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� | Words into Ac t ion

1707IMF-SymantecAdv.indd 1 7/27/06 5:29:19 PM

PublishersPeter M. Antell

Ross W. Jobson

Associate PublisherDavid Woods

EditorPhilippe Legrain

Authors Manu Bhaskaran

Diane CoyleSimon CoxGeoff Dyer

Barry EichengreenBethan EmmettDuncan Green

Philippe LegrainSimon Long

Johan NorbergNouriel RoubiniJeffrey D. Sachs

AnnaLee SaxenianMark StGiles

Guido Schmidt-TraubJohn Williamson

Sales & Marketing DirectorLawrence Rosenberg

Project ManagersTrevor Raymond

Lloyd Millett

Marketing ExecutivesMargaret Cole

Guy HayesStephen Idrissi

Gary Tarian

Design & Production ControllerSandip Patel

DesignersDorota MellorsVictoria Wren

Picture ResearchKay Rowley

Production CoordinatorColin Davidson

Office ManagerEkta Dash

Words into ActionDelegate Publication

forThe International Monetary Fund and World Bank Group

Boards of Governors Annual MeetingsSuntec Center, Singapore, 11th-�0th September, �006

Published by Faircount Ltd

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and created an innovative capital-raising structure that

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©2005 Merrill Lynch & Co., Inc. Approved for UK distribution by Merrill Lynch, Pierce, Fenner & Smith Limited. 2 King Edward Street, London EC1A 1HQ.The UK compensation scheme and rules for the protection of private customers do not apply to the services provided or products sold by non-UK regulated affiliates.

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.

Publisher’s foreword

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SAVED: PRINTED: Printed

DOC PATH: Production: PROD_MECHANICALS:12 WIP December 05-1: Merrill Lynch: R55166_Magazine Ads

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Following the Asian fi nancial crisis, the Panigoro family

lost majority control of Medco, the largest private oil & gas

company in Indonesia. In 2005, lacking the capital needed to

regain control and with four weeks remaining to exercise their

right to regain control, they turned to Merrill Lynch. Acting as

a Strategic Advisor, we bypassed traditional funding channels

and created an innovative capital-raising structure that

targeted equity & yield-oriented investors across the US, Asia

& Europe. We then followed up with a successful dual-listed

GDR and Indonesian Stock Exchange offering that constituted

a ‘secondary IPO,’ enabling Medco to pay down debt. And

their stock price rose 60%. Discover the many ways we deliver

exceptional fi nancial solutions for exceptional clients.

COMPLETELY NEW FINANCING SOLUTION.

WHAT’S REMARKABLE ISN’T THAT WE DEVISED A

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� | Words into Ac t ion

AMRB CLDN PEGA PRFT PSTI QGEN UBSI

NASDAQ makes no representation about the fi nancial condition of any company. Investors should evaluate companies carefully before investing. Logos are trademarks of their respective companies. ©2006 The Nasdaq Stock Market, Inc. All Rights Reserved.

WORLD’S HIGHEST LISTING STANDARDS

WORLD OF CORPORATE SERVICES

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NASDAQ has set the standard by which all other markets will be measured.

ForewordForeword

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.

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 low-income 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

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)

AMRB CLDN PEGA PRFT PSTI QGEN UBSI

NASDAQ makes no representation about the fi nancial condition of any company. Investors should evaluate companies carefully before investing. Logos are trademarks of their respective companies. ©2006 The Nasdaq Stock Market, Inc. All Rights Reserved.

WORLD’S HIGHEST LISTING STANDARDS

WORLD OF CORPORATE SERVICES

+

=BEST OF ALL WORLDS FOR NASDAQCOMPANIES AND INVESTORS

IT ALL ADDS UP. The NASDAQ Global Select MarketSM has the world’s highest listing standards,

plus a full array of exceptional corporate services, such as corporate governance, risk management,

market monitors and investor relations. It’s NASDAQ’s way of creating another notch in its 35 years

of innovation. And by creating the highest quality relationships between companies and investors,

NASDAQ has set the standard by which all other markets will be measured.


Great Eastern is the largest

insurance group in Singapore

and Malaysia, with USD25

billion in assets and 2.6 million

policyholders. Holding strong to our core values

Integrity, Initiative and Involvement, Great Eastern has

made life great for our policyholders for close

to a hundred years.

Today as we roll out the red

carpet for delegates of the

Annual Meetings of the Board

of Governors of the International

Monetary Fund and World Bank Group, we celebrate

Singapore’s achievement as a global player in

business and finance. A warm welcome to the land

of financial security – where life is great!

PAUL WOLFOWITZPresident 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)

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.

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

Foreword

Great Eastern is the largest

insurance group in Singapore

and Malaysia, with USD25

billion in assets and 2.6 million

policyholders. Holding strong to our core values

Integrity, Initiative and Involvement, Great Eastern has

made life great for our policyholders for close

to a hundred years.

Today as we roll out the red

carpet for delegates of the

Annual Meetings of the Board

of Governors of the International

Monetary Fund and World Bank Group, we celebrate

Singapore’s achievement as a global player in

business and finance. A warm welcome to the land

of financial security – where life is great!

1� | Words into Ac t ion

C M Y CM MY CY CMY K

06 Forewords

Global Economy and International Finance

18 Mind the gap ByNourielRoubini

34 Safe to return? ByJohnWilliamson

48 Submerging markets? ByBarryEichengreen

Focus on Asia

60 India’s soft spot: Can it let China do the hard stuff? BySimonLong

72 Restructured and resilient ByManuBhaskaran

84 In the shadow of the dragon ByGeoffDyer

96 Schedule of Annual Meetings, 2006

99 The new Argonauts ByAnnaLeeSaxenian

Contents

14 | Words into Ac t ionMerchant Banking

Understanding the fl uctuations of the international investment market allows for

innovative investment strategies. At Fortis, we combine experience, expertise and

technology to offer you insight that turns strategic decisions into fi nancial solutions.

From our offi ces around the world, we have the skills and local market knowledge to

support your needs wherever and whenever that may be.

www.merchantbanking.fortis.com

Getting you there.

focus2

608_14583_mb_singapore.indd 1 10-08-2006 10:18:26

Development Agenda

112 Hitting the target JeffreyD.SachsandGuidoSchmidt-Traub

120 Spanning the digital divide ByDianeCoyle

130 “Our Heroes” ByPhilippeLegrain

142 The missing link ByJohanNorberg

Reforming Global Governance

154 Fixing the Fund BySimonCox

164 In the public interest ByBethanEmmettandDuncanGreen

174 First off the mark ByMarkStGiles

Contents

Merchant Banking

Understanding the fl uctuations of the international investment market allows for

innovative investment strategies. At Fortis, we combine experience, expertise and

technology to offer you insight that turns strategic decisions into fi nancial solutions.

From our offi ces around the world, we have the skills and local market knowledge to

support your needs wherever and whenever that may be.

www.merchantbanking.fortis.com

Getting you there.

focus2

608_14583_mb_singapore.indd 1 10-08-2006 10:18:26

SINGAPORE 2006. 276x426SINGAPORE 2006. 276x426



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.

Mind the gap

NOURIEL ROUBINI

is Professor of Economics at the

Stern School of Business, New

York University and co-founder

and Chairman of Roubini Global

Economics LLC, a web-based

economic consultancy. He is a

senior academic researcher in

international macroeconomics and

has had broad policy experience

in the US government. His latest

book (co-authored with Brad

Setser), Bailouts or Bail-ins?

Responding to Financial Crises in

Emerging Markets, was published

by the Institute for International

Economics in 2004.

The vigorous debate about the

global current-account imbalances

is reminiscent of Akira Kurosawa’s

Rashomon. In that classic film, a terrible

crime occurs in a forest, and while the

five characters agree that something

serious has happened, each has a different

interpretation of what happened, why,

and who is at fault. Likewise, the facts of

the global imbalances are generally not

disputed: (nearly) everyone agrees that

they are large and growing, with the US

saving less than it invests and spending

more than its income – and thus running a

current-account deficit – while most of the

rest of the world saves more than it invests

and spends less than its income, and thus

runs a current-account surplus. But in this

contemporary Rashomon saga, there are

at least ten competing interpretations of

what is causing the imbalances, and what

(if anything) should be done to remedy them.

Interpretation one: many blame the global

imbalances on the US’s twin budget

and current-account deficits. Two: Ben

Bernanke, Alan Greenspan’s successor

as chairman of the US Federal Reserve,

claims the imbalances have little to do

with the US’s fiscal deficit – because the

world is Ricardian, that is, consumers and

companies offset an increase in government

borrowing by saving more, in anticipation of

the future tax rises needed to be pay off the

extra debt – and are instead caused by a

“global savings glut” triggered by developing

countries saving too much. Three: others

argue that the imbalances are largely due

to a global investment drought rather than

a savings glut. Four: in the Bretton Woods

II hypothesis advanced by Michael Dooley,

David Folkerts-Landau and Peter Garber,

China and other emerging markets are

causing the imbalances by keeping their

currencies artificially low so as to boost their

export-led growth. Five: the imbalances

are caused by China’s excessive saving,

owing not to its exchange-rate policy

but to the structure of its financial and

economic systems. Six: Richard Cooper

argues that the imbalances are caused by

demographics and low productivity growth

– Japan, Europe and China need to save a

lot because they are ageing very fast, while

low productivity growth in Japan and Europe

exacerbates this need. Seven: housing

bubbles in the US and a handful of other

countries, caused in part by easy money,

are responsible for the imbalances, because

they have increased investment (in housing)

while leading to a consumption boom,

and hence reduced saving. Eight: financial

globalisation is the explanation, because

as investors are diversifying their portfolios

and investing more of their funds abroad,

foreigners’ demand for US assets is greatly

increasing. Nine: Ricardo Hausmann and

Federico Sturzenneger argue that the US

Words into Ac t ion | 19

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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,

how should countries rectify their behaviour

so as to try to reduce them in an orderly

fashion?

Who is telling the truth?Interpretation one – the twin-deficits story

– is the most plausible explanation for the

growth of the global imbalances, at least

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

current-account deficit was caused by an

investment boom which outstripped the

increase in national savings arising from the

country’s sharp fiscal improvement. But after

the tech bust, national investment fell by

4% of GDP between 2000 and 2004. Had

US national savings remained unchanged,

the current account would have improved

by 4% of GDP; instead, the deficit widened

by another 2% of GDP. Why? Because

US fiscal policy swung from a surplus of

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

of GDP in 2004 – a deterioration of 6% of

GDP, which exactly mirrors the widening of

the current-account deficit adjusted for the

collapse in investment. In the 1990s, the US

borrowed from abroad to invest in new real

capital; since then, it has been borrowing to

finance its fiscal deficits, foreign wars and

lack of private savings. The pattern of capital

inflows matches this story: in the 1990s,

there was a large net inflow of FDI and

equity investments to the US; since then,

there have been large net outflows, offset by

a massive accumulation of US debt, mostly

Treasuries, by foreign central banks.

Since 2005, matters have changed a

little. The US current-account deficit has

continued to widen, while the fiscal deficit

has shrunk somewhat. Since last year, an

excess of savings in China and oil-exporting

countries has helped keep long-term US

interest rates low – thus explaining the

now infamous “bond-market conundrum”

– and fed the housing (and associated

consumption) bubbles. This, in turn, has led

to a further reduction in US private savings,

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



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.

with household savings actually turning

negative. It is true, then, that excess savings

in a few countries have swollen the global

imbalances since last year, but Bernanke

overstated his case by referring to a “global”

savings glut (interpretation two). If anything,

in fact, we are experiencing a – possibly

temporary – global investment drought

(interpretation three). Investment rates in

East Asia have never recovered since the

1997-98 crisis, while they have also been

low in slow-growing Europe and Japan for

quite a while.

The Bretton Woods II story (interpretation

four) is a variant of the Bernanke savings

glut argument where the excess savings

are caused by the mercantilist exchange-

rate policies of China and other developing

countries. It therefore has some truth to it.

But the Panglossian view of its proponents

that the global imbalances are optimal and

sustainable for decades is wishful thinking.

Inevitably, if the US continues to run current-

account deficits of some 7% or more of

GDP, its external liabilities will eventually

become unsustainably large, triggering a

collapse of the dollar and a global recession.

China’s excess saving is in part to structural

factors which hamper consumption

(interpretation five). Because the country’s

social safety net is threadbare, Chinese

households need to save for education,

health care, old age and possible

unemployment. Weaknesses in its financial

system – the lack of a sound consumer-

credit system and constraints in the way

housing is financed – also force households

to save too much. Structural reforms

– which China plans to implement in the

next few years – are needed so as to reduce

the economy’s reliance on net exports and

investment for its long-term growth and

boost the role of private consumption.

Demographic trends in Europe, Japan

and China combined with low productivity

growth in Europe and Japan imply that part

of these global imbalances is structural

rather than cyclical – and thus more

sustainable (interpretation six). But the

view that the imbalances are entirely due

to demographics is far-fetched. For a start,

while China may have an ageing problem,

its productivity growth is huge, so it does

not need to save as much as slow-growing

Europe and Japan. Also, although Europe

and Japan may require a structural current-

account surplus for demographic reasons,

in practice, the eurozone’s current account

is broadly in balance.

Easy money and other financial-sector

factors which have led to a housing boom

are a more promising partial explanation of

the global imbalances (interpretation seven).

Along with the US, the countries with large

current-account deficits include Turkey,

Hungary, Australia, New Zealand, Iceland

and Spain. All have experienced a housing

boom, which has led to a rise in residential

investment and a fall in private savings, as

households who feel richer because the

value of their home has increased spend

more – both of which swell the current-

account deficit. These countries also display

other common features: an overvalued

currency, a credit boom and a potentially

dangerous accumulation of external

liabilities. This year, as opportunities for yield

carry trades – borrowing in countries with

low interest rates, notably Japan, in order

to invest in countries with higher investment

returns – have been unwinding, all of these

countries (save for Spain, which is in the

eurozone) have experienced pressures on

their currency, in some cases quite severe.

The danger is that as interest rates are

raised to control inflation, their housing

bubbles could burst, causing investment to

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

fall and savings to rise, restoring balance

to their current accounts – by provoking

a recession.

Paradoxically, the recent flight of capital

from emerging-market economies with

large current-account deficits has led to a

temporary appreciation of the US dollar, as

investors fleeing risky assets are seeking

the safety of US Treasuries. But seeking

refuge in the country with the biggest

current-account deficit is a temporary and

unsustainable outcome. Eventually, the

dollar will again be pushed down by bearish

forces both structural (its large current-

account deficit) and cyclical (shrinking

interest-rate and GDP growth differentials

between the US, and Europe and Japan).

Even the dollar cannot defy the laws of

gravity forever.

It is often claimed that financial globalisation,

the reduction in home bias and the large

foreign demand for US assets, explains

the global imbalances (interpretation eight).

But this is incorrect. Financial globalisation

cannot explain changes in global savings

and investment (leading to current-account

imbalances), because these depend on

other factors. In any case, a diversification

of portfolios and a reduction in home bias

do not imply current-account deficits:

cross-border transactions of domestic

and foreign assets can lead to any level of

diversification and reduction in home bias

without changing net positions, that is, with

zero current-account deficits. What’s more,

in the past five years returns on US equities

have been significantly lower than those

on foreign ones. Foreigners are no longer

rushing to buy US shares; on the contrary,

net, they are pulling their money out of

US equities.

While financial globalisation is not causing

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

people all of the time. If investors expected

“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.”

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a necessary dollar depreciation – even a

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

assets should adjust upwards to offset

this expected fall in the US dollar. The US

would therefore not be able to reduce the

real value of its foreign liabilities through a

persistent dollar depreciation.

As for the supposed “dark matter”

(interpretation nine), it seems more like

a “black hole” once one considers the

evidence. The fable goes as follows: if the

US were truly a net debtor (to the tune

of over $2.5 trillion, according to official

figures), net factor income payments should

be negative (if the returns on US-owned

foreign assets are on average equal to the

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

net factor income payments have remained

positive, even after America formally became

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

foreign assets must therefore have some

intangible extra value – such as superior US

technology, skills or financial intermediation

– which explains this paradox. In which

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

is it even running a current-account deficit

This is nonsense. For a start, net factor

income is rapidly shrinking, and will

become negative in 2006. The reason why,

despite being a net debtor, the US has

earned more on its foreign assets recently

than it has paid out to its foreign creditors

is because while its foreign holdings are

mainly equities and FDI, its liabilities are

mainly bonds – and US interest rates have

temporarily been low. Also, tax arbitrage

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,

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

GDP forever. It would only mean that the

current-account position that eventually

stabilises the US’s net external liabilities

would be a small deficit (perhaps 1% of

GDP at most) rather than a small surplus

– and reducing the trade deficit from 7% of

GDP to 1% of GDP still implies a huge, and

painful, adjustment.

Oil exporters do account for part of the

recent increase in the global imbalances

(interpretation ten), but they are not the

main factor behind it, nor will the recycling

of petrodollars provide continued cheap

and easy financing for US current-account

deficits. So far, the US has reacted to

the oil shock as if it were temporary,

maintaining its high level of consumption

and reducing its savings in the face of the

loss of real income that higher oil prices

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

account deficit. Oil exporters have also

behaved as if the shock were temporary,

and saved most of their oil windfall. Yet

this shock is now semi-permanent – it has

already lasted several years – so the US

might do well to copy Europe and Asia,

where lower consumption has taken some

of the strain. Note that all of this implies

that the net increase in oil exporters’

savings has not been fully matched by

a drop in oil importers’ savings, so that

overall the oil shock has not led to a large

increase – or glut – in global savings and

cannot account, as some claim, for most

of the fall in global long-term interest rates.

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

➣


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.➣



some tax cuts that the US cannot afford

to make permanent. China and the rest of

the Bretton Woods II periphery in Asia must

let their currencies appreciate and adopt

structural reforms which stimulate domestic

consumption at the expense of net exports.

Europe and Japan must accelerate structural

reforms that will increase investment,

productivity and growth, thus reducing their

external surpluses. And oil exporters need

to let their pegged currencies appreciate

and start spending more of their windfall

gains on consumption and investment in

extra oil production. Each region requires a

combination of expenditure-switching policies

(via changes in relative prices triggered by

currency movements) and policies that

involve a change in the level of expenditure

(for the US, a reduction in spending relative

to its income; for other regions, an increase)

in order to achieve an orderly global

rebalancing. Without an offsetting rise in

foreign spending (and fall in foreign savings),

a big fall in the US dollar and an increase in

US private and public savings could lead to

a global slowdown. The burden of global

rebalancing must be shared.

But there is a big gap between the rhetoric

of what should be done and the reality

of what is actually being done. It is time

for the organisation charged with global

economic and financial stability to act. The

IMF has been assigned the role of impartial

“referee” in seeking an orderly resolution to

the global imbalances. But although it has

little enforcement power, or even leverage,

over sovereign countries that do not owe it

money, it is not wholly impotent. It should be

more assertive, by naming and shaming the

culprits in this saga. As each country seeks

to pass the buck, the twin spectres of trade

and asset protectionism are rearing their

heads.

Next year, the US current-account deficit

may top $1 trillion, and rising. Eventually,

such an accumulation of foreign liabilities will

become an unsustainable Ponzi scheme,

which implies an ever-expanding ratio of the

US’s foreign liabilities relative to its GDP.

Last year, even though the conditions for the

private sector to finance the US deficits were

almost perfect – the Fed was tightening

while the ECB and the Bank of Japan were

on hold; the US economy was growing

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

Homeland Investment Act heavily subsidised

the repatriation of US profits abroad; and

the dollar was rising, providing capital gains

to foreign holders of US dollar assets – only

half of the current-account deficit of some

$800bn was financed by private investors,

the rest being supplied by foreign central

banks.

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

rising; the Homeland Investment Act has

expired; and the returns on US equities and

housing are flat or negative. While the US’s

financing needs are larger, foreign investors

will be less willing to hold US dollar assets

than last year. So, unless foreign central

banks are willing to increase – relative

to the massive amounts of 2005 – their

accumulation of dollar assets, the dollar will

fall and US interest rates will rise.

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

➣

➣

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■

If central banks accumulate foreign reserves

at a slower pace than in 2005 (let alone

dump their existing stocks of such assets),

private investors will be unwilling to fill the

gap. Private demand for dollar assets is

complementary to, not a substitute for,

public demand. So long as Asian currencies

are not rising against the dollar, it makes

sense for private investors to finance the

US deficit, because the returns of carry

trades – for instance, borrowing at 0% in

Japan to invest at 5% in US assets – are

large and the currency risk close to nil. But if

central banks intervene less and allow their

currencies to appreciate somewhat, private

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

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

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

range of Asian currencies; or challenges to

US power in the Middle East or North Korea.

In an increasingly imbalanced global

economy, the risks of a hard landing are

rising. The world urgently needs to start

tackling the global imbalances. All major

countries and regions need to assume their

responsibilities and act soon, so that the

finale of this contemporary Rashomon saga

is less acrimonious and painful than the

ending of Kurosawa’s masterpiece. Time

is running out; we must move from debate

to action, starting here at the IMF annual

meeting in Singapore.

So long as Asian currencies are not rising against the dollar, it makes sense for private investors to finance the US deficit.

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

➣

Nomura’s activities reach across international boundaries to deliver focused

solution-based services to a broad spectrum of clients. As one of the world’s

leading investment banks, Nomura provides a full range of global products

and services. For details, visit www.nomura.com

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Who can provide a smooth path through the world’s financial markets?

Nomura’s activities reach across international boundaries to deliver focused

solution-based services to a broad spectrum of clients. As one of the world’s

leading investment banks, Nomura provides a full range of global products

and services. For details, visit www.nomura.com

Nomura Singapore Limited is regulated by the Monetary Authority of Singapore. Registered in Singapore no. 197201440E; GST no. M2-0014575-5. Registered Office: 6 Battery Road #34-01 Singapore 049909.A wholly owned subsidiary of Nomura Holdings, Inc, Japan.

Who can provide a smooth path through the world’s financial markets?



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.

Safe to return?

JOHN WILLIAMSON

is a Senior Fellow at the Institute

for International Economics in

Washington, DC. In 1996-99, he

was chief economist for South

Asia at the World Bank. In 2001

he served as project director

for the UN High-Level Panel on

Financing for Development (the

Zedillo Panel). He has taught

at a number of prestigious

universities and published

widely on international monetary

issues, most recently Curbing

the Boom-Bust Cycle: Stabilizing

Capital Flows to Emerging

Markets (Institute for International

Economics).

It is nine years since the IMF/World Bank

annual meetings were last held in East

Asia. Those Hong Kong meetings were

held during a lull in the financial crisis that

was ravaging the region. Partly at least to

prevent a recurrence, virtually every country

in the region has since built up its reserves

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

now, inconceivable. But everyone knows

that this insurance is expensive. One of

the main benefits of international capital

flows is negated if a country that receives

a capital inflow feels obliged to build up its

reserves to cover a subsequent outflow. If

the international capital market is ever again

to fulfil its potential of reallocating resources

to parts of the world where the return on

investment is highest, countries need to

be given the confidence to use their capital

inflows to finance current-account deficits.

Looming demographic and development

trends make this task especially important.

Over the next 50 years, virtually all

population growth will occur in parts

of the world that are now labelled as

developing countries, while most of the

currently developed countries are likely to

experience a gradual population decline.

Moreover, many (with luck, most) developing

countries – and certainly most in East Asia

– seem likely to develop. Undeniably, this

requires good institutions, a work ethic,

entrepreneurial attitudes and a good

education system, but it also requires lots

of investment. Meanwhile, many developed

countries should be saving more than they

can profitably invest, in part to build up

assets for the coming explosion in their

retired population. The world would benefit

from arrangements that facilitate a flow

of capital from developed to developing

countries. That means real capital flows,

transferred via current-account deficits,

not having reserve changes provide the

counterpart to capital inflows. Large capital

flows to emerging markets would also

help attenuate the pressure for large-scale

migration.

Several things can be done to facilitate

this process. Potential capital-importing

countries need to manage their economies

in ways unlikely to cause investors to

panic. They need to maintain low rates of

inflation and a sound fiscal position, adopt

modern methods of economic management

(involving flexible exchange rates and inflation

targeting), allow automatic fiscal stabilisers

to work, avoid large currency mismatches

in their asset/liability positions, borrow in

forms that do not impose the risk of sudden

large demands for repayment, and avoid a

reputation for corruption. The world’s major

economies need to maintain a healthy rate

of growth and avoid crises and recessions.


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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

repayment unrelated to the debtor’s actions.

I will focus principally on what types of

instruments would be best suited to

minimise the risk of sudden demands being

made on a country’s payments capacity

at inappropriate times. Introducing and

making use of such instruments will require

supportive actions by both emerging-

market borrowers, which need to issue their

instruments in the appropriate form, and

lenders, which need to recommend that

their clients buy appropriate instruments.

Some forms of debt are best avoidedFinancial crises such as the one in 1997

arise when a large number of creditors

seek immediate repayment of their loans.

For this to be possible, a large number of

short-term loans must be outstanding. For

it to be dangerous, the value of the short-

term loans outstanding has to be large

relative to the reserves held by the debtor

countries that are unconditionally available

to make payments. (Hence the popular

recommendation that countries should keep

reserves at least equal to their level of short-

term debt.) Debt is particularly dangerous

if it is denominated in foreign currency,

for then a crisis that reduces the value of

the domestic currency – as they tend to

– will automatically increase the domestic-

currency value of debt, and thus the burden

of servicing it.

This simple analysis points immediately to

two kinds of debt that developing countries

ought to avoid: short-term loans and

foreign-currency-denominated ones.

Of course, some debts are naturally short-

term, such as trade credit. Foreign banks

could hardly be expected to make a five-

year loan for imports that are due to be

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%.



