2016 | World Finance

Escalating global debt threatens a new financial crisis

Posted on January 13, 2016January 15, 2016 by Helen

In the aftermath of the 2008 financial crisis, a global economic recession – possibly the deepest, and most definitely the longest that the world has ever seen – took hold. The billions of taxpayer dollars that had been spent on bailing out the banks, combined with huge amounts of quantitative easing and reducing interest rates to rock-bottom levels, resulted in advanced economies holding the highest public debt-to-GDP ratios that had ever been seen.

To make matters worse, that debt, even now, continues to grow. Currently, global debt has risen to more than $57trn and, according to the management consultancy firm McKinsey & Company, this has subsequently increased the ratio of debt-to-GDP globally by more than 17 percentage points. With global debt at these levels, the compound annual growth rate comes in at 5.3 percent; far exceeding the 3.3 percent global growth predicted by the International Monetary Fund (IMF) in 2015 and the 3.8 percent that the organisation expects the world to achieve by the end of 2016. In short, the world is going to struggle to pay off the interest, let alone make any meaningful dent in the debt itself.

This massive accumulation of debt around the world, combined with the fact that very little has been done to deleverage the global economy both in terms of household or public debt, has led many commentators to contend that the seeds for the next economic crisis have already been sown. Some are even predicting that another global meltdown is imminent. If that is the case, it is important to understand how the world has arrived at this position – and, more importantly, to try and ascertain what will happen when the world eventually buckles under its own debt.

Those who control society are living in a bubble where the belief is that the tiny adjustments that have been made since 2008 are adequate

Rapid reduction
In an attempt to balance their books, various countries have implemented austerity measures, with many states cutting back on spending and raising taxes – however, some have found that such moves come with a number of drawbacks: if governments cut back on spending and stop investing in infrastructure and other vital projects, there is less economic output with which to reduce the deficit.

As such, a number of different fiscal policies have been put forward in the place of these austere economic ideologies. One of the more interesting stemmed from a report constructed by three IMF researchers, which asserts that if a ‘green zone’ exists – a state of high debt and full employment simultaneously, such as in the US – then it is in the public’s best interest to take on more debt. The report, When Should Public Debt Be Reduced?, argues that ‘the boom, not the slump, is the right time for austerity at the Treasury’.

Shortly after the report was released, Managing Director of the IMF, Christine Lagarde, told NPR journalist Renée Montagne, “[The US] needs to have a medium-term fiscal policy that is aiming at reducing the long-term debt… In the immediate short-term, there is no great risk of increase of [increasing] that US debt… In the short-term, some measures can be taken in order to sustain growth, in order to encourage growth by way of infrastructural investment, for instance.”

Lagarde’s position attempts to provide a balanced solution for reducing the debt of those advanced economies that exist in the green zone: when economic growth is minimal, focus should be diverted away from debt reduction and instead placed on public capital projects, which will exceed market returns and generate growth for the economy, allowing debt reduction programmes to take place at a later date.

If this solution sounds simple, that’s because it is: as with most theories, the major problem with this scheme is that it sounds great on paper, but the conditions that it requires do not exist in reality. Focusing on debt reduction during boom periods is good advice, but to this day growth remains stagnant, and many countries are struggling to stay out of recession. Lagarde’s theory is also simplistic in its suggestion that governments will make the right choices, and public investment projects will provide rates of return high enough for debt reduction to begin in the first place.

Reliance on debt
Ultimately, so long as the ratio of debt-to-GDP remains high, the debate over what the best method for reducing public debt is, will rage on. However, a great many economists are beginning to question why so little attention is being paid to the extreme levels of private household debt being accrued in many advanced economies (see Fig.1). If left unchecked, this has the potential to hamper economic growth far more than cutting back on public spending could, especially in consumer-based economies, as during levels of extreme debt people have a tendency to tighten their belts. As in these circumstances, the middle and lower classes often use their disposable income to pay down their debt instead of driving economic growth through consumption, Lagarde’s rose-tinted theories of debt reduction have been essentially rendered ineffective.

In the US – as is the case across many developed countries at the moment – the single largest driver behind increasing private debt levels has been the stagnation of real wages. “You have to remember that the US, as a society, one of its uniquenesses – or what it likes to call its ‘exceptional quality’ – was that it did see a rise in real wage for workers pretty much continuously for the 150 years before the 1970s”, according to Professor of Economics Emeritus at the University of Massachusetts and Producer of the Economic Update podcast, Richard D Wolff. “This gave the US not only an extraordinary level of wealth, but it made [the] working class believe that it had arrived in the best possible place on the planet, because [the US] could promise endless waves of immigrants rising wages over time.”

Not only did the US deliver on that promise, providing many of the people that came to its shores a level of prosperity and a standard of living that was not afforded elsewhere, but it also saw the birth of what was known as the ‘American dream’, with workers’ wages rising to reflect the boom in economic activity. However, over the last 35 years, wages for many Americans have failed to grow – which, according to the Economic Policy Institute, is the primary cause of not only a depreciation in family income over the past generation, but also an increase in income inequality across the country.

This stagnation of real wages in the US resulted in the American working class trying to solve its problems with debt. The American people have sustained a rising standard of living in the only way that is available to them when real wages don’t rise: through borrowing. They did so partially by developing the mass credit card, a phenomenon of the 1970s. During the same period, there was an explosion of another relatively new phenomenon – mortgage debt, which took off in a big way.

Christine Lagarde's solutions for reducing global debt have been deemed too simplistic by some — Christine Lagarde’s solutions for reducing global debt have been deemed too simplistic by some

“You have a population that is addicted to debt as a way to sustain the so-called American dream”, Wolff told World Finance. “To give the mass of Americans… at least a sustainable illusion that their promised well-being – the promised progress of each generation living at a higher standard of living than the one that preceded it – [is still intact]… To keep all that going, which is absolutely crucial for the self-image of American society, debt has become the answer.”

The Bank for International Settlements (BIS) has seen debt-to-GDP rise to worryingly high levels in a number of countries of late, leading many commentators, including Wolff, to fear that another major banking crisis is on the cards within the next three years. “I certainly think we are heading for one”, said Wolff. “I do not see, in any significant way, that [any] response to date – whether it is the Dodd-Frank bill in the US or the various banking regulations imposed in Europe – are adequate to or proportional to the level of the crisis”.

Wolff isn’t the only person to think that the US has failed to learn many lessons from the last financial crisis: speaking at the IMFs’ annual meeting in 2015, José Viñals, Director of the Monetary and Capital Markets Department at IMF, said that all advanced economies have yet to address the legacies of the 2008 crash – something that he argued is essential if there is any hope of financial stability and growth returning. Considering how much is at stake, it is baffling to many why policy-makers have not done more to fix the broken financial system that was at the heart of the last economic crisis.

Working the system
As Wolff sees it, there is a fundamental and constantly evolving social split in American society between the ‘haves’ and the ‘have-nots’, where ‘haves’ are able to live comfortably, and ‘have-nots’ find themselves frequently worrying about their livelihoods (see Fig. 2). Once that divide is fully understood, he believes that it becomes clear not only why the US has found itself in this precarious position, but why little – despite Lagarde’s assertions – is being done to fix it. However, while the vast majority of people are still suffering as a result of the financial turmoil of 2008 and the on-going economic crisis, a small percentage of the American income pyramid has done spectacularly well: between the 1970s and the present day, this group of high-earners has seen extraordinary levels of growth in both their absolute and relative wealth.

Wolff noted, “Yes, things went bad in 2008, but [this group] had the power then to direct the government to bailing themselves out. So for them, everything is working out fairly well, and has gone that way for almost half a century. Therefore, they are deeply persuaded that this [way of life] can and will persist, and the notion that the mass of people are falling ever further behind… becomes unimportant. They just think that this is the way things are now, and the mass of the working class will need to accommodate itself to the changed world.”

For Wolff, the folks at the top understand that they have become extremely powerful by virtue of this highly concentrated wealth pyramid, and that this puts them in a vulnerable position in a society that offers universal suffrage. In the US, according to Wolff, the elites have taken very concrete steps to immobilise the political system and create a systematic barrier against anything that will change the favourable situation they find themselves in.

“America is now a place where, to be a credible political candidate, you have to satisfy 500 people who sit at the top of the economic ladder of this society. And if you manage to displease any significant portion of them, your political career is either over or capped at a point of incapacity to do anything, no matter what the mass of opinion is in the country.” The political system, therefore, has either grown insensitive to the economic problems that it faces, or it has become systematically stymied to them. It is for these reasons that the shortcomings of the economic system have been allowed to persist for so long – because there is seemingly little to no resistance to it.

According to Wolff, politically speaking, there are only marginal signs of discontent about the way in which the country is structured, with only a few high-profile figures, including US Senator Bernie Sanders, publicly addressing inequality levels. However, the real danger with setting up a society up in this manner is that political explosion becomes the only feasible method for bringing about meaningful change for those who oppose the system. Wolff said, “If I were the bank of international settlements, I would be far less worried about a financial crisis than I would about the social explosion that is bubbling below the surface.

“If you read the financial press, there are widespread predictions that 2016 and 2017 are lining up to be difficult years, with various kinds of adjustments, downturns etc. If they are bad enough, and they set off the kind of cascades of trouble that [they have the potential to] – [which certainly happened] in 2008 – it could be the catalyst to social, political and economic reforms on a massive scale.”

Catalyst for change
Since 2012, the world has been talking about an economic recovery, despite the fact that many people have yet to feel the effects of one in their daily lives: most people’s wages haven’t recovered, and while unemployment rates appear to be shrinking at long last (see Fig. 3), for those willing to look a little more closely at the labour market, they will notice that almost all of the jobs that have been created in the last four or five years offer much lower pay without any of the benefits that many have come to expect. There is also much lower job security overall.

All of this is being imposed on the working class, while the government endlessly talks about recovery. In effect, what this does is make the majority of people feel as though there has been a recovery that they have somehow missed out on. This in turn forces people to turn inward and blame themselves for something that is a larger social issue – however, there is no saying that this anger will stay internal forever.

Wolff noted, “If the situation does get worse and you allow the left to function in the US, which it is now doing on a scale that I’ve never seen in my lifetime… Combined with the fact… that a phenomenon like Sanders – someone that identifies as a democratic socialist – can even run for office in some significant way… All this acts as a sign that, just below the surface, there is a lot of anger and a lot of bitterness waiting to be unleashed.” What will eventually ignite this process is difficult to predict – however, what is clear is that the US is a tinderbox.

US Senator Bernie Sanders is one of few politicians willing to publicly speak on the matter of inequality levels

Separated from reality
Those who control society are living in a bubble where the belief is that the crisis is manageable, and the tiny adjustments that have been made since 2008 are adequate, meaning that nothing is likely to change anytime soon. Meanwhile, the general public is both aware and slightly afraid of the social cataclysm that they know is coming.

As it stands, the US has neither the leadership at the top or – for the time being, at least – the pertinent formations below that are necessary to bring about change in any meaningful way. It is a difficult time, but Wolff admits that the consciousness of the majority is changing. People are growing more and more discontented and less and less patient with the current state of affairs, and while in the past people would put up with capitalism’s shortcomings because it at least ensured a better standard of living to what was afforded to the generation prior, that is no longer the case.

“The mass awareness of the inequality, and the sense of it being unfair and out of control – I’ve never seen that in the US in all my life”, according to Wolff. “This is socially explosive. I don’t think that it is sustainable long-term. The truth of it is that you now have a system that is desperately trying to figure out how to be successful… for those at the top, without being so disastrous for everyone else that it destroys itself. It gives me a sense that the system is en route to sowing the seeds of its own demise.”

There is a level of instability in the economic system that can be disguised and covered over. We can all become Keynesians who believe that governments’ monetary and fiscal policies can still keep everything going, as Lagarde has assured us – but it’s a concern how much longer this can be sustained before cracks begin to appear, and the debt finally takes its toll.

RBS tells its clients to “sell everything”

Posted on January 13, 2016January 21, 2016 by Helen

The world economy is set for a cataclysmic year in 2016, with a global deflationary crisis on the table, according to Andrew Roberts, Research Chief for European Economics and Rates at RBS. In a note written to its clients, RBS warned that the best course of action was to “sell everything”, except for high-quality government bonds.

The note prophesised a number of flash points that could take place in 2016 across the global economy, including major stock markets plummeting by a fifth of their value, and the price of oil falling well below $20 per barrel.

Roberts’ pessimistic outlook for 2016 follows on from a similarly bearish projection for the year ahead, made in late 2015.

According to Roberts, following the 2008 financial crisis, Asia took up the role of driver of economic growth. However, this growth was largely driven by debt. The limits of debt build-up have now reached a climax, resulting in negative growth for both world trade and world credit. With no regions able to pick up the role of driver for the world economy, Asia will no longer be able to drive forward the world’s economic growth.

According to Ambrose Evans-Pritchard, writing in The Telegraph, Roberts sees China as the “epicentre of global stress, where debt-driven expansion has reached saturation. The country now faces a surge in capital flight and needs a ‘dramatically lower’ currency. In [RBS’s] view, this next leg of the rolling global drama is likely to play out fast and furiously”.

