Global Drop in Direct Foreign Investment (DFI) may decelerate Job creation in Ghana! (Part 2)

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In the first part of this article, I elaborated on some incentives, disincentives and factors that can affect the flow of investments into Ghana. Furthermore, I discussed some shortfalls and ended with the issue of a high corporate tax of 25%.
In this segment of the article, I would like to discuss some pertinent issues regarding the country’s high corporate tax of 25%. The discussion will also include the rudiments of two risk-oriented factors namely cost of debt (also called cost of credit) and cost of equity which are likely to be affected by the high corporate tax and interest rates. The two risk factors constitute what is called cost of capital. Generally, investors cost of capital is made up of the cost of debt (of credit) and the cost of equity.Cost of debt results from the borrowed funds incurring an interest rate made up of risk-free rate and a risk premium based on credit rating. Cost of equity depends on retained earnings or funds obtained from issuance of stock. Foreign investors (namely those listed on the Ghana Stock Exchange or major international Stock Exchanges) tend to use both equity and debt financing so their cost of capital is predominantly made up of cost of debt and cost of equity. Local investors (presumably small businesses) tend to use debt financing so the cost of capital is primarily the cost of debt or better still the cost of credit. Tighter credit system due to high interest rates coupled with insufficient supply of loanable funds in Ghana will definitely result in higher cost of debt or credit. Subsequently, it becomes more difficult for local businesses or entrepreneurs or small scale businesses to thrive. Small scale businesses are engaged in projects categorized as short-medium term (duration of less than 10 years). Such businesses borrow short-term loans from banks and so incur a cost of debt (or credit). However, for large companies listed on the Stock exchange, equity financing is mostly used resulting in cost of equity. Generally, such companies incur cost of debt and cost equity because their short-term projects are mostly pursued using debt financing whilst long-term projects such as the expansion of a plant e.t.c are executed using equity financing which is the issuance of stocks or bonds to obtain the necessary capital for the project. Ultimately, the cost of debt together with the cost of equity gives the cost of capital for these large businesses.

Whichever method of financing is used by investors in Ghana, the high corporate tax does affect the cost of capital because any investor aspiring to invest in the country will think of how earnings from the project will be affected by the taxes and most importantly the corporate tax. The higher the corporate tax, the higher the cost of capital and the higher the expected returns from the investor or shareholders of the multinational corporation investing in Ghana. If the expected rate of return does not exceed that of the cost of capital, the investor may abandon the plan of investing in Ghana. For those multinational companies or foreign investors that will want to borrow locally from Ghana, the high interest rate would mean increased cost of debt (credit) and subsequently cost of capital even though debt financing is tax deductible. As matter of fact, the high interest loans is big setback and that in tandem with the high corporate tax will increase the cost of capital which puts the investors in position to expect higher rates of return. Obviously, the expected rate of return must exceed the cost of capital before an investor will accept the offer to invest in Ghana. Some may argue that cost of capital is difficult to calculate but at least an estimate can be made to serve as a guideline for the investor. They may also argue the leverage of corporate tax because of the presence of corporate tax differential among the companies and industries in Ghana but the fact remains that the country’s corporate tax generally is relatively high. Also, the high corporate tax of 25% is likely to have a heavier impact on the older and more profitable industries because of their bigger tax base. This will increase their cost of capital. On the other hand, the impact on the small firms is marginal because of their lesser profitability. Research by OECD has documented this defect of corporate tax. Consequently, mining companies such as AngloGold Ashanti, Newmont e.t.c may feel the tax pinch more compared to small scale mines in Ghana. Likewise Vodafone compared to small scale businesses in the agricultural and service sectors. Again, some analysts may argue that the high corporate tax may be overridden by the low cost of factors of production namely labor and land. However, I must caution them that the stringent labor laws of Ghana do not suggest low cost of labor. These laws make it difficult for multinational companies to discharge redundant employees when it is appropriate to do so thereby increasing cost. Remember, redundancy pursued by these companies is a re-engineering process meant to clean up and reduce cost for profitability.

Now, it appears the central bank and government of Ghana are enthusiastic about bringing down inflation probably for two reasons. First, to show to the world that Ghana’s inflation rate is low and that the environment is conducive for investment. Second, to produce an enabling environment where the current high interest rate can be lowered for investors (especially local investors) tentatively making borrowing easier. Judiciously, this will ease the tight credit system currently prevailing in the country. Now, the question that needs to be asked is what will happen to the high corporate income tax of 25% which is a risk to cost of capital and consequently the flow of DFI. If the government is interested in pursuing inflation reduction with subsequent interest rate reduction, then it must also consider the high corporate tax even if nothing is done about the high personal tax or VAT. The fact is investors are interested in the cost of doing business which primarily depends on the cost of capital. They know that cost of capital is not only affected by interest rate and inflation but also by corporate tax. It is really absurd for the country to hold onto this high corporate tax when every analyst and people in authority know that the higher the corporate tax, the higher the cost of capital and the lesser the investment inflow in the longer term. I must emphasize again that the relatively high corporate tax of 25% will stamp economic growth in Ghana. One may argue that a corporate tax of 25% is not that high. But the facts must be made clear here. Several countries have cut down on their corporate income tax as a reliable means to stimulating DFI flow. The following are some statistics. China has had to cut its corporate income tax from 33% to 25% in the last few years. South Africa also did cut its already low corporate tax from 12.5% to 10% to further stimulate investment inflow. Hong Kong did cut its corporate tax from 17.5% to 16.5% in order to remain competitive for DFI inflow in Asia. In 2008, Germany cuts its corporate tax by a whooping 8.7% (from 38.9% to 30.18%) in order to maintain its leadership as one of Europe destination for DFI. Countries such as Poland, Iceland, Ireland and Czech Republic have had to cut their already low corporate tax to 19%, 15%, 12.5% and 21% respectively in 2008 just to stimulate DFI and remain competitive on the global front. What stops Ghana from joining the corporate tax reduction “wagon”? As matter of fact, there is a host of countries that have reduced their corporate tax that were not mentioned here but the fact remains that there is strong pursuit of corporate tax revision taking place in several countries globally right now. I am of the view that these changes in taxes are a direct response to the global fall in DFI and also the long-term goal to stay competitive.

