Autumn/Winter 2010 by Wharton International Business Review

iBR

AIR BALTIC Clear For Take-Off CHINESE COPPER Surge Or Stockpile?

PUBLISHED BY UNDERGRADUATE STUDENTS OF THE WHARTON SCHOOL - UNIVERSITY OF PENNSYLVANIA

Fall 2010 - Vol. 2 No. 01

EQUITIES The Cult Is Dead

DEBT CRISIS IN EUROPE

Back From The Brink For Now?

INTERVIEW Dean Robertson, The Wharton School

INTERVIEW Dr. Josef Ackermann CEO, Deutsche Bank

EXPORTS & GERMANY Wirtschaftswunder 2.0 BRAZIL The Real Under Siege

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Until he perfected the invention that would change everything, Thomas Edison would not rest.

Until you see us in a diıerent light.

A light that reveals a new way of doing business. That shows there are new standards. That challenges convention. And opens up new opportunities. Until you see that what needed to shift has shifted. And what was good is still good. If not better. Until you see that we’re always working. Always improving. Without fuss. Without hype. But with integrity and utter clarity. Until then...

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International Business Review

Fall 2010

CONTENTS JOSEF ACKERMANN

DEUTSCHE BANK

For the Fall 2010 edition, the editorial staff of the IBR had the rare opportunity to interview Dr. Ackermann and talk about the future of the Euro, global debt crises, and the requirements of living a fulfilled life.

THE CULT IS DEAD: END OF THE AGE OF EQUITIES Eleni Spilopoulou

12 10

SPECIOUS CIRCULAR Sean Caverly and Randall Roth

EUROPEAN DEBT CRISIS: BACK FROM THE BRINK... FOR NOW Charles Hendren

THE FUTURE OF PRIVATE EDUCATION IN SWEDEN Adrian Bostrom and Carl Michael Tideback

DEAN THOMAS ROBERTSON THE WHARTON SCHOOL

40 24

Throughout our interview with Dean Thomas Robertson, we had the chance to learn about the future of the Wharton School, the importance of school rankings, and the new positioning of business education around the globe. FA L L 2 0 1 0

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ARTICLES BRAZIL THE REAL UNDER SIEGE Since the start of the global downturn, Brazilian central bankers have had a difficult time managing the country’s currency. On March 2009... Erik Buischi

AIR BALTIC NOT SO GREEN ANYMORE Try to find a flight from Paris to Tel Aviv, and airBaltic, Latvia’s national flag carrier, will probably offer to give you a lift. Your next stop will be in Riga... Janis Kreilis

TAIWAN AND CHINA ALL EGGS IN ONE BASKET?

30 44 46

RUSSIA’S TECH BOOM A FAIRY TALE OR REALITY? At the 3rd annual Russian nanotech conference that opened in November 2010, Steve Ballmer, the CEO of Microsoft, pledged full support to the development of... Serge Morell

MIDDLE EAST

54 IRAN’S TRYST WITH SANCTIONS 58

Iran’s nuclear program dominates most discussions on nuclear proliferation, potential weapons of mass destruction, and international security threats... Akshay Subramanian

Investors have to diversify their investments in order to safeguard their earnings. Taiwan, under President Ma Yingjeou, has taken steps in the opposite direction... Eli Tung

JANET ROTHENBERG PACK, PH.D. Janet R. Pack, Professor of Business and Public Policy and Real Estate at the Wharton School, provides some insight on the current real estate market within metropolitan Philadelphia, also in comparison with other cities throughout the United States.

INTERNATIONAL EDITORIALS AMERICAS Brazil: The Real Under Siege 30 Nationalization in Venezuela: 32 Chavez and the Agricultural Sector 30 US-Latin American Relations: The Big Downturn 34 EUROPE Germany and Oktoberfest: Deflation Kept at Bay Wirtschaftswunder 2.0: Germany - The Odd One Out Spain and the Case for Labor Reform Where is Italy’s Growth? Air Baltic: Clear for Take-Off

37 38 40 42 46

MIDDLE EAST 54 Iran’s Tryst with Sanctions RUSSIA 44 Russia’s Tech Boom: A Fairy Tale or Reality? ASIA 56 58 60 62 64

India: Labor Laws Taiwan and China: All Eggs in One Basket? Chinese Copper: Surge or Stockpile? China and Real Estate Singapore: World Class Business Hub

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iBR International Business Review

FROM THE EDITORS

Founder, Editor-in-Chief Daniel P. Hellwig Senior Manager Hamad A. Almudhaf

The International Business Review is a student-run publication,

Publishing Manager Diego Arroyo

featuring business-related editorials as well as internationally

Senior Editors David Vinnikov Art Director Tina Xie Online Editor Evan Rosenbaum Communication Nicole Hwang International Editors Erik Buischi Charles Hendren Janis Kreilis Nicholas Theuerkauf Contributing Authors Adrian Bostrom Sean Caverly Sindhura Chitturi Nelson Chiwara Romina Colmenares Sohum Doshi Akshay Kanoria Ian Lim Max Maeckler Serge Morell Cyrus Moshiri Ram Narayan Randall Roth Alan Sostek Eleni Spiliopoulou Akshay Subramanian Carl Michael Tideback Michael Totah Eli Tung Faculty Advisor Prof. Janice R. Bellace Prof. Nicholas Gonedes

oriented interviews and articles. We aim to provide a forum to exchange ideas, opinions, and perspectives on economic issues, as well as to enhance communication and spark debate amongst students, faculty, alumni and the business community, alike. The fall 2010 edition of the International Business Review focuses on this summer’s debt crisis in Europe. Throughout the Àrst quarter of 2010, the general atmosphere was marked by relief. The global economy was no longer on the brink of collapse, and markets continued to recover. Yet, only a few months later, the sovereign debt crises in Europe de-stabilized the world economy yet again. Dr. Josef Ackermann, CEO of Deutsche Bank, stated clearly during our interview that “the risk of unsustainable sovereign debt or even a sovereign default altered the sentiment in the markets and consequently the political community in the Euro area.” Going forward, we should continue to be alert and aware of how these changes will alter the global economy. In our quest for innovation and reader inclusion in ongoing iBR discussions, we are introducing iBR Reader Response, an interactive way for our readers to discuss issues on our website. We hope this

adds a more interactive element, allowing us to further explore the magazine’s content. We would also like to thank the Wharton Undergraduate Division for their continued support.

International Business Review 3925 Walnut Street, Suite 1403 Philadelphia, PA 19104 Telephone: 215-796-4975 contact@ibr-magazine.com www.ibr-magazine.com The IBR is published by undergraduate students of the Wharton School at the University of Pennsylvania.

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Daniel P. Hellwig (W’11)

Hamad A. Almudhaf (W‘11)

Editor-in-Chief

Senior Manager

danielpa@wharton.upenn.edu

almudhaf@wharton.upenn.edu

I N T E R N AT I O N A L B U S I N E S S R E V I E W

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THE CULT IS DEAD: END OF THE AGE OF EQUITIES BY E L E N I S P I L I O P O U LO U (C ‘ 1 2 )

he most recent decade has been

or whether it is merely a cyclical product

will allocate to the assets with the most

unkind to equity investors.

of managers getting burned in the recent

attractive expected return per unit of

downturn.

Depending on the temporal

risk (this is a gross representation of

Professor Jeremy Siegel of the Wharton

nature of such a shift, signiÀcant impact on

much more refined concepts, beyond

School, has returned an average of 6.5%-

asset prices will follow.

the scope of this article). Therefore,

For

an asset class that, according to

7% per year in real terms since 1802, the

if either risk goes up (denominator)

pathetic return of 4% earned on global

or expected return (numerator) goes

equities is disheartening. To add insult

down, equities will look less attractive

to injury, the 1999-2009 decade has seen

to investors going forward.

two bear markets with a 50% drop in

Let’s start off with volatility, a common

value, according to Robert Buckland of

measure of risk in portfolios. David Laster

Citi. What this means in practice is that

and Kevin Cole of the FRBNY

investors earned a paltry return but had

evidence of increasing equity volatility

to withstand considerable volatility.

since the 1950s in the chart below. Laster

provide

Thus, after such a decade that ended

& Cole attribute this mainly to the then

with the start of the Great Recession,

(1996) record levels of the Dow coupled

one cannot blame institutional investors

with mean- reverting tendency in price

for implicitly declaring the end of what

volatility, which would result in a climb

Buckland calls the “Cult of Equity”.

back up to pre-WWII volatility levels, up

The

from a period of relatively low volatility.

phenomenon, which started around the

To illustrate the effect of increasing

1950s, when according to Buckland, a time of world prosperity and Markowitz’

So why would it be different this

volatilities in the context of portfolio

Modern Portfolio Theory ushered in an era

time? After all, the US equity markets

management, it is useful to assess the

of escalating allocations to equities, is now

have gone through drastic downturns

amount portfolio volatility that one can

being questioned. Buckland estimates that

since 1950, and yet, the Cult of Equity

attribute to equity volatility.

in 2006, 70% of US pension fund assets

has remained steadfast.

Montier of GMO LLC

were invested in equities compared with

tackle this question, we must first

since the 1980s, 90% of the volatility in

2009 allocations of 55%. The question that

understand that asset allocation is at

a portfolio comprised of 60% equity/40%

remains is whether such a “de-equitisation”

least in theory driven by a trade-off

bonds

of institutional portfolios is a secular trend

between risk and return.

year) could be attributed to equity

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In order to

Managers

(returning

James

estimates that

around

11%

per

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Volatility Measures for the Dow Jones Indusrtial Average, 1946-96 Daily volatility (percent) 2.5 Panel A: Standard Deviation and Median Absolute Percentage Change 2.0

Standard deviation

1.5

October 1996, Laster & Cole

1.0

0.5 Median absolute percentage change 0 1946

95 96

Source: Current Issues In Economics & Finance – Volume 2 Number 11, October 1996, Laster & Cole

“IF THE US IS INDEED UNDERGOING A SECULAR CHANGE IN ASSET ALLOCATION STRATEGIES, THIS WILL LIKELY LEAD TO A LASTING CHANGE IN ASSET PRICES.” Thus, while many think

amounts of their portfolios to equities,

market will follow suit as investors

of a 60/40 equity to bond portfolio as

they pushed equity dividend yields to

have, for the 25th week in a row,

“balanced”, it is indeed exposed to

levels below that of both the 10 year

withdrawn funds from equity mutual

a disproportionate amount of equity

Treasury and A A A corporate bonds.

funds on a net basis, according to ICI.

risk. Therefore, a secular increase in

One can interpret this as a richening

If the US is indeed undergoing

volatility would only further lead to

of equities in relationship to bonds.

a secular change in asset allocation

even greater portfolio f luctuations due

Academics have found that dividend

strategies, this will likely lead to

to equity allocation and keeping the

yields are positively correlated with

a lasting change in asset prices.

equity premium constant, to a reduced

stock returns

decrease in demand for equities, while

equity bias in portfolios.

dividend yields could imply lower future

keeping

can

only

stock returns. Buckland defines this

result in a decrease in prices.

The

volatility.

Regarding returns,

expected

Buckland

also

future

and therefore, low

supply

constant,

makes

phenomenon as the “reverse yield gap”

implications for such a scenario, were

before

the

and as an indicator of the prevalence

it to come true, would span all sectors

start of the cult of equities in the

of the “cult of equities.”

of American life, from pension fund

1950s, the spreads between US equity

Buckland observes that the reverse

holdings

dividend yields and both the Moody’s

yield gap has disappeared, meaning

to the way individuals manage their

US Corp Bond Yield (A A A) and US 10

that investors’ irrational belief in the

retirement account. It seems that after

Year Treasury yield were both positive.

equity markets is already decreasing.

claiming major investment banks as

This meant that equities yielded more

In the US however, the SP 500 yielded

victims, the Great Recession rode on

than both corporate A A A rated bonds

1.85% while the US 10 Year Treasury

and buried the cult of equities. iBR

and 10 Year US government bond

bond yielded 2.66% (at time of print).

ever-increasing

Nonetheless, it is likely that the US

interesting

investors

observation:

allocated

In Europe,

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executive

compensation

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STIMULATORS VS. GREAT INFLATORS: SPECIOUS CIRCULAR BY S E A N C AV E R LY A N D R A N DA L L R OT H Sean Caverly is a professional in the Àeld with experience on both the buy and sell side working with a diverse set of asset classes. Randall Roth is an investment professional whose breadth of experience covers a range of functions from investment strategy and buy-side research to operational risk.

redicaments malaise

of economic conditions.

InÁators argue

current

Great InÁators contend that propo-

American

nents of additional stimulus are Àghting the

that more forward looking data suggests

the

afÁicting

wallets and psyches have thrown

last war. With over $11 trillion of liquidity

a different picture.

the investment punditry spin-cycle into

already injected into the economy, InÁators

are struggling, corporate America is doing

overdrive. Usually, as per the old adage,

argue that spurring capital availability is

well. Cash hoards on corporate balance

talk is cheap because supply exceeds

less of an impediment to a resumption of

sheets are already at historic highs and free

demand.

However, when direction is

growth than spurring capital deployment.

cash Áow generation continues to mount

lacking, the natural inclination is to look

SpeciÀcally, job-creating investment won’t

in the wake of higher productivity and cost-cutting programs implemented since

for a schema that makes sense of the world in unvarnished terms.

Even if households

2008.

Were one to go

Eventually, Áush balance sheets

shopping for an opinion, there would be an

should translate into jobs as productivity

option for every budget and ideology.

increases and the rest should take care of main

itself. The outstanding question is whether

The Stimulators versus the

government and consumers will choose to

The Great InÁators. The Stimuli crowd

consume or save once the good times are

argues that priming the demand pump

here again. InÁators think they already

is the imperative necessary to change the

have the answer according to the gospel

consumption and investment zeitgeist and

of history and foresee proÁigacy as the

beat back the symptoms of thrift that have

order of the day once conditions normalize.

ground growth to a standstill. InÁation

It is best now to start dispensing with

expectations remain anchored, TIPS-Long

the cotton-blended softness of the U.S.

Bond spreads remain muted, industrial

dollar toward something harder and more

capacity utilization remains below the

calculatingly resolute.

Enter contenders:

long-term

late

secular

2010’s

trend,

two

Both the Stimulators and InÁators

household

balance sheets are still in tatters, and most

occur until the uncertainty on the future

bring to mind shades of the acrimony

importantly, the labor market remains

of the tax code is removed. In the interim,

surrounding the Panic of 1837. Now, as

mired in a funk with the broadest based

more bouts of stimulus can only stoke the

then, concerns persist over the health of the

measure, U6, hovering in the high teens.

Áames of future inÁation.

nation’s medium of exchange. A speculative

Neither consumption nor the savings that

Though inÁation pressure may not be

fervor arose in response to loose credit

lead to capital formation and investment

appearing in indicators that Stimulators

meant encourage westward expansion of

can improve if there is no income feeding

like to cite, it is only because that data

America’s frontier as it sought to grow into

down to households.

provides at best a coincident description

its manifest destiny.

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President Andrew

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“THE OUTSTANDING QUESTION IS WHETHER GOVERNMENT AND CONSUMERS WILL CHOOSE TO CONSUME OR SAVE ONCE THE GOOD TIMES ARE HERE AGAIN. ” Jackson sought to drive out paper money

For just one example, opportunities

that it neglected to see the opportunities

with no intrinsic worth from serving from

abound in commodities that play into

of the frontier and instead chose to

as means of exchange for the purchase of

secular growth trends of urbanization

Àght unproductive rear-guard actions.

public lands by issuing an executive order

and mobility.

Rubber is one such

Likewise, investors would do well today

known as Specie Circular.

Henceforth,

opportunity. Rubber prices are up Àve-

to move beyond the subterfuge that is

only gold or silver was to be accepted as

fold in the last decade compared with

the debate over stimulus, quantitative

payment for purchases of government

an 18% rise in all other agricultural

easing, and inÁ ation protection and

owned land. The order induced a credit

raw material prices according to the

instead hone in on the most promising

contraction that threw the economy into

latest IMF economic data.

and

a depression for the next Àve years. Now,

the decline of the U.S. and Western

economy as the best defense against the

as then, the controversy circulating within

European auto markets since 2008, the

ills of the macro economy. iBR

the investment community was mainly

world auto market has been galloping

specious.

ahead as urbanization, investments in

The focus should have been

In spite of

on agitating for the growth that frontier

transportation

expansion promised.

incomes, the development of domestic auto

infrastructure,

rising

and

industries, and government deregulation

the broader U.S. body politic is again

have spurred emerging market consumer

wrestling with the dilemma of proÁigacy

uptake of cars.

or parsimony, Investors would be bettered

of cars grows rubber demand should

served looking for growth as the best way

continue to grow independent of auto

to shield themselves from a backslide to

sales growth as normal wear and tear

recession or an acceleration to inÁation.

necessitates replacement sales. In 1837

There is growth to be had if only one looks

Jacksonian America became so wrapped

in the right places.

up in its own vendettas over “bad” money

Fast

forward

late

2010

As the installed base

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productive

areas

the

world

Epigram For Wall Street I‘ll tell you a plan for gaining wealth, Better than banking, trade or leases — Take a bank note and fold it up, And then you will find your money in creases! This wonderful plan, without danger or loss, Keeps your cash in your hands, where nothing can trouble it; And every time that you fold it across, ‘Tis as plain as the light of the day that you double it!

-- Edgar Allan Poe, 1845

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INTERVIEW: Dr. Josef Ackermann, Deutsche Bank AG

“We have to take the steps necessary to align our efforts within the regulatory bodies...”

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I N T E R V I E W E D BY DA N I E L H E L LW I G ( W ‘ 1 1 )

FINANCIAL REGULATION AND MARKET EFFICIENCY Dr. Josef Ackermann chairs the Management Board of Deutsche Bank AG since 2002. He started his professional career in 1977 at Schweizerische Kreditanstalt (today’s Credit Suisse) where he held a variety of positions in Corporate and Investment Banking, before becomming president of the Executive Board. For the fall 2010 edition, the editorial staff of the IBR had the rare opportunity to interview Dr. Ackermann and talk about the future of the Euro, debt crises around the world, and the requirements of living a fulÀ lled life. In the spring of this year, the fear of a sovereign debt crisis for some EU member states led to the widening of bond yield spreads and risk insurance on CDS. What caused the lack of conÀdence in the euro? Was it really only Greece, Spain and Italy? The markets perceived the solvency and liquidity problems of Greece as indicators of the growing economic tensions in the euro area as a whole. We should be careful not to lump together countries that face challenges which are actually different in substance and extent – for instance, Spain and Ireland have been suffering from speculative bubbles in the real estate sector, while Greece needs a fundamental upgrade of its economic model. The risk of unsustainable sovereign debt or even a sovereign default altered the sentiment in the markets and consequently the political community in the euro area. Concerns rose that the break-up of the euro area might not be excluded anymore, thus weakening conÀdence in the euro. Meanwhile, the euro has bounced back again and conÀdence has returned as we can see in the exchange rate vis-à-vis the U.S. dollar.

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I N T E R N AT I O N A L B U S I N E S S R E V I E W

However, that does not mean that we can fully relax. The aftermath of the Ànancial and economic crisis has revealed that the rules and institutional arrangements of the European Monetary Union were either not welldesigned or insufÀciently enforced – or, to some extent, both. Various proposals have been made to improve the framework for the euro, and there is an intense debate among the euro area members on critical issues, such as a future crisis resolution mechanism, before À nal decisions will be taken. Furthermore, the countries have to do their homework at the national level – including Àscal consolidation and structural reforms to increase competitiveness and growth. Only hard work over the next few years will fully persuade the markets of the euro area’s future resiliency – but the efforts are worth it given the undisputable advantages of a common currency. On May 2, 2010, the eurozone countries and the IMF agreed to a €110 billion loan for Greece, conditional on the implementation of austerity measures. As of today, do you believe that this was the right thing to do at the time?

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In the wake of the Greek solvency crisis, the joint support from euro area countries and the IMF was indispensable and the most reasonable thing to do at that time. It has helped to reign in contagion risks and brought some relief to the still weak Ànancial sector and market participants engaged in Greece. I am conÀdent that the strong commitment and political will among the Greek authorities, the involvement of the IMF and the strict conditions for Ànancial assistance will help bring the country back onto the path of Àscal virtue and competitiveness. It will be a rocky road, but it has to be taken. Other countries have done so before – and succeeded.