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

sold within three months. Trade credits are

naturally short-term, and are normally rolled

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

banks may try to cut the trade credits that

they supply to a country, and occasionally

countries have tried to negotiate with their

banks to maintain aggregate trade credit

lines unchanged. It is difficult, though, to

envisage any pre-commitment to that effect.

One probably has to accept that banks may

try to curtail trade credit in a crisis, and any

attempts to modify that will have to be ad hoc.

But other forms of short-term debt could

be avoided. For sure, banks prefer to

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 short-

term loans other than for trade credit, or

by reducing short-term domestic interest

rates below the foreign rate. As countries

develop, the latter will become a real

possibility, but until then there is much to be

said for retaining some capital controls.

The other problem arises from currency

mismatches. 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. A part of the literature

argues that lenders are simply not prepared

to lend in the currencies of most emerging

markets, because the countries suffer

from “original sin”. This seems to me far

too defeatist. Once, investors had little

confidence in the monetary and statistical

authorities of most emerging markets, so if

those countries wanted to borrow abroad

they had to do so in foreign currency. But

nowadays, many emerging markets are

capable of borrowing on the international

market in loans denominated in their own

currencies (as recent local-currency loans

➣

➣

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.

C

M

Y

CM

MY

CY

CMY

K

C

M

Y

CM

MY

CY

CMY

K



issued by countries such as Brazil and

Colombia show). Even when international

markets do not have enough confidence

in local monetary authorities to make long-

term loans at reasonable interest rates, they

may well have sufficient confidence in the

integrity of their statistical services, and thus

be prepared to make loans indexed to the

local price level. These are still denominated

in the local currency, so that in the event of

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

borrower is unable to inflate away the real

value of its debts.

One measure needed to promote a shift to

local-currency financing is simple: sovereign

issuers need to be willing to issue local

currency debt, and overcome their fear

of “original sin”. But of course much debt

is private, and this cannot be converted

to local-currency form simply by the will

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.”

➣


of the sovereign. Issuing local-currency

sovereign debt might help – for example,

by establishing a yield curve – but it is

unlikely to be sufficient. Hence it is natural

to ask what other policies might help to

encourage private companies to issue debt

denominated in the local currency,

Apart from the heavy-handed tool of

administrative direction, which few

economists would wish to use unless there

seemed no feasible alternative, there are at

least two possibilities. One involves bank

regulation. Bank regulators could make it

clear that they wished the banks subject

to their supervision to maintain a balanced

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 insteadShort 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.

This is sovereign borrowing through growth-

linked (sometimes referred to as GDP-

linked) bonds.

Growth-linked bonds involve a yield that

varies according to a country’s rate of

growth. They could take several forms. They

could be for any maturity, though it is most

natural to think of them being used for fairly

long-term loans, since otherwise the return

to the lender (and therefore the cost to the

borrower) is unlikely to vary much from

what the market would otherwise require.

But in the longer term, our foresight is very

imperfect, so that an instrument whose

return varies with actual outcomes could ex ➣



➣

post yield substantially more (or less) than

the principals expected ex ante. Because

the yield would vary depending upon the

borrower’s ability to pay, the likelihood of

default would be lower than with a plain

vanilla loan. Only in bad states of the world

would the borrower have to pay less, but

this could help persuade a debtor not to

default if its payments were automatically

reduced at times when it confronted

difficulties. Lenders would expect those

low returns to be compensated by the high

payments that would accrue to them in

good states of the world. And by holding

a diversified portfolio of these assets issued

by a number of countries, lenders would

be able to reduce the expected variability

in their returns over time. If many countries

issued such bonds, one would expect

lenders to be able to diversify away most

of their risk.

Growth-linked bonds could also differ as

to the currency in which the bonds are

denominated and growth is measured.

Like plain-vanilla bonds, growth-linked

bonds could be denominated either in

the domestic currency or in a foreign one.

However, there would be strong advantages

in domestic-currency denomination. This

would give the borrowers the advantages

discussed above, of avoiding an increase in

their debt burden just when circumstances

are most difficult. Also, growth (both nominal

and real) is in the first instance measured

in terms of the domestic currency. It would

therefore be relatively simple and completely

unambiguous to calculate the debt service

implied by the contract.

The third dimension of designing a growth-

linked bond is the most interesting, because

it raises completely novel issues. Even if

we have agreed that we are talking about

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

currency denomination, we may think of

an instrument that promises to pay a given

proportion of GDP each year, perhaps with

a higher proportion in order to amortise the

instrument in the final year (or a number

of concluding years), as proposed by

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

country would have to raise the base offer

to something more than 7%, but one would Like plain-vanilla bonds, growth-linked bonds could be denominated either in the domestic currency or in a foreign one.

➣

➣



expect this premium to be small where

lenders have an opportunity of diversifying

their risks away.

What are the main differences between

these two instruments? Most obviously, the

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

the debtor is obliged to pay depends upon

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

grow will find these assets attractive. In the

long run, borrowers may not have to pay a

premium to borrow in this way, although it

would be sensible for them to be prepared

to pay somewhat more in order to reduce

their risk profile.

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

➣


Sceptics always ask whether countries

would not cheat and announce lower growth

figures in order to reduce their debt-service

payments. Since the increase in debt

service-payments is unlikely to be more

than a small part of an increase in growth,

there need be no fear that countries would

seek to reduce their growth in order to

reduce their interest bill. The more realistic

danger is that countries might lie about their

growth rate. But finance ministers usually

take pride in announcing higher, not lower,

growth, and it seems rather unlikely that they

would anticipate gaining political brownie

points by lying about how little their country

had grown. Furthermore, investors do not

fret about countries under-estimating their

inflation numbers in order to save interest

on inflation-linked bonds. Above all, this is

surely an issue where financial markets could

be relied on to discipline any rogue countries

that might consider manipulating their

published growth rates in order to reduce

their interest bill. A country that acquired a

reputation for doctoring its growth rate so as

to reduce its interest payments would before

long be forced to sell growth-linked bonds at

a higher premium. ➣

Since the East Asian crisis of the 90’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.



An Asian capital market?One of the financial initiatives currently

under way in East Asia involves an attempt

to build a regional capital market. In

addition to attracting private investors, it is

envisaged that countries will invest a part

of their reserves in liabilities issued by other

regional countries. Of course, this will only

reduce the volume of dollar assets that the

countries of the region collectively have

to buy to the extent that some countries

(presumably those that issue the liabilities)

adjust their current-account positions, but

they would be in a position to do this as a

result of the larger capital inflows.

There is a danger that any such regional

capital market would operate in excessively

traditional instruments. If creditors were

only willing to buy short-term, dollar-

denominated, plain vanilla bonds, it

is difficult to see that much would be

accomplished by having the intermediation

occur in Singapore rather than Wall Street.

But it does not have to be that way. The

most likely modification of conventional

arrangements would involve the issue of

bonds denominated in local currencies,

or a basket of local currencies, rather

than the dollar. The Asian Development

Bank has been advocating the creation

of a local-currency basket that could be

used to denominate loans. Such a basket

would go part of the way towards satisfying

the objectives that it was argued above

would be furthered by local currency

denomination: the basket would depreciate

in the event of a renewed regional crisis,

but the depreciation would be modest if a

crisis were confined to just one country. It

is therefore to be hoped that any regional

capital market would be open to the issue

of instruments denominated in the national

currencies as well as a regional basket.

A regional capital market would neither

preclude nor guarantee the issue of long-

term or growth-linked instruments. One

would not expect central banks to want to

place their reserves in such instruments,

but a number of countries are now realising

that their asset accumulation has already

exceeded prudent estimates of the need

for reserves and that the balance should

be invested to make money. These assets

might well take longer-term and growth-

linked forms. A regional capital market would

enable Asia to start issuing such instruments

internationally even if traditional creditors in

the developed countries resist this move.

My guess is that some of the less hidebound

moneymen from the developed countries

would soon be attracted to what had initially

been planned as an Asian regional market.

The whole world, North and South, old

industrial countries and emerging markets,

share an interest in reviving large capital flows

to developing countries. While it is important

to prevent these flows getting out of hand

and generating a new crisis, the current

problem is to re-establish the direction of

flows that prevailed prior to the 1997 crisis.

This will only happen if emerging markets

are convinced that a revival of capital inflows

does not threaten them with a new crisis.

Several conditions would help nurture such

a conviction, but one of the most important

is to develop new instruments that carry less

risk of provoking crisis. This implies longer-

dated debt, avoiding denominating loans

in the currencies of creditor countries, and

developing a market for growth-linked bonds.

An Asian regional capital market would not in

itself guarantee that instruments would take

this form, but it would give Asia the power

to decide for itself whether to issue such

instruments rather than also having to rely

on the goodwill of Wall Street.

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

➣

■

Financial bridges

Arab Bank, a 76-year-old Jordan-basedoperation, quoted on the Jordanian stockexchange has a regionally unparalledworldwide network and has developedstrong and long-standing relationships with global financial institutions. Itsshareholders, as well as the foundingShoman family, include the governmentsof Saudi Arabia and Jordan, while thePrime Minister of Lebanon is a formerboard member. The bank is the localequivalent of a Barclays or RBS in theMiddle East and North Africa.

Arab Bank plays a major role in financingstrategic projects in the MENA region, in areas such as power generation,desalination, petro-chemicals, aluminium,telecommunications and otherinfrastructure projects.

A significant increase in shareholdersequity through a new public offering, the first since 1964, as well as thecapitalisation of the 2005 income isunderpinning Arab Bank’s aim to enhanceits strategic positioning and to augment its earning power.

Arab Bank is extending its geographicalcoverage, widening its distributionchannels and diversifying the Bank’sservices and financial products, especiallyin the areas of private banking, treasuryand project financing. A major milestone inachieving this objective was the creationof Europe Arab Bank plc (EAB).

The IMF/World Bank meetings present a rare opportunity for financial institutions to engage with key global financial decisionmakers in a concentrated environment.

“They provide an excellent opportunity for us to meet senior representatives of our public and private sectorclients and to review new business opportunities across the Arab Bank Group”, says Phillip Monks, CEO ofEurope Arab Bank plc, the recently launched wholly owned subsidiary of the Arab Bank Group - established tohandle the Bank’s operations in the countries of the European Union. “This year’s event will provide Singaporeand its ASEAN neighbours with a unique opportunity to showcase their economic resurgence and growth asmajor financial forces in the international marketplace and will act as a spur to regional and global trade.”

Phillip MonksChief Executive Officer, Europe Arab Bank plc

Europe Arab Bank Moorgate office

“Arab Bank has an enviable brandreputation in the Middle East and it is thisthat it wants to leverage with its newventure.” says the CEO, Phillip Monks,“This new operation provides acommercial financial bridge between theMiddle East and Europe. I talked to clientsand they recognise the capability ArabBank has in the Middle East. They arelooking for a capable world-class Europeansubsidiary of a local bank to help them inArab Bank’s home markets. When youlook at all the wealth that’s beinggenerated Europe provides a goodinvestment home for Arab investors.”says Monks “At the same time” hecontinues, “EAB can help people whohaven’t been involved in the Middle Eastand North Africa by using its expertise toshow them the opportunities in the region.We want our bank to be a Europeangateway to the Arab and North Africanworlds.”

EAB plc, which was given a licence in Mayby the Financial Services Authority inLondon to begin operations, has its mainoffices in Arab Bank’s premises inMoorgate, in the heart of the City, just ashort walk from the Bank of England. Thenew concern is being gifted €500m by itsparent, with the firm instruction to go outand make itself the bank of choice forprivate and corporate clients operatingacross the European – MENA axis. The EUcurrently conducts some $250bn of tradewith the Middle East every year.

Monks joined Arab Bank in December lastyear after a career with Barclays in a wide variety of posts, including runningcorporate banking operations in the UKregions, private banking in Switzerland,and being in charge of Gerrard InvestmentManagement, Barclays private wealthmanagement operation, which looks aftermore than £12bn for its clients. It is, PhillipMonks says, “an opportunity few bankersever get - the chance to lead the start-upof a fully fledged multi-national full-servicebanking operation.”

Arab Bank’s chairman, Abdel HamidShoman, grandson of the bank’s founderand “an absolutely fascinating character,“Mr Monks says, “asked me, more or less,’How do you fancy running your ownbank?’“ It is Shoman’s vision, Monks says,which is the primary driver behind thelaunch of Europe Arab Bank, to distinguishArab Bank as more than just a regionalplayer. “I quizzed him hard on what hemeant,“ Mr Monks says, and he cameaway enthused with Shoman’s plans totransform Arab Bank’s European businessinto a world-class operation. Europe ArabBank “also provides the vehicle for theArab Bank Group to assess furthercorporate activity“. There is theopportunity too, at some unspecified timein the future, to raise more capital throughthe markets.

Much of Arab Bank’s subsidiary under-takings such as back office operations inFrankfurt, Paris, Rome, Vienna and Madrid,are now being folded into London underthe Europe Arab Bank brand. There will besome new hiring’s – “you need to look atgetting the best people you can possiblyafford,“ Mr Monks says. “This isfundamentally a growth strategy. You haveto seek out the best people for the job.The final result will be a European bankaligned to a fantastic franchise in theMENA region and people who have reallocal knowledge and deep industryexpertise in most sectors relevant to tradebetween Europe and MENA.

The new bank’s logo, which is now on all the windows of the Moorgate Streetoffices, is a minimalist rendering of thethree linked ’medallions’ used by ArabBank, 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 amulti-cultural and multi-racial environment,“Mr Monks says.

Although Europe Arab Bank is 100 percentowned by its parent, “we are legallyindependent and regulated“ Monks says.At the same time, the chairman of theEurope Arab Bank board is Abdel HamidShoman, chairman of Arab Bank itself. Heis ambitious for the bank and “I can tellyou that Chairmen in an Arab bank are noless demanding than they are across theworld,“ he says with a smile. There is, hesays, “a sense of patience and impatiencein equal measure,“ a desire to deliverresults as soon as possible off theplatform being built at Europe Arab Bank,while at the same time creatingsomething that will last: “

Monks is full of enthusiasm for the Middle East and its opportunities: “It’s afascinating, invigorating place to work.“

The support from Arab Bank’s bigshareholders for the new venture is“hugely exciting“, he says, and he has“buy-in“ from the staff who are beingtransferred into Europe Arab Bank forwhat he wants to achieve. At the sametime there is a growing queue of peoplewho have heard about what is happeningand would like to be part of it. “Theorganisational change just gives you thefoundation to build the bank you want tobuild.“ Future steps include achieving an “A+“ rating from the financial ratinginstitutions. There is no doubting Mr Monks’ zest for the task ahead.“Entrepreneurialism and banking aren’ttwo words normally seen hand in hand,“he says. “But anyone who comes in herenow can be handed the opportunity to beinvolved in shaping the biggest bankingstart-up in Europe.“

Arab Bank Group is in the vanguard of the banking industry, both regionallyand internationally. The Group has an enviable worldwide presence,including branches in Singapore, Chinaand a wholly owned subsidiarybusiness in Australia. The creation of its new European Operation furtherstrengthens the group’s ability to meetthe challenges of the future in servicingthe financial needs of people who areinvolved in trading in Middle East and North Africa, wherever they aredomicile.

EAB_IMFworldbank_advertorial 17/8/06 11:41 am Page 1

Financial bridges

Arab Bank, a 76-year-old Jordan-basedoperation, quoted on the Jordanian stockexchange has a regionally unparalledworldwide network and has developedstrong and long-standing relationships with global financial institutions. Itsshareholders, as well as the foundingShoman family, include the governmentsof Saudi Arabia and Jordan, while thePrime Minister of Lebanon is a formerboard member. The bank is the localequivalent of a Barclays or RBS in theMiddle East and North Africa.

Arab Bank plays a major role in financingstrategic projects in the MENA region, in areas such as power generation,desalination, petro-chemicals, aluminium,telecommunications and otherinfrastructure projects.

A significant increase in shareholdersequity through a new public offering, the first since 1964, as well as thecapitalisation of the 2005 income isunderpinning Arab Bank’s aim to enhanceits strategic positioning and to augment its earning power.

Arab Bank is extending its geographicalcoverage, widening its distributionchannels and diversifying the Bank’sservices and financial products, especiallyin the areas of private banking, treasuryand project financing. A major milestone inachieving this objective was the creationof Europe Arab Bank plc (EAB).

The IMF/World Bank meetings present a rare opportunity for financial institutions to engage with key global financial decisionmakers in a concentrated environment.

“They provide an excellent opportunity for us to meet senior representatives of our public and private sectorclients and to review new business opportunities across the Arab Bank Group”, says Phillip Monks, CEO ofEurope Arab Bank plc, the recently launched wholly owned subsidiary of the Arab Bank Group - established tohandle the Bank’s operations in the countries of the European Union. “This year’s event will provide Singaporeand its ASEAN neighbours with a unique opportunity to showcase their economic resurgence and growth asmajor financial forces in the international marketplace and will act as a spur to regional and global trade.”

Phillip MonksChief Executive Officer, Europe Arab Bank plc

Europe Arab Bank Moorgate office

“Arab Bank has an enviable brandreputation in the Middle East and it is thisthat it wants to leverage with its newventure.” says the CEO, Phillip Monks,“This new operation provides acommercial financial bridge between theMiddle East and Europe. I talked to clientsand they recognise the capability ArabBank has in the Middle East. They arelooking for a capable world-class Europeansubsidiary of a local bank to help them inArab Bank’s home markets. When youlook at all the wealth that’s beinggenerated Europe provides a goodinvestment home for Arab investors.”says Monks “At the same time” hecontinues, “EAB can help people whohaven’t been involved in the Middle Eastand North Africa by using its expertise toshow them the opportunities in the region.We want our bank to be a Europeangateway to the Arab and North Africanworlds.”

EAB plc, which was given a licence in Mayby the Financial Services Authority inLondon to begin operations, has its mainoffices in Arab Bank’s premises inMoorgate, in the heart of the City, just ashort walk from the Bank of England. Thenew concern is being gifted €500m by itsparent, with the firm instruction to go outand make itself the bank of choice forprivate and corporate clients operatingacross the European – MENA axis. The EUcurrently conducts some $250bn of tradewith the Middle East every year.

Monks joined Arab Bank in December lastyear after a career with Barclays in a wide variety of posts, including runningcorporate banking operations in the UKregions, private banking in Switzerland,and being in charge of Gerrard InvestmentManagement, Barclays private wealthmanagement operation, which looks aftermore than £12bn for its clients. It is, PhillipMonks says, “an opportunity few bankersever get - the chance to lead the start-upof a fully fledged multi-national full-servicebanking operation.”

Arab Bank’s chairman, Abdel HamidShoman, grandson of the bank’s founderand “an absolutely fascinating character,“Mr Monks says, “asked me, more or less,’How do you fancy running your ownbank?’“ It is Shoman’s vision, Monks says,which is the primary driver behind thelaunch of Europe Arab Bank, to distinguishArab Bank as more than just a regionalplayer. “I quizzed him hard on what hemeant,“ Mr Monks says, and he cameaway enthused with Shoman’s plans totransform Arab Bank’s European businessinto a world-class operation. Europe ArabBank “also provides the vehicle for theArab Bank Group to assess furthercorporate activity“. There is theopportunity too, at some unspecified timein the future, to raise more capital throughthe markets.

Much of Arab Bank’s subsidiary under-takings such as back office operations inFrankfurt, Paris, Rome, Vienna and Madrid,are now being folded into London underthe Europe Arab Bank brand. There will besome new hiring’s – “you need to look atgetting the best people you can possiblyafford,“ Mr Monks says. “This isfundamentally a growth strategy. You haveto seek out the best people for the job.The final result will be a European bankaligned to a fantastic franchise in theMENA region and people who have reallocal knowledge and deep industryexpertise in most sectors relevant to tradebetween Europe and MENA.

The new bank’s logo, which is now on all the windows of the Moorgate Streetoffices, is a minimalist rendering of thethree linked ’medallions’ used by ArabBank, 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 amulti-cultural and multi-racial environment,“Mr Monks says.

Although Europe Arab Bank is 100 percentowned by its parent, “we are legallyindependent and regulated“ Monks says.At the same time, the chairman of theEurope Arab Bank board is Abdel HamidShoman, chairman of Arab Bank itself. Heis ambitious for the bank and “I can tellyou that Chairmen in an Arab bank are noless demanding than they are across theworld,“ he says with a smile. There is, hesays, “a sense of patience and impatiencein equal measure,“ a desire to deliverresults as soon as possible off theplatform being built at Europe Arab Bank,while at the same time creatingsomething that will last: “

Monks is full of enthusiasm for the Middle East and its opportunities: “It’s afascinating, invigorating place to work.“

The support from Arab Bank’s bigshareholders for the new venture is“hugely exciting“, he says, and he has“buy-in“ from the staff who are beingtransferred into Europe Arab Bank forwhat he wants to achieve. At the sametime there is a growing queue of peoplewho have heard about what is happeningand would like to be part of it. “Theorganisational change just gives you thefoundation to build the bank you want tobuild.“ Future steps include achieving an “A+“ rating from the financial ratinginstitutions. There is no doubting Mr Monks’ zest for the task ahead.“Entrepreneurialism and banking aren’ttwo words normally seen hand in hand,“he says. “But anyone who comes in herenow can be handed the opportunity to beinvolved in shaping the biggest bankingstart-up in Europe.“

Arab Bank Group is in the vanguard of the banking industry, both regionallyand internationally. The Group has an enviable worldwide presence,including branches in Singapore, Chinaand a wholly owned subsidiarybusiness in Australia. The creation of its new European Operation furtherstrengthens the group’s ability to meetthe challenges of the future in servicingthe financial needs of people who areinvolved in trading in Middle East and North Africa, wherever they aredomicile.

EAB_IMFworldbank_advertorial 17/8/06 11:41 am Page 1



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.

Submerging markets?

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

Research and a Research Fellow

of the Centre for Economic

Policy Research. In 1997-98

he was Senior Policy Adviser at

the International Monetary Fund.

He has published widely on the

history and current operation of the

international monetary and financial

system, most recently Global

Imbalances and the Lessons of

Bretton Woods (MIT Press, 2006).

Emerging markets have been awash

with liquidity for several years.

In 2005, net capital inflows to

developing countries hit a record-high, of

nearly $500bn, for the second year running.

These funds came from private investors

– net official financing was negative, that is,

developing countries repaid more than they

borrowed from rich-country governments

and the international financial institutions

last year – and were spread broadly across

different forms of debt and equity in a large

number of recipient countries. Not since

the first decade of the 20th century has so

much foreign capital flowed to so many

emerging markets. Unfortunately, though,

the favourable financial conditions and

robust global growth that have given rise to

this happy era appear to be turning sour.

Until recently, global – and in particular, US

– interest rates have been exceptionally

low. Portfolio managers expected to match

historical returns have, in effect, been

forced to invest in emerging markets – the

only markets still offering sufficiently high

yields – and have funded their positions

by borrowing at low interest rates in the

advanced markets. Meanwhile, the world

economy is set to grow faster this year

than at any time since the breakdown

of the Bretton Woods System some 35

years ago, according to the IMF’s spring

forecast. As a result, corporate profits are

overflowing – and with emerging economies

notching up growth of over 5% for the

fourth year running, they are an obvious

place to reinvest these funds. High oil and

commodity prices have also heightened the

allure of countries that export energy and

raw materials.

But this happy era is now coming to a

close. Already, the US Federal Reserve

has sharply raised interest rates, while the

European Central Bank (ECB) and Bank of

Japan have also started to tighten, albeit

more slowly. Suddenly, global liquidity is no

longer so abundant. As a result, investors’

appetite for risk has declined since the

spring meetings of the IMF and World Bank

in April. What’s more, monetary tightening,

high energy prices and capacity constraints

are casting a shadow over prospects

for US growth. And while China may be

maintaining its extraordinary double-

digit growth rates for now, the faster its

economy grows the more investors fret

about the possibility of a hard landing.

Emerging markets could thus soon face a


➣

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 prudentAlthough 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

capitalised on investors’ appetite for their

domestic debt securities to eliminate their

foreign-currency debts. Since these prudent

economies do not have to borrow to roll

over maturing debts or finance current-

account deficits, they are less susceptible to

a shortfall of foreign funds. Having stockpiled

reserves, they have more scope to prevent

their currency collapsing if foreign investors

draw in their horns. And even if their

exchange rates do weaken, their banking

systems will not collapse because their

currency mismatches are better managed.

But if international investors’ tolerance for

risk continues to fall, profligate economies

could find that the inflows financing their

current-account deficits – which are now

approaching 7-8% of GDP in some cases

– dry up abruptly. Although they may buy

some time by spending their currency

reserves, they will eventually have to

dramatically improve their trade balance.

In the short term, that requires an import

squeeze, through a rise in interest rates

that curbs consumption and investment

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



➣ – resulting, more likely than not, in a

recession. In turn, this implies a rise in

nonperforming loans and problems for

banking systems. Eventually, the currency

depreciation that occurs as foreign investors

reduce their purchases of domestic

securities will boost exports, but that takes

time – and the interim could be painful.

The past few months suggest that investors

can distinguish between countries’ differing

circumstances. As investors’ appetite for

risk has declined, countries with large

current-account deficits have suffered

most. Surplus countries such as Mexico

and Brazil, which were susceptible to such

changes in sentiment in previous periods,

have remained largely immune. The risk of

financial instability is by no means gone, but

it appears to be much greater for profligate

emerging economies than for prudent ones.

Diversify your borrowingThat the risks have changed heightens

the danger of fighting the last war.

Countries such as Brazil have traditionally

experienced instability when the demand

for their foreign debt has declined. When

their currency has weakened, they have

been smashed by the increased cost of

servicing their dollar-denominated debt. To

avoid this, they have taken advantage of

the good times to exchange virtually all of

their dollar debt for securities denominated

in local currency, floating these on domestic

markets and selling them to both local and

foreign investors.

But much of this debt is short-term or at

floating rates. Although long-term issuance

is growing, investors remain wary of tying

up their funds at fixed rates for long periods.

