Laissez Faire: A Vacation from Overbearing Authorities

The recent economic turmoil that besieged the minds and homes of American citizens has been met with persistent, remedial efforts from the government and Federal Reserve. A freeze on floating rates and mandated extensions for those with mortgage troubles exemplifies the government's attempt to ease financial volatility as well as provide social aid. The Federal Reserve has also played a significant role in economic intervention by implementing protective policy for Wall Street institutions like Bear Stearns and steadily slashing interest points. Due to global growth and economic problems, America is witnessing a unique change in government involvement that manifests itself in a variety of markets, whether it is housing or finance. For example, the Federal Reserve's official authorization clearly states that its objective is to analyze important market data and govern monetary policy to influence healthy, economic growth. However, just recently, the Federal Reserve employed resources to rescue a private institution from bankruptcy and justified it as a necessary action to protect the economy. Additionally, there has been a rise in preemptive ordinances geared towards directly softening potential woes in the stock market. Though the ability to intervene when needed may sound appealing, it establishes a dangerous precedent. An organization that is allowed to decide whether or not their actions are justified tends to become more creative or aggressive with its policies. The non-laissez faire philosophy raises many questions and I have decided to explore the topic further by engaging other bloggers discussing relevant subjects. The first post I decided to comment on is written by a blogger named Mike Shedlock who operates Global Economic Trends. Though the writer does not supply an "about me," the extensive quality of his work establishes him as an intelligent and informed economist. In his post he discusses the Federal Reserve's recent plan to swap debt with banks and loan institutions. The second post I decided to comment on is by Tim Duy, an adjunct professor in economics at the University of Oregon who runs the blog Economist's View. Professor Duy comments generally on government regulation and reveals his personal beliefs on the subject. He does not engage in a deep investigation, but the post provides interesting grounds for discussion. I submitted my comments to each blog and posted a copy below.


"Fed Is Not King Midas" Comment (comments link located on Shedlock's page):


I want to thank you for the time and effort required to update your blog frequently. You conduct very informative entries that raise critical points and I specifically enjoyed your brief post on the Federal Reserve's debt-swap plan. Since the beginning of the year, the Federal Reserve has been under incredible pressure from financial institutions, both banks and equity firms, to assert monetary policy that will alleviate liabilities and strengthen markets. Unfortunately, it appears that the decisions of a government system entrusted to insure a stable and growing economy sans bias are influenced by the outside community. Most notably, the Federal Reserve continuously reduced interest rates throughout the last few months in response to a plummeting stock market. Though the cuts prevented further drops and even instigated several large, upward surges, it created significant risk to the long term health of America's economy. Therefore, I believe that after the first couple rate reductions, Bernanke respond solely from pressures to protect investors. However, even he realized that he was not going to be able to cut interest rates forever. This led Bernanke to address the large amount of bad debt floating around the financial realm and to devise the swap plan mentioned in your post. I think this is grounds for discussing the extent of the Federal Reserve's power and the precedent established from expanding their area of operations. In principle, if the Federal Reserve is acting ONLY in the best interest of the economy, then there would be no need for skepticism. The problem arises when Bernanke tries to do too much. First, the apparent urgency of the situation most likely "forced" him to rush out with an idea that was not in the best benefit of the economy. Second, it appears Bernanke is incapable of withdrawing and letting the market correct itself. I firmly believe that he overacted and the debt-swap was a futile effort in devising an alternative plan to aid the financial sector. Do you believe this to be true? What is your stance on the Federal Reserve's repetitive rate cuts? Do you think the economy may best be benefited by a more laissez faire approach to allow for market corrections? In your post you said that debt-swap instigates a "rise in abuse and mistrust." Obviously, those in the financial sector are happy this occurred. How much influence do you think they had in bringing about this plan?


