IMF World Bank Board of Governors Annual Meetings 2006 by Faircount Media Group

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Cambodia – since 2005

Philippines – since 1990

China – since 1986

Singapore – since 1974

Hong Kong – since 1972

South Korea – since 1978

India – since 1984

Taiwan – since 1980

Indonesia – since 1970

Thailand – since 1985

Japan – since 1969

Vietnam – since 1993

Malaysia – since 1971

Credits Words into Action Delegate Publication for The International Monetary Fund and World Bank Group Boards of Governors Annual Meetings Suntec Center, Singapore, 11th-20th September, 2006 Published by Faircount Ltd European Headquarters 5 Ella Mews, Hampstead London NW3 2NH United Kingdom Tel: + 44 (0)20 7428 7000 Fax: +44 (0)20 7117 3338 email: publisher@faircount.co.uk North American Headquarters 701 North Westshore Blvd. Tampa, Florida 33609 USA Tel: 1 (813) 639 1900 Fax: 1 (813) 639 4344 e-mail: publisher@faircount.com Publishers Peter M. Antell Ross W. Jobson Associate Publisher David Woods Editor Philippe Legrain Authors Manu Bhaskaran Diane Coyle Simon Cox Geoff Dyer Barry Eichengreen Bethan Emmett Duncan Green Philippe Legrain Simon Long Johan Norberg Nouriel Roubini Jeffrey D. Sachs AnnaLee Saxenian Mark StGiles Guido Schmidt-Traub John Williamson

Sales & Marketing Director Lawrence Rosenberg Project Managers Trevor Raymond Lloyd Millett Marketing Executives Margaret Cole Guy Hayes Stephen Idrissi Gary Tarian Design & Production Controller Sandip Patel Designers Dorota Mellors Victoria Wren Picture Research Kay Rowley Production Coordinator Colin Davidson Office Manager Ekta Dash

Photography: Corbis, IFRC, IMF, OnAsia, Oxfam, Panos, Still Pictures, World Bank Group Printed in Singapore ÂŠCopyright 2006, Faircount Ltd. All rights reserved. Reproduction of editorial content in whole or in part without written permission is prohibited. Faircount Ltd does not assume responsibility for the advertisements, nor any representation made therein, nor the quality or deliverability of the products themselves. Reproduction of articles and photographs, in whole or in part, contained herein is prohibited without express written consent of the publisher, with the exception of reprinting for news media use.

Words into Ac tion

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Foreword

Publisher’s foreword Publications in the Words into Action series have a well established record, not just for documenting major events and conferences, and the policies & initiatives evolving from them that aspire to improve the lives of many of the world’s population, but also for providing some of the most respected commentaries by world-renowned writers on the major development, finance, and sustainability issues. The United Nation’s World Summit on Sustainable Development in Johannesburg, the International Conference for Renewable Energies in Bonn, the World Water Forum in Mexico, and the Beijing International Renewable Energy Conference are amongst the major meetings whose organisers have worked with the Words into Action team to produce publications for their events. We hope that the fact that these publications are found on the desks and in the briefcases of world leaders, Ministers of State, Heads of NGO’s, CEO’s of corporations, and members of the media is recommendation enough for their content and reputation. As publishers of this Delegate Publication for the International Monetary Fund and World Bank Annual Meetings, the Words into Action team feels especially proud to have the publication distributed at such an important meeting. It would be difficult to overemphasize the significance of the roles of the International Monetary Fund, the World Bank and the other development banks and organisations with which they work. Together, they are in a position to do more good for more people than perhaps any other institutions in the world. Upon their decisions depend not just the livelihoods, but the very lives of millions of human beings, and their security both financial and physical. This publication will play its own small part in communicating some of the issues that will be under discussion in Singapore and we hope that you will agree that it does so intelligently, impartially, and reasonably and that it makes a positive contribution to the process.

Words into Ac tion

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Foreword

IMF strategy tries to set the framework for the future direction of the institution, and certainly the motivation behind putting forward a strategy is related to what we see as the needs of the member countries in the 21st century. Specifically, I mean the effects of globalization in all member countries, not only emerging and low income countries, but also developed economies. This Medium-Term Strategy will be part of the discussions, specifically in some of the issues like surveillance and quotas, in Singapore. The strategy covers all the areas of foreign activities. It proposes changes in the way we conduct bilateral surveillance, individual surveillance for member countries, known as Article IV Consultations. It also covers changes in the way we address global surveillance beyond our traditional or economic outlook. It presents changes in our approach to preventing and dealing with financial crisis in emerging economies. It refocuses our activities in low-income countries, and it also produces changes in our own governance, both in terms of streamlining our institution, and having a more medium-term budgetary objective. It also has regard for the institution’s need to reflect the changes in the global economy, and introduce changes in the quotas and, for example, participation of member countries. Surveillance is probably the core mandate of the Fund. We are proposing important changes, both in the policies and practices of surveillance to make it more effective, and at the same time helping member countries to tackle some of the most important problems they are facing. RODRIGO DE RATO Y FIGAREDO Managing Director of the International Monetary Fund Rodrigo de Rato took office as Managing Director of the International Monetary Fund in 2004. Before that, he was Vice President for Economic Affairs and Minister of Economy for the Government of Spain, as well as Governor for Spain on the Boards of Governors of the IMF, the World Bank, the Inter-American Development Bank, the European Investment Bank, and the European Bank for Reconstruction and Development. He also represented the EU at the Group of Seven Finance Ministers meeting in Ottawa, Canada, in 2002, when Spain held the EU Presidency. He was also in charge of foreign trade relations for the Government of Spain, and represented Spain at the World Trade Organization’s ministerial meetings in Seattle, United States, in 1999; in Doha, Qatar in 2001; and Cancún, Mexico, in 2003. He was a member of Spain’s parliament from 1982 to 2004. Mr. de Rato holds a law degree from the Universidad Complutense in Madrid, a Master of Business Administration from the University of California at Berkeley and a PhD in Economics from the Universidad Complutense. In his address to the Foreign Correspondents’ Club of Japan in Tokyo, Rodrigo de Rato delivered the following remarks (abstracted)

Words into Ac tion

One of these changes, Multilateral Consultations, refers to the global economy. We will not only address consultations at bilateral levels with member countries, but we will start looking at global issues having multilateral settings in which different economies will get together with the Fund to discuss global issues. We believe that narrowing global balance of payment imbalances is key for maintaining robust global growth. Another element of the Medium-Term Strategy regarding surveillance is going to be a more focused approach by the Fund on financial sector issues and we must make sure the importance of these are systemically reflected in the work of the institution. This effort of making the Fund more knowledgeable and more relevant in financial markets, understanding its consequences on macroeconomic and monetary policy, will take many forms. Another element of the Fund’s Medium-Term Strategy, is the question of a fair and comprehensive representation of members. I believe it is now time to recognize the rise in economic weight of a number of other countries—including some of the largest emerging market economies, some in Asia. In doing so, we will have to increase their relative quotas and voting shares. I envisage tackling the issue in a two-year program of action, beginning with some key decisions in Singapore. I would also want our members to agree in Singapore to move during the next two years on more fundamental changes, including a further round of ad hoc quota increases for underrepresented members following a review of the formula that we use to calculate the quotas, making it more transparent and more relevant, and also to make rebalancing a permanent feature of any future general quota increase. They will also include measures to protect the voice and representation of low-income countries that continue to borrow from the Fund, but have only a limited share in the Fund voting. There are other aspects of this Medium-Term Strategy, where changes are progressing more gradually, but which are also very important. For example, we are revisiting the instruments that we have to help prevent and respond to crisis in emerging market countries. At present, not many of our emerging market countries’ members are borrowers from the Fund. This is partly a reflection of good conditions in the global economy and financial markets, and also clearly partly of improved economic management in emerging market countries. But we need to make sure that if world financial conditions worsen we have the tools we need to support emerging economies. Another example of other activities in the Medium-Term Strategy is certainly our commitment to lowincome country members, and the international effort to reduce poverty. Our work is to improve our effectiveness by focusing our efforts more sharply on the areas of responsibility, macroeconomic and financial issues, in which we believe we have a comparative advantage, and also to have a cooperative approach with development banks, starting with the World Bank, to face what is really an important challenge for many low-income countries to meet the Millennium Development Goals. Rodrigo de Rato, August 3, 2006

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Foreword

The World Bank encompasses The International Bank for Reconstruction and Development and The International Development Agency, IBRD and IDA, which were the two original elements of The World Bank Group. It’s worth emphasizing that we are a group - sometimes people think it is just The World Bank. There is also the private sector arm, The International Finance Corporation; they have just celebrated their 50th birthday and the 50 billion dollars worth of commitments made over those years, 6 billion dollars of which were made in the last fiscal year. It’s a measure of how the importance of the private sector in development has grown over that half a century. Indeed, we meet at a time when private capital flows are becoming perhaps the most powerful force for development. The basic structure of financing for developing countries has been transformed over the last 20 years. For every dollar now in official development assistance to developing countries, there are more than $4 in cross-border private investment from rich to poor countries. A significant portion of these flows are coming from institutional investors. In the last 10 years, pension funds, foundations, and endowments have increased investments in emerging markets from nearly 10% of total assets 10 years ago, to more than 16% today, and that 16% now represents more than one trillion dollars in investments. There are some similar fascinating trends unfolding in the global economy: many developing countries are rapidly building up very large foreign reserves. These vast reserves, totaling more than 2 trillion dollars today, could help unlock private sector led investment. It’s not only investments from developed countries to developing countries, but what we call South-to-South foreign investment that is growing, and growing roughly 5 times faster than investment from North-to-South. While it’s still relatively small, South-to-South flows more than tripled from 14 billion dollars in 1995, to 47 billion dollars in 2003.

PAUL WOLFOWITZ President of the World Bank Group Paul Wolfowitz was appointed to his current office in 2005. In the previous thirty years, he has served under seven Presidents of the United States and in a variety of capacities as a public servant, an educator and as an ambassador in the developing world. In government, Mr. Wolfowitz was Ambassador to Indonesia for three years, head of the U. S. State Department’s Policy Planning Office for two years, and Assistant Secretary of State for East Asia and Pacific Affairs for three-and-a-half years, where he worked directly with the leaders of more than 20 countries. He has served as Under Secretary of Defense for Policy - also collaborating on the U.S. administration’s nuclear arms reduction initiative – and for four years as Deputy Secretary of Defense. He has also held posts as Dean and Professor of International Relations at the Paul H. Nitze School of Advanced International Studies of The Johns Hopkins University, as a lecturer in political science at Yale University, and has written widely on foreign policy, diplomacy, and national security, and was a member of the advisory board of Foreign Affairs. Mr. Wolfowitz majored in Mathematics at Cornell University, Ithaca, NY, and earned a Ph.D in Political Science at the University of Chicago. In his address to the International Corporate Governance Network (ICGN) Conference in Washington, Paul Wolfowitz delivered the following remarks (abstracted)

10 |

Words into Ac tion

There are other staggering statistics that are not such happy ones. Today, there are more than 1 billion people worldwide living on less than a dollar a day - our definition of extreme poverty - and another 2.6 billion people around the world, nearly half the population of this planet, who live on less than $2 a day, the official definition of poverty. For development institutions like The World Bank Group, the surge in capital flows represents both an opportunity and a challenge in our efforts to help developing countries achieve growth, combat poverty and give the poor people of the world those chances in life which we take for granted. It’s true that vast amounts of international capital are potentially available to help developing countries grow, create jobs and provide opportunities for their people to escape poverty, but to access that capital, to attract investors, developing countries - especially the poorest ones - need to improve their investment climates and ensure that these resources, private and public, are managed in a transparent way. That’s absolutely vital for harnessing the entrepreneurial energy of the private sector. Today the private sector accounts for 90% of jobs in the developing world, and ultimately it will be these jobs that offer the most promising path out of poverty. So, I believe the challenge of corporate governance is really about the broader challenge of creating an investment climate in developing countries in which the private sector can thrive. Corporate governance is one essential component of building a healthy investment climate and boosting investor confidence. We know that companies with well-defined shareholder rights, solid control environments, high levels of transparency and disclosure and an empowered board of directors, have no trouble attracting investors and lenders. Studies have shown over and over again that well-governed companies perform better. A World Bank study shows that US mutual funds were more likely to invest in emerging markets with strong shareholder rights, legal frameworks and accounting policies. One study of S & P 500 firms over a two year period shows that companies with either strong or improving corporate governance perform better by 19% than those with poor or deteriorating corporate governance. So it should come as no surprise that when institutional investors want to invest in developing countries, they will turn to well governed companies. Within developing countries, governments are also starting to pay more attention to corporate governance. To attract domestic and international investors, India unveiled a new set of major corporate governance reforms early this year for its public companies. And in Mexico, a new law introduced a series of reforms to raise corporate governance standards and to improve investor protection. Enforcing strong corporate governance standards not only improves the company’s performance, it also helps guard against corruption by encouraging greater transparency, disclosure of information and independent oversight. When corporate governance standards are weak or absent, it creates an opportunity for abuse and for the misuse of power in corporate practices. Corruption is one of the biggest obstacles to development today and it can undermine private sector growth, especially in the poorest countries. It drains resources and discourages investment; it benefits the privileged and robs the poor. Corruption though, isn’t just a disease of developing countries. In every corrupt transaction, there are at least two parties involved - a bribe giver and a bribe taker. Where most multinationals and their affiliates bring good corporate practice to developing countries, there certainly are cases where they have tried to bribe governments for large procurement contracts or for influence in policy making. We must not let a few bad players undermine the high corporate standards set by most firms. We must also recognize that taking responsibility for cleaning up our own laundry empowers leaders and the growing number of leaders in developing countries who are taking on these issues themselves. The World Bank Group has made a strong commitment to battling corruption and we recognize that better corporate governance can be a very effective tool for that agenda. It will not rule out corruption completely, but it can protect investors against the abuse of corporate assets for personal gain through better internal controls, through disclosure of rules and through strong codes and ethics. Paul Wolfowitz, July 6, 2006

Great Eastern is the largest

Today as we roll out the red

insurance group in Singapore

carpet for delegates of the

and Malaysia, with USD25

Annual Meetings of the Board

billion in assets and 2.6 million

of Governors of the International

policyholders. Holding strong to our core values

Monetary Fund and World Bank Group, we celebrate

Integrity, Initiative and Involvement, Great Eastern has

Singapore’s achievement as a global player in

made life great for our policyholders for close

business and finance. A warm welcome to the land

to a hundred years.

of financial security – where life is great!

  

   

 



Contents 06

Forewords

Global Economy and International Finance

Mind the gap By Nouriel Roubini Safe to return? By John Williamson Submerging markets? By Barry Eichengreen

Focus on Asia

96 99

12 |

Words into Ac tion

Indiaâ&#x20AC;&#x2122;s soft spot: Can it let China do the hard stuff? By Simon Long Restructured and resilient By Manu Bhaskaran In the shadow of the dragon By Geoff Dyer Schedule of Annual Meetings, 2006 The new Argonauts By Anna Lee Saxenian

CY CMY

Contents Development Agenda

112

120

130

142

Hitting the target Jeffrey D. Sachs and Guido Schmidt-Traub Spanning the digital divide By Diane Coyle â&#x20AC;&#x153;Our Heroesâ&#x20AC;? By Philippe Legrain The missing link By Johan Norberg

Reforming Global Governance

154

164

174

14 |

Fixing the Fund By Simon Cox In the public interest By Bethan Emmett and Duncan Green First off the mark By Mark St Giles

Words into Ac tion

focus

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Mind the gap The growing imbalances in the global economy are dangerously unsustainable, yet countries are recklessly failing to tackle them. It is time for the IMF to take the lead.

he vigorous debate about the

extra debt – and are instead caused by a

global current-account imbalances

“global savings glut” triggered by developing

is reminiscent of Akira Kurosawa’s

countries saving too much. Three: others

Rashomon. In that classic film, a terrible

argue that the imbalances are largely due

crime occurs in a forest, and while the

to a global investment drought rather than

five characters agree that something

a savings glut. Four: in the Bretton Woods

serious has happened, each has a different

II hypothesis advanced by Michael Dooley,

interpretation of what happened, why,

David Folkerts-Landau and Peter Garber,

and who is at fault. Likewise, the facts of

China and other emerging markets are

the global imbalances are generally not

causing the imbalances by keeping their

disputed: (nearly) everyone agrees that

currencies artificially low so as to boost their

they are large and growing, with the US

export-led growth. Five: the imbalances

saving less than it invests and spending

are caused by China’s excessive saving,

more than its income – and thus running a

owing not to its exchange-rate policy

NOURIEL ROUBINI

current-account deficit – while most of the

but to the structure of its financial and

is Professor of Economics at the

rest of the world saves more than it invests

economic systems. Six: Richard Cooper

Stern School of Business, New

and spends less than its income, and thus

argues that the imbalances are caused by

York University and co-founder

runs a current-account surplus. But in this

demographics and low productivity growth

and Chairman of Roubini Global

contemporary Rashomon saga, there are

– Japan, Europe and China need to save a

Economics LLC, a web-based

at least ten competing interpretations of

lot because they are ageing very fast, while

economic consultancy. He is a

what is causing the imbalances, and what

low productivity growth in Japan and Europe

senior academic researcher in

(if anything) should be done to remedy them.

exacerbates this need. Seven: housing bubbles in the US and a handful of other

international macroeconomics and has had broad policy experience

Interpretation one: many blame the global

countries, caused in part by easy money,

in the US government. His latest

imbalances on the US’s twin budget

are responsible for the imbalances, because

book (co-authored with Brad

and current-account deficits. Two: Ben

they have increased investment (in housing)

Setser), Bailouts or Bail-ins?

Bernanke, Alan Greenspan’s successor

while leading to a consumption boom,

Responding to Financial Crises in

as chairman of the US Federal Reserve,

and hence reduced saving. Eight: financial

claims the imbalances have little to do

globalisation is the explanation, because

with the US’s fiscal deficit – because the

as investors are diversifying their portfolios

world is Ricardian, that is, consumers and

and investing more of their funds abroad,

companies offset an increase in government

foreigners’ demand for US assets is greatly

borrowing by saving more, in anticipation of

increasing. Nine: Ricardo Hausmann and

the future tax rises needed to be pay off the

Federico Sturzenneger argue that the US

Emerging Markets, was published by the Institute for International Economics in 2004.

18 |

Words into Ac tion

current-account deficit is a statistical illusion, because “dark matter” – the intangible value of US-owned foreign assets – is not measured correctly. Ten: the oil exporters are to blame, because they are saving rather than spending their huge windfall gains from rising oil prices. While there is some truth to each of these stories, a lot of nonsense and misguided arguments also cloud the debate. This is not merely academic: it is vitally important for the future of the world economy that the causes of the global imbalances are correctly identified and the appropriate policy changes made. Are the imbalances sustainable for a long time, and likely to unwind in a slow and orderly manner? Or are they unsustainable, and liable to unravel suddenly, risking a global recession? If so,

Oil exporters do account for part of the recent increase in the global imbalances, but they are not the main factor behind it.

how should countries rectify their behaviour so as to try to reduce them in an orderly

collapse in investment. In the 1990s, the US

fashion?

borrowed from abroad to invest in new real capital; since then, it has been borrowing to

Who is telling the truth?

finance its fiscal deficits, foreign wars and

Interpretation one – the twin-deficits story

lack of private savings. The pattern of capital

– is the most plausible explanation for the

inflows matches this story: in the 1990s,

growth of the global imbalances, at least

there was a large net inflow of FDI and

from 2000 to 2004. In the 1990s, the US

equity investments to the US; since then,

current-account deficit was caused by an

there have been large net outflows, offset by

investment boom which outstripped the

a massive accumulation of US debt, mostly

increase in national savings arising from the

Treasuries, by foreign central banks.

country’s sharp fiscal improvement. But after the tech bust, national investment fell by

Since 2005, matters have changed a

4% of GDP between 2000 and 2004. Had

little. The US current-account deficit has

US national savings remained unchanged,

continued to widen, while the fiscal deficit

the current account would have improved

has shrunk somewhat. Since last year, an

by 4% of GDP; instead, the deficit widened

excess of savings in China and oil-exporting

by another 2% of GDP. Why? Because

countries has helped keep long-term US

US fiscal policy swung from a surplus of

interest rates low – thus explaining the

2.5% of GDP in 2000 to a deficit of 3.5%

now infamous “bond-market conundrum”

of GDP in 2004 – a deterioration of 6% of

– and fed the housing (and associated

GDP, which exactly mirrors the widening of

consumption) bubbles. This, in turn, has led

the current-account deficit adjusted for the

to a further reduction in US private savings,

➣ Words into Ac tion

| 19

Global Economy and International Finance

➣ with household savings actually turning

Japan, Europe and China need to save a great deal because their populations are ageing: low productivity growth in Japan and Europe exacerbates the problem.

Demographic trends in Europe, Japan

negative. It is true, then, that excess savings

and China combined with low productivity

in a few countries have swollen the global

growth in Europe and Japan imply that part

imbalances since last year, but Bernanke

of these global imbalances is structural

overstated his case by referring to a “global”

rather than cyclical – and thus more

savings glut (interpretation two). If anything,

sustainable (interpretation six). But the

in fact, we are experiencing a – possibly

view that the imbalances are entirely due

temporary – global investment drought

to demographics is far-fetched. For a start,

(interpretation three). Investment rates in

while China may have an ageing problem,

East Asia have never recovered since the

its productivity growth is huge, so it does

1997-98 crisis, while they have also been

not need to save as much as slow-growing

low in slow-growing Europe and Japan for

Europe and Japan. Also, although Europe

quite a while.

and Japan may require a structural currentaccount surplus for demographic reasons,

The Bretton Woods II story (interpretation

in practice, the eurozone’s current account

four) is a variant of the Bernanke savings

is broadly in balance.

glut argument where the excess savings are caused by the mercantilist exchange-

Easy money and other financial-sector

rate policies of China and other developing

factors which have led to a housing boom

countries. It therefore has some truth to it.

are a more promising partial explanation of

But the Panglossian view of its proponents

the global imbalances (interpretation seven).

that the global imbalances are optimal and

Along with the US, the countries with large

sustainable for decades is wishful thinking.

current-account deficits include Turkey,

Inevitably, if the US continues to run current-

Hungary, Australia, New Zealand, Iceland

account deficits of some 7% or more of

and Spain. All have experienced a housing

GDP, its external liabilities will eventually

boom, which has led to a rise in residential

become unsustainably large, triggering a

investment and a fall in private savings, as

collapse of the dollar and a global recession.

households who feel richer because the

CMY

value of their home has increased spend

20 |

Words into Ac tion

China’s excess saving is in part to structural

more – both of which swell the current-

factors which hamper consumption

account deficit. These countries also display

(interpretation five). Because the country’s

other common features: an overvalued

social safety net is threadbare, Chinese

currency, a credit boom and a potentially

households need to save for education,

dangerous accumulation of external

health care, old age and possible

liabilities. This year, as opportunities for yield

unemployment. Weaknesses in its financial

carry trades – borrowing in countries with

system – the lack of a sound consumer-

low interest rates, notably Japan, in order

credit system and constraints in the way

to invest in countries with higher investment

housing is financed – also force households

returns – have been unwinding, all of these

to save too much. Structural reforms

countries (save for Spain, which is in the

– which China plans to implement in the

eurozone) have experienced pressures on

next few years – are needed so as to reduce

their currency, in some cases quite severe.

the economy’s reliance on net exports and

The danger is that as interest rates are

investment for its long-term growth and

raised to control inflation, their housing

boost the role of private consumption.

bubbles could burst, causing investment to

➣

CMY

Global Economy and International Finance

➣

fall and savings to rise, restoring balance

It is often claimed that financial globalisation,

to their current accounts – by provoking

the reduction in home bias and the large

a recession.

foreign demand for US assets, explains the global imbalances (interpretation eight).

Paradoxically, the recent flight of capital

But this is incorrect. Financial globalisation

from emerging-market economies with

cannot explain changes in global savings

large current-account deficits has led to a

and investment (leading to current-account

temporary appreciation of the US dollar, as

imbalances), because these depend on

investors fleeing risky assets are seeking

other factors. In any case, a diversification

the safety of US Treasuries. But seeking

of portfolios and a reduction in home bias

refuge in the country with the biggest

do not imply current-account deficits:

current-account deficit is a temporary and

cross-border transactions of domestic

unsustainable outcome. Eventually, the

and foreign assets can lead to any level of

dollar will again be pushed down by bearish

diversification and reduction in home bias

forces both structural (its large current-

without changing net positions, that is, with

account deficit) and cyclical (shrinking

zero current-account deficits. What’s more,

interest-rate and GDP growth differentials

in the past five years returns on US equities

between the US, and Europe and Japan).

have been significantly lower than those

Even the dollar cannot defy the laws of

on foreign ones. Foreigners are no longer

gravity forever.

rushing to buy US shares; on the contrary,

net, they are pulling their money out of

“Because the US is an advanced economy which has never defaulted on its external debt and whose currency is still the world’s main reserve currency, its deficit may be sustainable for longer.”

US equities.

While financial globalisation is not causing

CMY

the global imbalances, it may make the

US current-account deficit easier to sustain for longer. Because the US is an advanced economy which has never defaulted on its external debt and whose currency is still the world’s main reserve currency, its deficit may be sustainable for longer. But even the US cannot pile up foreign debt ad infinitum. The “exceptional privilege” argument – that, because the US is able to borrow in its own currency, it can reduce the real value of its external liabilities through a persistent dollar depreciation – involves a basic conceptual fallacy. While you can fool all of the people some of the time (via an unexpected depreciation) and some of the people all of the time (the handful of central banks which do not care about the return on their dollar assets), you cannot fool all of the

The threat of trade wars in 1987 led to a stock market crash.

22 |

Words into Ac tion

people all of the time. If investors expected

➣

Global Economy and International Finance

temporarily been low. Also, tax arbitrage

“The global imbalances have a number of causes and can only safely be unwound if several countries take action.”

driven by high US corporate tax rates leads US firms to report more of their profits abroad, while foreign firms operating in the US do the reverse. Moreover, even if dark matter did exist and the US was a net creditor, this would neither imply that the US current-account was in balance,

➣

a necessary dollar depreciation – even a

nor that it could run a trade deficit of 7% of

modest 4-5% per year – the return on US

GDP forever. It would only mean that the

assets should adjust upwards to offset

current-account position that eventually

this expected fall in the US dollar. The US

stabilises the US’s net external liabilities

would therefore not be able to reduce the

would be a small deficit (perhaps 1% of

real value of its foreign liabilities through a

GDP at most) rather than a small surplus

persistent dollar depreciation.

– and reducing the trade deficit from 7% of GDP to 1% of GDP still implies a huge, and

As for the supposed “dark matter”

painful, adjustment.

(interpretation nine), it seems more like a “black hole” once one considers the

Oil exporters do account for part of the

evidence. The fable goes as follows: if the

recent increase in the global imbalances

US were truly a net debtor (to the tune

(interpretation ten), but they are not the

of over $2.5 trillion, according to official

main factor behind it, nor will the recycling

figures), net factor income payments should

of petrodollars provide continued cheap

be negative (if the returns on US-owned

and easy financing for US current-account

foreign assets are on average equal to the

deficits. So far, the US has reacted to

return on the US’s foreign liabilities). But US

the oil shock as if it were temporary,

net factor income payments have remained

maintaining its high level of consumption

positive, even after America formally became

and reducing its savings in the face of the

a net debtor in the late 1980s. US-held

loss of real income that higher oil prices

foreign assets must therefore have some

entail. This, in turn, has swollen its current-

intangible extra value – such as superior US

account deficit. Oil exporters have also

technology, skills or financial intermediation

behaved as if the shock were temporary,

– which explains this paradox. In which

and saved most of their oil windfall. Yet

case, the US is not actually a net debtor, nor

this shock is now semi-permanent – it has

is it even running a current-account deficit

already lasted several years – so the US might do well to copy Europe and Asia,

24 |

Words into Ac tion

This is nonsense. For a start, net factor

where lower consumption has taken some

income is rapidly shrinking, and will

of the strain. Note that all of this implies

become negative in 2006. The reason why,

that the net increase in oil exporters’

despite being a net debtor, the US has

savings has not been fully matched by

earned more on its foreign assets recently

a drop in oil importers’ savings, so that

than it has paid out to its foreign creditors

overall the oil shock has not led to a large

is because while its foreign holdings are

increase – or glut – in global savings and

mainly equities and FDI, its liabilities are

cannot account, as some claim, for most

mainly bonds – and US interest rates have

of the fall in global long-term interest rates.

Inevitably, oil exporters will eventually start to spend more of their oil windfall – and when they do, this will hurt the US in several ways. OPEC countries have traditionally had a greater propensity to spend on European and Japanese goods than on US ones, while they have so far favoured dollar assets over euro- or yen-denominated ones. When they do finally spend more, this will push down the dollar as demand for US assets is switched into demand for European and Asian goods. The oil exporters are also likely to diversify out of dollar assets when the dollar starts to fall, while the anti-Arab protectionism displayed in the Dubai Ports World case may accelerate their sale of dollar assets. The US is fortunate that China and other countries that are holding down their currencies are, so far, willing to subsidise American consumption and housing by selling their goods to the US on the cheap as well as by lending it so much that US interest rates are much lower than they would otherwise be. But if China responded to US protectionist threats by reducing its purchases of Treasuries and allowing its currency to rise before the US has tackled its savings drought, US import prices would soar and interest rates spike up, risking recession. These growing global imbalances do indeed create a “balance of financial terror”, as Larry Summers aptly put it.

What to do? The global imbalances are clearly dangerous and unsustainable. But they have a number of causes and can only safely be unwound if several countries take action. There is a growing, if shaky, international consensus, at least rhetorically, on who needs to do what. The US must address its twin savings deficit – its large budget deficit and its low level of private savings; this implies reversing

➣

Oil exporters need to let their pegged currencies appreciate and start spending more of their windfall gains on consumption and investment in extra production.

Words into Ac tion

| 25

Global Economy and International Finance

➣

some tax cuts that the US cannot afford

money, it is not wholly impotent. It should be

to make permanent. China and the rest of

more assertive, by naming and shaming the

the Bretton Woods II periphery in Asia must

culprits in this saga. As each country seeks

let their currencies appreciate and adopt

to pass the buck, the twin spectres of trade

structural reforms which stimulate domestic

and asset protectionism are rearing their

consumption at the expense of net exports.

heads.

Europe and Japan must accelerate structural reforms that will increase investment,

Next year, the US current-account deficit

productivity and growth, thus reducing their

may top $1 trillion, and rising. Eventually,

external surpluses. And oil exporters need

such an accumulation of foreign liabilities will

to let their pegged currencies appreciate

become an unsustainable Ponzi scheme,

and start spending more of their windfall

which implies an ever-expanding ratio of the

gains on consumption and investment in

US’s foreign liabilities relative to its GDP.

extra oil production. Each region requires a combination of expenditure-switching policies

Last year, even though the conditions for the

(via changes in relative prices triggered by

private sector to finance the US deficits were

currency movements) and policies that

almost perfect – the Fed was tightening

involve a change in the level of expenditure

while the ECB and the Bank of Japan were

(for the US, a reduction in spending relative

on hold; the US economy was growing

to its income; for other regions, an increase)

much faster than Europe’s and Japan’s; the

in order to achieve an orderly global

Homeland Investment Act heavily subsidised

rebalancing. Without an offsetting rise in

the repatriation of US profits abroad; and

foreign spending (and fall in foreign savings),

the dollar was rising, providing capital gains

a big fall in the US dollar and an increase in

to foreign holders of US dollar assets – only

US private and public savings could lead to

half of the current-account deficit of some

a global slowdown. The burden of global

$800bn was financed by private investors,

rebalancing must be shared.

the rest being supplied by foreign central banks.

