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

One, two, three, forex

Basics of foreign exchange


During the United States occupation of Iraq, at the American coffeehouse Starbucks, Bill Burbank made money by selling the same. From Middle Eastern suppliers, he bought 950 units of the Iraqi currency, the dinar, for a dollar – and sold them to Americans at the café to the tune of 500 dinar for a buck.  That was nearly double the original price.

Even amid the bloody occupation, speculators bought the dinar because they anticipated that Iraq would someday regain its feet and export oil, expanding its economy. As spending on Iraqi goods rose, demand for the dinar would increase, propelling its international price and blessing those who had bought it cheap.

That cunning typifies the market for foreign exchange (forex): Most currency trades are not to buy foreign goods but to take profits. In Kazakhstan’s stock exchange, dollar-and-tenge trades account for 99% of the forex market, averaging $4.8 billion (710 billion tenge) per month. Trading has been volatile but rising throughout 2012, according to data from the National Bank of Kazakhstan.

Most forex consists of bank deposits that traders swap – for example, a dollar account for a euro account.  Swaps are easy in such a gargantuan market. By 1998, daily trading in traditional forex products alone, such as spot trades, was already $1.5 trillion. Future market growth will depend on whether expansion of world trade will offset the tendency to simplify transactions by adopting a major currency. The euro reduced forex trading between European countries, but entry of post-Soviet nations into world markets increased it, noted the New York branch of the U.S. central bank, the Federal Reserve.

Getting a head in the forex market

Half of all trades occur in the United Kingdom or the United States. Traders prefer London for its time zone; its morning corresponds to the late hours of Asian and Middle East markets, and its afternoon overlaps the morning hours of North American markets. By trading through London, a seller can find as many buyers as is possible, and vice versa, said the New York Fed.

Almost 90 percent of all trades involve the dollar, partly because it offers thick markets. Suppose that you would like to sell Kazakhstani tenge for Philippine pesos. Probably you will trade the tenge for dollars, then the dollars for pesos. The market for either currency in dollars is thicker than is the market of tenge for pesos, so the exchange rates for the dollar reflect better information. The dollar is a vehicle currency.

Between the two world wars, the dollar and the British pound sterling – so called because it was originally a pound of silver – were vehicle currencies. But as America's economy waxed and Britain's waned, the dollar supplanted the pound. Momentum for the dollar reinforced itself. As fewer people used the pound, it became harder to find someone who would sell it at the price you sought, so you would buy the dollar instead, explained the former Fed chairman Alan Greenspan. Someday (but certainly not today), the euro may challenge the dollar as the vehicle of choice, suggested Mark Wynne.

The dollar also plays a riskier role. In 2004 – and, for that matter, in 2012 -- speculators took advantage of low interest rates in the U.S. to borrow dollars in order to buy currencies that paid a higher rate of return. The dollar is a funding currency.

Since it is widely accepted, the dollar is convenient in black-market transactions such as drug deals. Here the euro may supplant the dollar. The largest U. S. denomination is the $100 bill, which is mostly held overseas, reported Michael Lambert and Kristin Stanton. The Europeans offer a 500-euro bill, worth about $650, which would enable black marketers to carry their ill-gotten gains inconspicuously.

International transactions both demand and supply foreign exchange. The Kazakhstani importer of a Japanese car must pay for it with yen. To obtain them, he pays tenge to his bank, which then cuts a check denominated in yen for the Japanese bank. The Kazakhstani bank’s yen come from Japanese importers of our oil, who pay their home currency to obtain tenge.

A generation or so ago, most forex trades paid for imports and exports. Today, financial transactions dominate the market. Mutual funds trade forex to improve their rates of return. So, speculators may plague any nation that tries to steady its exchange rate. When they assailed the franc in 1992, the finance minister recalled -- with a twinge of nostalgia --  that they had been decapitated during the French Revolution. Moral for risk lovers: Don’t lose your head. –Leon Taylor, tayloralmaty@gmail.com

Good reading

Federal Reserve Bank of New York. The foreign exchange market in the United States. Online. A worthy primer.

Robert L. Hetzel. German monetary history in the second half of the twentieth century: From the deutsche mark to the euro. Federal Reserve Bank of Richmond, Economic Quarterly. Spring 2002. Online.  The source of the story about the French Revolution.