Dr. Josef Ackermann Josef Ackermann, born on February 7, 1948, in the Swiss Canton of St. Gallen, is Chairman of the Management Board and the Group Executive Committee of Deutsche Bank.

He studied Economics and Social Sciences at the University of St. Gallen, and in 1977 – after obtaining his doctorate – joined Schweizerische Kreditanstalt (SKA). In 1990, Ackermann was appointed to the Executive Board of SKA, becoming its President in 1993.

In 1996, Ackermann joined the Board of Managing Directors of Deutsche Bank, where he was

The concern about rising government deÀcits and debt levels together with the downgrading of European government debt has put the Ànancial markets in an alarmed state. The Prime Minister of Japan, Naoto Kan, said that Japan is in danger of falling into a debt crisis, just like Greece did. However, Japan’s public debt is much larger, more than 200% of the GDP, in comparison to only 115% in the case of Greece. Should the world be concerned about Japan’s deÀcit and debt rating? there are some reasons that make a comparison between the two countries misleading. First, Japan is a highly export-oriented country with persistent current account surpluses. The Bank of Japan holds the second biggest foreign exchange reserves in the world – around a trillion U.S. dollars – and the country is the largest net external creditor in nominal terms. Hence, despite the high level of public debt, the risk of an external payments crisis remains very low. Second, foreign investors hold only about seven percent of Japanese bonds. Hence, public debt remains a primarily domestic problem that can be solved if the political will is there. However, on one point the comparison is valid. Both the Euro area and Japan need to reduce their levels of public debt – and while most euro area members have put forward consolidation packages, painful ones in some cases, Japan has only announced a freezing of public spending. One reason for that might be that debt service payments have been relatively low so far. Furthermore, to maintain its growth model, Japan has to improve the competitiveness of its domestic sector in order to accelerate growth. Flanking structural reforms should make the social and Àscal systems Àt for the challenges of demographic change.

responsible for the investment banking division. Under his leadership, this business unit developed into one of Deutsche Bank’s principal revenue sources and entered the top group of global investment banks. In 2002, he became Spokesman of the Board of Managing Directors and Chairman of the Group Executive Committee. He was appointed Chairman of the Management Board on February 1, 2006.

Ackermann is a member of the Supervisory Board of Siemens AG (Second Deputy Chairman), a non-executive member of the Board of Directors of Royal Dutch Shell plc and a member of the Board of Directors of Zurich Financial Services Ltd (Vice Chairman). He also plays an active role in, among other things, the Initiative Finanzstandort Deutschland (member of the Initiators’ Group), the Institute of International Finance (Chairman of the Board of Directors), the World Economic Forum (Co-Chairman of the Foundation Board), the St. Gallen Foundation for International Studies (Chairman), the Foundation Lindau Nobelprizewinners Meetings at Lake Constance (Honorary Senate member) and the Metropolitan Opera New York (Advisory Director). In 2007, Ackermann accepted an appointment as Visiting Professor in Finance at the London School of Economics. In July 2008, he was appointed Honorary Professor at the Johann Wolfgang Goethe University Frankfurt. Furthermore, Ackermann is an Honorary Fellow of the London Business School and holds an Honorary Doctorate from the Democritus University of Thrace in Greece.

On May 9, 2010, Europe’s Ànance ministers approved a comprehensive rescue package worth almost a trillion dollars aimed at ensuring Ànancial stability across the European Union, by creating what they called the European Financial Stability Facility (EFSF). To what extent do you support this concept in its current form? The European Union had to take a clear stand after trust in European bond markets could not be re-established even with the Greek rescue package. Worries about the sustainability of public Ànance among southern European countries prevailed, leading to severe distortions in

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European sovereign bond markets. On May 7, even French bonds were facing increased risk premiums: As the fundamentals had not changed, the sudden crisis was actually caused only by changed perceptions among market participants. In this respect, I am convinced that the package was necessary and adequate to send a clear signal to the markets that euro area countries and the ECB would ensure the liquidity and stability of the Ànancial markets and support countries that are facing severe Àscal difÀculties. That having been said, the most important fact is that the rescue package has bought three years of time – this is how long the program is scheduled to run. These years must not be wasted, though: Europe will now have to take the necessary steps, at both the national and the European level. Most countries will have to reduce their public debt and address competitiveness problems. On a European scale, we need better macroeconomic surveillance mechanisms that will spot and sanction excessive deÀcits and competitive distortions before they become lethal. If the quick set-up of the EFSF can serve as a precedent for a new pragmatic approach to economic policy coordination in Europe, I am conÀdent that the challenges ahead will be mastered to Europe’s advantage. A possible alternative to the bailout agreement would have been for Greece to leave the eurozone. Do you believe that this, i.e. to have Greek exit the monetary union, would have been a possible alternative for dealing with the Greek “bond crisis”? The Greek crisis has indeed sparked a more general debate over an EMU country’s ability to leave the euro area. While it is clear that, despite legal provisions, anyone who wishes to leave can do so, I don’t consider it a politically or economically viable option for Greece. In particular, it would not solve the sovereign debt problems Greece is actually facing. Apart from tremendous transaction costs, an exit from the EMU would inevitably result in a sharp devaluation of the new currency. This would further increase the level of public and private debt, as existing bonds would still be denominated in euros. We should not forget that more than 80 percent of Greek sovereign bonds are owned by foreign creditors. Interest rates would spiral upwards, narrowing the Àscal scope of action, weighing on consumption and investment and thus hampering the return to a satisfying growth path. In my view, the Greek government chose the right path by

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embarking on a stability program, and so far compliance with its own reform commitments has been impressive. The only way forward is to restore public trust in the economic future of the country by pursuing institutional reforms, increasing competitiveness and accelerating growth again, thereby helping to improve the situation in Greece’s public Ànances. Do you think that it would be a plausible scenario to split the euro, for example, into a “development” euro and an “industrial” euro? I consider that to be a purely academic discussion – if at all – because it ignores the close economic and political ties between the EMU members. The same kind of problems would arise as in a unilateral exit from the EMU – and a softer “development euro” would not solve the problems of the countries involved, either. Apart from that: If you were to split the euro area where would you draw the dividing line?

Europe has shown that, in times of crisis, it has been able to move forward – politically and economically. I am conÀdent that the Eurogroup will be able to do its homework and that the nature of the euro area will have changed in three years’ time for good. Most probably, this will also include a convincing model of economic governance. Hence, in order to cope with the challenges ahead, constructive solutions have to be found that address the roots of the problems. Dissolving the euro area would be a destructive solution. The European Central Bank has been buying a signiÀcant amount of government bonds, in a way bailing out insurance companies. How will it be possible to keep Europe’s inÁation under control? In a move to ensure liquidity in the Ànancial markets, the ECB decided to intervene in the stressed bond markets on a limited scale, both in terms of volume and time. So far, we are talking about some €60 billion (USD 76 billion), which is

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quite a small amount compared to similar programs by the U.S. Federal Reserve, with a volume of USD 322 billion as of summer 2010, and the Bank of England, with a volume of USD 306 billion – although, admittedly, these programs were launched in 2009. Besides the amount there is another difference: The ECB sterilized these measures by instituting adequately sized weekly tenders, also intended to soak up any excess money supply. Together with the fact that growth prospects in the euro area are rather modest and capacity utilization remains below its long-term average, the risk of higher inÁation in the euro area is low. What was your experience during the days following the Lehman collapse? Could you describe the atmosphere at Deutsche Bank at that time? I believe the atmosphere can best be described as one of utmost concentration. We knew that we needed to do everything right in what was probably the most dangerous situation the Ànancial system had ever found itself in. We were conÀdent

not be just one of those recurrent economic turbulences our economies undergo now and then, but that it would really be a transformational crisis. This also applies to the geopolitical and economic balance of power, and to the role of the state in the economy. I think the jury is still out on the impacts on the free market economy: On the one hand, I have met many people who have indicated that their trust in the market economy and its protagonists has indeed been deeply shaken. After all, besides regulatory failure in the run-up to the crisis, there really were many cases of market failure – deÀcient corporate governance, failures in coordination and a lack of market discipline. In the end, however, only governments carried the sufÀcient credibility and Àrepower to restore calm and conÀdence. Furthermore, the role of the state in the economy has in fact increased – just think of the state investments in many countries’ banking systems! On the other hand, people are clearly aware of the limits of the state. They acknowledge that governments

“THE RESCUE PACKAGE HAS BOUGHT THREE YEARS OF TIME – THIS IS HOW LONG THE PROGRAM IS SCHEDULED TO RUN. THESE YEARS MUST NOT BE WASTED, THOUGH: EUROPE WILL NOW HAVE TO TAKE THE NECESSARY STEPS...” that we had done everything in our capacity to bolster the defenses of Deutsche Bank – we had raised fresh capital, increased our liquidity buffers, cut exposures and talked extensively to our investors and the authorities. Yet, we knew that one false move could have very severe consequences. In retrospect, the dedication that Deutsche Bank’s staff showed in those days, the team spirit and commitment were magniÀcent. The crisis had lasted more than a year already when Lehman went down. Many of us had already spent many nights and weekends on trying to avert the crisis – and yet, people remained fully immersed, still put in the extra hours and showed real passion to perform. The acceptance of the free market economy, as well as the faith in its representatives, has been shaken in the recent past. Would it be fair to say that this is a crisis for the free market economy? It occurred to me fairly early on in the crisis that this would

had to save the system in an emergency, but that does not mean they want governments to run the economy. Disillusionment with state ownership in the 1960s and 1970s – not to mention the socialist experiment – is still very present in peoples’ minds, I think. If you look at the results of the latest Pew Global Attitudes Survey you can see that solid majorities in almost all countries surveyed think that people are better off in a free market economy. Various politicians have been thinking about ways to limit competition among the different participants in the Ànancial markets. This can only be effective if enacted on a global scale. Do you see any realistic concept for such a global regulator? Based on my own conversations with legislators and regulators, I think there is a great deal of consensus around the world that healthy competition is the bedrock of sound and stable Ànancial markets.

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There are two aspects, however, to keep in mind where competition issues indeed play a role in the political discussion on financial regulation: First of all, the crisis has reduced tolerance vis-à-vis financial centers where regulatory and supervisory standards are sub-par. This kind of race-to-the bottom is no longer tolerated in light of the fragility of the global financial system revealed during the crisis. Dark corners counteract transparency and effective supervision, which are the prerequisites for stable financial markets. Secondly, financial market participants and legislators are keenly aware that the risk of market fragmentation and regulatory arbitrage is real, if we do not manage to harmonize rules and coordinate their implementation and enforcement. You don’t need a global regulator for this, but we have to

Being able to work as a member of a team is also crucial, in my opinion. In a leadership position, you have to demonstrate passion for your job. You have to really want to help the people who work for you and provide the conditions they need to do their job effectively, to motivate them to carry out their tasks well, irrespective of age. In today’s world, what talents - aside from analytical skills and academic knowledge – should graduating students from business schools like the Wharton School have in order to be successful in the Ànancial industry? To be successful in the financial services sector today, students must have a passion for this industry, in addition to the relevant academic credentials and analytical skills, as well as a genuine desire to

“FINDING AN APPROPRIATE WORK LIFE-BALANCE IS KEY TO SUSTAINING A PASSION FOR YOUR WORK. MAINTAIN A HEALTHY FOCUS ON YOUR PERSONAL LIFE AND THE WELLBEING OF YOUR FAMILY... ” take the steps necessary to align our efforts within the regulatory bodies, such as the Financial Stability Board and Basel Committee – as indeed the G20 leaders have committed themselves to do. At a very young age, you were in a position of leadership, managing many of your fellow employees. How did you reach this position of authority at such a young age? How did you deal with being in charge of people that were much older than you were? It is extremely important to always be open to new developments and to take advantage of life’s opportunities when they arise, even if they entail risks. One should also always aim to do things one really enjoys doing, because if you like what you do, there is a good chance that you will be successful at it. You have to be motivated in the sense that wherever you are, you should be dedicated to your work and committed to being as successful as possible. Everything else follows from there. The most important thing to me was that I always strived to do my best, whatever I did.

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constantly learn and grow. You must be intellectually curious with a capacity to absorb new knowledge and skills quickly. Given the dynamic, multicultural and global marketplace, students must also be able to appreciate the importance of teamwork and to communicate effectively. Self-starters usually do well in this industry, as do those who are willing to take “measured” risks, take the lead and be creative. As of today, where do you see chances for young people to attract attention to themselves, once they have entered the workforce? Be prepared to take risks, and dare to be different. It’s obvious that you will have to work hard and consistently deliver excellent results, demonstrating that you are reliable. Not only will this build your personal brand, but it will also enhance your professional reputation. Show courage in presenting your viewpoints and ideas. Be hungry and f lexible by demonstrating that you are prepared to say “yes” to taking on additional responsibilities and tasks that

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Dr. Josef Ackermann, Chairman of the Management Board and the Group Executive Committee of Deutsche Bank AG, at the General Meeting on May 27, 2010.

add value to the organization. Finally, networking is key to identifying sources of personal and professional support and effective mentors to assist in guiding your career.

On the issue of the enforcement of restrictions on compensation: If required by regulatory bodies, banks will of course comply and implement any compensation restrictions imposed on them.

Do you believe that the planned restrictions on compensation will be a discouraging factor for students who are attracted to the industry due to its high pay? Do you think that compensation restrictions can actually be implemented in the United States or Europe, if banks do not want to comply with them? I am not of the opinion that changes in the compensation structures in the financial services sector will have a negative impact on students seeking careers in this industry. Relatively speaking, salaries in the financial services industry remain competitive, and students will continue to be drawn to the sector’s excellent long-term career opportunities. People starting out in the industry know that if they work hard they will be rewarded accordingly.

A lot of students reading this interview hope to have a successful career in the À nancial services industry. If you could pass along one single piece of advice to these students – with respect to their career, education and private lives, what would this advice be? Finding an appropriate work life-balance is key to sustaining a passion for your work. Maintain a healthy focus on your personal life and the well-being of your family. This is essential in this fast paced, highly demanding industry. Continue to seek opportunities to learn and grow as you progress in your careers. Don’t be afraid to make mistakes as there is great value in learning from one’s failures. Finally, remember to always treat others with respect - it goes a very long way. iBR

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E U RO P E A N D E BT C R I S I S

BACK FROM THE BRINK… FOR NOW BY C H A R L E S H E N D R E N ( W ‘ 1 0)

s 2009 ended, investors breathed a cautious sigh of relief. The global economy was no longer on the brink of collapse, and for many countries a timid recovery had already begun. Few imagined that events in Greece—a country contributing less than

one percent of world GDP—would threaten to bring us once again to the brink. The resulting sovereign debt crises never managed to push us over the edge; however, the long-term effects of “Europe’s subprime” still threaten to destabilize world economy for years to come. Understanding the causes and consequences of this phenomenon is therefore crucial to ensuring a sustainable economic recovery.

Return to the Brink

comparable

increased

IMF, pledged assistance in March, which

Greece appeared to enjoy considerable

from around 10-40 to over 400 basis

Greece eventually accepted, following a

success since adopting the euro in 2001,

points by January. Surprisingly, the

ratings downgrade.

growing at a higher rate than its European

government was still able to raise funds

peers and avoiding many of the most

in international markets following these

received over $100 billion in emergency

damaging effects of the subprime crisis.

developments—albeit at higher rates.

loans, repayment of which is still not

In October 2009, however, the incoming minister,

George

revised the government’s budget deÀcit upwards, nearly doubling the Àgure from 6.7 to 12.7 percent of GDP; external debt stood at 115 percent.

bonds)

140

dust

settled,

Greece

leading to widespread strikes and violent

130

protests. Fear of contagion in other

120 110

“periphery” countries was rampant, the

100 90

This high debt burden left Greece’s

the

embarked on a strict austerity campaign,

150

1999

When

entirely certain. The government also

GDP over Time

Papandreou Index, 1999 = 100

prime

German

2001

2003 Greece

2005

2007

2009

European Avg.

euro plummeted, and European banks saw their share prices fall due to their

liquidity increasingly dependent on inves-

Even with these funds, the government

large holdings of government debt. For

tor conÀdence, which was compromised

still needed to raise in excess of $70 billion

at least a month, it appeared that the

following the deÀcit revision. Spreads

to meet its 2010 debt obligations. Fellow

European economy was once again on

Eurozone member states, along with the

the verge of collapse.

ten-year

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government

bonds

(over

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sectors alike to accumulate increasingly large amounts of external debt, ultimately culminating in the unsustainable levels seen this year. Government Debt

Percent of GDP

140 120 100 80 60 40 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

The Economist argues: “Greek governments have… spent years buying social peace and votes with public spending, government pensions, tax breaks, EU money and jobs for life, directed to an array of rent-seeking interest groups.” Indeed, Greece’s 2001-08 average Àscal deÀcit of Àve percent was more than double the Eurozone average. Factors driving this imbalance included inefÀcient public administration, tax evasion, and generous healthcare and pension programs. As a result, government How This Happened

euro in 1999, and Greece’s subsequent

expenditures grew an estimated 87 percent

Sovereign debt crises, like the one

adoption two years later.

since adoption of the euro, while revenues

recently experienced in Greece, have

Following

adoption,

Greece

saw

increased only 31 percent.

unfortunately occurred all too frequently

its borrowing costs drop dramatically.

When the subprime crisis struck,

throughout the history of capitalism.

Investors no longer feared devaluation,

deÀcits increased across the board in

and they recognized the government’s

Europe, tripling from around two percent

1.5

ofÀcial ties to the much larger and more

in 2008 to over six percent the following

1.4

stable economies of Germany and France.

year. Greece followed this trend, but,

1.3

These lower rates were a boon to the Greek

starting from a much higher initial level,

1.2

economy during the expansionary years

this increase produced an unsustainable

preceding the subprime mess. However, in

deÀcit of 12.7 percent—later revised

EUR/USD

Value of the Euro

1.1 Jan-10

Mar-10

May-10

Jul-10

Sep-10

Nov-10

many ways they both enabled and disguised

upward to 13.6 percent. It was this deÀcit

James Bullard, president of the St. Louis

fundamental problems facing the small

increase that spooked investors and

Federal Reserve Bank, reckons that there

nation, problems that ultimately led to this

ultimately caused what is now known as

have been at least 250 instances of full

year’s near catastrophic debt crisis.

the Greek Debt Crisis.

or partial government default in the past

Greece’s rapid growth prior to the

While Àscal irresponsibility was no doubt

200 years. Moreover, such events are

À nancial crisis was in large part driven

the proximate cause of the crisis, deeper

particularly likely following À nancial

by government spending and personal

structural problems, leading to a lack of

crises, which often lead to increased

consumption; exports, on the other hand,

international competitiveness, in many

deÀcits and frozen capital markets. Still,

grew less rapidly than in much of Europe.

ways constituted a more important driver.

this particular crisis, beginning in Greece

Implicit within this composition are the

Warren Coats, a former assistant director

and threatening to spread throughout the

two primary problems facing Greece:

at the IMF, argues that Greece’s pre-crisis

E.U. periphery, was in many ways unique

Àscal irresponsibility and a lack of

growth not only led to a growing Àscal

in its causes. To understand these causes,

external competitiveness. Together, these

deÀcit, but also to rising prices, leading

one must look back to the birth of the

factors pushed the private and public

to worsening external competitiveness.

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The Congressional Research Service also

“If the European crisis metastasizes,

percent, after increasing more than

attributes this problem to high wages

it could create a new Ànancial crisis

100 basis points in a single week.

and low productivity, pointing to the fact

with implications as grave as the U.S.-

Government bond markets have settled

that wages have increased at a rate of

originated crisis two years ago.” This claim

down somewhat in Italy and Spain,

more than twice the Eurozone average

undoubtedly has a certain degree of merit.

although the latter lost its A A A rating

since 2001. As a result of these combined

The size of the U.S. subprime market

in October. Clearly, problems remain

factors, Greece’s current account deÀcit

peaked at less than $2 trillion, while the

in this mix of highly leveraged and

over the period 2001-08 was nine percent,

combined debt of the so-called PIIGS

structurally unsound countries.

compared to a Eurozone average of only

countries (Portugal, Ireland, Italy, Greece,

one percent. In order to Ànance this deÀcit,

and Spain) was nearly triple this amount.