“As each country seeks to pass the buck, the twin spectres of trade and asset protectionism are rearing their heads.”

This year, with the deficit set to exceed $900bn, conditions are much less favourable. The Fed will eventually stop tightening, while the ECB and Bank of Japan are only starting to do so; US growth is slowing while Europe’s and Japan’s is

28 |

Words into Ac tion

But there is a big gap between the rhetoric

rising; the Homeland Investment Act has

of what should be done and the reality

expired; and the returns on US equities and

of what is actually being done. It is time

housing are flat or negative. While the US’s

for the organisation charged with global

financing needs are larger, foreign investors

economic and financial stability to act. The

will be less willing to hold US dollar assets

IMF has been assigned the role of impartial

than last year. So, unless foreign central

“referee” in seeking an orderly resolution to

banks are willing to increase – relative

the global imbalances. But although it has

to the massive amounts of 2005 – their

little enforcement power, or even leverage,

accumulation of dollar assets, the dollar will

over sovereign countries that do not owe it

fall and US interest rates will rise.

➣

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Global Economy and International Finance

demand for US dollar assets will fall sharply as capital losses on holdings of dollar assets accumulate. Like Alice in Wonderland who had to run faster to stay in the same place, the continued financing of the US deficits without a dollar and interest-rate hard landing depends on a pyramid scheme. Foreign central banks must accumulate dollar assets at ever-increasing rates year after year, despite the prospect of huge capital losses on their dollar assets once the US currency inevitably starts to fall. This Ponzi game cannot, and therefore will not, continue. Many factors may cause investors to realise that the Emperor has no clothes and unravel the Bretton Woods II system of “vendor financing” to the US. They include: the So long as Asian currencies are not rising against the dollar, it makes sense for private investors to finance the US deficit.

Fed stopping its tightening cycle; a sharp US economic slowdown; foreign central banks diversifying their reserves, as they are starting to do; anti-Chinese protectionism

“In an increasingly imbalanced global economy, the risks of a hard landing are rising: the world urgently needs to start tackling the imbalances.”

triggering a sharp fall of the dollar and greater diversification out of dollar assets (much as the threat of trade wars in 1987 led to a stock market crash); an episode of systemic financial risk having its source in the US; a Chinese currency revaluation followed by a similar appreciation of a wide

➣

If central banks accumulate foreign reserves

range of Asian currencies; or challenges to

at a slower pace than in 2005 (let alone

US power in the Middle East or North Korea.

dump their existing stocks of such assets),

30 |

Words into Ac tion

private investors will be unwilling to fill the

In an increasingly imbalanced global

gap. Private demand for dollar assets is

economy, the risks of a hard landing are

complementary to, not a substitute for,

rising. The world urgently needs to start

public demand. So long as Asian currencies

tackling the global imbalances. All major

are not rising against the dollar, it makes

countries and regions need to assume their

sense for private investors to finance the

responsibilities and act soon, so that the

US deficit, because the returns of carry

finale of this contemporary Rashomon saga

trades – for instance, borrowing at 0% in

is less acrimonious and painful than the

Japan to invest at 5% in US assets – are

ending of Kurosawa’s masterpiece. Time

large and the currency risk close to nil. But if

is running out; we must move from debate

central banks intervene less and allow their

to action, starting here at the IMF annual

currencies to appreciate somewhat, private

meeting in Singapore.

■

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Global Economy and International Finance

Safe to return? Nearly a decade after the Asian financial crisis, developing countries remain wary of global capital markets. But an Asian capital market could lead the way in issuing new growth-linked bonds that are less risky for emerging-market borrowers.

t is nine years since the IMF/World Bank

entrepreneurial attitudes and a good

annual meetings were last held in East

education system, but it also requires lots

Asia. Those Hong Kong meetings were

of investment. Meanwhile, many developed

held during a lull in the financial crisis that

countries should be saving more than they

was ravaging the region. Partly at least to

can profitably invest, in part to build up

prevent a recurrence, virtually every country

assets for the coming explosion in their

in the region has since built up its reserves

retired population. The world would benefit

to a level where a new crisis is, at least for

from arrangements that facilitate a flow

now, inconceivable. But everyone knows

of capital from developed to developing

that this insurance is expensive. One of

countries. That means real capital flows,

the main benefits of international capital

transferred via current-account deficits,

flows is negated if a country that receives

not having reserve changes provide the

a capital inflow feels obliged to build up its

counterpart to capital inflows. Large capital

reserves to cover a subsequent outflow. If

flows to emerging markets would also

JOHN WILLIAMSON

the international capital market is ever again

help attenuate the pressure for large-scale

is a Senior Fellow at the Institute

to fulfil its potential of reallocating resources

migration.

for International Economics in

to parts of the world where the return on investment is highest, countries need to

Several things can be done to facilitate

was chief economist for South

be given the confidence to use their capital

this process. Potential capital-importing

Asia at the World Bank. In 2001

inflows to finance current-account deficits.

countries need to manage their economies

Washington, DC. In 1996-99, he

in ways unlikely to cause investors to

he served as project director for the UN High-Level Panel on

Looming demographic and development

panic. They need to maintain low rates of

Financing for Development (the

trends make this task especially important.

inflation and a sound fiscal position, adopt

Over the next 50 years, virtually all

modern methods of economic management

at a number of prestigious

population growth will occur in parts

(involving flexible exchange rates and inflation

universities and published

of the world that are now labelled as

targeting), allow automatic fiscal stabilisers

developing countries, while most of the

to work, avoid large currency mismatches

currently developed countries are likely to

in their asset/liability positions, borrow in

experience a gradual population decline.

forms that do not impose the risk of sudden

Moreover, many (with luck, most) developing

large demands for repayment, and avoid a

countries â&#x20AC;&#x201C; and certainly most in East Asia

reputation for corruption. The worldâ&#x20AC;&#x2122;s major

â&#x20AC;&#x201C; seem likely to develop. Undeniably, this

economies need to maintain a healthy rate

requires good institutions, a work ethic,

of growth and avoid crises and recessions.

Zedillo Panel). He has taught

widely on international monetary issues, most recently Curbing the Boom-Bust Cycle: Stabilizing Capital Flows to Emerging Markets (Institute for International Economics).

34 |

Words into Ac tion

It would help if groups of capital-importing countries could create regional capital markets, in part because this would enable regional surplus countries to satisfy a part of the needs for capital, and also because it would reassure investors that unexpected changes in the rules of the game by debtors would be resisted by peers as well as outside lenders. The international financial institutions need to create mechanisms, such as the IMF’s proposed arrangements for high-access contingency financing, which will give confidence to debtor countries that in the event of a withdrawal of funds for reasons other than their own irresponsible policies they would be able to draw as quickly on liquid facilities as they can currently mobilise their reserves. Finally, the international capital market needs to play its part in creating and lending through instruments that do not pose the threat of imposing sudden large demands for

If, during the 1997 crisis, Thailand’s Borensztein bonds had carried a coupon of 7% when the growth rate was 5.5%, it would have made debt service only some 2%.

repayment unrelated to the debtor’s actions. relative to the reserves held by the debtor I will focus principally on what types of

countries that are unconditionally available

instruments would be best suited to

to make payments. (Hence the popular

minimise the risk of sudden demands being

recommendation that countries should keep

made on a country’s payments capacity

reserves at least equal to their level of short-

at inappropriate times. Introducing and

term debt.) Debt is particularly dangerous

making use of such instruments will require

if it is denominated in foreign currency,

supportive actions by both emerging-

for then a crisis that reduces the value of

market borrowers, which need to issue their

the domestic currency – as they tend to

instruments in the appropriate form, and

– will automatically increase the domestic-

lenders, which need to recommend that

currency value of debt, and thus the burden

their clients buy appropriate instruments.

of servicing it.

Some forms of debt are best avoided

This simple analysis points immediately to

Financial crises such as the one in 1997

ought to avoid: short-term loans and

arise when a large number of creditors

foreign-currency-denominated ones.

two kinds of debt that developing countries

seek immediate repayment of their loans. For this to be possible, a large number of

Of course, some debts are naturally short-

short-term loans must be outstanding. For

term, such as trade credit. Foreign banks

it to be dangerous, the value of the short-

could hardly be expected to make a five-

term loans outstanding has to be large

year loan for imports that are due to be

➣ Words into Ac tion

| 35

Global Economy and International Finance

“Potential capital-importing countries need to manage their economies in ways unlikely to cause investors to panic.”

make short-term loans because then they can tell their regulators that they have a balanced short-term position, even if this is based on a fallacy of composition, because not all banks could simultaneously liquidate their assets. Investment banks sometimes recommend their clients to invest in country X, but only in assets of less than six-months’ duration, because they believe that no crisis is likely to occur within six months. Such investments are useless to a developing country – except perhaps one nearing a crisis, but then such finance would not be available – because prudence demands that they be matched one-for-one by higher reserves. The only ways of avoiding such a burden are through exchange controls that prohibit shortC

term loans other than for trade credit, or M

by reducing short-term domestic interest Y

rates below the foreign rate. As countries CM

develop, the latter will become a real MY

possibility, but until then there is much to be CY

said for retaining some capital controls. CMY

The other problem arises from currency Loans denominated in a foreign currency are likely to increase in domestic-currency (and therefore real) value when the domestic currency depreciates, as it normally does when a country encounters economic difficulties.

mismatches. Loans denominated in a foreign currency are likely to increase in domestic-currency (and therefore real) value when the domestic currency depreciates, as

➣

sold within three months. Trade credits are

it normally does when a country encounters

naturally short-term, and are normally rolled

economic difficulties. A part of the literature

over as a matter of course. But in a crisis,

argues that lenders are simply not prepared

banks may try to cut the trade credits that

to lend in the currencies of most emerging

they supply to a country, and occasionally

markets, because the countries suffer

countries have tried to negotiate with their

from “original sin”. This seems to me far

banks to maintain aggregate trade credit

too defeatist. Once, investors had little

lines unchanged. It is difficult, though, to

confidence in the monetary and statistical

envisage any pre-commitment to that effect.

authorities of most emerging markets, so if

One probably has to accept that banks may

those countries wanted to borrow abroad

try to curtail trade credit in a crisis, and any

they had to do so in foreign currency. But

attempts to modify that will have to be ad hoc.

nowadays, many emerging markets are capable of borrowing on the international

36 |

Words into Ac tion

But other forms of short-term debt could

market in loans denominated in their own

be avoided. For sure, banks prefer to

currencies (as recent local-currency loans

➣

Global Economy and International Finance

It was 1997 when the IMF/World Bank annual meetings were last held in East Asia, during a lull in the financial crisis that was ravaging the region.

“Bank regulators could make it clear that they wished the banks subject to their supervision to maintain a balanced currency position.”

a real depreciation of the local currency in a crisis the borrower does not risk suddenly finding the burden of debt servicing has increased just when it is least capable of paying it. At the same time, the lender has the reassurance of knowing that the

➣

issued by countries such as Brazil and

borrower is unable to inflate away the real

Colombia show). Even when international

value of its debts.

markets do not have enough confidence

38 |

Words into Ac tion

in local monetary authorities to make long-

One measure needed to promote a shift to

term loans at reasonable interest rates, they

local-currency financing is simple: sovereign

may well have sufficient confidence in the

issuers need to be willing to issue local

integrity of their statistical services, and thus

currency debt, and overcome their fear

be prepared to make loans indexed to the

of “original sin”. But of course much debt

local price level. These are still denominated

is private, and this cannot be converted

in the local currency, so that in the event of

to local-currency form simply by the will

currency position. Of course, there is still a danger that enterprises that sell in the domestic market borrow foreign exchange in search of a lower interest rate, and thus expose themselves to currency risk, but regulators could also require that their clients guard against this (or suffer penalties such as higher reserve requirements). The other possibility is taxation. Payments of interest, and/or receipts of interest, on loans denominated in foreign exchange could be taxed at a higher rate than interest on domestic-currency loans. This would not involve the prohibition of foreign-currency loans, but it would create an incentive for borrowers and lenders to use such loans only where they perceived a compelling reason for not using the domestic currency.

Link bonds to growth instead Short maturities and foreign-currency denomination are the two features of standard loans that have been most conspicuous in past crises, and it would therefore be sensible to avoid them in the future. But once one begins to think of financial engineering that would be ex ante in the interest of both borrower and lender, at least one other possibility leaps to mind. of the sovereign. Issuing local-currency

This is sovereign borrowing through growth-

sovereign debt might help – for example,

linked (sometimes referred to as GDP-

by establishing a yield curve – but it is

linked) bonds.

unlikely to be sufficient. Hence it is natural to ask what other policies might help to

Growth-linked bonds involve a yield that

encourage private companies to issue debt

varies according to a country’s rate of

denominated in the local currency,

growth. They could take several forms. They could be for any maturity, though it is most

Apart from the heavy-handed tool of

natural to think of them being used for fairly

administrative direction, which few

long-term loans, since otherwise the return

economists would wish to use unless there

to the lender (and therefore the cost to the

seemed no feasible alternative, there are at

borrower) is unlikely to vary much from

least two possibilities. One involves bank

what the market would otherwise require.

regulation. Bank regulators could make it

But in the longer term, our foresight is very

clear that they wished the banks subject

imperfect, so that an instrument whose

to their supervision to maintain a balanced

return varies with actual outcomes could ex

➣ Words into Ac tion

| 39

➣

Global Economy and International Finance

➣

post yield substantially more (or less) than

bonds could be denominated either in

the principals expected ex ante. Because

the domestic currency or in a foreign one.

the yield would vary depending upon the

However, there would be strong advantages

borrower’s ability to pay, the likelihood of

in domestic-currency denomination. This

default would be lower than with a plain

would give the borrowers the advantages

vanilla loan. Only in bad states of the world

discussed above, of avoiding an increase in

would the borrower have to pay less, but

their debt burden just when circumstances

this could help persuade a debtor not to

are most difficult. Also, growth (both nominal

default if its payments were automatically

and real) is in the first instance measured

reduced at times when it confronted

in terms of the domestic currency. It would

difficulties. Lenders would expect those

therefore be relatively simple and completely

low returns to be compensated by the high

unambiguous to calculate the debt service

payments that would accrue to them in

implied by the contract.

good states of the world. And by holding a diversified portfolio of these assets issued

The third dimension of designing a growth-

by a number of countries, lenders would

linked bond is the most interesting, because

be able to reduce the expected variability

it raises completely novel issues. Even if

in their returns over time. If many countries

we have agreed that we are talking about

issued such bonds, one would expect

(say) a 30-year instrument with a domestic-

lenders to be able to diversify away most

currency denomination, we may think of

of their risk.

an instrument that promises to pay a given proportion of GDP each year, perhaps with

Growth-linked bonds could also differ as

a higher proportion in order to amortise the

to the currency in which the bonds are

instrument in the final year (or a number

denominated and growth is measured.

of concluding years), as proposed by

Like plain-vanilla bonds, growth-linked

Robert Shiller. Or, we might design an instrument that promises to pay (in addition to amortisation) a base rate if growth is (say) equal to the average over the past 10 years, plus or minus 1 percentage point (say) for every percentage point that the real growth rate exceeds or falls short of that past average growth rate, as proposed by Eduardo Borensztein. For example, a country that has grown at an average rate of 3% in the past and has been accustomed to borrowing at 7%, might offer an instrument that paid 7%, plus or minus the difference between measured growth and 3% (so that in a year when its growth was 5% it would pay 9% and in a year when real GDP stagnated it would pay only 4%). If it found no lenders on those terms, the

Like plain-vanilla bonds, growth-linked bonds could be denominated either in the domestic currency or in a foreign one.

40 |

Words into Ac tion

country would have to raise the base offer to something more than 7%, but one would

➣

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Global Economy and International Finance

the debtor is obliged to pay depends upon

“A regional capital market would neither preclude nor guarantee the issue of long-term or growth-linked instruments.”

performance. Clearly, though, they are not equities either, because they do not give a right to residual ownership if management fails. My guess is that if they take off they will soon be recognised as a new asset class. Investors who believe they have a knack for forecasting how fast different countries will

➣

expect this premium to be small where

grow will find these assets attractive. In the

lenders have an opportunity of diversifying

long run, borrowers may not have to pay a

their risks away.

premium to borrow in this way, although it would be sensible for them to be prepared

What are the main differences between

to pay somewhat more in order to reduce

these two instruments? Most obviously, the

their risk profile.

Shiller bonds are inflation-indexed whereas Borensztein ones are not. (A doubling of inflation doubles the nominal yield of the former, and leaves its real amortisation unchanged, but leaves the nominal yield and amortisation of the latter unchanged.) This is surely an advantage of the Shiller specification. However, the Borensztein version is far more sensitive to changes in the growth rate. Consider Thailand during the 1997 crisis. Suppose that its Borensztein bonds had carried a coupon of 7% when the growth rate was 5.5%, as it was in 1996 before the crisis. This would have made debt service only some 2% in 1997 (when growth was slightly negative) and zero in 1998 (when growth was strongly negative), whereas a Shiller bond’s yield would have fallen trivially in 1997 and by only 8% in 1998. This greater sensitivity to changes in the growth rate seems to me an advantage for the Borensztein variant. In any event, although both are “growth-linked”, these bonds are very different securities. It is interesting to speculate about some of the other consequences of introducing growth-linked “bonds”. For a start, it is not clear that they are “bonds” at all. A contract says what a bond will yield, whereas these instruments are equity-like in that how much

42 |

Words into Ac tion

Sceptics always ask whether countries

points by lying about how little their country

would not cheat and announce lower growth

had grown. Furthermore, investors do not

figures in order to reduce their debt-service

fret about countries under-estimating their

payments. Since the increase in debt

inflation numbers in order to save interest

service-payments is unlikely to be more

on inflation-linked bonds. Above all, this is

than a small part of an increase in growth,

surely an issue where financial markets could

there need be no fear that countries would

be relied on to discipline any rogue countries

seek to reduce their growth in order to

that might consider manipulating their

reduce their interest bill. The more realistic

published growth rates in order to reduce

danger is that countries might lie about their

their interest bill. A country that acquired a

growth rate. But finance ministers usually

reputation for doctoring its growth rate so as

take pride in announcing higher, not lower,

to reduce its interest payments would before

growth, and it seems rather unlikely that they

long be forced to sell growth-linked bonds at

would anticipate gaining political brownie

a higher premium. â&#x17E;Ł

Since the East Asian crisis of the 90â&#x20AC;&#x2122;s virtually every country in the region has built up its reserves to a level where a new crisis is, at least for now, inconceivable.

Words into Ac tion

| 43

Global Economy and International Finance

â&#x17E;Ł An Asian capital market?

A regional capital market would neither

One of the financial initiatives currently

preclude nor guarantee the issue of long-

under way in East Asia involves an attempt

term or growth-linked instruments. One

to build a regional capital market. In

would not expect central banks to want to

addition to attracting private investors, it is

place their reserves in such instruments,

envisaged that countries will invest a part

but a number of countries are now realising

of their reserves in liabilities issued by other

that their asset accumulation has already

regional countries. Of course, this will only

exceeded prudent estimates of the need

reduce the volume of dollar assets that the

for reserves and that the balance should

countries of the region collectively have

be invested to make money. These assets

to buy to the extent that some countries

might well take longer-term and growth-

(presumably those that issue the liabilities)

linked forms. A regional capital market would

adjust their current-account positions, but

enable Asia to start issuing such instruments

they would be in a position to do this as a

internationally even if traditional creditors in

result of the larger capital inflows.

the developed countries resist this move. My guess is that some of the less hidebound

There is a danger that any such regional

moneymen from the developed countries

capital market would operate in excessively

would soon be attracted to what had initially

traditional instruments. If creditors were

been planned as an Asian regional market.

only willing to buy short-term, dollar-

Prudent governments unable to borrow long-term at fixed rates should not rely exclusively on domestic-currency debt.

44 |

Words into Ac tion

denominated, plain vanilla bonds, it

The whole world, North and South, old

is difficult to see that much would be

industrial countries and emerging markets,

accomplished by having the intermediation

share an interest in reviving large capital flows

occur in Singapore rather than Wall Street.

to developing countries. While it is important

But it does not have to be that way. The

to prevent these flows getting out of hand

most likely modification of conventional

and generating a new crisis, the current

arrangements would involve the issue of

problem is to re-establish the direction of

bonds denominated in local currencies,

flows that prevailed prior to the 1997 crisis.

or a basket of local currencies, rather

This will only happen if emerging markets

than the dollar. The Asian Development

are convinced that a revival of capital inflows

Bank has been advocating the creation

does not threaten them with a new crisis.

of a local-currency basket that could be

Several conditions would help nurture such

used to denominate loans. Such a basket

a conviction, but one of the most important

would go part of the way towards satisfying

is to develop new instruments that carry less

the objectives that it was argued above

risk of provoking crisis. This implies longer-

would be furthered by local currency

dated debt, avoiding denominating loans

denomination: the basket would depreciate

in the currencies of creditor countries, and

in the event of a renewed regional crisis,

developing a market for growth-linked bonds.

but the depreciation would be modest if a

An Asian regional capital market would not in

crisis were confined to just one country. It

itself guarantee that instruments would take

is therefore to be hoped that any regional

this form, but it would give Asia the power

capital market would be open to the issue

to decide for itself whether to issue such

of instruments denominated in the national

instruments rather than also having to rely

currencies as well as a regional basket.

on the goodwill of Wall Street. â&#x2013;

Financial bridges The IMF/World Bank meetings present a rare opportunity for financial institutions to engage with key global financial decision makers in a concentrated environment. “They provide an excellent opportunity for us to meet senior representatives of our public and private sector clients and to review new business opportunities across the Arab Bank Group”, says Phillip Monks, CEO of Europe Arab Bank plc, the recently launched wholly owned subsidiary of the Arab Bank Group - established to handle the Bank’s operations in the countries of the European Union. “This year’s event will provide Singapore and its ASEAN neighbours with a unique opportunity to showcase their economic resurgence and growth as major financial forces in the international marketplace and will act as a spur to regional and global trade.” Arab Bank, a 76-year-old Jordan-based operation, quoted on the Jordanian stock exchange has a regionally unparalled worldwide network and has developed strong and long-standing relationships with global financial institutions. Its shareholders, as well as the founding Shoman family, include the governments of Saudi Arabia and Jordan, while the Prime Minister of Lebanon is a former board member. The bank is the local equivalent of a Barclays or RBS in the Middle East and North Africa. Arab Bank plays a major role in financing strategic projects in the MENA region, in areas such as power generation, desalination, petro-chemicals, aluminium, telecommunications and other infrastructure projects. A significant increase in shareholders equity through a new public offering, the first since 1964, as well as the capitalisation of the 2005 income is underpinning Arab Bank’s aim to enhance its strategic positioning and to augment its earning power. Arab Bank is extending its geographical coverage, widening its distribution channels and diversifying the Bank’s services and financial products, especially in the areas of private banking, treasury and project financing. A major milestone in achieving this objective was the creation of Europe Arab Bank plc (EAB).

“Arab Bank has an enviable brand reputation in the Middle East and it is this that it wants to leverage with its new venture.” says the CEO, Phillip Monks, “This new operation provides a commercial financial bridge between the Middle East and Europe. I talked to clients and they recognise the capability Arab Bank has in the Middle East. They are looking for a capable world-class European subsidiary of a local bank to help them in Arab Bank’s home markets. When you look at all the wealth that’s being generated Europe provides a good investment home for Arab investors.” says Monks “At the same time” he continues, “EAB can help people who haven’t been involved in the Middle East and North Africa by using its expertise to show them the opportunities in the region. We want our bank to be a European gateway to the Arab and North African worlds.” EAB plc, which was given a licence in May by the Financial Services Authority in London to begin operations, has its main offices in Arab Bank’s premises in Moorgate, in the heart of the City, just a short walk from the Bank of England. The new concern is being gifted €500m by its parent, with the firm instruction to go out and make itself the bank of choice for private and corporate clients operating across the European – MENA axis. The EU currently conducts some $250bn of trade with the Middle East every year.

Monks joined Arab Bank in December last year after a career with Barclays in a wide variety of posts, including running corporate banking operations in the UK regions, private banking in Switzerland, and being in charge of Gerrard Investment Management, Barclays private wealth management operation, which looks after more than £12bn for its clients. It is, Phillip Monks says, “an opportunity few bankers ever get - the chance to lead the start-up of a fully fledged multi-national full-service banking operation.” Arab Bank’s chairman, Abdel Hamid Shoman, grandson of the bank’s founder and “an absolutely fascinating character,“ Mr Monks says, “asked me, more or less, ’How do you fancy running your own bank?’“ It is Shoman’s vision, Monks says, which is the primary driver behind the launch of Europe Arab Bank, to distinguish Arab Bank as more than just a regional player. “I quizzed him hard on what he meant,“ Mr Monks says, and he came away enthused with Shoman’s plans to transform Arab Bank’s European business into a world-class operation. Europe Arab Bank “also provides the vehicle for the Arab Bank Group to assess further corporate activity“. There is the opportunity too, at some unspecified time in the future, to raise more capital through the markets.

Phillip Monks Chief Executive Officer, Europe Arab Bank plc

Much of Arab Bank’s subsidiary undertakings such as back office operations in Frankfurt, Paris, Rome, Vienna and Madrid, are now being folded into London under the Europe Arab Bank brand. There will be some new hiring’s – “you need to look at getting the best people you can possibly afford,“ Mr Monks says. “This is fundamentally a growth strategy. You have to seek out the best people for the job. The final result will be a European bank aligned to a fantastic franchise in the MENA region and people who have real local knowledge and deep industry expertise in most sectors relevant to trade between Europe and MENA. The new bank’s logo, which is now on all the windows of the Moorgate Street offices, is a minimalist rendering of the three linked ’medallions’ used by Arab Bank, designed for a more modern feel in line with the aspirations for the bank. As well as this modern image,

“we are deliberately trying to create a multi-cultural and multi-racial environment,“ Mr Monks says. Although Europe Arab Bank is 100 percent owned by its parent, “we are legally independent and regulated“ Monks says. At the same time, the chairman of the Europe Arab Bank board is Abdel Hamid Shoman, chairman of Arab Bank itself. He is ambitious for the bank and “I can tell you that Chairmen in an Arab bank are no less demanding than they are across the world,“ he says with a smile. There is, he says, “a sense of patience and impatience in equal measure,“ a desire to deliver results as soon as possible off the platform being built at Europe Arab Bank, while at the same time creating something that will last: “

The support from Arab Bank’s big shareholders for the new venture is “hugely exciting“, he says, and he has “buy-in“ from the staff who are being transferred into Europe Arab Bank for what he wants to achieve. At the same time there is a growing queue of people who have heard about what is happening and would like to be part of it. “The organisational change just gives you the foundation to build the bank you want to build.“ Future steps include achieving an “A+“ rating from the financial rating institutions. There is no doubting Mr Monks’ zest for the task ahead. “Entrepreneurialism and banking aren’t two words normally seen hand in hand,“ he says. “But anyone who comes in here now can be handed the opportunity to be involved in shaping the biggest banking start-up in Europe.“

Monks is full of enthusiasm for the Middle East and its opportunities: “It’s a fascinating, invigorating place to work.“ Arab Bank Group is in the vanguard of the banking industry, both regionally and internationally. The Group has an enviable worldwide presence, including branches in Singapore, China and a wholly owned subsidiary business in Australia. The creation of its new European Operation further strengthens the group’s ability to meet the challenges of the future in servicing the financial needs of people who are involved in trading in Middle East and North Africa, wherever they are domicile.

Europe Arab Bank Moorgate office

Global Economy and International Finance

Submerging markets? Emerging markets have thrived in the years of easy money and economic boom. But as interest rates rise, they are increasingly vulnerable to a downturn in global growth.

merging markets have been awash

than at any time since the breakdown

with liquidity for several years.

of the Bretton Woods System some 35

In 2005, net capital inflows to

years ago, according to the IMF’s spring

developing countries hit a record-high, of

forecast. As a result, corporate profits are

nearly $500bn, for the second year running.

overflowing – and with emerging economies

These funds came from private investors

notching up growth of over 5% for the

– net official financing was negative, that is,

fourth year running, they are an obvious

developing countries repaid more than they

place to reinvest these funds. High oil and

borrowed from rich-country governments

commodity prices have also heightened the

and the international financial institutions

allure of countries that export energy and

last year – and were spread broadly across

raw materials.

different forms of debt and equity in a large BARRY EICHENGREEN is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley. He is also a Research Associate of the National Bureau of Economic

number of recipient countries. Not since

But this happy era is now coming to a

the first decade of the 20th century has so

close. Already, the US Federal Reserve

much foreign capital flowed to so many

has sharply raised interest rates, while the

emerging markets. Unfortunately, though,

European Central Bank (ECB) and Bank of

the favourable financial conditions and

Japan have also started to tighten, albeit

robust global growth that have given rise to

more slowly. Suddenly, global liquidity is no

this happy era appear to be turning sour.

longer so abundant. As a result, investors’ appetite for risk has declined since the

Research and a Research Fellow of the Centre for Economic Policy Research. In 1997-98

spring meetings of the IMF and World Bank

– interest rates have been exceptionally

in April. What’s more, monetary tightening,

he was Senior Policy Adviser at

low. Portfolio managers expected to match

high energy prices and capacity constraints

the International Monetary Fund.

historical returns have, in effect, been

are casting a shadow over prospects

He has published widely on the

forced to invest in emerging markets – the

for US growth. And while China may be

history and current operation of the

only markets still offering sufficiently high

maintaining its extraordinary double-

international monetary and financial

yields – and have funded their positions

digit growth rates for now, the faster its

system, most recently Global

by borrowing at low interest rates in the

economy grows the more investors fret

advanced markets. Meanwhile, the world

about the possibility of a hard landing.

economy is set to grow faster this year

Emerging markets could thus soon face a

Imbalances and the Lessons of Bretton Woods (MIT Press, 2006).

48 |

Until recently, global – and in particular, US

Words into Ac tion

lethal combination of higher interest rates and slower global growth. Worse, the collapse of the WTO’s Doha Round makes it unlikely that world trade will continue to grow faster than incomes. The pattern of global imbalances – a disturbingly large US current-account deficit matched by large Asian surpluses – creates further uncertainty, not to mention the volatile geopolitical situation.

Blessed are the prudent Although the future is, of course, unpredictable, the risks to emerging markets are certainly different than in previous periods of volatility. For one thing, the financial effects will be more selective. Prudent emerging economies, such as Mexico and Venezuela, that have already funded their borrowing requirements for 2006 and beyond are in a much stronger position than profligate ones, such as Hungary, Turkey and South Africa, which have big current-account deficits and correspondingly large financing needs. Prudent governments have taken advantage of cheap and plentiful external finance to strengthen their financial positions. They have stockpiled reserves and pre-funded their borrowing needs; some have even

Countries such as Brazil have traditionally experienced instability when the demand for their foreign debt has declined.

capitalised on investors’ appetite for their domestic debt securities to eliminate their

But if international investors’ tolerance for

foreign-currency debts. Since these prudent

risk continues to fall, profligate economies

economies do not have to borrow to roll

could find that the inflows financing their

over maturing debts or finance current-

current-account deficits – which are now

account deficits, they are less susceptible to

approaching 7-8% of GDP in some cases

a shortfall of foreign funds. Having stockpiled

– dry up abruptly. Although they may buy

reserves, they have more scope to prevent

some time by spending their currency

their currency collapsing if foreign investors

reserves, they will eventually have to

draw in their horns. And even if their

dramatically improve their trade balance.

exchange rates do weaken, their banking

In the short term, that requires an import

systems will not collapse because their

squeeze, through a rise in interest rates

currency mismatches are better managed.

that curbs consumption and investment

➣ Words into Ac tion

| 49

Global Economy and International Finance

If Asian central banks grow reluctant to accumulate more US bonds, the dollar could fall sharply, pushing up import prices and forcing the Fed to raise interest rates further.