The RBS client note stated, “We are deeply sceptical of the consensus that the authorities can ‘buy time’ by their heavy intervention in cutting reserve ratio requirements (RRR), rate cuts and easing in fiscal policy.”

As a result of this pessimistic economic outlook, Roberts is warning clients to “sell everything”, with few exceptions. He informed clients that RBS is cynical about the performance of “mostly everything”, except for “high-quality, five-to-10-year government bonds”. He also warned clients that they should “stay short all commodities. Yes, especially oil”. Ominously, the note said that “this is about return of capital, not return on capital. In a crowded hall, exit doors are small”.

Not everyone, however, is convinced of such doom and gloom: Australian economist Stephen Koukoulas has cast doubt on the RBS note, confident that markets and global economic conditions will fare better in 2016. Writing on his website, Koukoulas lists 11 variables, including Chinese, Brazilian, Japanese and US stock prices, US house prices, and the price of copper and oil. According to Koukoulas, Roberts claims that each of these should be sold.
Challenging RBS’ dire prognosis, the Australian economist has offered Roberts a bet of $10,000 based on whether 2016 will end with six of the 11 variables at a lower number or not.

Climate change controversy could destroy big oil

Posted on January 13, 2016January 15, 2016 by Helen

The concentration of CO2 in the atmosphere recently exceeded 400 parts per million (ppm), according to data compiled by the Mauna Loa Observatory in Hawaii. The passing of this milestone cries out for immediate action to be taken by the international community to address dependence on fossil fuel and other contributors of greenhouse gases. It also serves as a reminder of the consequences of inaction.

But in order for decisive action to be taken on any issue, people must first agree that there is a problem in need of solving. However, it has taken far longer than many climate change campaigners would like for a consensus to be reached on the causes and effects of the continued rise in average global temperatures (see Fig. 1).

In the US, Republican presidential candidates are still sceptical over whether climate change is even real. Former Governor of Florida Jeb Bush told Esquire he thought “the science has been politicised”, and admitted he would exercise caution before taking any action that may “alter who we are as a nation because of it”. Donald Trump, in typical fashion, took an even harder line, calling global warming “a total hoax” during an interview on Fox News.

The left would like to blame conservatives’ denial of climate change science on pure pig-headedness. Sadly, as the recent ExxonMobil allegations suggest, their political position on the matter is more likely the result of them digesting misinformation produced and disseminated by corporations with vested interests in covering up the link between the burning of fossil fuels and global warming.

If the claims made by leading US environmental campaigners turn out to be true, it could end the debate over global warming once and for all. Not only that, but many climate activists hope it will bring about massive social change reminiscent of the attacks on the tobacco industry, which was sued en masse after information surfaced that companies knowingly spiked cigarettes with nicotine so smokers would become addicts. However, according to legal experts, while criminal prosecution and securities class action suits are definitely on the cards, climate change is not ideally suited for mass tort litigation – but Exxon should not underestimate the ingenuity and initiative of lawyers.

Investigate Exxon
In September, Inside Climate News and the Los Angeles Times claimed Exxon had known about the threat of climate change as early as the 1970s and 80s. But, instead of telling the world what it had deciphered from its research, the reports claimed that the oil company instead spent millions of dollars on setting up various think tanks and donating vast sums to various politicians in an attempt to spread doubt and misinformation about the existence of climate change, and the role fossil fuels played in its creation.

The reports led 350.org, an international environmental pressure group that wants to reduce CO2 levels in the atmosphere to 350 ppm, to call for an immediate federal investigation by the US Department of Justice (DOJ). “Despite Exxon’s wealth and power, people were eager to sign on to this statement”, said Bill McKibben, Co-Founder of 350.org, in press release requesting people petition the DOJ to take action. “Anyone who’s lived through 25 years of phony climate debate, or who’s seen the toll climate change is already taking on the most vulnerable communities, has been seething at these revelations.”

He certainly isn’t wrong about the public outcry that the allegations have caused; so far, more than 41,000 people have signed the petition calling for a federal investigation. Leading Democratic presidential candidates Bernie Sanders and Hilary Clinton announced their support, piling on the pressure for an official inquiry. Even Exxon’s hometown newspaper, The Dallas Morning News, has turned on it, with an editorial that said: “With profits to protect, Exxon provided climate change doubters a bully pulpit they didn’t deserve and gave lawmakers the political cover to delay global action until long after the environmental damage had reached severe levels. That’s the inconvenient truth as we see it.”

Exxon was quick to hit back at the media and environmental activists’ allegations that its climate research was inaccurate and deliberately misleading. “For nearly 40 years we have supported development of climate science in partnership with governments and academic institutions, and did and continue to do that work in an open and transparent way”, said Ken Cohen, Vice-President of Public and Government Affairs at Exxon, in a statement.

“Activists deliberately cherry-picked statements attributed to various company employees to wrongly suggest definitive conclusions were reached decades ago by company researchers. These activists took those statements out of context and ignored other readily available statements demonstrating that our researchers recognised the developing nature of climate science at the time which, in fact, mirrored global understanding.”

The company’s response has done little to quell the anger and intrigue surrounding the allegations. It certainly did not stop New York Attorney General Eric Schneiderman issuing Exxon with a subpoena requesting the company provide extensive information and documentation in order to ascertain whether it knowingly lied to its investors. Needless to say, New York’s decision to take legal action will be seen as a victory for the environmental movement, but in order for real political and cultural change to occur it will need to spread far beyond the Empire State.

Legal nightmare
When corporations are found to have lied, there is a significant risk of criminal prosecution and securities litigation being brought against them. This can be a fruitful area of litigation for lawyers and could lead to companies paying out large sums of money in penalties and fines. But if climate change activists really want to bring down Big Oil – which they do – then they will likely try and pursue massive class actions suits against Exxon in the same way many businesses did when they were harmed by BP’s Deepwater Horizon oil spill in 2010. The only problem they have, according to Howard Erichson, a civil procedure expert at Fordham University, is that it’s much harder to see how mass tort litigation will evolve with regards to climate change, because even though it is possible that it harms a lot more people than air crashes, cigarettes or even oil spills, the harms are diffused.

41,000

Signatories to a petition for a federal investigation of ExxonMobil

$2.03bn

Exxon’s ‘downstream’ earnings, Q3 2015

$603m

Exxon’s ‘upstream’ losses, Q3 2015

When plaintiff lawyers look to bring mass harm litigation, they need to identify a defendant or set of defendants who can be held liable to some identifiable set of claimants. The problem with climate change as mass harm litigation, Erichson explained, is that it becomes impossible to place the blame on any one individual, as the victims include every man, woman and child on this planet.

“One way to look at it, is you and I individually may bare some moral responsibility for climate change in the way we travel, heat our homes or any number of other things, but that doesn’t mean we are going to face civil liability to anyone”, said Erichson. “There are a small number of companies, such as Exxon, that are in the news right now that may bare more direct responsibility, but then the question is, to whom would they be liable? If the answer is to the public, then that is really an issue of regulatory enforcement and criminal liability, which may well be how things move forward. But as far as civil tort liability is concerned, the harms are so diffused. Virtually everybody is a potential victim.”

The question that needs to be answered is whether or not civil litigation over mass harms caused by climate change can be envisaged. Considering how the impact of climate change is so varied, widespread and therefore dispersed, it naturally becomes pretty difficult to picture mass tort litigation proceeding – but Big Oil would be foolish to underestimate the endless creativity of lawyers.

For years, the tobacco litigation over nicotine spikes went nowhere: for more than 40 years, people were filing lawsuits against the industry for cancer brought on by cigarettes, and losing. That all changed in the 1990s, when plaintiffs began to win. That means there is still hope for mass tort litigations cases against Exxon.

Perhaps lawyers will manage to find a way to make companies civically liable for harms caused to others. The diffusion of responsibility remains and climate change is lacking a well-defined group of plaintiffs similar to cigarette smokers. But if lawyers managed it then, who is to say they won’t do it again?

In the meantime, Exxon will continue to deny the allegations. Environmental activists will continue to put pressure on state attorneys general and the DOJ to take action against the company. And while it is yet to be seen if Exxon will be found guilty, the fact remains that the levels of CO2 emissions in our atmosphere continue to rise. Regardless of the eventual verdict, energy companies, governments and politicians the world over need to act, and fast.

What does the future look like for Glencore?

Posted on January 13, 2016January 14, 2016 by Helen

The largest commodities trading company on the planet is in bad shape. Back in September 2015, its share price took a nosedive and fell more than 29 percent – an event that wiped billions off its value – sending a shiver down the spine of investors and raising a lot of concern over the company’s ability to reduce its vast amounts of debt. In an attempt to quell shareholders’ jitters, its CEO Ivan Glasenberg put forward a debt-reduction plan, which had the desired effect. But analysts remain worried: if commodity prices do not pick up some time soon, negative shareholder sentiment is sure to return.

The core problem for Glencore is its debt, which currently stands at over $31bn, though there are fears that it is much higher than that, which has led to many market commentators contemplating the prospect of the company collapsing completely. If that does happen, as many people are predicating it will, it will send shockwaves through the entire financial system, as it holds billions of dollars worth of derivatives – leading some to wonder if Glencore could trigger the next financial meltdown in a similar fashion to how the debt-riddled Lehman Brothers did in 2008.

Unsustainable debt
When the firm’s share price plummeted, Glasenberg was quick to react; issuing a statement explaining to shareholders how Glencore would reduce its debt and take necessary steps to mitigate the risks brought on by the depressed commodities market. “Notwithstanding our strong liquidity, positive operational free cash flow generation, lack of debt covenants, modest near-term maturities and the recent affirmation of our credit ratings, recent stakeholder engagement in response to market speculation around the sustainability of our leverage, highlights the desire to strengthen and protect our balance sheet amid the current market uncertainty”, said the CEO and CFO, Steven Kalmin, in a joint statement.

“We remain very positive on the long-term outlook for our business and this is reinforced by senior management’s commitment to take up 22 percent of the proposed equity issuance. Copper and zinc are both supply-challenged and an essential ingredient of future global growth. In seaborne thermal coal, a capex drought and low prices have helped rebalance the market. We are confident that thermal coal’s position and availability as the lowest cost fuel source for many large economies will underpin its key role in the global energy mix for many years to come”, they added.

Analysts and investors are naturally worried about the future of Glencore because nobody really knows when the commodities market
will rebound

Pledging to reduce debt is one thing, but analysts at the global investment bank and securities firm Jefferies warned at the time that whatever action the company did decide to take would need to happen fast, as the company “does not have the luxury of time”. Glencore must have got the memo, because it quickly identified a number of assets that it was ready and willing to sell in a bid to balance its books. During the second week of October, it announced that it would begin the process of selling of two of its wholly owned copper mines: Cobar in Australia and Lomas Bayas in Chile.

The move has helped the commodities giant to recover from its record low share price, which now rests a touch above 90p as it headed into the new year, up from 68.62p in late September. However, it still has a long way to go before it is to return to 300p+ range that it held at the start of 2015.

The debt reduction plan is clearly working. Its success at rallying the share price has certainly reduced shareholders fears, but there are a number of analysts that argue that there is still a lot more to do, as Glencore’s debt is much higher than many may like to admit or even realise. “We estimate the financial system’s exposure to Glencore at over $100bn”, explained Bank of America analysts in a note to investors, “and believe a significant majority is unsecured. The group’s strong reputation meant that the build up of these exposures went largely without comment. However, the recent widening in [Glencore’s] debt spreads indicates the exposure is now coming into investor focus.”

The note to investors continued, “To us, it seems that the world has changed. With increased regulatory scrutiny on bank commodity exposure, we think that ‘business as usual’ won’t be an option. While we don’t see an imminent liquidity crisis we note that bank credit may inevitably tighten, albeit over time.”

Bank of America broke down the company’s debt as follows: $35bn in bonds, $9bn in bank borrowings, $8bn in available drawings and $1bn in secured borrowing, along with an estimated $50bn in “committed lines against which it can draw letters of credit with which to finance its trading inventories”. There is a clear divide among analysts regarding Glencore’s prospects. The financial services firm, Investec, made headlines after it claimed that the company maybe worthless on account of the fact that with debt levels in the hundreds of billions, the enterprise is “solely working to repay debt obligations” and, therefore, unable to concentrate on generating value for shareholders.

Paul Gait, an analyst at Sanford C Bernstein, is far more optimistic about the Swiss-based resource company – extremely so in fact. He thinks that Glencore will eventually rally to around 450p a share, one of the highest predictions of any market researcher. He also has taken umbrage with those analysts that beg to differ and who have been quick to predict the demise of the commodity trader.

Gait is certainly the most confident of all buy side analysts, but he isn’t the only bull out there. Deutsche Bank came out in support of the commodities trading company after initially warning investors to hold tight; upgrading its rating to ‘buy’ in early November, albeit with a much more modest target of 200p.

“The rapid debt reduction plans should remove the balance sheet and trading fears that have overly impacted the share price”, analyst Rob Clifford said in a note to investors. “Through to first quarter 2016 we should see a number of positive catalysts, including additional asset sales.”

The review of Glencore that got the most attention, however, was the one by Investec’s Mark Elliot, a leading analyst on the commodities giant. When things turned sour for Glencore, the bank, like many others gave it a ‘sell’ rating, and stuck with that sentiment in November, even when the Swiss-based mining company agreed to sell future silver output from its Antamina copper mine in Peru – a move that brought in more than $900m to the cash-strapped firm. Elliot and his team even cut their target price to 77p, down from 125p in September, solidifying their position that Glencore is not out of the woods yet.