So, if global interest rates spike up – which

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.

➣



➣ 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 developing-

country exports of goods and primary

commodities to their respective markets.

However admirable some developing

countries’ budget and current-account

surpluses may be, their restrictive policies

make them dependent on exports as a

source of demand. If the US slows, Mexico

and East Asia, in particular, will suffer. Nearly

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

Asian countries – especially small, highly

open economies such as Singapore and

Taiwan – also rely heavily on the US market.

Asian countries that specialise in producing

consumption goods – consumer electronics,

for example – will be hit hard by softening

US demand. If China slows, exporters of

raw materials and energy, such as Indonesia

and Peru, and exporters of capital goods,

such as South Korea, will be hit hardest.

A happy ending?The happy scenario is one in which slowing

growth in the US and China is offset by

accelerating growth in Europe and Japan.

Global imbalances decline gradually

towards more sustainable levels, with the

US consuming less while Europe and Japan

consume more. The world economy keeps

motoring along, and emerging markets

escape collateral damage.

Unfortunately, there are several less rosy

alternative scenarios. First, there could

be a hard landing in the US. US growth is

“Governments with big debts should spread their risks by issuing a diversified portfolio of securities denominated in both foreign and domestic currency.”


heavily dependent on consumer spending

– and if the housing market softens further,

consumer confidence will suffer. It also

depends on foreign investors, notably Asian

central banks – and if they 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. Rather than a gradual deceleration,

the US could experience an abrupt slump.

Second, efforts to prevent the Chinese

economy overheating could depress its

growth too much. Whereas in advanced

financial systems, the central bank can fine-

tune credit conditions and demand growth

by tweaking lending rates, China’s financial

markets are not sophisticated enough to

permit this. Also, China’s reluctance to see

its currency fluctuate more freely against the

dollar heavily constrains its ability to alter its

interest rates independently. So the Chinese

authorities must rely on blunt instruments,

such as raising reserve requirements and

instructing the banks to lend less, to slow

the breakneck speed of investment. Since

their efforts have been ineffective so far, they

may be tempted to resort to more extreme

measures – but if they overdo it, investment

could collapse, and with it Chinese growth.

Third, Europe and Japan could fail to pick

up the slack. The prospect of structural

reforms inevitably increases the uncertainty

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

➣



faced by European consumers, while the

size of government debts and deficits limits

the scope for fiscal stimulus. And with euro-

zone inflation above its target range, the

ECB is reluctant to apply monetary stimulus.

Germany has been able to grow by

exporting, but if the world economy slows

this last source of demand will disappear

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

headwinds of rising interest rates, as its

central bank seeks to move from a zero-

interest-rate policy to levels comparable to

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

both economies have ageing populations,

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 export-

dependent 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.

Europe and Japan should also avoid

excessive monetary tightening. With luck,

the Bank of Japan understands that it will

take some years to raise interest rates

to world levels. If Europe finally begins to

make progress on fiscal consolidation, there

would be more scope for the ECB to relax.

And if the dollar does fall sharply, European

exporters would face stiffer competition,

and therefore need a more accommodating

monetary policy that prevents the euro from

rising excessively.

China, for its part, would be able to manage

its economy more effectively if could adjust

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

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

➣

➣



interest rates more freely – which, in turn,

requires a more flexible exchange rate.

As its exposure to international capital

markets increases, China cannot enjoy

monetary autonomy if it insists on keeping

its exchange rate against the dollar stable.

It also needs to develop its financial

system to make it easier to fund the higher

consumer spending and increased public

expenditure on healthcare, education and

rural infrastructure that would reduce the

economy’s excessive dependence on

export demand.

But what about emerging markets other

than China? For the most part, they

must just sit tight and hope that they are

lucky. Asian countries could reduce their

dependence on uncertain world markets

by letting their currencies rise, while

supporting domestic demand by raising

public spending, but they are unlikely to

do either unless China does so first. Latin

America has little scope for using fiscal

policy, given its high public debts and

chequered fiscal history.

Since the turn of the century, most emerging

markets have embraced the conventional

wisdom that says: avoid budget deficits,

run current-account surpluses and keep

your currency competitively valued in order

to promote export growth. This strategy of

tying their fortunes to world markets has

served them well in the years of easy money

and global boom. But if the world economy

now turns sour, the future could be much

less rosy.

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.

■

➣

Certain activities and services referred to above are provided by Banc of America Securities LLC and other affiliates of Bank of America Corporation. © 2006.Certain activities and services referred to above are provided by Banc of America Securities LLC and other affiliates of Bank of America Corporation. © 2006.

Focus on Asia


The emergence of India in the past

few years as a global economic

force to be reckoned with seems

neatly complementary to China’s rise a

decade or more earlier. While China has

come to dominate markets in low-cost

manufactured goods, India is pre-eminent

in the fast-growing new business of

“outsourced” services – most famously,

software development and call-centres.

This has given rise to an appealing notion:

that India can achieve prosperity without

experiencing the boom in manufacturing

that has been the route out of poverty for

every other successful emerging economy.

China and India can carve up the “hard”

and “soft” parts of the global economy

between them, and India’s road to middle-

income status can somehow bypass the

sweatshops and smokestacks that have

disfigured China’s eastern seaboard. Sadly,

the idea that services alone can propel

India’s growth is flawed; to the extent that

it begins to influence not just public debate

but policymaking (which, mercifully, it has

not yet), it is also dangerous.

The danger is that it makes it seem

less urgent for India to tackle the many

constraints that have limited investment

in manufacturing industry. Unless those

constraints are removed, India will find it

almost impossible to create the employment

opportunities it will need as its population

continues to outgrow most of the rest of

the world, and, especially, China itself. Just

as China is emerging as a competitor in

India’s chosen niche of services, so India

needs to fight for market-share in products

such as consumer electronics, textiles and

garments. That is a daunting challenge.

But to give it up as impossible, which

many Indian manufacturers argue is the

only option, is to forget that most of the

obstacles in the way of Indian manufacturing

have been put there by government, and so

can be removed.

IT is not enoughThe justified pride that India takes in its

information-technology (IT) prowess, and the

“outsourcing” boom it has helped spawn,

cannot disguise its irrelevance to the vast

SIMON LONG is the South Asia

correspondent for The Economist,

and has been based in Delhi

since 2002. Before joining The

Economist, he worked for the

BBC World Service as a journalist

in London, Beijing and Hong

Kong, and as an investment

banker. He studied in Cambridge,

Boston, Beijing and Nanjing.

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.


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

“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.”

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

(“business-process outsourcing”) generated

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

the entire industry employed only around

1.3m people – a mere 0.25% of India’s

workforce. On the justifiably bullish projections

of the Indian industry’s lobbying group,

NASSCOM, and its consultants, McKinsey,

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

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

manufacturing for export did for China.

This may be true in terms of export

revenues. But the industry will still not

provide large numbers of jobs – the

NASSCOM projections suggest that by

2010, the industry will still employ fewer than

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

seriously the notion that India can somehow

skip a development phase and jump straight

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

Focus on Asia


That it has any currency at all stems from

what seems an odd phenomenon: as

agriculture’s share in the Indian economy

has slowly shrunk, it is not industry that

has grown, but services.

According to estimates by the Reserve

Bank of India, the central bank, agriculture’s

share of Indian GDP shrank from 22.2%

in the financial year ending in March

2004 to 19.7% two years later. Industry’s

contribution remained unchanged, at

19.5%, while services’ increased from

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

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

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

and construction and services 46.1%.

Research by Jim Gordon and Poonam

Gupta of the IMF shows that, although

services make up a somewhat bigger share

of its economy than is usual for a country

at its stage of development, India is far from

being a total oddity in this respect. Rather,

it is China that is peculiar in having such a

stunted services sector. This may be a relic

of the old Stalinist model with its emphasis

on heavy industrialisation and collectivisation

in the countryside. Or it may simply be

faulty data in the reformed economy: the

underreporting of China’s informal sector.

Jobs for the boys and girlsThe high share of services in India’s

economy does not mean it is becoming

a nation of software engineers and call-

centre workers. India is still primarily a

nation of farmers – agriculture accounts

for around 57% of total employment. It is

slowly turning into a nation of shopkeepers

(there are an estimated 15m retail outlets),

security guards and other low-end service

providers – but not of factory workers. The

number of workers employed in “organised”

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

employing more than ten people) has

actually shrunk marginally since India

launched its reforms in the early 1990s.

The total is still barely more than 6m. A

further 42m or so work in the “unorganised”

sector. But this is still a tiny number

compared with the 160m or so Chinese

manufacturing workers.

Even if one assumes that, for every person

directly employed in IT/BPO, three or

four find work to support their needs, in

transport, retail, domestic services and so

on, that is still not enough to provide jobs

for all that need them. India’s workforce is

set to grow by around 71m in the next five

years – around a quarter of the world’s new

workers. This “demographic dividend” is

one of the main reasons why many people

are so optimistic about India’s prospects

– demography will, as in China, help raise

the level of private savings, from about 29%

now, to 34% over the next five to seven

years. This will provide the economy with

a source for the investment it so badly

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

economic growth will continue to match the

annual rate of close to 8% it has achieved

over the past three years, much higher than

the 6% it has averaged since the beginning

of the 1990s.

But, as Shankar Acharya, a former

government economist, has pointed out,

nearly 60% of these extra workers will

be seeking jobs, initially at least, in “four

populous, slow-growing northern states,

with weak infrastructure, education systems

and governance.” One likely consequence is

an increase in internal migration; another, in

the absence of more job-creating industries,

is social tension.

In China, too, of course, the absorption

of excess agricultural labour has created It is China that is peculiar in having such

a stunted services sector.

➣


friction – notably in the form of widespread

if scattered protests over the forced

acquisition of agricultural land for industrial

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

the dismantling of the old rural collectives

and communes. The “responsibility”

system, in effect returning land to individual

farmers, boosted rural incomes, spurred

mechanisation and freed tens of millions

to work in new “township and village”

industries. India has no hope of such a one-

off miracle. But if it is to raise growth rates

to something approaching China’s, it has

to move people from the land into factories.

At present, roughly 70% of Indians live

in the countryside, compared with 60%

of Chinese. Both countries face similar

agricultural problems. After big surges in

yields, productivity has stagnated, albeit

at much higher levels in China than in India.

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,

many are on the move. In China the number

of migrant workers is estimated at anywhere

between 100m and 150m, despite a

restrictive registration system (“hukou”).

India has comparatively few – about 11m

in 1999-2000, according to national surveys.

It has not embraced either mass labour

mobility or urbanisation on the scale seen

in China.

The Chinese modelThe lack of mass migration in India also

reflects poor levels of basic education and

the lack of job opportunities. That is partly

explained by the barriers to investment,

which the government is pledged to lift.

When India’s prime minister, Manmohan

Singh, speaks of following “the Chinese

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

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

➣


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

single-minded success in becoming the

world’s workshop is well known. Mr Singh

and his advisers point to areas like textiles

and clothing and food-processing as the

way forward.

According to the Ministry of Commerce,

food processing in India adds just 7% to

the value of agricultural output, compared

with more than 40% in China and 60% in

Thailand. As Mr Singh puts it, this is one

area, promising large numbers of jobs,

where “we have barely scratched the

surface.” Much the same could be said

of textiles and clothing, even though the

industry is one of India’s most important.

India was prey to the global panic at the lifting,

at the end of 2004, of the quotas governing

imports to America and Europe under the

Agreement on Textiles and Clothing. There

were forecasts that China might snatch as

much as half of the big quota-constrained

markets, damaging the prospects not just

of those countries’ own textile and garment

workers, but those of workers in other

exporters, such as India. Yet this is a business

that relies on Indian strengths – cheap

labour, a domestic supply of both cotton and

manmade fibres and a long textiles tradition.

Pessimists fear that Chinese competition

will eat into India’s existing market share.

Optimists see the industry as an important

engine of job-creation.

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

➣

Focus on Asia

➣

cidem213x276 28/7/06 20:00 P gina 1


cidem213x276 28/7/06 20:00 P gina 1


Focus on Asia


The evidence so far is with the optimists,

if only just. Last year, exports of garments

to America rose by 26% and to Europe by

about 20%. Globally, Indian exports reached

about $7.5bn last financial year, out of total

textile exports of $17bn. Impressive though

that sounds, it is sobering to contrast

it with China’s performance: $107bn of

textiles exports last year, including $40bn

of clothing, despite the imposition of

“safeguard” quotas on some items.

For many global retailers, India has become

the favoured second-choice textile supplier:

a useful defence against renewed sanctions

imposed on Chinese exports, and a

sensible diversification of procurement

risks. The Confederation of Indian Textile

Industry (CITI), a lobby group, forecasts

that the industry can by 2010 generate

$40bn in annual exports and provide 12m

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

the vast majority of jobs in “unorganised”

manufacturing).

Non-industrial policyLiberal economist that he is, Mr Singh says

he does not believe in having an “industrial

policy”. The difficulty he faces is that he has

inherited an anti-industrial policy. That India

has flourished in the new service industries

is in large measure a consequence of

those industries’ emergence at a time and

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,

sales taxes and octroi (a tax on goods

in transit) accounted for nearly half of a 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.

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

➣


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

tax revenues. Import tariffs have fallen from

10% of government tax revenues in 1985 to

around 5% now, and direct corporation and

income taxes from around one-third to 15%.

Properly implemented, India’s tax reforms

could have a similar impact. They will also

speed up freight, as lorries no longer have

to stop at state borders. VAT should also,

in theory, be less prone to evasion, and,

eventually increase government revenues.

That should also help the government cut

customs duties, which at present account

for about one-sixth of its tax revenues.

India’s average import-tariff rate, close to

20%, is nearly double China’s.

Another big obstacle to labour-intensive

manufacturing in India is a restrictive labour-

law regime. In the garment industry, for

example, exporters habitually cite this as

their biggest headache. The most notorious

bugbear is Chapter 5B of the 1947 Industrial

Disputes Act, which, in establishments with

more than 100 workers, bans the laying-off

of employees without the permission of the

state government. This deters employment

and encourages the substitution of capital

for labour. One campaigner for labour-

law reform cites the example of a firm

that bought machines rather than give

permanent employment to 16 tea-boys.

Labour-law reform, despite its obvious

benefits, has always been politically difficult,

and is an especially big challenge for Mr

Singh’s government, which relies on the

parliamentary support of Communist

parties, which in turn are beholden to the

trade unions. In effect, this means that the

interests of the unemployed and even of

most workers in the “unorganised” sector

are held hostage to the tiny minority of some

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

employment.

Indian bureaucracy also continues to

slow things down. According to a World

Bank “Investment Climate Assessment”,

published in November 2004, after a

survey of private Indian firms, it took 89

days to secure the clearances needed to

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

➣

Focus on Asia


start a business in India, compared with

41 in China. Insolvency procedures take

10 years, compared with 2.4 in China.

Although the number of tax and regulatory

inspections endured by Indian businesses

was lower than in China, the percentage

of senior management time spent dealing

with government was higher: 11.9% against

7.8%.

Chindia Inc?In a curious little ceremony in late June, India

and China, with much hoopla, reopened an

historic border-trading post at Nathu-La,

on the border between the Indian state of

Sikkim and China’s “autonomous region”

of Tibet. It was taken as a symbol of the

healing of the wounds opened by the Sino-

Indian war of 1962, and of the potential

for economic co-operation. As so often

in Sino-Indian relations, the symbol was

more powerful than the substance. In this

instance, it transpires that the re-opening is

for very limited times and for “border trade”

only – i.e., not for transit trade. It will make

some difference to the lives of those near

the border, but hardly impinge on Sino-

Indian trade as a whole.

This is growing fast. Two-way merchandise

trade, at about $20bn in 2005, has

increased ten-fold since 1999. Just a few

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

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Focus on Asia


years ago, many Indian businesses viewed

China as a competitive menace that was

about to destroy them through the use

of an undervalued exchange rate, free or

subsidised land, and unlimited access to

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

of opportunity.

Nevertheless, there remains a huge

imbalance in the trading relationship. This is

not so much in the direction of trade, which,

on India’s figures, shows a small Chinese

surplus, as in its relative importance. China

is now India’s second-most important

trading partner, and its biggest source of

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

however, accounts for less than 1% of

China’s overall trade. This is a symptom

of the two countries’ relative weight in

the world economy. In each of the past

four years, China’s total foreign trade has

increased by an amount greater that the

total of India’s foreign trade.

This imbalance is accompanied by

continued Indian nervousness – in official

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

intentions. This is one reason for scepticism

about some of the rosier claims for Sino-

Indian economic co-operation. There

clearly is scope, and an agreement to work

together in some energy projects may

bear fruit. Some Indian manufacturers are

investing in China, either by building their

own plants, or by acquiring Chinese outfits,

as has Bharat Forge, the world’s second-

biggest maker of automotive forgings.

Similarly, Chinese firms are trying to expand

in India, though some are finding their way

blocked by the concerns of the Indian

security services.

However, the idea that somehow Indian

software skills can team up with Chinese

“hardware” to produce a world-beating

“Chindia” combination so far seems

fanciful. Indian software firms have no

option but to expand fast in China,

because their multinational clients demand

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

China is a big potential competitor.

Correspondingly, among some Chinese

policymakers, India’s rise is being viewed

with a certain edginess. They have noticed

that the emergence of China as a lower-

cost competitor was a proximate cause of

South-East Asia’s financial crisis in 1997.

Looking around for the source of such a

threat to China’s present dominance, India

seems the obvious candidate. It is not,

because of the many difficulties, outlined

above, faced by Indian manufacturing. But

it should be, and probably needs to be, as

China grows richer and ages, and a young

India grows up looking for work in the

global economy. ■

Agriculture’s share of Indian GDP shrank from 22.2% in the financial year ending in

March 2004 to 19.7%.

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

➣

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Focus on Asia


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

Fifty years ago, it was a scruffy,

politically unstable and poverty-

stricken city. Now, it is a thriving First

World nation and a development model.

Singapore is a stunning success – all the

more so considering that it is blessed

with few natural resources and has had

to overcome huge political and economic

hurdles. In the past decade alone, the

Asian financial crisis, the rise of China and

the dotcom bust have severely tested the

city-state’s resilience. Yet Singapore has

reinvented itself and its economy is booming

again. What, then, is the secret of its

success – and can it be sustained?

Few countries can match Singapore’s

record of economic growth: its real GDP

has grown by an average of 7.9 % a year

since 1960. Its performance has remained

vigorous in recent years (see chart 1), with

living standards (as measured by GDP

per person adjusted for differences in

purchasing power) rising by an average of

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

2005. Singapore is now richer than Japan

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

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

longer and healthier lives – newborns, who

face an infant mortality rate of only 2.29

deaths per 1,000 live births, can expect to

live 78.1 years. And the fruits of economic

success are widely shared: over 90% of

households, for instance, now own their

homes (see chart 2).

A country of only 4.5m people, a mere

0.07% of the global population, Singapore

accounts for 2% of world exports. Its

seaport is the second-busiest in the world,

while its airport ranks ninth in terms of cargo

handled. It is also an important oil-refining

centre as well as a major Asian financial hub,

while the government continues to look for

opportunities to direct the economy towards

new high-growth industries.

Prudent, pragmatic and politically stableSingapore has thrived in large part because

its government has been better at getting

the basics right than its competitors and

neighbours have. Its economy has therefore

offered relatively high returns to both foreign

and domestic investors.

These basics include sound economic

policies – such as fiscal prudence, monetary

stability, an open economy, an investor-

friendly regulatory framework, a high savings

Restructured and resilient

MANU BHASKARAN is head

of economic research for Asia

and a partner at the Centennial

Group. He is also an adjunct

senior fellow of the Institute of

Policy Studies in Singapore.


➣

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

years of self-government, Singapore has

been quick to adapt to changes in the global

environment.

A glance at the economic fundamentals

shows how well-managed the economy

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

exchange rate has been carefully managed,

delivering a steady appreciation over time

(see chart 5). And the national savings rate

has been exceptionally high (see chart 6).

Singapore’s leaders have not only pursued

enlightened economic policies. They have

also been careful to build the political

consensus needed to sustain this benign

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.

Singapore is renowned for its clean

government and its lack of corruption

more generally. Equally importantly, the

government has been careful not to

allow vested interests to influence policy,

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

CHART 3**No deficits, mainly surpluses

CHART 1*Stable and healthy growth

CHART 2*High house ownership achieved

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

Real GDP Growth

0.0

2.0

4.0

6.0

8.0

10.0

1980-1990 1990-1996 1997-1998 1999-2005

% y/y

SG World Developing Countries

House Ownership

0.0

20.0

40.0

60.0

80.0

100.0

1970 1980 1990 2000 2005

%

Fiscal Balance

-5000

0

5000

10000

15000

20000

25000

1963 1968 1973 1978 1983 1988 1993 1998 2003

SGD mn

Focus on Asia


partnership with government and employers

to push through policies that support long-

term development, while being permitted

to engage in a variety of activities, including

running businesses, which have allowed

them to deliver real benefits to their

members.

A core element of the political part of getting

the basics right has been the principle

of meritocracy. By and large, whether in

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

benefits for all even at the cost, sometimes,

of short-term losses for some people, rather

than on populist quick-fixes.

While Singapore is rightly known as a highly

open economy that is friendly to investors

and multinational companies, it has not

subscribed to a policy of laisser-faire. It has

instead adopted its own pragmatic approach

to state intervention and regulation.

State enterprises have played an important

role in the country’s development. While

avoiding burdening domestic firms with

controls and licensing requirements,

policymakers have used government-

linked companies (GLCs) and other forms

of state intervention to further economic

development. GLCs have played a crucial

role in domestic banking, telecoms,

infrastructure services (the port, airport,

airline and shipping line), construction (public

housing) and the marine sector (shipbuilding

and repair). Even today, they generate

around 12% of GDP.

Strong regulation has also been key. For

example, the banking sector was once

tightly regulated, with high capital-adequacy

requirements, stringent ownership rules and

CHART 6**High saving rate

CHART 4*Inflation contained

CHART 5**Controlled exchange rate

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

➣

➣

Inflation

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

1961 1966 1971 1976 1981 1986 1991 1996 2001

% y/y

Exchange Rate

60.0

70.0

80.0

90.0

100.0

110.0

120.0

19751978198119841987199019931996199920022005

SGD/USD

0.00

0.50

1.00

1.50

2.00

2.50

3.00Nominal Exchange Rate

SGD/USD

Saving Rate

0.0

10.0

20.0

30.0

40.0

50.0

60.0

1980 1983 1986 1989 1992 1995 1998 2001 2004

%

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Focus on Asia


Few countries can match Singapore’s record of economic growth: its real GDP has grown by an average of 7.9 % a year since 1960.

intrusive supervision. Other sectors such as

urban zoning, the media and utilities were

also fairly closely regulated.

Meanwhile, the mandatory savings scheme,

the Central Provident Fund, was used to

channel a big share of household savings

to favoured industries. People have since

been allowed to use their savings to buy

their homes and more recently to use part

of them to purchase financial assets such as

equities and unit trusts.

Together, this underlying pragmatism and

sound policy regime have created an

incentive structure that stimulates economic

growth. Businesses have an incentive to

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

South-east Asian region with transport,

telecoms, trading and financial services,

➣

➣

Focus on Asia


many of which have been highly profitable

and generated high employment growth.

Housing and construction have also

contributed to economic growth through

the government’s massive public-housing

programme and its emphasis on building

world-class infrastructure. Tourism has

been important too, generating benefits

for labour-intensive sectors such as hotels,

restaurants and transport services.

Restructuring for the 21st centuryBy building on these sound foundations,

Singapore had by the mid-1990s achieved

an income per person of $21,000, close

to that of a developed economy. Having

largely closed the gap with the First World,

the economy was poised to slow, since

opportunities for catch-up growth were

rapidly diminishing. But unfortunately, the

economy was also rocked by a series of

external shocks which dampened growth,

raised unemployment and caused deflation,

testing its resilience to the limit.

In the mid-1990s, China emerged as a

major competitor to Singapore’s hinterland,

South-east Asia, forcing restructuring and

policy changes, the need for which was not

immediately appreciated. Meanwhile, Japan’s

economy was mired in deflation, with its

financial institutions teetering on the brink of

collapse. Japanese trade, investment, bank

lending and other activities in the region

decelerated sharply. Singapore, which was a

major hub for such activities, suffered too.

In 1997, the devaluation of the Thai baht

unleashed a regional financial crisis which

led to political upheaval and deep economic

recession in many neighbouring countries.

And just as the region was recovering from

these shocks, it also had to deal with the

aftermath of the bursting of the technology

bubble, which reduced demand for the

region’s information-technology-related

exports, along with the post-9/11 upsurge

of terrorism in the region and the SARS

epidemic.

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

contemplating the need for fundamental and Educational reforms were introduced to make up for deficiencies in human-capital development.

➣


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

reforms. When the crisis hit, policymakers

had already prepared the ground for much-

needed reforms.

From 1997 on, even as the Asian crisis

was wreaking havoc around the region and

slowing Singapore’s economy, policymakers

began introducing sweeping – and

sometimes taboo-breaking – reforms.

The government embraced deregulation

with gusto. In banking, capital-adequacy

requirements were eased as were many

other restrictions. The sector was thrown

open to much more foreign competition,

and the dominant government-owned bank,

DBS Bank, began to restructure in ways

that forced other banks to change as well,

by merging, for instance. Major changes

were also instituted in telecoms, energy and

media, and a big effort was made to reduce

red tape that inhibited entrepreneurship.

Corporate and personal tax rates were

cut to a maximum of 20% each in order to

attract businesses and boost Singapore’s

role as a “talent capital”. The taxation

of dividends, interest and other income

was also reformed to encourage the

development of the financial sector. As a

result, Singapore now has one of the most

competitive tax regimes in the world.

The restrictions on the internationalisation

of the Singapore dollar were eased

considerably and the central bank’s

exchange-rate policy was made more

transparent in order to reduce uncertainty

and thus make policy more effective.