The good news is that the strong currency of Ghana will be a big incentive for investors as returns will be high and cost of capital low for a lowered corporate tax and interest rate. In fact, a lowered corporate tax will be the “icing” on the cake for investors. The country cannot continue to maintain a high corporate tax of 25% and still attract DFI considering what is happening in other economies. On the continental front South Africa and Botswana have strategic low-tax nets that makes them more attractive to DFI. No wonder their economies are ahead of Ghana based on GDP per capita estimates. Botswana also has a corporate tax of 25% for foreign investors yet its strategic tax-net has numerous exceptions for capital gains, local investors and even liquidated companies. The strategic low-tax nets of these countries makes productivity gains very high in them which no investor will refuse. Based on my deliberations so far, I would like to suggest that a revision be made to the corporate tax in Ghana in terms of leverage across all sectors in Ghana. For a long time preference has been given to the mining and agricultural companies because of the ideology that they provide most of the jobs in Ghana. It is time for change from this biasness and to seek for leverage of taxes concomitant with a strategic low-tax net for all sectors of the economy.

Finally, Ghana has done very well to become an epitome of democracy in Africa. Now is the time to become an archetype of economic prowess by revising some aspects of the fiscal policies especially the country’s tax-net to make it more lucrative for investors.

Author: Charles Horace Ampong
Blog: http://www.charliepee.blogspot.com

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Global Drop in DFI may decelerate Job creation in Ghana! (Part 1)

Click here to see publication of this article on Ghanaweb.com

Perhaps in the last few years and months, Ghana has received worldwide publicity and recognition for being Africa’s paragon of true democracy. Additionally, the discovery of potential world class oil reserves has boosted the confidence of most Ghanaians promoting an environment of elation in Ghana.
Strangely, in spite of the unprecedented accolade, the challenges ahead for its undaunting new President His Excellency Prof. John Atta-Mills are herculean and overwhelming. Beyond doubt the interplay of the controlling forces of the global recession has taken a hit on almost every country in the world including Ghana. Major economies of the world including but not limited to U.S, EU, and Japan have all been at the mercy of the global recession and so Ghana will be no exception. Nevertheless, in the midst of this global economic uncertainty, the main challenge of the current government will be to promote economic growth through policies that dampens the impact of inflation and exchange rate depreciation, stimulates capital inflow through DFI and privatization, reduce interest rate and most importantly unemployment in Ghana. The attainment of such goals may seem insurmountable yet it is realizable. Frankly, the odds against the feat are very high considering the level of pessimism surrounding global capital flows from DFI (a primary source of job creation) in the years ahead.
The recent economic news regarding the fall of 40% in global DFI in 2009 obviously has had a negative impact on the inflow of DFI in Ghana. This presupposes that Ghana is not immune to any global DFI shocks and it is imperative that the country augments its economic policies to absorb these shocks and stimulate economic growth. The fact is the shocks are not over as the global economy has become more stochastic than deterministic. In the past, manipulating the macro-factors to achieve economic growth has worked easily because the governing economic models were deterministic. However, it is not like that these days as major economies have struggled to control the macro-factors for economic growth but to no avail. According to World Investment Prospects Survey (WIPS) report on global FDI outlook for 2009-2011, multinational companies are skeptical about the growth prospects of DFI globally. Multinational companies who are prospective candidates for DFI in developing and developed countries expressed concerned about certain risk factors likely to cause a retreat in their investment activities internationally within the period 2009-2011. From the WIPS report, the major risk factors (based on percentage of respondents) likely to affect global FDI flows in the period 2009 – 2011 comprises the following;

• Exchange rate fluctuations - 54%
• Worsening global economic downturn - 39%
• Volatility of petroleum and raw material prices - 53%
• Volatility of prices in general (inflation or deflation) – 49%
• Increased financial instability – 40%
• Growing protectionism and changes in regimes in investment regimes – 53%
• Environmental crisis (example climate change) – 23%
• War and Political Instability – 16% (Source: WIPS 2009 Report)

