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SMU Political-Economic Exchange


- Brazil An increasingly Protectionist attitude? - Why is there Inequality? - The Ailing Elephant
The Fortnight In Brief (31 January to 13 February )
US: Too good to be true? January's macroeconomic figures were better than expected, injecting a dose of optimism in the economy. Recent unemployment figures have repeatedly surprised economists with the speed of its descent. Unemployment fell again to 8.3%, a three year low, from 8.5%. This improvement in the labour market suggests a general improvement in the economy, though growth is expected to remain sluggish. The ISM non-manufacturing indexwhich covers almost 90% of the economyedged up to 56.8 in January from 53.0 in December, indicating a faster pace of growth in the nonmanufacturing sector. The manufacturing sector also continued to show reasonable gains in January. The DJIA and S&P 500 improved slightly upon news of the positive reports, increasing by 1.3% and 2% respectively. However, the US economy still remains depressed, with the Economic Policy Institute forecasting that the US economy would only reach full-employment in 2019, given January's rate of job creation. Asia Pacific ex-Japan: Lunar New Year Effect or Global Slowdown? January passed with an overall decline in trade across the region, reportedly due to the reduced production during the Lunar New Year month. Exports in Taiwan contracted by 16.8% y/y while Chinas exports saw a decline of 0.5% y/y. Imports on the other hand, registered a drop of 15.3%, resulting to the widening of Chinas trade surplus to US$27.28 billion in January from US$16.52 billion in the previous month, reflecting the weakening of domestic demand. The fear of rekindling inflation resulted to a 28% y/y (January) drop in lending reported by the Chinese banks. EU: Countdown to Greek default? After many delays, Greek political leaders have finally agreed on a deal to make deep cuts in government spending and jobs. The deal includes a 22% cut in the minimum wage, as well as 15,000 layoffs in the civil service. At stake is a 130 billion lifeline to avoid defaults. Greece needs the money if it is to redeem more than 14 billion of debt by March 20 or risk defaulting and setting off a financial meltdown. Meanwhile, leaders in Europe are withholding the bailout funds until they get written guarantee that Greece will implement those cuts, and find an additional 325 million in savings by next week. The Greek economic situation continues to worsen with rising unemployment and falling output.



Brazil An increasingly protectionist attitude?

By Lisa Farrah Ho, Singapore Management University This article seeks to explore the increasingly protectionist behaviour of Brazil, particularly towards China, and its implications for Brazils economy. Trade dynamics between emerging economies is always engaging, and none more so recently than that between Brazil and China. Based on recent steps taken, Brazil appears to adopting an increasingly protectionist attitude. However, this article submits that this signal is unintended, and that Brazil should instead take measures which focus on its internal and exchange rate policies, which capitalize on present opportunities to upgrade its economy. Trade between Brazil and China has deepened significantly over the last decade, with China fueling much of Brazils growth. China has been Brazils largest trading partner since 2009. It now accounts for 12.49% of Brazils exports, a sharp rise from just 3% in 2001 (Figure 1). CESifo predicts that, should the present growth rate of bilateral trade continue undisturbed, total trade value could reach US$1,110bn by 2020, with Chinese exports to Brazil totalling US$722bn. Net trading value between Brazil and China

Source: OECD iLibrary (Jan 2012)

Given this rosy outlook, Brazils apparent shift to a protectionist policy1 seems peculiar. It has recently imposed taxes and other measures which have the effect of discouraging imports and foreign investment particularly Chinese in certain industries. Are these policies a genuine herald of a protectionist era, or are there alternative explanations? Either way, the retention of those policies will spell trouble for Brazil in the long run. SPEX takes a closer look at the situation. Increased import taxes in an industry dominated by Chinese products In December 2011, a 30% tax increase on cars with less than 65% local content took effect. This raises the tax on some imported models to a punitive 55%, and is in addition to import tariffs. This hits foreign carmakers hard; China particularly so, given that demand for Chinese cars rose almost fivefold in 2011. The official reason given was that Brazil was increasingly under siege from imports. Prima facie it certainly seems protectionist: high taxes would discourage importers from importing cars at present levels to Brazil, thereby forcing consumers to rely on locally-manufactured substitutes. Yet how accurate is this reading of the tax policy? Given that Brazils economy cannot, given present infrastructure, support a carmaking industry (making cars is 60% more expensive in Brazil than in China), the more logical objective is arguably to pressurise carmakers without plants in Brazil to build them. This seems to be working: JAC Motors, a state-owned Chinese 2 Copyright 2012 SMU Economics Intelligence Club