"The Deregulation Ideology among Economists" Comment:


The concept of regulation is of paramount significance and I was very happy to stumble across this post. I agree whole heartedly that government regulation should be dramatically limited in certain markets while expanded in others, the financial sector most notably. A great example of government interference that does little to streamline efficiency is satellite radio. As I am sure you have heard, XM and SIRIUS have been laboring away to pass a merger that has been stalled, first by the government, and now by the FCC (due to monopoly of the market). You stated that "monopoly was your main worry." And I also am wary of companies that are in complete control of very important market sectors. However, I think the taboo of monopolies tends to hurt companies like XM and SIRIUS radio that are incapable of competing against each other due to high costs. Granted, I am not a forecaster, but I do not believe that a merger between these two entities would increase consumer dead-weight loss. First, by merging, the company should be capable of offering lower prices and expanding the consumer base. Second, if the company did raise prices, customers are capable of resigning from their service as it is easily substituted. Digressing slightly, static government regulation presents only a small part of current involvement in economic matters. Because your post did not mention it, I was interested in your opinion towards the government's and Federal Reserve's recent trend in economic first aid. Though not specifically regulation, it follows the discussion of separation between government control and economic developments. Considering the Federal Reserve's debt exchanges, the multiple interest rate cuts, and the direct involvement in helping a private institution from becoming bankrupt, how do you feel about the Federal Reserve's active roll in the economy lately? Do you think they have done more harm than good? As an extreme case, what would you think if the Federal Reserve temporarily suspended its monetary policy to allow for market correction?

Economic Analysis: Law and Marijuana

The primary focus of this blog is economic and financial synergy. However, in today's discourse I would like to deviate from the usual objective to remind readers that economics harbors broad applications. Though market trends and unemployment rates are important, more interesting questions are often overlooked. Given the right data, a wide variety of social phenomena can be analyzed to unveil deeper understandings of culture and common practice. For example, the author of Freakonomics, Steven D. Levitt, explores the rationality behind drug dealers living with their mothers and provides a description of a world typically misunderstood. He reveals the creative and insightful contributions that economic logic has to offer, a rare accomplishment outside the cubicles of slide-rulers and supply-demand charts.

Like the living habits of criminals, marijuana laws are not often discussed in economic terms, even though many pro-decriminalization arguments stem from cost-benefit and game theory analysis. The most prevalent example condemns the prohibition as a quantifiable drain on resources. The National Organization to Reform Marijuana Laws (NORML) provides studies that show "the societal costs of propagandizing against marijuana and marijuana law reform, funding anti-marijuana 'science', interdicting marijuana, eradicating domestically grown marijuana and industrial hemp, law enforcement, prosecuting and incarcerating marijuana smokers costs U.S. taxpayers in excess of $12 billion annually." Upon deeper investigation, a lot of these expenditures are questionable. For example, approximately 90% of marijuana related arrests are credited to personal use (refer to the left graph for the numbers of arrests). A large portion of tax payer's money is utilized to process these detentions with little to no social benefit. There are more pressing matters than the brief imprisonment of a cannabis user. Drug trafficking for example. Additionally, Jeffery A. Miron, a Harvard economist, demonstrates that tax revenues of up to $6.4 billion can be obtained if marijuana was treated like tobacco and alcohol. The opportunity cost alone begs the question: are there more efficient allocations for prohibition expenditures? Miron's report claims marijuana decriminalization would create such a significant impact on available funds that it could single handily cover the entire cost of anti-terrorist port security as well as provide the resources to secure lost soviet nukes.

Furthermore, basic economic theory implies that dead-weight loss would be eliminated. Overt operations, in contrast to black markets, streamline supply and demand, and therefore reduce prices. Consumers can either save the excess cash or spend it on alternative items. Either way, the American economy would realize a surge in its gross domestic product, not only from the addition of a billion dollar crop, but also from the reallocation of consumer funds.

However, to understand why decriminalization is truly the best the solution, one has to examine the futility of the opponent's position. Those in favor of federal marijuana laws argue that legalization would raise consumption, increase the ill effects of use, make it more accessible to adolescents, create a rise in motor vehicle accidents, send mixed singles to citizens, and influence the migration to harder drugs. In essence, the social cost of decriminalizing marijuana would manifest itself through diminished productivity, specifically in the nation's youth and the health of citizens. The flaw in this dispute arises from the already widespread use and accessibility of cannabis. I personally know several parents, one a successful lawyer, who indulge in habitual, though not daily, use. Statistics from the National Institute on Drug Abuse also indicate that approximately half of 12th graders have tried marijuana while close to 25% use it monthly (refer to right graph).

