James Zhan, UNCTAD: Investment - In Need of Direction

Fragmented, incoherent investment policies, and regulatory uncertainty are dampening investor confidence in an economic environment already fragile and bruised by weak global demand. Moreover, the extent to which investment and trade have become interlocked through the pervasive spread of global production networks means the reluctance to invest is also dragging down trade. James Zhan argues for a comprehensive process to improve the investment regime.

The global financial crisis has impacted heavily on trade: annual trade expansion over the past three years has averaged a tepid 3% annually, compared to an annual pace of over 5% in the pre-crisis era. The extent of the slowdown is also apparent when comparing trade with global economic output. Traditionally, there has been a strong correlation between trade and GDP growth.

Bolstered by trade liberalisation, lower costs, and technology advances, trade took off in the second half of the last century, and has typically been expanding at double the pace of global GDP growth. However, this connection has become unhinged, with trade growing at roughly the same pace as GDP since 2012. Weak global demand, particular among high-income countries which account for almost two-thirds of global imports, largely explains the situation.

“In four of the seven years since it peaked in 2007, FDI has contracted.”

But cyclical factors are not alone to blame. Fundamental changes in the organisation of international production have taken place over the past twenty years, which have tied investment and trade together. These structural changes, connected to the changed production landscape, are a strong influencing factor on trade performance. A look at cross-border investment growth since the onset of the financial crisis shows investment in deeper straits than trade with foreign direct investment (FDI) seesawing.

In four of the seven years since it peaked in 2007, FDI has contracted. Following a rise in 2013, global FDI inflows stumbled again by 16 per cent in 2014 to an estimated $1.23 trillion. The mixed FDI performance since 2008 largely reflects the precariousness in the face of economic and policy uncertainty and rising geopolitical risk. The overall picture is lacklustre, and the prospects for a recovery are mixed. While GDP and trade have resumed modest growth since 2010, international investment flows are still a third below pre-crisis levels (see table 1). And this marked dip in investment activity, compared with activity before the crisis, has real implications for trade. The complex link is largely underpinned by the rise of global value chains.

Integrated production networks, set up by multinational enterprises (MNEs) to tap into inputs from a variety of countries for the assembly of final goods and services, have ballooned over the past twenty years. These cross-border production chains have become the engine room of the global economy. According to UNCTAD figures, over 90,000 MNEs have some $27 trillion of FDI stock invested in nearly one million foreign affiliates worldwide.

[caption id="attachment_10978" align="aligncenter" width="684"] Table 1: Growth rates of global GDP, trade and investment, 2008-2014 (per cent).
Source: UNCTAD based on United Nations for GDP and FDI, and IMF for trade.[/caption]

Together, these MNEs account for over a quarter of global GDP and some 30% of private sector value added. Their production networks also form the backbone of trade, now accounting for 80% of all cross-border sales. This development has inextricably linked international trade and investment. And the extent to which trade has become intertwined with the investment decisions of transnational corporates suggests that if constraints that throttle investment are not addressed, this may well augur an era of structurally weak growth for trade and the global economy at large.

Paradoxically, MNEs have ample capacity to invest, with an estimated $5 trillion accumulated on their balance sheets. However, the fragility of the global economy and market volatility have suppressed investment appetites. This skittishness is compounded by policy uncertainty fuelled by the lack of policy coordination at the global level in investment, trade and financial policies. The dynamic interface that has been established between trade and investment suggests that a closer coordination between trade, investment and other public policies is required at the global level to oil the functioning of the world economy.

But global governance has not kept pace with the fast unfolding restructuring of international production. While an internationally managed architecture governs and facilitates trade under the auspices of the World Trade Organization (WTO), no multilateral equivalent exists to give direction to investment. Instead, investment policy is fashioned piecemeal.

At the national level policy making has been dichotomous: while the bulk of national investment policy measures implemented in recent years tends towards investment liberalisation, facilitation, and promotion, the overall share of regulatory or restrictive measures has been on the rise (from an average of 5% in the early 2000s to an average of 35% in the past 5 years, according to UNCTAD data).

International investment policy developments have compounded the complexity, with the creation over the past fifty-odd years of thousands of investment pacts, hived off in bilateral or limited country group contexts, creating a labyrinthine and incoherent network of investment agreements. These developments have created a vastly complex, fragmented investment policy space that is incoherent with other policies such as those for trade and finance, essentially rendering investment rudderless.

The central position that investment has assumed in the global economy calls for action. The need to develop investment policy in a coordinated manner is key to enhancing predictability in the investment environment and for creating more certainty to boost confidence and reignite investment. What makes the need for intervention all the more urgent is the vast scope of global development challenges outlined by the post-2015 development agenda, which cannot reasonably be tackled without the participation of meaningful private sector investment.

Investment policy action is best taken collectively. A comprehensive multilateral approach to investment policy reform would be the most sensible way to address systemic deficiencies, and provide a stable regulatory environment for investment. The dynamics of multi-stakeholder engagements ensure the interests of all involved parties are represented and can facilitate enhanced coherence. Multiparty action also helps transcend narrow interests and can more effectively ensure that wider social, economic and other developmental challenges, such as those under the aforementioned development agenda, are implanted in the new investment policy architecture.

In the absence of an institutionalised investment body to spearhead change, options for concerted action have proved elusive. While good progress has been made with policy reforms at national and bilateral level, systemic fragmentation persists, which in reality has stoked up uncertainty, rather than allay it. A concerted reform effort at the global level is therefore highly desirable to facilitate greater coherence.

The existing governance vacuum has prompted UNCTAD to explore ways to spur collective action to shore up investment policy making along two paths: the facilitation of coherent policy making; and consensus building to buttress policy harmonisation. In broad strokes, the reform agenda should be guided by the need to create the right balance between investor interests as well as legitimate issues of public concern: that is, to set policies that will create a climate conducive to investment, alleviate obstacles to investment, and instil a principled openness to investment on the one hand, while at the same time safeguarding the ability of countries to protect public interests through regulation on the other.

This would be usefully accompanied by an effective and internationally recognised mechanism for dispute resolution. It would be a much needed improvement on the flawed existing mechanisms, the ad hoc nature of which sometimes yield conflicting rulings that detract from the evolution of a coherent, precedent-based dispute settlement system.

To further prop up investment, policy scrubbing should be complemented by proactive and clearly targeted investment promotion and facilitation strategies, supported by the requisite financial and institutional capacity, and technical assistance to ensure their effective execution. These can leverage regional cooperation for optimum impact. Given the wider sustainable development agenda context mentioned above, investment policy reforms should finally be anchored by responsible investment principles. These can be angled to proactively tap the positive contribution investors can make to achieve wider societal goals and/or to prevent their negative impact on these goals.

UNCTAD’s Investment Policy Framework supports the first avenue of investment reform by providing guidance for the formulation of both national and international investment policies. The framework has proved a useful reference for governments. The need for guidance in the investment policy realm is borne out by the extent to which a wide range of countries are consulting the Investment Policy Framework and incorporating its recommendations in policy formulation. This in itself could encourage greater coherence and harmonisation of investment policy and give impetus for collective action, albeit painstakingly slow.

UNCTAD also advocates for multilateral coordination through consensus building initiatives, including by enhancing private-public dialogue on investment policy. The hope is that these efforts could help spur incremental multilateralism and bring greater predictability, stability, and transparency to the investment system to help unlock much-needed investment, which in turn can help reignite trade flows and stir global growth. An updated investment regime is long overdue.

About the Author

James Zhan is director of the Investment and Enterprise Division at the United Nations Conference on Trade and Development (UNCTAD). He leads the team that produces the World Investment Report.


Billionaires’ Toys: There Is No Point other than Bigger is Better

[caption id="attachment_10989" align="alignright" width="300"] Azzam[/caption]

Turn the clock back a few centuries, and all a man had to do to show off his wealth was to build a massive castle and throw the odd pageant or two on its ground to entertain visiting royalty.

Sadly, no sooner had latecomers to fortification-building put the finishing touches to the drawbridge, when fashions changed and stately homes became de rigueur - the more outrageous, the better. By that time, the second Earl of Rockingham had his staff scattering coloured confetti so that guests could find their suites – the place was so shamelessly huge that people often became horribly lost wandering the eight kilometres or so of corridor at Wentworth House. However, as the twentieth century dawned, stately homes were past their prime.

Belatedly, wealth joined the Industrial Age to be expressed through machines such as lavish sports cars. Alas, cars are rather puny objects – no matter how luxuriously appointed or fast. As objects of opulence they barely make the grade. Besides, when you’ve got half the GDP of Sweden burning a hole in your back pocket even the most outrageous motor car doesn’t make much of a dent.