In same report, it was deduced that the overriding factors that could attract investors into a country inadvertently leveraging and immobilizing the impact of these major risk factors are the quality of business environment and market characteristics. The factors encompassing quality of business environment are government efficiency, quality of infrastructure and availability of skill and talents. Market characteristics include market growth, size, accessibility to regional markets and presence of suppliers. In fact, the market characteristics dimension may not resonate with the market potential of the Ghanaian economy in terms of size and consumer spending impact. However, the business environment aspect should have a direct correlation with the growth prospects of the economy of Ghana. It is good that the current government of Ghana is pursuing stringent fiscal and monetary policies to stabilize the economy and promote growth yet these three features of the quality business environment must be on the government’s priority list. Otherwise, job creation in Ghana could be a delusion. Analyzing the WIPS report, it can be deciphered that the factors namely exchange rate fluctuations, volatility of petroleum and raw materials and growing protectionism could be deciding factors for investor’s proclivity towards investment in the country. These critical factors may also be tied up to the efficacy of the government in terms of its ability to stabilize the Cedi, set-up appropriate legal and regulatory framework that is not local investors biased as against foreign investors, stimulate the banking system through its monetary policies so as to ease the credit crunch and make loans available, embark on infrastructure rehabilitation that leads to appreciable improvements in water, roads, sanitation, health sector, information and communication sector and the energy sector and overhaul the educational system to produce world class skilled graduates. All these culminate in an enabling environment for local and foreign investors to thrive and succeed resulting in job creation. As a matter of fact, the prime reason why DFI flows have failed to enter Africa is because of inefficient government, poor infrastructure and lack of skilled and talent personnel. Next, government must pay special attention to the energy sector as it is vital for the attraction of DFI. Continued dependence predominantly on Hydroelectric Power is not sustainable and as such government should create tax incentives, rebates that will promote renewable energy production such as wind power, solar energy and geothermal energy and even bio-fuels. I must say that the current import taxes of 5% on wind energy, solar energy generating sets should be repealed. Additionally, there should be immense tax rebates and lesser corporate tax for investors interested in setting up energy production projects in Ghana. It is sad to know that Ghana is currently an importer of energy and this ought not to be so. The last time I was in Ghana, I witnessed electricity rationing and I have a funny feeling that the insufficient energy could be a disincentive for attraction of foreign investors both in the capital and labor intensive industries.
Also, the current corporate income tax of 25% for listed companies should be reviewed and perhaps slashed to a smaller figure. Though when compared with that of countries like Germany (30.18%), U.S (39.25%), and U.K (28.00%) depending on the characteristics of the company, it appears to be low. However, a high corporate income tax puts the DFI flow into the country at risk. A comparatively low value of corporate tax should permit investors from countries like Germany, U.S, U.K to receive tax credits when they transfer their after-tax earnings from Ghana back to their host countries. Obviously, this stimulates DFI. However, it appears the tax-rebates or credits or incentives are more towards the agricultural sector than the manufacturing or service sectors. I am not against a corporate tax of 25% for hotels but my suggestion is that government should seek to leverage corporate taxes, rebates, VAT across the manufacturing, agricultural and service sectors so as to encourage diversification into all sectors and promote a diversified economy which is more resilient to global recessionary pressures. The good thing about the Ghanaian tax system is its consistency (continuity and stability) in terms of less susceptibility to change or uncertainty even when there is regime change. In most African countries regime changes goes with tax rates changes and so there is no continuity. Such contingencies do scare investors and retards the impact of DFI on a country. Fortunately, the constancy in tax rates in Ghana will permit foreign investors to do better capital budgeting analysis from the perspective of Net Present Value (NPV) or Cash flow projections. I must commend the government of Ghana for embarking on investment promotion and protections agreements for investors from countries such as U.K, Germany, Denmark, China, Netherlands and a host of others. All investors need is confidence in the system and such covenantal gestures have long – term effect of attracting investors. Again, such tax treaties help foreign investors avoid exposure to double taxation or triple taxation especially in the case where dividend disbursements are involved. Ultimately, earnings by foreign investors are not taxed by the country (Ghana) and then again by country of origin of the investor when the earnings are transferred back to their country. Frankly, such income tax treaties reduce taxes on earnings by investors and therefore stimulate DFI. On the other hand, my main concern is the corporate income tax, high personal income tax coupled with the high VAT of 12.5% because of the indirect effect these tax nets will have on doing business in Ghana: foreigners investors may be compelled to pay higher wages and second the VAT will affect the investor cash flows as it increases the prices of product from Ghana and makes them less competitive globally. I will discuss thoroughly the expected impact of the corporate tax level of 25% on the ease of doing business in Ghana and the need to review it in part two(2) of this article. Two main risk factors cost of capital and cost of debt emanating from this level of corporate tax will be the subject. I will also talk about the remedial measures needed to make it lucrative for both local and foreign investors alike. As an introduction, cost of capital is made up of cost of debt and cost of equity. For Ghana, the cost of capital can predominantly be attributed to cost of debt since most projects are pursued using debt financing as against equity financing. Now, I would not end this article without commenting on another positive dimension of the country’s tax system. That is the flexibility the system offers pragmatically to foreign companies through what is called “carry losses forward”. In this context, any losses in the earlier years for companies are not taxed but deferred onto future returns such that deductions takes place on future returns. This is a great incentive since companies are not afraid to start the business in the country knowing that the laws do not allow them to be tax in the first few years when they are incurring losses but rather to be tax in future when profit begins to show up. All these are incentives that should stimulate DFI and hence job creation.