With such widespread use and accessibility, what should the government do? Conventional wisdom and simple game theory mechanics make the solution painfully obvious. In the real world, the struggle between government and those for decriminalization is a complex, dynamic game of many players. However, basic generalizations can be made that greatly simplify the analysis. First, the population of smokers and nonsmokers for decriminalization can be aggregated into one player (called player one) while the government and those against decriminalization can be aggregated into another (called player two). Members who do not fit the extremes can be discarded since they do not have a significant effect on payoffs*. Second, since marijuana users have demonstrated consistent consumption, even under the scrutiny of legal action, it is safe to assume that this trend will not be deterred by any future government action. The government, on the other hand, can either choose to legalize marijuana or continue to enforce federal marijuana law. Note that the choice of player two will determine the payoff of player one. These simplifications reduce the game into a static, one player scenario.

If the government continues to enforce marijuana law, they will obtain the "alleged**" payoff of preventing diminished productivity, zero, minus the loss of resources discussed in paragraph two. On the other hand, if the government chooses to decriminalize marijuana, the payoff would be the increase in available resources minus the small decrease in productivity. Given these two options, it is apparent that both players benefit from decriminalization.

Notes:

*It is assumed that those not falling under either extremes will not effect payoffs because they will a) not change the choice of player one and b) not effect the numerical values of player two's payoffs. Technically, they can be grouped with either player without significance.

**The term alleged is employed because the already widespread use of marijuana and its accessibility make the calculable effects of legalization uncertain. For simplification, we will assume the loss from productivity will be minuscule due to the above reasons.

Final notes: No payoff is attributed for morality. It is assumed that if cigarettes and alcohol are legal, the government's view of marijuana is similar. This is based on the definition that marijuana is not a hardcore drug.

This game is a gross oversimplification of the real situation. It provides insight as to which of the two choices benefits the government, but excludes the complication of actually implementing the decision. The most efficient way to transition from a prohibition to a decriminalized state is another discussion entirely. However, the preceding analysis should exemplify the universal practicality of economic logic and the rational approach it can provide towards social subjects.

Information for the Masses: Another Dose of Links

In a previous post I evaluated a collection of internet sources using Webby Awards and IMSA guidelines. Today, I would like to continue this endeavor and provide a second assortment of information deposits. The intention is to uncover unknown sites that contain quality content; however, I would like to start off with an exception. The Economist is a popular and well-praised resource, delivering analytical articles about current affairs with the purpose of revealing market developments. Typically, a site as well known as The Economist will not be listed here, especially since its affiliate blog has already been mentioned. Nevertheless, the consistent and eminent quality this site provides is unparalleled and should be a daily reader for anyone interested in economics or finance. Unfortunately, unrestricted access to the site requires a subscription and may not be an option for some users. Economist's View, on the other hand, is a free blog that delivers multiple posts per day. The author is an economics professor at the University of Oregon who provides insightful expositions on current economic activity. The site is also frequented by many readers and a great place to interact with others. Regrettably, posts depend on quoting generously instead of providing unique analysis. Contrahour is a blog with exactly the opposite qualities. A period of three months can lapse between new content, but the writer tends to be very technical in nature and supports arguments with in depth reasoning and charts. Though not the best daily resource, contrahour provides specialized breakdowns that are rare to come by.

Economic and financial data is imperative for analysis and should always be at the fingertips of those trying to understand the market. For example, EconData.Net is a wonderful tool for gathering information. It is essentially a library of external web pages, breaking down inquiries by subject and provider, with a simple and navigable layout that makes for convenient researching. However, the site is bare of other important materials. On the contrary, The World Bank and International Monetary Fund are two resources that provide data and statistics as well as relevant publications. Both of these invaluable collections are important in understanding an ever expanding, global economy. Unfortunately, articles and briefs supplied on these sites are specifically geared towards international developments and commerce and do not provide general analysis. For a broader perspective on economic theory, one can turn to the Library of Economics and Liberty, Economic Policy Institute, or the National Bureau of Economic Research. With previous authors and members consisting of Nobel Prize winners, their goal is to deliver high quality, unbiased research. The paper topics on these sites range from labor markets to education and are a great help in following the developments of modern economics. Their use, however, will best be utilized with a specific purpose. Finally, I present a site with arguably useless posts. Between the Hedge's format is extremely difficult to follow and the synthesis of information is far from exemplary. Fortunately, the site's linkroll is impressively extensive and broken into accommodating categories, redeeming the blog of its major flaws. The site is a great portal for daily information.

As I've stated before, feel free to post links in the comment section and I will review them.

