Book Review: Niall Ferguson’s Civilization - Six Ways the West Beat the Rest

In much the same way Marxists internationalists held on to the belief that the workers’ revolution would sweep the world before it, today’s neoconservatives are convinced theirs is the only way forward. In this, neocons are but the most recent incarnation of the French Jacobins who considered liberty, equality, and fraternity the universal values that would create a new man devoid of superstition and given to pure reason. Today’s neocons may not emphasise equality and fraternity as much as the Jacobins did; they nonetheless are firm believers in freedom as defined by the American Founding Fathers – or so they say.

Curiously enough, neoconservative philosophy differs significantly from its real life applications. The classical liberalism of the 1689 English Bill of Rights and the 1788 US Constitution – both documents calling for small government and eschewing imperial practices – has become the preserve of exotic libertarians, a near-extinct species dwelling on the fringes of the political landscape. Neoconservatives, solidly embedded in mainstream politics, prefer to think big: big government, big military, big nation-building exercises, and big brother-like surveillance.

“According to Mr Ferguson it all boils down to six ‘killer apps’ that Western nations managed to “download” in the 1600s and used to impose their will on the wider world.”

British historian Niall Ferguson (51) is a reluctant neocon who prefers the epithet “doctrinaire liberal” to any other bestowed upon him by critics. A liberal right-winger, Mr Ferguson remains an unapologetic and committed believer in the gospel of free markets, individual rights, and assorted enlightenment values. He wholeheartedly approves of any and all military expeditions aimed at spreading the word to regions still marred by ignorance and darkness. Thus it is that Mr Ferguson considered the US attempts at nation-building in Afghanistan and Iraq worthwhile ventures undertaken by a power intent on promoting freedom and reason. Invariably, the good guys hail from the West.

Armed with this conclusion, Mr Ferguson embarked on an investigation to trace its roots back to the dawn of history in his book Civilization: Six Ways the West Beat the Rest (ISBN 978-1-8461-4273-4). Written for the benefit of those only partially versed in contemporary history, the modest tome aims to distil a formula for success – the power to gain prosperity – from the accomplishments of Western powers.

According to Mr Ferguson it all boils down to six “killer apps” that Western nations managed to “download” in the 1600s and used to impose their will on the wider world. The most important app concerned a fragmented political atmosphere that encouraged competition and rewarded excellence both between and within nation states. Another app provided for open inquiry into nature and the unencumbered pursuit of science while a third one combined higher labour productivity with increased returns on investments ensuring the rapid accumulation of capital with which to finance ever more ambitious business ventures.

Deployed in unison, Mr Ferguson’s killer apps gave rise to the vast overseas empires of Great Britain, France, and The Netherlands. Interestingly, Mr Ferguson seems to imply that European powers only rose to greatness in the early 1600s. Before that, the continent barely registered with the work of Greek philosophers and mathematicians, and the Roman Republic failing to have much of an impact. It is as if in Mr Ferguson’s reading of universal history Euclid, Archimedes, Seneca, and Virgil – and countless other brilliant thinkers – never constituted more than footnotes.

None of the killer apps identified and dissected are concerned with the arts. The poems of Ovid and Lucretius are passed over, as are Dante who placed vernacular literature on par its biblical and classical forebears and the many Cistercians, Franciscans, and Dominicans who advocated for religious heterodoxy and laboured for the laicisation of the mystical. Montaigne, Mozart, Spinoza, and Nietzsche are only briefly mentioned while others like Plato, Kant, and Luther are completely absent.

Yet, if the west can be defined at all as a distinctive and highly successful collectivist entity, it is precisely because European nations produced an almost unending stream of great thinkers and tinkerers who – perhaps unwittingly – contributed to the forming of a powerful civilization united by shared pursuits.

One wonders how others got ahead without the help of Mr Ferguson’s killer apps. China has steadfastly refused to download the plurality app yet still managed to attain a high degree of competitiveness. According to the historian the country made up for missing app by investing its resources in education, research, and development. No longer contend with being the world’s sweatshop, China upped its R&D spending by a factor of six over the past decade, doubling the number of scientists now producing almost as many scientific papers as the United States.

The Chinese way seems to undermine Mr Ferguson’s claim that Western powers will remain dominant because of their adherence to liberal values such as individual freedom and free enterprise within a pluralistic framework. The six killer apps are not as universal in nature as initially thought.

If China and the Asian tiger economies manage to prosper without embracing the full suite of Western values, how about the rest of the world? Mr Ferguson is rather dismissive of the Arab world noting that it remains recalcitrant and falls back to values not conducive to further development. This divergence – the looming clash of civilizations – seems to worry Mr Ferguson who fears that the West may fail to show the repressed masses the many benefits of its supposedly superior liberal culture.

What Mr Ferguson, however, fails to mention is that the universalising side of the Western heritage is grounded in the Age of Enlightenment which, as such, was the result of a specific historical setting that cannot be replicated elsewhere. The killer apps may have worked for European Powers but do not hold a universally applicable solution to the world’s ills. Each region will need to find its own bespoke apps. Thus, the magic bullet remains as elusive as before.


Nick Clegg: A Heart That Will Yet Be Sorely Missed

 As David Cameron was celebrating his party’s astonishing victory at the polls on May 8, his former coalition partner Nick Clegg delivered a mournful resignation speech. Immediately after the election, Mr Clegg stepped down as leader of the Liberal Democrats. He called the outcome “crushing and unkind”.

This was an apt assessment: of the fifty-seven seats won in 2010, only eight remained. The Lib Dems vote plummeted from 6.8m in 2010 to barely 2.4m in 2015. One of the constituencies the party managed to keep was the former deputy prime minister’s own Sheffield Hallam. As such – and possibly as a form of penance – Nick Clegg kept his seat in parliament.

The Tory victory now offers David Cameron a clear mandate to continue his austerity drive. No longer in need of a messy coalition, the Tories dutifully patted Mr Clegg on the head for being such a good sport. The few articles in the media defending the Lib Dems were in a similar vein: sacrificing himself for the good of the economy and putting the country before party. Mr Clegg is widely considered a nice chap.

“History can wait: the voters will undoubtedly come to judge Mr Clegg more kindly.”

These are attributes a politician could do without as some former supporters scream traitor and sell-out. Mr Clegg’s record is in no need of such faux-magnanimity emanating from the right: whether or not his disgruntled supporters realise it, Mr Clegg’s accomplishments are worthy of sincere praise.

By going into government with the Tories – the first coalition since World War II – Nick Clegg brought his party into power for the first time in its history. He proved that Liberal Democrats are indeed a party capable of governing, implementing policies, and assuming the responsibility that comes with it – and not a wishy-washy party of well-meaning fence sitters. They may have appreciated the anti-establishment bent Mr Clegg presented during the election campaign, being the firmly established third party of UK politics. However, the Lib Dems are not merely a protest party. If compromise is the price of actually affecting policy, then it is worthwhile to pay.

This brings the elephant – or 800lbs gorilla – in the room into view: tuition fees. The Lib Dems pledged to cap these but had to backtrack – the price of admittance to government. The party ended up signing off on a hike that saw tuition fees skyrocket by up to 200%. The Lib Dems were allowed a single fig leaf in the form of a raised income level beyond which repayment is triggered.

This constituted an unmitigated disaster and Mr Clegg and his party were correctly held accountable for breaking an important campaign promise. Following the coalition’s formation, support for the Lib Dems dropped slightly, only to nosedive after the tuition fee debacle. The party would not see disenchanted voters return to its fold.

But is this really fair? After the 2010 election, the Lib Dems had nowhere near the majority needed to fully implement all espoused policies. Such is the fate of smaller parties. Would a minority Tory government have fared any better? Or for that matter, what could have been expected of a Labour government? After all, it was Labour that introduced tuition fees to begin with. An inconvenient truth.

It is easy to cherish ideals if they are never put to the test. Labelling compromise as betrayal reveals a preference for keeping ideals safely seated on their lofty perch: pretty but pretty useless as well. However, many Britons have a hard time understanding the compromise needed for government by coalition to work.

Nick Clegg took a minority party and still managed to affect policy according to his party’s principles of social liberalism and economic centrism. In coalition, the Lib Dems secured a raise of the income tax threshold to £10,000, fulfilled their promise to end child migrant detention, and raised inheritance tax on estates over one million pounds.

More importantly, the Libs Dems managed to block a number of Tory legislative initiatives such as the Communications Data Bill commonly known as the Snoopers’ Charter. This bill would have greatly increased the government’s power to collect and store electronic data generated by its citizens. The Lib Dems also restrained their coalition partner when perhaps overly excited Tories attempted to repeal the Human Rights Act. Such a move would have effectively terminated the UK’s adherence to the European Convention on Human Rights and with it the right to appeal at European level.

Now unencumbered in government, the Tories have placed both initiatives back on the legislative agenda. They are now also free to slash and hack away at the budget without any restraints on their austerity impulses. As a result, welfare programmes are expected to be reduced by at least £12bn as the poor are again being punished for their supposed failings.

During the campaign, Mr Clegg put forth his vision of the liberal democrats: the head of a Labour coalition or the heart in one with the Tories. His track record, for all the let-downs, bears that out. History can wait: the voters will undoubtedly come to judge Mr Clegg more kindly. Over the next few years that heart will surely become sorely missed.


