Economic Background

2.1 Real Sector

Lao PDR is a poor country, with GDP per person in 2002 at US$ 310, and total GDP of US$ 1.7 billion. From 1991 to 2002 annual growth of GDP averaged 6.2 per cent per annum (annual data are in Figure 1 [ PDF 134.3KB | 1 page ]), or around 3.8 per cent per person. The agricultural sector dominates employment, with 80 per cent of the workforce and it contributes about 50 per cent of GDP. Lao PDR remains dependent on external support. In 2002/3 external donors contributed 61 per cent of the government’s capital budget, representing 39 per cent of total public expenditure, and 7.6 per cent of GDP.

Structural change within the Lao economy has been significant. The agricultural sector contracted from 61 per cent of GDP in 1990 to 50 per cent in 2002 (Figure 2 [ PDF 131.1KB | 1 page ]). Most of this contraction occurred in the crops sector (Figure 3 [ PDF 131.3KB | 1 page ]), but the contraction of the crops sector was concentrated in the first half of the 1990s, when its share of GDP fell from 37 to 25 per cent. From then until the present, the share of the crops sector recovered to around 30 per cent of GDP. Heavy public investment in irrigation in the second half of the 1990s accounted for this change.

One feature of the changes in the crop sector is important. The area planted to the total rice sector remained virtually unchanged from 1990 to 2000, but within this the irrigated rice sector expanded very markedly, responding to the irrigation investments mentioned above, and the upland rice area (non-irrigated) contracted by 70 per cent. Rice became a less attractive activity for upland people. To some extent this was due to the availability of alternative crops with market outlets both within Lao PDR and in neighboring countries, partly to the relaxed insistence from the government that all regions of the country strive for rice self-sufficiency, but it was also due to the declining profitability of rice itself, reflecting relative price movements within the country.

2.2 Monetary Sector

Inflation was moderate through the first half of the 1990s, at single digit levels for most of this period, but accelerated from 1998 to 2000, peaking at 142 per cent in 1999 (Figure 1 [ PDF 134.3KB | 1 page ]). This inflationary surge was related to agricultural policy. The government of Lao PDR is committed to a goal of rice self-sufficiency. However, it was apparent through the first half of the 1990s that rice output was not growing as fast as population. A massive public investment in irrigation facilities followed, beginning in 1996-97, producing large public sector deficits, especially in 1998-99, as shown in Figure 5 [ PDF 133.2KB | 1 page ]. But the deficits were financed to a considerable extent by monetary creation, producing the inflation of the late 1990s. Since 2001 consumer price inflation has been contained, with an average annual rate just under 10 per cent.

Figure 4 [ PDF 132.5KB | 1 page ] shows that the inflation in consumer prices in the late 1990s coincided with a collapse of the exchange rate. The kip / dollar rate collapsed from roughly 2,000 at the end of 1997 to 8,200 at the end of 2001. Since Thailand is the major trading partner of Lao PDR it is relevant to look at kip / baht exchange rates as well. These rates are shown in Figure 6 [ PDF 146.5KB | 1 page ]. Although the baht was also depreciating in the late 1990s, as a result of Thailand’s financial crisis, the kip’s depreciation far exceed this. The kip / baht rate declined from 47 at the end of 1997 to about 200 at the end of 2000. This depreciation of the nominal exchange rate had implications for real exchange rates, and these were relevant for the central theme of this report. These issues are discussed below.

2.3 External Sector

The volume of imports has exceeded exports in every year since the early 1990s. The current account deficit has averaged 12 per cent of GDP since 1991 (Figure 7 [ PDF 151.6KB | 1 page ]). The deficit is financed by inflows on capital account. Foreign aid contributes about 7.5 per cent of Lao GDP. In 2002/3 actual incoming foreign direct investment was 150 million US$, or 9.3 per cent of GDP, an increase from 100 million US$ (7.7 per cent of GDP) in 2001-02.

2.4 Real exchange rate movements since 1988

The macroeconomic events described above have produced significant relative price changes within Lao PDR. They are summarized in Figure 8 [ PDF 155.7KB | 1 page ]. Because producer prices are unavailable, this figure draws on consumer price data to show a decline in food prices relative to services prices. Because of changes in the way consumer price data are calculated, the figure contains three segments, spliced together.

