Local Economics

With CAFTA threatening to alter the economy here I thought I would talk about what the economy is and how easy it would be to, well, mess it up rather seriously. I also will suggest some positive steps that can be taken to improve it.

To get the CAFTA subject out of the way, while it is a big threat to the economies of more prosperous countries such as Costa Rica, it is unlikely to do significant damage here. It really is just a way for the US to get preferential treatment (over China, for example) into the markets of Central America. US health and other regulations tend to eliminate any chance of significant increases in exports from Central America.

If you are interested, there has been quite a bit of discussion of this in the press in Costa Rica as well as public strikes related to, for example, de-regulation of telecommunications as a requirement of CATFA. Check out the archives of La Nacion.

As the U.S. became more and more industrialized, people moved to the cities for the higher-paying jobs in industry. This was the Industrial Revolution and it made sense. Cheap food prices (partly because of subsidies for transportation costs and partly by importing food from countries with lower costs) meant that people in the cities could get food. The biggest cost increase was housing.

Today, the U.S produces little. That is, industry has pretty much disappeared. Products may be designed in the U.S. but actual manufacturing is seldom done there. Thus, you have cities full of people that, for the most part, are overhead. Financial institutions, insurance companies, government, sales and marketing but little in the way of producing goods or even needed services.

Jumping to Nicaragua, let's look at what is happening and why it is a problem--a more serious problem than what has happened in the U.S. The poor hear of higher paying jobs in the cities. When they arrive there they find high unemployment as well as significantly increased costs for necessities. The sale of a small plot of land in a rural area may give a one-time boost to pocket money but that is quickly depleted by city living where food and housing costs are higher.

Once that land is sold, the possibility of moving back to a rural lifestyle is gone. With no welfare system these people are pretty much out of luck. The result is begging, theft and, in some cases, starvation.

Beyond these locally-controlled non-reversible lifestyle changes, there are many external forces that may be a minor irritation in much of the world but can have devastating effects on someone in Nicaragua. Energy costs are one of the primary considerations here.

An example. If the cost of oil goes up 10%, people in the U.S. complain that it costs them more to drive to the grocery store. But, few stop driving or decide to car-pool with their neighbor. The situation is quite different in Nicaragua.

People are much more likely to buy at a local store or from a street vendor because they don't have a car and cannot afford one. For products produced in the near vicinity--fruit and eggs, for example--these fuel cost increases don't matter. But, even relatively local crops--rice, beans, corn, coffee and vegetables--tend to come in by truck of on the roof of a bus. A 10% increase in fuel costs could easily translate to a 5% increase in transportation costs here. That would, of course, have to be reflected in food costs.

This is a typical inflation spiral but, here, food and other delivered goods (clothing, soap, toilet paper, ...) are likely to be most of someone's monthly expenses. Another part will be electricity and other utilities. All these also depend on energy costs. Thus, a small increase in oil prices has a much more significant effect on people's costs of basic necessities.

Unfortunately, Nicaragua can do little to change the cost of oil but, equally unfortunately, the U.S. can. Overconsumption is one way--the U.S. accounts for about 25% of the world energy consumption today--an absolutely crazy number. A U.S. war in an oil producing region (Iraq being the hot one right now) or manipulation of the government in such a place (Venezuela being the hot one in that camp right now) can cause huge fluctuations in oil prices.

Jumping in to decrease costs does not necessarily help either. Again, the U.S. economy had a lot more room to absorb changes than the Nicaraguan economy has today or every has had. A big issue here is unemployment. Real numbers are hard to find but a common estimate is 60% of the people are unemployed or underemployed. Let's look at how capital investment could actually make that situation worse.

In the Seattle area this is called the "Boeing Effect". Boeing has been a huge part of the Seattle economy. It is rather well documented that one job leaving Boeing means a net job loss of 2-3 people in the Seattle area. Why? Boeing employees make much more money than the average person in the area. They spend much of their money locally. Thus, losing one Boeing job means the loss of many supporting jobs That includes cooks, car mechanics, teachers, janitors and much more.

In the U.S., "white collar welfare" tends to moderate these problems. For example, Boeing makes Cruise missiles. Thus, if you can do something to get the government to decide they need more Cruise missiles then you can transfer money to Seattle from other regions of the country. This is why Senator "Scoop" Jackson from Washington state was known as "the Senator from Boeing".