Journal reports: “OfÀcials in heavily

Greece borrowed from abroad, further

A string of restructurings or defaults could

indebted Greece are talking more openly

increasing the country’s debt burden.

mean signiÀcant losses for creditors and a

about potential debt restructuring.” The

potential double-dip recession.

Financial Times concurs, adding that this

promote

competitiveness

and

alarmingly,

The

Wall

Street

begin to close the current account gap, the

Signs of contagion abounded in the

type of talk could become a self-fulÀ lling

Greek government proposes, among other

weeks before the Greek bailout. Yields

prophecy, as Greece attempts to balance

measures, to curb public-sector wages

on government bonds in PIIGS countries

growth and austerity in the face of higher

and increase investment in competitive

moved upward together, and in some

borrowing costs. Any restructuring would

areas, such as tourism and shipping.

cases yield curves inverted—a clear sign

be a destabilizing event, potentially

These reforms are necessary, as high debt

of a looming crisis. Moreover, European

threatening Europe’s fragile recovery.

levels are likely to persist until exports

banks held an overwhelming majority of

Deeper questions remain about the

come in line with imports; however, they

Greek government bonds (89 percent),

future of the European Union itself.

will undoubtedly take time.

with the holdings in France and Germany

Some are skeptical of the Union, pointing

reaching 32 and 20 percent of GDP,

to the problems inherent to a system

respectively. Moody’s even warned that

of independent national À scal policies

“contagion risk” could spread to the much

and uniÀed monetary policy, as well

larger British banking system. Clearly,

as persistent North-South imbalances.

the crisis was no longer conÀ ned to

Others, however, argue in favor of

Greece—or even the periphery. Instability

increased integration to correct these

could potentially spread throughout the

imbalances. Disagreements came to a

entire continent.

head at recent talks over a permanent

Percent of GDP

14 12 10 8 6 4 1999

2001

20032

005

2007

2009

How Close We Were In early May, Eurozone Ànance ministers,

which carried below-market rates, required a harsh set of austerity measures, including budget cuts of around 13 percent of GDP. For

110

raising

if Greece and the other PIIGS countries

are able to avoid costly restructurings,

70 60 Mar-10M Greece

the time being, it appears that these measures

mechanism,

sanctions, and creditor liability. Even

100

Jan-10

resolution

questions of voting rights, automatic

120 Index, Jan = 100

bailout package for Greece. These loans,

crisis

Government Bond Prices

along with the IMF, approved a $146 billion

0M ay-10 Italy

Spain

Jul-10 Ireland

Sep-10

Nov-10

Portugal

the future structure of the E.U. remains very much in Áux.

have at least delayed a destabilizing debt

Verdict Still Out

restructuring or default, thereby averting

Over six months after the Greek bailout

crisis brought us again to the brink of

contagion in the E.U. periphery. One wonders,

package was approved, fears remain

collapse, before gradually abating. We

though, how close the European continent

about the long-term solvency of the

are now back from the brink, yet the long-

came to another full-blown economic crisis.

PIIGS countries. In November, Irish

term consequences are far from clear.

It’s astounding how quickly talk of a

yields hit an all-time high since euro

What is known, however, is that “Europe’s

Greek debt crisis quickly shifted to

adoption, reaching over seven percent.

subprime”

talk of a European one. For instance,

Portugal similarly saw record highs,

European - and indeed global - economic

Greece’s prime minister argued in March:

and Greek yields stood at close to 11

stability for years to come. iBR

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Looking back, the European debt

will

continue

threaten

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AFRICA: A NEW DESTINATION FOR GLOBAL CAPITAL BY N E L S O N C H I WA R A ( P R I N C E TO N ‘ 1 1 )

of this new African renaissance, after all

currency derivatives exchange,

Africa has had many false dawns – but

a continent not a country; but the region’s

Walmart made a preliminary, non-

judging by current capital ﬂows, most

recent economic track record and robust

binding proposal to enter the Southern

of the world is convinced. Standards

growth is testament to a changing

Africa retail market, and major venture

of governance have improved across

investment

capital

the

ecently, Africa opened its own

There are many that remain skeptical

To be sure, Africa continues to face

international commodity and

numerous challenges and Africa remains

environment.

According

major

to a report, by the Mckinsey Global

have trained their eyes on African

African cultural and economic centers

Institute, Africa is expected to have a

companies and African Real Estate.

and cities are as dynamic as any in the

collective GDP of $2.6 trillion, consumer

The

the

world. Africa’s Achilles heel remains the

expenditure of $1.4 trillion, 128 million

Africa based commodities exchange

misnomer that everything Africa is “dark”

households with progressively increasing

will sever the umbilical cord that ties

– both literally and ﬁguratively: the rest

discretionary spending, and an urbanized

Africa’s commodity prices and trade to

of the world still associates Africa and

population - with 50% of Africans living

foreign exchanges, Walmart’s entrance

Africans with civil wars, disease, drought,

in towns – by 2020. The fact that the

into Africa is expected to herald a new

and brutal dictators, stereotypes that

African economy has weathered the

age of foreign direct investment in

are as wrong as they are tired. There

current economic impasse shows Africa

Africa, and venture capital injections

however is considerable evidence that

is a viable capital destination not only

into African ﬁrms should help reduce

such tired stereotypes are in decline;

for

unemployment and encourage growth

Indian and Chinese direct investments

but also for those seeking to diversify

and development across the continent.

in Africa have quadrupled each year

their incomes and shelter their future

Africa’s attractions are numerous; with

since 2000 and domestic savings rates

economic returns from the demographic

Europe and the USA experiencing

in Africa have seen similar rises. Chinese

(aging populations) and debt challenges

subpar growth rates, Africa has risen

and Indian capital has been attracted by

that are sure to be haunting Western

from an economic pariah to a viable

the fact that the rate of return on foreign

economies over the next decade.

investment

the

investments in Africa is now higher

As a young African growing up

commodities boom has resulted in one

than in any other developing region,

during this time of African economic

of the fastest middle-class expansions

ROI across the continent continues to

promise, I never cease to profess

in African history. Currently the Africa

outstrip more famous developing regions

region is one of the fastest growing

and is expected to continue to do so over

opportunities

in the world and Africa has a larger

the next decade. Such proven ROI has

youngest generation. We are growing

and faster growing middle class than

however failed to attract commensurate

up in an age when diseases are

India. By 2040, Africa is projected to

investments from the Western world;

in decline, warlords are in retreat,

be home to one in ﬁve of the planet’s

instead

and

opportunities are abundant, and Africa

young people and the world’s largest

companies have continued to emphasize

is opening its doors not to foreign

working-age population, making Africa

aid over direct investment. This is in spite

invaders but investment partners. The

the youngest, fastest growing and

of the fact that direct investment has

recent world cup, gloriously hosted

most natural resource abundant region

been shown to be a better harbinger for

by South Africa, is but one example

in the world.

growth than any type of aid.

of the the new face of Africa! iBR

and

private

implications

are

equity

colossal;

destination,

and

ﬁ rms

continent

and

Western

numerous

governments

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those

all

seeking

and

sundry

outsized

the

available

returns,

incredible to

Africa’s

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I N T E R V I E W E D BY DAV I D V I N N I KOV ( W ‘ 1 3 ) , H A M A D A L M U D H A F ( W ‘ 1 1 ) , DA N I E L H E L LW I G ( W ‘ 1 1 )

THE FUTURE OF BUSINESS EDUCATION Dean Thomas Robertson, Reliance Professor of Management and Private Enterprise, and Professor of Marketing and Management, has been the Dean of the Wharton School since 2007. Throughout our interview with Dean Thomas Robertson, we had the chance to learn about the future of the Wharton School, the importance of school rankings, and the new positioning of business education around the globe.

It has been over three years since you became Dean of the Wharton School. What do you feel have been your greatest achievements so far? One of the major achievements was getting us through the Ànancial crisis and not losing money. That is not as exciting as saying that we launched something new, but it is very important, especially for a business school like Wharton. We have been very successful in terms of getting through the crisis. The Wharton School is all about intellectual capital and about the brilliance of our students and faculty. A major part of my job is to bring in fantastic new faculty members. We have increased our faculty count to 219, which is the largest number our school has ever had. We also continue to bring in fantastic students and wonderful staff that keep us moving in new directions. Looking forward, in particular, there are three pillars that we are building: the social impact pillar, the innovation pillar, and the globalization pillar. We are now institutionalizing these. We have vice deans for each one of these pillars. I am proud to say that the school is committed to that direction and things are moving along pretty well.

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You came in with an endowment of approximately $600 million. What have been the developments here? Obviously, the last few years have made it fairly difficult to realize big increases. I think that we are at about $800 million right now. Official figures are released at the end of each academic year, and at that point we were not quite back up to where we were. However, the stock market has been kind to us and the gifts keep coming. So, $800 million is a good estimate right now. The question students always want to know about is rankings; we’ve fallen down to number 4 for Business Week. How do you feel about the importance of rankings in general? Is it something we should think about at all? I believe that people don’t like rankings; however, they are a reality. Potential students look at rankings. So, whether you like it or not, rankings are there, and they are relevant. We have to look at them and see what is going on. If you were to average our rankings over the last 5 and 10 years, for the US News World Report, Business Week, and the Financial Times, we are tied with Harvard for the

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Dean Thomas Robertson: Reliance Professor of Management and Private Enterprise; Professor of Marketing and Management; Dean, The Wharton School

top spot. Sometimes we are number 1, and sometimes we are not. If there was a trend line downwards, we would be concerned, but there is not. Business Week is an interesting ranking: it essentially looks at how happy students are within a particular school. This is interesting, because they do not have a basis of comparison. We always look at the rankings, and we want to be number 1, and hopefully in the next edition they’ll be getting it right.

iBR Reader Response What should the Wharton School do at this point to resume its leading position in rankings? Log onto www.whartonibr.com/respond/robertson to respond

You mentioned the 3 pillars focusing on innovation, globalization and socially beneÀcial outlooks. They’ve all been around individually for some time, but this is the À rst time that they’ve been streamlined and integrated together and presented to the student population. How do you see the student’s education changing on the ground level because of them?

They have been around, it’s a matter of emphasis, and it’s a matter of institutionalizing them. Having vice deans at the head of each pillar, and having staff directors and managing directors supporting them, these pillars will become more central and important to us. We are already very international, and we will become more international going forward. At the undergrad level we have 35 exchange programs, and 17% of international students within the undergrad body. Our faculty is also 35% international. But we will become more international going forward. We plan to offer modular courses in other countries which are appropriate to those countries. We will open the possibility of having points of presence in Europe, India, and China. There will be even more opportunities for exchange programs and to participate in international ventures. Having an international faculty and international student body creates a more globalized curriculum. On social impact, we have been doing a lot. The world does not know about it yet, because there hasn’t been scale and synergy. On the undergrad level, we have

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added a social impact concentration. People can major in À nance and take 4 courses on social impact. We will have more of a relationship with the Netter center, and there will be more opportunity for students to participate in West Philadelphia, in terms of education, business training, and entrepreneurship. I think right now, it is a matter of bringing it together, focusing it, and providing opportunities for our students.

entire university, there are thousands of electives available. Recently, students have been broadening the portfolio of jobs that they are taking. There is a little less emphasis on investment banking and consulting than there used to be. Many students look at their Àrst job as part of an ongoing education that might change 5 years later. But if you go into Ànance, it’s a more linear path. For the last two years, more students have been going into NGOs, and a few more

“WE CAN ALL GET SO CAUGHT UP WITH OUR DAY-TO-DAY ACTIVITIES, AND THERE IS A REAL RISK OF BURNING OUT IF YOU ARE NOT OCCASIONALLY TAKING SOME TIME TO SIMPLY ENJOY LIFE...” The Wharton School has to be innovative. You are probably going to work in jobs that don’t exist right now, just as students twenty years ago: hedge funds, private equity, Google, and Facebook didn’t exist back then. Professor Karl T. Ulrich, who is our expert on innovation, has written a book on innovation tournaments. He is going to involve students in various innovation tournaments as to what the future of business education should look like, and where we should go from here. There is going to be one on branding: we will be using an innovative method to Àgure out how to brand and position the school going forward. Is this push towards social impact and innovation triggered by the crisis? Wharton has the Ànance reputation and there is always the push for Ànance jobs and the Ànancial sector. Many have switched from the ideal path of Investment Banking and consulting. Has there been a change in your focus to other concentrations? When I came to the Wharton School, I was talking about the force for good and that businesses have to create economic and social value. This is not a response to the financial crisis. I came in saying those more than 3 years ago. Overall, we don’t try to tell students what they should or shouldn’t do. We want to open up the landscape of opportunities. Students can follow whatever paths they want to pursue. As of now, we have 11 teaching departments and about 150 electives. If you look at the

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going into the real economy. Overall, more students are taking international positions. What do you think about blaming business schools for contributing to the Ànancial crisis of 2009? I think there is a lot of blame to go around. As people look around - not to make a political statement – they will blame whichever president that encouraged home ownership at the time. They will blame the Fed, the investment banks, the rating agencies, and also the business schools. Some people were blowing the whistle, but not enough of them did so loudly enough, with regards to the overheating of the housing sector. Or look at derivatives: there is nothing wrong with them unless people don’t understand what they really are, which is what was going on. Have you personally faced any criticism? Have things changed at Wharton? Things did change at Wharton, and I would assume that they changed at the other major business schools as well. After the Lehman demise in October 2008, a faculty member couldn’t just walk into a lecture the next day and pull out last year’s notes. It just wouldn’t have been relevant anymore. Courses began to evolve and change. We ran a teach-in, which held about 1,200 people, and we began this by simply asking: “What caused the crisis?” What can you learn from Chile, or Turkey, or Japan, or various other countries where this has happened before? We ran a Ànancial crisis course, taught by Professor

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Guillen. It was taught with 14 other faculty members, in the spring and fall of 2009. It is also important to note that Wharton has been teaching ethics for a long time. The ethics department has been around since 1979. Though blame was shared out, its not as if Wharton didn’t have a part of the curriculum dedicated to more than finance and profit maximization. When Wharton was founded, the legal name was the Wharton School of Finance and Commerce. It was only about 15 years ago that the name was changed. We are proud of how great we are in terms finance, and we don’t want that to go down. But if you look at US News rankings, in ten areas of business education, we’re top in 5. Wharton is a very large school; we have a total of 11 teaching departments. This scale creates wonderful opportunities, with many courses and the chance for our students to pursue whatever they want while they are here. That is a great advantage.

Dean Thomas Robertson, PhD.

iBR Reader Response What changes have you noticed in the classroom after the ﬁnancial crisis?

Thomas S. Robertson is Dean of the Wharton School and Reliance Professor of Management and Private Enterprise at the University of Pennsylvania, a position he has held since August 2007.

Log onto www.whartonibr.com/respond/robertson to respond

A seasoned business school administrator and a member of the Wharton faculty from 1971 to

Moving forward outside Philadelphia campus, we rejected an offer for 200 million from China? We did reject a proposal, an offer to go into a certain part of China. The brand is not for sale. We won’t franchise it or license it. One way or another, we will go into China. We are already in China; we have a research center in Guanghua School of Management as part of Peking University. We have alliances with Tsinghua University, Shanghai Jiao Tong University, and China Europe International Business School (CEIBS); basically four of the top business schools in China. So, we are in China, but we have not built a campus in China, and we have not offered a degree program in China. We do run executive education, non-degree courses in China. When we go into China, we must be in the right city and in the right location that’s appropriate to the stature of the University of Pennsylvania and the Wharton school. Do you think that a China campus could still transmit the diversity, values, and the levels of education that we have in the Philadelphia campus?

1994, he has long been a champion of international and interdisciplinary education. Since returning to Wharton as Dean, his focus has been to expand Penn’s global footprint while advancing Wharton as a force for social and economic good.

Prior to his second tenure at Penn, Robertson led Emory University’s extensive internationalization efforts. As Chair of International Strategy, he cultivated substantial strategic alliances with universities in China, Korea, and Ethiopia, established an international advisory board for the university, and developed and implemented new international and joint degree programs.

From 1998 to 2004, Robertson was Dean of Emory’s Goizueta Business School and is widely credited with positioning the school as an international leader in business education. From 1994 to 1998, he was Sainsbury Professor, Chair of Marketing, and Deputy Dean of the London Business School in charge of the School’s portfolio of degree and non-degree programs.

In his first tenure at Wharton, he was Pomerantz Professor of Marketing and Chair of the Marketing Department. As Associate Dean for Executive Education, he led the effort to build the Steinberg Conference Center, designed an innovative set of new senior-management programs, and substantially increased financial contributions.

Born in Gourock, Scotland, and raised in Scotland and Detroit, Robertson earned his BA in business from Wayne State University and his MA and PhD in marketing from Northwestern University.

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No. This is a fascinating question though. Let me tell you a story about one our alumni, Bill Mack, whose on the board of trustees and board of overseers, and also chairman of the board of the Guggenheim Museum. He was approached by Abu Dhabi, and asked to re-create the Guggenheim in Abu Dhabi. Talking with the chief curator, he realized that only 3 percent of the art is displayed at a given time. 97 percent is in storage. So, it would be pretty easy to take the Guggenheim into Abu Dhabi - and I think it could even look like the Guggenheim. I am not sure how easy it is to put Wharton into China or Abu Dhabi or any place else. I am not going to rule it out, but I will say that it would just be very difÀcult to do. Unlike the Guggenheim, we have no basement of great faculty to send abroad. At the end of the days, Wharton is its faculty, staff, and students.

iBR Reader Response How could an international campus beneﬁt Wharton students in Philadelphia? Log onto www.whartonibr.com/respond/robertson to respond

So the faculty would be the biggest obstacle? No, it’s the students as well. At the W harton School, just as at other top business schools, the student body is very diverse. There is a wonderful opportunity for learning, given that people are different, come from different backgrounds, and also from different cultures. If someday, in any particular country, a school could offer the same mix of students and faculty, then we would start to lose some of our competitive advantage. A question worth considering is whether or not you can replicate the culture in a meaningful way? Let me give you a corporate example. General Electric has its corporate training center In Crotonville, New York. They were considering creating one in Mumbai and Dubai. They studied this possibility, but haven’t done it yet. They fear that they won’t be able to replicate the same experience in Mumbai or Dubai. Crotonville is a very special place. It’s a mecca for GE employees, and there’s a whole history for many decades, and so can you replicate the culture is a very key question. Harvard Business School offered its advanced mana-gement program in Switzerland for 3 or 4

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years, before giving it up. That was not because of the curriculum of the program, but because people just didn’t think it was Harvard. But we are not limiting ourselves to the Wharton campus. We have the campus in San Francisco, the alliance with INSEAD. How is this reÁective of expanding past the Philadelphia campus and having more of an international mindset? We do have an international mindset. We are present in many countries in the world, both with relationships and exchange programs. We haven’t put physical presences in the sense of degree programs. We have done executive education programs in places such as Kuwait, Abu Dhabi, China, India, and many more. INSEAD gives us the opportunity to be aligned with opportunities in Europe, as well as their campus in Singapore, and the Abu Dhabi campus they are currently developing. We have the same strong INSEAD partnership with the Singapore Management University, Indian School of Business in Hyderabad, and Guanghua School of Management at Peking University. There are many opportunities for knowledge sharing, and opportunities for faculty and students. We are proud of the continuous synergies, and of the networking beneÀts that we derive from these strong alliances. We are actually celebrating our 10th anniversary of the INSEAD alliance next year. With so many students reading the interview, is there one piece of advice you could share with the students with respect to careers or life in general? There are a couple of things. I think it is important to smell the roses from time to time. We can all get so caught up with our day-to-day activities, and there is a real risk of burning out if you are not occasionally taking some time to simply enjoy life. I think that’s important. And the other thing is that, at the end of the day and the end of your life, you are only as good as your character. It’s very important to contribute to this world and to maintain integrity at all cost. Once you violate that integrity, it is pretty much all downhill from there and you lose the respect of your peers. iBR