Craig Karmin, Bullish on Iraq: Average Joes place bets on the dinar. Wall Street Journal. April 23, 2004.  Page A1. The source of the Starbucks story.

Mark Wynne. European Economic and Monetary Union (EMU). Federal Reserve Bank of Dallas, Expand Your Insight. February 1, 1999. Online.


References

Alan Greenspan. The euro as an international currency. Federal Reserve Board. November 30, 2001. Online.

Steve Johnson, Dollar drifting dangerously on overseas capital flows. Financial Times. March 19, 2004.

Michael J. Lambert and Kristin D. Stanton. Opportunities and challenges of the U.S. dollar as an increasingly global currency. Federal Reserve Board, Federal Reserve Bulletin. January 8, 2003. Online.

Pulling the trigger

When does stability destabilize?


Since February 2009, when the national economy was in the throes of a slowdown, the central bank has held the value of the currency to about 150 tenge to the United States dollar. This stability has surely made Kazakhstan more attractive to foreigners intent on building factories. But it also comes at a cost.

By defending the tenge’s foreign value, the National Bank deprives itself of the power to defend the currency's domestic value. Inflation may result. For example, suppose that world demand rises for the tenge, strengthening its foreign value to 120 tenge to the dollar. To bring the exchange rate back to 150 tenge, the National Bank may have to create more currency in order to satisfy the new demand. We thus have more tenge chasing the usual amount of products. Domestic prices will rise. In fact, Kazakhstan had an inflationary spike in April 2008, when consumer prices momentarily rose by more than 10% over the previous April. Although inflation is usually lower in Kazakhstan than in Russia, the former’s economy remains vulnerable to it.

What should sharpen our sense of danger is that a small open economy like ours faces a relatively large global demand for its currency. Changes in that demand can rock the tenge. When world oil prices escalate, demand will rise for Kazakhstani oil – and the tenge will rise, too. This is not an immediate problem, especially since one of our largest oil customers, China, has seen its economy cool off this year. But oil prices are volatile, and their sudden surge may force the National Bank to act so quickly as to create uncertainty about domestic prices. This may lead consumers to cut back spending – creating for themselves a nest egg – until they are surer of where the economy is headed. Due to less spending, Kazakhstan’s economy may stagnate.

In this light, we may be troubled that the rate of spending a tenge – called “velocity” -- has fallen steadily since 2000 (see the Notes). Velocity equals total spending on Kazakhstan products divided by the number of tenge. Evidently, the supply of tenge (cash and checking deposits) has long risen more rapidly than total spending has. The possibility of steep inflation someday is hard to dismiss. If, in some episode, the National Bank suddenly prints tenge in order to hold down the exchange rate, then it may trigger the inflation that has long remained latent. –Leon Taylor, tayloralmaty@gmail.com


Notes

1. For the M1 money supply, annual velocity has fallen from 4.0 in 2000 to 1.9 in 2011. The raw data for this calculation is from the National Bank of Kazakhstan.

Are we living in the fast lane?

Is the Age of Scarcity upon us?

If we could forecast the scarcity of such natural resources as oil, then we could remove much of the uncertainty in Central Asian economies that frightens investors. But analysts disagree over the extent of scarcity, largely because they differ over how to measure it.

Perhaps the most famous study of scarcity, by Harold Barnett and Chandler Morse, examined the cost of extracting resources in the United States from 1870 (the end of the Civil War era) to 1957. They treated rising extraction costs as signals of growing scarcity. In most extractive industries, unit costs fell, particularly after 1890. In fact, they fell even faster than those for non-extractive industries. The exception was the forestry.

Follow-up work found that extraction costs fell even more steeply from 1957 to 1970 – and that they kept falling in the 1970s for ferro alloys and nonferrous metals, noted a resource economist, Jeffrey Krautkraemer. However, extraction costs for coal and oil rose in the United States throughout the Seventies. Whether this was due to scarcity or to OPEC is a matter of conjecture.

