Thursday, 30 August 2018

Erdogan's macro populism is far from over


China, Ruanda or Singapore show that autocratic regimes can stay in power for a long time - provided that they can be effectively controlled and removed by a "selectorate"[1]. Recep Tayyip Erdogan's "career", however, has more of a role model in the emerging countries of Latin America. Rudi Dornbusch and Sebastian Edwards created the typical phantom image of the macropopulist in 1991, with the four phases he usually goes through[2]:

·         As a rule, populists exploit widespread unease among the population about inadequate economic performance, often as a result of an austerity policy demanded by the IMF. A blatant unequal distribution promotes dissatisfaction, because the poor and middle class usually pay the bill for the fund's stabilisation programmes. At the same time, a successful IMF programme will lead to higher foreign exchange reserves and lower budget deficits. Cash is seductive - the call for expansion is getting louder. The situation described by Dornbusch and Edwards was exactly right when Erdogan first took office in 2003.
·         Growth by stimulating demand (to increase popularity) and redistribution (to ensure proximity to the people) have top priority in the second phase. Erdogan, the underdog from Istanbul's rough neighborhood Kasımpaşa, finds his support especially among the "Dark Turks" - the poor and orthodox Anatolian masses[3].
·         Parallel to the postulate of growth and distribution, the macro populist typically (under)assesses the macroeconomic risks of price inflation, consumptive deficit financing and external imbalances as secondary. If necessary, from the populists' point of view, dampening inflation calls for suppression of corporate profit margins as well as price and rent controls - that is phase three. Macropopulist governments generally avoid massive wage increases being offset by currency devaluation. The artificial undervaluation of imports (and implicitly of tradable agricultural products) puts the unruly urban population at rest, as this increases the purchasing power of their wages.

Beside the last point, the sketch of Dornbusch/Edwards applies to Turkey. So far, the country has been characterised by an open capital account and flexible exchange rates. This can probably be explained by the fact that Erdogan is more committed to rural Anatolia than to the urban area of Istanbul. In contrast to the dictum of Friedrich August von Hayek that capital controls mean the "Road to Serfdom", Turkey went this direction under Erdogan with free movement of capital.

But what about phase four of the phantom image - namely the end of the macro populist regime?


Erdogan´s Achievements

When Erdogan took office in 2003, Turkey was undergoing a reform process led by IMF and Economics Minister Kemal Dervis to overcome the severe financial crisis of 2001. The fruits, for example in the form of a steep rise in per capita income, were harvested primarily by the ruling party AKP led by Erdogan. Outside agriculture in particular, the AKP generated strong employment growth in poor Anatolia. The absolute poverty rate (below $4.30 per capita income) declined steadily. Erdogan's economic achievements were considered a blueprint, especially in the Arab region. Measured in terms of the top half of OECD member countries, Turkey was able to catch up economically. This convergence process slowed just before the failed military coup in 2016, though (Fig. 1).


Figure 1: Turkey´s Convergence, GDP/cap
- in % of the mean upper half OECD by GDP/cap –



Erdogan´s Failures

China has shown that autocrats need high economic growth for legitimation. In order to maintain his rule and a strong economy, Erdogan used pro-cyclical monetary and fiscal policies to fuel overall economic demand, after the global financial crisis in 2009 and then again after the military coup in mid-2016. In addition to generous money supply and high deficits in the state budget, public loan guarantees for private companies fueled output. Infrastructure investment was booming but increasingly debt-financed (Fig.2). Although private banks and companies in particular have incurred increasing foreign currency debt, they often represent state contingent liabilities.


Figure 2: Investment and Debt, Turkey (% of GDP)



As a result of the increasing legal arbitrariness under Erdogan, the high current account deficit was less and less underpinned by direct investment. The demand stimulated by Erdogan met supply-side capacity bottlenecks, resulting in rising inflation that could not be effectively combated by the government controlled central bank. The erosion of investor confidence increasingly weakened the Turkish lira, which further fueled inflation.

The rising demand for gold from the Turks, who increasingly distrusted the arbitrariness of Erdogan's rule, had the same effect. Since 2017, annual inflation has been in double figures. So it was only a matter of time before Turkey became the victim of a currency crisis, especially since the strong US dollar put a global burden on emerging markets. Emerging economies can be defined not only by their poverty or economic growth - but also by their dependence on the dollar exchange rate through balance-sheet asymmetries and commodity markets.

