Escaping the Malthusian Trap

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Chile had escaped the Malthusian trap around the early 20th century. In this I will examine the factors that had enabled substantial growth in the Chilean economy including geography and trade, population, and institution within the period 1840-1930. The Chilean War of Independence against Spanish control began in 1810 with it ending in an independent republic being declared in 1818. From this point onwards Chile began to expand its territorial holdings in regards to assimilating the Mapuche population and gaining Northern territory, but it was only in 1840 that the economy had truly opened (Mamalakis, Markos J).Chile has a diverse regional market due to its geographic nature, as the country spans 6435 km of coastline going from desert in the North to arctic conditions in the South. (Please click to expand images!)

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As Chile lies upon the North-South axis it has distinct diversity in climate and geography, the economy had been able to surpass the Malthusian trap as a consequence of this rather than be limited by it. This diversity enabled trade, demand for its exports, and increasing market integration. Chile had a particular trade advantage due to access to the Pacific Ocean and the Atlantic Ocean through the Drake Passage, and the Strait of Magellan (The World Factbook). This was to prove pivotal for the export of the factor endowments present in Chile. In the central and southern zones there is particularly fertile soil for wheat production and grazing. Then in the northern zone there is the Atacama Desert, which is the source of Nitrate and Copper (The World Factbook). While the border to Argentina is defined by the Andes Mountain range providing Chile with access to natural minerals (The World Factbook). 

Trade routes proved to be integral to the growth of the export and import market that drove forward Chilean growth, which is exemplified by their increasing rate in growth rate of exports considering the data for 1850-1900, 1870-1920, and 1890-1900 shown in the table.

Screen Shot 2014-11-05 at 14.04.58Further examining exports Chile had an absolute advantage in the production of wheat during what was noted as the Great Wheat Trade between 1865 and 1900 (Mamalakis, Markos J).This wheat boom had begun in 1850 as a consequence of demand from the Californian and Australian gold rushes, as exports peaked at 276,664 qq.m (quintals) for California in 1850, then 323,607 qq.m for Australia in 1855 (Mamalakis, Markos J). This highlighted Chile’s advantage due to the pacific trade routes and fertile soil, while the wheat trade was to become global with England becoming a central importer, as production between 1867 and 1900 did not fall below 800,000 qq.m (Mamalakis, Markos J). This absolute advantage in wheat production attracted foreign investment, and led to the introduction of steam ship use in Chile (Mamalakis, Markos J). The wheat trade began to decline by 1900, due to California and Australia producing their own wheat (Mamalakis, Markos J). This decline in the pacific export market for wheat did not hinder Chile’s growth due to the export of copper and nitrate.

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The nitrate boom began after the War of the Pacific in 1880-82, as Chile had gained the entire Atacama Desert region from Bolivia and Peru (Hutchison, Elizabeth Q., Thomas M. Klubock, Nara B. Milanich, and Peter Winn). This had also landlocked Bolivia, resulting on a trade dependence on Chile. Between 1900 and 1930 more than 50% of government revenue came from nitrate and iodine export taxes (Mamalakis, Markos J), with the nitrate sector resource surplus averaging 14% of GDP between 1882 and 1930 (Mamalakis, Markos J). In regards to helping Chile escape the Malthusian trap the nitrate boom was far more important in regards to it being a source of modernization. Integrally, bringing it closer towards modern capitalism and into contact with the United States and the United Kingdom. However, due to the synthetic production of nitrate, Chile had experienced a rapid boom and bust cycle (Mamalakis, Markos J). In this the greater move towards capitalism became the main benefit of the nitrate boom, as the nitrate bust left behind it ghost mining towns and structural unemployment showing an example of mineral theory (Adelman, M. A., and G. C. Watkins). This left copper as the most sustained specialized export, ensuring growth.

It was specialisation in the extraction of copper that was to lead to sustained growth, institutional development, and greater market integration within the Chilean economy. Until 1880 Chile had been the world’s largest copper producer, but it experienced a rapid decline in easily available stocks as production fell (Mamalakis, Markos J).

