DEG: Turkey - Growth Market and Bridge to the East

[caption id="attachment_6157" align="alignright" width="261"] Author: Alexander Klein[/caption]

Turkey was long considered especially promising in the group of emerging-market countries. However, political developments and Turkey’s susceptibility to recent turmoil in financial markets means that the perception has now shifted. But which is the correct impression? Do current political events simply shroud the country’s economic potential? It’s a fact that many companies continue to operate successfully in Turkey, and are consolidating their position in the domestic market, as well as in the East. And yet, the development of the past years suggests a differentiated view needs to be taken of the opportunities and risks.

Following on from the successfully marketed concept of the BRIC states in 2001, Goldman Sachs presented the “Next Eleven” in 2005, as the “successor” to these booming emerging-market nations. Turkey was part of this group, besides countries such as Nigeria and Egypt. The reform economic policies of Recep Tayyip Erdogan, the prime minister elected in 2003 and former mayor of Istanbul, proved popular, and the country seemed to be well on the way to leaving behind the impacts of 2001’s economic crisis, as well as the fiscal austerity imposed as part of the IMF-assistance and structural reforms. The foundations seemed to be laid for Turkey to join the ranks of the industrialised nations.

Yet the euphoria has now subsided. Observers are perturbed by Erdogan’s authoritarian behaviour in particular, for instance his handling of the Gezi protests in the summer of 2013, or his reaction to allegations of corruption against members of government at the start of 2014. And still, Erdogan won the absolute majority in 2014’s presidential elections.

“The underlying economic conditions are still promising: the economy, with its population of approximately 80 million and a GDP of almost $900bn, is a heavyweight, not only in its own region.”

The economy too, is worrisome for several observers. The announcement by the US Federal Reserve to review its current monetary policy in the medium term, led in 2013 to capital flight from emerging markets. States reliant on foreign capital bore the brunt of this including Turkey, with its currency depreciating substantially during this period. In the end, Turkey was even considered as one of the “fragile five”.

The focus of this concept, marketed by Morgan Stanley at the end of the summer of 2013, was on the major emerging-markets, capital market relevant nations with a high susceptibility to capital outflows. Brazil, South Africa, India, and Indonesia joined Turkey in this group. In view of this development, the question is whether the previous euphoria regarding Turkey was excessive, and how to assess the situation.

The underlying economic conditions are still promising: the economy, with its population of approximately 80 million and a GDP of almost $900bn, is a heavyweight, not only in its own region. GDP growth has now evened out at about three to four per cent annually due to monetary and fiscal countermeasures after a short-term slump in economic output during the global financial crisis 2008/2009, and the temporarily increased volatility caused by the above mentioned global capital outflows from emerging-market countries in 2013.

This growth level is, in fact, lower than in the years preceding the global crisis, but on the other hand it is more sustainable. After years of credit-driven growth in the recovery phase, a few years of consolidating are now on the agenda, even though, during this “breather”, Turkey is still faring considerably better than the EU countries.
Turkey has a demographic advantage compared to many industrial countries, due to its young and frequently well-educated, growing population. In the past ten years, a strong middle class has emerged and the previous disparity in income between urban and rural areas has diminished.

Turkey also now has a much better transport and energy infrastructure than a few years ago. Turkish entrepreneurs have played the economic reforms to their advantage, and alongside the versatile small and medium-sized enterprises have generated successful international groups which are well represented in many sectors today.

For instance, Turkey has now grown to become the second largest steel producer in Europe. International consumer goods manufacturers, such as Beko, have long been expanding beyond European borders, and the shipbuilding industry, which has fared well since the start of the 20th century, is market leader in a number of niche segments.

The services sector was subject to strict regulation in the past, but still developed successfully in the major industrial centres. Alongside tourism, banking should also be highlighted. Additional impetus for growth and innovation was generated by further opening up the service sector.

In addition to the domestic market, the export business offers opportunities. Turkey would also benefit from an improved economic climate in the EU countries, as the EU is Turkey’s most important trading partner due to its membership in the EU Customs Union. About 40% of Turkish exports, valued at around $60bn annually, are destined for the EU. Turkey’s most important trading partners within the EU are Germany, Great Britain, and Italy. In 2014, Germany delivered goods to Turkey amounting to almost EUR20bn; mainly cars and car parts, machinery, and chemical products.

However, Turkey’s membership in the EU Customs Union also has a downside. It obliges the country to lower its import duties towards third countries with which the EU has negotiated bilateral free trade agreements – without automatically benefiting from customs-free market access itself. As Turkey is only a member of the customs union, it is not party to the bilateral EU agreements and is therefore compelled to negotiate separate agreements with these countries.

Against this backdrop, Turkey is concerned about the free trade agreement being discussed between the EU and the USA, which would not only open the door for competitive American companies to Turkey’s European sales market, but to Turkey itself too – without automatically granting permission for Turkish goods to flow in the other direction. As a result, Turkey is drawing on its geo-strategic position to build up additional economic ties and in doing so, focus on the countries in the Middle East, as well as those located on the Silk Road all the way to Asia.

Iraq, for example, is Turkey’s largest bilateral trading partner after Germany. Ten years ago, the country’s share in Turkish exports was less than three per cent. Now, around seven per cent of Turkish exports find their way into Iraq. The Shanghai Cooperation Organisation (SCO), a regional organisation for economic and military collaboration, is a further example of additional markets beyond the EU. The members include China, Russia, Pakistan, India, and Iran some of whom only have observer status. While Turkey is, at present officially a dialogue partner, in 2013 it applied for the next highest level which is observer status.

All in all, Turkey shows great economic potential, but is more volatile in comparison to a number of European countries. Many foreign companies use this potential not only through trade relations, but also through direct investments. In doing so, companies have an eye both on the large Turkish domestic market and the region as a whole. In the latest survey of the International Investors Association (YASED) around a third of the multinational companies polled stated that they have a local headquarters for working in the region based in Turkey.

The changing regional source of direct investments also mirrors this regional diversification. Accordingly, in 2009, direct investments from the EU amounted to more than three-quarters of the annual overall investment volume. This share is now declining in favour of companies from Asia and the Middle East.

Alongside changes in the share of source country, the increasing importance of services has also changed the sectorial distribution, because it has been recognised that there is potential besides the manufacturing industry. For instance banks from China, Japan, and the Gulf States have recently expanded their presence in Turkey through investing and opening branches.

These developments and the strategic alignment of many multinational companies clearly highlight that Turkey’s potential as a growth market and a bridge between the East and the West is still important. But although the potential in the dynamic environment in the markets on Europe’s doorstep should not be underestimated, neither should the risks be.

The International Monetary Fund (IWF) recently cautioned Turkey about its susceptibility to external shocks due to its dependency on foreign flows of capital for financing its chronic current account deficit, and at the same time, urged the country to instigate desperately needed structural reforms. Increasing Turkey’s competitiveness is important in order to avoid remaining in the “middle-income trap” and achieving a growth level of over 5% p.a. in the medium to long term.

Turkey’s further economic success will therefore hinge on whether the recent doubts regarding rule of law, and for example the independence of the central bank, prove to be justified, or not, and the government is prepared to push forward on further economic reforms after the parliamentary elections in the summer of 2015.

Despite these risks, Turkey remains a growth market in which activities can be carried out successfully supported by experienced partners. An experienced financing partner for investments in future markets is DEG – Deutsche Investitions- und Entwicklungsgesellschaft mbH, which has a representative office in Istanbul.

About DEG

DEG, a subsidiary of the KfW development bank finances investments of private companies in developing and emerging markets. As one of Europe’s largest development finance institutions, it promotes private business structures to contribute to sustainable economic growth and improved living conditions.

About the Author

Mr Alexander Klein is the senior macro economist in the Corporate Strategy and Development Policy Department at DEG – Deutsche Investitions- und Entwicklungsgesellschaft mbH.


Stealth at the Helm: The Manifest Destiny of Angela Merkel

[caption id="attachment_9771" align="alignright" width="230"] Angela Merkel[/caption]

As the Greek debt crisis inches to its climax, the euro’s guardians soften their tone of voice; not quite so sure any longer that contagion – and financial Armageddon – may yet be avoided. Over the past few weeks, the assurances that Europe will be fine, should Greece decide to drop out, have been gradually replaced by appeals to common sense. Jeroen Dijsselbloem, president of the Euro Group of finance ministers, spoke to no-one in particular when he asked all concerned not to play a game of chicken to see who can hold out longer.

Mr Dijsselbloem also stressed the need for a quick deal on Greece. The International Monetary Fund (IMF) chimed in as well with its managing director, Christine Lagarde, calling on the European Union to relax its demands on the struggling country.