Sebastião Salgado: Capturing the Moment

 Sebastião Salgado abandoned a promising career as an economist in his 30s to become a highly-regarded and iconic photojournalist. His extraordinary black and white images record the lives of people in harsh conditions, finding beauty and strength in the bleakest of environments. His portfolio is unlike that of any other photographer.

Mr Salgado was born on a farm in southeast Brazil. He gained a PhD in Economics and discovered the magic of photography while travelling the world working for the International Coffee Organisation in the 1970s. “When I first took a camera, I had never looked through a viewfinder in all my life.” He says it was electrifying, and he promptly abandoned coffee for the camera.

Mr Salgado’s distinctive pictures belong to a classic tradition of black and white documentary photographs from a pre-digital age. Humans are at the centre of much of his work. Over the last forty years he has documented many of the world’s major events from war to famine and from genocide to exodus.

Photography has taken him all over the world, recording extraordinary people, places, and events. A photograph records but an instant, but getting great images takes time. Mr Salgado immerses himself in his subject in order to understand the flow of events and the mood of people. “Photography is one 250th of a second,” he says. “There are a lot of variables. There must be light. There must be power. And if it is a portrait, there must be personality.”

Mr Salgado’s images are characterised by a sense of depth and scale. They are large panoramas encompassing human history and the environment. He is a self-taught photographer learning and refining his techniques over a lifetime. Digital photography does not interest him. He likes to work with celluloid, using very fast film and a small diaphragm to give a huge depth of field: “Reality is full of depth of field.”

Recently, the celebrated German filmmaker Wim Wenders collaborated with Sebastião Salgado’s son Juliano Salgado to make a documentary about the photographer. The Salt of the Earth, released last year, has been nominated for an Oscar and won awards at Cannes and a number of other film festivals. It sees Mr Salgado revisit his past and discusses some of his most famous photographs, providing personal, social, and political insights into the events around the stunning images.

Story telling is another of Mr Salgado’s skills. In the film, the director placed the photographer in a soundproof room, and projected his photographs with the camera hidden behind a one-way mirror. He then invited the photographer to talk about the shots. The striking and heart-wrenching images include those taken at the Serra Pelada mine in Brazil, where 50,000 distant miners scale rickety ladders that rise up from the mud pits, pictures of burning oilrigs in Kuwait after the First Gulf War, and some photos taken during the Rwandan genocide.

The footage is interspersed with film of Mr Salgado at work shooting his most recent photo-series, Genesis, which documents the world’s forgotten people and places. Genesis was shot between 2004 and 2011. It is a series of photographs of landscapes, wildlife, and human communities that continue to live in accordance with their ancestral traditions and cultures.

Work dictated that Mr Salgado was often away from home while his children were growing up. His son Juliano Salgado decided to accompany his father on some of his Genesis adventures. They visited Inuit tribes in Alaska and filmed great walruses in the Arctic Circle. The shared experience, shown in the film, helped the photographer to rekindle a strong relationship with his now adult son.

Over the last twenty years, Mr Salgado and his wife Lélia have worked to restore the former cattle ranch in Brazil’s Atlantic Forest inherited from Salgado’s father. The land had been over-farmed and they set out to return it to its natural subtropical state as a rainforest. In 1998, they turned the property into a nature reserve and created the Instituto Terra dedicated to reforestation, conservation, and environmental education, a symbol of hope for the future.

Words cannot do justice to Mr Salgado’s images, only a visit to an exhibition featuring his shots can do that. Prepare to be impressed.


Ray-Ban: Wearable Icon

[caption id="attachment_10502" align="alignright" width="300"] Leyte: General MacArthur[/caption]

October 20 1944, on the Philippine island of Leyte, Gaetano Faillace, personal photographer to General Douglas MacArthur, waded ashore at Dagupan just ahead of the general’s entourage. The beach had not been entirely secured and there was still sniper and sporadic mortar fire as the landing craft was forced to stop just off the shore, forcing the party to wade the rest of the way. Mr Faillace then turned and documented the moment the general made good on his promise to return to the Philippines accompanied by the country’s President Sergio Osmena.

Not only would this photograph become one of the most iconic images of the Pacific Theatre, alongside the flag-raising at Iwo Jima and the mushroom cloud over Nagasaki, but also the figure cut by the general would become emblematic of the archetypal US military officer: authoritative, resolute, unflustered, and – by extension – intimidating. Who’s to say what is really going on behind those shades, those Ray-Ban Aviators.

In the first half of the 20th century spectacles were still strictly used either as a medical or occupational device; the Aviators themselves were designed with purely practical considerations in mind. Developed by medical equipment manufacturer Bausch & Lomb, Aviators were made of tinted lenses to protect pilots from glare at high altitude, large and slightly convex so as to cover the entire range of the eye, and held together by a lightweight metal frame making them sturdy enough for the hassles of air combat: eyewear fit for heroes.

“Some brands may be sporty, others might be trendy or edgy, but Ray-Ban is iconic and timeless.”

However, the psychological effects of hiding one’s eyes – and in doing so denying any observer the benefit of nonverbal communication of either emotion or motivation – quickly became just as essential to military proceedings as more immediate considerations. To this day, metal framed bug-eyed glasses with mirrored lenses are visual shorthand for authority.

After the war, returning GI’s would continue to sport their army issue spectacles; this along with Hollywood, where actors and actresses had been wearing tinted glasses for decades to protect their eyes from the bright studio lighting, and the rise of beach culture, rehabilitated the public perception of the sunglasses from that of a medical necessity to a fashion statement.

The fifties saw the introduction of Ray-Ban’s Wayfarer model. If the Aviators were the eyewear of heroes, then Wayfarer were the shades of choice for the rebel; its robust plastic moulded frame, with the brow slanted upwards, gave it a character polar opposite to the Aviators, cool rather than authoritative. James Dean wore Wayfarers, as did Marylyn Monroe; while JFK sported a pair of knock-offs – he wouldn’t be the last. Through the decades the Wayfarer’s place in the zeitgeist has been reaffirmed by the patronage of celebrity – from Bob Dylan to Michael Jackson, from Tom Cruise to Bruno Mars.

Today Ray-Ban as a brand is stronger than ever. Its iconic personality and heritage play well with a generation (be they hipsters or yuccies or whatever the term du jour curmudgeons are using to disparage well-dressed millennials) that almost fetishizes the authentic. Ray-Ban occupies the odd position of being both a market leader and the brand of choice for a generation that prefers its products artisanal and homebrewed. The only brand comparable in this respect that springs immediately to mind is Apple.

2007 saw the launch of Ray-Bans’ latest media campaign created and developed around the concept Never Hide. This campaign, which has been kept alive by a steady stream of print, outdoor, and online content, aims to assert the brand’s maverick identity with a few short, bold, imperative sentences: Never pretend. Never be afraid. Never give up. Never hide. A message reinforced by original artwork while maintaining a vital link to their past by the inclusion or allusion to iconic photography.

It would seem that while the good people at TBWA/CHIAT and Carat International – the agencies responsible for the marketing campaign – are perfectly aware of the irony of using the strapline never hide to sell an accessory which hampers identification. However, there is a second level of irony they might not have picked up on.

In 1999, Bausch & Lomb sold the Ray-Ban brand for a reported $640 million to the Italian Luxottica Group. Under its founder and chairman Leonardo Del Vecchio, this Milan-based eyewear company has grown into the dominant force in the market, controlling fully 80% of the world’s major eyewear brands. It made Mr Del Vecchio the richest man in Italy. Besides owning Ray-Ban and its chief competitors Persol and Oakley, and a few other house brands, Luxottica also has licences to design and manufacture eyewear for the biggest designer labels: Chanel, Dolce & Gabbana, and Versace to name but a few.

Luxottica itself is not a brand, it has no public persona and that’s how Mr Del Vecchio likes it. The company is happy to supply the consumer’s need for variety and choice, perfectly willing to manage all these different brands, each with its particular style and relationship with the public. Two pairs of spectacles each designed by the same team, manufactured from the same materials, and put together on the same assembly line may differ in eventual retail price by hundreds of dollars simply by virtue of what the packaging reads. The correct price for any commodity – after all – is whatever someone is willing to pay for it.

Paying for the label rather than the actual product is of course nothing new and certainly not in the fashion industry, but Luxottica’s market share is so large they constitute a price setter. The company wields this power not only through its brands, but also through its dominance of the retail side of the business, acting as gatekeeper for competing brands with more than 7,000 locations all over the globe whether the sign outside reads Sunglass Hut, Pearle Vision, or Sears Optical – again to name but a few.

It’s a lucrative feedback loop; competing brands need to be carried by their stores, retail competitors need their brands in stock. This might was unleashed against their then-competitor Oakley through the 2000s, causing its stock to plummet, cutting the brand off on the retail end, and wearing the company down for the eventual merger. Top hat, wheelbarrow, racing car, thimble, shoe.

The second half of last year saw the departure in quick succession of two top executives from Luxottica: CEO Andrea Guerra was the first to withdraw. His replacement, Chief Financial Officer Enrico Cavatorta, did not last long at the top and resigned within weeks, also citing disagreements with Mr Del Vecchio as the reason for his sudden departure. Mr Guerra held his position for over ten years during which the value of the company’s share price almost tripled and sales went from $3.1 billion in 2003 to over $8 billion ten years later. Despite these most embarrassing episodes, the first half of 2015 saw Luxottica report revenues of $5.2 billion, compared to $4.4 billion over the same period last year.