Author: Charles Horace Ampong
Blog: http://www.charliepee.blogspot.com

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The intricacies of China unseating Germany as the world’s biggest exporter! (Part 2)

In the first segment of this article, the author deliberated on the episode surrounding the call for revaluation of the currency of China to forestall the growing trade imbalance between China and the rest of the world. In that segment, the author attributed the demand for its export as not only due to its low valued currency but also to other factors such as government subsidies for firms and investors, expansion in its trade horizon internationally and piracy problems. It was deduced that piracy was taking market share from the western world and also reducing the required imports for China.
In this segment of the article, the author would like first to consider some pertinent issues surrounding the trade imbalance between China and the rest of the world especially the western world. Second, whether the growing trade imbalance poses a threat in terms of monopoly. Third, whether the world has options to deal with the situation.
From the perspective of exports and imports composition, the following are some trade statistics estimates for China;

Exports - $ 1.435 trillion (2008 estimates)
Main Export partners (2008 estimates) – U.S 18.6%, Hong Kong 12.7%, Japan 8.2%, South Korea 5.1% and Germany 4.2%
Imports - $1, 074 trillion (2008 estimates)
Main Import partners (2008 estimates) - Japan 12.2%, South Korea 10%, U.S 6.6%, Hong Kong 4.9% and Germany 4.5%

According to the Center for Trade Intelligence report in 2007, China generally exports low tech goods which include but not limited to computers, printers (storage units generally), cell phones, video recorders, television, electronic integrated circuits, puzzles, toys, telephones, handbags, wallets, non-knit women and girls suits, leather footwear among others. Its topmost exports are computers, printers, storage units, office machine parts, cell phones, video recorders and radio transceivers. The topmost imports includes but not limited to electronic integrated circuits, computer and office machine parts, television radio and accessory parts and crude oil. Also, based on the report, China had much trade surplus with countries like Hong Kong, United States, Netherlands, United Kingdom and Spain in descending order of surplus magnitude whilst it had trade deficits with countries like Angola, Saudi Arabia, Philippines, Japan and South Korea in ascending of deficit magnitude. These statistics do suggest that China tends to have surpluses with the western world and on the hand deficits with developing world. Perhaps, the net is the surplus since the surplus with the western world is huge compared to the deficit with the developing and under-developed world. Ultimately, it is right to say that the trade imbalance with the world is the result of high balance of trade surplus with most countries including United States and United Kingdom. From the structure of its exports, it presupposes that China would need much technological innovation to keep up with its exports. Hence, the country cannot do without high tech machinery and other industrial inputs from the western world. Infact, resilience and low-tech manufacturing alone cannot support its exports. An economic analysis suggest that in the long term the trade imbalance should not pose a threat only if the country’s surplus in totality is expected to dwindle which is currently becoming evident. This is because recent reports have it that China’s total trade surplus has shrunk to $196.07 billion down 34.2%. As an analyst, the decrease is not shocking considering the global slump in demand. Also, it can be inferred that if the global slump continues and domestic demand in China continues to increase, then import would also increase. Increased import is possible because of the country’s large population. Next, the increased imports would factor into the exports bringing down the surplus. In the longer term, this would reduce drastically the surplus and pave the way for fair competition between China and the world. It must be emphasized that the dwindling in surplus should come predominantly from an expected increase in its imports as against its exports. Nevertheless, the resilience of the Chinese manufacturer to keep exporting may prove this analysis wrong. Eventually, these developments do not suggest a monopoly of the market by China and so there is no need for paranoid expectations.

Now, there is another salient reason why China is enjoying export superiority and that has got to with price elasticity of products in the current global recession. In the current slump of global demand, two things are imminent: the market has become competitive and goods are likely to be price elastic which makes it difficult to make profit. Under such prevailing conditions, any attempt to raise price could lead to a loss. Contrarily, lowering price can lead to increased sales and possibly profit. Apparently, the ability of China to present low priced products promotes its sales, exports ensuring more revenue and profitability. Again, China seems to be successful in this era because of its ability to take advantage of the price elasticity of goods in the current global slump in demand to make more sales and consequently profit. Furthermore, the country is exhibiting economies of scale in the production of its goods and this is also a plus for exports.

The whole story of the trade imbalance does not depend solely on the mentioned factors but it is indirectly enhanced by the country’s growing capital investment predominantly its direct foreign investments and portfolio investments. These two components of capital investment are serving as a backbone for its increasing export as they are consumer confidence boosters for the Chinese economy. The increased direct foreign investments and portfolio investments by China in other economies coupled with the huge accumulation of foreign exchange rate reserves is creating consumer confidence internationally in China’s capability and its products even though there are cases of a down side to the quality of its products and also its investments. Additionally, the country’s huge foreign reserves can be used to intervene in the foreign exchange market to influence its currency the yuan. Such action plan China may not do unless under severe pressure to strengthen or weaken its currency. Until then market forces will determine the yuan rate as it is allowed to float. Interestingly, for those economies with strong currencies as against China, opportunity is however available as well through the attraction of Direct Foreign investment and portfolio investments. On the downside products from such countries are expensive and unattractive but on the upside if their economy offers favorable low tax rates on earnings, have high interest rate and a stable exchange rate, they qualify as feasible candidates for Direct Foreign investment and Portfolio investment. Now, I would not like to end this article without talking about the impact of inflation on China’s goods pricing in the midst of the country’s stunning GDP growth. China’s inflation rate is comparatively high. Consumer Price Index (CPI) measures inflation and according reports, this value climbed 1.9% in December 2009 year-on-year. However, the low-value of its currency coupled with government subsidies overrides the potency of inflation. On the other hand, this is not sustainable as inflation can be a problem considering the increasing domestic demand in China. The increasing demand due to the large population coupled with a droop in supply of goods (imports) could trigger an increased inflation (demand-pulled). Additionally, increased demand for raw materials by its industrial and manufacturing sectors as against a fall in global supply of raw materials can augment inflation (cost-pushed) in China and globally. In reality, it is not the CPI alone that will be affected by these developments but also the Producer Price Index (PPI) which should be a bother to producers in China. These developments may also prompt increased interest rate in China to curb inflation.

