Evaluating Projections of African Economic Growth

A discussion of the African Development Bank’s report utilizing the Solow Model and examining welfare effects.

Student

Introduction

GDP per capita in Sub-Saharan Africa is the lowest in the world at $1,594 in 2015 (World Bank 2015). Rates of extreme poverty (living on less than $1.90 per person per day) are the highest in the world at 40 percent in 2015 (World Bank 2015). While other countries such as China, India, Vietnam and Cambodia have experienced rapid growth over the last quarter century, bringing millions of their citizens out of poverty and industrializing their economies, most African countries have economies based largely on agriculture and commodities, sectors that are susceptible to shifts in exogenous factors such as international prices and weather. As the continent seeks to alleviate the mass poverty, build its vital infrastructure, and join the ranks of other high-growth countries, the African Development Bank (AfDB) was instituted to “spur sustainable economic development and social progress in its regional member countries (RMCs), thus contributing to poverty reduction” (AfDB).

The AfDB recently held its 52nd annual meeting, at which it released its annual assessment on the economic outlook for Africa. A newspaper article in the Ugandan Daily Monitor, “Africa’s Economic Growth Bright – AfDB,” reported on the document and summarized its projections. The report predicted growth of 3.4 percent in 2017, up from 2.2 percent in 2016. The lower growth in 2016 was “due to low commodity prices, weak global recovery and adverse weather conditions” and the expected rebound in 2017 is “on the assumption that as commodity prices recover, the world economy will be strengthened and domestic macroeconomic reforms are entrenched” (Daily Monitor, June 2017).

Are the Report’s Assumptions Realistic?

The growth rates predicted in the AfDB’s report are higher than growth rates in the United States. This is not surprising, as developing countries typically have higher growth rates than developed countries. While higher than projected growth rates in developed countries, the AfDB report’s rates are lower than those projected in China. China’s growth rate, although slowing somewhat (from 14 percent in 2012 to 7 percent in 2015), remains one of the highest in the world. That the projection in the AFDB report is between that of the United States’ and China seems reasonable.

Although the figure might be within a reasonable range, it is important to evaluate if the assumptions made about the drivers of this growth are reasonable. The projection is based “on the assumption that as commodity prices recover, the world economy will be strengthened and domestic macroeconomic reforms are entrenched.”

The assumption that commodity prices will go up is line with most analysts’ estimates. The World Bank’s Commodity Markets Outlook forecasts higher prices for industrial commodities such as energies and metal and stable prices or a small decrease in the prices of grains and some other agricultural products (World Bank, April 2017). As different African countries contain different natural resources and have varying economic dependence on commodity exports, they will be affected individually by price changes. But the overall impact of price changes is likely to be positive.

It is a strong assumption to say that the world economy will be strengthened next year. There is a great deal of uncertainty in international trade and financial markets being caused by international terrorism and the nationalistic movements in the Europe and the United States. Furthermore, the continued cooling of China’s economy will not only affect international growth, but also will significantly reduce demand for raw materials. This will have a severe impact on Africa, as many African countries’ economies are reliant on exports of raw materials.

Finally, the reinforcement of domestic macroeconomic reforms within Africa depends on African leaders’ willingness to fight corruption and make their markets better for doing business. The incentives align for these reforms to advance and Africa’s economy should continue to become more pro-growth. So, while some of the assumptions in the AfDB’s report are more realistic than others, it is safe to expect economic conditions that are favorable for growth in Africa.

Evaluating African Growth Using Economic Models

Economists use formalized models to derive predictions about future economic growth within one country and differences in growth patterns among countries. One such macroeconomic model is the Solow Model, named after Robert M. Solow, who won the Nobel Prize in Economics for the 1956 paper in which he introduced the model (Solow 1956). It is a neoclassical model in that total output is a function of capital and labor. The model expresses output in per worker terms such that per capita GDP only grows with capital accumulation, which in turn only increases by a higher saving rate or lower rate of depreciation of capital. The implication is that a higher saving rate increases per-capita GDP, but that the growth rate of per capita GDP would return to zero. Later revisions to the Solow model added in a term for human capital to explain sustained economic growth and differences in cross-country differences in per-capita GDP (Mankiw et al, 1992).

Unfortunately, the Solow Model is not particularly suitable for evaluating the drivers of growth that are projected in the AfDB report. Higher commodity prices are essentially lump-sum payments to commodity exporting countries. While this is going to make those countries better off, changes in the terms of trade do not have an impact on the Solow Model output function or growth rate function. Similarly, a strong recovery in the global economy does not directly factor into the Solow Model. However, these sources of growth will have an indirect effect on the Solow Model output function. A stronger global recovery will give multinational corporations additional capital to invest, higher commodity prices will direct that capital towards commodity-rich countries, and African domestic macroeconomic reforms will encourage these corporations that Africa is business-friendly. This increase in foreign direct investment raises the level of capital. Per the Solow Model, this will lead to a higher level of output and a higher level of growth in the short-term. These results are consistent with the AfDB’s report.

Welfare Implications

            Assuming the projections within the AfDB’s report are accurate, how will this growth impact poverty, inequality and other measures of household well-being? Because the growth is mainly projected to be driven by changes in commodity prices, demand for the unskilled labor that produces these commodities will increase and the remote areas where these resources are located will gain greater access to domestic and international markets. These changes will reduce poverty and improve the standards of living among the rural poor in African countries. Nonetheless, the clear majority of the income that will arise from the increase in commodity prices will likely flow to wealthier portions of the population who provide the capital to produce these commodities. As such, the effect of the growth on measures of inequality such as the Gini Coefficient is unclear.

