In the period of 1973-1979, there was a growth slowdown signaled by a decrease in terms of trade and productivity. Also, this period was the end of fixed exchange rates in which high money supply led to high inflation. These accompanied by a general sense of economic and political insecurity.
In the case of US, Nixon resigned in 1974 because in 1973 political pressure favoured a 90-day freeze on all profits, interest, and prices in response to high inflation while Nixon’s price controls focused on agricultural export and limited the freeze to 60 days (Hetzel, 2008). His policy became unpopular with the public and businessman, who saw powerful labour unions as preferable to the price board bureaucracy, and they soon thought that the controls were permanent rather than temporary. As a result, the controls produced food shortages which put upward pressure against price. In addition, Nixon also set wage controls in response to high inflation which limit increases to 5.5% however it did not stop inflation and eventually, workers demand higher wages (Hetzel, 2008). Therefore, adding these failure policies with a defeat in Vietnam War and Watergate Scandal actually create the end of Nixon administration.
In the case of UK, labour party led by Jim Callaghan had already lost its majority in the House of Commons when he became Prime Minister in 1976. During his administration in the period of 1978-1979, there was a huge strike by local authority trade unions who demand larger pay raise for their member while the government wanted to control inflation by imposing unpopular policy on the public sector that pay rises must be kept below 5% (BBC, 2009). This strike known as “winter of discontent” forced Callaghan to call the 1979 election and eventually led to his lost.
After this, a period of conservative revival in US and UK led by Ronald Reagan (1981-1989) and Margaret Thatcher (1979-1990) appeared. Shortly, it was stimulated by two reactions as follows: First, there was reaction against welfare-state programs. Both administrations believed that market mechanism that reduces state intervention, emphasises on free market economy and privatizing nationally-owned enterprises, increases entrepreneurialism, and reduces the size of welfare-state will more reach economic prosperity (low unemployment and low inflation) than the government interfere in economy and increase dependency culture (Blackaby, 1999). Second, there was reaction in favour of more robust foreign policy to increase current government’s popularity. In the case of UK, Falklands War took place between UK and Argentine in response to seize Farkland Island in early 1982. Meanwhile, Reagan ordered U.S. forces to invade Grenada and Panama in 1983, leading to confrontation with USSR.
The main component of their economic policies was an adoption of market mechanism which focused on five key elements, as follows:
1. The need of keeping low inflation with tight monetary policy
The reason was because Keynesian approach on demand-side economies failed to stop high inflation at that period so that both Thatcher and Reagan pursue Monetarist approach on supply-side economies in which inflation occurs when money supply growth rate increase faster than real output growth rate (Blackaby, 1999). Therefore, the government must tighten monetary policy to prevent sustained inflation. In the end, both Thatcher and Reagan experienced dramatic decrease in inflation.
Supply-side economies maintain that the whole economy will flourish when business grows and their prosperities “trickle down” throughout the society (Hunt, 2009). In addition, policy should appeal to producers in order to reduce price and thus, make product become more affordable in order to increase economic prosperity.
2. The need of reducing tax rates and social spending
Monetarist believed that the high rate of taxes equates to the cutting of taxes. In addition, maximum benefits are achieved by optimizing the marginal tax rates of those with high incomes and capital investments, who are deemed most likely to increase supply and thus spur growth (Brownlee, 2006). In contrast, Keynesian contends that tax cuts should be used to increase demand instead of supply, and thus should be targeted at cash-strapped, lower-income earners, who are more likely to spend additional income (Bartlett, 2003).
Economic growth can be most effectively created by increasing incentives for people to produce goods and services such as lowering income and capital gain marginal tax rates, and increasing social security and medicare tax rates, and therefore consumers will then benefit from a grater supply of goods and services at lower prices (Niskanen, 2007). Also, many early proponents argued that the size of the economic growth would be significant enough that the increased government revenue from a faster growing economy would be sufficient to compensate completely for the short-term costs of a tax cut, and that tax cuts could cause overall revenue to increase (Bartlett, 2003).
In the case of Thatcher, direct taxes on income were lowered and indirect taxes were increased to amid a recession in 1981. In contrary, during Reagan's tenure, income tax rates dropped from 70% to 28% in 7 years, while social security and medicare taxes increased.
Another component of supply-side economies was reducing the growth of government spending (Niskanen, 2007). In accordance with her less-government intervention views, Thatcher introduced cash limits on public spending and reduced expenditures on social services such as education, housing, and health care (Clark and Dilnot, 2002). Meanwhile, Reagan boosted defence expenditure but restrained domestic spending in social services (Oxford, 2004). During his tenure, defence spending rose from 5.1% to 5.6% of GDP while non-defence fell from 17.1% to 15.6% of GDP and this figure wass contrast to Bush where both defence and non-defence spending increased.
3. The need of privatization and deregulation in the economy
The reason was to improve responsiveness in price signals. Privatization was important because revenue generated by this process allows tax to decrease without increasing budget deficits. However, the effect of privatization was more important in UK than US due to less public ownership in US. During her administration, the government sold most of the large national utilities to private companies. Many people took advantage of share offers, although many sold their shares immediately for a quick profit and therefore the proportion of shares held by individuals did not increase.
There was also evident of deregulation in both countries especially in transport and communications sector, and in financial sectors. In the former sector, the effect was increasing competition and technology change, leading to a decrease in relative costs of travel and phone calls. While in the latter, financial sector reforms not only produced better intermediation but also increased riskiness.
4. The need of reducing importance in trade unions
The reason was to increase labour market flexibility. Thatcher was committed to reducing the power of the trades unions. Several unions of mineworkers launched strikes in response to legislation introduced to curb their power, but these actions eventually collapsed, and gradually Thatcher's reforms reduced the power and influence of the unions. In contrast, the Reagan administration, the air traffic controllers launched a strike for large pay increase and eventually, he destroyed the union. This action had impact on labour relations where it set the stage for more timid labour demands and less excessive in wage growth (Oxford, 2004).
5. The need of free trade
Supply-side economics holds that increased taxation steadily reduces economic trade between economic participants within a nation and that it discourages investment (Case and Fair, 1999). Taxes act as a type of trade barrier or tariff that causes economic participants to revert to less efficient means of satisfying their needs. As such, higher taxation leads to lower levels of specialization and lower economic efficiency. Crucial to the operation of supply-side theory is the expansion of free trade and free movement of capital. It is argued that free capital movement frequently allows an economic expansion. Thus, lowering tax barriers to trade provides the advantages to domestic economy (Case and Fair, 1999).
While Thatcher’s international economic policy imposed the free movement of goods, services, capital, and people, Reagan’s policy was the most protectionist (Reinert et al, 2008). Unlike Thatcher, Reagan imposed more import restraints in steel, semi-conductors, machine tools, and textiles. However, he did attempt to promote global negotiations for more open markets such as bilateral trade arrangements with Israel in early 1980s and Canada in late 1980s (Oxford, 2004).
The criticism of supply-side economics came from those who understand in Laffer curve. Reagan claimed that by cutting upper bracket taxation rates and lowering tax rates on capital gains, national output would increase so much that tax revenues would also increase (Case and Fair, 1999). In the proponent view, Mundell believed that the economic expansion would also mop up excess liquidity and bring inflation back under control. After the tax cuts were implemented, nominal revenues quickly surpassed previous levels (Case and Fair, 1999).
However, excessive tax rates actually reduce potential tax revenues by lowering the incentive to produce. In other words, a rise of taxation rate does not increase tax revenue. In addition, the curve clearly shows that cutting tax rates to the right of the peak rate will increase revenues and cutting tax rates to the left of the peak rate will decrease revenues.
During Reagan administration, there was rapid increase in budget deficits because a rise in government expenditure (military spending) in response to Cold War outweighs a rise in tax revenue, thus IS curve shifted to the right. Meanwhile, the LM curve shifted to the left as the implementation of contraction monetary policy reduced money supply. As a result, interest rate increased.
Using exchange-rate channel, a rise in interest rate will produce capital inflow because domestic interest rate is higher than foreign interest rate, followed by a decrease in demand for foreign exchange and thus USD appreciate. This will lead to a fall in domestic competitiveness because domestic goods are more expensive than foreign goods, followed by US trade deficits. Therefore, Reagan tax policies push both international transaction of Current Account and the Fed budget into deficit and led to increase in public debt.
Pertaining to deployment of Thatcher-Reagan economic policies, Labor governments in both New Zealand and Australia are fully adopted market-oriented reforms. In Australia, the so-called economic rationalism occurs in late 1980s where it encouraged deregulation, privatization, and free market economy, lowered direct taxation, increased indirect taxation, and reduced the size of welfare state (Quiggin, 1997). On the other hand, NZ PM Roger Douglas led this reform in 1984 in which he reduced agricultural subsidies and trade barriers, encouraged privatization of public assets, controlled inflation through supply-side economics, deregulated financial market and removed control on foreign exchange, decreased marginal income tax rate, and forced more concessions on labour unions.
In slight different approach, Clinton and Blair modified the Reagan-Thatcher package with more emphasize on social policies. In the case of Tony Blair, he accepted trade union legislations, privatization and general free-market approach in relation with high economic growth and low unemployment rate. He also increased the taxes but did not increase income tax for high-earners and introduced a minimum wage concept. Moreover, he pursued market-based reforms in the social sectors (education and health) by increasing public spending. One thing should be noted that during his administration, inequality in the bottom half of income distribution decreased because redistributive social policies (minimum wage and tax credits) lower poverty, however inequality at the top increased and this is opposite to what happened during Thatcher administration (LSE, 2009).
In the case of Bill Clinton, he established fiscal diciplines by eliminating budget deficits, keeping interest rate low, and increase private-sector investment (BBC, 2001). He also invested people through education, training, science and research. Clinton also supported ratification of NAFTA which made it cheaper for manufacturing companies to outsource their jobs to different countries, especially Mexico, which then export their products back to US. This policy combined with increase in minimum wage caused a fall in the amount of unskilled jobs in US (Bartlett, 2004). Therefore, Clinton re-established the trend of reducing trade barriers and this is contrast to the protectionist of Reagan.
Monday, August 10, 2009
Asian Miracle in 1970s
There are four arguments which explain a miracle in East Asia countries. First, according to Krugman (1994) NIEs in East Asia attained rapid growth by increasing more mobilization of resources such as labour and capital than gains in efficiency. For example, in 1970s participation rate (workers / population) increased. Also, there was a rise in physical capital or investment rate (I/Y) as well as human capital investment (because educational attainment increases). However, there was a diminishing marginal return on total factor productivity. Krugman also made comparison with Japan’s growth in 1950s where this country grew through high rates of input and efficiency growth.
Second, Young (1994) argued that NIEs in East Asia attained rapid growth through factor accumulations, which encompass as follows: Firstly, a rise in female participation rate caused by a decline in birth rates that changed dependency ratio. Secondly, there was a large intersectoral transfer of labour to manufacturing sector. Thirdly, there was a rise in physical capital or investment rate (I/Y) and in human capital investment (because educational attainment increases). However, Young stated that there is no growth on total factor productivity.
Third, Lucas (1993) believed that NIEs in East Asia attained rapid growth through large scale exporters of manufactured goods, high urbanization, increase in education, high savings rates, and pro-business government. Lucas emphasised on on-the-job accumulation = learning by doing because experienced workers and managers earned more than inexperienced ones and human capital investment in formal schooling cannot be achieved in steady-state economies. Moreover, there was a relation between openness international trade and learning rates which stimulate many East Asia countries to more efficient and flexible in response to world market price through adoption of technology.
Last, Higgins and Williamson (1996) stated that NIEs in East Asia attained rapid growth through a decrease in birth rate and an increase in infant mortality rates which led to a decline in youth dependency ratio (0-14 years) and then followed by a rise in savings rates. Because working age population (15-64 years) increased, labour participation rate will rise, which equate a rise in investment rates.
Meanwhile, we can analyze the rapid growth of Germany, Japan, and US in the period of 1870-1914 in terms of 4 aspects. First, international trade aspects. International trade grew for many reasons. International freight rates declined steadily as a result of constant technical improvements and the growth in the usage of faster and more regular steamships, especially after the opening of the Suez Canal in 1869 (Daudin et al, 2008). However, as overland transport was much more expensive than water transport, the reduction of internal transport costs through the development of railways was crucial. In addition, peace between the main powers from 1871 to 1914 promoted trade (Jacks, 2006). The development of European formal and informal empires increased extra- European trade through the reduction of trade barriers, the inclusion of colonies in currency unions, and the better protection of (European) property rights (Mitchener and Weidenmier, 2007).
Falling transport costs implied increasing potential market integration, but politicians always had the possibility of muting or even reversing this via protectionist policies. Beginning in the 1870s Continental European countries raised barriers to trade in grain and other commodities (Bairoch, 1989). In Germany, Bismarck protected both agriculture and industry in 1879. In France, tariffs were raised in the 1880s, and in 1892. In Sweden, agricultural protection was re-imposed in 1888 and industrial protection was increased in 1892. In Italy, moderate tariffs were imposed in 1878, followed by more severe tariffs in 1887. While UK still maintained free trade after 1870s. The result was the countries that protect domestic industries (Germany, France, US, Italy) grew rapidly after 1870s and overtake UK as industrial powers by 1914.
In addition, there was also evident of imperialism. Capital exports to colonies were important, but not dominant. Europe was self-sufficient in coal and nearly self-sufficient in iron ore and other minerals. Textile raw materials were more of an issue as cotton, for example, it could not be produced in Europe in great quantities but it was largely supplied by US. Thus, colonial empires did not represent vital outlets for European goods either, absorbing less than 15% of all Western European exports (Bairoch, 1993).
Yet, it is true that one of the driving forces behind imperialism was the influence of European traders, who saw in political control a way to facilitate their economic exchanges with African and Asian producers and consumers. Some industrialists also believed that the creation of a reserved market would be a suitable answer to international competition. However, increasing in competitiveness causes the tension rise both domestic (distribution problem) and international (conflict between established and emerging powers).
Second, capital flow aspects. International capital market integration was extremely impressive during this period. Regions with good access to European capital and abundant resources such as the US, Canada, Japan, and Australia prospered most between 1870 and 1913 (Daudin et al, 2008). In addition, Europe as a whole dominated foreign investment where England (42%), France (20%) and Germany (13%), Belgium, the Netherlands, and Switzerland combined accounted for 87% of total foreign investment (Maddison, 1995). Edelstein (1982) showed that overseas portfolio investments yielded a higher realized return than domestic portfolio investment during 1870 – 1914.
Turning to economic institutions and policies, a great deal of attention has been devoted to the gold standard (Bordo and Rockoff 1996) and, more recently, to sound fiscal policies (Flandreau and Zumer 2004). Adherence to gold is seen as having promoted global financial integration in two ways. First, it eliminated exchange-rate risk. Second, it signalled that while economic institutions and policies can facilitate capital imports, they can never attract them if there is no genuine interest on the part of investors in what a specific country has to offer. This brings us to economic fundamentals as the main determinant in explaining the size and direction of flows. Clemens and Williamson (2004) provide econometric evidence in favour of this view, showing that British capital exports went to countries with abundant supplies of natural resources, immigrants, and young, educated, urban populations. While they also find that the gold standard and empire promoted foreign investment, supply and demand, rather than the presence or absence of frictions leading to price gaps between markets, were what was really crucial.
Widespread adherence to the gold standard was a central pillar of the pre-World War I financial system. This implied a commitment to a policy of external balance, even when that conflicted with domestic economic imbalances, notably unemployment. However, most capital circulates among rich countries are no longer connected by fixed exchange rates. Indeed, Obstfeld and Taylor (2004) pointed out that abandoning fixed exchange rates make it possible for countries to pursue both independent monetary policies and a commitment to open capital markets.
Third, migration aspects. The average Western European annual outmigration rate was 2.2 per thousand in the 1870s and 5.4 per thousand for the 1900s, very large numbers that are far in excess of any reasonable projections of African emigration between now and 2030 (Hatton and Williamson, 2005), although the latter would presumably be far higher than they actually are in the absence of today's very tight immigration restrictions in rich countries. The causes are obvious: the New World was endowed with a higher land-labour ratio than Europe, and hence American and Australian workers earned higher wages than their European counterparts. The gains from migration were thus potentially enormous, and once the new steam technologies had lowered the cost of travel sufficiently, mass emigration became inevitable. Also, rising fertility, structural transformation increased emigration rates, initially in the richer economies whose workers could best afford the cost of transport, and then in poorer economies as living standards rose across the continent.
While emigration benefited European workers, mass immigration hurt their counterparts overseas. Hatton and Williamson (1998) showed that immigration lowered unskilled wages in the United States, although this is a ceteris paribus finding, since economic growth was raising living standards generally during this period. Nonetheless, the effects were large. Relative to what they would have been in its absence, immigration lowered unskilled real wages by 8% in the US, 15% in Canada, and 21% in Argentina (Taylor and Williamson 1997). Counterfactual or not, such impacts did not go unnoticed, and the result was a political backlash, resulting in gradually tightening restrictions on immigration in the main destination countries (Timmer and Williamson, 1998).
Last, technological transfer aspects. Economic globalization is not simply about the movement of goods or factors of production. It also includes technological transfers and the deepening of other intellectual exchanges. Several new factors increased the speed and the reach of technological transfers. First, the flexibility of migration. Imperialism allowed European entrepreneurs to invest overseas, taking advantage of low wages, with no fear of expropriation by hostile governments. The decline in transport and communication costs helped the diffusion of ideas, new goods and machines. This last effect was especially important because more and more technology was embedded in machines rather than in individual know-how, even if training was still necessary. Firms could now export capital goods on a large scale. Second, the diffusion of technologies was also helped by the creation of international scientific and technical organizations with government increased formal technical cooperation. Most sovereign states, both European and non-European, joined these global institutions. Another form of rising globalization was the growing number of international exchanges and competitions, and labour movements.
Second, Young (1994) argued that NIEs in East Asia attained rapid growth through factor accumulations, which encompass as follows: Firstly, a rise in female participation rate caused by a decline in birth rates that changed dependency ratio. Secondly, there was a large intersectoral transfer of labour to manufacturing sector. Thirdly, there was a rise in physical capital or investment rate (I/Y) and in human capital investment (because educational attainment increases). However, Young stated that there is no growth on total factor productivity.
