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A Critical Review of International Finance Forum: Understanding the links between China Economy and International Monetary Fund

2/20/2015

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A Critical Review of International Finance Forum: Understanding the links between China Economy and International Monetary Fund
Author: Tomas Freitas 

This Paper has been prepared in response to Christine Lagarde the Managing director of International Monetary Fund during International Finance Forum in Beijing 9 of November 2011. Please read the IMF intervention on this link: https://www.imf.org/external/np/speeches/2011/110911.htm    

Introduction

After the global financial crises has been affected global economy. The phenomenon has started again and at this time smashed Europe’s which includes; Portugal, Spain, and Italy and Greece. The question is why these defaults repeatedly appeared in capitalism modern society?  

In contrast to Europe’s crises, Mrs Lagarde has congratulated China, because “fundamentally, China is on the right path”, however at the same time she also warned that global and regional economy is under the “dark clouds”. In her speech, she has highlighted fourth points which she thinks very important to guarding global economy governance (IMF, 2011), and

the points are; ‘Global and regional economic challenges, ‘Policy path’, ‘The Role of China’, and ‘Global economic governance’, (IMF, 2011). This essay will analyse her speech at the four points. The paper also will try to identify some logic of the argument in related to country risk.

 Growth and Crises

China Gross Domestic Products (GDP) have grown ten percent in average in the last decade, however, if we compare in the last three decades, the data have show us that GDP rates has rise up and down, and unemployment rates gradually increase fewer than five percent. 

Table 1. China GDP and Unemployment rates

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Sources: Worlbank  and International Labour Organisation (2012).

The GDP above has reflected political and financial estability. In the late 1970s, after the death of Mao Zedong in 1976, the GPD growth has fallen down from 11.7% in 1978 to 7.8% in 1980, (World Bank,2012). And the total unemployment rate in 1978 was 5.3% (ILO,2012). This is the begining of Deng Xiaoping economic reform which has bring fresh air to private sector development in China by replacing collective and state land ownership (Han & Pannell, 1999). This land policies reform also has affected grain production in China, (Rozelle, et al, 1997).
 
In 1988-1990 the GDP rates also felt which caused by adoptation of new plan called “New Order for the Socialist Commodity Economy” The Secretary General of  Chinesse Communist Party (CCP) Zhao Ziyang has took advantage of Deng Xiaoping leadership. Zhaos had brought new plan which introduced dissengagedment of the state in to price control and promote export by devaluing the currency, (Dittmer, 1990). However, according to James Dorn & Wang Xi (1990), the aim of the plan is to achieve Macro-Market which is deliberately by the state.
 
In 1998, the GDP rates has declining, the Asian crisis has affected China. However, the Chinesse government has prepared effectively in response to the crisis, starting by not devaluing their currency, consolidate national banking and as well as apply ‘accounting reform’ in order to standarizing accounting practices, which Chinese government believed that they can avoid ‘financial bubble’ by detecting instability in financial markets (Lin & Chen, 2000).  

In 2008 global financial crisis (GFC) has erupted, Chinesse scholar believe that the impact of GFC in China economy because of the reduction in the global demand of China exports and imports (Yu, 2010). Chinesse government has apply three levels of action in order to anticipate next global recession. And those are; Internationalising local currency Renmimbi (RMB), Regional monetary cooperation in East Asia and Reconstruction of international monetary regime. Chinesse government seems very anthusiastic in internationalising their local currency, they believes by swaps Chinesse RMB with other currencies through bilateral agreetment, it will help the countries easily to purchase China’s goods and products, (Zhang, 2009). 

The historical above will help us to understand the current development of China economy in rebalance the global economy.           

Global and regional economic challenges

In Mrs Lagarde (2011) first point, she have deeply concern about the global economy which she thinks has cross the thresholded of insecurity, she worried about the ultrapassing of financial sector beyong the real economy, which might cost more unemployment. Her bigest worries as quoted below:

“If we do not act, and act together, we could enter a downward spiral of   uncertainty, financial instability, and a collapse in global demand. Ultimately, we could face a lost decade of low growth and high unemployment”... “Asia is not immune, however, from developments in the rest of the world. The trade channel is critical, as the region still relies a lot on external demand to propel growth. Emerging Asia is also vulnerable to developments in the financial sector” (IMF, 2011).

The statement above can be defined as ‘cross-border risk to profitability of foreign investment’, because as second large exporter and third large importer in the world (Torres, 2011), foreign investors has play very crucial role in pumping China economy, with the advantage of high population and less labour cost, the investors has making profits by utilising cheaper labour power for assembly their products, (Foster & McChesney, 2012).

According to Deutsche Bank Research institute, that in the last ten years China financial market has moving up to 13%, which composed by 16% of stock market and 5% of bonds market, (Hansakul et al, 2009). However, living with the reality as second large exporter and third large importer in the world, China economy still classify as real economy because based on production of goods and services rather than financial speculative (Knight 2011).

If we apply the theory of elasticities approaches, with the relative price effects to analysing supply and demand of exports and imports, will China survive for the next crisis? Considering second and third large exports and imports in the world, it looks like China already moves in to internationalising their local currency Renmimbi (RMB) by bilateral swaps with the regional cooperation and cross border trade settlements.  According to the theory of elasticities approaches;

“Foreign exchange can be obtained exclusively by exporting and the only need for foreign exchange is to pay for imports. When disequilibrium occurs, the goal of devaluation is to bring the supply and demand of foreign exchange into equilibrium” (Bouchet et al, 2003, 32).  

In this case China already move beyond the theory above, which is does not needs to devaluing their currency for the equilibrium, because through bilateral swaps agreement, the exchange rates has been set by each central banks. Moreover, the bilateral swap agreement between china and their countries partner, has decided that the RMB cannot be use currently by those countries to intervene foreign exchange markets, (Zhang, 2009).

Policy Path
Her second though, is the intervention in fiscal and monetary policies which is aiming stability and growth. Ironically, the IMF has forgotten many times that they have spoken about strengthening financial regulation, and pushed their agenda in to internal country fiscal and monetary policy. Sadly there are no lessons, and outcomes from IMF, since the crises occurred in; Asia, US, Iceland, Spain, Portugal, Italy, Greece. Let’s have a look an interview below with former managing director of IMF Mr. Dominique Strauss-Kahn about the sub-prime mortgage crisis in the US.

“Q: Mr. Strauss-Kahn, the U.S. financial system is close to collapsing. Banks are being nationalized and taxpayers are expected to bail out Wall Street with billions. Is this the end of the free market economy?

A: Not at all. I believe that the market economy will emerge strengthened from this crisis. The free market economy needs regulations, a framework to function, and as soon as the immediate danger of a systemic crisis is over, new regulations will strengthen the financial system and thereby the market economy, and reduce the risks of market failures”, (IMF, 2008).

And please have a look the quoted below, the advice from Mrs Lagarde in the case of solving financial crisis in Greece;    

“As I said, I am encouraged that on October 26, Euro Area leaders agreed on a framework that would restore debt sustainability in Greece; recapitalize European banks; strengthen the firewall against financial contagion; and lay the foundations for robust economic governance in the euro area”, (IMF, 2011).

Those statement above has indicates that, the IMF still working on ‘new regulation’ which might be will strengthen the financial system in the future, and at the moment only one treatment that IMF can propose for financial recovery and that is ‘financial surgery’, or ‘loans with the conditionality’ in other words they called ‘debt sustainability’, etc.

In this second though, financial contagion can be approaches by investors and government, because fiscal and monetary regulation, as well as portfolios has relation to banking, which is can state reserve bank or private banks. In this case the risk can be relying on credit risk and sovereign risk.  

The role of China  

The third point, she has proudly applause to China, because in three decades still ‘on the right path’, and off course the right path of free market orientation. However, she also has mentioned that;

“Now is the time to move further from exports and investment toward consumption,” (IMF, 2011).

This means China households consumption needs to be increase in order to balance the growth. According to the editor of Monthly Review, John Bellamy Foster and Robert McChesney (2012), the ability of local consumers in China are decreasing, since the period of 2002 – 2008; it’s about ten percent lost.

If the GDP = C + I + G + Xn , as mentioned by Foster and McChesney (2012), that China consumption has gradually decrease, but is that matter with the GDP? The fact is the consumption are lower, the investment are high, the government spending relative steady, and the net of exports and imports are increase, China GDP still relative safe. The point is with the big population, lower wages it will affected households consumption.

Global economic governance

The last point, she has highlighted that China sit on the top three of IMF membership because of structure reform that the organisation has applied. Please have a look the graphic below.



















The grafic above have show us that, China quota as membership is US$ 9.5 million, come in fourth place after UK, Germany, Japan and the United States. It is not supprise that China has become top three out of 187 countries. What about India and Brazil, they both as developing countries, why they cannot in the top three, logically they can if they have big amount of money in their quota of membership.

Conclusion

We cannot judges the economy growth based on one decade only, at least two or three decades, and that can provide us strong and deeply analysis to understanding the context. Change in leaderships it always vulnerable to adaptation of new ideology, and if the new ideology did not match with the country characteristic, normally it can be survived but not grounded. Because has been survived for more than three decades, sometimes people think maybe this is a good model for the others to follow. Some people preferring the outcome instead than the process. Some people proudly with the ten percent growth and some people, some time miss interpreted of how can be that is ten percent.

References   Bouchet, H, M., Clark, E., & Groslambert, B., 2003. ‘Country risk Assessment: A Guide to Global Investment Strategy’, John Wiley & Sons Ltd, London

Dittmer, L., 1990. China in 1989: ‘The Crisis of Incomplete Reform’, Asian Survey, Vol 30, No 1, Pp 25-41. Retrieved 13 of April 2012 from http://www.jstor.org/stable/2644770

Dorn, A, J., & Xi, W., 1990. ‘Economic Reform in China: Problems and Prospects’, The University of Chicago Press, Chicago.

Foster, B, J., & McChesney, W, R., 2012. ‘The Global Stagnation and China’, Monthly Review, Vol 63, No 9. Retrieved 9 of April 2012, from http://monthlyreview.org/2012/02/01/the-global-stagnation-and-china

Han, S, S., & Pannell, W, C., 1999. ‘The Geography of Privatization in China, 1978-1996’,

 Economic Geography, Vol. 75, No. 3, Pp. 272-296. Retrieved 12 April 2012 from http://www.jstor.org.ezproxy2.library.usyd.edu.au/stable/pdfplus/144578.pdf

Hansakul, S., Dyck, S., & Kern, S., 2009. ‘China’s financial markets - a future global force’, Deutsche Bank Research, Frankfurt. Retrieved 15 April 2012, from http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000238901.PDF

International Labour Organizatiton., 2012. ‘LABORSTA: Database of Labour Statistic’, Retrieved 10 of April 2012, from http://laborsta.ilo.org/

International Monetary Fund., 2012. ‘Members Financial data’, IMF Country Information. Retrieved 15 April 2012. from http://www.imf.org/external/country/index.htm

International Monetary Fund., 2011. ‘An Address to the 2011 International Finance Forum’, IMF External Relations Department. Retrieved 8 April 2012,  from http://www.imf.org/external/np/speeches/2011/110911.htm

International Monetary Fund., 2008. ‘The Crisis is not the End of the Market Economy’, IMF External Relations Department. Retrieved 15 April 2012, from  http://www.imf.org/external/np/vc/2008/092408.htm

Knight, R., 2011. ‘Dark Clouds over the Boat: On China, Production, and Financialization’, Le Coup D’oeil. Retrieved 2 April 2012, from http://lecoupdoeil.wordpress.com/2011/11/11/dark-clouds-over-the-boat-on-china-production-and-financialization/

Lin, Z, J., & Chen, F., 2000. ‘Asian Financial Crisis and Accounting Reforms in China’, Managerial Finance, Vol 26, No 5, Pp 63-79. Retrieved 7 of April 2012, from http://search.proquest.com.ezproxy2.library.usyd.edu.au/docview/212677656/fulltextPDF?accountid=14757

Pei, M., 2002. ‘China’s Governance Crisis’, Foreign Affairs, Vol 81, Issue 5, Pp 96-109. Retrieved 13 of April 2012 from http://search.proquest.com.ezproxy2.library.usyd.edu.au/docview/214302379

Rozelle, S., Veeck, G., & Huang, J., 1997. ‘The Impact of Environmental Degradation on Grain Production in China, 1975-1990’, Economic Geography, Vol. 73, No. 1, Pp. 44-66. Retrieved 12 April 2012 from http://www.jstor.org.ezproxy2.library.usyd.edu.au/stable/pdfplus/144410.pdf?acceptTC=true

Torres, A, J., 2011. ‘China Leadership Role During the Global Financial Crisis’, The Journal of American Academic of Business, Vol 16, No 2, Pp  81-88. Retrieved 15 April, from http://search.proquest.com.ezproxy2.library.usyd.edu.au/docview/817185178

World Bank., 2012. ‘World Data Bank: World Development Indicators (WDI) & Global Development Finance(GDF)’, Retrieved 10 of April 2012, from http://databank.worldbank.org/ddp/home.do

Yu, Y., 2010. ‘China’s response to the global financial crisis’, East Asia Forum. Retrieved 14 of April 2012 from http://www.eastasiaforum.org/2010/01/24/chinas-response-to-the-global-financial-crisis/

Zhang, M., 2009. ‘China’s New International Financial

Strategy amid the Global Financial Crisis’, China and World Economy, Vol 17, No 5, Pp 22-35.  Retrieved 14 April 2012, from http://dd8gh5yx7k.search.serialssolutions.com/?ctx_ver=Z39.88-2004&ctx_enc=info%3Aofi%2Fenc%3AUTF-8&rfr_id=info:sid/summon.serialssolutions.com&rft_val_fmt=info:ofi/fmt:kev:mtx:journal&rft.genre=article&rft.atitle=China%27s+New+International+Financial+Strategy+amid+the+Global+Financial+Crisis&rft.jtitle=China+%26+World+Economy&rft.au=Zhang%2C+Ming&rft.date=2009-09-01&rft.pub=Blackwell+Publishing&rft.issn=1671-2234&rft.volume=17&rft.issue=5&rft.spage=22&rft.epage=22&rft_id=info:doi/10.1111%2Fj.1749-124X.2009.01164.x&rft.externalDBID=n%2Fa&rft.externalDocID=n%2Fa

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The influence of International Monetary Fund on Timor-Leste’s economic framework

2/16/2015

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The influence of International Monetary Fund on

Timor-Leste’s economic framework

Author: Tomas Freitas 

Introduction

In general the enforcement of Structural Adjustment Programs (SAPs) and Poverty Reduction Strategy Papers (PRSP) by the International Monetary Fund and World Bank are normally applied to countries that need loans to finance their budget deficits in order to promote growth and reduce poverty (Easterly, 2003). However, it does not mean that countries without debts with the IMF and World Bank will be able to independently set up their economic policies without IFI influence.