Barnett and Morse explained that when extractors exhausted high-grade resources in most industries, they would discover low-grade resources in even greater abundance. Also, the rise in the price of a resource that has become scarce for a while would induce searches for new deposits and cheaper substitutes. Innovation has sharply cut extraction cost “even as the quality of exploited deposits has declined,” observed Krautkraemer.


Keep these data under your hat

Writing in 1963, Barnett and Morse didn’t consider the cost of energy in extraction. In 1991, Cutler Cleveland found that the costs of labor and manmade inputs (capital) in extraction had fallen because extractors were replacing these with fossil fuels. Were fuels becoming more scarce, then extraction costs in general should rise (which is exactly what some statistical studies of the Seventies didn’t find). Data on extraction cost are hard to collect, because producers regard them as confidential. And as a measure of scarcity, extraction cost is flawed because it looks backward; it does not directly reflect expectations of scarcity.

A measure that does reflect expectations is the cost of exploring for another unit of resources. An expected increase in profits down the road will fuel exploration and thus push up its cost at the margin.

Unless we find cheap new ways to extract resources, or to substitute for expensive ones, resource prices will eventually rise because of scarcity. The prices may follow a U-shaped curve over time, falling and then rising. In 1982, Margaret Slade reported evidence of this curve in the prices of 11 of 12 metals and fuels studied over the period from 1870 to 1978. Other studies confirm that the prices of exhaustible resources don’t always rise or fall. However, not all of such prices kept rising after the 1970s, which is what a U-curve price path might suggest.


It’s about time

Most statistical analyses of resource scarcity use data that change over time, called “time series.” An example is the annual price of oil from, say, 1970 to 2010. The methods used to examine time series have changed dramatically over the past 30 years. Old methods assumed that the basic traits of a time series did not change over time. For example, the price of oil would have the same basic average in any year, although random events – such as Mideast wars -- may cause the observed price to differ from this fundamental average in a particular year. Today, we know that most economic time series do change in basic ways over time. For example, the value of production in the United States – gross domestic product – has usually risen for two centuries. It would be difficult to argue that GDP has the same fundamental average now as it had in 1812. GDP is “nonstationary.” For such a time series, the usual statistical model is not accurate, because it assumes that given factors, such as the number of workers, will affect GDP in the same way over time when in fact the response of output to labor is changing. Unfortunately, this was the approach taken by many statistical studies of resource prices in the early Eighties.

One way to handle nonstationarity is to put the time series into a form with essential characteristics that do not change over time. Such a form is “stationary.” Although GDP may be nonstationary, the annual change in it may well be stationary. Another approach is to estimate a GDP model that explicitly controls for a time trend. In either case, once the time series is rendered stationary, we can apply the usual statistical techniques to it, since we no longer need to worry that the estimated parameters, which are assumed constant over time, may mislead us. We can then reverse-engineer the model in order to get forecasts of the original variable – say, in the level of GDP rather than its annual change. (The Notes offer an example.)

In 1996, Peter Berck and Mike Roberts took this approach in estimating the price paths of natural resources like oil. From an extension of Slade’s dataset, they used the annual price changes for their stationary time series. They found “only a weak supposition that natural resource prices will rise….We would predict rising prices but be much less surprised about being wrong than were the previous authors.” Price increases were most likely for zinc and copper. The Age of Scarcity remains a strong possibility, but it is not entirely clear that it already engulfs us. – Leon Taylor, tayloralmaty@gmail.com



Notes

Suppose that we estimate the following model for the price of oil in year t: P(t) = 2 P(t-1). According to this model, whenever the price of oil rises by one dollar in the previous year (t-1), it will rise by two dollars in the current year (t). This model may work fine for the time period over which it was estimated – say, from 1970 to 1990. But if the time series for oil prices is nonstationary, then the model may not fit other time periods. Using it to forecast the 2013 price of oil would be futile.

Suppose, then, that we estimate a model for the annual change in oil prices. Denote this change as D(t) = P(t) – P(t-1). Suppose that our new model is D(t) = .5 D(t-1). Also suppose that D(t) is stationary. Then the new model would fit time periods in general, and we could use it to forecast the 2013 price of oil. To do this, note that we can write the new model as P(t) – P(t-1) = .5 D(t-1). Rearrange this: P(t) = P(t-1) + .5 D(t-1). Specifying the values of these variables will give us the forecast: P(2013) = P(2012) + .5 D(2012). For example, if P(2012) is $100 and D(2012) is $10, then the forecast for 2013 is $105.