Finally, the world may not have enough feasible options to deal with the imbalance situation except of course to pressure China to revalue its currency. However, with regards to the subsidies from the Chinese government, it is an internal affair which cannot be influenced from an external source. The rest of the world may have to agree with China to promote a free and fair market. Another option is for the world to do nothing and allow the global slump and market forces to deal with the situation in the longer term. The imposition of tariffs and quotas may have only a minimal effect and should not be resorted to.

Conclusion

The recent economic news about China unseating Germany as the world’s largest exporter has undoubtedly enlightened the world about the emergence of China as the new economic world super power and possibly a locomotive engine for the world economy. Behind these developments is the assertion that the feat has been enhanced by the low value of the Chinese currency the Yuan making its exports attractive and more competitive. Consequently, it is expected that in the next few months or years, China will be compelled under growing pressure to revaluate its currency to make its products less competitive so as to obviate the growing trade imbalance between China and the rest of the world. However, it is not only the low currency that is responsible for low priced exports but also other factors namely government subsidies, China’s trade horizon, piracy problems and price elasticity of goods in the global recession. Unfortunately, addressing these problems may prove a herculean task as there are not many options available for the world.

Author: Charles Horace Ampong [MSc(Eng), MBA]
GLG Councils Consultant
Blog: http://www.charliepee.blogspot.com

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The intricacies of China unseating Germany as the world’s biggest exporter! (Part 1)

In the January 10, 2010 edition of the yahoo.com news, it was promulgated that China has overtaken Germany as the world’s biggest exporter even though full confirmation is expected in February 2010 when the final figures for Europe’s biggest economy is released.

The assertion from the perspective of the author of the article is a reflection of the economic strides China has made to reach a pinnacle of an economic super power and also a vivid sign of a gradual shift of power from the West to the East. According to the article, the total export in 2009 for China was more than $1.2trillion as against $1.17 forecasted for Germany.
Really, this is not the first time China has overtaken Germany with regards to economy issues. More so, this is germane and a memento to what happened in 2007 with regards to the two countries. Recall in 2007, China overtook Germany as the world’s third biggest economy and obviously it should have served as a signal that the country is on course to unseat Germany as the world’s largest exporter. At least, the incident should not preposterous to the world considering the fact that the symptoms were evident enough.

In my article titled “Another Economic Bubble Burst Ahead- China, I prognosticated the possibility of China becoming the locomotive engine driving the world economy as it is predestined to lead the world in the industrial sector, technology sector and the financial sector. Believe it or not, the attainment of the status of the world’s largest exporter coupled with technology and strong financial base suggest a paradigm of the country being the “locomotive” engine driving the world economy. If China continues to maintain its GDP growth rate of over 8% whilst that of the western world hovers around growth values of less than 3%, it is likely China will dethrone Japan as the world’s second biggest economy by the year 2015 and if possible in the years after overtake United States as the world’s largest economy. This hypothesis is based on the 2008 GDP growth estimates where China recorded 9.6% with Japan having -0.4%, Germany 1% and U.S 1.1%. Optimists argue that it is not possible for China to overtake United States as the world’s biggest economy and they could be partially right. However, the world did not envision China would overtake United States in Auto sales in 2009. Again, analyst did not envisage China overtaking Germany so soon and here we are it has happened. Indeed, the moment may be right and China could be said to be on its way to the throne. As an analyst, I am of the view that China can overtake Japan but not United States. There are several factors involved here which will be discussed in a later article. But for now, I will touch on one of the factors namely the economic statistic GDP (purchasing power parity) per CAPITA which is only an indicator of the standard of living. Though this is not a true measurement for standard of living it can be used as a proxy for accessing the standard of living of countries. China has a population of about 1.3 billion with an estimated growth of 0.655 % (2009 estimate) whilst the U.S has a population of about 307 million and an estimated growth of 0.975 % (2009 estimate). China has estimated GDP (ppp) per CAPITA of $2,033 and is ranked 131th out of 207 economies in the world in terms of per capita income. United States value is $44,155 and is ranked 8th also out of 207 economies. Hypothetically, the standard of living of the people in the United States should be about ten times better than that of China. Doing the math here, it presupposes that the ability of the citizens to impact the economy (in terms of GDP growth) through their purchasing power is ten times more. This also means the ability of the United States to maintain its economy size judging from the fact that the U.S economy depends much on domestic consumer spending is more predictable as against China. If China’s economy is to be dependant on domestic spending in the midst of global slump in exports, then the low GDP (ppp) per CAPITA signals a disadvantage compared to United States. China may increase its GDP growth but it would have to leverage its per capita by bridging the wide purchasing power parity gap between its urban and rural population segments. Subsequently, it may call for policies that would increase the standard of living of its people across all segments.

How be it, China cannot overtake the U.S in terms of economy size until this population segment factor and other factors are diligently pursued and completed. Meanwhile, in terms of global competitiveness they are ranked nearly the same (U.S is 5.59/134 whilst China is 4.73/134). However, in terms of attracting and retaining investors or Foreign Direct Investment, U.S is better ranked than China. Reminder is the growing impasse between Google and China about the internet security breach prompting threats of Google leaving China. What is not clear is whether China would accept the departure of Google. If Google should leave, what effect will it have on the credibility of companies or nations doing business with China? Now, proponents of GDP per CAPITA economics may argue that the GDP per CAPITA statistic is not a good measure for standard of living and personal income levels in a country. Nevertheless, all things being equal there is a systematic level of correlation between GDP per CAPITA and standard of living in most countries. That is to say GDP per CAPITA decreases as the standard of living decrease and vice versa.

