Abstract
The December 2015 IMF Research Bulletin features a sampling of key research from the IMF. The Research Summaries in this issue look at 'The Impact of Deflation and Lowflation on Fiscal Aggregates (Nicolas End, Sampawende J.-A. Tapsoba, Gilbert Terrier, and Renaud Duplay); and 'Oil Exporters at the Crossroads: It Is High Time to Diversify' (Reda Cherif and Fuad Hasanov). Mahvash Saeed Qureshi provides an overview of the fifth Lindau Meeting in Economics in 'Meeting the Nobel Giants.' In the Q&A column on 'Seven Questions on Financial Frictions and the Sources of the Business Cycle, Marzie Taheri Sanjani looks at the driving forces of the business cycle and macroeconomic models. The top-viewed articles in 2014 from the IMF Economic Review are highlighted, along with recent IMF Working Papers, Staff Discussion Notes, and IMF publications.
The prevailing growth model for most oil-exporting countries has left them vulnerable to a sustained decline in oil prices and has resulted in a decline in income per capita relative to the United States. To achieve sustainable growth, oil exporters need to create a dynamic and diversified tradables sector. The standard prescription of tackling government failures will not be sufficient. Governments need to address the market failures stemming from oil export revenues and change the incentive structure of firms and workers. The experience of successful oil exporters shows that it takes a long time to diversify. A focus on competing in international markets, technological upgrading, and climbing the “quality ladder” is crucial.1
The 25 percent drop in oil prices in October 2014 revived the specter of the 1980s when prices fell and stayed depressed for more than 20 years. It is difficult to predict how persistent this decline will be, but it is a clear reminder of the fundamental volatility of oil prices. More importantly, with a gathering momentum in investment in renewable energy, fuel efficiency, and electric cars, a secular decline in oil prices cannot be ruled out. In Germany, for example, the share of renewable sources in electricity consumption rose from 6.3 percent in 2000 to 25 percent in 2013. Tesla’s electric cars recorded the largest sales in the luxury category in California in 2013.
The experience of the 1980s to 1990s highlights the substantial cost for oil exporters of a persistent decline in oil prices. Oil exporters went through what can be described as the “Greatest Depression” lasting about 30 years. Real consumption per capita on average fell by about 20 percent from the 1980 level and recovered to this level only in late 2000s as oil prices increased substantially (Figure 1).
Real Consumption per Capita and Real Oil Price, 1980–2010
Citation: IMF Research Bulletin 2014, 004; 10.5089/9781498388450.026.A002
Source: Penn World Tables 7.1; IMF, World Economic OutlookNote: Oil exporters sampleReal Consumption per Capita and Real Oil Price, 1980–2010
Citation: IMF Research Bulletin 2014, 004; 10.5089/9781498388450.026.A002
Source: Penn World Tables 7.1; IMF, World Economic OutlookNote: Oil exporters sampleReal Consumption per Capita and Real Oil Price, 1980–2010
Citation: IMF Research Bulletin 2014, 004; 10.5089/9781498388450.026.A002
Source: Penn World Tables 7.1; IMF, World Economic OutlookNote: Oil exporters sampleDealing with low oil prices in the current context of increased government spending and rising expectations of the provision of jobs and income transfers is even more challenging. Having learned from past experience, many oil exporters have accumulated large sovereign wealth funds (SWFs), which is optimal in the face of high oil income volatility and low productivity of the tradables sector (Cherif and Hasanov 2012, 2013). Yet, SWFs would only provide a temporary cushion. Even in the optimistic scenario in which oil prices stay at relatively high levels, the prevailing growth model could lead oil exporters to a decline in real income per capita relative to the United States, as observed in the past (Figure 2).
GDP per Worker Relative to the US (PPP 2005 Constant $), 1980 vs. 2010
Citation: IMF Research Bulletin 2014, 004; 10.5089/9781498388450.026.A002
Source: Penn World Tables 7.1GDP per Worker Relative to the US (PPP 2005 Constant $), 1980 vs. 2010
Citation: IMF Research Bulletin 2014, 004; 10.5089/9781498388450.026.A002
Source: Penn World Tables 7.1GDP per Worker Relative to the US (PPP 2005 Constant $), 1980 vs. 2010
Citation: IMF Research Bulletin 2014, 004; 10.5089/9781498388450.026.A002
Source: Penn World Tables 7.1The poor relative performance of most oil exporters can be attributed to low productivity gains and in turn to the absence of a dynamic tradables sector (Cherif and Hasanov 2014). To create sustainable growth, a country needs to constantly produce new goods and adopt and develop new technologies (Lucas 1993). Introducing new goods and tasks would allow managers and workers to continually learn and move up the “quality ladder” (Aghion and Howitt 1992). To achieve this on a large scale, Lucas (1993) argues that a country must be a large exporter. Empirically, high export sophistication is the major ingredient of sustainable growth (Hausmann, Hwang, and Rodrik 2007).