 

References

“Africas economic growth bright – AfDB.” Daily Monitor. Nation Media Group, 01 June 2017. Web. 06 June 2017.

 

“Industrial Commodity Prices to Rise in 2017.” World Bank. World Bank Group, 26 Apr. 2017. Web. 07 June 2017.

 

Mankiw, N. Gregory, et al. “A Contribution to the Empirics of Economic Growth.” The Quarterly Journal of Economics, vol. 107, no. 2, 1992, pp. 407–437. JSTOR, www.jstor.org/stable/2118477

 

“Mission & Strategy.” African Development Bank. N.p., n.d. Web. 06 June 2017.

 

Poverty headcount ratio at $1.90 a day (2011 PPP) (% of population) http://data.worldbank.org/indicator/SI.POV.DDAY?locations=ZG&view=chart

 

Solow, Robert M. “A Contribution to the Theory of Economic Growth.” The Quarterly Journal of Economics, vol. 70, no. 1, 1956, pp. 65–94. JSTOR, www.jstor.org/stable/1884513.

 

NBER Working Paper Discussion | Growing, Shrinking, and Long Run Economic Performance: Historical Perspectives on Economic Development

Introduction

This paper by Stephen Broadberry and John Joseph Wallis attempts to shift focus from the typically discussed topic of economic growth, to the often-neglected topic of economic shrinks. The idea is that controlling economic shrinks has more of an effect on long-run economic growth, than promoting economic growths. To test this theory, Broadberry and Wallis examine historical data from multiple time periods, to find trends in the growing and shrinking rates of poor, middle-income, and high income countries.

 
The terms “shrink” and “growth” refer to instances where a country’s economy gets smaller or larger. If, over the course of the year, the economy (measured by GDP per capita) gets smaller, we call this a shrink. Conversely, if we observe the economy to be getting larger, we call it a period of growth. In theory, if a country were to maximize its periods of growth, it would see long-term sustained growth. And in fact, much of the current research into growth theory has been about how to maximize the frequency and magnitude of growth periods. The information that Broadberry and Wallis present shows that the scope of this type of research is not wide enough, and that economic shrinks have a substantial effect on a growing economy, despite the lack of attention they have gotten.

Methods and Findings

To arrive at this conclusion, Broadberry and Wallis create values that they call “contribution of shrinking” and “contribution of growing” which essentially equal the frequency of shrinking times the rate of shrinking, and the frequency of growing times the rate of growing, respectively. Here, the rate of change refers to the average of all the shrinking or growing years over the stated period. Looking at short-run growth data, from 1950-2008, and long-run growth data, from 1348-2008, broken down into shorter periods of about 50 years, Broadberry and Wallis arrive at a few specific conclusions. First, growing and shrinking rates have been high and variable throughout most of history, and remain so in less developed countries today. This finding indicates that more developed countries have found a way to temper not only shrinking, but growing as well, and that consistency in rates of change is key for economic success. Second, improving long run economic performance has occurred because the frequency and rate of shrinking have both declined, rather than because the growing rate has increased. This may be the most important conclusion drawn by Broadberry and Wallis, because it provides a new metric for developing countries to target with policies. If, previously, countries were focused on achieving high growth, and neglecting shrinks, this finding represents a paradigm shift, and one that should, in theory, see results. Finally, the authors conclude that the rate of growing has typically declined rather than increased as long run economic performance has improved. This is interesting, because it is nearly antithetical with what one would intuitively suspect regarding growing rates.

 
After discussing the empirical evidence, Broadberry and Wallis then go on to mention how countries might stop their economies from shrinking, discussing both proximate and ultimate causes of economic shrinks. Four possible proximate causes are given to explain economic shrinks: structural change, technological change, demographic change, and changing incidence of warfare.

Structural change describes the shifting of an economy over time from being centered in one industry to deriving most of its growth from another. The paper uses Great Britain as an example, citing the shift from an agrarian economy in the pre-1800s, to one centered around services and industry (or manufacturing) now. The authors contend that developments within the services and industry sectors increased the net growth rate of Great Britain substantially.

 
Technological change by itself, in theory would lead to an upswing in the GDP of a nation. For this reason, Broadberry and Wallis chose to observe a metric called Total Factor Productivity, which roughly describes how efficiently inputs are used in production. An increase in TFP is associated with increasing efficiency in production, and is thereby used to describe a positive change in the level of technology. By looking at long-run growth rates in both TFP and output, Broadberry and Wallis found that economic growth outpaced technological change, between the formative years of 1760-1873, so that tech change only accounted for just one sixth of the increase in growth. They also found that a decrease in TFP coincided with a shrink in Holland in the 1700’s.

 
Demographic change is a field of study popularized by Thomas Malthus in the late 16th/early 17th centuries. Malthusian theory of population growth says that since population growth is geometric, and resource growth is linear, society will get to a point where a population will outgrow its resources, and experience short run shrinking. In this approach, any measure that increases birthrate, or decreases available land (resource constraint) will result in a short-run shrink (and vice-versa for growth). Broadberry and Wallis note that, for developing economies, this theory holds true.