➣

– resulting, more likely than not, in a

Diversify your borrowing

recession. In turn, this implies a rise in

That the risks have changed heightens

nonperforming loans and problems for

the danger of fighting the last war.

banking systems. Eventually, the currency

Countries such as Brazil have traditionally

depreciation that occurs as foreign investors

experienced instability when the demand

reduce their purchases of domestic

for their foreign debt has declined. When

securities will boost exports, but that takes

their currency has weakened, they have

time – and the interim could be painful.

been smashed by the increased cost of servicing their dollar-denominated debt. To

The past few months suggest that investors

avoid this, they have taken advantage of

can distinguish between countries’ differing

the good times to exchange virtually all of

circumstances. As investors’ appetite for

their dollar debt for securities denominated

risk has declined, countries with large

in local currency, floating these on domestic

current-account deficits have suffered

markets and selling them to both local and

most. Surplus countries such as Mexico

foreign investors.

and Brazil, which were susceptible to such

50 |

Words into Ac tion

changes in sentiment in previous periods,

But much of this debt is short-term or at

have remained largely immune. The risk of

floating rates. Although long-term issuance

financial instability is by no means gone, but

is growing, investors remain wary of tying

it appears to be much greater for profligate

up their funds at fixed rates for long periods.

emerging economies than for prudent ones.

So, if global interest rates spike up – which

➣

Global Economy and International Finance

➣

could happen if foreigners grow more reluctant to finance the US current-account deficit – so too will the cost of servicing this debt. Dollar-denominated debt may be out of fashion, but prudent governments unable to borrow long-term at fixed rates should not rely exclusively on domestic-currency debt. Rather governments with big debts should spread their risks by issuing a diversified portfolio of securities denominated in both foreign and domestic currency. Does this mean that countries in external surplus with light debt loads can relax? Hardly. For them, the main risk is that a global slowdown will depress export growth. By some measures, the US and China have together accounted for some two-thirds of global growth in recent years. But if growth in the US and China slows, so will developingcountry exports of goods and primary commodities to their respective markets.

“Governments with big debts should spread their risks by issuing a diversified portfolio of securities denominated in both foreign and domestic currency.” and Peru, and exporters of capital goods, such as South Korea, will be hit hardest. However admirable some developing countries’ budget and current-account

A happy ending?

surpluses may be, their restrictive policies

The happy scenario is one in which slowing

make them dependent on exports as a

growth in the US and China is offset by

source of demand. If the US slows, Mexico

accelerating growth in Europe and Japan.

and East Asia, in particular, will suffer. Nearly

Global imbalances decline gradually

80% of Mexico’s exports go to the US, while

towards more sustainable levels, with the

Asian countries – especially small, highly

US consuming less while Europe and Japan

open economies such as Singapore and

consume more. The world economy keeps

Taiwan – also rely heavily on the US market.

motoring along, and emerging markets

Asian countries that specialise in producing

escape collateral damage.

consumption goods – consumer electronics,

52 |

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for example – will be hit hard by softening

Unfortunately, there are several less rosy

US demand. If China slows, exporters of

alternative scenarios. First, there could

raw materials and energy, such as Indonesia

be a hard landing in the US. US growth is

Consumer spending has increased dramatically in China, but efforts to prevent the economy overheating could depress its growth too much.

heavily dependent on consumer spending

markets are not sophisticated enough to

– and if the housing market softens further,

permit this. Also, China’s reluctance to see

consumer confidence will suffer. It also

its currency fluctuate more freely against the

depends on foreign investors, notably Asian

dollar heavily constrains its ability to alter its

central banks – and if they grow reluctant

interest rates independently. So the Chinese

to accumulate more US bonds, the dollar

authorities must rely on blunt instruments,

could fall sharply, pushing up import prices

such as raising reserve requirements and

and forcing the Fed to raise interest rates

instructing the banks to lend less, to slow

further. Rather than a gradual deceleration,

the breakneck speed of investment. Since

the US could experience an abrupt slump.

their efforts have been ineffective so far, they may be tempted to resort to more extreme

Second, efforts to prevent the Chinese

measures – but if they overdo it, investment

economy overheating could depress its

could collapse, and with it Chinese growth.

growth too much. Whereas in advanced financial systems, the central bank can fine-

Third, Europe and Japan could fail to pick

tune credit conditions and demand growth

up the slack. The prospect of structural

by tweaking lending rates, China’s financial

reforms inevitably increases the uncertainty

➣ Words into Ac tion

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Global Economy and International Finance

“The happy scenario is one in which slowing growth in the US and China is offset by accelerating growth in Europe and Japan.”

which limits potential growth. At best, Europe and Japan will be lucky to grow by 2% a year. If one of these three events occurs – a hard landing in the US or China, or continued slow growth in Europe and Japan – the result will be a global slowdown. If two or more happen, this would almost guarantee a global recession, with exportdependent emerging markets suffering disproportionately. If the problem originates in the advanced economies and China, the solution must be found there too. The US could address the roots of its twin deficits by letting President Bush’s tax cuts expire. With less fiscal stimulus, there would be less need for monetary tightening to counter inflation, and less downward pressure on the housing market. If the dollar falls sharply before these adjustments are undertaken, the Fed could avoid overreacting. Weaker domestic demand would at least partially offset the inflationary effects of higher import prices. The Fed should avoid battering the economy with higher interest rates when activity is already on the way down.

China’s reluctance to see its currency fluctuate more freely against the dollar heavily constrains its ability to alter its interest rates independently.

➣ faced by European consumers, while the

Europe and Japan should also avoid excessive monetary tightening. With luck,

size of government debts and deficits limits

the Bank of Japan understands that it will

the scope for fiscal stimulus. And with euro-

take some years to raise interest rates

zone inflation above its target range, the

to world levels. If Europe finally begins to

ECB is reluctant to apply monetary stimulus.

make progress on fiscal consolidation, there

Germany has been able to grow by

would be more scope for the ECB to relax.

exporting, but if the world economy slows

And if the dollar does fall sharply, European

this last source of demand will disappear

exporters would face stiffer competition,

too. Japan, for its part, will be battling the

and therefore need a more accommodating

headwinds of rising interest rates, as its

monetary policy that prevents the euro from

central bank seeks to move from a zero-

rising excessively.

interest-rate policy to levels comparable to

54 |

Words into Ac tion

those of the Fed and the ECB. What’s more,

China, for its part, would be able to manage

both economies have ageing populations,

its economy more effectively if could adjust

➣

Global Economy and International Finance

China needs to develop its financial system to make it easier to fund higher consumer spending and increased public expenditure on healthcare, education and rural infrastructure.

➣ interest rates more freely – which, in turn,

by letting their currencies rise, while

requires a more flexible exchange rate.

supporting domestic demand by raising

As its exposure to international capital

public spending, but they are unlikely to

markets increases, China cannot enjoy

do either unless China does so first. Latin

monetary autonomy if it insists on keeping

America has little scope for using fiscal

its exchange rate against the dollar stable.

policy, given its high public debts and

It also needs to develop its financial

chequered fiscal history.

system to make it easier to fund the higher consumer spending and increased public

Since the turn of the century, most emerging

expenditure on healthcare, education and

markets have embraced the conventional

rural infrastructure that would reduce the

wisdom that says: avoid budget deficits,

economy’s excessive dependence on

run current-account surpluses and keep

export demand.

your currency competitively valued in order to promote export growth. This strategy of

56 |

Words into Ac tion

But what about emerging markets other

tying their fortunes to world markets has

than China? For the most part, they

served them well in the years of easy money

must just sit tight and hope that they are

and global boom. But if the world economy

lucky. Asian countries could reduce their

now turns sour, the future could be much

dependence on uncertain world markets

less rosy. ■

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Focus on Asia

India’s soft spot: Can it let China do the hard stuff? India’s prowess in IT services is remarkable, but it also needs Chinese-style labour-intensive manufacturing to develop.

The danger is that it makes it seem

few years as a global economic

less urgent for India to tackle the many

force to be reckoned with seems

constraints that have limited investment

neatly complementary to China’s rise a

in manufacturing industry. Unless those

decade or more earlier. While China has

constraints are removed, India will find it

come to dominate markets in low-cost

almost impossible to create the employment

manufactured goods, India is pre-eminent

opportunities it will need as its population

in the fast-growing new business of

continues to outgrow most of the rest of

“outsourced” services – most famously,

the world, and, especially, China itself. Just

software development and call-centres.

as China is emerging as a competitor in

This has given rise to an appealing notion:

India’s chosen niche of services, so India

that India can achieve prosperity without

needs to fight for market-share in products

experiencing the boom in manufacturing

such as consumer electronics, textiles and

that has been the route out of poverty for

garments. That is a daunting challenge.

SIMON LONG is the South Asia

every other successful emerging economy.

But to give it up as impossible, which

correspondent for The Economist,

China and India can carve up the “hard”

many Indian manufacturers argue is the

and “soft” parts of the global economy

only option, is to forget that most of the

between them, and India’s road to middle-

obstacles in the way of Indian manufacturing

Economist, he worked for the

income status can somehow bypass the

have been put there by government, and so

BBC World Service as a journalist

sweatshops and smokestacks that have

can be removed.

and has been based in Delhi since 2002. Before joining The

in London, Beijing and Hong

disfigured China’s eastern seaboard. Sadly,

Kong, and as an investment

the idea that services alone can propel

IT is not enough

India’s growth is flawed; to the extent that

The justified pride that India takes in its

it begins to influence not just public debate

information-technology (IT) prowess, and the

but policymaking (which, mercifully, it has

“outsourcing” boom it has helped spawn,

not yet), it is also dangerous.

cannot disguise its irrelevance to the vast

banker. He studied in Cambridge, Boston, Beijing and Nanjing.

60 |

he emergence of India in the past

Words into Ac tion

mass of Indians. In 2005, IT and “BPO”

This may be true in terms of export

(“business-process outsourcing”) generated

revenues. But the industry will still not

$36bn in revenues, or nearly 5% of GDP. But

provide large numbers of jobs – the

the entire industry employed only around

NASSCOM projections suggest that by

1.3m people – a mere 0.25% of India’s

2010, the industry will still employ fewer than

workforce. On the justifiably bullish projections

3m people. In this context it is hard to take

of the Indian industry’s lobbying group,

seriously the notion that India can somehow

NASSCOM, and its consultants, McKinsey,

skip a development phase and jump straight

IT/BPO will contribute 7% of GDP by 2010,

to a post-industrial, IT-services-led economy.

➣

and 17% of the growth in India’s economy between 2004 and 2010. As McKinsey’s Noshir Kaka interprets these forecasts: “This industry can do for India what automotives did for Japan, and oil for Saudi Arabia” – or, by extension, what labour-intensive

“Unless the many constraints that have limited investment in manufacturing industry are removed, India will find it almost impossible to create the employment opportunities it will need.”

manufacturing for export did for China.

As agriculture’s share in the Indian economy has slowly shrunk, it is not industry that has grown, but services.

Words into Ac tion

| 61

Focus on Asia

➣ That it has any currency at all stems from

employing more than ten people) has

what seems an odd phenomenon: as

actually shrunk marginally since India

agriculture’s share in the Indian economy

launched its reforms in the early 1990s.

has slowly shrunk, it is not industry that

The total is still barely more than 6m. A

has grown, but services.

further 42m or so work in the “unorganised” sector. But this is still a tiny number

According to estimates by the Reserve

compared with the 160m or so Chinese

Bank of India, the central bank, agriculture’s

manufacturing workers.

share of Indian GDP shrank from 22.2% in the financial year ending in March

Even if one assumes that, for every person

2004 to 19.7% two years later. Industry’s

directly employed in IT/BPO, three or

contribution remained unchanged, at

four find work to support their needs, in

19.5%, while services’ increased from

transport, retail, domestic services and so

58.3% to 60.9%. In China, by contrast,

on, that is still not enough to provide jobs

“primary industry”, i.e. agriculture, made

for all that need them. India’s workforce is

up 13.1% of GDP in 2004, industry 40.8%,

set to grow by around 71m in the next five

and construction and services 46.1%.

years – around a quarter of the world’s new workers. This “demographic dividend” is

Research by Jim Gordon and Poonam

one of the main reasons why many people

Gupta of the IMF shows that, although

are so optimistic about India’s prospects

services make up a somewhat bigger share

– demography will, as in China, help raise

of its economy than is usual for a country

the level of private savings, from about 29%

at its stage of development, India is far from

now, to 34% over the next five to seven

being a total oddity in this respect. Rather,

years. This will provide the economy with

it is China that is peculiar in having such a

a source for the investment it so badly

stunted services sector. This may be a relic

needs. So, almost by default, it is argued,

of the old Stalinist model with its emphasis

economic growth will continue to match the

on heavy industrialisation and collectivisation

annual rate of close to 8% it has achieved

in the countryside. Or it may simply be

over the past three years, much higher than

faulty data in the reformed economy: the

the 6% it has averaged since the beginning

underreporting of China’s informal sector.

of the 1990s.

Jobs for the boys and girls

But, as Shankar Acharya, a former

The high share of services in India’s

government economist, has pointed out,

economy does not mean it is becoming

nearly 60% of these extra workers will

a nation of software engineers and call-

be seeking jobs, initially at least, in “four

centre workers. India is still primarily a

populous, slow-growing northern states,

nation of farmers – agriculture accounts

with weak infrastructure, education systems

for around 57% of total employment. It is

and governance.” One likely consequence is

slowly turning into a nation of shopkeepers

an increase in internal migration; another, in

(there are an estimated 15m retail outlets),

the absence of more job-creating industries,

security guards and other low-end service

is social tension.

providers – but not of factory workers. The It is China that is peculiar in having such a stunted services sector.

62 |

Words into Ac tion

number of workers employed in “organised”

In China, too, of course, the absorption

manufacturing (i.e., in theory, in enterprises

of excess agricultural labour has created

friction – notably in the form of widespread if scattered protests over the forced acquisition of agricultural land for industrial

“In both countries, many farms are too small and farmers too poor to invest in inputs.”

development. But tens of millions of farmers’ children have found work in factories. In China, reform started in the late 1970s with the explosive burst of energy that came with

many are on the move. In China the number

the dismantling of the old rural collectives

of migrant workers is estimated at anywhere

and communes. The “responsibility”

between 100m and 150m, despite a

system, in effect returning land to individual

restrictive registration system (“hukou”).

farmers, boosted rural incomes, spurred

India has comparatively few – about 11m

mechanisation and freed tens of millions

in 1999-2000, according to national surveys.

to work in new “township and village”

It has not embraced either mass labour

industries. India has no hope of such a one-

mobility or urbanisation on the scale seen

off miracle. But if it is to raise growth rates

in China.

to something approaching China’s, it has to move people from the land into factories.

The Chinese model The lack of mass migration in India also

At present, roughly 70% of Indians live

reflects poor levels of basic education and

in the countryside, compared with 60%

the lack of job opportunities. That is partly

of Chinese. Both countries face similar

explained by the barriers to investment,

agricultural problems. After big surges in

which the government is pledged to lift.

yields, productivity has stagnated, albeit

When India’s prime minister, Manmohan

at much higher levels in China than in India.

Singh, speaks of following “the Chinese

➣

In 2001, China produced 6,350 kilos of rice per hectare of paddy, and 3,823 kilos per hectare of wheat, compared with 2,964 kilos of rice and 2,742 of wheat in India. Both have distorting price and subsidy regimes that favour excessive grain production. In both countries, many farms are too small and farmers too poor to invest in inputs. Access to rural credit is poor. Land has been degraded, water is scarce – less than one-third of Indian farmland is irrigated, and less than half of China’s – and in many places groundwater has been extracted to unsustainable levels. There is mounting competition with cities and industry for land and resources. Already, many farmers are idle much of the year. From fertile, labour-surplus places such as Sichuan in China, and Bihar in India,

India is still primarily a nation of farmers – agriculture accounts for around 57% of total employment.

Words into Ac tion

| 63

Focus on Asia

The number of workers employed in “organised” manufacturing has actually shrunk marginally since India launched its reforms in the early 1990s.

➣

model”, that is what he means. China’s

India was prey to the global panic at the lifting,

single-minded success in becoming the

at the end of 2004, of the quotas governing

world’s workshop is well known. Mr Singh

imports to America and Europe under the

and his advisers point to areas like textiles

Agreement on Textiles and Clothing. There

and clothing and food-processing as the

were forecasts that China might snatch as

way forward.

much as half of the big quota-constrained markets, damaging the prospects not just

64 |

Words into Ac tion

According to the Ministry of Commerce,

of those countries’ own textile and garment

food processing in India adds just 7% to

workers, but those of workers in other

the value of agricultural output, compared

exporters, such as India. Yet this is a business

with more than 40% in China and 60% in

that relies on Indian strengths – cheap

Thailand. As Mr Singh puts it, this is one

labour, a domestic supply of both cotton and

area, promising large numbers of jobs,

manmade fibres and a long textiles tradition.

where “we have barely scratched the

Pessimists fear that Chinese competition

surface.” Much the same could be said

will eat into India’s existing market share.

of textiles and clothing, even though the

Optimists see the industry as an important

industry is one of India’s most important.

engine of job-creation.

➣

CY CMY

Focus on Asia

➣

The evidence so far is with the optimists,

sensible diversification of procurement

if only just. Last year, exports of garments

risks. The Confederation of Indian Textile

to America rose by 26% and to Europe by

Industry (CITI), a lobby group, forecasts

about 20%. Globally, Indian exports reached

that the industry can by 2010 generate

about $7.5bn last financial year, out of total

$40bn in annual exports and provide 12m

textile exports of $17bn. Impressive though

additional jobs (from about 35m now, i.e.

that sounds, it is sobering to contrast

the vast majority of jobs in “unorganised”

it with China’s performance: $107bn of

manufacturing).

textiles exports last year, including $40bn of clothing, despite the imposition of

Non-industrial policy

“safeguard” quotas on some items.

Liberal economist that he is, Mr Singh says he does not believe in having an “industrial

For many global retailers, India has become

policy”. The difficulty he faces is that he has

the favoured second-choice textile supplier:

inherited an anti-industrial policy. That India

a useful defence against renewed sanctions

has flourished in the new service industries

imposed on Chinese exports, and a

is in large measure a consequence of those industries’ emergence at a time and

“Harder to fix is the tax system, which suffers from widespread evasion of direct taxes, and a proliferation of confusing indirect ones.”

in a way such that the government was less able to interfere and strangle them. Manufacturing industry has been less lucky. Unlike the IT industry, it cannot build almost all its own infrastructure, the shortcomings of which remain the biggest single obstacle it faces. There is also, however, a complex web of government policy that hinders the rise of labour-intensive manufacturing. Some impediments are already vanishing, as the relics of the “licence raj” are dismantled. Every year, for example, more products are released from the rules “reserving” their production for small businesses, and hence discouraging the economies of scale that international competitiveness often demands. Harder to fix is the tax system, which suffers from widespread evasion of direct taxes, and a proliferation of confusing indirect ones. A 2002 study by McKinsey for the Confederation of Indian Industry found that India’s cascading import duties, excises,

The Confederation of Indian Textile Industry (CITI), a lobby group, forecasts that the industry can generate $40bn in annual exports and provide 12m additional jobs by 2010.

66 |

Words into Ac tion

sales taxes and octroi (a tax on goods in transit) accounted for nearly half of a

roughly 30% price disadvantage suffered by manufacturers compared with their Chinese counterparts. Since then, in 2005, most of India’s states have introduced a harmonised value-added tax, and a transition to a national goods-and-services tax has been announced. But the lack of a single common market in India causes unnecessary delays and expense for industry. The Chinese experience is encouraging. Before 1994, its tax system suffered many of India’s current woes: cascading state and municipal sales taxes, state-border taxes, excise duties and levies. Since then, there has been a single VAT, levied at 17% on most manufactured goods in all provinces. It provides a steady one-third of government

India is pre-eminent in the fast-growing new business of “outsourced” services, such as software development.

tax revenues. Import tariffs have fallen from

state government. This deters employment

10% of government tax revenues in 1985 to

and encourages the substitution of capital

around 5% now, and direct corporation and

for labour. One campaigner for labour-

income taxes from around one-third to 15%.

law reform cites the example of a firm that bought machines rather than give

Properly implemented, India’s tax reforms

permanent employment to 16 tea-boys.

could have a similar impact. They will also speed up freight, as lorries no longer have

Labour-law reform, despite its obvious

to stop at state borders. VAT should also,

benefits, has always been politically difficult,

in theory, be less prone to evasion, and,

and is an especially big challenge for Mr

eventually increase government revenues.

Singh’s government, which relies on the

That should also help the government cut

parliamentary support of Communist

customs duties, which at present account

parties, which in turn are beholden to the

for about one-sixth of its tax revenues.

trade unions. In effect, this means that the

India’s average import-tariff rate, close to

interests of the unemployed and even of

20%, is nearly double China’s.

most workers in the “unorganised” sector are held hostage to the tiny minority of some

Another big obstacle to labour-intensive

30m, or around 7%, who are in “organised”

manufacturing in India is a restrictive labour-

employment.

law regime. In the garment industry, for example, exporters habitually cite this as

Indian bureaucracy also continues to

their biggest headache. The most notorious

slow things down. According to a World

bugbear is Chapter 5B of the 1947 Industrial

Bank “Investment Climate Assessment”,

Disputes Act, which, in establishments with

published in November 2004, after a

more than 100 workers, bans the laying-off

survey of private Indian firms, it took 89

of employees without the permission of the

days to secure the clearances needed to

➣ Words into Ac tion

| 67

Focus on Asia

If India is to raise growth rates to something approaching China’s, it has to move people from the land into factories.

➣

start a business in India, compared with

of Tibet. It was taken as a symbol of the

41 in China. Insolvency procedures take

healing of the wounds opened by the Sino-

10 years, compared with 2.4 in China.

Indian war of 1962, and of the potential

Although the number of tax and regulatory

for economic co-operation. As so often

inspections endured by Indian businesses

in Sino-Indian relations, the symbol was

was lower than in China, the percentage

more powerful than the substance. In this

of senior management time spent dealing

instance, it transpires that the re-opening is

with government was higher: 11.9% against

for very limited times and for “border trade”

7.8%.

only – i.e., not for transit trade. It will make some difference to the lives of those near

Chindia Inc?

the border, but hardly impinge on Sino-

In a curious little ceremony in late June, India

Indian trade as a whole.

and China, with much hoopla, reopened an

68 |

Words into Ac tion

historic border-trading post at Nathu-La,

This is growing fast. Two-way merchandise

on the border between the Indian state of

trade, at about $20bn in 2005, has

Sikkim and China’s “autonomous region”

increased ten-fold since 1999. Just a few 273 275 280

285 290

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Focus on Asia

“Chinese firms are trying to expand in India, though some are finding their way blocked by the concerns of the Indian security services.”

➣ years ago, many Indian businesses viewed

investing in China, either by building their

China as a competitive menace that was

own plants, or by acquiring Chinese outfits,

about to destroy them through the use

as has Bharat Forge, the world’s second-

of an undervalued exchange rate, free or

biggest maker of automotive forgings.

subsidised land, and unlimited access to

Similarly, Chinese firms are trying to expand

credit. Now, it is more often seen as a land

in India, though some are finding their way

of opportunity.

blocked by the concerns of the Indian security services.

Nevertheless, there remains a huge imbalance in the trading relationship. This is

However, the idea that somehow Indian

not so much in the direction of trade, which,

software skills can team up with Chinese

on India’s figures, shows a small Chinese

“hardware” to produce a world-beating

surplus, as in its relative importance. China

“Chindia” combination so far seems

is now India’s second-most important

fanciful. Indian software firms have no

trading partner, and its biggest source of

option but to expand fast in China,

imports, 7.3% of the total in 2005. India,

because their multinational clients demand

however, accounts for less than 1% of

it. But they know that, in the long run,

China’s overall trade. This is a symptom

China is a big potential competitor.

of the two countries’ relative weight in

Correspondingly, among some Chinese

the world economy. In each of the past

policymakers, India’s rise is being viewed

four years, China’s total foreign trade has

with a certain edginess. They have noticed

increased by an amount greater that the

that the emergence of China as a lower-

total of India’s foreign trade.

cost competitor was a proximate cause of South-East Asia’s financial crisis in 1997.

Agriculture’s share of Indian GDP shrank from 22.2% in the financial year ending in March 2004 to 19.7%.

70 |

Words into Ac tion

This imbalance is accompanied by

Looking around for the source of such a

continued Indian nervousness – in official

threat to China’s present dominance, India

circles, at least – about China’s long-term

seems the obvious candidate. It is not,

intentions. This is one reason for scepticism

because of the many difficulties, outlined

about some of the rosier claims for Sino-

above, faced by Indian manufacturing. But

Indian economic co-operation. There

it should be, and probably needs to be, as

clearly is scope, and an agreement to work

China grows richer and ages, and a young

together in some energy projects may

India grows up looking for work in the

bear fruit. Some Indian manufacturers are

global economy.

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Focus on Asia

Restructured and resilient Singapore’s economy has reinvented itself again – and now the good times look set to last.

ifty years ago, it was a scruffy,

deaths per 1,000 live births, can expect to

politically unstable and poverty-

live 78.1 years. And the fruits of economic

stricken city. Now, it is a thriving First

success are widely shared: over 90% of

World nation and a development model.

households, for instance, now own their

Singapore is a stunning success – all the

homes (see chart 2).

more so considering that it is blessed with few natural resources and has had

A country of only 4.5m people, a mere

to overcome huge political and economic

0.07% of the global population, Singapore

hurdles. In the past decade alone, the

accounts for 2% of world exports. Its

Asian financial crisis, the rise of China and

seaport is the second-busiest in the world,

the dotcom bust have severely tested the

while its airport ranks ninth in terms of cargo

city-state’s resilience. Yet Singapore has

handled. It is also an important oil-refining

reinvented itself and its economy is booming

centre as well as a major Asian financial hub,

again. What, then, is the secret of its

while the government continues to look for

success – and can it be sustained?

opportunities to direct the economy towards

MANU BHASKARAN is head of economic research for Asia

new high-growth industries. Few countries can match Singapore’s

Group. He is also an adjunct

has grown by an average of 7.9 % a year

Prudent, pragmatic and politically stable

senior fellow of the Institute of

since 1960. Its performance has remained

Singapore has thrived in large part because

Policy Studies in Singapore.

vigorous in recent years (see chart 1), with

its government has been better at getting

living standards (as measured by GDP

the basics right than its competitors and

per person adjusted for differences in

neighbours have. Its economy has therefore

purchasing power) rising by an average of

offered relatively high returns to both foreign

5% a year since the 1980s to $34,000 in

and domestic investors.

and a partner at the Centennial

record of economic growth: its real GDP

2005. Singapore is now richer than Japan

72 |

Words into Ac tion

($30,400) and almost as prosperous as the

These basics include sound economic

United States ($42,100). Its people are living

policies – such as fiscal prudence, monetary

longer and healthier lives – newborns, who

stability, an open economy, an investor-

face an infant mortality rate of only 2.29

friendly regulatory framework, a high savings

rate and a well-regulated financial sector – as well as clean government and socially inclusive policies which, by ensuring that the benefits of growth accrue to all sections of the population, have guaranteed political stability. What’s more, throughout its 47

CHART 1* Stable and healthy growth % y/y

Real GDP Growth

10.0

World

Developing Countries

8.0 6.0

years of self-government, Singapore has been quick to adapt to changes in the global environment.

4.0 2.0 0.0

A glance at the economic fundamentals

1980-1990

shows how well-managed the economy

1990-1996

1997-1998

1999-2005

has been. Since the early 1980s, the government’s budget has generally remained in surplus (see chart 3). Except for a brief period in the 1970s, inflation has been kept low; it has remained below 3.5% since the early 1990s (see chart 4). The

CHART 2* High house ownership achieved %

exchange rate has been carefully managed, delivering a steady appreciation over time

House Ownership

100.0 80.0

(see chart 5). And the national savings rate has been exceptionally high (see chart 6).

60.0 40.0

Singapore’s leaders have not only pursued enlightened economic policies. They have

20.0 0.0

also been careful to build the political

1970

consensus needed to sustain this benign

1980

1990

2000

2005

policy regime by ensuring that the benefits of economic growth are widely shared. A major plank of this approach has been the home ownership scheme, which has been a huge success. Since virtually all households now own their homes, most of the population feel that they have a stake in the economy, thereby boosting social cohesion.

CHART 3** No deficits, mainly surpluses SGD mn 25000

Fiscal Balance

20000 15000

Singapore is renowned for its clean

10000

government and its lack of corruption

5000

more generally. Equally importantly, the

government has been careful not to

-5000

allow vested interests to influence policy,

1963 1968 1973 1978 1983 1988 1993 1998 2003

so that this serves to bolster economic development rather than line the pockets of a handful of influential businessmen. Trade unions have been co-opted into a

➣

*Source: Collated by Centennial Group using DOS, CEIC & WEO databases **Source: Collated by Centennial Group using IFS database

Words into Ac tion

| 73

Focus on Asia

â&#x17E;Ł

CHART 4* Inflation contained % y/y

to push through policies that support longterm development, while being permitted

Inflation

25.0

partnership with government and employers

to engage in a variety of activities, including running businesses, which have allowed

20.0

them to deliver real benefits to their

15.0

members.

10.0

A core element of the political part of getting

5.0

the basics right has been the principle

0.0 -5.0

of meritocracy. By and large, whether in 1961 1966 1971 1976 1981 1986 1991 1996 2001

education, government service or politics, the route to glory has been through merit and performance. In economic policy, the emphasis has been on delivering long-term

CHART 5** Controlled exchange rate Exchange Rate

benefits for all even at the cost, sometimes, of short-term losses for some people, rather SGD/USD

120.0

Nominal Exchange Rate

3.00

110.0

SGD/USD

than on populist quick-fixes.

2.50

While Singapore is rightly known as a highly

100.0

2.00

open economy that is friendly to investors

90.0

1.50

and multinational companies, it has not

80.0

1.00

subscribed to a policy of laisser-faire. It has

70.0

0.50

instead adopted its own pragmatic approach

60.0

0.00

to state intervention and regulation.

1975 1978 1981 19841987 1990 19931996 1999 2002 2005

State enterprises have played an important role in the countryâ&#x20AC;&#x2122;s development. While avoiding burdening domestic firms with controls and licensing requirements,

CHART 6** High saving rate % 60.0

policymakers have used governmentlinked companies (GLCs) and other forms Saving Rate

of state intervention to further economic development. GLCs have played a crucial

50.0

role in domestic banking, telecoms,

40.0

infrastructure services (the port, airport,

30.0

airline and shipping line), construction (public

20.0

housing) and the marine sector (shipbuilding

10.0

and repair). Even today, they generate

0.0

around 12% of GDP. 1980 1983 1986 1989 1992 1995 1998 2001 2004

*Source: Collated by Centennial Group using IFS database ** Source: Collated by Centennial Group using IFS and EIU databases

Strong regulation has also been key. For example, the banking sector was once tightly regulated, with high capital-adequacy requirements, stringent ownership rules and

74 |

Words into Ac tion

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Focus on Asia

â&#x17E;Ł

intrusive supervision. Other sectors such as

their homes and more recently to use part

urban zoning, the media and utilities were

of them to purchase financial assets such as

also fairly closely regulated.

equities and unit trusts.

