africa and the perversities of international capital flows by howard stein professor, daas...

Africa and the Perversities of International Africa and the Perversities of International Capital Flows Capital Flows

ByHoward Stein

Professor, DAASUniversity of [email protected]

Introduction

• Neoclassicals inside and outside of the IFIs in 80s and 90s pushed for unfettered movement of capital flows –funds would flow from rich countries with low marginal productivity to poor countries with high marginal productivity.

• Promised gains in investment and production-African embraced financial globalization

Introduction

• Removed restrictions on capital accounts

• Open up to FDI

• Privatized state assets including selling banks to foreigners

• Built stock markets

• Accumulated reserves

• Under encouragement, supervision and financial support of IFIs

Introduction

• Promised gains not realized• Opposite occurred-funds flowed from poor African

countries to the rich• Mainstream Economists refer to this as the “Lucas

Paradox” based on his 1990 article which pointed to this phenomenon.

• Lucas and mainstream economists have used variety of explanations to explain away the paradox.

Introduction

• Including differences in labor productivity countering differences in marginal productivity of capital, introducing human capital into total capital measures, differences in sovereign risk, property right issues, etc.

• All have in common one belief-once an impediment or two are addressed then system will behave as neoclassical economics predicts

Introduction

• This paper rejects that premise in favor of one that points to a systemic explanation that focuses on the power asymmetries inherent in the structure of international flows

• We have witnessed a three decade project in creating a system I refer to as the global financialization imperative.

Introduction

• First is the attempt to commodify all products or services that have any use value.

• Second is financialization or the attempt to reduce all value that is exchanged (whether tangible, intangible, future or present promises, etc.) either into a financial instrument or a derivative of a financial instrument.

Introduction

• Third is to allow the unfettered movement of private financial institutions and their products into every corner of the globe by demobilizing the capacity of nation-states to impede or restrict their activities while building institutions that provide a common platform of accessibility.

Introduction

• Domestic financial flows everywhere become part of global flows and are tapped as component parts of the accumulation strategies of large financial corporate organizations and their wealthy clients. Increasingly official and private flows are blurred and closely interconnected.

Introduction

• Financial liberalization and its associated legitimizing theories have been embedded into the dictums and practices of the international aid community for decades.

• They have used their power and resources to alter the terrain for global capital with perverse consequences.

Introduction

• The idea of perversion is very different than a paradox which assumes that flows are contradictory to what we would expect.

• In fact, the result is not surprising given the underlying structure of power.

Introduction

• The idea of perversion here is ethical-where the poorest in the world are financially supporting the wealthiest

• where capital flows have pushed African economies into perverse economic structures

• where human needs become subservient to the whim of the accumulation strategies of hedge funds

• where debt generation has fueled massive capital flight

Part I

Financialization of Commodities

UNCTAD Study-2011

• “The mid-2000s marked the start of a trend of steeply rising commodity prices, accompanied by increasing volatility. The prices of a wide range of commodities reached historic highs in nominal terms in 2008 before falling sharply in the wake of the financial and economic crisis. Since mid-2009, and especially since the summer of 2010, global commodity prices have been rising again.”

• http://www.unctad.org/en/docs/gds20111_en.pdf

http://www.unctad.org/en/docs/gds20111_en.pdf

Commodity Price Movements (IMF, 2011)

Commodity Price Volatility (IMF, 2011)

Possible Causes of Volatility

• rapidly growing emerging economies

• growing urbanization

• growing middle class with changing dietary habits, including an increasing appetite for meat and dairy products

• expansion of biofuels

• conversion of land use from crops

• impact of climate changeood to crops for biofuel production has also affected the


• “However, these factors alone are not sufficient to explain recent commodity price developments; another major factor is the financialization of commodity markets. Its importance has increased significantly since about 2004, as reflected in rising volumes of financial investments in commodity derivatives markets – both at exchanges and over the counter (OTC). This phenomenon is a serious concern, because the activities of financial participants tend to drive commodity prices away from levels justified by market fundamentals, with negative effects both on producers and consumers.”-UNCTAD, 2011


• The term “financialization of commodity trading” indicates the increasing role of financial motives, financial markets and financial actors in the operation of commodity markets.

