Performance in Southeast Asia: Vietnam and India Under the Trade War

By: Jo Qiao

Why multinational corporations choose Vietnam instead of India?

The raising tariffs caused by the escalation of the US-China trade war and continuously increasing Chinese labor costs make exports from China more expensive for US importers. In reaction to this situation, numerous western companies and investors are relocating their manufacturing factories from China to Southeast Asian countries and generating a huge sum of Foreign Direct Investment – or FDI – and numerous development opportunities.

However, the performance of Southeast Asian countries is not very balanced amongst each-other. According to a finding by a Japanese financial group, Nomura, of the companies that relocated out of China, 3 out of 56 companies have relocated to India, while 26 went to Vietnam between April 2018 and August 2019. Despite the small population of only 100 million, Vietnam stood out from other Southeast Asian economies during the trade war. The Financial Times reported in their analysis of data from the United States International Trade Commission, imports from Vietnam to the U.S. surged nearly 40 percent in the first four months of 2019. Surprisingly, India has not capitalized on their position to take advantage of the current global economic situation, even with cheap labor costs and a huge population. The main reasons that cause this distinction between these two developing countries is dependent on the difference in their labor quality and trade policies.

Vietnam is now in a period of golden population structure – 45% are under 30 years of age. Each year, more than one million people are added to the workforce. With the strong power of its labor union and extremely progressive national labor laws, Vietnam has a strong workforce with competitive wages and a high female participation rate. Seeking to satisfy the need of tech companies, Vietnam now focuses on increasing the productivity, skills, and quality of labor to remain competitive. These high-quality labors will bring growth to the middle class, which is very attractive to Western corporations because it boosts not only production efficiency, but also consumption.

India, despite its huge population and low wages, is not competitive in its labor force. India’s population is amongst the unhealthiest in south Asia, and the quality of its education leaves a lot to be desired. India is still suffering from a low labor participation rate. Worse, within the Indian employment population, the vast majority is still stuck in informal sectors, which equates to low total factor productivity and quality. In recent years, some companies are choosing to go from manufacturing in India to just assembling in India because they cannot obtain parts in the quantity and consistency they demand.

What’s more, when seeking long-term, advanced socio-economic development, Vietnam is highly valuing “high quality” FDI inflows. Vietnam is now focusing on on FDI projects that use advanced technologies and projects with competitive products that could be part of the global production network and value chain.

To fulfill its goal, the government is committed to creating a fair and attractive business environment for foreign investors, and constantly improving its legal framework and building advanced infrastructure related to business and investment. Furthermore, Vietnam is a member of the World Trade Organization and a part of multiple frameworks for international economic integration, including free trade agreements with partners both within and outside the region. Viewing the success of FDI enterprises , Vietnam is now actively promoting the negotiation of a new generation of free trade agreements. These factors all contribute in some way to explain why so many choose to invest in Vietnam, and should draw in more foreign investors.

When seeking long-term development, India should learn from Vietnam. It needs to further liberalize trade, spend more on infrastructure construction, reform land, and labor laws and offer tax breaks for foreign investors. The good news is, India is aware of this and making moves in the right direction. The recent cut in the corporate tax rate will help put India in a new period of growth.

Work Cited:

1. (2015, May 05). Vietnam urged to prepare well to become “world’s factory”. Vietnamnet. Retrieved from https://english.vietnamnet.vn/fms/business/129684/vietnam-urged-to-prepare-well-to-become–world-s-factory-.html

2. Alicia Garcia Herrero. (2019, May 10). Impact of trade war on Emerging Asia: no short-term winner but Vietnam, India and Thailand to gain in the medium. Medium. Retrieved from https://medium.com/swlh/impact-of-trade-war-on-emerging-asia-no-short-term-winner-but-vietnam-india-and-thailand-to-gain-f3305b38bb05#_ftn1

3. ANI. (2019, Oct 07). Trade War: Why manufacturers are not rushing into India, Indonesia. The Economics Times. Retrieved from http://economictimes.indiatimes.com/articleshow/71474941.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

4. (2018, Jun 11). Indian workers have a productivity problem. Livemint. Retrieved from https://www.livemint.com/Opinion/3qjewAnLB1AxPOEhyhAEiN/Indian-workers-have-a-productivity-problem.html

5. Alberto Vettoretti. (2017, June 01) Why so Many Foreign Businesses are moving to Vietnam. Linkedin. Retrieved from https://www.linkedin.com/pulse/why-so-many-foreign-businesses-moving-vietnam-alberto-vettoretti/

6. Siddarth Shrikanth. (2019, June 28). Vietnam GDP grows on trade war. Financial Times. Retrieved from http://www.ftchinese.com/premium/001083411?full=y&from=singlemessage&isappinstalled=0&archive=#ccode=2G188002

7. Vietnam-Working Condition. National Encyclopedia. Retrieved from https://www.nationsencyclopedia.com/economies/Asia-and-the-Pacific/Vietnam-WORKING-CONDITIONS.html#ixzz62ljGcRN

8. Steve Johnson. (2019, September 17). Emerging market funds build up record exposure to Vietnam. Financial Times. Retrieved from http://www.ftchinese.com/premium/001084437?full=y&from=singlemessage&isappinstalled=0&archive=#ccode=2G188002

9. Henny Sender. (2019, July 26). India is failing to reap the benefits of China-US trade war. Financial Times. Retrieved from http://www.ftchinese.com/premium/001083775?full=y&from=singlemessage&isappinstalled=0&archive=#ccode=2G188002

10. Alex Donov. (2019, July 01). To win in tech and beyond, Vietnam should complement, not compete with ASEAN. The Business Times. Retrieved from https://www.businesstimes.com.sg/asean-business/to-win-in-tech-and-beyond-vietnam-should-complement-not-compete-with-asean

 

 

The Costs of Cleaning up the Shipping Industry

By: Chitanya Ajjarapu

The largest contributor to ocean pollution also has some of the largest costs to clean up

Traveling over water was once one of the cleanest ways to ship goods and get from one place to another. The wind in the sails and the current of the water fueled the ships. After the boom of manufacturing and trade during the industrial revolution, James Watt developed the steam engine which turned the shipping industry on its head, making it much more efficient but dirtier. The entire revolution was powered by fossil fuels, especially coal, and the steam engine was no exception. Now with our increased knowledge and responsibility for the damage fossil fuels are doing to the environment, we have made several attempts at reducing our carbon emissions and focusing on renewable energy for our consumption. The Paris Climate Accords were one of the first global deals to aim to reduce our carbon emissions as a planet. On that note, Ben Sutherland of The Economist claims that experts suggest shipping accounts for 3% of all greenhouse gases. If the industry say, were a country, it would be the sixth largest producer of greenhouse gas emissions, behind only the manufacturing giants such as the U.S. and China. Global efforts to reduce the effect of the shipping industry have been priorities for many activists and regulations are now in place requiring ships to be “zero-emission.” There have been many proposed solutions, but each has a cost to shippers themselves.

One such solution is to let history come in a full circle: return to relying on wind power and sails adapted to modern technologies. The global shipping firm Maersk is planning to install a Norsepower rotor sail to one of their oil tankers. Standing alone, this source of power is too weak to power the entire vessel by itself, so it needs to be supplemented by fuel, but the implementation of these rotors reduces both the fuel costs and emissions. Maersk estimates that the rotors will save them 7-10% in fuel costs, so it seems like a potential progressive step to mandate them across all shipping companies. A German company called SkySails has experimented with using kite-like parachutes to propel the ships and reduce costs. These two successes, relative to the entire romantic environmental pursuit of reviving sails nearly 200 years after they’ve been rendered obsolete, are pretty isolated. Most modern engineering reinventions of this wheel have been failures or high cost ventures. Furthermore, implementing the working marvel spinning rotor sails is easy for the $200 billion valued Maersk, but for smaller shipping companies that are less profitable, a universal mandate to implement these would inflict heavy costs that may not offset their savings in fuel for a very long time, if they can afford it at all.

Similar to the current situation of wind power, another proposed solution is using any kind of alternative fuel source to reduce the reliance on the most common fuel used in shipping: noxious bunker fuel. Bunker fuel is made from the dregs of the petroleum refining process, and is so toxic it is a solid at room temperature, needing to be heated up before use. It is heavy in sulfur, an element that causes respiratory problems and an increasing number of deaths, according to experts. However, a controversy lies in the elemental nature of sulfur itself. When in the atmosphere, sulfur can reflect radiation from the sun, theoretically being able to cool the planet and reverse global warming. There has been a mandate from the International Maritime Organization that requires a reduction of sulfur in fuel from 3.5% to .5%; which was driven by the amount of premature deaths that arise from high sulfur emissions. This mandate requires all shipping firms to reach this reduction by 2020. The problem with this deadline is that there are too few sophisticated oil distillers that can refine fuel to the required amount of sulfur. To meet the needs of the global shipping industry, estimates suggest that refineries will need to build 25 plants that will only be ready to distill oil in 2022. This means that by 2020, the supply of legal fuel would be heavily restricted, raising the price of crude oil by an estimated 30%. Once again, the costs of higher fuel prices are much harder to be absorbed by smaller shipping firms with less profit. The potential reverberations also will be felt throughout the world, with estimates suggesting a 2-4% drop in global GDP and a sharp increase in consumer prices due to decreased availability to trade, including a possible gas price increase of $6 per gallon.

