How to force industrialization

Is Astana’s industrial policy bound to fail?


The government of Kazakhstan has embarked upon an $80-billion campaign that it calls “the program of forced industrial-innovative development.” That term includes a misnomer. The Russian word that was translated into English as “forced” -- forSEERovanniy -- is a false cognate that means “accelerated”. (Then again, maybe “forced” is more honest.) The program – which government leaders vow will eliminate all unemployment -- also involves a misunderstanding: That industrialization is always the key to economic growth. This notion went out the economists’ window more than a half-century ago.

In poor countries, governments usually try to industrialize by protecting home factories from foreign competition. Officials argue that in such industries as automobile manufacturing, plants produce a unit most cheaply when they produce a lot of units – because the expense of buying equipment can be spread over more units, or because workers learn from experience. To reach such scale economies, a home plant should have the home market all to itself. So the government should deny entrée by foreign producers, even though they produce more cheaply than the home plant. Or so the story goes. Last year, the deputy prime minister of Kazakhstan said the government should not buy imports when domestic substitutes “of similar quality” were available, reported Kazinform.

In reality, such protectionism rarely pays off, because in a developing economy the home market by itself is rarely large enough to enable the plant to produce as cheaply as possible. The textbook example is Argentina. To minimize the cost of producing an auto engine or transmission, the plant should manufacture a million units per year, noted the economic historian Robert Allen. In recent decades, Argentine auto demand has amounted to only a few hundreds of thousands of autos per year. Thus the national market may be too small to support a single competitive plant, much less the baker’s dozen that popped up in Argentina. Kazakhstan is vulnerable to the same problem: The ninth largest country, in terms of land, has a population that would fit quite snugly into metropolitan New York City. Preventing Kazakhstanis from buying cheap imports will raise their cost of living while creating jobs in only the protected industries and in industries related to them.

With so much land per capita, Kazakhstan has a natural advantage in such land-intensive industries as oil and gas extraction and agriculture. Automaking, which is capital-intensive, is a delicate transplant here that may not survive a severe economic “winter” like that of 2009. It would make sense for Kazakhstan to export oil and food to the West – since these countries, being capital-intensive, find extraction and farming costly in the sense that their workers and machines could have been more profitably employed in industries using lots of capital.

At this point in the tale, the friends of protectionism usually break in to warn that export-led growth will someday prove pernicious. The prices of manufactured goods usually rise over time relative to the prices of natural resources and food, they say. Kazakhstan’s earnings from exports of oil and wheat will buy fewer and fewer imported autos. That is, the “terms of trade” will go against us. Ironically, export-led growth will impoverish us.

Who should pay? Who should pray?

In reality, Kazakhstan’s terms of trade with the United States have been moving sharply in our favor for more than a decade. But the protectionists have a point, even if they don’t make it explicitly: Drilling for oil and farming may impoverish us intellectually because workers must repeat mind-numbing tasks. That’s why Adam Smith urged the government to pay for educating laborers who were unable to pay for themselves (see the Notes). Moreover, knowledge is the source of sustained economic growth, since it increases the amount produced by a typical worker, given the number of laborers, buildings and machines.

And that’s where Astana is missing the boat. Since the chaotic mid-1990s, when Kazakhstan began shifting from colonial socialism and toward markets, the government has cut sharply the share of its budget that pays for higher education, to the equivalent of 4% of the economy (gross national product) by 1999. Meanwhile, the share of the eligible-age population entering colleges in the country was rising from 25% in 1999 to 48% in 2004, reported the United Nations Educational, Scientific and Cultural Organization (UNESCO).

True, if the student herself receives most of the fruits of her education, in the form of a higher salary, then it may make sense to let her pay her own college expenses, if she can borrow easily against her future expected income. But this condition does not hold in Kazakhstan. Youths from families with little wealth, and therefore with little to pledge as collateral, have trouble obtaining college loans from private banks. The government – and probably only the government – can address this market failure by guaranteeing these loans. Astana should compare the cost of inevitable loan defaults against the benefits to the nation of a work force that, being well-educated, rapidly introduces and diffuses innovations of production.