This essay will analyse the influence of IFIs on the Timor-Leste economic framework through adherence to Sound Macroeconomic Management (IMF, 2000). The IMF believes that with a foundation of Sound Macroeconomic Management, it will impose pro-poor policies. This paper will carefully examine one of the policies which is considered to have been a key factor in accelerating growth and reducing poverty, that is “Implementing trade and investment policies that promote growth of production and employment to benefit the poor” (IMF, 2005, pp.31). 

Structural Adjustment Policies (SAPs) were originally created for the restoration of growth after the debt crisis of the 1970s (United Nations Centre for Human Settlement, 2001). In fact, after the Asian crisis in the mid-1990s, the IMF and World Bank realised that SAPs do not really reduce poverty (Easterly, 2003). Therefore, PRSPs were designed to minimise poverty. Through the engagement of the private sector and civil society in the government sectoral working group (IMF, 2009), the IMF and World Bank believed that countries would boost investment and create jobs in the private sector.  

Historically, Timor-Leste was colonised by Portugal for 450 years, and occupied by Indonesia for 24 years. As a new country in the 21st century, Timor-Leste restored independence in 2002, and currently has a population of 1.2 million. Geographically Timor-Leste is located between the regions of the Pacific and South East Asia. With the official name Democratic Republic of Timor-Leste, the new nation is administratively divided into 13 districts with Dili as the capital. As a fragile State, Timor-Leste still faces basic problems common to those confronted by many post-conflict countries. The health sector is one example; every year 380 children die from diarrhoea (Ministry of Health, 2011); the under-five child mortality rate is 56 per 1000 births and life expectancy is 62.5 years (UNDP, 2012). Timor-Leste’s Gross National Income (GNI) per capita is about $3,005 million US Dollars (UNDP, 2012), and Gross Domestic Product (GDP) per capita is about $3,949 US dollars (IMF, 2012).

In October 1999, the IMF was appointed by the United Nations to manage the development of East Timor’s future economy. During the transition period from 2000 to 2002, the IMF was successful in establishing two important institutions, the Central Payments Office now known as the Central Bank of Timor-Leste, and the Central Fiscal Authority which became the Ministry of Finance (IMF, 2000). In addition, the IMF also successfully convinced the top Timorese leaders to accept the US dollar as the official currency, and also was instrumental in leading to decisions to limit numbers of civil servants and lower wages and salaries (IMF, 2000). At the same time, the World Bank led the implementation of all reconstruction projects funded by the Transitional Fund for East Timor (TFET) (Lao Hamutuk 2000). During the transitional period 2000-2002 until 2005-2006, the majority of government expenditure was from foreign aid such as bilateral and multilateral donors (Ministry of Finance, 2006).

According to the IMF (2007) one of the factors that could become a barrier for implementing trade and investment policies in Timor-Leste is government tax. Therefore, deregulation has been taking place since 2008, and the National Parliament at this time amended tax regulation No 2000/18 to suit trade and investment interests (Ministry of Finance, 2008). Existing taxes including import tax, excise tax, service tax, income and wages tax (UNTAET, 2000; Luta Hamutuk, 2008a) were reduced significantly to promote private sector activities in trade and investment, which they believed could generate growth of production and employment. The differences between previous and current regulation can be seen from the data in Table 1 below.

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Table 1. Sources: UNTAET (2000), Luta Hamutuk (2008a) & (2008b) and Ministry of Finance (2008)

 

According to this data, it is clear that deregulation has benefited business and the private sector, and discriminated against the ordinary person, as reflected in the wages tax, which has barely changed from before.

An interesting question is how much employment has been generated after the taxation law was amended in 2008. According to the Timor-Leste Labour Force Survey 2010, the total labour force above the age of fifteen is about 627,000 thousand, which has been categorised into the in-active labour force at 366,000 thousand and the active labour force at 262,000 thousand. Of the active labour force, 252,000 thousand are registered as employed and 9,000 as unemployed.

Accurate comparisons are difficult, because this is the first time labour force survey statistics have been comprehensively published. However, it is still possible to see the difference in jobs creation according to the statistical data survey (National Directorate Statistic, 2007) and the Timor-Leste labour force survey (National Directorate Statistic, 2010b), as follows:

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Table 2. Sources; Data Survey Statistic (National Directorate Statistic, 2007, pp207) and Timor-Leste Labour Force           Survey (National Directorate Statistic, 2010b, pp39) The data shows that from 2007 to 2010, jobs have been created, though not many, and the deregulation of the taxation law has affected this. As seen in the table, number of farmers in agriculture, forestry and fisheries has decreased by about 33%, while in industries such as wholesale trade, retail, restaurants and hotels there has been an increase of approximately 15%, in public administration 4% and community and other social services have also increased by about 1%.

Even though job opportunities have increased, this does not mean that jobs are secure. As seen above, 366,000 people are categorised as the inactive labour force; job creation is sporadic and not guaranteed. Table 3 below describes those jobs that have written contracts and are of unlimited duration – these are the most important things that employees look for. 

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Table 3. Sources; Data Survey Statistic (National Directorate 2007, pp209) and Timor-Leste Labour Force Survey (National Directorate Statistic 2010, pp51)

This data shows that government is the most respected institution that can guarantee income security for the future household income. According to the Labour Force Survey, 93% of government employees have written contracts, and about 82% of contracts are for an unlimited duration. For state-owned enterprises, private companies, NGOs, embassies and international agencies, 70% of contracts are of unlimited duration and written down in contract form (National Directorate Statistic, 2010b).


If the IMF is satisfied with employment growth as described in table 2, what then is happening with the growth of production? To analyse this it is necessary to check the components of Gross Domestic Product (GDP), as written in the formula of how to calculate the GDP = C + I + G + (M-X) (Leamer, 2009, pp 44), which is described as: Gross Domestic Product = Consumption + Investment + Government Spending + (Import – Export). Table 4 below shows the elements of Timor-Leste’s GDP based on the expenditure approach.

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Table 4. Sources: National Directorate statistic (2009 & 2010a), Central Bank of Timor Leste and Ministry of Finance (2012).

Looking at consumption in Table 4, household consumption has gradually increased by 7.3% every year on average. The question is: who is the consumer? Where is the income coming from? If we check the proportions of sources of employment in Table 3, we can see that 54.9% of jobs are supplied by government and the public sector such as civil servants and soldiers in the military, and that this sector is the highest supplier of jobs, more than any other sector.


Lack of investment from external and internal firms has affected local factors of production. According to the data in Table 3, the private sector has struggled to guarantee secure household income. Looking back at Table 2, and combining two items such as industries and wholesale retail, still only accounts for 26.7% and is not, therefore, even one third of the total.

According to the data in Table 4, for over eight years the government has spent 38.5% on health, education, agriculture, infrastructure and social security. Revenue from the Timor Sea has affected government expenditure (Ministry of Finance 2012), and has therefore also boosted GDP.

Table 4 also shows that the value of exports from 2004 to 2009 is not equal to the value of imports - the average of imports value every year is around 400% more than exports value. The IMF is not correct to think that the policies of trade and investment will drive growth of production.

Conclusion

Becoming a new independent country does not mean being economically independent; international financial institutions still have a strong influence and the potential to create an unstable economic situation for a new country such as Timor-Leste. This paper has illustrated that the implementation of policies under a system of sound macroeconomic management does not guarantee growth in production and employment. We have seen that the deregulation of the taxation law, though it has had some impact on assisting with jobs creation, still does not guarantee a future secure income source, which can only be guarantee by written contracts of unlimited duration. The IMF also believes that the implementation of trade and investment policies will assist growth in production; however, this essay has demonstrated this theory to be unsound, because growth in production, as described in table 4, is only driven by government expenditure; other components of GDP do not perform nearly as well. 

References

Central Bank of Timor-Leste., 2012. ‘Consumer Price Index’, available from http://www.bancocentral.tl/en/CPI.asp

Easterly, W., 2003. ‘IMF and World Bank Structural Adjustment Programs and Poverty’, National Bureau of Economic Research, Available from http://www.nber.org/chapters/c9656.pdf

International Monetary Fund., 2000. ‘East Timor: Establishing the Foundations of Sound Macroeconomic Management’, available from:  http://www.imf.org/external/pubs/ft/Etimor/timor.pdf

International Monetary Fund., 2005. ‘Democratic Republic of Timor-Leste: Poverty Reduction Strategy Paper - National Development Plan, Road Map for Implementation of National Development Plan, Overview of Sector Investment Programs—Strategies and Priorities for the Medium Term’, IMF Country Report, No 05/247 Available from

http://www.imf.org/external/pubs/ft/scr/2005/cr05247.pdf

International Monetary Fund., 2007. ‘Democratic Republic of Timor-Leste: Selected Issues and Statistical Appendix’, IMF Country Report, No 07/86 Available from http://www.laohamutuk.org/misc/AMPGovt/tax/IMFcr0786.pdf

International Monetary Fund., 2009. ‘The Poverty Reduction and Growth Facility (PRGF)’, Fact Sheet, Available from http://www.imf.org/external/np/exr/facts/pdf/prgf.pdf

International Monetary Fund., 2012. ‘World Economic Outlook Database’, Data Statistics. Available from: http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/weorept.aspx?sy=2002&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&c=853%2C536%2C537&s=NGDPDPC%2CNID_NGDP%2CPCPIPCH%2CLUR%2CLP%2CGGR%2CGGX%2CGGX_NGDP%2CBCA%2CBCA_NGDPD&grp=0&a=&pr.x=52&pr.y=13#download

Lao Hamutuk., 2000. ‘The World Bank in East Timor’, Lao Hamutuk Bulletin, Vol 1, No 4 Available from http://www.laohamutuk.org/Bulletin/2000/Dec/bulletin04.html

Leamer, E, E., 2009. ‘Macroeconomics Patterns and Stories: A guide for MBAs’, Springer-Verlag, Berlin.

Luta Hamutuk., 2008a. ‘Indirect tax’, Fact Sheet, Vol XXVI, available from http://lutahamutuk.org/yahoo_site_admin1/assets/docs/Vol_XXVI.12723445.pdf

Luta Hamutuk., 2008b. ‘Direct tax’, Fact Sheet, Vol XXV, Available from http://lutahamutuk.org/yahoo_site_admin1/assets/docs/XXV.12731432.pdf

Ministry of Finance., 2006. ‘General Budget of The State 2005-2006: Budget Paper No 1’, Available from http://www.mof.gov.tl/wp-content/uploads/2010/07/Final_Book_I_English_August_2005.pdf

Ministry of Finance., 2008. ‘Tax and Duties Act: Decree Law No: 8/2008’, Available from http://www.mof.gov.tl/wp-content/uploads/2010/07/Taxes_and_Duties_Act_2008.pdf

Ministry of Finance., 2012. ‘Budget Documents’, Available from http://www.mof.gov.tl/category/documents-and-forms/budget-documents/budget-previous/?lang=en

Ministry of Health., 2011. ‘World Hand-Washing with Soap Day 2011 in Timor-Leste’, Press Release. Available from  http://www.moh.gov.tl/?q=node/151

National Directorate Statistic., 2007. ‘Data Statistic Survey’. Available from http://dne.mof.gov.tl/TLSLS/Publication/finalstatisticalabstract.pdf

National Directorate Statistic., 2009. ‘External Trade Statistic: Annual Report 2009’, Available from http://www.dne.mof.gov.tl/trade/annualreports/Annual%20Reports/Annual%20Report%202009.pdf

National Directorate Statistic., 2010a. ‘Business Activity Survey’, available from http://dne.mof.gov.tl/TLSLS/BUSINESS%20ACTIVITY%20SURVEY/Business%20Activity%20Survey%20BAS/BAS%202010%20ENGLISH.pdf

National Directorate Statistic., 2010b. ‘Timor-Leste labour Force Survey’, Available from http://www.laohamutuk.org/DVD/docs/Timor%20Leste%20Labour%20Force%20Survey%202010.pdf

United Nations Centre for Human Settlements., 2001. ‘ From Structural Adjustment Programmes to Poverty Reduction Strategies’, Available from http://ww2.unhabitat.org/programmes/ifup/conf/HabitatPresentation-English.PDF

United Nations Development Program., 2012. ‘Human Development Report 2011’, Available from  http://hdr.undp.org/en/reports/global/hdr2011/download/

United Nations Transition Administration for East Timor., 2000. ‘Taxation Law No 2000/18’, Available from  http://www.un.org/en/peacekeeping/missions/past/etimor/untaetR/Reg0018E.pdf

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Can a Minskyian Perspective explain the Financial Crisis 2008?

9/5/2014

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Can a Minskyian Perspective explain the Financial Crisis 2008?

Author: Tomas Freitas

Introduction

Since 1957, Minsky has argued that a high capitalist economy with developed financial institutions is basically unbalanced, and will plunge into a depression as a consequence of a period of debt-financed “euphoria”. Minsky’s strictures were abandoned throughout the long boom of the 1960s, and even during the oil and Third World debt shocks of the 1970s (Keen, 1995). However, his theories cannot be disregarded after a long period of economic instability which began with the collapse of securitization of home mortgages in 1987 (Minsky, 2008). The collapse of the sub-prime market in August 2007 has been widely tagged a “Minsky moment,” (Palley, 2009a). This current crisis has invited many economists to interpret what is really going on and why these kinds of crisis are repeated. Apart from Marxist theories of economic crisis, there are a number of political economists attempting to follow and draw a picture of the roots of the crisis - one of them is Hyman Minsky.