“We haven’t really changed our position on Glencore. What we’re seeing in copper and across the commodity space shows that there are tough times ahead”, (see Fig. 1) Elliot said. “If US rates are going to rise and emerging markets are struggling, so commodity demand is weaker than we would all hope, and debt costs are going to go up, it doesn’t bode well for leveraged miners with thinner margins.”

Shrinking exposure
Analysts and investors are naturally worried about the future of Glencore because nobody really knows when the commodities market will rebound. The market’s prolonged period of depressed prices is an indicator that all is not well in the global economy. Demand from China has fallen considerably as result of its government opting for more sustainable growth rather than constantly striving to support the rest of the world through double-digit levels.

China’s decision to slowdown has hit commodity producers hard. For the last decade, they’ve grown accustomed to high levels of demand, increasing their supply accordingly. They are now adapting to slower growth in China and it will take time for commodity prices to adjust to this new reality. Glencore is certainly hoping that it doesn’t take too long for prices to rise, because the longer they stay low, the harder it is for them to drive down their debt. The bad news is that prices seem destined to remain low in 2016. In fact, according to a recent report by BMI Research, analysts “do not expect significant recoveries in the coming quarters, rather stabilisation”.

The combination of depressed prices, Glencore’s massive debt obligations and global investors high level of exposure to the company has some commentators fearing that the commodities giant could be the next Lehman Brothers, capable of dragging the world into another financial crisis before having the time to fully recover from the last one.

There are certainly comparisons to be made between Lehman and Glencore, but its financial market exposure is nowhere near the former investment bank. The commodities trader has done well to reduce its exposure, with it reducing its holdings in derivatives considerably from roughly $19bn at the tail end of 2014 to $9.8bn in Q2 2015. This trend is likely to continue in 2016 on account of poor commodity price forecasts. This doesn’t mean that another financial crisis is not on the cards, as commodities prolonged period of depression will drive greater market volatility and uncertainty this year – it’s just unlikely to be triggered by Glencore.

How independence could save Puerto Rico from financial ruin

Posted on January 13, 2016January 14, 2016 by Helen

Puerto Rico is up to its eyeballs in debt; so much so, in fact, that one commentator dubbed it “America’s little Greece”. Currently, the island owes more than $72bn to creditors. Combine this with the fact that debt-to-GDP ratio is more than 70 percent, and it is clear that the US territory is going to struggle to pay that off. In an attempt to try and make a dent in all this debt, Puerto Rico’s government sat down with its creditors, but negotiations broke down in October after the two sides were unable to reach a debt-restructuring deal.

The Puerto Rican government has implemented austerity measures and raised taxes in a desperate bid to shrink spiralling budget deficits, but so far these reforms have done little to reduce public debt in any meaningful way. The situation has become so bad that the Obama administration chose to enter the fray, looking for some way of helping its debt-laden territory out of the red and back into the black.

The proposed plan is ambitious to say the least. The White House wants to provide unparalleled bankruptcy rights to the territory and ramp up fiscal oversight of the island. It also plans to increase its federal Medicaid spending, as there are serious fears about local authorities’ ability to provide adequate services to its people. It is even looking to extend labour supply tax credits to the territory in order to offset the impact of
rising unemployment.

The comprehensive proposal has the ability to protect Puerto Rico from falling into the abyss, but for the plan to be implemented it must be approved by Congress, and fast. Administration officials in a joint statement stressed this point with the National Economic Council Director, Jeffrey Zients and the Health and Human Services Secretary, Sylvia Mathews Burwell.

“The Administration has been working with the Puerto Rico government to ensure that the Commonwealth is able to access all available, existing federal resources”, the statement said. “We have helped Puerto Rico attract job-creating investments, secure new funds to accelerate infrastructure projects, and lower energy costs on the island.

“These efforts are ongoing, but administrative actions cannot solve the crisis. Only Congress has the authority to provide Puerto Rico with the necessary tools to address its near-term challenges and promote long-term growth.

“Working together, Congress and the Administration can help Puerto Rico emerge from the current crisis. Without congressional action, Puerto Rico will face a long and difficult recovery that could have harmful consequences for the residents on the island and beyond.”

Getting any legislation through a Republican-majority Congress has been an uphill battle for the Obama administration, but the President will be hoping the GOP can leave its politics at the door and work with him to save the Puerto Rican economy.

The US mainland is pulling out all the stops in an effort to help the island navigate the tough economic time finds itself in. But despite the administration having the best intentions, there is a strong argument to make that Puerto Rico would be best off if it was left alone.

Welfare payments and Medicaid benefits can exceed the average worker’s salary
on the island

Go away US
Puerto Rico was colonised by Spanish expeditions in 1493 and remained under their control for more than 400 years. In the late 19th century, the American frontier was closed, ushering in a new era in US history – one in which expansion was necessary overseas because it was no longer possible at home. This desire to expand acted as a catalyst for the Spanish-American War, a conflict that would result in the handover of various territories from to the US, Puerto Rico among them.

After the US took control of the island, it introduced a government that was subject to federal law, but that was also granted certain rights that gave it autonomy over specific policies. This arrangement is still in place today, with Puerto Rico considered an unincorporated US territory. It is because of this unique arrangement that the island is unable to make the relevant structural reforms necessary to kick-start its economic recovery.

While it exercises some control over its economic fate, with the local government able to set its own tax policy, for example, the power exerted by the mainland dilutes the effectiveness of these local powers.

The Caribbean heavily relies on tourism to sustain itself, and while Puerto Rico may be home to just as many palm trees and sunny beaches as the Dominican Republic, it is struggling to keep pace with its rivals. Its inability to compete with its neighbours has a lot to do with its ties to the US mainland and the fact that the federal minimum wage of $7.25 applies in Puerto Rico, pushing the cost of labour up. What this means in real terms is that a member of staff working a 40-hour week at a hotel in San Juan will take home $290. Compare that with the $60 a week that a member of staff will take home working at a hotel in the Dominican Republic, and it becomes clear why Puerto Rico is struggling. Not only that, but with the US and Cuba in the process of rebuilding relations, it has yet another rival destination vying for American dollars.

Puerto Rico is also required to adhere to federal labour laws, which means employers must pay employees a mandatory bonus over the Christmas holidays, and are not allowed to ask staff to split shifts, pushing the cost of labour even higher. Not to mention the fact that welfare payments and Medicaid benefits can exceed the average worker’s salary on the island. In short, you have a relatively poor economy that, due to its status as a US territory, is forced to adhere to structural policies it simply can’t sustain.

Governor Alejandro Garcia Padilla has tried to bring down debt by imposing higher taxes, but all that has done is provide Puerto Ricans with an even bigger reason to leave the island for the mainland – a trend that is expected to grow as the economic crisis deepens.

Former IMF economists Jose Rajgenbaum, Jorge Guzmán and Claudio Loser, now working for Centennial Group, produced a report that outlined the steps Puerto Rico should take for economic recovery. Their advice: slash spending by as much as $2bn a year by 2020, and as much as $2.5bn by 2025. Naturally, the cuts will hit those at the bottom hardest, with the report recommending the island lay off teachers in order to “fit the size of the student population”, along with cutting excess Medicaid benefits.

$72bn

Puerto Rico’s debt

70%

Debt-to-GDP ratio

$2bn

Recommended annual spending cuts by 2020

$2.5bn

Recommended annual spending cuts by 2025

It should perhaps be unsurprising that a group of former IMF economists believe the best option for pulling an economy out of crisis is radical austerity, as it is what the IMF has been pushing on the other side of the Atlantic in Greece.

Keeping the island afloat
In many ways, Puerto Rico and Greece are facing very similar problems and both need similar solutions. Just like Greece, Puerto Rico has spent cheap money with complete disregard. They are both now unable to pay the price of all that reckless spending and have GDP-to-debt ratios that leave little to no hope of them ever being able to repay lenders. But, most problematically of all, they are controlled by a currency they are unable to devalue, making their exports unattractive.

The logical step for both countries is to bite the bullet and take control of their own destiny. Many would be understandably nervous to take such a big step, but the economic situation is only going to get worse if decisive action is not taken. As it stands, Puerto Rico’s level of debt, combined with its lack of autonomy and an inability to find the growth that is essential to paying off its debts, has left the island in limbo.

The plans for recovery put forward by the Obama administration will help the island stay afloat in the short-term, but it is essentially kicking the proverbial can down the road. As is the case in Greece, officials are too focused on the here and now, rather than looking at long-term solutions that will provide a way out of the crisis. It appears political leaders are unwilling to rip off the sticking plaster and address the issues at the heart of the economic crisis. If they do not act soon, an economic collapse may finally force their hand.

Why Indonesia urgently needs to address the burning issue of palm oil

Posted on January 12, 2016January 20, 2016 by Helen

Many people will be unaware of just how often they come into contact with palm oil or palm oil derivatives during their daily lives. The highly versatile ingredient can be found in products ranging from toothpaste and washing detergent to baked goods and chocolate. In fact, palm oil alone accounts for 65 percent of all vegetable oil traded worldwide, is used in around 50 percent of all packaged products sold in supermarkets, and is found in 70 percent of all cosmetics. Moreover, as a result of various governmental commitments to reduce the consumption of fossil fuels, palm oil is also increasingly used to generate bio-fuels.

Having a much higher yield in comparison to other crops, palm oil is cheaper to produce and more economical in terms of land use than its alternatives (see Fig. 1), making it the commodity of choice for mass-produced goods. With consumer spending on disposable products rising exponentially and the logistical ease of globalised networks ever-increasing, demand for palm oil has grown rapidly over the past few decades.

Dr Amanda Berlan, an expert in ethical business research and a fellow at the Centre for Business in Society at Coventry University, told World Finance, “One of the reasons for the growth in demand for palm oil is the rise in processed food, which also involves a much more significant carbon footprint and use of resources than ‘slow’ home-cooked food.”

Economic progression
Despite its attributes in terms of versatility and cost-effectiveness, palm oil is steeped in controversy due to the damage that it does to the environment. Such destruction includes the deforestation of some of the most bio-diverse areas on the planet, as well as being responsible for a shocking level of greenhouse emissions.

Although the plant is native to West Africa, cultivation in Malaysia began in the 1930s and soon spread to Indonesia. The two Asian countries now account for approximately 85 percent of the global production of palm oil, with Indonesia producing the lion’s share. With global demand having doubled in the past decade – and being set to double again by 2020 – the commodity has become a key driver in Indonesia’s developing economy. “It’s a major contributor to the Indonesian economy – either directly or indirectly, as it supports several million jobs”, said Mark Driscoll, Head of Food at the Forum for Future. “In the context of 2014, when the last figures came out, palm oil contributed roughly $20-21bn to the Indonesian economy.”

Palm oil has therefore become the archipelago’s biggest agricultural export and a vital earner of foreign capital. Given its fundamental financial role to the developing nation, the industry continues to expand at an unprecedented rate. According to a 2015 report by the Rights and Resources Institute, the production area for the commodity has almost tripled since 1997, now nearing eight million hectares, while a further 15 million hectares of production zones have been licenced to start development.

With over half of Indonesia’s population living in rural areas, palm oil production has become an important source of employment for the country. “It contributes to the employment opportunities of local people directly through producers, both large and small, and also indirectly through the manufacturing, processing and exporting of palm oil”, Driscoll told World Finance. Moreover, according to the World Bank, smallholders in Indonesia report a significantly higher income for palm oil cultivation than subsistence farmers or growers of competing cash crops, such as coffee and cocoa. Palm oil’s cultivation has also prompted a similar economic boost in Malaysia, serving to diversify the country’s agricultural sector, as well as providing employment to nationals and migrant workers from countries such as Bangladesh and Thailand.

Yet, despite the job creation and income levels afforded by the palm oil industry, some argue that the work is actually inconsistent, which can be disruptive to the labour force. Many allude to the unsatisfactory safety measures and poor working conditions for workers in the field, particularly among women, immigrants and casual workers, while several organisations have also raised concerns regarding forced labour, child labour and discrimination, in addition to a lack of government policy.

Irreversible damage
In the 2000s, news of the damage caused by the palm oil industry began spreading throughout Western media and the international NGO network. The rapid deforestation and illegal logging of Indonesia’s rainforests and peatlands then raised alarm among environmentalists across the globe, as did threats to a multitude of species in Sumatra and Borneo, including tigers, rhinos and elephants, as a result of the destruction of their natural habitat.

“The iconic orang-utan is probably the key species associated with deforestation and palm oil plantations”, Driscoll explained. “[Around] 20 percent of all global emissions are associated with food and agricultural production in some shape or form, but if you look at indirect land use change as a result of deforestation globally, that’s an additional 10 percent.” Palm oil production has also severely impacted several indigenous and local communities, as they have been permanently removed from their ancestral lands as a result of plantation development.

