Are we set to benefit or lose from large-scale foreign investments? | Interview

Are we set to benefit or lose from large-scale foreign investments? | Interview

Inflation Puzzle in Ethiopia

Single Digit Inflation Undesirable during Economic Takeoff

Source: addis fortune

Published On  Oct 30,  2011

by Eyob Tesfaye (PhD)

this article is written by Eyobe Tesfaye(PhD) under economic commentary page in addis fortune news paper and the whole idea of the article is solely to the writer.

Whilst the US economy teeters on the brink of a recession and many European economies are besieged by colossal public debt, several emerging and a few developing economies continue to enjoy robust growth.

Similar to other rapidly growing economies, the Ethiopian economy carries on to register vigorous Gross Domestic Product (GDP) growth. Although the growth performance remains exhilarating, the country’s economy remains in the grip of double digit inflation, currently standing at 40.1pc.

Apparently, the runaway inflation, together with the high inflation expectation, has become a serious predicament to the administration. Indeed, in early 2011, the country was able to achieve single digit inflation, leading everyone to believe that this nemesis was overcome.

Nevertheless, the inflation has once again resurfaced with a vengeance. The whole situation is reminiscent of a family that expressed gratitude for the survival of their home from a powerful hurricane but failed to prepare for more storms to come.

Inflation is an inevitable byproduct of economic growth, just like the increased exhaust emitted from a speedy car as it accelerates. As economies grow faster, it is inevitable for their engines to overheat.

The Ethiopian government has taken several policy and administrative measures to cool down the economy and keep a lid on the inflationary pressure. Despite these measures, inflation has refused to go away; its pressure has not yet been abated.

During his annual state of the union speech, President Girma Woldegiorgis indicated that fighting inflation will be the chief concern of the government in the 2011/12 fiscal year. He has vowed that the government will do everything possible to bring down inflation to a single digit soon.

Yet, whether it is possible to attain single digit inflation and there is a framework in place to attain it, it remains uncertain.

With inflation hovering and expectations remaining high, obtaining an easy answer to such a million dollar question is unimaginable.

Indeed, inflation provides an important insight on the state of the economy and the policies that govern it. Stable inflation provides impetus for economic growth. There is no doubt that stable prices are good for healthy economic growth.

There is no economic theory that states that an inflation rate of five per cent is better than one of 15pc. It is the structure of the economy that determines the threshold of healthy inflation.

Ethiopia has a chronically supply constrained economy with excess demand. Increasing government investment in infrastructure, rapidly growing private consumption, influx of foreign capital, and remittances have all exacerbated demand that outsprints supply at a haggle speed. Much of the resulting growth is gulled by real estate investment and property market.

Ethiopia's economy lacks financial depth and highly liquid marketable financial instruments. Domestic investment tends to get channeled into non-productive sectors over productive ones, which could have helped in correcting the imbalance between demand and supply. In a situation where there is a dearth of savings instruments to which people can turn, prices for consumer products tend to rise, creating ground for an inflationary spiral.

Addressing the demand and supply imbalance and spurring long-term growth requires vigorous infrastructure investment.

Infrastructure is a capital stock that provides public goods and services. It creates an environment for productive activities and allows wider movement of goods and people. It helps to commercialize and diversify the economy. Squeezing infrastructure spending to curb inflation does more harm than good to the economy.

Correcting the rise in food prices will also require structural changes in food production. This, on the other hand, requires increasing agricultural activities. Until meaningful and radical output increasing measures have taken root, it is hardly possible to head off inflationary expectations.

In the face of a chronic structural bottleneck and the need for increasing infrastructural investment activities, a single digit inflation target is neither attainable nor desirable. Curbing inflation must walk hand in hand with growth, as neither can walk alone to a useful end.

Instead of burdening itself with the task of achieving single digit inflation in a short span of time, the government would rather opt for moderate inflation ranging between 10pc and 15pc until the gap between demand and supply closes.

“capitalism with Chinese characteristics”

Bamboo capitalism

March 10, 2011

Source: The Economist

This article is taken from The Economist magazine under economics section, hence the whole ideas of the article is exclusively the reflection of the authors not necessarily the bloggers.

FEW would deny that China has been the economic superstar of recent years. Thanks to its relentless double-digit annual growth, it has become the world’s second-largest economy and in many ways the most dynamic. Less obvious is quite what the secret of this success has been. It is often vaguely attributed to “capitalism with Chinese characteristics”–typically taken to mean that bureaucrats with heavy, visible hands have worked much of the magic. That, naturally, is a view that China’s government is happy to encourage.