The Ministry of Education and Science has taken a step in the right direction – but only a step. Last year the ministry introduced a program paying 5% to 7% annual interest on a family bank account earmarked for a child’s education. That’s the State Educational Savings System, reported Centralasiaonline. But the program is small; the ministry projects that 17,000 Kazakhstanis – roughly one-tenth of one percent of the population -- will use it. And it doesn’t address what may be the prime problem in financing college education: College expenses can claim a larger share of wealth than parents are willing to set aside – particularly if they undervalue the child’s education.

Perhaps the government should subsidize far more college students than this plan does. It is hard to think of any other policy that could increase the long-run rate of economic growth so surely. – Leon Taylor, tayloralmaty@gmail.com


Notes


1. “Gross national product” is the market value of goods and services produced each year by Kazakhstanis, regardless of where in the world they are working.

2. Adam Smith writes: “The expense of the institutions for education and religious instruction, is likewise, no doubt, beneficial to the whole society, and may, therefore, without injustice, be defrayed by the general contribution of the whole society. This expense, however, might perhaps with equal propriety, and even with some advantage, be defrayed altogether, by those who receive the immediate benefit of such education and instruction, or by the voluntary contribution of those who think they have occasion for either the one or the other.

“When the institutions or public works which are beneficial to the whole society, either cannot be maintained altogether, or are not maintained altogether by the contribution of such particular members of the society as are most immediately benefited by them, the deficiency must in most cases be made up by the general contribution of the whole society.” (The wealth of nations, book 5, chapter 1.)


Good reading


Robert C. Allen. Global economic history: A very short introduction. Oxford University Press. 2011. A concise discussion of the sources of economic growth.

H. W. Brands. American colossus: The triumph of capitalism, 1865-1900. New York: Anchor Books. This lively history discusses the impact of scale economies on American industries. 2010.

Milton Friedman. Capitalism and freedom. University of Chicago Press.  1962.  Analyzes the economics of student loans.

Adam Smith. An inquiry into the nature and causes of the wealth of nations. Edited by Edwin Cannan. The University of Chicago Press. 1976 [1776].


References


Alexandra Babkina. College savings plan to be launched in Kazakhstan. April 2, 2012. centralasiaonline.com

Kazakhstan Today. Government confirmed plan of measures for realization of forced industrially-innovative development program. April 13, 2010. Online.

Kazinform. Carrying out forced industrial innovative development program is top government priority. February 6, 2012. Online.

Kazinform. Kazakhstan can eliminate unemployment through industrial program – Nazarbayev. January 16, 2012. Online.

Kazinform. Kazakhstan's Industrial Innovative Development Program to be fulfilled ahead of schedule – Nazarbayev. May 20, 2011. Online.

Kazinform. 389 new manufacturing facilities opened in Kazakhstan in the past two years. January 16, 2012. Online.

United Nations Educational, Scientific and Cultural Organization (UNESCO). Statistical tables. 2009. Online.

Get real

What is the tenge really worth?


On the surface, the central bank of Kazakhstan seems to have stabilized the tenge. The exchange rate has been within a tenge or two of its target rate, 150 tenge to the United States dollar, for nearly four years. But appearances can mislead. In terms of the U.S. products that it can buy, as compared to Kazakhstani products, the tenge has been gaining value since 2002.

The “real exchange rate” expresses the foreign purchasing power of a unit of some currency, relative to its power to buy local goods. Suppose that last year 1,000 tenge could buy either two U.S. newspapers or two Kazakhstani papers. This year, however, 1,000 tenge can buy only one Kazakhstani paper, although they can still buy two U.S. papers. Then, in relative terms, the foreign purchasing power of the tenge has increased: Last year, when you bought a U.S. paper, you had to give up a Kazakhstani paper; but this year, you give up only half of a Kazakhstani paper. The tenge has “appreciated”.

In practice, the real exchange rate is often expressed in terms of its value at some point in the past. The National Bank of Kazakhstan arbitrarily sets the December 2000 rate at 100. With respect to the dollar, the tenge in 2011 had appreciated 82% since December 2000, so the real exchange rate in 2011 was 182 (as defined by the National Bank; not everyone takes this approach). Thus the tenge could buy substantially more of U.S. goods in 2011 than in late 2000.