Meanwhile, the mandatory savings scheme,

Together, this underlying pragmatism and

the Central Provident Fund, was used to

sound policy regime have created an

channel a big share of household savings

incentive structure that stimulates economic

to favoured industries. People have since

growth. Businesses have an incentive to

been allowed to use their savings to buy

create wealth rather than lobby government for special favours. Workers have an incentive to be flexible and make short-term sacrifices in working conditions so as to win larger wage increases and better job security over time. Households have an incentive to save in order to buy their own homes. Students have an incentive to choose the right courses and work hard rather than rely on quotas or other political interventions to secure good jobs and incomes. Business has thrived in this favourable policy environment. At a time when most developing economies were hostile to multinational companies, Singapore welcomed their investment with open arms. Foreign firms brought with them superior technologies, management skills, distribution channels and access to export markets which a developing economy such as Singapore could not otherwise have tapped, enabling it to leapfrog into world-class manufacturing. Investment by multinational companies made the manufacturing sector a major driver of economic growth and it continues to lead the economy today. Singapore has also benefited greatly from being a competitive provider of a range of services to its regional hinterland. Because of its successful basic policies, its port, airport, trading hub and financial centre have been well placed to provide the rapidly growing

Few countries can match Singaporeâ&#x20AC;&#x2122;s record of economic growth: its real GDP has grown by an average of 7.9 % a year since 1960.

76 |

Words into Ac tion

South-east Asian region with transport, telecoms, trading and financial services,

â&#x17E;Ł

Focus on Asia

➣

many of which have been highly profitable

In the mid-1990s, China emerged as a

and generated high employment growth.

major competitor to Singapore’s hinterland, South-east Asia, forcing restructuring and

Housing and construction have also

policy changes, the need for which was not

contributed to economic growth through

immediately appreciated. Meanwhile, Japan’s

the government’s massive public-housing

economy was mired in deflation, with its

programme and its emphasis on building

financial institutions teetering on the brink of

world-class infrastructure. Tourism has

collapse. Japanese trade, investment, bank

been important too, generating benefits

lending and other activities in the region

for labour-intensive sectors such as hotels,

decelerated sharply. Singapore, which was a

restaurants and transport services.

major hub for such activities, suffered too.

Restructuring for the 21st century

In 1997, the devaluation of the Thai baht

By building on these sound foundations,

led to political upheaval and deep economic

Singapore had by the mid-1990s achieved

recession in many neighbouring countries.

an income per person of $21,000, close

And just as the region was recovering from

to that of a developed economy. Having

these shocks, it also had to deal with the

largely closed the gap with the First World,

aftermath of the bursting of the technology

the economy was poised to slow, since

bubble, which reduced demand for the

opportunities for catch-up growth were

region’s information-technology-related

rapidly diminishing. But unfortunately, the

exports, along with the post-9/11 upsurge

economy was also rocked by a series of

of terrorism in the region and the SARS

external shocks which dampened growth,

epidemic.

unleashed a regional financial crisis which

raised unemployment and caused deflation, testing its resilience to the limit.

Singapore’s policymakers reacted vigorously to these challenges, implementing radical policy changes that have helped to put the economy back on a dynamic growth track. Two key aspects of these responses highlight the core strengths that drive Singapore’s economy. For a start, Singapore’s policymakers were not caught completely off-guard by the succession of crises in the mid-to-late 1990s. In 1996 the government had already acted to deflate a property bubble, thus preventing Singapore’s real-estate sector from overheating as much as others in South-east Asia did and limiting the eventual damage from the bubble bursting. Singapore’s leaders were also already

Educational reforms were introduced to make up for deficiencies in human-capital development.

78 |

Words into Ac tion

contemplating the need for fundamental and

comprehensive policy reforms in response to the rise of competitors such as China. In late 1996, before the Asian financial crisis broke, Singapore’s prime minister and then senior minister began to articulate the case for fundamental and if necessary painful

“Singapore has also benefited greatly from being a competitive provider of a range of services to its regional hinterland.”

reforms. When the crisis hit, policymakers had already prepared the ground for muchneeded reforms.

The government holding company, Temasek Holdings, was shaken up, leading

From 1997 on, even as the Asian crisis

to the strengthening of GLCs through

was wreaking havoc around the region and

consolidation, the sale of non-core assets,

slowing Singapore’s economy, policymakers

improved capital management and foreign

began introducing sweeping – and

acquisitions.

sometimes taboo-breaking – reforms. Educational reforms were introduced to The government embraced deregulation

make up for deficiencies in human-capital

with gusto. In banking, capital-adequacy

development, with the aim of attracting

requirements were eased as were many

talent from the region in order to capture

other restrictions. The sector was thrown

a bigger slice of the world education

open to much more foreign competition,

market. Resources were poured into more

and the dominant government-owned bank,

and better universities, polytechnics and

DBS Bank, began to restructure in ways

vocational colleges. Foreign universities

that forced other banks to change as well,

were encouraged to establish full-fledged

by merging, for instance. Major changes

campuses in Singapore.

were also instituted in telecoms, energy and media, and a big effort was made to reduce

The government has also placed major

red tape that inhibited entrepreneurship.

bets on new growth sectors, such as pharmaceuticals, biotechnology and high-

Corporate and personal tax rates were

end electronics. Government investments

cut to a maximum of 20% each in order to

in infrastructure support, coupled with

attract businesses and boost Singapore’s

generous fiscal incentives, aim to stimulate

role as a “talent capital”. The taxation

growth in these strategically chosen

of dividends, interest and other income

industries and alleviate the strain on

was also reformed to encourage the

traditional sectors, such as manufacturing,

development of the financial sector. As a

which are facing increasing low-cost

result, Singapore now has one of the most

competition from developing economies in

competitive tax regimes in the world.

the region.

The restrictions on the internationalisation

The government has also eased restrictions

of the Singapore dollar were eased

on gambling with the aim of encouraging

considerably and the central bank’s

the development of casinos that attract

exchange-rate policy was made more

foreign tourists. Substantial investments are

transparent in order to reduce uncertainty

also being made to upgrade and enhance

and thus make policy more effective.

existing tourist attractions and centres, such

Since virtually all households now own their homes, most of the population feel that they have a stake in the economy, thereby boosting social cohesion.

➣ Words into Ac tion

| 79

Focus on Asia

CHART 7 Very high profit-GDP ratio %

CHART 6** Not delivering superior returns anymore?(1) %

Profits-GDP Ratio

52.0

6.0

50.0

Singapore Premium

4.0

48.0

2.0

46.0 44.0

0.0

42.0

-2.0

40.0 1995

2000

2001

2002

2003

2004

2005

-4.0

Source: Collated by Centennial Group using BEA Database and Yearbook of Statistics Singapore 2005-6 (1) Singapore premium is computed as the difference between the US return on capital employed in Singapore and the developing Asia average.

➣

as Sentosa Island and the Orchard Road

of President Yudhoyuno, Indonesia is

tourism belt.

overcoming the residual damage from the political and economic crises that had

Last but not least, a major effort is

plagued it since 1997 and is now poised to

underway to enhance the competitive

enjoy faster growth. Malaysia is also likely

position of Singapore’s port and airport

to enjoy renewed growth as the Abdullah

hub in response to growing challenges

government’s efforts to reform the economy

from regional competitors. The aim is to

and governance produce results. Within

enhance integration through the use of IT,

Singapore’s domestic economy, the long

and to develop a critical mass of logistics

decline in the housing and construction

professionals in order to ensure sustained

sectors is now over, laying the foundations

growth in the capacity and connectivity of

for renewed growth.

Singapore’s port and airport systems. As a result, the past three years have seen

Built to last?

strong growth which can, I believe, be

So far, so good. These ambitious reforms

sustained. The Centennial Group forecasts

have allowed Singapore to weather the

that Singapore can grow by nearly 6% a

storm and to take advantage of a recent

year between now and 2010 and by around

improvement in regional conditions. As

4% a year in the subsequent five years, no

Japan’s economy finally recovers, Japanese

mean feat in an advanced economy such

banks are stepping up their activities in

as Singapore.

the region and often using Singapore as a base to do so. As a major regional hub,

But while the prognosis is generally

Singapore stands to benefit from increased

positive, some weaknesses remain. While

flows of Japanese goods, foreign direct

Singapore’s foreign- and government-owned

investment, foreign portfolio flows, bank

companies are doing well, its domestic

lending and tourists in the region.

private sector remains weak. Studies show that privately owned local companies

80 |

The regional hinterland economies are

generally have lower rates of return on

also recovering. Under the leadership

capital than foreign-owned ones. The lack

➣

Words into Ac tion

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1408-SYMconsultingAdv(HEAD).indd1 1

8/17/06 4:45:39 PM

Focus on Asia

Its competitive position is based on the economy’s ability to deliver superior relative returns, but as chart 8 illustrates, the return on capital employed of US-owned firms in Singapore is now lower than the average return of US companies in developing Asia.

A rosy future The future looks bright for Singapore. Prospects in several sectors look particularly promising. In manufacturing, high-end electronics such as wafer fabrication and semiconductor-related activities are likely to prosper. The offshore marine sector – rig-building and related activities – is also set to boom. With financial reforms making Singapore more competitive and A country of only 4.5m people, a mere 0.07% of the global population, Singapore accounts for 2% of world exports.

➣

with renewed growth in the region, a whole range of financial activities – such as capital-

of a strong corporate sector is a structural

market-related support services, wealth

weakness which makes Singapore overly

management, regional loan syndication and

dependent on multinational companies.

structured products catering to regional

It is also contributing to an unwelcome

demands – are likely to do well. The new

rise in income inequality, because the

integrated resorts being built are likely to

ratio of profits to GDP is unusually high in

boost tourist revenues. Last but not least, the

Singapore (see chart 7), with a considerable

new high-value-added service activities, such

fraction of this high profit share going to

as consulting and the creative industries,

foreign companies.

spawned by the deregulation of recent years are likely to continue to grow fast.

The government may also loom too large in Singapore’s economy. With a big share

But Singapore cannot afford to rest on its

of the domestic corporate sector, national

laurels. In the years ahead, fresh reforms

savings and land ownership concentrated

will be needed to tackle the issues that I

in government or quasi-government hands,

highlighted, such as over-centralisation and

economic decision-making may be over-

the erosion of the “Singapore premium”.

centralised. While in economies where

But as recent history shows, the policy elite

decision-making is diversified, mistakes

has the courage and determination to break

typically cancel out and risk is thereby

taboos and make painful but necessary

managed, in Singapore too much economic

reforms, and I am confident that they will

decision-making may be concentrated in

continue to serve Singapore well in future.

government hands, raising the risk that

So long as Singapore continues to get

correlated errors could unsettle the economy.

the basics right while pursuing its goals pragmatically and adapting to changing

82 |

Singapore’s capacity to deliver superior

circumstances, the economy should continue

returns may also be coming under pressure.

to deliver greater prosperity for all.

■

Words into Ac tion

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17/8/06 17:33:12

Focus on Asia

In the shadow of the dragon Despite worries that China’s rise would eclipse south-east Asia’s success, the region’s businesses are learning to adapt profitably.

hina’s roaring economy

expansion: every country in the region grew

continues to strike fear among

by over 5% last year, with the exception

businesspeople in south-east Asia.

of Thailand, which notched up growth of

Many of the region’s “tiger” economies have

4.5%. What’s more, the Philippines’ trade

built their success on the manufacture of

with China has been in surplus over the past

basic consumer goods, such as clothes

three years, while Thailand’s exports to China

and electronics, which China can now

have risen by a third over the same period.

generally produce more quickly and cheaply. Even wealthy Singapore has felt

This is perhaps not so surprising. Even if

the pinch: having specialised in attracting

China were indeed more competitive than

foreign direct investment from companies

south-east Asia in all economic activities,

looking to expand in Asia, the city-state

the principle of comparative advantage

has seen multinationals shift their regional

dictates that it would specialise in those

headquarters to China. Indeed, for a time it

industries where its relative productivity was

seemed to the region’s anxious executives

greatest. But in fact, of course, China is not

as if China’s super-competitive companies

competitive across the board. The trick for

Shanghai Correspondent.

might sweep all before them. But while

south-east Asian companies has been to

He has previously been a

the challenge from China remains potent,

find the gaps – and then try to fill them.

GEOFF DYER is the FT’s

correspondent in Brazil, as well

the country’s growth is also opening up

as covering the healthcare and

new opportunities for south-east Asian

Fuel for China’s growth

pharmaceuticals sector for the

businesses – and, increasingly, they are

One obvious opening is to sell China

grasping them.

products that it desperately needs but

paper, based in London.

cannot provide for itself – such as raw

84 |

Words into Ac tion

A glance at the statistics confirms that

materials and energy. South-east Asia does

south-east Asia’s economies are bouncing

not enjoy as neat a fit with China as does

back from their recent difficulties, not least

Latin America, which supplies China with

the financial crisis of 1997 and the SARS

vast quantities of copper, iron ore, oil and

outbreak in 2003. Despite competition

soya beans. But some countries in the

from China and the burden of higher oil

region are benefiting from China’s near-

prices, 2005 was the third year of sustained

insatiable demand for raw materials.

One reason why CNOOC, the Chinese oil company, last year made its controversial and ultimately unsuccessful bid for Unocal was to get hold of the US company’s stake in the Yadan natural gas project in Myanmar. Take palm oil, which is used in detergents

group, the parent company of Asia Pulp &

and soaps, and potentially as a biofuel.

Paper, has set up a joint venture with Citic, a

China’s growing interest in biofuels as

Chinese conglomerate, to develop a $500m

a means of meeting some of its vast

palm-oil project with a projected annual

energy needs has provided a big boost

capacity of 1.5m tonnes.

for plantations in Indonesia and Malaysia, the world’s two largest palm-oil producers.

Some developments have caused

China’s imports of palm oil rose by 19% last

controversy, however. Last year, the

year, to nearly 3m tonnes, and the abolition

Indonesian and Chinese governments

this year of its quotas on palm-oil imports is

signed a memorandum of understanding on

likely to spur more trade. An EU requirement

a $7.5bin plan to establish a huge palm-oil

that all fuels contain some biofuel by 2010

plantation on the island of Borneo. To make

has provided a further fillip. In the past six

room for the plantation, a section of tropical

months alone, some 800,000 tonnes of

rainforest would have to be cut down. But

new biofuel capacity has been planned in

the plans were attacked by environmentalists,

south-east Asia. In Indonesia, the Sinar Mas

who labelled the end-product “cruel fuel”.

➣ Words into Ac tion

| 85

Mitsubishi UFJ Financial Group, Inc.

An interview with Nobuo Kuroyanagi President & CEO, Mitsubishi UFJ Financial Group, Inc. Mitsubishi UFJ Financial Group (MUFG)

corporate customers require in commercial

has started on the right track. In its pre-

banking, trust and custody services, and

merger incarnation as MTFG, it improved

the securities business. The next phase is

its average return on capital from 16.1% in

to firmly position ourselves as a leader in

2004 to 25.5% in 2005, while reducing its

international business where we already

non-performing loans to 2.3% of the total.

have global reach. In particular, we feel that,

With the merger of the respective holding

as an Asian bank, our customers expect us

companies of Bank of Tokyo-Mitsubishi

to help them grow their business in Asia.

(BTM) and UFJ Bank to create MUFG

Therefore, we are committing resources to

in October 2005, followed by the merger

significantly expand our service capabilities

of their subsidiary banks in January 2006,

throughout Asia. We also plan to strengthen

it has managed to increase pre-tax profits

our position in other regions where we

by 129%. Its tier 1 capital has grown to

already have significant investments.

$63.9bn, which has lifted its global tier the top 1,000 world banks as ranked by

What role do you see MUFG playing in Asia?

The Banker magazine.

We have historically supported our

1 ranking from 7th to 5th place among

Japanese corporate customers as they

Whatâ&#x20AC;&#x2122;s next?

expanded their business overseas, and

Well, we are quite pleased with these

Asia is no different. Our Japanese corporate

improving trends, but we are far from

customers continue to invest in a variety

finished with our strategic plan to expand

of Asian countries so our branch network

internationally and improve our global

is being expanded throughout Asia to meet

competitiveness. In order to be competitive

our customersâ&#x20AC;&#x2122; banking requirements.

globally, one must have a solid domestic

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base. We are now clear market leaders

We also provide financing to local Asian

in Japan, so that phase is successfully

companies, as well as to subsidiaries of

completed by the merger of BTM and

multinational companies located in Asia.

UFJ. We must also have a sound financial

As with our Japanese corporate customers,

base. And that too has been achieved,

we proactively help our Asian clients to

as the significant reduction in the non-

develop new markets in the region. For

performing loans (NPL) ratio and our solid

example, we helped a major beverage

capital base show. Product-wise, we can

company from the Asean region that was

now offer everything that our retail and

entering the Chinese market by arranging

financing in Chinese Yuan, thus allowing

Our strategy is quite simple. We aim to

it to avoid the exposure to foreign-exchange

grow by helping our customers to expand

risk it would have incurred had it borrowed

their business successfully. That has always

in US dollars. The company not only

been our philosophy and it will continue

appreciated our bank’s ability to provide

to be the pillar of our bank’s strategy.

local-currency financing, but also our vast will be able to support their expansion

Are you optimistic about Asia’s future?

throughout greater China.

Yes, I am. While the situation varies from

branch network in mainland China, which

country to country, Asia as a whole has In addition, our bank has been engaged

growing intra-regional trade as well as

in banking business in Asian countries

expanding domestic consumer markets,

for over a century to support the local

tremendous human talents, a good work

economic growth, which is quite important

ethic, high technology, plenty of capital and

for maintaining stability in the region.

natural resources. China should continue to grow strongly: we expect China’s GDP

We have been trying to help conclude

growth to be around 9.6% in 2006, only

various bond transactions as part of the

a fraction less than the 9.9% recorded last

Asian Bond Markets Initiative in cooperation

year. India’s economy is also expected

with local governments and public financial

to maintain solid growth, driven by strong

institutions. Thus, MUFG has been

domestic demand. We expect India’s GDP

contributing to the reform and development

growth to be 7.3% in 2006.

of financial markets in Asia. For example, bonds issued by an Indonesian company

What about the outlook for Japan?

in which a Japanese firm has a majority

We expect the pace of growth to slow

ownership, with a secondary guarantee

in the second half of fiscal 2006 due to

from the Japan Bank for International

the slowdown of overseas economies, a

Cooperation. We will continue to work in

stronger yen and rising raw material costs.

areas such as securitisation, syndicated

However, the underlying expansionary trend

loans and project finance to help raise the

should continue, with export growth likely to

level of sophistication and competitiveness

remain strong and capital investments firm.

of financial markets in Asia.

There is a structural change in that primary

we recently guaranteed the corporate

support of economic growth in Japan is In order to deliver the wide array of services

gradually shifting from the corporate sector

and products that our customers require,

to the household sector due to increases

we work closely with local banks in Asia

in employee compensation, retirement

as well as government organisations and

payments and interest income. All in all,

government-owned institutions. We are

we are forecasting real GDP growth of 2.2%

always interested to talk to local banks to

for fiscal 2006.

exchange information and introduce our customers to each other, which may result in new business.

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Focus on Asia

➣ They alleged that the real aim was to obtain

large importer of food, as the new middle

the rare hardwoods that would be cut down

classes splash out on a more exotic diet.

to make way for the plantation, which could

South-east Asian tropical-fruit producers

be used to build furniture and line floors

have found a ready market for their

in the apartments of China’s burgeoning

mangoes, melons and lychees. And although

middle-class. The Indonesian press recently

home-grown rice is a Chinese staple, China’s

reported that Chinese investors had pulled

new city-dwellers are developing a taste

out of the project.

for “fragrant” rice from Thailand. The Chia Meng Group, one of Thailand’s biggest rice

With energy in mind, China has been

producers, is opening a distribution centre in

assiduously building up ties with Myanmar,

China and hopes to export 600,000 tonnes

where it accounted for over four-fifths of

to the country this year.

foreign investment last year. In January,

South-east Asian tropical-fruit producers have found a ready market in China for their mangoes, melons and lychees.

PetroChina signed a preliminary deal to

China’s manufacturing sector might be

buy gas from the Shwe field in the Bay

advancing in leaps and bounds, but many

of Bengal, while a Chinese and Thai

of its service industries remain under-

consortium is to build a $1.4bn hydropower

developed, opening up opportunities for

plant on the Salween River. One reason

south-east Asian companies. Take finance.

why CNOOC, a Chinese oil company, last

China’s financial system, which is dominated

year made its controversial (and ultimately

by several large state-owned banks, is

unsuccessful) bid for Unocal was to get hold

highly rigid, with credit allocated to people

of the US company’s stake in the Yadan

with political connections rather than good

natural gas project in Myanmar.

business plans, while its capital markets remain shallow. It does not provide well

In the Philippines, the Nonoc nickel

for the new generation of private Chinese

complex, which has among the largest

companies; bankers estimate that as many

nickel reserves in the world but has been

as 50,000 businesses may be looking to

idle since the 1980s, may soon reopen

raise new equity capital.

thanks to Chinese money. Jinchuan and Baosteel, China’s largest producers of

Singapore, in particular, has tried to help

nickel and steel respectively, have signed

fill this gap. Earlier this year, the Singapore

a preliminary agreement with Philippine

Exchange (SGX) notched up its 100th IPO

Nickel Corporation to invest $1bn in the

by a Chinese company. Chinese firms now

facility so that it can resume production.

account for some 15% of the companies

Meanwhile, China’s Citic Group is investing

listed on the market. SGX – which refers to

in a $490m project to improve the transport

itself as “an Asian gateway” – has begun

infrastructure for Indonesia’s coal industry.

offering corporate-governance courses to

Jakarta hopes to receive around $30bn

companies in mainland China that have

in investment from China over the next

aspirations to float. Sometimes known

decade, mostly energy-related.

as “dragon chips”, most of the Chinese companies are small or medium-sized,

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Feeding and servicing the masses

although five have a market capitalisation

Once obsessed about agricultural self-

subsidiary of COSCO, the state-owned

sufficiency, China has recently become a

shipping group.

greater than $1bn, the biggest being a

But it is not all plain sailing. In 2004 SGX was rocked by the collapse of China Aviation Oil (Singapore), a state-owned oil-trading group which was the biggest stock on SGX until it was brought down by a derivatives-trading

“A glance at the statistics confirms that south-east Asia’s economies are bouncing back from their recent difficulties.”

scandal. And despite SGX’s success in attracting smaller Chinese companies, Hong Kong has become the market of choice for large Chinese companies wishing to list their

many Taiwanese entrepreneurs who have

shares, as the recent $12bn IPO for Bank of

prospered in China over the last decade

China highlighted.

are another important customer group.

Private banking has also become a lucrative

A recent survey by consultants PwC

niche for Singapore. Thanks to its booming

concluded that the city-state had become

private sector, China now has around

“the preferred choice in Asia for wealth

300,000 millionaires, according to Merrill

management” thanks to its strict bank-

Lynch, the US investment bank. Many of

secrecy laws and a tax regime that is

these new rich want to keep their wealth

favourable to non-residents. With an eye

offshore, given the paucity of investment

on Chinese (as well as Indian) clients,

opportunities at home and fears about

around 30 private banks have set up

arbitrary government decisions. The

operations in Singapore. Banking assets, ➣

Chinese travellers are placing new demands on the tourism sector.

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Focus on Asia

“South-east Asian companies are also prospering in sectors of the Chinese economy where local companies have been slow to raise their game.”

➣ which are growing at 15% a year, now top $150bn, and Singapore is home to Credit Suisse’s largest unit outside of Zurich. Tourism is also benefiting from China’s rise. Only in 1997 did the Chinese government first allow its citizens to make leisure trips abroad, yet in recent years the number of such visits has grown dramatically, with 31m foreign trips made last year. Admittedly, most are day-trips to neighbouring countries, such as Russia or Macao. But China’s south-eastern neighbours, notably Vietnam and Thailand, have also profited handsomely. The World Tourism Organisation forecasts that by 2010 the Chinese will make 50m foreign trips a year, rising to 100m by 2020. Chinese travellers are placing new demands on the tourism sector. Just as in the 1980s tourism companies had to adjust to the arrival of Japanese visitors, hotels have had to hire Mandarin-speaking staff, prepare breakfast menus that appeal to the Chinese and introduce Chinese-language television channels to cater for their new guests. Singapore is competing to lure Chinese gamblers away from whom Macao’s highly lucrative casinos by giving the go-ahead for the first casino in the city-state, overturning a five-decade-long ban on gambling. The casino – which is to be built by Sands International, the Las Vegas casino group – is set to cost $3.2bn, making it the most expensive in the world. Singapore is also considering bids for a new casino resort on Sentosa Island. One of the interested consortiums – which includes Kerzner International, a resort and casino operator,

China can now generally produce consumer goods, such as clothes and electronics, more quickly and cheaply than many of the region’s “tiger” economies.

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and CapitaLand, the Singapore property group – proposes to hire Frank Gehry, best-known for the Guggenheim Museum in Bilbao, to design the building. ➣

Focus on Asia

Computer component production and assembly work has seen major relocations to China.

➣

If you can’t sell there, invest there

on its investments – which have averaged

China’s rapid growth also provides

has decided to invest heavily in China.

investment opportunities for companies in

Notably, it spent $4.5bn last year on

the region, and those from Singapore have

5% stakes in both Bank of China (BoC),

been the most enterprising. Singapore has

the country’s second-biggest bank, and

plenty of experience of investing in China,

China Construction Bank, the third-largest

although not always successfully. In 1994,

– although it was forced to scale back its

the government invested several billion

initial plans to take a 10% holding in BoC

dollars in a new industrial park in Suzhou,

following a nationalist backlash against

a city an hour inland from Shanghai, but

foreign investment in the financial sector.

the early years of the project were marred

It also has a stake in the smaller Minsheng

by ill-feeling, with former prime minister

Banking Corporation.

only 3% a year over the past decade – it

Lee Kuan Yew accusing the local Chinese government of “municipal shenanigans” for

Temasek subsidiaries have been active

promoting a different industrial park nearby.

investors in China too. PSA International, the ports group, has stakes in several

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Temasek, Singapore’s state investment

Chinese ports, where turnover is rising

company, has been at the forefront of

fast due to the surge in trade. CapitaLand,

a new wave of investments in the past

the property group, has also started to

three years. In a bid to boost the return

make big investments. It is betting that the

Chinese property market will continue its

Adapt or die

explosive growth, fuelled in large part by

For manufacturers facing competition from

breakneck urbanisation. In a deal symbolic

China, the obvious response has been to try

of its new strategy, it last year sold Raffles

to make products with greater value-added,

Hotel – the Singapore landmark – and other

or to move into niche markets. As Singapore

hotel assets for $820m, and reinvested

has lost assembly-line manufacturing jobs

most of the proceeds in China. CapitaLand

– last year, for instance, Maxtor, the US

derives around a quarter of its earnings

computer hard-drive maker, said it would

from its $4.6bn portfolio of commercial and

cut 5,500 jobs in the city-state and shift

residential projects in China. The group is

production to China – it has sought to

also planning to launch a $800m real-estate

promote industries such as semiconductors

investment trust for its China portfolio later

and pharmaceuticals instead. Many of the

this year.

world’s largest drug-makers now have big manufacturing operations in Singapore,

South-east Asian companies are also

while Switzerland‘s Novartis and America’s

prospering in sectors of the Chinese

Eli Lilly have set up research laboratories.

➣

economy where local companies have been slow to raise their game to international levels. One notable example is the retail sector, which, until a few years ago, was dominated by stuffy, state-owned department stores that lacked branding

“China is losing some of its competitive edge as labour costs soar, especially in the coastal areas where most exporters are based.”

and customer-service skills. This allowed foreign competitors to steal a march. The leading department-store brand in mainland China (alongside Japan’s Isetan) is Parkson, part of the Lion Diversified Holdings Group from Malaysia. The company has 39 stores in the mainland, which contributed to a 62% rise in net profits in 2005. The first opened in 1994 – well before most other foreign retailers arrived – and the company has built a strong reputation in areas such as cosmetics and designer clothes for women, giving it a solid platform to capitalise on the rapid growth in the Chinese middle-class. Another example is BreadTalk, a Singapore food chain, which has 20 outlets in China. It is able to charge premium prices for its bakery products by using its interior design and branding skills – its products have names such as Floss and Earthquake – to appeal to aspirational Chinese consumers.

China’s growing interest in biofuels as a means of meeting some of its vast energy needs has provided a big boost for plantations in Indonesia and Malaysia, the world’s two largest palm-oil producers.

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Focus on Asia

Some companies have adopted a dual strategy of shifting low-cost manufacturing to China, while keeping the more technologically advanced operations at home. Singapore’s Keppel, the world’s largest builder of offshore oil rigs, uses two sites to manufacture ships used to support oil exploration. Vessels that need a high level of design and engineering expertise are made in Singapore, while the less sophisticated ones are built in Nantong, just north of Shanghai. Seeing Chinese cars penetrate the southeast Asian market, Proton, the Malaysian national carmaker, has signed a deal with China’s Chery that will allow them to produce cars in each others’ markets. This gives Proton access to the fastLocal officials at the foundation ceremony for Jiayuguan airport: the increase in air travel has been paralleled by airport expansions. Photo: Gansu Provincial People’s Government Website.

➣ When its electronics and textiles sectors

growing Chinese market and a boost after the collapse earlier this year of its negotiations with Volkswagen over

came under pressure in the 1990s,

a strategic alliance between the two

Thailand tried to build up its car and auto-

companies.

parts industries instead. But Chinese competition proved too strong, so Thailand

Moving up the value chain only buys

is instead focusing on a niche. Following

companies a limited amount of time,

big investments by Ford, Toyota, Nissan

however, because China’s manufacturing

and Mitsubishi, it has become the world’s

sector is also rapidly becoming more

second-largest producer (after the US)

sophisticated. Its steel industry has a

of pick-up trucks, a third of which are

long tail of small producers that make

exported.

low-quality steel, but also half a dozen large players that have invested heavily in

Malaysia’s steel producers, which are

more sophisticated products. Meanwhile,

reeling from a flood of cheap but low-quality

a handful of Chinese companies are

Chinese imports, are investing in new

becoming trusted providers of chemical

technologies to improve the quality of their

raw materials for medicines, and the

products. One, Malayawata, wants to raise

pharmaceuticals industry is investing in

the share of its production that is industrial-

new manufacturing plants in the country.

grade from 10% to 50% by 2010, including

China is even making inroads in drugs

through a $150m joint venture between

research – Lilly now has a research facility

its parent company and Kobe Steel of

there and Novartis is planning to open one.

Japan. Another, Ornasteel, is investing in

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a new cold-rolled plant which will produce

Yet the growing sophistication of China’s

extremely thin steel products.

manufacturers and its rising labour

costs are also opening up space for its

As a result, many Chinese businesses are

neighbours. Vietnam and Cambodia

seeking to shift production to lower-cost

have both built up large clothes-making

manufacturing locations. For instance, TCL,

industries in recent years, partly thanks to

the Chinese television maker, set up a factory

the international quota system that limited

in Vietnam several years ago, in part to

China’s global market share. Although they

serve the local market, but also to serve the

suffered when the quotas were abolished

entire region. It also now has factories in the

at the beginning of 2005, exposing them

Philippines and India.

to the full blast of Chinese competition, they have since recovered some of their poise.

In short, as China gets richer, the debate

Chinese exports to Europe and the US face

has come full circle. China’s manufacturing

fresh restrictions until 2008; but perhaps

base remains formidable, in terms of both

more importantly, China is losing some of

price and reliability. But as its companies

its competitive edge as labour costs soar,

begin to challenge the top end of markets,

especially in the coastal areas where most

space is reappearing at the bottom. And as

exporters are based. Guangzhou increased

its domestic market swells, it offer south-east

its minimum wage by 15.7% in July, while

Asian companies growing export opportunities.

Shenzhen lifted its basic salary by 20%

As long as they remain nimble, the tigers can

in May.

continue to prosper in the dragon’s shadow.

■

Thanks to its booming private sector, China now has around 300,000 millionaires, such as this property developer (below) who is happy for his wife (above) to shop at Beijing’s designer stores.

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| 95

Schedule of Events

2006 Annual Meetings of the Boards of Governors

International Monetary Fund World Bank Group September 2006, Singapore

MONDAY, SEPTEMBER 11

8:00 a.m.