Meanwhile back in Berlin, where real power resides, German Chancellor Angela Merkel intervened decisively to stop a rift between Greece and its creditors from developing into a break. She invited Prime-Minister Alexis Tsipras for a face-to-face talk, signalling her determination to keep the wayward nation aboard and the euro intact.

However, the world’s most powerful lady has so far been unable to defuse the time bomb ticking away in Athens, opting instead to periodically set back the clock. It is the Merkel Way: wield soft power to keep the flock together but ignore the larger issues that cause sheep to wander off.

The Decline of Vision

Angela Merkel (60) leads a generation without leaders. Her peers in contemporary Europe’s concert of nations and supranational entities – François Hollande, David Cameron, Mariano Rajoy, Matteo Renzi, Jean-Claude Juncker et al – have but limited appeal to voters and utterly fail to inspire the people whose destiny they hold. Mere pragmatics who favour technicalities and formalities over ideas and visions, the current crop of European presidents and prime-ministers administers the continent, rather than lead it.

Chancellor Angela Merkel’s remarkable rise to power – and her tenacity at clinging to it – may perhaps be ascribed to Europe’s singular success in forging unity and prosperity – the twin pillars of political stability. In politics it is an accepted truth that comfortable nations, those at peace with themselves and others, do not usually bring forth politicians of great stature. Mutti Merkel essentially rules by default.

“The shifting sands of German diplomacy – cajoling a reluctant continent to embrace financial prudence, keeping the American cowboys at arm’s length, and taming Russian irredentism – all show a country looking for a role to assume and an identity to embrace.”

Contrast Europe’s present ruling class with the one holding the reins of power just a single generation ago when Helmut Kohl, Margaret Thatcher, François Mitterrand, and Felipe González set the agenda in Western Europe while Václav Havel, Lech Wałęsa, and Mikhail Gorbachev reshaped the map east of the Oder-Neisse Line. Each of these titans was inspired, and propelled, to greatness by a vision or an ideal.

For all her power, Chancellor Merkel is but an administrator, albeit an exceptionally conscientious and skilled one. The Germans like it that way. Only Konrad Adenauer, Germany’s first post-war chancellor in office from 1949 to 1963 and architect of the wirtschaftswunder, has ever commanded a standing comparable to that of Angela Merkel.

Even after almost a decade in power, Chancellor Merkel is nowhere near the end of her career in domestic politics. She is widely expected to run for a fourth consecutive term in 2017 and has stoically refused to entertain ideas regarding international high office. She has been tipped as future president of the European Council and secretary general of the United Nations.

No Fig Leaf

Chancellor Merkel would much rather save the euro and with it, the European Union. As British Prime-Minister David Cameron discovered to his own detriment, Mrs Merkel is fully committed to the European project and will not tolerate – and ruthlessly deal with – anyone even considering moving the EU goal posts. Mr Cameron’s whimpering about the burden imposed on Britain by freedom of movement – one of the four foundational freedoms on which the entire union has been erected – received little, if any, sympathy in Berlin. The PM’s proposed tinkering with that freedom resulted in a rotund “nein” from the chancellor – end of.

While Prime-Minister Cameron, prodded into action by Nigel Farage and his UK Independence Party, takes on a quixotic fight he cannot possibly win, Chancellor Merkel tries to keep Europe together for her own ends. Hers is a particularly challenging – and thankless – task: holding the continent’s purse strings and heading its largest – and arguably most successful – nation, she also has to refrain from resorting to power politics when imposing her will.

As long as Germany sticks to defending the European Union, the country is allowed to employ its considerable might for the common good, as Mr Cameron found out when he was sent home without as much as a fig leaf to cover his failure. Good Germans are good Europeans – and nothing more. However, when Berlin attempts to suggest EU member states follow its exemplary lead on economic, financial and other affairs, howls of indignation immediately rise up, often accompanied by thinly-veiled references to a few less savoury aspects of Germany’s past.

The Greek are not the only ones still harbouring anger over unfortunate events now covered by seventy years of peace: scratch the civilised outer surface, and the façade of many a European nation takes on a different look. So far, and perhaps understandably given the country’s sorry plight, the Greek are the only ones openly venting their frustration by reminding Germany of its past. France, a veritable depository of wisdom regarding Germany and its role as European powerbroker, opts to just play along while steadfastly doing its own thing – politely ignoring any and all ukases emanating from, or inspired by, Berlin.

Do Mention the War

While it is quite ok to mention the war, the question is which one? As her handling of the crisis in the Ukraine shows, Chancellor Merkel seeks precedent in the lead-up to the First World War rather than in events such as the 1938 Sudeten Crisis – the prelude to the Third Reich unleashing its power for destruction. Taking a cue from 1914, Chancellor Merkel has tried – and succeeded – to stage the second act of Germany’s famed Ostpolitik (Eastern policy) of the 1970s that preferred engagement over confrontation when dealing with a recalcitrant Moscow.

Mrs Merkel is known to have been deeply impressed by reading Sleepwalkers: How Europe Went to War in 1914, an exhaustive study by Australian historian Christopher Clark, professor in Modern European History at the University of Cambridge. Prof Clark argues that the First World War was primarily caused by a breakdown in communication between the great powers. Skirting that pitfall, Mrs Merkel wants to keep talking to the continent’s current antagonists.

A debate organised in March 2014 by German Foreign Minister Frank-Walter Steinmeier between Prof Clark and his colleague Gerd Krumeich, retired from a professorship at Heinrich-Heine University in Düsseldorf, concluded that diplomatic dead ends – and a monumental failure of diplomacy coupled to a dialogue interrupted by the incessant rattling of sabres – caused a localised conflict in the Balkans to ultimately drag an entire continent into war.

At the end of the debate, which took place in the jam-packed atrium of the German Historical Museum, Foreign Minister Steinmeier emphasised that, back in 1914, there was nothing inevitable about war breaking out: in fact, it could have been stopped at any time had the protagonists decided to keep talking instead of mobilising their armies.

Shielding Putin from Himself

While most the entire world was screaming abuse at President Vladimir Putin of Russia for ordering the annexation of the Crimean Peninsula, Chancellor Merkel kept the lines with Moscow open. Though the Russian president’s conversational tone was reportedly blunt, and quite unlike that of a gentleman, Chancellor Merkel delivered her missives nonetheless – appealing to both reason and calm even when, during a meeting at his summer residence in Sochi, Putin failed to restrain his outsized black labrador knowing full well of the chancellor’s fear of dogs. She was badly bitten by a dog in 1995.

It certainly helps that Mrs Merkel is fluent in Russian and Mr Putin speaks impeccable German which he picked up while stationed in East Germany as a KGB agent. While by no means a cheerleader for the Russian president, Chancellor Merkel insists that his country must not be pressed into a corner or be made to suffer economic and social chaos: sanctions are fine as an expression of severe displeasure but may not cripple the nation. At the same time, Mrs Merkel has little patience with Mr Putin’s empire-building exercise which she considers an atavism that has no place in modern Europe.

Threading a fine line between the need to contain Russia’s expansionist tendencies and the necessity to keep that country diplomatically engaged and economically alive, Chancellor Merkel needs to draw on her capacity for stealth – brawn must give way to brain. And that is precisely the game she has been playing all along.

The Power of Stealth

As it happens, most people never saw her coming. Angela Merkel’s rise to power equates to a fastball out of left field, arriving with pinpoint precision at the plate to the surprise of all and sundry. After all, Angela Merkel was not destined for success. She had three strikes against: she is a woman (divorced, remarried, no children) in Germany’s still male-dominated society; a scientist (quantum chemistry) and thus somewhat of a nerd; and – most damaging of all – an Ossie, the product of a state that failed to produce anything of note but for a silly little car.

The oldest of three children, Angela Merkel – née Kasner – spent her childhood in Templin, a small town in the heavily-forested Uckermark District of Brandenburg, just north of Berlin. Here, she lived with her family at the Waldhof, a seminary and care home for mentally and physically disabled people maintained by the officially-sanctioned East German branch of the Lutheran Church.

Born in Hamburg in 1954, Angela Dorothea Kasner was only a few months old when her stern and demanding father Horst moved the family eastwards across the border to take up an ecclesiastical position in the German Democratic Republic – then colloquially known by its German acronym DDR. Meanwhile hundreds of thousands of East Germans were fleeing in the opposite direction.

Horst Kasner made a name for himself as an exceptionally pliable minister, faultlessly adhering to whatever instructions were handed down from party headquarters in Berlin. According to Joachim Gauck – a fellow Lutheran pastor and a dissident who in 2012 became the country’s last president after the only free multiparty elections ever celebrated in the DDR – people knew Horst Kasner as the Red Minister: “Most in the Lutheran Church preferred to stay well away from him.”