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After 1910 the Chilean copper sector experienced a massive transformation, as increasing foreign investment led to greater human and physical capital that resulted in large-scale mining. This had revived copper production, while emphasising an institutional and financial link with the United States (Mamalakis, Markos J). It is debated whether the foreign presence had upheld a weak Chilean economy, or whether it provided the backbone for the modernisation.

Exports

The geography of Chile proved to be vital in providing the correct environment for access to trade, as well as a diverse range of exports. Proving essential to an increase in economic growth and modernisation, in regards to escaping the Malthusian trap increasing income per capita was a result of this trade based growth. However, it is important to consider the demographic transition that occurred in the period.

The demographic transition in Chile took advantage of growth through trade, aiding in the escape of the Malthusian trap. In the table below we see a decreasing rate of increase in population for Chile during the period in question 1840-1930, with the authors estimates with a boom in population growth for 1915-1930. There was no dramatic change in population, with the main factor being the assimilation of indigenous Mapuche population through expanding the Chilean frontier in the south through war (Hutchison, Elizabeth Q., Thomas M. Klubock, Nara B. Milanich, and Peter Winn). Instead this demographic transition was based upon increasing urbanisation and a switch to more service based sectors. In 1930 49.4% of the country’s population was located in urban areas, and increasingly the capital Santiago (Mamalakis, Markos J).

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This was a consequence of the movement of employment from agriculture to industry and services, shown by the graph considering the production indices, as the public sector, and industry began to match then exceed agriculture in terms of production. This suggests that the Chilean economy had escaped the Malthusian trap between the period 1915-1930, especially considering the table below which considers the relative income and employment between 1907 and 1930, as 43% of the working population was employed in services which accounted for 50% of relative income, compared to 36% of the population being employed in agriculture (Mamalakis, Markos J).

Screen Shot 2014-11-06 at 10.40.54It is important to place the trade and demographic transition that allowed Chile to experience rapid levels of growth into context with the institutions that were available at the time. Having been a Spanish colony there was already the physical and human capital required to facilitate trade, moreover the Spanish had focused on the mining of silver and gold that was to benefit the Chilean economy in regards to the production of copper and nitrate (Hutchison, Elizabeth Q., Thomas M. Klubock, Nara B. Milanich, and Peter Winn). Chilean institution in relation to aiding the escape from the Malthusian trap may be more closely examined through considering capital accumulation through physical and human capital investment, this is a consequence of the government being able to focus on aiding the export sector. Travel was the greatest institutional issue as a result of the length of the country. Therefore, between 1888 and 1930 government development expenditure increased at a rate of 4% per year (Mamalakis, Markos J), this went towards the development of customs facilities, rail network, roads, and ports. Chile had effectively set up new institutions as a result of investment into human capital through education. The government realised that it had previously failed to spread education between 1840 and 1900 this was due to rural population, poverty, inequality, and inadequate enforcement. In 1900 the system was nationalised, creating a progression from primary education until university education. This also led to the rise of vocational education in agriculture, mining, industry, and trade (Mamalakis, Markos J). Therefore, Chile had inherited some degree of institution due to being a Spanish colony creating the base of development, but then was able to develop its own institutions enabling it to improve standards of living and aid in increasing wages beyond subsistence level.

The combination of geography, trade, population, and institution between 1840 and 1930 had placed Chile on the path to escape the Malthusian trap. Chile had a geographic advantage for trade with access to both the Atlantic and pacific oceans, while also being endowed with resources to export such as wheat, nitrate, and copper. Then due to the nature in which foreign investment defined the export sector there was a demographic transition, which resulted in increasing urbanisation. This was led with through the trading institution inherited from the Spanish colonialists. The economy was then transformed, as a strong government was able to build new institutions specifically education. Thereby, leading Chile out of the Malthusian trap by 1910-1920. Correlating to some degree with data map shown below:

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Chile was to go on to experience economic and political turmoil that would stagnate the economy, which meant that it didn’t follow a similar to path to other countries escaping the Malthusian trap until the era of neo-liberalist economics under Augusto Pinochet (Solimano, Andrés)

Bibliography

Adelman, M. A., and G. C. Watkins. Reserve Prices and Mineral Resource Theory. International Association for Energy Economics, 2008. Print.

