Middle-east discovers Adam Smith
The Syrian socialists of the Baath Party seem to be having an economic change of heart. According to Newsweek (14 May 2007), the Syrian banking system has been opened up to private sector competition and the tax & investment laws have been made more business-friendly. The economy has responded, growing 5.1% in 2006 and 5.6% in 2007.
Syria is not alone. Eygpt has floated their currency, liberalised their tax code and reduced tariffs. Relaxed investment rules have resulted in fast-growing foreign direct investment ($5.4b to $7.8b in 2 years) and nationalised companies are being prepared for re-privatisation. Their economy has been growing at an average of 5.5% over the past three years.
Saudi Arabia is also slowly liberalising, now allowing private insurance companies and they are in the process of introducing mortgage law. Even Iran is privatising. The result has been an impressive jump in middle-eastern (ME) growth rates. According to the World Bank, ME* growth averaged 3.6% in the late 90s. This increased to 4.6% (2000-03 average) and then up to over 6% (2004-06 average).
The history of the western world & east Asia suggests that economic freedom leads to economic development which then leads to greater social & political freedoms (and less chance of war). Most of the ME doesn’t yet have those social & political freedoms, but if they continue to liberalise their economies, then greater freedom & democracy will eventually follow.
Ultimately, the invasion of libertarian ideas & policies will be more successful in helping ME citizens than the invasion of troops. And it costs less in money & lives.
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* Excluding Iraq
What was the Eygtian currency formerly fixed to? Certainly not the US dollar if the following is any guide:-
http://finance.yahoo.com/currency/convert?from=EGP&to=USD&amt=1&t=5y
And inflation outcomes in Eygpt are:-
http://www.indexmundi.com/egypt/inflation_rate_(consumer_prices).html
I notice that the Saudi Riyal remains well and truely fixed:-
http://finance.yahoo.com/currency/convert?from=SAR&to=USD&amt=1&t=5y
And inflation in Saudi Arabia is as a consequence very low:-
http://www.indexmundi.com/saudi_arabia/inflation_rate_(consumer_prices).html
The idea that floating give low inflation and fixed doesn’t is pure prejudice.
In the paper today there was talk of wide spread protests in Iran as they move from petrol subsidies to rationing. It is somewhat amazing that a nation with so much oil should have such a shortage of petrol simply because they lack the capacity to refine oil.
Comment by terje (say tay-a) | June 28, 2007
And with serious talk of introducing the Khaleeji by 2010 (fixed to the US dollar) I don’t think the middle east trend is at all towards floating currencies.
Comment by terje (say tay-a) | June 28, 2007
And one more thing. Adam Smith was not into floating fiat currencies. Quite the contrary.
Comment by terje (say tay-a) | June 28, 2007
Stop it or you’ll go blind, Terje.
According to Wikipedia, Khaleeji can refer to:
* Gulf Arabic, a dialect of the Arabic language spoken around the shores of the Persian Gulf.
* Anything associated with the Arab Gulf states.
* A proposed name for the proposed unified currency of the member states of the Cooperation Council for the Arab States of the Gulf
* Another name for a Thobe (a robe type garment)
I’m guessing, but presumably you were referring to the third definition.
In that case, weren’t you the one going on and on about the lack of difference between pegging the Chinese yuan to the US dollar and US central bank control over interest rates?
A fiat currency is one authorised by the government, as distinct from one issued by a private institution such as a bank. Apart from Scotland and Northern Ireland there aren’t any non-fiat currencies.
So what exactly were you trying to say?
Comment by DavidLeyonhjelm | June 28, 2007
This wasn’t supposed to be a post about Terje’s money fetish.
Comment by John Humphreys | June 28, 2007
Yes the third item on the list.
The point I was making in regard to the Khaleeji is a minor and rather secondary point. It is merely that the Khaleeji arguable represents a trend towards exchange rate fixing in the middle east.
This point was merely an observation and not really a judgement. However on balance I would suggest that such fixing is probably a good thing. Witness the fixed exchange rate used by Saudi Arabia and the associated low rate of inflation. However I am not familiar with enough details to have a stong view on the Khaleeji.