If people care about what they can buy with their tenge, and not just about the number of tenge in hand, then the real exchange rate better measures the currency’s value, in terms of foreign goods, than does the rate usually quoted in the media, i.e., 150T = $1. The latter rate just expresses the number of dollars that you can buy with a given number of tenge. Economists call this the “nominal exchange rate”.

Watch out for wedges

With respect to U.S. goods, the tenge has been appreciating for years largely because prices have risen roughly four times faster here than in the U.S. Over time, American-made imports into Kazakhstan look more like bargains.

In terms of European goods and the euro, the tenge has appreciated about 20% since 2002. Like the U.S., Europe has not suffered much inflation recently.

This should please Kazakhstani consumers, but the flip side of the coin is that producers here lose domestic and foreign demand. Local consumers substitute some U.S. imports for goods made here. And American consumers buy some of our exports rather than goods made there, since the dollar can’t buy as many Kazakhstani goods as before.

This is not a general problem for the tenge. With respect to the Russian ruble, the real rate for the tenge has fallen 20% since 2001; that is, the tenge has depreciated. (In fact, it has weakened steadily ever since the ruble crashed in 1998.) With respect to our chief trading partner, our imports have become more expensive over time, and our exports have become cheaper. This would tend to increase the difference between our exports and imports -- our “balance of trade” with Russia. The tenge has depreciated compared to the ruble largely because prices rose faster in Russia than here from 2009 through 2011.

How has the National Bank’s stabilization of the nominal exchange rate of the tenge (with respect to the United States) affected the real rates? Let’s take 2009 as a starting point, since the Bank in February of that year weakened the tenge by 25% and announced that it would maintain thereafter an exchange rate of 150 tenge to the dollar. Relative to the West, the tenge has appreciated – by 11% or 12% in 2011 (compared to 2009) for both the United States and the euro region. Relative to the non-West, the picture is mixed. The real value of the tenge was virtually unchanged in 2011 relative to China, Kyrgyzstan and Ukraine. However, it had risen 23% relative to Belarus and fallen 7% relative to Russia.

In general, a wedge is developing in Kazakhstan’s trade picture. In terms of purchasing power, the tenge is strengthening relative to the currencies of rich nations and often weakening, or holding its own, relative to poorer nations. This would tend to reduce our trade balance with the rich and to maintain or increase it with the poorer.  Over time, Kazakhstan may rely less and less on Western economies, which grow more slowly than developing economies.

The wedge may occur for several reasons. Countries that rely on exports of natural resources have similar price patterns, so their real exchange rates may follow similar paths over time (Kazakhstan, Kyrgyzstan, Ukraine and Russia). Developing countries tolerate more inflation than does the West; when their prices rise faster than Kazakhstan’s, the tenge with respect to them will depreciate. Last, and perhaps not least, the National Bank holds the nominal exchange rate close to 150 tenge for a dollar, whatever the dollar’s foreign value, so that movements in the real rate depend entirely on price changes. In this sense, Kazakhstan’s true currency is not the tenge but the almighty buck. –Leon Taylor, tayloralmaty@gmail.com


Notes

In Kazakhstan, the Consumer Price Index (CPI) for December to December increased 6.2% in 2009, 7.8% in 2010, 7.4% in 2011, and 6% in 2012, according to data from the National Bank of Kazakhstan. In the United States, the annual CPI increased 0% in 2009, 2% in 2010, 3% in 2011, and 2% in 2012, according to data from the Bureau of Labor Statistics of the U. S. Department of Labor. The four-year average of the annual rate of change in the CPI was 6.85% in Kazakhstan and 1.75% in the U.S., a ratio of 3.9.


References

National Bank of Kazakhstan. Data on the price level and the real effective exchange rate. The Bank defines an increase in the real tenge rate as appreciation. But some economists define the real exchange rate in such a way that an increase in the rate denotes a depreciation. www.nationalbank.kz

Tradingeconomics.com . Offers an interactive graph for CPI inflation in Russia and other countries, using government data.

United States Department of Labor, Bureau of Labor Statistics. Data on the price level. www.bls.gov