do a lot of good because it will pay the local simple folks who will work on the projects.
This is a much better approach than spending nearly 250 billion dollars a year every year for an indefinite period on something that has not worked in the past and will not work in the future because it is a plan that was designed to fail. In fact, nobody who comes up with a plan like this has altruistic motives; these people only work for themselves.
They are people whose hearts bleed for their own bank accounts and whose props are images of the suffering that goes on anywhere. They want to see the suffering continue because replenishing their bank accounts continues to be their only mission. They rip off the World on account of every suffering in the same way that they ripped off the American treasury on account of the Katrina tragedy. If they can do it to their own people and congratulate themselves for being so smart at being so heartless and get away with it, they will do it to anyone anywhere in the World and congratulate themselves no less.
And if they must, these people will use some of the money they rip off their victims to foster unrest, foment revolutions, and start civil and cross-border wars so as to keep the misery going and the cash flowing into their wallets.
My submission, therefore, is to the effect that if you start with Africa on the right footing, there will be no need to help that Continent until it becomes like Dubai. All you need to do is start the process of development, educate enough local people to take over the work as soon as possible and then see your creation sustain itself from that point on. Thus, instead of spending 250 billion dollars every year going nowhere, you will spend 25 billion a year for 10 years and score a brilliant success that will be permanent and become a monument to your generosity.
And that is all it will take to pull sub-Saharan Africa out of its eternal slump. Just consider this, when a country is as poor as these countries are, you can create a super excellent job by local standard with only 5,000 dollars. Thus, in the first year of operation 25 billion dollars will create 5 million jobs that will sustain 5 million families at a level they could not dream of before. This is almost 6% of the total population and almost 15% of the desperately poor in those countries.
These people will work on the infrastructure and on the development of the agricultural and mineral resources that will pay their wages and salaries the following years as they move into the next phase which will be their industrial development. That phase will consist of the installation and the starting up of the industries which will export goods and services made in Africa for payments from the rest of the World not in response to a request for aid but in response to a commercial invoice.
All the work and the raw materials to establish those industries will be supplied by and from local sources but the machinery will be donated by the donor countries. Year after year more sophisticated industries will be established; and after ten years of this sort of effort, most of the countries in sub-Saharan Africa will have reached the point when they will no longer need any assistant.
But the work will not be finished because the sky is still the limit. It is only that the limit will now be one that the Africans themselves will aim for by the power of their imagination and the sweat of their forehead.
Tuesday, April 29, 2008
How To Avoid Hyperinflation (Part 2 of 2)
The Gross Domestic Product (GDP) is a measure of the economic activity in a country. Because in modern times innovation has become a permanent feature of the economy, the latter must always expand to keep unemployment from rising. And when the economy expands, the GDP shows a growth which we express as a percentage.
But what is it that causes an economy to grow in the first place? Well, the way things are concocted now - as they have been for decades - is that the money supply is made to increase. It is done in one of two ways or a combination of the two. They are the use of the fiscal tool and/or the monetary tool to stimulate the economy.
The fiscal stimulus takes the form of the lowering of taxes or the outright handing of money to the citizens by the government. As for the monetary stimulus, it takes the form of the lowering of the interest rate by the central bank. This encourages the businesses to borrow and produce more goods and services, and encourages the public to borrow and buy those extra goods and services.
But when you think about it, you realize that the availability of more money in the system is really not the cause for the increased business activity or the resulting economic expansion; the mood of the public and its level of confidence are. The money is only the means by which the level of confidence is raised, the mood is elevated and business is nudged. If this theory is correct, it gives rise to an interesting question which is this: Can we have an expansion that is not predicated on injecting extra money into the economy?
In my opinion the answer is yes, and I show why with this example. If a new product or service hits the market and gains popularity, and if the public clamors to buy it but the government and the central bank refrain from injecting extra cash into the economy, the business activity surrounding that product or service will still pick up.
To make this possible, something happens automatically in the economy which compensates for the lack of infusion of money; the existing supply circulates at a faster rate. The evidence that this is happening is seen in the bank transactions where the cash flow in the current accounts rises significantly, the demand for loans rises at a slower rate and the savings rise at an even slower rate.
These measurements will have to be recognized as a more accurate indicator that money is exchanging hands at a higher velocity than would be indicated by the equation MV = PQ which is increasingly coming under criticism due to the ongoing crisis related to the collapse of the housing market.
