July 9, 2013 7:26 pm

Why China will not buy the world
The Chinese economy is marked by its dependence on others
©Ingram Pinn
China frightens the west. Rarely, however, do westerners look at how the world looks to China. Yes, it has made enormous economic strides. But it still sees a world economy dominated by developed economies.
Among the few westerners able to look at the world from the Chinese point of view is Peter Nolan, professor of Chinese development at Cambridge university. In a thought-provoking book published last year, he addressed one of the big fears about Chinathat it is buying the world. His answer is no: we are inside China but China is not inside us.
To understand what Prof Nolan means by this, one must understand his view of what has happened during three decades of technology-driven global economic integration. The world economy has been transformed, he argues, by the emergence, through mergers, acquisition and foreign direct investment, of a limited number of dominant businesses, almost entirely rooted in advanced countries.
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At the heart of the new global economy are what Prof Nolan callssystems integrator companiesbusinesses with dominant brands and superior technologies, which are at the apex of value chains that serve the global middle classes. These global businesses, in turn, exert enormous pressure on their supply chains, creating ever-rising consolidation there, as well.

Using data from 2006-09, Prof Nolan concludes that the number of globally dominant businesses in the manufacture of large commercial aircraft and carbonated drinks was two; of mobile telecommunications infrastructure and smart phones, just three; of beer, elevators, heavy-duty trucks and personal computers, four; of digital cameras, six; and of motor vehicles and pharmaceuticals, 10. In these cases, dominant businesses supplied between half and all of the world market. Similar degrees of concentration have emerged, after consolidation, in many industries.

Much the same concentration can be seen among component suppliers. Look at aircraft. The world has three dominant suppliers of engines, two of brakes, three of tyres, two of seats, one supplier of lavatory systems and one of wiring. In the motor industries, as well as information technology, beverages and many others, the world has just a few dominant suppliers of the essential components.
We can now see the organisation of global production and distribution under the aegis of the integrator company. Such a businesstypically possesses some combination of a number of key attributes, among them the capability to raise finance for large new projects and the resources necessary to fund a high level of research and development spending to sustain technological leadership, to develop a global brand, to invest in state-of-the-art information technology and to attract the best human resources”.

Moreover, “one hundred giant firms, all from the high-income countries, account for over three-fifths of the total R&D expenditure among the world’s top 1,400 companies. They are the foundation of the world’s technical progress in the era of capitalist globalisation”.

These companies have invested hugely across borders, not least in China. In the process, they are losing national characteristics and loyalties. This creates growing tension, as governments findtheircompanies ever harder to tax or regulate. Nevertheless, the companies still retain national characteristics and remain rooted in national cultures.
How does China fit into this new world? It is a huge development success. But it has built that success on its willingness and ability to offer its workers and markets to the world’s producers.

So in 2007-09, foreign-invested companies were responsible for 28 per cent of China’s industrial value-added; 66 per cent of its output from high-technology industries; 55 per cent of its exports; and 90 per cent of its exports of new and high-technology products. Thus, the country is a crucial contributor to systems managed by foreigners. If the citizens and governments of advanced countries look askance at these global companies, how much more so must the Chinese?
China is not buying the world. Between 1990 and 2012, the global stock of outward FDI soared from $2.1tn to $23.6tn. High-income countries still accounted for 79 per cent of this in the latter year. In 2012, the outward stock of US investment was $5.2tn, while that of the UK was $1.8tn, against $509bn from China. China’s net stock (the difference between its inward and outward stocks) was hugely negative, at minus $324bn. In 2009, 68 per cent of its outward investment was supposedly in Hong Kong. (See charts.)

As Prof Nolan notes: “Chinese firms have been conspicuously absent from major international mergers and acquisitions.” In view of its lack of natural resources, China is investing abroad in this sector. But, even here, the scale of its foreign investments are dwarfed by those of dominant foreign companies.

What does this analysis suggest? The most important implication is that China has barely developed any globally significant companies. Moreover, such is the lead of the advanced countries’ incumbents that it is going to find it extremely hard to do so.

From the Chinese perspective, therefore, the striking feature of their economy remains its dependence on the knowhow of others. This explains China’s desperate efforts to obtain that knowledge. A further implication is that China is very far indeed from “buying up the world”. The paranoia about its impact is unwarranted.

A deeper question is whether, in a world of ever more global companies, it makes sense to worry that companies are notyours”. I suspect the answer is: yes. China is right to worry about this.