Registration Opens

Singapore City Hall

THURSDAY, SEPTEMBER 14

9:00 a.m.

Civil Society Forum opens

CSO Center, Suntec Singapore

3:00 p.m.

Press Briefing: World Economic Outlook (WEO); Suntec Singapore IMF Economic Counsellor and Research Department Director Raghuram Rajan

FRIDAY, SEPTEMBER 15

9:00 a.m.

Press Briefing: IMF Managing Director Rodrigo

Suntec Singapore

de Rato 10:30 a.m.

Press Briefing: World Bank President Paul

Suntec Singapore

Wolfowitz SATURDAY, SEPTEMBER 16

9:00 a.m.

12:00 noon

Annual Meetings

Pan Pacific Hotel

Group of 24 Ministers Meeting

Suntec Singapore

Press Briefing: World Development Report

Suntec Singapore

2007: Development and the Next Generation; World Bank Chief Economist Franรงois Bourguignon and WDR director Emmanuel Jimenez Press Briefing: Chair of the Group of 24 Ministers

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Suntec Singapore

SUNDAY, SEPTEMBER 17

8:30 a.m.

Annual Meetings

Pan Pacific Hotel

International Monetary and Financial Committee Suntec Singapore 11:00 a.m.

Press Briefing: African Finance Ministers

Suntec Singapore

Press Briefing: IMFC Chairman Gordon Brown

Suntec Singapore

and IMF Managing Director Rodrigo de Rato 3:00 p.m.

Per Jacobsson Foundation Lecture on “Asian

Marina Mandarin Hotel

Monetary Integration: Will It Ever Happen?” by Mr. Tharman Shanmugaratnam, Singapore’s Minister for Education and Second Minister for Finance MONDAY, SEPTEMBER 18

8:30 a.m.

Annual Meetings

Pan Pacific Hotel

9:00 a.m.

Development Committee

Suntec Singapore

11:00 a.m.

Seminar by the African Governors

Suntec Singapore

Development Committee Press Briefing:

Suntec Singapore

Minister Alberto Carrasquilla Barrera, Chairman of the Development Committee; Paul Wolfowitz, President of the World Bank; Rodrigo de Rato, Managing Director of the IMF TUESDAY, SEPTEMBER 19

10:00 a.m.

Annual Meetings Opening Plenary Session

Suntec Singapore

3:00 p.m.

Annual Meetings Plenary Session

Suntec Singapore

6:00 p.m.

Lecture by Anne Krueger (IMF First Deputy

Suntec Singapore

Managing Director, Sept. 2001- Aug. 2006) on “An Enduring Need: The Importance of Multilateralism in the 21st Century” WEDNESDAY, SEPTEMBER 20

9:30 a.m.

6:00 p.m.

Annual Meetings Plenary Session

Suntec Singapore

Annual Meetings Closing Plenary Session

Suntec Singapore

Civil Society Forum closes

CSO Center, Suntec Singapore

Words into Ac tion

| 97

www.johnniewalker.com

The new Argonauts Forget the brain drain – today’s highly skilled migrants circulate between the US and developing countries, creating new technology businesses and spreading prosperity along the way.

uly Systems, which develops

new Argonauts are in a strong position to

technology for selling content such

mobilise the expertise and capital needed

as games and ring-tones on mobile

to start successful global ventures. Their

phones, was founded by two Indian-born

success also forces us to think afresh about

repeat entrepreneurs. While its headquarters

how countries and regions grow.

are in California’s Silicon Valley, near game developers and mobile-content firms, it

In the late 1990s, nearly three in ten Silicon

develops its products in the Indian city of

Valley start-ups were run by immigrants,

Bangalore, where the founders have good

mostly from developing economies

business connections. In its first five years,

such as India and China. Since then,

July Systems has raised $28m from top US,

these immigrants have become global

Indian and Taiwanese investors.

entrepreneurs. Some remain based in Silicon Valley, while tapping low-cost

ANNALEE SAXENIAN is Dean and Professor at the School of

Verisilicon Holdings, which designs

technical talent and financing in their home

semiconductors, was started by a graduate

countries. Others return home to start

of the University of California at Berkeley

businesses but continue working with

Information and Professor in the

from mainland China. Based in Shanghai, at

customers and partners in Silicon Valley. As

Department of City and Regional

the heart of China’s fast growing integrated-

these cross-regional collaborations multiply

Planning at the University of

circuit (IC) market, it has development teams

and deepen, both the US and developing

California, Berkeley. She is author

in Silicon Valley and Taipei, the leading

economies benefit.

of The New Argonauts: Regional

centres of IC-design talent. Since it was

Advantage in a Global Economy

founded in 2001, VeriSilicon has raised

Entrepreneurs and their far-flung networks

(2006) and Regional Advantage:

$20m from Chinese and US venture-capital

now play a vital role in the technology

firms.

industries’ global expansion – and make

Culture and Competition in Silicon

an increasingly important contribution to

Valley and Route 128 (1994), both from Harvard University Press.

Like the Argonauts of Greek mythology

economic growth and development more

who ventured with Jason centuries ago,

broadly. Ventures such as July Systems

these US-educated but foreign-born

and Verisilicon are among the thousands of

entrepreneurs are embarking on risky

start-ups that have helped create dynamic

foreign adventures in pursuit of wealth.

technology clusters in countries such as

Armed with their knowledge of technology

Israel, Taiwan, India and China. These

markets and their global contact-books, the

investments may be small by comparison

➣

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| 99

Focus on Asia

Overseas technology investments are not motivated solely by low labour costs, as critics suggest.

â&#x17E;Ł

to total foreign direct investment, but by

complex tasks, with counterparts far away.

boosting indigenous entrepreneurship, they

Scientists and engineers from developing

create a huge potential for future growth.

countries, who were once forced to choose between settling abroad and returning

This globalisation of entrepreneurial

home to far less attractive professional

networks reflects dramatic changes in

opportunities, can now contribute to

global labour markets. Falling transport

their home economies while maintaining

and communication costs allow high-

professional and business ties in more

skilled workers to work in several countries

technologically advanced countries.

at once, while digital technologies make

100 |

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it possible to exchange vast amounts of

This is most evident in Silicon Valley,

information across long distances cheaply

where networks of foreign-born engineers

and instantly. International migration,

and entrepreneurs transfer technical and

traditionally a one-way process, has become

institutional know-how between distant

a reversible choice, particularly for those

regional economies faster and more

with scarce technical skills, while people

flexibly than most multinationals. The

can now collaborate in real time, even on

protagonists in this process are not large

“These US-educated but foreign-born entrepreneurs are embarking on risky foreign adventures in pursuit of wealth.” which exacerbates international inequality by enriching already wealthy economies at the expense of their poor counterparts. According to the 2000 Census, 2.5m highly skilled immigrants (not including students) resided in the United States. Silicon Valley has greatly benefited from this foreign brainpower. Tens of thousands of talented immigrants from developing countries, who initially came to the US to earn a graduate degree in engineering, accepted jobs in Silicon Valley rather than return home, where professional opportunities were limited. By the end of the 1990s, over half of Silicon Valley’s 200,000 scientists and engineers were foreign-born, primarily in Asia, and only a small proportion planned to return home. These immigrants, who were often excluded from established networks, corporations but the new Argonauts: the

nonetheless quickly created ethnic social

foreign-born engineers, entrepreneurs,

and professional networks which have

managers, lawyers and bankers who

supported their career advancement and

have the linguistic and cultural abilities

entrepreneurial success. High-profile start-

as well as the institutional knowledge

ups such as Sabeer Bathia’s Hotmail,

to collaborate with their home-country

Jerry Yang’s Yahoo and Min Zhu’s Webex

counterparts. While systematic data on

are only the most visible reflections of the

these highly decentralised two-way flows of

extent to which Silicon Valley’s immigrant

skill, technology and capital is scarce, their

engineers have mastered the region’s

impacts are arguably as important as more

entrepreneurial business system.

easily measured multinational investments. But these highly skilled emigrants are now

From brain drain to brain circulation

increasingly transforming the brain drain

The migration of talented youth from

to establish business relationships or start

developing to advanced countries has

new companies while maintaining their

traditionally been seen as a “brain drain”

social and professional ties to the US.

into “brain circulation” by returning home

➣ Words into Ac tion

| 101

Focus on Asia

started to influence economic development

â&#x20AC;&#x153;Because of their experience and professional networks, these cross-regional entrepreneurs can quickly identify promising new market opportunities.â&#x20AC;?

back home, both directly, by transferring technology and know-how when they return home to work or start businesses, and indirectly, by influencing policy formation and other aspects of the institutional environment. By 2004, venture-capital and private-equity firms were investing more

â&#x17E;Ł

Foreign-educated engineers turned venture

than $1bn annually in China, and a similar

capitalists often take the lead by investing

amount in India. While this is only a fraction

in their home countries. As experienced

of the venture capital invested annually

engineers, managers and investors return

in the US or, indeed, of total FDI in these

home, either temporarily or permanently,

economies, it is fostering local ecosystems

they export first-hand knowledge of US

which support indigenous entrepreneurship

capital markets and business models to

and which are an increasingly viable

peripheral regions.

alternative to the development opportunities provided by established domestic firms and

In the early 1980s, foreign-born engineers

multinational corporations.

transferred the Silicon Valley model of earlystage high-risk investing to Taiwan and

No longer on the sidelines

Israel, which US venture capitalists were

Traditional accounts of economic

typically neither interested in nor able to

development assume that new products

serve. Native-born investors provided the

and technologies emerge in advanced

cultural and linguistic know-how needed

economies, which have sophisticated

to operate profitably in these markets. As

skill and research capabilities as well as

well as capital, they brought technical and

large and wealthy domestic markets, with

operating experience, knowledge of new

mass manufacturing shifting to less costly

business models and networks of contacts

locations once a product is standardised

in the US. Israel and Taiwan now boast the

and mature. Development, in this view,

largest venture-capital industries outside

builds on success in advanced economies,

North America ($4bn is invested annually in

while peripheral economies remain followers.

Israel and $1.3bn in Taiwan.) Both have high

Both the strategies of multinational

rates of new firm formation, innovation and

corporations and the clustering effects

growth. Israel is now known for software

created by economies of scale perpetuate

and internet firms such as Mirablis (a

this divide.

developer of instant-messaging programs) and Checkpoint (security software); firms

This leaves little scope for the periphery

such as Acer (personal computers and

to develop independent technological

components) and TSMC (a semiconductor

capabilities. At best, foreign investment from

foundry) have transformed Taiwan into

the core might contribute to the incremental

a centre of leading-edge PC and IC

mastery of foreign manufacturing techniques

manufacturing.

and the upgrading of local suppliers. Even the most successful newly industrialising

102 |

Words into Ac tion

Immigrants from India and China with

countries are destined to remain imitators,

experience in Silicon Valley have also

because leading-edge skill and technology

reside in the corporate research labs and

to tap overseas expertise, cost savings

universities in the core.

and markets. Start-ups in Silicon Valley are often global actors from day one; many

But changes in the world economy have

raise capital, subcontract manufacturing

undermined this core-periphery model.

or software development, and market their

The increasing mobility of high-skilled

products or services outside the US.

workers and information, combined with the fragmentation of production

The scarce resource is no longer size but

in the information and communication

the ability to locate foreign partners quickly,

technology sectors, provide unprecedented

and then to manage complex business

opportunities for formerly peripheral

relationships and teamwork across cultural

economies to benefit from decentralised

and linguistic barriers. This is particularly

growth based on entrepreneurship and

challenging in high-tech industries where

experimentation. While policymakers and

products, markets, and technologies are

multinational corporations have a role

continually redefined â&#x20AC;&#x201C; and where product

to play, central to this are communities

cycles are often shorter than nine months.

of technically skilled immigrants with

First-generation immigrants have

experience in, and connections to, Silicon

a commanding advantage.

â&#x17E;Ł

Valley and other technology centres. As foreign-born, but US-trained engineers transfer know-how and market information to their countries of origin, and help jump-start local entrepreneurship, they are allowing their home economies to participate in the information-technology revolution. Because of their experience and professional networks, these crossregional entrepreneurs can quickly identify promising new market opportunities, raise capital, build management teams and establish partnerships with other specialist producers â&#x20AC;&#x201C; even those located far away. This decentralised responsiveness is a vitally important advantage which few multinationals have. As recently as the 1970s, only large, established companies could grow internationally, primarily by establishing marketing offices or factories overseas. Today, the fragmentation of production and the falling costs of transport and communication allow even small firms to build partnerships with foreign producers

Thousands of start-ups have helped create dynamic technology clusters such as The Cyber Gateway in Hyderabad.

Words into Ac tion

| 103

Focus on Asia

markets. Nor can new technological clusters be created simply by mobilising researchers, capital and a modern infrastructure: they also require the shared language and trust of a technical community, which permits open information exchange, collaboration and learning (often by failure) along with intense competition. The new technology centres differ in their specialities and level of technological sophistication. Cross-regional entrepreneurs rarely compete head-on with established US producers; instead they build on the skills and the technical and economic Building new technologies: female workers at the construction site for an IT company, Bangalore.

resources of their home countries. In the 1980s, Taiwan was known for its cheap PC clones and components; today, it is

➣

Developing economies typically have two

recognised for the flexibility and efficiency

major handicaps: they are remote from the

of its IC and electronic-systems producers.

sources of leading-edge technology and

In the 1990s, China was known for me-too

distant from developed markets and the

internet ventures; now, Chinese producers

interactions with users that are crucial for

are poised to play a lead role in developing

innovation. Firms in peripheral locations

wireless technology. In the 1990s, India

can try to overcome these disadvantages

was a provider of labour-intensive software

through joint ventures, technology licensing,

coding and maintenance; today, local

foreign investment, overseas acquisitions,

companies are mobilising the thousands

and so on. But a network of technologists

of underemployed English-speaking

with strong ties to global markets and the

Indian engineers to manage large-scale

linguistic and cultural skills to work in their

software services projects for leading global

home country is arguably the best way to

companies. Whereas in the 1980s, Israel

overcome these limitations. Cross-regional

was a low-cost research location, since

entrepreneurs and their communities can

then, local entrepreneurs have applied the

facilitate the diffusion of technical and

fruits of the country’s advanced military

institutional know-how, provide access to

research to pioneer sophisticated internet

potential customers and partners, and help

and security technologies.

overcome isolated economies’ reputational and informational trade barriers.

A new generation of cross-regional start-ups combine Silicon Valley’s new

104 |

While new technologies and more open

product vision, technology architecture,

global markets make this possible, long-

marketing, and research-and-development

distance collaborations still depend heavily

coordination with the technical capabilities

on a shared social context and language,

of distant regions. The emerging regions

which ensure partners understand each

are hybrids, which marry elements of

other well, which is vital in rapidly evolving

the Silicon Valley industrial system with

➣

Words into Ac tion

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Focus on Asia

Valley system – efficient capital markets, an independent judiciary, regulatory oversight, sophisticated education systems, research institutions, and physical infrastructure – are rarely present in these peripheral economies. Returning entrepreneurs have found different ways to overcome the weaknesses of their home countries. In India, entrepreneurs rely on private telecoms facilities and power supplies rather than on the country’s costly and unreliable infrastructure, while in China returning entrepreneurs have learned to negotiate the complex bureaucratic rules and politics which regulate private companies. They also rely on US institutions: in addition to receiving graduate training in the US, many establish headquarters or research labs in Silicon Valley, harness venture capital, professional services, and managerial and technical talent from the US, and even raise funds on US capital markets. These cross-regional start-ups still face significant challenges. Venture-capital investment is still in its infancy in most of the world. There are shortages of experienced managerial talent and ongoing difficulties coordinating distant activities, particularly Fragmentation of production in the information and communication technology sectors provides unprecedented opportunities to benefit from decentralised growth.

➣

106 |

Words into Ac tion

in developing organisational synergy and persistent, consistent communication. Entrepreneur-led growth, with highly

inherited local institutions and resources.

competitive, specialised technology

Returning entrepreneurs typically seek (with

producers in high-skill regions connecting

varying success) to transfer venture capital,

to, and collaborating with, counterparts

merit-based advancement and corporate

elsewhere, is only one possible future for

transparency to economies with traditions

these regions. If they are not careful, they

of elite privilege, government control,

may miss the opportunity to upgrade local

and corruption. They seek to reproduce

skills and capabilities, and instead remain

team-based firms with limited hierarchy in

suppliers of low-cost labour to global (or

an environment dominated by family-run

domestic) corporations. China and India

businesses or state-owned enterprises. And

have a big enough labour supply to do

they seek to influence policy because the

this for a relatively long time. However,

national institutions that support the Silicon

many cross-regional entrepreneurs are

➣

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Focus on Asia

➣

constructing firms committed to an

specific locations – where the advantages

alternative, high-value-added trajectory.

of locating in a crowded and costly place outweigh the increasing costs, resulting in

The world isn’t flat

a pronounced clustering process. The rise

Is brain circulation between technology

of entrepreneurship-led growth suggests

regions making the world “flat”, as

that the regional cluster may be replacing

Thomas Friedman of the New York Times

the national economy as the locus of

suggests? Hardly. The new Argonauts

economic growth.

cluster tenaciously in the leading technology centres, which is why Palo Alto

Overseas technology investments are not

now has more in common with Taipei and

motivated solely by low labour costs, as

Tel Aviv than with Fresno, a three-hour

critics suggest. The leading destinations

drive away. Residents of Bangalore enjoy

for cross-border technology investment

Western standards of living, while those in

are regions such as Bangalore and

nearby rural areas remain mired in poverty.

Shanghai, where wages and other costs are

Economic geographers have documented

significantly higher than in their surrounding

this phenomenon of increasing returns in

economies, and rising rapidly. Even when

Companies such as this American-owned manufacturer of flexible printed circuits has established itself in China to take advantage of the lower labour costs.

108 |

Words into Ac tion

low wages attract initial investments, local enterprises distinguish themselves from other low-cost regions by collaborating with Silicon Valley-based partners. This allows local producers to develop specialised

“Palo Alto now has more in common with Taipei than with Fresno, a three-hour drive away.”

skills, expertise and relationships which ensure a regional advantage that compensates for their high costs: Israel in sophisticated internet and security

high-end routers from Israel; and has most

technologies, Taiwan in global logistics and

of its hardware manufactured in Taiwan

design, China in efficient IT manufacturing,

and China. Like Intel and Acer, it also

and India in managing complex software

invests in foreign start-ups with promising

services and consulting projects.

technologies. A start-up such as July Systems obtained venture capital from

The old pattern of one-way flows of

the US, Taiwan, China and India, and its

technology and capital from the core to

products will likely incorporate components

the periphery is being replaced by a far

from all these locations, as well as being

more complex and decentralised two-

targeted at all their markets.

way flow of skill, capital and technology between regional economies with different

US technology producers now look to their

specialities. Silicon Valley is at the core

counterparts in Taiwan, China, India and

of this rapidly diversifying network of

Israel not simply for low-level implementation

economies because it is the largest and

but increasingly to co-develop products and

most sophisticated market as well as a

components. Firms in the new technology

leading source of new technologies. But this

regions are increasingly partnering with one

may change, as new relationships emerge

another, as well as with firms from Silicon

and new markets open up. The fast-growing

Valley. A Taiwanese semiconductor firm

Asian market for wireless communication,

invests in Israeli start-ups specialising in

for example, has enabled firms in China and

digital-speech-processing chips, while an

India to contribute to how the technology

Israeli company contributes intellectual-

and its applications are developed – even

property components to a chip-design firm

though they do not yet define its leading

in India. These collaborations deepen both

edge. Over time, producers in developing

partners’ capabilities and over time can

regions may be able to build independent

support a process of reciprocal innovation

capabilities and define entirely new

and upgrading.

specialisations and markets.

A model for others? Even the largest Silicon Valley companies

Not all developing economies can reap the

participate in all these regions not simply

benefits of brain circulation and peripheral

as competitors but also as investors and

entrepreneurship. For political reasons,

partners. An established firm such as

some of the largest technically-skilled

Cisco designs and sources critical parts

immigrant groups in Silicon Valley have not

of its operating-system software from

built business or professional connections

India; buys application-specific ICs for its

to their home countries. Most of the Iranian

➣ Words into Ac tion

| 109

Focus on Asia

➣

and Vietnamese immigrants, for example,

Cross-regional networks develop only

are political refugees and so not inclined

when skilled immigrants are both willing

to return to countries which, in any case,

and able to return to their home countries

lack the economic stability needed for

to do business in large enough numbers

technology investment or entrepreneurship.

to create close links to the technical

This is also true to varying degrees for

community in the home country. This

immigrants from Russia, parts of Eastern

requires political stability, economic

Europe and Latin America. Saint Petersburg

openness and a certain level of economic

or Buenos Aires may one day become more

development, notably a high level of

attractive to returning entrepreneurs, but

technical education. It often builds on

large parts of Africa and Latin America lack

multinational companies’ investments in

the skill base or political openness to foster

research and development which have

technology entrepreneurship.

helped develop a local skill base as well as an infrastructure which supports

The creation of a transnational community

entrepreneurship. Political leaders must

is a two-way process. While policymakers

also be committed to removing institutional

and planners can encourage cross-regional

obstacles to entrepreneurship-led growth.

connections, they cannot create or substitute for transnational entrepreneurs and their

Technology markets are shifting quickly,

decentralised networks. Foreign governments

with demand from outside the US growing

regularly sponsor networking events for

rapidly. While North America, Europe and

their expatriates in the Bay Area in order to

Japan account for less than 15% of the

recruit return entrepreneurs and investments,

world’s population, they produce more

but without entrepreneurial collaborators at

than half of global output. This is set to

home, these agencies will have little success.

change decisively, with Goldman Sachs, the US investment bank, predicting that customer demand from India and China will dominate global markets within a decade and that these two economies will be larger than the US by 2050. Producers in other peripheral economies will surely develop the capabilities to participate in global networks too. They will likely share with their predecessors a history of investments in education and research, as well as an institutional openness that ensures both competitive intensity and long-distance collaborations. Silicon Valley’s role as the dominant technology centre will most likely continue to diminish. This does not imply decline, rather that it will become one of many nodes in a more open and distributed global network of differently specialised and complementary

Silicon Valley’s role as the dominant technology centre will most likely continue to diminish.

110 |

Words into Ac tion

regional economies.

■

Development Agenda

Hitting the target The Millennium Development Goals to reduce extreme poverty by 2015 are still achievable, insist Sachs & Schmidt-Traub. Developing countries need to up their game, while rich countries, the IMF and the World Bank need to give them more support.

t the UNâ&#x20AC;&#x2122;s Millennium Assembly in

standing pledge to devote 0.7% of the

September 2000, the world adopted

gross national income (GNI) to official

the Millennium Development

development assistance. The Monterrey

Goals (MDGs) â&#x20AC;&#x201C; quantitative, time-bound,

consensus on development aid provides

achievable targets to address extreme

the right framework with its focus on

poverty in its many dimensions: income

improved governance, increased public

poverty, hunger, lack of education, disease,

and private investments, more and better

poor child and maternal health, gender

development assistance, and free trade

inequality, poor sanitation and environmental

for long-term economic development. Yet

sustainability.

with 2015 the deadline to meet the Goals, time is running out to get countries on track

Many countries, notably in East and South

towards achieving them. The cost of failure

Asia, have made substantial progress

in terms of lives lost, growing insecurity and

towards the Goals. Yet many others, and

accelerating environmental degradation is

indeed entire regions, remain dangerously

too high.

JEFFREY D. SACHS

off-track. Sub-Saharan Africa is the most

is Director of the UN Millennium

serious and persistent laggard, with food

Breaking through

shortages, a rapidly expanding population, a

Encouragingly, the past year has yielded

crushing disease burden and environmental

a series of breakthroughs, both in high-

Project, an independent advisory body to the United Nations

degradation combining to keep millions in

level global politics and on the ground,

Millennium Development Goals.

extreme poverty. Other regions, such as the

which are building up the momentum

He is also Director of The Earth

Middle East, Central Asia and parts of Latin

behind the Goals and give us cause

Institute at Columbia University,

America, have had mixed success, with

for optimism. The rich world has made

great progress on some of the Goals and

a series of commitments to provide

persistent inequalities in others.

financing at the scale needed to meet

Secretary-General on the

and President and co-founder of Millennium Promise Alliance, a non-

the Goals, while a number of initiatives

profit organisation aimed at ending extreme global poverty. He is the

As reports by the UN Millennium Project,

on the ground have demonstrated, and

author of many books, including

the Commission for Africa, and many others

continue to demonstrate, that scaled-

have shown, the tools and knowledge exist

up, targeted public investments can lead

to meet the Goals, as does the financing

to development success in some of the

â&#x20AC;&#x201C;provided rich countries meet their long-

poorest countries.

New York Times bestseller The End of Poverty (Penguin, 2005).

112 |

Words into Ac tion

The key breakthrough in 2005 was the commitment of European Union donors to achieve the target of 0.7% of gross national product (GNP) in official development

“16 out of 22 OECD donor nations have either achieved, or committed to a timeline for achieving, the ODA target of 0.7% of GNI by 2015.”

assistance by 2015. An intermediate benchmark of 0.56% of GNP in aid as of 2010 was also established. Encouragingly, the new (much poorer) EU member states

are affordable and, importantly, their results

committed to donating 0.33% of GDP by

can be easily measured and monitored.

2015. Following this landmark commitment,

They now need to be implemented at scale.

16 out of 22 OECD donor nations have for achieving, the ODA target of 0.7% of

Implementation is gathering pace

GNI by 2015. The six remaining countries

The key challenge now is implementation.

are Australia, Canada, Japan, New Zealand,

Fortunately, we are also beginning to see

Switzerland and the United States.

progress on this front. Remarkable results

either achieved, or committed to a timeline

have been achieved in some countries At Gleneagles in July 2005, the Group

that have implemented large-scale national

of Eight (G8) leaders made further

programmes to achieve the Goals. In

commitments to scale up financing for the

Ghana, a public-private partnership,

MDGs, specifically in Africa. An extra $25bn

with support from the government of the

in donor financing by 2010 was promised

Netherlands and Unilever, has launched

for sub-Saharan Africa alone. The G8 also

a national school feeding programme for

agreed to forgive the debt of several of

1m children using locally produced food.

the poorest countries, and committed to

This programme is not only improving child

ensuring universal access to anti-retroviral

nutrition and health; it is also boosting

treatment for AIDS by 2010.

school attendance, improving educational

GUIDO SCHMIDT-TRAUB

outcomes and creating a market for locally

is Associate Director at the UN

produced food.

Millennium Project. Previously,

At the UN World Summit last September, world leaders committed to prepare national

he was a partner at IndexIT

development strategies that are bold

Another powerful example is the Measles

Scandinavia, a strategic adviser

enough to achieve the MDGs. They also

Malaria Initiative, run by the Center for

for technology companies and

adopted several “quick-impact initiatives”,

Disease Control, Red Cross Red Crescent,

concurrently managed a private

designed to make rapid progress in many

UNICEF and WHO, which has implemented

investment fund for European

key areas: bed nets and medicines to fight

national campaigns for measles vaccination

technology companies. He holds

malaria, anti-retroviral medicines for AIDS,

and the free distribution of long-lasting

an M.Phil. in Economics from

fertilisers for replenishing soil nutrients and

insecticide-treated malaria bed nets.

Oxford University, where he was

launching the African Green Revolution,

Extremely successful campaigns have been

a Rhodes Scholar, and a Masters

hardware and software for rural connectivity,

implemented, most recently in Niger and

in physical chemistry from the Free

and countless other practical steps that

Togo, with many other African countries

University Berlin.

can relieve hunger, disease and isolation at

scheduled to follow in 2006 and 2007. The

relatively modest cost. These quick-impact

results include a sharp fall in the incidence

initiatives are already proven to work, they

of malaria and drastically lower measles

➣ Words into Ac tion

| 113

Development Agenda

➣ Quick-impact initiatives are already proven to work: they can relieve hunger, disease and isolation at relatively modest cost, are affordable and, importantly, their results can be easily measured and monitored.

➣

mortality. Perhaps most impressively, the

Once empowered with the means, farmers

campaigns lasted only a few days, were

have more than tripled their crop yields

implemented at an extremely low cost using

and food output in a single season. School

Red Cross Red Crescent volunteers, and

attendance has soared in response to school

achieved country-wide coverage. These

feeding programmes and the elimination of

and other programmes, such as the fertiliser

user fees. Healthcare has been dramatically

strategy currently being prepared by the

bolstered through the provision of local

government of Malawi, clearly demonstrate

clinics and the mass distribution of long-

the feasibility and success of national-scale

lasting insecticide-treated bed nets to fight

programmes to meet the MDGs.

malaria. The initiative, which is partially funded by the government of Japan, covers

114 |

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The Millennium Villages, a joint effort of the

some 390,000 people in 12 sites across

Earth Institute, UNDP, the UN Millennium

sub-Saharan Africa – one for each major

Project and Millennium Promise, are

agro-ecological zone. The results so far are

demonstrating that the MDGs can be met in

impressive, and show that this approach can

some of the poorest villages in sub-Saharan

be taken to scale. It is time for official donors

Africa through community-led development.

to build on these results.

➣

Development Agenda

â&#x17E;Ł

Preparing MDG-based national strategies At the UN World Summit, every country was called upon to prepare an MDG-based national development strategy. Such a goalbased approach requires a major shift in thinking, away from the marginal expansion of services and infrastructure provision towards a long-term programming of public expenditures to achieve the outcome goals agreed in the Millennium Declaration. Over five years after the adoption of the Millennium Development Goals, national strategies that are anchored in the Goals remain few and far between. Most Poverty Reduction Strategy Papers submitted for approval to the International Monetary Fund and World Bank reflect a shadow of what countries actually need to achieve the Goals. Countries are still advised by development partners to continue on a business-asusual scenario by keeping their strategies in line with the limited resources and aid flows at their disposal. It is no wonder that the resulting strategies cannot deliver on the Goals. Governments are accused of

governments should be encouraged and

incompetence, and sceptics feel vindicated

supported in mapping out the practical

in their view that the MDGs cannot be met.

investments needed to deliver basic infrastructure, ensure good health, promote

Fortunately, several countries have begun to

education and gender equality, improve

buck this trend. Ethiopia, Kenya, Senegal,

environmental management, and launch

Tajikistan and others have put forward the

the African Green Revolution. Imperfect

first MDG-based development strategies.

strategies should be improved instead of

Many other countries are approaching

serving as a justification for inaction, as is

the UN for support in preparing rigorous

still too often the case.

strategies to achieve the Goals. Their leadership now needs to be recognised

Fortunately, major strides are being

and reciprocated with bold support from

made in Africa and elsewhere towards

the international community to permit the

the integration of the MDGs into national

implementation of these strategies through

budgets, development initiatives and

a real international partnership.

poverty reduction strategies. NEPADâ&#x20AC;&#x2122;s African Peer Review Mechanism (APRM)

116 |

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Where available strategies fall short in terms

is making important contributions towards

of ambition, financing or analytical rigour,

strengthening governance across Africa. The

The Measles Malaria Initiative has implemented national campaigns for measles vaccination and the free distribution of long-lasting insecticidetreated malaria bed nets.

fact that so many countries are voluntarily subjecting themselves to scrutiny by their peers exemplifies the strong commitment among African countries to fulfil their side of the Monterrey Consensus.

“Over five years after the adoption of the Millennium Development Goals, national strategies that are anchored in the Goals remain few and far between.”