What is perhaps most shocking, however, is the amount of toxic chemicals that are emitted by the highly destructive enterprise. When peatlands are cleared and drained, huge quantities of greenhouse gases are released into the atmosphere, a phenomenon that is exacerbated further by producers’ chosen method of razing: deliberately setting forest fires. According to research conducted by the VU University Amsterdam, 122,568 active fires were detected in Indonesia from January until mid-November 2015, which collectively emitted over 1.5bn metric tonnes of carbon dioxide, nitrous oxide and methane.

Considering palm oil’s economic contribution to the nations that produce it, one thing is clear: cultivation will continue

Usually, the carbon dioxide discharged from forest fires is offset somewhat by the regrowth of vegetation. However, this compensation is not realised when land is cleared for monocropping. Furthermore, with methane being over twenty times more harmful to the environment than carbon dioxide, this particular concoction of pollutants is exceptionally damaging in the long-term.

So bad are Indonesia’s fires that the toxic haze they produce sometimes reaches Malaysia and Singapore, causing cancelled events and flights throughout the region. Last September, the smog reached such a critical level that the Indonesia National Board for Disasters declared a state of emergency in six provinces and closed 2,000 schools. According to the World Vision website, the haze has so far affected over 43 million Indonesians, caused acute respiratory infections in around 500,000, and killed 12 individuals.

The strongest haze for two decades also caused significant damage to the palm crops themselves, reducing production by between 10 and 20 percent in some areas, according to IJM Plantations Bhd. There have been various indirect implications as well, including traffic incidents, unemployment and disruptions to local businesses – yet the full cost to the Indonesian economy is unknown. “I have seen estimates ranging from $18bn to $34bn”, Dr Erik Meijaard, a Jakarta-based expert in environmental science, biogeography and zoology told World Finance. “Many costs remain unquantified, however: how do you cost unknown long-term health impact? How do you cost loss of wildlife… [or the] destruction of insect pollinators that will reduce crop yields for years? Many of these factors remain unstudied.”

The 2015 crisis has been a huge economic setback for a state that is already struggling with sluggish growth and a falling currency. But in spite of the evident social, environmental and economic damage caused, the Jowoki-led government has not yet implemented the necessary measures to bring an end to the currently legal practice.

Fighting back
In 2008, various multinational corporations came under fire from Greenpeace activists for the use of unsustainable palm oil in their products. Unilever, the world’s biggest buyer at the time, was among those targeted, with Dove – its leading beauty brand – being singled out in particular. The attack received widespread attention, as did the unwanted publicity for Kraft, General Mills, Cargill, HSBC and Nestlé.

The online spoofs, office raids and widespread criticism worked, causing big players in the consumer products industry making a marked shift in their respective policies towards palm oil. Following the publicity attack, Unilever announced a plan to acquire all of its palm oil from sustainable sources by 2015, while Nestlé, Danone and Kellogg’s have all since been rated as having a “strong commitment” to the cause in WWF’s latest Palm Oil Scorecard.

All too aware of the importance of trust in highly competitive markets, more and more consumer brands are taking extensive measures to ensure that their goods are ethically sourced. As such, over the past decade, numerous high-profile companies have gained membership to the Roundtable on Sustainable Palm Oil (RSPO), an organisation that strives to promote sustainability by setting a global standard for the industry. RSPO certification can only be obtained after undergoing a validation process that examines all participants along the supply chain, and can be withdrawn at any time. According to the website, RSPO’s criteria are based on extensive evidence that “sustainable palm oil production is comprised of legal, economically viable, environmentally appropriate and socially beneficial management and operations”.

A global perspective
Although encouraging multinational companies to guarantee that they will only use sustainable ingredients is in itself a big step, this is only a small part of the puzzle. Despite the success that environmental groups have had in publicising the havoc that the palm oil industry wreaks on rainforests and biodiversity, as of 2014, RSPO-certified farms still only account for 18 percent of global production, which in itself continues to rise exponentially every year (see Fig. 2).

An underlying problem is that many large companies buy from traders and processors, as opposed to from plantations directly. Moreover, due to the cost of international shipping, sustainable and unsustainable palm oil are not always segregated during transport, and so differentiating between the two can be unmanageable for even the most well-meaning corporation.

Even though companies that are headquartered in the West are increasingly taking notice of the issue of sustainable palm oil, the region only accounts for a small portion of the global supply. “We need to take a global perspective on this question”, according to Berlan. “Western consumption of palm oil is of course significant, but it is also important to realise that the largest global importer of palm oil is India, where it is commonly used in cooking. With a population of over one billion people, this represents an estimated 15 percent of the global supply of palm oil. In order to make the palm oil industry more sustainable, this is where major change needs to happen. However, there is no business case for companies in India to adopt certified sustainable palm oil if consumers are not demanding it – and this is problematic”.

The lesser evil
Hoping to tackle the problem, some firms are switching to alternative commodities, such as coconut oil. However, doing so actually exacerbates the problem further: as palm plantations produce as much as 10 times more oil than sunflowers, soybeans or rapeseed per hectare, in essence, this approach simply moves the problem elsewhere. What may help, however, are technological breakthroughs in finding alternatives that are even more economical to produce, such as microalgae, an ingredient that is currently being investigated for its potential as a palm oil replacement in cosmetic products.

Just like we reject slavery and child labour, the international community needs to develop a system that rejects unsustainable palm oil

Considering palm oil’s economic contribution to the nations that produce it, one thing is clear: cultivation will continue, and so simply finding alternatives is not the answer. In order to bring a halt to the damage inflicted by the industry, the support of the Indonesian and Malaysian governments is key. A drastic shift in policy is needed, whereby the agenda is pushed all the way through to the grassroots level: every plantation must be reviewed and certified on an on-going basis, while border controls can also stem the export of illegal palm oil. “Oil palm is the most profitable oil-producing plant, and it is not going to go away”, said Meijaard. “Consumer and buying governments need to recognise the difference between good and bad oil… as developed under the criteria of RSPO. Trade in bad oil needs to be phased out. Just like we reject slavery and child labour, the international community needs to develop a system that helps reject unsustainable palm oil.”

Indonesia’s fire and haze crisis still remains the most pressing issue at hand, however. “A lot has to do with land use planning”, according to Meijaard. “Oil palm expansion and related land speculation, especially at the small and medium-scale, are a major driver of fires. Lots of people with some cash are seeking access to land. The government is continuously changing and updating its land use maps, sacrificing more and more forest to development. What they do not realise is the major social and environmental impacts that are related to deforestation. These undermine the very fabric of Indonesian society.

“[There needs to be a] full fire ban on peat, with the means to enforce it, [which will involve] phasing out slash-and-burn cultivation, stabilising land use planning by permanently recognising which areas should remain forested, and providing the means to implement such planning.” Perhaps applying international political and economic pressure to the Jowoki regime may force the issue further, just as the international media spotlight forced the Indonesian government to take reactive action to the 2015 fires.

In any case, this is not an issue just for ‘animal lovers’ or for ‘tree huggers’ – this is a problem that faces the entire globe. We each have a role to play in it through our purchase of goods containing palm oil derivatives: no shampoo or confectionary product is worth the irreversible damage that is inflicted on the planet and the ozone layer as a direct result of palm oil plantations. A noticeable transformation will take time, and this is a luxury that we are quickly running out of – however, nothing is impossible with collective action in the right direction.

Reshoring the US manufacturing industry

Posted on January 12, 2016January 20, 2016 by Helen

America was originally thought of as the perfect place for an agrarian society composed of small-time farmers. Thomas Jefferson imagined the US, upon its founding, to be a republic made up of individual property owning farmers known as yeoman. This ideal was central to the republican liberty the country’s founding fathers thought themselves to have secured. Yet it was not meant to be. Within its first 100 years of existence the United States became the preeminent industrial power in the world, with one of the world’s most prosperous workforces. America and industry became synonymous. Following its rapid catch up with Britain in the late 19th century, the US became one of the centres of world manufacturing.

Key to America in the 20th century, manufacturing defined how the country viewed itself and how it related to the rest of the world. The well-paid industrial union jobs of the mid 20th century provided a comfortable wage, allowing US citizens to live in historically unrivalled mass prosperity. US industry in the post-war era allowed the dream to be lived up to. Throughout US history, manufacturing has often been seen as the back-bone of the nation’s prosperity. Now, however, industrial America is widely seen to be a thing of the past. In the popular American TV show The Wire, one of the general themes throughout is that the illicit drug trade thrives in the hollowed-out, post-industrial cities of America. Though the series focused on Baltimore, the same is true of Detroit, once considered the core of US manufacturing.

Indeed, there exists an idea in American politics that the US is no longer the industrial power it once was. There is a general sense, orthodoxy even, that the US no longer has the manufacturing base it did, contributing to its stagnating prosperity and frozen wages. The term ‘offshoring’, in reference to American firms relocating production abroad, became a political buzzword in the late 20th century. Globalisation was said to be dispersing American industry. Now however, the opposite is said to be taking place. There is increased talk about industry returning to American – known as ‘reshoring’ (see Fig. 2). Throughout US history, industry has often been seen as providing the back-bone of the nation’s prosperity – suggesting perhaps the US is also on the cusp on a new bout of prosperity.

Bringing trade home
In 2011, the Boston Consulting Group released a study titled Made in America, Again. The paper argued many goods manufactured abroad for American consumers would once again be made in the US. They argued 2015 would be the tipping point of such a trend. According to Michelle Comerford from the publication Trade and Industry Development, “the global economic indicators that led the Boston Consulting Group to predict a shift of manufacturing operations from China to the US, otherwise known as ‘reshoring’, are seemingly coming to fruition”.

The study forecasted that a number of industrial production sectors would see investment return to the shores of the States. The sort of products said to be seeing their manufacturing return included transport goods, electronics and IT goods, heavy machinery, synthetic materials such as plastic and rubber, and white goods such as appliances, electrical goods and furniture.

There is a general sense… that the US no longer has the manufacturing base it once did, contributing to its stagnating prosperity and frozen wages

One of the main reasons cited was that wages in China are on an upward trajectory (see Fig. 3). Of course China retains a comparative advantage in terms of labour costs, with average wages being around a 10th of American workers’. However, wages have risen, and when factored in with the rise of other costs such as transportation and logistics – as the goods in question produced are destined for US markets – the advantage is lost. Wages in China have risen rapidly since 2011, and show no sign of abetting, as the Communist Party of China adopts a plan of developing its internal market and reaching its stated target of becoming a middle-income country. As Comerford noted: “According to the National Bureau of Statistics in China, average yearly wages in manufacturing have increased by over 50 percent since 2011.”

When this rise is taken into account with other costs and liabilities of offshoring production, it becomes less economically rational to locate industry in the traditional low-waged areas of offshored production. For instance, as Comerfield wrote, the “costs to ship ocean freight from China to the US are higher than ever, with further rate hikes on the horizon. Delivery times also have been jeopardised by both natural and man-made risk factors. The longshoremen’s union strike at the Port of Los Angeles/Long Beach is the most recent example of delivery delay issues, which resulted in products stuck sitting on ships in the harbour for weeks while store shelves dwindled”. For companies with a primarily American consumer base, being closer to places of consumption allows quicker changes to reflect consumer behaviour and demand patterns. According to the Financial Times, some recent examples of companies announcing “plans to shift production from China to the US include K’Nex, the toy manufacturer, Trellis Earth Products, which makes bioplastic goods such as bags and utensils, and Handful, the bra manufacturer”.

A manufacturing factory in Lawrence, US. The US was once one of the world's foremost manufacturing powers — A manufacturing factory in Lawrence, US. The US was once one of the world’s foremost manufacturing powers

However, at the same time – despite Frank Sobotka’s opining of his country’s industrial demise – America has actually continued to ‘make stuff’. As an article in The Atlantic recently noted: “According to Martin Baily and Barry Bosworth of the Brookings Institution, for the past 50 years industrial production in the US has grown at the same rate or even faster than the economy as a whole. This means that contrary to conventional wisdom, manufacturing has not lost ground in terms of its importance in the US economy. Until 2011, when China inched slightly ahead, the US boasted the world’s largest manufacturing sector, and it continues to be an industrial powerhouse.” Much of the decline in manufacturing is localised in certain areas, while other areas have continued to expand.

Speaking to World Finance, radio host and editor of Left Business Observer Doug Henwood made a similar point. “US industrial production, as measured by the Federal Reserve’s index, is up 24 percent from the recession low, following a deep decline. It’s 12 percent above where it was in 2000, and 119 percent above where it was in 1980. Important sectors, like motor vehicles remain strong. Production is up 162 percent from the recession low, and 20 percent since 2000.”

Personally affected
Where the decline really has been in industry is within employment – not in actual output. As Henwood further explained: “The trend rate of growth [for employment in manufacturing] went negative in the early 1980s and has been ever since. Job losses in recessions have been savage, and growth in recoveries or expansions largely non-existent. Factory employment is 1.4 million, or about 10 percent, below where it was on the cusp of the Great Recession. It’s about five million below where it was in 2000, and in absolute terms about where it was in 1941, even though the workforce has quadrupled. It was about 30 percent of overall employment in 1950; it’s under nine percent today.” This has largely been the result of increased productivity and cost savings – part of which has been the export of some manufacturing jobs.