Third, Lucas (1993) believed that NIEs in East Asia attained rapid growth through large scale exporters of manufactured goods, high urbanization, increase in education, high savings rates, and pro-business government. Lucas emphasised on on-the-job accumulation = learning by doing because experienced workers and managers earned more than inexperienced ones and human capital investment in formal schooling cannot be achieved in steady-state economies. Moreover, there was a relation between openness international trade and learning rates which stimulate many East Asia countries to more efficient and flexible in response to world market price through adoption of technology.
Last, Higgins and Williamson (1996) stated that NIEs in East Asia attained rapid growth through a decrease in birth rate and an increase in infant mortality rates which led to a decline in youth dependency ratio (0-14 years) and then followed by a rise in savings rates. Because working age population (15-64 years) increased, labour participation rate will rise, which equate a rise in investment rates.
Meanwhile, we can analyze the rapid growth of Germany, Japan, and US in the period of 1870-1914 in terms of 4 aspects. First, international trade aspects. International trade grew for many reasons. International freight rates declined steadily as a result of constant technical improvements and the growth in the usage of faster and more regular steamships, especially after the opening of the Suez Canal in 1869 (Daudin et al, 2008). However, as overland transport was much more expensive than water transport, the reduction of internal transport costs through the development of railways was crucial. In addition, peace between the main powers from 1871 to 1914 promoted trade (Jacks, 2006). The development of European formal and informal empires increased extra- European trade through the reduction of trade barriers, the inclusion of colonies in currency unions, and the better protection of (European) property rights (Mitchener and Weidenmier, 2007).
Falling transport costs implied increasing potential market integration, but politicians always had the possibility of muting or even reversing this via protectionist policies. Beginning in the 1870s Continental European countries raised barriers to trade in grain and other commodities (Bairoch, 1989). In Germany, Bismarck protected both agriculture and industry in 1879. In France, tariffs were raised in the 1880s, and in 1892. In Sweden, agricultural protection was re-imposed in 1888 and industrial protection was increased in 1892. In Italy, moderate tariffs were imposed in 1878, followed by more severe tariffs in 1887. While UK still maintained free trade after 1870s. The result was the countries that protect domestic industries (Germany, France, US, Italy) grew rapidly after 1870s and overtake UK as industrial powers by 1914.
In addition, there was also evident of imperialism. Capital exports to colonies were important, but not dominant. Europe was self-sufficient in coal and nearly self-sufficient in iron ore and other minerals. Textile raw materials were more of an issue as cotton, for example, it could not be produced in Europe in great quantities but it was largely supplied by US. Thus, colonial empires did not represent vital outlets for European goods either, absorbing less than 15% of all Western European exports (Bairoch, 1993).
Yet, it is true that one of the driving forces behind imperialism was the influence of European traders, who saw in political control a way to facilitate their economic exchanges with African and Asian producers and consumers. Some industrialists also believed that the creation of a reserved market would be a suitable answer to international competition. However, increasing in competitiveness causes the tension rise both domestic (distribution problem) and international (conflict between established and emerging powers).
Second, capital flow aspects. International capital market integration was extremely impressive during this period. Regions with good access to European capital and abundant resources such as the US, Canada, Japan, and Australia prospered most between 1870 and 1913 (Daudin et al, 2008). In addition, Europe as a whole dominated foreign investment where England (42%), France (20%) and Germany (13%), Belgium, the Netherlands, and Switzerland combined accounted for 87% of total foreign investment (Maddison, 1995). Edelstein (1982) showed that overseas portfolio investments yielded a higher realized return than domestic portfolio investment during 1870 – 1914.
Turning to economic institutions and policies, a great deal of attention has been devoted to the gold standard (Bordo and Rockoff 1996) and, more recently, to sound fiscal policies (Flandreau and Zumer 2004). Adherence to gold is seen as having promoted global financial integration in two ways. First, it eliminated exchange-rate risk. Second, it signalled that while economic institutions and policies can facilitate capital imports, they can never attract them if there is no genuine interest on the part of investors in what a specific country has to offer. This brings us to economic fundamentals as the main determinant in explaining the size and direction of flows. Clemens and Williamson (2004) provide econometric evidence in favour of this view, showing that British capital exports went to countries with abundant supplies of natural resources, immigrants, and young, educated, urban populations. While they also find that the gold standard and empire promoted foreign investment, supply and demand, rather than the presence or absence of frictions leading to price gaps between markets, were what was really crucial.
Widespread adherence to the gold standard was a central pillar of the pre-World War I financial system. This implied a commitment to a policy of external balance, even when that conflicted with domestic economic imbalances, notably unemployment. However, most capital circulates among rich countries are no longer connected by fixed exchange rates. Indeed, Obstfeld and Taylor (2004) pointed out that abandoning fixed exchange rates make it possible for countries to pursue both independent monetary policies and a commitment to open capital markets.
Third, migration aspects. The average Western European annual outmigration rate was 2.2 per thousand in the 1870s and 5.4 per thousand for the 1900s, very large numbers that are far in excess of any reasonable projections of African emigration between now and 2030 (Hatton and Williamson, 2005), although the latter would presumably be far higher than they actually are in the absence of today's very tight immigration restrictions in rich countries. The causes are obvious: the New World was endowed with a higher land-labour ratio than Europe, and hence American and Australian workers earned higher wages than their European counterparts. The gains from migration were thus potentially enormous, and once the new steam technologies had lowered the cost of travel sufficiently, mass emigration became inevitable. Also, rising fertility, structural transformation increased emigration rates, initially in the richer economies whose workers could best afford the cost of transport, and then in poorer economies as living standards rose across the continent.
While emigration benefited European workers, mass immigration hurt their counterparts overseas. Hatton and Williamson (1998) showed that immigration lowered unskilled wages in the United States, although this is a ceteris paribus finding, since economic growth was raising living standards generally during this period. Nonetheless, the effects were large. Relative to what they would have been in its absence, immigration lowered unskilled real wages by 8% in the US, 15% in Canada, and 21% in Argentina (Taylor and Williamson 1997). Counterfactual or not, such impacts did not go unnoticed, and the result was a political backlash, resulting in gradually tightening restrictions on immigration in the main destination countries (Timmer and Williamson, 1998).
Last, technological transfer aspects. Economic globalization is not simply about the movement of goods or factors of production. It also includes technological transfers and the deepening of other intellectual exchanges. Several new factors increased the speed and the reach of technological transfers. First, the flexibility of migration. Imperialism allowed European entrepreneurs to invest overseas, taking advantage of low wages, with no fear of expropriation by hostile governments. The decline in transport and communication costs helped the diffusion of ideas, new goods and machines. This last effect was especially important because more and more technology was embedded in machines rather than in individual know-how, even if training was still necessary. Firms could now export capital goods on a large scale. Second, the diffusion of technologies was also helped by the creation of international scientific and technical organizations with government increased formal technical cooperation. Most sovereign states, both European and non-European, joined these global institutions. Another form of rising globalization was the growing number of international exchanges and competitions, and labour movements.
Stalin and Soviet Union
After Stalin came into power in 1926 he adopted the rapid industrialization strategy, which was a central planning economy. His economic strategy was totalitarianism. In 1926-7, investment increased by 32 percent with focus on industrial projects, tax revenue had increase on Kulaks. But grain crisis in 1927-8 forced the Soviet Union to increase use of compulsion to obtain gain. In 1928 1st five year plan emphasised investment in heavy industry. Economic strategy was associated with a totalitarian regime.
The main economic successes of the Soviet Union were – they could produce a standardised product; direct labour to clear task (clear division of responsibilities and duties); in peacetime, the USSR was successful at achieving goals such as providing basics to its people (e.g. housing, education, healthcare); sending the first person into space; wining Olympic medals; and They were influential in post-1945 development debates.
The main economic failures of the USSR were misallocation of scarce resources – wasteful by managers and queues by consumers. Secondly, the USSR failed to respond to consumers’ wants beyond the satisfaction of basic needs. These problems were less apparent to outsiders especially before 1960s. The inherent inefficiency of a command-administered economic system has come to dominate its effectiveness in achieving the priority objectives of the central authorities. Methods and institutions that were effective at an earlier, simpler stage of development no longer generate the desired outcomes. The mobilization of resources and effort that produced collectivization, industrialization, and a sizable chemical industry failed to develop modern computer technology, or modernize consumer goods industries. The administrative superstructure, methods of planning, and plans themselves have become ever less adequate to the needs and flow of economic activity. The natural consequence is an increase in dysfunctional behaviour by subordinators, increasingly obvious microeconomic waste and inefficiency, slowing or declining economic growth and productivity, and ever more frequent failures to achieve proclaimed priorities.
The Soviet Union economy would be better if they undertake another way. If they performed some form of a market-based economic system. This system include: generally free, market determined prices, generally independent firms, motivated by economic considerations; a significant, if not predominant role for state property; industrial regulation in the place of the industrial planning; generally hard currency; and modern financial system, including commercial banking, exchange, and other financial intermediaries.
The main economic successes of the Soviet Union were – they could produce a standardised product; direct labour to clear task (clear division of responsibilities and duties); in peacetime, the USSR was successful at achieving goals such as providing basics to its people (e.g. housing, education, healthcare); sending the first person into space; wining Olympic medals; and They were influential in post-1945 development debates.
The main economic failures of the USSR were misallocation of scarce resources – wasteful by managers and queues by consumers. Secondly, the USSR failed to respond to consumers’ wants beyond the satisfaction of basic needs. These problems were less apparent to outsiders especially before 1960s. The inherent inefficiency of a command-administered economic system has come to dominate its effectiveness in achieving the priority objectives of the central authorities. Methods and institutions that were effective at an earlier, simpler stage of development no longer generate the desired outcomes. The mobilization of resources and effort that produced collectivization, industrialization, and a sizable chemical industry failed to develop modern computer technology, or modernize consumer goods industries. The administrative superstructure, methods of planning, and plans themselves have become ever less adequate to the needs and flow of economic activity. The natural consequence is an increase in dysfunctional behaviour by subordinators, increasingly obvious microeconomic waste and inefficiency, slowing or declining economic growth and productivity, and ever more frequent failures to achieve proclaimed priorities.
The Soviet Union economy would be better if they undertake another way. If they performed some form of a market-based economic system. This system include: generally free, market determined prices, generally independent firms, motivated by economic considerations; a significant, if not predominant role for state property; industrial regulation in the place of the industrial planning; generally hard currency; and modern financial system, including commercial banking, exchange, and other financial intermediaries.
Fixed Exchange Rates in Three Periods
Trade created a global economy in the 1800s and lower transactions costs stimulated trade. An important element was establishment of an acceptable and efficient means of international payment. The development of the Gold Standard (GS) in some ways paralleled the development of national monies but with difference that no state could enforce its use as legal tender.
1897 – 1914:
The GS was established in 1800s by British and followed by other countries such the USA. Countries implementing the GS could convert their currencies into gold from gold into their currencies based on the exchange rate that was fixed. For instance, UK could convert pounds into gold (and vice versa) at 3 pounds 17 shillings and 10.5 pence per ounce, and the US could set the price of gold at $20.67 per ounce in 1834. The exchange rate between any pair of countries on the GS was fixed. Example one pound = $4.857.
Why had to be fixed? Fixed exchange rate could reduce uncertainty in trade. In addition it was easy for automatic adjustment process – the specie-flow mechanism. If the UK had a BOP deficit there would be an outflow of gold this leads to a decrease in money supply, thus price level would go down. This would encourage exports discourage imports. Hence reduce the BOP deficit.
Due to the UK pound at the time was as good as gold, other countries that had their accounts in London could address BOP deficit by running down their accounts while they took adjustment measures. Thus the system worked well to settle BOP imbalances as long as they were not large and there was a trust in London capital markets.
The GS became the international monetary system when the silver boomed and other on silver standard faced accelerating inflation. For instance, Austria and Russia gave up their free coinage of silver and joined the GS in the 1890s. By the 1897 the world economy was based on the GS.
1925 – 1933
Britain returned to GS in April 1925. To maintain exchange rate, the government maintained high interest rate in order to attract capital inflow. Due to high inflation rate the UK, market exchange rate in 1920-1921 was $3.50. UK government ran a contractionary fiscal policy that led to a reduction of wages about 40% the first half of the 1920s. UK pound increased in value over $4.50 by the end of 1924. The implementation of the contractionary policies from 1921 – 1931 had led UK to stagnation. At the time the UK economy grew very slowly – even during the global boom of the second half of the 1920s. It was the decade characterized by political conflict – general strike 1926. The Netherlands returned to the GS 1925 but its economy was less dramatic compare to UK because they had not suffered major fiscal dislocation during the War. In France, government expenditures exceed its revenues in the first half of 1920s (based on expected reparation). By 1926 the situation was verging on hyperinflation (and it was clear that Germany would never pay full reparations). Price increased dramatically (annual rate of 350% in the first half of 1926) and continuous short run debt which became harder to rollover. However, stabilization in 1926 enabled France to collect more tax and reduced government expenditures and increased investment. In 1928, France returned to gold standard at the current exchange rate of 20% of pre-war gold value. It was similar to France, Belgium franc was stabilized in 1926 at the rate of 1/7 pre-war value.
At the time output for Belgium, France, Italy and Germany was better but political conflicts remained. France and Italy were not satisfied with the benefits from winning the war while Germany economy affected by hyperinflation. Other countries, UK, Sweden, Denmark, the Netherlands and Spain, that were not affected by inflation turned to be lower output performance.
There was no problem with the pre-1914 GS because governments accepted automatic adjustment, however after 1919 governments were less willing to give up monetary policy independence. This caused BOP of some countries deficit while other surpluses.
Countries with BOP surpluses accumulated reserves and increased monetary base. This led an increase in price which cause rising in imports and reduced exports until the surplus country sterilizes. USA sterilized and ran BOP surpluses throughout the 1920s. This had attracted huge capital inflow (gold) without increasing price. And that put pressure on BOP deficit countries. Countries with BOP deficit lose reserves which led a decline in money supply and decrease in price. This caused goods in these countries became more competitive and exports had increased while imports declined until the deficit was eliminated. However it is harder for these countries to run deficits for long due to the loss of gold.
High interest rate in UK attracted huge capital inflow but caused unemployment to increase. France and Belgium had unvalued their currencies after 1928.
By 1928 the GS had been restored with some 50 nations on the GS. However, the system was unstable due to global imbalances. The BOP of the US was surplus while British and French deficits were not sustainable. And the system was vulnerable to real shocks. The decline in commodity prices in 1928-1929 drove Australia and other exporters off the GS in 1929. After 1929, lack of automatic adjustment or exchange rate flexibility contributed to making the 1930s depression global.
The decade after 1914 illustrated the potential importance of monetary policy, which allowed governments to increase its expenditures and financed the deficit by increased money supply which led hyperinflation in Germany, Austria and Hungary. Maintaining an overvalued exchange rate had also caused economic stagnation in UK. Lack of cooperation to reduce global imbalances contributed to instability. For instance, sterilization in the US put adjustment pressure on deficit countries, and undervalued French franc = beggar-thy-neighbour policy because not all countries could devalue and French exchange rate policy hurt those that did not like UK.
1958 – 1971
A feature of the post-1945 system was a belief that fixed exchange rate was necessary for a smoothly running global trading system. The designers (White and Keynes) recognized the shortcomings of the GS and of the competitive devaluations of the 1930s and tried to create a cooperative fixed exchange rate system.
Country still maintaining a fixed exchange rate however if a country run into a BOP deficit it could either do i) financing by using reserve assets to buy national currency; ii) controlling foreign exchange by limiting demand for foreign currency; iii) implement macro-policy (deflate by reducing demand for imports and increasing supply for exports and raising interest rate in order to attract capital inflow); and iv) devalue to a new fixed exchange rate.
Under the Bretton Woods ER system country implemented adjustable ERs. IMF lends to countries with short-term BOP problems, while fundamental disequilibria to be resolved by agreed change in ER. The system became operational after 1958 when major European currencies were convertible on current account.
At the time the US$ was convertible into gold at $35 per ounce but by the end of the 1950s US gold reserves were insufficient to cover its official liabilities . In 1968 a two-tier gold market was recognized – the value of gold in Central Bank reserves was decoupled from the market price of gold. Since the US dollar was set as dollar standard this made USA obtained seigniorage from issuing the world’s money.
Fixed ERs were unsustainable because governments were unwilling to allow BOP to rule macro policy. In UK BOP deficits led expectation of devaluation from 1964, and it was realized in Nov 1967. Inflation in France in 1968-9 led to devaluation in 1969 and asked for its US$ reserves to convert into gold, and low inflation in Germany contributed to an expectation of revaluation, and realized in 1969. Germany refused to revaluations in order to maintain export competitiveness and accepted inflationed US$ payments. Germany export-led growth could be sustained without inflation only with capital exports, hence German shift to liberalization of capital movements.
The 1960s loosening of the US monetary policy by printing US$ for Vietnam War and government spending increased dramatically for Great Society domestic programme. Excess US$ flow to export-countries such as Germany. In addition, the US government increase in taxes rates in 1968. All of these led to an increase in money supply which resulted in increase inflation from c2% in mid 1960s to greater than 5% in 1970. BOP deficit was the main reason for expectation of US$ devaluation but unclear how that could happen in the BW system where the dollar was the anchor currency.
Under a fixed exchange rate regime speculation attack was a one-way bet which could be led to quick gains for speculators at the expense of the CB. Although foreign exchange controls on capital account remained there was ways around them and capital markets were becoming more efficient.
In May 1971 DM fluctuating exchange rate and followed by Western European Union currencies. For instance, on May 4, 1971 German Central Bank bought $1 billion to maintain the fixed DM/$ER but the DM was floated in the next day. The CB recognized that it could not go on using its reserves to prop up the ER. In spite of this no one (speculators) who sold dollars to the German CB on May 4 could buy them back the next day at a lower price.
The Bretton-Woods system imposed free trade and trade-balance equilibrium , allowing financial national enclosure and domestic-intended monetary policy.
To maintain a fixed exchange rate systemt, all countries needed to revalue against the US$. On May 15, 1971 the US president, Nixon, announced a package of measures to stop selling gold to the central banks and a 10% surcharge on imports. The package was inttended to bring the other major trading partners to the negotiation table.