“Right now, Yacht Island Design is putting the finishing touches on a yacht so colossal, so over-designed, so unimaginably lavish, that it will simply – well – eclipse the Russian’s yacht and make all other floating castles look like bath toys.”

The post war age of jet propulsion presented new opportunities for frivolously inclined dispatching the superrich skywards. The seventies were a golden age for the private plane that allowed venerable sheiks and Hollywood’s finest to hop around the globe – jet-setting as it were. By the turn of the millennium, the rich had become vastly richer still and private airplanes became yesterday’s news.

Enter seaborne affluence. By 2000, advancements in shipbuilding technology were moving on apace. Hulls of oversized yachts were being designed in ways that would have seemed impossible just a decade before. Pretty soon, billionaires turned their heads from the runway to the slipway. Behold the mega-yacht.

Today, the fashion for owning the most lavish, gaudy, or grotesquely decked out boat shows no signs of abating. Spending anything less than £150m on a yacht would, these days, be considered almost rude – and certainly a sign of financial weakness. So when Russian billionaire and Chelsea FC owner Roman Abramovich splashed out a cool billion (dollars) on Eclipse, his floating toy, he set a new benchmark for those who thought they were rich. However, it would appear that Mr Abramovich outlay of cash, merely bought him a second fiddle.

Right now, Yacht Island Design is putting the finishing touches on a yacht so colossal, so over-designed, so unimaginably lavish, that it will simply – well – eclipse the Russian’s yacht and make all other floating castles look like bath toys.

The Streets of Monaco, as the designer’s dubbed their outlandish masterpiece, may not even be described as a superyacht or mega-yacht: the thing is so vast it warrants its own classification – the hyper-yacht.

The Streets of Monaco resembles an aircraft carrier, albeit one with a few mind-boggling extras such as charming (street) cafés, a bewildering choice of swimming pools, two speedboats, vast gardens, a full-sized submarine, a cineplex, 24 guest suites, tennis courts, and a go-kart track. All those goodies populate a 550ft long deck resembling a scaled-down version of Monaco. The vessel is expected to carry a bare-bone price tag of $1.3 billion. Whatever floats your boat.

It’s one thing to spend many millions on a seagoing playground; real wealth is displayed in the eye-watering running costs. If you’ve got the disposable income to own the ultimate luxury, you’re going to need plenty more to keep the thing ticking over. Take the £260m super-yacht A owned by Russian billionaire Andrei Melchenko: arguably lacking in imagination at the naming ceremony, A requires an astonishing amount of maintenance. Below its teak deck lies a cornucopia of things that require a crew of about 42 people to keep running. It’s the sort of hazard you would expect when a fully-featured discotheque with an illuminated dance floor and sitting just below the glass bottom of the huge swimming pool above.

Typically, the extras following the initial outlay add up, on average, to around 20% of a yacht’s original value. Fuel usage would be estimated at 500 litres per hour, which works out at about £265,000 a year. Docking costs gobble up £250,000 while ongoing repairs require an annual budget in excess of £600,000. Crew wages leave little pocket change from a million pounds. At least the insurance bill comes in at a risible £160,000. Of course, if you’re anything like Roman Abramovich, you’ll want lots of extras, such as a missile defence system slated a buy at £335m.

So, assuming you’ve got a spare billion squirreled away down the back of the sofa, take some inspiration and salivate over the world’s top five super-yachts…

1) Azzam (Length: 591ft, Speed: 31kts, Cost: $600m)
She’s not the priciest floating object plying the seven seas, but Azzam is certainly the biggest and fastest. At 180m LOA, and with seven decks, the mysterious Azzam is larger than Roman Abramovich’s Eclipse. Little is known of the Lürssen-built ship, but it is rumoured she was made for a member of the royal family of the United Arab Emirates. The interior was designed by Christophe Leone in Imperial French style.

2) Eclipse (Length: 533ft, Speed: 21kts, Cost: $1.2bn)
Manned by a crew of 70, and owned by Russian billionaire Roman Abramovich, the Eclipse took five years to design and build. She can accommodate 24 guests, comes with two helipads, and a private submarine. As well as anti-missile security system, the Eclipse also has special reflective features that block paparazzi from being able to take any useable photos. When she left the Voss shipyard in Hamburg on December 9, 2010, she sailed straight into the record books as the world’s largest super-yacht.

3) Dubai (Length: 532ft, Speed: 26kts, Cost: $350m)
The appropriately-named Dubai, currently owned by the Sheikh Mohammed bin Rashid Al Maktoum, is widely considered a blueprint for classic super-yachts. As well as the usual array of swimming pools, helipads, and speedboats, up to 115 guests may enjoy one of the most lavishly decorated interiors to be found on any yacht, anywhere – much of it accessible through the main staircase which is constructed entirely of glass.

4) Al Said (Length: 507ft, Speed: 25kts, Cost: $300m)
Few yachts are shrouded in as much mystery as the Al Said, owned by Sultan Qaboos Bin Said Al Said of Oman. What is known is that amongst the swimming pools, helipads, cinemas, bars, and exquisite suites, there is a concert hall that can accommodate fifty musicians. The ship can accommodate seventy people plus a crew of 154. The interior is believed to be one of the finest at sea, although this would be difficult to prove as it is understood no photographs of the yacht’s cabins or rooms exist.

5) Topaz (Length: 483ft, Speed: Unknown, Cost: $527m)
In 2012, Topaz sailed out of the same yard that created Azzam – currently the world’s largest super-yacht. Apart from three swimming pools, a gymnasium, cinema, and helicopter pad, little is known of the Topaz other than that she has impressive corporate facilities including a large boardroom and meeting complex. Said to be owned by a member of the Saudi Royal Family – purportedly billionaire Manchester City owner Sheikh Mansour – it is thought to have seven decks. The floating conference centre plays host to some of the world’s most high-stake business meetings.

By Darren Parkin


Winnie Byanyima: From the Bush to the Global Stage

Oxfam International’s dynamic director Winnie Byanyima possesses a most extraordinary CV. Her career includes working as Uganda’s first female aeronautical engineer, living in the bush as a guerrilla fighter, roles as a diplomat and a politician, and campaigning for human rights on the international stage. In her current job, Ms Byanyima is gunning multinational tax dodgers. Increasingly, multinationals who arrange their affairs so that profits are channelled via countries with low taxation reap a whirlwind of bad publicity. Starbucks, Facebook, Amazon, and Google are among the companies criticised for paying a pittance in UK corporation tax despite raking in huge profits.

At the OECD (Organisation for Economic Cooperation and Development) meeting in Lima last October, the world’s finance ministers agreed to change the rules on taxing profits. They warned multinational corporations that they would no longer be allowed to use their size and cross-border presence to dodge taxes. The OECD estimates this could boost the global tax yield by up to $250billion annually.

A recent Oxfam report concludes that the countries of Africa were cheated out of $11billion in 2010 alone via just a single of the many tricks employed by multinationals to reduce their tax exposure. This is roughly equivalent to six times the amount needed to plug the combined healthcare funding gap of Sierra Leone, Liberia, Guinea, and Guinea Bissau – countries that suffered greatly because of devastatingly inadequate healthcare systems during the recent Ebola outbreak.

Oxfam International’s Executive-Director Winnie Byanyima points out that “Africa is haemorrhaging billions of dollars because multinational corporations do not pay their fair share of taxes. If this revenue were invested in education and healthcare, societies and economies would flourish across the continent.” A product of the turbulent cauldron of Ugandan post-independence politics, Ms Byanyima grew up under the brutal military dictatorship of Idi Amin. Her parents were both social activists. Her father Mzee Boniface Byanyima was a secondary school teacher who became a member of parliament and opposed the corrupt and repressive regime.

In the harrowing times that followed, the legislature was dissolved and Mr Byanyima jailed. His wife Gertrude had been active in promoting women’s education, establishing women’s clubs and introducing literacy programmes. She was a fervent opponent of arranged girlhood marriages, often sheltering girls in the family home. Fearing for their daughter’s safety in Uganda, the Byanyimas acquired a false passport and whisked her out of the country; first to Kenya and then on to Great Britain where she secured refugee status. Ms Byanyima continued her studies in Manchester and won a scholarship to pursue a degree in Aeronautical Engineering.