All Work, No Play

As a teenager, Angela seemed utterly uninterested in nice clothes, outward appearances, or boys. She also steered clear of politics. Former classmates remember her as exceptionally intelligent, but always colourless and unfailingly serious. There was no flirtation with life or any other sign, however dim, of joie de vivre.

Academically, Angela did get ahead smoothly: she studied physics at Leipzig University. Not running afoul of the strictly enforced party line, the local branch of the Socialist Unity Party of Germany (SED) recommended the pastor’s daughter be allowed to pursue her studies and obtain a graduate degree at the Central institute for Physical Chemistry of the Berlin-Adlershof Academy of Sciences. Here, she received a doctorate in quantum chemistry (aka molecular quantum mechanics) and was promptly kept on as a researcher. Subsequently, Mrs Merkel churned out a number of peer-reviewed scientific papers.

It was only after the wall had come down in 1989 that Angela Merkel displayed any interest in politics. She joined the Demokratischer Aufbruch (Democratic Awakening) Party during the last hectic days of the DDR’s existence and soon became deputy-spokesperson for the Christian Democratic caretaker government of Prime-Minister Lothar de Maizière who voters had put in charge of the state’s dissolution and its absorption into a unified Germany.

Receiving less than one percent of the vote and only four seats in parliament, Democratic Awakening merged in 1990 with the East German Christian Democratic Union which was, in turn, absorbed into its Western counterpart CDU. Mentored by Mr De Maizière, Mrs Merkel soon worked her way up the CDU hierarchy without ruffling feathers or calling attention.

Seizing the moment, she acted fast. The German reunification process was more akin to an outright annexation of the east by the west which meant that – if only for appearance’s sake – a fair number of ossies needed to be awarded top functions in government. By now a member of the Reichstag for the constituency of Stralsund-Nordvorpommern-Rügen, Angela Merkel was an obvious choice. De Maizière arranged for Chancellor Helmut Kohl to meet the young Mrs Merkel and the next day suggested he appoint her to a cabinet post.

The Antechamber of Power

Much to her own surprise, Angela Merkel was immediately named minister of women and youth affairs. However, surprise soon turned into frustration: she was not the least interested in feminism. Youth affairs could only marginally pique her interest. Nevertheless, Mrs Merkel applied herself with characteristic vigour and discipline to the task at hand.

Though the new minister seldom spoke during cabinet meetings, she soon caught the eye of the ever-jovial Helmut Kohl who began addressing her as “mein Mädchen” – his girl. As such, Chancellor Kohl introduced her to visiting foreign dignitaries: a curiosity from the east. Mr Kohl never failed to mention that “his girl” even had to be taught how to use a credit card when she first arrived at the ministry.

Diligent, observant, hard-working, and an eager student, Mrs Merkel soon learned plenty more than just swiping a card: she discovered how the play the political game. Her secret weapon was not belonging: though part of the CDU – the Christian Democratic juggernaut of German political life – for a long time Mrs Merkel used the party as merely a temporary shelter – its social-democratic counterpart being perceived as less welcoming, and fitting, to ossies.

“Until quite recently, she was strange to everything in the party. It was only a function of her power, nothing else,” says parliamentary correspondent Karl Feldmeyer of the Frankfurter Allgemeine Zeitung.

Alan Posener of Die Welt agrees: “The issues that motivate the CDU – single mothers, gay marriage, divorce, etc. – for the most part did not mean a thing to her.” Mr Posener adds that most of Chancellor Merkel’s opinions stem from learned attitudes: “Her knowledge regarding Germany’s transatlantic alliance with the United States, the country’s democratic system and institutions, and even more recent events that shaped the nation such as the 1960s counterculture, and the violence perpetrated by the Baader-Meinhof Group, stems from books, manuals, and briefings. Her upbringing was not shaped by these developments. In that sense, she remains an outsider.”

Spoiled Brats

Mrs Merkel still has difficulty grasping the vast cultural divide between what were formerly East and West Germany. The upheavals of 1968 – the 68er Bewegung which marked the birth of contemporary Germany – were to Angela Merkel’s mind but tantrums thrown by spoiled children. At first, she could not recognise the need of a generation to tear down the societal edifice that had served the Third Reich and to bring morals-preaching parents, teachers, and other figures of authority to task for their complicity with the Nazis.
It was only in 1968 that Germany managed to break out of the straitjacket the nation had been lashed into by the hypocrites and cynics who, in the post-war years, smoothly switched allegiance from Hitler to the Allied Occupying Powers. It was also in 1968 that Germany first dared look in the mirror and face up to its past.

Mrs Merkel failed to relate. Her upbringing was quite different. It had focused on self-discipline, will power, and silence. The DDR made Merkel – and millions of others – into human automatons: success was attained only by those who made absolutely no errors and kept quiet all the while.

That stealthy and ruthlessly efficient approach served her well when in November 1999 the CDU became enmeshed in a major scandal over illicit campaign donations. Both Helmut Kohl and his successor as party chairman Wolfgang Schäuble – the country’s current minister of finance – were implicated and had their reputations tainted.

Power Grab

Without warning, Mrs Merkel struck a deadly blow. She submitted an opinion article – more akin to an oedipal war cry – to the Frankfurter Allgemeine. The piece, as blunt as venomous, called on the party to dump Kohl and the other old warhorses in order to wipe its slate clean. Kohl’s mädchen had stepped out of the shadows, no longer content to dwell in the curiosity cabinet.

A few months later, Angela Merkel was elected to the chair of the CDU. Asked at a dinner party what made Merkel turn on him, Helmut Kohl is reported to have answered with a single word: “power.” He then went on to lament bringing Mrs Merkel into his cabinet: “I brought in my own killer. I put the snake on my arm.”

Over the years that followed, Angela Merkel smartly outmanoeuvred her rivals inside the party; stepping back to let others suffer defeat at the ballot box, keeping quiet while they fought over the meagre spoils, and administering a slight push whenever a challenger wobbled. Former US Ambassador to Germany John Kornblum has no room for doubt: “If you cross her, you end up dead. There’s nothing cushy about her. There’s a whole list of alpha males who thought they would get her out of the way, and they’re all now in other walks of life.”

Unpretentiousness, patience, and stealth are Angela Merkel’s weapons of choice. They brought her to power in 2005 after an electoral showdown against two vain old boys – Gerhard Schröder and Joschka Fischer, political streetfighters with a penchant for wine and women – who made the fatal mistake of underestimating their opponent and, as a result, were summarily relegated to the wastelands of German politics.

Running the Show

The same qualities that made her chancellor, allowed Mrs Merkel to fend off opponents and to steer the continent. Keeping her options open to deal with both Moscow and Athens as she sees fit, Chancellor Merkel at times may seem aloof or even opportunistic. Her former defence minister, Karl-Theodor zu Guttenberg, has the impression that the chancellor hides behind a “cloud of complexity” so that she can seamlessly change her mind on any given issue without suffering politically for it: “Almost no-one sees this happening.” The approach has its advantages: “It sows confusion amongst opponents and antagonist alike while allowing policies to adapt to changing realities.”

Chancellor Merkel’s unwavering support of a united Europe – one of only a few constants throughout her time in office – is born out of German self-interest rather than an ideal or even a sense of history. Europe makes Germany a world power. Thus, it negates Henry Kissinger’s truism that “Germany is too big for Europe, yet too small for the world.” However, now that the country has taken the lead and moved onto the world stage, Germany seems paralysed by Chancellor Merkel’s mixed messages and a mild form of existential angst.
Russian advances on the Crimea and the Eastern Ukraine rudely disturbed the sense of peace and prosperity Germans had come to hold so dear. Suspended in between American talk of military intervention and the roar of Russian tanks and artillery on the roll, Chancellor Merkel had little to say or offer. She ruled out any and all military options and timidly called Moscow’s offensive attitude “unacceptable.”

However, most Germans couldn’t care less about the Ukraine, or its plight, and are uncomfortable confronting the country with which they share terrible memories of over twenty million dead. Germany’s symbiotic relationship with Russia is based on that of perpetrator and victim – Germans will not move against Russia, ever. Chancellor Merkel is much aware of the nation’s unwillingness to defend its Western values against Russian aggression, whatever form the latter takes. She has no option other than to wait for her opponent to self-destruct.

Turning the Tables on Putin

That, however, confers more power upon Germany than would seem at first glance. After Mr Putin, in May 2014, came out in support of the referendum organised by Ukrainian separatist in the Crimea – something he had promised Chancellor Merkel he would not do – she refused to take the Russian president’s phone calls for a week. Russians diplomats, stunned by the unspoken rebuke, promptly switched into panic mode: Germany was the last of the western powers they could talk to and the one country they could not afford to lose. Using backchannels, Moscow got the word to Berlin: “We went too far. What can we do to make amends?” The tables had turned.

