Why Luanda is the most expensive city in the world?
Since 2002, Angola has been growing at an interesting pace, the country´s natural resources endowment is outstanding, namely oil. Yet when the global oil price has negative swings, Angola economy becomes vulnerable, which happen in 2014. Broadly speaking, when a state is very exposure at one specific industry, more usual, one specific commodity, this creates a problem which it is called Dutch Dieses. So, I will try to explain how this event increase the relative price of non-tradable goods and make Luanda the most expensive city in the world according to Mercer’s annual “cost of living” ranking.
How to have a wealthy country in natural resources could be a diesis? First of all, I will try to show how labor and production will change during the “boom phase”. Typically, when a commodity becomes extravagant pricey, the countries producers gain with this event. So, this make the suppliers richer and creates an expansion of domestic demand, by arbitrage conditions the price of traded goods does not change, to do so, the relative price of non-tradable sector (Pn/Pt) need to increase, in order to respond for this excess demand. When I made this analysis, I am assuming fixed exchange rate, which is a realistic assumption because Kwanza at the “boom phase” had a peg with dollar.
Consequently, these movements of prices come along with a boost in nominal wages, which create a raise in real wages in traded sector (w/pt). Another important feature it is regard to the domestic absorption, which also increase. These two effects (which could be call substitution and income effect) made firms in these industries (exporting firms, except oil producers) reduced production in order to survive to international competition. Hence, labor shifts to the non-tradable side of the economy; a good example of this side is the building construction or services companies. In theory if I assumed flexible prices, which is a reasonable assumption in this phase because the adjustment is slow, the overall economy is in full employment.
Empirically, it is difficult to stated that a country as in full employment, usual when a country stays in 5% unemployment rate you can said that with confidence, but some countries have several socioeconomic environments which become hard to achieve such a truth statement. This applied to Angola, a country with a deep inequality between capitalist and workers. Another important feature which turn this analysis much more complex, it is that a considerable number of immigrants arrived at Luanda at this “boom phase”. So, the numbers of unemployment rates were ambiguous, but we could have looked at growth rates and concluded that Angola was booming.
In other words, this inflation on the endowment of Angola, between 2002 and 2014, creates a real exchange rate appreciation, which does not come along with an increase in productivity of the all traded sector, such as Blassa-Samuelson preposition. Therefore, Luanda saw the house prices hike in a way very dangerous for society, but in theory in full employment. Additionally, when the price of houses increases in that way create an illusion, because normally banks ask for houses or buildings as a collateral, so, in this time households and government does not face borrowing constraints. Moreover, the inflows of skilled immigration help to this bubble in house market.
However, when price of oil falls they could face a lot of limitations, which I will try to show how this happen for Angolans. In 2014 global oil price fall a brutally, which made Bank of Angola lose your peg and your growth to decline a lot. Now, this wealth, if it is not used in a sustainably way, looks more as a dieses. Currently, oil producers need to have diversified economies and other stabilizations tools, such as wealth funds like in Norway, to gain with past revenues and do not have currency or others crisis in the future, alike in Angola. Emerging markets have been restricting capital movements in order to mitigate this immersing growth, but it seems a good solution in short run, however, I strongly believe in that countries in the long run will always want to enter in the global world, so, this do not solve the headache of huge capital inflows just delay the problem.
Despite the fact that they do not hold a huge external imbalance as Portugal or Greece. They, also, suffer with credit limitations, so, financial market, now; do not play the role of smooth consumption like in theory. Regarding this, Angolans saw your domestic absorption declined and workers needed to adjust rapidly to the tradable sector. In reality, these adjustments are very difficult to achieved, because the price fall a brutally as I mentioned before, and adjustment needed to be almost instantaneous for economy still function in full employment. However, market frictions could complicate the process.
First complication is regard to skills and geographical mismatch, a worker in services probably does not know how to do manufacture or do not hold the mobility needed. Secondly, labor market regulations as syndicates which prefer higher wages and fewer workers in your industry, bureaucratic procedures or because it takes time to redefine a business. These innumerous examples of possible explanations for delays for the adjustment needed show how the real exchange appreciation before putted Angola out of full employment, when the price of oil declined.
Nonetheless, this environment has different redistributive effects, which are more aggravated for a country unequal as Angola. Owner of capital will prefer wage flexibility in light of higher profits and workers will be dividing in two groups. Those which are employed and those which are unemployed, in one hand, price stickiness would reveal higher wages, on the other hand, flexible wages put economy in full employment. Additionally, Angola have a suspicious democracy, so, more controversial was the choices implemented, in respect of legitimacy.
All in all, it is hard to adjust at once, to that end how to mitigate this exposure? Since 2014 become clear that oil producers will not hold the same power as previous years, for example as oil shocks in 70´s or 80´s. Developments in others energies less scarce and more friendly to world gain a lot of space nowadays. Several countries created laws in light of others renewable energies to earn more market power. Consequently, how oil producers, namely Angola, gain with them remain wealth and invest smartly in your future?
Now, it is time to construct incentives to shareholder and others economic agents to persecute others business with modern technologies and become competitive. Although, if they want to continue in energy market need to adapt. For example, as use of hybrid and electric cars grows, the transportation sector will rely increasingly on the electricity sector or from renewables, such as solar and wind. Others helpful policies could be real devaluation by nominal exchange rate or by fiscal (devalue) reforms.