By the time Ms Byanyima graduated with degrees from Manchester and Cranfield Universities, Idi Amin had been replaced by the civilian dictatorship of Milton Obote. She returned home to take up an engineering job at Uganda Airlines. Ms Byanyima’s childhood had imbued her with a keen interest in politics and a strong belief in human rights. While working at the airline, she helped the resistance movement working to undermine the government by meeting with dissidents and passing on information and messages.

When the regime’s security services uncovered her links to the opposition movement, Ms Byanyima had to flee Kampala and go underground. Shespent the next two years living with guerrilla fighters in the rural south of the country. The rebels had a well-defined sense of the country they wanted to build, moving Uganda away from its colonial past to become an independent and democratic state. Ms Byanyima credits this period of her life with developing a deeper understanding of human rights, democracy, and the causes of poverty.

One of the rebel leaders was childhood friend Yoweri Museveni. In 1986, after the National Resistance Movement (NRA) ousted the regime, Mr Museveni became president. Three years later, Ms Byanyima joined the diplomatic service representing Uganda in France and at UNESCO in Paris. Returning home in 1994, she threw herself into the country’s reconstruction. Ms Byanyima first served as a member of parliament for ten years. During that time, she created a female parliamentary caucus. She also helped found the Forum for Women in Democracy which champions gender equality in politics.

In 1998, Ms Byanyima married Dr Kizza Besigye who had been responsible for keeping the National Resistance Army guerrillas healthy. He was both a physician and confidante to NRA Chairman Yoweri Museveni. In 1986, as Mr Museveni assumed the presidency, he appointed the then-29-year-old Dr Besigye as minister of Internal Affairs.

However, by the turn of the century the couple had become disillusioned with the National Resistance Movement “no-party” system of government. They also were increasingly critical of corruption amongst ministers and other officials. In 2001, Dr Besigye contested the presidential leadership in elections ultimately won by Mr Museveni.

Dr Besigye contested the results at the Supreme Court of Uganda, citing massive rigging and electoral violence. However, his petition to have the election nullified was denied despite a unanimous ruling by the Supreme Court that the vote had been marred by widespread fraud. Subsequently, Dr Besigye was arrested and detained for treason. Fearing for his life, he fled to the United States. On his return in 2005 he said: “I left in order to continue my political engagement and avoid landing behind bars or six feet under.”

Despite her husband’s exile, Ms Byanyima remained a member of the Ugandan Parliament until 2004 when she quit national politics to head the Directorate of Women, Gender, and Development of the African Union in Addis Ababa. Two years later, she accepted a position at the United Nations Development Programme (UNDP). In 2013, Ms Byanyima was appointed executive-director of Oxfam International.


Mowgli Foundation Report: Mentoring Achieved Return on Mentoring Investment (ROMI) Returns of 890%

The Mowgli Foundation publishes a report that highlights the Return on Mentoring Investment (ROMI) and economic generation impact achieved through the mentoring of over 780 entrepreneurs in the Middle East and North Africa during their 12-month mentoring programs.

Governments, funders, corporations and philanthropic investors in Mowgli’s entrepreneurial mentoring model achieved significant ROMI returns of 890% across the MENA region, according to the report. The report highlights that the creation and safeguarding of over 3,470 jobs since 2009 has generated and contributed over USD 18 million to the region’s economies.

To calculate the ROMI, data collected from Mowgli Entrepreneurs since 2008 was used to determine the number of jobs created and safeguarded during the Mowgli facilitated mentoring year.

"Governments, funders, corporations and philanthropic investors in Mowgli’s entrepreneurial mentoring model achieved significant ROMI returns of 890% across the MENA region, according to the report."

Some other highlights from the report include key points about the best practices of mentoring which focuses on supporting both the professional and personal sides of the entrepreneur, which are together key to ensuring the greatest ROI. In addition, countries that have a developed and entrepreneur-serving ecosystem enable higher job creation levels than those that do not.

CEO of the Mowgli Foundation, Kathleen Bury, commented, “This report shows that funders really are achieving significant ROI when investing in mentoring as a key component of entrepreneurial support. The results we are sharing today are based upon the data relating to the mentoring year that Mowgli facilitates only and not from that which is created or generated afterwards. We can only assume that, like the entrepreneurial curve, it will increase exponentially as the foundations have been set, enabling further ROMI to be realized.”

Bury added, “Unemployment and sustainable economic growth continue to be some of the MENA region’s biggest challenges and so by sharing this analysis we look forward to seeing the region further embrace entrepreneurial mentoring, alongside the likes of business skills training and financial support, to achieve even greater results in the future.”

The returns mentioned in the report are in addition to the other benefits that the entrepreneurs have received during their mentoring relationships; increase in their profits and sales, expansion of their operations and feeling more confident in their abilities and skills to tackle future challenges. In addition, Mowgli’s programs have also trained more than 900 mentors who practiced new leadership skills based upon the “serve to lead” model. These benefits have been significant but are intangible and therefore cannot be quantified in the ROMI returns.

The report, which can be found on Mowgli’s website, includes specific country data from the different markets that Mowgli has operated in across the Middle East and North Africa.

For more details, inquiries and to receive a copy of the report, please email: info@mowgli.org.uk

About Mowgli Foundation

The Mowgli Foundation is an international UK headquartered award winning mentoring organisation that works with international and local governments, financial institutions, philanthropists and corporates across 14 countries to provide mentoring programs that empower entrepreneurs to drive economic growth and develop leadership models.

Mowgli provides mentoring programs that inspire, connect and guide entrepreneurs and leaders to overcome life's personal and business challenges through the:

Training and nurturing of mentors

Strengthening of entrepreneurs and their businesses by matching them with a trained mentor in facilitated and supervised long term relationships

Building of a global community of trained mentors and entrepreneurs that are able to access networking, learning and growth opportunities

Mowgli has an alumni with over 1680 members and has matched over 780 entrepreneurs with trained mentors in 14 countries; Algeria, Bahrain, Egypt, Jordan, Lebanon, Libya, Morocco, Palestine, Qatar, Saudi Arabia, Syria, Tunisia, Yemen and the UK.

In 2016, the European Mentoring & Coaching Council (EMCC) awarded the European Quality Award (EQA) to Mowgli for its Mowgli Mentoring Experience (MME) program and in 2012, Mowgli received the Mohammed bin Rashid Award for Young Business Leaders Award for the 'Best Mentor Network in the Arab Region’


Evan Harvey, Nasdaq: Something New Under the Sun

A report from the WFE annual meeting in Qatar.

Stock exchange leaders, policymakers, regulators, investors, and corporates all gathered in Doha, Qatar, for the World Federation of Exchanges (WFE) annual general meeting in October. The Qatar Stock Exchange (QSE) served as host for the event, and QSE leader Rashid al-Mansoori set an ambitious tone from the opening keynote.

“This event is an opportunity to exchange views and strengthen the means of cooperation between participating exchanges,” he said. “Exchanges must come together to address challenges, “especially in light of the rapid economic, social, and political changes seen throughout the world.” Mr al-Mansoori closed by highlighting “a responsibility to ensure that market participants can trade fairly and efficiently on our platform.”

The WFE represents virtually every public stock, futures, and options exchange on the planet. Over 44,000 companies representing a total market cap of $64 trillion (trading value of $76 trillion) list on WFE member exchanges. That’s the equivalent of more than 75% of global GDP. Its annual meeting is the largest and most comprehensive of its kind – and this marked the first time in its 55-year history that it was held in an Arab nation.

“Perhaps the first industry attempts to take sustainability seriously came in the form of the UN Sustainable Stock Exchanges (SSE) initiative, which has been driving towards consensus on this topic for several years.”

Economic vitality and market growth in the Middle East was another touchpoint for speakers, eliciting supportive comments from the Qatari Ministry of Economy & Commerce, IOSCO (International Organisation of Securities Commissions), and multiple exchange executives.

Exchanges Step Up Sustainability Reporting

Nasdaq Vice Chairman Sandy Frucher, a WFE board member, presented his case for making exchanges more active in the promotion of sustainable business practices.

“Stock exchanges are efficiently adapted to raise, sustain, and distribute capital,” Mr Frucher said. “We help businesses both large and small innovate, build better products, serve their customers, and create jobs. We also provide investors with access to a diverse and dynamic marketplace. But stock exchanges are also change agents, responsive to market demand for new products, better services, and more transparent data. The time has come to take sustainability seriously as part of that mission.”