1897 – 1914:
The GS was established in 1800s by British and followed by other countries such the USA. Countries implementing the GS could convert their currencies into gold from gold into their currencies based on the exchange rate that was fixed. For instance, UK could convert pounds into gold (and vice versa) at 3 pounds 17 shillings and 10.5 pence per ounce, and the US could set the price of gold at $20.67 per ounce in 1834. The exchange rate between any pair of countries on the GS was fixed. Example one pound = $4.857.
Why had to be fixed? Fixed exchange rate could reduce uncertainty in trade. In addition it was easy for automatic adjustment process – the specie-flow mechanism. If the UK had a BOP deficit there would be an outflow of gold this leads to a decrease in money supply, thus price level would go down. This would encourage exports discourage imports. Hence reduce the BOP deficit.
Due to the UK pound at the time was as good as gold, other countries that had their accounts in London could address BOP deficit by running down their accounts while they took adjustment measures. Thus the system worked well to settle BOP imbalances as long as they were not large and there was a trust in London capital markets.
The GS became the international monetary system when the silver boomed and other on silver standard faced accelerating inflation. For instance, Austria and Russia gave up their free coinage of silver and joined the GS in the 1890s. By the 1897 the world economy was based on the GS.
1925 – 1933
Britain returned to GS in April 1925. To maintain exchange rate, the government maintained high interest rate in order to attract capital inflow. Due to high inflation rate the UK, market exchange rate in 1920-1921 was $3.50. UK government ran a contractionary fiscal policy that led to a reduction of wages about 40% the first half of the 1920s. UK pound increased in value over $4.50 by the end of 1924. The implementation of the contractionary policies from 1921 – 1931 had led UK to stagnation. At the time the UK economy grew very slowly – even during the global boom of the second half of the 1920s. It was the decade characterized by political conflict – general strike 1926. The Netherlands returned to the GS 1925 but its economy was less dramatic compare to UK because they had not suffered major fiscal dislocation during the War. In France, government expenditures exceed its revenues in the first half of 1920s (based on expected reparation). By 1926 the situation was verging on hyperinflation (and it was clear that Germany would never pay full reparations). Price increased dramatically (annual rate of 350% in the first half of 1926) and continuous short run debt which became harder to rollover. However, stabilization in 1926 enabled France to collect more tax and reduced government expenditures and increased investment. In 1928, France returned to gold standard at the current exchange rate of 20% of pre-war gold value. It was similar to France, Belgium franc was stabilized in 1926 at the rate of 1/7 pre-war value.
At the time output for Belgium, France, Italy and Germany was better but political conflicts remained. France and Italy were not satisfied with the benefits from winning the war while Germany economy affected by hyperinflation. Other countries, UK, Sweden, Denmark, the Netherlands and Spain, that were not affected by inflation turned to be lower output performance.
There was no problem with the pre-1914 GS because governments accepted automatic adjustment, however after 1919 governments were less willing to give up monetary policy independence. This caused BOP of some countries deficit while other surpluses.
Countries with BOP surpluses accumulated reserves and increased monetary base. This led an increase in price which cause rising in imports and reduced exports until the surplus country sterilizes. USA sterilized and ran BOP surpluses throughout the 1920s. This had attracted huge capital inflow (gold) without increasing price. And that put pressure on BOP deficit countries. Countries with BOP deficit lose reserves which led a decline in money supply and decrease in price. This caused goods in these countries became more competitive and exports had increased while imports declined until the deficit was eliminated. However it is harder for these countries to run deficits for long due to the loss of gold.
High interest rate in UK attracted huge capital inflow but caused unemployment to increase. France and Belgium had unvalued their currencies after 1928.
By 1928 the GS had been restored with some 50 nations on the GS. However, the system was unstable due to global imbalances. The BOP of the US was surplus while British and French deficits were not sustainable. And the system was vulnerable to real shocks. The decline in commodity prices in 1928-1929 drove Australia and other exporters off the GS in 1929. After 1929, lack of automatic adjustment or exchange rate flexibility contributed to making the 1930s depression global.
The decade after 1914 illustrated the potential importance of monetary policy, which allowed governments to increase its expenditures and financed the deficit by increased money supply which led hyperinflation in Germany, Austria and Hungary. Maintaining an overvalued exchange rate had also caused economic stagnation in UK. Lack of cooperation to reduce global imbalances contributed to instability. For instance, sterilization in the US put adjustment pressure on deficit countries, and undervalued French franc = beggar-thy-neighbour policy because not all countries could devalue and French exchange rate policy hurt those that did not like UK.
1958 – 1971
A feature of the post-1945 system was a belief that fixed exchange rate was necessary for a smoothly running global trading system. The designers (White and Keynes) recognized the shortcomings of the GS and of the competitive devaluations of the 1930s and tried to create a cooperative fixed exchange rate system.
Country still maintaining a fixed exchange rate however if a country run into a BOP deficit it could either do i) financing by using reserve assets to buy national currency; ii) controlling foreign exchange by limiting demand for foreign currency; iii) implement macro-policy (deflate by reducing demand for imports and increasing supply for exports and raising interest rate in order to attract capital inflow); and iv) devalue to a new fixed exchange rate.
Under the Bretton Woods ER system country implemented adjustable ERs. IMF lends to countries with short-term BOP problems, while fundamental disequilibria to be resolved by agreed change in ER. The system became operational after 1958 when major European currencies were convertible on current account.
At the time the US$ was convertible into gold at $35 per ounce but by the end of the 1950s US gold reserves were insufficient to cover its official liabilities . In 1968 a two-tier gold market was recognized – the value of gold in Central Bank reserves was decoupled from the market price of gold. Since the US dollar was set as dollar standard this made USA obtained seigniorage from issuing the world’s money.
Fixed ERs were unsustainable because governments were unwilling to allow BOP to rule macro policy. In UK BOP deficits led expectation of devaluation from 1964, and it was realized in Nov 1967. Inflation in France in 1968-9 led to devaluation in 1969 and asked for its US$ reserves to convert into gold, and low inflation in Germany contributed to an expectation of revaluation, and realized in 1969. Germany refused to revaluations in order to maintain export competitiveness and accepted inflationed US$ payments. Germany export-led growth could be sustained without inflation only with capital exports, hence German shift to liberalization of capital movements.
The 1960s loosening of the US monetary policy by printing US$ for Vietnam War and government spending increased dramatically for Great Society domestic programme. Excess US$ flow to export-countries such as Germany. In addition, the US government increase in taxes rates in 1968. All of these led to an increase in money supply which resulted in increase inflation from c2% in mid 1960s to greater than 5% in 1970. BOP deficit was the main reason for expectation of US$ devaluation but unclear how that could happen in the BW system where the dollar was the anchor currency.
Under a fixed exchange rate regime speculation attack was a one-way bet which could be led to quick gains for speculators at the expense of the CB. Although foreign exchange controls on capital account remained there was ways around them and capital markets were becoming more efficient.
In May 1971 DM fluctuating exchange rate and followed by Western European Union currencies. For instance, on May 4, 1971 German Central Bank bought $1 billion to maintain the fixed DM/$ER but the DM was floated in the next day. The CB recognized that it could not go on using its reserves to prop up the ER. In spite of this no one (speculators) who sold dollars to the German CB on May 4 could buy them back the next day at a lower price.
The Bretton-Woods system imposed free trade and trade-balance equilibrium , allowing financial national enclosure and domestic-intended monetary policy.
To maintain a fixed exchange rate systemt, all countries needed to revalue against the US$. On May 15, 1971 the US president, Nixon, announced a package of measures to stop selling gold to the central banks and a 10% surcharge on imports. The package was inttended to bring the other major trading partners to the negotiation table.
Education Gini
I. INTRODUCTION
While income inequality in third world countries has aggressively been commented and studied extensively, little analysis is relatively available on measuring inequality in other dimensions of human development. After some decade of structural adjustment and reform without any major changing in the welfare of the majority people of third world countries, the emphases of economic policy have shifted toward and tackled poverty itself (Appiah-Kubi, 2002). In the era of economic reforms, as the foundations of education have changed, so has the distribution of illiteracy. Between rural and urban areas, male and female, inequality on education has risen substantially since the reforms began (Appiah-Kubi, 2002). In order to find a measurement of this inequality, a new indicator for the distribution of human capital and welfare have come up with an education Gini index that also facilitates comparison of education inequality across countries and over time (Thomas et al, 2000).
Education has a major role in the accumulation of human capital (Galor and Moav, 2004). In order to gain socio-economic equilibrium, government should invest a huge amount of money in public education. Easterly (2004) found that inequality in education is positively correlated with income inequality, however, there is a weak association between education attainment and output per worker. In the basis of economic logic, education enhances social and political mobility. Educated people are better to speak up their rights, to organize themselves, and to bargain in the political process where a substantial share of national resources is redistributed. In other words, if education is distributed unequally, income would be distributed unequally.
To reach equality on education, government must have a proper policy on demand and supply of education. There are four factors affecting individual demand of education (Tesfeye, 2002). Firstly, household characteristics. Secondly, children characteristics. Thirdly, quality of schooling. Lastly, return from schooling. Meanwhile, quantitative factor is one factor affecting individual supply of education (Tesfeye, 2002). It is undeniable that a good policy on demand and supply of education by the government may achieve equality on education in all levels of income, particularly the poorer.
Prior to determining education inequality in Indonesia, the author firstly ascertain at which level of education people attaining school. There are four indicators, recently used by the government, to measure education level in Indonesia. Firstly, school enrollment ratio or called Angka Partispasi Sekolah (APS), which is the number of Indonesian who attained three levels of education from the 7-to-12-year-old age group, represents primary school, to the 16-to-18-year-old age group, represents senior secondary school. Secondly, net enrollment ratio or called Angka Partisipasi Murni (APM), which is the number of Indonesian who are still schooling in three levels of education from primary school to senior secondary school. Thirdly, educational attainment, which is the number of Indonesian who completed six levels of education attainment from people who never been attended to school to people who completed university. Lastly, literacy rate, which determines the individual ability to read and write. From 1999 to 2005, there was a dramatic increase in APS, APM, educational attainment, and literacy rate respectively (BPS, 1999-2005).
Even though there was a steady increase in APS, APM, educational attainment, and literacy rate in 2005 that gives the indication of the improvement in education gaps among gender and areas, as reflected in productivity and earnings, these indicators do not clearly provide education equality and sufficiently reflect absolute and relative dispersion of human capital (Thomas et al, 2000). Hitherto standard deviations of schooling have been used to measure the dispersion of schooling distribution in absolute term, however, to measure the dispersion in schooling distribution in relative term, it appears that education Gini seems to be appropriate measure that reflects the improvement in the distribution of educational opportunities which is crucial for generating income (Thomas et al, 2000).
In this paper, I use the existence model of Thomas et al (2000) by using the educational attainment data from National Social Economic Survey (SUSENAS) between 1999 and 2005 in 23 provinces to clarify and compare the pattern of Gini coefficient of education among areas and gender. In addition, I investigate if education Gini positively influences the difference of illiteracy rate among gender and standard deviations of schooling respectively. Moreover, I resolve if education Gini negatively associates with average years of schooling. Lastly, I settle if the relationship between average years of schooling and standard deviations of schooling forms education Kuznets curve.
The main findings suggest that inequality in education as measured by education Gini is negatively associated with average years schooling, implying that higher education attainment are more likely to achieve equality in education. Moreover, a clear pattern on an education Kuznets curve exists if standard deviation of schooling is used. Furthermore, gender gaps are related to education inequality and the relation between these variables become stronger over time.
The paper is organized as follows. Section II provides literature review on the role and distribution of schooling and indicator of measuring education inequality. Section III describes research methodology in which I use both direct and indirect method. Section IV implies an empirical result about the relationship among variables. Section V explains conclusion and policy recommendations.
II. LITERATURE REVIEW
1. Empirical Studies on the Role and Distribution of Schooling
Mass and Criel (1982) examined the distribution of primary school enrollment and asserted that enrollment Gini is very enormously changed across countries. They describes a negative relation between the average enrollment and its distribution where the higher the average enrollment, the lower the Gini coefficient. On the other hand, Ram (1990) applied income Kuznets curve to form educational Kuznets curve. The finding confirms that as the average level of schooling rises, educational inequality first increases, then after reaching a peak, educational inequality starts to decline. The turning point of this declining is about seven years of education.
O’Neill (1995) argued that the stock of human capital is the accumulation of the past education and not sensitive to the current income level. The finding proves that among the developing countries, convergence in education levels has resulted in a reduction in income dispersion. Yet, incomes have diverged globally despite substantial convergence in education levels. In contrast, Birdsall and Londono (1997) used cross-country analysis to form a traditional growth model and put forward initial levels of educational inequality and land Gini have strongly negative impacts on economic growth and growth of the poorest income.
Lopez et al (1998) constructed the asset allocation model and Gini coefficient of educational attainment and investigated the linkage between distribution of education and growth. Their major findings are the following: Firstly, the distribution of education is very important to describe income levels and economic growth, and if it is distributed unequally, it would bring negative impacts on income levels and economic growth. Lastly, economic reforms improved the productivity of human capital in growth models. By controlling the distribution of education, which is one of the economic reforms agenda, the government can rise the average years of schooling.
Gregorio and Lee (1999) presented the empirical evidence on how education and income have related to income distribution. They validate higher attainment and distribution of education as a means of changing income distribution. In this case, the Kuznets inverted-U curve takes into account. In addition, government social expenditure contributes to the more equal distribution of income. Yet, the growth of income and education could not make income and education inequality decline substantially in a short and long period. Meanwhile, Inter-American Development Bank (1999) examined standard deviation of education to measure education inequality and claimed that there is a positive association between standard deviations of education and education inequality in the sense that the higher standard deviations of education, the greater education inequality measured by Gini coefficient education.
Thomas et al (2000) constructed Gini coefficient to find educational attainment inequality. The finding establishes that the inequality in educational attainment declined over three decades of 1960-1990 and it is negatively associated with the average years of schooling. Furthermore, the educational Kuznets curve exists when standard deviations of schooling are used and gender-gaps are closely associated to the education inequality where the connection between two variables boil down to stronger over time. Lastly, per capita PPP GDP increments are positively correlated with the labor force’s average years of schooling. In contrast, Siddhanta and Nandy (2003) maintained that education inequality, gender gaps of educational attainment, average years of schooling, standard deviations of schooling, and illiteracy rate in rural area are higher than urban area. In addition, prosperity and gender gap of education in urban area is negatively associated, while in rural area, this correlation turns to be positive.
2. Indicators of Measuring Education Inequality
2.1 Enrollment Ratios
The enrollment ratio for different levels of schooling was used as indicators of human development at the initial stage (Levine and Zervos, 1993). The most commonly used are the primary enrollment ratio, the junior secondary enrollment ratio, and the senior secondary enrollment ratio. Of all measurement of equality education, Bureau Statistic Indonesia is not only estimating school enrollment ratio but also appraising net enrollment ratio. However, enrollment ratio only measures the access of people’s education and it does not show the cumulated educational attainment. Thus, it is inappropriate to use these enrollment ratios in growth models. In addition, enrollment ratio does not reflect the stock of human capital (Thomas et al, 2000).
To counter the disadvantages of these indicators, there is a grade enrollment ratio based on the percentage distribution of pupils among grades in a particular schooling system (UNESCO, 1996). The advantages of the grade enrollment ratio as follows (Castello and Domenech, 2002): Firstly, the grade enrollment ratio captures more detail on student performances. Secondly, average attainment levels did not influence the grade enrollment ratio. However, the data do not reflect working age population so that is a time lag where student in primary grades will enter into the labor force after a lag of approximately 5 to 15 years (Frankema and Bolt, 2006).
2.2 Average Years of Schooling
Psacharopoulos and Arriagada (1986) suggested that the proper indicator of human development level is the stock of educational attainment defined as average years of schooling. They collected the information about each country’s schooling distribution and calculated educational attainment whereas Barro and Lee (1991) formalized the use of educational attainment for growth regressions. Nehru et al (1994) created a cross-country database for educational attainment, through evaluating the schooling distributions over time for various countries. Yet, this indicator does not describe the characteristic of human capital gap in terms of absolute and relative (Thomas et al, 2000).
2.3 The Quality of Schooling
Behrman and Birdsall (1983) believed that the quality of schooling should be taken into consideration when measuring the level of human development instead of using the quantity of schooling. There are two typical approaches used to measure the quality of education. The first approach is the input. It is very relevant to see which country provides more resources to education than other sectors. Pupil-teacher ratio, expenditures on teacher’s wage, books, and other reading materials can measure the inputted resources into education (Thomas et al, 2000). However, the high volume of input does not make the yield of schooling quality improve. Moreover, the inputs for schooling depend on the income level. Based on those matters, Hanushek and Kim (1995) refuted a limited feasibility of using input of schooling as the proxies for education equality.
The last approach is the output that directly measures the achievement of schooling by comparing the scores of cognitive performance. The students of the same-age group of various countries are obtained by the same international test on the same subject including mathematics and science (Thomas et al, 2000). The assessment of student achievement was conducted both by the International Association for Evaluation of Educational Achievement (IEA) and by International Assessment of Education Progress (IEAP) (Hanushek and Kim, 1995). Yet, Barro and Lee (1997) found that these measurements could only be explained in the Industrial Countries and could not comparable over time.
2.4 Standard Deviations of Schooling
Standard deviation has been used to measure the absolute dispersion of assets distribution. Ram (1990) used standard deviations of schooling to illustrate the existence of the education Kuznets curve. Birdsall and Londono (1997) investigated the impact of initial asset distribution on growth and poverty reduction and found a significant negative correlation between education dispersion, measured by standard deviations of schooling, and income growth. Inter-American Development Bank (1999) took standard deviations of schooling to measure education inequality.
2.5 Gini Coefficient of Education
As standard deviations of schooling only measures the absolute dispersion of schooling distribution, developing education Gini is very necessary for measuring the inequality of schooling in relative term. Education Gini concept is very similar to income Gini and can be calculated by using enrollment, financing, and attainment data. Rosthal (1978) estimated Gini coefficient using education finance data in several East African Countries. Sheret (1988) utilized enrollment data in Papua New Guinea to reckon Gini index. However, these studies do not emphasize on the distribution of school attainment.
