In Search of Convergence

Ricardo Hausmann

AUG 20, 2014
.
IBM Lenovo




CAMBRIDGEOne puzzle of the world economy is that for 200 years, the world’s rich countries grew faster than poorer countries, a process aptly described by Lant Pritchett as Divergence, Big Time. When Adam Smith wrote The Wealth of Nations in 1776, per capita income in the world’s richest country probably the Netherlands – was about four times that of the poorest countries. Two centuries later, the Netherlands was 40 times richer than China, 24 times richer than India, and ten times richer than Thailand.

But, over the past three decades, the trend reversed. Now, the Netherlands is only 11 times richer than India and barely four times richer than China and Thailand. Spotting this reversal, the Nobel laureate economist Michael Spence has argued that the world is poised for The Next Convergence.

Yet some countries are still diverging. While the Netherlands was 5.8, 7.7, and 15 times richer than Nicaragua, Côte D’Ivoire, and Kenya, respectively, in 1980, by 2012 it was 10.5, 21.1, and 24.4 times richer.

What could explain generalized divergence in one period and selective convergence in another? After all, shouldn’t laggards grow faster than leaders if all they have to do is imitate others, even leapfrogging now-obsolete technologies? Why didn’t they grow faster for so long, and why are they doing so now? Why are some countries now converging, while others continue to diverge?

There are potentially many answers to these questions. But I would like to outline a possible explanation that, if true, has important implications for development strategies today.

The economic expansion of the last two centuries has been based on an explosion of knowledge about what can be made, and how. An apt metaphor is a game of Scrabble: Goods and services are made by stringing together productive capabilitiesinputs, technologies, and tasksjust as words are made by putting letters together. Countries that have a greater variety of capabilities can make more diverse and complex goods, just as a Scrabble player who has more letters can generate more and longer words.

If a country lacks a letter, it cannot make the words that use it. Moreover, the more letters a country has, the greater the number of uses it could find for any additional letter it acquired.

This leads to a quiescence trap,” which lies at the heart of the Great Divergence. Countries with fewletterslack incentives to accumulate more letters, because they cannot do much with any additional one: you would not want a TV remote control if you didn’t have a TV, and you would not want a TV broadcasting company if your potential customers lacked electricity.

This trap becomes deeper the longer the alphabet and the longer the words. The last two centuries have seen an explosion in technologies letters – and in the complexity of goods and services that can be made with them. So the techies get techier, and the laggards fall further behind.

Why, then, are some poorer countries now converging? Is the technological alphabet getting shorter? Are products getting simpler?

Obviously not. What is happening is that globalization has split up value chains, allowing trade to move from words to syllables. Now, countries can get into business with fewer letters and add letters more parsimoniously.

It used to be that if you wanted to export a shirt, you had to be able to design it to the taste of people you didn’t really know, procure the appropriate materials, manufacture it, distribute it through an effective logistical network, brand it, market it, and sell it. Unless you performed all of these functions well, you would go out of business. Globalization allows these different functions to be carried out in different places, thereby allowing countries to participate earlier, when they still have few locally available capabilities, which can then be expanded over time.

A recent example is Albania. Known as the North Korea of Europe until the early 1990s, when Albania abandoned its quixotic quest for autarky, it started cutting and sowing garments and shoes for Italian manufacturers, gradually evolving its own fully integrated companies. Other countries that started in garments – for example, South Korea, Mexico, and Chinaended up reusing the accumulated letters (industrial and logistical capabilities) while adding others to move into the production of electronics, cars, and medical equipment.

Consider this a stylized version of the sale of IBM’s Thinkpad to China’s Lenovo. Once upon a time, IBM asked a Chinese manufacturer to assemble its Thinkpad using the components that it would supply and following a set of instructions – and send the final product back to IBM.

A couple of years later, the Chinese company suggested that it take responsibility for procuring the parts. Later, it offered to handle international distribution of the final product. Then it offered to take on redesigning the computer itself. Soon enough, it was no longer clear what IBM was contributing to the arrangement.

Learning to master new technologies and tasks lies at the heart of the growth process. If, while learning, you face competition from those with experience, you will never live long enough to acquire the experience yourself. This has been the basic argument behind import-substitution strategies, which use trade barriers as their main policy instrument. The problem with trade protection is that restricting foreign competition also means preventing access to inputs and knowhow.