 
Finally, changing incidence of warfare is just that – the increase or decrease a country sees in the incidence of warring over a period. Economic theory can be found supporting either side of this concept with regards to growth. Warfare can bolster a country’s manufacturing sector, and increase investment, while also increasing the mortality rate – all things that should lead to economic growth. Conversely, warfare necessarily leads to a decrease in the labor force, a possible decimation of infrastructure and physical capital, and a larger segment of the population dependent on social safety nets. What Broadberry and Wallis find, is that incidence of warfare is associated with variable growth and shrink rates.

Conclusions

These four proximate factors are found to be important by themselves in reducing economic shrinks, which leads Broadberry and Wallis to consider the ultimate factor of institutional change. The authors divide a political system into two different possible areas, one based on what they call “identity rules” and one based on “impersonal rules”. In short, an economy is more likely to experience less frequent and less severe shrinking periods once they transition from identity rules system of government, where different rules apply to different levels of society, to impersonal rules, where the same rules apply for everyone in society. Broadberry and Wallis then go on to mention how a government acting within an impersonal rules system can operate though changes in the proximate factors, to bring about periods of sustained growth through limited periods of shrinking. Key to this theory is a move away from agriculture, towards technological progress, and towards a more peaceful environment with stable demographics.

 
This paper refers directly to the development of nations, and as such it can be used as a benchmark for emerging economies. Since much of the research and theory being done now is on growth factors, this paper, and the conclusions that it draws – specifically the importance of limiting frequency and magnitude of shrinks – provides a new perspective on an age-old question. In addition, many poor and developing countries in the world now have political systems that can be described as “identity rules”. It is likely, according to the research done in this paper, that this one aspect may be holding these economies back and preventing them from making the transition into sustained growth.

By: Garrett Blom

 

For reference, the paper can be found here: http://nber.org/papers/w23343

Growing Indian Agriculture by Leaving Farmers Alone

The Economic Times of India published an article titled “Need policies to ensure farmers get better prices: Arvind Panagariya” last week. Though the article itself is relatively short, it fits into a broader policy debate that is being held in the Indian government. Namely, there has been a lot of discussion recently about whether to tax rural farmers, and if so, how much. The Indian central government does not have the constitutional authority to levy taxes on agriculture, so the debate is focused on a state by state basis, where taxing agriculture is allowed.

The Context

The National Institution for Transforming India (NITI Aayog), the leading think-tank in India, and India’s prime minister, Narendra Modi, have stated a goal of doubling agriculture income in India by 2022. Supporting technology adoption and ensuring competitive prices domestically and internationally are the main intended methods to achieve this growth. While India’s economy has developed significantly in recent years, its poorest citizens are still largely living in an undeveloped economy. According to Arvind Panagariya, “80% of the poor… in rural areas are dependent on farming.” In addition, it appears that most farmers in India rely on agriculture for subsistence.

NITI Aayog leaders and the prime minister have been asked about taxation of agriculture income in India. Almost unanimously, policy leaders have stated that there is not even a question of taxing agriculture income. However, most reports do not give a complete picture to the phrasing of “no question” when it comes to taxing farmers. Do they mean that it is obvious a provision will be included to tax farmers in the future, or that it is obviously a bad idea to tax subsistence farmers and the rural poor.

In a separate report, the Chief Economic Advisor, Arvind Subramanian, suggested that taxation of agriculture income is possible. He added, policymakers must make a distinction between rich and poor farmers.

The Model

Luckily, there are clear models that address production and wealth gains over time. Depending on the structure of the tax, a farmer would consider it as a fixed cost or a variable cost in their production function. In a developing economy, we must also realize that any money a farmer has to pay to the government cannot be used to re-invest in their farm, either as better inputs or durable goods. When analyzing this issue, it is important to make the same distinction that Mr. Subramanian did. Wealthier farmers, or those who have commercialized and see yearly profits, have much more flexibility to be taxed.

Unless state governments face strains, taxing all farmers would make the poorest and subsistence farmers much worse off, since their year on year gains in wealth and potential reinvestment would be undercut. In general, taxing farmers as their income increases from subsistence to commercial would reduce productivity and would be counterproductive to alleviating poverty.

On the most basic level, taxing subsistence farming would push the poorest farmers into a worse position, and would not encourage adoption of new inputs and technologies. In order to commercialize and take advantage of the government’s push to raise prices for agriculture products, poor farmers need access to new technology. We discussed the incentives farmers face when adopting new technologies; they must be educated and the benefits must outweigh the costs.

These policymakers are correct in their belief that taxing agriculture should be out of the question. By taxing agriculture, subsistence and poor farmers face a greater cost or diminished benefit to their yearly yields. In the face of uncertainty, they will be less likely to experiment with new technologies and will not have the resources to try new crops and inputs. The agricultural technology adoption model shows farmers each running experiments over time is the best way to increase their output. By limiting the resources for experimentation, agricultural growth will be significantly slowed, and this effect will compound over time.

Another factor of the agricultural technology adoption model at play in this decision is “information neighbors”. The policymakers aim to increase the prices of crops. In order for their ultimate goal to be achieved, doubling rural income by 2022, the first phase must be giving farmers the means to adopt new technologies. However, the real gains in production are compounded over time as farmers experiment and communicate with their neighbors.

Conclusion

If India’s policymakers are serious about increasing agriculture productivity and income, then taxation is absolutely “no question”. In a country like the United States, where industrial agriculture is the norm, taxation is possible because of the surplus that farmers face. However, in India’s case most farmers need to be nudged into commercialized agriculture and educated about the new technologies available. In order to achieve this, the whole system should be tailored toward the goal. Also, based on NITI Aayog’s statistics, increasing rural income can benefit a huge portion of the impoverished population in India as well. Based on these facts, Indian policymakers have made the right decision for ensuring growth of agriculture output.