This is all well and good for an economy that can afford it but, again, it doesn't work when most of people's income goes to meeting basic survival needs. While there is an upper class with lots of disposable income, they are not going to be the ones funding income redistribution programs. It will be, just like in the U.S., the middle class.

One big business (if you can call it that) in Nicaragua is education. There are lots of teachers and lots of schools. Many are government-run, some private. Teachers salaries are low but there are jobs. In addition, there are lots of support jobs in the education field. That's good but, it is also a fragile system as well. Here is a place where capital investment (new school buildings, for example) can do some good without negative effects. That is, a new building still needs as many teachers, a janitor, a gardener and so forth. But, having better facilities just makes things better for the students. You do need to consider, however, building in a sustainable way. For example, replacing a school building with good ventilation with an air conditioned one is not sustainable because of the costs associated with the operation and maintenance of the air conditioning system.

But, capital put in the wrong place in education could have a negative effect. An immediate negative effect could be the result of bringing in "free" teachers from outside or methods to decrease the number of teachers required thus decreasing employment in education. Even something appearing very positive on the surface--on-line learning opportunities to replace private schools, for example--could have a significant negative impact on employment.

Am I saying that nothing can be done to move Nicaragua--or, more importantly, the average Nicaraguan--up the world financial ladder? No, not at all. It is just that changes need to be well thought out to make sure the effect is sustainable.

For example, electricity distribution used to be state run but in the typical IMF fashion, it was "de-regulated". That means that a multinational corporation based in Spain now profits from electricity distribution in Nicaragua. The result to the average Nicaraguan is higher rates and no improvement in service.

There is room for some capital investment here that should have little damaging effects on the local economy and will result in long-term improvements in the quality of life. Solar electricity systems. Front-end capital is needed for the systems (about $4/watt for the panels plus controllers, batteries and inverters) but putting the systems in place offers local employment and in the long term, people will be less dependent on the every-increasing cost of grid-based power.

In addition, production of most of the components locally can offer another economic boost. Lead-acid batteries used to be produced in Managua and, I believe, still are. Controllers and inverters are well-defined technology and manufacturing facilities could be build in Nicaragua buying the special electronic parts externally. Finally, mounting and tracking systems for the panels are easily built using locally available metal, welding equipment and skills.

If such a plan is successful, Nicaragua could become an exporter of this technology. For example, systems could be installed in more prosperous Costa Rica resulting in increased employment for installation plus increased production of the components.

At this point, I feel I can define good capital investment vs. bad capital investment. This isn't unique to Nicaragua--it is just that a small mistake here can have a much larger impact than in a country with more disposable income.

Subsidizing costs is bad capital investment. There are hundreds of examples here. Paying people too much for their crops (or paying them not to grow crops as happens in the U.S.) just distorts the economy. I suppose this could best be defined as trying to effect social or economic change with capital. I cannot think of a case where you don't just end up creating a bigger or new division between people by doing this.

The U.S. semiconductor industry was a victim of this when the Japanese semiconductor industry started selling memory chips as less than their production cost. The Japanese had the capital and realized that if they could do this long enough the U.S. manufacturers would drop out of the market eliminating competition.

Doing something similar in the Nicaraguan market (not semiconductors but it could be schools that ran at a loss or grocery stores that sold food at a loss) could be extremely destructive. It could drive local businesses out of these markets making room for long-term single-vendor domination.

I have heard many people talk about how Nicaragua is not self-sufficient and depends on grants to make ends meet. I will guess that most of these grants have been of the "good capital" kind. For example, I know the Esteli fire department has a nice new Japanese fire truck which was a donation. That just helps them fight fires more efficiently and economically than older equipment that it replaced. This is a relatively-neutral contribution compared with, for example, what producing solar electric systems for export could do. The same goes for vocational training (computer skills, for example) such that external costs of computer software could be decreased and, eventually, Nicaragua could be a software exporter.

Just as a data point, the Cooperative Christine King with about 30 employees offers a lot of community services. Most are related to education and classes are offered at cost with grant money being used for capital improvements and scholarships. Their total budget is about the same as the cost of one software engineer in the Seattle area.

This article will not "fix Nicaragua's economy" but I hope it will help people see how it works and how to best help it move forward.