III. DATA and METHODOLOGY
1. Data
This research uses National Social Economic Survey (SUSENAS) data, which have been conducted by Bureau Statistics Indonesia (BPS). SUSENAS is a repeated cross-section and nationally representative household survey that has two main components. The first one is Core SUSENAS, which collects basic socio-demographic information on households and individuals and is conducted annually. The second component, Module SUSENAS, gathers detailed information on households. There are three different modules-consumption, health, and education and each module is conducted triennially. The Core covers about 200,000 households and 800,000 individuals, while the Module covers a sub-sample of about 65,000 households. I take Core SUSENAS from 1999 to 2005 in 23 out of 31 provinces in Indonesia because five provinces such as Banten, Gorontalo, Bangka Belitung, Riau Islands, and North Maluku are an extension of the previous provinces such as West Java in 2000, North Celebes in 2000, South Sumatra in 2000, Riau in 2004, and Maluku in 1999 respectively. The other provinces such as Maluku, Nangroe Aceh Darussalam, and Papua still flared up between 2000 and 2002, made the data unstable.
2. Methodology
On the purpose of estimating education inequality in Indonesia, I use direct method to capture education Gini coefficient, average years of schooling, and standar deviations of education. In addition, Lorenz curve based on the cumulative proportion of population and that of schooling will be visualized in indirect method.
2.1 Direct Method
The direct method states that the education Gini is defined as “the ratio to the mean (average years of schooling) of half of the average over all pairs of the absolute deviations between all possible pairs of people” (Deaton 1997). Thomas et all (2000) developed Deaton’s formula, which is shown in equation 1.
(1)
Where: E L is the education Gini based on educational attainment distribution; µ is the average years of schooling for the concerned population; pi and pj stand for the proportions of population with certain levels of schooling; yi and yj are the years of schooling at different educational attainment levels; n is the number of levels in attainment data.
Barro and Lee (1991) divided the population into seven categories include no schooling or illiterate, partial primary, complete primary, partial secondary, complete secondary, partial tertiary, and complete tertiary. However, BPS shared the population into six categories attainment include never been to school, not complete primary school, complete primary school, complete junior secondary school, complete senior secondary school, complete tertiary school or university.
The average years of schooling and standard deviations of schooling can be calculated in formula 2 and 3 respectively.
(2)
(3)
2.2 Indirect Method
The indirect method constructs the education Lorenz curve, shown in figure 1, which is the combination between the cumulative percentage of the schooling years on the vertical axis, shown in S, and the cumulative percentage of the population on the horizontal axis, shown in Q. The forty-five degree line is the education egalitarian line, represents a perfect equality of schooling. Thus, the education Gini is estimated using the indirect method as the ratio between the area of A and the area of OWQ.
Figure 1: Education Lorenz Curve
S W
Cumulative
Proportion of Egalitarian Line
Schooling A
Lorenz Curve
O Q
Cumulative Proportion of Population
IV. EMPIRICAL RESULTS
1. Education Gini in terms of Areas and Provinces
In terms of region, there was a significant improvement in Gini coefficient of education from 1999 to 2005 (see table 1). Between 1999 and 2005, the national Gini education decreased steadily. Both rural and urban Gini education fell significantly from 0.29 and 0.36 in 1999 to 0.27 and 0.32 in 2005 respectively. In addition, the effort of rural area to improve their education equality is more likely to outweigh urban area. According to Suwignyo (2004), both local and state government put their resources to improve quality of education, mainly in school infrastructure, to stimulate demand of education in rural area, so there is a tendency that rural area grows faster than the urban area.
Table 1: Development of Gini Coefficient of Education in Rural, Urban, and Indonesia
Area 1999 2001 2003 2005
Indonesia 0.35 0.35 0.33 0.32
Rural 0.36 0.35 0.34 0.32
Urban 0.29 0.30 0.28 0.27
Source: Author’s calculation, data available upon request
In terms of provinces, education Gini in 23 provinces fell gradually. There was a sharp decrease in Gini coefficient of education in West Borneo, Jambi, South Sumatra, East Java, North Celebes, and South-East Celebes. In contrast, Daerah Istimewa Yogyakarta (DIY) almost remained stable in its Gini education. Overall, DKI Jakarta has the lowest level of education inequality whereas the highest level is West Nusa Tenggara (NTB). In the case of NTB, regional budget in education sector is very limited (only 5 per cent) and it affects the supply education factors such as the inadequacy on facility and the less number of schools. Furthermore, the demand education factors, such as the inadequacy on household, child inability, and the low quality of schooling, give the impact on high education inequality in NTB. On the other hand, DKI Jakarta spends almost 20 per cent of total regional budget on education sector, primarily on the effort to increase quality and quantity of schooling (Digdowiseiso, 2007).
2. Education Lorenz Curve in terms of Areas
In Figure 2 distribution of schooling in 2005 is more equal than that in 1999 as the Gini coefficient of education in 2005 is much better than that in 1999. In addition, the same condition takes place in rural and urban area in distribution of schooling in 2005 (see Figure 3 and Figure 4).
Figure 2: Education Lorenz Curve in Indonesia
Source: Author’s Calculation
Figure 3: Education Lorenz Curve in Rural Area
Source: Author’s Calculation
Figure 4: Education Lorenz Curve in Urban Area
Source: Author’s Calculation
Figure 5 shows the comparison between rural Lorenz curve and urban Lorenz curve and indicates that the education inequality gap between rural and urban area is much more slightly. The fact that there is a promising development of distribution of education in rural area endorses a specifically targeted policy to reduce the gap between rural and urban area.
Figure 5: Education Lorenz Curve between Rural and Urban Area
Source: Author’s Calculation
3. Average Years of Schooling in the Period of 1999-2005 in Terms of Areas and Provinces
Average years of schooling in rural, urban, and Indonesia rose sharply (see table 2). It means that there is an improvement in education equality in these areas, particularly rural. Setyorini (2002) took issue with the differences between rural and urban average years of schooling that rural area was “gifted” an innate ability so that it boost the demand of education. However, it might not be true as increasing quantity of education and thus supply of education leads to a significant rise in average years of education (Duflo, 2001).
Table 2: Development of Average Years of Schooling in Rural, Urban, and Indonesia
Area 1999 2001 2003 2005
Indonesia 6.30 6.33 6.57 6.79
Rural 5.08 5.17 5.47 5.75
Urban 7.80 7.68 8.10 8.27
Source: Author’s calculation, data available upon request
In terms of provinces, there was a gradual increase in average years of schooling in 23 provinces in Indonesia from 1999 to 2005. North Celebes attains the greater difference on average years of schooling and an evidence of state government intervention, as in Duflo case, occurs in this area. Yet, Samiadji (2001) argued that the household characteristics are positively correlated with average years of schooling, while quantity of education has no impact in education equality in North Celebes. Furthermore, there was a significant rise in average years of schooling in East Java, Jambi, Central Borneo, and Bali. Overall, DKI Jakarta has the highest average years of schooling while East Nusa Tenggara (NTT) has the lowest one. In the case of NTT, the inadequacy on household (i.e. lack of income and higher siblings in the family) and the lower quality of schooling play a major role on the inefficiency demand of education (Samiadji, 2001).
4. Standard Deviations of Schooling in terms of Areas and Provinces
Standard deviations of schooling in rural, urban, and Indonesia fluctuated annually (see table 3). Increasing and decreasing on standard deviations of schooling will decrease and increase the level of education inequality. Thus, this condition is very contrast to the fact that Gini coefficient of education can measure the equality on education in rural, urban, and Indonesia appropriately.
Table 3: Development of Standard Deviations of Schooling in Rural, Urban, and Indonesia
Area 1999 2001 2003 2005
Indonesia 3.94 3.92 3.90 3.99
Rural 3.35 3.40 3.36 3.58
Urban 4.07 4.12 4.08 4.14
Source: Author’s calculation, data available upon request
In terms of provinces, standard deviations of schooling in Central Borneo, South Borneo, Riau, Daerah Istimewa Yogyakarta, and South-East Celebes fell significantly from 1999 to 2005. This means that education inequality between one province and the other is decreasing. In addition, standard deviations of schooling in 18 provinces rose dramatically in 2005. It indicates that the spread of education attainment between one province and another province becomes wide every year. Thus, education inequality between one province and the others is increasing.
5. Education Gini in terms of Gender
Education equality improved significantly from 1999 to 2005 (see table 4). In terms of total, there was a dramatic decline in both male and female Gini coefficient of education within this period. In terms of urban and rural area, between 1999 and 2005 both male and female Gini coefficient of education fell slightly. Overall, total population in urban area has bigger education equality than that in rural. Moreover, male population has bigger chance to extend their education, due to the possibility of the parents to give larger opportunity of schooling to male children (Digdowiseiso, 2007).
Table 4: Development of Gini Coefficient of Education in Rural, Urban, and Indonesia in terms of Gender
Gender Region 1999 2001 2003 2005
Male Rural 0.32 0.32 0.31 0.31
Urban 0.27 0.27 0.27 0.26
Female Rural 0.38 0.38 0.36 0.36
Urban 0.31 0.31 0.30 0.29
Total Rural 0.37 0.38 0.35 0.35
Urban 0.32 0.32 0.30 0.30
Source: Author’s calculation, data available upon request
6. Education Lorenz Curve in terms of Gender
In 2005 total female Lorenz curve moved closer to the male Lorenz curve (see Figure 6). On the other hand, the gap between female and male Lorenz curve decreased slightly in 2005 in both urban and rural Lorenz curve (see Figure 7 and 8). The positive developments in female education were apparently not large enough to reverse the widening education gender-gap in Indonesia. This proves that changing inequality in Indonesia requires increased public attention and proper policy targeting towards female schooling.
Figure 6: Gender Lorenz Curve in terms of Total
Source: Author’s Calculation
Figure 7: Gender Lorenz Curve in Rural Area
Source: Author’s Calculation
Figure 8: Gender Lorenz Curve in Urban Area
Source: Author’s Calculation
7. Average Years of Schooling in terms of Gender
The gap between male and female average years of schooling is an important indicator of developmental differential (Siddhanta and Nandy, 2003). Table 5 reveals that average years of schooling of male population, female population, and Indonesia rose significantly from 1999 to 2005. It shows that the difference of the increment in female average years of schooling is bigger than that in male. Siddhanta and Nandy (2003) argued that improving female education is far more than that of educating male. However, social preferences may deter investment in female education and thus, functioning equality (Samiadji, 2001).
Table 5: Development of Average Years of schooling in terms of Gender
Gender 1999 2001 2003 2005
Indonesia 6.30 6.33 6.57 6.79
Male 6.85 6.82 7.03 7.25
Female 5.88 5.94 6.24 6.46
Source: Author’s calculation, data available upon request
8. Standard Deviations of Schooling in terms of Gender
Male standard deviations of schooling and female standard deviations of schooling fluctuated gradually from 1999 to 2005 (see table 6). There was an improvement in male standard deviations of schooling and a decrease in female’s standard deviations of schooling. Intuitively, this result should give the impact on the higher male Gini coefficient of education and the lower one in female. However, both male and female Gini education falls significantly in table 4.
Table 6: Development of Standard Deviations of Schooling in terms of Gender
Gender 1999 2001 2003 2005
Indonesia 3.94 3.92 3.90 3.99
Male 3.92 3.96 3.82 3.95
Female 3.99 4.02 3.96 3.98
Source: Author’s calculation, data available upon request
9. The Difference Illiteracy Rate among Gender
To analyze education inequality among gender, the author uses the difference of illiteracy rate between male population and female population. The gap between men’s and women’s literacy rate is a rough but informative indicator of the gender difference in many forms of human capital (Siddhanta and Nandy, 2003). In the 2005 spatial pattern of gender inequality, If 6-percentage point of gender disparity is considered as a crucial level, then I found that 18 provinces lie below this level. Among these, the location of 17 provinces is striking; together they form a contiguous belt.
An even more striking spatial contiguity of provinces has been found for the rural population above the cut-off point 7.6-percentage point since most of them are located in western part of Indonesia. In the urban population, 6 provinces have gender gap in literacy rate more than national average. Of these, 5 provinces form a geographical contiguity. The pattern of the spatial contiguity for the urban population is similar with that of the rural population.
In 1999, DIY and North Celebes (SULUT) are the highest and lowest difference of illiteracy rate among gender in both rural and urban area respectively. The result is very surprising, considered that DIY is well known as “province of education”. Suwignyo (2004) claimed that DIY has low demand of education in rural area such as the tradition of parents to give education only on male children and insufficient household characteristics. In contrast, NTB and SULUT are the highest and lowest gender gap in illiteracy rate in terms of total.
In 2005, Bali and DKI Jakarta had the highest and lowest difference of illiteracy rate among gender in rural area and total respectively. Another shocking finding occurs in the former where tourism sector is the biggest contribution of its regional budget. Samiadji (2001) believed that culture in Bali is associated with gender bias and thus, functioning demand for education. On the other hand, NTB and SULUT are the highest and lowest gender gap in illiteracy rate in urban area.
10. The Association between Education Gini and Average Years of Schooling
This study proves that there is a significant association between Gini coefficient of education and average years of schooling. The relation between both factors is briefly explained in the exponential equation as shown below:
ln GINI = -0,171 LAMA (4)
R2 = 0.994 t = (-159.833)
Where: GINI is Gini coefficient of education; LAMA is average years of schooling.
Equation 4 states the estimation of t at -159.833, signification at 0.00, and R2 at 0.994, hence average years of schooling influence significantly to Gini coefficient of education at 5 percent level. Figure 9 shows the decreasing of Gini coefficient education, at the time average years of schooling rise. Thus, there is a negative correlation between Gini coefficient of education and average years of schooling and this supports Thomas’s et al (2001) finding.
Figure 9: Education Gini and Average Years of Schooling
Source: Author’s Calculation
11. The Relationship between Education Gini and Standard Deviations of Schooling
This research establishes a significant relation between Gini coefficient of education and standard deviations of education. The relation between two factors is briefly described in the linier equation as shown below:
GINI = 0,083 DEV (5)
R2 = 0.985, t = (101.419)
Where: GINI is Gini coefficient of education; DEV is standard deviations of schooling.
Equation 5 describes the estimation of t at 101.419, signification at 0.00, and R2 at 0.985, therefore standard deviations of schooling influence significantly to Gini coefficient of education at 5 percent level. Figure 10 indicates that once standard deviations of schooling increase, Gini coefficient of education rise. Thus, this result is very similar to Inter American Development Bank’s (1999) finding where Gini coefficients of education and standard deviations of schooling are positively correlated.
Logically, if there is any improvement on Gini coefficient of education, education inequality will increase represented by the increasing in standard deviations of schooling. Of course, it is very contrast to the principle of equality distribution of education. Therefore, standard deviation of schooling is not appropriate measure to describe educational equality (Thomas et al, 2001).
Figure 10: Education Gini and Standard Deviations of schooling
Source: Author’s Calculation
12. The Relationship between Average Years of Schooling and Standard Deviations of Schooling
This study finds that Gini coefficient of education associates with standard deviations of education where this relation will form education Kuznets curve. Figure 11 explains that at first, education inequality increases, then after reaching a peak, education inequality fall gradually. This result endorses Ram’s (1990) finding, however, the turning point of his finding is about 7 years while the turning point of this study is about 7.4 years. It means that a country with average years of schooling below 7.4 years should increase its standard deviations of schooling to gain equality on education. In contrast, a country with average years of schooling above 7.4 years should decrease its standard deviations of schooling to attain education equality.
Figure 11: Educational Kuznets Curve
Source: The Author’s Calculation
13. The Association between Gini Education and The Difference of Illiteracy Rate among Gender
Thomas et al (2001) suggested that the Gini coefficient of education is positively associated with gender gap in literacy rate and the relation between education inequality and gap among gender is getting much stronger over time. The result maintains that education inequality are clearly related to gender gap from 0.79 in 1999 to 0.83 in 2005 (see Figure 12 and 13).
GINI99 = 0.275 + 0.009 GENDER99 (6)
R2 = 0.625, R = 0.79, t = (5.914)
GINI05 = 0.248 + 0.011 GENDER05 (7)
R2 = 0.694, R = 0.83, t = (6.901)
Where: GINI99 is Gini coefficient of education in 1999; GINI05 is Gini coefficient of education in 2005; GENDER99 is difference illiteracy rate among gender in1999; GENDER05 is difference illiteracy rate among gender in 2005.
Equation 6 and 7 show that the estimation of t is 5.914 in 1999 and 6.901 in 2005 and most importantly, the signification of both years at 0.00. Therefore, difference of illiteracy rate and Gini coefficient of education is significantly related at 5 percent level.
Figure 12: Education Gini and Gender Gaps in 1999
Source: Author’s Calculation
Figure 13: Education Gini and Gender Gaps in 2005
Source: Author’s Calculation
V. CONCLUDING REMARKS
This study measures education inequality in Indonesia from the period of 1999 to the period of 2005 by using two methods, the direct method and the indirect method. The direct method will be focused on estimating Gini coefficient of education while the indirect method will be applied on formulating education Lorenz curve. By using both direct and indirect method, the author can analyze education inequality in terms of areas and gender. To sum up, there are several major findings on education inequality aspect in Indonesia.
Firstly, in terms of national, there was a significant decrease in education Gini from 0.35 in 1999 to 0.32 in 2005. Meanwhile, in terms of provinces in Indonesia, there is an annual improvement on education inequality. The exceptional case occurs in Bali, East Nusa Tenggara, and West Borneo where their Gini education is very vulnerable to the immediate shock. Secondly, study among areas describes that over time, rural area has higher education inequality than urban area. Between 1999 and 2005, the Gini coefficient of education of rural area decreased dramatically from 0.36 to 0.33 and there was a slight fall in Gini coefficient of education of urban area from 0.29 to 0.28.
Thirdly, study among gender shows that female population has higher education inequality than male population over time. Between 1999 and 2005, the Gini education of female population declined steadily from 0.37 to 0.35 and there was a significant decrease in the Gini education of male population from 0.32 to 0.30. Fourthly, the interrelatedness study between gender and area states that the level of education inequality of both female and male population in rural area is higher than that in urban area.