Participating in global value chains is an alternative way to learn by doing that is potentially more powerful than closing markets to foreign competition. It enables a parsimonious accumulation of productive capabilities by reducing the number of capabilities that need to be in place in order to get into business.

This strategy requires a highly open trade policy, because it requires sending goods across borders many times. But this does not imply laissez-faire; on the contrary, it requires activist policies in many areas, such as education and training, infrastructure, R&D, business promotion, and the development of links to the global economy.

Some dismiss this strategy, arguing that countries end up merely assembling other people’s stuff. But, as the famous astronomer Carl Sagan once said: “If you want to make an apple pie from scratch, you must first invent the universe.”



Ricardo Hausmann, a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank, is a professor of economics at Harvard University, where he is also Director of the Center for International Development.


Obama Spins Subsidies Both Ways

Aug. 19, 2014 10:19 AM ET

by: Peter Schiff

  • The Obamacare subsidies will hurt the economy much more than it helps.
  • The US standard of living will continue to drop with transfer subsidies.
  • Low-income subsidies will encourage some people to take a pass on the drudgery and inconvenience of working.

In our current age of spin and counter-spin, there is no contortion too great for a politician to attempt. On occasion, however, the threads of one story become entangled with another in a manner that should deeply embarrass, if the media were sharp enough to catch it.

This happened earlier this year in response to the Congressional Budget Office's (CBO) bombshell report on how Obamacare incentives could reduce the size of the labor force by more than two million workers by 2017. While the report did not reflect the Republican spin (that the law will cause employers to kill jobs - it will, but for reasons not detailed in the report), the reaction of the White House and congressional Democrats set a new mark in rhetorical boldness. In the ultimate act of making lemonade from lemons, they described the findings as unabashed good news. But to do so, they had to contradict their previously expressed views on unemployment insurance.

Soon after the report, White House press secretary Jay Carney said that the low cost of Obamacare health insurance will give workers the flexibility to leave the work force if they choose. He agreed with the CBO's opinion that many individuals work at jobs that they don't really value solely because the positions provide health insurance. So, whereas Obama once said, "If you like your health care plan you can keep it," he is now saying, "If you don't like your job, you can leave it."

The subsidies built into Obamacare are exceptional in their severity. As has been noted by many observers, even relatively small increases in income can result in substantial losses in federal subsidies. With health care costs eating up increasingly large portions of personal incomes, it is easy to see why health care subsidies could be the deciding factor for many people to stay home.

But this dynamic is the opposite of what the President and his allies are arguing in the ongoing debate about extending unemployment benefits. Republicans have pointed out that people are discouraged from taking marginal jobs because weekly government checks represent a more attractive option. The White House has responded with deep derision, with the President himself saying that he never met a single American who would prefer a check from the government to a check from an employer. (Perhaps he should get out more?)

In fact, he has accused Republicans of insulting the unemployed by insinuating that they are lazy. However, he is now guilty of the same thing. Of course, it was never about the unemployed being lazy, but about them not being stupid. If the government pays you not to work, either with cash or health care, some would be stupid to pass up the offer. Even more absurdly, Democrats have said that unemployment benefits keep people in the labor force by requiring them to look for a job in order to receive benefits. (This ignores the simple fact that job search claims are self-reported and that the government has no mechanism to verify their authenticity.)

But what is the difference between quitting a job you don't really want, because the government provides you with a health care subsidy, and not taking a job you don't really want because the government gives you an unemployment subsidy? While it's true that most Americans would gladly give up unemployment benefits if a good job came along, it is also true that the same people may pass on an unattractive job as long as they could get by without it. In fact, very low wage jobs can't compete at all with the full spectrum of benefits offered by unemployment, such as unlimited personal days, zero commuting costs, and lack of oppressive bosses. And while it may be rational for some individuals to hold out for something better, is the economy really better off with people deciding not to work?

The Obama administration is arguing that Americans who leave the labor force voluntarily will benefit the overall economy by their ability to take care of family members, get advanced degrees, or chart their career development without regard to the need for immediate employment that health concerns often require. That is wishful thinking. The economy is already being hamstrung by the lowest labor force participation rate since the late 1970s. Should we celebrate the likelihood that Obamacare incentives will knock it down even further? By showing how the participation rate will likely fall further as a result of Obamacare, the CBO study shows that law will put upward pressure on the federal deficit for years to come.