In May, African ministers and development partners met in Abuja for the Financing for

20 African countries announced that

Development Conference. The purpose was

they would present national strategies

to transform the recent commitments for

to meet the ‘Education for All’ Goals at

increased financing for African development

this September’s annual meetings of the

into action, with specific focus on meeting

World Bank and IMF. Implementing these

the MDGs and developing coherent national

education strategies will be an important

strategies to do so. Britain’s Chancellor of

breakthrough in moving towards national-

the Exchequer, Gordon Brown, delivered a

scale programmes to achieve the MDGs.

powerful speech in which he reiterated the UK’s commitment to providing $15bn over

Another area where African leaders are

the next ten years in support of ten-year,

taking the initiative is the African Green

costed education strategies. In response,

Revolution. In response to the UN

➣ Words into Ac tion

| 117

Development Agenda

IDE

Once empowered with the means, farmers have more than tripled their crop yields and food output in a single season.

➣

Secretary-General’s call for an African Green

governments in preparing and implementing

Revolution in early 2004, NEPAD convened

practical strategies to meet each Goal.

the Africa Fertiliser Summit in Abuja in June

Needless to say, the IMF and World Bank

this year. Summit participants pledged to

play a critical role in supporting this process.

improve access to fertilisers, improved through smart subsidies and strengthened

The role of the IMF and World Bank

private distribution networks. Malawi and

In his April report on the IMF’s medium-

many other African countries have already

term strategy, Rodrigo de Rato, the Fund’s

drawn up national strategies for agricultural

managing director, pledged to increase the

inputs. These practical commitments hold

organisation’s engagement in low-income

the promise of greatly reducing poverty and

countries to achieve higher growth and to

hunger in rural Africa, and now need to be

meet the MDGs. He called for an approach

implemented.

that assesses “if projected aid flows are

seeds and other key agricultural inputs

consistent with macroeconomic stability

118 |

Words into Ac tion

Together, these breakthroughs over the

and the estimated costs of achieving

past year show that the glass is half full. The

countries’ development goals” and urged

international community now needs to build

candour by informing “donors when there

on the momentum behind the Millennium

is scope for more aid to be absorbed and,

Development Goals by supporting

conversely, when it judges that expected

aid flows put macroeconomic stability at

In addition to the IMF and World Bank staff,

risk.” Through this document the IMF has

their Executive Boards needs to review every

taken its boldest step yet in aligning its work

country programme proposal for consistency

in low-income countries with the Millennium

with the MDGs. Standard checks applied

Development Goals.

to each programme should be whether the proposed level of financing is consistent with

We see three areas in which the IMF and

achieving the Millennium Development Goals

World Bank can, and must, go further

and if the financing strategy is compatible

in supporting the Goals. First, the World

with long-term economic growth and

Bank should work with the UN system

macroeconomic strategies.

to support every developing country in estimating the financial and human-resource

By building on the Fund’s medium-term

needs for meeting the MDGs. Second, the

strategy and taking decisive action to

Fund needs to support the preparation

implement these practical steps towards

of an MDG-consistent financing and

operationalising the MDGs, the IMF and the

macroeconomic framework. Next, the Fund

World Bank will make a critical contribution

staff should work not only with the finance

to sustaining and building on the accelerating

ministers of the developing country but also

momentum for achieving the Millennium

their counterparts in donor countries to

Development Goals. The fruit of this labour will

IDEA_PUB_singapour 8/17/06 4:22 PM mobilise the needed financing.

Page 1 be many lives saved and a better world for all.

■

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Development Agenda

Spanning the digital divide The most important issue for developing countries is not their relative lack of high-tech infrastructure, but how they make the most of what they have got.

echnology always plays the starring

in developed ones (where cell phones are

role in economic growth. Prosperity

already ubiquitous).

depends on the introduction of new

DIANE COYLE is managing director of Enlightenment Economics, and led

technologies by entrepreneurs seeking to

But the trouble with analysing ICT needs

offer better products and services at a lower

in terms of these generally depressing

cost, and their wide use by businesses

benchmarking exercises is that it focuses

and consumers. Today’s information and

attention on a single dimension of policy

communications technologies (ICTs) – such

– investment in physical technological

as the internet and mobile phones – hold

infrastructure and devices, such as PCs

out the promise of new opportunities for

and handsets. This narrow focus distracts

businesses to gain access to markets

attention from the all-important question

and customers. So it’s no surprise that

of what to do with the technology when

policymakers in developing countries hope

it is installed, and how to ensure that it

that ICTs can contribute to broad-based

will actually make the economy more

economic development. But how can they

competitive.

ensure that their high hopes are fulfilled? A new framework paper on ICT strategies

the research team which prepared the infoDev report. She is also a

Analysis of the impact of ICTs on

for competitiveness and growth that I

visiting professor at the University

development often takes as its starting point

prepared for infoDev (Information for

of Manchester and a member of

the scale of the digital divide. A comparison

Development), an international partnership

of access to new technologies in different

of bilateral and multilateral development

countries reveals a chasm between rich

agencies housed at the World Bank,

and poor on most indicators. To take the

looks at these broader policy issues. ICTs

example of internet access, developed

certainly can enhance competitiveness

countries have an average of 53 users per

and growth, as the many examples of how

and Growth: Challenges and

100 inhabitants, while developing countries

entrepreneurs and consumers in some

Opportunities for Developing

have only seven. There is no evidence

developing countries have been able to

Countries’, is available at

that the digital divide is narrowing, either

make productive use of mobile phones

www.infodev.org

– with the important exception of mobile

or internet access show. For instance,

phones, where penetration rates are rising

fishermen off Mafia Island in Tanzania ring

much faster in developing countries than

ahead on their mobiles to see where they

the UK’s Competition Commission. The infoDev framework report, ‘Information and Communication Technologies, Competitiveness

120 |

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There is no evidence that the digital divide is narrowing, with the important exception of mobile phones, where penetration rates are rising much faster in developing than in developed countries. will get the best price for landing their catch. The question is which policies can best help make these impacts more systematic, enabling developing countries to make the

“A comparison of access to new technologies in different countries reveals a chasm between rich and poor on most indicators.”

most of the new technologies’ development potential. The detailed answer will vary case by case,

Thus other aspects of physical infrastructure

because the first step in setting an effective

matter too, because they complement

strategy is a realistic assessment of each

ICT use. Electricity supply is one example,

country’s capabilities. The existing ICT

especially when it comes to using ICT in

infrastructure – including key measures such

business, because a reliable power supply is

as international bandwidth, or the scope of

critical for most applications. The transport

the mobile and fixed telephone networks – is

network is also important, because it often

certainly important, but it is not everything.

complements ICT use. For instance, if using

Each country’s competitiveness will also

the new technologies makes firms more

depend on a range of other capabilities, as

efficient and thus enables them to export

well as geographical and historical factors

more, demand for haulage and shipping will

which are beyond the reach of policy.

rise, as will road, rail and port use.

➣ Words into Ac tion

| 121

Development Agenda

country-specific characteristics must play an

“Competition puts pressure on firms to innovate and become more efficient, thus increasing their use of the new technologies which become available.”

important part. An effective ICT strategy must therefore start with a realistic assessment of a range of existing capabilities which will complement use of the technologies. This exercise in

➣

Going beyond infrastructure, human skills

itself might start to suggest policy priorities.

are another key capability. The use of

For example, a strategy centred on the

ICTs involves some specific skills, such as

delivery of the physical facilities for IT-

keyboard familiarity and knowing how to

enabled services is not likely to be a sensible

use standard software, as well as some

priority for a country where too few workers

general ones. Literacy is needed for even

have the literacy and foreign language skills

basic computer use, and some ICT-enabled

required, or where a lack of competition

activities require generally high cognitive

makes overseas calls expensive. Call

skills. The importance of human capital for

centres in some Caribbean countries, such

development is already well-known, but

as Antigua and Grenada, have fallen victim

introducing ICTs is likely to increase the

to high international call charges. But often

need for certain types of skill which are in

it is harder to set policy priorities which

short supply in many developing countries.

take account of the many relationships and feedbacks in an economy. For instance, a

A third important area of capabilities

seemingly small regulatory change can have

which complement ICTs can be put

a big impact on firms’ incentives to invest,

under the general heading of institutions.

which in turn might have an unexpected

Again, it is widely recognised that some

knock-on effect on consumer demand. This

institutions are more likely than others to

kind of virtuous circle, where investment

enhance growth. In the context of ICTs,

stimulates network effects, which in turn

the relevant institutional capabilities will

take consumer demand to a critical point,

include regulatory policies which encourage

seems to have occurred in the case of

competition, for example. This is because

mobile telephones. Certainly, the speed of

competition puts pressure on firms to

diffusion of mobiles in developing countries

innovate and become more efficient, thus

has taken everyone by surprise, not least

increasing their use of the new technologies

the mobile operators and the policymakers

which become available. In general,

who first introduced the relevant licensing

relationships between government, business

changes in the 1990s.

and consumers in the domestic market

122 |

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can either encourage or inhibit the diffusion

Conventional statistical regressions do

of ICTs, as can be seen from the different

not allow us to explore these non-linear

patterns of adoption of the technologies

feedbacks, and although they do give us

in countries which are otherwise similar

some idea of the long-term impact of policy

in terms of income per capita or other

variables on growth, in practice there is

economic benchmarks. A comparison of

rarely enough data to be confident that

PC or mobile-phone penetration rates in the

one policy is clearly preferable to another.

smaller sub-Saharan African economies, for

An alternative approach is to test how the

instance, shows such wide variation that

impact of a policy change works through the

➣

Development Agenda

capabilities need to be matched to its opportunities. As well as looking inward, policymakers need to look outward. While it is widely understood that ICTs have played a key part in restructuring the global economy, the generalisations have become so familiar that it is easy to overlook the type of opportunities which this is actually creating for firms from developing countries.

Capturing more of the value chain The most significant aspect of the global structural change is the splitting of supply chains in manufacturing and, increasingly, in services into ever-smaller links, which can be located wherever in the world each activity can most efficiently be carried out. Different countries are building highly Prosperity depends on the introduction of new technologies, yet many in developing countries still work with decades old equipment, such as these journalists at Mozambique’s Radio Xai Xai.

➣

specialised industries. So far, relatively few developing countries form part of

relationships and feedbacks in a particular

these global chains; the growth in trade

economy. Even qualitative judgements about

and foreign direct investment is heavily

key variables and the strength of the links

concentrated in a handful of countries,

between them are sufficient to place policies

notably China.

in order of effectiveness. The full infoDev report demonstrates this kind of prioritisation

What’s more, developed countries have by

with an illustrative example, but the policy

and large retained the high value-added

rankings will of course be specific to each

activities, often intangible and categorised

country and will depend on their existing

as services. These include R&D, design,

capabilities.

branding and marketing. These activities are located at either end of global production

Even benchmarking existing e-readiness and

chains, at the start in the case of product

adding an assessment of complementary

innovation and design, and at the consumer

capabilities is not the full story about ICTs’

end in the case of advertising and marketing

scope as tools of development. A country’s

(see diagram, below). Although developing

The production chain

R&D Design

High value

124 |

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Inbound Logistics

Higher value

Production

Low value

Outbound logistics, Distribution

Marketing, Market research Brand

Higher value

High value

countries’ share of world production has

efficiency. What options does this leave

climbed significantly, their share of world

businesses from developing countries?

value has risen only a little in ten years, creating a ‘value wedge’ (see chart, below).

As ICTs transform the global production landscape, they are also creating new

For example, some 45% of the retail price

opportunities. One path is for developing-

of a basic imported shirt sold in the US lies

country firms to pursue higher-value activities

in the design, branding and marketing of

through identifying market niches which bring

the product. In the European Union, car

them close to customers in export markets.

makers in the EU-15 countries have tended

Country studies carried out for infoDev

to retain their research, design and branding

document examples of successful – and

activities domestically, while among the new

less successful – attempts by companies

EU member states, the Czech Republic has

to capture some of the value either

become the most important centre for vehicle

‘downstream’ or ‘upstream’ from low-value

assembly, Hungary specialises in engine

manufacturing and processing activities.

manufacture and Poland in gear boxes.

For instance, Jamaican Signature Beats brings musicians from the island directly

Thanks to ICTs, global companies have

into contact with potential American and

been able to reallocate their activities more

European customers through a website as

efficiently. In contrast to the multinationals

well as marketing and promotional activities.

of the 1960s and 1970s, which typically

As well as initiating contact with customers,

sought access to markets or resources

the product – advertising jingles, for example

through FDI, global companies are today

– can be delivered online. A very different

using new technologies to pursue greater

example is Tanzania’s use of technologies

➣

40.00% 35.00% 30.00% 25.00% 20.00%

GDP share Production share

15.00% 10.00% 5.00% 0.00% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 The ‘value wedge’: developing countries’ share of world production and GDP Data source: World Development Indicators

Words into Ac tion

| 125

➣

Development Agenda

➣ such as weather and soil monitoring to

of its manufacturers are using sophisticated

improve the quality of coffee for delivery to

software and communications which give

customers in the US and the EU, although

them a now nearly unbeatable expertise in

it is not yet clear how much this will enable

the logistics of taking an order, sourcing all

producers to boost their margins.

the buttons, zips and so on, manufacturing in large quantities and completing the order

An alternative to seeking access to export

within ten days, or even a week. Often,

markets directly, perhaps in partnership

manufacturers make deliveries straight to

with small and medium-sized companies

the stores of major western retailers, without

located in the destination markets, is to sell

holding any inventory at any stage of the

into the multinational supply chains I have

supply chain.

described. To do so successfully requires an

The existing ICT infrastructure – including the scope of the mobile and ﬁxed telephone networks – is certainly important, but it is not everything.

understanding of these global corporations’

Such an operation requires a lot of ICTs,

strategies. ICTs can allow developing-

ranging from basic communications and

country suppliers to move up the value

web access to electronic data interchange,

chain – either upstream or downstream,

computer-aided design and manufacturing,

or both – from the low-value manufacturing

enterprise flow software, integrated

or processing. Upstream, the first step

point-of-sale feedback and, increasingly,

is likely to be making improvements in

radio-frequency identification tags, which

quality through incremental changes in

are soon expected to be incorporated

processes and delivery speed. The next will

directly into individual garments as they are

be introducing some innovations in both

made. Garment manufacture and delivery

processes and products, and the firm can

operations of this kind are extremely

then aim to move on to more sophisticated

sophisticated and rest on a long period of

R&D. Downstream, a firm can go from basic

accumulated expertise and management

assembly to an active sales effort, product

know-how. It is no surprise that these

marketing, establishing a distribution

manufacturers are able to capture a growing

network and on to developing own-brands,

share of the value in the global supply chain.

advertising and market research. Of course, China’s very successful and There are very few examples of developing

dominant specialisation is a threat to

countries with significant firms that have

textiles and clothing manufacturers from

started along this progression, but some

other countries, especially since the end

ICT-enabled Chinese and Indian companies

of the Multi-Fibre Arrangement (MFA)

do seem to be succeeding in capturing

quotas in 2005. What strategies can

a bigger share of the value added in the

companies in other developing countries

production chain. Consider China’s success

pursue? Chinese firms have a competitive

in the clothing industry.

advantage in the inbound and outbound logistics which lie to either side of the low-

126 |

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Some of the reasons for China’s success in

value manufacturing process. Firms from

world clothing markets are unrelated to ICT,

other countries which wish to move beyond

such as its large pool of suitable labour and

the basic manufacturing themselves can

the economies of scale arising from its big

sensibly look to compete at other stages

domestic market. However, many

of the supply chain.

➣

HowD

Development Agenda

➣

In India and Mauritius, for instance, ICTs are

example is a Ugandan t-shirt manufacturer,

enabling garment manufacturers to develop

which is making do with basic means of

innovative textiles and compete successfully

communication (telephone, fax and dial-up

on design. Broadband internet access is

email) and is struggling with high transport

important, as is computer-aided design

costs and long delays even in getting goods

and manufacturing software, and specialist

to port in Nairobi, but whose key asset is

software for grading patterns and so on.

access to high-quality organic cotton, for

Local craft skill can be a significant asset,

which European consumers are willing to

since traditional designs and handcrafting

pay a large premium. The relevant enabling

are highly valued by developed-country

factor in this case was not ICT at all, but

consumers. Mobile camera phones allow a

simply the relevant intelligence about

company’s representatives to send sample

market demand.

designs from far-flung villages to head office for speedy approval. Another interesting

Shaping an effective ICT strategy is not easy, as these examples demonstrate. Policymakers should beware excessively simple prescriptions, especially those drawn up simply by benchmarking a country’s ICT indicators. This type of descriptive assessment of the digital divide does not offer a useful guide to policy priorities. A prescriptive assessment of ICT needs should depend on the full range of relevant capabilities available in the economy – not just ICT indicators but also other relevant infrastructure, skills and institutions. It also depends on a realistic audit of the opportunities open to firms in domestic and export markets, whether selling directly into overseas markets or indirectly via multinational supply chains. ICTs are changing these opportunities and do offer firms from developing countries scope to move into higher-value activities than most have achieved so far. The infoDev framework report describes one approach to this kind of policy mapping exercise, taking account of the complicated links and feedbacks in any economy. The policy ranking can be surprising, because it is precisely these overlooked complexities which can make some policy interventions much more effective than expected, while seemingly

Literacy is needed for even basic computer use, and some ICT-enabled activities require generally high cognitive skills.

128 |

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more obvious interventions, as we know all too well, can be surprisingly ineffective. ■

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7/7/06

9:32 AM

Page 1

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Development Agenda

“Our Heroes” Migration is often caused by destitution and despair, but it is also making an increasingly large contribution to poor countries’ development.

very year, at Christmas, the

work programmes are a model for what

government of the Philippines

developing countries such as India are

prepares a special welcome for its

seeking to achieve through negotiations at

returning heroes. World-beating sports

the World Trade Organisation, and could

stars? Globe-trotting businessmen? No:

be applied more widely to the benefit of

Filipinos working abroad who are coming

rich and poor countries alike, without all the

home for the holidays. At the airport of the

political and cultural issues which permanent

country’s capital, Manila, prizes are handed

settlement entails.

out to lucky workers. And on Migrant Workers Day, the president awards the

The government reckons that more than 7m

“Bagong Bayani” (modern-day hero) award

Filipinos, or 9% of the country’s population,

to 20 outstanding migrant workers who

work abroad. They sent home $11.6bn

have demonstrated moral courage, hard

in 2004 through official channels – and

PHILIPPE LEGRAIN

work and a track record of sending money

perhaps twice that again unofficially. This

is the author of Open World: The

home. One government minister remarked

money represents at least 13.5% of the

Truth about Globalisation (Abacus,

that “Overseas employment has built more

economy – a more than five-fold increase

2002). His new book, Immigrants:

homes, sent more children of the poor to

since 1990. Remittances (the money that

Your Country Needs Them, will be

college and established more business

migrants send home) typically account for

enterprises than all the other programmes

two-fifths of the household income of those

of the government put together.”

with family abroad. These not only allow

published by Little, Brown in the world outside the US on 2 November.

Filipinos to enjoy a higher standard of living

He a contributing editor to Prospect magazine, a freelance writer for a

Unlike most developing-country

– televisions, home improvements and so

variety of publications such as the

governments, the Philippines’ actively

on – they also fund greater investment in

Financial Times, the Guardian, The

encourages its citizens to go work abroad.

education and enterprise. Studies show

New Republic and Foreign Policy, and

It tries to place workers overseas and also

that as migrants earn more, they send more

a commentator for BBC TV and radio

licenses and regulates private recruitment

money home – and that this extra income

agencies to do so. Migrants typically go

allows kids to stay longer in school, reduces

on globalisation. He blogs at www. philippelegrain.com. He was previously

work on two-year contracts that are usually

child labour and enables local people to

trade and economics correspondent

open to renewal, primarily in Saudi Arabia,

start new businesses, such as taxi services

for The Economist and special adviser

but also in Hong Kong, Taiwan, Singapore,

and dressmaking. Remittances really came

to World Trade Organisation director-

Japan and the US. They tend to go alone

into their own during the Asian financial

because they are not permitted to bring

crisis of 1997 when the Filipino currency

family members with them. Such temporary-

collapsed and the economy went into a

general Mike Moore.

130 |

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In poor countries, people’s incomes are often volatile as well as low. One year there is a bumper harvest, the next year the crop fails. tailspin. Receipts from workers abroad helped cushion the blow, as migrants sent home extra cash to help their hardup relatives and because the value of their dollar remittances was now higher in devalued Philippine pesos.

“As migrants earn more, they send more money home – and this extra income allows kids to stay longer in school, reduces child labour and enables local people to start new businesses.”

The government encourages migrants to go work abroad through official channels rather

loans through a government body called the

than illegally by offering them subsidised

a Overseas Workers Welfare Administration

benefits, such as training on social and

(OWWA). The government has also made

work conditions abroad, life insurance and

it easier for migrants to send money

pension plans, medical insurance and tuition

home cheaply and easily through private

assistance for migrants and their families,

banks, and even offers tax-free investment

as well as pre-departure and emergency

programmes aimed at overseas workers.

➣ Words into Ac tion

| 131

Development Agenda

➣

The OWWA also helps returning migrants

scarce highly-skilled graduates is viewed

make the most of the savings and foreign

as particularly worrisome. Certainly, if

know-how they have accumulated. Edgar

African countries lose the few doctors

Cortes worked as a casting operator

they have, they will suffer – although since

overseas for fourteen years. When he

governments do not own their people,

returned home, he set up a company to

preventing people from emigrating would

make aluminium side-wheels for tricycles,

grossly violate their human rights. But for

using his savings – and a 100,000 peso

the most part, emigration is a boon for

loan from the OWWA – to buy the machines

developing countries. It can boost the

and tools he needed. His shop, in one

wages of those who remain, while the

of Manila’s most depressed areas, now

money that migrants send back reduces

employs four people. Sotero Owen was a

poverty and can contribute to development.

welder in Saudi Arabia until a hefty pay cut

The Mexican government has started calling

made him decide to return home. With his

its citizens who work in the US “heroes” or

wife, he set up a loom-weaving operation in

“VIPs” in recognition of the huge financial

Baguio City with the support of loans from

contribution their remittances makes to the

OWWA. With income from his business, he

national economy. When migrants return,

has been able to see his children and two

as many do, they bring back the know-how

nephews and nieces through college. He

they acquired in rich countries. Half of the

was also able to build his house and buy

Turkish migrants who return from Germany

a five-hectare property, on which he has

start their own company with money saved

started to farm.

abroad within four years of returning home. In the case of highly skilled workers, such

Mixed feelings

as the Indian internet entrepreneurs who

Most developing-country governments

have returned from Silicon Valley to set up

have mixed feelings about emigration. The

world-beating companies in Bangalore, the

departure of workers overseas is often

circulation of brains from poor countries

seen as a sign of failure, and an exodus of

to rich ones and back can bring huge benefits. In fact, migration could do more to boost the economic prospects of many developing countries than overseas aid or foreign investment. Estimates of how much money developing countries receive from their citizens working abroad vary. But even according to officially recorded flows, remittances are huge – totalling $167bn in 2005, according to World Bank estimates. Including unrecorded flows, the true figure may be more than 50% higher, the World Bank reckons, or as much as three times higher, according to the Global Commission on International

Remittances can transform the lives of poor people for the better: They give farmers and small business people access to precious funds that help them set up and expand their business.

132 |

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Migration. Of that official total of $167bn, $45bn went to low-income countries such

➣

Development Agenda

➣

as India, $88bn to lower middle-income

underestimate the true figures, remittances

countries such as China and the Philippines

are arguably by far the biggest transfer from

and $33.8bn to upper middle-income

abroad that poor countries receive.

countries such as Mexico and Poland. The top developing-country recipients in 2004

In 20 developing countries, official remittances

were India ($21.7bn), China ($21.3bn) and

account for over a tenth of the economy.

Mexico ($18.1bn).

The small Pacific island of Tonga tops the list: nearly a third of its economy comes

134 |

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The $160bn that migrants sent home

from migrant’s remittances. In 36 countries,

in 2004 is over twice the $79bn that

remittances in 2004 were larger than public

developing countries received in aid from

and private capital inflows combined –

rich-country governments. It is also almost

government aid, foreign direct investment and

as much as the $166bn of foreign direct

net foreign purchases of bonds and shares.

investment – spending by foreign companies

They were larger than total merchandise

on factories, equipment and offices – which

exports in 12 countries or territories, and

developing countries received. And it is

larger than the earnings from the biggest

more than the $136bn of net purchases of

commodity export in another 28 countries.

developing-country bonds and shares by

In Mexico, remittances are larger than foreign

foreign investors. Since the official flows

direct investment; in Sri Lanka, they are worth

more than tea exports; and in Morocco, they bring in more money than tourism. Even better, remittances are rising fast. They are up by nearly three-quarters since 2001, with more than half of that increase

“Remittances from migrants were larger than total merchandise exports in 12 countries or territories, and larger than the earnings from the biggest commodity export in another 28 countries.”

occurring in China, India and Mexico. Of the 34 developing countries that received more than $1bn in remittances in 2004, 26 have

just been hit by a disaster like a crop failure,

notched up an increase of more than 30%

they should surely spend the money on

since 2001.

immediate consumption rather than invest it.

These official figures do not count the

Critics also point out, rightly, that those

money that is transferred through informal

who migrate to rich countries are rarely the

operators, or suitcases of cash carried by

poorest in society – because the poorest

travellers. Obviously, it is very hard to know

can’t afford to move and lack even basic

how much money is transferred in this way,

skills, such as being able to read and write

but it is likely to be a lot. The World Bank

– so that remittances may not help the

estimates, for instance, that less than half

worst off. But in fact, some very poor people

of the money sent to Bangladesh – and only

do move and even the relatively better off

a fifth of the money sent to Uganda – goes

people who do migrate are poor by Western

through official channels.

standards. Their remittances, moreover, benefit not just their friends and families but

Remittances and poverty

the local economy too, including the very

The beauty of remittances is that, unlike

poorest people. According to one estimate,

government aid, they end up directly in the

each dollar sent home by Mexicans boosted

pockets of the people they are trying to help.

the local economy by $2.90 thanks to this

When they are spent in the local economy

multiplier effect.

or used to set up small local businesses, they benefit the local community more

Study after study shows that remittances

generally. Critics claim that remittances do

can transform the lives of poor people for

little good to poor countries because they

the better. They alleviate poverty. They help

are frittered away on consumer goods such

cushion the blow, in countries where there

as televisions rather than being invested

is typically no social insurance, of potentially

more productively. For a start, that’s not

devastating events like a farmer’s crop

true: some of the money is spent, some

failing, or a worker losing his job or falling ill.

is invested. But in any case, what’s wrong

They give farmers and small businesspeople

with consumption? If poor people prefer to

precious access to funds that help them set

spend their money on a television, then it’s

up and expand their business. And they are

up to them. Privileged Westerners, who all

often spent on education and health, which

have televisions and video recorders, should

is good not just for the recipients but for the

not be criticising poor people’s perfectly

economy’s development in general.

valid spending choices. Moreover, if remittances are sent to poor people who are

Start with the impact on poverty. The World

struggling to put food on the table, or have

Bank has calculated what would happen to

➣ Words into Ac tion

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Development Agenda

➣

poor people’s incomes in a cross-section

because they generally have few assets to

of 37 developing countries if remittances

sell, or borrow against, to tide them through

dried up. It found that in the countries where

bad times, and because governments

remittances account for a large share of the

rarely provide any kind of social insurance:

economy – 11% of GDP on average – they

no unemployment benefits, no handouts

cut the poverty rate by a third. And even

to needy families, no sick pay, disability

in countries which receive relatively small

allowance or free healthcare. People often

amounts from migrants – 2.2% of GDP on

have to rely on their extended family as a

average – remittances can cut the poverty

form of social insurance, but this is of little

rate by nearly a fifth. Since the true level of

use if the whole community is hit by drought

remittances is probably much higher than

or a currency crisis.

the official figures, their impact on poverty is likely to be even greater.

Remittances help cushion the blow in several ways. They can provide poor people with a basic minimum when other sources of income dry up. They allow poor people to save more to tide them over bad times. And they can actually offset an unexpected

financial blow: migrants typically send more

money home if they know that their family

has fallen on hard times. For instance,

when Jamaica is hit by hurricane damage,

-9

migrants tend to send home an extra $25

for every $100 in damage suffered, thus

#-9

insuring local Jamaicans against a quarter

of their losses. People in poor countries are rarely able to borrow. But by providing a stable source of In Mexico, remittances are larger than foreign direct investment.

income, indeed one that typically rises when they need it most, remittances increase poor

Remittances also help protect poor people

people’s creditworthiness, because lenders

from harmful events from which people

perceive that they are more likely to be

in rich countries are largely insulated. In

able to repay their debts, allowing them to

poor countries, people’s incomes are often

borrow when they need to.

volatile as well as low. One year there is a

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Words into Ac tion

bumper harvest, the next year the crop fails.

When the recipients have incomes above

One year the price of copper soars, the next

the minimum needed to survive and when

it plummets. One year the economy grows

they have not just suffered an economic

in leaps and bounds, the next a financial

calamity, remittances tend to be channelled

crisis destroys people’s savings and throws

more into savings and investment than other

millions out of work. Illness and crippling

sources of income. In El Salvador, which

accidents are also much more common

experienced massive emigration during

than in rich countries. What’s more, people

its civil war in the 1980s, the children of

in poor countries are particularly vulnerable,

families that receive remittances are much

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Development Agenda

of Boston, Massachusetts, where a large community of Mirafloreños now lives. Even while they are abroad, many migrants increasingly remain intimately involved with life back home. The largest Dominican agency in New York, Alianza Dominicana, which mainly provides social services to immigrants, also helps out with emergency relief when disaster strikes in the Dominican Republic. When the town of Jimaní was flooded in 2004, and over 700 people died or disappeared, the Alianza channelled aid from the US through local churches, bypassing the often corrupt government authorities. People in poor countries are rarely able to borrow, so projects such as the DONGA women’s project in Benin are important for funding income generating activities like trade & agriculture.

➣

These are not just isolated examples of

more likely to remain in school. Perhaps

immigrants’ charity. Across the US and

because the income from abroad is more

Canada, migrants have set up thousands

regular, or because the sender earmarks it

of “hometown associations” and other

for kids’ education, remittances do not just

similar grassroots organisations over

make families better off: compared with an

the past decade, to help development

equivalent increase in income from other

projects in their home towns, mainly in Latin

sources, they have a disproportionately

America and the Caribbean. France has a

large impact – ten times as much in urban

thousand or so “organisations de solidarité

areas – on children’s chances of remaining

internationale issues de migrations”

in school. Remittances really can make a

(international solidarity organisations

huge difference.

stemming from migration, or OSIMs), and there are similar groups in Britain, such

Hometown associations

as the Sierra Leonean Women’s Forum,

The Miraflores Development Committee,

which provides food and clothing for people

which was set up to improve living

back home. Hometown associations can

conditions in a small town on the southern

make a huge difference: their donations are

coast of the Dominican Republic, has

often greater than the municipal budget for

made all sorts of improvements to local

public works. “Towns with a home town

life. It has paid for an aqueduct, providing

association abroad commonly have paved

residents with a reliable water supply for the

roads and electricity. Their soccer teams

first time. It has funded renovations to the

have better equipment, fancier outfits, and

village school, health clinic and community

perhaps even a well-kept field where they

centre. It is also paying for a funeral home

practice,” one study found.

and a baseball stadium. Where is this

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strikingly successful example of community

Some hometown associations are moving

development based? Not in the Dominican

beyond social projects and humanitarian

Republic, but in Jamaica Plains, a suburb

aid to investing in economic infrastructure

and community businesses – and

as fast-food delivery, software and video

developing-country governments are

stores, selling and renting mobile phones,

forming partnerships with them to leverage

based on ideas and skills they had acquired

their benefits. For instance, under Mexico’s

there. Meanwhile, Salvadoran businesses

3-for-1 programme, started in 1997, local,

have come to see the large immigrant

state and federal governments all contribute

community in the US as a big new market.

one dollar for every dollar of remittances

The Constancia Bottling Company, a beer

sent to a community for a development

and soft drinks firm, has set up a plant in

project. Thanks to the 3-for-1 programme,

Los Angeles to cater to the needs of the

Las Animas, a farming village of 2,500

“hermanos lejanos” (distant brothers, as

people, obtained a $1.2m drinking water

Salvadorans call emigrants). Others sell

and drainage project with $300,000 in club

Salvadoran newspapers and the latest

contributions.