car maker, and BMW have announced plans to build factories in Brazil since the import tax was unveiled in September 2011. Thus this seemingly protectionist policy arguably has a long-term objective instead. Dumping In 2008, Brazil applied 22 anti-dumping2 measures on Chinese products. All based their estimates of additional taxes on the grounds that China is not a market economy, resulting in higher levies being applied on imports from China than if it were classified as a market economy. In 2011, Brazil imposed a five-year anti-dumping tariff3 of US$743 per metric ton on steel pipes used in Brazils oil and gas industry, a major area of Chinese investment in Brazil. China also seems to be the target of Brazils anti-dumping investigations: In 2008, China was the investigated country of 34.9% of Brazils anti-dumping investigations, with 47 concerning manufactured goods. Advocates of this theory cite the rapidity of the increase in Chinas exports to Brazil as evidence of a dumping strategy. However, can the rise in exports be fairly construed as dumping? One must also realise that many other factors are at work: the slowed pace of the US economy has forced China to look for alternative markets. Together with Europes fragile state and an already-strong foothold in Africa, looking to South America as an alternative export base is a logical and defensible step for China to take. Changing the rules on foreign investment In 2010, Chinese investment in Brazil reached an impressive US$12.690bn. Yet the government seems to be increasingly rewriting rules to favour locals. Foreign firms are now permitted to pump oil in recently-discovered oilfields only as junior partners of the statecontrolled Petrobras. Previously they could do so on equal terms. Farmland is being treated in a similarly protectionist manner. In 2011, in an attempt to preempt vast tracts of land from being bought up by foreign sovereign-wealth funds and stateowned firms, the Brazilian government resurrected a 1971 law limiting the amount of rural land foreigners can buy. The legislation in question had, in the 1990s, been deemed incompatible with Brazils new democratic constitution and open economy. Its details are currently being reviewed: restrictions on foreigners may be relaxed slightly, particularly if the government considers the effects of foreign ownership to be sufficiently beneficial to the economy. However, there is no timetable for passing a new law. The uncertainty has caused an estimated US$15bn of planned foreign agriculture investments to be dropped. Clearly, whether motivated by protectionist intentions or not, these new laws and policies nevertheless have a detrimental effect on much-needed foreign investment. The pitfall of a strong Real A possible explanation lies in the relationship between the reals strength and trade levels. A stronger real generally increases the affordability of imports; and indeed, many authorities partially ascribe the boom period of Brazilian imports of Chinese products to the reals appreciation (Figure 2).

3 Copyright 2012 SMU Economics Intelligence Club

Brazilian Reals to 1 Chinese Yuan

This theory thus implies that the changes in amount of imports from China are due more to exchange-rate fluctuations than protectionist policies. It certainly is not without its merits: for instance, the reals depreciation in 2009 by 16% dampened domestic demand, in turn contributing to the 20.6% fall in imports from China for 2009. The real has since recovered. However, as it still remains weaker than the yuan, this could well be a stronger reason than protectionist policies for the fall in domestic demand for imports. Conclusion Arguably the short-term impact of Brazils protectionist policies in the manufacturing sector will not have an immediate dampening effect on Brazils growth. After all, its economy is still heavily reliant on commodities: commodity exports accounted for 45% of 2010s total exports. Yet Brazil cannot avoid an eventual shift to a manufacturing-based economy; after all, commodities are finite. If Brazil does not start to diversify its exports into processed goods, it risks falling victim to Dutch disease4, whereby commodity-driven currency appreciation crushes local manufacturing. Given this, Brazil ought to be laying the groundwork so as to smoothen the transition. Such policies, whether intentionally protectionist or not, should hence be stopped now, while their potential for long-lasting damages is still fairly low. Foreign investment and imports should be further encouraged, as it allows domestic industries to learn from their foreign counterparts. This in turn would not only expand Brazils current scope of economic activity and ensure continued growth, but also facilitate its progression to a manufacturing- and services-based economy. China would be an invaluable partner for this: As a major global manufacturing site, it would be able to induct Brazil in the nuts-and-bolts of a manufacturing-based economy. Furthermore, as China inevitably moves to a knowledge-based economy, Brazil could, if sufficiently prepared, take over as a major global manufacturing centre. Therefore, it is to Brazils immediate and long-term interests to avoid sending out protectionist signals. Not only do they provide fodder for politicians to capitalise on them at 4 Copyright 2012 SMU Economics Intelligence Club