The Khaleeji is not the only attempt at a unified currency in the region. There has been lots of talk about the islamic world adopting the gold islamic dinar as a universal currency. However other than in Malaysia I don’t think suggestions along this line ever went very far.
My more significant points were:-
1. Floating fiat exchange rates are not consistent with the thinking of Adam Smith. If anything can be said to unify Adam Smith and Karl Marx it was a shared belief in the efficacy of a currency fixed to gold.
2. Eygpt does not appear to have had a fixed exchange rate so any talk of a recent float seems somewhat incorrect. Perhaps John can clarify on this point.
3. Iran seems to have been moving away from free markets with it’s recent moves to ration fuel. Although this news is pretty hot off the press. See article below:-
http://www.ft.com/cms/s/5398fc38-2513-11dc-bf47-000b5df10621.html
Comment by terje (say tay-a) | June 28, 2007
I agree to a large extent. However given the history of such things I don’t think anybody should assume that the ascendance of free markets or libertarian ideas is a given.
Comment by terje (say tay-a) | June 28, 2007
Was somebody assuming that the ascendance of free markets or libertarian ideas was a given? Or was that just a random piece of advice?
In which case, I will respond with my own random advice — “always make sure there is toilet paper”.
Comment by John Humphreys | June 29, 2007
And despite Terje’s protestations, a fixed exchange rate with the rest of the world is going to result in bad monetary policy unless the exchange rate is being used to target inflation. And this has never — and I suggest will never — be the case.
Comment by John Humphreys | June 29, 2007
It was not random. When you say that libertarian ideas & policies will be more successful in helping ME citizens one could reasonably draw the inference that you are asserting that this will transpire. My comment was not directed at you specifically but at anybody that might draw that inference.
Of course you are also making a comparative statement about the use of ideas versus the use of force. And as such I agree to a large extent with the relative merit of enabling change through ideas. Although it does seems entirely plausable to me that libertarian ideas will be repelled in much the same way that an invading army might be repelled.
Comment by terje (say tay-a) | June 29, 2007
A floating exchange rate is going to result in bad monetary policy unless it doesn’t. Doh! History is littered with floating currencies that had terrible inflation.
A fixed exchange rate that involves a fix to some stable reference will deliver low inflation. It delivers low inflation for Denmark. It delivers low inflation for Saudi Arabia. It delivers low inflation for Togo. In fact it is hard to identify any nation using a fixed exchange rate today that does not enjoy low inflation.
For most of it’s history the USA had a fixed exchange rate between US dollars and gold. At no point did this system ever cause significant inflation or deflation. They did leave the gold standard during the civil war and after than they suffered inflation.
Despite Johns protestations a fixed exchange rate is a perfectly respectable approach to monetary policy that historical has delivered low inflation more consistently than floating exchange rates have.
Why would Denmark give up it’s current fixed exchange rate system? What possible benefit would it bring them?
In any case you must surely admit that floating exchange rates is not an idea that was promoted by Adam Smith. People don’t “discover” some merit in floating exchange rates after reading Adam Smith.
Comment by terje (say tay-a) | June 29, 2007
Reforming economies in the middle east? I’ll be dying of old age before than happens. The place is a corrupt socialist quagmire.
The only reason it has grown the why it has is because of oil.
Look most don’t allow interest in the banking system. I’m not gonna rush to my broker to by mid east stocks.
Comment by Jc | June 29, 2007
Terje, if I say that Ron Paul would be a better President than Rudy McRomneyson, that doesn’t mean I think Paul will win. Same with ME liberalisation. Just because I think it would be more successful than war doesn’t mean I think it will necessarily transpire. Indeed, when I later say “if they continue to liberalise”, that shows that I don’t think it’s inevitable that they will liberalise.
And my advice about toilet paper is good.
A floating exchange rate is not a monetary policy. A fixed exchange rate is a monetary policy. Therefore, it makes no sense to blame a floating exchange rate for inflation. Blame the monetary policy. Since the west has improved their monetary policy (inflation targeting interest-rate controls) inflation has been largely controlled.