CDs and videos, or transfer goods and remittances across countries.

Globalisation from below Most globe-trotting executives work for investment banks, management consultancies or big multinational companies. But much humbler migrants are increasingly taking advantage of cheaper

“Some hometown associations are moving beyond social projects and humanitarian aid to investing in economic infrastructure and community businesses.”

transport and communications to commute between countries too. Their to-ing and froing is creating new businesses and trade

But are such enterprises more than just

links that span several countries: a kind

interesting anecdotes? When Alejandro

of globalisation from below. For instance,

Portes of Princeton University and others

the Otavalan indigenous community from

surveyed over 1,200 Colombian, Dominican,

the highlands of Ecuador have taken to

and Salvadoran family heads in Los

travelling abroad to market their colourful

Angeles, New York and Washington DC,

ponchos and other woollens in major

they found that transnational businesses

European and North American cities. Some

were increasingly common – especially

have settled abroad, but they still earn a

among immigrants who had been abroad

living by running garment workshops in their

for a long time, presumably because they

home town in Ecuador, to which they travel

had accumulated enough capital, know-how

regularly and from which they source their

and contacts to get their businesses started.

clothes. In short, migration has allowed the than being constrained by their smaller and

Macroeconomic impact of remittances

much poorer local one.

Remittances can do more than just alleviate

Otavalan to access the global market rather

poverty and contribute to local development, The Otavalan are not the only ones whose

they can also bring wider benefits to the

businesses straddle different countries

economy as a whole. One study of 13

– or even continents – just as much larger

Caribbean countries found that when the

multinational companies do. In the mid-

economy shrank by 1%, remittances tended

1990s, Dominican immigrants returning from

to rise by 3% over the next two years.

the US pioneered new businesses, such

Much as rich-country governments boost

➣ Words into Ac tion

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Development Agenda

➣

spending in recessions to help stabilise

doubt whether they will be repaid. But

the economy – through public works

by providing a steady stream of foreign-

programmes, and because unemployed

currency earnings, remittances can improve

and needy people receive welfare benefits

a country’s creditworthiness, allowing it

– remittances can have a similar stabilising

to borrow more at lower interest rates.

effect in poor countries.

Developing-country governments are now even able to borrow using their country’s

Many poor countries find it hard to borrow

expected future remittances as collateral.

abroad because their foreign-currency

Mexico was the first to do so in 1994, and

earnings are so small or volatile that lenders

since then such “securitisation” has taken off. Between 2000 and 2004, Brazil, Turkey, El Salvador, Kazakhstan, Mexico and Peru together raised a total of $10.4bn. Even the poorest countries, which receive $45bn in remittances a year, could eventually tap this relatively cheap form of finance, giving them the opportunity of faster growth. The biggest potential prize is that remittances could boost long-term economic growth. Putting kids through school and paying for them to see the doctor benefits the economy as a whole, because healthier, better-educated workers are more productive. If recipients of remittances start up new businesses or invest more in existing ones, this can provide new jobs and boost growth. Of course, it is very hard to disentangle the precise impact of remittances on economic performance. But by looking at a sample of 73 countries between 1975 and 2002, Paola Giuliano and Marta Ruiz-Arranz of the IMF find that in countries with rudimentary financial systems where borrowing is difficult and costly, remittances allow people to bypass these problems, invest more and more wisely, and thus increase economic growth. If remittances increase by one percentage point of GDP, growth rises by 0.2 percentage points. So in a country where official remittances amount to a tenth of the economy, economic growth is boosted by 2 percentage points a year. That

Remittances can transform the lives of poor people.

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is not a prize to be sniffed at.

■

Development Agenda

The missing link The importance of entrepreneurship to development is worryingly under-appreciated.

i monumentum requiris, circumspice

Look around at just about any product you

– if you seek a memorial, look

use. Where does it come from? We tend

around. Sir Christopher Wren’s

to take things for granted, and not think

epitaph in St Paul’s Cathedral, which

about the individuals and institutions that

he designed, could equally apply to

make them possible. Often, it is hardest to

entrepreneurs in a market economy, as

see what is in front of your nose. Consider,

the Austrian economist Ludwig von Mises

for example, the computer which I used to

pointed out. Look around at all the wealth,

write this article. My tiny laptop has more

health, resources, technologies and

computing power than most countries

opportunities. They were not conjured out of

had 40 years ago. It performs in seconds

thin air, they were created by innovators who

calculations that have would taken hundreds

dared to imagine a different world – and set

of years with a pen and paper.

about creating it. Think about pioneers – people such as Steve It is easy to forget how fast the world has

Wozniak, Steve Jobs and Bill Gates – who

changed. Only a few generations ago, living

came up with the ideas and business models

conditions in today’s wealthiest countries

which have cut the cost of computing power

at www.johannorberg.net. He has

were worse than those in the poorest

by a factor of around a million in a few

an MA in the history of ideas from

countries are now. No cars, no trains,

decades. And how did the laptop get to me

JOHAN NORBERG is a Swedish author, who also blogs

no planes; no phone, no email, not even

this cheaply? By ship, thanks to Malcolm

Senior Fellow at the Centre for the

electricity; no running water, no indoor

McLean, a truck-driver from North Carolina,

New Europe and. His books cover

sanitation, no antibiotics. We stand a better

who in the 1950s came up with the idea

chance of reaching retirement age than

to load wheel-less containers onto ships

the University of Stockholm and is a

subjects such as human rights,

people in previous eras had of experiencing

and hoist them onto waiting trucks, thereby

liberalism. His book on globalisation,

their first birthday. My ancestors in mid-

reducing loading costs by over 97%. What’s

In Defence of Global Capitalism, has

19 century Sweden were starving. Back

more, the computer and its components

been translated in 24 countries. He

then, Scandinavia was poorer than Congo

travelled smoothly trough the logistics chain

has just completed a new book on

is today, while average life expectancy was

thanks to bar codes, invented by Jerome

only half, and infant mortality three times,

Lemelson in the 1950s after he realised that

the current developing-country average.

visual information could be read by a video

In the thousand years to 1820, average

camera and the signal then converted into

incomes in the world rose by no more than

digital information.

economic freedom and the history of

entrepreneurship, When Mankind Created the World.

half; since then, when innovators have

142 |

Words into Ac tion

been set free to create, incomes have risen

Give a thought too to the pioneers whose

ten-fold.

incremental ingenuity led to the outsourcing

of the production, metals and plastic my computer is made from. Not even “natural” resources are natural in any meaningful sense. To explore, exploit and renew them requires creativity and hard work, as many governments that have nationalised resource industries have discovered to their cost. We are all indebted to people such as McLean and Lemelson who saw new opportunities and took the risk of exploring them. The people who find new markets, create new products, think through a new way of handling a commodity commercially, organise work in a novel fashion, use new technology or transfer capital to a more productive use. The entrepreneur is an explorer, who ventures into uncharted territory, finds exotic new places, and opens up new routes along which many others subsequently travel. Without them, the world as we have come to know it would scarcely exist. In the past 100 years, we have created more wealth than in the previous 100,000 – even though people in the West now spend only half as much time working. It is because new ideas have made it possible for us to work smarter, and find easier ways to satisfy our needs and demands. Now that one man with a modern combine-harvester can reap and thresh as much grain in six minutes as 25 people could in a whole day in pre-industrial times, everybody can afford food and 24 men are freed to solve other problems and meet other demands.

The elephant in the room Joseph Schumpeter conceived of entrepreneurs as revolutionaries who destroy the old by creating the new. Yet

➣

The entrepreneur is an explorer who ventures into uncharted territory, finds exotic new places, and opens up new routes along which many others subsequently travel.

Words into Ac tion

| 143

Development Agenda

reducing poverty? Well, perhaps not, but that is of little help. In Ancient Egypt, nobody denied that the world had more than two dimensions, yet traditional art did not have room for perspective. Everyone worked within the existing paradigm, so that artists never really explored the real world, and how to interpret it realistically. The same is true in modern economics. The neo-classical mathematical descriptions of economic activities don’t have room for disruptors, innovators and revolutionaries. Entrepreneurs are everywhere – except in economic textbooks. Economists describe the wealth created when capital, labour and natural resources are combined, but make it seem as if they Certainly a lack of education and dismal institutions destroy opportunities, and aid, properly used, can help deal with these problems. ➣ many pioneers innovate through small,

just happened to meet in the lift one day, and got to work, since the person who connects them is nowhere to be seen.

ongoing attempts to reduce inefficiencies

The standard theories study equilibriums,

and find more practical ways of connecting

whereas the entrepreneur is the person

possible supply with potential demand.

who upsets equilibriums, or profits from

Perhaps the person who opened the store

turning disequilibrium into something that

where I bought my computer, and the Geek

approaches it. The theories study the

Squad, who visit my home to fix my laptop

supply of, and demand for, existing goods,

when the hard-drive crashes, are more

whereas the entrepreneur introduces new

representative of most entrepreneurs.

goods to the market. The theories study standard firms’ repeat decisions, whereas

This is more like Israel Kirzner’s perspective

the entrepreneur creates growth through

of entrepreneurs as the oil that greases the

unpredictable new decisions. As William

machinery of the market: individuals who

Baumol, one of the economists who has

see potential demand and therefore try

studied entrepreneurship and innovation

to supply it. But in my mind, Schumpeter

most, points out: “The entrepreneurial

and Kirzner are like the blind travellers who

mechanisms underlie continuous industrial

touched the trunk, a leg and the side of

evolution and revolution, and surely are not

an elephant, and described it as a snake,

the stuff of which stationary models are

a tree and a wall respectively. They have

built.”

all informed our world view by describing particular aspects of the same entrepreneur.

It’s like the old story about the lamp post. You might not have dropped your car keys

144 |

Words into Ac tion

So what? Don’t we know this by now?

under it, but you look there anyway, because

Does anyone deny the importance of

it’s the only place which is well-lit enough for

entrepreneurs in creating wealth and

you to look for them. That is one reason why

➣

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Development Agenda

In the slums of Nairobi, to get a permit to sell bread legally would need the signatures of 13 different bureaucrats.

“History shows that countries aren’t lifted out of poverty, they rise out of poverty, by liberating the creators and innovators back home.”

about entrepreneurs’ fundamental role in economic activity, they have to turn to glossy business magazines.

The developers So economists see market failures

➣

I think that economic history has been more

everywhere, but miss the entrepreneur

fruitful than economics in the last decades:

who also notices those inefficiencies, but

it sheds some light on the place where the

conceives of them as profit opportunities.

keys were really dropped. You can build a

This blind spot has distorted the debate

model without creators and innovators, but

about globalisation and development. Both

you can’t write history without them.

sides discuss how low-income countries are to be lifted out of poverty, either through

Dan Johansson, a Swedish economist,

vast aid projects or through huge foreign

has studied the most frequently used

investment. Think about the wording: who is

textbooks in Swedish PhD courses. Of 19

supposed to “lift them”? History shows that

books, only two included a reference to

countries aren’t lifted out of poverty, they

“entrepreneurs”, and one used it merely as

rise out of poverty, by liberating the creators

a synonym for borrower, to explain the loan

and innovators back home. Of course, poor

market. Most of these books are written by

countries make use of technologies that

American economists and are used in PhD

were created abroad, but they also have to

programmes worldwide, so the result is not a

adapt them to their own circumstances.

Swedish aberration, according to Johansson.

146 |

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If future economists in universities, politics

Certainly, disease, a lack of education and

and multinational institutions want to read

dismal institutions destroy opportunities, and

➣

8,000

34,192

executives representing 2,000 companies working in countries on Executive Education programmes

alumni in 160 countries

120

887

143

MBA participants of nationalities

resident faculty and 84 visiting faculty representing countries

Executive MBA participants of nationalities

Asia Campus Singapore Tel: +65 67 99 53 88 imf@insead.edu Europe Campus www.insead.edu

France Tel: +33 (0)1 60 72 40 00 imf@insead.edu

PhD students of nationalities

Development Agenda

➣

aid, properly used, can help deal with these

of risk-takers and problem-solvers. Without

problems. But massive transfers of capital to

them, you can import successful solutions,

very poor countries have also made it more

investments or aid projects, but you can’t

profitable for potential innovators to pursue

make it self-sustaining and self-generating.

a career in politics or bureaucracy than in

It’s akin to the difference between copying

business.

the correct solution to some mathematical problems and fostering a group of mathematicians who can use their talents

“Big investors can push countries to open up particular sectors, but potential future entrepreneurs don’t form pressure groups.”

to deal with unforeseen problems. Many kinds of rules and regulations limit the freedom to develop businesses and business models in developing countries, but most destructive are those that limit the right to do business generally, such

The Washington Consensus was right to

as licensing requirements, a lack of

point out that poor macroeconomic policies

property rights and the absence of the

can do great harm, but even with low

rule of law. This should be the focus of the

inflation and a balanced budget countries

development debate today – not to solve

can stagnate. Driving carefully is important,

problems, but to liberate those who solve

but it does not ensure that you move in

problems.

the right direction. Opening up to foreign investment and trade is also essential, but

In a global economy governments have to

if this is the only liberalisation that occurs

pay constant attention to macroeconomic

in a very unequal country with a privileged

indicators – because capital would

class of businesspeople, it tends to create

otherwise flee – but they don’t have the

new opportunities principally for those who

same pressure to deal with these kinds of

already have big businesses and political

microeconomic constraints. Big investors

connections.

can push countries to open up particular sectors, but potential, future entrepreneurs

No country will prosper unless it uses the

don’t form pressure groups.

creative resources of its entire population.

148 |

Words into Ac tion

Otherwise, new ideas and different solutions

Fortunately, we are starting to see a new

will be limited to the small group who

focus on how these types of regulations

already think alike and work within the old

hurt, partly inspired by the Peruvian

system. It was not the presence of big

economist Hernando de Soto, who has

businesses that made Europe and America

highlighted the thriving economic activity

rich, it was the fact that a couple of guys

in the informal sector, and pointed to the

with nothing but a great idea and a garage

benefits of legalising it. Thanks to the World

were allowed to succeed and create new

Bank’s annual Doing Business report,

companies, competing with the old. This

we now have a decent set of data about

not only increases wealth and keeps the

such obstacles in different countries.

establishment on its toes, it creates a large

Unfortunately, there is a lot to measure.

group of people obsessed with finding

Most of the world’s population is left outside

challenges and solving problems – a class

the legal market.

➣

Development Agenda

Poor countries are filled with entrepreneurs and people who work hard: Mark Shuttleworth became a billionaire at 25 when he sold his IT company and his achievements were honoured with a parade through Cape Town.

➣

150 |

Words into Ac tion

It often surprises people that poor countries

of Nairobi, I met Pamela, who sold bread

are filled with entrepreneurs and people

to her neighbours. To get a permit to do

who work hard. The streets of Kenya’s

so legally she would have needed the

capital, Nairobi, are thronging with young

signatures of 13 different bureaucrats. That

people selling food, music and clothes.

would have taken her at least two months

There is plenty of activity and energy,

and cost her half a year’s income in official

but unfortunately much of it has to be

fees – not to mention the cost of bribes. And

devoted to avoiding regulation, corruption

if you are not sure whether you will be able

and dealing with the legal vacuum of the

to feed your children next week, how would

informal sector. On one corner in the slums

you be able to save that much?

In a healthy economy you start a business because you want to get rich. In a regulated economy you have to be rich to start a company. Since Pamela doesn’t have a permit, she

“The entrepreneur looks upon the world with a certain focus, paying attention to challenges, and therefore becomes a serial problem-solver.”

is at the mercy of the authorities. She has to hide from law enforcers, and therefore also from potential customers. She can’t get a loan and can’t expand her business.

revolutionise an industry always start life

It’s dangerous to trade with strangers, since

as a minority view, considered stupid or

she can’t go to the police if contracts are

dangerous by the majority.

broken. Since she works outside the law, the authorities can demand bribes to leave

China’s rapid economic development is

her alone. The sarcastic joke in the slums is

largely a creation of foreign investment in

that it is dangerous to carry large amounts

the export industry. Even though private

of cash – because there are too many

businesses now have much greater

policemen.

freedom, there are few examples of small private Chinese companies that have grown

The biggest problem with the informal

to be successful world-class companies.

economy is rarely mentioned. It is that the

The heavy hand of the state makes it difficult

underground entrepreneur sticks to what

for the creative, rule-breaking spirit of the

is known to her – her own neighbourhood,

entrepreneur to thrive. Small companies

customers and original line of business.

find it harder to get capital from the state-

But as history shows, many of the most

controlled capital market, outsiders find it

successful entrepreneurs started in

more difficult to get the freedom to develop

one business, but then noticed bigger

their business models, and if a company

opportunities elsewhere and changed

competes too vigorously against the rulers’

tracks. For example, several courier services

friends or relatives, it could suffer.

were started by businesspeople dissatisfied with the reliability of their existing delivery

One exception is Lenovo, which bought

service. The entrepreneur looks upon the

IBM’s personal-computer division in 2004.

world with a certain focus, paying attention

Created in 1984 by 11 engineers who

to challenges, and therefore becomes a

didn’t think that the university gave them

serial problem-solver. But if they are stuck in

room to develop their visions, it was the

familiar territory, their talents may be wasted.

first Chinese company to build a brand via advertising. And they constantly followed

But even if people can overcome such basic

their own goals, rather than those the

obstacles and start their own businesses,

government chose for them. Staff incentive

overbearing government may subsequently

systems were introduced that were illegal at

stifle them. By preventing entrepreneurs

the time, and the company used Western

from developing their own visions and

technology instead of relying on the

ideas, governments impede the process of

Chinese components the state wanted it to.

trial and error which all progress is based

Lenovo is now the world’s third-biggest PC

upon. Remember that the new ideas which

manufacturer.

➣ Words into Ac tion

| 151

Development Agenda

The streets of Africa’s capitals, are thronged with young people selling food, music and clothes.

➣

Lenovo succeeded, but how many have the

dependence on us – or do we give people

courage and perhaps the political protection

opportunities to solve problems themselves?

to think differently in an economy where the government always has the last say?

Rulers and analysts may struggle to change their way of thinking. But they would benefit

The chimpanzee in the cage

from embracing entrepreneurship. The

Perhaps we should pay a little less attention

evidence from economic history as well as

to our textbooks, and a little more to history

evolutionary psychology clearly shows that

and all the innovations and wealth that

we all have something of the entrepreneur in

surround us. We might then realise how

us. We should nurture our natural curiosity

essential the entrepreneur is to economic and

and creativity rather than stifling it.

social development. Then we might grasp

152 |

Words into Ac tion

that we have a responsibility to promote

In a classic experiment, a chimpanzee in a

entrepreneurship as much as possible,

cage tried to reach a banana. After a long

to remove obstacles to it domestically,

struggle, it realised that it could rake the

and consider how our efforts to help poor

banana into its cage by fitting two hollow

countries may harm entrepreneurship

sticks together. This discovery caused the

there. Do we try to solve problems – and

monkey such pleasure that it kept repeating

thus perhaps entrench poor countries’

the trick, and forgot to eat the banana.

■

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Reforming Global Governance

Fixing the Fund The IMF is more accustomed to dictating reforms than conceding them, but Asian countries’ efforts to provide their own financial insurance are forcing the Fund to change its ways in order to stay in business.

he International Monetary Fund held

in some cases. Hungary’s current-account

its spring meetings in April fighting

deficit, for example, will exceed 9% of GDP

to dispel the impression that it was

this year, the Fund reckons.

obsolete. Even one of its own deputy governors – Mervyn King, the head of the

A dangerous sport

Bank of England – pronounced the institution’s

Perhaps surprisingly, the IMF blames

remit unclear, its role obscure. Imperious,

the recent market volatility in part on the

incompetent, indulgent – the IMF was used to

success of its spring meetings. The April

being called all of these things. But irrelevant?

communiqués issued by the G7 finance

That was a new and chilling charge.

ministers and by its own International Monetary and Financial Committee

Yet only a few months on, as the Fund

apparently drew fresh attention to the

SIMON COX

embarks on its annual meeting, the mood

dangers posed by America’s vast current-

is Economics Correspondent

is rather different. For that it should thank

account deficit. Bad for the markets, this

for The Economist in London.

the financial markets as much as its own

renewed concern has proved good for

He joined the paper in 2003,

efforts to reinvent itself. Between 8 May and

the institution. The Fund has been invited

after studying at Cambridge,

13 June, emerging-economy stock markets

to resume its initial role as a provider

lost a quarter of their value. Spreads on

of the “machinery for consultation and

of Economics. He now covers

emerging-market bonds remain tight, but

collaboration” between the big economic

the IMF, the World Bank and the

Harvard and the London School

whereas investors once seemed gripped

powers, as they decide what, if anything,

WTO, as well as contributing to

by an indiscriminate appetite for such risky

to do about the growing imbalances in the

the Economics Focus column.

securities, they now appear pickier.

world economy. It has begun what it calls “multilateral surveillance” of a group of

This new edginess in global markets has

countries – China, the euro area, Japan and

reminded everyone of two important truths

Saudi Arabia, as well as the United States

which the IMF’s premature obituarists had

itself – which, it hopes, can together resolve

tended to neglect. Not every developing-

the key macroeconomic issue of our time.

country government has more foreign-

154 |

Words into Ac tion

exchange reserves than it knows what to do

The IMF’s bosses are quite taken with their

with; and not all of them are net exporters

new role, however thankless it may seem.

of capital to the rich world. Although capital

Perhaps they are just grateful for an invitation

may be “running uphill” from many poor

to the high table of economic statecraft.

countries, the flow is very much downstream

When the leading powers last mounted a

collective response to an overvalued dollar – at New York’s Plaza Hotel in 1985 – the Fund’s managing director was not invited to the meetings or even told about the accord until the day before it was signed. As the IMF’s historian, James Boughton, has put it, the world’s pre-eminent monetary institution “participated only at the pleasure of the countries’ officials and had no real standing to guide the process”. (It did provide some handy figures, however.) Could the Fund do any more this time round? In a speech in New Delhi earlier this year, Mervyn King urged it to act as an “umpire” of the international monetary system. Its powers to rule against the various players would, of course, be limited. But, as in a genteel game of cricket, it could perhaps rely on the batsmen to declare themselves out, if gently

An IMF team meets a senior tax official and his staff in Afghanistan. The Fund provided the equivalent of 356 person-years of technical assistance in 2003.

reminded of the rules of the game. Yet both are proving remarkably persistent. King’s metaphor no doubt appealed to his

The Fund was founded to help Europe cope

Indian hosts, for whom willow and leather

with the large trade deficits which it was

are sacred. But exchange-rate politics is

expected to run as it struggled to find its

not cricket. If a sporting analogy is required,

feet after the Second World War. Its voting

sumo wrestling might be more apt. The two

structure still reflects those origins. As critics

giants of China and America are grappling

have pointed out, Italy, Belgium and the

at close quarters. For the moment, each is

Netherlands together have more votes on

propped up by the other’s vast bulk. But

the IMF’s board (7.76%) than China, India

that fragile equilibrium might not last. The

and Brazil combined (6.27%). Why should

Fund is brave – some would say foolhardy

Turkey heed the Fund’s sermons, when its

– to step between them.

representation at the IMF (0.45%) falls far short of its weight in the world economy

183 Luxembourgs

(0.57%, at market prices)? Can the IMF

America’s deficit is not the only imbalance

serve as an even-handed umpire between

that the IMF seems keen to resolve. In

America and China when the first casts over

his strategic review, Rodrigo de Rato, the

17% of the votes in the institution and the

Fund’s managing director, noted that the

second less than 3%?

gross inequities in the institution’s voting system were equally troubling to many.

A member’s “quota” simultaneously determines

“Neither imbalance is sustainable,” he wrote.

how much it must contribute to the Fund’s

➣ Words into Ac tion

| 155

Reforming Global Governance

The Fund was founded to help Europe cope with the large trade deficits which it was expected to run as it struggled to find its feet after the Second World War.

➣

coffers, the amount it can borrow, and

Americans decided on the allocation of

the number of votes it can cast. Because

votes they wanted, and then instructed an

they serve three different purposes, these

economist to play around with a formula

quotas are a peculiar concoction. They are

until it delivered the desired outcome.

supposed to reflect both an economy’s

156 |

Words into Ac tion

might – its ability to contribute – and its

A rejigging of these quotas appeals to

vulnerability: its potential need to borrow.

emerging economies on two counts, political

No fewer than five different formulae are

and financial. First, it would give them a greater

in circulation, which place slightly different

say over the Fund’s affairs. Second, it would

weights on a country’s GDP, its currency

grant them a more generous overdraft limit.

reserves, and the size and volatility of its

For some countries, the second consideration

external payments and receipts. These

may be more pressing than the first. But for

calculations have always been a bit of a

others, quota reform is a matter of justice. The

sham. At the Bretton Woods conference

misallocation of voting rights has plunged the

that established the IMF in 1944, the

IMF into a “crisis of legitimacy”, they say.

➣

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Reforming Global Governance

In his strategic review, Rodrigo de Rato, the Fund’s M.D. (above in a Clinton Global Initiative debate with Fernando Henrique Cardoso, former Brazilian President and U.S. Congressman, Jim Kolbe), noted that the inequities in the institution’s voting system were troubling to many.

➣

158 |

Words into Ac tion

As Ngaire Woods of Oxford University

Could a reform of quotas help redress

points out, the countries least represented

these grievances? It might cut both ways.

at the Fund are often those most

Certainly, China, South Korea and Japan

profoundly affected by its decisions.

deserve many more votes, given the size of

Between them, two dozen African

their economies. But the awkward truth is

members, most of them in the IMF’s

that poor African countries already enjoy a

“intensive care”, have just one out of 24

greater voting share than their weight in the

executive directors and cast only 1.41%

world economy warrants. Argentina and

of the votes on the board. If the Fund

Indonesia – the two countries that perhaps

cannot be made more answerable to

feel most victimised by the IMF – are also

these impoverished countries, Woods

overrepresented, relative to the size of their

argues, it should rein in its ministrations. Its

economies measured at market exchange

ambitions must not exceed the limits of its

rates. The G-24, a group of developing

accountability.

countries, thinks market clout should not

“The awkward truth is that poor African countries already enjoy a greater voting share than their weight in the world economy warrants.”

But this argument is unlikely to succeed. In 1999, the Fund appointed an outside group, led by Richard Cooper of Harvard University, to suggest a better way of calculating quotas. That group rejected measures based on purchasing-power parity. Part of the problem is that PPP is a unit of measurement, not a means of payment. An international obligation cannot be settled with a unit of purchasing power. Thus an economy’s size, calculated in PPP terms, is a poor measure of its need for foreign exchange or its ability to contribute hard currency to international bail-outs. If Indonesia, for example, had been able to pay off its anxious foreign creditors in 1997 at the rate of 756 rupiah to the dollar (its purchasing-power exchange rate for that year), rather than 2,906 (the market rate), it might never have needed the IMF in the first place. count for everything. It wants an increase in

There is a second inconvenient truth

“basic votes”, which a country gets just for

about quota reform: one of the most

being a member, regardless of its economic

underrepresented countries, relative to the

size. In 1945, these represented 11% of

size of its economy, is the US. It has 17%

the total, but as the IMF has grown, their

of the votes, but accounts for almost a

share has dwindled to just 2%. The G-24

third of world GDP (at market rates). This

also argues that market exchange rates

anomaly, which the Americans are fond of

understate the size of their economies.

pointing out, does not mean that the Fund’s

Non-traded goods and services are much

shareholder-in-chief is underrepresented.

cheaper in poor countries than in rich ones,

It just demonstrates, quite starkly, that a

so their economies are far bigger than their

country’s share of the vote is no measure

exchange rates, set by the supply and

of its influence. Many of the big decisions

demand of tradable goods and assets,

at the IMF, including the appointment of its

would imply. To take account of this, their

managing director, must be decided by an

economies should instead be measured

85% majority. Thus the US, with 17% of the

in purchasing-power parity (PPP) terms.

votes, always has a veto.

➣ Words into Ac tion

| 159

Reforming Global Governance

➣ But even on decisions that require a

economies now, in the hope of a broader

simple majority, America’s voting power is

reallocation of quotas in the future.

greater than its share of the vote suggests,

Unfortunately, it may take a long time for the

according to a study by Dennis Leech

second shoe to drop. No country has ever

of Warwick University and Robert Leech

agreed to a reduction in its quotas; the Fund

of Birkbeck College, London. How so?

cannot take votes from one country to give

Their argument is best illustrated by the

to another. It can only reallocate power in

“Luxembourg paradox”. The tiny Duchy

the organisation in the context of a general

was one of the original six members of the

increase in shares.

European Economic Community. Though its population was just 310,000, it commanded

But that would place the IMF at the mercy

one vote out of 17 in a system that required

of the US Congress, which must approve

12 votes to pass a motion. West Germany,

any increase in the country’s contributions.

with over 50m people, had just four votes.

Its consent cannot be taken for granted.

Luxembourg, one might say, was grossly

Despite America’s power over the Fund,

overrepresented at the EEC.

the institution is not popular in Congress. Indeed, precisely because America’s

Even one of the IMF’s own deputy governors – Mervyn King, the head of the Bank of England – pronounced the institution’s remit unclear, its role obscure. Photo: Newscast.

However, as Leech and Leech emphasise,

executive branch thinks it owns the IMF, its

a country has influence only to the extent

legislative branch resents it. The IMF is seen

that it can swing a vote, by serving as the

as a “geopolitical slush fund”, as Thomas

decisive member of a coalition that would

Willett of Claremont Graduate University, has

lose without it. Given the allocation of votes

put it – a big pot of money that the White

among the other five members of the EEC

House can throw around without asking

(Belgium and the Netherlands had two votes

Congress’s permission. In April 1998, the

each; Germany, France and Italy had four), it

House of Representatives decided, by a

was mathematically impossible for them ever

margin of 222 to 186, not to stump up

to split 11-5 on an issue. Luxembourg was

America’s $18bn share of a general increase

doomed either to be a redundant member

in IMF funds. Only after Russia defaulted,

of a 13-vote (or more) winning coalition, or

the American economy wobbled, and

to form part of a futile 11-vote (or less) losing

President Clinton upbraided Congress for

bloc. In other words, Luxembourg had 6%

its irresponsibility did they relent.

of the votes and 0% of the power. The Fund may fare no better in any future America’s position is rather the reverse.

fight. “If periodic approval of IMF capital

Leech and Leech calculate that America’s

increases were once viewed as tantamount

17% share of the vote gives it a 24.5%

to votes of confidence in the IMF,” said

share of the power in simple majority voting.

Congressman Jim Saxton, head of the

Their analysis explodes the supposedly

joint economic committee, in 2004, “that

tight link between a country’s clout and its

confidence is sorely lacking today.”

contributions. America has more power than it pays for.