The standard indicators to assess economic diversification and vulnerability to oil price shocks—the non-oil share in GDP and non-oil real growth rates—are misleading (Cherif and Hasanov 2014). Most oil exporters largely rely on oil and gas exports to cover the consumption of tradable goods while the domestic economy is mostly concentrated in the non-tradable sector. No matter how large or sophisticated the non-tradables produced are, they would not help acquire the hard currency needed to cover basic foods, medicine, and the maintenance cost of public infrastructure. Export diversification is the key metric.
To achieve export diversification, the standard policy advice—implementing structural reforms such as improving institutions and business environment, building infrastructure, and reducing regulations—while necessary, will not be sufficient because of market failures. Market failures could stem from learning externalities or coordination failures (Rodrik 2005). Learning externalities arise when firms do not internalize productivity gains in, for instance, manufacturing compared to traditional activities such as non-tradable services or agriculture, leading to lower output in high productivity sectors and lower relative incomes over time. The coordination failures necessitate a critical market size to justify investment in complex technologies (e.g., automotive and aircraft). If a large number of firms invest together, the economy reaches a higher level of productivity and development.
Despite minimal government failures, Norway could not escape market failures exacerbated by Dutch disease—broadly defined as the crowding out of the non-oil tradable sector by oil exports income. The measure of export sophistication in Norway started declining in the late 1970s, in contrast to Denmark. In addition, manufacturing hourly wages in Norway (despite the strict rules to sterilize oil income) were the highest in the world in 2012, about double that of the United States or Japan, according to the U.S. Bureau of Labor Statistics. Unit labor costs in Norway increased by 50 percent in the 2000s, whereas unit labor costs declined in Germany and Sweden. Norway’s annual average working hours per worker were the third fewest hours worked in the OECD in 2012.
To tackle market failures, the government needs to change the incentive structure of workers and firms. The prevailing growth model for many oil-exporting countries consists of exporting oil and gas, importing tradable goods, and producing non-tradables such as services and construction. The oil revenue distribution mechanism through transfers, public sector jobs, and contracts to firms in infrastructure projects skews the incentives toward the non-tradable sectors for firms and public employment for workers. The state needs to change this incentive structure to encourage individuals to develop skills and work in the private sector and provide incentives for firms to look beyond the confines of domestic markets and seek export opportunities.
Successful diversification strategies in Indonesia, Malaysia, and Mexico have relied on policies to create linkages in the existing industries and foster new industries with an emphasis on competing in international markets and technological upgrades to climb the “quality ladder.” As was done in Korea, the key element in providing state support is a strong governance and accountability framework in which the top management is responsible for the funds they receive. Cross-country experience shows that policies to develop tradable sectors and encourage firms to export include subsidies to support exporters and taxes on firms in the non-tradables, access to financing and business support services through development banks and export promotion agencies, and the creation of special economic zones, industry clusters, research and development centers, and start-up incubators.
Taiwanese and Norwegian experiences provide interesting case studies in developing local firms and clusters. In 1980, a Taiwanese venture capital initiative provided financial incentives and tax credits to encourage firms to set up business in the newly created Science Park after failing to attract multinationals (Kuznetsov and Sabel 2011). Two funds were established and run by U.S.-educated Chinese. The venture proved successful and large banks, corporations, and even
“The prevailing growth model for many oil-exporting countries consists of exporting oil and gas, importing tradable goods, and producing non-tradables such as services and construction.”
conservative family conglomerates started creating their own venture capital funds in information technology businesses. In Norway, in the 1970s, the government intervened directly in the procurement of oil operators to develop an oil suppliers’ cluster, required foreign operators to develop the competencies of local suppliers, and imposed a minimum of 50 percent of research and development spending to develop an oil field to take place in Norwegian entities (Heum 2008, Leskinen and others 2012). The government continued to support suppliers over the years to encourage firms to internationalize their activity. Eventually, the suppliers’ cluster became successful, spanning a large array of high value-added industries.