The final big solution towards the industry involves raising the efficiency of the fuel through exterior means, i.e getting more nautical miles per gallon of fuel used. The way to do this is to reduce the drag and weight on the ship allowing the ship to get to where it needs to go faster and with less fuel emissions. Fouling, a natural biotic process that involves barnacles and other marine life latching onto the ship is what causes this drag. Fouling is a big problem that affects the US Navy, and they conducted a study that found out that fouling accounts for 15% of their propulsion fuel, or $20 million worth of fuel. Proposed solutions involve preventing the fouling from occurring and periodically removing the fouling with brushes or a water blaster. The way it is prevented is spraying the ship with a toxic paint or layer that prevents the fouling from occurring, but it has proven to only hinder the growth. As the toxicity wears off, the fouling ends up happening naturally requiring expensive touch ups and paint jobs to fix the effects. The cleaning is a second option, and has opened up a fairly profitable industry in Norway that blasts the ships with high pressure jets through drones, cleaning up the ships. The process, as expected, is very expensive and can cost between $17,000 to $20,000 per ship. The gains from fuel efficiency theoretically more than balance out the costs of anti-fouling, so the problem once again lies with smaller firms. Large shipping firms can afford the initial investment and bask in the increased revenues and profits that follow, but can a small firm take the $20,000 hit per ship? That will be the big question moving forward.

Works Cited:

Aggidis, G. (2017, March 21). Spinning sail technology is poised to bring back wind-powered ships. The Conversation. Retrieved from http://theconversation.com/spinning-sail-technology-is-poised-to-bring-back-wind-powered-ships-74872

Carrington, D. (2017, March 14). Spinning sail’ rebooted to cut fuel and make ocean tankers greener. The Guardian. Retrieved from https://www.theguardian.com/environment/2017/mar/14/spinning-sail-reboot-cut-fuel-make-ocean-tankers-greener

Gallucci, M. (2017, November 16). The shipping industry needs to clean up its act. Heres where it can start. grist. Retrieved from https://grist.org/article/the-shipping-industry-needs-to-clean-up-its-act-heres-where-it-can-start/

Gallucci, M. (2017, November 6). The shipping industry needs to deliver cleaner cargo ships, or we’re all sunk. grist. Retrieved from https://grist.org/article/shipping-industry-destroying-climate-progress-were-all-to-blame/

Rathi, A. (2017, August 29). One of the world’s most polluting industries has two years to clean up—and it’s woefully unprepared. Quartz. Retrieved from https://qz.com/1064658/the-shipping-industry-one-of-the-worlds-biggest-polluters-is-being-forced-to-clean-up-its-dirty-fuel/

Smith, O. (2018, March 12). Norsepower: Why European Ships Are Switching Back To Sails. Forbes. Retrieved from https://www.forbes.com/sites/oliversmith/2018/03/12/norsepower-why-european-ships-are-switching-back-to-sails/#4aff322e26a0

Verleger, P.K. (2018, April 18). Limit Sulfur in Shipping Fuel, But Not So Fast. Bloomberg. Retrieved from https://www.bloomberg.com/opinion/articles/2018-04-18/limit-sulfur-in-shipping-fuel-but-not-so-fast

When it Comes to EXIM, SOEs Could Cost China

By Alex Benedict

The reauthorization of the U.S. import-export bank could be critical to U.S. companies who  in the wake of the trade war with China.

A recent piece of legislation sponsored by the House Financial Services committee Chairwoman, Rep. Maxine Waters (CA-43), and cosponsored by Vice Chairman Rep. Patrick McHenry (NC-10), would restrict certain transactions with Chinese state-owned enterprises (SOEs). This bill, H.R. 3407, the United States Export Finance Agency Act of 2019, would reauthorize‒or allow the continued subsidization of American exports. The Export-Import Bank of the United States (EXIM), which currently subsidizes the foreign transactions, could potentially be affected by the current state of the bill, which restricts EXIM’s ability to interact with Chinese SOEs. EXIM is the official export credit agency of the U.S. federal government and operates as a wholly owned federal government corporation that helps assist in financing and facilitating the export of U.S. goods and services.

While Republicans are generally more against EXIM than Democrats, the reauthorization of the bill is a bipartisan issue, with members of both parties on both sides of the debate. Many representatives are against EXIM to begin with, arguing that the Bank’s ability to subsidize foreign purchases of American-made products‒but not subsidizing American purchases of American-made products‒is harmful to American businesses.

This debate is particularly salient when it comes to China, whose SOEs have historically utilized EXIM subsidies. Given the recent economic and political tensions between the U.S. and China, reauthorization of EXIM‒with new specific restrictions in regard to China‒will face an uphill battle in Congress.

The Rise of Non-State-Owned Enterprises (NSEs) in Modern-Day China

The role of state-owned enterprises (SOEs) in the Chinese economy has changed substantially in the past forty years. SOEs had previously been at the core of Chinese economic reform, but recently have been surrounded by rapid and widespread privatization of enterprises throughout China as a result of the growing demand for global, and private, economic presence (Song 345). However, since the global financial crisis of 2007-2008, the majority of Chinese SOEs are not completely state-owned, but rather state-controlled shareholding corporations––corporations in which the state has majority stake, but there are privately owned shares––or fully privately owned corporations. This shift to privatization, which allows China to remain competitive in the ever-changing global economy, has been the main driver of China’s economic growth.

A research paper published by the National Bureau of Economic Research emphasizes the importance of distinguishing between non-state-owned entities (NSEs) that were previously SOEs, and those that were not. Former SOEs “enjoy lower interest rates, larger loan facilities, and more subsidies while suffering poorer performance than never-SOEs” (Harrison 4). In other words, former SOEs do not do as well as private enterprises who have no history of state-ownership, regardless of the state resources that were used for their upkeep.

Current and former SOEs still play an important role in the country’s heavy industries‒(oil, metals, and chemicals). NSEs have become more prevalent because of their flexibility in responding to market demands, something that classic and former SOEs have difficulty doing. This could be a result of how SOEs had been propped up by the Chinese government, allowing for extensive corruption and little efficiency when SOEs enter a global market that demands efficiency. As a result, in 2015, NSEs were responsible for upward of 70 percent of Chinese GDP, 78 percent of total employment, and over 70 percent of investment in research and development (“State-Owned Enterprises” 3).

As the Chinese government is encouraged to open its markets, the opportunity for expansion of these NSEs increases. SOEs have retreated from labor-focused industries, and now focus heavily on industries that are more crucial to the state itself (national security, business competitiveness). This shift of SOE focus and expansion of NSE territory is important for a number of reasons, primarily in terms of bolstering overall economic growth. Yet there’s pushback from the Chinese government, who sees itself as the sole controller of industries it deems of strategic importance‒ like electric and coal, aerospace, and military‒because a firm grip of these industries maintains a firm grip on the political economy of China as a whole. However NSEs have the potential to take over industries the state considers less critical.

How “Private” Are NSEs? True Levels of State-Ownership in NSEs

The decentralization of the economy gave rise to NSEs, which are primarily industrial collectives, principally township/village enterprises (TVEs)––market-oriented public enterprises under the purview of local governments based in townships and villages in China––and foreign-funded firms that satisfying labor-intensive industries like construction and retail (Song 349). There are still state-induced barriers preventing NSEs from entering critical sectors like petroleum and telecommunications, as well as other various industrial sectors. These barriers limit NSEs to industries the state does not monopolize. In addition to sector hurdles, NSEs still often face monetary barriers in competing with SOEs; government banks give preferential treatment to SOEs, making up an estimated 85% of all bank loans given out in 2009. SOEs oftentimes do not repay their loans, negatively affecting the economy that NSEs were initially permitted to help repair (“China’s Economic Rise” 27). As a result, SOEs contribute much more heavily to Chinese debt than do NSEs.

As NSEs began to enter the Chinese economy in the 1980s, they relied heavily on local governments to avoid interference from the federal government. This relationship proved symbiotic, with local bureaucrats, entrepreneurs, and natives benefitting jointly with the success of the NSEs. The majority of NSEs still maintain close working relationships with the state, but there has been a movement in recent years to separate the two. Regardless of company ties to the Chinese state, which comes with inherent political and personal advantages, increasing competition from the private sector has made it more difficult for state companies to function more efficiently than those that are privately-owned. However, SOEs and NSEs alike can find success internationally.

Enterprises in China can be categorized in three ways: 1) private enterprises, or NSEs; 2) SOEs; or 3) mixed enterprises with the state as the minority shareholder. In China, the effectiveness of complete privatization is unlikely, and the government often turns to a process of faux-corporatization to retain greater control of the economy. Mixed enterprises still have some state control, but the government holds far less than the majority of the firm’s shares and has no legal rights in regard to firm operations; however, mixed enterprises have the ability to promote government reforms in the corporate sector, as government interests can more readily align with private investors (Pargendler 2691-2).

Overall, a 2006 study conducted by the McKinsey Global Institute concluded that enterprises with majority-state ownership are 46 percent more productive than SOEs with no private ownership, and enterprises with minority-state ownership are 70 percent more productive (“Putting China’s Capital To Work”). Evident from the drop in percentage share of profits and much lower return on assets, the following graphic illustrates the ineffectiveness of SOEs as compared to private companies. The numbers are telling of the impact that maintaining control of these enterprises will have on productivity in the Chinese domestic and international economies.