• Heart of global finance-managing of vast amounts of wealth from rich people in hedge funds run by large global financial conglomerates

Implications

• Commodity markets are being driven not by fundamentals of producers and end users but by other factors--view that commodities are a good hedge when the value of the dollar falls which lowers the value of global commodities in non-dollar terms.

Implications

• Also issue of herdism-the tendency of individuals to mimic the actions of a larger group, rather than acting independently and on the basis of their own information.

• Rapid movements in and out of markets with terrible consequences to people

Not just oil!Food Prices 2011-2011

Index Mundi, 2011

The Ethics of Financialization

• For Alan Knuckman, there is hardly a nicer place than the CBOT trading floor. "This is capitalism in its purest form," the commodities expert raves. "This is where millionaires are made.“

• How he makes money doesn't make any difference to Knuckman. He draws no distinctions among commodities like petroleum, silver or food products. "I don't believe in politics," he says. "I believe in the market, and the market is always right."

The Ethics of Financialization

• How does he feel about exploding food prices?

• The age of cheap food is over," predicts Knuckman, noting that this can't be such a bad thing for US citizens. "Most Americans eat too much, anyway."

• http://www.spiegel.de/international/world/0,1518,783654,00.html-”How Global Investors Make Money Out of Hunger”

http://www.spiegel.de/international/world/0,1518,783654,00.html

http://www.spiegel.de/international/world/0,1518,783654,00.html

Part II

Orthodoxy and African Liberalization

Mainstream Arguments

• The key function of financial systems in the saving-investment-growth relationships is to act as an effective conduit for the mobilization and allocation of loanable funds; and the transformation and distribution of risks and maturities.


• In the mainstream literature, the role of capital markets in providing efficient and transparent price signals and liquidity in the secondary market for equities and bonds is emphasized as mechanisms for vigorous portfolio arbitrage of bond- and shareholders


• Extending these lines of arguments spatially to cross-border financial transactions and intermediation, effects of financial globalization on economic development and world `welfare’ are tacitly assumed to be positive through the same saving-investment-growth nexus.

Mainstream Arguments• Thus, financial globalization is seen to ensure an

efficient intermediation between saving and investment on a global scale (Rousseau and Sylla 2001).

• An intertemporal borrowing/lending model as applied to cross-border trade in capital is popularly used as a theoretical model for showing welfare gains from net resource transfer arising from increased financial openness and free capital mobility.


• With opening up to international borrowing, a capital-poor developing country is able to

• a) divert resources to more future production by undertaking extra investment at a lower world interest rate; and

• b) enjoy higher current consumption, as its saving-investment resource gap (and hence, the emerging current account deficit) is being filled by foreign saving (Obstfeld and Rogoff 1996).


• In short, the intertemporal model of capital trade is used to show benefits from financial globalization in allowing capital to seek out its highest rewards while providing means for consumption smoothing and insurance against shocks.


• In the extreme version of the neo-classical world with perfect information and no transaction cosst, once impediments to free capital mobility are removed, funds are seen to flow from low marginal product of capital-rich countries to high marginal product of capital-poor countries as the capital market works to equalize risk-adjusted marginal products of capital across borders.


• In particular, as the interest rate parity condition dictates, financial globalisation ensures asset markets to gravitate towards an equilibrium in response to risk-adjusted relative returns, even if instantaneous price adjustments are often prevented because international traded assets are imperfect substitutes in their risk characteristics under real world conditions.


• Consequently, it is claimed that as financial globalization proceeds, an efficiency in global resource allocation increases, while developing countries emerge as a winner, benefiting from higher investment and consumption with lower interest rates as well as from an opportunity of global risk sharing.


