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Erik van Dijk
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Hi! I am Erik L. van Dijk, principal at LMG Emerge. LMG Emerge is an internationally-operating institutional investment consultant with offices in the Netherlands and at Mauritius. Our clients are pension plans and other institutional investors, family offices and HNW individuals. In close... More
My company:
LMG Emerge
My blog:
LMG Emerge - New Economies
My book:
Asset Pricing and Risk in Emerging and Frontier Markets
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  • A Better Future for Africa - About the How and Why of African Wealth and Poverty of Africans

     

    Introduction: Is it about the leaders?

     

    Yesterday we presented you the link to an article by South African Gregg Mills for the Cato Institute. Topic: ‘Why is Africa so poor?’.  Main point in the article was that this is the case, because African leaders are the ones to blame. They have indulged in excuses, nepotism and corruption, according to Wells. We do normally appreciate the work of the Cato Institute as outstanding, and will continue to do so. However, we believe that the explanations given for African problems were one-sided and not incorporating substantial parts of the truth to the extent that they related to Western activities and policies.


    The Cato Institute: Top-level Think-Tank but is the treatment of Africa fair in the report Why is Africa Poor?

     


     

    Of course it is true that the leaders of the 50+ African nations were – on average, when treating them as managers of ‘enterprises’ with potential in terms of incredible natural resources and a young population -  below-standard. Example: oil giant Nigeria – the most populous African country – suffered from poverty in 1970 that looked less bad than at the beginning of this decade, notwithstanding the development in oil prices. In 1970 19 million of the 70 million inhabitants had to live of an income of less than $1 per day. Taking into account the purchasing power of the US dollar this number was 90 million out of a total population that had grown to 120 million as of 2000. In other words: the percentage of people living from less than $1 per day dropped from 27.1% to 75.0%. Unbelievable when taking into account that oil prices have since increased by a tenfold at least!

     

    And the Nigerian case is not an exception, on the contrary. When we look at some other statistics the story remains bad. A lot of African people are dependent on subsistence farming, with the agricultural sector therefore being extremely important. But at the same token, the bulk of African nations are net food importers. And when looking at global agricultural exports Africa’s share has dropped from 8% to 4% since 1970.

     

    Corruption and nepotism and lack of democracy, are they the factors that caused this prolonged misery and mismanagement? Maybe so to a certain extent, but is it correct to point our finger to African leaders only? At LMG we believe that this is totally wrong. Even when knowing that a continent where leaders like Idi Amin Dada are more of a standard than an exception should in all cases make sure it does investigate to what extent there is internal blame that can be transformed into positive actions.


    Even with leaders like Idi Amin Dada it is too simple to put all the blame on Africa


     

    Are Western nations playing games?

     

    LMG believes that to a large extent Western influence in Africa has been a large factor in explaining what went wrong. 

     

    Let us start with the corruption part of the explanation in the Cato Institute piece by Wells. Transparency International reports the Corruption Perception Index (NYSEARCA:CPI). In the CPI almost all African countries end up with lousy scores. However, there are a few mitigating factors. The first one is related to the structure of the CPI Index. The CPI Index allocates corruption completely to the receiver. But when a multinational firm or foreign government institution spends ‘extra’ money or ‘gifts’ so as to ensure that the receiver will opt for its proposition – even when actions like this are totally against the laws and ethical rules in the foreign entity’s own country – is it then fair to blame the poor receiver? Shouldn’t we recalculate the CPI Index putting the blame for 50% on the sponsor and 50% on the receiver? That would make the poor African receiver look less bad and the sponsor less ‘ethically correct’. As you know, LMG believes that this ‘grayish’ solution is closer to the truth. Western institutions have way too long ensured that they received the goodies from corrupt, poor African representatives because this basically ensured that money spent in Africa would generate a good return, either as financial  or political profit or – when talking about development aid – by ensuring that a large part of the aid would ultimately end not in Africa but in the pockets of Western advisers, institutions et cetera.

     

    Unequal Power Balance between Africa and the Rest of the World, but with exactly the opposite color dstribution as in this picture!

     

     

    Are African leaders ‘poor’ because they couldn’t defend themselves against this? Maybe so, but was it so easy to put up a strong defense? The answer is NO. Africa was and is the poorest continent. From the perspective of an international organization willing to use these corrupt methods it is therefore also the ‘cheapest’ continent. This is where you can probably get a good or maybe even excellent return percentage for your effort, but it is definitely the area where you need less money to achieve your goals in absolute terms. Example:  when government officials or intermediaries earn decent wages of let’s say $ 2-5,000 on average per month in other continents (average of lower and higher level representatives) one needs larger gifts or sums of money to ensure their loyalty than in situations where already a good bottle of Champagne would be worth a monthly wage!