This essay will attempt to explain how the current financial crisis relates to a traditional Minsky hypothesis. Minsky’s theory of financial instability hypothesis comes from John Maynard Keynes general theory (2008), which in argued with Adam Smith in his views of market processes in his book “An Inquiry into the Nature and Causes of The Wealth of Nations: Book IV, Chapter 2,” (1776).

These contradictory arguments have inspired Minsky to elaborate his financial instability hypothesis. To generate his hypothesis, Minsky uses several approaches including debt deflation by Irving Fisher, the credit view of money by Joseph Schumpeter which is in favour of Institutional Structural, Minsky’s own Cushions of Safety which were reviewed by Jan Kregel, as well as Minsky’s non-financial firms such as hedge fund, speculative and ponzi units. The financial instability hypothesis also is incorporated with the view of profits, which is developed by Kalecki (1991) and Levy (1983).

However, this essay will be limited to discussing two different views of Keynes and Smith which are fundamental to Minsky’s financial instability hypothesis and which have re-generated into two basics theories of “debt-deflations” and “cushions of safety” with the help of two importance variables including “Ponzi Pyramids” and “Institutional Structures”. Before moving into those discussions, the essay will provide a short biography of Minsky.

A biography of Minsky

Hyman Philip Minsky was born on 23 September 1919, completed his bachelor degree in Mathematics at Chicago University in 1941, and achieved his MPA in 1947 and PhD in 1954 at Harvard University. Two Chicago professors were the most significant early influences on his thought (Minsky, 1985). The inspiration to study economics came from Oskar Lange, who was at that time working out a synthesis of Marx and neoclassical economics that he called market socialism (Lange, 1938). Henry Simons was the source of Minsky’s lifelong interest in finance, as well as the idea that the fundamental flaw of modern capitalism came from its banking and financial structure (Simons, 1948). Taken together, Lange’s model of a possible socialism and Simons model of the ‘good financial society,’ represented the central features of Minsky’s ideal economic system,’ from which he would later analyse and criticise existing economic structures (Mehrling, 1999). After a sabbatical in 1969-70, Minsky seemed to view himself as Keynesian, seen through his assessment of certain fundamental institutional issues. Afterwards he became opposed to not only to monetarism but also to mainstream Keynesianism (Minsky, 1972). 

Financial Instability Hypothesis

Minsky’s Financial Instability Hypothesis mainly draws from Keynesian ‘General Theory’, which has identified “the capital development of the economy” as an economic problem rather than, “the allocation of giving resources among alternative employments”. As a detailed illustration, Minsky emphasises that the exchange of present money for future money is representative of the capital development of capitalist economy in the present day (Minsky, 1992).

Minsky has identified that the capital development of a capitalist economy provides a range of possibilities to build up financial fragility, which is why, in Minsky’s opinion, it is necessary to provide regulations and interventions. This notion is a synthesis of two fundamental arguments by Adam Smith and John Keynes about the result of market processes. We can see these two fundamental views about the outcome of a market economy have been achieved. One of them, as stated by Adam Smith, is as follows:

“As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention” (Smith, 1776, IV, Ch 2).

Keynes has interpreted Smith’s legacy of invisible hands in these days as speculatory behaviour, which is practically implemented by debtors and lenders in guarantee loans. In opposition to Smithian speculation, Keynes states his legacy of the alternative to the invisible hand – comparative static approach to economics.  Keynes wrote:

 “If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the terms of enterprises for assets over their whole life, it is by no means always the case that speculation predominates over enterprise. As the organization of investment markets improves, the risk of the predominance of speculation does however, increase. Speculators do no harm as bubbles on a sea of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill done” (Keynes, 2008, 142).

According to Minsky, in designing and advocating policies and practices, economists are likely to have to choose between Smithian and Keynesian theories, Smithian theory being that the market “always” leads to the promotion of the public welfare, and the Keynesian theory that market processes “may” lead to poor capital development of the economy (Minsky, 1991). The only answer to the “invisible hand” conjecture is to apply appropriate regulations and interventions, if the results of poor capital development are serious (1992). The financial instability hypothesis was used to explain the great financial construction of the United States in the 1932-1933, where the United States faced a crisis in the savings and loans of the banking system (Minsky, 1992). According to Minsky, the phenomena of changes in the institutions combined with the ordinary approach and bad performances of private and public decision makers has become vital to weaknesses, which often suggests promises of an overall theoretical perspective to current troubles always leading up to these problems (Minsky, 1977, 140 cited in Epstein & Gintis, 1995).

The system of capitalist economy evolved in the mid 1960s; this was a period of financial innovation, well known as the era of financial markets. The first serious test of financial innovation came in 1966 in the municipal bond market and the second in 1970 with a run of commercial paper – but each of these was determined through prompt central bank action (Minsky, 2008). Financial innovations are related to what has come to be known as Minsky’s financial instability hypothesis, which has allowed an existing quantity of high-powered money to support greater expenditure. Innovations allow “a pyramiding of liquid assets” to replace cash, government bonds, or short term bank debt in portfolios. This increases the instability of the system since failure by only a few large firms (financial or non-financial) to meet debt commitments can lead to an increase in failures as assets are written-down (Fazzari & Papadimitriou, 1992). According to Thomas Palley (2009a), Minsky’s financial instability hypothesis supports the reasoning that capital financial systems have an inherent proclivity to financial fragility, and that this proclivity can be summarised in the maxim “Success breeds success breeds failure” or “Success breeds excess breeds’ failure”.

Minsky’s framework is one of evolutionary instability and it can be thought of as resting on two different cyclical processes. The first cycle can be labelled the “basic Minsky cycle” while the second can be labelled the “super-Minsky cycle”, (Foster & McChesney, 2010).

The basic Minsky cycle concerns the evolution of patterns of financing arrangements, and it captures the phenomenon of emerging financial fragility in business and household balance sheets. The cycle begins with “hedge finance” when borrowers’ expected revenues are sufficient to repay interest and the loan principal. It then passes on to “speculative finance” when revenues only cover interest. Finally, the cycle ends with “ponzi finance” when revenues are insufficient to cover interest payments and borrowers are relying on capital gains to meet their obligations.

The basic Minsky cycle offers a psychologically-based theory of the business cycle (Palley, 2009b). Agents become progressively more optimistic, which manifests in increasingly optimistic valuations of assets and associated revenue streams and willingness to take on increasing risk in belief that the good times are here forever. This optimistic psychology afflicts both borrowers and lenders and not just one side of the market. That is critical because it means market discipline is progressively removed.

This process of rising optimism is evident in the way business cycle expansions tend to generate talk about the “death of the business cycle.” In the 1990s there was talk of the “new economy” that was supposed to have killed the business cycle by inaugurating a period of permanently accelerated productivity growth. In the 2000’s there was talk of the “Great Moderation” that claimed central banks had tamed the business cycle through improved monetary policy based on improved theoretical understanding of the economy. This talk is not incidental but instead constitutes evidence of the basic Minsky cycle at work. Moreover, it afflicts all, including regulators and policymakers. For instance, Federal Reserve Chairman Ben Bernanke himself indicated in 20 of February 2004 that he was a believer in the Great Moderation hypothesis (Bernanke, 2004).   

Debt Deflation or Over-Indebtedness

In the Keynesian view, over-protection during good times can be a result of crisis in the savings and loans and the banking system, a consequence of sectoral indebtedness by running out of the ability of sectoral cash flows to validate the contracts (Minsky, 1991).

Keynes ‘general theory’ also contained some elements of the financial instability hypothesis, provided by political economists such as Irving Fisher with his classical description of debt deflation. In Fisher’s argument, over-indebtedness is the only factor that disturbs general economic equilibrium. He also assumed that at some point in time a state of over-indebtedness will exist, which will tend to lead to liquidation, through the alarm either of debtors or creditors or both (Fisher, 1933).

Minsky’s analyses on Fisher debt-deflation has several emphasis, one being that debt-deflation occurs only while investment and capital assets are financed as economies have the benefit of an extended period of good times. Minsky also identified improvements in the market; like alterations in institutions, which is compatible with new instruments such as communicating and computing, is one aspect of the way financing changes over extended periods of good times. However, in Fisher’s theory of debt-deflation, he did not explain how over-indebtedness developed (Minsky, 1994).

Minsky also states that finance allows for a much faster growth of income and capital accumulation but, at the same time, increases the stock of debt, and the associated financial commitments affects the level of expected cash flows (Gatti & Gallegati, 1990). Over-indebtedness also tends to constrain investment by business and debt-financed consumption households. The United States economy was at that time burdened by a deadweight government debt accumulated as a result of the dreadful abuse of the government budget during the 1980’s, an abuse which is continuing today. These conditions mean that a recovery from the current recession will not be accompanied by buoyant private demand (Minsky, 1992).

Hedge, Speculative and Ponzi Finance

Which factors determine the importance of borrowers and lenders risk in establishing the level of investment? To address that question, Minsky distinguishes non-financial firms according to whether they are what he terms hedge, speculative, or ponzi units (Pollin, 1997).

As mentioned above, hedge financing has a normal cash flow large enough to meet both principle and interest that is due on debts. Speculative financing has the income of the debtor large enough to meet the interest but not principle payments and Ponzi financing takes place when not enough is earned to meet even the interest due on debts. Speculative finance involves rolling over debts and Ponzi finance involves the capitalisation of interest (Minsky, 1991).

Essentially, a Ponzi collapse is a debt crisis: when there is too much debt accumulated by an economic agent, and there is no way to either get the resources to pay the debt including interest, postpone the payments, or shift the debt on to someone else, economic agents such as debtors and lenders will face bankruptcy (Nesvetailova, 2008). According to Jan Kregel of the Levy Institute, the types of debt are critically related to the way risk has been valued, assessed, and modelled by banks and financial institutions since the liberalisation reforms were introduced in the 1980s (Kregel, 2008).

So, now comes the question, can debt-deflation theory with the help of Ponzi pyramids units explain the recent financial crisis? Yes, indeed, because oversupply of housing was exacerbated when interest rates were increased and hundreds of thousands of lower middle income borrowers in the United States could no longer afford their mortgage payments, (Gupta, 2008). Moreover, the diversification of collateral debt obligations into rating CCC which targeted the sub-prime level market meant that mortgages could not be re-sold because prices had dropped (Jarvis, 2009).

Cushions of Safety

Numerous analysts have distinguished the relevance of Hyman Minsky’s financial instability hypothesis to understanding the current crisis in the financial systems of developed countries. Central to Minsky’s analysis of financial fragility was the concept of a cushion of safety, an initiative related to the prominent security analyst and hedge fund investor Benjamin Graham (Graham & Dood, 2008).

The “cushion” covers the margin of error in anticipated returns from an investment project. Minsky analysed the investment decision from the point of view of the difference between prospective cash receipts and cash commitments that represent the margin of safety. For instance, the margin of safety for a banker lending to a businessman for a particular project would be determined by the difference between the amount loaned and the amount required to finance the project. The margin could also be determined by realisation of the value of the collateral required of the borrower, the amount of compensating deposits, or any other factor that the banker believed would allow him to recover his loan if future income from the project disappointed expectations (Kregel, 2008).

According to Jan Kregel (2008), financial fragility increased by a deliberate and unnoticeable erosion of margins of safety in the relative normal circumstances. He states that this situation can be drawn to holding-up payments, suffering borrowing, or even distress transactions of inventory and productive assets. In these activities sometimes, the banker may propose re-possession of the collateral behind the loan.

The result is a debt deflation process in which “position has to be sold to make position” and the downward pressure on prices raises real debt burdens. Lower prices increase the necessity to sell and reinforce the excess supply, making it even more difficult for the investor to fully repay his/her loan from asset sales (Kregel, 2008).

Minsky describe the weaknesses of banking institutions, which are usually better informed about the overall market environment and potential competitors, and are inherently sceptical of the borrower’s estimate of future cash flows and thus insist on margins of safety. The problem of declining margins of safety is because in the earlier 1980s there was an introduction of neoliberal concepts, well known as the “Washington consensus”. This original concept was written by Friedman and Hayek (Legge, 2009), and promoted by the Reagan and Thatcher governments. One of the central ideas is financial deregulation. Before the arrival of the neoliberal approach to economic thinking and policy, very strict regulations were applied by Section 20 of the Glass-Steagall Act of 1933 (Rosenblum, 2003). This regulation was to restrict the commercial banks from affiliating with firms “engaged principally” in potential profitability activities, such as underwriting and dealing in securities.  Since the Washington consensus, the commercial banks have urged relaxation of these and other constraints on their ability to enter new markets and new lines of business (Tarullo, 2008). As a result, for the first time in 1987 the Federal Reserve authorised an exemption on such a subsidiary and the first securitised investment vehicle was created the following year. Financial deregulation and liberalisation, so highly praised a decade ago, turned out to be a dangerous beast, and has gotten out of hand of the public authorities. According to the data from the Deutsche Borse Group (2008,6), the current Over the Counter (OTC), about 84% of all trade in financial derivatives take place in the markets, not in regulated exchanges.

Recent Financial Crisis

Let’s see if Minsky can explain the recent crisis which happened in the sub-prime mortgage market in the United States. Subprime mortgages represented an average of 8 percent of all loans in the 2001-2003 periods, rising to an average of 20 percent in the 2005-2006 periods, when over 80 percent of such mortgages were securitised with an average value of approximately $450 billion per annum (Randdal, 2007). This increase supports one of Minsky’s arguments which are that “finance allows for a much faster growth of income and capital accumulation but, at the same time, increases the stock of debt” (Gatti & Gallegati, 1990).