Perhaps the first industry attempts to take sustainability seriously came in the form of the UN Sustainable Stock Exchanges (SSE) initiative, which has been driving towards consensus on this topic for several years. The SSE recently published its Model Guidance on Reporting ESG Information to Investors: A Voluntary Tool for Stock Exchanges. That document is not necessarily advocating a new listing requirement, but rather aims to provide exchanges with a globally consistent base to start from as they work to create their own, locally customised, voluntary guidance to help their issuers meet investors’ need for ESG information.

[caption id="attachment_11034" align="aligncenter" width="601"] WFE Recommended Sustainability Disclosures (as identified in a recent publication to exchanges).[/caption]

And now, launched after the meeting in Qatar, we have the publication of the WFE’s own Exchange Guidance & Sustainability Recommendation. The WFE document provides a useful and necessary starting point for exchanges, because strategic and transparent ESG practices can be as beneficial to exchanges as they are to individual companies.

This document was the culmination of the work of the WFE Sustainability Working Group (full disclosure: I served as the group’s chairman for two years). The recommendation focuses on principles and data, with correlating bottom line impacts, but it also politely advocates for improvement and harmonisation in management practices. It also includes a selection of Material ESG Metrics, which call attention to 33 indicators across Environmental, Social, and Governance (ESG) categories that may well be of utmost concern for exchanges.

Balancing Regulation and Revenue

WFE Chairman Juan Pablo Cordoba, CEO of the Bolsa de Valores de Colombia, used the occasion of his concluding remarks to praise the Qatar venue and also highlight some of the challenges that exchanges face.

“We have received strong messages from regulators,” he said, “and we look forward to the conversation moving from stability and risk mitigation to economic development and the growth of capital markets. For most exchanges, the past five to six years have been bombarded by regulation that is hampering markets in certain ways, and it is clear that we are moving towards a constructive phase.”

[caption id="attachment_11036" align="alignleft" width="219"] Evan Harvey[/caption]

The proper role of sustainability in this “constructive phase” is still being debated. As listing venues, exchanges must serve the needs of public companies. Overregulation tends to crush the entrepreneurial spirit and may make companies less willing or able to capitalise on opportunities. The constant churn of filings, disclosures, statements, applications, and surveys may distract businesses from meeting long-term goals, but a lack of regulatory control emboldens bad leaders to grow into bad corporate citizens.

About the Author

Evan Harvey is the Director of Corporate Responsibility for Nasdaq. He also serves on the Board of Directors for the UNGC US Network and chairs the Sustainability Working Group at the World Federation of Exchanges.


SpaceX: Making a Splash in Privatised Space Exploration

[caption id="attachment_11041" align="alignright" width="221"] Dragon V2[/caption]

The United States government is outsourcing its business in space at an astronomical rate. Contracts worth billions of dollars are being awarded to private enterprise. This has caused a dynamic marketplace to emerge which supplies cost-effective solutions for NASA’s routine missions.

Initially dominated by corporate titans such as Boeing and SpaceX, smaller companies like satellite manufacturer Sierra Nevada are now making inroads. As a result, the markets gain depth and becomes more competitive.

In September last year, NASA assigned $6.8bn worth of contracts for the development of shuttles to ferry personnel to and from the International Space Station (ISS). That service is currently only provided by the Russian Soyuz spacecraft. Boeing and SpaceX managed to obtain the largest contracts ever awarded by NASA to private enterprise.

NASA’s new plan calls for private contractors to carry out more of the agency’s routine missions. The resulting cost-savings leave NASA more resources to focus on the next frontier in space travel, such as a human mission to Mars, or to an asteroid.

“If rockets can be reused, costs can come down to $300,000 or less per roundtrip.”

- Elon Musk

Apart from an unprecedented delegation of manufacturing tasks and launch missions, NASA’s new tack also highlights something rarely seen in the United States: The co-operation across governmental institutions and private companies. SpaceX made a statement regarding their collaboration with NASA, thanking the agency for the help received. In a statement, SpaceX recognised that the company owes part of its success to NASA which freely dispensed both advice and knowhow.

Before 2008, NASA never relied on third-party private companies to develop, launch, and manufacture rockets and satellites. That year, founder and CEO of SpaceX Elon Musk entered the market, suggesting he could provide both the hardware and the launch facilities at a price point that neither NASA, nor the military, could possibly match. At first, SpaceX was handed a $1.6bn contract to fly twelve resupply missions to the ISS.

Currently, SpaceX receives about $166m per launch. This amount includes the development outlay for the company’s Falcon 9 rocket. By comparison, the recently-retired Space Shuttle Programme cost US tax-payers a whopping $1.5bn per bang – or about nine times as much as Mr Musk’s contraption. In fact, the Space Shuttle’s bloated operating budget caused the programme’s demise and convinced NASA to explore private sector options.

Companies such as SpaceX aim even higher and are determined to further lower costs. Their holy grail is the reusable rocket. “Aircrafts are good for tens of thousands of flights,” Mr Musk told Bloomberg in January: “If rockets can be reused, costs can come down to $300,000 or less per roundtrip.”

However, NASA figureheads such as Neil Armstrong believe that SpaceX is overpromising and will not be able to blast manned spacecraft into space anytime soon. Mr Armstrong fears that NASA will be left at the mercy of Russian technology for years to come. However, defenders of the plan, including President Obama, argue that the shift to bigger more ambitious missions is needed for the agency to regain the kind of pioneering spirit it displayed during the Apollo years in the 1960s and 1970s, when it sent men to the moon and returned them safely to earth.

SpaceX has recently started to generate a profit from its resupply missions. In 2014, the company accumulated over fifty launches on its manifest, representing close to $5bn in contracts, of both commercial parties and NASA. Even Internet behemoth Google is now entering the scene and awarded SpaceX a contract worth $1bn to develop and launch a satellite capable of providing Internet access to parts of the world not yet online.

Until quite recently, terms such as privatisation, profits, and competition were alien to the world of space exploration industry. In the future, it may become synonymous.


Patrick Awuah: Educating the Future Leaders of Africa

The prestigious and pioneering Ashesi University in Ghana is on a mission to educate a new generation of business leaders. Built on a hilltop in the countryside near Accra, the private-run institution has set out to develop critical thought and empathy in students – two qualities Ashesi University considers indispensable tools for a new generation of leaders.

The liberal arts college is the brainchild of Patrick Awuah who abandoned a lucrative career in software development in the United States to return to his native land and build a university from scratch. As a young man, Mr Awuah left Ghana to take up a scholarship at a prestigious Little Ivy college. He double-majored in Economics and Engineering. After graduation, he joined Microsoft, where he met his future wife, and went on to make a fortune.

The birth of the Awuahs first child led the young father to reflect on his own childhood: “As a parent I began reconsidering the importance of Africa for my children and future grandchildren. It is when I really started thinking about a return home in order to do something that would help foster economic development.”

Mr Awuah was aware that the self-perception of Africans may be affected by the negative perception of the continent. He felt the time had come to do something about this. Mr Awuah first considered setting up a software business in Ghana. However, he was deterred by concerns about the quality and availability of local graduates. He also felt that Ghana’s educational system relied too much on committing facts to memory instead of encouraging critical thinking and developing problem-solving skills. These thoughts became the genesis of his idea to establish a university to educate Africa’s future leaders.

“I felt that if I could somehow get engaged in education and focus on forming a generation of compassionate leaders with a well-rounded sense of ethics, that would have a significant long-term impact on this country.”

Encouraged by his wife Rebecah, Mr Awauh quit Microsoft and enrolled at Berkeley’s Haas School of Business in order to evaluate the feasibility of his plan and gain the broader range of managerial skills needed for the founding and running of a university. His MBA thesis encompassed a detailed business plan for his university.

In 1999, Mr Awuah set up the Ashesi University Foundation. The family moved to Ghana where they acquired a plot of land and started building. In 2002, the first class of thirty students enrolled. The facilities soon needed expansion and upgrading as the student body swelled into four figures. The university’s growth has been financed through a combination of philanthropy and tuition fees.

At Ashesi University, students follow an interdisciplinary liberal arts curriculum that includes courses in the humanities and social sciences, as well as mathematics and preparatory business and computer science courses. Students’ critical thinking skills are developed by exploring the connections between fields of knowledge, questioning assumptions, reflecting on the dissident views, and exploring and analysing alternative explanations to the many aspects of human existence. Graduates major in Business Administration, Computer Science, and Management Information Systems. A suite of engineering subjects is available to the 2015 intake.

The university now attracts students from across the continent. Its graduates have an excellent record in securing jobs. Mr Awuah’s vision of educating a generation of future leaders is still in its early stages. However, the university’s progress is remarkable and it has already earned a stellar reputation. In 2015, Mr Awuah was ranked by Fortune Magazine as one of the World’s 50 Greatest Leaders.