Lastly, in terms of association between two variables, there is a negative correlation between Gini coefficient education and average years of schooling. This research substantiates standard deviations of schooling is not a proper measurement to estimate distribution of schooling, due to the increasing standard deviations of schooling will give a bad impact on education equality. Another major finding is that there is a relationship between standard deviations of schooling and average years of schooling which forms education Kuznets curve, where at first, educational inequality increases, then after reaching a peak at 7.4 years, educational inequality starts to decline. Furthermore, this study claims that there is a positive relation between education inequality and the difference of illiteracy rate of gender, and over time, the association between gender-gaps and inequality becomes stronger.
Based on these findings, it clearly states that Gini index need to be incorporated with the quality aspect and examined any causal relationship between education Gini and income growth, which are challenges for future studies. The need to disentangle the association between education inequality and other aspects of development, such as income inequality, income level and growth, gender gaps, education-related policies, poverty is very essential in any future research. Another item on research agenda is how to account the interaction effects between education inequality and economic freedom. Finally, this research shows the necessity for more complex interactions, mechanisms, and dynamic models of all kinds to be considered when studying within-country education inequality in the future.
There are several policies that the government could take the steps to help the efforts in achieving education equality in Indonesia. Firstly, both state and local governments must have taken over the responsibility to managing every potential resource in their own, primarily human resource. For instance, they have to increase both the quality and quantity of schooling such as teacher’s quality and qualification, student per teacher ratio, teacher’s wage and other incentives, school facilities and maintenance, and the number of school. Beside that, they have to empower female and rural population by mitigating literacy rate, applying the nine-year education program, and developing the one-roof education program which combines primary school and junior secondary school into one building closes to the community.
Secondly, the central government must increase national budget on education sector to improve education equality and to give financial support to both state and local governments, if required. Moreover, the central government has to alter the scholarship scheme to reach children who cannot continue to school after completing primary school. Another policy is that the central government must increase the opportunity cost of not going to school by providing cash subsidies directly to the family. In addition, the central government must give a specifically targeted campaign to promote the importance of education. Lastly, people should actively enact as a leading role in the implementation of education.
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While income inequality in third world countries has aggressively been commented and studied extensively, little analysis is relatively available on measuring inequality in other dimensions of human development. After some decade of structural adjustment and reform without any major changing in the welfare of the majority people of third world countries, the emphases of economic policy have shifted toward and tackled poverty itself (Appiah-Kubi, 2002). In the era of economic reforms, as the foundations of education have changed, so has the distribution of illiteracy. Between rural and urban areas, male and female, inequality on education has risen substantially since the reforms began (Appiah-Kubi, 2002). In order to find a measurement of this inequality, a new indicator for the distribution of human capital and welfare have come up with an education Gini index that also facilitates comparison of education inequality across countries and over time (Thomas et al, 2000).
Education has a major role in the accumulation of human capital (Galor and Moav, 2004). In order to gain socio-economic equilibrium, government should invest a huge amount of money in public education. Easterly (2004) found that inequality in education is positively correlated with income inequality, however, there is a weak association between education attainment and output per worker. In the basis of economic logic, education enhances social and political mobility. Educated people are better to speak up their rights, to organize themselves, and to bargain in the political process where a substantial share of national resources is redistributed. In other words, if education is distributed unequally, income would be distributed unequally.
To reach equality on education, government must have a proper policy on demand and supply of education. There are four factors affecting individual demand of education (Tesfeye, 2002). Firstly, household characteristics. Secondly, children characteristics. Thirdly, quality of schooling. Lastly, return from schooling. Meanwhile, quantitative factor is one factor affecting individual supply of education (Tesfeye, 2002). It is undeniable that a good policy on demand and supply of education by the government may achieve equality on education in all levels of income, particularly the poorer.
Prior to determining education inequality in Indonesia, the author firstly ascertain at which level of education people attaining school. There are four indicators, recently used by the government, to measure education level in Indonesia. Firstly, school enrollment ratio or called Angka Partispasi Sekolah (APS), which is the number of Indonesian who attained three levels of education from the 7-to-12-year-old age group, represents primary school, to the 16-to-18-year-old age group, represents senior secondary school. Secondly, net enrollment ratio or called Angka Partisipasi Murni (APM), which is the number of Indonesian who are still schooling in three levels of education from primary school to senior secondary school. Thirdly, educational attainment, which is the number of Indonesian who completed six levels of education attainment from people who never been attended to school to people who completed university. Lastly, literacy rate, which determines the individual ability to read and write. From 1999 to 2005, there was a dramatic increase in APS, APM, educational attainment, and literacy rate respectively (BPS, 1999-2005).
Even though there was a steady increase in APS, APM, educational attainment, and literacy rate in 2005 that gives the indication of the improvement in education gaps among gender and areas, as reflected in productivity and earnings, these indicators do not clearly provide education equality and sufficiently reflect absolute and relative dispersion of human capital (Thomas et al, 2000). Hitherto standard deviations of schooling have been used to measure the dispersion of schooling distribution in absolute term, however, to measure the dispersion in schooling distribution in relative term, it appears that education Gini seems to be appropriate measure that reflects the improvement in the distribution of educational opportunities which is crucial for generating income (Thomas et al, 2000).
In this paper, I use the existence model of Thomas et al (2000) by using the educational attainment data from National Social Economic Survey (SUSENAS) between 1999 and 2005 in 23 provinces to clarify and compare the pattern of Gini coefficient of education among areas and gender. In addition, I investigate if education Gini positively influences the difference of illiteracy rate among gender and standard deviations of schooling respectively. Moreover, I resolve if education Gini negatively associates with average years of schooling. Lastly, I settle if the relationship between average years of schooling and standard deviations of schooling forms education Kuznets curve.
The main findings suggest that inequality in education as measured by education Gini is negatively associated with average years schooling, implying that higher education attainment are more likely to achieve equality in education. Moreover, a clear pattern on an education Kuznets curve exists if standard deviation of schooling is used. Furthermore, gender gaps are related to education inequality and the relation between these variables become stronger over time.
The paper is organized as follows. Section II provides literature review on the role and distribution of schooling and indicator of measuring education inequality. Section III describes research methodology in which I use both direct and indirect method. Section IV implies an empirical result about the relationship among variables. Section V explains conclusion and policy recommendations.
II. LITERATURE REVIEW
1. Empirical Studies on the Role and Distribution of Schooling
Mass and Criel (1982) examined the distribution of primary school enrollment and asserted that enrollment Gini is very enormously changed across countries. They describes a negative relation between the average enrollment and its distribution where the higher the average enrollment, the lower the Gini coefficient. On the other hand, Ram (1990) applied income Kuznets curve to form educational Kuznets curve. The finding confirms that as the average level of schooling rises, educational inequality first increases, then after reaching a peak, educational inequality starts to decline. The turning point of this declining is about seven years of education.
O’Neill (1995) argued that the stock of human capital is the accumulation of the past education and not sensitive to the current income level. The finding proves that among the developing countries, convergence in education levels has resulted in a reduction in income dispersion. Yet, incomes have diverged globally despite substantial convergence in education levels. In contrast, Birdsall and Londono (1997) used cross-country analysis to form a traditional growth model and put forward initial levels of educational inequality and land Gini have strongly negative impacts on economic growth and growth of the poorest income.
Lopez et al (1998) constructed the asset allocation model and Gini coefficient of educational attainment and investigated the linkage between distribution of education and growth. Their major findings are the following: Firstly, the distribution of education is very important to describe income levels and economic growth, and if it is distributed unequally, it would bring negative impacts on income levels and economic growth. Lastly, economic reforms improved the productivity of human capital in growth models. By controlling the distribution of education, which is one of the economic reforms agenda, the government can rise the average years of schooling.
Gregorio and Lee (1999) presented the empirical evidence on how education and income have related to income distribution. They validate higher attainment and distribution of education as a means of changing income distribution. In this case, the Kuznets inverted-U curve takes into account. In addition, government social expenditure contributes to the more equal distribution of income. Yet, the growth of income and education could not make income and education inequality decline substantially in a short and long period. Meanwhile, Inter-American Development Bank (1999) examined standard deviation of education to measure education inequality and claimed that there is a positive association between standard deviations of education and education inequality in the sense that the higher standard deviations of education, the greater education inequality measured by Gini coefficient education.
Thomas et al (2000) constructed Gini coefficient to find educational attainment inequality. The finding establishes that the inequality in educational attainment declined over three decades of 1960-1990 and it is negatively associated with the average years of schooling. Furthermore, the educational Kuznets curve exists when standard deviations of schooling are used and gender-gaps are closely associated to the education inequality where the connection between two variables boil down to stronger over time. Lastly, per capita PPP GDP increments are positively correlated with the labor force’s average years of schooling. In contrast, Siddhanta and Nandy (2003) maintained that education inequality, gender gaps of educational attainment, average years of schooling, standard deviations of schooling, and illiteracy rate in rural area are higher than urban area. In addition, prosperity and gender gap of education in urban area is negatively associated, while in rural area, this correlation turns to be positive.
2. Indicators of Measuring Education Inequality
2.1 Enrollment Ratios
The enrollment ratio for different levels of schooling was used as indicators of human development at the initial stage (Levine and Zervos, 1993). The most commonly used are the primary enrollment ratio, the junior secondary enrollment ratio, and the senior secondary enrollment ratio. Of all measurement of equality education, Bureau Statistic Indonesia is not only estimating school enrollment ratio but also appraising net enrollment ratio. However, enrollment ratio only measures the access of people’s education and it does not show the cumulated educational attainment. Thus, it is inappropriate to use these enrollment ratios in growth models. In addition, enrollment ratio does not reflect the stock of human capital (Thomas et al, 2000).
To counter the disadvantages of these indicators, there is a grade enrollment ratio based on the percentage distribution of pupils among grades in a particular schooling system (UNESCO, 1996). The advantages of the grade enrollment ratio as follows (Castello and Domenech, 2002): Firstly, the grade enrollment ratio captures more detail on student performances. Secondly, average attainment levels did not influence the grade enrollment ratio. However, the data do not reflect working age population so that is a time lag where student in primary grades will enter into the labor force after a lag of approximately 5 to 15 years (Frankema and Bolt, 2006).
2.2 Average Years of Schooling
Psacharopoulos and Arriagada (1986) suggested that the proper indicator of human development level is the stock of educational attainment defined as average years of schooling. They collected the information about each country’s schooling distribution and calculated educational attainment whereas Barro and Lee (1991) formalized the use of educational attainment for growth regressions. Nehru et al (1994) created a cross-country database for educational attainment, through evaluating the schooling distributions over time for various countries. Yet, this indicator does not describe the characteristic of human capital gap in terms of absolute and relative (Thomas et al, 2000).
2.3 The Quality of Schooling
Behrman and Birdsall (1983) believed that the quality of schooling should be taken into consideration when measuring the level of human development instead of using the quantity of schooling. There are two typical approaches used to measure the quality of education. The first approach is the input. It is very relevant to see which country provides more resources to education than other sectors. Pupil-teacher ratio, expenditures on teacher’s wage, books, and other reading materials can measure the inputted resources into education (Thomas et al, 2000). However, the high volume of input does not make the yield of schooling quality improve. Moreover, the inputs for schooling depend on the income level. Based on those matters, Hanushek and Kim (1995) refuted a limited feasibility of using input of schooling as the proxies for education equality.
The last approach is the output that directly measures the achievement of schooling by comparing the scores of cognitive performance. The students of the same-age group of various countries are obtained by the same international test on the same subject including mathematics and science (Thomas et al, 2000). The assessment of student achievement was conducted both by the International Association for Evaluation of Educational Achievement (IEA) and by International Assessment of Education Progress (IEAP) (Hanushek and Kim, 1995). Yet, Barro and Lee (1997) found that these measurements could only be explained in the Industrial Countries and could not comparable over time.
2.4 Standard Deviations of Schooling
Standard deviation has been used to measure the absolute dispersion of assets distribution. Ram (1990) used standard deviations of schooling to illustrate the existence of the education Kuznets curve. Birdsall and Londono (1997) investigated the impact of initial asset distribution on growth and poverty reduction and found a significant negative correlation between education dispersion, measured by standard deviations of schooling, and income growth. Inter-American Development Bank (1999) took standard deviations of schooling to measure education inequality.
2.5 Gini Coefficient of Education
As standard deviations of schooling only measures the absolute dispersion of schooling distribution, developing education Gini is very necessary for measuring the inequality of schooling in relative term. Education Gini concept is very similar to income Gini and can be calculated by using enrollment, financing, and attainment data. Rosthal (1978) estimated Gini coefficient using education finance data in several East African Countries. Sheret (1988) utilized enrollment data in Papua New Guinea to reckon Gini index. However, these studies do not emphasize on the distribution of school attainment.
III. DATA and METHODOLOGY
1. Data
This research uses National Social Economic Survey (SUSENAS) data, which have been conducted by Bureau Statistics Indonesia (BPS). SUSENAS is a repeated cross-section and nationally representative household survey that has two main components. The first one is Core SUSENAS, which collects basic socio-demographic information on households and individuals and is conducted annually. The second component, Module SUSENAS, gathers detailed information on households. There are three different modules-consumption, health, and education and each module is conducted triennially. The Core covers about 200,000 households and 800,000 individuals, while the Module covers a sub-sample of about 65,000 households. I take Core SUSENAS from 1999 to 2005 in 23 out of 31 provinces in Indonesia because five provinces such as Banten, Gorontalo, Bangka Belitung, Riau Islands, and North Maluku are an extension of the previous provinces such as West Java in 2000, North Celebes in 2000, South Sumatra in 2000, Riau in 2004, and Maluku in 1999 respectively. The other provinces such as Maluku, Nangroe Aceh Darussalam, and Papua still flared up between 2000 and 2002, made the data unstable.
2. Methodology
On the purpose of estimating education inequality in Indonesia, I use direct method to capture education Gini coefficient, average years of schooling, and standar deviations of education. In addition, Lorenz curve based on the cumulative proportion of population and that of schooling will be visualized in indirect method.
2.1 Direct Method
The direct method states that the education Gini is defined as “the ratio to the mean (average years of schooling) of half of the average over all pairs of the absolute deviations between all possible pairs of people” (Deaton 1997). Thomas et all (2000) developed Deaton’s formula, which is shown in equation 1.
(1)
Where: E L is the education Gini based on educational attainment distribution; µ is the average years of schooling for the concerned population; pi and pj stand for the proportions of population with certain levels of schooling; yi and yj are the years of schooling at different educational attainment levels; n is the number of levels in attainment data.
Barro and Lee (1991) divided the population into seven categories include no schooling or illiterate, partial primary, complete primary, partial secondary, complete secondary, partial tertiary, and complete tertiary. However, BPS shared the population into six categories attainment include never been to school, not complete primary school, complete primary school, complete junior secondary school, complete senior secondary school, complete tertiary school or university.
The average years of schooling and standard deviations of schooling can be calculated in formula 2 and 3 respectively.
(2)
(3)
2.2 Indirect Method
The indirect method constructs the education Lorenz curve, shown in figure 1, which is the combination between the cumulative percentage of the schooling years on the vertical axis, shown in S, and the cumulative percentage of the population on the horizontal axis, shown in Q. The forty-five degree line is the education egalitarian line, represents a perfect equality of schooling. Thus, the education Gini is estimated using the indirect method as the ratio between the area of A and the area of OWQ.
Figure 1: Education Lorenz Curve
S W
Cumulative
Proportion of Egalitarian Line
Schooling A
Lorenz Curve
O Q
Cumulative Proportion of Population
IV. EMPIRICAL RESULTS
1. Education Gini in terms of Areas and Provinces
In terms of region, there was a significant improvement in Gini coefficient of education from 1999 to 2005 (see table 1). Between 1999 and 2005, the national Gini education decreased steadily. Both rural and urban Gini education fell significantly from 0.29 and 0.36 in 1999 to 0.27 and 0.32 in 2005 respectively. In addition, the effort of rural area to improve their education equality is more likely to outweigh urban area. According to Suwignyo (2004), both local and state government put their resources to improve quality of education, mainly in school infrastructure, to stimulate demand of education in rural area, so there is a tendency that rural area grows faster than the urban area.
Table 1: Development of Gini Coefficient of Education in Rural, Urban, and Indonesia
Area 1999 2001 2003 2005
Indonesia 0.35 0.35 0.33 0.32
Rural 0.36 0.35 0.34 0.32
Urban 0.29 0.30 0.28 0.27
Source: Author’s calculation, data available upon request
In terms of provinces, education Gini in 23 provinces fell gradually. There was a sharp decrease in Gini coefficient of education in West Borneo, Jambi, South Sumatra, East Java, North Celebes, and South-East Celebes. In contrast, Daerah Istimewa Yogyakarta (DIY) almost remained stable in its Gini education. Overall, DKI Jakarta has the lowest level of education inequality whereas the highest level is West Nusa Tenggara (NTB). In the case of NTB, regional budget in education sector is very limited (only 5 per cent) and it affects the supply education factors such as the inadequacy on facility and the less number of schools. Furthermore, the demand education factors, such as the inadequacy on household, child inability, and the low quality of schooling, give the impact on high education inequality in NTB. On the other hand, DKI Jakarta spends almost 20 per cent of total regional budget on education sector, primarily on the effort to increase quality and quantity of schooling (Digdowiseiso, 2007).
2. Education Lorenz Curve in terms of Areas
In Figure 2 distribution of schooling in 2005 is more equal than that in 1999 as the Gini coefficient of education in 2005 is much better than that in 1999. In addition, the same condition takes place in rural and urban area in distribution of schooling in 2005 (see Figure 3 and Figure 4).
Figure 2: Education Lorenz Curve in Indonesia
Source: Author’s Calculation
Figure 3: Education Lorenz Curve in Rural Area
Source: Author’s Calculation
Figure 4: Education Lorenz Curve in Urban Area
Source: Author’s Calculation
Figure 5 shows the comparison between rural Lorenz curve and urban Lorenz curve and indicates that the education inequality gap between rural and urban area is much more slightly. The fact that there is a promising development of distribution of education in rural area endorses a specifically targeted policy to reduce the gap between rural and urban area.