Strangely, the yahoo.com news article attributed the feat of China to its ability to enact policies to deal with the world recession. The article emphasized that its policies were able to cushion the economic shock from the global economic crises whilst other nations were overwhelmed by the crisis. It must be stressed here that much as the policies and global recovery were contributing factors, the real cause of China’s survival and stronger emergence is bottled up in its exchange rate policies and government subsidies and financial assistance package from the stimulus. In fact, the combine policy framework of exchange rate manipulation and government subsidies promotes low pricing strategy for its exports ultimately increasing the attractiveness of its products and also its market share of the world’s export. Now, the global imbalance cannot be completely removed as the Chinese government would want to enact policies and strategies that will give Chinese products an edge in exports in addition to promoting less import. Really, in the midst of all these developments there are two questions that would need to be addressed by the world and they are

1. Whether China the current locomotive engine of the world economy would bow to another currency revaluation pressure
2. Whether the trade imbalance between China and the world is a threat in terms of monopoly and whether the world has other options to deal with it.

The objective of this two part article is to discuss in circumspect the ramifications of the unanswered questions and what it means for the world.

Currency revaluation issue

In the next few months and perhaps years there is expected to be a growing pressure on China by the United States, Germany and the other economies of the world about the urgent need for China to revaluate its currency the Yuan to correct for and curtail the growing trade imbalance between China and these economies. It is an undisputable fact that China has trade surplus with almost all these countries as these economies are drowning in mounting trade deficit with no end in sight. The fact is China has been through such barrage of criticisms before with regards to the impact of its low valued currency on exports. Recall in 2005, China under growing criticism of the impact of its low valued currency on international trade was compelled to revalue the Yuan by a whooping 2% against the dollar. Additionally, a policy change of pursuing a floating exchange rate system for its currency was effected. The corollary was the creation of a currency (the Yuan) whose value was based on a set of major currencies which could deviate as much as 0.5% within a day. Yet again, the western world in the nearest future may be agitating for another round of revaluation. Europeans and the United States may be perturbed because competition with China is becoming difficult primarily due to the Yuan being relatively low in value which makes the products from China less expensive for foreign countries and that of EU and U.S more expensive. However, criticisms may not be feasible this time. It is likely China may not vouchsafe to the western countries led pressure to revalue its currency. Apparently, the world may be forced to seek for other options of dealing with the situation which could call for inferior tactics such as imposition of trade tariffs, quotas e.t.c. on Chinese exports. But one wonders if such option will yield the expected results as well judging from the fact that an action plan of this sort may seem more visionary to China than pragmatic and results-producing. On the other hand, China may argue that revaluation of the yuan will have marginal impact on the exports trend and subsequently the global imbalance using the developments in 2005 as the basis for argument. In retrospect, the revaluation of its currency in 2005 produced a marginal effect on the attractiveness of its exports and consequently China may not yield to the exchange rate policies again. Analytically, revaluation may not reduce the competitiveness of Chinese products neither would it correct the international trade imbalance due to the fact that there are other factors other than exchange rate policies that contribute to the attractiveness of its exports. These are factors that are contributing immensely to the low priced exports therefore exacerbating the global trade imbalance.

Now, the factors other than exchange rate that make its exports superior in terms of global demand are government subsidies, expansion of China’s trade horizon and piracy problems. Government provides subsidies for exporters which culminate in lower cost of production. These firms and investors receive free loans and some free factors of production such as land which has led to lower cost of production and lower pricing of exports. There are also cases of other government fiscal inputs such as increased tax rebates on exports, increased tax refunds and improved export credit insurance during the year 2009. Let’s not forget also the 4 trillion yuan ($586 billion) stimulus package injected into the economy by the government. All these factors are incentives that culminate in a lower cost of production and substantiate lower pricing of its exports in addition to making it more competitive. Ultimately, if China should revalue its currency again to make its products expensive, the effect on trade imbalance would be marginal. But the question that remains is whether the government would remove these incentives for its exports to be expensive and to plummet.

Currently, China has judiciously widen its trade horizon with several countries in the world and should the western world reduce their imports of Chinese goods, there is the possibility of China expanding its trade with the East (The Asian block), South America (predominantly Brazil based on BRIC alliance), and Africa where it has made unimaginable strides. This is even against the background that the western world is the major trading partner of China. Turning their attention away from the western world will be a desperate move as the country would want to maintain its superiority in exports. On the other hand, people in the western world attracted to China’s low priced products because of the propensity to make some savings in this era of economic hardships. So the situation is very paradoxical with regards to the export between China and the western world.

Another factor that has contributed to reduction in market share for the western world is the lack of restrictions on piracy in China. Individuals engage in fictitious production of products that are similar to those produced by EU or United States firms operating in China and abroad. For example low-tech goods or electronic gadgets such as CDs and DVDs can easily be produced by individuals and this is taking market share from other countries. The other serious defect of this problem is the reduction in imports as well for China. China much as it exports lots of low-tech goods also imports many as well. However, due to piracy products in the system, there is less import demand compared to actually what the import should have been. This is to the advantage of China obviously increasing its net exports and GDP as well.