While estranged in public, behind the scenes Chancellor Merkel and President Putin remain engaged with a modicum of civility. With the United States, the relationship is precisely the other way round. While over time Merkel and Obama established a reasonable rapport, the revelations of whistle blower Edward Snowden on US spying activities in Germany introduced a sour note.

When it became known that the Americans had been listening in on Chancellor Merkel’s phone calls for over a decade, the sense of betrayal turned into a nationally trending topic. The sour note had become an overtone. With President Obama refusing to publically apologise for the eavesdropping, and the Americans declining to sign a bilateral no-spying agreement, insult was added to injury and Berlin-Washington relations went into the cooler where they have stayed ever since – public displays of affection notwithstanding.

German Role & Identity

The shifting sands of German diplomacy – cajoling a reluctant continent to embrace financial prudence, keeping the American cowboys at arm’s length, and taming Russian irredentism – all show a country looking for a role to assume and an identity to embrace.

Taking a hint from Thomas Mann – who in 1916 interrupted his writing of The Magic Mountain to compose Reflections of a Non-Political Man, a collection of essays on the German national character – the contemporary Germany of Chancellor Merkel slowly drifts back to its conservative, slightly authoritarian, and apolitical roots. As a unified Germany – with an economy that dominates a continent – gains strength, the country becomes more German and less Western, shedding the skin it received from the victors and rediscovering its own roots.

Back to Greece and the time bomb ticking away in Athens. While bordering on the insignificant in the grand order of things European, Greece’s plight will ultimately not be allowed to endanger, let alone derail, the European project: the stage Germany needs to ensure its peace and prosperity. For all the posturing and lecturing, it is likely that – when the clock can no longer be turned back and hard reality needs to be faced – Mutti Merkel will offer just enough succour to keep Greece solvent.

Chancellor Merkel knows that her continued reign, the fourth term in office, will only be possible if her administration manages to perpetuate the nation’s feel-good times. Joschka Fischer of the Greens, a former foreign minister and vice-chancellor, explains: “Mrs Merkel is governing Germany at a time when the sun is shining every day. Germany under Merkel is akin to the Biedermeier Period between the end of the Napoleonic Wars in 1815 and the revolutions that began in 1848. Central Europe was at peace and concerned with amassing wealth and living in style. However, then as now, there was almost no intellectual debate. Such periods usually end with of clash of some sort.”


A Memorable Faux Pas: Warren Buffett Gets His Facts Wrong

[caption id="attachment_9776" align="alignright" width="317"] Warren Buffet[/caption]

Billionaire investor guru Warren Buffett has come to the defence of the American Dream – the promise of intergenerational upward social mobility enabled by a society that values hard work and knows few, if any, barriers. Usually quite sensible, spirited, and articulate, Mr Buffett on Thursday published a rambling op-ed article in the Wall Street Journal in which he argues, rather unconvincingly, that increasing the currently subpar minimum wage will do little to nothing for America’s working poor.

Mr Buffett’s article starts off reasonably enough, noting that the 400 richest Americans in 1982 boasted a combined net worth of $93bn. Today, that list – compiled by Forbes Magazine, the preferred mouth-piece of the haves and the financially well-heeled – represents a staggering $2.3tn in private wealth – an increase of some 2,400%. Over the same period, average US household income registered but a 180% increase. For all its prowess, the US economy has not managed to lift many out of poverty: while the tide is rising, most boats stay put and only a tiny few catch the upward drift. In 1982, almost 15% of Americans subsisted below the poverty lines versus 14.5% now.

So far, so good. However, Mr Buffett goes on to draw some peculiar conclusions. He doesn’t think that the über-rich are necessarily undeserving and points to, of all people, Sam Walton (1918-1992) as an entrepreneur who more than deserved the $23bn he made during his lifetime.

"The around 1.3 million workers at Walmart’s more than 5,000 US stores receive an average pay of $8.81 an hour which equates to an annual income of $15,576 – well below the federally established poverty level of $22,050."

Mr Walton was the founder of Walmart and the richest person in the United States between 1982 and 1988. While undoubtedly a businessman of note and perhaps even a genius of sorts, Mr Walton built his retail empire on the backs of his severely (and notoriously) underpaid employees most of whom needed – and still need – different forms of welfare support in order to survive.

The around 1.3 million workers at Walmart’s more than 5,000 US stores receive an average pay of $8.81 an hour which equates to an annual income of $15,576 – well below the federally established poverty level of $22,050. Because most Walmart employees need federal and state handouts in order to make ends meet, American taxpayers are effectively subsidising the Walton family business and adding to its formidable bottom line. In a 2013 study released by the Democratic caucus in the US Congress, a single Walmart store in Wisconsin cost the American taxpayers $900,000 annually in food stamps, home heating assistance, and a host of other aid programmes for the outlet’s 300 underpaid workers. Extrapolating from these numbers, it is not unreasonable to assume that Walmart annually receives close to $4bn in indirect subsidies from the US government.

Meanwhile, the company’s net income stands at $3.34bn for the three months ending April 30, 2015 with President and CEO Douglas McMillon slated to take home well over $19m this year – more than 1,200 times the median pay of his employees.

Yet according to Mr Buffett the plight of America’s working poor is not to be attributed to the country’s excessively rich who have – in his opinion – significantly contributed to the overall well-being of the nation through innovation and with managerial expertise, and need be properly rewarded for their genius.

Rambling on about the mismatch between skills offered and required, Mr Buffett concludes that, rather than increasing the minimum wage, the state should open its coffers even further and expand the Earned Income Tax Credit (EITC) Programme which, at its most basic level, pays a supplemental income to people whose employers do not provide a living wage in return for an honest day’s work.

In other words, Mr Buffett actually suggests the state expand its already formidable subsidy to corporations such as Walmart that operate failing business models which merely extract profit from over-exploited workers. This latter statement may seem rather quaint, it is not: hamburger flippers at McDonald’s restaurants in Australia make on average $14.50 an hour compared to their US counterparts’ paltry $9.90. According to McDonald’s own data, the fast food chain’s 900 or so Australian outlets are as profitable, if not more so, than the company’s US restaurants.

Apparently wholly ignoring reality – or perhaps in the process of losing his grip on it – Mr Buffett concludes his op-ed piece by stating that “America will deliver a decent life for anyone willing to work.” The billionaire investor argues, quite seriously, that any minimum wage hike will distort the country’s market system, “the key element required for growth and prosperity.” Mr Buffett goes on to explain that a higher mandatory minimum wage will “crush many workers only possessing basic skills.”

One is left wondering how little Denmark manages to survive and prosper with a minimum wage set by collective bargaining at $20 / hour, exclusive of pension benefits. Or how Switzerland can remain the world’s most competitive economy (Global Competitiveness Report 2015 as drawn up by the World Economic Forum) by paying unskilled workers between $2,363 and $4,511 monthly depending on the sector.

For all his business acumen, Mr Buffett seems not to consider worker productivity indicative of compensation levels. Statistics from the US Bureau of Labor show that whereas worker productivity has gone up by 253% since 1948, hourly compensation increased by only 113%. The gap largely represents wage monies redistributed to shareholders and the top-echelon managers who did their bidding.

Yet, Mr Buffett stoically dismisses rising inequality as the “inevitable product of an advanced market-based economy.” French economist Thomas Piketty, author of Capital in the Twenty-First Century, agrees. However, in sharp contrast to Mr Buffett, Mr Piketty thinks ahead and wonders what will happen should this trend be allowed to continue unabated. There is, of course, an end point as the rewards of the deserving rich grow ever larger while the crumbs left for the other 99.9% get fewer and farther in between. In order for Mr Buffett’s advanced market-based economy to be sustainable, it must diminish inequality lest the proles become restless and start taking matters into their own hands.

This, Mr Buffett fails to address entirely. His American Dream lies tatters. A recent study, quoted in the New York Times, by Harvard economics professor Raj Chetty and his colleague Emmanuel Saez of the University of California at Berkeley found that in the US the odds of escaping poverty is only half as high as it is in Denmark, Germany, and The Netherlands where upward mobility is built into the social fabric. “In the US, it now matters more who your parents are than it did in the past,” Mr Chetty concluded. So much for the New World.

As the Danish are living their American Dream, the US falls behind ever further: its economic infrastructure crumbling; its trade deficit ballooning to a six year high of $51.4bn in March; its current account in perpetual disarray, its politics fractured, and its workers underpaid. Meanwhile the federal budget deficit of $564bn (2015) is still creeping skywards while the US national debt now stands at $18.7tn – or 102% of GDP and sucking in the world’s savings.