There have also been plenty of examples of high inflation under fixed exchange rate systems. Perhaps fixing to gold is a better idea, but the reality is that most fixed exchange rate regimes aren’t fixed to gold and they aren’t managed with monetary stability in mind.
I agree that nobody learned floating exchange rates from Adam Smith. My reference to him was supposed to be a general reference to capitalist ideas. Perhaps I should have written “ME discovers Milton Friedman”, but the general vibe of the title is the same.
Comment by John Humphreys | June 29, 2007
John - I was not saying the inference that libertarian ideas would liberate the middle east was the correct inference or that it was your intended meaning. I merely passed comment saying that people should not assume such a thing. Perhaps my style of writing does not distinguish clearly between a retort and an intended point of clarification.
You are 100% correct that a floating exchange rate is not a monetary policy. It is a notion consistent with either relative monetary stability (eg Australia), rampant inflation (Zimbabwe) or deflation (Japan until recently). Yet for some strange reason some economists celebrate when a nation floats it’s exchange rate. As if heading off on some random undefined journey is necessarily a good thing and staying fixed is automatically foolish. This is why I asked if Denmark should float. I can’t see any monetary alternative for Denmark that would be better than it’s current fix to the Euro. The fix gives them certainty in trade, low inflation and low rates of interest. Why would a float be automatically good?
In your article you indicated thay Egypt had floated it’s exchange rate. I can’t find any indication that it was previously fixed so this seems like an odd claim. And I can’t see why foating is a good thing unless they have moved from a fix with poor monetary outcomes to a system expected to deliver better outcomes. Merely floating does not mean better outcomes. Given the frequent governance issues I am never automatically heartened by floats. For instance Saudi Arabia is fixed to the US dollar and enjoys low inflation. It is a highly accountable system because the central bank can’t fudge on this monetary target without being discovered and blamed within a day or two. However if the Saudis floated a lot of trust would then rest on the alternate management approach and the managers involved. Any poor performance would take a considerable amount of time to show up and a million excuses can always be found for failure within most other monetary management approaches.
A fixed exchange rate is a technically simple monetary policy that requires little access to data or complex management decisions. And whilst it continues to deliver low inflation to a given nation why embark on some alternate route or celebrate such a departure?
When Australia floated off the US dollar the fixed system wasn’t delivering so fair enough. When the US floated off gold (circa 1970) the system had been delivering so the decision (by Nixon) was folly. What followed was not better. What followed was highly destructive to both the USA and the world.
You would have been better advised to observe that Egypt had decided to use “Inflation Targeting” using interest rate targets and they had appointed a really well regarded guy to chair the monetary committee. Had this been your observation and had it been true then I might be inclined to share some optimism. Even though “Inflation Targeting” via interest rate management is not my preferred monetary scheme it is a very good scheme relative to many alternatives. In the mean time I can only note that inflation outcomes in Saudi Arabia are better than in Egypt and have been for some time.
Comment by terje (say tay-a) | June 29, 2007
p.s. The claim that most nations that fix their exchange rate don’t do so with monetary stability in mind is surely insincere. What alternate motive do you suggest?
Comment by terje (say tay-a) | June 29, 2007
The motive for managing a fixed exchange rate is fairly clear and uncontroversial — to manage the current account.
Early in this century many western countries were in a “bidding war” to devalue their currency so as to encourage exports in an unfortunate reversion to a mercantalist mentality. This continues to be a strong pressure on politicians.
Compared with this mentality (which is the dominant mentality in the “government-controlled exchange rate” world), a floating exchange rate is clearly better.
I cited my source for my information in my article. I didn’t check all the information & that source may be wrong. Really, the float of the Egyptian currency was a fairly minor side-point to the issue I was trying to raise.
Comment by John Humphreys | June 29, 2007
I can understand the current account being used as a motive to justify devaluing a nations currency. However devaluing your currency and fixing your currency are not the same thing.