The government holding company,

Temasek Holdings, was shaken up, leading

to the strengthening of GLCs through

consolidation, the sale of non-core assets,

improved capital management and foreign

acquisitions.

Educational reforms were introduced to

make up for deficiencies in human-capital

development, with the aim of attracting

talent from the region in order to capture

a bigger slice of the world education

market. Resources were poured into more

and better universities, polytechnics and

vocational colleges. Foreign universities

were encouraged to establish full-fledged

campuses in Singapore.

The government has also placed major

bets on new growth sectors, such as

pharmaceuticals, biotechnology and high-

end electronics. Government investments

in infrastructure support, coupled with

generous fiscal incentives, aim to stimulate

growth in these strategically chosen

industries and alleviate the strain on

traditional sectors, such as manufacturing,

which are facing increasing low-cost

competition from developing economies in

the region.

The government has also eased restrictions

on gambling with the aim of encouraging

the development of casinos that attract

foreign tourists. Substantial investments are

also being made to upgrade and enhance

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.

➣

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

Focus on Asia


➣

as Sentosa Island and the Orchard Road

tourism belt.

Last but not least, a major effort is

underway to enhance the competitive

position of Singapore’s port and airport

hub in response to growing challenges

from regional competitors. The aim is to

enhance integration through the use of IT,

and to develop a critical mass of logistics

professionals in order to ensure sustained

growth in the capacity and connectivity of

Singapore’s port and airport systems.

Built to last?So far, so good. These ambitious reforms

have allowed Singapore to weather the

storm and to take advantage of a recent

improvement in regional conditions. As

Japan’s economy fi nally recovers, Japanese

banks are stepping up their activities in

the region and often using Singapore as

a base to do so. As a major regional hub,

Singapore stands to benefi t from increased

fl ows of Japanese goods, foreign direct

investment, foreign portfolio fl ows, bank

lending and tourists in the region.

The regional hinterland economies are

also recovering. Under the leadership

of President Yudhoyuno, Indonesia is

overcoming the residual damage from

the political and economic crises that had

plagued it since 1997 and is now poised to

enjoy faster growth. Malaysia is also likely

to enjoy renewed growth as the Abdullah

government’s efforts to reform the economy

and governance produce results. Within

Singapore’s domestic economy, the long

decline in the housing and construction

sectors is now over, laying the foundations

for renewed growth.

As a result, the past three years have seen

strong growth which can, I believe, be

sustained. The Centennial Group forecasts

that Singapore can grow by nearly 6% a

year between now and 2010 and by around

4% a year in the subsequent fi ve years, no

mean feat in an advanced economy such

as Singapore.

But while the prognosis is generally

positive, some weaknesses remain. While

Singapore’s foreign- and government-owned

companies are doing well, its domestic

private sector remains weak. Studies show

that privately owned local companies

generally have lower rates of return on

capital than foreign-owned ones. The lack

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

CHART 7Very high profi t-GDP ratio

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.

➣

Profits-GDP Ratio

40.0

42.0

44.0

46.0

48.0

50.0

52.0

1995 2000 2001 2002 2003 2004 2005

% Singapore Premium

-4.0

-2.0

0.0

2.0

4.0

6.0

%

1408-SYMconsultingAdv(HEAD).indd1 1 8/17/06 4:45:39 PM

1408-SYMconsultingAdv(HEAD).indd1 1 8/17/06 4:45:39 PM

Focus on Asia


of a strong corporate sector is a structural

weakness which makes Singapore overly

dependent on multinational companies.

It is also contributing to an unwelcome

rise in income inequality, because the

ratio of profits to GDP is unusually high in

Singapore (see chart 7), with a considerable

fraction of this high profit share going to

foreign companies.

The government may also loom too large

in Singapore’s economy. With a big share

of the domestic corporate sector, national

savings and land ownership concentrated

in government or quasi-government hands,

economic decision-making may be over-

centralised. While in economies where

decision-making is diversified, mistakes

typically cancel out and risk is thereby

managed, in Singapore too much economic

decision-making may be concentrated in

government hands, raising the risk that

correlated errors could unsettle the economy.

Singapore’s capacity to deliver superior

returns may also be coming under pressure.

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 futureThe 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

with renewed growth in the region, a whole

range of financial activities – such as capital-

market-related support services, wealth

management, regional loan syndication and

structured products catering to regional

demands – are likely to do well. The new

integrated resorts being built are likely to

boost tourist revenues. Last but not least, the

new high-value-added service activities, such

as consulting and the creative industries,

spawned by the deregulation of recent years

are likely to continue to grow fast.

But Singapore cannot afford to rest on its

laurels. In the years ahead, fresh reforms

will be needed to tackle the issues that I

highlighted, such as over-centralisation and

the erosion of the “Singapore premium”.

But as recent history shows, the policy elite

has the courage and determination to break

taboos and make painful but necessary

reforms, and I am confident that they will

continue to serve Singapore well in future.

So long as Singapore continues to get

the basics right while pursuing its goals

pragmatically and adapting to changing

circumstances, the economy should continue

to deliver greater prosperity for all.

A country of only 4.5m people, a mere 0.07% of the global population, Singapore accounts for 2% of world exports.

➣

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unilever ad [final].indd 1 17/8/06 17:33:12

A little bit of soap is all it takes to prevent children

from succumbing to one of the world’s biggest

child killers, diarrhoeal disease, which causes over

3 million deaths a year. And a pinch of iodised

salt added to cooking can help keep at bay iodine

deficiency disorder, which causes mental retardation,

brain damage, miscarriages and goiter.

Today, in some of India’s remotest villages,

thousands of people, most of them children, are

being taught about the existence of germs and

the importance of hand washing with soap before

eating food. It is part of a $US 5.4 million hygiene

education initiative sponsored by Unilever’s Lifebuoy

soap brand that aims to reach 200 million people

over a five year period and teach them to wash

their hands with soap.

And in Africa Unilever has introduced Annapurna

– a range of low-cost basic foods fortified with

micronutrients, such as iodised salt and biscuits

containing vitamin A and zinc. Under the banner

of ‘iodised salt for growing minds’, Annapurna’s

nutrition education programmes are teaching people

the benefits of iodised salt and helping to reduce the

estimated 740 million people, mostly in developing

countries, who suffer from iodine deficiency.

These are just two examples of how Unilever is

helping to address the Millennium Development

Goals and, in particular, MDG 4 - reducing child

mortality. Unilever is working in partnership with

UNICEF to tackle nutrition and hygiene challenges

and with the World Food Programme to combat

child poverty and hunger.

Every day millions of people in 150 countries around

the world choose Unilever products to feed their

families and clean themselves and their homes.

We are committed to tackling these challenges

not just because we believe we have a social

responsibility to do so but because, as a foods and

home and personal care products company, the

long term sustainability of our business is wholly

dependent on the vitality of the communities in

which we operate.

For more details about

our hygiene education

and food fortification

programmes and other

social and environmental

initiatives in Asia, Africa

and Latin America, visit

www.unilever.com

A little bit of soap and a pinch of salt

unilever ad [final].indd 1 17/8/06 17:33:12


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

In the shadow of the dragon

GEOFF DYER is the FT’s

Shanghai Correspondent.

He has previously been a

correspondent in Brazil, as well

as covering the healthcare and

pharmaceuticals sector for the

paper, based in London.

China’s roaring economy

continues to strike fear among

businesspeople in south-east Asia.

Many of the region’s “tiger” economies have

built their success on the manufacture of

basic consumer goods, such as clothes

and electronics, which China can now

generally produce more quickly and

cheaply. Even wealthy Singapore has felt

the pinch: having specialised in attracting

foreign direct investment from companies

looking to expand in Asia, the city-state

has seen multinationals shift their regional

headquarters to China. Indeed, for a time it

seemed to the region’s anxious executives

as if China’s super-competitive companies

might sweep all before them. But while

the challenge from China remains potent,

the country’s growth is also opening up

new opportunities for south-east Asian

businesses – and, increasingly, they are

grasping them.

A glance at the statistics confirms that

south-east Asia’s economies are bouncing

back from their recent difficulties, not least

the financial crisis of 1997 and the SARS

outbreak in 2003. Despite competition

from China and the burden of higher oil

prices, 2005 was the third year of sustained

expansion: every country in the region grew

by over 5% last year, with the exception

of Thailand, which notched up growth of

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

with China has been in surplus over the past

three years, while Thailand’s exports to China

have risen by a third over the same period.

This is perhaps not so surprising. Even if

China were indeed more competitive than

south-east Asia in all economic activities,

the principle of comparative advantage

dictates that it would specialise in those

industries where its relative productivity was

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

competitive across the board. The trick for

south-east Asian companies has been to

find the gaps – and then try to fill them.

Fuel for China’s growthOne obvious opening is to sell China

products that it desperately needs but

cannot provide for itself – such as raw

materials and energy. South-east Asia does

not enjoy as neat a fit with China as does

Latin America, which supplies China with

vast quantities of copper, iron ore, oil and

soya beans. But some countries in the

region are benefiting from China’s near-

insatiable demand for raw materials.

Focus on Asia


➣

Take palm oil, which is used in detergents

and soaps, and potentially as a biofuel.

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.

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

year, to nearly 3m tonnes, and the abolition

this year of its quotas on palm-oil imports is

likely to spur more trade. An EU requirement

that all fuels contain some biofuel by 2010

has provided a further fillip. In the past six

months alone, some 800,000 tonnes of

new biofuel capacity has been planned in

south-east Asia. In Indonesia, the Sinar Mas

group, the parent company of Asia Pulp &

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

Chinese conglomerate, to develop a $500m

palm-oil project with a projected annual

capacity of 1.5m tonnes.

Some developments have caused

controversy, however. Last year, the

Indonesian and Chinese governments

signed a memorandum of understanding on

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

plantation on the island of Borneo. To make

room for the plantation, a section of tropical

rainforest would have to be cut down. But

the plans were attacked by environmentalists,

who labelled the end-product “cruel fuel”.

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.


Mitsubishi UFJ Financial Group, Inc.

Mitsubishi UFJ Financial Group (MUFG)

has started on the right track. In its pre-

merger incarnation as MTFG, it improved

its average return on capital from 16.1% in

2004 to 25.5% in 2005, while reducing its

non-performing loans to 2.3% of the total.

With the merger of the respective holding

companies of Bank of Tokyo-Mitsubishi

(BTM) and UFJ Bank to create MUFG

in October 2005, followed by the merger

of their subsidiary banks in January 2006,

it has managed to increase pre-tax profits

by 129%. Its tier 1 capital has grown to

$63.9bn, which has lifted its global tier

1 ranking from 7th to 5th place among

the top 1,000 world banks as ranked by

The Banker magazine.

What’s next?Well, we are quite pleased with these

improving trends, but we are far from

finished with our strategic plan to expand

internationally and improve our global

competitiveness. In order to be competitive

globally, one must have a solid domestic

base. We are now clear market leaders

in Japan, so that phase is successfully

completed by the merger of BTM and

UFJ. We must also have a sound financial

base. And that too has been achieved,

as the significant reduction in the non-

performing loans (NPL) ratio and our solid

capital base show. Product-wise, we can

now offer everything that our retail and

corporate customers require in commercial

banking, trust and custody services, and

the securities business. The next phase is

to firmly position ourselves as a leader in

international business where we already

have global reach. In particular, we feel that,

as an Asian bank, our customers expect us

to help them grow their business in Asia.

Therefore, we are committing resources to

significantly expand our service capabilities

throughout Asia. We also plan to strengthen

our position in other regions where we

already have significant investments.

What role do you see MUFG playing in Asia?We have historically supported our

Japanese corporate customers as they

expanded their business overseas, and

Asia is no different. Our Japanese corporate

customers continue to invest in a variety

of Asian countries so our branch network

is being expanded throughout Asia to meet

our customers’ banking requirements.

We also provide financing to local Asian

companies, as well as to subsidiaries of

multinational companies located in Asia.

As with our Japanese corporate customers,

we proactively help our Asian clients to

develop new markets in the region. For

example, we helped a major beverage

company from the Asean region that was

entering the Chinese market by arranging

President & CEO, Mitsubishi UFJ Financial Group, Inc.

An interview with Nobuo Kuroyanagi


financing in Chinese Yuan, thus allowing

it to avoid the exposure to foreign-exchange

risk it would have incurred had it borrowed

in US dollars. The company not only

appreciated our bank’s ability to provide

local-currency financing, but also our vast

branch network in mainland China, which

will be able to support their expansion

throughout greater China.

In addition, our bank has been engaged

in banking business in Asian countries

for over a century to support the local

economic growth, which is quite important

for maintaining stability in the region.

We have been trying to help conclude

various bond transactions as part of the

Asian Bond Markets Initiative in cooperation

with local governments and public financial

institutions. Thus, MUFG has been

contributing to the reform and development

of financial markets in Asia. For example,

we recently guaranteed the corporate

bonds issued by an Indonesian company

in which a Japanese firm has a majority

ownership, with a secondary guarantee

from the Japan Bank for International

Cooperation. We will continue to work in

areas such as securitisation, syndicated

loans and project finance to help raise the

level of sophistication and competitiveness

of financial markets in Asia.

In order to deliver the wide array of services

and products that our customers require,

we work closely with local banks in Asia

as well as government organisations and

government-owned institutions. We are

always interested to talk to local banks to

exchange information and introduce our

customers to each other, which may result

in new business.

Our strategy is quite simple. We aim to

grow by helping our customers to expand

their business successfully. That has always

been our philosophy and it will continue

to be the pillar of our bank’s strategy.

Are you optimistic about Asia’s future?Yes, I am. While the situation varies from

country to country, Asia as a whole has

growing intra-regional trade as well as

expanding domestic consumer markets,

tremendous human talents, a good work

ethic, high technology, plenty of capital and

natural resources. China should continue

to grow strongly: we expect China’s GDP

growth to be around 9.6% in 2006, only

a fraction less than the 9.9% recorded last

year. India’s economy is also expected

to maintain solid growth, driven by strong

domestic demand. We expect India’s GDP

growth to be 7.3% in 2006.

What about the outlook for Japan?We expect the pace of growth to slow

in the second half of fiscal 2006 due to

the slowdown of overseas economies, a

stronger yen and rising raw material costs.

However, the underlying expansionary trend

should continue, with export growth likely to

remain strong and capital investments firm.

There is a structural change in that primary

support of economic growth in Japan is

gradually shifting from the corporate sector

to the household sector due to increases

in employee compensation, retirement

payments and interest income. All in all,

we are forecasting real GDP growth of 2.2%

for fiscal 2006.

Focus on Asia


They alleged that the real aim was to obtain

the rare hardwoods that would be cut down

to make way for the plantation, which could

be used to build furniture and line floors

in the apartments of China’s burgeoning

middle-class. The Indonesian press recently

reported that Chinese investors had pulled

out of the project.

With energy in mind, China has been

assiduously building up ties with Myanmar,

where it accounted for over four-fifths of

foreign investment last year. In January,

PetroChina signed a preliminary deal to

buy gas from the Shwe field in the Bay

of Bengal, while a Chinese and Thai

consortium is to build a $1.4bn hydropower

plant on the Salween River. One reason

why CNOOC, a 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.

In the Philippines, the Nonoc nickel

complex, which has among the largest

nickel reserves in the world but has been

idle since the 1980s, may soon reopen

thanks to Chinese money. Jinchuan and

Baosteel, China’s largest producers of

nickel and steel respectively, have signed

a preliminary agreement with Philippine

Nickel Corporation to invest $1bn in the

facility so that it can resume production.

Meanwhile, China’s Citic Group is investing

in a $490m project to improve the transport

infrastructure for Indonesia’s coal industry.

Jakarta hopes to receive around $30bn

in investment from China over the next

decade, mostly energy-related.

Feeding and servicing the massesOnce obsessed about agricultural self-

sufficiency, China has recently become a

large importer of food, as the new middle

classes splash out on a more exotic diet.

South-east Asian tropical-fruit producers

have found a ready market for their

mangoes, melons and lychees. And although

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

new city-dwellers are developing a taste

for “fragrant” rice from Thailand. The Chia

Meng Group, one of Thailand’s biggest rice

producers, is opening a distribution centre in

China and hopes to export 600,000 tonnes

to the country this year.

China’s manufacturing sector might be

advancing in leaps and bounds, but many

of its service industries remain under-

developed, opening up opportunities for

south-east Asian companies. Take finance.

China’s financial system, which is dominated

by several large state-owned banks, is

highly rigid, with credit allocated to people

with political connections rather than good

business plans, while its capital markets

remain shallow. It does not provide well

for the new generation of private Chinese

companies; bankers estimate that as many

as 50,000 businesses may be looking to

raise new equity capital.

Singapore, in particular, has tried to help

fill this gap. Earlier this year, the Singapore

Exchange (SGX) notched up its 100th IPO

by a Chinese company. Chinese firms now

account for some 15% of the companies

listed on the market. SGX – which refers to

itself as “an Asian gateway” – has begun

offering corporate-governance courses to

companies in mainland China that have

aspirations to float. Sometimes known

as “dragon chips”, most of the Chinese

companies are small or medium-sized,

although five have a market capitalisation

greater than $1bn, the biggest being a

subsidiary of COSCO, the state-owned

shipping group.

South-east Asian tropical-fruit producers have found a ready market in China for

their mangoes, melons and lychees.

➣


Chinese travellers are placing new demands on the tourism sector.

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

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

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

China highlighted.

Private banking has also become a lucrative

niche for Singapore. Thanks to its booming

private sector, China now has around

300,000 millionaires, according to Merrill

Lynch, the US investment bank. Many of

these new rich want to keep their wealth

offshore, given the paucity of investment

opportunities at home and fears about

arbitrary government decisions. The

many Taiwanese entrepreneurs who have

prospered in China over the last decade

are another important customer group.

A recent survey by consultants PwC

concluded that the city-state had become

“the preferred choice in Asia for wealth

management” thanks to its strict bank-

secrecy laws and a tax regime that is

favourable to non-residents. With an eye

on Chinese (as well as Indian) clients,

around 30 private banks have set up

operations in Singapore. Banking assets,

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

➣

Focus on Asia


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,

and CapitaLand, the Singapore property

group – proposes to hire Frank Gehry,

best-known for the Guggenheim Museum

in Bilbao, to design the building. ➣

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

China can now generally produce consumer goods, such as clothes and

electronics, more quickly and cheaply than many of the region’s “tiger” economies.

➣

Focus on Asia


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

If you can’t sell there, invest thereChina’s rapid growth also provides

investment opportunities for companies in

the region, and those from Singapore have

been the most enterprising. Singapore has

plenty of experience of investing in China,

although not always successfully. In 1994,

the government invested several billion

dollars in a new industrial park in Suzhou,

a city an hour inland from Shanghai, but

the early years of the project were marred

by ill-feeling, with former prime minister

Lee Kuan Yew accusing the local Chinese

government of “municipal shenanigans” for

promoting a different industrial park nearby.

Temasek, Singapore’s state investment

company, has been at the forefront of

a new wave of investments in the past

three years. In a bid to boost the return

on its investments – which have averaged

only 3% a year over the past decade – it

has decided to invest heavily in China.

Notably, it spent $4.5bn last year on

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

the country’s second-biggest bank, and

China Construction Bank, the third-largest

– although it was forced to scale back its

initial plans to take a 10% holding in BoC

following a nationalist backlash against

foreign investment in the financial sector.

It also has a stake in the smaller Minsheng

Banking Corporation.

Temasek subsidiaries have been active

investors in China too. PSA International,

the ports group, has stakes in several

Chinese ports, where turnover is rising

fast due to the surge in trade. CapitaLand,

the property group, has also started to

make big investments. It is betting that the


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

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.

Chinese property market will continue its

explosive growth, fuelled in large part by

breakneck urbanisation. In a deal symbolic

of its new strategy, it last year sold Raffles

Hotel – the Singapore landmark – and other

hotel assets for $820m, and reinvested

most of the proceeds in China. CapitaLand

derives around a quarter of its earnings

from its $4.6bn portfolio of commercial and

residential projects in China. The group is

also planning to launch a $800m real-estate

investment trust for its China portfolio later

this year.

South-east Asian companies are also

prospering in sectors of the Chinese

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

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.

Adapt or dieFor manufacturers facing competition from

China, the obvious response has been to try

to make products with greater value-added,

or to move into niche markets. As Singapore

has lost assembly-line manufacturing jobs

– last year, for instance, Maxtor, the US

computer hard-drive maker, said it would

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

production to China – it has sought to

promote industries such as semiconductors

and pharmaceuticals instead. Many of the

world’s largest drug-makers now have big

manufacturing operations in Singapore,

while Switzerland‘s Novartis and America’s

Eli Lilly have set up research laboratories. ➣

Focus on Asia


When its electronics and textiles sectors

came under pressure in the 1990s,

Thailand tried to build up its car and auto-

parts industries instead. But Chinese

competition proved too strong, so Thailand

is instead focusing on a niche. Following

big investments by Ford, Toyota, Nissan

and Mitsubishi, it has become the world’s

second-largest producer (after the US)

of pick-up trucks, a third of which are

exported.

Malaysia’s steel producers, which are

reeling from a flood of cheap but low-quality

Chinese imports, are investing in new

technologies to improve the quality of their

products. One, Malayawata, wants to raise

the share of its production that is industrial-

grade from 10% to 50% by 2010, including

through a $150m joint venture between

its parent company and Kobe Steel of

Japan. Another, Ornasteel, is investing in

a new cold-rolled plant which will produce

extremely thin steel products.

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 south-

east 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 fast-

growing Chinese market and a boost

after the collapse earlier this year of

its negotiations with Volkswagen over

a strategic alliance between the two

companies.

Moving up the value chain only buys

companies a limited amount of time,

however, because China’s manufacturing

sector is also rapidly becoming more

sophisticated. Its steel industry has a

long tail of small producers that make

low-quality steel, but also half a dozen

large players that have invested heavily in

more sophisticated products. Meanwhile,

a handful of Chinese companies are

becoming trusted providers of chemical

raw materials for medicines, and the

pharmaceuticals industry is investing in

new manufacturing plants in the country.

China is even making inroads in drugs

research – Lilly now has a research facility

there and Novartis is planning to open one.

Yet the growing sophistication of China’s

manufacturers and its rising labour

Local 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.

➣


■

costs are also opening up space for its

neighbours. Vietnam and Cambodia

have both built up large clothes-making

industries in recent years, partly thanks to

the international quota system that limited

China’s global market share. Although they

suffered when the quotas were abolished

at the beginning of 2005, exposing them

to the full blast of Chinese competition, they

have since recovered some of their poise.

Chinese exports to Europe and the US face

fresh restrictions until 2008; but perhaps

more importantly, China is losing some of

its competitive edge as labour costs soar,

especially in the coastal areas where most

exporters are based. Guangzhou increased

its minimum wage by 15.7% in July, while

Shenzhen lifted its basic salary by 20%

in May.

As a result, many Chinese businesses are

seeking to shift production to lower-cost

manufacturing locations. For instance, TCL,

the Chinese television maker, set up a factory

in Vietnam several years ago, in part to

serve the local market, but also to serve the

entire region. It also now has factories in the

Philippines and India.

In short, as China gets richer, the debate

has come full circle. China’s manufacturing

base remains formidable, in terms of both

price and reliability. But as its companies

begin to challenge the top end of markets,

space is reappearing at the bottom. And as

its domestic market swells, it offer south-east

Asian companies growing export opportunities.

As long as they remain nimble, the tigers can

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.


MONDAY, SEPTEMBER 11 8:00 a.m. Registration Opens Singapore City Hall

THURSDAY, SEPTEMBER 14 9:00 a.m.

3:00 p.m.

Civil Society Forum opens

Press Briefing: World Economic Outlook (WEO);

IMF Economic Counsellor and Research

Department Director Raghuram Rajan

CSO Center, Suntec

Singapore

Suntec Singapore

FRIDAY, SEPTEMBER 15 9:00 a.m.

10:30 a.m.

Press Briefing: IMF Managing Director Rodrigo

de Rato

Press Briefing: World Bank President Paul

Wolfowitz

Suntec Singapore

Suntec Singapore

SATURDAY, SEPTEMBER 16 9:00 a.m.

12:00 noon

Annual Meetings

Group of 24 Ministers Meeting

Press Briefing: World Development Report

2007: Development and the Next Generation;

World Bank Chief Economist François

Bourguignon and WDR director Emmanuel

Jimenez

Press Briefing: Chair of the Group of 24

Ministers

Pan Pacific Hotel

Suntec Singapore

Suntec Singapore

Suntec Singapore

2006 Annual Meetings of the Boards of Governors

International Monetary FundWorld Bank GroupSeptember 2006, Singapore

Schedule of Events


SUNDAY, SEPTEMBER 17 8:30 a.m.

11:00 a.m.

3:00 p.m.

Annual Meetings

International Monetary and Financial Committee

Press Briefing: African Finance Ministers

Press Briefing: IMFC Chairman Gordon Brown

and IMF Managing Director Rodrigo de Rato

Per Jacobsson Foundation Lecture on “Asian

Monetary Integration: Will It Ever Happen?” by

Mr. Tharman Shanmugaratnam, Singapore’s

Minister for Education and Second Minister for

Finance

Pan Pacific Hotel

Suntec Singapore

Suntec Singapore

Suntec Singapore

Marina Mandarin Hotel

MONDAY, SEPTEMBER 18 8:30 a.m.

9:00 a.m.

11:00 a.m.

Annual Meetings

Development Committee

Seminar by the African Governors

Development Committee Press Briefing:

Minister Alberto Carrasquilla Barrera, Chairman

of the Development Committee; Paul Wolfowitz,

President of the World Bank; Rodrigo de Rato,

Managing Director of the IMF

Pan Pacific Hotel

Suntec Singapore

Suntec Singapore

Suntec Singapore

TUESDAY, SEPTEMBER 19 10:00 a.m.