What all this means is that we can now decouple the fiscal tool from the monetary tool and not be bound to think of both as if they were inseparable twins. More than that, we should be able to use one tool to do one thing, use the other tool to do another thing and do them both at the same time even though they may look like two contradictory activities.
Let us now do a thought experiment. Assume we lower the interest rate to stimulate the economy artificially. The resulting regime of easy money will encourage the existing businesses to expand and will prompt a few people to start new businesses. This will add to the production of goods and services and thus help expand the economy.
But not every one of these ideas will deserve to stay alive for the long haul. And in fact, the mere presence of shaky businesses in the system has always been instrumental in feeding the inflationary pressures that develop into a bubble. These businesses stay alive only because the high tide of inflation lifts all boats and in return they nurture the high tide.
If nothing is done to remedy the situation, those ideas will linger on as long as money is easy to have. So we face a dilemma; if we change the easy money regime we kill the expansion of the economy, but if we do not change the regime, the inflation or the bubble will damage the economy and kill the expansion. What do we do?
Faced with a similar situation in the past, the decision has been to fine-tune the economy but this course of action, if it worked at all, worked for a short period of time after which the economy inflated. So the question now is this: Can we find a way to have it both ways? That is, can we maintain the economy in the expansion mode more or less indefinitely and still avoid the inflationary pressures and the dreaded bubble?
I believe there is a way. By mentally decoupling the two stimuli as we have, we created a new tool that can help us achieve that goal. What we do is keep the interest rate low but raise the taxes either selectively or across the board. The rationale is this. The low interest rate will encourage entrepreneurs to come up with new ideas and realize them, and it will encourage the public to consume the fruits of those ideas.
But if any of these ideas are shaky, the high taxes will not allow them to survive longer than they should. This course of action, though painful at first, will prevent inflation from spreading and will maintain the economy in the expansion mode. New business activities will come into existence where new businesses will be incubated to replace the dying ones.
The principle around which this approach must be designed is that the money supply should remain steady or grow at no more than 3% a year as suggested by Milton Friedman. Thus, the government will have to watch the growth of the money supply and adjust the taxes to siphon off at one end of the pipeline the extra money that goes into it at the other end due to the low interest rate.
And because the money supply will remain more or less steady, money will automatically circulate faster and thus maintain the economy in a state of expansion. The net result will be that we will have it both ways; the expansion we want without the inflation we dread.
There is now the question of what to do with the money collected through the extra taxes. I here presume that the government will be enjoying a budget surplus in which case three priorities should be set up. The first is to pay the foreign debt. The second is to pay the local debt. And the third is to destroy the rest of the money.
That last point is based on the notion that there should be no money floating out there which is not someone’s debt that is backed by an asset equivalent to its value or better. And we will know this point has been reached when the destruction of the money begins to raise the value of the currency. And this will happen because the removal of money from circulation will have the same effect as a company buying back its own shares on the stock market.
And this is why the destruction of the extra money should be set as the last priority lest you pay the debt with a high valued currency.
But what is it that causes an economy to grow in the first place? Well, the way things are concocted now - as they have been for decades - is that the money supply is made to increase. It is done in one of two ways or a combination of the two. They are the use of the fiscal tool and/or the monetary tool to stimulate the economy.
The fiscal stimulus takes the form of the lowering of taxes or the outright handing of money to the citizens by the government. As for the monetary stimulus, it takes the form of the lowering of the interest rate by the central bank. This encourages the businesses to borrow and produce more goods and services, and encourages the public to borrow and buy those extra goods and services.
But when you think about it, you realize that the availability of more money in the system is really not the cause for the increased business activity or the resulting economic expansion; the mood of the public and its level of confidence are. The money is only the means by which the level of confidence is raised, the mood is elevated and business is nudged. If this theory is correct, it gives rise to an interesting question which is this: Can we have an expansion that is not predicated on injecting extra money into the economy?
In my opinion the answer is yes, and I show why with this example. If a new product or service hits the market and gains popularity, and if the public clamors to buy it but the government and the central bank refrain from injecting extra cash into the economy, the business activity surrounding that product or service will still pick up.
To make this possible, something happens automatically in the economy which compensates for the lack of infusion of money; the existing supply circulates at a faster rate. The evidence that this is happening is seen in the bank transactions where the cash flow in the current accounts rises significantly, the demand for loans rises at a slower rate and the savings rise at an even slower rate.
These measurements will have to be recognized as a more accurate indicator that money is exchanging hands at a higher velocity than would be indicated by the equation MV = PQ which is increasingly coming under criticism due to the ongoing crisis related to the collapse of the housing market.