Picture2
Source: The Economist

EXIM and H.R. 3407

H.R. 3407 is part of a trade war perpetuated by the Trump administration’s own concern regarding Chinese economic strength and tries to address the struggles that the WTO has with economic regulation of Chinese enterprise. In a report on the U.S.-China Economic Relationship, the Brookings Institute writes that “state control over public and private businesses makes it difficult to distinguish between what is a public body and what is private, thereby making unclear whether…there is a rule or regulation issued by a public entity that is subject to WTO rules” (Meltzer).

The way to remedy the trade war is not to impose greater restrictions on business with Chinese SOEs, but to enact WTO guidelines. China is notorious for disregarding WTO rules, and the WTO is unequipped to reprimand China for its noncompliance. The trade war is already detrimental to American workers, especially farmers and manufacturers, whom the tariffs imposed by China affect most.

The reauthorization bill stipulates that any transaction that EXIM finances over $25 million relating to a Chinese SOE cannot be used to “provide material or financial support to the following policies and operations of China: 1) military or intelligence; 2) ‘One Belt, One Road’ initiative, a program started by Chinese President Xi Jinping. The initiative is to create “a vast network of railways, energy pipelines, highways, and streamlined border crossings” westward, southward, and throughout the rest of Asia, subsequently increasing the use of Chinese currency, the renminbi; 3) abuse of human rights, including freedom of speech” (FSC Majority Staff) [Chatzky]. Additionally, any SOE-related transactions greater than $25 million require the consultation of an appropriate federal agency, as well as a US Trade Representative’s certification within 60 days. H.R. 3407 will reauthorize EXIM if passed, but has a way to go before that happens.

While the presence of NSEs in China is increasing, the Chinese Communist Party (CCP) still retains control of China’s economy, hurting China if this bill is passed. But the passage of the bill with such heavy restrictions will also have severe implications on U.S. companies and businesses, many of which benefit from trading with China and its SOEs.

A Bipartisan Bill

The bill is contentious with Republicans and Democrats alike, many of whom have their qualms with the bank. Representatives on both sides of the aisle are worried about its impact on U.S. companies who do business with China. They see certain U.S. trade, especially that H.R. 3407 restricts with Chinese SOEs, as of economic importance and not detrimental U.S. foreign policy. Many business deals between U.S. companies and Chinese SOEs are thought to be simply transactional and not related at all to foreign policy.

While opposition is a bipartisan front, there is a core group of fiscal conservatives who vehemently oppose EXIM. They oppose because of instances like the following: American company Boeing was able to sell their jets to AirIndia through EXIM subsidies, even though AirIndia is in direct competition for trade routes with American airline Delta. EXIM’s role allowed for AirIndia to offer lower fares for certain flights, beating out Delta and hurting American enterprise.

Just as opposition to EXIM is a bipartisan issue, so is its reauthorization without restriction. Members who represent districts with high levels of manufacturing or those that contain large American corporations (i.e. Boeing) will be more invested in the bank’s reauthorization without restriction since it is in the best interest of their district (and reelection).

While there are a multitude of problems with EXIM–especially that of promoting corporate welfare at the expense of the American people–shutting down EXIM likely will only further hurt U.S. companies. There are over 100 export credit agencies globally today, all of which will remain intact if EXIM is not reauthorized, putting foreign countries and companies at an inherent advantage over U.S. companies.

With the reauthorization of EXIM and the ongoing trade war, tensions are running high. The implications of H.R. 3407 on American businesses are real, but so are concerns of American business contributing to Chinese state-owned enterprises. While it may be true that China is a threat to U.S. global hegemony, restricting American enterprise, especially when other foreign EXIM-like banks go unaffected, is not the way to tackle this economic threat.

Works Cited:

Image: https://www.gtreview.com/news/global/expert-analysis-how-trading-companies-can-circumvent-protectionist-policies/

Chatzky, Andrew et. al. “China’s Massive Belt and Road Initiative.” Council on Foreign Relations. https://www.cfr.org/backgrounder/chinas-massive-belt-and-road-initiative

“China’s Economic Rise: History, Trends, Challenges, and Implications for the United States.”Congressional Research Service.

FSC Majority Staff. “Memorandum: June 26, 2019 Full Committee Markup.” The House Financial Services Committee.

Harrison, Ann et. al. “CAN A TIGER CHANGE ITS STRIPES? REFORM OF CHINESE STATE-OWNED ENTERPRISES IN THE PENUMBRA OF THE STATE.” The National Bureau of Economic Research.

Meltzer, Joshua, et. al. “The US-China economic relationship: A comprehensive approach” The Brookings Institute.

Pargendler, Mariana. “State Ownership and Corporate Governance” The Fordham Law Review. “Putting China’s Capital to Work: The Value of Financial System Reform.” McKinsey Global Institute.

Song, Ligang. “State-owned enterprise reform in China: Past, present and prospects.” China’s 40 Years of Reform and Development.

“State-Owned Enterprises in the Chinese Economy Today: Role, Reform, and Evolution.” University of Alberta China Institute.

 

Will Stablecoin ever become a reality?

By: Quoc Doc

With innovations and new ideas being developed for stablecoin, it seems that stablecoin is here to stay. However, being implemented or not lies in the hands of the users and government approval.

In the crypto community, figures such as Gabriel Cardona, senior developer of Bitcoin Cash, and the Winklevoss Twins, who are the founders of Gemini exchange and creators of a pegged USD stablecoin called Gemini dollar, have raised their opinions that stablecoin is one of the next big innovations in the cryptocurrency market. Yet despite this optimism, there have also been some drawbacks that imply stablecoin won’t have an easy transition in the near future. In fact, just months ago, the United States based stablecoin project, Basis, was shut down due to regulatory concerns and the SEC mandated that Basis return capital to investors, including Andreessen Horowitz and Bain Capital Ventures. The news along with suspicious activities associated with prominent stablecoin Tether USD, have created skepticism on  stablecoin’s future impact.

In general, a stablecoin is a type of digital currency that aims to limit the volatility in price of itself or its underlying cryptocurrencies by either posting some sort of collateral, pegging relative to a basket of assets and less volatile cryptocurrencies or attaining backing from a well-reputed institution or government-backed entity. For a brief overview, there are three types: pegged, collateralized, and algorithmic stablecoin.

  1. Pegged stablecoins are fully collateralized coins. They are controlled by a single operator who ensures that the reserve has the same exact value as the volume of digital currency being circulated in the market. Examples of Pegged stablecoin are Tether, which is backed 1:1 to the dollar, TrustToken and Paxos.
  2. Collateralized stablecoins are coins that are collateralized with a variety of cryptocurrencies such as Ethereum. Coins in this group that are widely known in the cryptocurrency space include MakerDai and Havven.
  3. Algorithmic stablecoins, unlike the two types above, aren’t backed by any crypto or fiat currencies. Rather they are governed by algorithm that ensures the digital currency to be stable in value. Basically, the platform algorithmically issues crypto-bonds in exchange for their coins and ensure that their crypto holders buy it back at a later time. Examples of these coins include the project mentioned above, Basis, and CarbonUSD.

Over the course of last year, stablecoins have gained high traction. The number of live stablecoins, available for purchase in the cryptocurrency market, grew from 9 to 28 coins by the end of the year while over 160 projects were initiated, and are in the process of development. Many believe that the stablecoin frenzy didn’t start until people started looking for alternatives to Tether, a USD backed cryptocurrency, after it broke its 1:1 peg in October last year. This event news reaffirmed earlier suspicions about the company’s reckless spending, improper planning, and insufficient funding, and prompted investors to find new stable coin projects to back. This has resulted in the decline of Tether’s market share from 98% to around 70%, as coins such as PAXOS, TUSD and USDC have started to gain adoption. Big companies such as Facebook and banks such as JP Morgan have also decided to venture into the space as well, despite their earlier explicit positions against cryptocurrencies. Central banks around the world have also started to develop their own stabilized digital currencies. According to a recent research by BIS, The Bank for International Settlement, 70% of central banks worldwide are currently conducting research regarding digital currency, and half of them have moved onto experiments and proof of concept work.

Yet despite the increased funding and development in the space, there has also been a wave of criticism  and skepticism towards the viability of stablecoin. In an article written by UC Berkeley Economics professor Barry Eichenberg, each stablecoin has its own major flaw. Pegged stablecoins, like Tether for example, require a certain amount of faith and trust to exchange a full U.S. government backed currency for a questionably backed coin that no one would be willing to trade, except for money launderers. Partially collateralized stablecoins run the risk of a “bank run,” where a large number of people exchange their collateralized stablecoins  for the deposited cryptocurrency in the midst of doubts. Algorithmic stablecoins on  the other hand may experience limited platform growth. In this case, when the crypto-bonds are being issued no one would buy them because their belief in the platforms has failed. Other critics, such as Preston Byrne who has written extensively on the matter share similar views.

The overall stablecoin market doesn’t seem to hold up to its true value of decentralization either. Currently in the market, pegged coins take up the most shares, especially those that are backed 1:1 to USD. The problem is that these projects are operated by an identity or a group of people and the decision is not decentralized for the holders of the tokens at all. This is even worse than placing trust is central banks where you know there are actual expertise involved in controlling the flow of your money. Nonetheless it is important to remember that stablecoin or cryptocurrency in general wasn’t created to open a different path for centralized currency governance. It was to pave ways for decentralization and the exploration of a peer to peer system. For more on this discussion, please read my article HERE.