Companies still have national attachments that shape how they behave and, in particular, their role in developing a particular country’s competences. But, for a nation as vast as China, this may matter less than for most others.

In the end, almost all global companies are likely to find themselves enveloped by China: it will be too central to their activities for them to escape its demands.

If that happens, it will be because of a natural process of integration. For the future of the world economy and indeed the world, the further development of such deep global entanglements is desirable. We should keep calm and just carry on.

Copyright The Financial Times Limited 2013

Europe’s Zombie Banks

Daniel Gros

10 July 2013
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BRUSSELSWhat is wrong with Europe’s banks? The short answer is that the sector is too large, has too little capital, and contains too many players that lack a viable long-term business model. It is the combination of the last two factors – an overabundance of banks with no sustainable way to turn a profit – that constitutes the most serious and most difficult problem.
The banking sector’s size is a cause for concern because, with total liabilities amounting to more than 250% of the eurozone’s GDP, any major problem could over-burden public budgets. In short, the banking sector in Europe might be too big to be saved.
Undercapitalization can be cured by an infusion of new equity. But the larger the banking sector, the more difficult this might become. More important, it makes no sense to put new capital into banks that cannot return profits for the foreseeable future.
The difficulties in southern Europe are well known, but they differ fundamentally from country to country. In Spain, banks have historically issued 30-year mortgages whose interest rates are indexed to interbank rates such as Euribor, with a small spread (often less than 100 basis points) fixed for the lifetime of the mortgage.
This was a profitable model when Spanish banks were able to refinance themselves at a spread much lower than 100 basis points. Today, however, Spanish banksespecially those most heavily engaged in domestic mortgage lending – must pay a much higher spread over interbank rates to secure new funding. Many local Spanish banks can thus stay afloat only because they refinance a large share of their mortgage book via the European Central Bank. But reliance on cheap central bank (re)financing does not represent a viable business model.
In Italy, the difficulties arise from banks’ continued lending to domestic companies, especially small and medium-size enterprises (SMEs), while GDP has stagnated. Even before the eurozone crisis erupted in 2010, the productivity of capital investment in Italy was close to zero.
The onset of the current recession in Europe has exposed this low productivity, with the failure of many SMEs leading to large losses for the banks, whose funding costs, meanwhile, have increased. It is thus difficult to see how Italian banks can return to profitability (and how the country can resume economic growth) unless the allocation of capital is changed radically.
There are problems north of the Alps as well. In Germany, banks earn close to nothing on the hundreds of billions of euros of excess liquidity that they have deposited at the ECB. But their funding costs are not zero. German banks might be able to issue securities at very low rates, but these rates are still higher than what they earn on their ECB deposits. Moreover, they must maintain an extensive – and thus expensivedomestic retail network to collect the savings deposits from which they are not profiting.
Of course, some banks will always do better than others, just as some will suffer more than others from negative trends. It is thus essential to analyze the situation of each bank separately. But it is clear that in an environment of slow growth, low interest rates, and high risk premia, many banks must struggle to survive.
Unfortunately, the problem cannot be left to the markets. A bank without a viable business model does not shrink gradually and then disappear. Its share price might decline toward zero, but its retail customers will be blissfully unaware of its difficulties. Other creditors, too, will continue to provide financing, because they expect that the (national) authorities will interveneeither by providing emergency funding or by arranging a merger with another institution before the bank fails. Recent official tough talk in the European Union about “bailing inbank creditors has not impressed markets much, not least because the new rules on potentially imposing losses on creditors are supposed to enter into force only in 2018.
Starting next year, when it takes over authority for bank supervision, the ECB will review the quality of banks’ assets. But it will be unable to review the longer-term viability of banks’ business models. Current owners will resist to the end any dilution of their control; and no national authority is likely to admit that their nationalchampionslack a plausible path to financial viability.
Keeping a weak banking system afloat has high economic costs. Banks with too little capital, or those without a viable business model, tend to continue lending to their existing customers, even if these loans are doubtful, and to restrict lending to new companies or projects. This misallocation of capital hampers any recovery and dims longer-term growth prospects.
What should be done is clear enough: recapitalize much of the sector and restructure those parts without a viable business model. But this is unlikely to happen any time soon. Unfortunately, until it does, Europe is unlikely to recover fully from its current slump.
Daniel Gros is Director of the Brussels-based Center for European Policy Studies. He has worked for the International Monetary Fund, and served as an economic adviser to the European Commission, the European Parliament, and the French prime minister and finance minister. He is the editor of Economie Internationale and International Finance.