According to the Congressional Budget Office (2008,23) of the United States, sub-prime mortgages account for more than half of expected credit losses and are now forecast in the range of $300 billion to $400 billion. However, since 2005 after rates have been counted for two years, this amount rose to roughly $1.5 trillion. If house prices fell by 30 percent, these figures would double, but not including additional defaults. In addition, there has been an unexpected increase in prime mortgage defaults that could bring the total credit losses to nearly $900 billion as a high estimate (Kregel, 2008). These dynamic figures have shown that the losses would be distributed among borrowers, creditors and banks. This phenomena is reflected in the theory of debt-deflation or over-indebtedness in which “the rise of debt-deflation can only happen while investment and capital assets are financed as economies have the benefits of an extended period of good times” (Minsky, 1994).

Institutional Structure

The financial instability hypothesis also supports the credit view of money and finance by Joseph Schumpeter (1934). In 1911 Schumpeter argued that the services provided by financial intermediaries , which are mobilising savings, evaluating projects, managing risk, monitoring managers, and facilitating transactions, are essential for technological innovation and economic development (King & Levine, 1993).

Schumpeter characterised the banker as the ephor of developing capitalist economies. At an earlier meeting of the Schumpeter Society, Minsky characterised central bankers as the “ephor of the ephors” of capitalism (Minsky, 1994). In 1797 – 1800, the Bank of England was suspended because of the war of inflation in which the Bank of England had obligations to cash notes in gold, which resulted in a great impact on prices and foreign exchange rates (Schumpeter & Schumpeter, 1934).

According to Schumpeter, Keynes, in order to overcome the malfunctions of capitalism, broke down the conventional belief that saving, as a part of the bourgeois scheme of life, and unequal distribution of income and wealth, as a necessary evil for progress, were social virtues. This was, Schumpeter declared, the essence of the Keynesian Revolution. However, this renouncement of support for these values was the most basic non-economic factor leading to the fall of capitalism (Moss & Schumpeter, 1996).

There is no doubt that Minsky took some lessons from Joseph Schumpeter’s theories on credit, money and finance, as Minsky’s basic ideas to construct institutional structures reflects legislation, administrative actions, and the evolution of institutions and traditions that represented the past behaviour of market participants. The legislation reflects the understanding of the economy as maintaining economic theory, which was a rule among policy establishment at the time the institutions were created (Minsky, 1994). Minsky also emphasised that law and policy makers needed to be aware of institutional evolution which means sometimes bankers change their monetary policy which can lead to serious disruptions in investment and profit flows (Minsky, 1991).

Conclusion

This essay has presented and discussed a number of elements of economist Minsky’s theories on capitalist economy and economic systems in general. Minsky’s basic hypothesis is that capitalist economies are fragile, unstable and unbalanced. When capitalist economy gets to a stage that it is basically financed by debt, as per his financial instability hypothesis, the risk of plunging into crisis becomes great. Capitalist economic systems increased greatly in instability and fragility since 1987 with the collapse of securitisation of the home mortgage market. Minsky’s theories are therefore intimately related to the global financial system collapse two years ago, which was a cause of over-indebtedness, particularly in the sub-prime mortgage market in the United States.

In particular this essay has discussed elements of Minsky’s “financial instability hypothesis” and how it relates to the recent financial crisis. The two main elements that have been presented are that of “debt-deflations” and “cushions of safety”, backed up by a discussion of the related elements of “Ponzi Pyramids” and “Structural Institutions”. The paper has discussed how the evolution of Minsky’s theories have been grounded in the original theories on economic systems and capitalism of John Maynard Keynes and Adam Smith, one of which was critical of and the other in favour of capitalism. Essentially, Minsky sides with Keynes in purporting that a capitalist system must be grounded by regulation and intervention, to prevent it from becoming unstable. A market which is allowed to reign free is inherently unstable, leading to crisis.

In assessing how Minsky’s theories relate to the recent global economic crisis, a discussion of the elements of hedge, speculative and ponzi finance have been used to support the theory of debt-deflation, related to his financial instability hypothesis. The conclusion here is that over-indebtedness, an essential element of free market capitalist economy, is intimately related to the collapse of the market in the United States in 2008. Cushions of safety, another element of Minsky’s financial instability theory, has also been shown in this paper to be related to a neoliberal economic model that warrants no regulation or interference and hence the market is free to govern as it likes, resulting in a lack of any form of security should things go wrong, as happened in the recent financial crisis. Finally, institutional structures were discussed as one aspect of Minsky’s financial instability hypothesis. As a result of the above detailed analysis, it can be concluded that Minsky’s economic theory of financial instability can be related too much of what occurred in the 2008 global financial crisis, in particular the sub-prime mortgage market collapse in the United States. 

References

Bernanke, S, B., 2004. ‘The Great Moderation’, The Federal Reserve Board. Available from: http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/default.htm   

Congressional Budget Office., 2008. Budget and Economic Outlook: Fiscal Year 2008 to 2018. Congress of the United States.

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A Comparison views of Marxian and neoclassical economics

7/13/2014

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The different emphasis on individuals and class in the economy:

A comparative view of Marxian and Neoclassical economics

Author: Tomas Freitas 

Introduction

Neoclassical economics has influenced the capitalist economy today; we can see that the market determines a price which in some stages has replaced the labour theory of value which was claimed in earlier classical economics. According to the ‘Marshallian Cross’ theory of supply and demand, neoclassical economics strongly believes that the market will provide an equilibrium of prices (Stilwell, 2002). As stated by Say’s law, supply for goods and services can create their own markets, (Baumol, 1999). These notions need to be tested through empirical study, however neoclassical deductive methodology maybe difficult to justify. This paper will present the different Marxian and neoclassical views on individuals and classes in the contemporary economy. This essay also will introduce some historical background of how neoclassical ideas developed their theories, some of which have become strong ideology today.

Historical Background

Traditionally, neoclassical ideas come from some of the greater classical political economists such as David Ricardo with his ‘Marginal principle’ (Kaldor, 1956), John Stuart Mill (2007) with his ‘Utilitarianism’, Jeremy Bentham (2009) with his ‘Greatest Happiness’, and Jean Baptiste Say with his famous ‘Say’s Law’(Kates, 2003). All these ideas have inspired some of the neoclassical economists.

Neoclassical economics was born in the late 1830s to mid 1850s and become strong and influential in the early 1870s, growing to be very popular in the mid-1880s to mid-1890s. This historical background can see as three evolutionary which include the proto-marginalists, the revolutionaries and the consolidators of neoclassical economic ideas.


The Proto-Marginalists

Historically, neoclassical economics was born from a few founders considered as main proto-marginalists including Augustin Cournot, Jules Dupuit, Johann Thunen and Heinrich Gossen. Cournot (2008) began his work with Researches into the Mathematical Principles of Wealth in 1838’ he also developed an analysis of monopolies which later on created his concepts of a profit-maximising producer.  Jules Dupuit was an engineer of bridges with his history curve of Diminishing Marginal Utility in 1844 (Vickers, 1995). Despite the curve of diminishing marginal utility, Dupuit also had a brilliant argument for delivery of ideas of free exchange in 1861. Johann Thunen was a German landowner who developed the essence of The Marginal Productivity Theory of Distribution in 1850 (Ekelund & Hebert, 1999). The last of the protagonist marginalists was Heinrich Gossen with his famous ‘Gossen Second Law’ in 1854, which described equalisation between the ratios of exchange of goods to the ratio of marginal disutility of work (Blaug, 2003). These four protagonists successfully delivered their original theories which later on become embryos for marginal theories of neoclassical economics.

The Revolutionaries

After the main marginalist protagonists drew the foundation for marginal theory from 1838 up to 1854, neoclassical economics began to be born starting with the revolutionary marginalists like William Stanley Jevons, Carl Menger and Leon Walras. In launching the ‘marginal revolution’, Jevons began with his famous work of Theory of Political Economy in 1871. He began by underlining the principle of diminishing marginal utility and introduced individual preference (Steedman, 1997). After Jevons, the revolutionary marginalists were followed by Carl Menger from Austria at the same time, 1871, Menger’s Grunds tze was considered to represent the basic concepts of marginal value theory or marginal utility, despite the fact that he did not officially use the term “marginal”; he did however state that the consumer usually formed lists of needs, classifying them as less satisfying or less urgent needs (Streissler & Streissler, 1994). After Menger emphasised his marginal utility theory in 1871, in 1874 French economist Leon Walras was one of the three revolutionists who cemented marginal theory as a formal general equilibrium setting and later on become the father of general equilibrium theory. Besides his general equilibrium theory, Walras also contributed several other theories including providing reflections on monopoly market and imperfect competition (Tieben, 2009).

The Consolidators

In order to consolidate the ideas of neoclassical economics apart from the three famous revolutionary marginalists, there are a number of neoclassical economists who provide additional reasons to support neoclassical ideas, including; Eugen Bohm-Bawerk with his famous work of Capital and Interest which he wrote in 1884, explaining the positive side of real interest rates (Pressman, 1999). There was also Friedrich von Wieser in 1889 with his two main contributing theories including the theory of ‘imputation’ which established that factor prices are determined by output prices (Albertazzi et al, 1996). Alfred Marshall in 1890 became famous with his Marshallian Cross which analysed the market with the theory of supply and demand (Stilwell, 2002). John Bates Clark was an American neoclassical economist who in 1891 proudly contributed one of his works called ‘marginal productivity concept’ which assumed that the contribution of output by additional workers has determined the value of demand for labour (Geetika et al, 2008). Irving Fisher was one of the famous consolidators, whose contribution to neoclassical theories included the curve device invention for the Walrasian theory of equilibrium price in 1892 (Fisher, 2007), and his last works which were popular in the post-Keynesian era include his debt-deflation theory in 1933, which has been used by Hyman Minsky for developing Financial Instability Hypothesis, (Minsky, 1986). After Fisher neoclassical economists consolidated their works through Knut Wicksell with his works of Value, Capital and Rent in 1893 (Lutz, 2006). Philip Wicksteed in 1894 produced his work Co-ordination of the Laws of Distribution, which criticised some of the economists who preferred to recast the theory of distribution. Wicksteed preferred to use mathematics as an investigation method to ensure the allocation of distribution (Marchionatti, 2004). Vilfredo Pareto in 1896 was part of the second generation of neoclassical revolutionaries even though his works of tastes-and-obstacles (Gomes, 2003) only gently resurrected the general theory of equilibrium, however he was one of the leaders of the Lausanne School which was one of the famous neoclassical schools in constructing Walras’ general equilibrium theory (Andersen, 2009). The last consolidators for neoclassical economics is Enrico Barone, an Italian economist who gave his dedication to follow Walras and Pareto, his main contribution to the neoclassical school being to influence Walras to integrate some elements into production technique, his works considered an extension to marginal productivity theory (Jaffe & Walker, 1983). After all of them consolidated neoclassical theory, only Alfred Marshal become popular in synthesising Jevons, Menger and Walras’ earlier theories into the ‘Marshallian Cross’ which illustrated that supply and demand determined the equilibrium price which satisfied both sides, consumers and sellers.  

 
Comparison between Marxian and Neoclassical Economics

Deductivism Vs Historical Materialism

The neoclassical method of deductive methodology, according to John Stuart Mill, is..

 “ a complex subject matter like political economy can only be studied scientifically by means of the deductive method. Since so many causal factors influence economic phenomena, and experimentation is generally not possible, there is no way to employ the methods of induction directly”, (Hausman, 1992, pp14)

In a reverse of the neoclassical approach of deductive methodology, Marxian economics preferred to study historical processes (Stilwell, 2002), through historical dialectic of materialism, or bourgeoisie class, or capitalist society. Marxism found that these brought broad pictures to understanding the construction of modern capitalism (Lunn, 1982).

If we apply these notions to the contemporary economy today there will appear some disparities. Deductivism these days is still adopted by economic rationalists (Katouzian, 1980) such as international financial institutions like the World Bank and IMF. These institutions still hold regular annual general meetings (IMF, 2010) for evaluating their strategy and methods which they have applied, and normally through these annual meetings they can study economic activities which have taken place over the last twelve months. Deductivism may be good for some economists to make their own judgement after coming to the end of a project or activity, however indirect observation may also miss some evidence uncovered during the process of observation.

Opposed to neoclassical deductivism, Marxism believes that historical materialism is the only way to understanding capitalist and bourgeois society in terms of the mode of production (Rockmore, 2002) because according to Stalin “historical materialism is the extension of the principle of dialectical materialism to study of social life” (Rockmore, 2002, pp7). Marx’ historical materialism does make sense in understanding capitalist economy today because capitalism as a mode of production already includes technical and social characters in producing goods and services. Social characters mean the class relationship between the labourers as the working class and the bourgeoisie society as the capitalist who own the firms, technologies and raw materials (Stilwell, 2002).

Individuals Vs Classes

In contrast to neoclassical theory, Marxian economic analysis focuses on classes not individuals. Classes mean the proletariat as labour power which produces goods and services, and bourgeoisie as capitalists who own the means of production (Stilwell, 2002). Individuals according to neoclassical theory are the consumers and sellers who freely exchange their income and goods; in other words allocation in free market economies occurs via voluntary exchange among individuals (Bergh, et al, 1997).

Both terminologies are still relevant these days, because presumably individuals according to neoclassical theory are consumers who have ultimate power in determination of prices. Classes in contemporary economy are also still relevant because these days labourers as working class have organised themselves and established and joined unions, syndicates and legal organisations to protect their rights and advocate their interests. The idea of ‘free exchange’ was adopted in the 19th century by neoliberal economists which become ‘free market’ ideology and this faith has been strongly pushed by the World Bank and IMF today.

Utility Vs Value

In contrast to neoclassical theory, Marxist economics analyses production based on the labour theory of value and neoclassical analysis of exchange based on the theory of utility, (Stilwell 2002). Labour theory of value means the price of the goods or products is determined by the quantity or qualitative of labour power. In neoclassical theory of utility means the price of commodities determined by consumer satisfaction, (Stilwell 2002). According to Menger in his marginal utility theory, this is when the consumer decides to spend their income on goods or products depending to which goods or products provide the most satisfaction (Stilwell, 2002). And according to Jevons diminishing marginal utility theory is when the consumer decides to allocate their earnings into several commodities. The consumer will test each commodity one by one and try to find out which commodities provide the most satisfaction. The extra satisfaction gained will determine the price of the commodity (Stilwell, 2002). 