In parallel, the state needs to provide incentives to workers to develop their skills and work in the private sector. The public sector should not be the employer of first resort, offering high compensation and benefits compared to most of the private sector. Firm limits need to be placed on public sector jobs and wages with training and support for work in the private sector provided to workforce entrants. As in Belgium and Germany, vouchers could be used for training programs, apprenticeships, and vocational education. Skill development should also start at an early stage. The quality of early childhood education determines long-lasting outcomes and mainly works through positive effects on non-cognitive skills (Heckman and others 2013). Improving teacher quality, which is highly correlated with students’ achievements, is paramount (Dolton and others 2011).
Fostering a spirit of self-reliance and creativity is another important element in the development strategy. Korea’s “Saemaul Undong” provides an example of a social program that succeeded in changing the attitudes of citizens to support development (Kwon 2010). The main elements were first, to encourage communities to undertake small-scale projects to improve their surrounding environment, followed by investment in infrastructure. The government helped with funding and provided support in leadership, accountability, regional/national coordination, and technical assistance.
To achieve sustainable growth, countries have gone beyond the comparative advantage sectors and targeted high value-added industries such as manufacturing and innovation sectors with large spillovers and high productivity gains (Chang and Lin 2009). Simultaneously, the incentive structure of workers was tackled to develop needed skills. It takes decades to achieve high export sophistication, and it can no longer be postponed.
References
Aghion, Philippe and Peter Howitt. 1992. “A Model of Growth through Creative Destruction,” Econometrica, 60 (March): 323–351.
Callen, Tim, Reda Cherif, Fuad Hasanov, Amgad Hegazy, and Padamja Khandelwal. forthcoming. “Economic Diversification in the GCC: The Past, the Present, and the Future,” IMF Staff Discussion Note (Washington: International Monetary Fund).
Chang, Ha-Joon and Justin Lin. 2009. “Should Industrial Policy in Developing Countries Conform to Comparative Advantage or Defy it? A Debate Between Justin Lin and Ha-Joon Chang,” Development Policy Review, 27 (September): 483–502.
Cherif, Reda and Fuad Hasanov. 2012. “Oil Exporters’ Dilemma: How Much to Save and How Much to Invest,” IMF Working Paper 12/4 (Washington: International Monetary Fund).
Cherif, Reda and Fuad Hasanov. 2013. “Oil Exporters’ Dilemma: How Much to Save and How Much to Invest,” World Development, 52 (December): 120–131.
Cherif, Reda and Fuad Hasanov. 2014. “Soaring of the Gulf Falcons: Diversification in the GCC Oil Exporters in Seven Propositions,” IMF Working Paper 14/177 (Washington: International Monetary Fund).
Dolton, Peter, and Oscar D. Marcenaro-Gutierrez. 2011. “If You Pay Peanuts Do You Get Monkeys? A Cross-Country Analysis of Teacher Pay and Pupil Performance,” Economic Policy, 26 (January): 5–55.
Hausmann, Ricardo, Jason Hwang, and Dani Rodrik. 2007. “What You Export Matters,” Journal of Economic Growth, 12 (March): 1–25.
Heckman, James, Rodrigo Pinto, and Peter Savelyev. 2013. “Understanding the Mechanisms Through Which an Influential Early Childhood Program Boosted Adult Outcomes,” American Economic Review, 103 (October): 2052–2086.
Heum, Per. 2008. “Local Content Development-Experiences from Oil and Gas Activities in Norway,” SNF Center for Applied Research at Norwegian School of Economics, Bergen.
Kuznetsov, Yevgeny and Charles Sabel. 2011. “New Open Economy Industrial Policy: Making Choices without Picking Winners,” World Bank PREMnotes 161, September.
Kwon, Huck-ju. 2010. “Implications of Korea’s Saemaul Undong for International Development Policy: A Structural Perspective” The Korean Journal of Policy Studies, 25 (December): 87–100.
Leskinen, Olivia, Paul Klouman Bekken, Haja Razafinjatovo, and Manuel García. 2012. “Norway Oil and Gas Cluster: A Story of Achieving Success through Supplier Development,” Harvard Business School.
Lucas, Robert Jr. 1993. “Making a Miracle,” Econometrica, 61 (March): 251–272.
Rodrik, Dani. 2005. “Growth Strategies,” in Philippe Aghion and Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 14, 967–1014. (Oxford: Elsevier).
See the high-level conference, “Economic Development, Diversification, and the Role of the State,” at http://www.imf.org/external/np/seminars/eng/2014/mcd/, organized by the IMF and Kuwait’s Ministry of Finance in Kuwait City, April 30-May 1, 2014. See also Cherif and Hasanov (2014) and Callen and others, forthcoming.