Type Ray-Ban into YouTube and you’ll find page after page of how-to-videos instructing viewers how to tell a fake Ray-Ban from the genuine article. It’s so hard to spot the difference that even while holding a pair one needs a detailed tutorial. But if that fact had mattered at all, there wouldn’t be page after page of people helping each other figure out who has an actual pair of Ray-Bans and who was duped. Luxottica can concern itself solely with being an industry-dominating company precisely because each separate brand in its own unique way is worth buying into.

Some brands may be sporty, others might be trendy or edgy, but Ray-Ban is iconic and timeless. For anyone aspiring to attain timeless status, only a genuine pair will do. Genuine since 1937.


European Court of Justice: Looking for the Digital Utopia

[caption id="attachment_10508" align="alignright" width="281"] European Court of Justice[/caption]

In a textbook case of be-careful-what-you-wish-for, frustrated lobbyists plying their trade in Brussels on behalf of Google, Microsoft, and other Internet giants earlier this week suggested Europe could of course always build its own search engine since the US-based ones seems to cause such offence. The last time Europe set out to break US industrial hegemony, it succeeded beyond all expectations with Airbus effectively ending the near-monopoly on commercial aircraft manufacturing enjoyed by Boeing and McDonnell Douglas since the dawn of aviation. Underestimating the resourcefulness of the Old World does not usually pay off.

In a remarkably strong-worded verdict, the European Court of Justice on Tuesday struck down the “safe harbour” provision of the European Commission (EC) which essentially allowed Internet companies such as Google, Microsoft, Facebook, Amazon, and many others to store the private data of EU citizens on servers in the US. The court ordered national privacy watchdogs to investigate “with all due diligence” complaints by users concerned their information may be accessed without their knowledge or consent by US intelligence agencies.

"In a remarkably strong-worded verdict, the European Court of Justice on Tuesday struck down the “safe harbour” provision of the European Commission (EC) which essentially allowed Internet companies such as Google, Microsoft, Facebook, Amazon, and many others to store the private data of EU citizens on servers in the US."

National supervisory entities had so far dismissed such complaints as either frivolous or vexatious considering the EC’s safe harbour decision a blanket authorisation for the storage of private data in the US. However, the court reasoned that since the national security and law enforcement of the US take precedence over the safe harbour provisions, the scheme fails to properly protect the fundamental rights to privacy of EU citizens and thus contravenes European law.

The court based its verdict on the European Commission’s own findings that US authorities are able to access and process the personal data of EU citizens in way that goes beyond what is strictly necessary and proportionate to the protection of national security. The court also chided the European Commission for failing to ensure US authorities comply with the safe harbour provisions and thus with the privacy guarantees enshrined in the EU Charter. The judges concluded that the European Commission took the assurances of US authorities at face value and did not monitor compliance.

Effective immediately, Internet companies must store all personal data of European citizens on servers that are physically located in a EU member state. In anticipation of the ruling, larger corporations already built new server farms in Europe that enable them to fully comply with the union’s strict data protection regulation.

In a curious twist of reality, US officials came out in force to condemn the court’s ruling and promise digital mayhem. Conveniently ignoring the unlawful wholesale snooping by his country’s intelligence community, US Commerce Secretary Penny Pritzker expressed “deep disappointment” at the verdict and warned that both private businesses and consumers will be inconvenienced. Meanwhile, White House Press Secretary Josh Earnest appeared most concerned about the economic consequences of the ruling.

Most industry reps noted that the ability to transfer vast amounts of data cheaply and quickly between Europe and North America constitutes the backbone of the digital economy. They lamented the extra layer of complexity, and the added expense, now introduced by the court. An estimated 4,400 companies used the safe harbour legal framework to shift vast amounts of data across the North Atlantic. These businesses now need to scramble their resources in order to keep the personal data of their EU clients and users out of reach of US intelligence agencies.

The corporate whining emanating from the United States has a rather hollow ring to it. Microsoft is currently seeking the protection of the courts against the US Department of Justice which in December 2013 obtained a warrant to gain access to private documents stored on a Microsoft server in Ireland. Microsoft lawyers argue that the DoJ’s reach does not extend to Ireland. However, the company already lost twice in lower courts and is now pleading its case before the Second Circuit Court of Appeals.

The vigour displayed by US authorities as they seek access – openly or covertly – to the world’s data, rather than the rulings coming out of Luxemburg, is now seen as the most serious impediment to the continued growth of Internet companies. Increasingly, large US companies are looking beyond low corporate tax rates when searching for new operational bases with the existence of solid data protection laws and privacy safeguards becoming a prime consideration.

Contrary to the European Commission, the ECJ has pointedly ignored the financial impact of its ruling. Whereas the EC argues that the unimpeded flow of data across borders is as essential to economic health as the free flow of goods and services, the European Court of Justice strongly disagrees. In their ruling, the judges mention that personal data does not arise from a vacuum. Thus the human dimension, even in its digitised form, may not be ignored. In a roundabout way, the ECJ ruling reaffirms that now unfashionable notion that not all thing equal money.

The ECJ ruling puts a damper on the secretive negotiations between the US and Europe over a comprehensive transatlantic trade deal that includes a number of reportedly highly contentious provisions on privacy and the treatment of personal data. Already made more complicated by the revelations of whistle-blower Edward Snowden – who exposed a vast US/UK spying operation that potentially affects every mobile phone and computer user in the world – the negotiations are now perilously close to breaking down over the ECJ’s effective ban on the export of personal data from the EU.

Rather than criticise the ECJ for insisting EU law is adhered to, indignant US officials and industry reps may want to ask their government to get its snoops under control. While some progress has been made – the US Freedom Act stops spying agencies from collecting meta data – information stored on American servers is far from secure. While Europe indeed has a much more robust legal framework in place to protect personal data from unauthorised access, privacy advocates hardly have cause for celebration. Last May in the wake of the terrorist attacks on Charlie Hebdo, the French parliament awarded the country’s intelligence services sweeping powers to intercept email traffic and tap phone conversations. France’s security agencies are now allowed to plant black boxes directly onto network nodes and servers in order to monitor digital traffic.

Meanwhile, the master snoops at the UK’s Government Communications Headquarters (GCHQ) merrily harvest untold terabytes of data each day tapping wholesale into submarine cables, microwave transmissions, and satellite links without much oversight.

In a sense the ECJ judges and advocate general, however brave and well-meaning, are fighting a losing battle. Due to its very nature, digital data is hard to safeguard – it may easily be tapped into, transmitted, copied, and analysed. All this can be done without leaving a trace. Whilst a welcome statement, the latest ECJ ruling also smacks of wishful thinking: it reads like a description of a digital utopia – as much desired as impossible to attain.


Energy Case Study: Peru

[caption id="attachment_10518" align="alignright" width="300"] Peru: Lima[/caption]

Peru is the third largest country in South America with a land area five times that of the UK. Peru has a long Pacific Ocean coastline buttressed by the high and rugged mountain ranges of the Andes which are flanked to the east by the heavily forested slope leading down to the Amazonian plains. The tropical latitude and varied topography give Peru a large diversity of terrain and climates including beaches, plains, deserts, mountains and rainforest.

Peru is one of the region’s fastest growing economies. It is rich in mineral resources including silver, zinc, copper, molybdenum, lead and gold. Ores and minerals make up over half the country’s exports with China a key trading partner. Demand pull from Chinese manufacturers for raw materials is so significant that the strength of Peru’s economy shadows the health of the Chinese manufacturing sector.

Peru has a vibrant economy but a small energy sector. Energy prices have been kept low by successive governments and both installed capacity and energy consumption are currently at modest levels. Increase in demand for energy is highly dependent on new mining investments. Current growth levels of around eight per cent mean that the installed capacity will need to double within ten years from its current level of less than 8GW.

“Peru’s energy sector is proving an attractive market for foreign investors and big consulting and construction firms.”

Peru is blessed with rich energy resources. It has substantial reserves of proved onshore oil reserves in the Amazon region and third largest natural gas reserves in Central and South America, following Venezuela and Mexico. While difficult geography and a lack of investment means that much of the established reserves remain in the ground, the oil industry believes there is considerable unexplored potential for new discoveries.

Historically Peru relied on hydropower until natural gas from its huge Camisea field in the Amazonian rainforest came on-stream in 2004 and now electricity generation capacity is split equally between thermal and hydropower. Peru’s National Energy Plan for the decade to 2025 aims for sixty per cent of generation to come from renewable sources, including traditional hydro. Renewable energy resources are excellent notably because Peru’s climate and terrain is so suitable for hydropower. The potential for wind and solar power is good, but a lack of infrastructure, regulatory framework and investment means that these new industries are in their infancy.

Electricity Market

In 1972 Peru’s biggest electricity distribution network owner Electrolima was nationalised and a state-owned company Electroperu created with exclusive rights on national generation expansion. Peru’s public service system was organised into vertically integrated power utilities with Electroperú and Electrolima providing about two-thirds of the country’s electricity services through the national interconnected system Sistema Eléctrico Interconectado Nacional (SEIN) and nine regional companies providing the rest to isolated power systems.

The last two decades of the twentieth century saw a worldwide trend for restructuring and liberalisation of state-owned electricity monopolies. The rationale was to unbundle vertically integrated power generation and distribution systems in order to attract private investment and increase efficiency. Globally, the standard reform model has arguably been most influential and far-reaching in Latin American countries.