Good reading

J. A. Krautkraemer. Nonrenewable resource scarcity. Journal of Economic Literature 36(4). 1998. Pages 2065-2017.



References

Harold Barnett and Chandler Morse. Scarcity and growth: The economics of natural resource availability. Baltimore: Resources for the Future. 1963.

Peter Berck and Michael Roberts. Natural resource prices: Will they ever turn up? Journal of Environmental Economics and Management 31. 1996. Pages 65-78. Online as Working Paper 699, California Agricultural Experiment Station, Giannini Foundation of Agricultural Economics.

Cutler J. Cleveland. Natural resource scarcity and economic growth revisited: Economic and biophysical perspectives. In Robert Costanza, editor, Ecological economics: The science and management of sustainability. New York: Columbia University Press. 1991.

Margaret E. Slade. Trends in natural resource commodity prices: An analysis of the time domain. Journal of Environmental Economics and Management 9. 1982. Pages 122-137.

Is the world still running out of oil?

Can Kazakhstan count on the blessing of rising oil prices?


When people forecast continued growth of the Central Asian economy, they usually assume that the prices of natural resources – such as oil, natural gas, and gold – will keep growing, too. How likely is this?

Those who foresee price hikes point out that as population and income keep growing, so will the demand for natural resources. Some resources, like oil, are finite; others, like whales, grow slowly. When demand for a resource grows faster than supply, its price will increase.

How can we tell when we may reach the point of scarcity for resources in general?

This is an old problem. In 1980, the late economist Julian Simon challenged biologist Paul Ehrlich (author of The population bomb) to a $1,000 bet over whether resources were becoming more scarce. Ehrlich invested $200 in each of five metals on the commodities market: Copper, chrome, nickel, tin and tungsten. In 1990, the bettors would assess the new prices of the metals.

Exploration may mitigate oncoming scarcity. The oil firm will spend more money to discover deposits until the additional bit of revenue from another discovery equals the additional cost. Up to that point, exploration tends to be profitable because the firm begins with its best prospects – fields that promise to yield a lot of oil at a relatively low cost.

New technology also delays exhaustion. For example, pelletization lowered the cost of producing steel, noted economist Tom Tietenberg. The producer extracts iron ore from taconite ore of a low grade and processes it at the mine. This cuts labor and energy costs.

Finally, when one resource becomes too costly to extract, we can often substitute a cheaper resource for it. To produce electricity, Kazakhstan has plans to substitute nuclear energy for coal-burning that incurs such environmental costs as air pollution that aggravates lung disease and carbon gases that strengthen global warming. Looking at the big picture, H. Goeller and Alvin Weinberg foresaw that, over the centuries, an “age of substitutability” would dawn in which virtually inexhaustible elements would replace the fossil fuels. “To reach this state without immense social disruption will, however, require unprecedented foresight and planning.”


The good ol’ days of copper


Indeed, the price increase of the exhaustible resource may induce firms to develop its substitute, in order to earn profits. Copper telephone wires today are valuable only to nostalgia buffs.

How can we gauge imminent scarcity? The most popular measure is the ratio of reserves to current consumption. If oil reserves are 40 times annual consumption, then we supposedly would run out of oil in 40 years.

Since the reserve-to-use ratio is a physical measure, it would make sense to count as reserves the entire endowment of the resource. In 1976, Goeller and Weinberg did just that, defining the endowment as the atmosphere, the oceans, and a one-mile-deep layer of earth. They computed reserve-to-use ratios for every element in the periodic table and for some compounds. The common element that would run out first, phosphorous, would last 1,300 years. For most elements, supply was practically unlimited. Exceptions included trace elements used in farming (cobalt, copper and zinc) -- and the fossil fuels (oil, coal and natural gas), “by far the most important scarce natural resource[s].” Some assumptions underlying the study may have been strong: Lower grades contained more of the resource; the economic and environmental costs of extraction were not prohibitive.