Stablecoin is still in its nascent years of development. Even the blockchain space itself has not finished its stages of building infrastructure or finding the right framework to implement all applications, let alone stablecoin ( introduced five years ago). And although there are many doubts and criticisms toward stablecoin, they are mostly based on theories and won’t likely be true about the industry. With innovations and new ideas being developed for stablecoin, it seems that stablecoin is here to stay. However, being implemented or not lies in the hands of the users and government approval. When we compare the blockchain innovation between that of the U.S. and that of Switzerland, it is noticeable that the room for improvements of the technology differ quite significantly. The strict regulation in the US have thwarted the innovation of the technology. As seen through the example of Basis, no matter how innovative the project is and no matter how highly skilled the team are, without conforming to the law, no project would be able to continue operation. Switzerland on the other hand has opened itself to blockchain. Its crypto friendly regulatory framework has led to the fruition of projects such as Ethereum and Tezos. But with recent news about easing regulations and countries exploring the opportunities of adopting blockchain technology, we might, in the future, use stable coin for daily transactions.

Works Cited:

Chaparro, F. (2018, December 12). Stablecoin project Basis is shutting down and returning nearly all capital raised to investors. The Block. Retrieved from https://www.theblockcrypto.com/2018/12/12/stablecoin-project-basis-is-shutting-down-and-returning-the-majority-of-capital-raised-to-investors/

CementDAO. (2018). End of Year Review: Stablecoin Ecosystem [Data File]. Retrieved from https://medium.com/@CementDAO/end-of-year-review-stablecoin-ecosystem-ebfe3bb2927b

CoinCola. (2018). Stable Coins Market Review 2018 [Data File]. Retrieved from https://www.coincola.com/blog/stable-coins-market-review-2018/

Eichengreen, B. (2018,  September 11). Why ‘stable coins’ are no answer to bitcoin instability. The Guardian. Retrieved from https://www.theguardian.com/technology/2018/sep/11/stable-coins-bitcoin-cryptocurrencies-tether

Finder. (2019, January 3). What is a stablecoin?. Retrieved from https://www.finder.com/stablecoins

Horowitz, J. (2019, February 19). JPMorgan’s move into crypto puts the rest of the industry on notice. CNN. Retrieved from https://www.cnn.com/2019/02/19/business/jpmorgan-jpm-coin-banks-blockchain/index.html

O’Neal, S. (2018, December 28). From Blanket Ban to Its Own Stablecoin: How Facebook’s Relationship With Crypto Changed Over 2018. Cointelegraph. Retrieved from https://cointelegraph.com/news/from-blanket-ban-to-its-own-stablecoin-how-facebooks-relationship-with-crypto-changed-over-2018

The Many Faces of Bankruptcy

By: Ian Peterkin

“Our capital position at the moment is strong.” – Former Lehman Brothers CFO Ian Lowitt, five days before Lehman’s bankruptcy filing

Financial distress is among the most important and pivotal situations that a company may find itself in. It raises important questions about the core operating nature of a business and the responsibilities of its Board and Management, while providing lucrative opportunities for debt-savvy investors. While an attempt to answer every question regarding financial distress is out of the scope of this article, we can still provide a high level of detail about the roles of each party in a bankruptcy process to remove some of the smoke and mirrors surrounding bankruptcy. With the cyclical nature of the corporate landscape, understanding who’s who in times of distress is one of the keystones to making judgements on the nature of a distressed Company.

Company players are those parties involved with the Company pre-filing for bankruptcy. This group usually consists of the Company’s Board of Directors, Management, as well as all of the Company’s creditors (in complex cases, the list of Company creditors can be quite long). 

The Board

First, the Board of Directors is a group of people elected to represent Company shareholders. The Board is almost always primarily concerned with maximizing shareholder value. However, when facing insolvency (i.e. the Company can’t pay its debt), the Board must realize that its fiduciary duties extend beyond those of a Board not experiencing distress. Instead of being solely concerned with shareholders, the Board must now consider both the short and long-term effects of its actions. A Board in distress effectively operates under a microscope, with every action and reaction subject to judgement by the court.

The essential first step for a Board in distress is to prepare for this oversight by engaging experienced legal and financial professionals to advise on important decision making. Maintaining effective legal counsel helps to ensure that the Board will make effective use of the “Business Judgement Rule”, a legal protection against litigation brought about by dissatisfied shareholders and bondholders. Meanwhile, effective advisors operate as the strategists of the insolvent Board, guiding them through every potential course of action. If, after consultation with its advisors, the Board concludes that bankruptcy is the best plan of action, the advice of its advisors will prove invaluable as it navigates the bankruptcy process.

Management

Next, Management faces similar fiduciary duties as the Board, but also has its own distinct responsibilities. Management’s compensation often relies heavily on significant equity incentives that, under distress, may have diminished value. As a result, Management might adopt a short-sighted view of embracing less than optimal deals with parties such as unsecured creditors in order to protect their own interests.

Good Management, however, understands that its fiduciary duties supersede its own interests. By colluding with unsecured creditors like bondholders, management may be starting a slippery slope to a Company sale at less than optimal prices, effectively wiping out Old Equity (more on this later). During distress, Management is concerned with operating on a tight budget, utilizing the help of financial advisors to identify areas where it had gone astray leading up to distress, hoping that through this careful analysis, it can confidently come up with meaningful ways to restructure the Company around a less burdensome capital structure.

Bondholders

Now onto Bondholders, who are individuals or entities that maintain ownership of outstanding bonds. Bondholders can come in two broad categories: secured and unsecured. These can each be split up into two groups as well: par holders, who purchased the bonds at face value when they were issued, and so called, vulture investors.  By and large, ALL bondholders are purely financial players concerned with maximizing their returns, and NOT with keeping the firm alive (unless those bondholders maintain other interests in the firm). If both options are possible, then the bondholders can be quite amenable to a restructuring. However, if the bondholders see an opportunity for increased returns in a liquidation scenario, they will not hesitate to push for liquidation.

Typically, the “right” way to deal with bondholders is through constant communication. Generally, if the bondholders go quiet, something is up. Recently though, a new group called “vulture investors” have seen a rise. See for example the recent Puerto Rico debt crisis, in which firms like Oppenheimer, Franklin, and Aurelius Capital Management scooped up billions in distressed bonds and pension debt, hoping to profit from a rebound. These investors aim to purchase the secured debt (usually at a discount) from its original holders, seeking to maximize its internal rate of return, without giving much thought to its reputation on the street or the Company’s going concern status. The process usually goes like this: As signs of distress start to creep and the Company’s status as a going concern is brought into question, the bonds will start to lower in pricing as risk averse holders begin to fear less (or no) returns in a potential bankruptcy and start to sell off their holdings. Enter the vultures. The vultures see this lower pricing as an opportunity to bet on the Company’s status as a going concern, and purchase the bonds from their original holders.

Trade Creditors

Trade creditors are those creditors whose claims are based on goods they have sold to the Company prior to its entry into bankruptcy (this is an example of a pre-petition trade creditor, a creditor who continues to supply after filing would be considered post-petition). For example, in the recent Toys “R” Us filing, many creditors continued supplying the bankrupt retailer after its filing, hoping it would emerge from bankruptcy able to pay its debts. When the Company ended up liquidating, trade creditors collectively lost out on hundreds of millions of dollars in trade credit. In general, the trade-creditors’ claims make up the “accounts-payable” line item on a firm’s balance sheet.

There are two types of trade creditors: critical vendors and general unsecured creditors. Critical vendors are those vendors whose functions are essential to the functions of the business. Without their continued service, the Company could no longer operate. It is these critical vendors who are often paid at the onset of the bankruptcy to ensure the going concern of the business during its stay in bankruptcy. While it may seem odd that a supplier would continue to deal with a bankrupt firm, critical vendors are usually able to strike deals on terms for their continued supply in exchange for a wide range of benefits, such as priority payment in a liquidation scenario (commonly called critical vendor claims). General unsecured creditors  are those creditors who are last in the payment waterfall (there are some exceptions to this rule). The outcome of a bankruptcy for them depends on the nature of the process, but often results in little to no recoveries.

Old Equity

Last in the priority waterfall is old equity. We use the term “old” equity to differentiate those holders of equity pre-bankruptcy from those who hold the equity post-process (which is often composed of different groups). Generally quite passive in the process, no one really represents Old Equity in bankruptcy besides the Board. For private companies with a few high stake holding owners, Old Equity can be very active, but in public cases, Old Equity often finds itself disenfranchised.

However, just because they are disenfranchised, does not mean Old Equity will not see any recovery. In fact, there are actually many paths to meaningful recovery for Old Equity, and if possible Old Equity should attempt to maintain some sort of financial advisor of its own to evaluate these options. For example, one way is to demonstrate that the value of the enterprise is such that the equity has value in excess of the debt.

Now that we have gone through the company players, we can move onto the next group,   Outside professionals. These are all of the parties brought in after the Company realizes its situation of distress, usually with the goal of ameliorating the problem(s) that the Company is facing. This group consists of legal counsel, financial advisors, and any other parties that the Company may deem necessary. This group also carries with it fees, so it is important to consider engagements economically.