 

 

Sources Cited:

http://economictimes.indiatimes.com/news/economy/policy/need-policies-to-ensure-farmers-get-better-prices-arvind-panagariya/articleshow/58432724.cms

http://economictimes.indiatimes.com/news/politics-and-nation/bjp-to-promote-pm-narendra-modi-govts-pro-farmer-policies/articleshow/57918815.cms

http://economictimes.indiatimes.com/news/economy/policy/no-question-of-taxing-agriculture-income-arvind-panagariya/articleshow/58424238.cms

Image:

http://www.newsgram.com/what-indian-agricultural-sector-needs-to-learn-from-denmark/

 

Credit Plan to Revitalize Rural India

By: Tim O’Shea

Introduction

The rural population growth in India has been decreasing on average at a rate of 0.3 percent per decade since 1960, causing more and more entrepreneurs to migrate to big cities to find sustainable income. The Indian government is beginning to recognize a big need to increase rural production to further develop the economy. According to The World Bank database, since 1960 there has been a 15 percent decrease in rural population in India to 67 percent, and resulted in 0.64 percent annual growth for rural population in 2015. The decrease in rural population has been partially due to the volatility of the agriculture industry and the opportunity to make immediate cash in larger urban areas. This has resulted in 80 percent of the poor population in India living in rural areas; 62 percent of which is from seven states combined. The majority of agricultural expenses occur at the beginning of the season and the benefits are reaped at the very end, which is why local farmers will often not have enough money to make it through the entirety of the season. The linking of plant fruition to input requirements (animals, seed, etc.) remain uncalculated for farms in India causing them to overcompensate and waste money in certain areas. If farmers run out of money while still in season they will turn to local cash lenders to get them through the season. The current plan is to hook up over 85 million homes in poverty with up to $100,000 by 2019. The rural development ministry acknowledges the difficulty in starting and maintaining a farm, and wants to revitalize production or help farmers use their other skillsets to make money. The loans should be collateral-free and have subsidized interest rates to reward the use of national banks. With this plan there will be increased opportunities in the rural population of India from the increasing amount of loans being distributed.

Loan Supply and Repayment

Although microcredit has been around for centuries, there have been adjustments and changes made along the way to ensure maximum fairness for both parties involved. Theoretically, a bank gives a loan to a group of well-qualified farmers that are looking to get into the agriculture industry. If the farmers are able to cover variable and fixed costs, then they repay the bank with the amount they loaned out. If they are unable to repay the loan, they then are not allowed to take out loans in the future and suffer the social negligence from your partners because of being unable to repay the bank. The difficulty from this is the inability of knowing who are safe and risky borrowers to loan your money out to. The end goal being a provision of small scale financial services to poor borrowers for small businesses. The advantages from microcredit is the ability to deal with market failures and the joint liability aspect where communities are responsible for making sure everyone is doing their part. The rural development ministry headed by Amarjeet Sinha is using a subvention to cover 4 percent of the banks current 11 percent interest rates, causing the rural households to only have to cover 7 percent of the original loan interest rate. The hopes of increasing rural development have been laid out by the Indian government in an effort to “diversify livelihood opportunities,” said Sinha. In addition, the households in the backward districts (most underdeveloped) of India will get an additional 3 percent subvention which lowers their output requirements even more to cover the banks interest rates. The goal of the attempt by India is to lower costs and increase activity for all rural production through compatible incentives for local farmers.

The grouping together of people in poverty has been studied from the Tamil Nadu Panchayat Level Federation program and Telangana Stree Nidhi Cooperative which provide easy access of credit to groups in need. The Panchayat Level Federation formed Self Help Group’s (SHG) based off of different status levels to help give people a platform to share their experiences and increase transparency. However, problems still arise under these platforms when comparing the agricultural output statistics and the rural population growth. Rural population growth has decreased significantly and consistently over the last 20 years, but the total agriculture sector output in India has increased by over 20 percent in the last four years alone. This is because the State Bank of India in Tamil Nadu issues gold loans based off of the best looking loan portfolio. This gold loan is for more safe borrowers has a higher success rate than the traditional loan and ensures that the bank is automatically receiving gold in return, which makes it more appealing for the moneylender. As a result, 31.5 percent of the loans given out in India belong to 11,000 people within the country. Some people will use the loan amount to pay off a previous loan, further burying themselves in a debt crisis that they cannot solve. This shows huge amounts of disparity and unevenness of the loan process in India, which is why the credit program needs to be properly regulated when implemented for small scale rural businesses. This is accurate with our studies throughout the class and how the adverse selection model works in how risky match with other risky groups and safe like to match with safe.

Impact on households

With the increased amount of loans being given out to households, credit in India has been trending upward. The gold loan is creating a wider gap in agricultural production and not granting equal loans to all eligible parties. The goal of this micro-credit program is to reduce the poverty gap and dependence on local money lenders by promoting the efficient use of loans provided by the government. Non-affiliated moneylenders will come in and charge astronomical interest rates for farmers in need, usually to cover general upkeep charges of maintaining a farm or business because of the frontloaded costs. This subsidy from the government is aimed to be a reward like system for borrowing from the national bank and avoiding smaller micro lenders that will significantly upcharge the interest rates. Rural households in poverty will be able to borrow a smaller amount than they needed for less of a cost, which saves money in the short- and long-run for each household. Along with that, there have been expansions made in the dairy industry in an effort to decrease transportation costs and create more of a consistent revenue stream. The demand for dairy is fairly stagnant and can provide a good source of side income for farmers, so the market linkages between the two groups is huge. Credit in India will have to be monitored over the coming years because of the unpredictability of success rates. The rural population in India is a developing area that needs to be invested in to further develop and fully reach its potential. This is a groundbreaking proposition that could change the lives of the Indian economy forever because of the potential market size and the attempt to lower rural poverty numbers.