For example if the A$ was fixed to the $US such that $A1 = US$1 then we might attempt to gain some current account improvement by moving to a new fix at $A1 = US$0.95. As I am sure we agree any such advantage is mostly an illusion as real prices adjust, but I can see that some might see advantage in such a devaluation.
However what you have offered is an incentive for devaluation, not an incentive for fixing. Towards the end of the Brenton Woods gold standdard the USA devalued the US dollar by moving from a fix at $35 per ounce to a new fix at $44 per ounce. They then floated which caused an even bigger devaluation. Both changes were an instance of devaluation but this motive does not define the difference between choosing a new fix and a choosing to float. You can devalue via a new fix or via a float so why choose a fix?
If all you want to do is devalue that can be done as readily under a floating regime as with some form of crawling peg. In fact you can devalue much more seemlessly with a floating currency as has been the case in Zimbabwe. The motive you suggest does not define the reason people might choose to fix their exchange rate.
The Hong Kong dollar has been fixed to the US dollar since 1983 at a constant rate. The Saudi Riyal has been fixed since 1986. Surely you are not suggesting that these nations have fixed at a constant rate for these last two decades in order to activively manage their current account? I think it far more likely that they have done this for the purposes of monetary stability.
Regards,
Terje.
p.s. I accept that the floating of the Egyptian currency was probably a minor point. However it stuck out like a sore thumb.
Comment by terje (say tay-a) | June 29, 2007
I know devaluing & fixing aren’t the same. I never said they were. But if politicians control the exchange rate they will often use it to achieve their goals (like increasing exports). If the market controls the exchange rate then politicians won’t be able to distort them.
I thought the HK dollar was now fixed to the RMB.
Comment by John Humphreys | June 29, 2007
According to Wikipedia and other sources it is still fixed to the US dollar:-
http://en.wikipedia.org/wiki/Hong_Kong_dollar
You are right that monetary policy should not be decided on day to day political whim. However most fixed exchange rates are not. Denmark has been fixed to the Euro within a 2.25% band and this fix is managed by a central bank as independent as our own.
In New Zealand the central bank must pursue price stablity. But the parliament defines how that is measured. If parliament decided that it was measured in terms of the exchange rate with US dollars or Euros then they (politicians) could fix (and/or devalue) the New Zealand dollar.
In any case we are now discussion governance issues. And one of the neat things about a fixed exchange rate is that the governance over the monetary authority is very simple. They either meet their target every day or they fail. There is no room for fudging figures. In a nation like Saudi Arabia where corruption is prevalent this factor is significant.
Short term political agendas should not decide monetary policy. However a fiat currency is never entirely above political consideration. There is no national currency perfectly isolated from political meddling. However there are fixed exchange rate regimes and inflation targeting regimes and other regimes that are generally free from meddling.
Regards,
Terje.
p.s. I note that the Heriatge Foundations 2007 index of economic freedom gives Saudi Arabia and Australia a roughly similar score on monetary management.
Comment by terje (say tay-a) | June 29, 2007
p.s. I meant to say Denmark has been fixed to the Euro since 1999 within a 2.25% band …
Comment by terje (say tay-a) | June 29, 2007
I apologise for providing Terje with an opportunity to play with his money fetish. Yes, it will send him blind, but for now he can still see the keyboard.
As to the actual point of this post, the idea that capitalism might be growing roots in the middle east warrants serious consideration.
As JC said, the ME is essentially a corrupt socialist quagmire. But it wasn’t always socialist. Prior to that it was feudal. Applying a bit of revisionist Marxism, perhaps capitalism is the next evolutionary phase.
India, China and Vietnam have shown that once the economic freedom genie is out of the bottle, the government finds it hard to put back. I understand the only real challenge to the government of Iran is from people who fear it will undermine economic prosperity. Even the nuclear program is unpopular due to the risk of sanctions.
On the other hand, I am not convinced the roots are deep enough in the ME to be sure the process will keep moving. A certain critical mass, based on an aspirational middle class, seems to be required for that. In most of the ME there is only an elite governing class and the peasants.
On a practical note, what could Australians do that would help move the process in the right direction? Free trade agreements that excluded government-owned businesses?