It's ironic that the Obama administration is claiming credit for liberating women from the workforce. But before the 1960s, most married women already enjoyed those luxuries. But when taxes and inflation rose to pay for the roll out of the welfare state, the single income household went the way of black and white TV. In the 70s and 80s, the huge influx of women into the workforce was heralded as a great boost to the economy. Oh how times have changed.

The truth is that most people would prefer not to have to work, and many plan their lives so they can leave the workforce at their earliest convenience. Being freed from the drudgery of daily labor as a result of rising productivity (as was the case for much of our history) is clearly a positive development. More stuff with less work means higher living standards. To the extent that individuals drop out due to accumulated personal savings, society benefits both from the work required to generate the savings, and the productive investments it supports. But if people leave the labor force due to government transfer subsidies, our collective standard of living must drop, as fewer people contribute into the economic pot and more people take from it.

The bottom line is that any society will get more of what it subsidizes and less of what it taxes. By providing a low-income subsidy, Obamacare will encourage some people to take a pass on the drudgery and inconvenience of working. Unemployment insurance does the same, at least temporarily. The White House should learn to keep its story straight.


What It Really Costs To Mine Gold: The Kinross Gold Second Quarter Edition

Aug. 21, 2014 6:32 AM ET

by: Hebba Investments


  • Kinross’s costs on both a core and a core non-tax basis have continued to fall significantly on a year-over year basis.
  • Sequentially though the second quarter saw Kinross's cost rise from the surprisingly good first quarter numbers.
  • While Kinross's silver production was down due to the closure of La Coipa operations, gold production has been rising.
  • Investors should also monitor the company's ability to service its debt as at current gold prices it is essentially breaking even.


Introduction


In our previous complete Q3FY13 cost analysis, we went over a number of the industry's all-in costs to mine an ounce of gold in 2013 and discussed one of the most important metrics to analyze the gold industry, the actual cost of mining an ounce of gold, which can help an investor figure out whether it is time to buy GLD and/or the gold miners. In that analysis, we used the 2013 financials to calculate the combined results of publicly traded gold companies and come up with a true all-in industry average cost of production to mine each ounce of gold.

In this analysis we will calculate the real costs of production of Kinross Gold (NYSE:KGC), a mid-tier producer of gold and silver with operations that span the globe. They have operating mines in North America, South America, West Africa, and Russia.


How to Use Our All-in Costs Analysis with Your Investments


In the previously mentioned article, we gave a thorough overview of the current way that mining companies report their costs of production and why it is inaccurate and significantly underestimates total costs. Then we presented a more accurate methodology for investors to use to calculate the true costs of mining gold or silver. Please refer to that article for the details explaining this methodology, which is an important concept for all precious metals investors to understand.

The best way to use this analysis for individual companies is to compare the different production cost metrics with the company's profits to look for any anomalies (e.g. large net profits but high costs). Also, we provide historic data to allow investors to check out any trends in regards to costs or production totals that may be an early warning to future successes or failures for the company. Ultimately, this analysis is best used as a first step to further investigative work, and that is our purpose with releasing this series.


Explanation of Our Metrics


For a detailed explanation of the metrics and each metric's strengths and weaknesses please check out our previous full quarterly all-in costs gold report where we discuss them in detail.

All Costs per Gold-Equivalent Ounce - These are the total costs incurred for every payable gold-equivalent ounce, which includes everything. This is the broadest measure of costs, and since it includes write-downs, it is essentially the "accounting cost" of producing gold-equivalent ounces.

Costs Per Gold-Equivalent Ounce Excluding Write-downs and S&R -This is the cost to produce each gold-equivalent ounce when subtracting write-downs and smelting and refining costs, but including everything else.

Costs Per Gold-Equivalent Ounce Excluding Write-downs - This is similar to the above-mentioned "Costs per Gold-Equivalent Ounce Excluding Write-downs and S&R" but includes smelting and refining costs. That makes this measure one of the best ways to estimate the true costs to produce each ounce of gold, since it has everything (including taxes) except for write-downs.

Costs per Gold-Equivalent Ounce Excluding Write-downs & Taxes -This measure includes all costs related to gold-equivalent production excluding all write-downs and taxes. Essentially this is the bottom dollar costs of production with an artificial 0% tax rate (obviously unsustainable) which works well because it removes any estimates of taxation due to write-downs or seasonal fluctuations in tax rates, which can be significant. The negative to this particular measure is that since it does not include taxes, it will underestimate the true costs of production.