References:

Chitravanshi, Ruchika. “Government Planning an Easy Credit Scheme for Rural Households.” The Economic Times. Economic Times, 19 Apr. 2017. Web. 09 May 2017. <http://economictimes.indiatimes.com/news/economy/policy/government-planning-an-easy-credit-scheme-for-rural-households/articleshow/58250161.cms&gt;.

 

Schaffner, Julie. Development Economics. N.p.: Wiley, 2014. Print.

 

Janardhanan, Arun. “Tamil Nadu: Lion’s Share of Bank Loans against Gold, Villages Fall Prey toLoan Sharks.” LexisNexis® Academic. LexisNexis, 23 Mar. 2017. Web. 09 May 2017. http://www.lexisnexis.com/lnacui2api/results/docview/docview.do?docLinkInd=true&risb=21_T25937755023&format=GNBFI&sort=DATE%2CD%2CH&startDocNo=1&resultsUrlKey=29_T25937755016&cisb=22_T25937755015&treeMax=true&treeWidth=0&csi=354268&docNo=4

 

India’s Poverty Profile.” World Bank. N.p., n.d. Web. 09 May 2017.

<http://www.worldbank.org/en/news/infographic/2016/05/27/india-s-poverty-profile&gt;.

When There Is Not Enough Credit to Go Around: The Challenges of Accessing Microcredit in Myanmar

As financial regulations lax and with the entrance of more nongovernmental organizations into Myanmar, microfinance and the availability of microloans have made it much easier for citizens of Myanmar to gain access to credit that they would not otherwise have access to. However, the demand for credit is far greater than the current supply. Currently, over 2.8 million clients have access to microloans in Myanmar. As that number continues to grow, credit constraints, the lack of credit availability, and the lack of financial literacy has made it difficult for people who need credit the most to access it. (The World Bank)

An article from the Myanmar Times published on March 1, 2017, Agricultural Sector and SMEs to Receive Private Bank Loans, talks about recent policy changes implemented to help farmers and small business owners. With the intervention of the Myanmar Private Sector Development Committee (PSDC), the committee has passed into law that private banks in Myanmar must grant a minimum percentage of all their commercial loans to people in the agricultural or SMEs (Micro, small, and medium-sized enterprises) sectors (Htwe.)

The current Agricultural Minister of Myanmar, Myint Hlaing, has stated, “The agricultural sector is the backbone of Myanmar’s economy as the entire agricultural sector contributes 30% of its current GDP. In addition, 61% of the country’s labor force is working in the agricultural sector” (Centre for Agriculture and Bioscience International.) Since agriculture is such a large part of the Myanmar economy, it is understood that additional funding and capital is required for the industry and economy to develop.

As of now, microloans are only made by state-owned banks. Local private banks rarely lend to local borrowers because of the lack of profitability and high risks of lending. Many of the private citizens who require microloans do not have the collateral nor credit history to justify receiving a loan, and laws set by the government cap the amount of interest that private banks can charge on these private loans (13%.)

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(The World Bank)

The state-run banks currently charge an 8.5% interest rate and an 8% interest rate to SMEs and farmers, respectively. Should a borrower go to a private bank, they would be charged a 13% interest rate. Currently, it is unfeasible for private banks to
match the interest rate of the state-run bank, as they pay 8% interest rates on banking deposits (Htwe.) The main issue here, is deciding upon interest rate that would satisfy the state-run bank, the privately-owned bank, and the borrower.

With the passing of the 2016 Monetary Law, banks are no longer required to collect collateral when deciding who to give loans out to, but that just makes the vetting process more difficult. Despite the law, many private banks still require collateral as they cannot thoroughly vet borrowers, and many banking relationships in Myanmar are built on trust and reputation (Htwe.)
U Thein Myint, a deputy general manager at one of Myanmar’s privately-owned banks argues that, “If people fail to pay back their loans, the banks will encounter difficulties in paying deposits from its customers. This is detrimental to the financial system and the national economy. Therefore, for people seeking bank loans, they need to provide strong guarantee.” Until there is a proven high chance that commercial banks will be paid back, loans provided for the agricultural and SMEs sectors will remain low (Htwe.)

A retired vice president of the Myanmar Central Bank, U Than Lwin, hopes that the government can work out an arrangement with private banks so that money can be lent to people who need it the most. A proposed idea would be for the government to implement a system so that they can partially guarantee loan repayment, which would make the lending process for banks much easier. Another idea would be to mitigate risk by lending to a larger group of people, by spreading the amount of risk that people would take on when taking out a loan.

Some of the issues described in the article written by Chan Mya Htwe regarding microcredit are also issues seen in countries struggling to meet the demand for microcredit by their citizens. This is amongst one of the many challenges encountered for governments or NGOs implementing a microcredit and microfinance program in a developing country (Schaffner.) In a country where access to finance is difficult and people are spread out across rural areas, there is adverse selection on both sides for both the borrower and lender. Lending caps and inconsistent lending practices make it hard for borrowers to access loans. This usually results in a loan from multiple financial institutions or a loan shark (Schaffner.) The inconsistent income that depends on the planting and growing season along with the lack of good jobs makes it difficult in certain cases, for people to pay back their loans. With the new law instituted by the government preventing banks from collecting collateral on loans, the end result is an inefficient outcome where the borrower does not get the money they need for their everyday life and the lender just makes loans elsewhere where the financial institution knows they will be paid back.