But is it true? Of course, the state’s activity has been vast and important. It has been effective in eradicating physical and technological obstacles: physical, through the construction of roads, power plants and bridges; technical, by facilitating (through means fair and foul) the transfer of foreign intellectual property. Yet China’s vigour owes much to what has been happening from the bottom up as well as from the top down. Just as Germany has its mighty Mittelstand, the backbone of its economy, so China has a multitude of vigorous, (very) private entrepreneurs: a fast-growing thicket of bamboo capitalism.

These entrepreneurs often operate outside not only the powerful state-controlled companies, but outside the country’s laws. As a result, their significance cannot be well tracked by the state-generated statistics that serve as a flawed window into China’s economy. But as our briefing shows, they are an astonishing force.

The Mittel Kingdom

First, there is the scale of their activities. Three decades ago, pretty much all business in China was controlled by one level of the state or another. Now one estimate—and it can only be a stab—puts the share of GDP produced by enterprises that are not majority-owned by the state at 70%. Zheng Yumin, the Communist Party secretary for the commerce department of Zhejiang province, told a conference last year that more than 90% of China’s 43m companies were private. The heartland for entrepreneurial clusters is in regions, like Zhejiang, that have been relatively ignored by Beijing’s bureaucrats, but such businesses have now spread far and wide across the country.

Second, there is their dynamism. Qiao Liu and Alan Siu of the University of Hong Kong calculate that the average return on equity of unlisted private firms is fully ten percentage points higher than the modest 4% achieved by wholly or partly state-owned enterprises. The number of registered private businesses grew at an average of 30% a year in 2000-09. Factories that spring up alongside new roads and railways operate round-the-clock to make whatever nuts and bolts are needed anywhere in the world. The people behind these businesses endlessly adjust what and how they produce in response to extraordinary (often local) competition and fluctuations in demand. Provincial politicians, whose career prospects are tied to growth, often let these outfits operate free not only of direct state management but also from many of the laws tied to land ownership, labour relations, taxation and licensing. Bamboo capitalism lives in a laissez-faire bubble.

But this points to a third, more worrying, characteristic of such businesses: their vulnerability. Chinese regulation of its private sector is often referred to as “one eye open, one eye shut”. It is a wonderfully flexible system, but without a consistent rule of law, companies are prey to the predilections of bureaucrats. A crackdown could come at any time. It is also hard for them to mature into more permanent structures.

Cultivate it, don’t cut it

All this has big implications for China itself and for the wider world. The legal limbo creates ample scope for abuse: limited regard for labour laws, for example, encourages exploitation of workers. Rampant free enterprise also lives uncomfortably alongside the country’s official ideology. So far, China has managed this rather well. But over time, the contradictions between anarchic opportunism and state direction, both vital to China’s rise, will surely result in greater friction. Party conservatives will be tempted to hack away at bamboo capitalism.

It would be much better if they tried instead to provide the entrepreneurs with a proper legal framework. Many entrepreneurs understandably fear such scrutiny: they hate standing out, lest their operations become the focus of an investigation. But without a solid legal basis (including intellectual-property laws), it is very hard to create great enterprises and brands.

The legal uncertainty pushes capital-raising into the shadows, too. The result is a fantastically supple system of financing, but a very costly one. Collateral is suspect and the state-controlled financial system does not reward loan officers for assuming the risks that come with non-state-controlled companies. Instead, money often comes from unofficial sources, at great cost. The so-called Wenzhou rate (after the most famous city for this sort of finance) is said to begin at 18% and can even exceed 200%. A loan rarely extends beyond two years. Outsiders often marvel at the long-term planning tied to China’s economy, but many of its most dynamic manufacturers are limited to sowing and reaping within an agricultural season.

So bamboo capitalism will have to change. But it is changing China. Competition from private companies has driven up wages and benefits more than any new law—helping to create the consumers China (and its firms) need. And behind numerous new businesses created on a shoestring are former factory employees who have seen the rewards that come from running an assembly line rather than merely working on one. In all these respects the private sector plays a vital role in raising living standards—and moving the Chinese economy towards consumption at home rather than just exports abroad.

The West should be grateful for that. And it should also celebrate bamboo capitalism more broadly. Too many people—not just third-world dictators but Western business tycoons—have fallen for the Beijing consensus, the idea that state-directed capitalism and tight political control are the elixir of growth. In fact China has surged forward mainly where the state has stood back. “Capitalism with Chinese characteristics” works because of the capitalism, not the characteristics.