Updated July 10, 2013, 11:42 a.m. ET

Germany Shoots Down EU Resolution Proposals for Distressed Banks

The Proposal Would Contravene EU Treaties, the German



BRUSSELS Germany swiftly rejected the European Commission's proposal for a single authority to wind down failing euro-zone banks Wednesday, signaling a rift between the European Union's executive and its biggest economy over the next step in exiting the region's debt crisis.

The proposal on bank resolution—the so-called "single resolution mechanism"— announced Wednesday was to form the second pillar in the euro-zone's banking union project which aims to sever the toxic link between troubled euro-zone banks and their sovereigns. The first pillar is a single supervisor for euro-zone banks, a task the European Central Bank is expected to assume in the fall of 2014.
Under the commission's proposal, a "single resolution board" would prepare and carry out restructurings of any of the 6,000 euro-zone banks that hit financial problems. It would be backed by a shared fund financed by contributions from banks. Crucially, the commission alone would decide whether and when to place a bank in resolution.

But Germany shot down the proposal in its present form almost as it was announced.

"In our view, the commission proposal oversteps [its] authorities," Steffen Seibert, a spokesman for Germany's government, said at a news conference in Berlin. "That's why in our view it isn't something that can bring about great credibility," he said.
Germany has consistently resisted previous efforts to transfer financial risks from national economies to the broader euro zone, because it feels it would end up by paying a large part of the bill.

"We need a system which can deliver decisions quickly and efficiently, avoiding doubts on the impact on public finances, and with rules that create certainty in the market," Michel Barnier, the EU commissioner responsible for financial-market regulation, said at a news conference earlier on Wednesday announcing the proposal.

Germany has warned repeatedly that a single authority risks contravening EU treaty law, which limits the power of Brussels over national finances. Berlin is calling instead for a two-step approach that starts with a network of national authorities, and only creates a centralized authority once EU treaties have been changed.

A spokeswoman for Spain's finance ministry said Wednesday that while the country wants a complete banking union, "we can live with a transitional solution of coordinating among national authorities."

Dutch Finance Minister Jeroen Dijsselbloem welcomed the commission's proposal "It is the next important building block toward a Banking Union. I hope we can reach agreement by the end of the year and come to an effective and independent authority that can act and decide rapidly when banks are in trouble."

Mr. Barnier stressed that the commission thinks its proposal can be enacted under current EU treaties. The Commission is open to a change to EU treaty law that would deal with Germany's concerns but the bloc cannot wait for the completion of what could be a very time-consuming process.

"I listen very carefully to what people tell me about the need for legal certainty," he said, mentioning the German finance minister among them. "We are prepared to consider this question but we have immediate responsibilities."

Still, he suggested that a possible compromise with Germany could lie in the scope of the new authority, or the number of banks it covers. For instance, one option might be for the central authority to be given responsibility for only the biggest, systemically-important institutions, with national resolution authorities handling the rest—similar to the way in which the single bank supervisor only directly oversees the biggest banks.

But Berlin's worries don't relate to the scope of the new authority, an EU diplomat said. Instead, they concern whether the commission can be given powers to decide on winding down banks under current treaties; the decision-making process for the resolution board, which doesn't provide veto rights; and whether the single resolution fund could legally use money built up by national funds.  Nevertheless, Berlin hopes to find a solution that is convincing for everybody, the EU diplomat said.

"We're not blocking or delaying anything here…we want to come to a sustainable solution," German finance ministry spokeswoman Marianne Kothe said Wednesday.

The standoff isn't the first time that Germany has clashed with the EU over its plans for a banking union.

In March, Germany delayed approval of the region's new single bank supervisor amid concerns over its legal basis, and whether its setup could blur the lines between monetary policy and supervision within the ECB.

Berlin ultimately approved the single supervisor after extracting a "declaration" by all member states that they were "ready to work constructively on a proposal for treaty change."

—Laurence Norman and Harriet Torry contributed to this article.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

July 9, 2013 5:11 pm
Asset management hits record level
The animal spirits are stirring again in the markets as the asset management industry grows to a record level and shrugs off some of the debilitating effects of the financial crisis.

The amount of money invested globally by asset managers has for the first time surpassed the highs before the 2007-08 crisis, according to Boston Consulting Group, the management consultants.