Private financial institutions need a new way to thoroughly vet prospective borrowers if they cannot collect collateral beforehand (Htwe.) There is a possibility of lending to large groups and spreading out risk through group liability, but in every borrowing and lending situation, I feel that the lender assumes a lot more risk than the borrower.

The first microloan programs were first instituted in Myanmar in the mid-1990s (Soe.) As new laws are passed and as regulations become more lax, there have been an increase in NGOs in the country, making small loans to farmers and small business owners. The exchange rate, interest rate caps, along with high denominations in its currency discourage more NGOs coming in (Soe.) As the program continues to grow, I hope that microloans and microfinance can reach people in areas that still are not developed, or destroyed by the ongoing Civil War. I think that the Myanmar government needs to do more for its citizens, rather than rely on outside humanitarian organizations to provide a basic lifestyle for people who need it the most. This is a difficult problem that I feel would not be solved anytime soon, as lack of financial literacy in its citizens, lack of access to large amounts of credit, and lack of willing lending institutions keeps people stuck in the cycle of poverty.

References

Schaffner, Julie. Development Economics. N.p.: Wiley, 2014. Print.

Ray, Debraj. Development Economics. N.p.: Princeton UP, 1998. Print.

C. (n.d.). CABI and China boost agricultural development in Myanmar. Retrieved May 09, 2017, from http://www.cabi.org/membership/news/cabi-and-china-boost-agricultural-development-in-myanmar/

Tun, T., Kennedy, A., & Nischan, U. (2015). • Promoting Agricultural Growth in Myanmar: A Review of Policies and an Assessment of Knowledge Gaps (No. 230983). Michigan State University, Department of Agricultural, Food, and Resource Economics.

Htwe, C. M. (2017, March 01). Agricultural sector and SMEs to receive private bank loans. Retrieved May 09, 2017, from http://www.mmtimes.com/index.php/business/25141-agricultural-sector-and-smes-to-receive-private-bank-loans.html

Soe, H. K. (2016, September 06). Can microfinance still make a difference? Retrieved May 09, 2017, from http://frontiermyanmar.net/en/can-microfinance-still-make-a-difference

A Fresh Look at the Tontine Loan Scheme

Women in the West Senegal region of Medine are exploring the use of Tontines to replace traditional loans

SUMMARY:

On April 30th, 2017, AfricaNews published an article about the recent resurgence of an old type of loan, the tontine, entitled “Traditional micro-credit scheme helps Senegalese women do business.”  The article explains that women’s access to credit has long been severely restricted in Africa.  Prohibitively high interest rates, low literacy rates, and cultural barriers all contribute to Senegalese women’s lack of willingness to sign formal loan contracts.  Tontines are being explored as an alternative option to formal loans from banks.

In the Médina area of Grand-Mbao, a neighborhood within Senegal’s capital, Dakar, women use the tontine to great benefit.  There are 250 women in the tontine.  They each contribute about three euros to the calabash daily, either in cash or via mobile banking transfers.  Every day, following a specific predetermined order, one woman gets the lottery payout of nearly 760 euros.  The members of the tontine describe it as having a family atmosphere in which the members support one another.  In order to ensure members continually pay each day, a Sanctions Regime is created to enforce the rules, promote transparency, and instill confidence in the process.  There are late fees for missed payments – which are less than a euro.  If a member is continuously late, their place in line for the payout will be pushed back.  If they continue to miss payments, they may be unable to collect their lottery payout until their late payments have been rectified with the Sanctions Regime.

Additionally, women must use the money productively.  If they are found to have squandered the payout on food or some other consumable item, they will lose face in their community.  In Médina, social standing within the village is paramount.  One woman goes so far as to say that not only will the individual have to pay it back, but even their grandchildren will likely be affected by those actions.  The women are supposed to use the payout for investments that they could not otherwise afford, such as construction, the purchase of durables, or investments in business.  One specific woman, Mame Ngone Cisse, stated that the tontine enabled her to purchase chicks to save her poultry farming business.

ANALYSIS:

This article proposes a type of loan similar to the group lending model we have discussed in class.  We can compare this informal loan to a more formal loan through some of the theories covered in class, including Moral Hazards, Adverse Selection, and Time Preferences.  The tontine has both advantages and disadvantages as compared to a formal bank loan that we will discuss in this post.

Regarding Ex-Post Moral Hazard, the tontines use both monetary and social fines to incentivize members of the group to keep up their part of the contract.  Hypothetically, a woman who collects her payout could stop paying into the tontine if she no longer wants to participate.  The monetary fine of one euro each time a payment is late and the social fine of a loss of social standing within the local community strongly incentivize the members to continue to make their payments.  The fact that these women’s families generally live in the same town for years adds to the social incentive because, as mentioned in the article, an individual’s actions can affect their family’s social standing for generations.  As compared to banks, the only enforcement against Ex-Post Moral Hazard would be a loss of credit and seizure of collateral – if collateral was part of the contract.  As we have seen in class, areas with improved access to credit tend to also increase the community members’ access to informal credit regardless of if those seeking informal loans have access for formal loans or not.  Thus, locals frequently have workarounds to loss of credit, but in the case of tontines, there is no workaround as you would be stealing from your neighbors.  The community atmosphere of the tontine also naturally protects against Ex-Ante Moral Hazard, as the women can easily tell what the winner uses the payout for.  If the woman uses the payout for consumables, she will lose face in the community.