Peru’s neighbour Chile pioneered privatisation of power generation and distribution systems and liberalisation of the electricity market with its 1982 Electricity Reform Act. In Peru the poor performance of companies, cross subsidy policies, political intervention in price regulation and adverse macroeconomic conditions were identified as the main drivers for change. Peru applied a standard reform model including the creation of independent regulator, unbundling, privatisation and wholesale competition in its electricity market reform which began in 1992. The Peruvian power sector saw the generation, transmission and distribution activities of Electroperu and Electrolima unbundled as private companies emerged as a result of the reforms. Currently six private companies own nearly all the high voltage transmission system, with the public sector owning some lines to supply remote areas.

The last two decades have seen expansion of electricity coverage, reduction of distribution losses and improvements in quality (duration and number of interruptions). In 1990 only 45 percent of the population had access to electricity but this figure has doubled in the last thirty-five years.

Between 2006 and 2013 Peru increased access to electrical power to more than one hundred thousand low income rural households in a project to extend the electrical grid and install solar power systems. The project required investment of 145 million US dollars, with a World Bank loan accounting for around a third of the total. Schools, health clinics and community centres benefitted as well as householders and small businesses. The project was instrumental in the establishment of a national tariff for regulated service with household off-grid photovoltaic systems and led electricity distribution companies to devise and operate rural electrification subprojects as part of their regular commercial operations.

Peru’s energy sector is proving an attractive market for foreign investors and big consulting and construction firms including Siemens, Alstom, Vestas and Voith are finding Peru a key emerging market to offset the decline of projects in Europe.

Development of an integrated electricity market is a key plank of a liberalised energy policy. European countries transmission systems are linked with interconnectors bringing islands (including the UK) into the market. Integrating South America’s energy markets could be advantageous, but political will as well as infrastructure is lacking. Peru’s previous government’s ambitions to turn the country into a regional energy hub, generating electricity from the Amazonian rivers and its abundant supplies of natural gas for export to Brazil and Chile foundered on social and environmental objections. An existing transmission line connecting Peru with Ecuador is under-utilised because the two countries cannot agree a price for electricity.

A recent report on Peru’s power sector by London-based Business Monitor International says:
“We hold a positive outlook for Peru’s power sector, based on our forecast for strong growth in power consumption over the coming decade and abundant investment opportunities in both the generation and transmission and distributions segments. The energy-intensive mining sector and expanding consumer base will continue to drive economic growth in Peru - and by extension fast growth in power consumption. Growth in electricity generation will come primarily by additional hydropower and thermal (particularly natural gas-fired) capacity, but we also expect to see increasing investment into the solar and wind power sectors over the coming quarters. Delays to project implementation remain the main risk to our upbeat growth forecasts for this market.”

By Penny Hitchin


Otaviano Canuto, IMF: Trade Opening Could Be a Source of Growth for Brazil

International trade has undergone a radical transformation in the past decades as production processes have fragmented along cross-border value chains. The Brazilian economy has remained on the fringes of this production revolution, maintaining a very high density of local supply chains, the flipside of which has been low levels of trade integration with the rest of the world. Such option has meant opportunity costs in terms of foregone productivity gains and a reversal might contribute to restoring economic growth in that country.

In terms of foreign trade, Brazil is a relatively closed economy. While the Brazilian economy is financially integrated abroad and relatively open to foreign direct investment, it is closed in terms of foreign trade. Its degree of trade integration as measured by ratios of exports and imports to GDP rank the country among the closest economies (see figure 1).

As one can see in the graph, Brazil’s size does not explain its low level of trade penetration: “Even among the six countries with a larger economy than Brazil, the average trade-to-GDP ratio is 55 percent. In fact, just looking at size of GDP we would expect Brazil’s trade to stand at 85 percent of GDP, three times the observed 28 percent.”

“It looks hard to state that the recent performance and macroeconomic prospects of Brazil can be predominantly explained by the commodity price super-cycle.”

As demonstrated by Canuto, Fleischhaker, and Schellekens (2015b), even when taking into account other dimensions of country size (surface area and population) and other features often associated with trade openness (urbanisation rate, manufacturing share in GDP) still Brazil stands out as a case of relatively low trade integration.

Brazil’s trade figures contrast with those of its peers and reflect the fact that the country’s economy remained relatively segmented from a deep transformation that took place in the global economic geography in the last decades. From 1990-2008, world trade volume expanded at a pace of six percent annually, well above the global real GDP growth of 3.2 percent a year over the same period. To a large extent, such high elasticities of trade with respect to global growth was the expression of an underlying mutation taking place in production processes and in the global economic geography.

A Reshaped Global Economic Geography

In recent decades, international trade has gone through a revolution, with the wide extension of the organisation of production in the form of cross-border value chains. This extension was a result of the reduction of tariff and non-tariff barriers, the incorporation of large swaths of workers in the global market economy in Asia and Central Europe, and technological innovations that allowed modularisation and geographic distribution of production stages in a growing universe of activities. International trade has grown faster than world GDP and, within the former, the sales of intermediate products has risen faster than the sale of final goods.

[caption id="attachment_10523" align="aligncenter" width="919"] Figure 1: Trade Penetration. Source: Canuto, Fleischhaker and Schellekens (2015a).
Selected large Economies: Exports as percent of GDP (2013) (left) and Imports as percent of GDP (2013) (right).[/caption]

The geography of industrial production has changed dramatically, with unskilled labour-intensive sectors moving out of advanced economies rapidly. Although the “hollowing out” of such jobs in advanced economies may have been, to a greater or lesser extent, determined by biases in trends of technological progress, the transfer of unskilled labour-intensive segments of supply chains has been part of the explanation. On the other side of such transfers, low-income countries have experienced rapid economic growth processes stemming from the structural transformation that has resulted from the large-scale migration of workers from subsistence to modern tradable activities.

Sharp changes in relative prices in the global economy have accompanied this process. While labour prices fell – as well as prices of manufactured products, according to their labour intensiveness – prices rose for natural resource-intensive goods, following an increase in demand coming from economically-growing low-income areas.

The logic of value chains was also extended to sectors beyond manufacturing. Producers are opting for less self-sufficient, in-house capacities, choosing instead to subcontract activities that are not essential to their business. This is also one reason for the expansion of services in GDP accounting in recent decades. Commodity chains have increasingly relied on sophisticated services both upstream and downstream. The content of services embedded in industrial products has also increased. Additionally, technological innovations have increased the marketability of various services, as expressed in the growth of international trade in services.

The opportunities and challenges of the international industrial division of labour are reconfigured in this new world of cross-border value chains. For low-income economies, one can say that it has become relatively easier – especially for small countries – to increase their local industrial production, since joining the market through labour-intensive segments of existing chains allows them to circumvent the limits of (a lack of) scale and sophistication in local markets. Nevertheless, such entry is volatile and can easily be undone and relocated soon after any adverse signal comes out. This process of entry – with easy exit – corresponds to a window of opportunity for local accumulation of skills and a leap forward.

For high- and middle-income economies, in turn, it has become increasingly difficult to maintain competitiveness in those segments. It should also be noted that some technological trajectories currently in early stage – such as 3D printing – may require the substitution of qualified for unqualified labour in a wide range of segments of existing chains, partly reversing the spatial dynamics described above.

Middle-income economies are also facing a new landscape in other aspects. On the one hand, technological spill overs, productivity increases, and wider market access are now facilitated via entry at points that require intermediate sophistication levels within existing value chains. On the other hand, the consolidation of existing value chains raises the stakes in terms of the competition for core positions. For consolidated and mature branches, creating new chains and challenging established ones is the only alternative.

The Flipside of Low Trade Integration

Value-added trade statistics give a view of how Brazil maintains a level of density in its chains of domestic industrial production above what one would expect in the case of a middle-income country. Figure 2 shows ratios of value added relative to gross exports in various countries. While the weight of commodities partly explains why the ratio is so high in the case of the total export bill (left side), the index is also very high in manufacturing branches (93 percent), as illustrated on the right side of figure 2.

The high level of domestic value added in exports shows that the fragmentation of the production process along cross-border value chains has largely bypassed Brazil. Geographic distances from advanced economies – reduced but not completely annulled by revolutions in transport and communications – partially explain why Brazil’s production-chain density remains well above its notional counterfactual. After all, in many branches, cross-border production chains are regional and focus on dynamic markets of high-income countries (Asia, Europe, and North America).

However, the Brazilian deviation from its notional density levels also reflects trade and local-content policies which have remained more prevalent than in most of Brazil’s peer countries including China (World Bank, 2014). Likewise, Brazil’s precarious logistics and high transaction costs in trading across borders are incompatible with the logic of cross-border value chains.

[caption id="attachment_10524" align="aligncenter" width="907"] Figure 2: Domestic value added as percent of exports. Source: Canuto, Fleischhaker and Schellekens (2015a).[/caption]

Eliminating these factors would reduce the deviation between actual and notional densities, leading to a corresponding closure of less competitive production chain segments and a rise in import substitution. On the other hand, the businesses left standing would be more competitive and final products would have lower production costs and/or higher quality. Furthermore, in dynamic terms, such as when the adjustment implications of changing chain densities unfold, gains would increase by dint of greater technological spill overs and market extension relative to the current scenario.

Brazil has remained outside the process of cross-border production fragmentation. The technological dynamics and cost reductions in the global economy due to the increase in value-chain fragmentation have been significant, increasing the opportunity cost of the ongoing gap between actual and notional production densities.

There are few exceptions, like Embraer, which operates in the centre of its own global value chain. The automotive Mercosur regional network also seems to escape the rule, but it is in fact the extension of a chain with a low degree of integration with the rest of the world. High coefficients of value-added to exports demonstrate local levels of production far above what one would expect for a middle-income economy with average levels of technological sophistication.