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THE FUTURE OF PRIVATE EDUCATION IN SWEDEN BY A D R I A N B O S T R O M A N D C A R L M I C H A E L T I D E B AC K (S TO C K H O L M S C H O O L O F EC O N O M I C S ’ 1 1 )

weden’s 2010 general election

enrolled.

other

of education in Sweden. In their view,

produced a historic outcome:

industries, independent school groups

as ﬁnancial buyers aim to maximize

the

Alliance

offer very predictable forms of income,

proﬁts, they have an incentive in the

was the ﬁ rst non-Social Democratic

making them a very desirable target for

shorter term to minimize the amount of

government

private equity ﬁrms who are typically

teachers per student and maximize the

Swedes

highly dependent on projects with

number of students per classroom. For

seem to approve of the coalition’s

stable cash ﬂow streams. Today, with

example, some independent school

attempts to cut income taxes and

one exception, all privatized schools

groups boast an educational system

Swedish

centre-right to

modern

reelected

history.

comparison

state-heavy

with a focus on students working on

social welfare system. For example,

projects in their spare-time, reducing

the government saw through the

the

privatization

Signiﬁcant synergies arise from a larger

liberalize

Sweden’s

the

educational

need

for

teacher

system at a faster rate than any

organization

other European country. In the past

work can be streamlined and facilities

ﬁ ve years, the amount of students

can be shared across schools. Today,

attending independent schools has

the

more than doubled. The system has

equity-owned

produced a plethora of heavily niched

groups

schools

three in

where

assistance.

most

administrative

dominant

independent

Sweden

have

private school acquired

everything

several competitors in the ﬁeld, and

from sports to computer sciences

are expected to further consolidate the

or religious teachings and has, as

industry. This development could serve

far as students’ freedom of choice is

to undermine the incentives of owners

concerned, been a success. Britain’s

to focus on the quality of education, as

specializing

pre-election

debate

it limits students’ possibilities to exit

education

less well-managed schools.

saw the Tories drawing heavily upon

with a compound annual growth rate

the Swedish experience of education

(CAGR) over 10% and an EBITDA-

The debate about whether to

reform. However, the Swedish debate

margin above 12% are private equity-

privatize educational systems or not

has shifted away from whether free

owned. Some argue that these owners

has been extensive in scope and

schools provide adequate education

have strong incentives to establish an

diff erences in opinions. The success

toward the ownership structures that

efficient and competitive educational

of this endeavor is key to Sweden’s

are emerging after more than 15 years

system within Sweden as schools need

move toward a more liberal society

of relatively lax regulation.

to be well run in order to attract students

and so it is in the interest of all parties

Revenues for independent school

- their only form of income. Others

that reform is not undermined by

groups in the region are paid by local

point to the fact that, in the longer

destructive short-term interests. iBR

authorities and consist of a ﬁxed

term, the monetization of students is

monetary contribution per student

likely to signiﬁcantly reduce the quality

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B Y E R I K BU I S C H I ( W ‘ 11)

BRAZIL:

THE REAL UNDER SIEGE S ince the start of the global downturn,

This of course poses a couple of issues for

Brazilian

have

Brazilian policymakers. This is due to the

had a difficult time managing the

fact that a rapidly appreciating currency

country’s currency. On March 2009, about

makes Brazilian exports less competitive by

ﬁve months after the enormous fear-driven

immediately raising the prices of Brazilian

dumping of global stocks that followed the

goods to foreigners. In an economy that

Capital inÁows from abroad into

Lehman debacle and resulted in the major

thrives on exports such as Brazil, this is

Brazilian equities strengthened the

Brazilian equity index, the Ibovespa, losing

an immediate source of concern. A more

Brazilian Real in comparison to the

about 50% of its value between April and

subtle effect is the increasing in borrowing

US dollar

November 2008, investors realized that

costs for Brazilian ﬁ rms borrowing from

maybe ﬁnancial Armageddon was not right

foreigners. This is a result of the fact that if

round the corner.

Putting away all their

Brazilian ﬁ rms are borrowing in US dollars,

canned food, T-bills and other hedges for

the lender must charge a higher rate in order

an eventual cataclysm, investors started

to account for the expected depreciation

reallocating to risk assets. These included

of the dollar vis-à-vis the real.

the risk-asset du jour: Brazilian stocks. Thus,

words, if the lender is going to lend today

on March 9th 2009, the Brazilian iBovespa

“expensive” US dollars, she must charge a

started an upward march which eventually

higher interest rate in order to achieve the

brought it back to 97% of its pre-meltdown

desired return when the borrower repays

value, or about 70,000 points.

using “cheap” US dollars.

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bankers

In other

Maybe it was the relatively healthy

Thus, it is of no surprise that Brazilian

Brazilian banking system, maybe it was

policymakers have been trying to stop the

the emergence of the Brazilian middle

inﬂow of foreign capital into the Brazilian

class or maybe, it was just being the

ﬁnancial markets.

right country at the right time. Whatever

capital control policy took the shape of a

the reason was for the resilience of the

2% tax levied on all foreign inﬂows directed

Brazilian economy, one thing is certain:

towards portfolio investments in equity and

capital inflows from abroad into Brazilian

ﬁxed income instruments. It is key to notice

equities strengthened the Brazilian Real in

that the government did not tax foreign

comparison to the US dollar.

direct

Without

central

delving

into

any

ﬁnancial

The ﬁrst incarnation of

investments,

since

these

remain

crucial for development in Brazil.

theory as to why this is so, one can

With a roaring equity market and

intuitively imagine that as demand for Real-

probably the highest real interest in the

denominated assets (i.e. stocks in this case)

worlds, it is no wonder that the 2% tax did

rises, so must the demand for the Real.

little to stop yield-hungry investors around

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Brazil battles to curb currency rally

Source: Reuters

The government and the central bank have taken increasingly aggressive measures in the market. Brazil reals per dollar (inverted scale)

1.60

1.65

1.70

1.75

1.80 July

Aug

Sept

Oct

July 23:

Sept 8:

Sept 20:

Sept 27:

Oct 4:

Oct 18:

Central bank tests demand for reverse currency swaps (futures market intervention)

Central bank starts calling two auctions per day to buy U.S. dollars

Government authorizes the use of its sovereign wealth fund to buy dollars in the spot market

Finance Minister Mantega says world is engaged in a “currency war,” making the term famous worldwide

Government doubles tax on bond purchases by foreigners to 4 percent

Tax on foreign bond purchases raised to 6 pct, tax on derivative margins raised

the world from buying Brazilian ﬁ xed

in November that the IMF develops and

income assets. To add insult to injury, the

maintains a currency-manipulation index.

US’ Federal Reserve’s constant attempts

Mantega told Brazilian newspaper O Globo

to lower rates seem to be highly correlated

that “The IMF would have to come up with a

with the weakening of the dollar, and therefore, the strengthening of the Real. Seeing little result from the 2% tax, Brazilian Finance Minister Guido Mantega doubled

the

tax

foreign

portfolio

The government did not tax foreign direct investments...

investments in Real-denominated assets to 4% in early October 2010, after declaring that an “international currency war has

method to measure which currencies reﬂ ect

broken out” in late September 2010. Still

the structural situation of their countries,

not enough, the country raised the tax on

which are ﬂoating currencies, and which

portfolio bond investments a further 2%,

ones are forcing their hand.” On top of this,

totaling 6% taxation.

Brazil has already acquired $5.9 billion US

But gone are the days when Brazilian central bankers and Finance Ministers would just watch and moan about a changing

dollars in an attempt to contain further devaluation of the greenback Despite the feeling that the global

It seems that Brazilian

currency war is in full swing, one has to be

officials have developed the courage to

amazed at how far Brazil has come. From

implement change, as opposed to react to it.

being fearful of the IMF, a long-standing

Taking advantage of Brazil’s unprecedented

symbol of “American imperialism” in the

importance as a source of global economic

early 90s, Brazil is now in a position where

growth, Mantega and company have claimed

it can conﬁdently suggest policy changes

that they shall propose in the G20 meeting

to its former creditor. iBR

macro landscape.

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B Y R OM I N A C OL M E N A R E S ( W ‘ 1 2)

NATIONALIZATION IN VENEZUELA:

In September of this year, Chavez’s political opponent, MUD, rallied together and obtained 47.17% of the popular vote in mid-term elections.

CHAVEZ & THE AGRICULTURAL SECTOR V enezuelan President Hugo Chavez

adverse effects on the entire industry, with

began his October 4th Sunday

food production dropping and preferential

TV program “Aló Presidente” with

interest rates to farmers rising due to

relatively little fanfare. Little did the world

government mismanagement. Venezuela may

know what was about to happen.

be forced to import food to avoid shortages.

“Agroisleña is expropriated, time is up

But while Agroisleña will have profound

for this Agroisleña. I will call the owners and

consequences for the economy, it is hardly

tell them to talk to the Ministry. Agroisleña

an unprecedented case. Chavez already

is public property, property of the nation.”

controls

With

that

unilateral

proclamation,

the

country’s

agricultural

food distribution, the supermarket chains MERCAL, PDVAL, and BICENTENARIO. 75%

placed under the direct control of the

of coffee and 45% of corn ﬂour produce is

government. Constitutional protections and

done by government entities, while 4 of the

compensation to the expatriated owners were

top 10 sugar companies have been taken

not mentioned. These are realities that the

over. In effect, the government has a heavy

Venezuelan businessman has gotten used to

hand in almost all stages of food harvesting.

most

important

in the past decade; but they may soon come

Chavez, who has overstayed the legal amount of presidential term limits, came

to a sudden halt.

111210 hq.indd 32

imports,

supplier was seized from its board and

Vene-zuela’s

food

agricultural land, and the main channels of

Agroisleña is Venezuela’s leading farm

into power in 1998 with a relatively modest

supplier, providing the country’s farmers

nationalization agenda. Over time, his position

with the vast majority of their agricultural

has seen a sharp transformation and grown

equipment. It is also their major supplier of

increasingly pervasive. The government seized

credit, giving low interest loans to more than

around 3 million hectares of land, while the

18,000 low-income farmers. The expulsion

total amount of private enterprises shrank from

of its management board and government

11,000 to 4,000. The past 5 years have seen over

takeover of its operations will likely have

200 nationalizations in Venezuela, including:

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- VENEPAL, one of the country’s largest paper producers. (2005) - CANTV and Electricidad de Caracas, the leading telephone & electricity companies. (2007) - Siderúrgica de Orinoco C.A., Venezuela’s largest steel corporation. (2008) - Banco de Venezuela, an international universal bank based in Caracas. (2009) - EXITO, leading French-Colombian retail hypermarket chain. (2010)

These actions are reﬂective of Chavez’s

would actually have Chavez’s agenda sped

general disdain for private property and free

up rather than slowed down. Since the new

enterprise. His stated goal is to reduce the

Parliament will not begin to serve until January,

size of the private market from two-thirds

Chavez has an ample window to leverage the

of the economy to one half, and there is no

country further into debt and rush the execution

industry that has not been directly affected

of various socialist projects. The President may

by government intervention. In September of this year, Chavez’s

The past 5 years have seen over 200 nationalizations in Venezuela.

political opponent, MUD, rallied together and obtained 47.17% (5,334,309 people) of the popular vote in mid-term elections. While Chavez’s party, PSUV, still won the election with 48.2% (5,454,422 people),

look for ways to shift legal powers to other

there are signiﬁcant consequences from

organs of state he still controls, in a move

these results. After losing 43 seats, PSUV

similar to his neutering of an opposition mayor

will no longer enjoy a super-majority in

in Venezuela’s capital city, Caracas. Worst of

Parliament, meaning that its ability to pass

all, nationalizations may take up a new fervor,

legislation without opposition will come to

further damaging the business community.

an end. Chavez will have to contend with a

The recent nationalization of Owens Illinois,

legitimate check on his power.

But even more signiﬁcant is the strength of the results in light of changes to electoral districts. Sensing political opposition, the government

Fortune

500

company

and

leading

manufacturer of packaging products and glass containers, serves to reinforce these fears. The

reinvigorated

opposition

changed the assignment of Parliamentary seats

movement may still have great power when

in the states of Venezuela to favor pro-Chavez

it does come on board, ending unilateral

populations. The fact that MUD was able to

appointments to the judicial system and

break the super-majority anyway is a testament

blocking major legislation. But its greatest

to how powerful the reform movement has

strength will likely come not from legislative

grown in Venezuela. Constant government

powers, but from its emergence as a viable

interference has created political hostility

alternative to 12 years of Chavez rule. “The

towards the current administration. Soaring

opposition has a chance to sell the idea that

crime rates, blackouts, high inﬂation and food

it is stronger; that Chavez is not a majority

shortages are all deeply ingrained traits of

and that there is a large gulf between the

Venezuelan life, and the September elections

votes and composition of Parliament,” says

are an expression for change. A search for a new

Luis Vicente Leon, DatAnalysis Pollster

political equilibrium has begun.

President.

“This

fertile

ground

for

It is highly unlikely that Chavez will meet

someone to capitalize on the idea of change

these challenges lying down. Analysts have

and motivate the critics.” One can only hope

predicted that signs of political opposition

his words will bear fruit in the future. iBR

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B Y S OH U M D O S H I ( W ‘ 14)

US-LATIN AMERICAN RELATIONS:

Vintage cars in Havana, Cuba.

THE BIG DOWNTURN F or nearly two centuries, the United

could strengthen regional relations, but a desire

States has had a sphere of inﬂ uence

to protect “recovering” U.S. industries from an

in Latin America. Starting in 1823

inﬂ ux of foreign goods, alongside trade deﬁcit

with the Monroe Doctrine, which emphasized

concerns and the President’s goal to double

freedom of the newly independent Latin

exports in 5 years, is preventing their passage. Second,

American colonies from European intervention

111210 hq.indd 34

there

are

political-historical

(and thereforeensured U.S. dominance in the

complexities that have impacted US-Latin

region), this relationship would eventually be

American relations. Many countries in Latin

deﬁned by the superpower status of the United

America have not forgotten a history of US

States. Abastion of democratic governance,

imperialism in the region. The 21st century

free market success, and protector of human

has seen the rise of the “Pink Tide” in Latin

rights, the United States has long tried to stand

America

as an example to Latin America. But things are

political ideology is a source of friction

changing quickly in what has characteristically

between them and the United States. This

been called America’s “backyard”, as America’s

problem exists beyond just the inﬂammatory

credibility and inﬂuence are slowly atrophying

language of the governments of Hugo Chavez

in the region.

(Venezuela) and the Castro regime (Cuba).

leftist

governments

whose

There are three reasons why the United

Even moderate countries such as Brazil,

States is losing inﬂuence in Latin America.

Bolivia, and Nicaraguahave adopted more

The ﬁrst reason is a ﬂuttering of protectionist

socialist

sentiment in the U.S. that is preventing the

“anti-imperialist” in a clear denunciation of the

passage of US-Latin American free trade

United States. Moreover, the rise of Brazil as

agreements (FTAs). A number of tentative

a regional and world power is also impacting

FTA agreements started during the Bush

US-

administration,

allies

perceived to be a leader among its fellow

Colombia and Panama, have yet to be concluded

developing countries and therefore outside

by the Obama administration. These pacts

the scope of U.S. control and inﬂ uence.

including

I N T E R N AT I O N A L B U S I N E S S R E V I E W

those

with

policies

Latin

and

American

labeled

themselves

interactions.

Brazilis

FA L L 2 0 1 0

11/27/2010 3:13:12 PM

Third, the US has failed over the past

the Brazilian arm of Spanish Repsol for

line of credit was issued to Venezuela

decade to engage in mutually-beneﬁcial,

$7.1 billion with the hopes of producing

from the Chinese Development Bank. By

active dialogue with Latin America. As

200,000 barrels of oil per day;this is a lofty

giving Latin American countries cheap

the War on Terror and national security

goal for China’s second largest acquisition

access to credit with few strings attached,

concerns largely dominated the agenda

of an oil company to date.In addition,

the Chinese are quickly redirecting focus

of the Bush and Obama administrations,

China

free-trade

from US-led institutions like the IADB.

efforts to engage Latin America were

agreements with many Latin American

With more than $2 trillion dollars in U.S.

forgotten or relegated to the backseat.

countries

currency

Most Latin American countries ignored the

trade with the region. The Chinese and

strength of the dollar, the Chinese see

War on Terror and focused their resources

Peruvians signed a Free-Trade agreement

hard assets, such as the raw materials they

in April of 2009, and China has already

are buying in Latin America, as a more

ofclean

displaced the U.S. from its eighty-year

secure investment.

energy practices. Past dialogue between

streak as Brazil’s largest trading partner.

Third, military relations between China

the U.S. and Latin America on economic

In exchange for raw materials from Latin

and Latin America have been growing

policies is another source of tension. Latin

American countries, the Chinese supply a

in the past decade. While the arms sales

Americans ﬁnd a great hypocrisy in the

wealth of consumer products such as cars,

that China has made to countries such as

the

elimination

alleviation,

and

the

poverty,debt

creation

rapidly to

forming

facilitate

its

booming

and

uncertainty

about

the

fact that the United States, a country that

The US has failed over the past decade to engage in mutuallybeneÀcial, active dialogue with Latin America.

had lectured them on debt reduction, transparency, and growth, now faces a terrible ﬁnancial crisis which originated out of its shady banking practices. The above issues might have been forgotten had another world power not exploited this decline in relations. China, the Asian economic giant, has made great

cell phones, and batteries, to a consumer

Venezuela, Brazil, Bolivia, and Cuba have

forays into Latin America in the previous

market of 600 million individuals.

been relatively small (anywhere from ten to a few hundred million dollars), they have

few years, and its inﬂuence is rising rapidly

In addition to joint ventures with

throughout the region. More importantly,

Latin American countries, Chinese loans

still made signiﬁcant inroads in building

Latin American countries are eager to

help secure its inﬂuence and help China

military relations. A US Military Review

enter into a partnership with China, one

diversify assets away from US dollars.

in 2008 noted that that over 100 junior

that is based on a different paradigm than

economic

or senior officers representing 12 Latin

the region’s centuries-old relationship

assistance

directed

American countries have graduated from

with America.

towards the Inter-American Development

Chinese military academies in the past

China sees Latin America as offering

Bank (IADB), largely headed by the

few years. While this number may seem

three mutually-beneﬁcial opportunities.