1. Food / Services I – 1988 to 1997. This series shows the ratio of food to services prices, intended as proxies for traded and non-traded goods prices, respectively.
2. Food / Energy and Construction – 1997 to 2000. In 1997 the consumer price category ‘services’ was discontinued and for this purpose the category ‘Energy and Construction’ has been used as a proxy for non-traded goods prices.
3. Food / Services II. The format of consumer prices was changed again in 2000 and the third series constructs a ‘services’ price series as a weighted average from components of the new classification corresponding to services, using the CPI weights to aggregate these series.

These data tell a clear story. They indicate that agricultural commodity prices declined markedly relative to non-agricultural prices, especially those of services and construction. An economic boom followed the more open economic environment created by the reforms, but this boom was concentrated in the services and construction sectors of the economy, which drew resources from elsewhere, especially from agriculture.

The inflow of foreign capital that accompanied the NEM had indirect macroeconomic effects on agricultural output, which were in some cases negative. The increased domestic expenditure made possible by foreign aid and foreign investment produces demand-side effects that imply contraction of agriculture. Increased demand produces increases in the domestic prices of those goods and services that cannot readily be imported. These include most services and construction and the expansion of these sectors attracts resources, including labour, away from agriculture. This phenomenon has been observed in many countries experiencing large increases in capital or export revenue inflows from abroad and it is known as the ‘Dutch Disease’ or ‘booming sector’ effect. It causes the prices of agricultural and other traded commodities to decline relative to other prices, with negative effects on agricultural production. To the extent that the NEM increased the exposure of agricultural commodities to international markets, this policy change indirectly increased the impact that these market phenomena had on agricultural production.

From 1997 to 1999 this real appreciation was reversed by the massive nominal depreciation described above. The mechanism is that a nominal depreciation increases the nominal prices of traded goods. Some stickiness in non-traded goods prices caused them to respond slowly to the monetary expansion that was occurring at the same time, with the result that the ratio of traded goods prices to non-traded goods increased. This effect ceased after 2000 and real appreciation resumed.

The relevance of these events is that since around 1990 agricultural producers in Laos have been subject to a considerable cost-price squeeze. This phenomenon has accelerated the rate of rural to urban migration that would otherwise have occurred. The deterioration in the profitability of agricultural production for the market has also impeded the entry into the market economy of subsistence agricultural producers. In short, these events have resulted in higher levels of rural poverty incidence than might otherwise have occurred. This background is important for understanding rural poverty in Laos.

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Comment(s)

There are [3] comment(s) for this entry. Post a comment.

1. Ahmad Raza Khan
   (posted 28 November 2008 / 02:15:56 PM)
   
   It is very impressive and one can learn from the report and implement these findings in our own country. I am from Pakistan where the major portion of population lives in rural areas. The road network in Pakistan is not impressive especially in rural areas the situation is even more worse.
   by building road infrastructure and improving the alread existing , we can change the lives of people.
   
2. Arounyadeth
   (posted 22 October 2008 / 08:38:37 PM)
   
   Road is very important for development in Laos as many studies suggested. However, the project from ADB or other donors mostly concentrate on East-West road network. So far, North-South road network has been mostly untapped, except some maintenance project for route 13. However, the study on direct link road from North-South should be studied, because North-South regions hold comparative advantages, which they could trade to each other, e.g. livestock and paddy. I really hope that there will be more studying on this matter.
3. Karel Martens
   (posted 29 June 2007 / 05:44:52 PM)
   
   It is important to note that roads will only alleviate poverty if it goes together with a transport service that is accessible for the poor. The expectation that roads alleviate poverty is based on the assumption that some form of para-transit will be available to travel with or without goods.
   In current circumstances, such services will most likely be provided by the market. However, as affluence increases, so will car ownership, and the same roads build to alleviate poverty, may become instruments to increase the gaps between those with and those without cars.
   it is therefore important to stress what is alleviating poverty: not the roads as such but the transport service it provides to the poor. By focusing on the transport service rather than roads the proper link between poverty alleviation and accessibility is made.