Opening Up to Support Brazil’s Growth Agenda

Opening up and integrating more deeply in global value chains would result in the closure of uncompetitive production chain segments and their substitution with imports. The surviving businesses would be more competitive due to access to imported inputs, allowing them to create products of lower costs and higher quality. Furthermore, in dynamic terms, integration in global value chains would allow scarce domestic resources such as skilled labour to be reallocated to the most productive firms and activities, increasing overall productivity.

In an economy with a propensity to face skilled-labour shortages and a generalised aspiration of rising worker purchasing power, productive activities would be strengthened by the availability of cheaper local consumer goods and equipment, as wage and investment costs would be lower. That would facilitate the creation of global value chains with a core in the country in natural resource-associated industries, where there clearly exists a greater scope.

Brazil’s immersion into global value chains would allow the country to leverage its comparative advantages which clearly exists in natural resource-associated industries but which could also emerge in specific activities in manufacturing or services, once industries have access to cheaper inputs.

As productivity gains from participation in global production networks increase, so does the opportunity cost associated with the ongoing closed-ness of the Brazilian economy. The alternative approach, vertically integrated supply chains behind protectionist barriers, is likely to be futile in the longer term. Despite rising trade barriers, Mercosur’s coefficient of imports from China has continued to increase in recent years (World Bank, 2014). Private investors understand this, as they shy away from activities which are viable only under permanent protection.

Of course, public policy support remains essential. However, this support should be more horizontal in nature, rather than further encouraging the ongoing high density of production chains and perpetuating the extraordinary closed-ness of the Brazilian economy.

About the Author

Otaviano Canuto is the executive director at the Board of the International Monetary Fund (IMF) for Brazil, Cabo Verde, Dominican Republic, Ecuador, Guyana, Haiti, Nicaragua, Panama, Suriname, Timor Leste and Trinidad and Tobago. Views expressed here are his own and do not necessarily reflect those of the IMF or any of the governments he represents.

Mr. Canuto has previously served as vice president, executive director and senior adviser on BRICS economies at the World Bank, as well as vice president at the Inter-American Development Bank. He has also served at the Government of Brazil where he was state secretary for international affairs at the ministry of finance. He has also an extensive academic background, serving as professor of economics at the University of São Paulo and University of Campinas (UNICAMP) in Brazil.

The views expressed are those of the author and do not necessarily reflect the views of the IMF.

References
Canuto, O, Fleischhaker, C, and Schellekens, P (2015a). The cost of Brazil’s closed economy, Financial Times – January 14.
Canuto, O, Fleischhaker, C, and Schellekens, P (2015b). The curious case of Brazil’s closed-ness to trade, World Bank Policy Research Working Paper 7228 – April.
World Bank (2014). Implications of a changing China for Brazil: A window of opportunity? – World Bank.


Brazil & Argentina: Only One Getting Real

[caption id="attachment_10547" align="alignright" width="300"] Argentina: Buenos Aires[/caption]

Brazil is just one step removed from facing its reality. With nearly all macroeconomic indicators pointing in the less desirable of directions, the country is facing a downgrade of its sovereign credit rating with S&P on July 28 changing its outlook on Brazil from neutral to negative. As it stands, the country is only a single notch removed from having its government bonds reduced to junk status.

Public debt has ballooned to levels now deemed too high for an emerging market to maintain its investment grade status. Even in the most optimistic of scenarios, Brazil’s debt-to-GDP ratio is expected to peak at around 73% in 2019 from less than 50% ten years ago.

Retreating into junk territory would imply an exit of institutional investors from the Brazilian bond market, driving up interest rates as they slam the door on the country. Most institutional investors are not allowed to buy or hold equities that are rated below investment grade. Currently, about a quarter of Brazil’s domestic federal debt is held by foreign investors.

Their departure is expected to cause havoc in an already unstable market. Gone are the days that Brazil was universally hailed as the economic powerhouse of the emerging world, second only to China in its potential to change the global balance of economic power. However, with unemployment, inflation, interest rates, and debt levels shooting up and economic growth dipping into negative territory while consumer confidence remains weak, Brazil’s present looks dismal and the country’s future gloomy.

“Gone are the days that Brazil was universally hailed as the economic powerhouse of the emerging world, second only to China in its potential to change the global balance of economic power.”

The stock market reflects this sorry state of affairs with the formerly stellar-performing Bovespa Index tumbling down from a high north of 60,000 to around the 46,000 mark. The second largest exchange in the Americas according to market capitalisation, the Bovespa is now even outperformed by the Moscow Stock Exchange whose MICEX Index eked out an 18.7% annualised return despite the international sanctions. As far as the BRICS economies go, Brazil is hanging on by a thread.

In the weekly survey of the prevailing sentiment amongst top economists, a poll conducted by Brazil’s central bank, most of those questioned agree that the country’s GDP will contract by close to 2.1% in 2015 after moving ahead a barely noticeable 0.1% last year.

Getting Real

The administration of President Dilma Rousseff is valiantly attempting to replace its slant from ideology to pragmatism. The president started her second term in office with the intention of pursuing a much more ideologically driven set of policies designed to redress remaining social inequities. President Rousseff put long-serving finance minister Guido Mantega in charge of shifting to a more heterodox – and slightly less business-friendly – approach to economic management.

The administration’s pronounced shift towards more progressive policies coincided with a marked deterioration of Brazil’s terms of trade. As the commodities boom ended and growth returned, albeit slowly, to both North America and Europe, investors traded the iffy outlook of an overrated emerging market for the certainties of generally under-appreciated traditional markets. Thus, Brazil got caught in the perfect storm: income from commodity exports fell off a cliff while foreign investors lost their appetite and government expenditure snowballed.

In all fairness, the resulting economic downturn does carry a silver lining: the weak real and manufacturers seeking to compensate lacklustre domestic consumer demand via increased exports have managed to get the balance of trade back in black. Blamed, justly or not, for the country’s economic malaise, Guido Mantega was replaced by Joaquim Levy.

With a PhD in Economics from the University of Chicago – and as such a confidence-inspiring latter-day Chicago Boy – Mr Levy previously worked at the International Monetary Fund (IMF) and held a number of top jobs in the Cardoso Administration (1995-2003) and at state level. Known as “scissorhands,” Joaquim Levy promptly embarked on a mission to rein in expenditure, imposing budget cuts across the board, and taking to task colleagues who showed reluctance in complying with the restrictions on spending.

Brazil’s central bank has also let go of heterodoxy – a perennial policy favourite of the country’s left – to concentrate on its main task of keeping inflation in check. The stated goal of slashing the annual inflation rate in half to 4.5% by the end of this year is no longer within the realm of reality, much like Mr Levy’s promise to run a primary fiscal account surplus of 2% in 2015.

Faltering on All Cylinders

Judging by the volume and intensity of criticism levelled against Mr Levy, one could be forgiven for thinking the minister is already heading towards the exit. However, President Rousseff – not usually accused of strong leadership – seems to be holding firm. Hers is not an enviable position at all: beset by protesters demanding her resignation or impeachment – both rather silly propositions – over the still escalating corruption affair involving state-owned oil company Petrobras, President Rousseff has but the smallest windows of opportunity to show leadership.

Brazil’s chickens are now coming home to roost. While it was relatively easy for the first Workers Party administration to deliver the goods amidst a situation of overall plenty and unbound optimism, the second one requires a bit more vision and policy acumen in order to become a success.

As China is faltering as the engine of global economic growth, demand for Brazil’s main commodities has slackened significantly. At the same time, low oil prices transform the country’s deep water drilling efforts into an expensive – and quite possibly losing – proposition. With oil at barely $45 per barrel, the bonanza expected from the huge offshore fields could cause disappointment. Industry experts estimate that the deep water wells now producing 1.4m barrels per day – a volume expected to double by 2020 – need crude prices to hover around $60 in order to break even.

Both the United States and Europe also contribute to Brazil’s predicament: the former mulling an interest rate hike, and the latter showing weak growth and continued worries surrounding Greece and other trouble spots.

While Finance Minister Joaquim Levy and his team are making the right noises and know full-well what needs doing in order for the country to return to sustainable growth, they depend on President Rousseff for authority and leadership. That is troublesome, for Ms Rousseff has an increasingly vociferous left flank to contend with and is not really interested in economic matters. Hers is – au fond – a government that prefers to concentrate on spending, rather than on generating income or cash flow.

A Dissonant Tango

What happens when this is kept up long enough may be appreciated in next-door Argentina which has caused its neighbours nothing but trouble for the past decade. Argentina’s haphazard economic policies – more akin to a collection of ad hoc decisions than a framework for the management of the nation’s affairs – have caused Brazil and other countries in the region no end of trouble.

It first started in 2005 when Argentina left Chile – its neighbour on the western fringe of the Andes – out in the cold after it flatly refused to honour its obligations under a treaty signed in 1995 to supply natural gas, forcing the Chileans to scramble for prohibitively expensive alternative sources. The Argentinean government of the day, headed by Néstor Kirchner, reneged on its commitment to Chile solely to keep domestic energy prices artificially low and reap the resulting electoral rewards.

Uruguay, just across the River Plate from Buenos Aires, has suffered severe fallout from the currency controls Argentina imposed in 2012 to relieve pressure on the country’s dwindling foreign exchange reserves. The controls also kept Argentinean tourists at home. Uruguay responded by exempting visitors from VAT and offering rebates on holiday rentals, Argentinean vacationers never returned in significant numbers. Uruguay’s hospitality sector has yet to recover from this heavy blow.

