Thursday, 30 January 2014

Insights from Asia: More infrastructure for everyone

Infrastructure is like eating vegetables – more is always better (with one exception) 

Infrastructure was on the mind of Your Neighbourhood Economist during a recent trip around Asia.  Roads
in Cambodia were so bumpy that it was often difficult to think about anything else.  Investing in infrastructure is a no brainer for developing countries – it helps the economy run more smoothly by lowering the costs of doing business as well as helping to create jobs.  The same logic also applies to richer countries although it is tougher to decide where to spend any available funds.

Infrastructure – what is it and why is it good?

Infrastructure is easy to spot but hard to define.  Essentially, it is the facilities that are necessary for an economy to function.  Companies need electricity to power their factories and offices, roads to be able to move goods around, and phones and the Internet to communicate with others.  The concept of infrastructure could also be stretched to include the courts and laws which govern business, hospitals to heal sick workers, schools to produce the necessary skills in the workforce, and police to reduce the effects of crime.  However, let’s stick to the basic definition to keep things simple.

A lack of proper infrastructure can get in the way of doing business.  Clogged up roads or an intermittent power supply will create delays which put operations behind schedule.  The extra costs of power generators or the time taken in transporting goods will eat into profits.  A patchy phone or Internet network will hamper access to information needed for key decisions.

Shortfalls in infrastructure are more obvious in developing countries as by definition major parts are still being built.  Construction typically struggles to keep up with rapid growth in economic activity.  The large number of new cars on the road in Phnom Penh was a surprise but the amount of work being done on the roads was not.

In order to generate higher levels of wealth (which will typically mean more new cars), a developing economy needs people to move from working on the land to engaging in more economically productive activities in the cities.  Insufficient infrastructure is an obstacle that can inhibit economic expansion and trap a country at a lower level of income.

Tough decisions lead to neglect of infrastructure

The potential benefits from infrastructure also extend to richer countries.  More developed economies typically already have considerable infrastructure but this requires maintenance as well as extra spending due to shifting economic conditions.   It is far trickier for governments in developed countries to figure out what new infrastructure is worthwhile.  That spending on faster internet connectivity will be beneficial is a given, but it may be less obvious where to allocate the budget for, say, transport infrastructure.

Whether to invest in more roads, better railways, or bigger airports depends on predicting the lifestyles people will adopt in the future.  Ideally, the private sector would take on this burden but the copious amounts of cash along with the risks involved in major construction projects and the long-term scale of such operations are too much for businesses to handle.  Consequently, it is left to governments to determine the best courses of action.

This often results in tough infrastructure decisions being kicked down the road. Despite large budget deficits, the case for ending the neglect of infrastructure seems stronger than ever (following this link for the exception) due to high unemployment and the fact there are few engines of economic growth.  Just like your mother would tell you to eat your veggies, more infrastructure would be good for our economic health.

Monday, 27 January 2014

Insights from Asia: New Opium Needed

China has always been a tricky country to trade with but there are still ways of tapping into its growing wealth

Your Neighbourhood Economist has just returned from a four week trip around Asia which provided a few insights worth mentioning.  The first of these came during a layover in the bustling metropolis of Hong Kong with its unique mix of the old and new.  It was the history behind Hong Kong becoming a British colony that caught the attention of Your Neighbourhood Economist because it now seems as if history is repeating itself.

Similarities between Past and Present

In the 18th century China was beginning to open up to trade with European countries.  Goods from China including tea, silk, and porcelain were proving popular in Europe but there was nothing that Europeans merchants could tempt the Chinese into buying in return.  Thus, payment for Chinese goods was made in the form of silver which became a drain on finances.  As a solution, Britain increasingly relied on bringing opium into China but this created conflict between the two countries as importing opium into China was illegal.  The result was the Opium Wars which ended with a British victory and the island of Hong Kong being ceded to Britain by the Chinese as part of their surrender.

Move the clock forward a hundred and fifty years or so and some things are still the same.  China is again exporting goods that the West is keen to purchase – nowadays it is not luxuries but items produced using cheap Chinese labour.  Further similarities include the strong grip exerted by Chinese leaders over the management of the local economy.  Western firms are still eager to sell to Chinese consumers but their options for doing so are limited.  However, this is not because foreign companies have nothing with which to entice the Chinese.  This time the reason is that the Chinese government is acting to stall an invasion of multinational firms until local businesses become large enough to compete.

It makes sense for China to keep control over one of its main resources – a domestic consumer market with one billion enthusiastic participants.  Your Neighbourhood Economist would also advise the same policy of protecting up-and-coming Chinese firms from their battle-hardened Western rivals.  There are few things that China needs at its current state of economic development that it cannot provide for itself.  One of the handful of sectors where imports are important is commodities but China already gets most of its supplies from other emerging economies.

What to do differently this time around

All this has left Western governments scratching their heads with regard to selling to China.  Some countries such as Germany have prospered by selling machinery for Chinese firms to use in their factories.  But most other developed countries are struggling to find their own niche products to sell to China.  As a consequence, large numbers of container ships sail back to China mostly empty.  Opium is obviously no longer an option yet countries like Britain do need to find a way to tap into the growing wealth in China.

It is trade in services that is likely to be key.  Britain has lots of creative and business savvy firms specialising in the design and technology sectors.  Finance is one area which is still out of bounds in China but other sectors are open to outsiders.  Education, on the other hand, is a service that China is finding it hard to provide for itself in either sufficient quantity or quality.  Countries such as Britain can access Chinese wealth while also expanding its educated workforce either through Chinese students who study aboard or foreign schools set up in China.  In the future, higher paying service jobs rather than employment in declining industries such as manufacturing are more likely to provide the bulk of “good jobs”.  China will not always be so closed off or in need of education services but a focus on education seems like a winning formula in the meanwhile.