In the hot summer of 2018 nothing could stop the Turkish lira´s crash (Fig. 3). After his re-election in June, Erdogan had announced that he would have a stronger influence on economic policy in the future; in July he appointed his son-in-law as Minister of Finance. At the same time, the USA and Turkey overdid themselves with punitive tariffs, which further weakened the lira. Finally, the three major rating agencies put Turkey's creditworthiness even deeper into the junk status. When the lira crashed on 13 August, the Turkish currency, although already severely undervalued, was now worth just under 50% less than in June. Erdogan's macro populism had failed.


Figure 3. Turkish Lira/Euro, Summer 2018




Is Erdogan at the End as Many Hope?

For the time being, he does not want to resort to classical austerity measures. Restrictive monetary policy, especially higher interest rates to support the currency and fight inflation, is an abomination for Erdogan. The central bank is on a short leash, and interest rates are "mother and father of all evils" for Erdogan.

Indeed, higher interest rates would at best support the Turkish lira in the short term - in the medium term the largely credit-financed economy and the banks would collapse, which in turn would probably weaken the currency. The IMF could support the Turkish central bank by adding to its rather meagre foreign exchange reserves, in order to secure the refinancing of the Turkish economy's foreign exchange debts. Erdogan doesn't want to hear about that either: "We know very well that those who propose a deal with the IMF are actually proposing to give up our country's political independence," he said. Erdogan does not want to be domesticated from outside.

Erdogan not only has orthodox instruments at his disposal to keep himself at the top until his desired departure in 2025, especially since Turkey has become member of the BRICS Plus grouping since the BRICS summit 2017 in Xiamei..

The Russian Foreign Minister recently visited, and the Qatari ruling family has already promised USD 15 billion. That is only about 10% of the liabilities due next year. But in the area of global development banks (AIIB, NDB) and with China's new Silk Road, powerful resources have opened up outside the multilateral financial system dominated by the West. The "charm" of these new donors to autocrats like Erdogan is that the governance rhetoric about democracy, human rights and the rule of law plays little role. Even Germany, in the hands of Erdogan as a result of Merkel´s  migration deal, wants to help out.

Erdogan could also have recourse to capital controls. Prime Minister Mahathir responded to the speculative attacks of George Soros' Quantum Fund in 1997 with strict capital controls during the so-called Asian crisis, thus saving Malaysia from ruin. However, capital export controls only make sense for Erdogan if Turkey's external deficit is reduced to a level that can be financed by the new donors. However, this should be achieved with a degree of austerity that does not upset Erdogan's position of power.

Alas, Erdogan is far from over.


[1] Helmut Reisen (2018), „Paradigm Lost“, OECD Development Matters, 10. April.
[2] Rudi Dornbusch & Sebastian Edwards (1991), „The Macroeconomics of Populism in Latin America”, NBER, January.
[3] Jan-Werner Müller (2017), What is Populism?, Penguin Books.

Monday, 30 July 2018

Europe´s migration trilemma*



According to the latest data from the United Nations High Commissioner for Refugees (UNHCR), 68.5 million people were on the run at the end of 2017 - around three million more than in the previous year and more than at any time since the end of the Second World War. Overall, the countries in the global South bear the main burden of receiving refugees: 85 percent of all refugees registered by UNHCR worldwide have found refuge in developing regions. 
Africa's future migration potential is of particular concern to politicians. The first worry is of demographic nature as the decline in birth rates is painfully slow south of the Sahara. According to UN projections, Africa's population will double to 2.5 billion by 2050. Although medical progress and the expansion of health systems are increasing life expectancy, the standard of living has remained low, not least because of high birth rates.
The second worry are, despite improvements, much of Africa´s economic perspectives: Low training and labour market opportunities for a young growing population feed migration. According to the IMF, 85 percent of African migrants are economically motivated.
The proportion of African migrants who actually leave their continent has increased from a quarter to a third in the last quarter of a century, to six million today. Population growth and the increasing proportion of intra-African migrants suggest that their number will rise to 20 million in the coming decades. Most of these Africans nowadays want to migrate to Western Europe. Sure, actual migration to Europe has declined since the peak in 2015/16. This is due to Frontex, border closures, drowning and enslavement of migrants - but it says little about Africa´s future migration potential.
According to Dani Rodrik's globalization trilemma, democracy, national sovereignty and global economic integration are mutually incompatible: combine any two of the three, but never have all three simultaneously and in full. Politics can only choose two of three options: full global market liberalization (hyper globalization), national sovereignty or democracy. If it accepts unrestricted globalisation, politics must abandon its own course. A good example is the gold standard prevailing until the beginning of the 20th century, to which an independent monetary policy had to be sacrificed. Alternatively, autocratic or technocratic governments could decree that full market liberalization or the globally harmonized rules negotiated by the government must be accepted by all. Finally, a fairly unrealistic alternative would be a world government: democracy and the global market would be maintained, national sovereignty renounced. An international government and a global parliament would correct the mistakes of globalisation.