• This is precisely the perspective embedded in arguments by Stanley Fischer and other senior IMF officials as they pushed for an amendment to the Articles of Agreement which would make capital account liberalization a prerequisite for IMF membership


• …free capital movements facilitate a more efficient global allocation of savings, and help channel resources into their most productive uses, thus increasing economic growth and welfare. From the individual country’s perspective, the benefits take the form of increases in both the potential pool of investable funds, and the access of domestic residents to foreign capital markets…


• ”And just as current account liberalization promotes growth by increasing access to sophisticated technology, and export competition has improved domestic technology, so capital account liberalization can increase the efficiency of the domestic financial system.(Fischer, 1997).

Integrating Africa into Global Flows-Stock Markets

• With these neoclassical formulations in mind, the IMF and other donors pursued an active agenda to build stock markets while removing capital account restrictions.

• In 1980, prior to the start of era of structural adjustment, there were only three stock exchanges in sub-Saharan Africa (Kenya, Nigeria and South Africa).

• In 2011 there were 22 exchanges covering 31 countries in SSA.


• Most have been organized after the beginning of the Asian Crisis when the logic of capital account liberalization came into question even within the IMF.

• In all exchanges covering 21 countries in Africa were established in 1997 and after many with the support of foreign assistance


• Few have any restrictions on the foreign purchase and sale of stocks.

• For example T.Rowe Price’s Africa and Middle East Fund lists investments in stocks in a dozen SSA countries

Integrating Africa into Global Flows-FDI

• The World Bank’s FDI project in Africa has deliberately pushed countries into privatization and a minimalist and uniform regulatory and legal framework aimed at encouraging countries to follow their comparative advantage in resource extraction.

• A particular emphasis in the effort over the past two decades or more was on reforms aimed at attracting FDI to the mining sector in Africa


• Chilean Standard in World Bank influential 1992 mining document: “Chile has been the most successful of the countries surveyed. The economy is completely free and there are virtually no restrictions on foreign exchange. Foreign investment is permitted under general legislation and there is no discrimination between local and foreign ownership.


• “ Neither is there a specific law governing investment in mining…mining rights have all the attributes of property rights being freely mortgageable transferable, and protected by the constitution against confiscation…Effective Taxation Rates are the lowest of all countries studied


• Closest to this was 1986 and 2006 mining acts of Ghana designed with assistance of the World Bank which becomes the standard pushed by the Bank in other African countries (Campbell, 2008)

Integrating Africa into Global Flows-FDI and Stock Exchanges

• In African countries resource industries have a heavy representation on local stock exchanges which both opens up the resources to further financialization while also providing a mechanism for FDI to liquidate their assets.

Integrating Africa into Global Flows-FDI and Stock Exchanges

• Ghana 37 stocks listed on the exchange--Two completely dominate the exchange AngloGold Ashanti Limited and Tullow Oil PLC-all other stock only 15% of the total of the two. AngloGold Ashanti is the largest holding in T.Row Price’s Africa and Middle East Fund and accounts for 4.3% of their total portfolio ..

•

Source: Murinde, 2009

Murinde, 2009

Part III

Flows and Their Perversities

FDI Flows• Marginalization then a resurgence almost all due to oil –

but always oil and other resource focused FDI dominates• During the 1980-85 period 52% of the total excluding

South Africa went to the four oil exporting countries Angola, Nigeria, Cameroon and Congo.

• By 1985 to 1990, two oil producers Angola and Nigeria, alone were attracting more than 50% of the FDI to SSA excluding South Africa rising in 92 to 97 to 57%.

FDI Flows• By 2005 there was a significant recovery of

Africa’s share of DC FDI flows to around 8.5 % of total-quadrupling.

• The vast majority of the increase in inflows went to the traditional oil exporters Nigeria and Angola along with new oil producers like Sudan and Equitorial Guinea.