True Costs of Production for Kinross Gold


Let us use this methodology to take a look at the company's results and come up with the true cost figures for each ounce of production. When applying our methodology, we standardized the equivalent ounce conversion to use the average price for Q2FY14 which results in a silver-to-gold ratio of 65.7:1.

Since our conversions change with metal prices, this may influence the total equivalent ounces produced for past quarters - which will make current-to-past quarter comparisons much more relevant.


(click to enlarge)


Notes about All-in Costs Table


In Kinross's quarterly reports there is a bit more difficulty finding the underlying attributable production gold totals, we cannot find the exact amount of attributable gold ounces produced in the quarter summed up in one location (note that the company does provide gold-equivalent totals). That's not a problem because the company does provide the ratio used to calculate gold-equivalent totals and so we calculate gold production based on silver production and gold-equivalent production to get the amount of gold produced. A bit more work then we believe should be necessary to see underlying gold production totals and we hope in the future management does sum up gold and silver production separately in one location to make it easier on investors and analysts.


Observations for Investors


Kinross gold's production totals have been heavily influenced by write-downs over the last few years as write-downs have been more than $3 billion per fiscal year over the last two years. We're happy to see in FY2014 there have been no significant write-downs so that gives us a much better look into the company's true costs of production but it does make year-over-year comparisons much more difficult.

Core costs for Q2FY14 were $1272 per gold-equivalent ounce, which was around 10% higher than costs experienced in the first quarter ($1170 per gold-equivalent ounce), but were far better than costs experienced over the last few years - though we do stress that large write-downs significantly affect core costs so this measure isn't best for quarters with large write-downs.

As for core non-tax costs (costs excluding taxes), they also rose on a sequential basis from a surprisingly good $1123 in Q1FY14 to $1246 in the current quarter. Since its below the gold price Kinross was making money at current gold prices, but the rise in costs on an equivalent ounce basis is something investors should note.

On a comparative basis, we've only published the analysis from a few other competitors with Goldcorp GG) registering core non-tax costs of under $1050 per gold-equivalent ounce, Yamana Gold (NYSE:AUY) registering core non-tax costs of under $1200 per gold-equivalent ounce, Barrick Gold (NYSE:ABX) registering core non-tax costs of under $1300 per gold-equivalent ounce, Agnico-Eagle Mines (NYSE:AEM) registering core non-tax costs of under $1200 per gold-equivalent ounce, Alamos Gold (NYSE:AGI) registering core non-tax costs of around $1200 per gold-equivalent ounce, Allied Nevada Gold (NYSEMKT:ANV) registering core non-tax costs of over $1300 per gold-equivalent ounce, Eldorado Gold (NYSE:EGO) registering core non-tax costs of under $1000 per gold-equivalent ounce, Iamgold (NYSE:IAG) registering core non-tax costs of under $1300 per gold-equivalent ounce, Randgold (NASDAQ:GOLD) registering core non-tax costs of under $1000 per gold-equivalent ounce, and Newmont Mining (NYSE:NEM) registering core non-tax costs of under $1150 per gold-equivalent ounce. As investors can see, based on the rankings of other gold miners Kinross ranks in the middle group on a core non-tax basis.


Conclusion for Investors


The last two quarters have given us a much better picture of some of Kinross's core costs as significant write-downs have not occurred and that means core costs provide a much more accurate picture of the company's true production costs. With core costs of $1272 in the second quarter, the company is another one of the many miners treading water at the current gold price, but that isn't much different than many other gold miners.

One other thing to note is that Kinross's silver production has dropped significantly due to the closure of the company's La Coipa operations. These operations may be reopened if the company finds that the feasibility analysis is promising, but at this point we have no confirmation about any reopening of these operations

Investors should note that even with the loss of these ounces, gold-equivalent production has risen as Kinross has been significantly increasing gold production at its existing operations and we think they are on pace to hit the higher end (or beat) existing guidance of 2.5 to 2.7 million ounces of gold-equivalent in FY2014 - that may be a positive for investors.

At current gold prices (and with companies essentially breaking even in terms of their profits), investors need to pay particularly close attention to the cash flows of miners with higher debt loads and Kinross gold is one of those miners. While cash equivalents are high at over $700 million dollars, debt is also very high at over $2 billion dollars and that is something that Kinross gold investors should be monitoring carefully because it is much easier to tread water without a large debt load. A complete credit analysis is beyond the scope of this article, but the ability of the company to maintain its debt (and hopefully pay it off) is something very important for investors to watch.