Category: International

How Do Entrepreneurs Operate in Afghanistan?

“Uncertainty, not insecurity, is the fundamental problem for business” in Afghanistan according to a new study by Jake Cusack and Erik Malmstrom at the Center for a New American Security (ht: Zach W.). In “Afghanistan’s Willing Entrepreneurs: Supporting Private-Sector Growth in the Afghan Economy,” they report:

In national surveys, insecurity ranks at the top of the most serious concerns of Afghan businesses. However, discussions with local business owners revealed a critical qualification to this finding. Surprisingly, Afghans were more concerned with the uncertainty of the business environment than with physical insecurity. In Kandahar, which is considered one of the most dangerous areas of the country, conversations with business people highlighted uncertainty about the quality and timing of the power supply, about supplies flowing in through the border crossing of Spin Boldak, about the local/national government, about financing,about American force posture and about the sanctity of obligations should political power shift – more than security issues. In Kabul, two manufacturers noted that they had received seven-year tax break guarantees from a minister of finance only to see them rescinded by his successor. This act understandably rendered the companies reluctant to make subsequent investments.

So how do Afghanistan’s entrepreneurs respond to this uncertainty? Cusack and Malmstrom find that “businesses adapt by integrating vertically, emphasizing short-term profits and ‘buying’ security”:

Businesses employ a number of common strategies to adapt to Afghanistan’s uncertain business environment. First, they seek to vertically integrate operations, generally within family and tribe, to minimize reliance on untrustworthy business partners and the government. “We have the most corrupt government and people in the world. I don’t like relying on people outside of my family if I don’t have to,” stated Mohammad Jalil Rahimi, General Manager of the Mazar-based Barakat Group, an import-export conglomerate. The process of vertical integration begins around a central business, often import-export, and grows to include supporting businesses, such as transportation and logistics. It can then grow to include other sectors such as construction, agriculture and light manufacturing.

Second, businesses seek to remain as flexible as possible in order to hedge against uncertainty, valuing short-term but dependable gains over developing long-term productive capacities. A Western official explained, “Afghans go to the highest-margin businesses that require the least amount of capital and that produce benefits in the least amount of time.

This means that they often start in trade, then pick productive business opportunities in services, agriculture and construction. But even then, people are loathe to invest in manufacturing versus trade because it is easier and quicker.” Despite this adaptation, producers continue to face challenges from a variety of sources. For instance, a Mazar cable and wire producer was being put out of business due to competition from cheaper Iranian imports; a Jalalabad-based box manufacturer could not afford his onerous credit payments, was accumulating debt and was unable to sell his business; and a Kandahar beverage company could not convince needed Pakistani technical engineers to visit and repair manufacturing breakdowns.

We observed four primary strategies for managing physical insecurity: 1. shifting operations away from unstable areas; 2. negotiating with government or insurgent power brokers, often through payment of informal taxes and bribes; 3. allocating up to 20 percent of an operating budget to formal security costs, including a security director, guards, etc.; or 4. implementing community-based strategies in cooperation with local elders and staff. The choice businesses make depends on an individual business’ toleration of risk, past experience and influence within society. An Afghan mining executive explained his predicament: “I can’t complain to the police or the government because it will make the problem bigger. My only strategy is to negotiate directly with the Taliban. My last option is to pay them. But I don’t want to pay them because it will make them stronger.”

Well worth a read.

For previous discussions of Afghanistan’s economy, see this post on resource wealth and this one on opium.

How Corrupt is the United States?

According to a recent study, the United States has more public sector corruption than do many other developed economies. More precisely, Transparency International reports that corruption perceptions are higher for the United States than for 21 other countries. Those nations perceived to be less-corrupt are:

  • Australia, Canada, Ireland, New Zealand, and the United Kingdom;
  • The Nordics: Denmark, Finland, Iceland, Norway, and Sweden;
  • Austria, Germany, Luxembourg, Netherlands, and Switzerland;
  • Hong Kong, Japan, and Singapore;
  • Barbados and Chile; and
  • Qatar.

A more positive spin would be that the United States is viewed as less corrupt than 155 other nations in the study. But many of those other nations are much poorer. For benchmarking purposes, it makes sense to compare the United States to other developed economies. The following chart thus shows the Transparency International measure (in which higher numbers represent less corruption) for all the members of the Organization for Economic Cooperation and Development:

The United States ties with Belgium as the 18th least corrupt member of the OECD.

These findings gibe with what several friends in the international investment community have told me. In their view the United States has slipped in its commitment to the rule of law. At the margin, that makes places like New Zealand, Australia, and the Nordics more attractive places to invest.