Oil on the Rise: Cause and Effect

High oil prices (left picture) have always been a source of social and economic anguish and with an average savings rate of below one percent, American citizens are not budgeting for expensive energy costs. Today, oil soared to $108, leaving many wondering how the future will unfold. Preliminary evaluations suggest consumption patterns will dramatically change and a larger percentage of household incomes will be devoted to food, housing, utilities, and other basic necessities. For example, gas is expected to reach an average of $3.40 in the coming months, up from the current average of $3.22. Consequently, the shift in consumption will result in depressing an already sagging U.S. economy. President Bush recently requested an increase in crude output to help prevent additional hikes in oil prices; however, OPEC stringently refused to raise production until the "market justifies it," implying their belief that, because of the global economic slow down, consumption rates have fallen below expectations. Unfortunately for Bush, prices have soared, not due to fundamentals, but because of speculative and uncertain times.

The threat of high inflation has prompted analysts to search for alternative investments to companies on U.S. indices and instigated a fervent plunge into commodities, ironic since investors play a significant role in increased oil prices. Non-Profit Radio spokesman, Adam Davidson, claims that world demand and expected shortages account for prices "up to $80 a barrel." Recent surges, however, can be attributed to pension and sovereign wealth funds, to name a few, dispersing over "$250 billion into oil futures in the last few years, the equivalent to several months of world consumption. Additionally, inflation has reduced American purchasing power and made it difficult to compete in an oil market where OPEC prices its barrels in dollars. Therefore, countries such as France and Britain are capable of placing relatively higher bids in the commodities market because of their stronger currency. Given recent trends, oil prices will most likely continue to rise and pessimists predict a peak as high as $200 a barrel within twelve months.

Kenneth Rogoff, an economist at Harvard University, says "the effect of high oil prices today could be the difference between having a recession and not having a recession." After the speculative burst in the housing market, Americans are attempting to reduce consumption of luxury items. Increase in crude oil costs will prevent this excess cash from being conserved and a larger proportion of income will have to be allocated towards subsistent goods. The consumer price index rose 0.4% in January largely due to the 0.7% increase in both food and energy, giving a rough estimate of inflation. The lethality of this situation is the inability to save. Under normal circumstances, a woeful economy triggers frugal behavior and consumers as well as businesses hoard liquidity to invest in recession proof assets. Theoretically, this should lead to growth and allow the economy to pull up from its downturn. However, investing in oil futures creates a complex problem. Sparked by a weakening economy, speculative oil bids raise prices and further depress growth, threatening stagflation. In turn, the financial gurus of Wall Street are even more eager to invest in "inflation protected" commodities and dump more American equity into oil funds. As a result, oil becomes more expensive and once again there is more inflation. This cyclical process prevents people from making the required transition to saving and investing as it forces money that could be used for such activities to be spent on basic goods.

Fortunately, in the past, dramatic increases in energy prices have been followed by shifts in consumer demands. Hybrid vehicles are a perfect example of a change in habits due to a rise in crude oil prices (right picture). Sparked several years ago, sales of hybrids are still increasing and were up 27% in January. Similar changes in energy conservation and demand for alternative fuels can be expected if the price of oil continues to go up. Given the rate of current technological advancement, and using the hybrid as evidence, rapidly implementing alternative energy sources such as solar power in a majority of American homes appears feasible. If this were to happen, the value of oil would quickly come under scrutiny. Furthermore, even with a lack of options, consumers will only be willing to pay a limited amount for goods. Given a theoretical cap, this prevents speculators from creating a severe, long term discrepancy from fundamental prices.

However, the oil bubble is very different from the 2001 dot-com bust or the recent housing burst and much more difficult to predict. Steven Forbes believes "soaring oil prices will lead to a crash that could make the hi-tech bust of 2000 'look like a picnic.'" Typically, this occurs when investors realize a commodity is overvalued and begin a sell off which sparks a chain reaction. One can not apply the same rule to oil. Unlike land or virtual sites, oil inherently retains productive worth because of its use as a power source. An energy commodity is generally much more practical compared to real estate or advertisements hubs, granted that one has the capability of conversion. Given current, global economic problems and the amount of energy required for countries to sustain growth and function, hording oil could potentially turn out to be a shrewd strategy. As a country weakens, oil also becomes fundamentally more valuable. The reduction of economic power makes it more difficult to compete for scarce resources and therefore necessitates stockpiling reserves, offsetting the artificial value of oil. Assuming prices were ridiculously out of sync, the bubble would burst, but the drop in price would presumably stop above market (consumption) forces.