3:00 p.m.

6:00 p.m.

Annual Meetings Opening Plenary Session

Annual Meetings Plenary Session

Lecture by Anne Krueger (IMF First Deputy

Managing Director, Sept. 2001- Aug. 2006)

on “An Enduring Need: The Importance of

Multilateralism in the 21st Century”

Suntec Singapore

Suntec Singapore

Suntec Singapore

WEDNESDAY, SEPTEMBER 20 9:30 a.m.

6:00 p.m.

Annual Meetings Plenary Session

Annual Meetings Closing Plenary Session

Civil Society Forum closes

Suntec Singapore

Suntec Singapore

CSO Center, Suntec

Singapore

www.johnniewalker.com


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.

➣

The new Argonauts

July Systems, which develops

technology for selling content such

as games and ring-tones on mobile

phones, was founded by two Indian-born

repeat entrepreneurs. While its headquarters

are in California’s Silicon Valley, near game

developers and mobile-content firms, it

develops its products in the Indian city of

Bangalore, where the founders have good

business connections. In its first five years,

July Systems has raised $28m from top US,

Indian and Taiwanese investors.

Verisilicon Holdings, which designs

semiconductors, was started by a graduate

of the University of California at Berkeley

from mainland China. Based in Shanghai, at

the heart of China’s fast growing integrated-

circuit (IC) market, it has development teams

in Silicon Valley and Taipei, the leading

centres of IC-design talent. Since it was

founded in 2001, VeriSilicon has raised

$20m from Chinese and US venture-capital

firms.

Like the Argonauts of Greek mythology

who ventured with Jason centuries ago,

these US-educated but foreign-born

entrepreneurs are embarking on risky

foreign adventures in pursuit of wealth.

Armed with their knowledge of technology

markets and their global contact-books, the

new Argonauts are in a strong position to

mobilise the expertise and capital needed

to start successful global ventures. Their

success also forces us to think afresh about

how countries and regions grow.

In the late 1990s, nearly three in ten Silicon

Valley start-ups were run by immigrants,

mostly from developing economies

such as India and China. Since then,

these immigrants have become global

entrepreneurs. Some remain based in

Silicon Valley, while tapping low-cost

technical talent and financing in their home

countries. Others return home to start

businesses but continue working with

customers and partners in Silicon Valley. As

these cross-regional collaborations multiply

and deepen, both the US and developing

economies benefit.

Entrepreneurs and their far-flung networks

now play a vital role in the technology

industries’ global expansion – and make

an increasingly important contribution to

economic growth and development more

broadly. Ventures such as July Systems

and Verisilicon are among the thousands of

start-ups that have helped create dynamic

technology clusters in countries such as

Israel, Taiwan, India and China. These

investments may be small by comparison

ANNALEE SAXENIAN is Dean

and Professor at the School of

Information and Professor in the

Department of City and Regional

Planning at the University of

California, Berkeley. She is author

of The New Argonauts: Regional

Advantage in a Global Economy

(2006) and Regional Advantage:

Culture and Competition in Silicon

Valley and Route 128 (1994), both

from Harvard University Press.

Focus on Asia


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

➣ to total foreign direct investment, but by

boosting indigenous entrepreneurship, they

create a huge potential for future growth.

This globalisation of entrepreneurial

networks reflects dramatic changes in

global labour markets. Falling transport

and communication costs allow high-

skilled workers to work in several countries

at once, while digital technologies make

it possible to exchange vast amounts of

information across long distances cheaply

and instantly. International migration,

traditionally a one-way process, has become

a reversible choice, particularly for those

with scarce technical skills, while people

can now collaborate in real time, even on

complex tasks, with counterparts far away.

Scientists and engineers from developing

countries, who were once forced to choose

between settling abroad and returning

home to far less attractive professional

opportunities, can now contribute to

their home economies while maintaining

professional and business ties in more

technologically advanced countries.

This is most evident in Silicon Valley,

where networks of foreign-born engineers

and entrepreneurs transfer technical and

institutional know-how between distant

regional economies faster and more

flexibly than most multinationals. The

protagonists in this process are not large


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

“These US-educated but foreign-born entrepreneurs are embarking on risky foreign adventures in pursuit of wealth.”

corporations but the new Argonauts: the

foreign-born engineers, entrepreneurs,

managers, lawyers and bankers who

have the linguistic and cultural abilities

as well as the institutional knowledge

to collaborate with their home-country

counterparts. While systematic data on

these highly decentralised two-way flows of

skill, technology and capital is scarce, their

impacts are arguably as important as more

easily measured multinational investments.

From brain drain to brain circulation The migration of talented youth from

developing to advanced countries has

traditionally been seen as a “brain drain”

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,

nonetheless quickly created ethnic social

and professional networks which have

supported their career advancement and

entrepreneurial success. High-profile start-

ups such as Sabeer Bathia’s Hotmail,

Jerry Yang’s Yahoo and Min Zhu’s Webex

are only the most visible reflections of the

extent to which Silicon Valley’s immigrant

engineers have mastered the region’s

entrepreneurial business system.

But these highly skilled emigrants are now

increasingly transforming the brain drain

into “brain circulation” by returning home

to establish business relationships or start

new companies while maintaining their

social and professional ties to the US. ➣

Focus on Asia


Foreign-educated engineers turned venture

capitalists often take the lead by investing

in their home countries. As experienced

engineers, managers and investors return

home, either temporarily or permanently,

they export first-hand knowledge of US

capital markets and business models to

peripheral regions.

In the early 1980s, foreign-born engineers

transferred the Silicon Valley model of early-

stage high-risk investing to Taiwan and

Israel, which US venture capitalists were

typically neither interested in nor able to

serve. Native-born investors provided the

cultural and linguistic know-how needed

to operate profitably in these markets. As

well as capital, they brought technical and

operating experience, knowledge of new

business models and networks of contacts

in the US. Israel and Taiwan now boast the

largest venture-capital industries outside

North America ($4bn is invested annually in

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

rates of new firm formation, innovation and

growth. Israel is now known for software

and internet firms such as Mirablis (a

developer of instant-messaging programs)

and Checkpoint (security software); firms

such as Acer (personal computers and

components) and TSMC (a semiconductor

foundry) have transformed Taiwan into

a centre of leading-edge PC and IC

manufacturing.

Immigrants from India and China with

experience in Silicon Valley have also

started to influence economic development

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

than $1bn annually in China, and a similar

amount in India. While this is only a fraction

of the venture capital invested annually

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

economies, it is fostering local ecosystems

which support indigenous entrepreneurship

and which are an increasingly viable

alternative to the development opportunities

provided by established domestic firms and

multinational corporations.

No longer on the sidelinesTraditional accounts of economic

development assume that new products

and technologies emerge in advanced

economies, which have sophisticated

skill and research capabilities as well as

large and wealthy domestic markets, with

mass manufacturing shifting to less costly

locations once a product is standardised

and mature. Development, in this view,

builds on success in advanced economies,

while peripheral economies remain followers.

Both the strategies of multinational

corporations and the clustering effects

created by economies of scale perpetuate

this divide.

This leaves little scope for the periphery

to develop independent technological

capabilities. At best, foreign investment from

the core might contribute to the incremental

mastery of foreign manufacturing techniques

and the upgrading of local suppliers. Even

the most successful newly industrialising

countries are destined to remain imitators,

because leading-edge skill and technology

“Because of their experience and professional networks, these cross-regional entrepreneurs can quickly identify promising new market opportunities.”

➣


reside in the corporate research labs and

universities in the core.

But changes in the world economy have

undermined this core-periphery model.

The increasing mobility of high-skilled

workers and information, combined

with the fragmentation of production

in the information and communication

technology sectors, provide unprecedented

opportunities for formerly peripheral

economies to benefit from decentralised

growth based on entrepreneurship and

experimentation. While policymakers and

multinational corporations have a role

to play, central to this are communities

of technically skilled immigrants with

experience in, and connections to, Silicon

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 cross-

regional entrepreneurs can quickly identify

promising new market opportunities, raise

capital, build management teams and

establish partnerships with other specialist

producers – 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

to tap overseas expertise, cost savings

and markets. Start-ups in Silicon Valley are

often global actors from day one; many

raise capital, subcontract manufacturing

or software development, and market their

products or services outside the US.

The scarce resource is no longer size but

the ability to locate foreign partners quickly,

and then to manage complex business

relationships and teamwork across cultural

and linguistic barriers. This is particularly

challenging in high-tech industries where

products, markets, and technologies are

continually redefined – and where product

cycles are often shorter than nine months.

First-generation immigrants have

a commanding advantage.

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

➣

Focus on Asia


Developing economies typically have two

major handicaps: they are remote from the

sources of leading-edge technology and

distant from developed markets and the

interactions with users that are crucial for

innovation. Firms in peripheral locations

can try to overcome these disadvantages

through joint ventures, technology licensing,

foreign investment, overseas acquisitions,

and so on. But a network of technologists

with strong ties to global markets and the

linguistic and cultural skills to work in their

home country is arguably the best way to

overcome these limitations. Cross-regional

entrepreneurs and their communities can

facilitate the diffusion of technical and

institutional know-how, provide access to

potential customers and partners, and help

overcome isolated economies’ reputational

and informational trade barriers.

While new technologies and more open

global markets make this possible, long-

distance collaborations still depend heavily

on a shared social context and language,

which ensure partners understand each

other well, which is vital in rapidly evolving

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

resources of their home countries. In the

1980s, Taiwan was known for its cheap

PC clones and components; today, it is

recognised for the flexibility and efficiency

of its IC and electronic-systems producers.

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

internet ventures; now, Chinese producers

are poised to play a lead role in developing

wireless technology. In the 1990s, India

was a provider of labour-intensive software

coding and maintenance; today, local

companies are mobilising the thousands

of underemployed English-speaking

Indian engineers to manage large-scale

software services projects for leading global

companies. Whereas in the 1980s, Israel

was a low-cost research location, since

then, local entrepreneurs have applied the

fruits of the country’s advanced military

research to pioneer sophisticated internet

and security technologies.

A new generation of cross-regional

start-ups combine Silicon Valley’s new

product vision, technology architecture,

marketing, and research-and-development

coordination with the technical capabilities

of distant regions. The emerging regions

are hybrids, which marry elements of

the Silicon Valley industrial system with

Building new technologies: female workers at the construction site for an IT company, Bangalore.

➣

➣

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DRDN_Singapore_FP_approved.indd 1 7/21/06 11:04:42 AM

Focus on Asia


inherited local institutions and resources.

Returning entrepreneurs typically seek (with

varying success) to transfer venture capital,

merit-based advancement and corporate

transparency to economies with traditions

of elite privilege, government control,

and corruption. They seek to reproduce

team-based firms with limited hierarchy in

an environment dominated by family-run

businesses or state-owned enterprises. And

they seek to influence policy because the

national institutions that support the Silicon

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

in developing organisational synergy and

persistent, consistent communication.

Entrepreneur-led growth, with highly

competitive, specialised technology

producers in high-skill regions connecting

to, and collaborating with, counterparts

elsewhere, is only one possible future for

these regions. If they are not careful, they

may miss the opportunity to upgrade local

skills and capabilities, and instead remain

suppliers of low-cost labour to global (or

domestic) corporations. China and India

have a big enough labour supply to do

this for a relatively long time. However,

many cross-regional entrepreneurs are

Fragmentation of production in the information and communication technology sectors provides unprecedented opportunities to benefit from decentralised growth.

➣

➣

Focus on Asia


constructing firms committed to an

alternative, high-value-added trajectory.

The world isn’t flatIs brain circulation between technology

regions making the world “flat”, as

Thomas Friedman of the New York Times

suggests? Hardly. The new Argonauts

cluster tenaciously in the leading

technology centres, which is why Palo Alto

now has more in common with Taipei and

Tel Aviv than with Fresno, a three-hour

drive away. Residents of Bangalore enjoy

Western standards of living, while those in

nearby rural areas remain mired in poverty.

Economic geographers have documented

this phenomenon of increasing returns in

specific locations – where the advantages

of locating in a crowded and costly place

outweigh the increasing costs, resulting in

a pronounced clustering process. The rise

of entrepreneurship-led growth suggests

that the regional cluster may be replacing

the national economy as the locus of

economic growth.

Overseas technology investments are not

motivated solely by low labour costs, as

critics suggest. The leading destinations

for cross-border technology investment

are regions such as Bangalore and

Shanghai, where wages and other costs are

significantly higher than in their surrounding

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.

➣


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

skills, expertise and relationships which

ensure a regional advantage that

compensates for their high costs: Israel

in sophisticated internet and security

technologies, Taiwan in global logistics and

design, China in efficient IT manufacturing,

and India in managing complex software

services and consulting projects.

The old pattern of one-way flows of

technology and capital from the core to

the periphery is being replaced by a far

more complex and decentralised two-

way flow of skill, capital and technology

between regional economies with different

specialities. Silicon Valley is at the core

of this rapidly diversifying network of

economies because it is the largest and

most sophisticated market as well as a

leading source of new technologies. But this

may change, as new relationships emerge

and new markets open up. The fast-growing

Asian market for wireless communication,

for example, has enabled firms in China and

India to contribute to how the technology

and its applications are developed – even

though they do not yet define its leading

edge. Over time, producers in developing

regions may be able to build independent

capabilities and define entirely new

specialisations and markets.

Even the largest Silicon Valley companies

participate in all these regions not simply

as competitors but also as investors and

partners. An established firm such as

Cisco designs and sources critical parts

of its operating-system software from

India; buys application-specific ICs for its

high-end routers from Israel; and has most

of its hardware manufactured in Taiwan

and China. Like Intel and Acer, it also

invests in foreign start-ups with promising

technologies. A start-up such as July

Systems obtained venture capital from

the US, Taiwan, China and India, and its

products will likely incorporate components

from all these locations, as well as being

targeted at all their markets.

US technology producers now look to their

counterparts in Taiwan, China, India and

Israel not simply for low-level implementation

but increasingly to co-develop products and

components. Firms in the new technology

regions are increasingly partnering with one

another, as well as with firms from Silicon

Valley. A Taiwanese semiconductor firm

invests in Israeli start-ups specialising in

digital-speech-processing chips, while an

Israeli company contributes intellectual-

property components to a chip-design firm

in India. These collaborations deepen both

partners’ capabilities and over time can

support a process of reciprocal innovation

and upgrading.

A model for others?Not all developing economies can reap the

benefits of brain circulation and peripheral

entrepreneurship. For political reasons,

some of the largest technically-skilled

immigrant groups in Silicon Valley have not

built business or professional connections

to their home countries. Most of the Iranian

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

➣

Focus on Asia


■

and Vietnamese immigrants, for example,

are political refugees and so not inclined

to return to countries which, in any case,

lack the economic stability needed for

technology investment or entrepreneurship.

This is also true to varying degrees for

immigrants from Russia, parts of Eastern

Europe and Latin America. Saint Petersburg

or Buenos Aires may one day become more

attractive to returning entrepreneurs, but

large parts of Africa and Latin America lack

the skill base or political openness to foster

technology entrepreneurship.

The creation of a transnational community

is a two-way process. While policymakers

and planners can encourage cross-regional

connections, they cannot create or substitute

for transnational entrepreneurs and their

decentralised networks. Foreign governments

regularly sponsor networking events for

their expatriates in the Bay Area in order to

recruit return entrepreneurs and investments,

but without entrepreneurial collaborators at

home, these agencies will have little success.

Cross-regional networks develop only

when skilled immigrants are both willing

and able to return to their home countries

to do business in large enough numbers

to create close links to the technical

community in the home country. This

requires political stability, economic

openness and a certain level of economic

development, notably a high level of

technical education. It often builds on

multinational companies’ investments in

research and development which have

helped develop a local skill base as well

as an infrastructure which supports

entrepreneurship. Political leaders must

also be committed to removing institutional

obstacles to entrepreneurship-led growth.

Technology markets are shifting quickly,

with demand from outside the US growing

rapidly. While North America, Europe and

Japan account for less than 15% of the

world’s population, they produce more

than half of global output. This is set to

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

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

➣

Development Agenda


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.

Hitting the target

At the UN’s Millennium Assembly in

September 2000, the world adopted

the Millennium Development

Goals (MDGs) – quantitative, time-bound,

achievable targets to address extreme

poverty in its many dimensions: income

poverty, hunger, lack of education, disease,

poor child and maternal health, gender

inequality, poor sanitation and environmental

sustainability.

Many countries, notably in East and South

Asia, have made substantial progress

towards the Goals. Yet many others, and

indeed entire regions, remain dangerously

off-track. Sub-Saharan Africa is the most

serious and persistent laggard, with food

shortages, a rapidly expanding population, a

crushing disease burden and environmental

degradation combining to keep millions in

extreme poverty. Other regions, such as the

Middle East, Central Asia and parts of Latin

America, have had mixed success, with

great progress on some of the Goals and

persistent inequalities in others.

As reports by the UN Millennium Project,

the Commission for Africa, and many others

have shown, the tools and knowledge exist

to meet the Goals, as does the financing

–provided rich countries meet their long-

standing pledge to devote 0.7% of the

gross national income (GNI) to official

development assistance. The Monterrey

consensus on development aid provides

the right framework with its focus on

improved governance, increased public

and private investments, more and better

development assistance, and free trade

for long-term economic development. Yet

with 2015 the deadline to meet the Goals,

time is running out to get countries on track

towards achieving them. The cost of failure

in terms of lives lost, growing insecurity and

accelerating environmental degradation is

too high.

Breaking throughEncouragingly, the past year has yielded

a series of breakthroughs, both in high-

level global politics and on the ground,

which are building up the momentum

behind the Goals and give us cause

for optimism. The rich world has made

a series of commitments to provide

financing at the scale needed to meet

the Goals, while a number of initiatives

on the ground have demonstrated, and

continue to demonstrate, that scaled-

up, targeted public investments can lead

to development success in some of the

poorest countries.

JEFFREY D. SACHS

is Director of the UN Millennium

Project, an independent advisory

body to the United Nations

Secretary-General on the

Millennium Development Goals.

He is also Director of The Earth

Institute at Columbia University,

and President and co-founder of

Millennium Promise Alliance, a non-

profit organisation aimed at ending

extreme global poverty. He is the

author of many books, including

New York Times bestseller The End

of Poverty (Penguin, 2005).


➣

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

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

committed to donating 0.33% of GDP by

2015. Following this landmark commitment,

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. The six remaining countries

are Australia, Canada, Japan, New Zealand,

Switzerland and the United States.

At Gleneagles in July 2005, the Group

of Eight (G8) leaders made further

commitments to scale up financing for the

MDGs, specifically in Africa. An extra $25bn

in donor financing by 2010 was promised

for sub-Saharan Africa alone. The G8 also

agreed to forgive the debt of several of

the poorest countries, and committed to

ensuring universal access to anti-retroviral

treatment for AIDS by 2010.

At the UN World Summit last September,

world leaders committed to prepare national

development strategies that are bold

enough to achieve the MDGs. They also

adopted several “quick-impact initiatives”,

designed to make rapid progress in many

key areas: bed nets and medicines to fight

malaria, anti-retroviral medicines for AIDS,

fertilisers for replenishing soil nutrients and

launching the African Green Revolution,

hardware and software for rural connectivity,

and countless other practical steps that

can relieve hunger, disease and isolation at

relatively modest cost. These quick-impact

initiatives are already proven to work, they

are affordable and, importantly, their results

can be easily measured and monitored.

They now need to be implemented at scale.

Implementation is gathering paceThe key challenge now is implementation.

Fortunately, we are also beginning to see

progress on this front. Remarkable results

have been achieved in some countries

that have implemented large-scale national

programmes to achieve the Goals. In

Ghana, a public-private partnership,

with support from the government of the

Netherlands and Unilever, has launched

a national school feeding programme for

1m children using locally produced food.

This programme is not only improving child

nutrition and health; it is also boosting

school attendance, improving educational

outcomes and creating a market for locally

produced food.

Another powerful example is the Measles

Malaria Initiative, run by the Center for

Disease Control, Red Cross Red Crescent,

UNICEF and WHO, which has implemented

national campaigns for measles vaccination

and the free distribution of long-lasting

insecticide-treated malaria bed nets.

Extremely successful campaigns have been

implemented, most recently in Niger and

Togo, with many other African countries

scheduled to follow in 2006 and 2007. The

results include a sharp fall in the incidence

of malaria and drastically lower measles

GUIDO SCHMIDT-TRAUB

is Associate Director at the UN

Millennium Project. Previously,

he was a partner at IndexIT

Scandinavia, a strategic adviser

for technology companies and

concurrently managed a private

investment fund for European

technology companies. He holds

an M.Phil. in Economics from

Oxford University, where he was

a Rhodes Scholar, and a Masters

in physical chemistry from the Free

University Berlin.

“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.”

Development Agenda


➣

mortality. Perhaps most impressively, the

campaigns lasted only a few days, were

implemented at an extremely low cost using

Red Cross Red Crescent volunteers, and

achieved country-wide coverage. These

and other programmes, such as the fertiliser

strategy currently being prepared by the

government of Malawi, clearly demonstrate

the feasibility and success of national-scale

programmes to meet the MDGs.

The Millennium Villages, a joint effort of the

Earth Institute, UNDP, the UN Millennium

Project and Millennium Promise, are

demonstrating that the MDGs can be met in

some of the poorest villages in sub-Saharan

Africa through community-led development.

Once empowered with the means, farmers

have more than tripled their crop yields

and food output in a single season. School

attendance has soared in response to school

feeding programmes and the elimination of

user fees. Healthcare has been dramatically

bolstered through the provision of local

clinics and the mass distribution of long-

lasting insecticide-treated bed nets to fight

malaria. The initiative, which is partially

funded by the government of Japan, covers

some 390,000 people in 12 sites across

sub-Saharan Africa – one for each major

agro-ecological zone. The results so far are

impressive, and show that this approach can

be taken to scale. It is time for official donors

to build on these results. ➣

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.

➣

Development Agenda


Preparing MDG-based national strategiesAt the UN World Summit, every country

was called upon to prepare an MDG-based

national development strategy. Such a goal-

based 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-as-

usual 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

incompetence, and sceptics feel vindicated

in their view that the MDGs cannot be met.

Fortunately, several countries have begun to

buck this trend. Ethiopia, Kenya, Senegal,

Tajikistan and others have put forward the

first MDG-based development strategies.

Many other countries are approaching

the UN for support in preparing rigorous

strategies to achieve the Goals. Their

leadership now needs to be recognised

and reciprocated with bold support from

the international community to permit the

implementation of these strategies through

a real international partnership.

Where available strategies fall short in terms

of ambition, financing or analytical rigour,

governments should be encouraged and

supported in mapping out the practical

investments needed to deliver basic

infrastructure, ensure good health, promote

education and gender equality, improve

environmental management, and launch

the African Green Revolution. Imperfect

strategies should be improved instead of

serving as a justification for inaction, as is

still too often the case.

Fortunately, major strides are being

made in Africa and elsewhere towards

the integration of the MDGs into national

budgets, development initiatives and

poverty reduction strategies. NEPAD’s

African Peer Review Mechanism (APRM)

is making important contributions towards

strengthening governance across Africa. The

➣


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.

In May, African ministers and development

partners met in Abuja for the Financing for

Development Conference. The purpose was

to transform the recent commitments for

increased financing for African development

into action, with specific focus on meeting

the MDGs and developing coherent national

strategies to do so. Britain’s Chancellor of

the Exchequer, Gordon Brown, delivered a

powerful speech in which he reiterated the

UK’s commitment to providing $15bn over

the next ten years in support of ten-year,

costed education strategies. In response,

20 African countries announced that

they would present national strategies

to meet the ‘Education for All’ Goals at

this September’s annual meetings of the

World Bank and IMF. Implementing these

education strategies will be an important

breakthrough in moving towards national-

scale programmes to achieve the MDGs.

Another area where African leaders are

taking the initiative is the African Green

Revolution. In response to the UN

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

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

➣

Development Agenda


Secretary-General’s call for an African Green

Revolution in early 2004, NEPAD convened

the Africa Fertiliser Summit in Abuja in June

this year. Summit participants pledged to

improve access to fertilisers, improved

seeds and other key agricultural inputs

through smart subsidies and strengthened

private distribution networks. Malawi and

many other African countries have already

drawn up national strategies for agricultural

inputs. These practical commitments hold

the promise of greatly reducing poverty and

hunger in rural Africa, and now need to be

implemented.

Together, these breakthroughs over the

past year show that the glass is half full. The

international community now needs to build

on the momentum behind the Millennium

Development Goals by supporting

governments in preparing and implementing

practical strategies to meet each Goal.

Needless to say, the IMF and World Bank

play a critical role in supporting this process.

The role of the IMF and World BankIn his April report on the IMF’s medium-

term strategy, Rodrigo de Rato, the Fund’s

managing director, pledged to increase the

organisation’s engagement in low-income

countries to achieve higher growth and to

meet the MDGs. He called for an approach

that assesses “if projected aid flows are

consistent with macroeconomic stability

and the estimated costs of achieving

countries’ development goals” and urged

candour by informing “donors when there

is scope for more aid to be absorbed and,

conversely, when it judges that expected

➣

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

The Institute has developed an integrated approach combining :

ADVISORY SERVICES- Strategic and Operational Planning and Budgeting- Implementation and Management of Public Programmes- Monitoring & Evaluation (M&E)

CAPACITY BUILDING- Master Certification as Public Program

Management Professional (PPMP) New in 2007- Workshops (in English, French, Spanish)- Customized Training

INFORMATION SYSTEM SOLUTIONS- Diagnosis and Need Assessment- M&E System Implementation- Electronic Documentation Management System

M&E System in Mexico and Vietnam Design and set up of monitoring and evaluationsystems of public programmes within a ResultsBased Management (RBM) perspective.

International Professional TrainingAll over the world, IDEA International trains public officers and professionals on themanagement of public programs with a resultbased approach.