•

FDI Flows• In all roughly 78% of the 16.1 billion increase in

inflows to non S. African SSA from 2000 to 2005 went to these four countries-same 2005-08.

• The focus of the FDI flows was having a profound impact on the structure of exports perversely returning SSA to a colonial structure of pure extraction.

FDI Flows• Such FDI--limited economic and developmental

benefits because they usually do not

• stimulate general, broad-based development;

• significantly expand employment opportunities

• diversify exports;

FDI Flows• facilitate meaningful transfer of technology to

recipient countries except for the limited purpose of more profitable resource extraction.

• And due to the structure of taxation encouraged by the World Bank, the revenue generated tends to be rather limited.

Foreign Bank Ownership

• The relaxation of foreign ownership regulations has also had a large impact in the composition of banking in Africa.

• The rapid foreign takeover of banking assets where the Bank and Fund dominated policy formation is no coincidence. In many countries Bank and Fund sponsored financial liberalization which had emphasized privatization to domestic banks led to financial crises.


• Following these crises banks were either sold off to foreign owners or new licenses were issued to foreign banks. Increasingly the Bank and Fund began to see foreign ownership as the best route to prevent or even cure a financial crisis (Stein, 2010)

Foreign Bank Ownership-Consequences

Reserves

• In additional dimension of the perverse nature of global finance can be found in the statistics on reserves.

• The increasing and high level of global financial instability associated with globalization has driven countries toward a form of self-insurance by dramatically increasing reserves.

• African countries are no exception.

Reserves-More Perversion…

• The vast majority of these funds are kept in financial assets in developed countries thus perversely financing the standard of living of rich countries.

• Based on the rule of thumb of reserves of 3 months of imports, one can calculate a rough measure of excess reserves which went from $10.9 billion in 2000 to $75.3 billion 2009 or a more than seven fold increase.

Reserves-More Perversion…

• This is not insignificant.

• 2009 -- 40% of gross capital formation in SSA or roughly $90 for every man, women and child in SSA.

• In Nigeria, in 2008 the excess reserves were 270 per cent of gross capital formation or roughly $315 for every person in Nigeria in a country where 67% of the population live on less than a $1.25 per day

Non-FDI Flows to SSA-overall

• Overall the figures for non-equity non-FDI private flows to SSA as whole were dismal between 1996 and 2001 and amounted to an outflow of 4.9 billions dollars as private banks stopped lending to SSA instead pulling money out of the continent.

• Rise in 2007-large bond issue to Gabon and Ghana but at very high interest rates-large outflow again in 2009

Non-FDI Flows to SSA-Equity

• In 2006 non S.African SSA equity flows began to rise and peaked at nearly 2 billion dollars.

• However, we can see from the figures from 2006 to 2009 there was actually a net outflow of equity capital of more than 700 million dollars.

• In other words the stock market was used as a vehicle for capital export.

Odious Debt and Capital Flight

• Rapid Proliferation of Debt as seen in Table Eleven associated with failed neoliberal lending in 80s and 90s

• Some debt relief through HIPC and MDRI, but problem is much of it is odious debt which has helped fuel capital flight


• Odious debt-incurred by regimes and military dictators often for their personal enrichment rather for the interests of the nation

• In the perverse world of international finance, nations are held responsible for debt that did not benefit them.


• Moreover, the problem is systemic. The process that generates debt also fuels capital flight.

• There are willing participants both within African countries and in the private banks in the developed world who generate large fees and interest returns on the loans and deposits.

Odious Debt and Capital Flight• International financial institutions are also driven by

success criteria measured by the quantity of loans and were driven by the political priorities of the US to lend to corrupt military governments with ties to the West-famous case of IMF and World Bank loans to Mbutu of Zaire

• Ndikumana and Boyce (2003) examine data from 28 African countries covering the period 1970 to 1996 and estimate that every dollar of additional debt generated 80 cents of additional capital flight.