Mr Buffett is, however, no fool and seems to be preparing for yet another meltdown of the failing model. His investment company Berkshire Hathaway has been aggressively dumping shares of companies exposed to retail spending, reducing its overall stake in consumer product stocks by 21% over the past year.

With about 70% of the US economy geared towards consumer spending, Mr Buffett is essentially exiting from the market altogether. Whatever his assessment, the Oracle of Omaha does not stand alone: billionaire investors such as John Paulson (of subprime mortgage fame) and George Soros (who in 1992 singlehandedly broke the Bank of England) are also limiting their exposure to the severely strained US consumer.

In an ominous sign of the times, Mr Buffett seems to have misplaced the most basic of economic tenets: companies cannot sell to people who have no money to spend. Rather than having the federal government bankroll private business – a proposition he could not possibly condone – by supplementing workers’ paltry incomes, Mr Buffett could do worse than espouse a much more straightforward idea: business that go belly-up because their model depends on low pay which does not permit them to fork over a living wage at $15 / hour, should simply be allowed to wither and die. They surely have no place in an advanced market-based economy.


Natalia Vodianova: Rags to Riches Russian Style

Her face has graced the cover of all the major magazines, from Cosmopolitan to Marie Claire to Vogue in its many incarnations. Natalia Vodianova is one of the world’s top-earning models and the protagonist of a rags to riches fairy tale – Russian style.

When just a toddler, her father walked out never to return. Selling fruit on the streets of Nizhny Novgorod – Gorky in Soviet times, named after the writer Maxim Gorky who was born there – Natalia helped her mother supplement a meagre state income. Peddling bananas, Natalia Vodianova was discovered aged 17 and whisked away to a life of luxury as the face of high-end brands such as Calvin Klein, Stella McCartney, Louis Vuitton, Gucci, and many others.

While her daughter was raking in millions, back in Nizhny Novgorod her mother Larissa kept the fruit stall; not for want of help, but simply an independent lady unwilling to give up work and insisting she provide for her family. In London, Natalia Vodianova continued on her rags to riches journey: in 2001 she married Justin Portman, heir to some 100 acres of prime central London real estate. Ten years and three children later, the marriage stranded.

Not one to suffer bachelorette status for long, Ms Vodianova met and hooked up with Antoine Arnault, CEO of Berluti footwear and son of luxury goods purveyor Bernard Arnault, founder of the Luis Vuitton / Moët Hennessy (LVMH) conglomerate. Living the good life, Ms Vodianova has not forgotten her past, nor her roots. In fact she ascribes her success to the trials and tribulations of days long gone: “I live a very different life now, with incredible privileges, but looking back I realise that growing up in Russia gave me tools that other people don’t necessarily have – such as the will to push that bit further, to make things happen, to succeed. I try to use these now to help other people.”

And so she does. In 2004, Ms Vodianova founded the Naked Heart Foundation to help disadvantaged children in Russia. The charity aims to provide a safe and caring environment to kids in impoverished areas of the country. The foundation was set up in response to the horrors inflicted upon children during the Beslan school siege when over 1,100 people, including 777 children, were held hostage by separatist militants. An assault by Russian security forces resulted in the death of 186 children and 199 adult hostages.

Ms Vodianova supports an impressive number of other worthy causes such as an initiative to help fight the spread of HIV in Africa and the Tiger Trade Campaign, a group of 38 organisations dedicated to halt the sale of products derived from tigers. Russia is home to the last 350 Siberian tigers surviving in the wild.

Her activism has not gone unnoticed: last year Ms Vodianova was chosen one of the Glamour Women of the Year for her charity work and strength in the face of adversity. She has also been honoured by Harper’s Bazaar for being an inspiration to women the world over.


Russia - Moving Borders Politely

[caption id="attachment_9786" align="alignright" width="311"] St. Petersburg, Russia: The Church of the Savior on Spilled Blood[/caption]

Vladimir Putin’s index finger is hovering over the, presumably red, button that activates nuclear Armageddon. The president of Russia threatened to bring the finger down should NATO further reinforce its defence of the Baltic States or make any attempt, covert or otherwise, to wrestle control of the Crimean Peninsula away from Moscow. President Putin had his disconcerting habit of fumbling with nuclear control buttons conveyed to US intelligence officers during a meeting – cloaked in secrecy of course – with their Soviet Russian counterparts. The spy summit reportedly took place in Moscow earlier this year.

The get-together allowed the Russians to give their American peers a heads-up regarding the intentions of the Putin Administration. The Russian president is said to mull responses “ranging from nuclear to non-military” in order to undermine NATO’s presence in the Baltics where a rapid reaction force to counter Russian advances is now taking shape. In their post-meeting assessment, the American spooks concluded that Russia probably aims to “unsettle” the Baltic States with cyber-attacks and by stoking up ethnic tensions. Lithuania, Latvia, and Estonia all have sizeable populations of ethnic Russians that eventually may need rescuing.

This dovetails nicely with the domestic charm offensive that the Russian Army recently unleashed. With the full blessing of the top brass, the design bureau of the Ministry of Defence has produced a formidable new weapon: a fashion line. It is aptly – albeit rather predictably – named The Army of Russia. The collection was unveiled to oohs and aahs at the Mercedes-Benz Fashion Week in Moscow which ended March 31.

"Lithuania, Latvia, and Estonia all have sizeable populations of ethnic Russians that eventually may need rescuing."

The design bureau’s director Leonid Alexeev was on hand to present the balaclavas, boots, tops, sweatpants, and accessories that seek to cash in on the Russian public’s love affair with the nation’s armed forces. The apparel comes emblazoned with curious slogans. One of these – “Politeness Conquers Cities” – seems to refer directly to the events of 2014 when Russian forces “politely” requested the Ukraine military to vacate the Crimea.

Failed Diagnosis

The Russians’ reading of what Western powers consider an invasion followed by an annexation is more than the deferred post-imperial syndrome usually diagnosed. While many Russians applaud their country’s geopolitical ascendancy, there is more at play than just jingoism. In the most basal of terms: President Putin is buying support; his cross-border forays are merely an added dimension.

Though at times statistics may be misused to underwrite flights of fancy; they can also shed light on otherwise inscrutable developments. Abraham Lincoln remarked that: “You can fool all the people some of the time, and some of the people all the time; but you cannot fool all the people all the time.” Honest Abe forgot to mention that you can actually buy people. President Putin knows this only too well: it has kept him in power.

Where have all the white ribbons gone that enlivened the failed Snow Revolution of December 2011? This was when protesters filled Moscow’s Bolotnaya Square in the tens of thousands to express collective disgust with the widespread vote rigging that allowed President Putin’s United Russia Party to cling to a narrow majority in the State Duma. At the time, polls showed that well over 40% of the population supported the protesters’ demands to at least some degree. More than half of the Russians queried felt that corruption had significantly increased and constituted the country’s most serious challenge.

While the crackdown on political dissent certainly contributed to the restoration of order, it remains curious that relatively few people actually joined the protests before the repression hit. Most Russians kept their grumblings private and their heads down. Sociologists have pondered this pervasive indifference exhaustively and concluded that, while to most Russians the outlook may have seemed bleak, their actual circumstances in 2011-2012 were none too bad. This helps explain why the protests in Russia failed to gain traction whereas those elsewhere – Ukraine, Egypt, Tunisia – did succeed in toppling presidents. Here, the present moment looked so atrocious that the future – whatever its shape – could only bring improvement.

Spreading Cash Around

With oil prices at or near historical highs, Russia in 2012 raked in over $512bn in export revenue. Part of that cash was spread around. While in 2011 the country’s GDP expanded by 4.8% and government revenue increased by 8%, average salaries shot up by 13.6%. Another statistical jewel shows the proportion of welfare payments in relation to overall incomes. Between 2005 and 2007, social benefits represented slightly over 12% of the total salary pie. By 2012, the share of social pay-outs had increased to 18.1%.

Simultaneously, pay derived from entrepreneurial activities decreased as a share of total income: from 20.6% in 2007 to barely 14% in 2012. Finally, the income of workers employed by the state – about one in three Russians are on the government’s payroll – increased 1.6 times faster than take-home pay of people employed by private business.

These numbers paint an interesting picture: people exposed to the vagaries of the free market fared markedly less well than those dependent on the state, either as workers or benefit claimants. At the time of the protests, most Russians doubted that their prosperity would last; however, President Putin made sure it did and thus removed the publics’ anxieties.

By vastly increasing the number of people co-opted into the system, the Putin Administration not only managed to survive, but actually saw its popularity explode. Now that the bread had been provided, the games could begin.