Assets under management

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Gary Shub, partner at BCG, agreed that animal spirits, a term used by economist John Maynard Keynes to describe positive actions because of instinctive optimism, had recovered in the markets, although he warned it was not a fully fledged revival.
“The worst appears to have passed, but there is uncertainty over the unwinding of quantitative easing and the impact of the eurozone, where there are still problems,” he said.

Assets under management (AUM) rose to $62.4tn in 2012, a 9 per cent increase compared with 2011, when assets were valued at $57tn. The previous record was $57.2tn in 2007.

The emerging markets grew at a faster pace than the markets in the developed countries. AUM in emerging markets grew 16 per cent, with China leading the way with an increase of 23 per cent.
However, the developed markets still represent about 90 per cent of global AUM, growing at 9 per cent in 2012. The US grew at 9 per cent and Europe increased by 8 per cent.

There was a north-south divide in Europe. Northern Europe, including Germany, the Netherlands and the Nordic countries, grew 11 per cent, while southern Europe, including Italy, Spain, Portugal and Greece, shrank 7 per cent.

The rally in equities and parts of the fixed-income markets in the second half of the year were responsible for lifting AUM and boosting profits and investment flows, BCG said.

However, profits were below pre-crisis levels as growth had been in areas that offered lower margins, such as fixed income and passive products. Profits were $80bn in 2012, a 7 per cent increase compared with 2011’s $74bn. This is 15 per cent below pre-crisis highs.

Significantly, managers have changed the way they achieve improvement in profits as cutting costs has become a more important way to boost margins rather than attracting new business.

The industry is also taking on winner-takes-all characteristics. For example, the top 10 US managers took almost two-thirds of all net new fund assets among managers with positive net flows in 2012 compared with 54 per cent in 2011.

The big groups, such as Pimco, which runs the world’s biggest bond fund, and BlackRock, the world’s biggest manager of money, were dominant in terms of winning net flows. The two groups took first and second spot in Europe respectively and second and third respectively behind Vanguard in the US.
Copyright The Financial Times Limited 2013.


Updated July 10, 2013, 3:48 p.m. ET

SEC Lifts Ban on Hedge Fund Ads

Move Reverses Decades-Old Restriction for Private Offerings


WASHINGTON — The Securities and Exchange Commission voted to lift an 80-year-old ban on publicizing shares of hedge funds and other businesses issuing private stock, a move expected to transform how startups and investment firms raise cash.
The vote satisfies a provision in last year's Jumpstart Our Business Startups Act, which was aimed at making it easier for small businesses to raise funds. The ad ban will officially end 60 days after the rule is published in the Federal Register.
The relaxation was approved 4-1, with Luis Aguilar, a Democrat, voting against ending the ban and warning that the agency was "reckless" to ease restrictions without finalizing appropriate safeguards.
The SEC did propose a package of investor protections that officials said will help the agency track and police the roughly $900 billion in private offerings sold annually affected by the ban. The proposal would require hedge funds and companies to notify the SEC 15 days before an offering will be publicized.

Currently, businesses must file a notification within 15 days following the first sale, but there are few if any penalties for failing to do so. Companies that fail to provide advance notice would be disqualified from making new private offerings for one year. Firms also would have to provide the SEC with additional information about their offerings.
SEC Chairman Mary Jo White said the agency would move swiftly to finalize the package of protections. Yet the decision to lift the ban without finalizing the protections prompted concerns from investor advocates, who are worried that some investors could be drawn in without fully understanding the risks.
"It is a sad day for the commission when it treats investor protection as an afterthought, something it may get around to addressing in the future if it can only find the will and the time," said Barbara Roper, director of investor protection at the Consumer Federation of America.
Two Republican commissioners, Troy Paredes and Daniel Gallagher, voted against the investor-protection package, warning that the restrictions were too onerous on businesses and would harm private markets.
Investor advocates had wanted the SEC to consider raising the asset and income thresholds to be deemed an "accredited" investor. But agency officials said they were prohibited from taking on that issue for at least another year because of congressional restrictions.
Accredited investors are generally those with a net worth of more than $1 million excluding the value of one's primary residence, or more than $200,000 in annual income for the past two years. Hedge-fund investors have to meet a net-worth threshold of at least $2 million, excluding their primary residence.
The final regulation would include a list of verification methods that businesses may use to determine whether an investor is accredited, including reviewing copies of Internal Revenue Service filings.
The SEC also voted unanimously to bar felons and other "bad actors" convicted of securities fraud from participating in the private offerings, finalizing provisions it originally floated two years ago.
Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved