As published in Dawn on July 27th, 2012.

There has been lots of talk lately of Pakistan’s massive and largely untapped mineral potential. More specifically, Imran Khan, chairman of the Pakistan Tehreek-e-Insaf, has hinted at various rallies and forums that Pakistan’s future economic growth could be fueled by a natural resource boom supported by foreign direct investment. Pakistan boasts the world’s 5th largest reserve of coal along with substantial reserves of copper, zinc, lead, and aluminum. Dr. Shaukat Hameed Khan, a former physicist at the Pakistan Atomic Energy Commission, maintains that Pakistan’s copper reserves alone are large enough to restructure Pakistan from a cotton-producing economy to a copper-producing one. Therefore, as Pakistan looks to increase its natural resource exploitation, the country that it should closely monitor is Mongolia – which has mastered the strategy of mining-led growth.

Mining has propelled the land of Genghis Khan and nomadic herders to be one of the fastest growing economies in the world. While mining in Pakistan accounts for a meager 2.4 per cent of the GDP as of 2011, in Mongolia, mining is almost 16 per cent of the GDP. Mongolia’s vast deposits of coal, copper and gold has led an investment boom in mining, driving economic growth to an unprecedented 17 per cent last year. While China and India are suffering from growth fatigue and economic overheating, Mongolia could see the size of its economy double every three or four years. The chart below illustrates Mongolia’s economic growth relative to other emerging economies, including Pakistan.

Data: IMF

Mongolia’s economic growth is primarily attributed to a surge in foreign direct investment (FDI). The net FDI inflows reached about $1.5 billion in 2010, increasing threefold from previous year. Below are Mongolia’s net FDI inflows from the year 2000 onwards.

Data: World Bank

Though the nature of the boom is primarily capital-intensive, it has provided employment opportunities for Mongolian workers. This has motivated more and more people to flock to the mine-rich area of the Gobi desert in search of jobs.

But there is one worry which keeps economists and policymakers awake at night. The natural resource boom is prone to what is referred to as the “Dutch disease” in economic lexicon. The increase in the exploitation of natural resource base leads to a decline in sectors like manufacturing and agriculture. In other words, a natural resource boom causes a rise in demand for the currency of the resource-rich country. The subsequent appreciation of the exchange rates makes exports more expensive, and it becomes difficult for other sectors to compete domestically and abroad. The result, of course is the perpetual shrinkage of the manufacturing and agriculture sectors. There are ways to mitigate the impact of the Dutch disease. The most common method is to deposit the earnings from the sale of natural resources to an offshore investment fund, known as a sovereign wealth fund. This would limit the amount of foreign currency inflows into the country. The interest earned on the sovereign wealth fund could then be repatriated and spent in the annual budget.

The long-run sustainability of the Mongolian economy rests largely on how Mongolia addresses and deals with its policy challenges. This would dictate whether Mongolia could actually become the Saudi Arabia of north Asia. However, the more important question here is if Pakistan could imitate Mongolia with equal, if not greater, success. Unlike Mongolia, the challenges facing Pakistan are many and multipolar in nature. But the most immediate issue is the lack of internal stability, actuated by armed conflicts and rampant corruption. Pakistan needs to address its internal security and bureaucratic bottlenecks to permit the expansion of natural resource exploitation and attract more foreign investment. The mining sector can no longer be afforded to be kept at the periphery. We need careful road-mapping to insure that mining contributes its fair share to the future economy. There is no reason to believe that Pakistan cannot be the next Mongolia (or better) of south Asia.


Should states offer debt relief to their poor farmers?

A new paper from Martin Kanz tries to test the long run impact of the debt relief program in India for small and marginal farmers- and the results offer a cautionary tale. Here’s a sneak peek into the findings:

Debt relief leads to short run improvements for the recipient households, however they tend to accumulate new debt fairly quickly after the settlement.

It doesn’t lead to investment and productivity gains for the recipient households.

Finally, the debt relief doesn’t improve recipient households’ access to bank credit lines.

The full paper is here.

Why fossil-fuel subsidies should be phased out

In recent weeks I have come across seminal literature on how the elimination of fossil-fuel subsidies are a relatively low-tech free-market solution to tackle global warming. The elimination of fuel subsidies is projected to curb fuel use and lead to the emissions cut necessary to avert a 2 Celsius rise in global temperature.

Source: International Energy Agency / Click the map for the larger version.

However there is another silver lining in phasing out these subsidies. The fossil-fuel subsidies tend to be incredibly regressive- considering that most of these subsidy programs are intended as poverty reducing measures. According to IMF estimates of 2010, 65% of total fuel subsidies benefit the richest 40% of households in developing countries. Only 8% of subsidies went to the poorest 20% of the population.  These statistics clearly indicate an inequitable distribution of subsidy benefits. Fossil-fuel subsidies are also a tremendous strain on public budgets. For instance, in countries like Pakistan and India, large proportion of these subsidies are actually debt-financed. Further, the periodic upward revisions of the international fuel prices forces these governments to plow even more money into subsidies to keep pace with the global oil market. In a report last year, International Energy Agency (IEA) found that the rise fuel subsidies closely tracked the rise in international fuel prices. So a gradual drawdown of these unsustainable fuel subsidy programs would not only avoid unintended distributional consequences but relieve budget pressures.

A proportion of the budgetary savings could then be used to make compensatory payments to lower-income households. The qualified households could use these payments to purchase fuel or petroleum products. Similar payments or tax credits would also need to be offered to relevant businesses to ameliorate the possible food price inflation that might result as a consequence of the rise in transportation and shipping costs.

Model predicts global food price hike!

New England Complex Systems Institute (NECSI) released a new report boasting their food price model. The institute – using mathematical modeling – issued a report last year detailing that a rise in US ethanol consumption in conjunction with financial speculation explained the uptick in food prices during 2007-8 and 2010-11. Their new report extends the model to January 2012 and confirms the predictive validity of the food price model.

Source: NECSI

With this new development, I think it is reasonable to identify bio-fuels expansion and price volatility due to financial speculation as a major source of the global food crisis. For them to go unabated would mean a contiguous and constrained food supply, and in effect a secular rise in food prices- not considering environmental shocks (i.e. floods) that might drop in during June-September 2012.

Complete report found here.

Does austerity leads to violence?

In the wake of the shocking riots in Britain, I’ve come across a very instructive CEPR paper which attempts to explore the historical causation between extreme fiscal tightening and social unrest.

Here is an abstract of the paper:

Does fiscal consolidation lead to social unrest? From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble cross-country evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor. We also analyze interactions with various economic and political variables. While autocracies and democracies show a broadly similar responses to budget cuts, countries with more constraints on the executive are less likely to see unrest as a result of austerity measures. Growing media penetration does not lead to a stronger effect of cut-backs on the level of unrest.

Read the full paper here.

The Debt Paranoia!

It is astonishing to me how the carnage in the stock market this past week was completely misrepresented and misattributed to the debt downgrade by the S&P. There is a critical distinction that is being missed by the pundits on CNBC and other business networks. The reaction of the stock market earlier this week was NOT due to the concerns about the US solvency but more about the economy’s poor growth-prospects.

US 10-Year Bond Yield

Just to recap a bit: S&P downgraded the US bond rating- raising doubts about the credit worthiness of the country. However, rather than shedding US bonds, investors are crowding into US debt. This sudden rise in the appetite for the US debt has drove down the 10-year treasury interest rate to 2.24 percent (the higher the demand for bonds, the lower the interest rates on them). This indicates the markets’ complete repudiation of the diagnosis offered by the S&P. For the investors, the US remains a safe haven for their investments.

So, the real worry in the market is not the US’s inability to service and payoff its debt, but rather the pockets of stress that remain in the economy. The shortfalls in private investment and aggregate demand, anemic job-growth, stress in the housing market, etc. continue to impair the growth potential of the economy. Until we successfully ameliorate these problems, the stock market would remain volatile and extremely sensitive to the news headlines.

Italian 10-Year Bond Yield

Spanish 10-Year Bond Yield

So, why is the US 10-year rate at a record low despite the downgrade? One word: Europe. The sovereign debt contagion has spread from the periphery economies like Greece, Portugal, etc. to major economies like Italy and Spain. Above are the 10-year rates on Italian and Spanish bonds. Both are hovering between 4.99 to 5.2 percent. These problems in  Europe have forced the investors to pull their savings out from the EU and pile into the US bonds. So, thanks to the tepid steps taken by the European Central Bank and Brussels, the US debt continues to retain its status as the safest security to invest in.

NOTE:  A 10-year bond rate above (>) 5 percent signals impending debt crisis leading to a possible speculative attack.


Um, okay. I recently came across this statement by Steve Wynn, a Las Vegas entrepreneur, who called President Obama “the greatest wet blanket to business…”. These kind of  statements are being copiously repeated in the conservative echo chamber. So, I decided to do some quick research and discovered this gem of a graph below.

Click to make it bigger

The trend-line above illustrates the corporate profits after taxes (CP) for the past 10 years.  The shaded region in the graph indicates the recessionary period where the corporate profits took a plunge. However, what has happened since then has taken even me by surprise. Subsequent to the recession (at least in technical terms), the corporate profits have risen to the highest level in the past decade. Now, this is maybe a positive symptom for the administration, but there is an important silver lining in it. The rise in corporate profits is not accompanied by job-creation. This is especially disconcerting because it indicates that despite growth in worker productivity and overall output, the job-growth has remained anemic.

This whole episode takes me back to my undergrad History of Econ. Thought class where we studied about a Polish economist named Michel Kalecki. Mr. Kalecki argued that recessions were extremely sympathetic to the elites and corporations because they create a surplus labor supply and forces the existing workers to work even harder to save their jobs– this ends up raising  the rate of relative surplus-value for a corporation.

To sum it up, this is bad, real bad.