     

    But there is more: Was or is the Western world really interested in African development? When hearing people talk, the answer is YES. But actions and their consequences talk louder than words. As you know LMG likes the work of Zambian economist Dambisa Moyo quite a bit. Moyo – in her book ‘Dead Aid’ – made it clear that what Africa and Africans need is economic support and not aid. 

     

     

    Africa needs Economic Support instead of Aid (Dambisa Moyo)

     

     

    But the Western model focused all the time on aid, education, emergency packages etc. Of course, in-and-of-itself this is all well-meant and nice. But: if a country or continent has natural resources, agricultural potential and cheap labor isn’t it then most helped by opportunities to export its produce into richer, but more expensive markets? For many years it was clear that the European Union for instance created an agricultural tariff, duty and levy structure that made it complicated for exporters from outside its borders to sell into Europe with the latter protecting their own farmers. This was even the case when as a result of price subsidies Europe ended up building a 'milk lake' and 'butter mountain' (nick names for the strange result that subsidies led to producers producing more than needed, with the main problem actually being that these producers were too expensive to survive as a sector without protection of import duties and tariff walls). 

     

    At the moment these rules have been modified to some extent, but only under strict conditions and mainly for subsistence style farm produce only (the Fair Trade lobby). We believe that it would be much better for Africa to get no aid, but at the same time lower tariffs and import levies into Europe and the US as well. In such a way that it could start building an agricultural and food sector internally. Not  a subsistence one focused on the poorest of the poor but one that can compete with the more expensive products from within the EU or USA higher up in the value chain within the food industry. Instead of aid, subsidies for Western investors who will set up these type of facilities in Africa (knowledge transfer!) would be an interesting and fascinating alternative. But at the moment these initiatives are paralyzed. True, western private equity providers and/or entrepreneurs could consider African initiatives but they have to deal with lacking local infrastructure, institutional and governance problems and other political risks next to uncertainty concerning the possibility to successfully focus their new African firms on the richer Western markets at home.

     

    In the meantime aid (blankets, bibles and education) were an important ‘tool’ in regional control with weak local leadership being more a ‘pro’ than a ‘con’. Education in this list? Yes to some extent: Is it correct to stress educational initiatives at a higher level when you know that a country's main competitive strength lies basically in industries that need unskilled labor most? 

     

    Bottom-line: to a large extent the Western position was a post-colonial one. If you believe that LMG’s stand is a leftist one, don’t get us wrong. We are definitely not left wing, anti-Western or extremely negative about capitalism. On the contrary, we believe that a ‘private sector’ solution – when given a fair chance – will help develop Africa.

     

    The comparison with other Emerging regions is a logical one, albeit not totally fair. Wells indicates that African leaders were too often lavishing themselves in poor excuses related to a past with slavery. But the fact is that historically those countries were coming from that background, with other Emerging regions being confronted with less misery and/or even being instrumental as indirect participants at a higher level within the Western slavery-based development model (e.g. the traders, logistical specialists from the Middle East, supervisors of Indian descent et cetera). So even if you don’t want to talk about historical excuses per se, you still have to recognize that the past for those regions that you compare things with was a better one.

     

    Slavery Past an excuse? Maybe yes to some extent, but it definitely provided Africa with a tougher starting position than other Emerging Markets who in some cases actually participated in the Slavery model. So we shouldn't over estimate history compared to what can be done now, but we should also not explain the situation as one in which African leaders try to get away with things by using it as a lame excuse.

     

     

    We do actually agree with Wells that there is far too much complaining about the past going on in Africa, albeit that we also recognize – see also above – that Africa was so far not offered the full opportunity set to do something constructive with respect to improvement of its own economic development path. And that was related to the unfair balance of power, i.e. having to deal with a partner who had no intention to really develop the continent while keeping it checkmate through aid.

     

    But there is hope: the new development model of China

     

    But there is hope. China has imported a totally different business model into Africa. Not based on aid, but on infrastructure support to develop roads, railways, harbors, airports all with just one goal: ensuring that natural resource development in Africa can continue or even expand. China needs resources and Africa can deliver them. Of course, the Chinese are not known for their benevolent activities in the countries that the deal with (see also our previous blog contribution on April 30, 2011 on Chinese foreign investments). It is definitely not aid, but it does help those countries further in that it generates employment and (the start of an) economy that can grow. And the latter is in the longer run of the utmost important, as Dambisa Moyo teaches us. Aid is dead, economic support the only way forward.