Legal Counsel

Legal Counsel, along with the other professional groups, plays an essential role in the bankruptcy process. As much of the process is centered on the bankruptcy courtroom and the bankruptcy judge has the final say before giving effect to a transaction, the roles of the lawyers are of extreme importance. As a result, the Board is often not the only party to hire on legal counsel. In cases involving many claimants and uncertainty around their respective payouts, it’s not uncommon to see multiple legal firms present in the courtroom, arguing for the interests of their clients.

The responsibilities of legal counsel include maintaining meticulous records of the Company’s bankruptcy related filings; Contacting the legal counsel of other parties in order to effect a consensual sale or restructuring; Advising the Company on the legal nuances of its proceedings; Drafting legal documents; Reviewing legal documents presented by other parties; Representing the best interests of the Company in a courtroom.

Investment Banker

The investment banker is a sort of jack of all trades when it comes to bankruptcy cases. A debtor-side investment banker may responsible for a myriad of tasks depending on the goals of her clients, including: Providing financial advisory services; Mergers and acquisition services in cases where the Company is looking (or is forced) to sell; Litigation support; Raising capital for post-filing financing; Financial opinions; Soliciting bids for assets during a sale process.

Financial Advisor

The financial advisor role may be played by the investment banker, though this is not always the case. In complex cases with multiple conflicting parties it is generally beneficial for each party to hire their own financial advisors to provide opinions and analysis on the specific situation. The financial advisor is responsible for assisting the Company in evaluating all of its potential options. In other words, the financial advisor is the Company’s guide in distress. When the Company wants to conduct sensitivity analysis, cash forecasts, or any other sort of financial diligence, they often enlist the help of their financial advisors. An experienced board may be great at running a Company under normal circumstances, but lost when distress begins to creep in. A competent financial advisor with experience aiding distressed Companies can be the saving grace of a lost management team.

Finally, the last major group is the Court. The “court” is a catch all category for the many moving parts of the legal system as defined by the U.S. Bankruptcy Code. At the head of this group is the bankruptcy judge, someone (often an ex lawyer) who is responsible for ruling on any matter connected with a bankruptcy case, such as eligibility to file or whether a debtor should receive a discharge of debts .

The bankruptcy judge is appointed by the U.S. Court of Appeals, and there are 94 federal judicial districts that handle bankruptcy cases. As of September 2012, there are 350 authorized bankruptcy judgeships, with each judge serving a term of 14 years. The defining moments of a bankruptcy take place under the supervision of the judge, and careful consideration as to which district the Company files for bankruptcy in must be made to ensure the best outcome for the Company. Legal counsel often determines jurisdiction through a careful study of past cases taken on in the district and their respective rulings.

Works Cited:

Image Source: https://yourmoneyrelationship.com/5-ways-gain-control-mounting-debt/

DiNapoli, J. (2019, January 08). On brink of demise, Sears to reconsider billionaire chairman’s bid. Retrieved from https://www.reuters.com/article/us-sears-bankruptcy-liquidation-exclusiv-idUSKCN1P218J

Hashmall, M. J. (2018, October 16). Business Judgment Rule. Retrieved from https://www.law.cornell.edu/wex/business_judgment_rule

Kaufman, P. S. & Owsley, H. F. (2015). Distressed investment banking – to the abyss and back – second edition (2nd ed.). Place of publication not identified: BEARD Books.

Process – Bankruptcy Basics. (n.d.). Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/process-bankruptcy-basics

Unglesbee, B. (2018, August 28). Burned by Toys R Us, will suppliers ever trust a bankrupt retailer again? Retrieved from https://www.retaildive.com/news/burned-by-toys-r-us-will-suppliers-ever-trust-a-bankrupt-retailer-again/530926/

U.S. Code: Title 11. BANKRUPTCY. (n.d.). Retrieved from https://www.law.cornell.edu/uscode/text/11

Destiny of the “Hockey Stick” Economic Growth

By Alper D. Karakas

Technology is running and running quickly, but it does not seem to be giving as big of a boost as past inventions. Is the digital revolution not as revolutionary as its predecessor…?

You don’t need to be in Silicon Valley to hear all the buzz about where technology can take us. The supposed glory of artificial intelligence and its potential uses are ubiquitous: whether it’s tech company adverts on television, articles in newspapers, or geeky word of mouth. In fact, the growth of this innovation is said to be the next revolution for humanity, surpassing the agricultural revolution and the industrial revolution. Today, our world is experiencing the technological revolution. The amount of new technology being introduced to consumers and workers is growing at an increasingly fast pace which should translate to global production growth.

Picture2

Lately, however, the world growth rate has slowed. Although there has been an increase in technological progress and globalization, data on global production does not corroborate the expected improvements. For example, as seen from the graph above, the US GDP growth rate has been decreasing since the second world war—even during the 21 century. According to economist Robert Gordon, America’s decreasing GDP growth per person is a result of three occurring events. Firstly, hours of labor per person have been decreasing due to higher education requirements for jobs, and the baby-boomer generation finds itself in the retirement stage of the life cycle. Secondly, higher education’s price inflation has been too high, and thus new members of the labor force are paying back debt instead of increasing GDP. Lastly, economic inequality, which is also a global issue, caused most growth to only be experienced by the top percent. When the majority does not experience the benefits of increased production it is regressive to the economy. While the industrial revolution demonstrated substantial exponential growth, the growth from technology does not seem to be as beneficial as it has been made out to be.

Consider the toilet versus the iPhone. This is the anecdotal example that provides an explanation for the disparity between world GDP growth during the two revolutions. When the iPhone was first introduced, it changed the mobile phone market due to its innovative features and superior functionality. Although the technology is impressive, the marginal benefit of the iPhone’s invention does not compare to that of a toilet. Yes, the technology behind a toilet is quite simple, but its marginal benefit is huge in terms of sanitation, pollution, and convenience. The iPhone did improve the mobile phone experience, but would you really rather live without toilets than have a basic cell phone? The point is, during the industrial revolution, many of the inventions completely turned peoples’ lives around. They were able to live much more smoothly and cleanly. Now, however, new inventions are technologically impressive, but they don’t improve our lives as much since many of the inconveniences we face were solved already. Yes, the new stuff is cool, but maybe it’s not as helpful. Maybe now there aren’t as many major inconveniences in our lives that need fixing.

Picture3

Lastly, this second graph shows the “hockey stick” GDP growth curve. For the past 1700-1800 years, global production has been a flat line, but the industrial revolution in the 19th century spiked the growth rate up for the last 200-300 years. In the grand scheme of time, the past couple centuries seem like an anomaly, giving the line a “hockey stick” look. It begs the question: which part of the line seems “normal”? Arguably, returning to minimal production growth—which seems to be the trend based on the first graph—can be expected. GDP per person growth falling down to a fraction seems like it is coming back to its natural state after a shock that started in the 1750s.

On the other hand, if you go back to Silicon Valley, where there is the highest concentration of engineers working toward artificial intelligence and big data projects, they’ll say you ain’t seen nothing yet. Of course, data is data. Are world production rates growing as if there is currently a revolution? No. But, economist Erik Brynjolfsson notes that GDP calculations miss $300 billion from free goods and services that come from new technologies since many of them are free or cheaper services and GDP measures through prices.

In more depth, Erik Brynjolfsson claims that lower production is not because technological improvements are less significant than industrial ones, rather it is because we are competing with technology rather than working with it. He states the world economy’s productivity has been growing at rates mirroring the industrial revolution. To differentiate, productivity is output per unit of effort while production is output in general. Therefore, since production growth has been decreasing but productivity is increasing, people have been putting in less effort which decreases output. Brynjolfsson states that this duality is rooted in humans competing with technology rather than using it. Technology has been putting people out of jobs, so they’ve had no opportunity to make efforts towards embracing the wave of new advancements. Although productivity has increased due to technology, units of effort have decreased due to technology; therefore, the key to unlocking technology’s potential is to work with it.

The key to the argument is that people can adopt technology for their efforts to maximize efficiency. An economist can try to manipulate and analyze data by hand, but they will never do it as efficiently as a computer could. However, if the economist uses a computer, nothing will beat the efficiency and quality of the combined effort. For example, after the massive Californian wildfire outbreaks in 2017, there have been many efforts to aid disaster response with predictive algorithms. Through satellite images and meteorology maps, these software can notify where a fire is starting and where there is a high probability of a fire starting. Disaster responders can use these digital tools to combat devastation wildfires more beneficially and efficiently.

Furthermore, the development of AI technology continues to grow extensively, and later it will be connected to aspects of human life that will cause great progress in people’s livelihood, such as medicine and energy. The innovations that are currently on the market are advanced, but they are minute relative to their potential. Social media allows us to interact more and big data allows marketers to advertise more intelligently, however, these advances may still not be as marginally comparable as those of toilets with regards to human productivity and ease of life. AI engineers will soon connect its capabilities to mediums which greatly benefit our lives, and thus allow for another revolution. We just have to wait because we ain’t seen nothing yet.