The reserve-to-use ratio is easy to interpret -- but inaccurate, because it treats scarcity as a physical concept. In truth, the market determines scarcity if we define it as unsatisfied demand at the given price. Such scarcity raises the price, which discourages consumption and encourages production, obviating the scarcity, be it physical or economic. In this cornucopian perspective, Goeller and Weinberg overstate the need for planning. A drop in the reserve-to-use ratio may predict impending abundance about as well as it does an impending shortage. In 1960, use-to-reserve ratios for gold, lead, mercury, silver, tin and zinc were less than 30 years. But we still have all of these resources.

So why not use movements in the market price to gauge whether scarcity in the near term is rising or falling? Well, markets are not well defined for all resources. The unregulated market for coal takes no account of the illnesses and storms that arise from coal burning, since a particular illness cannot be traced back to a particular power plant. The market price for coal is too low. The “market” for the fishery is a misleading concept, since no fisher owns a migratory school of fish. Since no fisher gains from conserving the school that he happens to be harvesting today, he will overfish. The result is that the price of fish is too low, because it does not represent the loss of fish to future consumers that occurs through overfishing.


Simon says…


Another possibility is to look at the profit rate for extracting, say, oil. The oil producer can choose between drilling and selling the oil today or doing so next year. If oil is becoming more scarce over time, then next year’s price ordinarily would be higher than this year’s, even though we adjust for inflation. To prevent a loss of profits, the oil producer would raise his price this year. The greater the expected scarcity, the greater the boost in the current price. This boost, called “scarcity rent,” thus measures expected scarcity. An example is the stumpage fee that timbermen pay for the right to cut.

Being a price increase, the scarcity rent is subject to the same weaknesses as a measure of scarcity as is the market price. In an unregulated market, an increase in pollution costs over time will not show up in the scarcity rent. And even when the rent accurately measures expected scarcity, it will not indicate whether this arises from an expected increase in demand or an expected decrease in supply.

Despite their flaws, economic measures of scarcity, such as the market price and the scarcity rent, at least account for a dimension that physical measures, like the reserve-to-use index, ignore – human behavior. Which brings us back to Simon’s bet.

In 1990, the market prices for all five metals in the bet had fallen, reported John Tierney. Ehrlich paid Simon $576. Simon then challenged Ehrlich to a $10,000 bet, based on any resources that Ehrlich wished to choose. Ehrlich took a pass. – Leon Taylor, tayloralmaty@gmail.com


Good reading

Harold Barnett and Chandler Morse. Scarcity and growth: The economics of natural resource availability. Baltimore: Resources for the Future. 1963.

H. E. Goeller and Alvin M. Weinberg. The age of substitutability. American Economic Review 68. December 1978. Pages 1-11. Reprinted from Science, February 20, 1976.

J. A. Krautkramer. Nonrenewable resource scarcity. Journal of Economic Literature 36(4). 1998. Pages 2065-2017.

Bjorn Lomborg. Environmental alarmism, then and now. Foreign Affairs. July/August 2012.

John Tierney. Betting on the planet. The New York Times Magazine. December 2, 1990.

Tom Tietenberg. Environmental and natural resource economics. Boston: Addison Wesley. Seventh edition. 2006. Chapter 14 discusses generalized resource scarcity.

Where’s the silver lining?

Are the banks of Kazakhstan long on cash and short on chutzpah?


A stark lesson of the 2008-9 financial crash is that reckless lending in real estate can create a price bubble that perpetuates itself…for a while. The complement may also hold: A lack of lending inhibits future loans. The hesitation of banks to lend conveys a pessimism about the economy that eventually infects potential investors.

Real estate and construction loans still comprise a large share of the loan portfolios of some banks, including 45% of Kazkommertsbank’s and nearly three-fourths of BTA’s, reported the business weekly Delovaya Nedelya. This concentration contributed to Standard & Poor’s downgrade three weeks ago of Kazkommertsbank, from “stable” to “negative.” Real estate prices have fallen by half since the bubble burst in mid-2008, reducing the collateral backing the loans, which themselves are often delinquent, noted Standard & Poor’s.