The unique nature of speculative oil bids presents an interesting and unprecedented problem for contemporary economists and investors. Within a year, market developments should reveal predictable indicators as to the consequences of large oil funds. Contrary to Forbe's beliefs, I foresee a steady rise in prices. Technological innovations will counter exponential hikes, but there is no escape until energy demands are successfully distributed amongst numerous power sources. Nuclear energy, solar power, wind farms, and other alternatives will provide a dynamic solution to a monochromatic problem. I suggest diversifying one's energy portfolio.

Less Common Sources: Disposable Information or Not, Read it Anyways

The economic and financial realm epitomizes the Information Age. Predictably, when such a large amount of data is available, economists and investors rely on a few agents to synthesize and interpret facts. Practically every stock player uses Google Finance and reads the Economist or the Wall Street Journal. Though there are a variety of well known news hubs which sum up current events, it is important to routinely, if not often, explore supplementary wells of information. These sources do not have to be as intensively exercised as Bloomberg or Market Watch, but should have a constant presence in one's research. I have chosen to blog about a few of many underused or unknown internet sites that provide quality information and evaluate them with respect to Webby Awards and IMSA criteria. Keep in mind, content is the most important benchmark; however, the type of content may differ greatly.

For example, the Central Intelligence Agency (CIA) World Fact Book is an incredibly useful site, but may not adhere to standard expectations of an economic or investment resource. Ever since globalization became prominent, detailed facts regarding other countries are imperative to understanding financial forces. The CIA Fact Book is an immense library of aggregated data on hundreds of countries. The information is well organized and in depth, providing everything from literacy rates to amounts of irrigated land. Unfortunately, the site provides no interpretation or interaction and is useful only for raw data collection. Similarly, the Federal Reserve is a great source of economic statistics when researching the United States. Unlike the CIA Fact Book, the Federal Reserve has a library of research publications to compliment the data. There is too much information to sift through without purpose and I recommend having an agenda before referring to this site. Additionally, as with any government source, a researcher should always be aware of possible biases. In contrast, the Political Economy Research Institute (PERI) and the Peterson Institute for International Economics (IIE) are two high quality, nonpartisan academic sites. Both display a professional design and host up-to-date analysis and policy solution based papers which are full of useful insights. The works can be dense and technical and therefore don't provide efficient, daily reading material. Global Economy Matters (GEM), Econbrowser, and Free Exchange are three other technical sites, but the material is presented in blog format and much easier to frequent. Econbrowser appears to host the highest level of interactivity with multiple comments per post. Unfortunately, the other two blogs' comment sections are barren. All three blogs, though, lack citations and do not link to exterior sites where facts were gathered.

Another data hub is The Online Investor. The content on this site tends to be more informative than analytical and it is grouped accessibly without excessive detail. The site's main downfall is lack of scope and hopefully the editors will expand their research. Like The Online Investor, Ticker Sense's scope of information is rather limited. However, this site contains curt posts that remind readers of simple daily analyses which are easily overlooked. Finally, I leave you with a site that was recently launched and may not yet be well known--U.K. Google Finance. This is a great place for obtaining European economic and financial reports and it provides access to what foreign audiences receive. However, don't expect any unique perspectives as it is comparable to the original Google Finance. If you encounter any substantive sites, feel free to post the link in the comment section.

America's Economic Future: The Ineluctable Plunge

The subprime mortgage crisis has captured recent headlines in economic and financial reports. Unarguably, foreclosures and mortgage defaults have delivered a severe blow, one which threatens to send America's economy into recession. The upcoming election coupled with newfound fear of an economic slump puts the economy back into the forefronts of discussions, giving attention to more fundamental issues such as the devaluation of the dollar, national debt, and over consumption, topics which have been threatening the economy for years without receiving the same attention as the mortgage crisis. Though more thought has been given to the current state of our economy, it is not enough. Without proper fiscal and monetary guidance, America could potentially face conditions reminiscent of the 1930's. The weakening dollar will deter foreign funding of government bonds and eventually, assuming no miraculous influx of money, the national debt will force the government to cut expenditures, jeopardizing education, social programs, and other important services. The devaluation of the dollar will also pose serious financial dilemmas for American manufacturing companies who outsource their work as well as to consumers who will be forced to spend more money on goods. Given these impending issues, I have decided to probe blog posts discussing America's recent economic developments. The first post I decided to comment on was written by Tim Duy, an adjunct assistant professor in economics from the University of Oregon, but posted by his colleague Mark Thoma on the blog Economist's View. Tim Duy analyzes recent interest rate cuts to determine the Federal Reserve's current position on the economy and possible future implications. The second post I decided to comment on is by a retired economist strategist and International Monetary Fund employee, Desmond Lachman, and is hosted on a geopolitical web publication. Desmond touches on various factors threatening long term growth and provides a summative break down of each point. I submitted my comments to each blog and posted a copy below.