References

  1. Bhatia, Anshu, et al. “Mobile Phones Over Toilets : Technology Over Hygiene.” AetosEye, 17 Nov. 2017, blog.safetykart.com/mobile-phones-over-toilets/.
  2. Brynjolfsson, Erik. “The Key to Growth? Race with the Machines.” TED, http://www.ted.com/talks/erik_brynjolfsson_the_key_to_growth_race_em_with_em_the_machines.
  3. Gordon, Robert. “The Death of Innovation, the End of Growth.” TED, http://www.ted.com/talks/robert_gordon_the_death_of_innovation_the_end_of_growth.
  4. “Has the Ideas Machine Broken down?” The Economist, The Economist Newspaper, 12 Jan. 2013, http://www.economist.com/briefing/2013/01/12/has-the-ideas-machine-broken-down.
  5. Roser, Max. “Economic Growth.” Our World in Data, 24 Nov. 2013, ourworldindata.org/economic-growth.
  6. Snow, Jackie. “Future Wildfires Will Be Fought with Algorithms.” Fast Company, Fast Company, 26 Nov. 2018, http://www.fastcompany.com/90269483/how-ai-software-could-help-fight-future-wildfires.
  7. “The Digital Industrial Revolution.” NPR, NPR, 21 Apr. 2017, http://www.npr.org/programs/ted-radio-hour/522858434/the-digital-industrial-revolution.
  8. “United States GDP Growth Rate.” United States GDP Growth Rate | 2019 | Data | Chart | Calendar | Forecast, Trading Economics, tradingeconomics.com/united-states/gdp-growth.

The Past, Present and Future of Global Inequality

By: Buyi Wang

Income and wealth are increasingly in the hands of the top 1%. How have we arrived at this stage of global inequality and what does the future have in store?

How much do you have to earn to be considered rich? According to Bloomberg, if you live in countries like China, where income and wealth inequality are relatively moderate, you need to earn $105k annually to be considered as the top 1%. In the United Arab Estimates, the number is $891k. In the United States, the number is $478k.

Inequality is a global phenomenon. According to the World Inequality Report 2018, from 1980 to 2016, almost every region in the world has experienced increasing income inequality. The United States, for example, stands out compared to Western Europe. In the 1980s, the two regions shared the same level of inequality, with the top 10% accounting for roughly 10% of the national income. However, by 2016, the top 10% in the U.S. took up 20% of national income while their counterparts in Western Europe took up 12%. Aside from income, the U.S. also has one of the highest levels of wealth inequality. In 2014, the top 1% in the U.S. held 39% of national wealth, while the figure was 30% in China and 20% in the UK.

Although some might find global inequality an outdated subject(global inequality in this article means income inequality and wealth inequality), a closer look at the world today invalidates such belief. For instance, many regions in the world, especially Europe and North America, are still recovering from the 2008 financial crisis, which has made inequality actually grow. While the upper class was less impacted, the sluggish economic growth during the recovery period has especially eroded the living standards of the lower and middle class in these developed countries. Such imbalance was partially the reason why populism emerged. In other parts of the world, especially the Middle East, Latin America and Africa, inequality has not increased much but remained high. The rich and the poor live drastically different lives. While the wealthy might be able to enjoy high quality healthcare and send their children to study abroad, the poor might be struggling to get medicine and supporting their children to even finish primary school. In general, global inequality must continue to be addressed.

Throughout history, inequality has been driven by inter-country inequality and within-country inequality. According to a research by Brookings, which gives a well-analyzed summary of how these two forces evolve, before 1980s, inter-country inequality was the main force of global inequality. Countries in Western Europe and North America outperformed others economically thanks to the Industrial Revolution. After 1980s, inter-country inequality started decreasing as developing countries, especially China and India, caught up with the developed world. The strong economic growth has transferred huge number of people out of poverty into the global middle class. At the same time, within-country inequality became a more serious issue. The extent of within country inequality depends on national policies. For instance, both China and Russia have gone through the transition from a planned economy to a more market-oriented economy. However, inequality increased slower in China due to a more timid pace of privatization.

Like many other global trends, the development of inequality has produced its winners and losers. Not surprisingly, the global top 1% is the biggest winner. According to the elephant curve in the Inequality Report pictured at the very beginning which shows how economic growth was captured by people of different income levels from 1980 to 2016,  the bottom 50% has captured 12% of total economic growth while the top 1% has captured 27%. The Brooking paper, which  provided an analysis from a different perspective, regards middle class in developing countries and upper class in developed countries as the biggest beneficiaries of growth since 1980s. Lower and middle classes in developed countries saw the least growth.

The World Inequality Report also discusses three potential future inequality outcomes. In the first case, inequality follows the pace experienced by the U.S. In the second case, inequality follows the moderate growth experienced in European countries. In the third case, inequality continues to grow at its current pace. The report concludes that inequality would rise the most under the first case where the global income the top 1% would capture would increase from 20% to 27.5%. Inequality  would only decrease under the third case where the this share would fall from 20% to around 19%. Seeing the future through another perspective, if emerging markets can still be counted to deliver strong economic growth, inter-country inequality can be expected to decrease continually. However, this might not be the case with China’s growth. As previously mentioned, the strong economic growth of China since the 1980s has decreased global inequality because of rising Chinese middle-class population. Nevertheless, income inequality in China has been rising fast. China is the country with the greatest number of billionaires in 2018 and the rich captures one third of the national wealth. Further growth of inequality within China might thus exacerbate global inequality.

In conclusion, global inequality is still a major issue today. If emerging markets can still deliver strong economic growth, then inter-country inequality can continue falling. Within-country inequality would be more difficult to solve. National governments still should carry out reforms to ensure that income and wealth are not under the full control of just a few.

Works Cited:

Image Source: Figure E2a, World Inequality Report 2018. https://wir2018.wid.world/files/download/wir2018-summary-english.pdf

  1. Steverman, B., Pickert, R. (2019, Feb 4). This is what it takes to be in the 1% around the world. Bloomberg. Retrieved from https://www.bloomberg.com/news/articles/2019-02-04/a-global-guide-to-what-it-means-to-be-part-of-the-1?te=1&nl=dealbook&emc=edit_dk_20190205&fbclid=IwAR3jE_ic27M5EkpjBDLWCZMvwnPfLYnSgenGWjw-wMGIwDyzsL3TqhXEsRw
  1. Alvaredo, F., Chancel, L., Piketty, T., Saez, E., Zucman, G.(2018). World Inequality Report 2018. WID. World. Retrieved from https://wir2018.wid.world/files/download/wir2018-summary-english.pdf
  1. Qureshi, Z. Trends in income inequality: global, inter-country, and within countries. Brookings. Retrieved from https://www.brookings.edu/wp-content/uploads/2017/12/global-inequality.pdf.
  1. Alvaredo, F., Chancel, L., Piketty, T., Saez, E., Zucman, G.(2018). World Inequality Report 2018. WID. World. Retrieved from https://wir2018.wid.world/files/download/wir2018-summary-english.pdf

What does Italy’s recession mean for Europe?

By: Andrea Ferrell

Europe’s third largest economy just entered into a recession.  What may this contraction mean for the rest of Europe?

At the end of 2018, Italy entered into its third recession in the past ten years while a new government made up of the Five Star Movement and the League parties took power. The Italian economy, dominated by the import/export of machines, is still reeling from the European debt crisis in 2012 while the new government, intentionally or not, has accelerated the contraction of Italy’s shrinking manufacturing sector and increased political gridlock. To see how Italy got here, let’s explore its past economic woes.

The European debt crisis began on the heels of the financial crisis of 2008 when fringe countries of the European Union (Greece, Spain, Portugal, Ireland and Cyprus) were unable to pay their debt without the help of a third party, mainly the International Monetary Fund (IMF) or the European Central Bank (ECB). In addition to the 2008 financial crisis, the debt crisis was also rooted in a housing/property bubble in many European countries. During the crisis, rating agencies downgraded debt from Portugal, Greece and Ireland to junk status, sovereign bond yield peaked, and high interest rates continued to spook investors. In 2011, the yield on the Italian 10 year bond was 7.19% and interest rates reached a high of around 7%. In order to deal with the crisis, the ECB and IMF bailed out out Greece and dropped interest rates to near zero. It has been more ten years since the crisis began, and the ECB’s interest rates continue to stay at zero as Europe deals with the effects of the debt crisis. At the end of 2018, manufacturing confidence was down as investors began to worry about the negative effects of trade wars on the productivity of European countries.

While Italy did not default on their debt during the crisis, many investors worried about the Southern-European country. Since the 1990s, Italy has had high debt. In 2007 their debt-to-GDP ratio, which measures how well a country can pay back their debt, was 103.1%. The financial crisis of 2008 lead to major liquidity problems as the uncertainty around borrowers lead to a reduction of credit and a decrease in consumption, which crippled the already weak economy. During the debt crisis, Italy’s problems lay in their public debt, and so it used capital markets to raise funds, whereas other European countries used the ECB for bailouts. Italy’s high debt only became a problem in the context of other European countries defaulting on their debt because investors began to “lose confidence in the ability of the Italian state to service its debt.” The 2018 election did not help improve the future outlook for Italy.  The newly elected Italian government was one of gridlock as the lower house was dominated by the center-left and the majority of the upper house was  center-right.

The Frustrations of the Italian people came to a head in the 2018 elections when a new populist coalition was formed by the Five Star Movement and the League. These two “parties” focused on the ordinary Italian and are working to increase government spending to improve overall quality of life. This political change is rooted in economic inequality (seen in high youth unemployment), a frustration with government corruption and high immigration. One factor that holds these two parties together is a resistance to the European Union. It took this new coalition almost nine months to agree on an Italian budget with the European Union, where many of the populist goals were cut out of government spending. This coalition has been in power for less than a year, but there have already been negative effects on the economy.