This utility theory and labour value theory are still relevant today, because both can be applied depending on how big the market and the firm are. For example, if I as a consumer go to a small local business of handmade furniture, the theory of marginal utility or my satisfaction will not determine the price because normally such a small business would determine the price of goods depending on raw materials and the value of labour power plus some profits. However, if I as a consumer go to a large furniture retailer, the theory of utility can be applied because the seller who represents the big company provides various numbers of furniture with variable prices which can be compared for my satisfaction.   

Equilibrium Vs Underconsumption

According to neoclassical theory, general equilibrium means that prices for commodities and the factors of production will be determine by the balance of supply and demanded for that product. As mentioned before in Say’s Law, supply can generate its own demand. However, in contrast to Marxian economics, oversupply can generate underconsumption which means that if supply of goods runs out of consumers, the market can turn to failure (Stilwell, 2002). According to Marshallian Cross, determination of price depends on the quantity of demand and supply; let us have a look the scissor theory, which has two characteristics; first, when price decline this normally provokes more consumers to buy, and when prices increase, this can induce firms to supply more quantity (Stilwell, 2002). 

As reflected in the market these days, when prices decline this can provoke more consumers to buy and then when demand increases, suddenly the sellers shifted the prices and it requires more supply from the firms; then when firms increase the supply, prices will fall again. This phenomenon is a cycle each with its own movements. According to Marx this is an unstable economy because more supply can result in underconsumption and the market can face a downturn.   

Marginal Vs Structural

The neoclassical theory of marginal analysis originated from the David Ricardo theory of marginal principle which has been used for analysing rent, and this theory has been adopted as a doctrine for neoclassical economists broadly, taking for granted that all the factors are related. However, to apply the marginal principle Ricardo has introduced the principle of substitution in order to understand the relationship between labour and land (Kaldor, 1956).

In contrast to the neoclassical theory marginal analysis, Marxist structural analysis criticised capitalist the state which stays in power. In his manifesto communist Marx described the exploitation of the workers by the bourgeoisie, finding that the bourgeoisie keeps manipulating in order to maintain capitalist power. The capitalist system as a tool of the state has created devices to protect their regimes, including institutions of the state such as the police, judicial system, universities and religions. Marxism strongly criticised these institutions which kept providing their blessing to the state, creating a ‘false consciousness’ (Newton & Deth, 2005).

Conclusion

This essay has explored some of the fundamental ideas and theories of both neoclassical and Marxist economics. Through this expose, it has provided a comparison between the two. Neoclassical theory has brought us an elegant theory of supply and demand which neoclassical economists believe will provide equilibrium of prices. The free exchange between consumers and buyers has indicated that prices are determined by the markets, and with the elaboration of deductive methodology, individual’s analysis, utility theory, equilibrium prices and marginal analysis, have given reasons for neoclassical economics to claim the consumer as the ultimate power in deciding the price.

The original ideas from classical economists like Ricardo with his marginal principle, John Stuart Mill with his utilitarianism, Jeremy Bentham with his greatest happiness and Jean Baptiste Say with his Say’s law, has provided the greatest ideas for neoclassical economists. With help from excellent works of proto-marginalists likes Cournot, Dupuit, Thunen and Gossen, and the marginalist’s revolutionaries such as Jevons, Menger and Walras, including consolidators such as Bohm-Bawerk, Wieser, Marshal, Clark, Fisher, Wicksell, Wicksteed, Pareto and Barone, neoclassical economics has contributed a magnificent number of theories, and some of these theories have become pioneers in capitalist economics today, such as the free exchange between consumer and buyers becoming the embryo for the free market ideology as one of the neoliberal missions.

Marxism on the other hand has provided a fundamental contribution to economic phenomena today. Through historical materialism, class analysis, labour theory of value, underconsumption, and structural analysis, all of these arguments and notions have been used for debates in the political economy arena today. For example, one Marxist theory that is still popular and has become a pioneer in market analysis is underconsumption theory, which believes that oversupply can result in market failure.   

 
References

Albertazzi, L., Libardi, M., & Poli, R., 1996. ‘The school of Franz Brentano’, Kluwer Academic Publisher, Netherlands

Andersen, S, E., 2009. ‘Schumpeter's Evolutionary Economics: A Theoretical, Historical and Statistical Analysis of the Engine of Capitalism’, Anthem Press, United Kingdom

Baumol, J, W., 1999. ‘Retrospectives Say’s Law’, The Journal of Economic Perspectives, Vol 13, No 1, pp 195-204

Bentham, J., 2009. ‘Deontology or, the science of morality: In which the harmony and co-incidence of duty and self-interest’, Bibliobazaar LLC, United States

Bergh, V, D, C, J, M, J., Straaten, V, D, J., & International Society for Ecological Economics., 1997. ‘Economy and ecosystems in change: analytical and historical approaches’, Edward Elgar Publishing, United States

Blaug, M., 2003. ‘Economic theory in retrospect’, Cambridge University Press, United Kingdom

Cournot, A, A., 2008. ‘Researches into the Mathematical Principles of Wealth’, Bibliobazaar, New York

Ekelund, B, R., & Hebert, F, R., 1999. ‘Secret origins of modern microeconomics: Dupuit and the engineers’, The University of Chicago Press, Chicago

Fisher, I., 2007. ‘The nature of capital and income’, Cosimo Inc, New York

Geetika., Ghosh, P., & Choudhury, R, P., 2008. ‘Managerial economics’, Tata McGraw-Hill, India

Gomes, L., 2003. ‘The economics and ideology of free trade: a historical review’, Edward Elgar Publishing, United Kingdom

Hausman, M, D., 1992. ‘Essays on philosophy and economic methodology’, Cambridge University Press, United States

International Monetary Fund., 2010. ‘About the annual meetings’, available from http://www.imf.org/external/am/2010/about.htm

Jaffe, W., & Walker, A, D., 1983. ‘William Jaffe’s Essays on Walras’, Cambridge University Press, United States

Kaldor, N., 1956. ‘Alternative theories of distribution’, The Review of Economic Studies, Vol 23, No 2, pp 83-100

Kates, S., 2003. ‘Two Hundred Years of Say's Law: Essays on Economic Theory's Most Controversial Principle’, Edward Elgar Publishing, United Kingdom

Katouzian, H., 1980. ‘Ideology and method in economics’, Macmillan, London

Lunn, E., 1982. ‘Marxism and modernism: an historical study of Lukacs, Brecht, Benjamin, and Adorno’, University of California Press, United States

Lutz, A, F., 2006. ‘The theory of interest’, Transaction Publisher, New Jersey

Marchionatti, R., 2004. ‘Early mathematical economics’, 1871-1915’, Routledge, New York

Mill, S, J., 2007. ‘Utilitarianism, Liberty & Representative Government’, Wildside Press LLC, United States

Minsky, P, H., 1986. ‘Stabilizing an unstable economy’, Yale University Press, United States

Newton, K., & Deth, W, J., 2005. ‘Foundations of comparative politics: democracies of the modern world’, Cambridge University Press, United States

Pressman, S., 1999. ‘Fifty major economists’, Routledge, New York

Rockmore, T., 2002. ‘Marx after Marxism: the philosophy of Karl Marx’, Wiley-Blackwell, Great Britain

Steedman, I., 1997. Jevons's Theory of Political Economy and the 'Marginalist Revolution’, The European Journal off the History of Economic Thought, Vol 4, No 1, pp 43-64 available from: http://pdfserve.informaworld.com.ezproxy2.library.usyd.edu.au/50145_731193556_739386890.pdf

Stilwell, F., 2002. ‘Political Economy: the contest of economic ideas’ Oxford University Press, Singapore.

Streissler, W, E., & Streissler, M., 1994. ‘Carl Menger’s lectures to crown Prince Rudolph of Austria’, Edward Elgar Publishing Limited, United Kingdom 

Tieben, B., 2009. ‘The concept of equilibrium in different economic traditions: a historical investigation’, Rozenberg Publishers, Amsterdam

Vickers, D., 1995. ‘The tyranny of the market: a critique of theoretical foundations’, The University of Michigan Press, United States

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Timor-Leste external interventions

6/19/2014

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Political Economy of Global Change and Security

‘UN Intervention in East Timor’

Author: Tomas Freitas

Background

After the referendum of 30 August 1999, East Timorese become the newest country of the 21st century. The riots and burnings occurred around the whole country from 4th of September 1999 after hearing the results of the voting. The International Force for East Timor (INTERFET) led by the Australian Defence Force arrived in Dili on 20 September 1999. The crisis began then: no food, no clean water, and no shelter for almost three months before the United Nations Transitional Administration in East Timor (UNTAET) officially opened and run from 2000 to 2002.

This learning journal will analyse the elements of the United Nations intervention with regard to conflict and violence post-referendum.

Intervention and Aid Industries

The UN intervention has enabled aid industries to absorb aid money for their own pockets. UNTAET itself spent US$1 billion just in operating the UN office in Dili and the other 13 district. Bilateral projects came to about US$180 million, the Trust Fund for East Timor (TFET) spent US$168 million, the Consolidated Inter-Agencies Appeal spent US$156 million, local and international spent US$50 million, and the Consolidated Fund for East Timor (CFET) spent US$50 million, in addition to which there was US$25 million from the Timor Sea revenue, (La’o Hamutuk, 2001). The total of this money is around two billion US dollars.

It is clear that intervention has become a great opportunity for aid industries to exercise and implement their own agenda. Many times they have overlapping programs and activities; even if this is realised, it cannot be changed because it is already designed from their own headquarters which not based in Dili. As an example, one of the international agencies delivered dozens of colourbond roofs to the community in Manatuto District, and at the same place two weeks before, another International NGOs also delivered the same products to the same families. Such an incident happens not only because of lack of coordination but also related to budget execution, in which the budget must be spent before the end of the financial year.        

Intervention and the Neoliberal Agenda

The International Monetary Fund (IMF) has been appointed for the development of East Timor’s future economy. During the transition period from 2000 to 2002, the IMF recommended two proposals for the establishment of the Central Payments Office which became the Banking and Payments Authority, and the Central Fiscal Authority became the Ministry of Finance. According to an IMF report, this established East Timor’s economic framework based on macroeconomic management (Valdivieso et al, 2000). Implementation of one of the policies involved future spending cuts, which resulted in a reduction of 6.5% being spent on wages and salaries, and a 13% cut on goods and services, for example wages for civil servants was reduced from US$123 per month to US$85 per month during the transition (La’o Hamutuk, 2001). 

Deregulation is one of the critical recommendations that the IMF always provides for its clients, which includes cutting taxes, and cutting spending on public services. The reduction in wages has affected the efficiency of public services; corruption has grown because the small salary is not equivalent to the cost of living. However, this kind of deregulation only applies to local staff not international staff, the lowest of which receives above US$3000 per month.     

The World Bank had the responsibility of managing donor’s contributions to rebuilding the country with a total of US$166 million for two and a half years. That money has been divided into several projects including 23% being allocated for health sector rehabilitation and development, 14% for community empowerment and local government, 12% for agriculture rehabilitation, 8% for emergency school readiness, 6% for small enterprise, 5% for microfinance development, 2% for capacity-building for economic institutions and support for budget preparation,  less than 1% for Dili community employment generation, and the Asian Development Bank separately has managed 18% of the fund for emergency infrastructure rehabilitation (La’o Hamutuk, 2001).

Although it has some genuine programs, the World Bank never forgets its own principle in driving neoliberal ideas; one of the programs called ‘small enterprises’ which is worth about ten million US dollars has been given to a Portuguese commercial bank called Banco Nacional Ultramarino (BNU). The program is to provide loans to East Timorese small business groups with ‘viable business plans’, which can receive loans worth US$500 to US$50,000, on a 36-month term, (La’o Hamutuk, 2001). Those who can repay the loan will have another chance at additional loans.

However, in one of the districts, Bobonaro, west of Dili, the program failed - most of the small businesses do not have any experience in doing business. A large number of kiosks were opened up within 20 meters from each other, all kiosk selling pretty much the same products such as cigarettes, soft drinks, canned food, noodles and others basics, (Moxham, 2005). Because they could not repay their loans, some of them lost property including land and homes as they had used these as warranty for the loans.       

Intervention and Inequality

The UNTAET budget for the fiscal year 2001 with a total amount of US$563 million included an allocation of US$199 million for wages and salaries for the UN staff, including 1350 UN Police, with living expenses calculated at US$95 per person per day and with wages at US$3,000 per person per month, and also receiving a salary form their national governments. The budget also has used to pay 1200 international staff salary with an average pay of US$7,800 per person per month and also including their per diem at approximately US$3,000 per person per month. The budget also paid for approximately 800 UN volunteers with a living allowance of US$2,250 per person per month. The 1% of the budget which was allocated to local staff totalled US$5.5 million, paying for 2,000 local staff with an average wage of US$240 per person per month (La’o Hamutuk, 2001).

US$5.5 million for local staff and US$194 million for international staff shows a huge gap. The concern is not only about discrimination, but about the functioning of the transitional administration. Let’s take an example, a local staff who is working in the political affairs division is supposed to provide accurate data and information to the head of the UN mission in regarding to a plan for an upcoming protest rally. How seriously will this local staff provide this very important information, if he or she is living on only US$240 a month? With such gaps in benefits, it is no wonder that the UN mission in East Timor many times responded late to crises.  

Conclusion

The aim of the intervention is to prepare a new country as a nation and as a state. Generous contribution of tax payers from each country has become an aid industry, which is supposed to be in the form of grants, not small loans. Some people say the variable of wages is determined by level of skill and background of education. Yes, perhaps that is rational but these matters are not brought to attention when fundraising for aid is happening. 