It is, however, the Brazilians who have had to endure the brunt of Argentina’s seemingly never-ending antics. While both countries are founding members of the Mercosur trading block and customs union, trade flows between them have been subjected to a draconian regulatory system imposed by Argentina with the express view of reducing its imports. Any item ordered from abroad by a business or private person, no matter how small or cheap, must first be vetted and approved by the state. The process involves establishing a Kafkaesque paper trail that defies all but the most persistent of importers.

Since the introduction of the much-maligned import control system in 2012, Brazilian exports to Argentina have dropped by nearly 20%. While it has been ruled illegal by the World Trade Organisation, the government in Buenos Aires has so far refused to dismantle the system.

Facing mounting obstacles and even outright hostility, Brazilian companies operating in Argentina have now joined forces to petition the government in Brasília to get tough with Buenos Aires. Brazilian corporations with a presence in Argentina have been prohibited from remitting profits, suffer price controls, and are often unable to keep production lines operating due to a shortage of imported parts and components.

While ignoring the country’s obligations under the Mercosur free trade agreement, the government of President Cristina Kirchner has actively tried to stop Brazil from pursuing a trade deal with the European Union. While Brazil’s other Mercosur partners Uruguay and Paraguay have already put all requisite trade liberalising measures in place, Argentina steadfastly refuses to implement the reforms necessary to clear the road towards an intra-block deal between the Mercosur and the European Union.

On the world stage, Brazil’s close association with an increasingly recalcitrant and contrarian Argentina has significantly weakened the country’s position and profile. Brazil has been instrumental in shielding its Mercosur partner from sanctions for failing to abide by the rules of the International Monetary Fund (IMF). Argentina has consistently declined to provide the IMF with accurate data on its economic performance in violation of the fund’s articles of agreement.

Last year, Brazilian representatives rallied the support of other emerging market members to stop the IMF from throwing the book at the Argentineans. Though they managed to spare Argentina the worst, the Brazilians did end up with a reputation for tolerating rule-breaking behaviour.

Wanted: A Less Abrasive Leader

However, the Kirchner era now seems to be drawing to its close – sort of. A general election is scheduled for October 25 and voters are slowly moving away from Kirchnerism in the direction of candidates proposing slightly more pragmatic policies for addressing the country’s lingering ills. However, and most significantly, Argentineans are not turning their backs on outgoing president Cristina Kirchner; they are just choosing a slightly less abrasive version of her in opting for Daniel Scioli, a former vice-president and currently the governor of Buenos Aires Province – and as such the second most powerful politician of the country.

During their twelve years in power, the Kirchners – Néstor (2003-2007) and Cristina (2007-2015) – have expertly manhandled the nation into a time capsule: by any measure, progress has been negligible though the country’s economy fares not as bad as many outside observers and other assorted pundits would have their readers believe.

A high-income nation with the statistical appearance of a faltering pioneer market, Argentina presents a baffling conundrum to most observers brave enough to make an attempt at unravelling the country’s inner contradictions. What most outsiders fail to appreciate is that Argentina, for all the urban swank of Buenos Aires, remains a rural nation perhaps best described as the agricultural equivalent of a gushing oil well.

“Since the introduction of the much-maligned import control system in 2012, Brazilian exports to Argentina have dropped by nearly 20%.”

While in Brazil the administration of President Dilma Rousseff is now determined to disentangle the country from its love affair with economic heterodoxy, no such thing is being considered in Argentina – not even by the front-running presidential hopefuls. There is a simple reason for this: the country has benefited tremendously from the near-record high prices that its agricultural commodities demand.

For an economy that stands in dire need of maximising foreign exchange receipts on short notice, maintaining an overvalued currency may not make much sense: however, in Argentina it does. The high-riding peso essentially constitutes a tax levied on agricultural exports. It is much more palatable to farmers than the export taxes that caused a widespread rural protests in 2008. The resulting inflow of cheap dollars helps spread the rural wealth around.

By keeping the dollar cheap – and mostly unavailable thanks to currency controls – the government is also able to cobble together and pursue an industrial policy by deciding which sectors are granted access to dollars, and which are starved of foreign exchange. The policy entails limiting imports by means other than tariffs and subsidising industry via a backdoor.

While the policy is, well, unorthodox in the extreme, it bears fruit: whilst inflation has been running at an annual average of 24% during President Cristina Kirchner’s second term in office, median wages have increased by slightly over 28% annually. Meanwhile, unemployment has remained stable at around 7%.

The heterodoxy is in the weighing of interests: whilst holders of peso denominated bonds may certainly prefer official policy to alleviate inflationary pressure, most workers and businesspeople would opt for keeping unemployment low and internal demand – boosted by rising wages – up.

The Argentine Way

It is the Argentine way – imperfect, perhaps, but surprisingly resilient and moderately successful. It is also how the country managed to progress in the decades following World War II when Argentina enjoyed robust and sustained economic growth, with an attendant rise in living standards, while strict import and currency controls were kept in place. At the time, inflation hovered around twenty percent annually and the economy periodically suffered short, sharp recessions. However, unemployment levels remained steady throughout and gains in living standards were mostly preserved.

After the turbulent 1970s, things turned awry each time heterodoxy was dumped to allow for a more monetarist approach. What the Kirchners concluded from the economic upheavals of the 1980s and 1990s was that orthodox monetary policy simply has no place in Argentina’s development model. The wider world may find this remarkable, seen from Buenos Aires’ perspective the conclusion was not entirely irrational.

The economic orthodoxy Argentina pursued during the 1990s pushed the purchasing power of the median wage down to barely 65% of its 1975 level. At the same time, unemployment levels jumped from the historical average of 6-7% to just shy of 20%.

Today, Argentina may not be a trustworthy international partner, left to its own devices the country is doing reasonably well. Argentina’s GDP has been expanding steadily, poverty levels are falling as are the number of jobless people, and inflation is high but not out of control. In fact, since the financial meltdown of 2002, Argentina’s growth has bested even regional top performers with prosperity levels now reaching almost 150% of the Latin American average, compared to 101% for Brazil, 128% for Mexico, and 138% for Chile.

Not bad for a notoriously contrarian nation. Just don’t believe a word coming out of Buenos Aires: Argentina’s discourse is meant for domestic consumption only and so is the country’s economic policy.


Book Review: Squeezing Cash Out of Milliseconds

Time is money. To high-frequency traders, it means big money. HFTs make cash by being milliseconds faster than the other guy – or system. These are not mom-and-pop investors: high-frequency traders employ ultra-fast Internet connections and powerful computers to catch buy and sell orders just moments before they hit the trading floor and affect equity prices. By unleashing sophisticated algorithms on the captured data, HFTs can trade on marginal price differences. A position is often assumed and liquidated within a fraction of a second. In this curious segment of the market, there is no place for basic research, buy-and-hold, or any consideration other than raw computing power.

Whilst not illegal, high-frequency traders have been receiving plenty of attention from regulators, prosecutors, and from Michael Lewis – the American financial journalist who has been at the forefront of uncovering the many exotic ways in which the real wolves make their billions. A graduate from the London School of Economics and trained by Salomon Brothers as a bond salesman, Michael Lewis exited the trading floor to write Liar’s Poker, an exposé of life on 1980s Wall Street.

“Time is money. To high-frequency traders, it means big money.”

Now considered mandatory reading for future traders – alongside Tom Wolfe’s (fictional) The Bonfire of the Vanities and Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar – Liar’s Pokers tell the story of how the Salomon Brothers investment bank, since absorbed by Citigroup, almost single-handedly invented the mortgage bond and scooped up untold billions as a result. If anything, Liar’s Poker, published in 1989, reads like a work of prescient knowledge, announcing a crisis thus foretold.

With his first book, Mr Lewis set the tone for many others to come. He has since authored no less than fourteen books, mostly about the inner working of the usually opaque financial world. Mr Lewis displays a knack for explaining in clear layman’s terms even the most complex and esoteric of stratagems deployed by the financial wizards of Wall Street and London’s City to extract maximum profit from equity trading.

His latest work Flashboys: A Wall Street Revolt reveals how vast amounts of human ingenuity, intelligence, and resourcefulness are employed to empower the HFT groups set up by most large trading firms and investment banks to claim profit from arbitrage. Mr Lewis profusely laments the vast amounts of human talent wasted on a wholly unproductive pursuit. While doing so, he also provides fascinating insights such as details on the 830-mile long dark fibre cable put in between Chicago and New York at a cost of $300m to decrease line latency from 17 to 13 milliseconds.

The cable allows HFTs that use it a tiny, but hugely lucrative, edge over the competition. However, just as the secretive cable became operational, an even faster microwave link between the two financial centres was established, reducing latency to barely nine milliseconds. Because microwave transmission only covers small distances and requires repeaters, a new transatlantic cable is now being laid to connect New York and London fully five milliseconds faster than the current infrastructure allows.

In Flashboys, Mr Lewis concludes that the market is “rigged” and argues that HFTs cost regular brokers and fund managers anywhere between $5bn and $15bn annually in profits lost to the jacking up of equity prices in the split second it takes for a buy or sell order to travel from broker via exchange servers to trading floor. The allegations contained in Mr Lewis’ book prompted an investigation by the Securities and Exchange Commission (SEC) which earlier this year imposed a $4.5m fine on the New York Stock Exchange and two of its affiliated exchanges. Pointedly, the NYSE has refused to admit to any wrongdoing.