What all this means is that we can now decouple the fiscal tool from the monetary tool and not be bound to think of both as if they were inseparable twins. More than that, we should be able to use one tool to do one thing, use the other tool to do another thing and do them both at the same time even though they may look like two contradictory activities.
Let us now do a thought experiment. Assume we lower the interest rate to stimulate the economy artificially. The resulting regime of easy money will encourage the existing businesses to expand and will prompt a few people to start new businesses. This will add to the production of goods and services and thus help expand the economy.
But not every one of these ideas will deserve to stay alive for the long haul. And in fact, the mere presence of shaky businesses in the system has always been instrumental in feeding the inflationary pressures that develop into a bubble. These businesses stay alive only because the high tide of inflation lifts all boats and in return they nurture the high tide.
If nothing is done to remedy the situation, those ideas will linger on as long as money is easy to have. So we face a dilemma; if we change the easy money regime we kill the expansion of the economy, but if we do not change the regime, the inflation or the bubble will damage the economy and kill the expansion. What do we do?
Faced with a similar situation in the past, the decision has been to fine-tune the economy but this course of action, if it worked at all, worked for a short period of time after which the economy inflated. So the question now is this: Can we find a way to have it both ways? That is, can we maintain the economy in the expansion mode more or less indefinitely and still avoid the inflationary pressures and the dreaded bubble?
I believe there is a way. By mentally decoupling the two stimuli as we have, we created a new tool that can help us achieve that goal. What we do is keep the interest rate low but raise the taxes either selectively or across the board. The rationale is this. The low interest rate will encourage entrepreneurs to come up with new ideas and realize them, and it will encourage the public to consume the fruits of those ideas.
But if any of these ideas are shaky, the high taxes will not allow them to survive longer than they should. This course of action, though painful at first, will prevent inflation from spreading and will maintain the economy in the expansion mode. New business activities will come into existence where new businesses will be incubated to replace the dying ones.
The principle around which this approach must be designed is that the money supply should remain steady or grow at no more than 3% a year as suggested by Milton Friedman. Thus, the government will have to watch the growth of the money supply and adjust the taxes to siphon off at one end of the pipeline the extra money that goes into it at the other end due to the low interest rate.
And because the money supply will remain more or less steady, money will automatically circulate faster and thus maintain the economy in a state of expansion. The net result will be that we will have it both ways; the expansion we want without the inflation we dread.
There is now the question of what to do with the money collected through the extra taxes. I here presume that the government will be enjoying a budget surplus in which case three priorities should be set up. The first is to pay the foreign debt. The second is to pay the local debt. And the third is to destroy the rest of the money.
That last point is based on the notion that there should be no money floating out there which is not someone’s debt that is backed by an asset equivalent to its value or better. And we will know this point has been reached when the destruction of the money begins to raise the value of the currency. And this will happen because the removal of money from circulation will have the same effect as a company buying back its own shares on the stock market.
And this is why the destruction of the extra money should be set as the last priority lest you pay the debt with a high valued currency.
Sunday, April 27, 2008
How To Avoid Hyperinflation (Part 1 of 2)
Why inflation happens to an economy is a phenomenon that is often discussed in the public discourses but very little is said about hyperinflation This happens perhaps because the latter is a scarier thing and it has not happened to us yet even though we came close to it in the Nineteen Seventies. But hyperinflation is nothing more than a galloping inflation that gets out of hand and goes high in a short period of time. It can happen to anyone so let us look at the subject from a fresh angle.
People toss around the saying: “All money is borrowed money” without thinking much what it means yet the reality is that the saying describes how an economy works. The trouble is that it is impossible to give much detail while discussing a large and modern economy. Thus, a better approach would be to imagine an island populated by say, 10,000 people who live in a simple, almost primitive economy. However, these people will have to be modern because, when all is said and done, their activities will have parodied a modern economy.
The island has a central bank where every morning business people go to borrow the money they will need for the day. They hire people to work for them and pay wages and salaries with the borrowed money. They also pay themselves what they call profit. At the end of the day, wealth will have been created in the form of food to eat, clothes to wear, homes to shelter from the elements, furniture for the homes, agricultural implements, and a host of services such as education, medical care, entertainment and so on.
Before heading home at the end of the day, the workers use all the money they receive; and the business people use all the profit they make to buy the products and services that were produced in that day. In theory, every business that borrowed money should have the same amount come back to it at the end of the day, and the money is then returned to the bank.