 

The Political Economy of Oil:

‘East Timor Natural Resources’

Author: Tomas Freitas

Introduction

Despite some arguments stating that the war in Iraq is not because of oil, it is indeed the case because the international oil companies prefer to deal with a stable and secure country in order to extract the resources (Zadeh, 2006). The notion that the presence of giant oil companies such as British Petroleum, Exxon Mobile, Chevron, Conoco Philips, Woodside, Shell and others around the world has nothing to do with any conflicts, invasions or economic changes has to be re-examined. This learning journal will analyse this statement in relation to the political economy of oil in East Timor (Timor-Leste) and try to illustrate the interconnection between oil companies, states and conflicts around oil issues.   

Historical background

The Indonesian military invaded East Timor in 1975 with United States supplied weapons (Burr & Evans, 2001), and the official visits by United States President Gerald Ford and Secretary of State Henry Kissinger in early 1975 gave a green light to Soeharto to kill thousands of civilians during the invasion. The Carnation Revolution in Portugal 1975 and the issue of communism silenced the Australian government during the assault from Indonesia. And on 20 January 1978 the Australian government officially recognised that East Timor is part of Indonesia, a state of affairs which continued until the referendum in East Timor in 1999.

The question is: Why did the Australia government remain silent?

Conflict of interest

There are several facts that might justify Australia’s position. Let’s start with the treaty of the Seabed Boundary between Indonesia and Australia which was signed in 1972; the boundary itself at that time could not be finalised because at that time East Timor was still under Portuguese territorial administration, which is why this area of sea was known as the ‘Timor Gap’. According to Woodside, Greater Sunrise was discovered in 1974 (Woodside, 2011), the location of which is exactly at the end of the seabed line boundary, the east coast of the island of Timor (La’o Hamutuk, 2008). According to petroleum geologists, there are several steps before production of the first barrel of oil, starting with exploration, appraisal, development, and production (O’Connor, 2011), and the exploration stage normally takes 3 – 5 years before the announcement of a new discovery. In the case of the seabed boundary treaty, it is hard to ignore the proposition that this period of time brought to light some of the information in regard to oil and gas fields which would economically benefit both parties (Australia and Indonesia) in the future.

The Timor Gap Treaty was signed in 1989. After the Santa Cruz massacre in November 1991, and in December, Australia and Indonesia awarded production sharing contracts to one of the U.S. based companies Philips Petroleum (which later become Conoco Philips) and after four years; in 1995 Philips Petroleum announced a new discovery, of the Bayu Undan fields. Conoco Philips has a majority share (56.7%) of Bayu Undan, together with IMPEX (12%), ENI (12%), and Santos (10%), (Wilkinson, 2006).  Besides that, Conoco Philips also has a 30% share of Greater Sunrise, which is in a joint venture with Australian based company Woodside, as operator with a 33.44% share, Shell (26.56%) and Osaka Gas (10%).

Generally, oil companies are considered to be one hundred percent profit-seeking ventures which are not related to local or global geopolitical tension. However, let’s have a look some of the members of the board of directors inside Conoco Philips, such as Stapleton Roy, Managing Directors of Kissinger Associates in 2001, Assistant secretary of state for intelligence and Research in 1999 to 2000, and former ambassador of U.S. to Singapore, Indonesia and China(Conoco Philips, 2004); Kenneth Duberstein, former White House Chief of Staff and Deputy Chief of Staff to President Ronald Reagan and Deputy Under-Secretary of Labour during the Gerald Ford administration (Conoco Philips, 2006); Richard Armitage, U.S. Deputy Secretary of State from 2001 to 2005, Assistant Secretary of Defense for International Security Affairs from 1983 (Conoco Philips, 2009); and Charles Krulak, former Commander of the U.S. Marine Corps and member of the Joint Chiefs of Staff from 1995 to 1999 (Conoco, Philips 2006).

If we consider the profiles of the members of the Board of Directors above, it is hard to avoid the conclusion that their military knowledge and political experience can influence the company direction. 

Conclusion

The issue of communism in South East Asia, especially in East Timor, has become a key issue for the United States and its cronies like Indonesia and Australia, to expand their economic interests. Invasions, treaties, and contracts are the usual strategies for exercising their economic profits; and through their military knowledge and political experience, they are able to maintain their economic benefits.    

 

The Political Economy of ‘Interventions’

‘Australia’s Second Intervention in East Timor’

Author: Tomas Freitas

Background

The dismissal of six hundred troops from the East Timor Defence Force in early 2006 was the precursor to major unrest in Dili that year. In May 2006, the East Timor government officially requested international military assistance; troops were provided by Australia and New Zealand, and police by Malaysia and Portugal. The Australian government willingly deployed a 1300-strong battalion of the Australian Defence Force (ADF), with the aim of re-establishing and maintaining public order.

This learning journal will analyse the interest of the Australian government in intervening in the 2006 political crisis in East Timor.

One month after the arrival of Australian troops, Prime Minister Alkatiri resigned from his position, and according to an ABC television program, President Xanana Gusmao accused the Fretilin leader that he had armed militias and asked him to step down (Thompson, 2006).  

Reasons behind the Intervention

However, according to Tim Anderson’s articles on Australia’s second intervention in East Timor (2006), the main reason that the Australian government cited for the intervention was to use Australian assistance to stop East Timor from disintegrating into a ‘failed state’. Tim Anderson has analysed that there are three reasons behind the intervention - firstly the issue of oil and gas in Timor Sea, secondly Ausaid’s contribution in consolidating the neoliberal agenda through collaboration with the World Bank and their allies, and thirdly that East Timor’s bilateral cooperation with China and Cuba had caused concern for the Australian government. 

These reasons make sense: in the first issue, Australia rejected the settlement of the maritime boundary according to the United Nations Convention on the of Law of the Sea (UNCLOS), withdrawing from the International Court of Justice and refusing to accept the median line as an equitable solution – if not, all of the natural resources inside the Joint Petroleum Development Area (JPDA) would belong to East Timor.

In regard to the second reason, the Ausaid contribution for the period 2008-2012 which will total AUD$250 million in commitment, as well as funding already promised, would be managed by several agencies, Australian agencies (25%), World Bank (18%), United Nations agencies (8.5%), Asian Development Bank (4.9%), and the remainder (43.6%) divided between several international agencies (Ausaid, 2011). Even though the implementation of the program would be coordinated with the East Timor government as a counterpart, the East Timor government receives nothing from this funding.

The third reason, that Australia is suspicious of the relationship between China and East Timor, in which China has promised US$1.5 billion to East Timor (Macauhub, 2011), also building the palace of the President of the Republic, the new foreign affairs building and the military training centre for the Timorese Defence Force. The Australian Government is also concerned regarding the relationship between East Timor and Cuba, and under the Alkatiri government, the Cuban government provided 1000 scholarships for Timorese students to study medicine. In comparison, each year eight Timorese students receive scholarships from Ausaid to study at Australian universities. Why can the Australian government not provide a similar number of scholarships as the Cuban government? The answer is the Cuban education system is free because they are a socialist economy, whereas Australia has a capitalist economy. This means that in Australia universities are businesses, meaning that Ausaid has to pay huge amounts of money, just for bringing one international student, costing twenty to thirty thousand dollars. 

After Mari Alkatiri resigned in 2006 and after the coup of the Fretilin government in 2007, which was replaced by the Gusmao government, what has changed? The answer is not much, the Gusmao government is still resisting the gas pipeline to Darwin, the Gusmao government still supports medical students in Cuba until their graduation, and the Gusmao government still accepts Chinese bilateral contributions to infrastructure. Prime Minister Xanana Gusmao felt very upset when, as President, he asked John Howard and Alexander Downer to open up TAFE positions for Timorese students, and to allow Timorese to pick fruit in Australia, without a favourable response. Even after a change of government from Fretilin to AMP, Ausaid still does not trust the Timorese government to manage the funds, and the numbers of scholarships are still the same as under the previous government.

What does Australia actually want from this intervention? Oil, perhaps yes, but this is not one hundred percent true, because Australia also has bigger fields like Gordon, Evan Shoals, and hundreds of oil and gas fields around Australia both offshore and onshore, which provide billions of dollars of revenue to the government. If it is not about oil, maybe the intervention is to prevent Alkatiri government from turning towards communism? This cannot be true because the Fretilin Party itself has declared their ideology to be social democrat and practically speaking also the Fretilin government has in that period provided space for private business to be involved in the development of infrastructure.

The only possible answer is that Australia wants to create a ‘puppet government’ which can be commanded by ‘remote control’ from Canberra. The latest issue of a detention centre in East Timor, which the Gusmao government has not accepted, could affect the relationship between the two countries, and it will then be even harder for the Timorese government to advocate for more scholarships for Timorese students. 

Conclusion

External intervention by the military is always a chance for a change of government, even with or without being forced. Canberra’s strategy in removal Alkatiri has been successful, with ABC television playing a very important role as a tool in displacing Alkatiri from the Prime Minister-ship. However, Canberra failed in programming the Gusmao government and Prime Minister Gusmao has maintained the relationship with China and Cuba and is still thinking of new strategies of how to win and bring the pipeline to East Timor. The neoliberal ideas of free market, privatisation, deregulation etc, can be more advanced in practicality if the ruling government shows willingness, and only a ‘puppet government’ can guarantee this willingness.   

References

Anderson, T., 2006. ‘Timor-Leste: The Second Australia Intervention’, Journal of Australian Political Economy, Vol 58, pp 62-93

Australian Agency for International Development., 2011. ‘East-Timor Country Profile’, Available at http://www.ausaid.gov.au/country/country.cfm?CountryID=911&Region=EastAsia

Burr, W., & Evans, M., 2001. ‘Ford and Kissinger Gave Green Light to Indonesia’s Invasion of East Timor, 1975: New Documents Detail Conversations with Soeharto’, The National Security Archive. Available at http://www.gwu.edu/~nsarchiv/NSAEBB/NSAEBB62/press.html  and http://www.gwu.edu/~nsarchiv/NSAEBB/NSAEBB62/doc3a.pdf

Conoco Philips., 2004. ‘Annual Report 2004’, Available at http://wh.conocophillips.com/about/reports/ar04/index.htm

Conoco Philips., 2006. ‘Annual Report 2006’, Available at http://www.conocophillips.com/EN/about/company_reports/annual_report/Documents/2006%20Annual%20Report.pdf

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Does the informal economy benefit the poor?

5/6/2014

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Does the informal economy benefit the poor?

Women Roadside Sellers in Madang Province of Papua New Guinea

Author: Tomas Freitas

 Introduction

The tendency for rural people to engage in multiple, informal occupations is widespread. Women often take on small business training and technical assistance, are encouraged to form stakeholder associations, and to participate in additional community-level activities sponsored by various projects (Asian Development Bank 2002). The proliferation of informal professions in developing countries has been seen both as a phase in the process of development and a negative path leading a country back into underdevelopment (Arizpe 1977).

Both of these positions are often subscribed to by modernist scholars, who prefer the small informal sector to take a step-by-step approach in developing their business, with the possibility of access to more credit, which can be provided by big institutions with high interest. Is it possible that rural women in the informal economy will one day become rich and living in an affluent society? This is unlikely; the reason why many engage in the informal economy is because they are marginalised by the modern economy, which has left them with no choice.

Presenting the case study of roadside sellers in Madang province in Papua New Guinea, this essay will explore a number of reasons for why the informal economy does benefit the poor.

The paper will in particular focus on the way that the informal sector provides economic benefit to women in rural areas. 

Definition

The informal economy has been described in various ways. Writing about the informal sector in Sri Lanka, Sandaratne (2002) explains that the informal economy has various definitions including,

the ‘unorganised sector’, ‘unregistered economy’, ‘third economy’, ‘parallel economy’, ‘non-institutional’, ‘bazaar economy’, ‘lower circuit’, ‘black economy’, ‘shadow economy’, ‘underground economy’, ‘peasant form of production’, ‘peddlers’, ‘the unremunerated’, (Sandaratne, 2002,4).  

 

This paper will adopt a definition of the informal economy which applies to the case study of roadside sellers in Papua New Guinea, and will refer to the informal economy variously as the ‘unregistered economy’, ‘non-institutional economy’ and as a ‘peasant form of mode of production’ as described by Karl Marx in his economic model ‘relations of production’, concerned with how people are organised for the purpose of producing goods and services (Marx, cited in Stilwell, 2002). ‘Unregistered economy’, refers to the characteristic of the informal economy as being mobile, moving from one place to another, making registration or documentation of their existence difficult (Kari, 2005) and ‘non-institutional economy’ because they are not institutionalised, or integrated into any legal entity in the form of big institutions. Some, however, have organised themselves into small cooperatives whose members are composed of families and neighbours (Gustafsson, 2002); these small cooperatives have existed in the rural economy as a type of social protection (Ratuva, 2010). A peasant form of ‘mode of production’ according to Karl Marx is a type of economic structure of a society which focuses only on the social organisational aspect of the production process (Marx, cited in Mackenzie, 1984). In other words, this is a relationship of production which is concerned only with how these rural farmers have organised and produced their crops.   

Demographics

Papua New Guinea is a poor country in the Pacific region. According to the census data of 2008, the total population is about 6.468 million, with a growth rate of 2.7%. The annual Gross National Income per person is $1.040 and the real GDP annual growth rate is 4.5%. The percentage of the population below the poverty line is 39.6%. Enrolment in primary education is 63.6%, with the balance of gender parity in primary education 91 girls for every 100 boys. The mortality rate for children under five years old is 69 per 1000 births, and the maternal mortality rate is 733 per 100.000 live of births (Ausaid, 2011). The benefits that the informal economy can bring to poor farmers are substantial. 

Social and Cultural Advantage

Most of the Pacific Island communities such as Papua New Guinea, Fiji, Samoa, Solomon Islands, Vanuatu, Tonga, Tuvalu, Kiribati, Nauru, Marshall Islands, and Cook Islands, have a strong dependence on subsistence agriculture, which is closely linked to their social context. The culture of exchange has been practically implemented generation by generation in this society as a means of building social and economic relationships. In Vanuatu about 80 percent of the population is engaged in the informal economy in some way, which is based on commodities exchange and social networking activities (Ratuva, 2010). The informal economy, based on subsistence agriculture, is a strong component of these communities’ social and cultural context. One of the fundamental advantages of the informal economy in these Pacific Island countries is that the majority of the population live on thousands of hectares of land under customary land tenure.  