Hutchison, Elizabeth Q., Thomas M. Klubock, Nara B. Milanich, and Peter Winn. The Chile Reader: History, Culture, Politics. Print.

Mamalakis, Markos J. The Growth and Structure of the Chilean Economy: From Independence to Allende. New Haven: Yale UP, 1976. Print.

Solimano, Andrés. Chile and the Neoliberal Trap: The Post-Pinochet Era. New York: Cambridge UP, 2012. Print.

The World Factbook. “South America: Chile.” Central Intelligence Agency, 22 June 2014. Web. 30 Oct. 2014.

Staring, Chris. “The Nitrate Towns of Chile Photography.” Atlas Obscura.
Web. 29 Oct. 2014.

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Long Run Aggregate Supply

There are two theoretical outlooks on long run aggregate supply; there is the neo-classical/monetarist model and then the Keynesian model.

Neo-classical/Monetarist Model

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In the short run producers will respond to a change in price, but also higher demand by bringing in more inputs of production and utilising existing means of production. But in the long run in this model it can be note that supply is independent of price.

This makes the assumption that all prices are flexible, and if some prices go up others will go down. Furthermore, this displays that the potential of an economy to grow is based on four central factors land, labour, capital, and enterprise. There can also be an increase in productivity and efficiency which is the better utilisation of already existing factors of production.

An outward shift would be considered an increase in productive potential. This particular model also states that at that given point all resources are being employed and there is a point of full employment.

As a result of this model monetarists would argue that stimulating aggregate demand is artificial manner of promoting growth, and therefore shows that fiscal policy is ineffective.

Equilibrium Neo-classical/Monetarist Model

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This diagram determines that at the point aggregate demand meets long run aggregate supply that it is at the point of full employment of all resources including labour.  There can only be short term fluctuations as ultimately prices are completely flexible so there are no inflationary or recessionary gaps. The economy should always go back to the point of full employment level of output.

It also shows that increasing aggregate demand only invokes an inflationary response, rather than growth. This shows how supply side policies are extremely effective in regards to the monetarist model as an outward shift of LRAS would mean that there is great output at lower prices if it were to meet the same level of demand.

Keynesian model

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This model contains an element of the neo-classical model, but otherwise there are two significant differences. These differences are highlighted as this model can be separated into three different sections.

The first section is the horizontal line this is recognition that there are downward inflexible prices (sticky prices). This is because of factors such as labour contracts, unions, minimum wage, etc. At any point of alongside the horizontal line it is the recognition that some resources are not being employed and that there is production capacity which is not utilised.

Then there is the curve section which introduces the concept that there is still some response to price in the long run.  As the output increases so does the employment of resources, this causes prices to rise. To continue output firms must be able to continue increasing prices.

Finally there vertical section where there is the potential of full employment of resources. This is where prices can increase rapidly and GDP can’t increase as all aspects are being utilised.

Similar to the monetarist model, there can be an outward shift in long run aggregate supply. This is where the four main factors land, labour, capital, and enterprise are being utilised in a more efficient or productive manner. There may also be an introduction of new resources, which would cause the expansion. This particular model shows the benefits of using fiscal policy to stimulate aggregate demand as you achieve growth without an inflationary response.

An outward shift would mean an increase in productive potential, as the economy can utilise more resources in order to produce more. In this model however there are inflationary and deflationary gaps, as a result of the price sensitivity.

Equilibrium Keynesian model

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As shown in the diagram it can be noted that the economy can be at equilibrium at a variety of points where the economy is not at the point of full employment level of output. For AD1 it can be noted that there is not the full utilisation of resources.

