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Future Development

What it will take to boom after the bust? Trade and competitiveness at a time of lower oil prices

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In 1977, the Economist coined the term “Dutch disease” to describe an economic malaise that often plagues resource-rich developing economies. As the Dutch started exploiting the large Groningen natural gas field in the northeastern Netherlands, and lucratively exporting its product, the Dutch guilder appreciated markedly. This made imports cheaper, allowing Dutch citizens to consume more. However, these short-term gains created long-term pain because non-oil exports became more expensive, eventually leading to a partial deindustrialization of the economy.

A similar story was at play, over the last two decades, in many countries of the former Soviet Union—including Russia but also Kazakhstan, Azerbaijan, and Turkmenistan—which benefitted from a dramatic “oil and gas bonanza.” While most of these emerging markets (except Russia) had never fully industrialized in the first place, the appreciation brought about by the boom hurt export competitiveness beyond oil and gas. Although some countries, such as Kazakhstan, managed their resources quite well, accumulating savings and sharing the benefits broadly, economic diversification objectives remained largely unfulfilled.

The question today, at the heart of policymaking debates in Central Asia, is whether a “reverse Dutch disease” can be engineered. With oil prices at around $50 a barrel, they are barely at half of what they were for most of the last decade, and most analysts agree that structural shifts in supply will keep them low for the foreseeable future. While the short-term adjustment is particularly painful for oil producing countries, there are new opportunities for non-oil exports of goods and services (such as tourism or information technology related services). In Central Asia’s resource-rich economies, national currencies have lost much of their value relative to the dollar: Their populations can no longer afford the cheap imports they used to enjoy, but their production now has a substantial cost advantage abroad.

So what will it take to boom after the bust?

In order to benefit from more favorable export prices, resource-rich countries need to rebalance their economies, hitherto centered on highly profitable extractive industries. Sustaining prosperity gains will require higher growth, which can be achieved by unleashing the countries’ potential in non-commodity exports. Take for example Kazakhstan; in the past, the resource boom fueled strong domestic demand, including a massive expansion in construction. Today, the country is desperately looking for new sources of economic growth.

Currency adjustments are necessary but not sufficient to make exports competitive. If goods and services cannot flow freely, these new sources of growth will not emerge. At the same time, the opportunities are substantial if countries leverage the following four factors:

  1. The potential for trade remains enormous. While the popular belief is that we live in a world of hyper-globalization, the opposite is true. Most trade and investments in the world happen within countries, which means that a big boost from exploiting trade opportunities is still ahead of us. In turn, the potential for trade is supported by ongoing technological revolutions. Specifically, land transportation, which is cheaper than air and faster than sea, is being reshaped by technology, like driverless vehicles, reducing costs and increasing the use. 
  2. Opportunity costs are the new driver of profitability. The cost of trade goes well beyond the price of transportation. Delays in shipping goods, especially at borders, are also a major hindrance to trade. They not only increase transport time and price, but also create opportunity costs as unreliable supply chains force firms to build inventory. These “hidden costs” have become increasingly salient with the emergence of global value chains, where parts and components are sourced from many places before they are assembled to make a finished product.
  3. Soft measures matter as much as hard investments. Many countries have invested heavily in upgrading their physical infrastructure. However, today, bottlenecks at ports and borders and excessive government red tape are the key factors inhibiting trade in many countries. For example, a one-day delay reduces the export value of most goods by 1 percent; for agricultural products, by as much as 7 percent.
  4. Agglomerations drive economies of scale. Modern logistics operate from few central hubs. A country’s fortune therefore, will depend to a large extent on the strength of its economic capital, and its ability to act as a regional consolidation point or to connect to nearby hubs.

Central Asia is literally at a crossroads. Economically it is undergoing a massive transformation brought about by lower commodity prices and plunging currencies. Strategically, the transport revolution has the potential to make the region central again—connecting east and west, and north and south—as in the heydays of the Silk Road. Massive Chinese investment, pledged under the One Belt, One Road initiative can provide the needed financing. But realizing the vision will require understanding and leveraging the four trends outlined above.    

Authors

This blog was first launched in September 2013 by the World Bank in an effort to hold governments more accountable to poor people and offer solutions to the most prominent development challenges. Continuing this goal, Future Development was re-launched in January 2015 at brookings.edu.

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