Customary land tenure

Customary land refers to ‘communal ownership’, and land boundaries are normally based on rivers, trees, or even mountains, which have no official demarcation and the land title has not been registered under the formal law. The title is however recognised by custom through the elders, which usually does not allow the sale of land to persons outside the kin group or other than relatives, and also prevents individual or groups selling the land to foreigners (Cooter, 1991).

Customary tenure in PNG accounts for about 97 percent are of the land (47 million hectares). Less than three percent (1.2 million hectares) is alienated land, meaning that it does not belong to the customary landowners. Of this three percent, about 125,000 hectares is owned by missionaries or churches and about 950,000 hectares belongs to the government. The government has also leased to other parties about 120,000 hectares, under 99 year leases (Trebilcock, 1983). The 97 percent of land owned by customary tenure forms the livelihoods of around 85 percent of the 6.7 million people of PNG (Bismarck Ramu Group, 2009). As far back as 1990, about 7 million hectares of land were used for cultivation, which at that time was about 1.5 hectares per person (Anderson, 2006b). In other words, 7 million hectares were utilised for subsistence-based agriculture, which the majority of the people use for plant-food crops.

The existence of customary land tenure has made it possible for many rural farmers to base their subsistence on plant food crops, which is beneficial in a number of ways. Plant-food crops form part of the economic structure of the society; they are important because if at the end of the day the crops are not bought by consumers, they will be consumed at home. In addition, plant-food crops are not for the export market, which means that there is not demand to produce huge quantities, meaning that rural subsistence farmers do not need to borrow a lot of money from microcredit institutions to meet the cost of production.

Women and the informal economy

There are two types of custodianship land applied in Papua New Guinea: the majority have adopted a patrilineal system, however some of the islands have implemented a matrilineal system. Under a patrilineal system, the senior male in the family has the right to determine and distribute land within the family. However, in some of the eastern islands, such as in the region of Milne Bay, only the matrilineal system is recognised, which means that women have control over the land. Men in this context can also have access to the land through their mothers, sisters or wives (Anderson, 2008).

In contrast to the World Bank opinion of traditional women hardly having access to land (Deininger, 2003), the case of customary land in PNG is different. For instance a woman from Madang province has testified that even though she is married to her husband from another province, when she returns to her father’s village she is still respected and still has access to land title, no matter where she is living (Bismarck Ramu Group, 2009).

The advantages of having access to land and the consideration of the culture of exchange as mutual gifts has benefited women in the informal sector in Papua New Guinea, especially rural women in Madang province. Despite utilising four to six hectares of land for oil palm farming, and two to four hectares for vanilla and cocoa plantations, most rural farmers still have one to two hectares just for the cultivation of crops and vegetables (Anderson, 2010). The average cash income from palm oil Palm is around 4,000 kina per year, which is less than cocoa and vanilla cash returns of 14,000-16,000 kina per year, and cash crop returns of around 13,500 kina per year (Anderson, 2006a).

Higher income

Women and men in PNG including in Madang province also have the potential to generate more income by participating in the informal as opposed to the formal economy. Activity in the informal economy has the potential to earn more income compared to national standard wages. In Madang province, a survey has been conducted which focuses on roadside seller activity in eleven different places. The Watta Rais roadside market has 30 sellers, Sausi has 40 sellers, Yakumbu 20 sellers, Usino 50 sellers, Mambu 70 sellers, Four Mile 200 sellers, Maiwara 13 sellers, Pau 120 sellers, Selon 40 sellers, Nagada 10 sellers and Baitabag 20 sellers, and the minimum average income per week in these eleven places is 138 kina higher than the national minimum wage which is only 37.20 kina per week (Anderson, 2008). These particular roadside sellers sell their local produce along the main roads, and target people who are travelling from one province to another (Ausaid, 2010).

According to a rural informal sector survey report, the informal sector income in four other provinces including Central, East New Britain, Morobe, and Western Highlands is three times higher than the normal national minimum wage. Daily activities that these informal sectors conduct are buying and selling fish, local transport, trade store, selling cattle, potatoes, cocoa, coffee, food crops, betel nuts and copra (Sowei, et al, 2003). 

It might be asked why these roadside sellers do not want to sell their local produce at the normal local market; the fact is that they do not have a choice - there is not enough infrastructure at the local market that the government can provide to rural subsistence farmers (AusAid, 2000). Due to the difficulty of distance, some of the women who do sell at the marketplace have to organise themselves into groups for walking there together, and carry their produce on their heads to get to there, (Epstein, 1982).

The difficulty of accessing the local market and not having many local markets around is one factor that highlights the importance of the 47 million hectares of customary owned land in PNG. We might ask why the roadside sellers have set themselves up alongside most of the national roads. One of the reasons is because they are tired of fighting for a place in the regular marketplace, and also because many of these sellers live close to main roads, and they don’t have to pay too much for local transport to carry their crops and vegetables.

Interestingly, most of the sellers are housewives, who do multiple tasks by selling their local produce as well as looking after their children (Porter & Porter, 2008). Every day their husbands work in the fields, and some of them have other jobs as well such as working as labourers on construction sites or doing some other informal activity. Roadside sellers primarily sell local produce from their home farms including sweet potato, bananas, taro, coconuts, sugar cane, cassava, yams, sago, peanuts, aibika, betel nuts, eggs, chicken, lamb, pork, and rice.

Price control

Customary land tenure again proves to play an important part in the informal economy as regards price control. As the owners of the land, the roadside sellers are also able to control the price of their goods in the market by controlling the supply, because most of the crops and vegetables are seasonally grown. These roadside sellers also know how much they will charge for each specific crop after deducting their labour costs, including costs for local transport to transport their goods to the market place or main road. Such a system is unusual from a neoclassical economic perspective, which always maintains that prices are determined by consumers, not sellers (Stilwell, 2002).

Sustainability

Inspired by the ability to control the supply in the market, it has given self-confidence to rural farmers to sustain their productivity. In contrast to large farms which use chemicals or fertiliser, these rural farmers only produce their own organic compost which is why they usually produce good quality crops and rarely experience delays in harvesting (Sillitoe, 1998). As a tropical country, typically most of the crops are seasonal, and the rural farmers generally know very well when it is time for them to start planting their seeds (Allen et al, 1995). This activity is repeated season by season and continues year after year, which is why such a system is well maintained and sustainable.

Secure and Protected

Because their system is well maintained and sustainable, it has protected the activity of roadside sellers from external intervention. The women roadside sellers of Madang are different to women in other countries. If we compare to women in Bangladesh, the microcredit institutions have exploited Bangladeshi women and maintained a strong patriarchal system (Karim, 2008). This is not the case in PNG, because rural women in PNG have always relied on their families’ contribution. The culture of exchange has been considered as mutual gifts, and this has become a barrier for external intervention such as the introduction of micro-credit or micro-finance.

The culture of exchange has been a part of rural economy activities, for example canoes are traded as gifts rather than commodities (Gregory, 1982). Such a form of commodity exchange has been discussed many years ago by great philosophers, for example according to Karl Marx (1867) in his social pre-conditions for commodity exchange:

“The reality of the value of commodities differs in this respect from Dame Quickly, that we don’t know “where to have it.” The value of commodities is the very opposite of the coarse materiality of their substance, not an atom of matter enters into its composition. Turn and examine a single commodity, by itself, as we will, yet in so far as it remains an object of value, it seems impossible to grasp it. If, however, we bear in mind that the value of commodities has a purely social reality, and that they acquire this reality only in so far as they are expressions or embodiments of one identical social substance, viz., human labour, it follows as a matter of course, that value can only manifest itself in the social relation of commodity to commodity. In fact we started from exchange value, or the exchange relation of commodities, in order to get at the value that lies hidden behind it. We must now return to this form under which value first appeared to us.” (Marx, 1867; 16).

If we analyse this paragraph and link it into Melanesian communities in Papua New Guinea and other Pacific countries, it shows that commodity exchange depends on the value of the commodity itself, and that this is determined by the social relation between two commodities. The ‘social relation’ in this case might refer to the culture of exchange that has been applied generation by generation as anthropologists referred to in ‘primitive societies’.

Another barrier that has protected this informal activity from external intervention is customary land tenure (Fingleton, 2004). The financial institutions such as microcredit and microfinance prefer to grant credit for individual land ownership rather than communal (Gosarevski, et al, 2004). Despite the existence of individual property rights, many attempts to introduce a land registration system by the government and western institutions have failed (Yala, 2006).   

Conclusion

In this paper land has been identified as a fundamental structure of the rural economy, which has empowered subsistence rural agriculture and become a strong factor in economic production. In particular customary land tenure and women’s access to land in matrilineal societies such as that of Madang province in Papua New Guinea has been shown to benefit the poor. Supporting the view that the informal economy does benefit the poor, this essay has explored a number of points that support this view. These benefits are strongly contingent on the large basis of customary land ownership in Papua New Guinea. The informal sector in PNG has been shown to earn more income compared to average national standard wages. Sellers can control the price in the market, which is actually a counter argument to the neo-classical economy which maintains that consumers have the ultimate power in determining price. In addition, due to the basic subsistence agricultural system and the geographic condition of seasonal harvesting in PNG that is repeated year after year, a sustainable cycle of productivity has developed. The culture of exchange has become a barrier of protection from external intervention, and the collective ownership of land title has become an obstacle for financial institutions to implement their programs of borrowing and microcredit. The system of customary land ownership is a strong factor in the benefits that the informal economy can bring to rural subsistence farmers in Papua New Guinea. In some provinces, such as Madang, the matrilineal system that operates has benefited poor women, giving them more control over land and produce.   

References

Allen, J, B., Bourke, M, R., & Hide, L, R., 1995. ‘The Sustainability of Papua New Guinea agriculture systems: the conceptual background’, Global Environmental Change, Vol 5, No 4, Pp 297-312.

Anderson, T., 2006a. ‘Oil Palm and Small Farmers in Papua New Guinea’, Report for the Centre for Environmental Law and Community Rights on the economic prospects for small farmers in PNG’s oil palm industry. Available from https://files.pbworks.com/download/dbes3v7EBj/np-net/12638881/Anderson%20(2006)%20Oil%20palm%20and%20small%20farmers%20in%20PNG,%20CELCR.pdf

Anderson, T., 2006b. ‘On the economic value of customary land in Papua New Guinea’, Pacific Economic Bulletin, Vol 21, No 1, Pp 138-152.

Anderson, T., 2008. ‘Women Roadside Sellers in Madang’, Pacific Economic Bulletin, Vol 23, No 1, pp. 59-73.

Anderson, T., 2010. ‘Land registration, land markets and livelihoods in Papua New Guinea’, Aidwatch.  Available from http://www.aidwatch.org.au/sites/aidwatch.org.au/files/Tim%20Anderson.pdf

Arizpe, L., 1977. ‘Women in the Informal labor Sector’: The case of Mexico City, The University of Chicago Press. Vol. 3, No.1, pp 25-37

Asian Development Bank (ADB), 2002. Papua New Guinea Country Strategy and Program Update, 2003 – 05, Asian Development Bank, Manila. Available from  www.adb.org/Documents/CSPs/PNG/2002 .

Australian Agency for International Development., 2000. ‘Income generation for the rural poor: The Australian aid program’s rural development strategy’, Available from http://www.ausaid.gov.au/publications/pdf/ruralstrategy.pdf

Australian Agency for International Development., 2010. ‘The Socio Economic Impact of AusAID Funded Road Maintenance And Rehabilitation On National Priority Roads in Ten Province of Papua New Guinea’, Available from http://www.pngtssp.com/publications/pdf/SEIS%20Report%20October%202010.pdf

Australian Agency for International Development., 2011. ‘Papua New Guinea: Country Profile’, Available at http://www.ausaid.gov.au/country/papua.cfm

Bismarck Ramu Group, 2009, ‘Defending Melanesian Land’, Available at http://www.youtube.com/watch?v=bmolHFFdNyc

Cooter, R., 1991. ‘Inventing Market Property: The Land Courts of Papua New Guinea’, Law & Society Review, Vol 25, No 4. Available at http://works.bepress.com/robert_cooter/42

Deininger, K., 2003, ‘Land Policies for Growth and Poverty Reduction’, A World Bank Policy Research Report, Oxford University Press, Washington. Available at http://info.worldbank.org/etools/docs/library/34919/landpoliciesexecsummary.pdf

Epstein., S, T., 1982.‘Urban Food Marketing and Third World Rural Development’, Biddles Ltd, Guildford and King’s Lynn, London. 

Flingleton, J., 2004. ‘Is Papua New Guinea viable without customary groups?’, Pacific Economic Bulletin, Vol 19, No 2, Pp 96-103.

Gosarevski, G., Hughes, H., & Windybank, S., 2004. ‘Is Papua New Guinea Viable with Customary Land Ownership?’, Pacific Economic Bulletin, Vol 19, No 3, Pp 133-136.

Gregory, C.A., 1982. ‘Gifts and Commodities’, Academic Press, London.

Gustafsson, B., 2002. ‘Rural Households and Resource Management in Papua New Guinea’, Resource Management in Asia Pacific Program, Canberra. 

Kari, S, S., 2005. ‘The Origin and Setting of the National Goals and Directive Principles in the process of writing the Constitution of Papua New Guinea’, Centre for Social Change Research. Available from http://eprints.qut.edu.au/16071/1/Sam_Kari_Thesis.pdf

Karim, L., 2008. ‘Demystifying micro-credit: the Grameen Bank, NGOs and neoliberalism in Bangladesh’. Cultural Dynamics, Vol 20, No 1, Pp 5-29.

Mackenzie, D., 1984. ‘Marx and the Machine’, Technology and Culture, Vol 25, No 3, Pp 473-502.

Marx, K., 1867. ‘Capital’, Progress Publisher, Moscow.