President Putin is quite frank when discussing his government’s mission: it is to cast a New Russia along the historical, cultural, religious, and geographical lines that existed during the weaning years of the Romanoff Dynasty. President Putin denies that he wishes to impose a state doctrine based on religious and historical values to replace Marxism as the driver of national purpose. However, he does seem to value a reappraisal of lost cultural values and the introduction of a vaguely termed “qualitative democracy” not necessarily linked to conventional electoral arithmetic.

Taking a Cue from Portugal

Eschewing the anthropocentric ways of the perfidious Western powers, President Putin proposes a more benevolent corporatist alternative not unlike the Estado Novo (New State) created by António Salazar, Portugal’s prime-minister and virtual dictator between 1932 and 1968: not so much fascist state as conservative, technocratic, nationalist, and authoritarian one.

Parallel to the Estado Novo – which aimed to preserve and perpetuate Portugal’s vast colonial empire through its doctrine of Lusotropicalism – President Putin’s New Russia can only come about if it manages to re-establish the country’s role as the powerbroker in Eastern Europe. Although the Crimea was easily snatched and Eastern Ukraine quickly destabilised, these were but the low hanging fruits. The geopolitical objectives – or irredentism – pursued by Moscow to implement Putin’s grand vision may yet result in the reabsorption of the Ukraine’s rump. However after that, Russia will need to reach higher, punching – perhaps – above its weight.

Attempts at regaining its influence on the Balkans have not produced any tangible results, with even its formerly staunch ally Bulgaria turning west. The amorous looks cast by Greece are merely the result of that country’s sorry predicament. Athens’ flirtations thus seem narcissistic in nature; not the stuff President Putin can use to further his goals.

Then again, Belarus is firmly in Moscow’s pocket and the Kaliningrad exclave adds a nice touch as well; but that’s about it. Crossing any other meridians to the west will meet with a response that may cause President Putin’s trigger-finger to itch.

Determined to stay in power, President Putin has to deliver: either rising incomes or adding territories – politely or not. Both the United States and the European Union would be well-advised to recognise two plain facts: Vladimir Putin will hang on to power and Russia needs some room to throw its weight around – preferably in a gentlemanly way.

Devoid of Sense

In light of these facts, the biting sanctions currently in place have stopped making sense. Their efficiency, which even surprised the imposing parties, is undermining Russia’s economy. GDP growth has petered-out to a barely measurable 0.6% in 2014, while inflation is rampant at over 16%.

It is only a question of time before the public’s returned anxieties boil over into protests. For now, President Putin enjoys popular admiration – if not adulation – for his geopolitical accomplishments. Since he cannot deliver sustained growth, President Putin has no choice but continue his quest to reconquer lost lands.

It is a rather simple either-or proposition. Lifting the sanctions – for which surely a politically expedient excuse can be phrased – would allow the Putin Administration to fire-up the bread oven instead of the military rhetoric. The man will not be unseated without a fight of possibly global consequences. Western powers could do worse than to just deal with the facts and draw a line that allows their foe some wiggling room. The steady progression of time – though it may not be accelerated without causing great disruption – will eventually stop even President Putin in his tracks. i


Luisa Nenci, CEO of SustainValues: A Capital Market Union or a Sustainable Financial Market?

[caption id="" align="alignright" width="164"] Author: Luisa Nenci[/caption]

In his political guidelines for the next European Commission, President Jean-Claude Juncker pushed for the establishment of a capital market union. Such a union should develop and integrate capital markets in order to cut the cost of raising capital. This is especially important for small and medium-sized businesses (SMEs). A capital market union should also reduce dependence on bank-sourced funding and increase the attractiveness to invest in the EU. Mr Juncker also suggested to reform the Economic and Monetary Union in an attempt to enhance the convergence of economic, fiscal and labour markets across the Eurozone which would help to preserve the stability of the euro as well. He supported the introduction of additional controls on banks with a single supervisor and resolution mechanisms.

To make integration and convergence feasible, a transformative roadmap should be formulated for every country: a new strategy for the post–2015 agenda. For the successful implementation of such an approach, the financial sector has an essential role to play, steering economic actors towards the adoption of more responsible investment solutions. The proposed strategy should furthermore include a set of legislative tools to facilitate the creation of a transformative framework for the financial sector.

“The new policy framework will give the financial sector, through political consensus, the possibility to enhance its role from intermediary to proactive.”

A number of steps have already been taken by the G20 and the European Union to strengthen financial regulation pertaining to capital and liquidity requirements, licensing, and supervision such as the Basel Capital Accords II and III, the core principles for effective banking supervision, etc. In particular, actions covering three basic fields of financial regulation, are ongoing for:

Prudential regulation – to ensure improved stability and solidity of financial institutions;

Conduct of business regulation – to introduce a fairer and more transparent business management practices; and,

Systemic regulation – to increase financial market stability and improve access to finance.

Further steps may be taken if it considered convenient to extend financial regulation to include the current sustainability initiatives and principles such as the Equator Principles, the UNEP Finance Initiative Partnership, the Principles for Responsible Investment, the Global Compact Principles, the IFC/EBRD Performance standards and exclusion lists, National Environmental Standards, Universal Declaration of Human Rights, WBCSD 2050 vision, UNFCCC Climate Finance Principles, and others.

The implementation of a sustainability rationale will lead to the building of an appropriate governance structure that facilitates financial institutions (FIs) attain improved transparency and management policies, in addition to better monitoring for green investments. Being market driven, FIs should be free to consider each financial instrument on its merit. FIs’ choices and market decisions regarding the strengths and weaknesses of any given instrument are to be based on market criteria. However, political institutions should develop policy objectives and formulate rules for the guidance, evaluation, and monitoring of the green investment without trespassing on the flexibility and autonomy of financial institutions.

The current, and highly complex, system of financial regulation was not designed to encourage innovative interventions and approaches to overcome risk barriers and market failures and/or imperfections. The new policy framework will give the financial sector, through political consensus, the possibility to enhance its role from intermediary to proactive. The selection and financing of companies that are not merely reacting to standards, but effectively pursue green market opportunities, allows FIs an opportunity to actively promote the allocation of financial resources to green and profitable business ventures.

The proposed framework may be created by applying the same methodology of the Basel Committee on Banking Supervision (2012). The assessment should moreover seek full compliance with the 29 Core Principles for Effective Banking Supervision published by the Bank for International Settlements. The implementation of sustainability principles will be graded by measuring the level of compliance to defined criteria. To customise the framework at the national level, these criteria could be weighted differently from country to country. At supranational level, adherence to the framework can then be evaluated by defining minimum and maximum levels of achievement on each of the criteria established.

The assessment process will consist of three main steps:

An assessment of the current financial core principles in order to evaluate their compliance with the identified sustainability and good governance principles to be included in the framework; establish the framework; identify the main and direct eco-systemic risks facing the financial system; monitor and analyse markets and other financial and economic factors that may lead to the indirect accumulation of eco-systemic risks; systematically proof and review the framework in order to achieve objectivity and comparability between countries.

Formulate appropriate policy objectives addressing future emerging risks, as well as opportunities for reform toward a green economy. Global environmental policy objectives and other long-term shared policy objectives at international level – such as the Kyoto Protocol, the Convention for Biodiversity, and others – should also be included in order to align the framework at European and international levels. The framework should also include mechanisms for effective cooperation and coordination amongst the relevant agencies at both national and international levels.

Run a sensitivity analysis on possible future stress-test scenarios to assess how such policies may affect the financial markets – money, capital, and bond markets, and banks and other financial institutions.

The following limitations should be analysed:

Favouring green investments in financial market regulation could create new risks and/or a failure to adequately regulate the existing risks;

The construction of a framework could lead to a build-up of dangerous trends, resulting in a compliant / non-compliant structure.

In fact, a transformative sustainability policy framework will cause remarkable changes in the environmental and social fields through harmonisation. It will not create a restrictive regulatory framework erected around pollution / emission punishment. The inclusion of sustainability criteria into policy interventions should transform the actual use of prudential regulation, ethical conduct, and the systemic control of the financial sector’s actors. Consequentially, the public and private trust will increase, thus facilitating the integration of different national and regional markets.

Moreover, the framework will identify innovative interventions and approaches for overcoming current national barriers to low-carbon and climate-resilient investments. Risks, costs, and liquidity gaps will be reduced because of improved financial stability – itself the result of better regulatory policies. Scaling up green investments will also have a transformational impact on both cost and performances. It is the goal of the shared policy objectives to mobilise as much green capital as possible. Therefore better performance may be achieved with the increased ability of rallying private capital to leverage and multiply public green investments.

About the Author

Luisa Nenci is CEO of SustainValues. She is an environmental economist and green finance strategist. Please visit www.sustainvalues.net for contact and additional information.