"Fed Watch: Fed Set to Cut Again, But Looking For a Chance to Pause" Comment:

The Federal Reserve does seem incapable of promoting the confidence required to rally people but I too want to believe. What I do believe, though, is that recent housing afflictions have aggravated and hastened an already serious problem in the economy and the Federal Reserve would be naive to believe interest cuts will remedy or divert the inevitable clash of several key economic complications. Bernanke's (right image) wishful tone when discussing future interest cuts (or should I say lack thereof) is "commendable" but also a blatant lie and a failed attempt at shaping market participant's beliefs, as your colleague noted. I enjoyed reading your colleagues piece and I found it very informative; however, though Tim is most likely correct about future interest cuts, I disagree on a couple points. The current interest rate at 3% will drop incrementally over several months, but the target 2% predicted by Tim appears as a shy estimate. American manufacturing and unemployment growth are far from impressive and given the housing market (including byproducts such as utilities and manufacturing) is approximately 10% of the GDP we can assume interest rates will drop closer to 1%. The Federal Reserve has tremendous pressure on its shoulders and if history is any indicator than such a decrease is almost certain. Additionally, I do not believe this will be "an end to end this cycle." Most likely, there will be economic tension more damaging than market correction under moderate interest cuts. The financial sector is already strained from red ink and even with interest cuts there will be hesitation in lending practices. On a more global level, Tim is right, other countries will want to avoid the high risk of inflation and stop funding America's debt. However, the "impact of past policy" will not be felt with much firmness by summer. Any threat of further decline will amplify economic weaknesses already present such as the devalued dollar and national debt. The economy will continue to rise and fall, but each fall will outweigh previous gains. Maybe the economic stimulation package will provide a silver lining, but most likely we will have to hope the next president will implement comparatively sound economic policy. This cycle has just begun.

"Bearing Down - The Coming Recession" Comment:

I agree very much with most of the points established in your post. And it is frightening to even suppose the similarities between Japan's 1990 economy (left image) and our own. The asset price bubble ballooned since the dot-com crash and the heavy reliance on the housing market for GDP growth has become painfully obvious. America is now stuck in a balancing act; the government has to find a way to deflate the bubble without crippling the economy. Unfortunately, I do not believe there is neat solution. At some point the market will correct itself and in our current state, an overabundance of fiscal and monetary policy may prove to be more detrimental than helpful. The government has to avoid worsening economic weaknesses, namely inflation. In fact, America would not even have to experience full fledged inflation to feel its repercussions. As soon as foreign entities detected unmanageable risk we would witness a rapid flight in funding. Though I agree the government has to react in some capacity, I am not sure I believe Bush and his administration "have finally grasped the urgency of the present situation." Or if they have, then another agenda is affecting their performance. The Federal Reserve is limited in its economic tools and the burden is on Congress and the Executive Branch to execute policy which will promote growth and tighten certain fiscal sectors. For example, I strongly believe temporary credit codes need to be implemented to begin counteracting the credit crunch and restricting plastic based consumption. Furthermore, immediate and aggressive policy to reinforce American jobs and production need to be established. Stimulating the economy from a monetary stand point, such as tax refunds, will not establish long term growth and will only delay the inevitable. That being said, how do you think current solutions will impact our economy in the long run? Do you believe it will provide a realistic opportunity in diverting massive recession? Or do you believe "we are due" given the many problems with our Economy? And finally, what types of changes need to be realized to insure long term stability?

Dubai: An Attempt at Transmuting Sand into Gold

The 21rst century is witness to unprecedented developments, a hallmark of globalization, and no entity better exemplifies this progress than Dubai. The emirate plans to rival China's economic growth rate within the next decade, targeting 11% by 2015. Already surpassing expectations set for 2010, there is little doubt Dubai has become an economically diverse powerhouse in the Middle East. The large, vested interest in rapid expansion results from the fact that within ten years the current rate of oil extraction will deplete supplies, forcing Dubai to rely solely on alternative domestic productions. Luckily, heavy investment in growth sectors such as tourism, finance, manufacturing, and free zone privatization has allowed Dubai to reduce oil dependency to less than 6% of its gross domestic product (GDP). In essence, Dubai's objective is accomplished. However, the price aggregated during their expedited growth may prove to be too costly.