     

    China increasing its influence in Africa (meeting PM Wen and Kabila in Beijing in 2007)

     

     

    Skeptics point out that the Chinese goal of gaining additional influence in the African political arena is a bad side-effect of the Chinese activities. Maybe so, but let’s be honest for once. Is all support by Western nations in Africa solely humanitarian without any political agenda? Of course not, so basically this is a case of Westerners blaming China for doing what they themselves are doing as well albeit in a different format. We believe that it is a good thing that different parties with opposing political agenda’s do now have to compete for a piece of the action in Africa. The old balance of power with one strong party having to deal with a weak African leader and a poor African people was more instable and less good for Africa than the one that results when strong nations have to take into account counteractions by other strong nations. The Arab spring is a 

    nice example of the benevolent effect of these kind of semi-stalemates.

     

    Our conclusion therefore: Africans are poor, but Africa is certainly not and  the new equilibrium with activities by not just Westerners but also by Chinese, Indians and Russians (the leading Emerging Markets foreign investors) and Middle Eastern wealth funds provides for a future in which chances to develop African wealth have increased dramatically, be it in the Agriculture/Food, Resources, Tourism or other industries. LMG believes that good chances for Africa and Frontier Market investment strategies as a result of this is a logical side effect, with the increase in share prices leading developments in the real economy.

    May 30 2:35 PM | Link | Comment!
  • The Growing Importance of China - A Closer Look at their Foreign Direct Investments

    It is obvious that the influence of China in the global economic and geopolitical arena is growing dramatically. To a large part this is the result of the spectacular economic growth of the country. For many years now, GDP growth figures are close to or in the double digit zone.


    And the Yuan Renminbi is one of the strongest currencies in the world, carried by China's position as the world's number one when it comes to Foreign Currency and Gold Reserves. This, combined with a huge current account surplus helps the Yuan. However, it is also clear that so far the Chinese have done all they can to ensure that the currency remains relatively affordable so that the export machinery won't be hurt.


    Using data from the Heritage Foundation, LMG Emerge itself and the CIA World Factbook we take a closer look at the Foreign Direct Investment (NYSE:FDI) activities of Chinese firms. This activity is linked to Chinese government activity to the extent that the government uses state-related firms for this expansion (e.g. oil company Sinopec).


     

    Foreign Direct Investments by China, 2010



    The table above lists the top-20 countries in FDI, with China as the investor. When looking at the absolute investment amount the USA and Australia were last year's winners with a total amount of USD 28.1 billion. Nigeria, Iran and Brazil are the other top-5 countries with a combined investment amount of USD 45.4 billion. Three countries from the Emerging Markets group who are all known as commodity providers with a strong export machinery when it comes to energy. Logical, when taking into account the energy hunger of China. Nevertheless, the top-5 positions of Nigeria and especially Iran (still suffering under Western embargo's) might be shocking to many Westerners.


    As always, Western observers do immediately when numbers get bigger suggest that the Chinese investments have 'only one main goal, namely to buy political influence'. Interestingly enough, they always seem to forget about this idea when it is about Western FDI's in other countries. So as to analyze the potential political impact in more detail, we also created a column with relatively numbers by dividing the FDI by last year's GDP.


    The top 5 changes dramatically, with now the Democratic Republic of Congo, Kazakhstan, Nigeria, Vietnam and Algeria the most important investment destinations of China. In all 5 cases the Chinese investments represent more than 5 percent of GDP, with the impact in Congo being 46.8 percent. Conclusion: true, China is important and might be a political factor. But, buying votes? Except for DR Congo this is just as likely as what one could say about investment activities originating in countries like the USA, Germany, France and the UK. We believe that the bulk of Chinese FDI is directly linked to the Chinese 5- and longer-term plans: ensuring a structural, smooth inflow of necessary resources (commodities, energy, knowledge).