IT support in CambodiaDevelopment of a Poverty Management Infor-mation System with a data warehouse approach,for various poverty-related administrative and survey data bases.

The Institute for Development in Economics and Administration (IDEA InternationalInstitute) is a private institute. Its mission is to support governments in their effort to implement Results Based Management approaches for public programmes in the context of poverty reduction and sustainable development.

IDEA INTERNATIONAL INSTITUTE — certified ISO 9001-2000962 Mainguy, Quebec (QC) Canada G1V 3S4Tel : 1-418-266-1223 | Fax : 1-418-266-1225 | E-mail : [email protected] | Website : www.idea-international.org

IDEA_PUB_singapour 8/17/06 4:22 PM Page 1

■

aid flows put macroeconomic stability at

risk.” Through this document the IMF has

taken its boldest step yet in aligning its work

in low-income countries with the Millennium

Development Goals.

We see three areas in which the IMF and

World Bank can, and must, go further

in supporting the Goals. First, the World

Bank should work with the UN system

to support every developing country in

estimating the financial and human-resource

needs for meeting the MDGs. Second, the

Fund needs to support the preparation

of an MDG-consistent financing and

macroeconomic framework. Next, the Fund

staff should work not only with the finance

ministers of the developing country but also

their counterparts in donor countries to

mobilise the needed financing.

In addition to the IMF and World Bank staff,

their Executive Boards needs to review every

country programme proposal for consistency

with the MDGs. Standard checks applied

to each programme should be whether the

proposed level of financing is consistent with

achieving the Millennium Development Goals

and if the financing strategy is compatible

with long-term economic growth and

macroeconomic strategies.

By building on the Fund’s medium-term

strategy and taking decisive action to

implement these practical steps towards

operationalising the MDGs, the IMF and the

World Bank will make a critical contribution

to sustaining and building on the accelerating

momentum for achieving the Millennium

Development Goals. The fruit of this labour will

be many lives saved and a better world for all.

The Institute has developed an integrated approach combining :

ADVISORY SERVICES- Strategic and Operational Planning and Budgeting- Implementation and Management of Public Programmes- Monitoring & Evaluation (M&E)

CAPACITY BUILDING- Master Certification as Public Program

Management Professional (PPMP) New in 2007- Workshops (in English, French, Spanish)- Customized Training

INFORMATION SYSTEM SOLUTIONS- Diagnosis and Need Assessment- M&E System Implementation- Electronic Documentation Management System

M&E System in Mexico and Vietnam Design and set up of monitoring and evaluationsystems of public programmes within a ResultsBased Management (RBM) perspective.

International Professional TrainingAll over the world, IDEA International trains public officers and professionals on themanagement of public programs with a resultbased approach.

IT support in CambodiaDevelopment of a Poverty Management Infor-mation System with a data warehouse approach,for various poverty-related administrative and survey data bases.

The Institute for Development in Economics and Administration (IDEA InternationalInstitute) is a private institute. Its mission is to support governments in their effort to implement Results Based Management approaches for public programmes in the context of poverty reduction and sustainable development.

IDEA INTERNATIONAL INSTITUTE — certified ISO 9001-2000962 Mainguy, Quebec (QC) Canada G1V 3S4Tel : 1-418-266-1223 | Fax : 1-418-266-1225 | E-mail : [email protected] | Website : www.idea-international.org

IDEA_PUB_singapour 8/17/06 4:22 PM Page 1

Development Agenda


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.

Spanning the digital divide

Technology always plays the starring

role in economic growth. Prosperity

depends on the introduction of new

technologies by entrepreneurs seeking to

offer better products and services at a lower

cost, and their wide use by businesses

and consumers. Today’s information and

communications technologies (ICTs) – such

as the internet and mobile phones – hold

out the promise of new opportunities for

businesses to gain access to markets

and customers. So it’s no surprise that

policymakers in developing countries hope

that ICTs can contribute to broad-based

economic development. But how can they

ensure that their high hopes are fulfilled?

Analysis of the impact of ICTs on

development often takes as its starting point

the scale of the digital divide. A comparison

of access to new technologies in different

countries reveals a chasm between rich

and poor on most indicators. To take the

example of internet access, developed

countries have an average of 53 users per

100 inhabitants, while developing countries

have only seven. There is no evidence

that the digital divide is narrowing, either

– with the important exception of mobile

phones, where penetration rates are rising

much faster in developing countries than

in developed ones (where cell phones are

already ubiquitous).

But the trouble with analysing ICT needs

in terms of these generally depressing

benchmarking exercises is that it focuses

attention on a single dimension of policy

– investment in physical technological

infrastructure and devices, such as PCs

and handsets. This narrow focus distracts

attention from the all-important question

of what to do with the technology when

it is installed, and how to ensure that it

will actually make the economy more

competitive.

A new framework paper on ICT strategies

for competitiveness and growth that I

prepared for infoDev (Information for

Development), an international partnership

of bilateral and multilateral development

agencies housed at the World Bank,

looks at these broader policy issues. ICTs

certainly can enhance competitiveness

and growth, as the many examples of how

entrepreneurs and consumers in some

developing countries have been able to

make productive use of mobile phones

or internet access show. For instance,

fishermen off Mafia Island in Tanzania ring

ahead on their mobiles to see where they

DIANE COYLE

is managing director of

Enlightenment Economics, and led

the research team which prepared

the infoDev report. She is also a

visiting professor at the University

of Manchester and a member of

the UK’s Competition Commission.

The infoDev framework report,

‘Information and Communication

Technologies, Competitiveness

and Growth: Challenges and

Opportunities for Developing

Countries’, is available at

www.infodev.org


➣

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

most of the new technologies’ development

potential.

The detailed answer will vary case by case,

because the first step in setting an effective

strategy is a realistic assessment of each

country’s capabilities. The existing ICT

infrastructure – including key measures such

as international bandwidth, or the scope of

the mobile and fixed telephone networks – is

certainly important, but it is not everything.

Each country’s competitiveness will also

depend on a range of other capabilities, as

well as geographical and historical factors

which are beyond the reach of policy.

Thus other aspects of physical infrastructure

matter too, because they complement

ICT use. Electricity supply is one example,

especially when it comes to using ICT in

business, because a reliable power supply is

critical for most applications. The transport

network is also important, because it often

complements ICT use. For instance, if using

the new technologies makes firms more

efficient and thus enables them to export

more, demand for haulage and shipping will

rise, as will road, rail and port use.

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

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.

Development Agenda


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

Going beyond infrastructure, human skills

are another key capability. The use of

ICTs involves some specific skills, such as

keyboard familiarity and knowing how to

use standard software, as well as some

general ones. Literacy is needed for even

basic computer use, and some ICT-enabled

activities require generally high cognitive

skills. The importance of human capital for

development is already well-known, but

introducing ICTs is likely to increase the

need for certain types of skill which are in

short supply in many developing countries.

A third important area of capabilities

which complement ICTs can be put

under the general heading of institutions.

Again, it is widely recognised that some

institutions are more likely than others to

enhance growth. In the context of ICTs,

the relevant institutional capabilities will

include regulatory policies which encourage

competition, for example. This is because

competition puts pressure on firms to

innovate and become more efficient, thus

increasing their use of the new technologies

which become available. In general,

relationships between government, business

and consumers in the domestic market

can either encourage or inhibit the diffusion

of ICTs, as can be seen from the different

patterns of adoption of the technologies

in countries which are otherwise similar

in terms of income per capita or other

economic benchmarks. A comparison of

PC or mobile-phone penetration rates in the

smaller sub-Saharan African economies, for

instance, shows such wide variation that

country-specific characteristics must play an

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

itself might start to suggest policy priorities.

For example, a strategy centred on the

delivery of the physical facilities for IT-

enabled services is not likely to be a sensible

priority for a country where too few workers

have the literacy and foreign language skills

required, or where a lack of competition

makes overseas calls expensive. Call

centres in some Caribbean countries, such

as Antigua and Grenada, have fallen victim

to high international call charges. But often

it is harder to set policy priorities which

take account of the many relationships and

feedbacks in an economy. For instance, a

seemingly small regulatory change can have

a big impact on firms’ incentives to invest,

which in turn might have an unexpected

knock-on effect on consumer demand. This

kind of virtuous circle, where investment

stimulates network effects, which in turn

take consumer demand to a critical point,

seems to have occurred in the case of

mobile telephones. Certainly, the speed of

diffusion of mobiles in developing countries

has taken everyone by surprise, not least

the mobile operators and the policymakers

who first introduced the relevant licensing

changes in the 1990s.

Conventional statistical regressions do

not allow us to explore these non-linear

feedbacks, and although they do give us

some idea of the long-term impact of policy

variables on growth, in practice there is

rarely enough data to be confident that

one policy is clearly preferable to another.

An alternative approach is to test how the

impact of a policy change works through the

➣

➣

Development Agenda


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.

relationships and feedbacks in a particular

economy. Even qualitative judgements about

key variables and the strength of the links

between them are sufficient to place policies

in order of effectiveness. The full infoDev

report demonstrates this kind of prioritisation

with an illustrative example, but the policy

rankings will of course be specific to each

country and will depend on their existing

capabilities.

Even benchmarking existing e-readiness and

adding an assessment of complementary

capabilities is not the full story about ICTs’

scope as tools of development. A country’s

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 chainThe 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

specialised industries. So far, relatively

few developing countries form part of

these global chains; the growth in trade

and foreign direct investment is heavily

concentrated in a handful of countries,

notably China.

What’s more, developed countries have by

and large retained the high value-added

activities, often intangible and categorised

as services. These include R&D, design,

branding and marketing. These activities are

located at either end of global production

chains, at the start in the case of product

innovation and design, and at the consumer

end in the case of advertising and marketing

(see diagram, below). Although developing

R&D Design Inbound Logistics Production Outbound logistics, Distribution

Marketing, Market research Brand

High value Higher value Low value Higher value High value

The production chain

➣


countries’ share of world production has

climbed significantly, their share of world

value has risen only a little in ten years,

creating a ‘value wedge’ (see chart, below).

For example, some 45% of the retail price

of a basic imported shirt sold in the US lies

in the design, branding and marketing of

the product. In the European Union, car

makers in the EU-15 countries have tended

to retain their research, design and branding

activities domestically, while among the new

EU member states, the Czech Republic has

become the most important centre for vehicle

assembly, Hungary specialises in engine

manufacture and Poland in gear boxes.

Thanks to ICTs, global companies have

been able to reallocate their activities more

efficiently. In contrast to the multinationals

of the 1960s and 1970s, which typically

sought access to markets or resources

through FDI, global companies are today

using new technologies to pursue greater

efficiency. What options does this leave

businesses from developing countries?

As ICTs transform the global production

landscape, they are also creating new

opportunities. One path is for developing-

country firms to pursue higher-value activities

through identifying market niches which bring

them close to customers in export markets.

Country studies carried out for infoDev

document examples of successful – and

less successful – attempts by companies

to capture some of the value either

‘downstream’ or ‘upstream’ from low-value

manufacturing and processing activities.

For instance, Jamaican Signature Beats

brings musicians from the island directly

into contact with potential American and

European customers through a website as

well as marketing and promotional activities.

As well as initiating contact with customers,

the product – advertising jingles, for example

– can be delivered online. A very different

example is Tanzania’s use of technologies

The ‘value wedge’: developing countries’ share of world production and GDP Data source: World Development Indicators

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

GDP share

Production share

➣

Development Agenda


➣

such as weather and soil monitoring to

improve the quality of coffee for delivery to

customers in the US and the EU, although

it is not yet clear how much this will enable

producers to boost their margins.

An alternative to seeking access to export

markets directly, perhaps in partnership

with small and medium-sized companies

located in the destination markets, is to sell

into the multinational supply chains I have

described. To do so successfully requires an

understanding of these global corporations’

strategies. ICTs can allow developing-

country suppliers to move up the value

chain – either upstream or downstream,

or both – from the low-value manufacturing

or processing. Upstream, the fi rst step

is likely to be making improvements in

quality through incremental changes in

processes and delivery speed. The next will

be introducing some innovations in both

processes and products, and the fi rm can

then aim to move on to more sophisticated

R&D. Downstream, a fi rm can go from basic

assembly to an active sales effort, product

marketing, establishing a distribution

network and on to developing own-brands,

advertising and market research.

There are very few examples of developing

countries with signifi cant fi rms that have

started along this progression, but some

ICT-enabled Chinese and Indian companies

do seem to be succeeding in capturing

a bigger share of the value added in the

production chain. Consider China’s success

in the clothing industry.

Some of the reasons for China’s success in

world clothing markets are unrelated to ICT,

such as its large pool of suitable labour and

the economies of scale arising from its big

domestic market. However, many

of its manufacturers are using sophisticated

software and communications which give

them a now nearly unbeatable expertise in

the logistics of taking an order, sourcing all

the buttons, zips and so on, manufacturing

in large quantities and completing the order

within ten days, or even a week. Often,

manufacturers make deliveries straight to

the stores of major western retailers, without

holding any inventory at any stage of the

supply chain.

Such an operation requires a lot of ICTs,

ranging from basic communications and

web access to electronic data interchange,

computer-aided design and manufacturing,

enterprise fl ow software, integrated

point-of-sale feedback and, increasingly,

radio-frequency identifi cation tags, which

are soon expected to be incorporated

directly into individual garments as they are

made. Garment manufacture and delivery

operations of this kind are extremely

sophisticated and rest on a long period of

accumulated expertise and management

know-how. It is no surprise that these

manufacturers are able to capture a growing

share of the value in the global supply chain.

Of course, China’s very successful and

dominant specialisation is a threat to

textiles and clothing manufacturers from

other countries, especially since the end

of the Multi-Fibre Arrangement (MFA)

quotas in 2005. What strategies can

companies in other developing countries

pursue? Chinese fi rms have a competitive

advantage in the inbound and outbound

logistics which lie to either side of the low-

value manufacturing process. Firms from

other countries which wish to move beyond

the basic manufacturing themselves can

sensibly look to compete at other stages

of the supply chain.

The existing ICT infrastructure – including the scope of the mobile and fi xed telephone networks – is certainly

important, but it is not everything.

➣

➣

Development Agenda


In India and Mauritius, for instance, ICTs are

enabling garment manufacturers to develop

innovative textiles and compete successfully

on design. Broadband internet access is

important, as is computer-aided design

and manufacturing software, and specialist

software for grading patterns and so on.

Local craft skill can be a significant asset,

since traditional designs and handcrafting

are highly valued by developed-country

consumers. Mobile camera phones allow a

company’s representatives to send sample

designs from far-flung villages to head office

for speedy approval. Another interesting

example is a Ugandan t-shirt manufacturer,

which is making do with basic means of

communication (telephone, fax and dial-up

email) and is struggling with high transport

costs and long delays even in getting goods

to port in Nairobi, but whose key asset is

access to high-quality organic cotton, for

which European consumers are willing to

pay a large premium. The relevant enabling

factor in this case was not ICT at all, but

simply the relevant intelligence about

market demand.

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

more obvious interventions, as we know

all too well, can be surprisingly ineffective.Literacy is needed for even basic computer use, and some ICT-enabled activities require generally high cognitive skills.

➣

■

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HowDoYouJul06 7/7/06 9:32 AM Page 1

How do you become a strong leader? Focus on people. For over 170 years.

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NUMBER ONE IN THE WORLD FOR RETURN ON INVESTMENT.Nothing says “you’ve found a winner” like deep roots and a corporatephilosophy that garners outstanding results for both customers andshareholders. In 2005, Scotiabank led all full-service banks in the worldfor total and risk-adjusted shareholder return.† In the Caribbean andCentral America alone, Scotiabank’s goal-focussed brand of customerand community service has earned us the honours†† of Best Bank inJamaica, Dominican Republic, Mexico, Costa Rica and in the Caribbeanas a whole. Globally, we continue to expand and today 50,000employees in some 50 countries deliver customized financial services inall areas of personal, commercial, corporate, and investment banking tohelp you get ahead.

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Development Agenda


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

“Our Heroes”

Every year, at Christmas, the

government of the Philippines

prepares a special welcome for its

returning heroes. World-beating sports

stars? Globe-trotting businessmen? No:

Filipinos working abroad who are coming

home for the holidays. At the airport of the

country’s capital, Manila, prizes are handed

out to lucky workers. And on Migrant

Workers Day, the president awards the

“Bagong Bayani” (modern-day hero) award

to 20 outstanding migrant workers who

have demonstrated moral courage, hard

work and a track record of sending money

home. One government minister remarked

that “Overseas employment has built more

homes, sent more children of the poor to

college and established more business

enterprises than all the other programmes

of the government put together.”

Unlike most developing-country

governments, the Philippines’ actively

encourages its citizens to go work abroad.

It tries to place workers overseas and also

licenses and regulates private recruitment

agencies to do so. Migrants typically go

work on two-year contracts that are usually

open to renewal, primarily in Saudi Arabia,

but also in Hong Kong, Taiwan, Singapore,

Japan and the US. They tend to go alone

because they are not permitted to bring

family members with them. Such temporary-

work programmes are a model for what

developing countries such as India are

seeking to achieve through negotiations at

the World Trade Organisation, and could

be applied more widely to the benefit of

rich and poor countries alike, without all the

political and cultural issues which permanent

settlement entails.

The government reckons that more than 7m

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

work abroad. They sent home $11.6bn

in 2004 through official channels – and

perhaps twice that again unofficially. This

money represents at least 13.5% of the

economy – a more than five-fold increase

since 1990. Remittances (the money that

migrants send home) typically account for

two-fifths of the household income of those

with family abroad. These not only allow

Filipinos to enjoy a higher standard of living

– televisions, home improvements and so

on – they also fund greater investment in

education and enterprise. Studies show

that as migrants earn more, they send more

money home – and that this extra income

allows kids to stay longer in school, reduces

child labour and enables local people to

start new businesses, such as taxi services

and dressmaking. Remittances really came

into their own during the Asian financial

crisis of 1997 when the Filipino currency

collapsed and the economy went into a

PHILIPPE LEGRAIN

is the author of Open World: The

Truth about Globalisation (Abacus,

2002). His new book, Immigrants:

Your Country Needs Them, will be

published by Little, Brown in the world

outside the US on 2 November.

He a contributing editor to Prospect

magazine, a freelance writer for a

variety of publications such as the

Financial Times, the Guardian, The

New Republic and Foreign Policy, and

a commentator for BBC TV and radio

on globalisation. He blogs at www.

philippelegrain.com. He was previously

trade and economics correspondent

for The Economist and special adviser

to World Trade Organisation director-

general Mike Moore.


➣

tailspin. Receipts from workers abroad

helped cushion the blow, as migrants

sent home extra cash to help their hard-

up relatives and because the value of

their dollar remittances was now higher in

devalued Philippine pesos.

The government encourages migrants to go

work abroad through official channels rather

than illegally by offering them subsidised

benefits, such as training on social and

work conditions abroad, life insurance and

pension plans, medical insurance and tuition

assistance for migrants and their families,

as well as pre-departure and emergency

loans through a government body called the

a Overseas Workers Welfare Administration

(OWWA). The government has also made

it easier for migrants to send money

home cheaply and easily through private

banks, and even offers tax-free investment

programmes aimed at overseas workers.

“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.”

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.

Development Agenda


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.

The OWWA also helps returning migrants

make the most of the savings and foreign

know-how they have accumulated. Edgar

Cortes worked as a casting operator

overseas for fourteen years. When he

returned home, he set up a company to

make aluminium side-wheels for tricycles,

using his savings – and a 100,000 peso

loan from the OWWA – to buy the machines

and tools he needed. His shop, in one

of Manila’s most depressed areas, now

employs four people. Sotero Owen was a

welder in Saudi Arabia until a hefty pay cut

made him decide to return home. With his

wife, he set up a loom-weaving operation in

Baguio City with the support of loans from

OWWA. With income from his business, he

has been able to see his children and two

nephews and nieces through college. He

was also able to build his house and buy

a five-hectare property, on which he has

started to farm.

Mixed feelingsMost developing-country governments

have mixed feelings about emigration. The

departure of workers overseas is often

seen as a sign of failure, and an exodus of

scarce highly-skilled graduates is viewed

as particularly worrisome. Certainly, if

African countries lose the few doctors

they have, they will suffer – although since

governments do not own their people,

preventing people from emigrating would

grossly violate their human rights. But for

the most part, emigration is a boon for

developing countries. It can boost the

wages of those who remain, while the

money that migrants send back reduces

poverty and can contribute to development.

The Mexican government has started calling

its citizens who work in the US “heroes” or

“VIPs” in recognition of the huge financial

contribution their remittances makes to the

national economy. When migrants return,

as many do, they bring back the know-how

they acquired in rich countries. Half of the

Turkish migrants who return from Germany

start their own company with money saved

abroad within four years of returning home.

In the case of highly skilled workers, such

as the Indian internet entrepreneurs who

have returned from Silicon Valley to set up

world-beating companies in Bangalore, the

circulation of brains from poor countries

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

Migration. Of that official total of $167bn,

$45bn went to low-income countries such

➣

➣

Development Agenda


as India, $88bn to lower middle-income

countries such as China and the Philippines

and $33.8bn to upper middle-income

countries such as Mexico and Poland. The

top developing-country recipients in 2004

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

Mexico ($18.1bn).

The $160bn that migrants sent home

in 2004 is over twice the $79bn that

developing countries received in aid from

rich-country governments. It is also almost

as much as the $166bn of foreign direct

investment – spending by foreign companies

on factories, equipment and offices – which

developing countries received. And it is

more than the $136bn of net purchases of

developing-country bonds and shares by

foreign investors. Since the official flows

underestimate the true figures, remittances

are arguably by far the biggest transfer from

abroad that poor countries receive.

In 20 developing countries, official remittances

account for over a tenth of the economy.

The small Pacific island of Tonga tops the

list: nearly a third of its economy comes

from migrant’s remittances. In 36 countries,

remittances in 2004 were larger than public

and private capital inflows combined –

government aid, foreign direct investment and

net foreign purchases of bonds and shares.

They 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.

In Mexico, remittances are larger than foreign

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

occurring in China, India and Mexico. Of the

34 developing countries that received more

than $1bn in remittances in 2004, 26 have

notched up an increase of more than 30%

since 2001.

These official figures do not count the

money that is transferred through informal

operators, or suitcases of cash carried by

travellers. Obviously, it is very hard to know

how much money is transferred in this way,

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

estimates, for instance, that less than half

of the money sent to Bangladesh – and only

a fifth of the money sent to Uganda – goes

through official channels.

Remittances and povertyThe beauty of remittances is that, unlike

government aid, they end up directly in the

pockets of the people they are trying to help.

When they are spent in the local economy

or used to set up small local businesses,

they benefit the local community more

generally. Critics claim that remittances do

little good to poor countries because they

are frittered away on consumer goods such

as televisions rather than being invested

more productively. For a start, that’s not

true: some of the money is spent, some

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

with consumption? If poor people prefer to

spend their money on a television, then it’s

up to them. Privileged Westerners, who all

have televisions and video recorders, should

not be criticising poor people’s perfectly

valid spending choices. Moreover, if

remittances are sent to poor people who are

struggling to put food on the table, or have

just been hit by a disaster like a crop failure,

they should surely spend the money on

immediate consumption rather than invest it.

Critics also point out, rightly, that those

who migrate to rich countries are rarely the

poorest in society – because the poorest

can’t afford to move and lack even basic

skills, such as being able to read and write

– so that remittances may not help the

worst off. But in fact, some very poor people

do move and even the relatively better off

people who do migrate are poor by Western

standards. Their remittances, moreover,

benefit not just their friends and families but

the local economy too, including the very

poorest people. According to one estimate,

each dollar sent home by Mexicans boosted

the local economy by $2.90 thanks to this

multiplier effect.

Study after study shows that remittances

can transform the lives of poor people for

the better. They alleviate poverty. They help

cushion the blow, in countries where there

is typically no social insurance, of potentially

devastating events like a farmer’s crop

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

They give farmers and small businesspeople

precious access to funds that help them set

up and expand their business. And they are

often spent on education and health, which

is good not just for the recipients but for the

economy’s development in general.

Start with the impact on poverty. The World

Bank has calculated what would happen to

“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.”

➣

Development Agenda


poor people’s incomes in a cross-section

of 37 developing countries if remittances

dried up. It found that in the countries where

remittances account for a large share of the

economy – 11% of GDP on average – they

cut the poverty rate by a third. And even

in countries which receive relatively small

amounts from migrants – 2.2% of GDP on

average – remittances can cut the poverty

rate by nearly a fifth. Since the true level of

remittances is probably much higher than

the official figures, their impact on poverty

is likely to be even greater.

Remittances also help protect poor people

from harmful events from which people

in rich countries are largely insulated. 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.

One year the price of copper soars, the next

it plummets. One year the economy grows

in leaps and bounds, the next a financial

crisis destroys people’s savings and throws

millions out of work. Illness and crippling

accidents are also much more common

than in rich countries. What’s more, people

in poor countries are particularly vulnerable,

because they generally have few assets to

sell, or borrow against, to tide them through

bad times, and because governments

rarely provide any kind of social insurance:

no unemployment benefits, no handouts

to needy families, no sick pay, disability

allowance or free healthcare. People often

have to rely on their extended family as a

form of social insurance, but this is of little

use if the whole community is hit by drought

or a currency crisis.

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,

migrants tend to send home an extra $25

for every $100 in damage suffered, thus

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

income, indeed one that typically rises when

they need it most, remittances increase poor

people’s creditworthiness, because lenders

perceive that they are more likely to be

able to repay their debts, allowing them to

borrow when they need to.

When the recipients have incomes above

the minimum needed to survive and when

they have not just suffered an economic

calamity, remittances tend to be channelled

more into savings and investment than other

sources of income. In El Salvador, which

experienced massive emigration during

its civil war in the 1980s, the children of

families that receive remittances are much

In Mexico, remittances are larger than foreign direct investment.