United States (with a 30% stake and

small, it represents a growing number

First, China is a rapidly growing power

Washington DC headquarters). In light of

of upcoming Latin American officers

that must meet the material demands of

the Chinese alternative, however, those

who have extraordinarily close ties to

more than 1.3 billion people. To this end,

loans havetoo many strings attached

the Chinese military and would likely

several Chinese state-owned enterprises

and are often too small. For instance,

welcome increaseda Chinese presence in

have moved into Latin America to secure

while the IADB approved a total of $11.2

their country.In addition, Chinese military

raw materials such as copper, oil, and

billion in loans for 2008, most individual

hardware, while limited, still affects U.S.

even soybeans for their use back home.

loans from China are equivalent to this

interests. Chinese “gifts,” such as the 38

In 2007 the Aluminum Corporation of

amount. Last year a $10 billion deal (made

HN5 rocket launchers given to Bolivia, were

China (CHINALCO) bought Peru Copper

in Yuans) with Argentina secured China’s

smuggled into Colombia and used against

for $860 million dollars.In October 2010,

imports to the country, while this year,

American-made

corporation

on top of an existing $12 billion dollar

by anti-narcotic Colombian pilots. The

namedSinopec bought a 40% stake in

bilateral investment fund, a $20 billion

Chinese are also willing to spend money to

Chinese

petrochemical

the

past,

requests

and

loans

for were

FA L L 2 0 1 0

111210 hq.indd 35

helicopters

piloted

I N T E R N AT I O N A L B U S I N E S S R E V I E W

11/27/2010 3:13:12 PM

make friends. Chinese “friendship prices,” which are prices that result in monetary loss on the sale, allow older, less expensive military hardware to be transferred to Latin American countries in exchange for future favors.These favors can likely be traced to another matter of importance that

China

has

with

Latin

America-

diplomatic recognition. Particular strategic importance is placed on the fact that 12 of the 23 countries that maintain diplomatic recognition of Taiwan are in Latin America. If China develops a relationship with these countries it can leverage its economic powerto reduce that number. While China’s expansion into Latin America is extensive, the two centuries of inﬂuence the United States has had over Latin Americawill not disappear within one decade. There arestill ways by which

As a result, in many countrieslike Brazil

population reduces perceptions of it as

the United States can retain its leadership

and Argentina, accusations that China

an outsider. US companies could try

position in Latin America. First, the IADB

is dumping its goods in Latin American

to emphasize these differences as a

has increased its lending to$15.5 billion

markets has prompted an increase in

way to procure business with Latin

dollars lastyear from a previous $11.2

tariffs on various products and a surge in

American countries.

billion dollars in 2008. While this may

anti-China protests. Third, the cultural and

not be a large difference, the emphasis

historical ties between Latin American

astrong

of these loans is placed on small to

countries and the United States provide a

tionship with Latin America. However,

medium size businesses. For instance,

strong bond between them that can prove

this August the organization secured a

invaluable. The Chinese, newcomers to

multi-polar and the United States faces

$36 million dollar loan for MiBanco, the

the area, can make the mistake of failing

a decline in its global inﬂuence, it must

largest microcredit organization in Peru.

to respect cultural norms. As a New York

go beyond what it has done in the past

Bybeing a large donor in this regionally

Times article reported, tensions between

to protect its relationshipsin this region.

run organization (developing countries

the Shougang Corporation of Bejingand

Rising powers such as China, are clearly

have a 50% stake),the U.S. is funding

iron miners in Peru demonstrate this

aware of the political and economic

small to medium sized companies and

unfamiliarity.

forceful

beneﬁts of maintaining close ties to Latin

reestablishing American inﬂuence and

attempts to approach Chinese executives

American countries and are devoting a

respect in the region.Second, recent

by workers protesting low wages and

great deal of resources to this cause. Not

tensions between China and Latin America

environmental pollution have been met

only must the United States recognize this

with respect to trade practices could

with physical violence by hired security

investment, but it must also do whatever

allow the US a role in mediation. Many

guards. The death of a 21 year old worker

it can to match or exceed it. Efforts need

experts note that there is growing reason

as a result of this violence hastarnished

not necessarily be monetary in nature.

to believe a “neo-colonial” relationship is

China’s image in the area. This could be

The United States must deal with Latin

developing between the two partners-

indicative of a wider shift in the view of the

American countries as equals and end

with China taking raw materials and selling

Chinese as equal partners to dictatorial

the historically paternalistic nature of the

back ﬁnished products. Though China

managers. In contrast, the United States

relationship. Equal treatment allows for

touts its relationship with Latin America

has relatively strict environmental and

dialogue, planning, and action and thus

as win-win, the simple fact remains that

wage

can build and protect U.S. inﬂuence in

its policies are essentially mercantilist.

while its fast growing Spanish-speaking

111210 hq.indd 36

I N T E R N AT I O N A L B U S I N E S S R E V I E W

Strikes

practices

and

foreign

countries,

The United States has long had

the

and

mutually-beneﬁcial

world

becomes

rela-

increasingly

Latin America. iBR

FA L L 2 0 1 0

11/27/2010 3:13:13 PM

B Y N IC HOL A S T H E U E R K AU F ( W ’ 11)

GERMANY & OKTOBERFEST:

DEFLATION KEPT AT BAY

he world’s largest fair starts at exactly noon each year in midSeptember, when Munich’s mayor

taps the festival’s ﬁrst keg and declares, “O’ zapft is!” (“it’s tapped!”). The festivities will last the next 17 days and this year there is much to celebrate. Not only is it Oktoberfest’s bicentennial, but the German economy

thriving.

Unemployment

fell to its lowest levels since Germany’s reuniﬁcation and exports are souring. The German economy grew at a spectacular annualized rate of 9% in the second quarter (more than other developed economies). Although

Oktoberfest

rooted

tradition, the festival has become big business. About six million people attend the fair each

“Drink up, Helmit! Have no fear. This mighty beer has been approved by the European Commission, regulation 4064/89, log 24, article 58...”

year. This year’s celebrations injected about one billion euros into Munich’s economy

year, while last year it sold for EUR 8.44. To

(nearly 2% of the city’s GDP) with beer

evaluate Oktoberfest’s impact on inﬂation

accounting for, by far, the greatest portion.

more broadly, UniCredit economists devised a

But, in today’s economic environment the

basket of goods and services called the Wiesn

primary beneﬁt of the fest may be to mitigate

Visitor Price Index, which includes the price

deﬂation. Germany’s economy-wide inﬂ ation

of public transportation and a half a grilled

rate of only one percent falls signiﬁ cantly

chicken (Hendl) in addition to two Masses. The

short of the European Central Bank’s target

index has increased by more than 4% per year

euro-zone inﬂ ation rate of just under 2%.

since the mid-1980s, double Germany’s annual

That’s why the nearly 2.5% price increase

inﬂation rate over the same period.

in one liter (or Mass) of beer since last year,

While the United States and Japan are

a strikingly greater value than the 0.3%

ﬁguring out new methods to keep deﬂation at

inﬂation rate for bottled beer, is signiﬁcant.

bay, Germany, it seems, will rely on the 200-

The average Mass sold for EUR 8.65 this

year old Oktoberfest for now. iBR

FA L L 2 0 1 0

111210 hq.indd 37

I N T E R N AT I O N A L B U S I N E S S R E V I E W

11/27/2010 3:13:13 PM

B Y M A X M A E C K L E R ( N Y U ’ 13)

WIRTSCHAFTSWUNDER 2.0:

GERMANY - THE ODD ONE OUT Audi production in Aurangabad, India.

111210 hq.indd 38

n an interview just prior to the Democrats’

forces rising at a breathtaking pace in Asia

sweeping defeat in the November midterm

and elsewhere in the world. With regard to

elections, Barack Obama confessed that

Germany, the continued high unemployment

what keeps him up at night is the fact that

and the near stagnating growth ﬁgures of

“China, Germany, India and Brazil are moving”.

the early 2000s, supported this impression.

While this is not particular surprising given the

Germany’s

current state of the US economy, it is worth

traditional industrial sector – most of all the

taking a closer look at the list of countries

car industry – was seen as outdated in a world

that cause the President sleepless nights.

where the developed countries outsourced

While China, India and Brazil are all emerging

their industries to low-wage countries around

economies that promise to be economic

the world.

heavy

dependence

the

powerhouses of the coming century, Germany,

During the same years, however, the

with a developed economy and an aging

government under then Chancellor Schroeder

population, is clearly the odd one out..

introduced

wide-ranging

reforms

the

With a population of just over 80 million

labor-market and the social welfare system,

the central European country is a fraction

collectively known as the Agenda 2010. These

of the size of the newly emerging economic

measures, which, for example, made it easier

powers, but unlike them it is a developed

for ﬁ rms to lay off workers, together with

country and looks back at a long history of

agreements between labor and management

economic growth and stability. Partly for

to abstain from wage increases in return for job

these reasons the country (as well as Europe

security (as a result, real wages have declined

as a whole and more recently

between

the United

2004

and

2008)

have

greatly

States) has often been portrayed as beyond

increased the competitiveness of German

its heyday and in relative decline, just waiting

products, especially when compared with

to be outperformed by the new, more dynamic

those of its European neighbors. This has led

I N T E R N AT I O N A L B U S I N E S S R E V I E W

FA L L 2 0 1 0

11/27/2010 3:13:13 PM

to substantial growth rates in the years before

machinery and automobiles. A recent study

the 2008-2009 global recession. Germany’s

by the Munich based Ifo Institute, one of

exports, which make up a substantial share of

Germany’s

its GDP, where not hampered by the strong

concluded that by 2011 German companies

Euro because as of 2008 sixty-four percent of

will for the ﬁ rst time export more goods to

German exports went to other EU-countries

China than to the United States. German

(with France being the largest single importer

luxury cars enjoy the greatest popularity

of German goods and services).

among the newly rich in Asia where car

most

inﬂ uential

think

tanks,

Exports also played a major role in

salesmen describe the demand as “explosive”.

Germany’s rapid and full recovery from its

In October, the members of the board of

worst recession since the Second World

trade of the rapidly developing Indian town

War. Having experienced a massive slump

of Aurangabad jointly placed a single order of

Exports also played a major role in Germany’s rapid and full recovery from its worst recession since the Second World War. in 2009 when the country’s GDP fell almost

150 Mercedes-Benz cars as a publicity stunt

5%, the economy was already growing again

to gain attention for their little known town.

at a rate of 2.2% in the second quarter of

In early November, BMW announced that it

2010 (the fastest quarterly growth since the

had sold almost 122,000 cars in China since

reuniﬁ cation of the country 20 years ago). The

the beginning of the year, almost doubling the

European Commission expects Germany’s

sales of 2009.

growth rate for the whole year to exceed

With these trends expected to continue

3.4%. By comparison, its forecast for the euro

in the next decade, Germany seems to have a

zone is a mere 1.7%. According to the German

bright economic future lying ahead. Of course,

Federal Statistics Offi ce, German exports

there are some signiﬁcant challenges to

grew by 3% in September and unemployment

overcome. One is Germany’s increased reliance

(at 3.15 million in September) was already

on markets such as China and Russia, which are

lower than before the beginning of the crisis

prone to interference by their unpredictable

in the fall of 2008. While the unemployment

governments. The recent row over China’s

rate

curbing of its rare earth exports, which are

9.6 percent [October 2010] and hasbeen

vital for many of Germany’s key industries,

essentially unchanged since May” according

is illustrative. Another even more daunting

to the U.S. Bureau of Labor Statistics, German

problem arises from Germany’s aging society.

companies are now publicly worrying about

A recent OECD study found that in a decade

labor shortages.

from now the number of people leaving the

the

United

States

“remained

One crucial factor contributing to the rapid rise in German exports is the equally rapid recovery of the emerging markets from the global recession, which has led to a

German labor market will be up to 75% higher than the number of those entering. Nevertheless, for the time being President Obama is right. Germany is moving. iBR

strong surge in demand for German produced

FA L L 2 0 1 0

111210 hq.indd 39

I N T E R N AT I O N A L B U S I N E S S R E V I E W

11/27/2010 3:13:14 PM

B Y S I N DH U R A C H I T T U R I ( W ’ 13)

EUROPE:

SPAIN & THE CASE FOR LABOR REFORM Gran Via Street in Madrid, Spain, at night.

pain’s economy continues to lag

country had been shaken by the bursting of

behind many of its European peers.

its construction bubble. But the bust alone

The country’s unemployment rate of

cannot explain the country’s economic woes.

20% is the second highest in the European

Much of the answer lies in the country’s

Union behind Latvia’s. Furthermore, Spain’s

antiquated and inﬂ exible labor market.

youth unemployment rate makes the overall

market

commonly

comparison. Half of all Spaniards under the

labor market, permanent workers receive

look

minuscule

age of 25 are out of work. Spain’s deficit to

secure

GDP ratio was about 7.9% in 2009, more

Government regulations make it very costly

than twice the European Union’s limit of

for employers to ﬁ re these workers. Until this

3%. As a result, Spain is widely referred to

June, permanent workers received severance

as one of the PIIGS (Portugal, Italy, Ireland,

payments of up to 45 days in wages for each

Greece, and Spain), a rather unflattering

year worked. Meanwhile, temporary workers

designation for Europe’s reckless spenders.

comprise the lower tier of the labor market.

What is difficult to believe is that just three

They work on short-term contracts and can

years ago, Spain’s economy was one of the

be fired at will. Most of Spain’s temporary

strongest in Europe. In 2007, the country’s

workers are immigrants or young adults

unemployment rate was only 8%, high by

and make up about a third of Spain’s

American standards, but low compared to

workforce. While some temporary workers

its European counterparts’.

are eventually able to secure permanent

from grace? For starters, the global ﬁ nancial crisis of 2008 hit Spain at a particularly inconvenient time, just a year after the

111210 hq.indd 40

labor

referred to as two-tier market. In a two-tier

rate

How do we explain Spain’s rapid fall

Spain’s

unemployment

I N T E R N AT I O N A L B U S I N E S S R E V I E W

employment

and

good

beneﬁ ts.

jobs, many work contract to contract with frequent bouts of unemployment. When

the

economy

ﬁ rst

entered

recession in 2008, the government responded

FA L L 2 0 1 0

11/27/2010 3:13:14 PM

with stimulus spending. Its €11 billion stimulus

Structural reforms to the labor market

package provided money for public works

are needed to secure the country’s long-

and the declining auto industry. But while

run economic prosperity. The left-leaning

this spending helped to halt the country’s

government has already recognized this.

economy from spiraling further downward, it

In June, it cut the maximum severance

did not create lasting employment because it

pay from 45 days to 33 days. It also

lacked much needed labor reform. Employers

made it easier for businesses to reduce

were reluctant to hire permanent workers, who

work hours for permanent workers. The

would be expensive to ﬁ re, in the uncertain

measures are steps in the right direction,

times. Instead many employers cut back their

but the government needs to do much

Structural reforms of the labor market are needed to secure the country’s long-run economic prosperity. labor costs and either did not hire or hired

more. Unfortunately, there is widespread

temporary workers. Unemployment increased

resistance to any changes. Labor unions are

until it reached its current level of 20%.

against a more flexible labor market because

High

unemployment

has

exacerbated

it will decrease their bargaining power and

The

benefits. And it does not help that Spain’s

government’s deﬁ cit, already high because

Socialist Prime Minister Zapatero depends

of the stimulus spending, rose even more

on the support of labor unions. Permanent

because

workers

other

problems

the

country

increased

faces.

unemployment

oppose

any

changes

because

spending. As a result of increased debt and

they will lose job security. Additionally, a

uncertainty, rating agencies like Moody’s

more flexible labor market is likely to lead

and Standard & Poor’s downgraded Spanish

to an increase in unemployment initially

debt. With lower ratings, government debt

before employment picks up again. Labor

became more expensive. Higher interest

reform should have been made during the

rates increased the need for additional debt,

2006-2007 construction boom when the

resulting in a vicious cycle of increasing

country could have coped with an increase

interest payments and increasing debt. The

or at the height of the financial crisis when

unemployment problem is also lowering the

political obstacles for action were weakest.

country’s productivity. Young adults straight

Unfortunately,

out of university have trouble ﬁ nding work

structural issues like the labor market while

despite their high level of education. At the

expansions tend to hide these problems.

same time, many permanent workers do

It is up to Spain’s political leaders to make

not work as hard because they have almost

the case for labor reform. So far, Spain has

complete job security. It is no surprise

missed its chances. iBR

recessions

often

reveal

that Spain has one of the lowest levels of productivity in Europe.

FA L L 2 0 1 0

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I N T E R N AT I O N A L B U S I N E S S R E V I E W

11/27/2010 3:13:14 PM

B Y M IC H A E L T O TA H ( B O C C ON I ’ 11)

EUROPE:

Italy: People protesting against unemployment and current politics.

WHERE IS ITALY’S GROWTH? A of

bargaining at a national level which, even

ﬁ nancial markets and of the EU

though it has not resulted in excessive

debt crisis, added focus has been

wage growth. It makes wages much more

given to the issue of economic growth, and

“sticky” and exacerbates regional diff erences

the lack of it in Europe and the US. In fact,

many western countries are suff ering from a

generous

slow down in economic activity that is due to

(cassa integrazione guadagni) coupled with

both business cycle and structural long-term

high employment protections for full-time

issues. But among the developed economies,

employment enhances the rigidity of the

Italy has been experiencing growth rates

market. Italy’s low economic productivity

below its peers for the last two decades,

and

which can only be explained by structural

regulation and governmental oversight of the

peculiarities of the Italian economy.

product market: due to restrictive regulatory

fter

the

partial

stabilization

First of all, Italy is characterized by numerous

111210 hq.indd 42

market

rigidities

due

the

economic

development.

wage

growth

addition,

supplementation

also

aff ected

funds

strict

measures, entry costs are extremely high, especially

for

start-ups.

Italy’s

product

country’s regulatory and social framework.

market is the third most regulated among

The labour market is particularly ineffi cient,

the 27 OECD countries, ranks ﬁ rst in terms

with

European

of administrative burdens to start-ups and

average: in fact, the low participation rate

state involvement, in the form of public

(60%) and

ownership

productivity

below

the

weekly hours worked in line

and

involvement

business

with the European average (41 hours per

operations, is one of the highest in Europe.

week), determine a comparatively low total

It has to be pointed out that regulation in the

labour utilization. The inability to allocate

product market is not homogeneous, so as

labour in an effi cient and timely manner,

to hamper the international competitiveness

which in turn aff ects labour productivity,

and productivity of speciﬁ c industries: the

is due to a widespread system of collective

bulk of regulation, in fact, aff ects the service

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11/27/2010 3:13:14 PM

sector, with retail distribution, road freight, mobile telephony and railways being the most regulated industries. Other factors inﬂ uencing Italy’s slow economic growth, related to the saving and capital formation process, are the precarious situation

public

ﬁ nances

and

the

ineffi ciency of the judicial system. Since the ‘80s, Italy has been massively increasing its public debt, which has been mostly ﬁ nanced by local savings. The huge debt build-up, coupled with a negative budget balance, has, and still is, crowding out a substantial amount of savings from the private sector and

hindering

Italy’s

capital

formation

capabilities. In addition to that, the worrying level of Italy’s public ﬁ nances is also aff ecting

Italy’s economy is still only halfliberalized, with important service industries being heavily regulated.

expectations regarding future tax rate hikes, so as to discourage long-term investments. An important role in discouraging investments is also played by the ineffi cient judicial system which, with its abnormally lengthy trials, increases legal risk and the costs of doing

on maintaining the status quo rather then

business in the country.

implementing an aggressive policy of cost-

These well-known structural problems have

been

inadequately

addressed

cutting that would liberate resources for private investments.

governments of diff erent political parties. The

It is then evident how insufficient the

labour market has undergone a signiﬁ cant

reforms of the last ten years have been.

reform in 2003 with the Biagi reforms, which

To solve

has deregulated the use of atypical work

necessary to address the market rigidities

arrangements

Italy’s “growth problem” it is

work,

created by the current regulatory framework

part-time work, on-call jobs and occasional

and remove the disincentives to private

work). But, despite

investment. These are pervasive reforms

(temporary

agency

adding ﬂ exibility at

the “margin”, not having tackled the issues

which

even

collective

bargaining

and

excessive

would in

take

stable

time

political

implement

environment;

but an incremental approach is possible

“duality” in the labour market and had no

and needed, starting from administrative

signiﬁ cant impact on labour productivity. The

simplification and the lowering of regulatory

product market regulatory framework, after

burdens for start-ups. Therefore, it is only

the wave of liberalizations of mid-90s, has

by addressing its structural inefficiencies

remained unchanged and state involvement

and by intervening on the two main drivers

remains high; Italy’s economy is still only

of long-term economic growth, productivity

half-liberalized,

of capital and labour, that Italy can solve its

employment

protections

with

has

created

important

service

industries being heavily regulated. Nothing

economic growth issues. iBR

has been done yet to solve the ineffi ciency of courts and present ﬁ scal policy is focused

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11/27/2010 3:13:14 PM

B Y SE R GE MOR E L L ( W ’ 10 )

RUSSIA’S TECH BOOM:

A FAIRY TALE OR REALITY?

t the 3rd annual Russian nanotech

Over the past year, buzzwords such as

conference that opened in November

“modernization” and “nanotechnology” have

2010,

CEO

entered the vocabulary of everyone from

of Microsoft, pledged full support to the

school children to local politicians across

Russia displays technology at a fair in

development of Skolkovo, a $2 billion high

Russia. The idea of “catching up” to the rest

Paris, 2009.

tech complex outside of Moscow. Many see

of the world is of course nothing new to

it as Russia’s attempt to clone the innovative

Russia.

hub in the Silicon Valley. Russia will channel

of modernization that spanned from reformist

another $5 billion in investments towards

Czars, such as Peter the Great and Alexander

the creation of a $30 billion nanotechnology

II, to Soviet leaders, such as Gorbachev, who

industry in Russia by 2015. In its traditional,

sought

grandiose fashion, the sixth-largest economy

Focusing on technological competitiveness

in the world, known more for its abundance

has a certain nostalgia to many Russians. This

of natural resources and nuclear stockpiles, is

can only be done by reversing the massive

making way for the next tech boom.

brain-drain that started at the beginning of the

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Steve

Ballmer,

the

The county cycled through periods

“perestroika”

and

“acceleration”.