The Sanctions Regime has better information than a bank has; therefore, they are less susceptible to adverse selection.  Due to the fact that tontines consist only of members within the community, the Sanctions Regime has nearly perfect information regarding an individual’s past credit record and their character.  The members of the community are able to select individuals to take part in the tontine only if they are in good standing within the community, are considered financially responsible, and are believed to be trustworthy.  Access to this sort of intimate information would be highly unlikely for the banks, so they are at a real disadvantage as compared to the tontines.

The expectation of time inconsistent preferences makes the tontine an interesting loaning format.  Generally speaking, we know that people tend to have a classic hyperbolic discount rate – meaning that they are more patient with payouts in the future rather than in the present.  An individual adhering to time inconsistent preferences would be less willing to wait a month now for extra money as opposed to waiting an additional month atop an already six-month waiting period for extra money.  Due to the fact that, in a tontine with 250 people, each member gets paid roughly every eight months, there is an extended waiting period imposed upon them.  My main concern is that the relatively minimal monetary fine on late payments wouldn’t be enough to incentivize payments to always be on time.  One could only surmise that the social standing loss must be significantly severe to the point that the members would do all they can to avoid missing payments.  Aside from the social loss, the additional punishment of pushing the date of collection back would be a poor deterrent based on time inconsistent preferences.  An average person would likely think “I already have to wait eight months for this payout – what’s another few days?”  Though, I would say the punishment of restricting a member’s ability to collect the payout when they miss many payments is a strong refutation of that line of thinking.

CONCLUSION:

In summary, the use of tontines in the Médina area of Senegal are a unique approach to solving the credit access issue many women in Africa face today.  By circumventing the high interest rates, large initial down payments, and cultural barriers, these women have employed an intelligent solution to their financial woes.  As we know, many people in developing nations are frequently unable to save significant sums of money to purchase durables for their entrepreneurial aspirations due to budget constraints.  These Senegalese women have created a way to provide themselves with a large sum of money at least once a year at relatively minor costs to their daily income.  We saw how the theories of Moral Hazard, Adverse Selection, and Time Inconsistent Preferences are affected under the system of tontines.  Overall, tontines are an interesting temporary solution employed by the people of Médina who face credit access problems.

WORKS CITED:

  1. http://www.africanews.com/2017/04/30/traditional-micro-credit-scheme-helps-senegalese-women-do-business/

Peru’s Recovery From El Niño

A look at how a natural disaster affected Peru’s economy

When El Niño struck Peru earlier this year, it left a line of destruction that must be revived for the country to continue to prosper.  To be able to reconstruct, the Ministry of Economy and Finance (MEF) must dig into public sector budget. This will cause the fiscal deficit to increase with the higher amount of public spending that is being used to fix the city.

Since the government’s previously set deficit goal of 2.5% of GDP had been exceeded by February, a necessary change is needed to prevent the loss of regular expenditures to reconstruction costs. Although the government is hesitant to extend this deficit budget, an economist argues that it is necessary and won’t reflect poorly on the MEF because caring for a natural disaster can be clearly justifiable.

Comparing this natural disaster to an earthquake the country endured previously, there is reason for caution in efficient spending by the government for reconstruction. When the earthquake hit, the country worked to rehabilitate over the course of multiple years. The difference that can be made to make this situation better is to react as soon as possible. An economist, Flavio Ausejo, comments that the state should work on creating a disaster management plan and work on creating preventative measures.

The MEF is already working to accommodate those affected by El Niño. Local governments that have already spent at least 75% of the 100k Sol that had been given before the disaster were transferred an additional 100k Sol. They also gave 1000 Sol bonds per hectare to farmers who were affected. As pointed out by the president of Conveagro, a group of Peruvian agrarian producers, these payments are not completely satisfactory because each hectare planted comes with a generous amount of investment. The type of crop produced by the individual farmer should be taken into account.

Although those efforts have been criticized, the MEF has positively made use of other resources that directly affect the damaged areas. They have created a disaster care budget program that amounts to about 1,088.1 million Sol; they have an intervention fund equaling about 321 million Sol as well as a line of credit worth about $3.7 billion US dollars. There is a Fiscal Stabilization Fund worth around $9 billion US dollars that can be used to rebuild their cities after natural disasters. It is managed by the MEF, Central Reserve Bank, and the Presidency of the Council of Ministers.

How the MEF’s Allocation of Funds Can Affect Farmers

As stated above, the farmers who were affected by this natural disaster were all given a standard consolation of 1000 Sol bonds per hectare, no matter what each individual farm produces. It’s likely that multiple farmers are given too much, while others are given too little and this uncertainty could play a role in an investor’s willingness to support the farmers.

If an unlucky farmer produces a good that needs more than the allocated 1000 Sol bond, only risk-loving investors will want to stay and people have shown to be more risk averse after a natural disaster (Cassar et al. 2017). This would decrease the amount of produce that can be bought and traded, eventually removing the contribution that farmers can make to the GDP.

Given that a natural disaster such as this one will affect everyone, not just the farmers, there could be benefit from using some kind of informal insurance institution, as described by Schaffner (2014). If everyone in the community would assist those farmers who did not receive enough to revitalize the entirety of their farms, there would be benefits for all. The farmer would benefit by not losing his farm and source of income, and the community would benefit by not losing that specific product.