Comment by DavidLeyonhjelm | June 29, 2007
I don’t agree economic liberalism leads to freedom. I think its idealistic rubbish.
As China liberalises its economy it is doing nothing but convincing the population that the authoritarian regime they currently have is doing a good job. The people are becoming more prosperous and comfortable and so are less likely, not more likely, to revolt.
It gives its government more tax dollars to build up its armed forces, making the government stronger, and as the economy is strong we aren’t going to see anything like the Soviet implosion, infact had the Soviets liberalised, we would probably still have them around today (ignoring the fact they we almost do, in Putin).
I would be interested in any objective studies into whether the Chinese populous is any less ‘happy’ than we are, in any case. If they are happy with their lives, western views on the evils of authoritarianism would seem irrelevant, even evangelical.
Comment by Steve | June 29, 2007
Strangly, the “ideolistic rubbish” that economic freedom leads to wealth and wealth leads to personal & democratic freedoms is backed up by overwhelming evidence. Indeed, there are very few (if any) counter-examples.
Every OECD country is democratic. Poor countries either have no or unstable democracy. As Korea & Taiwan developed they slowly shifted (note: not a revolution) into real democracies. China is still too poor to expect it to be democratic.
Robert J. Barro did a study comparing economic wealth & democracy. In 1980 he looked at countries that had “too much democracy” for their level of wealth and predicted their democracy would not last. And for countries that had “too little democracy” for their level of wealth were predicted to find democracy. His predictions came true.
Not only does the above idea have significant supporting evidence but it is also quite logical. It is well known that democracy, the environment, women’s rights, civil liberties etc are “luxury goods” that people care about after they have satisfied their basic wants.
Finally, the happiness literature is problematic at best and entirely useless at worst… but that is a debate for a different day.
Comment by John Humphreys | June 29, 2007
Steve, your argument is irrational. Economic liberalism amounts to a substantial increase in freedom. Perhaps it is limited to the right to changes jobs, earn higher wages and buy consumer goods, but it’s a lot freer than a command economy. You can’t define freedom in limited terms.
Obviously the absence of democracy and social freedom are drawbacks, but interest in these grows as wealth increases. In China, for example, corrupt government officials are being increasingly exposed and imprisoned (or in some cases executed) as economic prosperity rises. The recent outcry against child slaves in brickworks would never have happened without economic freedom.
Governments are also reluctant to retreat from economic freedom due to the potential for a backlash. Military action that would damage the economy, eg invading Taiwan, is in that category.
What the hell has being “happy” got to do with anything? Happiness is entirely relative. Until I have a Porsche Carrera 4 alongside a Bentley in my garage, there’s no way I’ll be happy.
Comment by DavidLeyonhjelm | June 29, 2007
John - where can I read more about the work of Robert.J.Barro? I find the concept that you cite very interesting. The general explaination I have heard for the correlation between wealth and democracy has tended to be that democracy causes wealth. Admitedly I have never heard this explaination as authorative but it does seem to be a form of assumed orthodox. The alternate theory that you cite actually seems more likely to me but I was not aware of any specific work on this and I’d love to read/discuss more. It would seem to have rather direct implications with regards to strategies for fostering democracy in poor nations via foreign intervention.
Comment by terje (say tay-a) | June 30, 2007
The study by Barro that I referred to was in his pop-economics book “getting it right” (1996) that I read long ago. I was writing from memory, so I might have got the base year wrong, but the general story was quite convincing. He also has some other quite interesting chapters in that book.
Barro’s Harvard homepage can be found here. He is also famous for work on Ricardian equivalence (that government dis-saving encourages private saving), but besides that I can’t really comment on his work.
Comment by John Humphreys | July 1, 2007
Somewhat ironically (given the flow of this discussion) I happened across the following quote by the same Robert.J.Barro:-
Granted it is an old quote and he may no longer stand by that last sentence.
Comment by terje (say tay-a) | July 1, 2007
[...] of setting a minimum wage can be mitigated by regionalising it while John Humphreys finds hints of free market reform in the Middle [...]
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