Thus, Microsoft’s loss appears to be Africa’s gain. The quietly spoken, reflective, and modest Ghanaian had awards and honours heaped upon him but only time will tell if Mr Awuah’s vision will come to pass.


Michael Pettis: Money Is Not Created Out of Thin Air

A recurring conversation I have with clients concerns the ability of banks to create credit, and of governments to monetise debt, and whether this ability is the solution to or the cause of financial instability and economic crisis. Monetarists and structuralists have very different answers to that question as each side may assume an idealised version of an economy.

We are normally taught that banks allocate credit by lending the money that savers have deposited in the banking system, but in fact banks create deposits in the banking system by creating credit, so it seems to many as if they can create demand out of nothing. Similarly, if governments are able to create money, and if they can borrow in their own currency, they can easily monetise debt, seemingly at no cost, by printing the money they need to repay the debt – or by crediting bank accounts, which amounts to the same thing. This means that when they borrow, rather than repay by raising taxes in the future, all they have to do is monetise the debt by printing the money needed to repay it. It seems that governments too can create demand out of nothing, simply by deficit spending.

There is a rising consensus – correct, I think – that the misuse of these two processes – which together are what we mean by endogenous money – were at the heart of the debt surge that was mischaracterised as “the Great Moderation.” For example, in a book published earlier this month, Between Debt and the Devil, in which he provides a description of the rise of debt financing in the four decades before the 2008-09 crisis, Adair Turner specifies these two as fundamental to the rising role of finance in the global economy. He writes:

“…in modern economics we have essentially two ways to produce permanent increases in nominal demand: either government fiat money creation or private credit money creation.”

I am less than half-way through this very interesting book, so I am not sure how he addresses the main characteristics of debt, nor whether he is able to explain how much debt is excessive. He invokes the work of Hyman Minsky often enough, however, to suggest that unlike traditional economists he fully recognizes the importance of debt.

And it is because of this importance that the tremendous confusion about what it means to create demand out of nothing is dangerous. When banks or governments create demand “out of thin air”, either by creating bank loans, or by deficit spending, they are always doing one or more combinations of two things. In some easily specified cases they are simply transferring demand from one sector of the economy to themselves. In other equally easily specified cases, they are creating demand for goods and services by simultaneously creating the production of those goods and services. They never simply create demand “out of thin air”, as many analysts seem to think, as doing so would violate the basic accounting identity that equates total savings in a closed system with total investment.

The questions arise in the context of a discussion of some of Steve Keen’s work among several regular commenters. Keen is an Australian post-Keynesian who heads the School of Economics, History, and Politics at Kingston University in London.

I’ve known of Keen’s work for many years, and last year he spoke at a seminar on central banking. He is one of the most hard-core proponents of Hyman Minsky, and regular readers know that I think of Minsky as one of the greatest economists since Keynes. In the third chapter of my 2001 book, The Volatility Machine, I explain the ways in which developing countries designed balance sheets that systematically exacerbated volatility – and which eventually led to debt-based contractions or financial crises – in terms of a framework that emerges from the work of Minsky and Charles Kindleberger. This framework – something that many Latin American economists have no trouble understanding but which has been ignored by nearly all Chinese and foreign economists covering China – explains why three decades of economic expansion in China, underpinned by rapid growth in credit and investment, would lead almost inevitably to destabilising debt structures.

Hyman Minsky’s Balance Sheets

Minsky is important not so much for the “Minsky Moment”, a phrase he never used, but rather because of his profoundly intuitive balance sheet-oriented understanding of the economy. Minsky’s insights include his now well-known description of accelerating financial fragility, along with his explanation of why instability is inherent to the financial sector in a capitalist economy.

Most insightful of all, Minsky characterised the economy as a system of interlocking balance sheets, and because he taught us to think of every economic entity as effectively a kind of bank, with one entity’s assets being another’s liabilities, it follows that economic performance is partly a function of the direction and the extent in which the two sides of each balance sheet are mismatched.

Minsky’s framework made it especially easy to predict the difficulties that China would face once it began to rebalance its economy. China can be described as an extremely muscular illustration of Minsky’s famous dictum that “stability is destabilising.” Its financial system was designed to meet China’s early need for rapid credit expansion, and it evolved around what seemed like permanently high growth rates and uninterrupted access to financing. Two decades of “miracle” levels of investment-driven growth made it obvious that the interlocking balance sheets that make up the Chinese economy had added what was effectively a highly “speculative” structure onto the way economic entities financed their operations.

This would sharply enhance growth rates during the expansion phase, but at the expense of sub-par performance once conditions reverse. The process is actually quite easy to describe, and the fact that it caught nearly the entire community of analysts by surprise should indicate just how unfamiliar economists are with the approach championed by Minsky.

Ignoring the balance sheet framework does not always result in bad economics. When debt levels are low, and the economy close to the kind of Adam Smith described, in which there are no institutional constraints and no entities large or important enough to affect the system as a whole, it makes sense to ignore liabilities and to analyse an economy only from the asset side in order to understand and forecast growth. Evaluating only the asset side would still be conceptually wrong, because both sides of the balance sheet always matter, but the difference between analyses that ignore the liability side and analyses that incorporate the liability side are small enough to ignore.

When conditions change in certain ways, however, the differences can become too large to ignore. The more deeply unbalanced an economy, the higher its debt levels, or the more highly systematically distorted its balance sheets, the more the two forecasts will diverge and the more urgent it is that economists incorporate the balance sheet in their analyses.

In the early 1990s, the models that most economists used to analyse and explain Chinese economic growth were good enough. By the late 1990s, however, the sheer extent of bad debt within the banking system should have provided a warning that mismatches and imbalances might have become large enough to invalidate the old models. They clearly did invalidate the old models over the next few years as credit misallocation accelerated, along with the depth and direction of now-unprecedented imbalances and highly self-reinforcing price changes in commodities, real estate, stock markets, and other variables – what George Soros might have cited as extreme cases of reflexivity.

Violating Identities

To get back to the discussion, a very brisk and active debate broke out among a number of readers over Keen’s claim that next period growth is a function of both this period’s economic conditions as well as this period’s change in debt. Part of the disagreements has to do with whether Keen’s dynamic model, which incorporates changes in debt, and implies that the accounting identities I use are somehow invalid.

I don’t know if Keen actually rejects the identity, but I doubt that he does because he is too good a mathematician not to know that identities cannot be “accepted” or “rejected” like hypotheses or models. More generally, I would never say that I am using this (or any other) identity as the basis for my research, because the point of research is to test hypotheses. You cannot “test” accounting identities, however, because they are not hypothetical. They are true either by definition or as a logical necessity, and there is no chance that they can be wrong.

The important point about accounting identities is that they do not prove anything, nor do they create any knowledge or insight. Instead, they frame reality by limiting the number of logically possible hypotheses. Statements that violate the identities are self-contradictory and can be safely rejected.

Accounting identities are useful, in other words, in the same way that logic or arithmetic is useful. The relevant identities make it easier to recognise and identify assumptions that are explicitly or implicitly part of any model, and this is a far more useful quality than it might at first seem. Aside from false precision, my biggest criticism of the way economists use complex math models is that they too often fail to identify the assumptions implicit in the models they are using.

While economists tolerate models that are not constrained by accounting identities because, for some reason, economists do not seem constrained by the need for their models of the economy to conform to reality. Remembering always to maintain accounting identities does not lead to true statements or to brilliant insights, but it does make it easy to reject a very large class of false or muddled statements. Just as logic doesn’t create science, but it prevents us from making bad science, identities do not create models, but they protect us from useless models.

Keynes, who besides being one of the most intelligent people of the 20th century was also so ferociously logical that he was almost certainly incapable of making a logical mistake or of forgetting accounting identities. Not everyone appreciated his logic. For example, his also-brilliant contemporary, Ralph Hawtrey, was “sharply critical of Keynes’s tendency to argue from definitions rather than from causal relationships,” according to FTC economist David Glasner whose gem of a blog Uneasy Money is dedicated to reviving interest in the work of Ralph Hawtrey. In a recent entry Glasner quotes Hawtrey:

“[A]n essential step in [Keynes’s] train of reasoning is the proposition that investment and saving are necessarily equal. That proposition Mr Keynes never really establishes; he evades the necessity by defining investment and saving as different names for the same thing. He so defines income to be the same thing as output, and therefore, if investment is the excess of output over consumption, and saving is the excess of income over consumption, the two are identical. Identity so established cannot prove anything. The idea that a tendency for investment and saving to become different has to be counteracted by an expansion or contraction of the total of incomes is an absurdity; such a tendency cannot strain the economic system, it can only strain Mr Keynes’s vocabulary.”