In general, construction's share of all industrial bank loans in Kazakhstan fell steadily after March 2011, when it was 19.1%, and most sharply after October 2011, falling to 14.9% by January 2012, or 3.2 percentage points lower than in January 2011, according to the National Bank of Kazakhstan.

Is this cooling-off auspicious? The answer is unclear. A rising share of construction in the economy (measured as gross domestic product, or GDP) is not always troubling. In an economy expected to grow rapidly, firms may add buildings in order to house future inputs. At present, investors do not seem to anticipate the 10%-plus rates of annual economic growth that Kazakhstan enjoyed before the financial crisis. Adjusted for inflation, the value of new physical capital in Kazakhstan has grown slowly or stagnated for several years. This hardly signals great expectations for the economy. The IMF projects a rate of economic growth of 6% or so through 2017.

Perhaps the country is still digesting the effects of the construction bubble. Adjusting for inflation, investment in fixed capital (durable and immobile inputs) in Kazakhstan was the same in 2011 as in 2010. New floor area in Kazakhstan more than tripled from 2003 to 2008, from 2.1 million square meters to 6.8 million, before leveling off at 6.4 million square meters in 2009 and 2010, according to the national statistical agency.

The cities dominate new construction. Almaty and Astana account for 38% of all new floor area in the country. This statistic leveled off in Almaty in 2010, at 1.1 million square meters; but it kept rising in Astana, to 1.4 million square meters. Although construction loans endangered the banks in 2008, new floor area kept increasing in the cities and is growing slightly faster in the oblast surrounding Almaty than in the city itself.

Bank credit in Kazakhstan grew 15% over 2011 after stagnating for three years, noted the International Monetary Fund (IMF). The banks still have lots of money that they could lend but don’t. Instead, they park much of it at the central bank (basically, the banks’ bank). The National Bank of Kazakhstan held as much as 5.5% of their assets in 2009, when their dread of risk was understandable, and 3.1% as late as March 2012, according to the IMF.


Pay it again, Sam


Not all of this mattress-stuffing is due to timidity. Some banks can’t lend their excess funds to those short on money, because the interbank market is sketchy. Other banks can’t find good borrowers. Real estate and construction firms propose fewer projects than before the crash.

Finally, the banks are saddled with bad debt. As a share of all loans, “nonperforming” ones (no interest paid in 90 days) quadrupled in 2009 to 21.2%...and kept rising, to 31.9% by March 2012. For BTA, which the government took over, it’s 80%. Moreover, overdue interest has increased from 2% to 7% of all bank assets. For banks like BTA that are trying to recover from bankruptcy – the polite term is that they have “restructured” – the figure rose from 3% to 17%. This suggests that the bad-loan ratio is higher than reported, said the IMF. However, the bad-loan ratio varies considerably from bank to bank. For Halyk, it is 8.3%, said Standard & Poor’s.

In general, the banks’ lack of lending renders them unprofitable. Their rate of return on assets was zero or negative from 2008 through 2010 and was only 1% in 2011, reported the IMF. In addition, a measure of the banks’ inability to cover bad loans – the assets-to-capital ratio – has been rising for more than two years.

“In the end, restoring the banking systems’ health requires recapitalizing viable banks and restructuring or closing unviable ones,” writes the IMF (wisely neglecting to define “viability”). “Capital shortfalls [roughly, the lack of money on hand to cover bad loans] represent public contingent liabilities, given the need to protect depositors and the fact that [Samruk-Kazyna, a government holding company] is the biggest shareholder in several large banks.” The capital shortfall for BTA alone is 2.5% of GDP. The government’s “Too Big to Fail” policy may be leading to another: “Too Big to Do Anything But Fail.” – Leon Taylor, tayloralmaty@gmail.com


Good reading

International Monetary Fund. Republic of Kazakhstan 2012 Article IV consultation. 2012. www.imf.org


References

National Bank of Kazakhstan. Statistical bulletin. Various issues. www.nationalbank.kz

Reuters. TEXT-S&P revises Kazkommertsbank's outlook to negative. July 31, 2012. Online.

Semen Skarga. Kazkommertsbank prodolzhaet “zarivat’sa” v nedvyzhymost’. (Kazkommertsbank continues to “bury itself” in real estate). Delovaya Hedelya.  August 10, 2012. Page 1.