This raises the question, then, of what the impact of this so-called reshoring effort will be on the US economy. Clearly, as the figures show, it won’t lead to a ‘revival’ in American manufacturing output, for output has not really suffered a decline. What America has seen, however, is a fall in the number of people employed in manufacturing jobs – perhaps then, as jobs are repatriated, it will lead to a revival of America’s previously prosperous industrial working class, as in the past. The Boston Consultancy Group has predicted the end of the decade will see potentially over one million new manufacturing jobs in the US. Indeed, if the past is anything to go by, bouts of industrial job creation in the US have coincided with increased American prosperity, particularly for those employed in manufacturing.

The story of American industrial might began in the post-Civil War era. With the slave society of the South defeated, the US began to rapidly industrialise. This era saw the widespread introduction of railroads, telegraph and telephone communications, and the internal combustion engine, the steam turbine and electricity – as a result, industry took off. Americans and immigrant labour, primarily from Europe, flocked to new centres of industry in the US, forming a new industrial work force.

Known as the Gilded Age, this was an era of rapid economic expansion. Between the 1870s and 1880s, the US expanded at a faster rate than any time in its history, in terms of output, with wages and capital formation. Between 1865 and 1898, coal output rose by 800 percent. In 1860, national wealth was $16bn; by 1900 it had grown to $88bn. By 1895, the US had surpassed Britain in industrial output. This was a time of prosperity for American workers.

Within its first 100 years of existence the United States become the preeminent industrial power in the world, with one of the world’s most prosperous workforces

According to James Livingston, Professor of History at Rutgers University, US workers were in a relatively strong position, allowing them to benefit from this new industrialisation, accruing higher incomes. “There were two moments in the post-Civil War history of the US when labour held its own against capital”, he told World Finance. “These were roughly between 1873 and 1896, and 1933 and 1973. In the first moment, income shares shifted away from capital, toward labour.” Despite myths of the era characterised by ‘robber barons’, much of the population saw meaningful improvements in their living standards, thanks to wage increase. According to Hugh Rockoff, wage growth for unskilled labour was nearly 1.5 percent annually.

As Livingston also noted, the period from the 1930s to the 1970s saw workers in a relatively strong position to extract higher wages from employers. A large part of this came from the industrial expansion the US saw after, and partially during, the Second World War. The post-war era was a time of unbridled prosperity and economic growth. A huge expansion in the defence sector and a self-perpetuating (for a time at least) dynamic between growing wages and growing consumer demand resulted in an expanding industrial centre for manufactured consumer goods, with firms such as Ford being archetypal.

Not on these shores
It might therefore seem that reshoring offers a new era of industrial production, and, if the past history of manufacturing expansions in the US is anything to go by, this could mean a new wave of prosperity is also about to reach the shores of the US along with repatriated jobs. This, however, seems not to be the case.

The very reason for the return of manufacturing to the US shows how it is perhaps unlikely to boost American prosperity, as past waves of industrial expansion have done. Although logistics costs and transport costs have played a role in firms deciding to relocate back to the US, the fact is that the US has become, in recent years by advanced economy standards, a low-waged economy.

The production line at the Ford factory in 1931, in Detroit, US

Wages in the US have, for the most part, stagnated since the 1970s. According to Henwood, the fact is “that the US is a ‘low-wage’ country by first world standards. New hires in Mississippi auto plants can make less than Walmart workers. To European and Japanese manufacturers, the US has become a relatively low-wage country, which is why we’re seeing so many auto plants in the non-union[ised] South.” At the same time, he said, “state governments, like those of Mississippi and Tennessee, have showered so many subsidies on carmakers that their plants end up being practically free”.

As the publication Manufacturing noted, the US’ “23,914 reshored jobs — tracked mostly between 2010 and 2014 — were fuelled by South Carolina, whose 7,530 reshored jobs nearly doubled that of its closest rival… Each of the top five reshoring states, however, were located in the South. Texas saw 3,792 jobs returned from overseas, followed by Kentucky at 3,412 jobs, Georgia at 3,145 jobs and Tennessee at 3,137 jobs”.

Jobs may come, but they won’t be the high-waged union jobs of yesteryear. As Henwood concluded: “You could argue that having more manufacturing here has ancillary benefits – every new factory job, for example, can result in another job or two at suppliers. But manufacturing employment, though up, is growing at only about a third of the rate of overall employment, meaning its share of the job market continues to shrink – and its hourly wage advantage over service work has disappeared.”

Perhaps then, as jobs are repatriated, it will lead to a revival of America’s previously prosperous industrial working class

An uncertain homecoming
It is not clear how significant reshoring itself will be to the US economy. Clearly it is not something plucked out of thin air – the examples of firms returning exist. However, there are doubts over its true significance, with some citing relatively low numbers of firms returning. For instance, a study by Jim Rice, Deputy Director of MIT’s Center for Transportation and Logistics cast doubt on the extent of the rise in job repatriation and significance of reshoring. “In the majority of cases, the companies involved plan to invest in US-based production capacity; they have not actually made the move”, reported the Financial Times.

“The data indicates that there are relatively few published instances of reshoring”, the newspaper went on, citing Rice’s observation that, “even among reshoring projects that had gone ahead… some had produced only modest employment growth. One widely touted case – the return of some manufacturing of Wham-O Frisbees to California – had led to the setting up of a factory employing eight people”.

Livingstone concluded: “The repatriation of those jobs is a fool’s errand that cannot solve the problems of wage stagnation and income inequality. It won’t re-enfranchise the labour movement, either. Nothing can change the fact that output increases without larger inputs of labour or capital.” While America may see some new job creation from manufacturing, the idea of it returning to its glory days of highly paid industrial work for a large amount of the population is a little optimistic.

Reshoring is providing some jobs to more impoverished sectors in the South, but the sort of wages received are still part of America’s new reality of being a low-wage economy. The US continues to be an industrial powerhouse – it just doesn’t need so many residents working in one place. The solution to low and stagnating American wages must be sought elsewhere.

Saudi Arabia tackles its oil dependency

Posted on January 12, 2016January 20, 2016 by Helen

The current oil price slump began in June 2014, and has since sent ripples throughout the global economy. For Saudi Arabia, the world’s biggest exporter of the commodity, the impact has been direct and palpable: given that more than 80 percent of government revenue is earned through its petrochemical sector, over the past year the nation has amassed a budget deficit of around 20 percent of its GDP. And yet, despite the drop in income for the Saudi state, spending did not slow in 2015 – in fact, in some areas it even increased.

According to figures published by the Stockholm International Peace Research Institute (SIPRI) in April 2015, Saudi Arabia has become the world’s fourth biggest military spender, having increased its defence budget by 17 percent between 2013 and 2014. The annual $80.8bn that the country now spends on arms can be attributed to worsening levels of security in the region and a sustained military campaign in Yemen, both of which show no signs of abating. What’s more, spending elsewhere also continued at a fervent pace last year, not only on state infrastructure and large-scale projects, but also on what some may consider unnecessary endeavours: one such expenditure that received widespread criticism was the coronation celebration for King Salman bin Abdulaziz Al Saud, which totalled a mammoth $32bn.

Saudi Arabia’s rising deficit, together with its spending sprees, has led international onlookers to make downcast predictions about the kingdom’s economic wellbeing and future. In October 2015, the International Monetary Fund (IMF) estimated that Saudi Arabia would be bankrupt within the next five years, a suggestion that saw a horde of media outlets echoing the prognosis. While it is true that the state’s foreign reserves have fallen by around $72.8bn, the reality of the state’s economic situation is far more complex – and far less dire – than is presumed in the IMF’s forecast.

The Saudi Arabian economy has weathered similar storms in the past – more severe ones, in fact – and survived intact

Overstating implications
While it was presenting its bankruptcy predictions, the IMF failed to include a number of crucial details regarding Saudi Arabia’s current monetary policy and the robustness of its economy. “These expectations are not only exaggerated, they are outright wrong”, said Jan Dehn, Head of Research at the Ashmore Group. “Saudi Arabia used the oil boom of the past decade to pay down its debt. As oil prices fell last year, it had one of the lowest debt levels in the world (a low single digit figure as a percentage of GDP). It had also established a huge stock of forex reserves. This has given [the country] considerable room to manage the adjustment to lower oil prices in a gentler manner than other countries that had prepared themselves less well.

“[Saudi Arabia’s] initial response has been to sustain domestic demand by issuing more debt and running down forex reserves. However, since the currency is pegged to the US dollar and unlikely to change, it will ultimately have to bring down domestic demand to be consistent with lower external revenue. This points to a gradual reduction in domestic demand stimulus – but bankruptcy is simply not on the books.”

Diminished foreign reserves are mostly responsible for the bankruptcy prediction made by the IMF and other media outlets, but what many did not make clear is that, rather than spending this capital, as was widely presumed, around $71bn of the $72.8bn had actually been transferred. As a precaution, the Saudi Arabian Monetary Agency (SAMA) reinvested foreign capital into less volatile and lower risk products. “It is public information that Saudi Arabia’s reserves have been declining. Oil revenues are lower, and [the government] has chosen deliberately to sell reserves in order to maintain the import levels associated with the recent levels of domestic demand. However, this policy is obviously not sustainable and Saudi Arabia is likely to move to more debt issuance and gradually lower domestic demand in order to stabilise reserves”, Dehn told World Finance. Furthermore, last year the government introduced a series of departmental and ministerial budget cuts in addition to tightening the management of its finances and eliminating discretionary spending at one stage. Likewise, infrastructure spending has been reviewed, resulting in the extension of various large-scale projects, such as the Riyadh and Jeddah metros, and the postponement of others, including the construction of new sporting stadiums. Such moves indicate that the government is in fact taking measures to curb its spending until oil prices increase once more.

Naturally, one downside to this necessary strategy has been a reduction in confidence in the country’s private sector, as it still relies largely on government expenditure. And yet, interestingly, Riyadh has actually begun working towards the privatisation of state-owned infrastructure facilities and enterprises, starting with the sale of its stake in the National Commercial Bank.

Long-term strategy
The state’s deep-seated economic transition does not stop there. At present, Saudi Arabia is implementing a long-term holistic strategy to create the much-needed diversification that its economy requires. Being so dependent on one sector is not conducive for the sustainable economic growth of any country, and this is a fact that the Saudi government is all too aware of. As such, its focus on helping the development of other industries, such as mining, automobiles, plastic and pharmaceuticals, is enhancing swiftly. Moreover, the nation’s financial sector is better positioned than many would assume, with a consistently low rate of non-performing loans, while bank reserves remain high (see Fig. 1).

In order to help lower the budget deficit, Riyadh began issuing domestic bonds last summer. Of course, diversification is needed in the long-term so as to maintain adequate levels of available liquidity for private sector loans, but the decision certainly helps somewhat in the immediate-term as well. Likewise, the government has also decided to participate in the international bond market for the first time, which is expected to take place in January. This is another prudent move, as tapping into international debt markets can help fund government spending without resorting to the absorption of bank liquidity.

Also during the summer of 2015, Saudi Arabia opened up its stock exchange, the Tadawul, to foreigners for the first time in the country’s history. The decision to do so again plays a big role in the government’s wider strategy to diversify the economy away from oil. Although a flood of foreign capital was not witnessed from the outset, an increasing flow can be expected as international investors realise the potential of many of Saudi’s non-oil markets. Moreover, in two to three year’s time, the kingdom is expected to achieve the MSCI ‘emerging economy’ status, which will not only encourage foreign investment considerably, but will also fully immerse the state into the global community of emerging economies.

A clearer understanding
Again, the Saudi economy is one that is often over-simplified and understated. Certainly, there is much work to be done before Saudi Arabia can be said to have reached the next stage in its economic development, and while oil prices remain low, the nation’s oil exporters continue to face a significant hit. “SAMA can only do so much”, Dehn explained. “Changing the composition can only affect the level of reserves at the margin. Perhaps more important for the level of reserves are (a) oil prices, (b) Saudi’s current account and the factors that drive domestic demand, including fiscal policy and exchange rate policy, (c) Saudi’s capital account – here the government is gradually opening its market, which could result in inflows – and (d) global exchange rate movements – for example, reserves can change even if there are no flows at all. Ultimately, I think the level of reserves is mainly decided by the oil price and by broader government policy, particularly exchange rate policy and the management of domestic demand. This is outside of SAMA’s remit.” Yet the low oil prices of present are only a small glitch in the wider scheme of things.

It is worth noting that the Saudi Arabian economy has weathered similar storms in the past – more severe ones, in fact – and survived intact. During the recession of the 1980s and 1990s, Riyadh faced far greater fiscal challenges than it does today: its cash reserves were only 25 percent of its GDP, in comparison to being 100 percent in 2014. Furthermore, the nation’s budget deficit rocketed to 52 percent in 1983 and then climbed to its highest ever level of 77 percent in 1991, yet once again, the economy prevailed.

In the years since, the government has set itself on a path of market diversification and greater participation in the global economy. Additionally, the country’s levels of inequality and unemployment have improved significantly over the past decade. As such, Saudi Arabia is still in the process of undergoing a transformation that will improve its social capital and encourage more parties to participate in its growing private sector. Of course, these measures take time, particularly as they are tied to social status and cultural perceptions – but what is important is that they have begun.
As for the issue of bankruptcy, given the reserves that the state accrued during the years of the oil boom and the discernible financial steps that it has taken over the past year, this scenario is simply not on the cards.

