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4: Global shocks: oil prices

4: Global shocks: oil prices. Overview. Global shocks and responses Oil price World economic growth Real interest rates Indonesia’s “other” D.D. Philippine currency crisis. The resource wealth paradox.

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4: Global shocks: oil prices

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  1. 4: Global shocks: oil prices

  2. Overview • Global shocks and responses • Oil price • World economic growth • Real interest rates • Indonesia’s “other” D.D. • Philippine currency crisis

  3. The resource wealth paradox • “Since the second world war it has become quite clear that rapid economic growth is available to those countries with adequate natural resources which make the effort to achieve it.” • W.A. Lewis 1968, Some Aspects of Economic Development: ix • “Incentives to create wealth sometimes get blunted by the ability to extract wealth from the soil or the sea. Rich parents sometimes spoil their kids; Mother Nature is no exception.” • J. Sachs and A. Warner 2001: “The curse of natural resources”, Eur. Econ. Rev. • “You can’t build ships by selling fish” • B.J. Habibie, Indonesian minister for science & technology (1997)

  4. The resource curse hypothesis • Sachs and Warner: countries with abundant natural resource wealth grow more slowly • Dutch disease: non-resource tradable sectors don’t grow as fast • NR-rich econs don’t invest in renewable assets (capital, education) • Returns to human capital investments are likely to be low • E.g. Thailand’s low secondary enrollment rates • Resource wealth may promote inefficiency and corruption • Commodity price instability may reduce investment efficiency • Puzzle: why are major SE Asian countries exceptions to the Sachs-Warner story?

  5. Reasons for the SE Asian difference?

  6. Model: resource exports and Dutch Disease • Traded (T) and non-traded (N) goods in a ‘small’ economy • Assume traded goods enter domestic market at (given) world price • Global demand (exports) or supply (imports) infinitely elastic • Non-traded goods: domestic market clears; price is endogenous • Assume 3 sectors: • T = Traditional exports and import-competing sectors • N = non-traded services; demand is highly income-elastic • Labor is mobile among all sectors • Real exchange rate RER = pN/pT = pN/EpT* , where pT* are world prices (in $) and E = Rp/$ • Ex. 1: nominal exch rate appreciation (fewer Rp per $) real appreciation, or a rise in RER. • Ex. 2: Rise in pN also  real appreciation

  7. Salter-Swan diagram Traded goods A u(T, N) RER Nontraded (services) • All traded goods aggregated on vertical axis • All non-traded goods on horizontal axis • Cannot trade N goods, so eq’m at A: production = consumption • RER = pN/pTthat clears domestic markets and trade

  8. Resource movement effect of a boom Traded goods T1 T0 B C A RER1 RER0 Nontraded (services) N1N0 • Resource boom moves PPF out in direction of T only • Assume (for now) that demand for N remains constant at N0 • At initial prices (RER0), move to B: but excess demand for N • Adjustment requires a real appreciation to RER1 , i.e. pN/pTrises

  9. Income effect of a boom Traded goods B RER2 C D Income exp. path for RER0 A RER0 Nontraded (services) N1N0 N2 • The boom generates new income for consumers • Assume demand for N is income-elastic (grows along inc. exp. path) • At initial prices (RER0), move to D, but excess demand for N • Adjustment requires another real appreciation toward RER2

  10. Summary: the story so far • The ‘boom’ in one tradable sector (say, oil) has supply and demand side effects on the rest of the economy • Supply side: resources (e.g. labor) pulled in from other sectors, incl. non-tradables • To sustain N production equal to demand, their price must rise • Demand side: boom creates new income, and some (all) is spent back into economy. • Spending on N raises their price • Two sources of real exchange rate appreciation • What do these price changes, and associated reallocation of productive resources, mean for the rest of the economy? • Implications for growth, econ. structure, income dist?

  11. Effect of the boom in the labor market d w2 c w1 LN1 a w0 LT1 LM LN0 LT0 0N L0LM0 0T • Measure N sector employment from 0N, T sector emp. from 0T • Initial labor market equilibrium at (L0, w0) = full employment • Resource boom increases jobs in resource sector, moves LT to LT1 and wage to w1 • Spending effect increases jobs in N to LN1, raises wage to w2. ? What happens to M sector employment (and thus output)?

  12. Resource boom and Dutch disease • In an economy producing resources, manufactures and services, a ‘boom’ (discovery of new resources): • Raises output of resource sector and reduces output of both other sectors through competition for labor, which raises wages … … and leads to excess demand for services, which produces a real appreciation … … which diminishes output gain in resources sector and further reduces jobs and output in manufacturing. • The spending of new income created by the boom: • Raises demand for all goods, including services, which leads to a further real appreciation and wage rise … … which once again reduces jobs and output in manufacturing

  13. More on resource booms • Sector described as ‘manufacturing’ could instead be traded agriculture (hence ‘deagriculturalization’), or both • Technical progress such as green revolution can also be a source of a ‘boom’ • ‘Enclave’ sectors (e.g. oil) may have little or no factor market impact -- but income (spending) effect may be very large

  14. The OPEC oil price booms • OPEC oil price rises (1973 and 1978-80) raised Indonesia’s terms of trade with rest of world.

  15. The OPEC oil price booms • Big income effects: • Indon. GDP up by ~15% in OPEC I, and ~20% in OPEC II

  16. Indonesia’s “other” Dutch disease • Big real exchange rate effects (domestic inflation):

  17. Indonesia’s “other” Dutch disease • Big structural change effects… but a puzzle too * Why did manufacturing output not decline as predicted?

  18. How Indonesia avoided Dutch disease • Increased protection for industry • Nominal devaluations to offset inflationary effects of real appreciation: 1978, 1983, 1986 • Support for other tradable sectors, especially agriculture: • Infrastructure investments -- irrigation, roads, market facilities • Capital market investments -- rural credit • Human capital investments in rural areas (health & nutrition, education) • Agricultural R&D investments-- new rice research • Land colonization (transmigration programs) to maintain labor productivity * These measures also reduced poverty and rural-urban inequality-- and so built political support for Suharto regime

  19. Policy implications of Dutch disease • If the ‘boom’ is permanent, change in economic structure should not present a policy dilemma • But for a temporary change, possible problems: • If structural change is costly (transactions costs) • If some sectors or industries suffer irreversible changes (e.g. go out of existence) • Moreover, deindustrialization could be a problem: • If industry sectors exhibit positive externalities, e.g. from increasing returns to scale, or learning by doing, or inter-industry productivity spillovers • Foreign exchange windfalls can be ‘sterilized’ by saving them as foreign assets rather than spending them in domestic economy • But political costs of this strategy

  20. Other examples of Dutch Disease in SE Asia • Your thoughts?

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