The latest modernization crusade, spear-

20th century. The high proportion of Russian

headed by president Medvedev, is an attempt

educated scientists in universities across the

to diversify the Russian economy away from

world implies that Russia’s education is not

its dependence on oil and gas (currently

at fault for Russia’s lag. To this day, a large

80% of exports), clean up corruption, and

number of physicists, computer scientists,

provide sustained economic growth. After the

biologists leave Russia to pursue better

ﬁ nancial crisis of 2008, a highly vulnerable

paying jobs in the West.

and volatile oil-based economy was deemed

However, brain-drain is not the only factor

unhealthy for a government that intends on

contributing to the lack of investment in the

staying in power. In an eff ort to modernize

tech space. Weak intellectual property laws and

and revamp the Russian economy, the Kremlin

an unpredictable judicial system have stymied

is focusing on ﬁve industries: biomedicine,

a number of potential investment projects. The

space and information technologies, energy,

international venture capital community had

and telecommunications.

steered clear of direct investments into Russian

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startups and instead focused on exporting

Critics believe that the current Russian

technology it ﬁnds at Russian universities for

government’s modernization initiatives are

commercialization in the West. That’s why

really a publicity stunt to create an impression

President Medvedev has been on a mission to

that something has been done. Some even

woo foreign investors. He has visited Silicon

suggest that the nanotech investment fund

Valley and has extended invitations to the

is nothing more than a money laundering

venture capital community to come to Russia.

vehicle for government offi cials. They claim

A number of initiatives, such as lowering the

that without modernization of the rule of

tax on foreign proﬁts, cutting capital gains

law, nothing will ever change. The Russian

taxes, reforming white-collar criminal law, and

economy will remain a natural resources

privatizing state enterprises, demonstrate the

economy

government’s commitment to attract foreign

exception of a few successful companies,

professionals and drive modernization.

which will have diffi culty competing against

the

near

future,

with

the

Weak intellectual property laws and an unpredictable judicial system have stymied a number of potential investment projects. Despite the success of Russian scientists

subsidized, state run ﬁ rms. However, the

in the theoretical ﬁelds of science, where they

government’s hand will always be there

have produced a number of technologies with

to promote domestic industry, especially

wide applications, Russia has never been a

in technology. For instance, this summer

global leader in technology. This can be largely

Russia introduced legislation to prevent the

attributed to a lack of an entrepreneurial

future sale of electronic equipment that

culture as well as a dearth of qualiﬁ ed

utilizes the GPS navigational system, forcing

management. To this day, Russia is trying to

manufacturers to replace the international

push technology and innovation from the

version with a Russian version – GLONAS.

top down by either forcing scientists into this

Perhaps, this top down approach to

new “silicon valley” or by creating a state-run

create a thriving technology industry in Russia

investment fund in nanotechnology. With a few

will be successful. After all, this approach is

exceptions, the only proﬁtable business model

inherently part of Russian culture and there are

in Russia over the past 20 years has been one

some signs it is working. One recent example

based on cheaply privatized factories from

continues to baffl e investors. Statistically,

Soviet times and cheap energy and electricity,

Russians spend more time than any other

often subsidized by the government. In other

nation on social networks. Goldman Sachs and

words, businesses at the bottom of the value

JP Morgan are underwriting the latest Russian

chain, such as the metal and mining industry,

IPO, Mail.ru, which was oversubscribed 5 times

aluminum, and potash. Accordingly, stock

and valued at 55xEBITDA. The conglomerate

indices, ETFs and investment funds tracking

of Russian internet companies is reminiscent

Russia are allocated mostly to the natural

of valuations from the tech bubble era.

resources sector. Despite recent efforts, it will

Perhaps, Winston Churchill was right calling

take a long time before the technology sector

Russia “a riddle, wrapped in a mystery, inside

will have a major impact on the economy.

an enigma.” iBR

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11/27/2010 3:13:16 PM

B Y JA N I S K R E I L I S (C ’ 11)

AIR BALTIC:

CLEAR FOR TAKE-OFF T ry to ﬁnd a ﬂight from Paris to Tel

From a point-to-point carrier operating from

Aviv, and airBaltic, Latvia’s national

several airports, the company has transformed

ﬂag carrier, will probably offer to

itself into a transit-focused airline hauling

In 2009, airBaltic carried almost 2.8

give you a lift. If you agree (and you might,

travelers through Riga as its main hub. For this

million passengers.

given the price), your next stop will be in

achievement, the European Regions Airline

Riga, the Latvian capital and the main hub

Association awarded to airBaltic its 2009/10

of the airline. And you will not be the only

Airline of the Year Gold Award. Later, for the

one there. Despite the current economic

same reasons, the Latvian company earned

meltdown in the Baltics, airBaltic looks

the Phoenix Award from Air Transport World,

remarkably strong. It’s on a green branch -

a major magazine of the airline industry.

as the Latvians would say - and, in the case

The most recent award has come from the

of airBaltic, that branch seems as green as

World Low Cost Airlines Congress, recognizing

the lime tailﬁns of its planes.

the new ‘hybrid’ business model of airBaltic.

During the summer of 2009, the airline

Like other low-cost airlines, airBaltic offers

served over 100 destinations from its hubs

signiﬁcantly lower rates compared to traditional

in the three Baltic capitals Riga, Tallinn, and

European

Vilnius as well as a number of Scandinavian

baggage and refreshments on board. However,

airports. With a ﬂ eet of 32 aircraft, airBaltic

like ‘legacy’ or ‘network’ carriers, airBaltic sells

focuses

Europe

its tickets through travel agencies, participates

and Scandinavia to the countries of CIS

in codeshare agreements, and offers business

and the Middle East. Meanwhile, Latvians,

class service on most ﬂights. So far, the model

Lithuanians, and Estonians enjoy a great

has worked remarkably well: airBaltic ended

number of direct ﬂ ights—currently over 70—

2009 with a 20 million euro proﬁt, and the

from its home base in Riga.

number of its ﬂights as well as passengers has

connecting

Western

At the Riga International Airport (RIX), one now hears other languages as much as

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airlines,

but

also

charges

for

kept rising throughout 2010, all amidst a global recession and the crisis in Latvia.

the native Latvian. Last year, airBaltic carried

The airline has been innovating constantly

2.76 million passengers, more than the total

to stay on the upward curve. Last year, it

population of Latvia. This success reﬂects

introduced BalticMiles, its own frequent-ﬂyer

the change of airBaltic’s business model.

program, and by now, the program has grown

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to include a large number of partnering

other associated brands (see above) to

sides have not reached a consensus,

companies in the tourism and retail

BAS for around 12 million euros without

and airBaltic keeps paying the airport in

industries. In October 2010, airBaltic

properly consulting the government

advance by the week, lest it terminate

announced it would become the ﬁrst

as the major stakeholder. Treating this

service. The Latvian government has

airline in Europe to introduce Apple iPads

deal as decreasing the value of the

expressed resentment over the clash

for its in-ﬂight entertainment.Similarly, it

company, while giving exclusive powers

between

might be the ﬁrst airline in the world to

to the CEO, the Latvian minister of

companies, and has threatened to ﬁ le

offer ﬂat-screen TVs for sale onboard.

these

two

state-owned

economics got involved, demanding an

a claim against the executive board of

It does not end with ﬂights either.

explanation. Mr. Flick claimed that this

airBaltic if the company has to suff er

The airline has been extremely proliﬁc

deal strengthened the ﬁ nancial indices

ﬁ nancial damage because of its inability

in creating a large number of off-shoots

to settle matters outside of court.

associated with its brand. It runs its own

arose over the bill for the use of the

The idea of privatizing airBaltic has kept

online travel agency, AirBalticTravel. The

brand. Although Mr. Flick originally

appearing rather regularly in the Latvian

airline is also a member of the Riga Tourism

stated that airBaltic could use its own

mass media. The state as a stakeholder

Development Bureau, which runs LIVE

brand for free, an investigation revealed

may lack the sufficient control over

RīGA, a brand for promoting Riga as a travel

that, under the conditions of the deal,

decision making in the company, as these

airBaltic,

but

much

controversy

The airline has been extremely proliÀc in creating a large number of off-shoots associated with its brand. destination. Once in Riga, the company, in

airBaltic would have paid 1.4 million

controversial episodes show. Mr. Flick has

partnership with other private and public

euros per year to BAS. By the time of

suggested making an initial public offering

investors, offers two options for ground

the investigation, 130,000 euros had

as a way of attracting new investors.

transportation: BalticTaxi, by now one of the

already been transferred, the fate of

Staving off fears of his takeover of the

leading cab service providers in Riga, and

which has sparked much controversy.

company, the CEO has suggested that

BalticBike, a bicycle rental service with a

Meanwhile, Mr. Flick has taken BAS to

BAS would not make use of preemption

ﬂeet of over 100 bikes in Riga and Jurmala,

the Lithuanian market and founded an

rights. Rumors about Chinese investors

the neighboring seaside town.

airline that will start competing with

have circulated in the Latvian media,

Because of all these efforts, airBaltic

airBaltic, operating from Vilnius, in

but, so far, the government has not

has become Latvia’s leading exporter,

early 2011. Although he has denied any

revealed any plans of selling its stake in

amounting to 350 million euros, or about

conﬂ ict of interest, Mr. Flick’s actions

the near future, claiming that the time is

8% of Latvia’s total export turnover,

do seem confusing at the very least.

not right.That might be true: if airBaltic has

emerges from the crisis even stronger,

Finland’s exports. All of this seems even

strained

between

the government would be able to sell its

more surprising, considering that the

airBaltic and Riga International Airport,

shares more dearly, and the company

Latvian state still owns the majority

also owned by the Latvian state. This

would attract serious investors to expand

of shares (52.6%) in the company. The

year, the airport ﬁ led a lawsuit against

its operations. One thing is sure, however:

other 47.2% are owned by the CEO

airBaltic over the collection of unpaid

even if airBaltic does not need Latvia as

Bertolt Flick, whose company, Baltic

fees amounting to 7 million euros. The

its main stakeholder, Latvia still needs

Aviation Systems, Ltd. (BAS), purchased

airline retaliated by suing the airport for

airBaltic to bring in those tourists and

the stake from SAS last year.

unfair competition practices, claiming

generate the ﬂow of exports, especially

Despite his evident success, Bertolt

that the airport charged the Irish low-

given today’s recession. The two will have

Flick’s reputation has been tarnished

cost carrier, Ryanair, a fee of 1 euro per

to ﬁnd an agreement. iBR

in Latvia. In December 2009, airBaltic

plane, or 500 times less than what it

sold its brand along with a number of

charged airBaltic. Currently, the two

which is higher than that of Nokia in

Another the

prolonged

conﬂ ict

relationship

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11/27/2010 3:13:16 PM

BY T I N A X I E (C ‘ 1 2) A N D DA N I E L H E L LW I G ( W ‘ 1 1 )

THE FUTURE OF METROPOLITAN PHILADELPHIA Janet Rothenberg Pack, Professor of Business and Public Policy and Real Estate at the Wharton School, provides some insight on the current real estate market within metropolitan Philadelphia, also in comparison with other cities throughout the United States. During our interview, we learned about the difficulties associated with privatization and private sector altervatives, recent cost cutting measures, and with the provison of financial incentives to local businesses. Can you give us a brief overview of today’s real estate environment in the Philadelphia center city area? In the current market environment, it’s difÀcult to talk about trends, everything is very idiosyncratic. One of the arguments about why house prices went up in the second quarter is that they had fallen so much before. Also, in June, the federal tax credit for home purchases ended. People who wanted to take advantage of the tax credit jumped into the market in the second quarter, and therefore, in the third, the market was expected to slow down both in terms of growth in house prices and in the volume of house purchases and it did. House prices in Philadelphia in the third quarter of 2010 (July-September) fell by 4.6% on average (seasonally and quality adjusted), compared with an average increase of 3.8% in the previous quarter (when the federal tax credit was still available), and a decline in the Àrst quarter of 4%. Thus in the quarter and before the end of the housing stimulus program, house prices in Philadelphia fell. This is similar to what happened to automobile sales when the federal credit ended. (The Àgures cited here on the Philadelphia

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housing market are based upon quarterly reports on house values produced by Kevin Gillen of Econsult.) Have there been major differences between parts of the city? Variation in house prices within the city was substantial.

Variation in house prices within Philadelphia* Neighborhood

Q. 1 (Jan.-Mar.)

Q. 2 (Apr. - Jun.)

Q. 3 (Jul. - Sep.)

University City

-10.90%

12.20%

-0.30%

South Philadelphia

-8.90%

5.50%

-2.50%

Kensing.-Frankford

-5.60%

2.90%

-3.20%

CC-Fairmont

-3.40%

3.80%

-4.30%

Lower N.E.

-2.20%

1.90%

-5.00%

Upper N.E.

-1.30%

0.70%

0.40%

Northwest

-1.30%

0.10%

-5.30%

North Philadelphia

-0.90%

6.30%

-10.30%

West Philadelphia

-0.10%

3.70%

-10.00%

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Several things stand out: (1) the decreases in house prices in quarters 1 and 3, and increases in Q2. (2) The clear negative correlation between prices across neighborhoods in Q1 and Q2 – With the exception of North and West Philadelphia, the neighborhoods with the largest house price declines in the Àrst quarter were followed by the highest increases in the second quarter – whether due to recovery or stimulus is unclear. (3) However, comparing the 2d and 3d quarters, the opposite would seem to be the case, again North and West Philadelphia being the exceptions. With those two exceptions, the greater the increase in Q. 2, the smaller the decline in Q.3, which appears to suggest that at least part of the Q. 2 increase was due to the large decreases in the previous quarter, not simply to the federal stimulus program. In center city at least part of the decline is the large overhang of supply. If you walk through Center City, you can see a lot of what we call “see-through” buildings: brand new or rehabilitated buildings that are largely empty. I look out on one of these buildings and there are maybe two or three lights on at night. The Murano, on Market Street between 21st and 22nd Streets, had an auction. In all they years that I have lived in Philadelphia, I have not heard of new expensive condominium apartments being auctioned. Is all this only a result of the over-supply of apartment units in the Center City area? There is as I said before a large overhang of expensive buildings in Center City. In terms of the overall city change, however, prices hit an all time high in the Second Quarter of 2007. That is before the recession and they bottomed out in the Àrst quarter of 2009. They were down 12% at that point. That is a relatively small decline compared to most cities, but then Philadelphia did not have the very large run-up that a lot of these cities had. In the ten largest cities in the US, prices fell on average 30% to date, but only 7% in Philadelphia. What would you say about the Center City renter versus homeownership rates as of today? I know that there are some buildings that were condominiums that were converted to rentals in Center City. I can’t think it’s due to anything other than the soft sales market. In the current economic environment it is easier to rent. Walking around Center City now both for sale and for rent signs abound. There are blocks where almost every building has a sign, which is of course a terrible for thing for anyone trying to sell on that block.

Janet Rothenberg Pack, Ph.D. Prof. Janet R. Pack is Professor of Business and Public Policy and Real Estate at the Wharton Business School. She received her PhD. from the University of California. Prof. Pack has been at the Wharton School since 1983. She served as the chairperson of the Public Policy and Management Department from 1992 – 1997.

From 1999 – 2009, Prof. Pack was the organizer and co-editor of the Brookings Conference and Papers on Urban Affairs. Prof. Pack is a member of the Foreign Advisory Board of the Taub Center for Social Policy Studies in Israel, and since 2002, a member of the editorial board of the Journal of Comparative Policy Analysis.

When people who want to buy see that every other house has a sign, it is a danger signal. For the Comcast Center, Liberty Property Trust had originally hoped to get the One Pennsylvania Plaza site designated a Keystone Opportunity Improvement Zone. Comcast eventually received over $40 million in Ànancial incentives. What is your opinion on this? At the time that it happened, the Republican legislature did not end up voting on this. They never actually turned it down. They didn’t vote on the keystone opportunity zone. The state government, headed by a governor, who had been the mayor of Philadelphia and very much a Philadelphia person, allocated the $40 million dollars. Philadelphia ofÀcials, and business people were very worried that many leases, for large commercial companies, for large commercial spaces, were coming due at that time,. They were worried that some of these À rms might locate to other places and wanted to keep them in Philadelphia. Whether they would have relocated without the incentives, one doesn’t know.

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Comcast would not have located in Philadelphia otherwise? Personally, I would probably have said they were more likely to have stayed, but I don’t know. An argument against the KOZ or incentive subsidies for Comcast was that a lot of people were concerned that if you subsidized the Comcast Center at One Pennsylvania Plaza, firms would move from Center City to this new building and new location. Although there were some relocations from Center City, at the time the Comcast Center was Àlling up, vacancy rates in Center City were going down simultaneously. So, one of the major things that people were concerned about didn’t happen. Also, a large percentage of Comcast’s occupancy was by Àrms that were not in Philadelphia before. Was it worth $40 million is another question. As I said, many of the occupants of the Comcast Center did not come from Center City; they came from outside the area. The second largest tenant was new to the city. So aside from the fact that it’s an interesting building and adds to the skyline, I don’t know if it would have been built without the subsidy. The subsidy may have helped. But, to repeat, I doubt Comcast would have moved out of Philadelphia. It’s hard to tell. It would require a very speciÀc analysis of the company. There was a proposal some years ago to build a federal ofÀce building on land around 30th street station to consolidate all the federal ofÀces scattered throughout ofÀce buildings in Philadelphia. That proposal died -- the major argument against it was that the loss of federal ofÀces would have a major effect on occupancy of Center City ofÀce buildings—buildings in which these federal ofÀces were then located.

iBR Reader Response Do you believe that providing ﬁnancial incentives for Comcast was the right decision? Log onto www.whartonibr.com/respond/philadelphia to respond

Could you outline where you see the main differences in the way the crisis affected the residential and the commercial real estate? Vacancy rates are much higher in the commercial market and much higher in the suburbs. One reason is that there was a lot of ofÀce construction in the suburbs. They have a lot of vacant land and there was decentralization of all kinds of businesses into the new suburban ofÀce parks. And much of that space came online at a time when there was not as much commercial expansion. Center City did a lot better in

that respect. Vacancy rates in downtown Philadelphia are lower than in the suburbs. As of the third quarter of 2010, commercial vacancy rates are about 16% in the city, compared to 23% in the suburbs, which surprises a lot of people. It is not surprising that many of these new ofÀce parks have a lot of empty space now because À rms just aren’t moving around and there is not much expansion. There has to be both movement and expansion in order to À ll the spaces. So, to that extent, there is a high vacancy rate in commercial ofÀce space. But the leasing prices are not very different in the city and the suburbs, even though they differ by area. The average in the city is about $25.78 per sq. feet and $24.72 in the suburbs. It’s really about the same on average. How does Philadelphia compare to this? What regions were hit hardest within the United States? In 2008 Philadelphia had about 5 building permits per 1000 residential units. This fell to 3.3 in 2009. If you look at a place like Phoenix, in 2008 it had 15 permits per 1000 residential units, but fell to 7.8—almost half. That is a very substantial hit on the market. If you go to the Phoenix area, it’s interesting to see the building projects that have been abandoned. It’s not simply that they’re empty, but, for example, there are three high rise buildings in Tempe that were begun during the boom but are now just standing unfinished—never been topped off, the inside never finished. The place that’s probably closest to Philadelphia is Chicago. And Philadelphia did much better: in Chicago building permits per 1000 existing residential units fell to 1.9 from 4.9 over the 2008-2009 periods, whereas Philadelphia was at 5 when Chicago was 4.9 and fell to 3.3, rather than 1.9. With respect to the excess supply of the construction at this point, where would you see a potential for a local governments or local ofÀcials to tackle the issues? I don’t think that there is much that local governments can do. I believe that this is a matter of national Àscal policy: interest rates can barely be lower; banks are holding large excess reserves and borrowing at approximately zero percent and buying long term treasuries yielding 3+ percent. And there is little demand for loans from À rms or consumers. We keep talking about stimulating small businesses, but there are few borrowers out there.