    Chinese PM meets DR Congo President Kabila

    Beijing 2005



    Apr 30 9:34 AM | Link | Comment!
  • Generational Accounting and Why the West Needs Emerging Countries: The Work of Larry Kotlikoff

    Introduction

    In this contribution we pay attention to the work of Boston University professor Larry Kotlikoff. Kotlikoff is a well-respected economist, but one with relatively negative views when it comes to the future of the rich, developed world. Already in 2006 he wrote a paper entitled ''Is the United States Bankrupt?'' that more or less foresaw a lot of what was about to happen 2-3 years down the road during the Global Financial Crisis, albeit that his paper was more general and longer-term (link to this article at the bottom of this page). In his work Kotlikoff suggested that the Western financial system was one in which beggar's acted as choosers in an environment in which the amount of saving was structurally too low. That was not a global problem, but a Western developed world problem. The global economy was and isn't doing that bad with a real growth rate in excess of 4 percent. However, liquidity is leaking out of the developed world into emerging markets who now run huge savings surpluses. Unless we find a way to re-establish equilibrium the system in the Western world will burst.

     

     Larry Kotlikoff: Agent of Doom?

    Yes, if you count out Emerging Markets. No, if you accept a growing role for them.

     

    Generational Accounting

    An important part of Kotlikoff's work about Government Finance is about flawed Public Accounting. Concepts like Budget Deficit, External Debt, Tax Burden et cetera don't mean anything according to Kotlikoff, the reason being that they are very sensitive to labeling. Idea: when the government would label its revenues as 'tax income' it would reduce its debt and run a lower deficit. It could then say that for the taxes now future transfers would be handed over to these taxed citizens. The other way round: if it would like to keep the tax burden low, it could finance things by borrowing. This would increase 'debt' and lead to a larger deficit. In the future it would then have to repay principal plus interest. At that time it could finance things by increasing taxes, or again finance by issuing debt. The government could always 'finance its way out' by issuing money and/or ensuring that inflation is high enough. But what it is all about is simply that the paper in these transactions - 'money' - will lose its value thereby adding to the generational mismatch: earlier generations enjoyed a good life with stronger value money and a better balance between lifetime resources and taxes than future generations will.

     

    Inflation high enough? Financing your way out by printing money? QE2? Hmm....aren't we going through a period of money printing and inflation creeping up?

    The above does also imply that it is not possible to simply evaluate the external debt burdens of countries and based on that conclude who is closest to 'bankruptcy'. The debt of Japan far exceeds that of the USA, but does that mean that the US is safe and Japan not? And what about the European PIGS nations? 

     

    The analysis of Kotlikoff is mainly US oriented and came to the conclusion that - when using Generational Accounting - already back in 2005 the overall shortage of the US was USD 65.9 trillion (i.e. more than 4 times more than its external debt, its government deficit and the size of the economy!) (for more information see the 2006 paper in our LMG slideshare account). Similar exercises can be done for other countries of course and they will lead to similar conclusions: Generational Accounting - when done the proper way - will show problems far bigger than what governments in Western nations tell us these days. Basically what it is all about in Generational Accounting: 

     

    Lifetime resources of a generation have to be linked to the lifetime fiscal burdens of generations. 

    And whenever there is a mismatch, you get inter-generational wealth transfers. 

    And these wealth transfers in itself can already may lead to problems for the system.

     

    The models of Kotlikoff, Auerbach, Gokhale and others are ultra-long-term, incorporating and adding up the situation per age group (vintage group) over many decades into the future. True, technically the models are infinite but when analyzing things you have to apply a discount rate so as to bring things back to its net present value as a result of which the first couple of decades are relatively most important. However, with any reasonable discount rate - except for ultra-high ones! - we are still talking about an analysis that urges us to take into account the situation of at least 20-30 if not 50 years into the future.

     

     

     

     

     Why Generational Accounting is not in synch with day-to-day Political Practice

    Now when we match that with democracies that turn into short-term media circuses more and more, in which the average politician is already afraid to look further than 4-5 years into the future, there is a huge mismatch. Taking into account that young people, who are just starting their career or enjoying growth on their career ladder, care less about situations that arise when they are in their retired years than do older people, most policies 'sold' by politicians these years in developed economies are policies that imply a transfer of wealth from the younger generations to the older ones.

     

    The older generations get more than prudent financial policy warrants. Political rationale: the moment the financial system seems to burst, you can always increase borrowing, taxes or print money and finance yourself out of the problems, again misusing future generations. But wait a minute! What are we saying here? That sounds like the situation of a once glorious firm that is now gradually but slowly losing its dominant position, seeing its cash flow position weaken by the year.

     

    Evaluation

    Kotlikoff's calculations show that most developed nations, and especially the United States, have reached the point of no return. A point where - when they want to continue doing things the way they always did - the end will be substantially lower real wage rates, unemployment problems and a demographic situation that will make our Western economies resemble large macro senior citizens homes. In that kind of situation successful firms with a product that they can sell globally will increase their foreign direct investments, thereby creating employment abroad - mostly in emerging nations - and sooner or later growing numbers of younger workers will follow the market drums and leave the country, thereby increasing the ratio elderly/workers even further.