Just how profitable high-frequency trading can be was gleaned from the corporate filings and disclosures of Virtu Financial – one of the world’s leading HFT firms – as it prepared to obtain a NASDAQ listing. Using proprietary trading software, Virtue Financial managed to beat the markets and rake in a profit on 1277 out of 1278 days of trading over the past five years. The company had to postpone its IPO on a number of occasions due to the firestorm that erupted after Flashboys was first published. Virtue Financial operates on over 250 exchanges and maintains dark pools – private trading spheres – in 34 countries.

Whereas high-frequency trading is not unlawful per se, front-running most certainly is. This is when less savoury brokers profit from the advance knowledge of large orders placed by their clients. A front-running broker trades on his own account before putting through the client’s order and so easily rides the tailcoats of the market as it moves in either direction. The distinction between high-frequency trading and front-running is rather blurred and comes down to semantics.

Coincidence or not, Flashboy’s publication – and its taking the best-seller charts by storm – occurred just moments before regulators snapped into pursuit-mode to flush out market wrongdoers and other miscreants harvesting profits on the margins of the permissible. HFTs have now been heaped together with ordinary fraudsters as threats to the proper, fair, and transparent functioning of markets.

If it exposes anything, the HFT pseudo-scandal merely emphasises that insiders have always enjoyed an advantage on equity markets. However, it does dispel the equal access myth that keeps smaller investors locked in by perpetuating the notion of a level playing field. As Mr Lewis shows in Flashboys, equal access is just a myth kept alive in order for the party to continue ad infinitum.

Interestingly, high-frequency traders prey on brokers and hedge fund managers who are the high-frequency traders’ true chumps. From the much ado surrounding Mr Lewis’ book, one may be forgiven the impression that wider society actually pities the HFTs’ victims. As such, the book does a disservice, for while regular brokers and flashboys battle over disputed milliseconds, the banksters of old go about their sorry business with renewed vigour, inflating and deflating bubbles, sacrificing private individuals, corporations, and entire nations on the altar of financial propriety.

For anyone interested in getting a real good peek behind the scenes of the sordid finance perpetrated by fraudsters in three-piece suits, there is The Divide: American Injustice in the Age of the Wealth Gap – the much less touted work by Rolling Stone Magazine’s reporter Matt Taibbi who paints a scary picture of an exclusive club hell-bent on destroying whatever stands between its members and other people’s money. That whatever happens to be you.

Flashboys: A Wall Street Revolt by Michael Lewis (isbn 978-0-3932-4466-3)
The Divide: American Injustice in the Age of the Wealth Gap by Matt Taibbi (isbn 978-0-8129-9342-4)


Adam Smith: The Original Economic Thinker

The year 1776 marked the dawn of modern capitalism: nothing to do with a few rebellious colonies unleashing a revolutionary war against the crown of England. It was in 1776 – 239 years ago – that Adam Smith published The Wealth of Nations: a book that marked the birth of financial understanding and left its author – a mild-mannered scholar from the east coast of Scotland – forever known as the Father of Economics.

Born in Kirkcaldy in the summer of 1723, Adam Smith quickly learned to adapt in the world. His widowed mother lived hand-to-mouth working in a mill or helping process fish in the harbour. Deprived of a father, the young Adam Smith had to quickly assume as the man of the house. He displayed a talent for helping his mother run the home while dedicating himself to the study of Latin, mathematics, writing and history at nearby Burgh School. He quickly mastered skills that would serve him well when, at the age of 14, the intelligent young man was offered a scholarship at the University of Glasgow.

It was in Glasgow that both tutors and peers began to notice Mr Smith’s aptitude for translating complex problems into layman’s terms. By 1740 he had been urged to take his talents to Oxford where his burgeoning ingenuity could be further honed.

In 1748, Mr Smith returned to his native Scotland, delivering public lectures at the University of Edinburgh where he was discovered by David Hume, the philosopher and economist. The two became great friends. Mr Hume helped him to write The Theory of Moral Sentiments in which Adam Smith examined human morality. Although the book didn’t change the world, it did set him on a new path. Before long, Mr Smith had become the tutor of the future Duke of Buccleuch whom he accompanied on his travels to France. It was during these trips that Adam Smith rubbed shoulders with some of the most known thinkers of his generation such as Benjamin Franklin and Anne-Robert-Jacques Turgot.

While forging these chance friendships, Adam Smith spent time examining the infrastructure of other countries, allowing his growing appetite for economics to blossom. In his usual style, he quickly grasped the complexity of it all, and then set about compiling something that really would change the world.

Despite his analytical mind and gift for swift interpretation, it took nine years to publish An Inquiry into the Nature and Causes of the Wealth of Nations. Above all else, Adam Smith was a perfectionist. He always had been. Perfection takes time, so he didn’t allow the manuscript to leave his desk until he knew it was ready.

The book was an instant sensation. It focused the great minds of a generation on what really made economies tick.

At the time, a country’s wealth was largely determined by how much gold it had locked away in vaults. In The Wealth of Nations, however, Smith had determined that it was in fact the sum of production and commerce (known today as gross national product, or GDP) which accounted for financial worth. He also explained division of labour and the productive capacity.

His work could not have been better timed. Great Britain was poised and twitching in the starting blocks of the Industrial Revolution, and, suddenly, here was the book – often playfully labelled The Capitalists’ Bible – that provided a practical guide on how to leverage capitalism’s inner logic. In a nutshell, The Wealth of Nations explains how and why free-market economies become not only the most prosperous, but also the most beneficial, to society and the people therein.

It’s hard to imagine if Adam Smith ever fully appreciated the unprecedented and lasting impact his classic book would have on the world of economics. It remains, to this day, one of the most influential works ever published. And although some critics at the time complained Adam Smith had not, in fact, originated many of the ideas within the book’s pages, he was undoubtedly the first person ever to compile and join them, together with his own philosophies, into a format that easily explained the intricate workings of a contemporary economy.

Fine restaurants may serve as a simple analogy. Nearly all the world’s best chefs are “classically trained,” in as much as they have all benefited from a thorough schooling in the cooking of the classic dishes. In the same way, most of the leading economists of our time will have spent their formative years with their noses in the pages of Adam Smith’s work. A copy of his book even had a permanent place in the handbag of the late British Prime Minister, Margaret Thatcher – a fact which is often considered to be the reason his image features on the back of a £20 banknote.

Adam Smith isn’t just regarded as a great economic thinker: he was the original economic thinker.


IFC: Corporate Governance Gains Prominence with the Forthcoming ASEAN Economic Community

[caption id="attachment_10595" align="alignright" width="300"] Thailand: The Democracy Monument[/caption]

One of the much-anticipated events in Asia this year is the formation of the ASEAN Economic Community which will allow goods, services, and investments to flow more freely across the borders of Southeast Asian countries. The potential economic upside is significant. According to 2013 figures, ASEAN countries have a combined per capita gross domestic product of just $3,800 – only slightly more than half of China’s $6,600 and a fraction of developed East Asian countries such as Japan ($38,000), South Korea ($23,000), and Taiwan ($20,000). Amongst other things, the ASEAN Economic Community is expected to bring more foreign investment to the member countries and help unlock their potential.

This, however, will present both opportunities and challenges for companies in those markets. One critical factor in determining their chances for success will be ensuring these companies possess the high standards of corporate governance that are needed in order to remain competitive and well-positioned to attract foreign investment.

Numerous studies have shown that investors have greater confidence in companies with good corporate governance, and more generally, in markets that are backed by sound legal and regulatory regimes. For example, one regional study shows that both firm-level governance improvements and country-level investor protections in Asia can lead to significant reductions in the cost of capital (The University of Hong Kong, 2003).

“One critical factor in determining their chances for success will be ensuring these companies possess the high standards of corporate governance that are needed in order to remain competitive and well-positioned to attract foreign investment.”

Yet, comparisons across the six primary ASEAN markets – Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam – reveal a significant asymmetry of governance standards and practices. Two recent studies are instructive in this regard.

First, the Asian Corporate Governance Association (ACGA) produces a bi-annual corporate governance update across the top eleven markets in Asia (not just ASEAN), covering both overall country-level rankings and ratings of specific companies. The 2014 results are largely consistent with those of prior years, revealing a clear dichotomy for the five ASEAN countries included in the study.

Three of them – Singapore, Thailand, and Malaysia – ranked in the top half, with Singapore tying for first with Hong Kong and Thailand and Malaysia clinching the 4th and 5th spots respectively. On the other hand, Indonesia and the Philippines ranked at the bottom for the third consecutive time (Vietnam was not included in this study). Further, amongst the Top 20 companies ranked across all eleven markets, not a single one comes from either of those two bottom-ranked countries.

The second notable study is the Asian Development Bank’s annual ASEAN Corporate Governance Scorecard Report which examines the corporate governance practices of the largest listed companies in the six primary ASEAN markets. Once again, the results reveal a similar split between the top performers (Singapore, Thailand, and Malaysia) and the bottom ones (Indonesia, the Philippines, and Vietnam).

What does all of this tell us? It clearly shows that, as the ASEAN countries prepare for further integration, three of the key countries involved – Indonesia, the Philippines, and Vietnam – need to push for corporate governance reforms.