Porter, J., & Porter, J., 2008. ‘The Markets of Madang Papua New Guinea’, Available at http://www.youtube.com/watch?v=96-gA8IGxqo&feature=related

Ratuva, S., 2010. ‘Back to basics: towards integrated social protection for vulnerable groups in Vanuatu’. Pacific Economic Bulletin, Vol 25, No 3, Pp 40-63

Sandaratne, N., 2002. ‘The Informal sector in Sri Lanka: its nature and extent and the impact of globalisation’, International Labour Organization, Geneva. Available from http://ilo-mirror.library.cornell.edu/public/english/region/asro/colombo/download/nmlfml01.pdf

Sillitoe, P., 1998. ‘It’s All in the Mound: Fertility Management Under Stationary Shifting Cultivation in the Papua New Guinea Highlands,’ Mountain Research and Development, Vol 18, No 2, Pp 123-134.

Sowei, J.W., Lahari, W., & Vatnabar, M., 2003. ‘Rural Informal Sector survey Report’, National Research Institute (Social and Environmental Studies Division), Port Moresby.

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Trebilcock, J, M., 1983. ‘Customary Land Law Reform in Papua New Guinea: Law, Economics and Property Rights in a Traditional Culture’, Port Moresby. Available at http://www.austlii.edu.au/au/journals/AdelLawRw/1983/17.pdf

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Country risk analysis: A macroeconomic risk (presented at development future conference, 22-23 nov 2013, uts) 

4/6/2014

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Timor-Leste Macroeconomic Risk

Country Risk Analysis

Author: Tomas Freitas




Introduction

Theoretically, the basic circular flow of income is the interaction between household and firm through factor of production and transaction of goods and services in the market, (Frey, 1978). However, these days, in the modern capitalism economy, the basic circular flows become huge and complex, and the leakages in the circular flow such as; paying taxes, buying import goods, and saving, at some stage has to balance the injections by government spending in health, education, agriculture, infrastructure and social security, including exports of national production and investment.

This essay will use the Keynesian approach to analyse the complexity of circular flow of income in the context of Timor-Leste. The analysis will investigate the injections and leakages in the circular flow, and will present a conclusion on macroeconomic risk in Timor-Leste. To justify the context, the paper will outline a few points such as the background of the country, the transparency and accountability, the economic performance, and the elements of GDP of the country. 

Background

Timor-Leste gained independence in 2002, and currently has a population of 1.2 million. Geographically Timor-Leste is located between the regions of the Pacific and South East Asia; the country is divided into 13 districts with Dili as the capital. With guidance from the United Nations, the World Bank and IMF, Timor-Leste still faces basic problems common to those confronted by post conflict countries. The health sector is one example; according to the Ministry of Health, every year 380 children die from diarrhoea (Ministry of Health, 2011); the under five child mortality rate is 56 per 1000 births, compared to Indonesia 39 (UNDP, 2012); life expectancy is 62.5 years, compared to Indonesia at 69.4 years and Papua New Guinea (PNG) at 62.8 years (UNDP, 2012).

Transparency and Accountability

Normally to call for foreign investment, a country has to apply several indicators, one of which is to be accountable to ratings agencies. Unfortunately Timor-Leste does not apply any ratings agencies such as Standard and Poor or Moody’s; however there are some international institutions that actively monitor transparency and accountability in Timor-Leste.

Transparency, accountability and corruption indexes, as well as other indexes published by several institutions, have become significant sources of information for investors before deciding to invest their money in particular country. For example, an empirical study conducted in 40 countries over seven years identified that high corruption and low transparency has become the main reason for investors to withhold investment (Zhao, et al, 2003). In the case of corruption perceptions, the rating index has underpinned Timor-Leste in position 143 out of 183 (Transparency International, 2012), which is extremely high, and can be attributed to a lack of law enforcement. According to one of the World Bank reports (2009) on enterprises in Timoe-Leste, to get a construction permit more than a third of large firms expected to pay bribes to government officials.

Economic Performance

According to the United Nations Development Program (UNDP) (2012), Timor-Leste’s Growth National Income (GNI) per capita is about $3,005 million US Dollars. Although Timor-Leste suffers from lack of investment from both sides, foreign investors and the local private sector, it still performs well is comparison to two neighbouring countries Indonesia, with GNI per capita of $3,716 US dollars and Papua New Guinea (PNG) with $2,271 US dollars per capita. According to the International Monetary Fund (2011), Timor-Leste’s Gross Domestic Product (GDP) per capita is about $3,949 US dollars, which is higher than Indonesia with $3,508 and PNG $1,900. Timor-Leste’s GDP can be seen in Table 1 below:

Gross Domestic Product

Picture
The table demonstrates that the percentages of GDP has dropped to -0.1% in 2003 after the United Nations administration terminated in 2002, and subsequently the oil revenue began to filter in, increasing GDP to 4.3% in 2004 and 6.5% in 2005. In 2006 internal political conflict negatively impacted GDP which fell to -3.1%; however it has since climbed again to 11.6% in 2007.  In 2008 GDP reached 14.6%, which was very different to the world economy at the time which was experiencing a financial crisis. This insulation from the global financial crisis was possible because Timor-Leste does not have any foreign debts, local firms do not have any equities in financial markets, and the Petroleum Fund had at the time invested 100% in Merrill Lynch 0-5 year government bond index (Central Bank of Timor-Leste, 2008). In 2009 GDP dropped slightly, 1.8% from previous year, and then again decreased 3.3% in 2010, with a small increase of 1.1% in 2011. The projection for 2012 is that it will stay at 10%.

 Timor-Leste’s GDP performance is contributed to by the injection of Gross National Income, as per Table 2 below:

Picture
Table 2. Source: The World Bank Statistic database (2010)
Table 2 demonstrates that GNI per capita is more than GDP per capita, which is ideal because it is better to have some leftover income. The difference between the two variables GNI and GDP per capita from 2002 to 2003 is only 3.1%. However, from 2004 to 2010 when oil revenue began to inject state expenditure, the difference between GNI and GDP per capita in an average year became 65.2%.


Picture
Table 3. Sources: National Directorate Statistic, Central Bank of Timor-Leste and Ministry of Finance (2012).

Table 3 shows the elements of GDP which are based on the expenditure approach as described in the formula GDP = C + I + G + (M-X).


Consumption

Looking at consumption in Table 3, household consumption has gradually increased 7.3% every year on average. The question is: who is the consumer? Where is the income coming from? If we check proportions of income distribution in Table 4 below, we can see that 37.3% of jobs are provided by the government and public sectors such as civil servants and soldiers in the military, followed by non-government organisations (NGOs) at 16.2% and private individuals (such as taxi drivers, maids etc) at 16%. Private companies stand at only 9.9%. For circular flow of income, companies need to be key actors in providing income to households, but in Timor-Leste this is not the case. According to a Business Survey Report published by the National Directorate Statistic (2010, 5) total employment in Timor-Leste is 46,700 thousand, comprised of 32,700 males and 13,900 females. See Table 4:

Picture
Table 4, Source National Directorate Statistic 2007
This only represents 15% of the total livelihoods in Timor-Leste, because the majority of the population (85%) are farmers who work without wages in the agriculture sectors, with minimal income because food production cannot compete with food imports which are cheap and dominant the market.


Investment

Lack of investment from external and internal firms has affected local factors of production. According to the Ministry of Finance (2012), the country has struggled to stimulate job creation. High unemployment in the rural area which is about 80% compared to urban areas at 42% has indicated that there is a concentration of jobs in the capital. Looking back at Table 4, if we combine the livelihood sectors of industry and wholesale trade, retailers, restaurants and hotels, this accounts for only 3.1%. Why is the predominance of companies so very low?

According to Joseph Stiglitz (2000), Foreign Direct Investment (FDI) is one of the most important factors that need to be addressed in order to propel the economy, because FDI not only brings resources, but also technology, access to markets, and improvements in labour skills. If so, what then are the factors that slow down FDI in Timor-Leste?

As mentioned previously, Timor-Leste is not engaged with any rating agencies, such as Standard and Poor’s or Moody’s, which are very important for investors to decide whether or not to invest in Timor-Leste. However, there are several institutions which independently survey transparency and accountability in Timor-Leste. According to the Transparency International index (2012), the effectiveness of rule of law in Timor-Leste is only 10%; the independence of judicial system is ranked 86 of 142; and the capacity of oversight institutions such as the Ombudsman, the Anti Corruption Commission and anti corruption NGOs is only 18%.

Government Expenditure   

According to the data shown in Table 3, of the total budget over eight years, the government has spent 38.5% on health, education, agriculture, infrastructure and social security. According to local NGO Luta Hamutuk (2007), the majority of six infrastructure projects investigated by the NGO including road rehabilitation, primary school and health centre rehabilitation, were of very poor quality (Luta Hamutuk, 2007). This investigative project was on a very small scale; it is not known what has been the case for other projects not yet investigated.

There is lack of information in rural areas about infrastructure projects, which are often carried out by private companies and do not involve local labour. Rural communities also do not feel ownership of projects because they do not pay any direct taxes, such as income tax, withholding tax, or even wages tax; on the other hand the community do not realise that they do contribute through indirect taxes such as when purchasing goods they are contributing to import tax, sales tax and excise taxes. Lack of ownership of these projects has affected accountability and means that the community do not report mistakes or bad quality of the projects.     

Trade Balance

According to Table 3, exports and imports from 2004 to 2009, have show us that the value of exports is not equal to the value of imports - the average of imports value every year is around 400% more than exports value. So, what commodities are used for exports and imports? Data from the National Directorate of Statistics regarding merchandise exports and imports can be seen in Table 5 below.

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Sources of table 5 and 6 from National Directorate Statistic 2010.

The data shows that the only commodity exports that Timor-Leste produces are coffee beans and heavy containers, which are empty containers that are sent back after being used for packing goods from imports. Coffee is only produced by three districts on the western side of the island. Ermera is the largest coffee producing district. Table 7 below shows us a district lifestyle comparison comparing the district of Ermera with three other districts, including Manatuto from the Eastern region, Dili the Capital and Manufahi from the Southern region.  


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The data demonstrates that the people of Ermera district are far below the others in terms of lifestyle factors. So who actually exports the coffee beans? The National Cooperative Business Association (NCBA) has been involved in Timor-Leste coffee exports since 1994, with financial support from the United States Agency for International Development (USAID) (NCBA, 2011). NCBA actually monopolises the market. This gives no option to the coffee farmers who must become members and sell their coffee to NCBA. Those who sell more than 1000kg a year to NCBA will receive free services from NCBA clinics; if selling less than that, members still can access the clinics but have to pay (Lao Hamutuk, 2002): 

“More recently, one of our most successful projects is in East Timor. NCBA/CLUSA’s Cafe Coopertiva Timor has become the largest supplier of single source coffee to Starbucks and the primary health services provider of the island nation”, (NCBA, 2011).      

Ironically, the above quote is contradicted by data from the National Directorate of Statistics (see Table 7) in which Ermera district has the highest percentage of less than adequate health care from among the three comparison districts. Table 6 shows that the value of coffee exports in 2009 is about 8.2 million US dollars, however, according to Lao Hamutuk (2002) the NCBA or CCT buy Timorese coffee at 10 to 12 cents per kilogram, and now the coffee market is around 15 cents per kilogram. It is clear therefore who benefits from this business partnership in coffee exports.

All the elements of GDP as described above, including consumption, investment, government spending and trade balance, can be simplified by drawing of charts below, which is hardly no private investment for generating employment, and Timor-Leste revenue from Timor Sea is the main income for paying government bills.

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In Timor-Leste there is no factor of production - the government acts like companies by recruiting 37.3% of civil servants and creating temporary jobs (13.8%) in rural public works programs (National Directorate Statistic, 2007). On the other hand, the oil revenue has played a very crucial role, becoming the only factor running the economy of the country.

Second, not only households spend their income on imports of goods and services; government and private sector also does. For example in the 2010 state expenditure, the government spent 23.250 Million US Dollar just for importing rice directly from Laos, Vietnam, Thailand and Indonesia (Ministry of Finance, 2010). The local private sector also spends money on importing goods and services, for example when the private sector wins a bidding contract from government for the building of an infrastructure project, almost 90% of construction material will be imported from the global market. If the Timor-Leste economy remains as is for another 10 years, the country will face a great disaster because the oil resources from Bayu Undan will only last until 2022 (Lao Hamutuk, 2012). If the volume of oil resources can be predicted, the government of Timor-Leste should think about how to find another alternative in order to continue to run the economy. There are two options that the government can take to anticipate the transition from oil revenue into a real economy before the oil runs out.

First, if foreign investment or the local private sector is still unwilling to invest their money because of corruption and accountability, the government should avoid direct import activity, meaning that it should not buy rice directly from the global market, but let the private sector or retailers deal with that, and the government can then buy from the private sector or retailers. While the price will be more than the original price, the private sector will employ more labour just for unloading the rice from containers, which is positive for the employment sector. 

Second, the government should think about creating more community based cooperatives; the goal is to anticipate foreign business such as NCBA which has taken more advantage of coffee farmers rather than helped them. If the government wants to attract foreign investment, it should be proactive and ensure that investors do not engage in business practices that disadvantage farmers or community. 

Conclusion

This paper has explored macroeconomic risk for Timor-Leste. A number of factors have been discussed. An increase in the percentage of GDP does not mean that the economy is doing well. Transparency and accountability is always a question for investors before making any decision about investment. High consumption can be reflected as stability of income but it does not mean that everyone has equal income to consume. Solving unemployment issues does not mean making an urgent call to foreign direct investment, but rather first addressing enforcement of the rule of law and judicial independence. Investing in government expenditure in infrastructure projects in terms of budget allocation does not mean that enough has been done. A trade balance deficit does not mean increasing the volume of exports or commodities, but can also mean reducing some items of import commodities. In terms of circular flow of income, it appears that the Timor-Leste government is heading in the wrong direction; this is a macroeconomic risk.     

References

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    TheThAuthor

    Tomas Freitas, Co-founder and former director of Luta Hamutuk, former member of Consultative Council of Petroleum Fund, and Master of Political Economy from University of Sydney  

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