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Are there direct consequences for the way in which cities operate today? Yes, deÀ nitely. Take Philadelphia, for example. The city is closing À re stations on a rotating basis, one day a week. That is something that would have been unthinkable not long ago; people are very upset about this, and rightly so. And other cities and states are making cutbacks in a wide variety of ways now. California is laying off large numbers public employees, instituting mandatory furloughs, e.g., a reduction in the work week by one day, with commensurate decreases in pay.

iBR Reader Response How do you feel about the cost-cutting measures taken on by the city of Philadelphia? Log onto www.whartonibr.com/respond/philadelphia to respond

Is this a question of Àscal policy? Cities just can’t do Àscal policy, and it’s not a time when cities can really bid against each other, because there are no great expansions or Àrms that want to relocate, given the uncertainty of the market. So bidding for business now doesn’t make a lot of sense. Firms are just not thinking about moving because their future is very uncertain. So I don’t think that cities can really do much. In fact, I would argue that cities can’t do anything; they need help, and it has to be a national effort. It has to be a national Àscal policy or some monetary policy, but we can’t lower the interest rate any further. You conducted research about the implementation of private sector alternatives to the production of public sector services. Where do you see the biggest potential for improvement for that area and on what level? It’s a difÀcult question in the following sense: there’s much less potential for real privatization - that is turning things over to the private sector, than there is for contracting out with private Àrms. Many public goods and services can and have long been provided through city contracts with private providers. Some examples: state and local road construction, as contrasted with road maintenance, is done by private companies under contract; the recently reconstructed South Street Bridge in Philadelphia was done under contract; most large cities don’t change light bulbs and take care of the wiring; the electric companies do that under contracts with cities. In general individual contracting for trash collection does not work very well in cities. The prevention of negative

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externalities would require substantial city oversight. Yet, in Philadelphia, multiple family dwellings (more than six units?) are required to contract with private contractors for trash collection. Examples abound of contracting out maintenance of parks and recreation facilities, employee training, local transit. One example of what we might think of as a local public service that is private (has not been privatized but is provided privately) is in New York City, well known for its public transit networks. NY has for many years permitted the operation of private intra city bus companies that provide express services on routes on which city buses operate. Another is the Dulles Toll Road out of Washington, D.C., privately built, owned and operated. In the current environment of Ànancial stringency for many state and local governments, this is becoming evermore frequent as are contracts by smaller cities with larger governments. An extreme example is the small city

of Maywood California which is now contracting for ALL of its city services, e.g., the Los Angeles County Sherriff’s department will take care of public safety. One might even view private security guards in shopping centers and in individual stores in Center City, for example, as private provision of what is viewed as inadequate public safety provision. One of the problems with contracting is monitoring: smaller cities either don’t have the capacity or they don’t do good monitoring. So what you Ànd in many of these contracts is that after a few years, they end. Sometimes it is because the governments believe they’re not saving money, and sometimes it is because they just can’t keep up with the monitoring of the private providers; citizens complain and the appropriate city agencies don’t follow up by checking on the contractors. So it is a problem but there are lots of things that can be contracted out, if you had precise ways of specifying what you want, which is often not so easy. If you were able to devise multiple sectors of a city, for example, you could not only get multiple bids and compare them but also compare performance. This is often done for trash pick up.

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So, I think the big area is contracting out rather than pure privatization. One additional example: some years ago, the Edison Company proposed to take over many school systems, or parts of school systems – to build large urban campuses. They were not in the business of contracting but were proposing alternative systems. They ended up contracting with local governments. Another example of privatization is the Business Improvement District. They don’t like to be thought of as providing “public services” but rather supplements to public services. Their initial goal was “clean and safe.” To clean up the downtown (to supplement highly inadequate city sanitation services) and to put uniformed BID employees on the street who had direct contact with the police department via walkie-talkies. When the Center City District in Philadelphia was started, it required state enabling legislation because

reinforcing the sense of safety. Following on the success of the Center City Bid are numerous smaller BIDs: the University City BID and the South Street BID for example. They began by contracting with the Center City BID, but I’m not sure they still do that. New York City currently has 64 BIDs. The largest ones are the Time Square BID, the Grand Central BID, and the Union Square BID. But there are some very small ones, too. There is a small area in Queens, Jamaica. Jamaica has a small indoor shopping center, and that shopping center is the BID. They have made it cleaner: the area around it is cleaner; they have people on patrol walking around. In many areas of New York what we think are public services are provided by the BIDs. One further note on BIDs: they generally replaced Business groups, Chamber of Commerce groups; voluntary associations, with similar goals to the BIDs but lacking legal sanction, requirements for membership and for

“THERE’S MUCH LESS POTENTIAL FOR REAL PRIVATIZATION - THAT IS TURNING THINGS OVER TO THE PRIVATE SECTOR THAN THERE IS FOR CONTRACTING OUT TO PRIVATE FIRMS...” they charge an annual fee which all property owners are required to pay, and so it had to be enforced by law. Pennsylvania has an enabling law, and the city also has to approve the BID. Residents were asked vote but votes are not based upon one person, one vote; they are based upon the value of property owned. As a result, a few large, really large, property owners dominate the vote, and it was approved. But you mentioned that these are not really privatization? I think BIDs can be thought of as privatizing public services, although they do not want to be thought of that way. Nonetheless when you see their mechanized street sweeping machines cleaning the streets, their employees sweeping the streets, it is difÀcult to think they are not providing public services. And they have cleaned up the downtown; they have made it safer not only by putting uniformed personnel on the streets but by making the city, center city, more attractive for restaurants, retail stores…all of which bring more people to the streets,

payment of assessments. Thus, free riding was common and these organizations were largely ineffective or disbanded entirely. In what ways did Center City improve as a result of BIDs? As indicated above, it has improved Center City enormously: it is clean. It used to be that trash was all over. There was a very high crime rate. The Center City you see today did not exist twenty years ago. Right now, you can go downtown at eleven o’clock at night and the city is booming. BID personnel are on the streets, you’ve seen them in their turquoise or mango-color jackets. Prof. Pack, would there be one piece of advice that you would like to pass on to our student readers? I believe that you want to be as well-trained as possible, regardless of what you intend to do and to think broadly about what you might want to do. iBR

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B Y A K S H AY S U B R A M A N I A N ( W ’ 13)

MIDDLE EAST:

IRAN’S TRYST WITH SANCTIONS I ran’s nuclear program dominates most discussions

these moves have crippled its economy.

potential weapons of mass destruction,

The Iranian Central Bank has not issued

international

An Iranian woman protesting in New

despite

York City.

negotiations,

their

nuclear

security

importance economic

threats. in

aspects

Yet

an annual economic report in three years.

ongoing

Rising inflation, now at around 10%, has

the

posed major problems for Iranian traders

conﬂict are not discussed with the same

and consumers. The Iranian Rial experienced

frequency. Sanctions on Iran, often criticized

heavy

as toothless due to the united opposition of

foreign currency exchange was cut off.

China and Russia, have begun to ﬂash teeth

The decision of four major European oil

sharp enough to take a sizeable bite of the

companies (Shell, Total, Eni and StatOil)

Iranian economy. Iran’s trade partners are

to cease all investment in Iran, combined

ﬁnding it increasingly difficult to maintain

with reports of the Stuxnet computer virus

healthy relations with the Islamic Republic

at the proposed nuclear site in Bushehr,

without drawing the ire of the permanent

completes a very black picture.

members of the UN Security Council.

111210 hq.indd 54

Though Iran may not publicly admit it,

proliferation,

and

volatility

late

September

The greatest sign that the sanctions are

The ﬁrst effect of the sanctions was to

having the desired eff ect are the actions

extend the arms embargo on Iran to include

of one of Iran’s largest trading partner,

most military equipment. However, the sanctions

the United Arab Emirates. The passing of

did not stop there, targeting the central

sanctions sprung the UAE into taking tangible

operations of the Iranian Revolutionary Guard

measures to distance itself from Iran. Under

Corps, Iranian ﬁnancial institutions, and shipping

heavy US pressure, the UAE announced that

units. Increased inspections were approved for

it had complied with the UN’s sanctions. 17

all vessels suspected of supporting the nuclear

blacklisted Iranian banks have had their

program. Prominent Iranian ﬁnancial institutions

UAE ties severed. 40 organizations tied to

like Bank Saderat Iran, Bank Mellat, and Bank

the nuclear program have been shut down,

Sepah have been blacklisted by the United

with the money laundering unit of the UAE’s

Nations, cutting their ability to provide ﬁnancial

Central Bank closing their ﬁ nancial accounts

services and insurance. Iran and its proxy

and increasing its vigilance of all Iran-UAE

companies have effectively been shut down.

cash ﬂ ows.

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These measures are particularly crucial

Adding to their woes, Iranian shipping

because of how economically close the UAE

companies and exporters in the UAE have

and Iran have been historically. Bilateral trade

found their access to basic insurance cut.

between the two countries stood at close to

Without proper coverage for damages, they

$8.45 billion in 2009, while re-export trade

are bound to be denied entry to most ports.

volume amounted to close to $7.1 billion. This

Iranian letters of credit are no longer valid

places Iran as the Emirate of Dubai’s number

outside of Iran, so most transactions must

two re-export partner after India. Estimates by

now be done in cash. These spiraling costs and

the Iranian Business Council of Dubai have trade

trade risks have created an atmosphere ruinous

declining 29% to $6 billion in 2010.

to small traders and shipping giants alike.

Anecdotal evidence provides an even clearer picture of this deterioration in trade.

The proportion of the UAE’s economy linked to Iran is rather signiÀcant.

Dhows, Arab sailing vessels, used to hop with considerable frequency across the Persian Gulf to Iran, but are now sinking under the weight of the clampdown. Smaller sailors, whose boats lie dormant in the Dubai Creek,

The UAE needs to take into account the

have been hit hardest. In an interview with Gulf

resultant economic impact of its estrangement

News, a local newspaper, Mazher Hussain, a

from

sailor who sailed regularly between the Dubai

strengthening ties with the US and restoring

and Iran, said “The loads have decreased.

trade relations with Iran. The proportion of

Earlier, one dhow was ﬁlled up in a day. Now it

the UAE’s economy linked to Iran is rather

takes a week.”

signiﬁcant. The 23% of total trade volume

Iran.

associated

faces

with

tradeoff

re-exports

between

accounts

will

suffer major declines. There are over 8000 Iranian-owned businesses in Dubai alone (a ﬁgure that has dropped by nearly 400 since the past year.) The Iranian community also has a large presence in the UAE. Needless

say,

there

are

major

implications for cutting economic relations with Iran. The UAE needs to carefully weigh them and consider just how far it is willing to accommodate the US’s demands to abandon a close trading partner. The list of countries in the Middle East distancing themselves from Iran is growing, increasing pressure on the UAE. Other countries like Qatar, also under US pressure, will likely follow in the UAE’s footsteps. Though the exact impact of these choices is unknown, it is safe to say that both Iran and the UAE will struggle to cope with the consequences. iBR

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B Y A K S H AY K A N OR I A ( W ’ 13) A N D R A M N A R AYA N ( W ’ 13)

INDIA:

LABOR LAWS ttam Nakate was ﬁred in 1984 for

of the colonialist era, many Indians felt that

sleeping on the job. Since this was

capitalism itself was the source of India’s

his fourth such offence, he was

sorrows, and laws were passed with the

brought to disciplinary proceedings by his

intent of restricting the perceived animalistic

employer, Bharat Forge, and was ﬁred soon

instincts of the proﬁteering, rent-seeking

after. However, Nakate refused to relent. He

capitalists. As this socialist model began to

approached the Maharashtra State Labor

crumble in the 1990s, most of India’s “license-

After the rampant exploitation of the

Court and claimed that he was a victim

permit Raj” was rapidly dismantled. However,

colonialist era, many Indians felt that

of unfair labor practices at the hands of

India’s

capitalism itself was the source of

Bharat Forge. The State Labor Court ruled in

draconian socialist measures. Chief amongst

India’s sorrows.

Nakate’s favor, reinstating him to his former

these are India’s labor laws, which Nandan

position, and also awarding him 50% of his

Nilekani,

lost wages. An industrial tribunal then ruled in

Infosys, says are “fossilized and intact, a net

his employer’s favor and conﬁrmed Nakate’s

of tripwires across the economy”.

111210 hq.indd 56

constitution

former

still

head

harbors

several

software

giant

dismissal. But Nakate persisted, appealing

India’s Constitution grants labor a special

to the State High Court, which ruled in

status, where both state governments and the

his favor. The case was then taken to the

Central Government have the right to legislate

Supreme Court, where after 17 long years of

on law. The lack of synergy between these

legal tussles, Nakate was ﬁnally pink-slipped.

equal levels of government has spawned a

Strangely enough, this case is an exception,

myriad of laws that oftentimes conﬂict with

not because it took so long to ﬁre him, but

each other, leading to a state of legal entropy.

because Nakate was ﬁred at all! The Uttam

The Central Government legislates on matters

Nakate case was a high-proﬁle example of

as diverse as trade unions, labor disputes,

the difficulties facing employers in India,

insurance and wages, as well as speciﬁc

direct results of India’s archaic labor laws.

regulations on various industries. Absurdly

Article 39 of the Indian Constitution

enough, State Governments have their own

idealistically states: “the citizen, men and

laws concerning many of these same issues.

women equally, have the right to an adequate

It is hardly unreasonable to assume then, that

means of livelihood.” Unfortunately enough,

anyone looking to invest in India would feel

as seen with the case of Mr. Nakate, the very

threatened by a legal maze.

laws enacted by the Indian government to

To observe the failure of these laws, its

realize this lofty goal have in fact stymied its

best to look at India’s garment industry. While

development. After the rampant exploitation

the going rate for labor is only 33 cents an

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hour in India (as compared to approximately

why not reform it? The answer? Politically

90 cents an hour for coastal China), the

powerful unions. Although they constitute

small garment industry continues to work

only 15 million people out of a population

toward mechanizing its production processes,

of 1.2 billion, the Public Sector Unions

lowering the need for extraordinarily cheap

have staggering political strength. They

labor. To an outside observer, this may seem

are almost entirely politicized in a Western

rather silly. However, a review of the provisions

sense of the word, and are the home to

of India’s Industrial Disputes Act of 1947 and

the origins of many powerful politicians in

the Contract Labor Act of 1970, makes it quite

India. India’s state owned airline, ‘Air India’

evident why Indian companies, big and small,

is heavily unionized and overstaffed. While

are reluctant to hire more workers.

most airline companies hire approximately

The laws state that if a ﬁ rm with 100 or

100 staff per plane, Air India’s ratio is more

more workers seeks to retrench any of them,

than 200 to 1. This has led to inefficiency and

it must do so with the express consent of the

staggering losses for the public airline. Thus

state government. Given that many of India’s

a small proportion of the total workforce

states are larger than G-20 nations, this law

holds the rest to ransom to the detriment of

is manifestly unworkable. As an example,

the entire country.

the garment industry operates with seasonal increases and decreases in demand, requiring the ﬁ rm to lay off workers in times of low demand, and hire temporary workers in times of high demand. Thanks to these antiquated

The going rate for labor is only 33 cents per hour in India.

laws, this otherwise simple process is made into a herculean task by the permissions and

India has a population of more than a

regulations surrounding labor. It is unsurprising

billion people, 75% of whom are below 30 years

then that India’s growth is derived mostly

of age. It will add some 120 million people to

from service sectors, leaving manufacturing

its workforce within a decade. They will all be

growth relatively undeveloped.

scouring the market for jobs, and if they ﬁnd the

The complexity of these laws makes

market wanting, serious social instability may

enforcement virtually impossible, especially if

occur. India also has an unemployment rate of

the government’s aim is encouraging economic

11%. Given the country’s rapid growth and rising

growth. The states, confronted with the task of

consumer demand, this is totally unnecessary.

enforcing pointless laws, turn a blind eye to

While it can be remedied by giving companies

them, collecting bribes in return for allowing

incentives to hire more workers, the current

industry to hire workers from the informal labor

laws, sadly, seem to be doing the very opposite.

pool. These workers are hired on a contractual

The most recent reform of labor law came in

basis, outside the scope of the law, and are

March 2005, when women were ﬁ nally given

often paid below minimum wage without a

the right to work at night. This is good news for

pension or other beneﬁts that a typical union

the service sector, which can now expand its

worker would expect. Furthermore, it makes

nighttime call center work force. But a country

efforts to combat child exploitation and HIV/

of 1 billion people cannot grow by relying solely

AIDS more difficult, as these workers do not

on call centers and outsourcing! Unless India

technically exist in any database. It is estimated

can reform its labor laws and open up its job

that in a workforce of some 500 million people,

market, it could risk losing out on its much-

only 7% are employed properly, and only 15

touted demographic dividend. India faces a

million are unionized.

crossroads; whether to continue strangling

The obvious question that one asks is, if everyone agrees that the law is unhelpful,

its economy, or whether to unshackle its companies and its workers. iBR

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B Y E L I T U N G ( W ’ 13)

TAIWAN AND CHINA:

ALL EGGS IN ONE BASKET? W ise investors know that placing all

your

money

intellectual property protection. Controversy

stocks

has centered on the ﬁ rst condition, since

of one company is a risky

tariff s in major sectors must be eliminated

strategy. Investors have to diversify their

within

investments in order to safeguard their

signing. President Ma believes that Taiwan

earnings

strikes.

is desperately in need of such an economic

Taiwan, under President Ma Ying-jeou,

agreement with China, as he fears that Taiwan

has taken steps in the opposite direction,

will become more and more “marginalized”

increasing its reliance on China to solve

in the global economy. His fear stems from

the nation’s problems. The most recent

China signing free trade agreements such as

example of this is Taiwan’s signing of

the ASEAN+1, with the member countries of

the

Framework

the Association of Southeast Asian Nations

Taiwan’s pavilion in the Expo 2010 in

Agreement (ECFA) on June 29, 2010 with

and the ASEAN+3 (with South Korea and

Shanghai, China.

China seeking to foster better cross-strait

Japan), both of which Taiwan is not a member

investment

was

of. Hence, President Ma warns that failing

implemented in September, Taiwan saw an

to sign ECFA will be detrimental to Taiwan’s

inﬂ ow of USD 3 billion of new investments,

economic competitiveness.

111210 hq.indd 58

when

Economic

ﬁ nancial

crisis

Cooperation

relations.

After

ECFA

years

from

the

agreement’s

a semi-annual growth rate of 13.1%, one of

This economic agreement opens up

the highest in the world, and an increase

bilateral trading markets for both nations.

of 285,000 new job opportunities. But

It states that, under the “early harvest”

this seemingly easy money does not come

program, tariff s on 539 Taiwanese goods

without a price; Taiwan may ﬁ nd itself

(estimated at USD 13.84 billion annually) and

giving up a lot more by continuing to

267 Chinese products (USD 2.86 billion) will

depend on China to protect its economy.

be reduced to zero in three phases within

What is ECFA? The majority of Taiwanese

three years of Jan. 1, 2011. China will also open

citizens still cannot give a deﬁnitive answer

markets in 11 service sectors such as banking,

to that question, partially due to the lack

securities, insurance, and healthcare, while

of transparency from the Ma government

Taiwan will offer wider access in seven areas,

to disclose the details of the agreement to

including banking and movies. President Ma

the general public. The ﬁrst public outline

believes that signing the ECFA with China is

the ﬁ rst step for Taiwan in pursuing free trade

televised debate on April 25, 2010 between

agreements with other countries such as the

President Ma and the opposition Democratic

US, Japan or Europe, which have previously

Progressive Party (DPP) Chairwoman, Tsai

ﬂ oundered due to negative pressure from

Ing-wen. Ma stated that the ECFA has three

China. Yet China has not explicitly guaranteed

general functions: tariff reduction, protection

Taiwan the right to expand trade with other

of cross-strait investments, and increased

countries, and if this agreement represents

the

agreement

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was

given

during

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a further subjugation of Taiwan under China,

failed to secure a referendum on this issue

what political right would Taiwan have to sign

of great national importance. Parliament’s

other free trade agreements?

refusal to acknowledge this motion by the DPP

During the public debate, Tsai Ing-

reconﬁ rms President Ma’s lean towards China,

long-term

and his sympathy to the One-China policy

consequences that would arise in Taiwan.

proposed by PRC President Hu Jintao in his

Medium and small-sized corporations will

Six Protocols. Signing ECFA means an implied

not beneﬁ t from ECFA, which is more

concession to President Hu’s demands.

wen

also

named

numerous

heavily focused on helping Taiwan’s largest

China remains Taiwan’s largest trading

corporations. Moreover, it will potentially

partner by far, with 70% of Taiwanese exports

damage all local Taiwanese businesses, as

going to China, and so maintaining close

the inﬂ ux of cheap products and labor from

economic ties is essential. However, even

China puts many out of business, particularly

without ECFA, Taiwan still enjoys a strong

in agricultural industries, a key component of

overall economy, with a low deﬁ cit and

Taiwan’s exports. Further job losses will arise

little debt. President Ma and the Taiwanese

as Mainland Chinese white-collar workers

people must come to realize that China is

and

not the only solution to Taiwan’s problems,

professionals

relocate

Taiwan.