Analogous to Rodrik's Trilemma, Europe looks increasingly confronted with a migration trilemma. Only two out of three options can be achieved at the same time: mass immigration, a self-determined social contract or democracy with respect for human rights. In his much maligned book Exodus: How Migration is Changing Our World, Paul Collier discusses a limit beyond which immigration could be harmful to a society's complex social model due to alienation and erosion of public trust. In his long essay After Europe, Ivan Krastev argues how massive immigration promotes populist parties and threatens the future of the entire European project. In her 1943 essay We Refugees, Hannah Arendt had already pointed to the dilemma between mass refuge and respect for human rights. Allowing massive refuge means respecting human rights but, according to Arendt, losing national sovereignty, i.e. self-determination.
These trade-offs of the migration trilemma certainly lack rigour. But they cannot be denied. It is possible to promote immigration and become a melting pot, just as in the past in Argentina, Australia, Brazil and North America, all sparsely populated areas before settlement. The multicultural melting-pot perspective is quite tempting and shows its appeal not only in France's soccer team. The settlement strategy requires immigrants to identify with the host country and to feel that they belong to their new country. Historically, inclusion of immigrants has worked best with the help of compulsory military service, the right to vote and, above all, patriotic education and training. However, the urban ghettos of, say, Brazil, France or the United States also testify to blatant integration deficits that are intolerable for socially homogeneous societies.
From an ethical point of view, the global governance of migration would be a possible way out of the migration trilemma. This route remains unrealistic as national jurisdiction on migration would have to be subjugated in a legally binding manner. The recently adopted draft 2018 global migration compact - signed by all UN member states except the USA – has so far not passed that legal threshold and remains a legally non-binding document laying down principles for dealing with migrants and refugees.
Thus, akin to national capital controls under the Bretton Woods compromise in Rodrik's globalization trilemma, a realistic option remains the control of migration flows through national immigration laws that legalize a selection of admitted immigrants. As suggested by former Mexico-US border evidence, regular migration (if paired with ´robust enforcement´) can reduce the inflow of clandestine migrants. To be sure, the offset between legal and illegal immigrants is one only if all migration is regularized. Migration laws can attenuate the trilemma presented here; they cannot solve it.


*Originally published in German: https://makronom.de/europa-im-migrationstrilemma-27303

Saturday, 30 June 2018

A New Geography of Development Finance




Especially since the early 2000s, large emerging countries have become important providers of development funds. Shifting Wealth has allowed governments to tap a bigger pool of ´transformative infrastructure finance´ (Xu and Carey, 2017) and to choose from more financing options. From a long-term development perspective, infrastructure finance is arguably the most important prerequisite to close the infrastructure gap that has been identified as the major bottleneck for delivering on growth and on the SDGs, notably in Africa. Much of the new funding supply is through official bank credit outside the Paris Club framework, however.  So concerns that a new debt overhang might be building in the absence of a concerted mechanism for debt prevention and resolution have become louder recently.

The rise in South-South finance is being channelled through three major vehicles: i) a rise in remittances within the non-OECD area, often resulting from oil riches; ii) growing corporate equity participation via mergers and acquisitions as well as greenfield FDI by emerging multilateral companies; and iii) an extension of bilateral and multilateral bank credit supply, notably by China. The overall rise of development funds occurred despite a downward trend of official development assistance (ODA) as a fraction of recipient countries rising GDP. Western donors, including private, had reduced in the past decades investment in infrastructure, instead devoting more attention to poverty reduction, health, good governance, and climate change mitigation.

Research at ODI (Prizzon, Greenhill and Mustapha, 2016) found total external development finance to all developing countries to have more than doubled between 2003 and 2012 to $269 billion. In 2012, development finance flows beyond ODA by DAC donors – excluding FDI and portfolio equity and remittances - accounted for $120 billion, or around 45%. 13%  of this $120 billion by so-called emerging donors (13%), such as Brazil, China, the Gulf States, India, Malaysia, the Russian Federation and Thailand. 