Figure 5: Education Lorenz Curve between Rural and Urban Area
Source: Author’s Calculation
3. Average Years of Schooling in the Period of 1999-2005 in Terms of Areas and Provinces
Average years of schooling in rural, urban, and Indonesia rose sharply (see table 2). It means that there is an improvement in education equality in these areas, particularly rural. Setyorini (2002) took issue with the differences between rural and urban average years of schooling that rural area was “gifted” an innate ability so that it boost the demand of education. However, it might not be true as increasing quantity of education and thus supply of education leads to a significant rise in average years of education (Duflo, 2001).
Table 2: Development of Average Years of Schooling in Rural, Urban, and Indonesia
Area 1999 2001 2003 2005
Indonesia 6.30 6.33 6.57 6.79
Rural 5.08 5.17 5.47 5.75
Urban 7.80 7.68 8.10 8.27
Source: Author’s calculation, data available upon request
In terms of provinces, there was a gradual increase in average years of schooling in 23 provinces in Indonesia from 1999 to 2005. North Celebes attains the greater difference on average years of schooling and an evidence of state government intervention, as in Duflo case, occurs in this area. Yet, Samiadji (2001) argued that the household characteristics are positively correlated with average years of schooling, while quantity of education has no impact in education equality in North Celebes. Furthermore, there was a significant rise in average years of schooling in East Java, Jambi, Central Borneo, and Bali. Overall, DKI Jakarta has the highest average years of schooling while East Nusa Tenggara (NTT) has the lowest one. In the case of NTT, the inadequacy on household (i.e. lack of income and higher siblings in the family) and the lower quality of schooling play a major role on the inefficiency demand of education (Samiadji, 2001).
4. Standard Deviations of Schooling in terms of Areas and Provinces
Standard deviations of schooling in rural, urban, and Indonesia fluctuated annually (see table 3). Increasing and decreasing on standard deviations of schooling will decrease and increase the level of education inequality. Thus, this condition is very contrast to the fact that Gini coefficient of education can measure the equality on education in rural, urban, and Indonesia appropriately.
Table 3: Development of Standard Deviations of Schooling in Rural, Urban, and Indonesia
Area 1999 2001 2003 2005
Indonesia 3.94 3.92 3.90 3.99
Rural 3.35 3.40 3.36 3.58
Urban 4.07 4.12 4.08 4.14
Source: Author’s calculation, data available upon request
In terms of provinces, standard deviations of schooling in Central Borneo, South Borneo, Riau, Daerah Istimewa Yogyakarta, and South-East Celebes fell significantly from 1999 to 2005. This means that education inequality between one province and the other is decreasing. In addition, standard deviations of schooling in 18 provinces rose dramatically in 2005. It indicates that the spread of education attainment between one province and another province becomes wide every year. Thus, education inequality between one province and the others is increasing.
5. Education Gini in terms of Gender
Education equality improved significantly from 1999 to 2005 (see table 4). In terms of total, there was a dramatic decline in both male and female Gini coefficient of education within this period. In terms of urban and rural area, between 1999 and 2005 both male and female Gini coefficient of education fell slightly. Overall, total population in urban area has bigger education equality than that in rural. Moreover, male population has bigger chance to extend their education, due to the possibility of the parents to give larger opportunity of schooling to male children (Digdowiseiso, 2007).
Table 4: Development of Gini Coefficient of Education in Rural, Urban, and Indonesia in terms of Gender
Gender Region 1999 2001 2003 2005
Male Rural 0.32 0.32 0.31 0.31
Urban 0.27 0.27 0.27 0.26
Female Rural 0.38 0.38 0.36 0.36
Urban 0.31 0.31 0.30 0.29
Total Rural 0.37 0.38 0.35 0.35
Urban 0.32 0.32 0.30 0.30
Source: Author’s calculation, data available upon request
6. Education Lorenz Curve in terms of Gender
In 2005 total female Lorenz curve moved closer to the male Lorenz curve (see Figure 6). On the other hand, the gap between female and male Lorenz curve decreased slightly in 2005 in both urban and rural Lorenz curve (see Figure 7 and 8). The positive developments in female education were apparently not large enough to reverse the widening education gender-gap in Indonesia. This proves that changing inequality in Indonesia requires increased public attention and proper policy targeting towards female schooling.
Figure 6: Gender Lorenz Curve in terms of Total
Source: Author’s Calculation
Figure 7: Gender Lorenz Curve in Rural Area
Source: Author’s Calculation
Figure 8: Gender Lorenz Curve in Urban Area
Source: Author’s Calculation
7. Average Years of Schooling in terms of Gender
The gap between male and female average years of schooling is an important indicator of developmental differential (Siddhanta and Nandy, 2003). Table 5 reveals that average years of schooling of male population, female population, and Indonesia rose significantly from 1999 to 2005. It shows that the difference of the increment in female average years of schooling is bigger than that in male. Siddhanta and Nandy (2003) argued that improving female education is far more than that of educating male. However, social preferences may deter investment in female education and thus, functioning equality (Samiadji, 2001).
Table 5: Development of Average Years of schooling in terms of Gender
Gender 1999 2001 2003 2005
Indonesia 6.30 6.33 6.57 6.79
Male 6.85 6.82 7.03 7.25
Female 5.88 5.94 6.24 6.46
Source: Author’s calculation, data available upon request
8. Standard Deviations of Schooling in terms of Gender
Male standard deviations of schooling and female standard deviations of schooling fluctuated gradually from 1999 to 2005 (see table 6). There was an improvement in male standard deviations of schooling and a decrease in female’s standard deviations of schooling. Intuitively, this result should give the impact on the higher male Gini coefficient of education and the lower one in female. However, both male and female Gini education falls significantly in table 4.
Table 6: Development of Standard Deviations of Schooling in terms of Gender
Gender 1999 2001 2003 2005
Indonesia 3.94 3.92 3.90 3.99
Male 3.92 3.96 3.82 3.95
Female 3.99 4.02 3.96 3.98
Source: Author’s calculation, data available upon request
9. The Difference Illiteracy Rate among Gender
To analyze education inequality among gender, the author uses the difference of illiteracy rate between male population and female population. The gap between men’s and women’s literacy rate is a rough but informative indicator of the gender difference in many forms of human capital (Siddhanta and Nandy, 2003). In the 2005 spatial pattern of gender inequality, If 6-percentage point of gender disparity is considered as a crucial level, then I found that 18 provinces lie below this level. Among these, the location of 17 provinces is striking; together they form a contiguous belt.
An even more striking spatial contiguity of provinces has been found for the rural population above the cut-off point 7.6-percentage point since most of them are located in western part of Indonesia. In the urban population, 6 provinces have gender gap in literacy rate more than national average. Of these, 5 provinces form a geographical contiguity. The pattern of the spatial contiguity for the urban population is similar with that of the rural population.
In 1999, DIY and North Celebes (SULUT) are the highest and lowest difference of illiteracy rate among gender in both rural and urban area respectively. The result is very surprising, considered that DIY is well known as “province of education”. Suwignyo (2004) claimed that DIY has low demand of education in rural area such as the tradition of parents to give education only on male children and insufficient household characteristics. In contrast, NTB and SULUT are the highest and lowest gender gap in illiteracy rate in terms of total.
In 2005, Bali and DKI Jakarta had the highest and lowest difference of illiteracy rate among gender in rural area and total respectively. Another shocking finding occurs in the former where tourism sector is the biggest contribution of its regional budget. Samiadji (2001) believed that culture in Bali is associated with gender bias and thus, functioning demand for education. On the other hand, NTB and SULUT are the highest and lowest gender gap in illiteracy rate in urban area.
10. The Association between Education Gini and Average Years of Schooling
This study proves that there is a significant association between Gini coefficient of education and average years of schooling. The relation between both factors is briefly explained in the exponential equation as shown below:
ln GINI = -0,171 LAMA (4)
R2 = 0.994 t = (-159.833)
Where: GINI is Gini coefficient of education; LAMA is average years of schooling.
Equation 4 states the estimation of t at -159.833, signification at 0.00, and R2 at 0.994, hence average years of schooling influence significantly to Gini coefficient of education at 5 percent level. Figure 9 shows the decreasing of Gini coefficient education, at the time average years of schooling rise. Thus, there is a negative correlation between Gini coefficient of education and average years of schooling and this supports Thomas’s et al (2001) finding.
Figure 9: Education Gini and Average Years of Schooling
Source: Author’s Calculation
11. The Relationship between Education Gini and Standard Deviations of Schooling
This research establishes a significant relation between Gini coefficient of education and standard deviations of education. The relation between two factors is briefly described in the linier equation as shown below:
GINI = 0,083 DEV (5)
R2 = 0.985, t = (101.419)
Where: GINI is Gini coefficient of education; DEV is standard deviations of schooling.
Equation 5 describes the estimation of t at 101.419, signification at 0.00, and R2 at 0.985, therefore standard deviations of schooling influence significantly to Gini coefficient of education at 5 percent level. Figure 10 indicates that once standard deviations of schooling increase, Gini coefficient of education rise. Thus, this result is very similar to Inter American Development Bank’s (1999) finding where Gini coefficients of education and standard deviations of schooling are positively correlated.
Logically, if there is any improvement on Gini coefficient of education, education inequality will increase represented by the increasing in standard deviations of schooling. Of course, it is very contrast to the principle of equality distribution of education. Therefore, standard deviation of schooling is not appropriate measure to describe educational equality (Thomas et al, 2001).
Figure 10: Education Gini and Standard Deviations of schooling
Source: Author’s Calculation
12. The Relationship between Average Years of Schooling and Standard Deviations of Schooling
This study finds that Gini coefficient of education associates with standard deviations of education where this relation will form education Kuznets curve. Figure 11 explains that at first, education inequality increases, then after reaching a peak, education inequality fall gradually. This result endorses Ram’s (1990) finding, however, the turning point of his finding is about 7 years while the turning point of this study is about 7.4 years. It means that a country with average years of schooling below 7.4 years should increase its standard deviations of schooling to gain equality on education. In contrast, a country with average years of schooling above 7.4 years should decrease its standard deviations of schooling to attain education equality.
Figure 11: Educational Kuznets Curve
Source: The Author’s Calculation
13. The Association between Gini Education and The Difference of Illiteracy Rate among Gender
Thomas et al (2001) suggested that the Gini coefficient of education is positively associated with gender gap in literacy rate and the relation between education inequality and gap among gender is getting much stronger over time. The result maintains that education inequality are clearly related to gender gap from 0.79 in 1999 to 0.83 in 2005 (see Figure 12 and 13).
GINI99 = 0.275 + 0.009 GENDER99 (6)
R2 = 0.625, R = 0.79, t = (5.914)
GINI05 = 0.248 + 0.011 GENDER05 (7)
R2 = 0.694, R = 0.83, t = (6.901)
Where: GINI99 is Gini coefficient of education in 1999; GINI05 is Gini coefficient of education in 2005; GENDER99 is difference illiteracy rate among gender in1999; GENDER05 is difference illiteracy rate among gender in 2005.
Equation 6 and 7 show that the estimation of t is 5.914 in 1999 and 6.901 in 2005 and most importantly, the signification of both years at 0.00. Therefore, difference of illiteracy rate and Gini coefficient of education is significantly related at 5 percent level.
Figure 12: Education Gini and Gender Gaps in 1999
Source: Author’s Calculation
Figure 13: Education Gini and Gender Gaps in 2005
Source: Author’s Calculation
V. CONCLUDING REMARKS
This study measures education inequality in Indonesia from the period of 1999 to the period of 2005 by using two methods, the direct method and the indirect method. The direct method will be focused on estimating Gini coefficient of education while the indirect method will be applied on formulating education Lorenz curve. By using both direct and indirect method, the author can analyze education inequality in terms of areas and gender. To sum up, there are several major findings on education inequality aspect in Indonesia.
Firstly, in terms of national, there was a significant decrease in education Gini from 0.35 in 1999 to 0.32 in 2005. Meanwhile, in terms of provinces in Indonesia, there is an annual improvement on education inequality. The exceptional case occurs in Bali, East Nusa Tenggara, and West Borneo where their Gini education is very vulnerable to the immediate shock. Secondly, study among areas describes that over time, rural area has higher education inequality than urban area. Between 1999 and 2005, the Gini coefficient of education of rural area decreased dramatically from 0.36 to 0.33 and there was a slight fall in Gini coefficient of education of urban area from 0.29 to 0.28.
Thirdly, study among gender shows that female population has higher education inequality than male population over time. Between 1999 and 2005, the Gini education of female population declined steadily from 0.37 to 0.35 and there was a significant decrease in the Gini education of male population from 0.32 to 0.30. Fourthly, the interrelatedness study between gender and area states that the level of education inequality of both female and male population in rural area is higher than that in urban area.
Lastly, in terms of association between two variables, there is a negative correlation between Gini coefficient education and average years of schooling. This research substantiates standard deviations of schooling is not a proper measurement to estimate distribution of schooling, due to the increasing standard deviations of schooling will give a bad impact on education equality. Another major finding is that there is a relationship between standard deviations of schooling and average years of schooling which forms education Kuznets curve, where at first, educational inequality increases, then after reaching a peak at 7.4 years, educational inequality starts to decline. Furthermore, this study claims that there is a positive relation between education inequality and the difference of illiteracy rate of gender, and over time, the association between gender-gaps and inequality becomes stronger.
Based on these findings, it clearly states that Gini index need to be incorporated with the quality aspect and examined any causal relationship between education Gini and income growth, which are challenges for future studies. The need to disentangle the association between education inequality and other aspects of development, such as income inequality, income level and growth, gender gaps, education-related policies, poverty is very essential in any future research. Another item on research agenda is how to account the interaction effects between education inequality and economic freedom. Finally, this research shows the necessity for more complex interactions, mechanisms, and dynamic models of all kinds to be considered when studying within-country education inequality in the future.
There are several policies that the government could take the steps to help the efforts in achieving education equality in Indonesia. Firstly, both state and local governments must have taken over the responsibility to managing every potential resource in their own, primarily human resource. For instance, they have to increase both the quality and quantity of schooling such as teacher’s quality and qualification, student per teacher ratio, teacher’s wage and other incentives, school facilities and maintenance, and the number of school. Beside that, they have to empower female and rural population by mitigating literacy rate, applying the nine-year education program, and developing the one-roof education program which combines primary school and junior secondary school into one building closes to the community.
Secondly, the central government must increase national budget on education sector to improve education equality and to give financial support to both state and local governments, if required. Moreover, the central government has to alter the scholarship scheme to reach children who cannot continue to school after completing primary school. Another policy is that the central government must increase the opportunity cost of not going to school by providing cash subsidies directly to the family. In addition, the central government must give a specifically targeted campaign to promote the importance of education. Lastly, people should actively enact as a leading role in the implementation of education.
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Stock Market Crash
THE 1929 STOCK MARKET CRASH:
Lessons Learnt
Abstract
The complexity and magnitude of the economic catastrophe during the period of stock market crash made governments worldwide reassess their current economic framework. This paper will focus on how the 1929 stock market crash taught the need for international cooperation to prevent policies such as protectionism, which could lead to trade wars and competitive devaluation by countries. In conjunction with the need for appropriate macroeconomic policies influenced by new theories and national experiences of recovery that took place throughout this time. Thus, nations need to ensure a financial market infrastructure that inspires confidence through transparency. In addition, macroeconomic policy, especially monetary policy, now pays more attention to financial stability issues, with a global perspective.
Keywords: Stock, Trade, Macroeconomics, International
I. INTRODUCTION
The conceptual frameworks of the global and national economies are forever changing and improving as they are influenced by national as well as global experiences, continual integration, and application of new and existing economic theories. Some of the most notable and significant global economic changes stems from the 1929 stock market crash.
Over the four years beginning in the summer of 1929, financial markets, labour markets and goods markets all virtually ceased to function. The defining characteristic of this period is the collapse of virtually every aspect of the economy. Throughout this term, the government policymaking apparatus seemed helpless. The complexity and magnitude of the economic catastrophe during this period made governments worldwide reassess their current economic framework. For this reason economic institutions are very different today than they were in 1929. Globalized markets now operate within politically defined rules and governance institutions. As well as the creation of global regulations, institutional framework, and economic governance sanctioned.
This paper examines the lesson learnt from the 1929 stock market crash. Procuring the view that the 1929 stock market crash provided numerous lessons to be learnt, identifying and recognizing two overall lessons were therefore fundamentally important in changing the global economy to its current framework. In addition, this paper also discusses the consequences of stock market crash in the context of Italy because Italy experienced a lower degree of industrial development during that period.
II. THE 1929 STOCK MARKET
This section will elucidate, illustrate, and define the causes, impacts, solutions and events that transpired throughout the 1929 stock market crash and great depression
2.1 What transpired?
In October 1929 shares in Wall Street fell sharply following a speculative boom during the period known as the Roaring Twenties. Within two days, the Dow Jones industrial average fell by 25% ending on Black Tuesday, 29th of October. The volume of stocks traded set a record that was not broken for 40 years. When it finally reached its record low in July 1932, the Dow Jones had fallen 89%, and it did not recover to 1929 levels until 1954 (Galbraith, 1997; Weidenbaum & White, 1990).
In the US, the recession began in September 1929 and continued officially until March 1933. By the end of the 3.5‐year long down‐ turn, industrial production shrank by half. Consumer prices dropped by over a quarter and unemployment surged from 3.2 % to nearly 25 %. This period is visually aided below in figure 1, illustrating the stock market and its level in conjunction with the year (Galbraith, 1997; Weidenbaum & White, 1990).
Figure 1: The 1929 Stock Market
Source: The Great Stock Market Crash of 1929, 2009
2.2 What was the cause?
Debates continue over the causes of the Wall Street crash, there are numerous contributing arguments and factors that are defined throughout this period. Although the prevailing mainstream economic belief today is that monetary policy errors transformed what may have been a normal recession in the early 1930s into the Great Depression. It is believed that the Federal Reserve was the foundation of the Great Crash and the subsequent economic downturn by tapering policy in order to deflate the asset bubble fermenting in the equity markets. The Federal tightened monetary policy from the march of 1928 until the Great Crash despite moderate economic performance, many Federal officials at the time believed that speculative investment was fruitless and required hindering. This was part of a set of guidelines, that if banks limited their lending to sound businesses, the appropriate amount of money would automatically regenerate (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & White 1990).