A recession is  defined as two consecutive periods of contraction, and Italy fits this rule as GDP growth was -0.1% and -0.2% in the third and fourth quarter of 2018, respectively. Prior to the 2018 elections, Italy’s economy was stagnant, but since the coalition came to power the European Commission has cut Italy’s GDP growth projections from 1% to 0.6%. What has caused this slowdown in Italy? The populist government continues to swell the government budget even though there has been little change in consumption. Manufacturing contracted 2.5% and 5.5% in November and December of 2018, respectively. Likewise, the coalition continues to break European Union rules of fiscal discipline. As a result of these factors, the Italian economy entered into a recession at the end of 2018.

Italy is Europe’s third largest economy, so the possibility of a debt default could have detrimental effects on the European economy. Many European banks hold Italian bonds, and an increase in Italian sovereign bond yields would make government payments harder to fulfill. Likewise, the ECB would be unable to bailout Italy’s $2 trillion economy, which would force Italy into deeper problems. Overall, European growth is slowing, as seen in Germany’s slowing car sales and threats from Brexit, adding more pressure to Italy’s ability to grow. While uncertainty around debt payments continue to plague Italy, investors are still buying sovereign debt, stating that the 2.785% yield on the Italian ten-year is higher than any other yield on other European sovereign debt (for context, the yield on Germany’s ten-year bond is 0.1%).

How can Italy deal with its debt problem? More immigration would help alleviate such high youth unemployment, but increasing quotas would be almost impossible in a government lead by an anti-immigrant party. Similarly, Italian banks have slowed their lending to citizens, which has hurt production and growth in the country. An increase in bank loans could also help jumpstart consumer spending as people and businesses would have more money to build infrastructure and spend within the Italian economy.

For decades the Italian government has been heavily debt ridden, and the future seems to be no exception. Italy’s future growth is reliant on its ability to jumpstart consumption and the overall trajectory of European growth, which seems to be slowing.

Works Cited:

Image source: https://www.japantimes.co.jp/opinion/2015/01/12/commentary/world-commentary/europes-unending-crisis/#.XHBhwi2ZMb0

Amadeo, K. (2019, February 01). Eurozone Debt Crisis. Retrieved February 22, 2019, from https://www.thebalance.com/eurozone-debt-crisis-causes-cures-and-consequences-3305524

Beker, V. A. (2014). The European Debt Crisis: Causes and Consequences. Journal of Stock & Forex Trading,03(02). doi:10.4172/2168-9458.1000115

Chiltoki, A. (2019, February 20). Investors Flock to Italy Despite Troubles. Wall Street Journal. Retrieved February 22, 2019, from http://ereader.wsj.net

Chu Economics Editor, B. (2018, May 29). This is what’s caused Italy’s political crisis and what it could mean for the Euro. Retrieved February 22, 2019, from https://www.independent.co.uk/news/business/analysis-and-features/italy-crisis-2018-explained-political-financial-markets-euro-five-star-sergio-mattarella-a8374091.html

Girardi, A. (2019, February 01). Italy Falls Back Into Recession As The World Fears Global Economic Slowdown. Retrieved February 22, 2019, from https://www.forbes.com/sites/annalisagirardi/2019/02/01/italy-falls-back-into-recession-as-the-world-fears-global-economic-slowdown/#1d559064225f

Giugliano, F. (2018, October 10). Italy’s Banks Stumble Into a New Crisis. Retrieved February 22, 2019, from https://www.bloomberg.com/opinion/articles/2018-10-10/italy-s-banks-stumble-into-a-new-crisis

Hannon, P. (2018, August 12). Optimism on European Growth Reverses as Headwinds Mount. Retrieved from https://www.wsj.com/articles/optimism-on-european-growth-reverses-as-headwinds-mount-1534089601

Hazel, R. L. (2017, December 5). The Evolution of U.S. Monetary Policy[PDF]. Richmond, VA: Federal Reserve Bank of Richmond.

Italy. (n.d.). Retrieved February 22, 2019, from https://atlas.media.mit.edu/en/profile/country/ita/#Trade_Balance

Kenton, W. (2019, February 14). European Sovereign Debt Crisis Definition. Retrieved February 22, 2019, from https://www.investopedia.com/terms/e/european-sovereign-debt-crisis.asp

McBride, J. (2018, October 18). Does Italy Threaten a New European Debt Crisis? Retrieved February 22, 2019, from https://www.cfr.org/article/does-italy-threaten-new-european-debt-crisis

Molinari, M. (2018, November 07). Italy’s battle with Brussels is about more than money | Maurizio Molinari. Retrieved from https://www.theguardian.com/commentisfree/2018/nov/07/italy-brussels-money-coalition-italy-eu

Policy Tools. (n.d.). Retrieved from https://www.federalreserve.gov/monetarypolicy/openmarket.htm

Wearden, G., & Inman, P. (2019, January 31). Italy slips into recession for third time in a decade. Retrieved from https://www.theguardian.com/world/2019/jan/31/italy-slips-into-recession-for-third-time-in-a-decade-economy

A Primer on the Federal Funds Rate

By: Andrea Ferrell

What’s the relationship between the Federal Funds rate and the 10 year treasury?

As the U.S. economic expansion crosses the ten year mark, the Federal Funds rate has been under a magnifying glass. The rate is the Federal Reserve’s, America’s Central Bank, main tool in controlling monetary policy as well as a  tool for the government to control reserve requirements and keep inflation in check. Generally,  if the Federal Reserve sets a higher Federal Funds rate, it causes a reduction in money supply and other short-term rates to increase, thus lowering inflation and controlling price fluctuations. As of this writing, the Federal Reserve is aiming for a 2% inflation rate, which would ensure that the U.S. economy does not “overheat” with excessive inflation.

Prior to the 2008 Financial crisis, the Federal Reserve would set a target rate and adjust this rate depending on how strong or weak the economy was at the time. This fixed rate proved to be detrimental as the rate was not able to make small adjustments to market swings between meetings and inflation skyrocketed. Over the course of 2008, the crisis deepened and the Federal Open Market Committee the Fed funds rate from 3.5% to a floating target between 0 and 0.25% as a tool to bring down other short term rates. The floating target range, though does not determine the actual rate. Rather the overnight supply and demand by banks for loans performs this function.

After the 2008 financial crisis, the Federal Reserve used an expansionary approach where rates were cut in an effort to spur consumer spending. Having a new target approach allowed the Federal Funds rate to move between two set rates and for more adjustments when there were sudden movements in the markets, as opposed to the prior rigid rate. Likewise between 2008 and 2015, the Federal Reserve began to use Open Market Operations to purchase long term securities and treasuries as a tool to stimulate long term growth and raise long term rates. In 2015, the Federal Reserve began to use a contractionary approach, whereby short-term rates were raised in an effort to cool inflation and keep economic expansion on track, as too much inflation can erode the value of a currency. The current target is now between 2.25% and 2.5%, with the current rate moving for the last few months within the said interval from 2.33-2.4%.

The Federal Funds rate has a ripple effect on the so called “yield curve” for U.S. issued Treasury Bills, and consequently longer term bonds and notes, as both are competing short-term investments. The  curve generally follows Treasury Bills in increasing yield, as longer term Treasuries are riskier and require a higher return to entice investors. Experts often talk about this yield curve, which is a snapshot of  treasury rates on a given day. An inverted yield curve (where shorter bills have a higher yield than longer bills) could arguably imply an upcoming recession. The yield curve inverted in 2005, 2006 and 2007 preceding the 2008 crisis. While these events occurred over a year before the 2008 recession, this inverted yield curve shows that investors see more risk in the near future than the far. Many investors look to the ten year Treasury as a way to gauge future outlook because the ten year influences other financial tools like mortgage rates. Since 2018 began, the ten year treasury has been between 2.3% and 3.25%,  showing some, but not complete, correlation with the increases in the Federal Funds rate.

So why do people look at the spread, or difference, between the Federal Funds rate and the ten year treasury? Both of these securities are competing with each other for investor money, so a narrow spread implies a flattening yield curve and more cautious investors.For example,  on February 8 2019 the spread was 0.23 percentage points, while in January of 2018, the spread was 1.17 percentage points, showing how investors  have more trepidation about the future.

Now, should the ten year rate  be higher with the Fed Funds Rate hikes? Well yes and no. In an ideal world, with no other variables, the Ten Year Treasury should increase with hikes in the Federal Funds rate, as this rate sets the yield curve; however, the ten year yield is influenced by other variables like consumer confidence data and domestic and foreign growth, all of which decrease the correlation between Treasuries and the Federal Funds Rate. For example, when retail sales were lower than expected for December 2018, treasury yields decreased from 2.706% to 2.659%, showing how investors entered safer investments.  With the possibility of more rate hikes in the upcoming year, the spread between this rate and the ten years’ yield is going to be an interesting financial tool to watch as a gauge of the health of the US economy.