The next day the people of the island go through the cycle again in that they borrow the money, create the wealth and return the money to the bank. Some of the wealth they create will be non durable goods and they will consume it in a relatively short period of time; some will be durable goods and they will keep using it for two years or longer.
Let us now ask a simple question: What happens if a businessman borrowed money to make pottery but an accident occurs and the pottery is destroyed after he pays the workers but before he delivers the goods to his clients? The answer is that he will have no money to return to the bank because the money will now be in circulation where it will remain for ever.
But a new situation will have been created where the total amount of goods and services on the island has diminished by a value equal to the price of the pottery. And because at the end of the day all the available money will be spent on buying all the remaining goods and services, prices will rise across the board. This is inflation.
Stripped to its essence, this is how an economy that is based on paper money works. But of course things will be more complicated in a real economy even on that primitive island. To begin with, not every undertaking can be started and finished the same day, therefore workers and business people will have to keep some of the money for more than a day. Because of this reason and a few other ones, the principle of paying interest on borrowed money will have to be introduced.
There is also the fact that in a large economy the central bank cannot deal directly with all the business people who will want to use its services. Thus, another industry called financial services will have to be added to the sector. It will comprise the commercial or chartered banks and the other lending institutions which will stand as “middleman” between the central bank on one hand and the public and business people on the other. These institutions will borrow money at a certain rate of interest from the central bank and lend it at a higher rate to their clients.
The institutions will also accept deposits from their clients. At the end of the day each branch may show a surplus or a deficit, or it may break even in the sense that it will have lent as much money as came to it in the form of deposits. By law the banks that show a deficit must borrow overnight money from another bank that happens to have a surplus or from the lender of last resort which is the central bank. In this, the modern operation of a bank mimics what we had on the island when the money was returned to the central bank at the end of each day.
Still, there is a difference between the two in the sense that we now have a set up that will be conducive to unleashing the forces of hyperinflation. The reasons why this can happen are many, so let me discuss a few.
First, when you have a large and complex economy you need a government of civil servants to run the country. You also have large pools of workers in the same profession who may be members of the same union. If as a result of a persistent inflation the civil servants or one of the unions demand and receive an increase in salary, they may trigger a vicious cycle.
This will happen because an increase in wages for one party will aggravate the inflation which may prompt another party to demand a pay hike which will further aggravate the inflation and prompt still another party to demand a pay hike and so on. A galloping inflation may result and get out of hand to become a hyperinflation.
Second, because there is a relationship between growth of the money supply and growth in the size of the economy, a persistent inflation can lead to shortages in the labor market or the commodities market. By the law of supply and demand, this too can lead to a galloping inflation and the eventual hyperinflation.
Third, when a lending institution becomes too greedy, it borrows from the central bank and lends more than it should thus increasing the money supply more than is warranted. While this will look healthy in the short run in that it will stimulate the economy, it may start a bubble that feeds on itself and grow to a dangerous level. This is triggered when the other lending institutions jump into the act for fear of being left behind and do the same thing.
Eventually the bubble will burst and the institutions will be left holding IOUs whose real value will be close to worthless. They will cease to lend to each other fearing they may never get their money back and will curtail their lending to the public as a result. This situation creates a credit crunch in an economy whose lifeblood is credit.
To ease the problem, the central bank will swap the dubious loan portfolios at the lending institutions with cash or with the near excellent securities it keeps in its own vault. The justification the bank will give for doing this is that the measure will be temporary, meant to last only until the institutions get back on their feet at which time the swaps will be reversed.
But if the situation with the credit crunch is not reversed soon enough and the institutions start to go belly up, the money will never be returned to the central bank. In this case, we shall have a situation analogous to the pottery accident on the island when the money was not returned to the bank but remain in circulation for ever. The situation will also be akin to the printing of money such as it happened in a number of countries since the invention of paper money.
And this, in my opinion, can be the trigger to ignite a wild inflation and gallop to become a hyperinflation. How to avoid it is the subject of the next article.
People toss around the saying: “All money is borrowed money” without thinking much what it means yet the reality is that the saying describes how an economy works. The trouble is that it is impossible to give much detail while discussing a large and modern economy. Thus, a better approach would be to imagine an island populated by say, 10,000 people who live in a simple, almost primitive economy. However, these people will have to be modern because, when all is said and done, their activities will have parodied a modern economy.