Therefore, the Federal was to constrain any manner of lending, especially loans for buying stocks or bonds. This policy resulted in a pro-cyclical monetary strategy, since business loans had a propensity to enlarge and contract with the economic cycle. The unconstructive monetary policy and the aspiration to discontinue speculative investments are aspects that contribute to the Great Depression. At that time, professional economists such as Irving Fisher provided no consensus view, but a number of them also argued that the stock market was in line with fundamentals (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & White, 1990).
2.3 What was the impact?
The Wall Street crash correspond to an astute decline in US economic output, which eventually spread around the world. The US economy shriveled by a third illustrated by Figure 2 it demonstrate the dramatic drop in GDP over this period. While unemployment constantly rose, with many more workers on short hours, Figure 3 below visually depicts the unemployment rate rising, as US economic output withered. In conjunction, the US banking system had seized up completely, and the first act of the new Roosevelt administration when it came to power was to close all banks for two weeks while Federal inspectors examined their books.
Bankruptcies were increasingly numbered, while bank loans were not being repaid, furthermore there was no federally guaranteed depositors insurance to inspire depositor confidence, and in 1929 alone, there had been 659 bank failures. With no unemployment benefits or government help, the sharp fall in workers income had a big effect on consumption and led to a negative spiral of more factory closures, as the vicious cycle continued. Most observers believe that economic policymakers made the economic downturn worse by adopting tight monetary policy and balanced budgets as the crisis exacerbated. International trade also shrank as the US went off the gold standard and erected high tariff barriers to prevent foreign imports (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
Figure 2: GDP of USA in the Period of 1920-1940
Source: Carter, 2006
Figure 3: The Unemployment Rate from 1929 to 1940
2.4 How was the situation and responded to and resolved?
The Great Depression lingered on despite the variety of New Deal measures that attempted to alleviate the suffering of individuals by providing government jobs, welfare relief, or mortgage protection. On top of the federal governments actions, such as tightening of monetary policy, tariffs, and increasing discount rates. Initially the authorities tried to rebuild confidence in markets by making reassuring speeches, but only a shakeout of workers from industry would ultimately restore prosperity (Hall & Ferguson, 1998).
Private charity was relied on to help the victims of the slowdown. In 1932, the US government intervened to provide unemployment relief, to stabilize markets by restricting production, to encourage unions, and to create a government system of old age pensions and unemployment insurance known as social security. However, the administration had less success in reviving economic growth and business confidence remained weak (Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
It was only the onset of World War II, when the US government finally embraced Keynesian-style deficit spending on a large scale that the economy recovered. US economic output doubled during the war, and unemployment vanished as women and African Americans were drawn into the workforce to substitute the millions drafted into the military. At its peak, the US government was borrowing half the money needed to finance the war, while half raised by taxes (Galbraith, 1997, Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
The 1929 stock market crash and the great depression following cannot be pinpointed from one action alone, although blame namely rests with a failure of monetary policy and political decisions such as implementing trade tariffs. Furthermore, these failures
III. LESSONS LEARNT
This section will explicate the need found for appropriate macroeconomics policies, influenced by new theories and national experiences of recuperation throughout this period. In addition, it will elaborate on the need for international cooperation, to ensure prevention of trade wars and competitive devaluations.
3.1 The Need for Appropriate Macroeconomic Policies
3.2.1 New Theories of Economic Governance
One of the most significant lessons learnt throughout this period was the need for transformation in current economic theories and economic governance. The notion that the stock market crash and the Great Depression would turn out to be “good medicine” for the economy, and the proponents of simulative policies were shortsighted enemies of the public welfare was the belief by many countries throughout this period. Hence, fiscal policy also failed to respond immediately to the Great Depression, prior to the 1930s, since active fiscal policies was nonexistent (Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
Economist such as Keynes believed governments should use its immense financial powers such as taxing and spending, as a sort of counterbalance to stabilise the economy. Thus, depressions ought to be attacked with increased government spending at the bottom of the income pyramid. This position is the opposite of the trickle down affect. Keynesian economists call this counter‐cyclical demand management, believing that the government's massive financial impact can be used as a counterweight to current market forces. (Cechetti, 1997; Eichengreen, 1995; Fair, 2000)
Keynes feared that "the slump" that he saw in 1930 possibly will pass over into a depression, along with a drooping price level, that has the capacity to last for years with incalculable damage to the material wealth and to the social stability of every country alike. Calling for a resolution via coordinated monetary expansion by the major industrial economies would repair confidence in the international long-term bond market and raise prices and profits, so that in due course the commerce of the world’s economy would be in motion once more (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
Keynes believed that people did not have enough income to buy everything the economy produced, so prices fell and business went bankrupt. He argued that governments could halt the vicious cycle by increasing spending on its own or by cutting taxes. Either way incomes would rise or people would spend more. If the government had to run a deficit, so be it, because the alternative would be much worse, believing it was common sense to put idle resources to work. Furthermore, savings otherwise not invested and workers left unemployed could generate beneficial public assets if the government took the initiative (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
When Keynesianism ideology was applied to construct a fiscal revolution to pull the economy out of depression, this challenged the idea of constantly balancing the budget, via boosting effective demand by stimulating consumption. Keynes rightly invoked fresh economic approaches rather than taking refuge in motionless policy. The pronouncement “in the long run we are al dead” was an scolding reproach against the irresponsibility of doing naught if economist rely on the self-correcting power of market forces (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
Although there were exceptions of the economic collapsed, this period substantiated need for alternative policies of economic governance at an international and state level. Allowing them to gain from alternative thoughts and new models that arose out of this period and hence, the exploration of a country’s economic policies in this time, enabled states to learn and will encourage appropriate monetary policy in the future situations.
3.2.2 National Experiences of Recovery
Sweden provides example of how a small country could close its door to the transmission of the depression by following a wise economic and financial policy. To some extent, this was due to good advice by Swedish economists to a government that was prepared to listen to them. However, it was also because Sweden had no deep homemade catastrophe to cope with. The Swedish central bank followed a cautious and steady policy aimed at stabilizing the price level. The central bank did not indulge in deflationary measures nor did it give in to an inflationary course. Its monetary policy was close to the ideals of the monetarists (Fregert, 2000; Kindleberger, 1986).
The performance of the Swedish central bank before September 1931 was quite similar to that of the Bank of England. It tried to stick to the gold standard, although it was forced to withdraw from it, as was the Bank of England, due to Swedish banks had also been in the business of accepting short‐term deposits and lending money abroad at long term rates. Going off the gold standard was not an automatic reaction to the British decision. The Swedish central bank tried to stick to the gold standard for two more weeks, but the outflow of reserves forced it to follow the British precedent. The bank’s period of wisdom began only after that decision. Money supply tied into a consumer price index that the bank compiled and published every week. With regard to the exchange rate, the bank sought to follow a course of keeping it down so that Sweden would gain a competitive edge over other countries. However, the bank did not have enough reserves to sell Swedish currency abroad, consequently driving the rate down. At this stage, a financial disaster that came as a great surprise to the bank finally confirmed to be a positive in disguise (Fregert, 2000; Kindleberger, 1986).
The disaster was the abrupt collapse of the financial empire of Ivar Kreuger. Although, it was how the Swedish central bank managed the collapse is the lesson, instantaneously rescuing the affected banks and restoring confidence in the Swedish system. Although, doing nothing to inflate the exchange rate, as it had sought to drive it down. Thus, Sweden had the best of both worlds, admired for its prompt rescue operation it could not be liable for driving down the exchange rate (Fregert, 2000; Partnoy, F 2009).
Sweden adapted and coped with this period, using new thoughts and economic frameworks such as Keynes. The discussion and analysis on the trials and tribulations of governments and central banks globally throughout the stock market crash, provides us with a guide and framework on how to cope with a crash in the future by using appropriate macroeconomic policies.
Figure 4: Summary of the Swedish Markets Response to The Recession
Source: Fregert, 2000; Kindleberger, 1986
3.2 The Need for International Cooperation
3.2.1 Protectionism and International Trade Throughout the Crisis
The stock market crash of 1929 and the great depression following was a worldwide phenomenon, affecting the majority of the industrialized countries. The pervasiveness of the economic collapse saw countries looking after themselves first. Hence, protectionism and devaluation had been discussed as alternative measures of crisis management. Keynes and other economists thought that there was no need to opt for protectionism after one had already opted for the other alternative. But political pressure had gathered such momentum in most countries that protectionism could not be stopped any longer. Many industries, which had priced themselves out of the market internationally and now, wanted to be sure of their control of the home market. Export industries were in favour of free trade but the abandonment of the principle of free trade and the recourse to protectionism was a global trend, which many could not resist for any length of time. America had set a precedent, which was followed by one nation after another. When US government devalued the dollar, the impact of the devaluation of the pound was reduced in this way hence the protectionists succeeded. Those who had advocated the measure could announce they had been right with the bonus of gaining new converts (Pomfret, 1988; Banziger, 2008).
As global trade came to a halt, and a series of sovereign debt defaults lead to the collapse of the international financial system. It is tempting to imagine that the period was a time of international policy paralysis with policymakers purely ignorant of the risks they were running. There were plenty of attempts to tackle problems on an international level, this culminated in a World Economic Conference in 1933 that brought 66 nations together. Surveying the conference’s wreckage, Keynes’s conclusion was a sobering one, 66 countries could never be expected to agree. Only a ‘single power or a like‐minded group of powers’ could prevail. Furthermore, only then if they were equipped with a new understanding of the world’s systemic problems, and a new toolbox with which to tackle them and the forces that were to lead to war. These forces were already building, the projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise appeared to exercise almost no influence at all on the ordinary course of social and economic life. Rapid social, technological and economic development had brought about a new paradigm of ‘industrial war’. Countries were enmeshed in a system of diplomacy that was intricate in its operation, but in which levels of mistrust had steadily grown (Banziger, 2008; Steven, 2009).
3.2.2 Global Organizations
This period bought the need to form central multilateral institutions concerned with the overall functioning of the global economy and the global monetary and financial system with goal such as diplomacy. These organsisations need to cover three goals as shown in figure 5.
Figure 5: Three Goals for Creating and Running Multilateral Institutions
Source: Steven, 2009
Shared awareness, which will cover the joint analysis of future challenges, one that is sufficiently broad to bring together economic, security and scarcity issues, and that has buy‐in not just from governments, but from non‐state actors too. Shared platforms allowing coalitions of countries that begin to harmonize their domestic policies and commitments in example whether on banking reform, or climate change, or investment in agriculture, and use this as the basis for lobbying for more fundamental international reforms.
A shared operating system, which works on new global frameworks and institutions, with a mandate to deliver security and sustainable growth over the long‐term to promote the cooperation of central banks and governments to provide a meeting place for international organizations and governments to exchange information, discuss common problems, agree on shared aims, set common standards, and possibly even provide mutual support. This objective is to be viewed against the background of the 1920s, when there had been episodic, typically bilateral cooperation among central banks. Indeed episodes of cooperation could of prevented and stopped tariffs and quotas etc. and allowed a more harmonized financial world supporting each other (Banziger, 2008; Steven, 2009).
3.2.3 Major Policy Differences from the Past
Governance is not simply a matter of designing an optimal system and then putting it in place through whatever mechanisms are available including coercion if necessary. Rather, it should be thought of as a communicative and consultative process through which disputes are resolved, consensus is built and performance is continually reviewed. No less critical to its success than its policy instruments is the forum that a governance arrangement must provide for the expression of claims, review, and discussion of continuing reform. Above all, good governance is good process.
To develop the required new arrangements for the effective governance of the global economy one must therefore begin with an effective and credible process ideally involving civil society and business provided there is appropriate limitations, as well as governments and existing international organizations (Banziger, 2008; Steven, 2009). The 1929 crisis illustrated the need for international structure and capacity as it allowed authorities to understand that a protectionism attitude will endanger global trade and the capacity for the economy to recover in a depression. Throughout the crisis it was proven protectionism accelerated the cyclical downturn and the capital destruction process, it has now been learnt that transparency and nationalization was needed.
IV. CASE STUDY: ITALY
The economic recession experienced by many countries in the late 1920s and early 1930s also affected Italy. Despite the lower degree of industrial development in the Italian economy, the dynamics of the depression in Italy were not very different from those of more industrialized countries like England, France, and the United States. Although the fall in aggregate production was smaller as shown below in figure 6, the contraction in industrial production was as rigorous as in more industrialized countries. Furthermore, the key features of the Italian depression can be summarized as a persistent decline in international trade. A large fall in hours worked and production in the tradable sector, but negligible changes in the non-tradable sector, with a hefty fall in investment, and stability of the real wages which is depicted in figure 7 (Cole & Ohanian, 2001; Crucini & Kahn, 1996; Mattesini & Quintieri, 1997).
Figure 6: Industrial Production Per Capita
Source: Mattesini & Quintieri, 1997
Figure 7: Average Industrial Wages in Liras per Hour
Source: Mattesini & Quintieri, 1997
Finding the causes of the fall in foreign trade is not difficult. Many countries, including Italy, implemented protectionist policies starting in the late 1920s. These policies took several forms, such as import tariffs, currency control, and quota restrictions. The consequence was a dramatic fall in international trade. Increasing barriers to trade was the main cause for Italy’s economic downfall, restrictions and protectionist policies weren’t in place and stronger international cooperation Italy would of felt the depression alot less. Looking back, the need for international cooperation is quite significant as increasing barriers to trade, together with real wage rigidities, can explain a large proportion of the economic downturn experienced by Italy at the beginning of the 1930s (Cole & Ohanian, 2001; Crucini & Kahn, 1996; Mattesini & Quintieri, 1997).
The fall in international trade is probably the most striking aspect of the period surrounding the Great Depression. Foreign trade was relatively stable until the end of the 1920s, when it started a rapid and persistent decline. Hence protectionist policies implemented at the end of the 1920s and during the 1930s were an important driving force of the Great Depression in Italy. The political forces motivating the adoption of these policies in Italy and in many other countries had detrimental effects on international trade and the Italian economy as a whole. Hence the lesson of smarter governance and international cooperation was a strong message throughout that time, with the ability of a more adaptive government and better global framework Italy could have forgone the depression altogether.
V. CONCLUDING REMARKS
Financial markets are at the heart of modern economies and there can be no doubt that the financial innovations and change since the 1929 have contributed positively to the global and state economies on both a framework and social level. Through discussing the stock market crash and period following we have came to significant conclusions surrounding the lessons learnt. It is prominent that the global economy requires a sound financial infrastructure that gives dependable, significant and consistent signals to all global participants, as well as adequate recognition for the central role financial institutions and central banks play. Thus, nations need to ensure a financial market infrastructure that inspires confidence through transparency. In addition, macroeconomic policy, especially monetary policy, now pays more attention to financial stability issues, with a global perspective. Although it is has taken years for the global frame work to be established, no doubt the blue-prints will continue to change and improve, but the 1929 stock market crash set off a new wave. Thus, inventing a contemporary way of thinking, governance and institutionalization is very essential.
FELICITY FORD 17
Reference:
Banziger, H. (2008). “Setting the right framework for modern financial markets.” Journal of valuation and financial stability, vol. 12 no. 10 pp. 714
Carter, S. (2006). Historical Statistics of the US: Millennial Edition. Cambridge University Press, Cambridge
Cechetti, S. (1997). “Understanding the great depression: Lessons for current policy.” NBER Working Paper No. 6015, Cambridge
Cole, H & Ohanian, L. (2001). “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis.” Federal Reserve Bank of Minneapolis, Working paper 597
Crucini, M. & Kahn, J. (1996). “Tariffs and aggregate economic activity: Lessons from the Great Depression.” Journal of Monetary Economics, No. 38, PP. 427‐467
Eichengreen, B. (1995). Golden Fetters: The Gold Standard and the Great Depression, 1919-1939. Oxford University press, New York
Fair, R. (2000). “Fed policy and the effects of a stock market crash on the economy.” Business Economics, no. 4, pp. 7‐14
Fregert, K. (2000). “The Great depression in Sweden as a wage coordination failure.” European Review of Economic History, vol. 4, no. 3, pp. 341‐360. Retrieved June 2, 2009, from Science Direct Database
Galbraith, J.K. (1997). The Great Crash 1929. Houghton Mifflin Harcourt, New York Hall, T & Ferguson, D. (1998). The Great Depression: An International Disaster of Perverse Economic Policies. University of Michigan Press, Michigan
Kindleberger, C. (1986). The World in Depression 1929-1939. Rev. Edition, University of California Press, California
Mattesini, F & Quintieri, B. (1997). “Italy and the Great Depression: an Analysis of Italian Economy, 1929‐1936.” Explorations in Economic History, no. 34, PP. 265‐294
Partnoy, F. (2009). The Financial Genius Behind a Century of Wall Street Scandals. Public Affairs, New York
Pomfret, R. (1988). “Commercial Policies in the thirties.” in Unequal Trade, Blackwell Publishing, New York
Steven, D. (2009). “A Year for International Reform.”. Retrieved May 30, 2009 from http://globaldashboard.org/articles‐and‐publications/
The Great depression of the US: 1929 to 1940. (2005). Retrieved June 1, 2009 from http://news.bbc.com/2/hi/business/765322.stm.
The Great Stock Market Crash of 1929. (2009). Retrieved June 1, 2009 from http://symonsez.wordpress.com/2008/10/29/a‐look‐at‐the‐stock‐market‐crash‐of‐1929‐freeze‐ watch/
Weidenbaum, M & Robbins, L. (2009). The great Depression. Transaction Publishers, New York
White, E. (1990). “The stock market boom and crash of 1929 revisited.” Journal of Economic Perspectives, vol. 4, no. 2, pp. 67‐83
Lessons Learnt
Abstract
The complexity and magnitude of the economic catastrophe during the period of stock market crash made governments worldwide reassess their current economic framework. This paper will focus on how the 1929 stock market crash taught the need for international cooperation to prevent policies such as protectionism, which could lead to trade wars and competitive devaluation by countries. In conjunction with the need for appropriate macroeconomic policies influenced by new theories and national experiences of recovery that took place throughout this time. Thus, nations need to ensure a financial market infrastructure that inspires confidence through transparency. In addition, macroeconomic policy, especially monetary policy, now pays more attention to financial stability issues, with a global perspective.