This is a very typical criticism of certain kinds of logical thinking in economics, and of course it misses the point because Keynes is not arguing from definition. It is certainly true that “identity so established cannot prove anything”, if by that we mean creating or supporting a hypothesis, but Keynes does not use identities to prove any creation. He uses them for at least two reasons. First, because accounting identities cannot be violated and second, even when accounting identities have not been explicitly violated, by identifying the relevant identities we can make explicit the sometimes very fuzzy assumptions that are implicit to the model an analyst is using, and focus the discussion, appropriately, on these assumptions.

No Surpluses on Capital and Current Accounts

A case in point is The Economic Consequences of the Peace, the heart of whose argument rests on one of those accounting identities that are both obvious and easily ignored. When Keynes wrote the book, several members of the Entente – dominated by England, France, and the United States – were determined to force Germany to make reparations payments that were extraordinarily high relative to the economy’s productive capacity. They also demanded, especially France, conditions that would protect them from Germany’s export prowess (including the expropriation of coal mines, trains, rails, and capital equipment) while they rebuilt their shattered manufacturing capacity and infrastructure.

The argument Keynes made in objecting to these policies demands was based on a very simple accounting identity, namely that the balance of payments for any country must balance, i.e. it must always add to zero. The various demands made by France, Belgium, England, and the other countries that had been ravaged by war were mutually contradictory when expressed in balance of payments terms, and if this wasn’t obvious to the former belligerents, it should be once they were reminded of the identity that required outflows to be perfectly matched by inflows.

If Germany had to make substantial reparation payments, Keynes explained, Germany’s capital account would tend towards a massive deficit. The accounting identity made clear that there were only three possible ways that together could resolve the capital account imbalance. First, Germany could draw down against its gold supply, liquidate its foreign assets, and sell domestic assets to foreigners, including art, real estate, and factories. The problem here was that Germany simply did not have anywhere near enough gold or transferable assets left after it had paid for the war, and it was hard to imagine any sustainable way of liquidating real estate. This option was always a non-starter.

Second, Germany could run massive current account surpluses to match the reparations payments. The obvious problem here, of course, was that this was unacceptable to the belligerents, especially France, because it meant that German manufacturing would displace their own, both at home and among their export clients. Finally, Germany could borrow every year an amount equal to its annual capital and current account deficits. For a few years during the heyday of the 1920s bubble, Germany was able to do just that, borrowing more than half of its reparation payments from the US markets, but much of this borrowing occurred because the great hyperinflation of the early 1920s had wiped out the country’s debt burden. But as German debt grew once again after the hyperinflation, so did the reluctance to continue to fund reparations payments. It should have been obvious anyway that American banks would never accept funding the full amount of the reparations bill.

What the Entente wanted, in other words, required an unrealistic resolution of the need to balance inflows and outflows. Keynes resorted to accounting identities not to generate a model of reparations, but rather to show that the existing model implicit in the negotiations was contradictory. The identity should have made it clear that because of assumptions about what Germany could and couldn’t do, the global economy in the 1920s was being built around a set of imbalances whose smooth resolution required a set of circumstances that were either logically inconsistent or unsustainable. For that reason, they would necessarily be resolved in a very disruptive way, one that required out of arithmetical necessity a substantial number of sovereign defaults. Of course this is what happened.

From Then to Now

The same kind of exercise eight-five years later, shortly after the euro crisis, made it clear that Europe was limited by similar accounting identities to three options. First, Germany could reflate domestic demand by enough to exceed the consequent increase in its domestic production of goods and services by at least 4-5% of GDP, and probably more (i.e. it had to run a current account deficit). Second, peripheral Europe could tolerate excruciatingly high unemployment for at least a decade, and probably more.

Third, peripheral Europe could leave the euro and restructure its debt with substantial debt forgiveness – or, which is nearly the same, force Germany to leave the euro, which would require much less debt forgiveness – causing losses in the German banking system at the same time that it caused Germany’s manufacturing sector to drop precipitously – a fourth option, that Europe could run huge surpluses with the rest of the world, perhaps two times or more than its current surplus, was too implausible to consider, and although Europe is certainly running irresponsibly high surpluses, they are not high enough to allow Europe to grow. So far Europe has chosen the second option, with a high probability, in my opinion, that before the end of the decade it will be forced into the third.

This is why we must keep accounting identities firmly in mind.

Creating Demand Out of Thin Air

Banks can fund investment by creating debt out of thin air. This statement is either highly confused or it too easily leads others into confusion. There is a related form of this question that often seems to come out of the MMT (modern monetary theory) framework, although I have no idea if this is a misreading of MMT or if it is fundamental to the theory, but while banks can create debt, they do not automatically create additional demand. According to MMT, as I understand it, there is no limit to fiscal deficits because governments who control the creation of money can repay all obligations regardless of their taxing capacity simply by monetising the debt.

A lot of people seem to think that this means the state can create demand out of thin air, and so demand created by the state can be added to existing demand with no other change, including no increase in savings. If savings and investment had previously balanced, according to this argument, and the state creates new demand, either this new demand is in the form of investment, in which case investment becomes greater than savings, or the new demand is in the form of consumption, in which case savings is reduced, and so once again investment exceeds savings.

This seems like a perfectly logical argument, except that it is perfectly impossible. For reasons that I will explain in the appendix to this essay, to say that investment is greater than savings is to say that the total amount of goods and services we produce is greater than the total amount of goods and services we produce, and that cannot be true.

So where is the flaw in the argument? It turns out that thanks to these same identities it is pretty easy logically to work out the flaw, and in fact to extend this process of working it out to show – and maybe this is contrary to what MMT implies – that there most certainly are limits to fiscal deficits, and that the state’s ability to monetise its debt does not mean that it can borrow indefinitely without, eventually, destroying the economy and undermining the credibility that allows it to borrow in the first place.

To work through the two different ways demand seems to be created, for convenience I will refer to the entity for whom demand is created out of thin air as Thin Air. Thin Air, in other words, is either the entity to whom the bank made a loan, or it is the government agency responsible for the deficit spending:

In the first case, assume that we are in an economy in which there is absolutely no slack. Workers are fully employed, inventories are just high enough to allow businesses to operate normally, factories are working at capacity, and infrastructure is fully used.

If Thin Air wants to spend money to buy goods and services, it must displace some other entity that is already using the goods and services that are being created by the economy, and it can only do so by bidding up the price of wages or resources. As a result, prices will rise, and these higher prices will reduce the real value of money.

Because higher prices reduce the total amount of goods and services that can be acquired with a fixed amount of money, every economic entity that is long monetary assets – assets such as money, deposits in the bank, bonds, or most expected payments, like wages, pension receipts, etc. – loses some amount of wealth equal to the reduction in the real value of these monetary assets. Everyone who is short monetary assets – anyone who has fixed obligations, for example a borrower, or an employer who owes wages, etc. – gains some amount of wealth. The losses of the former exceed the gains of the latter, with the balance representing a net transfer of wealth to the government or to the bank that created the loan for Thin Air.

The transfer need not occur only through inflation. In a financial system that is highly repressed, Thin Air’s actions might even be disinflationary. China’s case shows how. Until 2012, whenever credit was created by the system, it was done at extraordinarily low interest rates. These low rates represented a transfer of purchasing power from net savers, who were households for the most part. In that case the consequent growth in production exceeded the consequent growth in consumption (because it repressed household income growth) and so was disinflationary, but once again Thin Air’s spending represented a transfer because it simultaneously suppressed consumption.

Demand can only be created out of thin air, in either case, by suppressing consumption or investment elsewhere. At the moment the new demand is created, there is no change in the real value of GDP, although of course nominal GDP can rise or fall, depending on whether the transfer is inflationary or disinflationary.

Either way, if the suppressed demand consisted of investment, investment in the rest of the economy declined, whereas if it consisted of consumption, savings in the rest of the economy rose. This reduction in investment, or increase in savings, is the exact obverse of the increase in investment or consumption set off by the new demand created out of thin air, so that at no point is the identity between savings and investment ever violated.

In the second case, assume the other extreme, in which the economy has a tremendous amount of slack – there are plenty of unemployed workers who have all the skills we might need and can get to work at no cost, factories are operating at well below capacity and they can be mobilised at a flick of a switch, and there is enough unused infrastructure to satisfy any increase in economic activity.