Over recent years, remittance flows - funds sent by migrants living and working abroad to their home countries - have been increasing rapidly. Booming oil prices translated in higher demand for immigrants in the construction and other service sectors of the Gulf States and Russia.  While private capital mainly flows to emerging countries, remittances are particularly important in poorer countries where they can represent up to a third of GDP. India, China the Philippines and Mexico are the largest remittances receiving countries in the world. As a share of GDP, however, smaller countries such as Tajikistan (42 percent), the Kyrgyz Republic (30 percent) and Nepal (29 percent) were the largest recipients.

The top six immigration countries, relative to population, are outside the high-income OECD countries (World Bank, 2016b): Qatar (91 percent), United Arab Emirates (88 percent), Kuwait (72 percent), Jordan (56 percent), and Bahrain (54 percent). As a consequence of an upsurge in migration, remittance flows into developing countries sprung up in the 1990s, becoming another important financial resource for developing countries. During the period 1970-2000, workers´ remittances to Sub-Sahara Africa had only reached 2.6% of GDP, an inflow clearly lower than its official inflows that added up to 11.5% of Sub-Saharan Africa´s GDP (Buch and Kuckulenz, 2010). This was in contrast to North Africa and the Middle East that received almost 9% of GDP through remittances over the timespan.  By 2015, remittances represented the largest source of external finance for many developing countries, ahead of ODA and FDI. Then, worldwide remittance flows were estimated to have exceeded $601 billion. Of that amount, developing countries are estimated to receive about $441 billion, nearly three times the amount of official development assistance.

Table 1: Developing-Country FDI Outflows and Inflows, bn $
FDI Outflows
1990
2000
2008
2016
LDCs
0.0
2.1
18.4
11.9
China
0.8
0.9
55.9
183.1
Total Dev
13.1
90.0
288.6
383.4
FDI Inflows




LDCs
0.6
5.3
32.3
37.9
China
3.5
40.7
108.3
133.7
Total Dev
n.a.
233.8
592.7
646.0
Source: UNCTAD, World Investment Report 2017,  http://unctadstat.unctad.org/wds/ReportFolders/reportFolders.aspx


Traditionally, and until the late 1990s, developing countries have rather hosted than homed FDI flows. While inward FDI have plateaued for many of the emerging economies in the 2010s, much of the dynamism is now taking place in outward FDI.  Table 1 provides evidence on FDI outflows and inflows for the years 1990, 2000, 2008 and 2016. It shows that FDI flows have increasingly turned into a two-way street since the GFC. Up to the GFC, Latin American companies used to spearhead outward investment from emerging economies. Since then, China raised its percentage share in developing-country FDI outflows from 1% in 2000 to almost half by 2016. Chinese multinationals have increasingly taken the mergers and acquisitions (M&A) route for their overseas expansion, particularly after the global financial crisis of 2008-09.

Greenfield investment is an important mode of entry for Indian and Malaysian multinationals compared to mergers and acquisitions, behind China the only two other emerging countries listed among the top 15 countries for greenfield FDI in 2016. Emerging countries continue to primarily invest South-South in other emerging and developing economies, as most emerging economies’ regional markets serve as the primary destination for their outward greenfield FDI flows. However, the share of the E20 group OFDI projects (in value) directed to the Asian-Pacific region has declined while the shares of Africa, Latin America and especially North America increased (Casanova and Miroux, 2017).

It is noteworthy that the poorest countries classified by UNCTAD as LDC group has started to participate at last in hosting considerable FDI inflows, as a proportion of their GDP. South-South FDI contributed to that new trend, with growing activity from many firms in China, Brazil, India and South Africa. Keep in mind that net FDI flows do not constitute net capital flows as they are often financed in the host country´s domestic financial markets, as multinational companies try to keep currency and expropriation risk down.

In the 2000s, China became a global leader in official bank credit for infrastructure funding, benefitting Africa above all, by building roads, dams, bridges, railways, airports, seaports, and electricity grids. Meanwhile, China has established a number of bilateral and multilateral funds across the world, in addition to two policy banks, the China Development Bank (CDB) and the Export Import Bank of China (C-EXIM). Figure 22 suggests (for Africa) that in recent years bilateral official lending flows have been substituted for multilateral flows. Despite steady growth in private sector funding in the past decade, official development finance backs 80% of Africa´s infrastructure funding, for example (ECN, 2015).  ). China has also pioneered a host of bilateral and regional development funds in the wake of founding the Belt and Road Initiative (BRI) in 2013 (see next section). These funds add upwards of $100 billion in development finance; a major portion of these Chinese investments is in Asia, with the largest being the $40 billion Silk Road Fund established in 2014 (Kamal and Gallagher, 2016).