All in all, the demand by the world on China to pursue exchange rate policies to correct the imbalance in trade may not suffice because of these factors and secondly China would want to maintain its position in the world economy. Nevertheless, on a positive note the growth of China is good for the world. Like a German analyst said, growth in China is good for the other economies of the world as the country’s demand for capital goods such as machinery, raw materials, oil and high value products used in its industrial sector also stimulates exports from other countries such as Germany and United States. However, what remains to be known is whether future policies would seek to monopolize the world economy by promoting vertical integration in the Chinese industrial sector. An action plan of vertical integration will ultimately reduce the importation of heavy duty or high valued products by firms in China. Read the next segment of this article!

Author: Charles Horace Ampong [MSc(Eng), MBA]
GLG Councils Consultant
Blog: http://www.charliepee.blogspot.com

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Why Ghana could be the right place for foreign investors? (Part 2)

Click here to see publication of this article on Ghanaweb.com

In the first part of this article, I elucidated on the policies required for the rejuvenation of the economy of Ghana with special attention to Direct Foreign Investment and Portfolio investment. In the ensuing discussion, I would continue with the policies that are required for a successful economy and job creation with particular emphasis on the impact of the country’s strong currency on DFI, Portfolio investment and some pertinent issues regarding the Ghana Stock Exchange.

Also, I will commence with the discussion of the factors that are likely to determine the pricing of the oil, the magnitude of the revenue to be incurred and why there should not be much euphoria over the discovery of the oil in Ghana. However, this would take us into Part 3 of this article. Continuing from the previous article, I would like to say that government policies should encompass diversification not only into oil, gold and tourism but all sectors namely industrial, agricultural and service. I am of the view that the agricultural and service sectors need more augmentation. Opportunities are abundant in these sectors and the government should do well to identify them. The service sector presents opportunities for value added activities as technology is fast expanding in this sector and Ghana can take advantage of it. Moreover, a diversified economy is more resilient and can endure global recessionary pressures compared to a less diversified one. Consider the case of China whose exports covers a wide spectrum of items from computers to crude oil making its economy more resilient to the global downturn. Most of China’s products are very price elastic and its low valued currency enables it to reap much revenue from it as fall in prices is accompanied by increased demand. What’s more, diversification would reduce the risk of the impact of price elasticity on the country’s exports. I am of the view that Ghana’s strong currency is expected to increase its balance of trade deficit if its traded goods are price elastic (sensitive to global price changes). A typical example is its top export Cocoa and its processed forms such as cocoa butter or paste. From international perspective, this main export has many substitutes and is likely to be price elastic if economics is applied here. In fact, the strong currency should make the price of the Cocoa and the processed forms expensive. Apparently, if there is global fall in prices possibly due to the presence of many substitutes coupled with the drop in demand, loss in revenue will be quite a lot and this will have negative impact on the balance of trade of Ghana.

Next, lowering of restrictions on DFI by removing government barriers to privatization can be a good step to take. Privatization would allow for greater international business between Ghana and the world, prevent nationalization of the economy and monopoly of state-owned enterprises thereby promoting value-added corporations. The fact is that most of the corporations handled by the government lack the value-added dimension. Take the case of former Ghana Telecom. Until it was divested to Vodafone, there was serious lack of value-added activities. Vodafone has managed to bring this principle of value-added into the company which is commendable. As a matter of fact, all these have become possible because of privatization. I am not advocating for foreign invasion of the country by investors. That is tantamount to treason as a Ghanaian. However, I am an advocate for economic liberalization which culminates in trade liberalization (including liberalization of DFI and Portfolio investment), privatization of some state enterprises, deregulation, financialization of capital in the midst of better fiscal policies. I don’t believe in extreme economic liberalization which is equivalent to Neoliberalism. Ghana does not need neoliberalism but rather better fiscal and monetary policies that can promote economic liberalization. Neoliberalization is ultimate transfer of control of the economy from the public or government to the private sector.

Again, policies should also be geared towards lowering corporate tax to improve after-tax cash flow for investors as such action plan will be an incentive for DFI attraction. To the best of my knowledge, the current strength and stability of the Cedi is a plus for the country as it could be a bench-mark of decision making for serious investors. Additionally, it should attract investors into the foreign exchange investment at the Ghana Stock Exchange which would be a plus for the country’s capital account. However, our strong currency is meaningless unless other policies are in place to attract DFI and Portfolio investors into the country.

Economics analyses suggest that investors prefer to pursue DFI in countries where the local currency is expected to strengthen against that of their country of origin. In this wise,earnings from their activities in the host country can be converted back to their country’s currency at a favorable rate. In fact, this could be one of the reasons why Chinese and South African investors have flooded Ghana. There is the perception that the Yuan or rand their currency is expected to remain at its low level as against the dollar or cedi in the years ahead. Also, it is possible China would not revalue its currency in the years ahead so this condition serves them well. With regards to portfolio investment, investors would like to invest in a country where taxes on interests or dividend income from their investment are low even though returns on their investments are high. Supposedly, the high interest rate and the strong and stable currency of Ghana depict a conducive business environment for portfolio investment. If the ruling government can maintain the stable and strong currency, there is the possibility of portfolio investors flocking to Ghana to invest in stocks, bonds(government, corporate, 1 year bond, 2 year bonds e.t.c). However, if signs show they will not be able to maintain it, then expect investors not to come and even those who are already in Ghana would start to leave. Accordingly, two factors are non-trivial here. First, if the investors expect the economic conditions to be favorable in Ghana in the years ahead they would be attracted to invest in the stock market or any Eurobonds the government might be selling. Second, the investors would be interested if only they know that the cedi would strengthen over time against the dollar or the currency of their country of origin.