The massive amount of construction occurring (as seen in the image on the right) demands large quantities of immigrant laborers, specifically Indian expatriates. Theoretically, if worker supplies can continue to grow, aggressive building techniques pose no imminent threat. Unfortunately, Dubai's labor vulnerability is vividly apparent. Just recently, the Economist reported that 40,000 workers "expos[ed] the frailty of Dubai's economic boom" by bringing several large projects to a two-week standstill during a strike. Simultaneously, India's prosperity is providing competitive jobs for expatriates and forcing construction companies to raise wages. Heightened tensions stemming from increased costs, unstable work groups, and alternative employment are characteristics of economic volatility. Though Dubai continues efforts in improving laborer accommodations by placing pressure on respective employers, there is no adequate way to quell the increasing need for migrant workers.

Additionally, there are natural resource problems. A region containing over half of the world's identified oil reserves is, ironically, desperately struggling with energy issues. In 2005, blackouts and spikes in oil prices demonstrated even the Middle East is not immune from energy shortages and this presents a serious problem for a Dubai that depends on constant power to sustain its radical growth. To compound the problem, Dubai Electricity and Water Authority stated "power...demand is rising by an average rate of 20%...each year." Much like the worker strike that halted construction, if energy supplies dwindle to levels restricting ongoing projects, Dubai could find itself in a serious financial quandary. Billions of dollars invested in incomplete projects is sunk cash that will provide no return. However, even if Dubai is capable of obtaining enough natural resources and workers to complete constructions, future success is based on the assumption that incredibly large amounts of energy will be disposable. Although solar power may present a solution to this problem, it is far from established and only underlines the speculative nature of Dubai's growth strategy.


An alarming example that demonstrates the absurd amount of power expected to be consumed is Dubai's indoor ski resort (as seen in the image on the left). The structure will be approximately 400 meters in length and 18 meters high, housing over 6000 tons of snow at fluctuating temperatures below 0 degrees Celsius. This will be accomplished in an environment that frequently breaks 40 Celsius and can reach temperatures as high as 48 degrees Celsius. Though it appears no specific energy estimate has been publicly published, just theorizing about the amount of power required to keep a "warehouse" below zero in such a hot climate is astronomical. Considering the body of energy Dubai will depend on in the future and the lack of established, foreseeable alternatives, such an ambitious development plan is a high risk investment.

Dubai's problems are broader than just construction and resource dilemmas. Currently, the emirate is home to over 1.5 million people and roughly 70% are expatriate workers. As land development slows, available construction employment will decrease and substitute jobs will have to be found. The problem is that the jobs available will be imported professions requiring a certain degree of education. Even with recent improvements in teaching facilities, there will be a lack of instructors to appropriately accommodate the demand. One may argue that Dubai's large service industry will provide a niche for low skilled workers. Though this is true, it will still be impossible to satisfy the rapid assimilation of over a million laborers. Alternatively, the government could expel people, but since such a large majority of the population is expatriate, the risk of social upheaval makes this an unlikely solution. Furthermore, foreign investment and immigrant businesses have replaced oil but are far from permanent fixtures. Christopher Davidson from Shariah Finance Watch says that any economic swing triggered by aforementioned problems or instability rising in the region can create a massive evacuation of foreign capital. After extensive investigation, I believe the underlying issue surrounding all of Dubai's problems is the absence of developed social and economic infrastructure. Successful, rapid growth requires stability in both realms.

Investing heavily in tourist and service industries, massive construction, and outlandish amenities is a recipe for rapid but risky growth. The major focus of Dubai should be human capital and gradual political reforms; primarily, education and the creation of a stable and productive work force. Afterwards, Dubai should demonstrate economic and political stability within its own borders and with neighbors such as Iran to encourage foreign business growth. This plan would reduce the demand for natural resources and laborers and render Dubai self-sufficient, relying on less risky inputs. Unfortunately, the Arab world has proved to be remarkably stubborn and my proposal requires the distribution of wealth, not an appealing perspective granted the leaders of Dubai want to consolidate national pride in the form of extravagance and the population largely consists of immigrants.