Brazils expense; they would only hurt Brazils economy and reduce its presence in global trade. These generally refer to government restrictions or restraints on international trade aimed at protecting local businesses and jobs from foreign competition. Typical methods of protectionism are import tariffs, quotas, subsidies or tax cuts to local businesses and direct state intervention.

Anti-dumping measures aim to rectify the trade distortions caused by one countrys dumping of goods in another country. Dumping occurs when products are exported at prices significantly lower than what it normally is in the exporting countrys domestic market.

A tax imposed on imported goods and services. Tariffs are used to restrict trade, as they increase the price of imported goods and services, making them more expensive to consumers. They are one of several tools available to shape trade policy.

A concept in economics that explains the relationship between the increase in the exploitation of natural resources and the decline in the manufacturing sector. The increase in revenue from the sale of natural resources would lead to an appreciation of the local currency, thereby adversely affecting the competitiveness of the manufacturing industries.

Sources: The Economist, L.A. Times, Financial Times, CESifo, Ipeadata, CEIC database, OECD iLibrary.

5 Copyright 2012 SMU Economics Intelligence Club

Why is there Inequality?

By Timothy Ong, Singapore Management University The world today seems to be suffering from an uncontrollable spasm. Weakened and still in the throes of economic and political upheaval, any wrong step threatens to hurl us at breakneck speed to social unrest and other unpleasant consequences. Amidst the uncertainty of the future, the World Economic Forum has rated severe wage disparity as the global risk with the highest likelihood the direction where our wrong step is most likely to bring us. This is due to two potent and inexorable forces Globalization and Technological Advances. Highly interconnected countries coupled with rapid technological changes have led to an extremely complex and delicate equilibrium for the entire world where the slightest tremor in one part could cause serious repercussions in another. We will explore how these two forces widen inequality.
Source: World Economic Forum

Globalization and International Trade It is no longer possible for any country to willfully isolate and sustain itself. The complexity that globalization has wrought forces the entire world into an endless loop of international trade, whether out of sheer necessity or a desire to simply consume more. While it is true that international trade increases production efficiency and reduces overall costs; the tradeoff is greater exposure to global risks and competition. For a developed economy, the influx of cheap goods and services stifles its producers, forcing them into a dilemma between raising productivity levels and keeping domestic costs and wages low by hiring cheaper foreign labor. Matters get more complicated if a particular segment of the workforce is reliant on the production of such goods as they would then bear most of the burden with depressed wages. In most cases, these would be the unskilled, low-educated, and least privileged laborers. Inequality is worsened as a disproportionate burden is placed on the weakest and most vulnerable segment while almost everyone enjoys the fruits of international trade such as through the growth of GDP. Besides the liberalization of barriers to international trade, the increasing openness of financial institutions is also associated with a rise in income inequality. Foreign Direct Investment (FDI) 1 into an economy tends to favor and stimulate demand for workers with relatively higher education and skills in both developed and developing economies such as high-skill and high-technology industries and non-agricultural employment respectively. Moreover, as the wages of high-income earners are pegged globally due to increased labor 6 Copyright 2012 SMU Economics Intelligence Club