Then the following point of AD2 it reaches the beginning of the section which is considered the deflationary gap. In this model the economy can stay at this gap. This is shown at the equilibrium with AD3. The economy can remain at this point because the model argues that without intervention the economy will not tend towards the point of full employment of output.

AD4 in contrast is presiding in the inflationary gap, where any increase in demand results in inflation rather than growth. At the turning point between the curve and the vertical line it can be considered the maximum potential output in the long run as it is the point that coincides with the greatest value of real output.

It is important to look at the point between AD1 and AD2 as this is the justification for the use of fiscal policy to increase aggregate demand. It can be seen that there is only an increase in real output between the two points, and not an inflationary response. This is because while shifting alongside this point the economy is simply using already existing spare capacity. The only point where there is a price increase is the deflationary and inflationary segments.

Evaluation

It is clear that there are strong arguments proposed for both models, the question to apply in the scenario is which one is more relevant to our current economic state. This however leads to a obvious split in decision making in regards to which model is followed, in brief terms Keynes’ model suggest that you must spend to save, whereas the monetarist model argues that there is the cyclical nature and any changes we make are artificial.

The main downfall of the monetarist model in regards to solving recessionary crisis or promoting growth is the extent to which it requires long-term planing. The Keynesian model creates a short-term effect as well as long-term which can make it seem more favorable for economic policy. However to apply the Keynesian model to today’s economic situation in Britain there is a curious result. In regards to aggregate demand there is expansionary monetary policy (low interest rates, increasing money supply i.e. QE) but there is an environment of deficit control which could be counteracting any effects on AD. But in regards to aggregate supply, in the current scenario I would support the Keynesian model as there is currently clear unfulfilled capacity.

 

Monetary Policy Basics

Interest Rates:

The interest rate determines the rate of interest at which borrowers pay lenders.  This can be on a consumer level or a business level and may or may not involve the central banks or private banks. When the base interest rate is lowered by the central bank of a country, it can be noted that borrowing is in a sense cheaper. When the base interest rate is increased the cost of borrowing is seen to become more expensive.

Money Supply:

Money supply is the total amount of monetary assets within the economy during a given period of time.  It consists of bonds, investments, other financial instruments, as well as cash. Traditionally an increase in money supply sees the price level of an economy increase, as there is “more money, chasing the same amount of product”. Whereas maintaining a specific money supply or reducing it leads to the price level of an economy decreasing, as there is “less money, chasing the same amount of product” meaning that there is no longer effective demand.

Expansionary Monetary Policy:

This would be pursued in order to achieve increased economic activity in the pursuit of growth. One manner of pursuing expansionary policy is to increase the money supply, while lowering interest rates. This will increase the output of the economy, but consequently an inflationary response.

This would be noted as a shift in aggregate demand outwards as you are increasing factors such as consumer spending, and investing. However, this does not directly affect government spending and the balance of trade may not change.

Contractionary Monetary Policy:

This would be pursued in order to achieve a lower price level in the economy, and to induce a cool-off period for the economy. One manner of pursuing contractionary policy is to decrease or maintain money supply, while increasing interest rates. This will reduce the output of the economy, while reducing the price level. This can be noted as a deflationary response.

This would be noted as shift in aggregate demand inwards as you are reducing factors such as consumer spending, and investing as you are making it more difficult to obtain credit, and establish effective demand.

Monetary Policy:

The most popular type of monetary policy to pursue is currently inflation targeting, whether to induce inflation or reduce it. There are however other factors that come into play in regards to monetary policy, which increase its complexity and its possible results. There is the issue of the velocity of money throughout the economy, and this considers how and where the money is moved and what economic activity it actually participates in.

It was Irving Fisher in 1911 who had established the clear relationship between money supply, velocity of money, and inflation. This can be noted as MV=PQ where M represents money supply, V represents velocity of money; P represents the price level of the economy, and Q the total quantity of goods available.