About the Transparency International numbers: TI creates its Corruption Perceptions Index by aggregating 13 corruption surveys performed by other organizations (e.g., the World Bank and the Economist Intelligence Unit). As The Economist notes, the TI methodology raises some questions. But it’s still an interesting snapshot of corruption perceptions in the world.

Investors Should Be Prepared to Face Financial Oppression

That’s the conclusion of a new report by Morgan Stanley analyst Arnaud Mares.

And what, you may ask, is financial oppression? Speaking from the perspective of investors in sovereign debt, Mares defines it as “imposing on creditors real rates of return that are negative or artificially low.” Which doesn’t require outright default. Instead, it

[C]an take other forms: repaying debt in devalued money (e.g., through unanticipated inflation), taxation or regulatory incentives on institutions to purchase government debt at uneconomic prices.

Mares sees sovereign creditors as tempting targets when over-indebted governments decide which of their many fiscal promises they can’t keep.  After all, elderly pensioners cast more votes than coupon-clipping bond holders. And he thinks current low yields provide little protection against that threat.

His piece is definitely worth a read if you want to consider a bearish view on U.S. and European sovereign credit.

The Rise and Fall of World House Prices

The Bank for International Settlements has a great chart of house prices in its latest annual report (p. 39):

The rise and fall of U.S. house prices (red) is painfully familiar. The U.K. (brown) outdid the U.S. on the upswing, but hasn’t corrected quite as much. (Some other European nations also saw strong booms, but they are averaged into the figures for the Euro area (green)).

House prices in Canada (black) and Australia (olive green) have been showing notable strength. But is it sustainable? Or are some places (e.g., Vancouver) in bubbles?

And then there’s Japan (blue) and its persistent declines. If you worry that the U.S. is turning Japanese (an increasingly popular view with 10-year Treasury rates below 3%), you may want to ponder what a continuing, relentless decline in house prices would do the American financial system.

Expeditionary Economics

The U.S. military is now a major player in economic development. In Iraq and Afghanistan, for example, economic stabilization is a core tenet of its counterinsurgency strategy. Which makes good sense, in theory, but raises a troubling practical question: does the military actually know anything about economic stabilization and development?

In a recent essay in Foreign Affairs (Expeditionary Economics: Spurring Growth after Conflicts and Disasters), Carl Schramm answers in the negative. The U.S. military does not have these skills in anywhere near the measure that it should. He then recommends that:

[P]ostconflict economic reconstruction must become a core competence of the U.S. military. … It is imperative that the U.S. military develop its competence in economics. It must establish a new field of inquiry that treats economic reconstruction as part of any successful three-legged strategy of invasion, stabilization or pacification, and economic reconstruction. Call this “expeditionary economics.”

Schramm goes on to argue that expeditionary economics should emphasize entrepreneurship and “messy” capitalism, not just large-scale infrastructure efforts that often get the most attention. If you are interested in these issues, his essay is definitely worth a read.

For more context and other views, you should also check out the conference that Kauffman held to discuss these issues. You can read highlights from the conference here.

Some excerpts (not attributed to any of the specific participants):

The core idea behind the Marshall Plan was to stimulate the private sector through direct financial support of businesses rather than distribution through local government institutions, and it continues to serve as a potential model for efforts today, especially insofar as it deeply considered the nature of the war and the pre-existing institutional conditions in Europe.

…

Stability and economic development operations in Iraq and Afghanistan have been problematic for quite different reasons. In Iraq, the United States squandered the opportunity to demonstrate a real concern for the welfare of the Iraqi people in the months after the invasion because it failed to adequately plan for stabilization and reconstruction activities after major combat operations—as a result, both the economic and security planning systems failed. Many government agencies were complicit in this failure, including the military. In Afghanistan, the rush to respond and the limits of time constrained stabilization and reconstruction planning along with a desire to maintain a light footprint. Military, political, and development strategy was cobbled together as the conflict progressed. This meant the United States began trying to catch up with ideas, and has been trying to acquire and deploy resources ever since. As part of a “peacebuilding” strategy for the future, the military should address these core challenges to improve its stabilization operations

…

One pre-requisite of a market economy might be the rule of law, although China’s success over the past few decades offers an interesting challenge to that premise.

…

There is debate and uncertainty over what we mean by the phrase, “rule of law,” and whether it simply includes a justice system, courts, and efficient policing or extends beyond that to contracts, finance, commerce, and beyond. The answer is no one knows, and the rules of the game don’t have to be perfect—they just have to be certain and perceived as fair. The two things businesses always look for are stability and certainty.

…

In war, just as there are human casualties, there also are financial casualties, and we need to accept this reality. Some dollars will be misappropriated, and some will go to the enemy, to criminal networks, to ineffective local leaders, and to bad projects. This doesn’t make it okay, but we need a productive dialogue to determine what is a reasonable level of these financial casualties.