mobility, corporations have to offer a competitive wage to avoid brain drain. In effect, this will only increase the wages and opportunities of those already fortunate to be in a higher position. On the other hand, FDI flowing out of developed countries would reduce employment opportunities and wages in low-skilled sectors. The net effect then would be employment opportunities and wages rising at the top tier and diminishing at the bottom tier, hence resulting in rising inequality. Let us also not neglect the two rising giants in Asia, namely China and India. As their growth and progress skyrocket, they become increasingly embedded in global and regional supply chains. Already, both nations account for a large majority of global labor supply, concentrated at the lower end of the wage scale in developed countries. This not only affects the wages of low-skilled workers in the nations they export to, but also their employment opportunities as companies outsource labor. Over time, as these two juggernauts climb up the rungs of the value-added ladder to reach middle-skill industries such as in Information Technology, they present greater wage competition for a larger proportion of a developed countrys labor force. Technological Advances The current reality of the world is also such that there is a constant state of flux due to rapid technological advances. To have the capability to navigate this complex maze and avoid pitfalls is a growing concern for many corporations, institutions and states alike. Technological advances have been increasingly prevalent in manufacturing and services throughout both the developed and developing world. As these are two of the most important sectors in an economy, it is no surprise then that a substantial proportion of the workforce is affected. When unskilled or semi-skilled labor is substituted by technology and mechanization, it results in depressed wages for this segment of the population, resulting in rising inequality. The impact of technology is also similar to that of financial globalization. As society becomes more technological savvy, a greater premium is placed on skills able to capture the most out of technology. Professionals, managers and those engaged in abstract or analytical work become highly sought after and receive greater benefits or incomes compared to others, thereby exacerbating the inequality in wages. Coupled with the squeeze of middle-skilled labor in white and blue collar occupations by advances in technology, job opportunities are becoming increasingly polarized which results in greater wage disparity. One possible explanation is that while technology easily replaces routine tasks, it is a poor substitute for jobs that require personal interaction and abstract thinking. At the same time, advances in information technology lower the barriers to competition and allow firms to coordinate their operations more efficiently, thus contributing to the creation of winner-take-all markets 2. Just take a look at large multi-national corporations like Wal-Mart who squeeze out their competitors. The consequence is widening inequality as the super-rich enjoy magnificent profits whereas those in the middle and at the bottom receive only mediocre profits. 7 Copyright 2012 SMU Economics Intelligence Club

Some segments of society would also be less able in capitalizing on technological advances. For instance, a significant share of the older generation as well as the less-educated generally struggle to take advantage of recent technological advances and boost their productivity. Comparing Impacts While globalization and technological advances are very significant in causing a rise in wage inequality (measured by changes in the Gini Coefficient 3), they do so in different ways and have different impacts on developed and developing economies. This is attributed in part to the differences in infrastructure and domestic policies such as immigration control between countries.

Source: International Monetary Fund

Conclusion It is perhaps wise to understand the interaction between these two powerful forces, albeit each would be strong enough to stand alone. For instance, globalization and international trade tend to raise the prices of high-tech and high-skilled products, raising incentives for corporations and prompting even greater research and development of highly profitable technologies. Alternatively, improvements in communications and information technology have made it much easier for companies to coordinate their operations globally, thus increasing outsourcing opportunities and allowing them to hire less workers in rich countries to save costs. Ignoring the interaction effect between these two forces might result in an underestimate of their impact on inequality. Are we forced to consign ourselves to this bleak future of inequality? I do not think so. While both forces seem overbearing, inequality as a consequence is not inevitable. To avert such a future, it is essential for the world to muster up its strength to act and find a solution to its problems through a repeated process of trial and error. Teetering on the precipice of uncertainty does not afford us the luxury of refusing to take a step forward.

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An investment abroad, where the company being invested in is usually controlled by the foreign corporation
1 2

Market where only the top performers reap extremely large returns

A measurement of the income distribution of a country's residents. This number, which ranges between 0 and 1 and is based on residents' net income, helps define the gap between the rich and the poor, with 0 representing perfect equality and 1 representing perfect inequality.

Sources: World Economic Forum; International Monetary Fund

The Ailing Elephant

By Adam Tan, Singapore Management University This article seeks to briefly explore Indias membership in the Twin Deficit Club along with the analysis of the implications that ensue. Membership status in clubs and societies these days are highly regarded by many as exclusive and prestigious - but this is certainly not the case for the Twin Deficit Club (TDC). With members in the recent years such as Portugal, Ireland and Greece joining the likes of America and Britain, this club seemed oblivious to the public until several of these members started appearing on the news headlines lately for the wrong reasons. Basic membership requirements of the club include having the nation to be running a both a current account1 and fiscal deficit2, making many wonder where the money they are spending comes from. Sadly to mention, the latest member joining the TDC while chasing high economical growth appears to be the pride of South Asia, India. With current account deficit at 3.5% of Gross Domestic Product and fiscal deficit expected to be around 5.5% in 2011-2012, Indias nearterm outlook is looking grim. India, the second most populous nation in the world with growing affluence has always been touted to be the third largest economy in the world by 2030, succeeding Japan. This optimistic forecast had been constantly challenged over the past year with Indias growing deficit during uncertain global economic conditions. Oblivious to many, especially when India is often associated with the term growing emerging market, India has always been a net importer over the past decade, with heavy reliance on crude oil to drive economic growth. With an average of 30% of their imports comprising of black gold3, higher crude oil prices at the forecasted level of U$103 per barrel till 2014 looks to add insult to the injury. Lowering export growth due to lower demand from European trading partners can be seen as a protracted problem with the brewing Eurozone crisis. The growing divergence between imports and exports since 2003 may continue to stay in the coming decade as India struggles to differentiate herself competitively through exporting more variety of goods and services other than the more commonly known textile, leather goods and call centre services.