There is also one key issue that is often debated in regards to monetary policy, and that is the role of the gold standard. Traditionally, the value of a currency had been derived from gold which held actual value and was in existence at any one point. The reset of a currency back to the gold standard has often been used to combat high levels of inflation or hyperinflation as it has a “real value”. However the use of the gold standard restricts our ability to create money in order to manipulate currency, and a common use of monetary policy today has been to decrease/increase the value of a currency to achieve economic goals such as increased exports.

It can be noted that keeping the gold standard is difficult as economies tend to grow faster than the supply of gold, and this results in deflation. This is shown in the case where money supply is reduced, as there is no longer the effective demand at current market prices. The gold standard does to a degree have transparency as it is difficult to manipulate, but it restricts economies when there is a need for higher debt in order to fund war efforts, or revive the economy.

Eurozone Unemployment

As a result of the financial crisis in 2007 countries within the European Union have struggled to maintain low levels of unemployment, this is the outcome of retracting economies and austerity measures. Across the Eurozone the average unemployment rate has reached a peak of 12%. The article identifies the occurrence of this peak as countries such as Greece, Spain, and Portugal all have unemployment rates around 25%. There are also fears that unemployment will further increase during April as a result of the Cypriot crisis.

Unemployment can be defined as “Those out of work, actively seeking work at the current wage rate”. This can be calculated in two ways, the first being through a claimant count (those requiring unemployment benefits) and the second being through a labour force survey. The labour force survey most often releases figures higher than through the claimant count, which is why governments tend to publish the claimant count unemployment rate.

Analysis:

As the current unemployment rate of the Eurozone is at 12% it is understood that there is a clear surplus of people willing to work. This can be clearly shown through the demand and supply relationship for labour.

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The highlighted triangle represents the unemployment as labour is demanded at LD but supplied at LS. This shows a simple representation of the current unemployment, but it does not display the causes of it.

The causes of this unemployment can be recognised through the article as cyclical and structural. Germany maintains to be the manufacturing powerhouse of the Eurozone helping keep unemployment of the country down, however countries such as Greece and Portugal do not have strong industry. This is the presence of structural unemployment as the economies require people to work jobs that they are not trained for or overqualified. The cyclical unemployment was initially the result of the initial financial crisis recession, but double-dip recession has magnified the impact on unemployment. Countries that struggle to create economic growth tend to struggle creating jobs.

The article identifies that as a result of this continuous unemployment, the Eurozone has fallen back into recession. Manufacturing industries and other business have seen a decline in business activity, thereby showing a lack of aggregate demand throughout the European Union.

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The graph above shows how unemployment in the region has affected growth prospects for the future, as shown through the movement from Eq to Eq1. The shift in aggregate demand inwards is a result of unemployment, as when people do not have a salary their effective demand is further restricted.

Evaluation:

There are clear limitations to the initial demand and supply of labour model above, this model fails to show where the unemployment is allocated (i.e. agriculture, finance, or manufacturing). Furthermore, it does not accurately represent the actual quantity of those currently unemployed. However, it does help establish the significance of unemployment as it contributes to understanding that there is a fall in aggregate demand, and therefore a dampening on growth prospects for the European Union.

The aggregate demand and supply diagram clearly shows the effect of unemployment on the European economies, and it also shows how the price level has gone down. This is true to an extent as European inflation is estimated to be at 1.8%. This identifies that in the short run disinflation is occurring within the Eurozone. This low level of inflation as a result of the drop in aggregate demand signifies that the European Union economies are struggling to achieve growth and employment. However, in the long run there may be the occurrence of reflation as the economies pursue growth, through creating more jobs and reducing unemployment.

The continuous unemployment and resultant fall in aggregate demand will have a negative effect on European manufacturing. There are already signs that business activity is diminishing (PMI=46.8 Contraction), and further unemployment will only hinder European manufacturers.

Currently across the Eurozone governments are pursuing austerity budgets to attempt to reduce debt, and climb out of recession. However, this is keeping unemployment at high rates. This attributes to a Keynesian solution of spending more to save more. If governments were to create more debt in pursuit of structural investments there may be a spur in economic growth. This can take the form of updating road networks, creating new airports, and building factories. This would help significantly aid in reducing unemployment rates in countries such as Greece, which need an infrastructural upgrade regardless.

