Internal Code: MAS5721
Case Study 1:
“Dead capital” is Hernando de Soto’s term for an asset that cannot easily be bought, sold, valued or used as an investment. Despite obvious poverty in the informal sector in Peru, de Soto’s work shows that even those who live in slums possess far more capital than anyone realizes. In fact, the informal economy is so large in Peru that almost 70 percent of the working population work in informal arrangements. ... Possessions ... are not represented in such a way as to make them fungible (i.e. easily exchangeable) assets. Dead capital cannot, therefore, create value for the poor. What you’re really leaving behind is the world of legally enforceable transactions and property rights. The developed world has devised a formal property system of titles, title registries, and inclusive property law that includes real estate used for homes or businesses. De Soto shows that this is a large part why some nations are rich while others remain in poverty. He says:
With titles, shares and property laws, people could suddenly go beyond looking at their assets as they are — houses used for shelter — to thinking about what they could be—things like security for credit to start or expand a business. The moment Westerners were able to focus on the title of a house and not just the house itself, they achieved a huge advantage over the rest of humanity. When purchasing a home, an open
records system enables buyers and sellers not only to gauge the value of homes in nearby areas but to set reasonable prices based on comparative values. Clear titles and title insurance give buyers the confidence they need to complete a purchase. No clear title? No sale. The system also gives banks the assurance they need to offer a mortgage. It represents a real house
1) Many of the owners of houses in ‘shanti towns’ in the outskirts of Peru’s capital Lima are happy that they do not have to pay land taxes, or municipal rates, as we do in Australia. Is this an advantageous situation to be in for the poor in Peru? Explain your answer.
2) Would the informal economy hinder or promote economic growth in Peru? Explain your answer.
Case Study 2:
Unlike most of the rich world, it [Australia] sailed through the global financial crisis, and unlike most commodity exporters, it has weathered the raw-materials price slump. Its GDP growth rate of 3.1% dwarfs that of America and the euro zone. ......... The story of Australia’s success starts with what its government did not do: spend beyond its means. Tight budgets in the late 1990s and early 2000s, combined with improving terms of trade, meant that when the financial crisis hit, the government was running budget surpluses (though the country as a whole has a long-running current-account deficit). It could thus afford stimulus packages in late 2008 and early 2009 worth more than A$56.6 billion (US$42.8 billion) [recall that a large proportion of the stimulus was given to consumers directly]. Only China provided greater stimulus as a share of GDP. ...... The Reserve Bank of Australia (RBA) estimates that, during that period, mining raised real disposable
household income by 13% and wages by 6%, boosting domestic purchasing power. Saul Eslake, an independent economist, argues that “except for the Chinese people, no country derived more benefit from the growth and industrialisation of China” than Australia. The value of the Australian dollar also rose, which dented non-mining exports. But since demand from Asia kept prices high for Australia’s agricultural commodities (such as beef and wheat), and because it exports relatively few manufactured goods, the damage was contained. As China rebalanced and commodity prices tumbled, other exporters such as Russia, South Africa and Brazil fell into recession. In Australia, although business investment has fallen sharply, GDP growth remains near its 25-year average of 3% (and as a side benefit, the commodity-price fall
quelled rising inflation). For that, thank two factors. First, the rise in mining investment during the fat years led to increased production. Commodity exports have continued to grow (albeit modestly and less profitably). Though prices of iron ore and coal are well below the past decade’s peaks, they remain above pre-boom levels. More important, Australia let the dollar depreciate, which made its exports more appealing. Today Australia benefits from a growing number of Chinese consumers, who buy Australian food products that are widely seen as safer than their home-grown equivalents.
Given the information in the above article, explain, in economic terms and using the AD/AS framework, how Australia avoided negative economic growth during the global financial crises.