Luckily, there are localized groups who value the social and necessary need for these farmers and their crops. Conveagro, a group who shares goals of educating about agriculture. On their website, their listed “Declaration of Principles” shows support to not only make the earth more sustainable, but also decentralization of the economy and a support for social justice.

Disaster Relief and Beyond

The beginnings of a disaster care budget program and an intervention fund will be valuable to stabilizing the economy of a country that is prone to be affected by the natural elements. If the funds are not needed a particular year, then there is an increase in the wealth of the country. If the funds are needed, then there shouldn’t be an increase in the budget deficit goal because those funds have already been accounted for and, if properly funded, shouldn’t exceed the amount needed to rebuild. Additionally, the funds will already be there, so the amount of time it will take to reconstruct will decrease.

As described in the article, the Fiscal Stabilization Fund wasn’t created to assist economy during a natural disaster, but the additional funds would make the increased deficit less hurtful to the population, specifically the farmers and the funds they receive.

Works Cited

“About Us.” Conveagro.org. Accessed May 7, 2017. http://www.conveagro.org.pe/quienes-somos.

Cassar, Alessandra, Andrew Healy, and Carl Von Kessler. “Trust, Risk, and Time Preferences After a Natural Disaster: Experimental Evidence from Thailand.” World Development 94 (June 2017): 90-105. Accessed May 7, 2017. doi:https://doi.org/10.1016/j.worlddev.2016.12.042.

“El impacto de los desastres naturales en las cuentas públicas.” El Comercio, March 17, 2017. Accessed May 7, 2017. http://elcomercio.pe/economia/peru/impacto-desastres-naturales-cuentas-publicas-noticia-1976722?ref=flujo_tags_17964&ft=nota_39&e=titulo.

Schaffner, Julie. Development Economics: Theory, Empirical Research, and Policy Analysis. Wiley, 2014.

Translation:

“The impact of coastal El Niño on the economy is not yet known . Analysts are still measuring the effect. However, the potential magnitude of this phenomenon is already being compared with that of the 1998 El Niño phenomenon that swept the country.

The Ministry of Economy and Finance (MEF) has announced that it has the necessary resources to handle the emergency and reconstruction, but it is anticipated that these will exceed what is projected in the public sector budget for this year.

Increasing public spending would inevitably increase the fiscal deficit. “But in this context, you have to do it,” says Carlos Casas, a professor at the University of the Pacific.

The target for the fiscal deficit for this year was set at 2.5% of GDP and in February the annualized figure closed at 2.7%. If the goal remained unchanged, extraordinary expenses for emergency care and reconstruction would force the execution of ordinary expenditures to be sacrificed, warns economist Luis Alberto Arias.

“These [extraordinary] expenses should not be accounted for for the purpose of meeting the fiscal target,” says Arias, who believes that emergency care justifies the state’s level of indebtedness. Thus, it recommends extending the deficit fence by 2017 in an exceptional way so that it can be “spent quietly”. For this, Congress is required to approve the change in the fiscal trajectory.

REBUILDING AND REACTIVATING

This week, Central Reserve Bank President Julio Velarde said that public spending that will be made to recover the country from the damages suffered will be a driver of the economy.

However, the recent recent reconstruction experience of Peru after the Pisco earthquake revealed a great inefficiency in spending and severe problems in its execution. For example, it was expected that the rehabilitation of the city would take three years, but almost a decade later the process does not end. For this, Arias recommends that this phase be planned and executed as soon as the disaster ends.

“These things can not happen again [as in Pisco]. They have to establish expeditious procedures to be able to spend the money in a timely manner, not two or three years later, “Arias concludes.

“This phenomenon tests the state’s ability to react to natural disasters, but it also highlights the tremendous institutional shortcomings we have,” said Pacific University economist Flavio Ausejo. He adds that the next item on the agenda is to work on disaster management and prevention mechanisms to make the country more resilient to these phenomena.

In this way the El Niño phenomenon would affect our economy. In January the GDP growth rate was 4.8%, but for February it is estimated to be half of that. (Video: El Comercio)

RESOURCE MANAGEMENT

The MEF announced this week the immediate measures that are being implemented to mitigate the effects of disasters. These include the transfer of an additional S / 100 thousand to local governments that have executed 75% or more of the S / 100 thousand already delivered to them in February.

It was also decided to deliver S / 1,000 bonds to farmers for each affected hectare. However, guilds of the sector have considered it insufficient. “It is still much lower, because on the coast when one hectare is planted there is a strong investment. The average amount should be evaluated according to the crops of each farmer, “said Héctor Carrasco, president of Conveagro, to the newspaper” Gestión “.

On the other hand, there are three sources of resources to face the climate phenomenon and to rebuild the damaged. On the one hand, a budget program for disaster care amounting to S / 1,088.1 million. To this is added an exclusive intervention fund for these anomalous cases amounting to S / 321 million, of which S / 42 million have already been transferred to subnational governments. And, finally, a contingent line of credit that amounts to US $ 3.7 billion.

The resources of the Fiscal Stabilization Fund are also available. These resources are assigned to the MEF and are managed by a board composed of three representatives distributed between the MEF, the Central Reserve Bank and the Presidency of the Council of Ministers. Although their primary use is to provide the country with a “mattress” in the face of adverse economic cycles, they can also be used in the face of natural disasters. Currently, the fund is around US $ 9 billion.”