In this case when loan creation or deficit spending creates demand out of thin air, it also creates its own supply. When Thin Air spends money to buy certain goods or services, those goods and services are automatically created by switching on the factory equipment and putting unemployed workers to work.

There is also a multiplier at work here. Assume that Thin Air’s spending is for investment, and that it plans to acquire $100 of goods and services for investment purposes. Because it has no need to build capacity or acquire inventory, the full expenditures will go towards paying wages. Let us further assume that the newly hired workers save one-quarter of their income.

As Thin Air pays wages, the workers will spend 75% of those wages on their own consumption, and they will save 25%. Their own consumption will require the production of additional goods and services, which will require hiring more workers. In order that Thin Air acquire $100 of goods and services, it can easily be shown that the total expenditures of Thin Air and of consuming workers will be the original $100 divided by the 25% savings rate, so that in the end GDP will rise by $400, consisting of $300 additional consumption and $100 additional investment. Because the increase in GDP exceeds the increase in consumption by $100, total savings will have risen by $100.

In an economy with enough slack to absorb Thin Air’s investment fully, in other words, the investment creates enough of a boost in the total production of goods and services that it becomes self-financing – it increases savings by the same amount as it increases investment. Notice then, once again, that at no point is the identity between savings and investment ever violated.

Reality

In reality no economy will ever have zero slack, as in the first case, or full slack, as in the second, but instead will exist in some combination of the two.

An important point that is often obscured by the intensely political discussion about savings is that in the second case, in which the demand created by Thin Air creates its own supply, it turns out that the lower the savings rate, the more GDP is created by any additional spending unleashed by Thin Air. Savings automatically rises to fund investment by causing the total amount of additional goods and services produced to rise by more than the total amount of additional goods and services consumed, with the difference between the two, savings, rising by exactly enough to fund Thin Air’s investment.

What this exercise shows, among other things, is that in an economy working at full capacity, a higher savings rate is likely to increase GDP by more than a lower savings rate, whereas in an economy operating with a considerable amount of slack, a lower savings rate is likely to increase GDP more. What this also shows is that in an economy that has recently experienced a crisis, with falling output to below capacity, there is a tendency for households to raise their savings rate, and because of the multiplier, as they increase their savings rate they reinforce the downward trend in the economy.

In the first case, the monetarist’s world, if Thin Air’s demand is invested in a project that increases productivity by more than the reduction in productivity caused by the transfer of wealth, it is sustainable. Otherwise it is not. If Thin Air suppresses consumption to fund productive investment, it will always lead to higher growth. If Thin Air suppresses productive investment to fund consumption, it will always lead to lower growth.

If Thin Air suppresses private sector investment to fund investment, it becomes a little more complicated, and depends on which of the two “investments” is more productive. Because monetarists usually do not believe that government can ever choose investment projects that are more productive than the market can, they would argue that if Thin Air were a government agency engaged in deficit spending, GDP growth would be reduced, because more productive investment by the private sector was suppressed in favour of less productive investment by Thin Air.

There are however many cases of highly productive investment that the government directed in the past which the private sector was unlikely to have initiated. Today, with the private sector unwilling to fund much productive investment because of weak demand, much private sector investment consists of buying assets, which is not productive. In countries that have weak infrastructure, if Thin Air, whether a government entity or a government-encouraged entity, were to build infrastructure, it would almost certainly lead to higher growth.

In the second case, the structuralist’s world, as long as there is enough slack in the economy that the new demand causes an increase in output that is equal to the sum of new demand and the marginal cost of new output, it is sustainable. Otherwise we eventually revert to the first case.

Monetarists always insist that if the government is to spend money, it should not be in the form of deficit spending. The expenditure should be fully funded by tax increases. Notice, however, that in the first case, expenditures are fully funded by tax increases, but this tax consists of the inflation tax. The monetarists argue that deficit spending, aside from reducing overall productivity, is inherently inflationary and increases economic uncertainty by undermining the stability of money. This is likely to be true the closer we are to an economy that resembles the first case.

Enter China

Finally, one of the stranger and more incoherent arguments used by China bulls to propose that China’s large and soaring debt burden doesn’t matter is that China owes the money to itself. In that case why not simply monetise or socialise the debt, as MMT seems to suggest? One of the reasons is that in a world without an infinite amount of slack, monetising the debt is no different than paying taxes, except that the tax is borne by those who are long on monetary assets, i.e. Chinese households.

If China were to monetise the debt, which is effectively what it did in the past decade to resolve the enormous amounts of bad debt it had accumulated in the 1990s, this would simply reduce the household share of GDP and with it the household consumption share. Put differently, it would force up the savings rate, which is the opposite of what China needs to do if it is to limit the growth of its debt burden. And notice that, as the savings rate rises, growth drops through the declining multiplier as the GDP impact of Thin Air’s activities increases the savings rate.

This exercise shows that fiscal deficits or credit creation are good for the economy when there is enough slack that Thin Air’s expenditures do not suppress investment or consumption elsewhere in the economy, and they are good for the economy if and when Thin Air’s spending is more productive than private sector spending. Otherwise they are bad for the economy and are not sustainable.

But we already knew that. Supply-siders have explained why it is the case in a well-functioning economy, and Keynesians have explained why it is the case when the economy is operating far below capacity.

Savings Equal Investment

While defining investment and saving as different names for the same thing might at first glance seem a useless exercise, in fact, it is a rich way of understanding the links among national economies within the global economy as a single system. Savings can be defined in a number of ways, but the most useful way is to define the supply of all the goods and services an economic entity produces in any period as consisting of two things. The first is everything currently consumed, including things that are lost, thrown away, or that rot away to nothing. What is left and stored for future use is savings.

The intuition is fairly obvious: everything that the economy produces is either currently consumed or set aside for future consumption.

Supply is equal to demand (another accounting identity), so that we can restate the accounting identity by saying that the demand for everything produced is either the demand for stuff we currently want to consume, or for stuff that we want to use in the future. We call the latter investment.

We might find it useful to further distinguish between two kinds of investment. One, which we might call an increase in inventory, consists of taking some of the goods we consume and storing them for later consumption. The other consists of goods and services that we cannot directly consume, but we produce them anyway because they might help us produce even more goods and services for us to consume in the future. If we produce a hammer or a tractor, we will probably never want to consume either. Rather these can help us produce even more goods and services in the future.

Because the supply of all the goods and services an economy produces is equal to the demand for all the goods and services that an economy produces, then as long as we are consistent in our definition of consumption, it is true by definition that investment is equal to savings. This is only the case, of course, in a closed system, like the global economy. In an open system, like a country, investment and savings are rarely equal, but the sum of the excess of savings over investment in some countries and of the excess of investment over savings in others must always equal zero – another accounting identity.

This is just a way of saying that all the current account or trade surpluses in the world must add up to the same number as all of the current account or trade deficits. Because savings and investment must always balance, the idea that the savings rate in any country is determined at home is nonsense. In countries that intervene heavily in trade and capital flows, this is almost true, but in countries that do not, like the US, the truth is almost completely the opposite. The US does not determine its own savings rate, and cannot as long as it allows unlimited access by foreigners to its asset markets. Knowing the accounting identities would have made this very clear.


Ross Jackson: Stemming the Flow of Refugees - An Holistic Approach

The unprecedented surge of refugees streaming into Europe is no doubt due to the ongoing wars in Syria and Iraq and the unstable situation in Libya. However, refugees were arriving in Europe long before these wars began. They will continue to do so, even when civil strife has come to an end.

The wars distract our attention from the fundamental causes that underlie the long-term migration pattern from Africa to Europe. This trend is partly driven by climate change. Africa will continue to be hit hard by droughts while the continent must also suffer the hypocritical policies Western powers have followed over the past seventy or so years, and continue to follow to this day. The major instruments of that policy are the WTO (World Trade Organisation), IMF (International Monetary Fund), and the World Bank.

I call the policies hypocritical, because – in spite of all the claims made to the contrary on festive occasions – the developing countries’ role in the Orwellian world of neoliberalism is to remain undeveloped. Their role is merely to provide the West with cheap raw materials. They are allowed to compete with each other on who can best satisfy our needs at the lowest cost. However, they must not dream of building up value-added production chain for that privilege is reserved for Western powers only.

“The unprecedented surge of refugees streaming into Europe is no doubt due to the ongoing wars in Syria and Iraq and the unstable situation in Libya. However, refugees were arriving in Europe long before these wars began. They will continue to do so, even when civil strife has come to an end.”