IFC: The Art and Science of Benefits Sharing

Non-renewable natural resource projects – that is oil, gas, and minerals – are usually seen as part of a nation’s wealth. Accordingly, their use for the long-term sustainable development of a country is a prime objective of any legitimate government. The role of government in establishing a framework to manage and invest revenues derived from oil, gas, and mining projects is crucial to ensure that the sector contributes positively to sustainable development.

The fair sharing of the net benefits of natural resource developments, i.e. benefits in excess of costs, between government, investors, and other stakeholders, is important to ensuring that projects and their positive impacts are durable and resilient to change over time. Investors, governments, communities, and other stakeholders share a strong interest in a reasonable distribution of benefits.

[caption id="attachment_9799" align="aligncenter" width="664"] Figure 1: IFC Stakeholder Framework and Areas of Project Impact[/caption]

Most private-sector investors realise that projects that are good for the host country and communities, and whose benefits are perceived to be shared reasonably, are less likely to face disruption, renegotiation, or even expropriation. Terms and conditions that deliver shared benefits are more likely to survive changes in societal expectations, political regimes, or market disruptions and reward investors over the long run for the capital and skills deployed and the risks taken. As developers better understand this connection and experience stakeholder challenges and even social conflict, their interest in a dialogue to create shared benefits and value is growing.

“High levels of cross-shareholding and concentrated ownership in the banking sector and the overall market means related-party transactions, particularly lending, remain a key challenge.”

The International Finance Corporation (IFC) recognises the important technical and economic differences between the oil, gas, and mining industry, and understanding project and country specifics is crucial. Nonetheless, the three sectors share certain characteristics that distinguish them from any other industry, including high degrees of uncertainty and risk (geological, exploration, technical), price volatility, long project lead times with significant capital expenditures up front, and often a large footprint with environmental social effects.

These factors profoundly influence how, when, and to whom benefits and costs accrue and the process by which a durable benefit sharing agreement across stakeholders can be reached. In this light, an overall approach to assessing benefit sharing that covers oil, gas, and mining is proposed.

The IFC Approach

Guided by its development mandate, IFC looks carefully at an extractive project’s potential to contribute to a country’s economic and social development, and how project costs and benefits will be distributed when considering a potential investment. IFC also reviews the profitability of the proposed investment and the underlying economics of the project to make a financial decision on whether or not to put its own capital at risk. These factors are considered throughout the life cycle of an IFC investment along with other key criteria that determine IFC’s engagement, including IFC’s prospective role and value addition, strategic fit with World Bank Group country engagement, and institutional priorities as well as general compliance with policies.

A full investment cycle from early review to investment and eventual exit from a project consists of many steps and can unfold over many years, especially in the natural resource sector, where projects have long lead times and face high levels of uncertainty.

An assessment of prospective project development impacts and benefit sharing is an integral part of IFC’s investment appraisal approach. A benefit-sharing assessment typically considers:

The country and community context, the processes by which sharing was determined and how proceeds are managed and used;

Environmental and social issues and risks, mitigation measures, and opportunities to enhance outcomes beyond mitigation as well as stakeholder expectations and concerns;

The overall distribution of diverse, uncertain and sometimes unquantifiable benefits and costs across affected stakeholders, using IFC’s stakeholder framework (Lysy, Bouton, Karmokolias, Somensatto and Miller 2000). The timing of these, which are grouped by financial, economic, environmental and social impacts, is also reviewed.

IFC will assess the broader context, starting with the role of the natural resource sector in the country, its economic contribution to date, its prospects, and government vision for its future. Understanding country and sector governance issues and capacity, as well as expectations and concerns by host governments can help determine whether a project will likely contribute to sustainable development.

The assessment includes a review of “traditional corruption”, as it may occur during the acquisition of mineral rights. IFC looks carefully at the private investors in projects it is asked to support. This is done both to satisfy IFC of their integrity and the possible presence of political insiders whose presence may be an indication of a sweetheart deal. Where corruption is a factor, IFC will not invest.

Poor country and sector governance often poses an impediment to the transformation of resource wealth into sustainable development. The engagement of the World Bank (WB), the International Monetary Fund (IMF) and other development actors in a country will help judge the risks along the value chain and verify a country government’s commitment to reform and change.

IFC reviews ex ante the risks weak governance poses to key project development benefits. In general, IFC makes careful judgments about whether it should support natural resource projects where governance is weak but development pay-off may be significant, such as supply chain development, shared infrastructure, investment in local communities. IFC also considers project-specific arrangements that can help reduce governance risks, such as technical assistance to build local capacity in revenue management, enhance transparency and accountability. IFC supports the global transparency agenda and initiatives like the Extractive Industries Initiative (EITI). Also, IFC has taken the lead among other development finance institutions by championing full revenue and contract disclosure in its projects.

Understanding who the key stakeholders are, what their aspirations, concerns, and expectations of a project are, and what drives these is important for judging the reasonableness of a benefit sharing settlement and its legitimacy and durability over time. If project realities are not commensurate with stakeholder perceptions – be they informed or not – a project may be at risk. Typically, key stakeholders include the government (federal and sometimes subnational), citizens at large, affected communities, and investors.

As part of its due diligence before investing and part and parcel of project supervision, IFC through its performance standards requires a stakeholder analysis and engagement plan for the range of stakeholders that are interested in the project. Stakeholder engagement plans must be scaled to the risks and impacts, the development stage of the project and tailored to the characteristics and interests of affected communities.

Stakes in project may go much beyond the immediate project boundaries and the directly affected communities, and they can be high. Especially, projects that are big in scale and are transformational for an entire country or even region, national expectations and concerns will inform project-level dynamics and vice-versa.

At the core, IFC assesses a project’s costs and benefits and their distribution across stakeholders, in three broad, overlapping areas of impact. IFC considers a variety of questions as part of its due diligence and decision-making process:

Fiscal impacts: How are the net financial benefits of projects shared through profit sharing, taxation, and in other ways – at both the national and subnational levels of government and with communities and others?

Economic impacts: What additional economic costs and benefits are generated and shared, such as jobs and training, the introduction of technologies, spending with local suppliers, investment in infrastructure, the supply of energy, such as oil, gas, coal and electricity, or the supply of other raw materials at competitive prices to local industry and households?

Environmental and social impacts: What are the positive and negative environmental impacts and risks that the project brings and who bears them? How do impacted communities, including vulnerable groups within communities, gain or lose from the development in other ways?

IFC Experiences and Lessons Learned

As both a development institution and an investor, IFC is in a unique position to simultaneously share the perspectives of investors, host countries, and other stakeholders. As a result of balancing these dual roles over many years, through commodity price cycles and industry change, a number of lessons have emerged that have a bearing on how to assess and secure a durable benefit-sharing arrangement:

1. Uncertainty is a key feature throughout the project life cycle
A project’s expected business outcomes and performance over time are exposed to many uncertainties. The future values of key drivers of project performance, such as costs of production and commodity prices, are uncertain and can be volatile. Even the scale and quality of a resource may not be fully known until late in the development and its extraction. And there may be substantial technical and production challenges that need to be addressed.

Projects may require many billions of dollars, may take years to come to fruition and many more to generate a financial return once operational. Against this backdrop, the planning of programs intended to benefit communities may be difficult, given business and other uncertainties.

Government policies and regulations can change and other political events may have major impacts on a project’s success and commercial viability. Tax frameworks and agreements and their impacts on projected benefit sharing that seemed reasonable at the outset of a project may look very different in the future. For example, much-higher-than-expected commodity prices over the last decade boosted the profitability of natural resource projects and companies. A number of governments came to believe they were not receiving a fair share of project benefits because their incomes from taxes did not increase in parallel – partly because tax structures and agreements were not designed to cope with these changes.

The considerable deterioration in prices for various commodities in the recent past, as well as the notable price volatility generally seen during the last years, has changed the conversation again, bringing into relief the uncertainty that medium- to long-term investors and governments face in this sector.

2. Every project is unique
Individual projects vary greatly in their size and life cycles, the richness of the resource, ease of access, cost of extraction, profitability, and impacts on people and the environment. Oil and gas is a different business from mining. However, gas is also very different from oil, and mining projects vary greatly from one another.

In regulating the natural resource sector, governments must strike a balance between accommodating the special circumstances of projects and maintaining a transparent, standard, and manageable regulatory framework and a bureaucracy that supports it. The way a project is treated and perceived depends on its host country and community context, the present and future economic role of the natural resource sector, and the government’s vision for it as an engine for sustainable development.

Investors seek acknowledgement for the uncertainty and unique project circumstances they face and value stability of the arrangements that govern their obligations to the government and other stakeholders. Especially for megaprojects, investors and governments may enter negotiations about specific aspects as regards project development and benefit sharing. While deal-by-deal negotiation allows for greater tailoring to project specifics, legitimacy rests heavily on transparency of process, symmetry in the access to information, and technical know-how and capacity. This may not be achieved in many weak governance countries.