Works Cited:

Image source: https://www.inkcinct.com.au/web-pages/cartoons/past/2007/2007-531-interest-rate-rise-lever-23Aug.jpg

10 Year Treasury Rate – 54 Year Historical Chart. (n.d.). Retrieved from https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart

Chen, J. (2018, December 30). Federal Funds Rate. Retrieved from https://www.investopedia.com/terms/f/federalfundsrate.asp

Chen, J. (2019, February 05). Inverted Yield Curve. Retrieved from https://www.investopedia.com/terms/i/invertedyieldcurve.asp

Federal Funds Rate – 62 Year Historical Chart. (n.d.). Retrieved from https://www.macrotrends.net/2015/fed-funds-rate-historical-chart

Federal Reserve Bank of St. Louis. (2017, October 06). How Might Increases in the Fed Funds Rate Impact Other Interest Rates? Retrieved from https://www.stlouisfed.org/on-the-economy/2017/october/increases-fed-funds-rate-impact-other-interest-rates

Harper, D. R. (2018, November 21). Understanding Treasury Yield And Interest Rates. Retrieved from https://www.investopedia.com/articles/03/122203.asp

Hazel, R. L. (2017, December 5). The Evolution of U.S. Monetary Policy[PDF]. Richmond, VA: Federal Reserve Bank of Richmond.

Policy Tools. (n.d.). Retrieved from https://www.federalreserve.gov/monetarypolicy/openmarket.htm

U.S. Department of the Treasury. (n.d.). Retrieved from https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield

Using the yield spread to forecast recessions and recoveries. (n.d.). Retrieved from https://journal.firsttuesday.us/using-the-yield-spread-to-forecast-recessions-and-recoveries/2933/

China’s Social Credit System

By: Daksh Sharma

If it is fully realized, the SCS would be one of the most ambitious and consequential government programs in the world

China’s Social Credit System (SCS) is a heavily debated topic. To Westerners, it looks like a dystopia come true. To the Chinese Communist Party and most Chinese citizens, it looks like a step towards a better society. If it is fully realized, the SCS would be one of the most ambitious and consequential government programs in the world. This article will explain how and why the SCS came about, how it impacts both domestic and international life, and the challenges it faces in implementation.

China has seen tremendous growth in the past few decades. But the growth came with a trust problem. As of 2017, 225 million Chinese are unbanked with no financial credit to speak of. Economic reforms in the 90s required banks to lend to individuals and private enterprises in addition to state-owned enterprises. The household and private sectors were finally integrated into the financial sector, but it was a messy marriage. There was lots of excess borrowing and fraud because a borrower’s creditworthiness was either not readily shared or nonexistent altogether. Banks were giving out loans to people who might have had multiple defaults with other banks.

The first attempts at creating credit systems came in 1999. The term “social credit” came about in 2003, but the idea was similar to regular credit systems used in the U.S. and elsewhere. From 2003 to 2007, local pilot programs for financial credit registries were created and eventually combined to form a system called the Credit Reference Center of the People’s Bank of China. Finally, lenders could share and access credit reports to evaluate their borrowers.

However, the trust issue persisted. For example, say a borrower refused to pay back her debt. The lender then would take the borrower to court and win, but the borrower still would not pay back the loan. In fact, if her credit history was practically nonexistent, then she could have gone out and got another loan from someone else! Thus, little enforcement led to too many people getting away with this criminal behavior.

The trust issue was not limited to individuals but extended to enterprises and to problems beyond simple creditworthiness. Companies that were also at fault for tax evasions, factory accidents due to poor management, and food safety issues were able to receive financing. For example, during the 2008 Chinese milk scandal, the Sanlu brand of infant formula was found to have been contaminated with melamine, causing kidney failures among hundreds of babies.

In response to these trust issues, the government came up with the 2014 plan for the SCS. If borrowers did not have a sufficient or documented financial history, they reasoned, the SCS could take note of other types of behavior and extrapolate “trustworthiness” from those actions.  It is touted by the government as a tool to reduce transaction costs, help gain competitive advantages in the market, and increase globalization. It has two main parts. Firstly, it has a large dataset. The plan is to create an “interconnection and interactivity of… credit information systems and… networks that cover all information subjects, all credit information categories, and all regions nationwide.” They will collect data on individuals (including government officials), government departments, NGOs, and private businesses. Secondly, it uses a system of rewards and punishments to shape the behavior of people. The goal is to use this automated system of law enforcement and economic regulation to incentivize citizens to take positive actions.

While the SCS appears similar to other credit systems, it differs drastically in a few ways. First,  SCS is implemented and controlled by the National Development and Reform Commission, a macroeconomic government agency. Its goal, as stated above, is to collect data on the creditworthiness of individuals and businesses in order to build trust and morality in the financial markets and in Chinese society. On the other side, Alibaba uses a program called Sesame Credit, whose goal is to expand consumer credit and create more demand for goods for its partner companies.

Second, corporate credit systems’ analyses, in contrast with SCS’ methods, of the data they collect, aim to relate the consumers to the products. In 2015, the government gave licenses to private enterprises such as Ant Financial, the creator of Sesame Credit, and the Tencent, a conglomerate which specializes in internet service, entertainment AI, and technology, to set up credit evaluation businesses. For instance, consumers who shop at Alibaba can opt-in to have a Sesame Credit score based on their purchasing habits. Having a higher score could mean easier loans from Ant Financial. These scores are very heavily biased, however. If a person buys diapers, their Sesame Credit score goes up because the company sees that as evidence of a responsible person. If they buy video games, however, their score goes down because that is evidence of laziness. It is because of this bias that the government allows the licenses to “expire.” However, it is also  indefinitely allowing and regulating these massive company systems. This is perhaps because one day, they might combine these data sources with the ones in the SCS.

The SCS is not yet implemented nationwide, but there are three dozen pilot programs being testing in various cities. Each of them has a different method. In the city of Rongcheng, for example, citizens start out with 1000 points and a rating from A+++ to D. Getting a traffic ticket deducts 5 points. Helping your family in unusually tough circumstances rewards 30 points. (How could the government possible obtain this sort of information? They employ citizens to be watchdogs in their neighborhoods, effectively snooping and reporting on their community). Drunk driving automatically brings the rating down to a C. Citizens get rewarded for having good scores, from getting free public bike rentals to getting a heating bill subsidy from the government. The rewards and punishments vary from city to city. Some punishments are quite severe. For instance, a low enough score could ban parents’ kids from attending private schools or universities. Employees could also face indirect punishment because they will be prevented from being  promoted at their jobs.

The only punishment that appears nationwide is the dreaded blacklist. If a person has not paid back a loan or accuses the government of corruption, she is banned from purchasing airplane or high-speed train tickets, and she may not take out loans. That person is put on the “Dishonest Persons” or “Untrustworthy Persons” list. If the person calls someone, the recipient will hear a siren along with a message warning the recipient that the caller is untrustworthy. The faces of blacklisted people can even be posted on massive billboards in public! To get off the blacklist, the person must either pay back the loan or appeal to the court and pay a fine.

The SCS has effects that spread beyond China’s borders. For example, in April 2018, the Civil Aviation Administration of China demanded that international airlines show Taiwan as part of China and threatened to take disciplinary actions against the companies who did not comply. They used a pilot credit system to back up their threats. In another example, companies who want to do business in China need a business ID, which is used to score companies. These scores may have a large impact on the company’s presence in China.

The 2014 SCS plan is supposed to be fully implemented by 2020, but that is unlikely to happen. This is because it faces political, societal, and international challenges. Firstly, establishing a shared data repository between government agencies is tough. Data is political capital, and some departments are not willing to provide information that may give up that capital. This is the same situation between the federal government and the local governments. Another issue is privacy. Chinese citizens, although less privacy-minded that the U.S. for example, will oppose data collection without user consent. According to recent studies, citizens do not yet fully grasp the implications of the SCS. A third issue comes from the EU: the General Data Protection Regulation (GDPR). Chinese companies that serve in the European market have to meet this privacy standard to sell to countries in the EU. Companies are worried that the GDPR and the SCS simply cannot coexist, therefore shutting off access to the EU market.

So although the SCS is an impressive creation, it may be some time before China and the rest of the world sees its true potential.

Works Cited:

Image Source:  https://commons.wikimedia.org/wiki/File:Pinball_Dot_Matrix_Display_-_Demolition_Man.JPG

Chorzempa, M., Triolo, P., & Sacks, S. (2018, June). China’s Social Credit System: A Mark of Progress or a Threat to Privacy?[PDF]. Peterson Institute for International Economics.

Kobie, N. (2019, January 24). The complicated truth about China’s social credit system. Retrieved February 8, 2019, from https://www.wired.co.uk/article/china-social-credit-system-explained

Mistreanu, S. (2018, April 03). China is implementing a massive plan to rank its citizens, and many of them want in. Retrieved February 8, 2019, from https://foreignpolicy.com/2018/04/03/life-inside-chinas-social-credit-laboratory/

Mistreanu, S. (2018, April 03). China is implementing a massive plan to rank its citizens, and many of them want in. Retrieved February 8, 2019, from https://foreignpolicy.com/2018/04/03/life-inside-chinas-social-credit-laboratory/

Munro, K. (2018, June 27). China’s social credit system ‘could interfere in other nations’ sovereignty’. Retrieved February 8, 2019, from https://www.theguardian.com/world/2018/jun/28/chinas-social-credit-system-could-interfere-in-other-nations-sovereignty

Smith, S. V., & Garcia, C. (2018, October 09). China’s Social Credit System. Retrieved February 8, 2019, from https://www.npr.org/templates/transcript/transcript.php?storyId=655914994

Udemans, C. (2018, October 23). Blacklists and redlists: How China’s Social Credit System actually works · TechNode. Retrieved February 8, 2019, from https://technode.com/2018/10/23/china-social-credit/