The last thing the West wants to see is competition from developing countries. Thus the WTO, for example, adopts a rule that says no member country may give any advantage to a domestic producer that is not also given to a foreign company. This is the key rule that prevents developing countries from following the path that every industrialised nation, without exception, has followed: from Great Britain in the 18th century to China more recently. All have provided protection to domestic producers from more efficient foreign competitors and have done so until a more level playing field was established.

This is fine for the multinational corporations that wrote this rule into the WTO in 1994 and the 0.1% wealthiest citizens who control them. It is a disaster for developing countries, not least in Africa where a growing population clamours for jobs.

The World Bank has done its part by saddling the people of the developing countries with loans that can never be repaid. These loans were often extended to corrupt leaders, interested only in personal power and gain. Other credits have been awarded for large infrastructure works such as ports, roads, and railways that unlock the mineral resources on which the West is dependent.

Almost none of these investments trickle down to people in the rural communities who suffer in poverty while Western billionaires reap the rewards. These poor folk had no say in the awarding of these loans, which in most cases may be labelled “odious” in the sense that they have been adopted in a conspiracy between corrupt local leaders and willing Western banks without the acceptance of the people.

There is no doubt that for decades, the net flow of cash has been from the developing countries to the industrialised countries. For example, the US Treasury has openly admitted that for every $1 contributed to the World Bank, more than $2 arrives back to US exporters via procurement contracts.

The 2014 State of Finance for Developing Countries report published by the European Network on Debt and Development (Eurodad), concluded that developing nations are losing – through illegal activities, debt, lost profits, and loans – twice as much as they gain through aid, investment, charitable donations, and remittances.

The World Bank’s strategy was spelled out clearly in John Perkin’s book Confessions of an Economic Hit Man. Mr Perkins was a project leader at a major US engineering firm (MAIN) working on World Bank projects. He writes that his bosses explained to him directly that his job was “to bankrupt the countries that received loans so that they would be forever beholden to their creditors, and so they would present easy targets when favours are needed, including military bases, UN votes, or access to oil and other natural resources.”

Then there is the IMF, which completes the picture of developing country exploitation with its structural adjustment policies designed to accomplish the same ends as the World Bank and WTO. In order to get loans the IMF has in numerous cases insisted on the developing countries doing the following:

Lowering tariffs on Western industrial products

Depreciating their currency

Waiving all rights to capital controls, thus exposing the currency to speculators

Privatising public monopolies.

Raising interest rates, causing unemployment

Removing food and educational subsidies to the poor

Accepting the right of Western countries to dump their excess food products on their markets

Charging fees to school children

Cutting welfare programmes

Repaying debts to the IMF as first priority

Switching from import substitution to exporting raw materials

Of these policies, Joseph Stiglitz – former chief economist at the World Bank – said that the IMF’s forced contraction of these developing economies would have John Maynard Keynes “rolling over in his grave.” Mr Stiglitz has also called neoliberal economics “more religion than economics.”

The West has created a situation whereby the people of poor countries have no chance of ever developing viable economies—not even when they enjoy a clear comparative advantage such as West African cotton. The US places tariffs on cotton imports from West Africa and even higher tariffs on value-added products like textiles. At the same time, the US government gives substantial subsidies to cotton farmers in the southern states who cannot compete otherwise. Nor will Europe allow African countries to export their very competitive agricultural products. Instead, subsidies are given to European farmers and excess produce is dumped on the developing countries, destroying local markets.

The bottom line is that the surge of migrants is a direct blowback of our own policies over several decades. If we are ever to reverse the flow, we must change our attitudes toward the developing countries. We must help the rural people there to build viable local communities and encourage them to form and run their own businesses with value-added production that they can export to the EU and the USA. We also must begin to see them as extended family rather than competitors. Moreover, we must accept that we cannot continue expanding our Western economic growth on a planet with finite resources. Quite to the contrary, we should rather use future productivity increases to cut working hours, and give Western citizens a better quality of life.

Further material growth in the West can only be achieved at the cost of less material growth in the developing countries and a corresponding increase in migration to Europe. The chickens have come home to roost and it is time we acknowledged our past mistakes.

An example of what is needed to reverse the flow of migrants is the type of project now being promoted by Gaia Education, a Gaia Trust project on whose board I sit. Our goal is to build the capacity of migrants in refugee camps. We do so by teaching and demonstrating the fundamental design principles of sustainable communities from a holistic point of view. This includes economical, ecological, social, and cultural dimensions, so that the migrants can get useful work in Europe as teachers of these same principles or as organic farm workers or entrepreneurs. They may also elect to return to their countries of origin where they can begin to rebuild local communities based on sustainable principles and engaged entrepreneurship.

If we want to be serious about solving the refugee problem over the long-term, we must reverse the “no development” policies of the WTO, IMF, and World Bank, reverse the tariff policies of the EU and USA, and accept that we must make a real effort to help the developing countries to build viable economies that can compete with us. This is the only realistic and just solution to the refugee problem.

About the Author

Ross Jackson, PhD, worked for 25 years in the foreign exchange world as currency adviser to international corpora-tions, currency fund manager, and research head of a team of mathematicians and IT experts. He is author of Occupy World Street: A Roadmap for Radical Economic and Political Reform (Chelsea Green, 2012).


CFI.co Meets the CEO of Rothschild & Cie Gestion: Jean-Louis Laurens

[caption id="attachment_12284" align="alignright" width="281"] CEO: Jean-Louis Laurens[/caption]

Displaying a strong preference for the pursuit of returns over long investment cycles, Rothschild & Cie Gestion, one of France’s leading conviction-based asset managers, offers institutional investors, independent financial advisors, and external distributors a full suite of services extending across equities, fixed-income instruments, bonds, and other asset classes. The Paris-based firm, fully-owned by Rothschild & Cie Banque, also maintains office in New York and London.

“Rothschild & Cie Gestion is at heart a multi-specialist firm that concentrates on three distinct areas closely related to the in-house core competencies honed to excellence over time,” explains Jean-Louis Laurens (61), CEO and global head of Asset Management, and managing partner.

Mr Laurens emphasises that Rothschild & Cie Gestion does not aim to be a jack of all trades. Rather, he argues, the firm is careful to operate on the basis of its strengths: “We are an active manager in European assets and, as such, prefer to adhere to long-term strategies as opposed to tactical investing. The firm also obtains solid results as a smart beta manager, extracting returns from systemic biases and perceived market inefficiencies. This, moreover, allows for prudent risk management. Our third area of expertise entails innovation and open architecture. In particular, the fund of funds business has proven quite successful.”

With a long history, strong values, and time-honoured principles, Rothschild & Cie Gestion remains committed to expunging volatility from its portfolio: “An asset manager should reflect the principles it lives by. We aim to be a safe haven in a dangerous world. Asset management is as much about the preservation of capital as it is about growing capital. It is with this in mind that our firm attaches great importance to risk mitigation which also includes incorporating non-financial criteria into the decision-making process.”

Rothschild & Cie Gestion is a pioneer in recognising sustainability parameters as key to long-term profitability and was an early adopter of the Principles for Responsible Investment as defined by the United Nations Environment Programme’s Finance Initiative (UNEP-FI). “We are keen to include environmental, social, and governance [ESG] criteria in all our investment processes and, indeed, have been at the forefront of this development. As such, we recognise that clients may have their individual requirements for, say, decreasing their carbon footprint. At Rothschild & Cie Gestion we are able, and eager, to help investors attain their ESG goals.”

The firm currently manages, or guides, around €52bn in funds. “We are, of course, specialist managers serving a, admittedly sizeable, niche by combining the pursuit of high alpha and smart beta with a high-conviction approach which, ultimately, means that we have a distinctive view of the market and are quite flexible in the way we create our portfolios.”

Mr Laurens unveils that his firm is currently considering ways to increase its presence in the United States with the full support of Rothschild & Cie Banque. The firm already has a dynamic team working in New York and is considering bolstering its US footprint. “There is a strong demand for innovation, but one delivered with excellence. We already have a strong client base of institutional investors, third party distributors, and major banks. We have also established strategic partnerships such as with Pacific Life, a California-based insurance company.”

In the end, it is differentiation – in both approach and results – that counts in the asset management industry. With an impeccable track record as impeccable as its pedigree, Rothschild & Cie Gestion has managed to transcend the universe of ready-made stock-in-trades to offer a mix of investment products and vehicles that do not merely respect client specifications but adjusts to individual constraints and objectives.