China’s urbanisation developments cause mass movement of people

Posted on January 12, 2016January 21, 2016 by Helen

For thousands of years, the vast majority of Chinese people lived in rural areas. While the emperors held their seats in powerful cities, the ordinary people toiled in the countryside. Rural China was also instrumental in the official story of how the Chinese Communist Party assumed power, with Chairman Mao’s strategy being to build up strength in the countryside before surrounding the cities. Now, however, it is the cities that are increasingly surrounding the countryside.

Chinese urbanisation has triggered the biggest movement of people in history. Rural to urban migration has been a constant in all industrialising economies – from the forced enclosures of early modern Britain, to the creation of slums rimming Latin American cities in the 20th century – but never has such a large wave of humanity departed the countryside for the city as in China in recent years. When China’s Communist Party leaders assumed power in 1949, only 12 percent of the population lived in urban areas. Since the gradual liberalisation of internal migration and economic growth since the 1980s, just under half of China’s billion-plus population has become urbanised.

300 million more Chinese citizens are expected to join them by 2030 – a figure which will require nearly 1.5 million people, roughly the population of Estonia, to become urbanised every month. Chinese urbanisation, however, is not as straightforward as simple rural to urban movements: while old cities are absorbing China’s newly urbanised population, and new cities are springing up, China is seeing urban growth in other, less conventional ways. There are many aspects of China’s urbanisation to consider when trying understanding the astronomical figures.

Nation reclassification
A large part of the urbanisation that China is experiencing is not coming from any migration at all. Of the hundred of millions of Chinese people that have become urbanised in the past few decades, many have become so through the reclassification of Chinese land. Of the projected 300 million new Chinese urban dwellers, 40 percent are expected to become so without having to leave the area in which they live.

Never has such a large wave of humanity departed the countryside for the city as in China in recent years

As Wade Shepard, in his book Ghost Cities of China, noted, this method of urban development in China is known as ‘chengzenhua’, or townification. This, Shepard wrote, is the “transformation of an existing town or village into a small urban centre. It is not urbanisation in the sense of the creation of a city, but the legal reclassification of an area once classed as rural into urban”.

According to The China Story, chengzenhua urbanisation consists of four major components, as sanctioned by the state: “Converting collective land ownership to state ownership; converting the rural household registrations of villagers into urban registrations; reassigning social services provided by village collectives to selected municipal bureaus; and redeveloping villages according to the urban spatial planning regime.”

While this sort of urbanisation is much less intense than that associated with images of concrete tower blocks being erected at breakneck speeds, it is – and will be – much more widespread and in many ways is more experimental and radical. “Rather than migrating to the cities, the cities will literally come to them”, Shepard observed. “This is perhaps one of the largest social experiments that has been played out in human history.”

Cities within cities
Another unusual aspect of Chinese urbanisation is the creation of what amount sub-cities, within the boundaries of existing cities. These new outskirts cities are often larger than many major cities in the West.

For instance, Zhengdong New District is an urban area the size of San Francisco. By 2020, Shepard noted, it will be home to five million people. Founded at the start of the century, and kicked off with $25bn of state funding in 2003, Zhengdong New District seems to have all the hallmarks of an emerging city. Yet a city, in the traditional sense, it is not. Rather, it is an appendage of an even larger city, Zhengzhou, the capital of Henan province.

Zhengzhou is a city of 11 million people and is growing by nearly 10 percent every year, largely as a result of China’s great rural to urban migration. The city itself is old, although it has gone through a number of transformations over the centuries. As this historic city is stretched to its limits, new urban areas such as Zhengdong New District offer an opportunity to relieve some of the pressures of constant expansion. According to Shepard, such new areas on the outskirts of historic cities are acting “as modern, better functioning, car-friendly complements of existing cities”.

Shepard added: “Municipalities all across China are doubling down and building newer versions of themselves.” For instance, Shanghai has developed Pudong, home to five million inhabitants, in a similar fashion, while Tianjin has its Binhai New Area and Changsha has its new eco-city Meixi Lake City. In China, a “twin city paradigm” is emerging, according to James Von Klemperer, designer of Meixi Lake City.

As noted, the increased strain on old cities is seeing these new zones spring up on municipal outskirts. However, it would be a mistake to think of these areas as the sites of migration for new populations pouring in from the countryside. Rather, it is the wealthy citizens in the old historic centres who are moving out to the new urban developments, leaving the crowded centres of historic cities to incoming migrants.

Land grab
China itself isn’t exactly lacking in land, but, as Shephard noted, “along with manufacturing new cities, China is also manufacturing the land that some of them are built on”. For instance, the city of Gansu Province in north-west China, home to over three million people, is sandwiched on narrow 50km strip of land, between the Yellow River and a mountain range. According to News China Magazine, this has caused trouble for its expansion: “It has been suffering from a severe shortage of usable land for years. The city’s airport, for example, had to be built 75km from the downtown area.”

“At present, only 1.3 square kilometres of land is available each year for urban construction in Lanzhou, the smallest area of any city throughout the country. Given the current pace of urbanisation, Lanzhou will have no land for construction within five years”, Li Changjiang, Vice-Director of the Lanzhou Land Resources Bureau, told News China Magazine. As a result, the city has been engaged in a number of plans aimed at levelling and reclaiming land from the surrounding mountains. At the same time, Chinese urbanisation is reclaiming land from the sea. One example among many is Nanhui New City, a new urban area being built within Pudong that is planned to be complete by 2020 and is already home to over half a million people. Built at the tip of the peninsula between the Yangtze and Qiantang rivers, a large part of this new urban development was reclaimed from the sea.

Future towns
Many of China’s new urban builds have been mistakenly labelled ‘ghost cities’, due to the relatively small number of people currently populating them. Reporters from various news outlets have ventured into recently built urban districts or cities, filming eerie footage of seemingly abandoned and uninhabited neighbourhoods. Gazing upon the formidable tower blocks and lonely, wide streets, with scarcely a person in sight, the conclusion is often that China’s urbanisation efforts are in serious trouble.

Yet, in reality, these new cities are not ghost cities: they are yet to be inhabited. These new urban centres are expected to eventually be filled up with new dwellers, looking for city-style homes and lifestyles. Construction on many of these only began in the 2000s; just a decade ago they did not exist. Most of those currently unoccupied were always expected to be so at this moment in time. Most outlines for the construction of new areas put the timeline for completion at 19 to 22 years, noted Shepard. As a result, many are only at mid-development level. As Shepard wrote: “All of the new cities, towns and districts that have been heralded as ghost cities in the international media are just that: new.”

China is in the midst of an extraordinary transition in many ways. Since the 1980s, the country has racked up a number of impressive achievements: the largest amount of people raised out of poverty, unprecedented levels of economic growth, and the largest movement of people from countryside to city – and on the back of all this, it is undertaking the greatest urbanisation project in human history. By 2020, one in eight people in the world will live in a Chinese city.

Addressing the youth unemployment crisis through externships

Posted on January 12, 2016January 21, 2016 by Helen

When it comes to introducing fresh faces into the workplace, one often-heard complaint is that secondary and tertiary education offers little-to-no experience of the skills that are required in industry. With this in mind, alternative forms of employment have emerged as a means of easing new candidates into the workforce – and though the pay is less, the insight into any one particular field of work is invaluable for jobseekers.

Internships, for example, have enjoyed a sudden surge in popularity in recent times. The model is not without its critics, however: ‘exploitative’, say some, and ‘menial’, say others. Indeed, the promise of valuable experience has been obscured somewhat by employers who see the system as little more than a way of accessing cheap – or even free – labour. But irrespective of its critics, the fact remains that ideas like this hold the solution, at least in part, to a youth unemployment crisis in Europe, the US and beyond (see Fig. 1). As such, externships have re-emerged recently as a means to this same end.

Rise of the externship
In short, externships give students and workers an opportunity to shadow an experienced professional, usually over a much shorter timeframe than an internship or apprenticeship might. While internships usually last upwards of four weeks, externships typically range from one day to two weeks and involve far more observation than they do hands-on experience. With less practical work on offer, the nature of the process means that the level of commitment is less for both the student and the company in question.

“Externships serve as valuable opportunities to become immersed in a host’s (and hosting organisation’s) daily activities in order to gain a better understanding of a particular career field”, according to Melissa Schultz, Associate Director of Gateway Programme and Graduate School Advising at Lafayette College. “While traditionally observational in nature, some opportunities may allow for the extern to gain hands-on exposure to work tasks. Through externships, students are often able to attend meetings, tour the workplace, visit with clients and meet with other members of the organisation.”

Externships have been welcomed by employers, as well as students, as a means of plugging the skills gap that exists in certain industries

Those in favour of externships usually hold the opinion that graduates are of limited use to employers without at least a brief stint of practical training, and so learn-and-earn programmes could play an important part in preparing workers for a particular career. “Learn-and-earn is important in today’s increasingly competitive and turbulent work environment, particularly for low-income or under-skilled workers who seek better jobs, a better standard of living and a potential for career success”, according to An analysis of US learn-and-earn programmes, a report published by Michigan State University’s Collegiate Employment and Research Institute.

Keith Bevans, a partner at Bain & Company and leader of the firm’s global consultant recruiting, told World Finance, “At Bain, externships have been a part of our professional development offering for a really long time. I think the surge [in popularity] is felt more by companies that have not thought about it as part of their employee development toolkit. Many young professionals are interested in validating the career vision they have. For us, allowing them to do externships has been a great tool for them to ‘scratch the itch’ while staying at Bain.”

Getting a head start
Mentoring and networking are invaluable aspects of the experience, and an opportunity to preview a field of work can offer a real and intelligible insight into what exactly the job demands of entry-level candidates. Those involved in the scheme often report that the process leaves a long-lasting impression on them during their time in work and, crucially, their decision over which field they would like to work in. “Students benefit from externship opportunities in a myriad of ways”, Schultz told World Finance, “including gaining a realistic understanding of a career field, exploring career options connected to their major, learning about the daily activities of an occupation, gathering information and advice by asking questions of their host and colleagues, and gaining insight that allows them to plan for future courses, internships, and other ways to explore their career interests.”

Schultz told Forbes in 2013 that 86 percent of the students in a Lafayette survey reported that they had stayed in touch with their extern host. What’s more, 99 percent said that an externship had helped them to clarify their career goals, and as many as 93 percent of the hosts surveyed confirmed they would participate in the programme again if given the opportunity.

“For some students, an externship may be their first exposure to a professional setting, which can also help them to gain first-hand experience with standard business practices, professional etiquette, and the culture of the organisation and/or industry they’re exploring”, she told World Finance. “Each of these benefits translates into allowing them to launch professionally (upon graduation) with greater confidence and clarity around the alignment between their skills, abilities, and interests with the professional pathway they are exploring.” However, placements like this are not always the responsibility of the student, and a number of schools and universities are fast beginning to realise that too many students are graduating ill-prepared for the working environment. Discerning institutions, therefore, are forming partnerships with major industry names in the hopes that doing so will smooth their transition into the workplace. “Our education system can no longer afford to wall itself off from the world of industry”, wrote Ayesha Khanna, Co-Founder and CEO of The Keys Academy, in a Project Syndicate opinion piece.

Youth unemployment
The resurgence of the externship concept, which first appeared in the Merriam-Webster dictionary of 1945, at this moment in time is no coincidence: with the issues that are currently plaguing the labour market, both in the US and across Europe, an extra bit of experience can make all the difference.

Looking at figures compiled by the International Labour Organisation (ILO) in its Global employment trends for youth 2015 report, the youth share of global unemployment stood at a worrying 36.7 percent in 2014, and deficiencies in job quality are troubling developed and developing markets alike. On a smaller scale, youth unemployment in the Middle East, Asia and North Africa worsened in the period through 2012 to 2014, and two thirds of all European nations were found to have an over-20 percent youth unemployment rate, with 35.5 percent of that sample out of work for a year or more.

Looking at the period spanning 1991 to 2014, the youth labour force has declined by approximately 29.9 million people. This was during a time where the youth population expanded by 185 million, representing an 11.6 percent decline in the youth labour force. To compound the problem, and underline the case for externships, the reason for the decline is due, partly at least, to greater engagement in secondary and tertiary education – and while it is true that improved education amounts to a positive development, the suggestion that these institutions are largely isolated from the workplace looks only to exacerbate the central issue of youth unemployment.

“Youth employment is now a top policy priority in most countries across all regions, and at the international level is being translated into the development of a global strategy for youth employment and embedded into the 2030 development agenda”, according to the report. “With a growing multitude of country-level initiatives involving many actors and institutions from the public and private sectors, focus now turns to forging partnerships for policy coherence and effective coordination on youth employment.”

An externship, while not necessarily the solution to a gathering youth unemployment crisis, is simply one way of preparing today’s youth more effectively for the demands of the modern-day workplace. Additionally, while much has been made of the obstacles standing in the way of graduates and well-paying jobs, this isn’t to say that there aren’t benefits for employers seeking new talent. Although the issue of recruitment is secondary to that of youth unemployment, externships have been welcomed by employers, as well as students, as a means of plugging the skills gap that exists in certain industries.

Skills shortage
The issue of youth unemployment boils down to much more than there being fewer jobs than there are candidates in the labour market: in fact, McKinsey figures show that a quarter of European employers were struggling to fill vacancies in 2014. Rather than a simple shortfall, there is a mismatch in many parts of the world between young people’s skills and the specific needs of employers.