Common themes emerge both at the company and market level in these three countries which together represent around 70% of ASEAN’s total population. For individual companies, some of the common challenges include:

Improving levels of transparency, particularly the disclosures of non-financial information and price-sensitive or insider information, which is now often not disclosed, or at least not in a timely manner;

Improving the functioning of corporate boards, such as by increasing their level of independence, strengthening their stewardship and oversight roles, reinforcing director duties, and adopting more effective procedures;

Strengthening risk management, internal control, and audit functions by ensuring formal structures are put in place with appropriate levels of independence;

Managing conflicts of interest and related-party transactions better, through fair and transparent processes;

Improving shareholder rights and practices, including more formal shareholder meeting procedures and stronger protections for minority shareholders.

At the market level, there is still much work to be done by regulators and governments in these three countries. For example, regulators should continue to strengthen and harmonise corporate governance codes and regulations to ensure international standards are incorporated, as appropriate, and to help create a level-playing field with the other ASEAN countries.

State ownership remains high, particularly in Vietnam and Indonesia, which can hinder overall market competitiveness. In Vietnam, more than a third of the country’s GDP stems from state-owned enterprises and over 350 of more than 600 listed companies have some state ownership (World Bank, 2012).

Indonesia’s capital market likewise has a significant level of state ownership. Lastly, more should be done to raise awareness and advocacy for good governance across markets by regulators and through local partners such as institutes of directors. Indonesia and the Philippines already have established institutes, while Vietnam is in the process of creating one.

It is crucial that the governance improvements not only focus on large companies and banks, but also consider the needs of small and medium enterprises. SMEs are the backbone of the ASEAN economies, accounting for roughly 96% of companies and between 50-85% of domestic employment.

ASEAN integration will bring opportunities to many SMEs in the region, including possibilities to expand into new markets. These SMEs will be seeking more capital to fuel their growth. Yet, enterprise surveys conducted by the World Bank confirm quite clearly that SMEs in emerging markets face more severe financing constraints than do large firms. For example, about 77% of Vietnamese SMEs are reportedly undercapitalised (Economic Research Institute for ASEAN and East Asia, 2009). Thus, future governance improvements should include efforts to help SMEs adopt proper standards of governance, which will give banks and investors – not to mention potential customers and business partners – higher levels of confidence.

To be sure, all three countries have made substantial progress in recent years. There have been various changes in laws and regulations to promote good governance and strengthen investor protection. For example, Indonesia’s Financial Services Authority (OJK) developed its ambitious Corporate Governance Roadmap in January 2014, which will lead to important governance improvements in the coming years. Likewise, Vietnam’s new company law, the Law of Enterprises, just took effect in July and introduced key changes such as strengthening the notion of independent directors and audit committees, improving shareholders’ rights, and introducing good governance practices such as board and internal control to state-owned enterprises.

In the Philippines, a number of governance improvements have been made in recent years, particularly for listed companies and banks. The Philippine government is revising its Company Law and the Philippines Securities Exchange Commission plans to strengthen its code for listed companies this year.

With such big changes ahead for the ASEAN community, it is crucial that Indonesia, Vietnam, and the Philippines continue such reforms. IFC (International Finance Corporation) and the World Bank Group – with support from the Swiss government – are committed to helping these countries raise their corporate-governance standards and transparency.

About the Author

Chris Razook is the IFC Corporate Governance Lead for the East Asia Pacific region. He has more than fifteen years of experience in the area of corporate governance and supports IFC’s investments by working with companies to strengthen their governance frameworks. Mr Razook has also supported central banks, capital market authorities, and other regulatory bodies in drafting corporate governance laws, codes, and listing rules to help develop stronger investment climates. He has an undergraduate degree in Engineering, an MBA in International Finance, and an LLM in Corporate Law.


IREIS Conference: UAE Property Market in Phase of Optimistic Consolidation

The conference at the annual IREIS (International Real Estate & Investment Show) at the ADNEC centre in Abu Dhabi is typically stacked with high calibre speakers and thus gives investors a unique opportunity to gain valuable insights into property markets, both international, regional, and local.

Last year, the IREIS conference was a big success in fulfilling its objectives. This year’s conference did not disappoint either. Dr Nick Cole and his team from IREIS put together a compact and exhilarating programme.

The decline in oil prices and mounting regional geopolitical instability cause some concern for the Middle East property market, including in the UAE. However, while words such as “soft” and “consolidation” was aired, the general spirit and outlook was upbeat.

"The last two years have seen a significant rise in cross-regional capital flows into global commercial real estate."

Simon Townsend, the director of strategy from CBRE Middle East, opened the event with a presentation entitled Market Trends in Global Investment in which he analysed the changes in investment flows both globally and regionally. Mr Townsend had a tough act to follow from last year’s sterling performance by his colleague Nicholas Maclean. He succeeded in delivering great insights.

CBRE Research has recently published a study – In and Out – focused on regional commercial real estate which shares some of this insights and states: “The last two years have seen a significant rise in cross-regional capital flows into global commercial real estate. In 2014 alone, a total of $125 billion of cross-regional commercial real estate transactions were recorded, up 39% year-on-year, and close to triple the value reported in 2011. The first three months of 2015 have already seen a further $32 billion in cross-regional investments – setting the scene for another record year.”

Hani Shammah, managing-director of Morningside, moderated a high-profile panel on key trends in the UAE property market. On that panel was David Dudley, the international director of JLL MENA who covered the Abu Dhabi real estate market that now is in a phase of consolidation after suffering booms, busts, and recoveries. Prices in Abu Dhabi are holding up even though there is still a significant volume of new property assets coming to the market across various segments such as residential, commercial, retail mixed-use, and hospitality.

Bloom Holdings CEO Sameh Muhtadi outlined his business strategy focused on core diversification to ensure a sustainable business. Bloom is arguable one of the best regional integrated community developers. One way, the company ensures the building of successful mixed-use and smart communities is to partner with best-in-class providers – such as Harvard – in education and health offerings. Bloom Holdings also focuses on investor yield and affordability of offerings.

The Mubadala-owned Masdar City project was presented by Anthony Mallows, architect and director and another champion of employing best international practices to push towards a knowledge-based society. Masdar City employs new game-changing rewards systems to shape behaviour and promote energy efficiency in order to obtain savings. Mr Mallow’s team has been successful in creating great operating efficiencies for corporates, such as Siemens, by focusing on a better understanding of the client’s real needs. Mr Mallow drew historic parallels to Venice and Amsterdam when pointing to Dubai’s unique position as a globally central and very well-located international transportation and trading hub and destination which drives visitors – all underpinning long-term real estate demand.

Onur Camurlu from AE7 powerfully presented the vision of new $4.5 billion Meydan City project in Dubai. With contemporary villas surrounded by beautiful landscaped terrain consisting of boardwalks, waterways, fountains, and lagoons Meydan City has every chance of becoming the premium integrated lifestyle community to which it aspires. One of Meydan City’s central objectives is to fluidly integrate residential life with extracurricular communal activities, including skiing.

David Godchaux, CEO of Core-Savills, moderated a panel discussion on fiscal and business considerations which emphasized the need for enhanced transparency. Mr Godchaux sees the slowdown from declining oil prices as a major challenge to the property market as the region’s governments need to support both supply and demand though public investment and spending. He foresaw that regional oil producers in need of revenue would eventually cut production to boost prices, as they control the oil market.

However, that analysis does not stack up. The days when the major Middle East players – including OPEC – could control oil prices are now well behind us. Now, oil producers cannot afford to cut production because that translates into declining revenues. The US is now self-reliant on energy. A much more likely scenario sees oil prices stay low. Producers will need to tighten their belt. For now, the producers are digging into their vast reserves, but eventually fiscal contractions could impact the property market.

Carine Souaiby, managing-partner from Knowledge Vision, stressed that the legal and regulatory framework varies across the seven emirates. She welcomed new legislation to commence in January 2016 which could support foreign investor transparency. One question that Ms Souaiby felt should be debated in UAE’s society going forward concerns “what kind of developers do we want?” The answer should be reflected in regulation and transparency.

Digital marketing of real estate investment offerings is a cost-effective and attractive alternative to offline alternatives stressed Andrej Olejnik, the CEO of Prof Estate. Still, digital marketing appears underused in UAE. Mr Olejnik suggested developers should – instead of just hosting a web site – boost their emphasis on online communication, and sharpen up their promotional approach to include using other than English languages and move up the Google search scale. He also wished for an industry-wide concerted effort to promote the great pulls of UAE’s property market globally: “The UAE’s market is very attractive and not in danger of collapsing anytime soon. I have seen many other property markets internationally in decline and danger – and this is not one of them.”

Cluttons’ Murray Strang emphasised the EXPO 2020 impact on the UAE market. Already within two years the positives of the impact would be felt. The state of the post-Expo market is anybody’s guess. He stressed that the UAE market is not insular from the state of the rest of the Middle East.

Chris Taylor from Abu Dhabi Finance is very much leveraging the power of the Internet to efficiently drive his mortgage finance business in competition with larger players. He was suggesting that fist-time buyers should be given a break in terms of affordability. The required down payment could be reduced from currently 25% of the purchase price to 5% or 10% in order to give first time buyers and youngsters (maybe with some family assistance) a chance to step up on the property ladder.

In sum, the UAE property market is humming along nicely at high price levels. So much so that affordability has become an issue. Demand is soaring, in particular in the hospitality sector. Supply remains solid with continued construction – including of brand new smart cities. Capital is available. Regional problems may persist but the outlook by UAE’s best-in-class is sunny.