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Imports / Exports
Billions (USD)
400 350 300 250 200 150 100

50 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Import Export Import (Oil)

Source: IMF World Economic Outlook

Another pressing issue that needs to be addressed immediately to prevent worsening of trade balance is the recent depreciation of Indian Rupees (INR) which stemmed from weaker market sentiments brewing from the Eurozone crisis. A weaker currency not only translates to higher cost to importers, it further threatens to derail India from her recent trend of high growth through possible inflationary concerns. However, many finance professionals expect the India Central Bank, Reserve Bank of India (RBI) to act quickly in the near term to stabilise these fluctuation as the RBI has always maintained a conservative policy to keep the Rupees at a stable exchange rate of 45 USD/INR since 2004 through repeated interventions (see chart below) in the currency market. Such currency market interventions are deemed necessary to provide a more conducive business environment to home-grown businesses to spur domestic demand, an area which India is underperforming her BRIC4 counterparts.

Indian Rupee Exchange Rate

50 45 40



RBI USD Net Sale (RHS)

Source: Reserve Bank of India

On the bright side, stringent restrictions put in place by the RBI on the purchase and sale of Indian Rupees on the onshore currency market help to shelter the Rupees against any speculative attack - preventing any potential Soros5 from breaking the Bank of India. On top of the exogenous economic factors afflicting Indias economy, home-grown politics has been a driving factor behind the fiscal deficit. With the current party in power favouring 10 Copyright 2012 SMU Economics Intelligence Club

Billions (USD)


25 20 15 10 5 0 -5 -10 -15 -20

policies geared towards encouraging inflow of capital to help spur growth, these policies can be seen as a double-edged sword during times of uncertainty as seen in the case of Greece where external credit dries up. Proceeds from the recent 3G network auction and surge in tax revenues has helped to temporarily to offset the growing fiscal deficit but leaves the root of the problem unsolved. This can only be resolved if the government can better reconcile the difference between the objective of balancing growth and containing the risk involved. Prolonged membership in the Twin Deficit Club with uncertainty in the global outlook will probably drive India towards a crisis if the current government at helm do not act fast enough. Reliance in general is never a good thing, and for Indias case, their model to rely on external capital to spur growth should be reviewed against the possible risks they are exposed to. After all, no one should be following the footsteps of Portugal, Ireland and Greece.

Situation where a nation is importing more than exporting, thus making the nation a net debtor to the rest of the world
1 2

Situation where a Governments expenditure is more than its revenues Crude oil which is black in colour and is valuable like gold due to its usefulness

Acronym coined for the four growing nations Brazil, Russia, India and China 5 George Soros, notoriously known to have profited from speculating the British Pound in 1992, causing the central bank, Bank of England to lose over a billion worth of its reserve

Sources: Bloomberg, the Wall Street Journal, Financial Times

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The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents Shane Ai Changxun (Vice President, Publication) Singapore Management University Singapore Kwan Yu Wen (Vice President, Operations) Singapore Management University Singapore Herman Cheong (Marketing Director) Singapore Management University Singapore Randy Lai (Editor) Singapore Management University Singapore Timothy Ong Singapore Management University Singapore Lisa Ho Singapore Management University Singapore
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Ben Lim (Vice President, Publication) Singapore Management University Singapore Tan Jia Ming (Publications Director) Singapore Management University Singapore Vera Soh (Liaison Officer) Singapore Management University Singapore Seumas Yeo (Editor) Singapore Management University Singapore Adam Tan Singapore Management University Singapore

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