Figures cited by The Economist, for example, show that 70 companies – not least Microsoft, Verizon and Lockheed Martin – are working with schools to redefine vocational education and cherry pick what skilled employees they find. Likewise, IBM’s Pathways in Technology Early College High School combines high-school education with community college courses and, again, with paid work experience.

Employers, as much as prospective employees, stand to benefit from externships, and should the scheme bridge the skills gap at all, we can expect to see them grow in popularity even more than they already have done. “As employers are seeking to secure interns earlier and earlier in their academic training, the externship programme can often allow the employer to “test” the fit of a potential intern through the shorter-term externship. It also allows employers to showcase their culture and brand to prospective interns or staff members”, according to Schultz.

With students on the one hand struggling to lock down a permanent position, and companies on the other struggling to attract the right candidate, an externship arrangement means that both parties can finally begin to act on the issues dogging the labour market.

Does IKEA truly deserve its non-profit status?

Posted on January 12, 2016January 20, 2016 by Helen

Despite having a reputation as a store that people loathe having to visit, IKEA has established itself as the world’s premier place for all manner of cheap furniture. It has expanded rapidly over the last few decades, becoming the natural first suggestion when anyone says they need a new piece of home furnishing.

With reported global sales of €26bn each year, the company is far and away the largest furniture retailer in the world. It now has around 135,000 employees spread across 44 countries around the world, and whenever a new store opens, its presence is seen as a signifier of a newly gentrified region.

However, thanks to a somewhat unique corporate structure, the company has managed to position itself as a non-profit organisation that doesn’t play by the same tax rules as its rivals – indeed, IKEA is reported to have managed to pay around 33 times less tax than its rivals. While charitable organisations are rightly given tax exemptions that enable them to continue to do their good work, it is somewhat questionable whether a company the size of IKEA – which is unrivalled within its marketplace – deserves such a status.

Charitable CEO
Swedish businessman Ingvar Kamprad founded the firm in 1943. Though official figures are hard to come by, Kamprad claimed in 2013 that his wealth was a mere €108m, a disclosure that was forced from him after he chose to move back to Sweden from the tax haven of Switzerland. However, despite his claims, it is thought that he is worth considerably more, with some estimates putting his empire at around €43.2bn and the value of IKEA itself widely thought to be around €66bn. In fact, Kamprad is considered to be the eighth wealthiest person in the world. However, according to a 2014 article in Australian Financial Review, the 89-year-old Kamprad insists that he gave away all his wealth to charity back in 1982. The main charity in this case – a Dutch institution called the Stichting Ingka Foundation – was set up with the intention of “safeguarding the future of furniture”.

Kamprad has recently begun paying normal taxes in his homeland of Sweden, having lived outside the country for more than 40 years: he fled in 1973 to avoid paying the high levels of tax that the government of the time imposed, and has lived in Switzerland for much of the time since. This is despite his passion for his homeland, with all of his stores proudly promoting a variety of Swedish products, including food.

Part of the reason for his move back to Sweden is the new, lower tax rate that the country is offering. However, despite this relocation back to the company’s homeland, the Stichting Ingka Foundation continues to enjoy a non-profit status, resulting in minimal tax levels for the whole company. This fact comes in spite of its position as the leading furniture retailer in the world, operating within a marketplace full of privately run businesses that are required to pay normal levels of tax.

€26bn

IKEA’s reported annual
global sales

375 Stores worldwide

884m

Store visitors every year

Not for profit
IKEA has taken pains to position itself as a caring, sustainable and environmentally conscious firm in recent years. Investments in renewable energy schemes have come alongside a series of community projects and plans to encourage people to save on energy and waste in their homes. The firm’s not-for-profit status has partially come as a result of its stated ambition to provide cheap and affordable furniture to aid living standards, with its mission statement claiming that it wants to “create a better everyday life for the many”. In the same statement, the company claimed: “Our business idea supports this vision by offering a wide range of well-designed, functional home furnishing products at prices so low that as many people as possible will be able to afford them.

“Low prices are the cornerstone of the IKEA vision and our business idea. The basic thinking behind all IKEA products is that low prices make well-designed, functional home furnishings available to everyone. We are constantly trying to do everything a little better, a little simpler, more efficiently and always cost-effectively.” However, critics across the globe are beginning to question whether this is in fact true.

Despite the caring demeanour, the finer details of IKEA’s corporate structure suggest that it isn’t quite as generous as appearances might suggest. The Stichting Ingka Foundation is reported to have made billions of dollars in profit, but has donated relatively small amounts to actual projects. Indeed, 10 years ago the foundation was estimated to have accrued around €33.5bn in funds in a report by The Economist, which made it the world’s wealthiest charity at the time. The article went on to point out just how stingy the foundation was, giving comparatively little to projects or other charities while paying considerable amounts to the Kamprad family itself.

Instead of pouring its resources into charitable projects, the foundation owns Dutch company Ingka Holdings. This firm in turn owns the IKEA Group, which operates all of IKEA’s global retail stores. Such a complex structure isn’t entirely unheard of, but in this instance, the fact that Ingka Holdings is owned by a non-profit foundation means that it has been able to secure far lower tax rates than its competitors. However, the structure of the company gets even more convoluted: the ‘IKEA’ trademark itself is owned by yet another company called Inter IKEA Systems, which is based in the tax haven of Luxembourg. This firm takes care of the franchising side of the business, while Ingka Holdings is in charge of operations.

In response to the article by The Economist, Kamprad did make an effort to change the structure of the foundation in the Netherlands so that it would contribute more of its resources towards fighting child poverty around the world – however, many global firms run charitable programmes without qualifying for non-profit status, and as a result, questions still remain over whether IKEA’s corporate structure truly warrants this designation.

As recently as November, the company was doing battle with a US tax authority, when a much-delayed store being built in Memphis, Tennessee faced challenges from the Shelby County tax assessor over a $9.5m tax break that IKEA had received from the local government. While IKEA’s store is highly coveted in the area, signifying gentrification and bringing in much-needed new jobs, concerns over a major corporation receiving such a generous tax exemption are understandable.

Green fingers
The company has been doing its part in certain areas, however. Its sustainability efforts have been widely praised; in particular, its determination to run operations using almost entirely renewable energy sources. Earlier this year, the company unveiled a massive campaign to highlight its green credentials, dedicating a huge amount of money to making its retail stores and factories more energy efficient.

Thanks to a somewhat unique corporate structure, the company doesn’t play by the same tax rules as its rivals

In an interview with innovation website Co.Exist in June, IKEA’s Chief Sustainability Officer, Steve Howard, spoke of how the company is committed to fighting climate change through its business practices. Having pledged €1bn towards renewable energy and climate change combatting schemes, Howard spoke of how the business community was only now beginning to take climate change seriously: “We looked at this issue and said there hasn’t been enough positive advocacy from the business community. It’s only now that we’re starting to see more businesses step up in this space.”

While many other firms have invested considerable sums of money into existing renewable projects, or have taken stakes in other schemes, IKEA’s approach has been to wholly own the projects they’ve invested in. The company currently has around 23 wind farms and 700,000 solar panels around the world, according to Howard. He told Co.Exist: “We’ve said we’ll go a little bit further and directly own and operate the renewables ourselves. We haven’t got a specialist, dedicated team who manages our wind operations worldwide – we’re an independent renewable power company at the same time as a home furnishings business.”

Part of the reason for purchasing its own renewable energy infrastructure was to insure against an uncertain future for the global energy market, said Howard. “I’ve often said that, from a sustainability point of view, you can always construct a business case for doing the right thing. This delivers a deep return on investment. But it’s also the most enabling thing we can do to help grow renewable energy production worldwide at a time when we need to really rapidly decarbonise our energy systems. It’s a meaningful thing that we can do at scale.”

While IKEA has pressed ahead with many of its renewable partnerships, in November it was reported to have cancelled a large deal with Hong Kong-based Hanergy Thin Film Power, a solar panel maker that is currently under investigation for questionable accounting policies. While IKEA didn’t use the panels itself, it has sold them within its stores.

The company’s pledge of €1bn for renewable technologies and its stated commitment to powering all stores using renewable energy by 2020 are certainly laudable. However, questions remain about whether such promises are mere window dressings for a hugely profitable company that has come under intense scrutiny in recent years for its tax affairs.

Ascott REIT on target for S$6bn assets as Asia’s hospitality market booms

Posted on January 11, 2016January 11, 2016 by World Finance

The real estate market in Asia has been sizzling over the past years. And with the region an important destination for business travel, it’s sparked demand for serviced residences. Ronald Tay, CEO of Ascott Residence Trust Management, talks about the REIT’s growth prospects, Ascott’s latest acquisition in New York’s Times Square, and the differences in hospitality across different regions.

World Finance: The real estate market in Asia has been sizzling over the past years. And with the region an important destination for business travel, it’s sparked demand for serviced residences. With me to discuss is Mr Ronald Tay of Ascott Residence Trust Management.

Mr Tay, it’s been nine years since Ascott REIT launched: what’s been your management strategy, and how do you ensure the stable and growing distribution for unit holders?

Ronald Tay: Today, I’m quite proud to say that Ascott REIT is the largest hospitality REIT that’s listed on the Singapore stock exchange by asset size, as well as by market capitalisation.

We have a three-prong strategy. First, we have been very aggressive and active on the acquisition front. Second is in terms of active asset management: all the assets that we own, all the properties that we own, we ensure that they are up to date. This is obviously to drive the revenue path of the property, and to drive the underlying performance as well.

And the last prong is in terms of prudent capital management – that is in terms of our balance sheet management, how we hedge our interest rate risk and our foreign exchange risk to mitigate the volatility of the earnings of the REIT.

Read more from Ascott Residence Trust Management

World Finance: We have of course been hearing a lot about the Asian growth story, so is Asia a key growth market for you? And why?

Ronald Tay: If you look at our acquisitions over the last 18-24 months, I would say the bulk of them would be from Asia.

Europe obviously is a big market for us; it’s a very important market. But Europe is a more stable market for us. Whereas, if you look at the growth market in Asia, according to some IMF studies, in 2015 and 2016 Asia is looking at GDP growth of about five to six percent.

And that is primarily one of our key growth drivers as well. Because we are focusing on the corporate market, the extended stay market. So key indicators like GDP growth and FDI growth are important factors for us. And that is where I think in the medium to long term, Asia will be the growth market for the REIT.

World Finance: You’ve set a target asset value SGD6bn by 2017 – are you on track?

Ronald Tay: We have been growing very aggressively since our listing in 2006. Today our asset size is about SGD4.7bn, and we will reach about SGD5bn by 2017 with one of the contracts that we have signed. Over the last 18 months we have acquired about 14 properties.

We hope to continue this growth momentum, and I think given that our mandate is a global mandate, we will look at Asia, Europe, and of course most recently we have gone to the US market as well. So these are the markets we will be targeting, and keeping our fingers crossed we should be able to reach our SGD6bn target.

World Finance: Why did you choose to enter the US market? And why Times Square in particular?

Ronald Tay: Obviously it’s a very, very developed, very mature market, the US hospitality market. But to be a global hospitality player, we cannot ignore the US market. And also, over the last two years or so, the US economy has been on the upswing.

Why Times Square? We focus mainly on business cities, so where else to go but the Big Apple, New York City itself. It’s a great location, midtown Manhattan, just five minutes walk from Times Square. But most importantly it is built as an extended stay product, which is very similar to what we do.

So we like the product, we like the location. Obviously the pricing is something that we find attractive as well. So that’s our maiden acquisition in the US: hopefully more to come.

World Finance: And finally, how does the hospitality market differ in different regions, from the Asia-Pacific to Europe, and indeed to the Americas?

Ronald Tay: In the US and Europe, it’s a much more developed market compared to Asia. Asia of course includes some of the emerging markets like the Philippines, Vietnam, and even Indonesia. Because of the difference in developing markets, the average length of stay in Europe and the US tends to be a bit shorter, because there are a lot more accommodation options available in developed markets such as Europe and the US.

The other main difference is that of course, being more developed markets, the capital values of the real estate in Europe and the US tend to be a lot higher, compared to Asia.

It’s important for us to have a good balance between the developed market, where the income is a lot more stable, and the growth market in Asia, which gives us the growth in terms of revenue and income stream over the medium to longer term.

Top 5 trends from the Legatum Prosperity Index

Posted on January 11, 2016January 19, 2021 by Ashton Wenborn

What can be expected from the 2015 Legatum Prosperity Index is a handful of countries located in Northern Europe consistently dominating the top places of the overall rankings, while countries whose names have become synonymous with political instability tend to languish near the bottom.

However, the rankings, being both comprehensive and annually produced, allow for some interesting trends and developments to be identified. Here are five of the most interesting findings from the 2015 Legatum Prosperity Index, released in January 2016.

Canada, Norway, New Zealand, Iceland and Ireland are the world’s five most tolerant countries when it comes to immigration

1. Norsemen head south
Scandinavian countries are used to dominating international rankings, be it for economic prosperity, political stability, education or well being. When it comes to the Legatum Prosperity Index, they remain high: Norway has topped the rankings for the past seven years with no exception this year, while Denmark came up third, followed by Sweden in fifth places and Finland in ninth, while Iceland sat at a 12.