3. Government policy impacts benefit sharing
Governments face multiple competing demands and the policy objectives they set impact benefit sharing—including whether, when, and how to develop their natural resources. Although the overriding objective of most governments is to ensure their country benefits to the greatest extent from its natural resources, there are many different ways they may try to ensure this. Government commitment to transparency and accountability, due process and prudent public financial management are key.

Good policy does not necessarily require governments to maximise the net revenue they receive from every project. The benefits of offering standard terms and conditions may outweigh the costs and complexity of trying to implement a more sophisticated tax system or setting terms and conditions project by project. New, emerging countries may be best served by setting relatively attractive terms to encourage a steady flow of new investment. It may also be an appropriate long-term strategy for building a robust, lasting industry, as some of the most important, resource-producing countries, such as Australia, Canada, Chile, and Peru demonstrate.

Governments may accept less tax income in return for investors helping them achieve other development objectives. For example, investors may be expected to increase local procurement and skills development, build, manage, and provide affordable access to infrastructure (power, rail, roads) for use by others, or process production locally rather than export raw materials.

Governments play an important role in providing an enabling environment for private-sector actors so that natural resource projects can link into the local economy and generate benefits for as long as resources are economically recoverable.

4. Perceptions and expectations matter
Diverse stakeholder groups have different perceptions and expectations about natural resource projects and their potential impacts. In particular, countries and communities with little experience developing natural resource projects may have difficulties to fully understand all of the issues, including the scale and nature of future impacts. Even when projects have been constructed and in operation for some time, it can be difficult to fully capture the economic and social impacts that have accrued over decades. Many older projects lack baseline data which can further impede tracking and may breed distrust of company practices and government policies.

Expectations and perceptions by host communities and other affected stakeholders will have a bearing on project success. Stakeholders are unlikely to share equal access to information or understanding of a project’s fiscal, economic, social, and environmental effects and impacts. Transparency and access to information are essential to manage misperceptions and enforce mutual accountability among stakeholders. In IFC’s experience, imbalance of information coupled with poor stakeholder engagement can derail an otherwise healthy project. Proactive management of diverse local expectations via honest dialogue about benefits, costs, risks, and mitigation measures can help build trust. Ideally, this creates a platform to cooperatively plan strategies to smooth costs and benefits across constituencies.

5. Processes are important
The processes by which benefit sharing is determined directly influences public perceptions about the reasonableness of the distribution of costs and benefits. This starts with how contracts were awarded, how environmental and social impacts are monitored, how affected communities are consulted to the collection and use of fiscal revenues for the economic development of the country. Transparency of processes along the value chain is important for creating accountability of key actors by enabling access to information and a better understanding of the project benefits and costs.

A process that is perceived as opaque and not inclusive can generate suspicion and negatively impact a project, as stakeholders may persistently challenge the arrangement, including any proclamations about net benefits. Even if company and government agree on what they view as a reasonable split over time, an uninformed, excluded electorate may at some point decide to change the government and the project terms as a result.

There has been a welcome trend of greater transparency about natural resource projects – including revenue flows, contract terms, and reporting to communities. But for benefit-sharing arrangements to be durable, the process must be consultative and participatory. Consultation with affected communities should start early – even during the exploration phase – and should be iterative throughout a project’s life, taking into account dynamic, environmental, and social risks. Communities must be able to register their grievances and see them addressed. Resilient agreements are those that are supported by affected stakeholders who have meaningfully participated and can influence decisions about project aspects that affect them. This may relate to land access, water management, immigration, and infrastructure development. Broad community support is central to managing project risks over time.

6. Fiscal benefits are only one part of a project’s costs and benefits
Benefit-sharing discussions usually focus on the distribution of the financial (fiscal) benefits and costs of the project between private investors and the central government. However, there is a broader range of other non-fiscal costs and benefits that need to be considered to understand the full range of impacts and opportunities of natural resource development

For example, communities are immediately – and sometimes negatively – impacted by projects near them. Their lives will be impacted in varying ways, and different groups within these communities will fare differently. In addition to tax revenue, projects may bring jobs, infrastructure, local sourcing, and competitive supplies of energy and other materials that may benefit the country as a whole or particular regions and sectors. Projects will also have environmental impacts that need to be assessed and tracked.

7. The arts and science of benefit sharing
For IFC, determining whether a project has a reasonable balance of benefits and costs depends on an informed, overall judgment based on expert, multi-disciplinary input and review. From a development and commercial perspective, IFC tests for a range of outcomes, and thresholds exist with respect to financial, economic, environmental, and social considerations. For a project to be supported, it must demonstrate, at minimum, that it is profitable, that its economic benefit to society and economic return on investment is positive and greater than its financial return, that it is compliant with IFC Performance Standards (IFC PS), and that affected communities are broadly supportive.

However, given the diversity of national contexts, geographical potential, and business arrangements, IFC has found that there is no single blueprint that can be used to determine what equitable sharing looks like. In practice, investigation and professional judgment from a diverse team of experts, representing specialty areas such as finance, engineering, environmental and social, economics, and law, to name a few, is required.

Often precise measures or cut-offs between what is acceptable, for example with respect to the fiscal sharing between the public and private sector, and what is not, are at best imperfect and at worst misleading. Rather, it is important to contextualise and assess fiscal sharing against other project characteristics and drivers, stakeholder expectations and concerns (see Figure 1), and potential impacts. Even when the overall judgment is that there is a balance of costs and benefits at a particular moment in time, circumstances can change and present risks that need to be addressed and managed carefully.


Jeremy Howard: Make Way for the Smart Machine

Uber cabbies may have built their careers on modern technology, their job prospect is none too bright all the same. While old-school drivers wielding clubs pose the immediate threat to life, limb, and headlight; it is the robots who will do them in.

Over the next twenty odd years, robots are set to replace human workers in almost half the world’s professions and trades. Please direct any anger at Jeremy Howard. He is the one teaching robots how to run the world – or at least 50% of it.

A leading authority on machine learning, Mr Howard develops highly complex algorithms that enable innate objects to learn from data. As machines gather data through a multitude of inputs, this flow of information is then stored, compartmentalised, analysed, and otherwise processed and used to expand the device’s situational awareness and its responses to changing externalities. Machine learning begets artificial intelligence (AI).

Mr Howard is after the holy grail of AI: the point at which machine learning becomes akin to a self-fulfilling prophecy and the rate of data acquisition and processing takes off in a vicious – and hopefully benevolent – circle of learning that allows the contraption to become as smart as a human being, if not considerably more so.

Technology is not quite there yet, but it is catching on at a disconcertingly fast and dizzying pace. Late last year, Mr Howard founded a company that will try to apply machine learning and deep learning technology to medical tools used for the diagnosis of illness and disease. Mr Howard is convinced that machines are already now vastly better than humans at collecting and analysing medical data and thus able to set a much more accurate diagnosis.

“Medical diagnostics is, at its heart, a data problem. Recent machine learning breakthroughs have shown that computers can rapidly turn large amounts of data into deep insights, and find subtle patterns.”

With his start-up company, Mr Howard makes no secret of the fact that he hopes to emulate Star Trek’s Dr Spock – the endearing Vulcan addicted to high logic – who worked his medical magic aboard Starship Enterprise with the help of Data, a Soong Type android with scanning powers and a positronic brain that can access all information ever generated. Data unfailingly sets diagnoses with pinpoint precision, devoid of any and all human idiosyncrasies. This certainly seems to facilitate the healing and recovery of frail human bodies.

Meanwhile back in Australia, Jeremy Howard continues his esoteric pursuits by coupling big data to another relatively obscure science – deep learning, on offshoot of machine learning – in an attempt to make sense of the universe. With fellow Australian Brian Schmidt, an astrophysicist and Nobel Laureate, Jeremy Howard is developing ways to have machines, rather than humans, unlock the secrets of the universe.

All this heady stuff also has more down-to-earth applications such as self-driving vehicles and real-time translations generated by machines and delivered in a natural sounding humanoid voice. While Google is busily bolting together the driverless car, Microsoft-owned Skype has been tinkering with translation algorithms based on deep learning principles in order to finally demolish the Tower of Babel and have the world talking again.

In between his research into robotics and AI, Mr Howard has also found time to develop a new way of acquiring basic Chinese language skills in under a year. Geared towards humans, his model is named spaced repetitive learning and prompts learners to remember information just moments before forgetfulness kicks in. It also has the power to become excessively annoying.

However, Mr Howards readily admits that his novel approach to language learning may have a limited shelf life as Skype will have us shortly speaking Chinese and any other language without breaking a sweat.