…

Some disagree that economics is … a soldier’s job. Yet, economics is required to win, and a soldier’s job is to win. The military has no choice but to use economics as a weapon in stability operations, so let’s be as good as possible at it. What we need to be thinking is, “What are the appropriate economic principles we can teach military leaders so they can use them to accomplish their mission?”

Vuvuzelas, Afghanistan, and Fannie and Freddie

Updates on some previous posts:


Afghanistan and the Resource Curse

Yesterday, the New York Times reported that the United States has identified “vast mineral riches in Afghanistan“:

The United States has discovered nearly $1 trillion in untapped mineral deposits in Afghanistan, far beyond any previously known reserves and enough to fundamentally alter the Afghan economy and perhaps the Afghan war itself, according to senior American government officials.

The previously unknown deposits — including huge veins of iron, copper, cobalt, gold and critical industrial metals like lithium — are so big and include so many minerals that are essential to modern industry that Afghanistan could eventually be transformed into one of the most important mining centers in the world, the United States officials believe.

An internal Pentagon memo, for example, states that Afghanistan could become the “Saudi Arabia of lithium,” a key raw material in the manufacture of batteries for laptops and BlackBerrys.

This report has generated some healthy skepticism (e.g., here). So let me add my own.

First, it appears that the $1 trillion figure reflects the gross value of the resources at current market prices. But it doesn’t reflect the cost of extracting and transporting them. When you factor those in, the net resource wealth of Afghanistan will be much lower than the $1 trillion headline figure.

Second, if these resources are real, Afghanistan may well fall prey to the resource curse that has hit so many other resource-rich nations. Last September, I quoted a Financial Times article on oil that described the problem very nicely:

Poor countries dream of finding oil like poor people fantasise about winning the lottery. But the dream often turns into a nightmare as new oil exporters realise that their treasure brings more trouble than help. Juan Pablo Pérez Alfonso, one time Venezuelan oil minister, likened oil to “the devil’s excrement”. Sheikh Ahmed Yamani, his Saudi Arabian counterpart, reportedly said: “I wish we had found water.”

Such resignation reflects bitter experience of the way that dependency on natural resources can poison a country’s economic and political system. Inflows of hard currency push up prices, squeezing the competitiveness of non-oil businesses and starving them of capital. As a result, productivity growth withers (a phenomenon known as “Dutch disease” after the negative effects of North Sea gas production on the Netherlands). Meanwhile, the state institutions in charge of oil often become corrupt and evade democratic control. And oil-rich states almost invariably waste the income it brings, many ending their oil booms deeper in debt than when they started.

As the FT notes, some countries, most notably Norway, have managed to elude the resource curse. But it’s hard to believe that Afghanistan will be able to follow Norway’s lead.

Financing Needs of Advanced Economies Remain Exceptionally High

The International Monetary Fund released its latest Fiscal Monitor last week. As expected, the headline message was quite grim for the advanced economies, many of which face grueling fiscal adjustments in coming years.

One of the IMF’s most important findings is that the government financing needs of many advanced economies “remain exceptionally high.” As illustrated in the following chart, Japan will have to sell debt equivalent to 64% of GDP this year in order to rollover maturing debt (54% of GDP) and finance new deficits (10% of GDP):

The United States comes in second, needing to sell debt equivalent to 32% of GDP in order to rollover maturing debt (21% of GDP) and cover new deficits (11% of GDP).

Why does the USA come in ahead of more troubled economies such as the UK and the PIIGS? Because our debt has a much shorter average maturity. According to the IMF, the average maturity of US debt is only 4.4 years. Portugal, Italy, Ireland, and Spain have maturities that are about 50% greater (from 6.2 to 7.4 years), and the UK is almost three times as long at 12.8 years.

The short maturity of US debt is a blessing in the short run, since we can benefit from lower interest rates. But it is also poses two risks in the long-run: greater exposure to interest rate increases (if and when they materialize) and a relentless need to ask capital markets to rollover existing debts. Both good reasons why Treasury should continue to gradually extend the maturity of federal borrowing.

Can Greece Cut Its Deficit by 10% of GDP, Part II

As  I noted a few days ago, some nations have managed even larger budget adjustments than the one that Greece faces today.  Several commenters rightly noted, however, that this slim reed of hope becomes even slimmer when you consider other factors such as the pace of adjustment (Greece would have to cut very quickly) and its inability to devalue its currency (unless it leaves the eurozone).

Michael Cembalest of JP Morgan put together a sobering chart that highlights how severe Greece’s challenges are compared to other nations that have accomplished major budget adjustments in the past (hat tip: Paul Kedrosky at Infectious Greed):

Today Greece finds itself high on the vertical (i.e., needing a very rapid fiscal adjustment) with minimal growth prospects and no ability to devalue.