The island has a central bank where every morning business people go to borrow the money they will need for the day. They hire people to work for them and pay wages and salaries with the borrowed money. They also pay themselves what they call profit. At the end of the day, wealth will have been created in the form of food to eat, clothes to wear, homes to shelter from the elements, furniture for the homes, agricultural implements, and a host of services such as education, medical care, entertainment and so on.
Before heading home at the end of the day, the workers use all the money they receive; and the business people use all the profit they make to buy the products and services that were produced in that day. In theory, every business that borrowed money should have the same amount come back to it at the end of the day, and the money is then returned to the bank.
The next day the people of the island go through the cycle again in that they borrow the money, create the wealth and return the money to the bank. Some of the wealth they create will be non durable goods and they will consume it in a relatively short period of time; some will be durable goods and they will keep using it for two years or longer.
Let us now ask a simple question: What happens if a businessman borrowed money to make pottery but an accident occurs and the pottery is destroyed after he pays the workers but before he delivers the goods to his clients? The answer is that he will have no money to return to the bank because the money will now be in circulation where it will remain for ever.
But a new situation will have been created where the total amount of goods and services on the island has diminished by a value equal to the price of the pottery. And because at the end of the day all the available money will be spent on buying all the remaining goods and services, prices will rise across the board. This is inflation.
Stripped to its essence, this is how an economy that is based on paper money works. But of course things will be more complicated in a real economy even on that primitive island. To begin with, not every undertaking can be started and finished the same day, therefore workers and business people will have to keep some of the money for more than a day. Because of this reason and a few other ones, the principle of paying interest on borrowed money will have to be introduced.
There is also the fact that in a large economy the central bank cannot deal directly with all the business people who will want to use its services. Thus, another industry called financial services will have to be added to the sector. It will comprise the commercial or chartered banks and the other lending institutions which will stand as “middleman” between the central bank on one hand and the public and business people on the other. These institutions will borrow money at a certain rate of interest from the central bank and lend it at a higher rate to their clients.
The institutions will also accept deposits from their clients. At the end of the day each branch may show a surplus or a deficit, or it may break even in the sense that it will have lent as much money as came to it in the form of deposits. By law the banks that show a deficit must borrow overnight money from another bank that happens to have a surplus or from the lender of last resort which is the central bank. In this, the modern operation of a bank mimics what we had on the island when the money was returned to the central bank at the end of each day.
Still, there is a difference between the two in the sense that we now have a set up that will be conducive to unleashing the forces of hyperinflation. The reasons why this can happen are many, so let me discuss a few.
First, when you have a large and complex economy you need a government of civil servants to run the country. You also have large pools of workers in the same profession who may be members of the same union. If as a result of a persistent inflation the civil servants or one of the unions demand and receive an increase in salary, they may trigger a vicious cycle.
This will happen because an increase in wages for one party will aggravate the inflation which may prompt another party to demand a pay hike which will further aggravate the inflation and prompt still another party to demand a pay hike and so on. A galloping inflation may result and get out of hand to become a hyperinflation.
Second, because there is a relationship between growth of the money supply and growth in the size of the economy, a persistent inflation can lead to shortages in the labor market or the commodities market. By the law of supply and demand, this too can lead to a galloping inflation and the eventual hyperinflation.
Third, when a lending institution becomes too greedy, it borrows from the central bank and lends more than it should thus increasing the money supply more than is warranted. While this will look healthy in the short run in that it will stimulate the economy, it may start a bubble that feeds on itself and grow to a dangerous level. This is triggered when the other lending institutions jump into the act for fear of being left behind and do the same thing.
Eventually the bubble will burst and the institutions will be left holding IOUs whose real value will be close to worthless. They will cease to lend to each other fearing they may never get their money back and will curtail their lending to the public as a result. This situation creates a credit crunch in an economy whose lifeblood is credit.
To ease the problem, the central bank will swap the dubious loan portfolios at the lending institutions with cash or with the near excellent securities it keeps in its own vault. The justification the bank will give for doing this is that the measure will be temporary, meant to last only until the institutions get back on their feet at which time the swaps will be reversed.
But if the situation with the credit crunch is not reversed soon enough and the institutions start to go belly up, the money will never be returned to the central bank. In this case, we shall have a situation analogous to the pottery accident on the island when the money was not returned to the bank but remain in circulation for ever. The situation will also be akin to the printing of money such as it happened in a number of countries since the invention of paper money.
And this, in my opinion, can be the trigger to ignite a wild inflation and gallop to become a hyperinflation. How to avoid it is the subject of the next article.
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