These features of ECFA are uncomfortably close parallels to CEPA (Closer Economic

Medium and small-sized corporations will not beneÀt from ECFA

Partnership Agreements), signed between China and its special administrative regions, Hong Kong and Macau. After CEPA was implemented,

Hong

Kong’s

wealth

gap

has widened; Hong Kong today has one of

especially

the highest Gini coeffi cients in the world.

about

President Ma’s boast of generating 263,000

made. President Ma has been successful in

new jobs in Taiwan fails to include these

easing tensions with Beijing by focusing on

losses, and even today he has no tangible

economic issues since he took power, but

solutions to address their impact.

this has come at the cost of failing to protect

Taiwan’s

fundamental existence

concessions need

Ma has also not been clear on whether

Taiwan’s sovereignty. Ignoring the political

any political concessions need to be made

implications of signing ECFA to focus only on

by signing this agreement; evidently there

achieving stronger economic ties with China

are. DPP opposition leaders criticize ECFA as

will have dire consequences. If Taiwan is to

being another one of President Ma’s policies

maintain its current state and build trust with

towards eventual reuniﬁ cation with China.

its people, Ma must properly consider these

Since Ma’s election in 2008, Taiwan has

consequences and off er solutions to them as

already negotiated 14 diff erent cross-strait

quickly as possible before it is too late.

agreements, and Ma’s plans for “cultural”

As much as one can disagree with ECFA,

and “educational” ECFAs suggest that his

it has already been implemented, so it is

ambitions do not stop here. The central issue

now up to the government to manage terms

with this consolidation is the secession of

that will ultimately be advantageous to the

Taiwan’s sovereignty and respect for basic

Taiwanese economy and people, without

human rights: the Fifth Freedom of the Air

the cost of further political concessions. As

was denied to Taiwan, meaning that China will

stated succinctly by DPP Chairwoman Tsai,

remain the main hub for all passenger routes,

everything that Taiwan does “should be

with Taiwan acting merely as a stopover. An

looking to face China through the world, and

undemocratic approval process is rampant,

not face the world through China.” iBR

as a 100,000-man protest on June 26, 2010

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B Y DAV I D V I N N I KOV ( W ‘ 13) A N D A L A N S O S T E K ( W ‘ 14)

CHINESE COPPER:

SURGE OR STOCKPILE? W hether it was used in ancient

for

plumbing or decorative works

westerners have long taken for granted.

of art, copper has always been a

the

many

These

electronic

types

appliances activities

that need

staple of civilization. The metal’s malleability,

telecommunications and power grids on a

electro-conductivity, and ability to combine

massive scale. Even with China’s slowdown

China’s State Reserve Bureau made a

with other metals made it a staple of the 20th

from 2007’s construction frenzy, China still

pivotal decision last year to stockpile

century, used prevalently in ﬁelds like wiring,

consumed an astonishing 5,198 thousand

copper.

household products, electrical appliances,

tonnes of copper, more than two and a half

construction,

transmission

times what the United States consumed.

networks. But while copper’s uses have

This gap will widen as China maintains a

long been known, its users are growing at a

9% GDP growth rate relative to the United

breakneck speed. One country in particular,

States’ anemic recovery.

and

electric

China, is reshaping world copper markets.

consumption total is the low amount of

lay well behind that of the western world’s

copper that China can produce internally.

for many centuries, this sleeping giant has

Even at 4th place in the world, China had a

awoken to an economic renaissance. The

shortfall of over 4,000 tonnes in 2009. In

industrialization practices that took decades

order to make up this domestic shortage,

to complete in the United States are being

China has resorted to more dynamic options

built in the span of a few short years in China,

than simple imports. Using its massive foreign

creating a natural resource starved consumer

reserves, China is making aggressive deals

ready to ﬁll its needs at any cost. While China

around the world to secure supplies at their

gets a great deal of attention for its oil and

source. Chinalco purchased 9% of Rio Tinto

steel consumption, its demand for copper may

for over $14 bn in 2008. 40% of all Australian

outstretch anything else.

mining deals in 2009 were done by Chinese

Its use of one third of the world’s copper supply is driven by a 1.3 billion person

111210 hq.indd 60

What complicates this already astronomic

Although China’s economic development

acquirers. Shandong Group announced the $1.5 bn buyout of African Minerals Ltd.

population rapidly entering the information

But unlike 5 years ago, when conservative

age. In June alone, 8.5 million new customers

Chinese investors would only purchase fully

purchased telephones, increasing the amount

established mines, there is now a major drive

of telephones in China to 1.1 billion. Industries

for opening new sources. For instance, China

like LCD TVs grew at over 40%, while the

is spending $1.5 bn on the Toromocho mine

growing middle class has developed a craving

ﬁ eld in Peru, which may increase the 3rd

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largest supplier’s copper exports 25% by

has knowingly been stockpiling the metal for

itself. Total foreign mining investment stood

quite some time. He believes that China’s rapid

at $13 bn, 100 times the amount invested in

buying was only “an attempt to take advantage

2005 and constituting one third of all mining

of cheap prices and stock up on commodities

mergers and acquisition activity worldwide.

for future growth.”

Deals like these establish new import sources and secure China’s supply for the long haul.

“In fact, the country is likely facing an oversupply situation given record high

These strategies may not be enough in any

copper imports in February as well as

case; J.P. Morgan estimates say that demand

industrial production growth slowing to its

will outstrip supply by 180,000 tonnes, largely

lowest level since 2001 in the ﬁ rst two months

due to Chinese purchases. This same report

of the year,” Crane said.

has the deﬁcit swelling to 482,000 tonnes

BMO

next year. In light of this, China’s purchases

Radclyffe

Capital

of the copper may be attributable to a shift in

copper is likely to slow now that copper

the country’s overall investment perspective.

prices are higher. “Prices have recovered to

As currencies, especially the U.S. Dollar,

current levels quicker than anticipated and,

become less assured investments, China has

on balance, shorter term prices have the

said

Markets

the

analyst

Chinese

David

appetite

for

moved into investments with a more practical function. John Reade, metals chief strategist at UBS, said the country may be making a tactical decision to stockpile metal as an alternative to foreign bonds. “We’re very surprised by

China is buying much more copper than it will need this year...

Chinese demand. China is buying much more copper than it will need this year. If this is

potential to retrace some of the recent gains

strategic, there may be no effective limit on the

if sentiment weakens or inventories begin to

purchases as China’s pockets are deep.”

build again,” Radclyffe said.

Prices for copper are reaching record

These conﬂicting viewpoints bring up an

highs on this news, but investors who are

interesting series of questions: has China really

hopeful this signiﬁes an uptick in demand

had the opportunity to buy enough inventories

and is an early indicator of a global economic

to signiﬁcantly alter its future demand? Could

recovery should take caution – China and its

this simply be an investment diversiﬁcation

state run corporations are big buyers and they

strategy for its massive national reserve fund?

like to hoard for the long-term.

These are the keys to copper’s price shifts over

China’s State Reserve Bureau made a pivotal decision last year to stockpile copper,

the coming months. It is important to remember that the short-

been

term price climate does not reﬂect the macro-

building up an impressive inventory for quite

dynamics of the international copper market.

some time. China kept on buying and hoarding

The global copper economy, despite recession

copper, iron ore, zinc and crude oil even as

and possible stockpiling, will continue to grow.

commodity price collapsed in the ﬁ nancial

Innovation and growth will spark the need for

crash two years ago because it was, and still is,

sustained development, both in China and in

focused on supply for years to come.

other countries, where copper will be the key

and

the

bureaucrat

investors

have

As in all investment situations, opposite

resource. Without substantial supply increases,

opinions are widespread on these mixed

fundamental demand increases in rebounding

signals. Analyst Joel Crane of Deutsche Bank

and emerging economies will lead to higher

doesn’t believe that China’s sudden appetite

prices and deeper shortages, a direct threat to

for copper represents a rebound in industrial

the Chinese machine that created this situation

consumption, especially since the country

in the ﬁrst place. iBR

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B Y C Y RU S MO S H I R I ( WA S H I N G T ON A N D L E E U N I V E R S I T Y ’ 10 )

ASIA:

A key question going forward is the stability of property markets in second and third tier cities.

CHINA & REAL ESTATE C hina’s large migratory ﬂows from rural

areas

into

urban

centers

have

market. 60% of LGFVs are secured with land

been the fundamental drivers of property

or project revenues. Local governments also

price appreciation over the past decade.

rely on land sales for 35% of revenue. In a

Nevertheless,

deep property price decline scenario, local

and

rapid

income

property

growth

prices

retreated global

government’s ability to service loans will be

economic slowdown. The Chinese mobilized

hampered, but local governments still have

massive infrastructure investment on the back

vast land holdings and therefore the ability

of RMB 9.59tn of loan origination in 2009.

to post more collateral to existing loans. Land

The combination of these factors allowed for

collateralized investment ﬁ nancing supported

a property price explosion after the ﬁ nancial

infrastructure

crisis. Local governments, constitutionally

of the global economic downturn, but this

barred from direct borrow-ing or issuance

mechanism is no longer viable.

signiﬁ cantly

2008

during

the

of debt, turned to the use of SIV-like Local Government

111210 hq.indd 62

The viability a local government ﬁnances

is dependent on a robust Chinese property

Financial

Vehicles

(LGFVs)

investment

the

bottom

Price to rent and price to income growth, two affordability ratios, have nearly doubled in

to ﬁnance the vast majority of urban ﬁxed

ﬁ rst tier cities. Signiﬁ cant corrections of 50%+

asset investment. LGFVs are no longer in the

in those property markets appear imminent

headlines as a result of explicit efforts from

given these metrics. In August 2010 the CBRC

the China Banking Regulatory Commission

has already taken this into account by requiring

(CBRC) and State Council to limit the reckless

banks stress test 60% property price declines.

use of such vehicles. Nevertheless, the scale

A key question going forward is the stability

and structure of the vehicles already in

of property markets in second and third tier

existence are a fundamental weakness in the

cities. The vulnerabilities of these markets will

Chinese ﬁ nancial system and could necessitate

be exposed if global economic growth slows

a bailout on a national scale.

since local governments are ﬁscally tapped

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Price to rent and price to income growth, two affordability ratios, have nearly doubled in Àrst tier cities... out. Deep declines in these markets would

raises over the summer, LGFV loan losses

precipitate a worst-case scenario, ﬁ ltering

and

through to banks balance sheets and further

create capital shortages going forward. In

hampering local government budgets. This

the early part of the decade the Ministry of

could require a national bailout.

Finance segregated non-performing loans

Basel

III

capital

requirements

will

The CBRC estimates the total amount of

in a good bank/ bad bank model. It is likely

LGFV debt at RMB 7tn, while Northwestern

that the Chinese government will purchase

University’s

non-performing LGFV loans. This will not

Victor

Shih

estimates

the

amount stands at RMB 11tn. A CBRC source

precipitate

in China Securities News stated that at the

sovereign crisis since even after including

end of June 2010, 50% of LGFV loans are

upper estimates of LGFV loans and other

to projects that must borrow from other

implicitly government backed debt, total

sources to supplement revenue to make

debt to GDP stands at roughly 75%. The

interest

likely outcome will be painful for a handful of

payments

and

26%

are

highly

problematic loans that were either originated

European

periphery

style

banks, but the risk is not systemic.

fraudulently or misused. In addition there are

The 30.1% ﬁ xed asset investment surge in

approximately RMB 2tn+ LGFV loans in off-

2009 illustrates China’s reliance on investment

balance sheet securitizations marketed as

spending to escape the brunt of the ﬁnancial

short-term deposit alternatives. With 2010Q2

crisis. The rise of the Chinese consumer is

total banking sector assets of RMB 87.2tn

not only desirable for the Chinese economy,

and the average capital adequacy ratio of

but

11%, a 2.5tn+ increase in non-performing

demonstrates that driving GDP via ﬁxed asset

loans would prove extremely damaging to

investment is no longer viable in China. China

bank capitalizations. The CBRC is forcing

must retool its economy to tap its latent

Chinese banks to recognize non-performing

domestic consumption demand to create

LGFV loans this year. Despite bank capital

more sustainable growth going forward. iBR

also

essential.

The

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story

LGFVs

I N T E R N AT I O N A L B U S I N E S S R E V I E W

11/27/2010 3:13:23 PM

BY I A N LIM Ian Lim is a current exchange student at the Wharton School, University of Pennsylvania.

SINGAPORE:

The Merlion is an imaginary creature with the head of a lion and the body of a Àsh, and is used as a mascot of Singapore.

WORLD CLASS BUSINESS HUB I magine an island nation in Southeast

tariffs and quotas as a knee-jerk solution to

Asia spanning only seven hundred square

create and protect domestic companies. Instead,

kilometers,

natural

they embraced the virtues of international free

resources– no agriculture, minerals, or water

trade, creating an export-oriented industrial

supply.

It was a ﬁshing village in the 18th

policy that now features 50 double taxation

century, colonized by the British in the 19th

avoidance treaties and 18 FTAs with 24 bilateral

century, and declared independence in 1965.

partners. Net exports form 21.1% of GDP.

with

virtually

You might not think much of it, especially in

An aggressive industrialization policy was

the shadow of growing economic behemoths

implemented to move up the value chain. Foreign

like China and India.

multinationals were incentivized to set up offices

Yet this tiny nation - Singapore - has

in Singapore, bringing foreign expertise, training,

achieved world class stature, ranking among

and employment to Singapore’s young economy.

the top ten most desirable locations to live and

iIcome and corporate taxes are among the world’s

work. It boasts political stability, no corruption,

lowest, below 20%. The Jurong marshland area

and vibrant industries in ﬁnance, manufacturing,

was cleared and designated an industrial hub

and pharmaceuticals.

for these new companies. Competition from

How did Singapore transform from an

Chinese low-cost manufacturing and Indian

economic backwater to the world’s fourth most

low-cost service industries forced Singapore’s

affluent society? How did it become a global

government to constantly innovate and attract

research and development hub with a previously

advanced industries, including ﬁnancial services,

uneducated workforce? What lessons are we

life sciences, and pharmaceuticals.

taught from this experiment in state building?

The Singapore Story – How to Build a Nation 1. Visionary, competent, and pragmatic political leadership

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2. Geographical location is Singapore’s greatest “natural” asset It is said that “geography is the mother of history.” Singapore capitalizes on its strategic

In 1963 Singapore tried to merge with the

location at the Straits of Malacca, arguably the

Malaya. Political differences in 1965 would have

busiest waterway in the world, and key link

the deal fall apart; it was a blessing in disguise.

between Asia and Europe. 50,000 vessels,

With its small population and domestic

a quarter of the world’s trade, pass through

market, Singapore could not survive as a mere

here each year, making Singapore the busiest

transshipment hub. Yet the government avoided

transshipment port in the world.

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3. High returns on human capital Singapore’s only capital is human capital.

The

government

seeks

free of crime. They have had obvious

supply from Malaysia, Singapore has

success; Singapore enjoys low crime,

to develop cutting-edge solutions to

safe streets, and almost no drug issues.

maximize available supplies. Singapore has led innovations in water recycling

produce a labor force that is highly educated,

technically

proﬁcient,

and

5. Chinese collaboration

and desalination of sea water to the point

English speaking. Wharton, Yale, MIT,

Singapore and China have had a close

where domestic companies like Hyﬂux

Chicago Booth, Duke and INSEAD have

relationship since the 1980s, when Deng

export their expertise as far as water

all established major partnerships or

Xiao Ping observed “Singapore enjoys

treatment plants in Chinese cities and

campuses within Singapore. Singapore

good social order and is well managed.

the world’s largest desalination plant in

has come so far ahead in math skills

We should tap on their experience, and

Tlemcen, Algeria.

that

learn how to manage better than them.”

In adapting to the times, Singapore’s

actually being exported to American

Initiatives for economic collaboration

government has relaxed its historically

schools, including the Sidwell Friends

between Singapore and China, such as

strict

School,

the

“Singapore

Method”

social

policies.

After

banning

Obama’s

the China-Singapore Suzhou Industrial

casinos for years due their social costs,

children attend. This commitment has

Park built in 1994, are mutually beneﬁcial.

the government has done an about face

caused

Today,

for newly-founded casinos Marina Bay

where

President

Singaporeans

ranked

Singapore

collaborating

#1 worldwide by BERI’s Labor Force

with

Evaluation Measure for 30 years running.

developing “a socially harmonious, en-

China

the

Tianjin

Eco-city,

Sands, operated by Las Vegas Sands, and Resorts World Sentosa.

resource

This is in line with a larger vision of

4. Strong legal system: effective legislation, regulation and enforcement

conserving city in China”. This builds

transforming Singapore into a leading

on Singapore’s successful track records

lifestyle destination. It has transformed

Singapore implemented a rigorous

in urban development and sustainable

itself from a staid commercial hub in the

environmental solutions.

1990s to a world-class cosmopolitan city

Singapore Today

Formula 1 Night Race, the Night Safari,

vironmentally

legal system where laws are enforced

friendly

and

today. Attractions include the world’s ﬁrst

effectively. Tough rules are set to prevent economic disruptions; strikes, disruptive to daily business activity, are illegal.

Singapore is still a young country,

and a Universal Studios theme park.

Worker grievances are addressed by

and it is constantly adapting to changing

Singapore’s rank as #1 in Asia and #11 in the

the National Trades Union Congress.

circumstances.

was

world for “work and play” (Mercer 2010),

Corruption,

ranked the easiest place in the world to

along with its rank by foreign expatriates

many countries, is heavily discouraged

do business in 2009 by the World Bank,

as #1 in Asia and #2 worldwide as a place

in Singapore, which has the 4th lowest

dethroning the United States after 16

to stay (IMD World Competitiveness

corruption level and highest level of

years, it can never rest easy.

Report 2009), reﬂects the success that

“cost

business”

transparency in the world (IMD World also

has

Singapore

Singapore boasts what is arguably the

this liberalization has had.

most advanced military in Southeast Asia.

What does this mean overall? A

intel-

A two year military conscription exists for

sterling testimonial by prominent US

attracts

Competitiveness report 2009). Singapore

While

strict

all able bodied men. Military hardware,

investor Jim Rogers, co-founder of the

who

like German Leopard 2 tanks, F-15s, and

Quantum Fund, says it best.

need protection for their research and

Swedish attack submarines, is imported

“Singapore is a special city, it has

development projects.

from around the world and modiﬁed for

great infrastructure, terriﬁ c education,

lectual

property

laws.

knowledge-intensive

This

companies

Many believe that Singapore’s laws

local needs. Singapore’s own thriving

unparalleled healthcare, nature with

are overly authoritarian. The penalties

defense industry has produced guns that

lots of green spaces… it’s one of the

for crimes like drug trafficking are

even the US Special Forces has considered.

great cities of the world… Singapore is

extremely business friendly and they

These laws are essential, however,

constant. Because it lacks a sufficient

will do anything to make sure your

because they allow the country to

self-sustaining

business works.” iBR

enjoy a stable business environment

dependent on a politically contentious

among the strictest in the world.

Technological

innovation

water

supply,

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is and

I N T E R N AT I O N A L B U S I N E S S R E V I E W

11/27/2010 3:13:24 PM

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