Keywords: Stock, Trade, Macroeconomics, International
I. INTRODUCTION
The conceptual frameworks of the global and national economies are forever changing and improving as they are influenced by national as well as global experiences, continual integration, and application of new and existing economic theories. Some of the most notable and significant global economic changes stems from the 1929 stock market crash.
Over the four years beginning in the summer of 1929, financial markets, labour markets and goods markets all virtually ceased to function. The defining characteristic of this period is the collapse of virtually every aspect of the economy. Throughout this term, the government policymaking apparatus seemed helpless. The complexity and magnitude of the economic catastrophe during this period made governments worldwide reassess their current economic framework. For this reason economic institutions are very different today than they were in 1929. Globalized markets now operate within politically defined rules and governance institutions. As well as the creation of global regulations, institutional framework, and economic governance sanctioned.
This paper examines the lesson learnt from the 1929 stock market crash. Procuring the view that the 1929 stock market crash provided numerous lessons to be learnt, identifying and recognizing two overall lessons were therefore fundamentally important in changing the global economy to its current framework. In addition, this paper also discusses the consequences of stock market crash in the context of Italy because Italy experienced a lower degree of industrial development during that period.
II. THE 1929 STOCK MARKET
This section will elucidate, illustrate, and define the causes, impacts, solutions and events that transpired throughout the 1929 stock market crash and great depression
2.1 What transpired?
In October 1929 shares in Wall Street fell sharply following a speculative boom during the period known as the Roaring Twenties. Within two days, the Dow Jones industrial average fell by 25% ending on Black Tuesday, 29th of October. The volume of stocks traded set a record that was not broken for 40 years. When it finally reached its record low in July 1932, the Dow Jones had fallen 89%, and it did not recover to 1929 levels until 1954 (Galbraith, 1997; Weidenbaum & White, 1990).
In the US, the recession began in September 1929 and continued officially until March 1933. By the end of the 3.5‐year long down‐ turn, industrial production shrank by half. Consumer prices dropped by over a quarter and unemployment surged from 3.2 % to nearly 25 %. This period is visually aided below in figure 1, illustrating the stock market and its level in conjunction with the year (Galbraith, 1997; Weidenbaum & White, 1990).
Figure 1: The 1929 Stock Market
Source: The Great Stock Market Crash of 1929, 2009
2.2 What was the cause?
Debates continue over the causes of the Wall Street crash, there are numerous contributing arguments and factors that are defined throughout this period. Although the prevailing mainstream economic belief today is that monetary policy errors transformed what may have been a normal recession in the early 1930s into the Great Depression. It is believed that the Federal Reserve was the foundation of the Great Crash and the subsequent economic downturn by tapering policy in order to deflate the asset bubble fermenting in the equity markets. The Federal tightened monetary policy from the march of 1928 until the Great Crash despite moderate economic performance, many Federal officials at the time believed that speculative investment was fruitless and required hindering. This was part of a set of guidelines, that if banks limited their lending to sound businesses, the appropriate amount of money would automatically regenerate (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & White 1990).
Therefore, the Federal was to constrain any manner of lending, especially loans for buying stocks or bonds. This policy resulted in a pro-cyclical monetary strategy, since business loans had a propensity to enlarge and contract with the economic cycle. The unconstructive monetary policy and the aspiration to discontinue speculative investments are aspects that contribute to the Great Depression. At that time, professional economists such as Irving Fisher provided no consensus view, but a number of them also argued that the stock market was in line with fundamentals (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & White, 1990).
2.3 What was the impact?
The Wall Street crash correspond to an astute decline in US economic output, which eventually spread around the world. The US economy shriveled by a third illustrated by Figure 2 it demonstrate the dramatic drop in GDP over this period. While unemployment constantly rose, with many more workers on short hours, Figure 3 below visually depicts the unemployment rate rising, as US economic output withered. In conjunction, the US banking system had seized up completely, and the first act of the new Roosevelt administration when it came to power was to close all banks for two weeks while Federal inspectors examined their books.
Bankruptcies were increasingly numbered, while bank loans were not being repaid, furthermore there was no federally guaranteed depositors insurance to inspire depositor confidence, and in 1929 alone, there had been 659 bank failures. With no unemployment benefits or government help, the sharp fall in workers income had a big effect on consumption and led to a negative spiral of more factory closures, as the vicious cycle continued. Most observers believe that economic policymakers made the economic downturn worse by adopting tight monetary policy and balanced budgets as the crisis exacerbated. International trade also shrank as the US went off the gold standard and erected high tariff barriers to prevent foreign imports (Galbraith, 1997; Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
Figure 2: GDP of USA in the Period of 1920-1940
Source: Carter, 2006
Figure 3: The Unemployment Rate from 1929 to 1940
2.4 How was the situation and responded to and resolved?
The Great Depression lingered on despite the variety of New Deal measures that attempted to alleviate the suffering of individuals by providing government jobs, welfare relief, or mortgage protection. On top of the federal governments actions, such as tightening of monetary policy, tariffs, and increasing discount rates. Initially the authorities tried to rebuild confidence in markets by making reassuring speeches, but only a shakeout of workers from industry would ultimately restore prosperity (Hall & Ferguson, 1998).
Private charity was relied on to help the victims of the slowdown. In 1932, the US government intervened to provide unemployment relief, to stabilize markets by restricting production, to encourage unions, and to create a government system of old age pensions and unemployment insurance known as social security. However, the administration had less success in reviving economic growth and business confidence remained weak (Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
It was only the onset of World War II, when the US government finally embraced Keynesian-style deficit spending on a large scale that the economy recovered. US economic output doubled during the war, and unemployment vanished as women and African Americans were drawn into the workforce to substitute the millions drafted into the military. At its peak, the US government was borrowing half the money needed to finance the war, while half raised by taxes (Galbraith, 1997, Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
The 1929 stock market crash and the great depression following cannot be pinpointed from one action alone, although blame namely rests with a failure of monetary policy and political decisions such as implementing trade tariffs. Furthermore, these failures
III. LESSONS LEARNT
This section will explicate the need found for appropriate macroeconomics policies, influenced by new theories and national experiences of recuperation throughout this period. In addition, it will elaborate on the need for international cooperation, to ensure prevention of trade wars and competitive devaluations.
3.1 The Need for Appropriate Macroeconomic Policies
3.2.1 New Theories of Economic Governance
One of the most significant lessons learnt throughout this period was the need for transformation in current economic theories and economic governance. The notion that the stock market crash and the Great Depression would turn out to be “good medicine” for the economy, and the proponents of simulative policies were shortsighted enemies of the public welfare was the belief by many countries throughout this period. Hence, fiscal policy also failed to respond immediately to the Great Depression, prior to the 1930s, since active fiscal policies was nonexistent (Hall & Ferguson, 1998; Weidenbaum & Robbins, 2009).
Economist such as Keynes believed governments should use its immense financial powers such as taxing and spending, as a sort of counterbalance to stabilise the economy. Thus, depressions ought to be attacked with increased government spending at the bottom of the income pyramid. This position is the opposite of the trickle down affect. Keynesian economists call this counter‐cyclical demand management, believing that the government's massive financial impact can be used as a counterweight to current market forces. (Cechetti, 1997; Eichengreen, 1995; Fair, 2000)
Keynes feared that "the slump" that he saw in 1930 possibly will pass over into a depression, along with a drooping price level, that has the capacity to last for years with incalculable damage to the material wealth and to the social stability of every country alike. Calling for a resolution via coordinated monetary expansion by the major industrial economies would repair confidence in the international long-term bond market and raise prices and profits, so that in due course the commerce of the world’s economy would be in motion once more (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
Keynes believed that people did not have enough income to buy everything the economy produced, so prices fell and business went bankrupt. He argued that governments could halt the vicious cycle by increasing spending on its own or by cutting taxes. Either way incomes would rise or people would spend more. If the government had to run a deficit, so be it, because the alternative would be much worse, believing it was common sense to put idle resources to work. Furthermore, savings otherwise not invested and workers left unemployed could generate beneficial public assets if the government took the initiative (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
When Keynesianism ideology was applied to construct a fiscal revolution to pull the economy out of depression, this challenged the idea of constantly balancing the budget, via boosting effective demand by stimulating consumption. Keynes rightly invoked fresh economic approaches rather than taking refuge in motionless policy. The pronouncement “in the long run we are al dead” was an scolding reproach against the irresponsibility of doing naught if economist rely on the self-correcting power of market forces (Cechetti, 1997; Eichengreen, 1995; Fair, 2000).
Although there were exceptions of the economic collapsed, this period substantiated need for alternative policies of economic governance at an international and state level. Allowing them to gain from alternative thoughts and new models that arose out of this period and hence, the exploration of a country’s economic policies in this time, enabled states to learn and will encourage appropriate monetary policy in the future situations.
3.2.2 National Experiences of Recovery
Sweden provides example of how a small country could close its door to the transmission of the depression by following a wise economic and financial policy. To some extent, this was due to good advice by Swedish economists to a government that was prepared to listen to them. However, it was also because Sweden had no deep homemade catastrophe to cope with. The Swedish central bank followed a cautious and steady policy aimed at stabilizing the price level. The central bank did not indulge in deflationary measures nor did it give in to an inflationary course. Its monetary policy was close to the ideals of the monetarists (Fregert, 2000; Kindleberger, 1986).
The performance of the Swedish central bank before September 1931 was quite similar to that of the Bank of England. It tried to stick to the gold standard, although it was forced to withdraw from it, as was the Bank of England, due to Swedish banks had also been in the business of accepting short‐term deposits and lending money abroad at long term rates. Going off the gold standard was not an automatic reaction to the British decision. The Swedish central bank tried to stick to the gold standard for two more weeks, but the outflow of reserves forced it to follow the British precedent. The bank’s period of wisdom began only after that decision. Money supply tied into a consumer price index that the bank compiled and published every week. With regard to the exchange rate, the bank sought to follow a course of keeping it down so that Sweden would gain a competitive edge over other countries. However, the bank did not have enough reserves to sell Swedish currency abroad, consequently driving the rate down. At this stage, a financial disaster that came as a great surprise to the bank finally confirmed to be a positive in disguise (Fregert, 2000; Kindleberger, 1986).
The disaster was the abrupt collapse of the financial empire of Ivar Kreuger. Although, it was how the Swedish central bank managed the collapse is the lesson, instantaneously rescuing the affected banks and restoring confidence in the Swedish system. Although, doing nothing to inflate the exchange rate, as it had sought to drive it down. Thus, Sweden had the best of both worlds, admired for its prompt rescue operation it could not be liable for driving down the exchange rate (Fregert, 2000; Partnoy, F 2009).
Sweden adapted and coped with this period, using new thoughts and economic frameworks such as Keynes. The discussion and analysis on the trials and tribulations of governments and central banks globally throughout the stock market crash, provides us with a guide and framework on how to cope with a crash in the future by using appropriate macroeconomic policies.
Figure 4: Summary of the Swedish Markets Response to The Recession
Source: Fregert, 2000; Kindleberger, 1986
3.2 The Need for International Cooperation
3.2.1 Protectionism and International Trade Throughout the Crisis
The stock market crash of 1929 and the great depression following was a worldwide phenomenon, affecting the majority of the industrialized countries. The pervasiveness of the economic collapse saw countries looking after themselves first. Hence, protectionism and devaluation had been discussed as alternative measures of crisis management. Keynes and other economists thought that there was no need to opt for protectionism after one had already opted for the other alternative. But political pressure had gathered such momentum in most countries that protectionism could not be stopped any longer. Many industries, which had priced themselves out of the market internationally and now, wanted to be sure of their control of the home market. Export industries were in favour of free trade but the abandonment of the principle of free trade and the recourse to protectionism was a global trend, which many could not resist for any length of time. America had set a precedent, which was followed by one nation after another. When US government devalued the dollar, the impact of the devaluation of the pound was reduced in this way hence the protectionists succeeded. Those who had advocated the measure could announce they had been right with the bonus of gaining new converts (Pomfret, 1988; Banziger, 2008).
As global trade came to a halt, and a series of sovereign debt defaults lead to the collapse of the international financial system. It is tempting to imagine that the period was a time of international policy paralysis with policymakers purely ignorant of the risks they were running. There were plenty of attempts to tackle problems on an international level, this culminated in a World Economic Conference in 1933 that brought 66 nations together. Surveying the conference’s wreckage, Keynes’s conclusion was a sobering one, 66 countries could never be expected to agree. Only a ‘single power or a like‐minded group of powers’ could prevail. Furthermore, only then if they were equipped with a new understanding of the world’s systemic problems, and a new toolbox with which to tackle them and the forces that were to lead to war. These forces were already building, the projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise appeared to exercise almost no influence at all on the ordinary course of social and economic life. Rapid social, technological and economic development had brought about a new paradigm of ‘industrial war’. Countries were enmeshed in a system of diplomacy that was intricate in its operation, but in which levels of mistrust had steadily grown (Banziger, 2008; Steven, 2009).
3.2.2 Global Organizations
This period bought the need to form central multilateral institutions concerned with the overall functioning of the global economy and the global monetary and financial system with goal such as diplomacy. These organsisations need to cover three goals as shown in figure 5.
Figure 5: Three Goals for Creating and Running Multilateral Institutions
Source: Steven, 2009
Shared awareness, which will cover the joint analysis of future challenges, one that is sufficiently broad to bring together economic, security and scarcity issues, and that has buy‐in not just from governments, but from non‐state actors too. Shared platforms allowing coalitions of countries that begin to harmonize their domestic policies and commitments in example whether on banking reform, or climate change, or investment in agriculture, and use this as the basis for lobbying for more fundamental international reforms.
A shared operating system, which works on new global frameworks and institutions, with a mandate to deliver security and sustainable growth over the long‐term to promote the cooperation of central banks and governments to provide a meeting place for international organizations and governments to exchange information, discuss common problems, agree on shared aims, set common standards, and possibly even provide mutual support. This objective is to be viewed against the background of the 1920s, when there had been episodic, typically bilateral cooperation among central banks. Indeed episodes of cooperation could of prevented and stopped tariffs and quotas etc. and allowed a more harmonized financial world supporting each other (Banziger, 2008; Steven, 2009).
3.2.3 Major Policy Differences from the Past
Governance is not simply a matter of designing an optimal system and then putting it in place through whatever mechanisms are available including coercion if necessary. Rather, it should be thought of as a communicative and consultative process through which disputes are resolved, consensus is built and performance is continually reviewed. No less critical to its success than its policy instruments is the forum that a governance arrangement must provide for the expression of claims, review, and discussion of continuing reform. Above all, good governance is good process.
To develop the required new arrangements for the effective governance of the global economy one must therefore begin with an effective and credible process ideally involving civil society and business provided there is appropriate limitations, as well as governments and existing international organizations (Banziger, 2008; Steven, 2009). The 1929 crisis illustrated the need for international structure and capacity as it allowed authorities to understand that a protectionism attitude will endanger global trade and the capacity for the economy to recover in a depression. Throughout the crisis it was proven protectionism accelerated the cyclical downturn and the capital destruction process, it has now been learnt that transparency and nationalization was needed.
IV. CASE STUDY: ITALY
The economic recession experienced by many countries in the late 1920s and early 1930s also affected Italy. Despite the lower degree of industrial development in the Italian economy, the dynamics of the depression in Italy were not very different from those of more industrialized countries like England, France, and the United States. Although the fall in aggregate production was smaller as shown below in figure 6, the contraction in industrial production was as rigorous as in more industrialized countries. Furthermore, the key features of the Italian depression can be summarized as a persistent decline in international trade. A large fall in hours worked and production in the tradable sector, but negligible changes in the non-tradable sector, with a hefty fall in investment, and stability of the real wages which is depicted in figure 7 (Cole & Ohanian, 2001; Crucini & Kahn, 1996; Mattesini & Quintieri, 1997).
Figure 6: Industrial Production Per Capita
Source: Mattesini & Quintieri, 1997
Figure 7: Average Industrial Wages in Liras per Hour
Source: Mattesini & Quintieri, 1997
Finding the causes of the fall in foreign trade is not difficult. Many countries, including Italy, implemented protectionist policies starting in the late 1920s. These policies took several forms, such as import tariffs, currency control, and quota restrictions. The consequence was a dramatic fall in international trade. Increasing barriers to trade was the main cause for Italy’s economic downfall, restrictions and protectionist policies weren’t in place and stronger international cooperation Italy would of felt the depression alot less. Looking back, the need for international cooperation is quite significant as increasing barriers to trade, together with real wage rigidities, can explain a large proportion of the economic downturn experienced by Italy at the beginning of the 1930s (Cole & Ohanian, 2001; Crucini & Kahn, 1996; Mattesini & Quintieri, 1997).
The fall in international trade is probably the most striking aspect of the period surrounding the Great Depression. Foreign trade was relatively stable until the end of the 1920s, when it started a rapid and persistent decline. Hence protectionist policies implemented at the end of the 1920s and during the 1930s were an important driving force of the Great Depression in Italy. The political forces motivating the adoption of these policies in Italy and in many other countries had detrimental effects on international trade and the Italian economy as a whole. Hence the lesson of smarter governance and international cooperation was a strong message throughout that time, with the ability of a more adaptive government and better global framework Italy could have forgone the depression altogether.
V. CONCLUDING REMARKS
Financial markets are at the heart of modern economies and there can be no doubt that the financial innovations and change since the 1929 have contributed positively to the global and state economies on both a framework and social level. Through discussing the stock market crash and period following we have came to significant conclusions surrounding the lessons learnt. It is prominent that the global economy requires a sound financial infrastructure that gives dependable, significant and consistent signals to all global participants, as well as adequate recognition for the central role financial institutions and central banks play. Thus, nations need to ensure a financial market infrastructure that inspires confidence through transparency. In addition, macroeconomic policy, especially monetary policy, now pays more attention to financial stability issues, with a global perspective. Although it is has taken years for the global frame work to be established, no doubt the blue-prints will continue to change and improve, but the 1929 stock market crash set off a new wave. Thus, inventing a contemporary way of thinking, governance and institutionalization is very essential.
FELICITY FORD 17
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