Consumer revolt If the Fund does face a crisis of legitimacy,

160 |

Rodrigo de Rato has proposed a two-

as some argue, then quota reform will do

step quota reform. He wants to sprinkle a

little to rescue it. Any feasible reallocation of

few extra votes on a handful of emerging

votes and voice would not loosen America’s

➣

Words into Ac tion

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26-07-06 10:09:03

Reforming Global Governance

As a financial middleman, the Fund

“Shrinking budgets have a knack of concentrating bureaucrats’ minds, and, by its own projections, the IMF will face a budget shortfall of $280m in the 2009 fiscal year.”

is always vulnerable to the threat of disintermediation, if lenders and borrowers can match up without its help. The arkbuilders in Asia are experimenting with just such a venture, a web of bilateral promises to provide foreign exchange to each other in a pinch. First announced

➣

grip. But votes are not the only way to

in 2000, the Chiang Mai Initiative, as it is

get the IMF’s attention. Indeed, a fixation

called, has attracted commitments worth

with quotas may obscure the fact that the

over $60bn. Japan has pledged more

emerging economies are now exercising

money (over $30bn) to Chiang Mai than it

great influence over the Fund – not as

has to the Fund. Indonesia can now tap its

shareholders, but as dissatisfied customers.

neighbours for amounts worth three times its IMF quota, and the Philippines can call

Developing countries may have little voice

on four times its IMF limit.

within the IMF, but the threat of exit – of taking their custom elsewhere – still speaks

This is not yet an “Asian Monetary Fund”

eloquently. Argentina and Brazil have

to rival the Washington original. About

prepaid their IMF loans, while some of the

80% of the money on offer is intended

Fund’s biggest borrowers of yesteryear have

to “top up”, rather than replace, an IMF

now elected to insure themselves, rather

loan. The promises are not unconditional:

than relying on the Fund’s condition-laden

even the most neighbourly of creditors

cover. Eight East Asian countries have

wants to make sure it gets repaid. And

together amassed hard-currency reserves

the initiative has inherent limitations. If

worth about ten times the IMF’s total. “It’s

several countries in the region fall foul of

understandable to save for a rainy day,

the same local difficulties, they will all call

but they are building Noah’s Ark,” quipped

on their neighbours’ help at the same time.

Kenneth Rogoff, the IMF’s former chief

Emanuel Kohlscheen and Mark Taylor of

economist, earlier this year.

Warwick University show that extending the web to countries on the other side of the

If no one takes its loans, the Fund doesn’t

Pacific, such as Chile and Mexico, would

make any money. Shrinking budgets have

dramatically improve the pooling of risks.

a knack of concentrating bureaucrats’

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Words into Ac tion

minds, and, by its own projections, the IMF

In principle, the IMF, as a global organisation,

will face a budget shortfall of $280m in the

should provide the best risk-pooling of all.

2009 fiscal year. It has turned to a group of

And spurred by its Asian defectors, it is

eminent persons, including Alan Greenspan,

trying. Rato is in favour of introducing an

the former US Federal Reserve chairman,

insurance mechanism, which might surpass

to look for new ways to cover its annual

the commitments made under the Chiang

budget, which was frozen at around $1bn

Mai initiative. He thinks the IMF should

this financial year, and is supposed to fall, in

promise loans in advance to countries

real terms, by 1% next. The irony of the IMF

which are fundamentally solvent, but are

facing a modest fiscal crisis of its own is not

nonetheless vulnerable to self-fulfilling runs

lost on its critics.

on their credit or their currencies.

The idea is not new. The IMF has already experimented (in vain) with “contingent credit lines” – funds for which countries could apply in advance of actually needing them. But the idea is resurfacing, not only because it is intellectually appealing, but also because the IMF’s survival requires it. If it is to remain of use to countries that are vulnerable to crises but not predestined to them, the Fund will have to compete with the alternatives offered by self-insurance and the Chiang Mai initiative. Such loans would have to be quick, sure and big. If skittish investors have reason to worry that the money will prove too little, or arrive too late, they will act on their concerns, and thus prove themselves right. Countries would therefore have to “prequalify” for the funds, according to some predictable, transparent criteria. Tito Cordella, an economist at the IMF, and Eduardo Levy Yeyati of Argentina’s Universidad Torcuato di Tella have played with various indicators of solvency. In their view, the IMF should precommit to lend to any country that could sustain its debts at the high, but not prohibitive, rate that the promised loan would charge. By their criteria, Thailand, Indonesia and South Korea were all solvent prior to their crises, but Russia, Brazil and Argentina were not.

International Monetary Fund Managing Director Rodrigo de Rato visits children who are living at the SOS Children’s Village, Bata, Equatorial Guinea. (International Monetary Fund Staff Photographer/Michael Spilotro)

How much money would the Fund offer? Rato has suggested countries could

South Korea in 1998 amounted to 18 times

borrow up to three times their quotas in

the country’s quota.

the first instance. Would that be enough? Not quite, according to Cordella and Yeyati.

The Fund is not yet obsolete, and its future

By their calculations, the IMF would need

is worth fighting for. Rato, for his part,

to promise its average client 4.7 times its

is battling on three fronts. The first two

quota. This is a big sum, but if the promise

– multilateral surveillance and quota reform

were credible, the money might never be

– are potential quagmires. But on the third

called on. Conversely, if a run were allowed

– offering better insurance cover to its

to gather momentum, a bail-out might

members – the Fund just might recapture

prove more expensive still. The rescue of

some ground.

■ Words into Ac tion

| 163

Reforming Global Governance

In the public interest Oxfam International, the development charity, is launching a campaign to improve access to education, healthcare, clean water and sanitation in poor countries by investing in public services. We need to act now, say Emmett & Green.

“

I will never forget how I suffered due to

of millions of people will continue. The good

the lack of water. There was no water

news is that this suffering can be avoided if

to wash the baby or myself. I was

lessons are learned from countries that have

ashamed of the unpleasant smell, especially

succeeded in providing essential services

when my neighbours visited me,” says Misra

that meet the needs of poor people and

Kedir, recalling the birth of her child, Hitosa,

work for women and girls.

in Ethiopia. The evidence shows that developing Essential services – basic things like running

countries will only achieve a healthy and

taps, working toilets, classrooms with

educated population if their governments

teachers, and clinics with nurses – transform

take responsibility for providing essential

people’s lives. It is a scandal that in 2006

services, with civil-society organisations and

some people still live without them. Yet

private companies integrated into strong

BETHAN EMMETT

millions of families do. Today, 4,000 children

public systems, but not substituting for

is a policy adviser for Oxfam GB

will be killed by diarrhoea, a disease of dirty

them. Some governments have successfully

working on essential services,

water; 1,400 women will die needlessly in

built universal essential services, delivered

governance and public

pregnancy or childbirth; 115m school-age

through strong public systems, free or

spending. She has a background

children, mostly girls, will not go to school.

heavily subsidised for the poor and geared to the needs of women and girls. Many

in public expenditure management, Decent health and education, clean water

others have lacked the commitment, the

3 years as an economist for the

and adequate sanitation are among the

capacity or the cash to deliver on their

Ministry of Finance in Rwanda.

most basic of human rights, enshrined

responsibilities to the poor. International

in many international covenants. The

donors are crucial partners in supporting

international community has recognised

public systems, but too often are blocking

their critical importance by pledging to meet

progress even where governments have

targets, the UN’s Millennium Development

good intentions, by failing to deliver debt

Goals, such as ensuring universal primary

relief and predictable aid that supports

education by 2015 and reducing by two-

public systems, and by pushing private-

thirds the mortality rate among children

sector solutions that do not benefit the poor.

and has previously worked for

under five. These were deemed realistic and

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Words into Ac tion

achievable, but unless leaders both North

To try to assess governments’ performance

and South act now, most will be missed

in providing essential services, Oxfam

and the needless deprivation of hundreds

has devised an Essential Services Index.

This ranks countries according to their

The Indonesian government, for instance,

achievements in four social areas – child

massively expanded public education in the

survival rates, schooling, access to safe water,

1970s; it now runs 150,000 primary schools,

and access to sanitation – and compares

covering 85% of all enrolments. More

this performance with per capita national

recently, countries such as Uganda and

income. The comparison shows that some

Brazil have doubled the number of children

governments have consistently punched

in school, halved AIDS deaths and extended

above their weight. For instance, while average

safe water and sanitation to millions.

incomes in Kazakhstan ($6,980 a year) are much higher than in Sri Lanka ($4,000), a child

Learning from success

in Kazakhstan is five times more likely to die

Studies of the policies that underpin

in its first five years, and is far less likely to go

developing-country success stories show

to school, drink clean water and have the use

that, despite some differences in approach,

of a latrine (see figure below).

the measures taken by successful countries have much in common. The recipe for

Sri Lanka is not unique. Within a generation,

success is generous investment in public

countries as diverse as Barbados,

services that are provided universally, free

Botswana, Costa Rica, Cuba, Malaysia

at the point of use, and geared to the needs

and Mauritius, along with Kerala state in

of women and girls.

India, have made advances in health and education that it took industrialised countries

Successful countries have greatly expanded

200 years to achieve. In East Asia, the

publicly funded infrastructure, especially

importance of the links between equitable

in rural areas. In Botswana, for instance,

access to social provision, poverty reduction

public construction and post-independence

and growth was recognised early on.

training programmes doubled the number

➣

DUNCAN GREEN is Head of Research at Oxfam GB. He previously worked for DFID as a Senior Policy Adviser on Trade

Kazakhstan 6,980

and Development. He has written widely on themes related to globalisation and Latin America.

Sri Lanka 4,000

Kazakhstan 73

Sri Lanka Kazakhstan 100 92

Sri Lanka 86 Kazakhstan 78

Sri Lanka 91 Kazakhstan 72

Sri Lanka 15 Income per capita US$*

Under 5 mortality rate per 1,000 of population

Net primary enrolment %

Improved drinking water coverage %

Sanitation coverage %

Even though Sri Lanka is poorer than Kazakhstan, its people are healthier and better educated.

Words into Ac tion

| 165

Reforming Global Governance

schooling for up to four children in every household, and there was an 84% increase in attendance at clinics countrywide after user fees were scrapped at all government health clinics. A study funded by the UK government comparing health systems across Asia found that in low-income countries, the most pro-poor health systems were those providing universal services that were free or almost free. Water services differ from education and health in that some form of user charge is necessary to conserve water and maintain infrastructure, but in high-performing countries water tariffs have been subsidised to ensure equity and improve access for the poor. In the Malaysian state of Pulau Penang, for instance, the public water utility, Successful countries have also made providing safe water and sanitation a priority.

PBAPP, supplies water to 100% of urban residents and 99% of rural ones, and does so equitably: it sets a subsidised price for the first 20,000 litres of water a household

➣

of health posts so that, by the 1980s,

uses each month, giving poorer consumers

over four-fifths of the population lived

affordable access to drinking water.

within 15km of a health facility. Successful

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Words into Ac tion

countries have also made providing safe

Public services in successful countries focus

water and sanitation a priority. In Costa Rica,

on women and girls. In high performers,

water supply, latrine construction and public

women’s and girls’ access to education is

education on hygienic practices have gone

higher than the regional average and there

hand-in-hand with extending rural health

is a high proportion of female teachers and

services. Botswana’s government invested

health workers, which encourages others to

in a major programme of groundwater

use the services. This is all underpinned by

drilling and water network construction soon

government actions to strengthen women’s

after independence in 1966, achieving near-

social status and autonomy. In Mauritius,

universal access to safe water by the 1990s.

Cuba and South Africa new legislation has

Rural households were subsidised to build

enshrined the rights of women to own and

latrines and the government invested in

inherit property, and their rights to freedom

health and hygiene education programmes.

from violence and discrimination.

Making services free at the point of use

Successful countries have invested heavily

has been critical in expanding access for

in training, as well as in frontline workers,

poor people. Uganda’s primary-school

such as teachers, health workers and water

enrolments nearly doubled within a decade

technicians. Brazil increased net school

when the government introduced free

enrolment rates to nearly 100% for both girls ➣

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Reforming Global Governance

“Some governments have successfully built universal essential services, delivered through strong public systems, free or heavily subsidised for the poor and geared to the needs of women and girls.”

is unlikely to be able to access medical care, clean water or basic sanitation. Even relatively poor governments have choices over how to allocate spending – and many are not spending enough on social services. The Indian government continues

➣

and boys by instituting broad-based national

to spend almost twice as much on the

reforms to improve teacher qualifications

military as it does on health, while social

and training, along with performance-related

spending goes disproportionately towards

pay and increased salaries with generous

services that mainly benefit the middle

pension benefits. Many governments have

classes, such as hospitals and universities,

also taken measures to ensure that rural

or on other skewed priorities.

facilities are well staffed, often by requiring publicly trained workers to work in rural

The services that do exist are kept afloat by

areas for a time. In Sri Lanka, all teachers are

a skeleton staff of poorly paid, overworked

expected to work for three to four years in

and undervalued teachers and health-

‘difficult schools’, and a teacher deployment

workers. In the least developed countries,

project has implemented a ‘staff equalisation

teachers’ salaries have halved since 1970,

plan’ that penalises provinces with too

and there are far too few of these public-

many teachers and provides resources for

sector heroes to go around. There is a

provinces with teacher shortages.

global shortage of 4.3m health workers and 1.9m trained teachers.

Public failure – when governments fail to act

Where states lack the capacity or

“At the health centre they get annoyed

commitment to fund services, poor people

when they treat you,” says Marta Maria

are made to pay instead. Despite widely

Molina Aguilar, the mother of a sick child in

recognised gains in countries that have

Nicaragua. “If you don’t have any money

scrapped fees in primary education, 89 out

they won’t take you. Then what? Well, you’ll

of 103 surveyed countries still levy official

just be left to die.”

or informal charges for schooling. User fees in healthcare are a life or death issue. In

For every Sri Lanka, there are other poor

one Nigerian district the number of women

countries where millions of people cannot

dying in childbirth doubled after fees were

afford to see a doctor, girls have never been

introduced for maternal health services,

to school and homes have neither taps nor

while the number of babies delivered in

toilets. Countries such as Yemen, where

hospitals halved.

only one in three women can read and

168 |

Words into Ac tion

write. A Yemeni woman having a baby has

Whether services are provided privately

only a one in five chance of being attended

or publicly, corruption is a major problem.

by a midwife. If she and her child survive

In the worst instances, a vicious circle is

childbirth, her child has a one in three

created where a culture of impunity further

chance of being malnourished and a one in

weakens crumbling public systems through

nine chance of dying before his or her fifth

bribery and misappropriation. Where the

birthday. If she lives in a rural area, her family

providers are private but publicly funded,

corruption generally involves overcharging

have to buy it from private vendors who

government, paying bribes for contracts

are not regulated by the government in

and failing to deliver quality services. Where

their pricing or service quality.

the public sector is the provider, corruption takes place through absenteeism and staff

The result of such a reliance on private

taking second jobs in the private sector,

provision can be a patchwork of services, a

funds going missing and the creation of

lottery for citizens depending on where they

â&#x20AC;&#x2DC;ghost workersâ&#x20AC;&#x2122; to divert payrolls.

live and what they can afford. It was these very failings that prompted governments in

When governments fail to provide services,

now-successful countries to take action in

most poor people get no education,

the first place.

healthcare, clean water or sanitation. Those that do either have to bankrupt themselves

Worse, market reforms can undermine

to pay for private services or are reliant

essential services. When China phased

on a patchwork of civil-society providers,

out free public healthcare in favour of profit-

such as mosques, churches, charities and

making hospitals and health insurance,

community groups. These civil-society

household health costs rose forty-fold

groups offer a lifeline for the lucky few.

and progress on reducing infant mortality

They can reach remote and marginalised

slowed. When multinational companies

communities and provide community-based

enter into contracts with low-income and

services, such as home-based care for AIDS

low-capacity governments, the imbalance of

sufferers. But their coverage is patchy and

power can easily lead to abuse. The global

fragmented, their services are hard to scale

water market is dominated by a handful of

â&#x17E;Ł

up and the quality can vary greatly. They work best when integrated into a publicly led system, while retaining their autonomy.

The market is not the answer When faced with failing government services, many look to the market for answers. In some cases, private providers have indeed increased efficiency and, in the face of poor-quality public services, people often prefer them. But the private sector and the market alone will not deliver for poor people: services are provided instead for those who can afford them and the heavy presence of the private sector in essential services brings inequalities, high costs and skewed treatment practices, because private providers are notoriously hard to regulate. Poor people in the cities of Accra and Dares-Salaam pay up to five times more for a litre of water than other users because they

There is a global shortage of 4.3m health workers.

Words into Ac tion

| 169

Reforming Global Governance

As much as 70% of aid for education is spent on technical assistance rather than on recruiting and retaining teachers.

➣

US, French, and UK companies, such as

Early high-performers in essential services

Bechtel, Suez, and Biwater, which negotiate

all received considerable foreign assistance.

contracts that often ‘cherry pick’ the most

Virtually all the roads, schools and health

profitable market segments, require guaranteed

facilities built in Botswana in the 1960s and

profit margins, and are denominated in

1970s were financed largely from donor

dollars. If governments try to terminate these

sources, as part of a co-ordinated national

contracts, they risk being sued, as recent

development plan. Costa Rica received

cases in Tanzania and Bolivia show.

$3.4bn between 1970 and 1992, mostly from the United States, and this helped it to shield

Regulating private providers can also be

its social spending during the economic

more difficult for weak states than directly

crisis of the 1980s. South Korea and Cuba

providing services. There is no alternative to

benefited from direct foreign aid from the

building public capacity to organise, provide

US and the Soviet Union respectively;

and regulate essential services.

importantly, this aid did not undermine recipient countries’ freedom to make their

Rich countries are responsible too

own decisions on the best way to provide

While poor-country governments can make

public services.

or break progress in delivering decent

170 |

Words into Ac tion

healthcare, education, water and sanitation to

More recently, some rich countries have

their people, rich-country governments can

supported public systems in poor countries

also have a great, often decisive, influence.

by channelling their aid through national

plans and budgets, enabling governments

and retaining teachers and nurses. A study

to plan for the future and pay decent salaries

of technical assistance in Mozambique found

for frontline workers. In Malawi, which is

that rich countries spent a total of $350m

seen as a high-risk country due to endemic

a year on 3,500 technical experts, while the

corruption under the previous government,

entire wage bill for 100,000 Mozambican

donors are now funding a salary increase for

public-sector workers was a mere $74m.

public health-workers, an intervention that

In health, numerous different ‘vertical’ health

is already stemming the tide of emigrating

initiatives increase transaction costs, duplicate

doctors and nurses and improving the

and undermine health delivery, distort health

quality of care on the wards.

priorities and undermine sector-wide planning. Angola and the Democratic Republic of

But instead of helping to revitalise public

Congo have each been required to set

services, rich-country governments too

up four HIV/AIDS ‘coordinating’ bodies.

often push private-sector solutions to public-service failures, despite the evidence

IMF-imposed ceilings on public-

that this is not working. Central to this is

sector wages and recruitment prevent

the practice by both the World Bank and

governments from expanding health and

the IMF of making governments introduce

education services. The WTO or regional

privatisation or other market reforms in

trade agreements may also threaten public

return for aid and debt cancellation. A 2005

services by limiting how governments

study of the World Bank’s latest adjustment

regulate foreign service-providers.

loans, the Poverty Reduction Support Credits, found that 11 out of 13 schemes

Rich countries are encouraging a

studied contained such conditions. These

haemorrhage of nurses and teachers from

included water privatisation in Nicaragua

developing countries. Of the 489 students

and the greater involvement of the private

who graduated from the Ghana Medical

sector in health-care provision in Senegal.

School between 1986 and 1995, 61% have left the country, more than half of them to

In many countries, the World Bank is

the UK and a third to the US. The African

pushing governments to contract out

Union estimates that poor countries are

services to non-state providers. This can

in effect subsidising public services in rich

speed the scale-up of services, but places

countries to the tune of $500m a year.

unrealistic demands on weak governments to regulate and manage contracts.

Despite recent progress on debt cancellation, many poor countries that

What poor-country governments need is

desperately need it are still being ignored.

aid that is well-coordinated, predictable

Only 17 of the more than 60 countries that

and channelled through public systems

need full cancellation have so far received

and national budgets. What poor countries

it from the World Bank and IMF.

typically get is insufficient, unpredictable aid, disbursed through a jumble of different

A manifesto for change

projects that compete directly with public

Oxfam International calls on developing-

services for staff and scarce resources. As

country governments to make sustained

much as 70% of aid for education is spent on

investments in essential education, health,

technical assistance rather than on recruiting

water and sanitation systems and services,

➣ Words into Ac tion

| 171

Reforming Global Governance

“While poor-country governments can make or break progress in delivering decent healthcare, education, water and sanitation to their people, rich-country governments can also have a great, often decisive, influence.”

Track Initiative. They should also work with poor countries to recruit 4.5m new health workers, 1.9m teachers and other key workers, reduce their own active recruitment of health and other professionals from poor countries, and pay restitution to these

➣

working with civil society and the private

countries for graduates they have poached.

sector within an integrated public system. They need to train and recruit millions

Civil society too needs to act to hold

of desperately needed health workers

governments to account. It has to build

and teachers, and improve the pay and

popular movements to demand that

conditions of existing workers. They have

governments provide quality public services,

to build an ethos of public service, in which

including free health and education; engage

both public and essential-service workers

in local and national planning processes;

are encouraged to take pride in their

work with parliaments to monitor budget

contribution. They need also to ensure citizen

spending, to ensure that services are

representation and oversight in monitoring

reaching the poorest and corruption is

public services, as well as taking a public

not tolerated; and challenge rich-country

stand against corruption. They should abolish

governments, the World Bank and the IMF

fees for basic education and health care

when they fail to support public services.

and subsidise water for poor people. Last

but not least, they need to make services

Within a generation, for the first time in

work for the welfare and social status of

history, every child could be in school.

women and girls by reducing educational

Every woman could give birth with the

CMY

disparities, promoting women’s employment

best possible chance that neither she nor

in public services and guaranteeing women’s

her baby will die. Everyone could drink

economic and social rights.

water without risking their life. Millions of new health workers and teachers could be

Rich countries, the World Bank and the IMF

saving lives and shaping minds.

must support poor country governments to do this. They should stop pushing the

We know how to get there – through

inappropriate privatisation of public services

political leadership, government action and

through aid conditions, technical advice

public services, supported by long-term

and trade agreements. They should keep

flexible aid from rich countries and debt

their promise to give 0.7% of their national

cancellation. We know the market alone

income as foreign aid and allocate a fifth of

cannot do it, civil society can only fill gaps,

that aid to basic services. They should also

and that governments must act. There is

fully implement commitments to improve aid

no short cut, and no other way. ■

quality, including the Paris commitments on aid effectiveness. They should pay for the removal of user fees in primary health and education and the subsidising of water fees for poor people, as well as fully financing

172 |

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Footnote: This article draws on ‘In the Public Interest’ (working title), a report to be published by Oxfam International and WaterAid at the World Bank/IMF annual meetings in Singapore. For the full version,

the Global Fund for HIV/AIDS, Tuberculosis

including the sources for the facts and figures in

and Malaria, and the Education for All Fast

this article, please visit www.oxfam.org.uk

Reforming Global Governance

First off the mark A healthy financial sector is vital to development, yet donors often neglect it. One of the best ways they can help is by providing the sound financial advice that poor countries are crying out for.

MARK ST GILES is Managing Director of the FIRST Initiative. After a career in

ven the richest of countries may

Set up in 2002 by Britain’s Department for

struggle when a natural disaster

International Development together with

such as an earthquake or a hurricane

the development agencies of Canada,

strikes, but what are poorer countries to

the Netherlands, Switzerland and (later)

do? While an international humanitarian

Sweden, as well as the IMF and the World

relief effort may help with the immediate

Bank, it gets many things right that other

crisis, governments are still often lumbered

aid programmes often do poorly. It is quick,

with a vast longer-term legacy of shattered

nimble, sharply focused and responsive to

towns, uprooted plantations, bankrupted

individual countries’ needs, while avoiding

businesses, broken bridges and other

unnecessary duplication. And at a cost

ripped-up infrastructure. The financial

of only $65m, it’s a snip for international

burden of rebuilding a devastated region

donors, while providing invaluable financial

may be too great for a local insurer or

know-how to developing countries.

reinsurer to cover – but it is a drop in the ocean for global capital markets. By issuing

Take Mongolia, where over half of the

“catastrophe bonds”, developing-country

population, and 30% of the economy,

asset management and financial-

governments can purchase insurance from

depends on livestock herding. Unfortunately,

services regulation, he has for the

international investors, who forfeit part of

extremely cold weather, or drought,

15 years prior to joining FIRST run

their loan when a natural disaster exceeds

occasionally devastates the country’s herds

broking, investment banking,

defined limits – in effect, an insurance

of cashmere goats, cattle, sheep and

Financial, which specialises in

payout – but earn an above-average rate

other animals, threatening semi-nomadic

advising developing countries on

his own consultancy, Cadogan

of interest, the equivalent of an insurance

herders and their families with destitution

the establishment of collective

premium. Mexico has blazed a trail by

and damaging important export markets.

investment funds and defined-

issuing such bonds to insure against

Worse, Mongolia does not have a functioning

contribution pension funds. He

earthquake damage, and other developing

livestock-insurance market, because insurers

has served as Chairman of the

countries could now follow in its footsteps.

do not have adequate information to cover herders – whose flocks are undocumented,

British Association of Investment Funds, President of the European Federation of Investment Funds,

and often roam over huge distances – for

financial techniques to help alleviate

their individual losses, while the risk that

poverty is one of the hallmarks of the FIRST

much of the country’s livestock will be wiped

Savings, and was Chairman of an

Initiative, a low-profile, but high-impact

out at once is too great for the country’s

SRO established under the 1986

programme to help reform and strengthen

fledgling private insurance companies to

the financial sector in developing countries.

bear. But FIRST has developed a novel

a board member of National

Financial Services Act.

174 |

Such ground-breaking use of sophisticated

Words into Ac tion

scheme that will provide affordable cover which is available to all, by spreading risk

“Despite all the evidence of its importance to growth and poverty reduction, aiding the financial sector is usually low on donors’ list of priorities.”

nationally, as well as among the industry, the government and the World Bank. Instead of insuring individual losses, the innovative insurance system uses a national mortality index to gauge the extent of livestock deaths. When this is low, herders must bear the loss of their livestock themselves, but when it rises beyond a certain point, the country’s private insurance companies step in to help. Their risk is capped, however, because if the index skyrockets, the government must provide a disaster-recovery programme, with World Bank assistance. One day, the government may even be able to lay off this risk with international reinsurers. FIRST is not only about financial wizardry, important though it can be in providing ingenious solutions to problems that blight poor people’s lives. It also helps countries develop new ways of increasing poor people’s access to much-needed finance. In Colombia, for instance, it has helped draw up a housing micro-credit scheme, a creative mix of self-help, subsidies, government guarantees and loans that enables poor people to get a proper roof over their head. This could be a model for helping the millions of slum-dwellers who eke out a living on the edges of many big cities in developing countries to buy their own homes. Indeed, such schemes could have broader benefits, because, as the Peruvian economist Hernando de Soto has pointed out, giving poor people property rights can unleash a burst of entrepreneurship and economic growth.

Nuts and bolts Most of FIRST’s work is not as eyecatching and exciting as earthquake bonds – but then again financial-sector regulation

➣

In Colombia, FIRST has helped draw up a housing micro-credit scheme, a creative mix of selfhelp, subsidies, government guarantees and loans that enables poor people to get a proper roof over their head.

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Reforming Global Governance

The financial burden of rebuilding a devastated region may be too great for a local insurer or reinsurer to cover â&#x20AC;&#x201C; but it is a drop in the ocean for global capital markets.

â&#x17E;Ł

and supervision are not meant to be. The

opportunities and allow insurance

important thing is to get the nuts and

companies, pension funds and other

bolts right, laying solid foundations for

institutional investors to spread their risks.

a thriving financial sector which boosts

Research shows that growth rates are one

economic growth and reduces poverty,

to two percentage points higher in countries

while ensuring stability and protecting

with sound financial sectors than those

against excessive risks. FIRST helps

without â&#x20AC;&#x201C; a crucial advantage when seeking

countries close dangerous gaps in their

to reduce poverty. Developing countries with

laws and regulations, and strengthen vitally

strong and stable financial systems are also

important financial institutions, such as

less vulnerable to economic shocks.

supervisory bodies. But poorly designed (or non-existent)

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Poor countries have much to gain from

financial regulations and supervision can

well-functioning capital markets that

prove extremely costly. Developing countries

channel savings to profitable investment

lost around $1 trillion through banking crises

in the 1980s and 1990s – roughly as much as they have received in foreign aid since the 1950s. Such crises can cause wrenching recessions which hurt the poor and the vulnerable most, while potentially spreading

“FIRST helps countries close dangerous gaps in their laws and regulations, and strengthen vitally important financial institutions, such as supervisory bodies.”

like a virus to rich-country markets too. As was highlighted by the devastating financial crisis which began in Thailand in 1997 and

Technical assistance is often delivered

soon rocked emerging markets, roiled rich-

in a haphazard fashion, if at all. It may

country ones and threatened to plunge the

come too late, and is often inappropriate.

world economy into recession, rich countries

Outsiders may pay little attention to local

have a powerful interest in ensuring financial

conditions and to the appropriate sequence

stability in emerging markets.

of reforms, while their efforts often overlap or even duplicate each other. There are

In a speech to the US Council on Foreign

even examples of different donors financing

Relations in September 1999, Britain’s

separate projects with the same objective at

Chancellor of the Exchequer, Gordon Brown,

the same time. Moreover, poor coordination

called for “a framework of internationally

often prevents countries from benefiting

agreed codes and standards, new economic

from recommendations that are replicable

disciplines, to be accepted and implemented

across several countries in a region.

by countries which participate in the international financial system…They will

FIRST is different. Its approach is one of

deliver the transparency and accountability

“ownership, harmonisation, alignment,

which I believe is the only answer to the

results and mutual accountability”, the

uncertainty and unpredictability of ever more

model endorsed by the Paris Declaration

➣

rapid financial flows.” While such codes and standards apply mostly to rich and middleincome countries with developed financial sectors, it is also important that poorer countries seek to abide by them. FIRST helps emerging markets bring their financial rules up to scratch, to their benefit and to that of donor countries.

Good advice Despite all the evidence of its importance to growth and poverty reduction, aiding the financial sector is usually low on donors’ list of priorities. This is a mistake – finance is not just a luxury for the rich, it is also a necessity for the poor, as the success of micro-credit schemes vividly demonstrates. Unfortunately, developing countries often find good financial advice hard to come by. FIRST is trying to change that.

In Mongolia, over half of the population, and 30% of the economy, depends on livestock herding.

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Reforming Global Governance

➣

on aid effectiveness in March 2005, which

identify their own problems and contribute

united ministers from both developed and

to the solutions. As Adolf Denk, the head

developing countries. It puts recipients in

of legal services at Namibia’s Financial

the driving seat, rather than telling them

Institution Supervisory Authority, remarked,

what they need. They are encouraged to

“It is imperative that the assisted should not feel patronised, and in this regard we felt like a partner [with FIRST] in the project

“Research shows that growth rates are one to two percentage points higher in countries with sound financial sectors than those without.”

throughout the process.” FIRST responds quickly and flexibly to local requests for help. It gave “a fast and thoughtful answer to our financing needs,” says Angelique Kantengwa, the director of Rwanda’s Bank Supervision Department. Luz Maria de Portillo, the president of the Central Bank of El Salvador, said that FIRST’s “consultants’ attention to recipients needs is first-class in terms of timeliness, quality and flexibility.” Its projects remain relevant in the context of overall financial-sector development by following up on work identified by the IMFWorld Bank’s Financial Sector Assessment Programmes (FSAP), a voluntary healthcheck for a country’s financial system, and their Reports on Codes and Standards (ROSCs), which gauge a country’s compliance with internationally recognised standards and codes in 12 areas such as auditing and securities regulation. The initiative pools the efforts of several development agencies, leveraging their expertise and reducing needless duplication. It often takes on small, targeted projects which donors could not carry out costeffectively themselves. And once projects are completed, the results are widely disseminated in order to boost their impact and catalyse long-term support from donors. All the results are available on FIRST’s website, www.firstinitiative.org, and

Finance is not just a luxury for the rich, it is also a necessity for the poor, as the success of microcredit schemes vividly demonstrates.

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can be used by any country that has similar needs to those already addressed.

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