➣

➣

O

Development Agenda


more likely to remain in school. Perhaps

because the income from abroad is more

regular, or because the sender earmarks it

for kids’ education, remittances do not just

make families better off: compared with an

equivalent increase in income from other

sources, they have a disproportionately

large impact – ten times as much in urban

areas – on children’s chances of remaining

in school. Remittances really can make a

huge difference.

Hometown associationsThe Miraflores Development Committee,

which was set up to improve living

conditions in a small town on the southern

coast of the Dominican Republic, has

made all sorts of improvements to local

life. It has paid for an aqueduct, providing

residents with a reliable water supply for the

first time. It has funded renovations to the

village school, health clinic and community

centre. It is also paying for a funeral home

and a baseball stadium. Where is this

strikingly successful example of community

development based? Not in the Dominican

Republic, but in Jamaica Plains, a suburb

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.

These are not just isolated examples of

immigrants’ charity. Across the US and

Canada, migrants have set up thousands

of “hometown associations” and other

similar grassroots organisations over

the past decade, to help development

projects in their home towns, mainly in Latin

America and the Caribbean. France has a

thousand or so “organisations de solidarité

internationale issues de migrations”

(international solidarity organisations

stemming from migration, or OSIMs), and

there are similar groups in Britain, such

as the Sierra Leonean Women’s Forum,

which provides food and clothing for people

back home. Hometown associations can

make a huge difference: their donations are

often greater than the municipal budget for

public works. “Towns with a home town

association abroad commonly have paved

roads and electricity. Their soccer teams

have better equipment, fancier outfits, and

perhaps even a well-kept field where they

practice,” one study found.

Some hometown associations are moving

beyond social projects and humanitarian

aid to investing in economic infrastructure

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.

➣


and community businesses – and

developing-country governments are

forming partnerships with them to leverage

their benefits. For instance, under Mexico’s

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

state and federal governments all contribute

one dollar for every dollar of remittances

sent to a community for a development

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

Las Animas, a farming village of 2,500

people, obtained a $1.2m drinking water

and drainage project with $300,000 in club

contributions.

Globalisation from belowMost globe-trotting executives work

for investment banks, management

consultancies or big multinational

companies. But much humbler migrants are

increasingly taking advantage of cheaper

transport and communications to commute

between countries too. Their to-ing and fro-

ing is creating new businesses and trade

links that span several countries: a kind

of globalisation from below. For instance,

the Otavalan indigenous community from

the highlands of Ecuador have taken to

travelling abroad to market their colourful

ponchos and other woollens in major

European and North American cities. Some

have settled abroad, but they still earn a

living by running garment workshops in their

home town in Ecuador, to which they travel

regularly and from which they source their

clothes. In short, migration has allowed the

Otavalan to access the global market rather

than being constrained by their smaller and

much poorer local one.

The Otavalan are not the only ones whose

businesses straddle different countries

– or even continents – just as much larger

multinational companies do. In the mid-

1990s, Dominican immigrants returning from

the US pioneered new businesses, such

as fast-food delivery, software and video

stores, selling and renting mobile phones,

based on ideas and skills they had acquired

there. Meanwhile, Salvadoran businesses

have come to see the large immigrant

community in the US as a big new market.

The Constancia Bottling Company, a beer

and soft drinks firm, has set up a plant in

Los Angeles to cater to the needs of the

“hermanos lejanos” (distant brothers, as

Salvadorans call emigrants). Others sell

Salvadoran newspapers and the latest

CDs and videos, or transfer goods and

remittances across countries.

But are such enterprises more than just

interesting anecdotes? When Alejandro

Portes of Princeton University and others

surveyed over 1,200 Colombian, Dominican,

and Salvadoran family heads in Los

Angeles, New York and Washington DC,

they found that transnational businesses

were increasingly common – especially

among immigrants who had been abroad

for a long time, presumably because they

had accumulated enough capital, know-how

and contacts to get their businesses started.

Macroeconomic impact of remittancesRemittances can do more than just alleviate

poverty and contribute to local development,

they can also bring wider benefits to the

economy as a whole. One study of 13

Caribbean countries found that when the

economy shrank by 1%, remittances tended

to rise by 3% over the next two years.

Much as rich-country governments boost

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

➣

Development Agenda


spending in recessions to help stabilise

the economy – through public works

programmes, and because unemployed

and needy people receive welfare benefits

– remittances can have a similar stabilising

effect in poor countries.

Many poor countries find it hard to borrow

abroad because their foreign-currency

earnings are so small or volatile that lenders

doubt whether they will be repaid. But

by providing a steady stream of foreign-

currency earnings, remittances can improve

a country’s creditworthiness, allowing it

to borrow more at lower interest rates.

Developing-country governments are now

even able to borrow using their country’s

expected future remittances as collateral.

Mexico was the first to do so in 1994, and

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

is not a prize to be sniffed at.Remittances can transform the lives of poor people.

➣

■

Development Agenda


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

The missing link

Si monumentum requiris, circumspice

– if you seek a memorial, look

around. Sir Christopher Wren’s

epitaph in St Paul’s Cathedral, which

he designed, could equally apply to

entrepreneurs in a market economy, as

the Austrian economist Ludwig von Mises

pointed out. Look around at all the wealth,

health, resources, technologies and

opportunities. They were not conjured out of

thin air, they were created by innovators who

dared to imagine a different world – and set

about creating it.

It is easy to forget how fast the world has

changed. Only a few generations ago, living

conditions in today’s wealthiest countries

were worse than those in the poorest

countries are now. No cars, no trains,

no planes; no phone, no email, not even

electricity; no running water, no indoor

sanitation, no antibiotics. We stand a better

chance of reaching retirement age than

people in previous eras had of experiencing

their first birthday. My ancestors in mid-

19th century Sweden were starving. Back

then, Scandinavia was poorer than Congo

is today, while average life expectancy was

only half, and infant mortality three times,

the current developing-country average.

In the thousand years to 1820, average

incomes in the world rose by no more than

half; since then, when innovators have

been set free to create, incomes have risen

ten-fold.

Look around at just about any product you

use. Where does it come from? We tend

to take things for granted, and not think

about the individuals and institutions that

make them possible. Often, it is hardest to

see what is in front of your nose. Consider,

for example, the computer which I used to

write this article. My tiny laptop has more

computing power than most countries

had 40 years ago. It performs in seconds

calculations that have would taken hundreds

of years with a pen and paper.

Think about pioneers – people such as Steve

Wozniak, Steve Jobs and Bill Gates – who

came up with the ideas and business models

which have cut the cost of computing power

by a factor of around a million in a few

decades. And how did the laptop get to me

this cheaply? By ship, thanks to Malcolm

McLean, a truck-driver from North Carolina,

who in the 1950s came up with the idea

to load wheel-less containers onto ships

and hoist them onto waiting trucks, thereby

reducing loading costs by over 97%. What’s

more, the computer and its components

travelled smoothly trough the logistics chain

thanks to bar codes, invented by Jerome

Lemelson in the 1950s after he realised that

visual information could be read by a video

camera and the signal then converted into

digital information.

Give a thought too to the pioneers whose

incremental ingenuity led to the outsourcing

JOHAN NORBERG

is a Swedish author, who also blogs

at www.johannorberg.net. He has

an MA in the history of ideas from

the University of Stockholm and is a

Senior Fellow at the Centre for the

New Europe and. His books cover

subjects such as human rights,

economic freedom and the history of

liberalism. His book on globalisation,

In Defence of Global Capitalism, has

been translated in 24 countries. He

has just completed a new book on

entrepreneurship, When Mankind

Created the World.


➣

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 roomJoseph 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.

Development Agenda


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,

ongoing attempts to reduce inefficiencies

and find more practical ways of connecting

possible supply with potential demand.

Perhaps the person who opened the store

where I bought my computer, and the Geek

Squad, who visit my home to fix my laptop

when the hard-drive crashes, are more

representative of most entrepreneurs.

This is more like Israel Kirzner’s perspective

of entrepreneurs as the oil that greases the

machinery of the market: individuals who

see potential demand and therefore try

to supply it. But in my mind, Schumpeter

and Kirzner are like the blind travellers who

touched the trunk, a leg and the side of

an elephant, and described it as a snake,

a tree and a wall respectively. They have

all informed our world view by describing

particular aspects of the same entrepreneur.

So what? Don’t we know this by now?

Does anyone deny the importance of

entrepreneurs in creating wealth and

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

just happened to meet in the lift one day,

and got to work, since the person who

connects them is nowhere to be seen.

The standard theories study equilibriums,

whereas the entrepreneur is the person

who upsets equilibriums, or profits from

turning disequilibrium into something that

approaches it. The theories study the

supply of, and demand for, existing goods,

whereas the entrepreneur introduces new

goods to the market. The theories study

standard firms’ repeat decisions, whereas

the entrepreneur creates growth through

unpredictable new decisions. As William

Baumol, one of the economists who has

studied entrepreneurship and innovation

most, points out: “The entrepreneurial

mechanisms underlie continuous industrial

evolution and revolution, and surely are not

the stuff of which stationary models are

built.”

It’s like the old story about the lamp post.

You might not have dropped your car keys

under it, but you look there anyway, because

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

you to look for them. That is one reason why ➣


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

I think that economic history has been more

fruitful than economics in the last decades:

it sheds some light on the place where the

keys were really dropped. You can build a

model without creators and innovators, but

you can’t write history without them.

Dan Johansson, a Swedish economist,

has studied the most frequently used

textbooks in Swedish PhD courses. Of 19

books, only two included a reference to

“entrepreneurs”, and one used it merely as

a synonym for borrower, to explain the loan

market. Most of these books are written by

American economists and are used in PhD

programmes worldwide, so the result is not a

Swedish aberration, according to Johansson.

If future economists in universities, politics

and multinational institutions want to read

about entrepreneurs’ fundamental role in

economic activity, they have to turn to glossy

business magazines.

The developersSo economists see market failures

everywhere, but miss the entrepreneur

who also notices those inefficiencies, but

conceives of them as profit opportunities.

This blind spot has distorted the debate

about globalisation and development. Both

sides discuss how low-income countries

are to be lifted out of poverty, either through

vast aid projects or through huge foreign

investment. Think about the wording: who is

supposed to “lift them”? History shows that

countries aren’t lifted out of poverty, they

rise out of poverty, by liberating the creators

and innovators back home. Of course, poor

countries make use of technologies that

were created abroad, but they also have to

adapt them to their own circumstances.

Certainly, disease, a lack of education and

dismal institutions destroy opportunities, and

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

Development Agenda

➣

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Development Agenda


aid, properly used, can help deal with these

problems. But massive transfers of capital to

very poor countries have also made it more

profitable for potential innovators to pursue

a career in politics or bureaucracy than in

business.

The Washington Consensus was right to

point out that poor macroeconomic policies

can do great harm, but even with low

inflation and a balanced budget countries

can stagnate. Driving carefully is important,

but it does not ensure that you move in

the right direction. Opening up to foreign

investment and trade is also essential, but

if this is the only liberalisation that occurs

in a very unequal country with a privileged

class of businesspeople, it tends to create

new opportunities principally for those who

already have big businesses and political

connections.

No country will prosper unless it uses the

creative resources of its entire population.

Otherwise, new ideas and different solutions

will be limited to the small group who

already think alike and work within the old

system. It was not the presence of big

businesses that made Europe and America

rich, it was the fact that a couple of guys

with nothing but a great idea and a garage

were allowed to succeed and create new

companies, competing with the old. This

not only increases wealth and keeps the

establishment on its toes, it creates a large

group of people obsessed with finding

challenges and solving problems – a class

of risk-takers and problem-solvers. Without

them, you can import successful solutions,

investments or aid projects, but you can’t

make it self-sustaining and self-generating.

It’s akin to the difference between copying

the correct solution to some mathematical

problems and fostering a group of

mathematicians who can use their talents

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

as licensing requirements, a lack of

property rights and the absence of the

rule of law. This should be the focus of the

development debate today – not to solve

problems, but to liberate those who solve

problems.

In a global economy governments have to

pay constant attention to macroeconomic

indicators – because capital would

otherwise flee – but they don’t have the

same pressure to deal with these kinds of

microeconomic constraints. Big investors

can push countries to open up particular

sectors, but potential, future entrepreneurs

don’t form pressure groups.

Fortunately, we are starting to see a new

focus on how these types of regulations

hurt, partly inspired by the Peruvian

economist Hernando de Soto, who has

highlighted the thriving economic activity

in the informal sector, and pointed to the

benefits of legalising it. Thanks to the World

Bank’s annual Doing Business report,

we now have a decent set of data about

such obstacles in different countries.

Unfortunately, there is a lot to measure.

Most of the world’s population is left outside

the legal market.

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

➣

➣

Development Agenda


It often surprises people that poor countries

are filled with entrepreneurs and people

who work hard. The streets of Kenya’s

capital, Nairobi, are thronging with young

people selling food, music and clothes.

There is plenty of activity and energy,

but unfortunately much of it has to be

devoted to avoiding regulation, corruption

and dealing with the legal vacuum of the

informal sector. On one corner in the slums

of Nairobi, I met Pamela, who sold bread

to her neighbours. To get a permit to do

so legally she would have needed the

signatures of 13 different bureaucrats. That

would have taken her at least two months

and cost her half a year’s income in official

fees – not to mention the cost of bribes. And

if you are not sure whether you will be able

to feed your children next week, how would

you be able to save that much?

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.

➣


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

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.

It’s dangerous to trade with strangers, since

she can’t go to the police if contracts are

broken. Since she works outside the law,

the authorities can demand bribes to leave

her alone. The sarcastic joke in the slums is

that it is dangerous to carry large amounts

of cash – because there are too many

policemen.

The biggest problem with the informal

economy is rarely mentioned. It is that the

underground entrepreneur sticks to what

is known to her – her own neighbourhood,

customers and original line of business.

But as history shows, many of the most

successful entrepreneurs started in

one business, but then noticed bigger

opportunities elsewhere and changed

tracks. For example, several courier services

were started by businesspeople dissatisfied

with the reliability of their existing delivery

service. The entrepreneur looks upon the

world with a certain focus, paying attention

to challenges, and therefore becomes a

serial problem-solver. But if they are stuck in

familiar territory, their talents may be wasted.

But even if people can overcome such basic

obstacles and start their own businesses,

overbearing government may subsequently

stifle them. By preventing entrepreneurs

from developing their own visions and

ideas, governments impede the process of

trial and error which all progress is based

upon. Remember that the new ideas which

revolutionise an industry always start life

as a minority view, considered stupid or

dangerous by the majority.

China’s rapid economic development is

largely a creation of foreign investment in

the export industry. Even though private

businesses now have much greater

freedom, there are few examples of small

private Chinese companies that have grown

to be successful world-class companies.

The heavy hand of the state makes it difficult

for the creative, rule-breaking spirit of the

entrepreneur to thrive. Small companies

find it harder to get capital from the state-

controlled capital market, outsiders find it

more difficult to get the freedom to develop

their business models, and if a company

competes too vigorously against the rulers’

friends or relatives, it could suffer.

One exception is Lenovo, which bought

IBM’s personal-computer division in 2004.

Created in 1984 by 11 engineers who

didn’t think that the university gave them

room to develop their visions, it was the

first Chinese company to build a brand via

advertising. And they constantly followed

their own goals, rather than those the

government chose for them. Staff incentive

systems were introduced that were illegal at

the time, and the company used Western

technology instead of relying on the

Chinese components the state wanted it to.

Lenovo is now the world’s third-biggest PC

manufacturer.

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

➣


Lenovo succeeded, but how many have the

courage and perhaps the political protection

to think differently in an economy where the

government always has the last say?

The chimpanzee in the cagePerhaps we should pay a little less attention

to our textbooks, and a little more to history

and all the innovations and wealth that

surround us. We might then realise how

essential the entrepreneur is to economic and

social development. Then we might grasp

that we have a responsibility to promote

entrepreneurship as much as possible,

to remove obstacles to it domestically,

and consider how our efforts to help poor

countries may harm entrepreneurship

there. Do we try to solve problems – and

thus perhaps entrench poor countries’

dependence on us – or do we give people

opportunities to solve problems themselves?

Rulers and analysts may struggle to change

their way of thinking. But they would benefit

from embracing entrepreneurship. The

evidence from economic history as well as

evolutionary psychology clearly shows that

we all have something of the entrepreneur in

us. We should nurture our natural curiosity

and creativity rather than stifling it.

In a classic experiment, a chimpanzee in a

cage tried to reach a banana. After a long

struggle, it realised that it could rake the

banana into its cage by fitting two hollow

sticks together. This discovery caused the

monkey such pleasure that it kept repeating

the trick, and forgot to eat the banana.

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

Development Agenda

➣

■

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Pub: IMF WBG, Sept 11-20 2006

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Partners in business combating HIV/AIDS

Over the last 20 years, more than 40 millionpeople worldwide have become infectedwith HIV, and that figure is expected to reachat least 90 million in the next five years.Alarmingly, 95 percent of those infected withHIV don’t know it, unwittingly contributingto its rapid expansion.1

The GBC believes a strong coalition ofcompanies worldwide is the best weaponbusiness can contribute to the fight againstthis epidemic as it strives to achieve the goalsof advocacy, education, and policy change.

A proud member of the GBC, BD fully supportsits efforts to unite businesses worldwide in the

war against HIV/AIDS, and is privileged bothto contribute to the GBC’s communicationsefforts to recruit new members and to findways to deliver advanced technologies to theplaces that desperately need them.

BD—selected as one of America’s MostAdmired Companies by FORTUNE magazine2—is a medical technology company servingsome of the greatest needs of the globalcommunity. Healthcare institutions, lifesciences researchers, clinical laboratories,industry, and people in every corner of theglobe rely on BD products every day.

BD—Helping all people live healthy lives.

Please visit www.bd.com1 ”How Can Your Business Fight AIDS?” © Global Business Coalition on HIV/AIDS.2 “America’s Most Admired Companies” annual survey, 2005; FORTUNE magazine, March 7, 2005 BD and the BD Logo are trademarks of Becton, Dickinson and Company. © 2006 BD

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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.

Fixing the Fund

The International Monetary Fund held

its spring meetings in April fighting

to dispel the impression that it was

obsolete. Even one of its own deputy

governors – Mervyn King, the head of the

Bank of England – pronounced the institution’s

remit unclear, its role obscure. Imperious,

incompetent, indulgent – the IMF was used to

being called all of these things. But irrelevant?

That was a new and chilling charge.

Yet only a few months on, as the Fund

embarks on its annual meeting, the mood

is rather different. For that it should thank

the financial markets as much as its own

efforts to reinvent itself. Between 8 May and

13 June, emerging-economy stock markets

lost a quarter of their value. Spreads on

emerging-market bonds remain tight, but

whereas investors once seemed gripped

by an indiscriminate appetite for such risky

securities, they now appear pickier.

This new edginess in global markets has

reminded everyone of two important truths

which the IMF’s premature obituarists had

tended to neglect. Not every developing-

country government has more foreign-

exchange reserves than it knows what to do

with; and not all of them are net exporters

of capital to the rich world. Although capital

may be “running uphill” from many poor

countries, the flow is very much downstream

in some cases. Hungary’s current-account

deficit, for example, will exceed 9% of GDP

this year, the Fund reckons.

A dangerous sportPerhaps surprisingly, the IMF blames

the recent market volatility in part on the

success of its spring meetings. The April

communiqués issued by the G7 finance

ministers and by its own International

Monetary and Financial Committee

apparently drew fresh attention to the

dangers posed by America’s vast current-

account deficit. Bad for the markets, this

renewed concern has proved good for

the institution. The Fund has been invited

to resume its initial role as a provider

of the “machinery for consultation and

collaboration” between the big economic

powers, as they decide what, if anything,

to do about the growing imbalances in the

world economy. It has begun what it calls

“multilateral surveillance” of a group of

countries – China, the euro area, Japan and

Saudi Arabia, as well as the United States

itself – which, it hopes, can together resolve

the key macroeconomic issue of our time.

The IMF’s bosses are quite taken with their

new role, however thankless it may seem.

Perhaps they are just grateful for an invitation

to the high table of economic statecraft.

When the leading powers last mounted a

SIMON COX

is Economics Correspondent

for The Economist in London.

He joined the paper in 2003,

after studying at Cambridge,

Harvard and the London School

of Economics. He now covers

the IMF, the World Bank and the

WTO, as well as contributing to

the Economics Focus column.


➣

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

reminded of the rules of the game.

King’s metaphor no doubt appealed to his

Indian hosts, for whom willow and leather

are sacred. But exchange-rate politics is

not cricket. If a sporting analogy is required,

sumo wrestling might be more apt. The two

giants of China and America are grappling

at close quarters. For the moment, each is

propped up by the other’s vast bulk. But

that fragile equilibrium might not last. The

Fund is brave – some would say foolhardy

– to step between them.

183 LuxembourgsAmerica’s deficit is not the only imbalance

that the IMF seems keen to resolve. In

his strategic review, Rodrigo de Rato, the

Fund’s managing director, noted that the

gross inequities in the institution’s voting

system were equally troubling to many.

“Neither imbalance is sustainable,” he wrote.

Yet both are proving remarkably persistent.

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. Its voting

structure still reflects those origins. As critics

have pointed out, Italy, Belgium and the

Netherlands together have more votes on

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

and Brazil combined (6.27%). Why should

Turkey heed the Fund’s sermons, when its

representation at the IMF (0.45%) falls far

short of its weight in the world economy

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

serve as an even-handed umpire between

America and China when the first casts over

17% of the votes in the institution and the

second less than 3%?

A member’s “quota” simultaneously determines

how much it must contribute to the Fund’s

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.



coffers, the amount it can borrow, and

the number of votes it can cast. Because

they serve three different purposes, these

quotas are a peculiar concoction. They are

supposed to reflect both an economy’s

might – its ability to contribute – and its

vulnerability: its potential need to borrow.

No fewer than five different formulae are

in circulation, which place slightly different

weights on a country’s GDP, its currency

reserves, and the size and volatility of its

external payments and receipts. These

calculations have always been a bit of a

sham. At the Bretton Woods conference

that established the IMF in 1944, the

Americans decided on the allocation of

votes they wanted, and then instructed an

economist to play around with a formula

until it delivered the desired outcome.

A rejigging of these quotas appeals to

emerging economies on two counts, political

and financial. First, it would give them a greater

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

grant them a more generous overdraft limit.

For some countries, the second consideration

may be more pressing than the first. But for

others, quota reform is a matter of justice. The

misallocation of voting rights has plunged the

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

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.

➣

➣

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• Developer: Richmond Hotel Pte Ltd (Registration No.: 198804282E) • Tenure of Land: 999 years from 24 Nov 1995 • Lot No.: LOT (S) 1706L, 1707C, 1708M & 1709W TS24 at Tanglin Road/Tomlinson Road/Cuscaden Road • Developer’s License: C0045 • Building Plan Approval No:A0219-00001-2004-BP01 (13/05/2005), A0219-00001-2004-BP02 (04/01/2006) • Expected Date of TOP: 28 February 2009 • Expected Date of Legal Completion: 29 February 2012 • The St. Regis Residences, Singapore are not owned, developed, or sold by Starwood Hotels & Resorts Worldwide,Inc. or its affiliates. Richmond Hotel Pte Ltd uses the St. Regis Trademarks under a license from Sheraton International, Inc., an affiliate of Starwood Hotels & Resorts Worldwide, Inc. The St. Regis and the St. Regis logo are registered trademarks. ©2005 Starwood Hotels & ResortsWorldwide, Inc. Information is correct at time of printing and is subject to changes.

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As Ngaire Woods of Oxford University

points out, the countries least represented

at the Fund are often those most

profoundly affected by its decisions.

Between them, two dozen African

members, most of them in the IMF’s

“intensive care”, have just one out of 24

executive directors and cast only 1.41%

of the votes on the board. If the Fund

cannot be made more answerable to

these impoverished countries, Woods

argues, it should rein in its ministrations. Its

ambitions must not exceed the limits of its

accountability.

Could a reform of quotas help redress

these grievances? It might cut both ways.

Certainly, China, South Korea and Japan

deserve many more votes, given the size of

their economies. But the awkward truth is

that poor African countries already enjoy a

greater voting share than their weight in the

world economy warrants. Argentina and

Indonesia – the two countries that perhaps

feel most victimised by the IMF – are also

overrepresented, relative to the size of their

economies measured at market exchange

rates. The G-24, a group of developing

countries, thinks market clout should not

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.

➣


count for everything. It wants an increase in

“basic votes”, which a country gets just for

being a member, regardless of its economic

size. In 1945, these represented 11% of

the total, but as the IMF has grown, their

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

also argues that market exchange rates

understate the size of their economies.

Non-traded goods and services are much

cheaper in poor countries than in rich ones,

so their economies are far bigger than their

exchange rates, set by the supply and

demand of tradable goods and assets,

would imply. To take account of this, their

economies should instead be measured

in purchasing-power parity (PPP) terms.

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.

There is a second inconvenient truth

about quota reform: one of the most

underrepresented countries, relative to the

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

of the votes, but accounts for almost a

third of world GDP (at market rates). This

anomaly, which the Americans are fond of

pointing out, does not mean that the Fund’s

shareholder-in-chief is underrepresented.

It just demonstrates, quite starkly, that a

country’s share of the vote is no measure

of its influence. Many of the big decisions

at the IMF, including the appointment of its

managing director, must be decided by an

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

votes, always has a veto.

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

➣



But even on decisions that require a

simple majority, America’s voting power is

greater than its share of the vote suggests,

according to a study by Dennis Leech

of Warwick University and Robert Leech

of Birkbeck College, London. How so?

Their argument is best illustrated by the

“Luxembourg paradox”. The tiny Duchy

was one of the original six members of the

European Economic Community. Though its

population was just 310,000, it commanded

one vote out of 17 in a system that required

12 votes to pass a motion. West Germany,

with over 50m people, had just four votes.