     

    The interesting thing is that Kotlikoff c.s. did also run calculations in which they added China - with its long-term policy, hunger for knowledge and technology and its huge savings surplus - to their models. When using realistic empirical input values the result was that China (and other Emerging Nations, especially those with big Sovereign Wealth Funds) could make the picture look less dim. Even when over time - with ongoing development - their savings rates diminish it would still be the only way out for Western governments to allow Emerging Countries a larger role in a global system, with that role implying that those nations would be allowed more direct investments in the Western world without immediately blocking them as being 'strategical' (as is done so often when it is about investments by companies, wealth funds or governments from China, Russia or the Middle East) but also a continuously growing role in the arena of financial investing. The role of Sovereign Wealth Funds will further increase and through their transfer of investment money (savings surpluses) into Western capital markets they will ensure that the amount of available capital per worker in Western countries will one or the other way translate into productivity growth that is sufficient to avoid the collapse of real wages.

     

    But unfortunately....Western governments do still think they can 'solve' it the old way. I.e. do it themselves. Without the rich Emerging Markets. But the only way that that will work is by using all the instruments that Kotlikoff warns against and that will in the end lead to burdens on growing numbers of people in current and new generations that will outweigh a reasonable percentage of the resources available to them.

     

    It is indicative that Kotlikoff - working together with various scholars that were linked to the US government as adviser (including himself!) when coming up with a proposed new tax system consisting of a retail sales tax of 33 percent that should replace income taxes (including all kinds of deductions that would lead to an opaque system that is prone to fraud), a restructuring of the health care sector and social security system  - was not received with a warm welcome. On the contrary, the direct influence of him and co-scientists expressing this kind of ideas on the government went actually down! They did not want to hear this kind of stories about governments facing bankruptcy unless they overhaul the fiscal, health care and social security system.

     

    Interesting stuff, that confirms that Emerging and Frontier Markets are the place to be. It also makes it clear as to why so many Western nations do not want to stop colonializing the Middle East.

     

    But what we don't understand

    Is the work by Kotlikoff that of a visionary that so far was not as well received as some of the others (e.g. Taleb and Roubini) were for the nomination as Professor of Doom? To a certain extent yes. We believe that the main reason for this is that the others translated their warnings into a so-called 'short'-selling strategy in which investors bet against the growth of the system. Kotlikoff feels that the Western financial system - taking into account the financial state of the system - is basically a pyramid game and going against that in short transactions would be way too dangerous and maybe even immoral. His solution would probably be increased pressure on governments and increased investments in Emerging Markets, with the reason for the latter being that the longer Western governments refrain from going for the 'only' solution the lousier their bargaining power when they will have to accept a large-scale entrance of EM investors to their markets. At that time the latter can acquire stakes in firms at a lower price per share, thereby further improving the relative position of EM investors and the firms they represent. Over the last 10-20 years the willingness to invest in EMs was lower than the willingness to invest in short positions. Maybe that explains.

     

    And what we also don't understand - actually, we think it is the only big flaw in Kotlikoff's work - is why he did not touch the issue of Military and Defense spending. That is about one-third in the US. Why immediately go for Health Care and Social Security cost cutting when the policy of trying to rule the whole world your way through a dominant military force is so much against your longer term interests when knowing that you are - by doing this - acting against the interests of the nations that in the longer run are the only ones that can save you financially. This would only be rational in case you want to follow a colonialist strategy of gaining control over foreign resources (while telling the rest of the world it is because of security reasons that you act the way you act) and when you are indeed willing to go all the way with a policy that is so much against what you stand for as a country politically. With Western nations in the longer-run not willing to go all the way against bigger nations (China, Russia, Iran etc) it is clear that the cost of the military apparatus is way too high a burden when taking into account the state of the economy. Dialogue with giants - even the ones that you don't like - seems to be far more efficient and through international trade it could lead to a safer world with a larger amount of financial and political equilibrium. Let's hope that Kotlikoff in one of his future paper's will also address this issue.  

    References

    For more information on all of this, visit Kotlikoff's Wikipedia page or his own personal website with a lot of interesting information.

     

    And click here for the link to LMG's slideshare page with the original 2006 article by Kotlikoff.

    Apr 18 9:56 AM | Link | Comment!
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