• Four different linkages between loans and capital flight debt-fueled capital flight; flight-fueled foreign lending; debt-motivated capital flight and flight-driven foreign lending.

Odious Debt and Capital Flight• So how much capital flight has occurred and how does it

compare to debt levels?

• Ndikuma and Boyce (2011) use a methodology to measure the degree of unrecorded capital flight from Africa.

• Their starting point arises from the observation of the huge divergence between the balance of payments data of African countries and the World Bank’s Global Development Finance Data on changes in the stock of debt.

Odious Debt and Capital Flight• Overall they start with changes in external debt in debt

tables add net foreign direct investment subtract the current account deficit (surplus is negative) subtract change in reserves add adjustment for export misinvoicing (positive sign indicates underinvoicing) add adjustment for import mininvoicing (positive sign indicates net overinvoicing negative net underinvoicing-eg. Smuggling) and adjustment for unrecorded transfers. remittances.

Conclusions-Beyond Orthodoxy

• From an institutional perspective, the challenge of finance in the poorly formed markets of developing countries and in a world of rapid global flows is much more profound than simply the issue of bonds vs. stocks vs. bank lending as a financial source for productive investment.

Conclusions-Way Forward

• Financial flows can be seen as a series of domestic and international circuits that intersect among themselves and with the real flows of commodity and productive resources. Institutionally, each flow has a set of internally concatenating capacities, incentives, norms, regulations and organizations.


• Each flow can also be defined relative to other flows which helps to give them scope, content and meaning.

• A shift in the institutional dimensions of any one flow such as the regulations or capital account liberalization has direct implications to the nature of the interaction with other flows and can create the perverse results discussed above.


• New Institutions must be put in place to connect the financial and real flows in the economy

• This is not possible where internal financial flows are being dictated by the vagaries and priorities of external flows.


• Controls must be firmly in place and can take many forms and will depend on country specific conditions and capacities (trip wires and speed bumps, Tobin type taxes on financial transactions, taxing, limiting or setting reserve requirements on some transactions, restrictions on currency convertibility, etc.)


• Industrialization and agriculture have suffered badly in this system, yet they are essential to the development process in Africa

• Africa needs new industrial and agricultural policies with new financial institutions to support them -take the example of industrial policy

Industrial Policy and Finance

• State financial organizations are essential. • At the heart of many of the industrial policy instruments

are state capacities to direct financial flows toward productive private sector enterprises. .

• Simply as Stigliz (1989, 1994) has pointed out in the poorly developed financial markets in developing countries there will be a profound difference between the social value of lending and the private benefits.


• Banks, if left to their own devices will gravitate to finance projects with short turnover, lower working capital, and lower risk (such as financing imports or government paper) avoiding more developmentally enhancing projects such as manufacturing which has a higher working capital, and much greater risk.

• States must create incentives to encourage private bankers to support loans which have greater social and economic benefit. In the early stages, before bankers see that loans can be both socially beneficial and profitable, states will need to be involved with risk sharing.


• In the absence of the socialization of private risk, it is difficult to see how private investment and accumulation can occur to spur African industry.

• There are many options for ensuring that the criteria for subsidization or access to funds are being realized and are consonant with industrial policy objectives (Korean-style policy loans, Japanese main bank system, business-government councils, planning agencies, partial state ownership of banks, developmental banks, etc.).

• Each of these implies the creation of particular types of state capacities.

New Economic Thinking

• While some types of perversions occur quietly behind bedroom doors with both parties enjoying the results, this type of perversion has millions of victims.

• The moment is ripe for new thinking in economics so we can begin to understand and reverse the crimes and perversions of the global economy.

New Economic Thinking

• Thanks to the Cambridge Trust for New Thinking in Economics for organizing and sponsoring this conference.

africa and the perversities of international capital flows by howard stein professor, daas...

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