Luxembourg, one might say, was grossly

overrepresented at the EEC.

However, as Leech and Leech emphasise,

a country has influence only to the extent

that it can swing a vote, by serving as the

decisive member of a coalition that would

lose without it. Given the allocation of votes

among the other five members of the EEC

(Belgium and the Netherlands had two votes

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

was mathematically impossible for them ever

to split 11-5 on an issue. Luxembourg was

doomed either to be a redundant member

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

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

bloc. In other words, Luxembourg had 6%

of the votes and 0% of the power.

America’s position is rather the reverse.

Leech and Leech calculate that America’s

17% share of the vote gives it a 24.5%

share of the power in simple majority voting.

Their analysis explodes the supposedly

tight link between a country’s clout and its

contributions. America has more power than

it pays for.

Rodrigo de Rato has proposed a two-

step quota reform. He wants to sprinkle a

few extra votes on a handful of emerging

economies now, in the hope of a broader

reallocation of quotas in the future.

Unfortunately, it may take a long time for the

second shoe to drop. No country has ever

agreed to a reduction in its quotas; the Fund

cannot take votes from one country to give

to another. It can only reallocate power in

the organisation in the context of a general

increase in shares.

But that would place the IMF at the mercy

of the US Congress, which must approve

any increase in the country’s contributions.

Its consent cannot be taken for granted.

Despite America’s power over the Fund,

the institution is not popular in Congress.

Indeed, precisely because America’s

executive branch thinks it owns the IMF, its

legislative branch resents it. The IMF is seen

as a “geopolitical slush fund”, as Thomas

Willett of Claremont Graduate University, has

put it – a big pot of money that the White

House can throw around without asking

Congress’s permission. In April 1998, the

House of Representatives decided, by a

margin of 222 to 186, not to stump up

America’s $18bn share of a general increase

in IMF funds. Only after Russia defaulted,

the American economy wobbled, and

President Clinton upbraided Congress for

its irresponsibility did they relent.

The Fund may fare no better in any future

fight. “If periodic approval of IMF capital

increases were once viewed as tantamount

to votes of confidence in the IMF,” said

Congressman Jim Saxton, head of the

joint economic committee, in 2004, “that

confidence is sorely lacking today.”

Consumer revoltIf the Fund does face a crisis of legitimacy,

as some argue, then quota reform will do

little to rescue it. Any feasible reallocation of

votes and voice would not loosen 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.

➣

➣

STAT0203_IMF_WorldBankMeeting.in1 1 26-07-06 10:09:03

STAT0203_IMF_WorldBankMeeting.in1 1 26-07-06 10:09:03



grip. But votes are not the only way to

get the IMF’s attention. Indeed, a fixation

with quotas may obscure the fact that the

emerging economies are now exercising

great influence over the Fund – not as

shareholders, but as dissatisfied customers.

Developing countries may have little voice

within the IMF, but the threat of exit – of

taking their custom elsewhere – still speaks

eloquently. Argentina and Brazil have

prepaid their IMF loans, while some of the

Fund’s biggest borrowers of yesteryear have

now elected to insure themselves, rather

than relying on the Fund’s condition-laden

cover. Eight East Asian countries have

together amassed hard-currency reserves

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

understandable to save for a rainy day,

but they are building Noah’s Ark,” quipped

Kenneth Rogoff, the IMF’s former chief

economist, earlier this year.

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

make any money. 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. It has turned to a group of

eminent persons, including Alan Greenspan,

the former US Federal Reserve chairman,

to look for new ways to cover its annual

budget, which was frozen at around $1bn

this financial year, and is supposed to fall, in

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

facing a modest fiscal crisis of its own is not

lost on its critics.

As a financial middleman, the Fund

is always vulnerable to the threat of

disintermediation, if lenders and borrowers

can match up without its help. The ark-

builders 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

in 2000, the Chiang Mai Initiative, as it is

called, has attracted commitments worth

over $60bn. Japan has pledged more

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

has to the Fund. Indonesia can now tap its

neighbours for amounts worth three times

its IMF quota, and the Philippines can call

on four times its IMF limit.

This is not yet an “Asian Monetary Fund”

to rival the Washington original. About

80% of the money on offer is intended

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

loan. The promises are not unconditional:

even the most neighbourly of creditors

wants to make sure it gets repaid. And

the initiative has inherent limitations. If

several countries in the region fall foul of

the same local difficulties, they will all call

on their neighbours’ help at the same time.

Emanuel Kohlscheen and Mark Taylor of

Warwick University show that extending the

web to countries on the other side of the

Pacific, such as Chile and Mexico, would

dramatically improve the pooling of risks.

In principle, the IMF, as a global organisation,

should provide the best risk-pooling of all.

And spurred by its Asian defectors, it is

trying. Rato is in favour of introducing an

insurance mechanism, which might surpass

the commitments made under the Chiang

Mai initiative. He thinks the IMF should

promise loans in advance to countries

which are fundamentally solvent, but are

nonetheless vulnerable to self-fulfilling runs

on their credit or their currencies.

“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.”

➣


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.

How much money would the Fund offer?

Rato has suggested countries could

borrow up to three times their quotas in

the first instance. Would that be enough?

Not quite, according to Cordella and Yeyati.

By their calculations, the IMF would need

to promise its average client 4.7 times its

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

were credible, the money might never be

called on. Conversely, if a run were allowed

to gather momentum, a bail-out might

prove more expensive still. The rescue of

South Korea in 1998 amounted to 18 times

the country’s quota.

The Fund is not yet obsolete, and its future

is worth fighting for. Rato, for his part,

is battling on three fronts. The first two

– multilateral surveillance and quota reform

– are potential quagmires. But on the third

– offering better insurance cover to its

members – the Fund just might recapture

some ground.

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)

■



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.

In the public interest

“I will never forget how I suffered due to

the lack of water. There was no water

to wash the baby or myself. I was

ashamed of the unpleasant smell, especially

when my neighbours visited me,” says Misra

Kedir, recalling the birth of her child, Hitosa,

in Ethiopia.

Essential services – basic things like running

taps, working toilets, classrooms with

teachers, and clinics with nurses – transform

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

some people still live without them. Yet

millions of families do. Today, 4,000 children

will be killed by diarrhoea, a disease of dirty

water; 1,400 women will die needlessly in

pregnancy or childbirth; 115m school-age

children, mostly girls, will not go to school.

Decent health and education, clean water

and adequate sanitation are among the

most basic of human rights, enshrined

in many international covenants. The

international community has recognised

their critical importance by pledging to meet

targets, the UN’s Millennium Development

Goals, such as ensuring universal primary

education by 2015 and reducing by two-

thirds the mortality rate among children

under five. These were deemed realistic and

achievable, but unless leaders both North

and South act now, most will be missed

and the needless deprivation of hundreds

of millions of people will continue. The good

news is that this suffering can be avoided if

lessons are learned from countries that have

succeeded in providing essential services

that meet the needs of poor people and

work for women and girls.

The evidence shows that developing

countries will only achieve a healthy and

educated population if their governments

take responsibility for providing essential

services, with civil-society organisations and

private companies integrated into strong

public systems, but not substituting for

them. 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. Many

others have lacked the commitment, the

capacity or the cash to deliver on their

responsibilities to the poor. International

donors are crucial partners in supporting

public systems, but too often are blocking

progress even where governments have

good intentions, by failing to deliver debt

relief and predictable aid that supports

public systems, and by pushing private-

sector solutions that do not benefit the poor.

To try to assess governments’ performance

in providing essential services, Oxfam

has devised an Essential Services Index.

BETHAN EMMETT

is a policy adviser for Oxfam GB

working on essential services,

governance and public

spending. She has a background

in public expenditure management,

and has previously worked for

3 years as an economist for the

Ministry of Finance in Rwanda.


This ranks countries according to their

achievements in four social areas – child

survival rates, schooling, access to safe water,

and access to sanitation – and compares

this performance with per capita national

income. The comparison shows that some

governments have consistently punched

above their weight. For instance, while average

incomes in Kazakhstan ($6,980 a year) are

much higher than in Sri Lanka ($4,000), a child

in Kazakhstan is five times more likely to die

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

to school, drink clean water and have the use

of a latrine (see figure below).

Sri Lanka is not unique. Within a generation,

countries as diverse as Barbados,

Botswana, Costa Rica, Cuba, Malaysia

and Mauritius, along with Kerala state in

India, have made advances in health and

education that it took industrialised countries

200 years to achieve. In East Asia, the

importance of the links between equitable

access to social provision, poverty reduction

and growth was recognised early on.

The Indonesian government, for instance,

massively expanded public education in the

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

covering 85% of all enrolments. More

recently, countries such as Uganda and

Brazil have doubled the number of children

in school, halved AIDS deaths and extended

safe water and sanitation to millions.

Learning from successStudies of the policies that underpin

developing-country success stories show

that, despite some differences in approach,

the measures taken by successful countries

have much in common. The recipe for

success is generous investment in public

services that are provided universally, free

at the point of use, and geared to the needs

of women and girls.

Successful countries have greatly expanded

publicly funded infrastructure, especially

in rural areas. In Botswana, for instance,

public construction and post-independence

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

and Development. He has written

widely on themes related to

globalisation and Latin America.

➣

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

Kazakhstan 6,980

Sri Lanka 4,000

Sri Lanka 15

Sri Lanka 100Kazakhstan

73

Kazakhstan 92 Kazakhstan

78 Kazakhstan 72

Sri Lanka 86

Sri Lanka 91

Income per capita US$*

Under 5 mortality rate per 1,000 of population

Net primary enrolment %

Improved drinking water coverage %

Sanitation coverage %



➣ of health posts so that, by the 1980s,

over four-fifths of the population lived

within 15km of a health facility. Successful

countries have also made providing safe

water and sanitation a priority. In Costa Rica,

water supply, latrine construction and public

education on hygienic practices have gone

hand-in-hand with extending rural health

services. Botswana’s government invested

in a major programme of groundwater

drilling and water network construction soon

after independence in 1966, achieving near-

universal access to safe water by the 1990s.

Rural households were subsidised to build

latrines and the government invested in

health and hygiene education programmes.

Making services free at the point of use

has been critical in expanding access for

poor people. Uganda’s primary-school

enrolments nearly doubled within a decade

when the government introduced free

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,

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

uses each month, giving poorer consumers

affordable access to drinking water.

Public services in successful countries focus

on women and girls. In high performers,

women’s and girls’ access to education is

higher than the regional average and there

is a high proportion of female teachers and

health workers, which encourages others to

use the services. This is all underpinned by

government actions to strengthen women’s

social status and autonomy. In Mauritius,

Cuba and South Africa new legislation has

enshrined the rights of women to own and

inherit property, and their rights to freedom

from violence and discrimination.

Successful countries have invested heavily

in training, as well as in frontline workers,

such as teachers, health workers and water

technicians. Brazil increased net school

enrolment rates to nearly 100% for both girls

Successful countries have also made providing safe water and sanitation a priority.

➣

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and boys by instituting broad-based national

reforms to improve teacher qualifications

and training, along with performance-related

pay and increased salaries with generous

pension benefits. Many governments have

also taken measures to ensure that rural

facilities are well staffed, often by requiring

publicly trained workers to work in rural

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

expected to work for three to four years in

‘difficult schools’, and a teacher deployment

project has implemented a ‘staff equalisation

plan’ that penalises provinces with too

many teachers and provides resources for

provinces with teacher shortages.

Public failure – when governments fail to act“At the health centre they get annoyed

when they treat you,” says Marta Maria

Molina Aguilar, the mother of a sick child in

Nicaragua. “If you don’t have any money

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

just be left to die.”

For every Sri Lanka, there are other poor

countries where millions of people cannot

afford to see a doctor, girls have never been

to school and homes have neither taps nor

toilets. Countries such as Yemen, where

only one in three women can read and

write. A Yemeni woman having a baby has

only a one in five chance of being attended

by a midwife. If she and her child survive

childbirth, her child has a one in three

chance of being malnourished and a one in

nine chance of dying before his or her fifth

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

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

to spend almost twice as much on the

military as it does on health, while social

spending goes disproportionately towards

services that mainly benefit the middle

classes, such as hospitals and universities,

or on other skewed priorities.

The services that do exist are kept afloat by

a skeleton staff of poorly paid, overworked

and undervalued teachers and health-

workers. In the least developed countries,

teachers’ salaries have halved since 1970,

and there are far too few of these public-

sector heroes to go around. There is a

global shortage of 4.3m health workers and

1.9m trained teachers.

Where states lack the capacity or

commitment to fund services, poor people

are made to pay instead. Despite widely

recognised gains in countries that have

scrapped fees in primary education, 89 out

of 103 surveyed countries still levy official

or informal charges for schooling. User fees

in healthcare are a life or death issue. In

one Nigerian district the number of women

dying in childbirth doubled after fees were

introduced for maternal health services,

while the number of babies delivered in

hospitals halved.

Whether services are provided privately

or publicly, corruption is a major problem.

In the worst instances, a vicious circle is

created where a culture of impunity further

weakens crumbling public systems through

bribery and misappropriation. Where the

providers are private but publicly funded,

“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.”

➣


corruption generally involves overcharging

government, paying bribes for contracts

and failing to deliver quality services. Where

the public sector is the provider, corruption

takes place through absenteeism and staff

taking second jobs in the private sector,

funds going missing and the creation of

‘ghost workers’ to divert payrolls.

When governments fail to provide services,

most poor people get no education,

healthcare, clean water or sanitation. Those

that do either have to bankrupt themselves

to pay for private services or are reliant

on a patchwork of civil-society providers,

such as mosques, churches, charities and

community groups. These civil-society

groups offer a lifeline for the lucky few.

They can reach remote and marginalised

communities and provide community-based

services, such as home-based care for AIDS

sufferers. But their coverage is patchy and

fragmented, their services are hard to scale

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 answerWhen 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 Dar-

es-Salaam pay up to five times more for a

litre of water than other users because they

have to buy it from private vendors who

are not regulated by the government in

their pricing or service quality.

The result of such a reliance on private

provision can be a patchwork of services, a

lottery for citizens depending on where they

live and what they can afford. It was these

very failings that prompted governments in

now-successful countries to take action in

the first place.

Worse, market reforms can undermine

essential services. When China phased

out free public healthcare in favour of profit-

making hospitals and health insurance,

household health costs rose forty-fold

and progress on reducing infant mortality

slowed. When multinational companies

enter into contracts with low-income and

low-capacity governments, the imbalance of

power can easily lead to abuse. The global

water market is dominated by a handful of

There is a global shortage of 4.3m health workers.

➣



US, French, and UK companies, such as

Bechtel, Suez, and Biwater, which negotiate

contracts that often ‘cherry pick’ the most

profitable market segments, require guaranteed

profit margins, and are denominated in

dollars. If governments try to terminate these

contracts, they risk being sued, as recent

cases in Tanzania and Bolivia show.

Regulating private providers can also be

more difficult for weak states than directly

providing services. There is no alternative to

building public capacity to organise, provide

and regulate essential services.

Rich countries are responsible tooWhile 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.

Early high-performers in essential services

all received considerable foreign assistance.

Virtually all the roads, schools and health

facilities built in Botswana in the 1960s and

1970s were financed largely from donor

sources, as part of a co-ordinated national

development plan. Costa Rica received

$3.4bn between 1970 and 1992, mostly from

the United States, and this helped it to shield

its social spending during the economic

crisis of the 1980s. South Korea and Cuba

benefited from direct foreign aid from the

US and the Soviet Union respectively;

importantly, this aid did not undermine

recipient countries’ freedom to make their

own decisions on the best way to provide

public services.

More recently, some rich countries have

supported public systems in poor countries

by channelling their aid through national

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

➣


plans and budgets, enabling governments

to plan for the future and pay decent salaries

for frontline workers. In Malawi, which is

seen as a high-risk country due to endemic

corruption under the previous government,

donors are now funding a salary increase for

public health-workers, an intervention that

is already stemming the tide of emigrating

doctors and nurses and improving the

quality of care on the wards.

But instead of helping to revitalise public

services, rich-country governments too

often push private-sector solutions to

public-service failures, despite the evidence

that this is not working. Central to this is

the practice by both the World Bank and

the IMF of making governments introduce

privatisation or other market reforms in

return for aid and debt cancellation. A 2005

study of the World Bank’s latest adjustment

loans, the Poverty Reduction Support

Credits, found that 11 out of 13 schemes

studied contained such conditions. These

included water privatisation in Nicaragua

and the greater involvement of the private

sector in health-care provision in Senegal.

In many countries, the World Bank is

pushing governments to contract out

services to non-state providers. This can

speed the scale-up of services, but places

unrealistic demands on weak governments

to regulate and manage contracts.

What poor-country governments need is

aid that is well-coordinated, predictable

and channelled through public systems

and national budgets. What poor countries

typically get is insufficient, unpredictable

aid, disbursed through a jumble of different

projects that compete directly with public

services for staff and scarce resources. As

much as 70% of aid for education is spent on

technical assistance rather than on recruiting

and retaining teachers and nurses. A study

of technical assistance in Mozambique found

that rich countries spent a total of $350m

a year on 3,500 technical experts, while the

entire wage bill for 100,000 Mozambican

public-sector workers was a mere $74m.

In health, numerous different ‘vertical’ health

initiatives increase transaction costs, duplicate

and undermine health delivery, distort health

priorities and undermine sector-wide planning.

Angola and the Democratic Republic of

Congo have each been required to set

up four HIV/AIDS ‘coordinating’ bodies.

IMF-imposed ceilings on public-

sector wages and recruitment prevent

governments from expanding health and

education services. The WTO or regional

trade agreements may also threaten public

services by limiting how governments

regulate foreign service-providers.

Rich countries are encouraging a

haemorrhage of nurses and teachers from

developing countries. Of the 489 students

who graduated from the Ghana Medical

School between 1986 and 1995, 61% have

left the country, more than half of them to

the UK and a third to the US. The African

Union estimates that poor countries are

in effect subsidising public services in rich

countries to the tune of $500m a year.

Despite recent progress on debt

cancellation, many poor countries that

desperately need it are still being ignored.

Only 17 of the more than 60 countries that

need full cancellation have so far received

it from the World Bank and IMF.

A manifesto for changeOxfam International calls on developing-

country governments to make sustained

investments in essential education, health,

water and sanitation systems and services, ➣



working with civil society and the private

sector within an integrated public system.

They need to train and recruit millions

of desperately needed health workers

and teachers, and improve the pay and

conditions of existing workers. They have

to build an ethos of public service, in which

both public and essential-service workers

are encouraged to take pride in their

contribution. They need also to ensure citizen

representation and oversight in monitoring

public services, as well as taking a public

stand against corruption. They should abolish

fees for basic education and health care

and subsidise water for poor people. Last

but not least, they need to make services

work for the welfare and social status of

women and girls by reducing educational

disparities, promoting women’s employment

in public services and guaranteeing women’s

economic and social rights.

Rich countries, the World Bank and the IMF

must support poor country governments

to do this. They should stop pushing the

inappropriate privatisation of public services

through aid conditions, technical advice

and trade agreements. They should keep

their promise to give 0.7% of their national

income as foreign aid and allocate a fifth of

that aid to basic services. They should also

fully implement commitments to improve aid

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

the Global Fund for HIV/AIDS, Tuberculosis

and Malaria, and the Education for All Fast

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

countries for graduates they have poached.

Civil society too needs to act to hold

governments to account. It has to build

popular movements to demand that

governments provide quality public services,

including free health and education; engage

in local and national planning processes;

work with parliaments to monitor budget

spending, to ensure that services are

reaching the poorest and corruption is

not tolerated; and challenge rich-country

governments, the World Bank and the IMF

when they fail to support public services.

Within a generation, for the first time in

history, every child could be in school.

Every woman could give birth with the

best possible chance that neither she nor

her baby will die. Everyone could drink

water without risking their life. Millions of

new health workers and teachers could be

saving lives and shaping minds.

We know how to get there – through

political leadership, government action and

public services, supported by long-term

flexible aid from rich countries and debt

cancellation. We know the market alone

cannot do it, civil society can only fill gaps,

and that governments must act. There is

no short cut, and no other way.

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,

including the sources for the facts and figures in

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

“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.”

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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.

First off the mark

Even the richest of countries may

struggle when a natural disaster

such as an earthquake or a hurricane

strikes, but what are poorer countries to

do? While an international humanitarian

relief effort may help with the immediate

crisis, governments are still often lumbered

with a vast longer-term legacy of shattered

towns, uprooted plantations, bankrupted

businesses, broken bridges and other

ripped-up infrastructure. The financial

burden of rebuilding a devastated region

may be too great for a local insurer or

reinsurer to cover – but it is a drop in the

ocean for global capital markets. By issuing

“catastrophe bonds”, developing-country

governments can purchase insurance from

international investors, who forfeit part of

their loan when a natural disaster exceeds

defined limits – in effect, an insurance

payout – but earn an above-average rate

of interest, the equivalent of an insurance

premium. Mexico has blazed a trail by

issuing such bonds to insure against

earthquake damage, and other developing

countries could now follow in its footsteps.

Such ground-breaking use of sophisticated

financial techniques to help alleviate

poverty is one of the hallmarks of the FIRST

Initiative, a low-profile, but high-impact

programme to help reform and strengthen

the financial sector in developing countries.

Set up in 2002 by Britain’s Department for

International Development together with

the development agencies of Canada,

the Netherlands, Switzerland and (later)

Sweden, as well as the IMF and the World

Bank, it gets many things right that other

aid programmes often do poorly. It is quick,

nimble, sharply focused and responsive to

individual countries’ needs, while avoiding

unnecessary duplication. And at a cost

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

donors, while providing invaluable financial

know-how to developing countries.

Take Mongolia, where over half of the

population, and 30% of the economy,

depends on livestock herding. Unfortunately,

extremely cold weather, or drought,

occasionally devastates the country’s herds

of cashmere goats, cattle, sheep and

other animals, threatening semi-nomadic

herders and their families with destitution

and damaging important export markets.

Worse, Mongolia does not have a functioning

livestock-insurance market, because insurers

do not have adequate information to cover

herders – whose flocks are undocumented,

and often roam over huge distances – for

their individual losses, while the risk that

much of the country’s livestock will be wiped

out at once is too great for the country’s

fledgling private insurance companies to

bear. But FIRST has developed a novel

MARK ST GILES

is Managing Director of the

FIRST Initiative. After a career in

broking, investment banking,

asset management and financial-

services regulation, he has for the

15 years prior to joining FIRST run

his own consultancy, Cadogan

Financial, which specialises in

advising developing countries on

the establishment of collective

investment funds and defined-

contribution pension funds. He

has served as Chairman of the

British Association of Investment

Funds, President of the European

Federation of Investment Funds,

a board member of National

Savings, and was Chairman of an

SRO established under the 1986

Financial Services Act.


➣

scheme that will provide affordable cover

which is available to all, by spreading risk

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 boltsMost of FIRST’s work is not as eye-

catching and exciting as earthquake bonds

– but then again financial-sector regulation

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

In Colombia, FIRST 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.



and supervision are not meant to be. The

important thing is to get the nuts and

bolts right, laying solid foundations for

a thriving financial sector which boosts

economic growth and reduces poverty,

while ensuring stability and protecting

against excessive risks. FIRST helps

countries close dangerous gaps in their

laws and regulations, and strengthen vitally

important financial institutions, such as

supervisory bodies.

Poor countries have much to gain from

well-functioning capital markets that

channel savings to profitable investment

opportunities and allow insurance

companies, pension funds and other

institutional investors to spread their risks.

Research shows that growth rates are one

to two percentage points higher in countries

with sound financial sectors than those

without – a crucial advantage when seeking

to reduce poverty. Developing countries with

strong and stable financial systems are also

less vulnerable to economic shocks.

But poorly designed (or non-existent)

financial regulations and supervision can

prove extremely costly. Developing countries

lost around $1 trillion through banking crises

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

➣


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

like a virus to rich-country markets too. As

was highlighted by the devastating financial

crisis which began in Thailand in 1997 and

soon rocked emerging markets, roiled rich-

country ones and threatened to plunge the

world economy into recession, rich countries

have a powerful interest in ensuring financial

stability in emerging markets.

In a speech to the US Council on Foreign

Relations in September 1999, Britain’s

Chancellor of the Exchequer, Gordon Brown,

called for “a framework of internationally

agreed codes and standards, new economic

disciplines, to be accepted and implemented

by countries which participate in the

international financial system…They will

deliver the transparency and accountability

which I believe is the only answer to the

uncertainty and unpredictability of ever more

rapid financial flows.” While such codes and

standards apply mostly to rich and middle-

income 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.

Technical assistance is often delivered

in a haphazard fashion, if at all. It may

come too late, and is often inappropriate.

Outsiders may pay little attention to local

conditions and to the appropriate sequence

of reforms, while their efforts often overlap

or even duplicate each other. There are

even examples of different donors financing

separate projects with the same objective at

the same time. Moreover, poor coordination

often prevents countries from benefiting

from recommendations that are replicable

across several countries in a region.

FIRST is different. Its approach is one of

“ownership, harmonisation, alignment,

results and mutual accountability”, the

model endorsed by the Paris Declaration

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

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

➣



on aid effectiveness in March 2005, which

united ministers from both developed and

developing countries. It puts recipients in

the driving seat, rather than telling them

what they need. They are encouraged to

identify their own problems and contribute

to the solutions. As Adolf Denk, the head

of legal services at Namibia’s Financial

Institution Supervisory Authority, remarked,

“It is imperative that the assisted should

not feel patronised, and in this regard we

felt like a partner [with FIRST] in the project

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 IMF-

World Bank’s Financial Sector Assessment

Programmes (FSAP), a voluntary health-

check 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 cost-

effectively 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

can be used by any country that has similar

needs to those already addressed.

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

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.

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imf world bank board of governors annual meetings 2006

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