 In 2015, two new multilateral financial institutions of consequential size and scope came into existence as legal entities: The Asian Infrastructure Investment Bank (AIIB), a Chinese led initiative, and the New Development Bank (NDB), an effort championed and owned by the BRICS nations (Brazil, Russia, India, China and South Africa) to strengthen cooperation among themselves and beyond. The advent of these new multilateral development banks is emblematic of a decentralization of power from the Bretton Woods system. It reflects a shift in terms of soft power distribution beyond the G-7. Their potential role and influence stems from: 1) the size of their lending activity, even relative to long-established institutions such as the World Bank and the Asian Development Bank (ADB); 2) their relatively high capitalization; and 3) their focus on infrastructure—a sector that is vital for growth and development. AIIB and NDB are expected to add significant financing capabilities with combined loan portfolios estimated at $230 billion (Reisen, 2015).

Staying outside the relatively transparent DAC framework, China does not disclose comprehensive or detailed information about its international development finance activities. Aid Data (Dreher et al., 2017) constructed a dataset with a new methodology for tracking underreported financial flows. According to these new data, the scale and scope of China´s overseas infrastructure activities now rival or exceed that of other major donors and lenders. Between 2000 and 2014, the Chinese government committed more than $350 billion in official finance to 140 countries and territories in Africa, Asia and the Pacific, Latin America and the Caribbean, the Middle East, and Central and Eastern Europe. Transport and power generation are the two main sectors financed. Chinese cooperation also invests significantly in health, education, water and sanitation, agriculture, and other social and productive sectors.

Chinese official finance consists of Official Development Assistance (ODA), which is the strictest definition of aid used by OECD-DAC members, and Other Official Flows (OOF). China provides relatively little aid in the strictest sense of the term (development projects with a grant element of 25 percent or higher). A large proportion of the financial support that China provides to other countries comes in the form of export credits and market or close-to-market rate loans. Table 2 provides a calculation of the weighted average of China´s development finance that was extended at concessional ODA terms: 24.5 percent for the period 2000 – 2014.



Table 2. Recipients of Chinese Official Finance, 2000 - 2014
World Region
Total, $bn
ODA Terms, %

No. of Projects

Africa
118.1
58

2345

Eastern Europe
56.7
3

171

Latin America
53.4
12

317

South Asia
48.8
10

423

Southeast Asia
39.2
7

507

Other Asia
28.5
6

183

Middle East
3.1
1

93

Pacific
2.8
3

265

Total/Average
350.6
24.5

4304

Source: Aid Data (2017); authors´ calculation


Table 2 shows that Africa benefitted most from Chinese development finance during the period 2000-14 – in terms of amounts, degree of concessionality (percentage share at ODA terms) and number of projects. Zimbabwe, Angola, Sudan, Tanzania, Ghana, Kenya and Ethiopia headed the ranking of Africa´s recipients in number of projects. Africa has received more Chinese ODA-like finance than all other developing regions in the world combined.

Infrastructure funding has risks for low-income countries with low debt tolerance, however, despite its transformative nature. Much of China´s and other emerging creditors´ new funding supply is through official bank credit outside the Paris Club framework.  Concerns have become louder recently (notably in Washington DC) that a new debt overhang might be building in the absence of a concerted mechanism for debt prevention and resolution. The expansion of available borrowing opportunities has provided more room to expand development-oriented spending and address infrastructure gaps. But long-term growth is enhanced only if borrowed funds are used productively, yielding a high economic rate of return that exceeds borrowing costs. The IMF (2018) has noted, however, that higher budgetary borrowing levels have been associated with a drop in public investment in many LIDCs.

The Fund is particularly worried by the rise since 2013 and by the composition of debt in several post-HIPC countries now judged by then IMF at high risk of or in debt distress. Those countries are all African: Cameroon, Chad, DR Congo, Ethiopia, Ghana, Mauritania, Mozambique and Zambia. Their rise in debt levels has been financed by a mix of emerging bilateral creditors, commercial external creditors, and the domestic financial system. By contrast, the contribution of traditional creditors (the multilateral development banks, Paris Club creditors) has been modest as they tend to limit their provision of loans to countries at high risk of/in debt distress, or are more likely to provide grant finance in such cases.

Washington DC is also worried by prospective debt distress in connection with the BRI. A recent policy paper at CGD (Hurley, Morris and Portelance, 2018) cites media sources, according to which the BRI could span at least 68 countries with an announced investment as high as $8 trillion over the coming years and decades. The CGD paper identified a subset of 23 countries to be significantly or highly vulnerable to debt distress, of which ten are Asian and four African.

Are these concerns more than ´sour grapes´?