South Africa: Sink or Swim

South Africa is currently suffering from a high rate of unemployment making it difficult for the economy to grow. Forecasted growth rates have already been downscaled as the largest economy in Africa is struggling to meet targets. The countries main contributor to GDP can be identified as consumer spending and this is why the persistent unemployment is having a considerable effect on growth forecasts.

Key Terms:

Unemployment – “Those out of work, actively seeking work at the current wage rate”

GDP/Growth – Measured by the output of an economy (gross domestic product)

Consumer Spending – Spending on retail goods, energy consumption, transportation, housing costs, and other areas where disposable income is spent.

Due to the high levels of unemployment it can be noted that there is a decline in aggregate demand within the economy. Colen Garrow states that the retail sector is weakening and there is going to be pressure overall as there is a lack of demand. It can be noted that to an extent the South African economy is contracting as there has been increased inflation as a result of a cost-push and fall in aggregate demand (shown below).

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The shift for aggregate demand from AD to AD1 is a result of the rise in unemployment, the people have less spending power and therefore there is an overall decrease in consumer demand. The shift of aggregate supply is a result of the tightening credit environment as firms struggle to meet their costs. The red rectangle represents the inflationary response in the economy as a result of the shift in aggregate supply. So as a whole the South African economy has retracted as output has significantly decreased (resulting in forecasts for future growth to decline) and there has been an inflationary response, as the price level has increased.

There is also the factor of unemployment which is 24.9% falling from the peak during Q4 of 2012 at 25.5%.This is shown simply below with a demand and supply relationship of labour in South Africa.

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Currently in the market labour is only being demanded at the point of LD but the supply is at LS. This surplus of labour is the current unemployment. With so many out of work and seeking work it is clear that economy is not working to full capacity. If a production possibility frontier for the economy was shown it would be operating within the curve. This further explains the economies inability to have substantial growth.

Consumer spending has radically decreased, making it difficult for the economy to grow and therefore attempt to combat the unemployment. This is realised by the fact that private sector demand for credit dropped from 10.09% to 8.64%. This is why the retail sector is struggling, as the unemployment and inflation has led to the decline of demand.

The unemployment in South Africa can be seen as a combination of structural and cyclical unemployment. Mining has been one of the major consumers of labour in the region, and recent closing of mines and movement by companies to other African regions for mining has meant a structural change in labour demand. The cyclical unemployment is a result of the struggling economy, as different firms reduce the amount of people they employ to meet the higher costs of production.

In the short run the economy is not likely to recover, growth is a must if the government aims to combat the high rate of unemployment. It is essential to restore consumer confidence in the economy, and also enable people to obtain credit more easily as to restore the aggregate demand of the economy.

In the long run for the economy to attempt to maintain growth, eliminating unemployment is essential to attempt to get the economy working back at a point of the PPF. However this could lead to an inflationary response in the form of a demand pull, and the government will need to begin considering how to reduce already increasing inflation as a result of increasing production costs.

Currently in the South African economy the rate of unemployment is pulling it down, in this situation there are no winners within the country. Exports may become more favourable as the inflation will weaken the South African Rand, but make investing in South Africa unlikely. To solve the unemployment in South Africa is difficult as a result of its cyclical and structural qualities; the first step would be to create more job opportunities. However, it is also essential that a greater majority of people achieve education and training whether it is academic or vocational to help improve employability prospects.

Expected growth by 2014 is forecasted at around 3.4% which is still considerable in comparison to some countries in the EU. There is still risk though investing within the country and the government must do more to encourage foreign investment and begin a round of serious structural investment such as roads to create jobs and spur on growth.

There is the potential for South Africa to climb out of the current situation, and unemployment stands at the centre of it. The country is still Africa’s biggest economy and will continue to be so if it can achieve consistency with its currency and sustained growth.