However, three out of the five countries that make up Scandinavia have seen their places within the economy subsection of the index decline since 2009. Much of this is a result of the failure of these nations to deal with chronic unemployment. Sweden has an unemployment rate of 7.8 percent, Denmark 6.3 percent, while Finland has a rate of 9.4 percent.

Although other countries have seen their unemployment rates decline having previously risen from the fallout of the 2008 financial crisis, Nordic rates have persisted, failing to reach pre-crisis levels.

2. Fifty-year landmark
Last year was a landmark year for Singapore. The small island city-state marked 50 years of being an independent nation, following its messy divorce from a union with its neighbour Malaysia in 1965. The man who weathered the new nation through this split, Lee Kwan Yew also died in 2015. Both events prompted much reflection upon the course that Singapore has travelled over these 50 years of nationhood, particularly its story of economic success, turning from a small and insignificant fishing island, to a modern economic powerhouse and world financial centre.

It is fitting then, that the country in 2015 achieved first place in the economy subsection of the Legatum index. The country now has a per capita income of $240,750 per worker, while nearly half of its manufactured exports are classified as ‘high-tech’, the third highest proportion in the world.

3. UK on the up
Since 2013, the United Kingdom has seen dramatic economic improvement. According to Sian Hansen, the Executive Director of the Legatum Institute, in the forward of the index, “since 2013, the UK has improved the most economically of any major EU economy. This is partly because full time employment amongst the poorest has risen from being the second lowest of any major developed economy in 2009, to the highest of any major economy in the EU.”

Linked to this – either stemming from, or being the cause of – the UK is an increasing world-leader in entrepreneurship. In this years’ index, the UK ranked 6th on the Entrepreneurship & Opportunity subsection and improvement up from 8th place last year.

Further, the country has seen cultural attitudes towards entrepreneurialism increase: according to Legatum, 88 percent of Britons believe that if you work hard you can get ahead in life, a slight increase from the 84 percent who said they believed so last year, and a sharp increase from the 78 percent who responded in the affirmative in 2010.

4. Indonesia improving
For much of human history, the centre of the world economy was in Asia. For a brief interim, Western Europe took up the position of world economic leader, before reluctantly passing the mantle to the US. In recent years however, the axis of the global economy is tilting back towards to the East.

While China and India, as the two most populous countries in the world, are at the forefront of the re-rise of Asia, other countries in South East Asia have also been quietly picking up steam – Indonesia in particular. In the past seven years the archipelago nation has climbed 21 places upon the Prosperity Index – more than any other country in the world. It has risen by 23 places in the Economy subsection and 14 in the Entrepreneurship and Opportunity subsection.

5. Migrants welcome
Immigration increasingly fuels political debate in the advanced economies of Europe and North America. Some nations have seen the rise of anti-immigrant parties or political candidates, while others have seen governments increasingly crackdown on immigration. Some countries, however, have remained steady in their welcoming attitudes towards migrants wishing to live among them.

Canada, Norway, New Zealand, Iceland and Ireland are the world’s five most tolerant countries when it comes to immigration. When asked if their country is a good place for immigrants, over 90 percent of respondents responded yes, with the exception of Ireland, where 89 percent replied in the affirmative.

Belfius Bank secures EIB partnership to build Belgium’s smart cities

Posted on January 11, 2016January 11, 2016 by World Finance

In the age of sustainability, smart cities are becoming more important. One bank at the forefront of this is Belgium’s Belfius Bank, which offers specialised financing for such projects. Belfius Bank’s Karmen Wijnant talks about the aims and objectives of its €400m partnership with the European Investment Bank, and the kinds of projects already benefitting from the funding.

World Finance: In the age of sustainability smart cities are becoming more and more important. One bank at the forefront of this is Belgium’s Belfius Bank, which offers specialised financing for such projects. Karmen Wijnant from the bank joins me down the line.

Karmen, firstly: how did the idea for smart cities emerge? Who were the key instigators and founding partners?

Karmen Wijnant: We developed this programme together with the European Investment Bank in order to offer specific financial solutions to local authorities that want to finance smart and sustainable projects in the fields of urban regeneration, energy efficiency and mobility.

These solutions complement other, more classic solutions that have existed for a long time already, such as straight loans, bonds etcetera.

From the beginning, we wanted a programme that was within reach of all cities and municipalities, big or small. The Smart Cities programme needed to be adapted to the Belgian context, with over 98 percent of Belgians living in an urban environment, but only a few Belgian cities having more than 100,000 inhabitants.

As a consequence, cities and municipalities often operate one a small scale and lack the financial means to realise important projects, especially when they should be combined and integrated into a larger urban development plan.

Our programme facilitates the access to funding in order to realise these projects. Besides, almost half of the Belgian local authorities signed the Convention of Mayors and committed themselves to reduce CO2 emissions. We help them meeting that challenge.

World Finance: How did Belfius Bank get involved?

Karmen Wijnant: For over 150 years, we have been the financial partner of local authorities. Sustainability is also part of our own ambition: being a sound bank-insurer with the highest commitment to society. We want to stimulate and support the Belgian cities and municipalities to integrate a holistic approach towards the subject of smart cities. This requires more than just offering the financial solutions you’d expect from your bank.

World Finance: The bank decided to collaborate with the EIB for this programme. What does the partnership consist of?

Karmen Wijnant: We approached the European Investment Bank in 2013 with the proposal to develop a co-financing programme based on very concrete criteria around urban regeneration, energy efficiency and mobility.

It’s the first time in Europe that these domains are being covered in such a programme. In this way, we created a €400m credit line – €200m by the EIB and €200m by Belfius – for projects that match those criteria.

Each project needs a case study of its own, resulting in its own optimised financing solution for the administration and their partners realising the project.

World Finance: Partnerships really seem to be key in the bank’s Smart Cities approach: would you say that’s correct?

Karmen Wijnant: Absolutely. We want to go beyond providing just financial solutions you would expect from any bank. Together with our partners, we play an active role in the exchange of knowledge.

Just to mention a few examples: we are member of BELESCO, the Belgian federation of energy service companies (ESCOs), in order to develop financial solutions to create a take-up of the ESCO-market in Belgium. We are the only commercial bank collaborating in the European Innovation Platform to develop new business models for smart cities.

We also collaborate on the European Horizon 2020 project around deep renovation of social and individual housings. And in Belgium, we are one of the founding partners of the Smart City Institute, hosted in the university of Liège.

And, last but not least, we have a Smart Cities partnership with Agoria, the Belgian federation of technological industry.

World Finance: How important is technological research and development and long-term urban planning to the success of the Smart Cities idea?

Karmen Wijnant: It’s very important: long-term urban planning and technology play a key role in the success of smart cities for many reasons.

For instance, one of the major criteria for all supported projects is that a city or municipality must demonstrate through a pluri-annual plan that they have a long term sustainable strategy and vision that confirms the European 2020 objectives.

Technology and R&D is also key, because innovation in technology, ICT, servicing and governance is one of the criteria we set out with the EIB in our co-financing programme in order to be an eligible project. We also support technological research in the field.

Belfius is the first commercial Belgian bank signing the InnovFin programme for small and medium enterprises and small midcaps with the European Investment Bank. We also work together with Agoria, the Belgian federation of the technical industry. Smart Cities is one of their major transversal business development themes and we are the only bank in the Smart Cities workgroups.

World Finance: Finally could you give us some cases of realised projects in Belgium?

Karmen Wijnant: We recently inaugurated two projects: one of them is the new town hall of the Town of Gembloux, in the Walloon region. The project was based on an integrated, innovative and sustainable approach, with a strong focus on energy performance and accessibility for persons with reduced mobility. And that’s why it became eligible to receive funds through our programme.

The second one is the installation of a plant for compressed natural gas (CNG) by IMOG, an inter-municipality in the Flemish region. IMOG encourages people and businesses to use this cleaner means of transport: a successful approach since several companies already bought trucks and cars running on CNG.

Apart from these two inaugurations, more than 100 projects are under investigation, and plenty of them are already being financed via this programme.

Saudi Arabia’s energy reforms could save billions

Posted on January 11, 2016January 21, 2016 by Helen

On December 28, 2015, Saudi Arabia introduced energy subsidy reforms that were expected to save $7bn a year. Released by the Finance Ministry, the reforms, along with spending cuts aimed at raising tax revenues, marked the biggest reorganisation of the country’s economic policy for over a decade. However, Saudi Arabia’s cradle-to-grave welfare state has bred a society that is reliant on subsidies, and so, while the reforms may be necessary to stabilise the economy, they face the challenge of public opposition.

Last year the world’s top oil exporter posted a record budget deficit of $98bn – 15 percent of GDP – while the total cost of energy subsidies was estimated at $61bn. Due to a $123bn fall in oil revenues, income for the year dropped to $162bn, the lowest since the global financial crisis. Over the last decade, oil accounted for an average of 90 percent of total revenues, yet looking at last year alone, this figure dropped to 73 percent.

Public backlash

The IMF has estimated that energy subsidies have cost Saudi Arabia $107bn, an extortionate amount that is massively in need of a reduction. In the state’s budget report, energy subsidy reforms were central to reducing the pressure on the country’s economy.

According to Jadwa Investment, direct savings from the price hike on diesel are estimated at $2.75bn. Gasoline price rises are expected to save an additional $2.5bn. The rest will come from price hikes on natural gas, fuel oil and propane.

It is clear that these reforms are essential for nurturing the Saudi Arabian economy: the former Saudi petroleum ministry senior advisor, Dr Mohammed, told the BBC that they are “necessary, and not a luxury”. However, with the cradle-to-grave welfare state mind-set ingrained in the country’s economic policy, a negative popular reaction is expected to hinder the reforms. Such drastic alterations have the potential to provoke a social backlash, especially if the rulers ignore the people’s most basic requirements.

At the risk of agitating the population, King Salman nonetheless announced the first subsidy price rise in the budget, and so the price of cheap petrol increased by 40 percent overnight. It was also announced that there were more changes to come, with plans to decrease other subsidies, reduce the growth of public sector salaries and limit the country’s dependence on oil in the pipeline.

There are already people opposing the energy subsidy reforms: Saudi Arabia’s oil minister, Ali al-Naimi, disagrees with the subsidy lifts. “You only go back and take away assistance if you are in dire need. And, fortunately, Saudi Arabia is not today in such dire need”, he told a forum in Riyadh.

The reforms may have a substantial impact on the population’s wellbeing, and will therefore likely prove unpopular, but the state has set in place other measures so that residents are not left in financial jeopardy. According to the Financial Times, a senior official said that the government plans to extend welfare payments, such as unemployment benefits, so that the country’s poor and middle-classes are not as largely affected by the subsidy cut. He also said that businesses affected by the rise in expenses would be offered cheap loans in order to lessen the impact.

Leading the rest of the region

If the economic improvements outweigh the social repercussions of the energy subsidy reforms, it could potentially create a knock-on effect throughout the rest of the Gulf region. In a press release in November, Christine Lagarde recommended a course of action for the GCC on how to move beyond the oil drop, saying that “the main elements are common across countries: an expansion of non-oil tax revenues; raising energy prices which are still well below international norms; firm control of current spending, particularly on public sector wages; and a review of capital expenditures. Reforms to strengthen the fiscal frameworks would support these consolidation efforts.” The IMF stated that it expects the Arabian Gulf states to move faster on spending cuts rather than introducing taxes in the face of massive budget deficits.

Kuwait has shown its intentions to proceed with subsidy cuts. But as the state also has a large population that is dependent on government support and subsidies, the reforms face the same social obstacles as those in Saudi Arabia.

With oil accounting for more than 90 percent of Kuwaiti revenues, the Kuwaiti leader, Sheikh Sabah al-Ahmad Al-Sabah, called for “urgent measures”, one of which was to adopt economic reforms. Last September he said, “The decline in global oil prices has caused state revenues to drop by around 60 percent while spending remained without any reduction, leading to a huge deficit”. He added, “I also call on every citizen to realise the importance and usefulness of these reforms.”

However, these reforms are easier said than done: Kuwait already attempted to lift energy subsidies last year, on both kerosene and aviation, and both came up against a public backlash. Strikes occurred, and the government began making exemptions for particular groups. As such, further spending cuts to electricity, water and petrol subsidies could create further agitation among the Kuwaiti population.

There is no doubt that to alleviate the pressure of the oil drop, spending on energy subsidies needs to be significantly reduced, yet implementing these reforms without consequence for the population at large is unlikely. The process needs to be handled carefully. The UAE this year managed to lift subsidies on petrol with no public backlash, if Saudi Arabia can do the same, then the rest of the Gulf region may follow.

41,000

Signatories to a petition for a federal investigation of ExxonMobil

$2.03bn

Exxon’s ‘downstream’ earnings, Q3 2015

$603m

Exxon’s ‘upstream’ losses, Q3 2015

$72bn

Puerto Rico’s debt

70%

Debt-to-GDP ratio

$2bn

Recommended annual spending cuts by 2020

$2.5bn

Recommended annual spending cuts by 2025

€26bn

IKEA’s reported annual global sales

375

Stores worldwide

884m

Store visitors every year

IKEA’s reported annual
global sales