Fortunately, the crude oil discovery presents a deceptive picture of the prospects of Ghana’s fiscal or current account balance becoming stronger in future. This in itself should be a plus for Ghana to attract investors to invest in its economy. Another fact about portfolio investment is its prevalence in a country where equity financing is favored over debt financing. Corollary, one way to enhance the status of Ghana Stock Exchange is promote equity financing in Ghana. The current situation of company ownership of shares as against individual ownership should be reviewed. Policies should be put in place that will encourage Ghanaians and foreigners alike to invest in stocks and bonds. In this way, shares ownership on Ghana Stock Exchange would not only be about company ownership but also individual investor ownership of shares. Judiciously, emphasis would be shifted from the prevailing company ownership of shares to individual ownership. In this way, companies in Ghana can raise large amounts of capital by issuing stocks, bonds. Another issue worth mentioning is investor protection not only at the stock market but also other sectors of investment presumably DFI sector. In fact, effective policies are needed here.

Policies that will promote liquidity on the market such that foreign investors with holdings on Ghana Stock Exchange can easily sell their holdings of stocks locally in the local currency without any problems. Policies that would give more power to shareholders to sue publicly traded firms if their executives are caught in fraudulent deals and also ensure the enforcement of market securities laws. Meanwhile, I must commend Ghana Stock Exchange for removal of restrictions on holdings of foreigners as well as the capital gains and related earnings in 2006. Another commendation goes for the introduction of electronic trading platform for transactions of settlement trades, interactions between investors, traders and brokers on the floor. This shows the exchange has come of age but there is still room for improvement. Generally, polices that would promote more legal protection, more enforcement of security laws, less corruption and more stringent accounting requirements is likely to attract more portfolio investors to Ghana. This is because they would enhance market efficiency by stimulating confidence in the market and improving pricing efficiency.

Unfortunately, these measures may be more effective in markets at least a little larger than Ghana Stock Exchange. So, I look forward to the day when African Union will be a reality so that markets across Africa can also unite to become big and efficient as it is happening in Europe and Asia. Recall in 2000, the Amsterdam, Brussels and Paris stock exchange merged to create the Euronext stock market. In 2007, NYSE joined Euronext to form the NYSE Euronext the largest global exchange. In fact, the merging of financial markets in Africa can begin with regional ones. For example there can be the formation of West African Stock Exchange which will comprise of the merging of the different financial markets in West Africa. However, for this to happen there has to be first the union of these states which I foresee happening in future. In fact, the merging of different financial markets in Africa to create a high volume large size financial market would be efficient in terms of number of investors, pricing and generation of large financial capital for companies through stock issuance. Now, until this happens small markets like Ghana Stock Exchange would continue to be in the status of limited number of investors, minimal volume of shares, minimal capital generation and less market efficiency.

Now, I read from Bloomberg news that Ghana’s dollar dominated Eurobond (with yield 8.5% and due in 2017) surged 93% in Jul 2009 and the reason given was the expected fiscal position of the country because of the oil discovery and the fact that it could serve as a gateway to other countries in Africa. At least Eurobonds is good for the country as it provides a means to attract funds without much input. A good thing about this is that Eurobonds have limited protected covenants for the issuer. With regards to the buy, it presents the ability for the bond holder to convert it into a specified number of shares of common stock. In reality, regarding crude oil production in Ghana, there are four factors that would determine pricing in the next few years.
They are

• An expected drop or increase in demand by the two world’s largest importers of crude oil namely United States and China

• Strong divestiture into Renewable energy production as against non-renewable energy

• OPEC cuts in supply of oil because of drop in demand

• More tensions in the middle East, Nigeria, South America(between Chavez
America)

I would discuss these factors in the final part of my article - that is the part 3.

Finally, all things being equal these policies and strategies should culminate in job creation in the short and long term and also help to improve the standard of living of the people of Ghana. In the final part of this article I would be discussing the global factors that are expected to determine the pricing of crude oil and the magnitude of the revenue to be expected.


Author: Charles Horace Ampong
Blog: http://www.charliepee.blogspot.com/

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Why Ghana could be the right place for foreign investors? (Part 1)

Click here to see publication of this article on Ghanaweb.com

As an economic analyst and a follower of the economic trend in Ghana, I have found it expedient to write this article to highlight some salient points which can accelerate the economic progress of the country. After a period of observation, there are four major economic determinants that I think are needed for the economic growth and prosperity of its people.
I realize also that several economic statistics such as inflation, interest rate, GDP, GDP per capita e.t.c all interplay into these four major primers and determinants of economic progress. I call them primers because they are needed to jump-start a slumping economy. Also, I call them determinants because they provide a certainty trajectory for the economy besides describing the state of the economy.These four major economic primer determinants are Foreign Direct Investment (DFI), Portfolio investment, Exchange rate stabilization and Unemployment. Direct Foreign Investment encompasses investment in fixed assets including but not limited to setting up of new companies, construction of new plants or its expansion, acquisition of existing companies and mergers as well. Portfolio investment on the other hand involves transactions in long-term assets such as stocks, bonds, Eurobonds. Really, I am optimistic that if the ruling government can enact economic policies that are pioneered towards the improvement of these entities coupled with the existing fiscal and monetary policies, the attainment of a prosperous nation would be inevitable. Until now, the fiscal polices in the form of taxation and spending regulation and the monetary policies meant to control the money supply in the economy appears to be in place and this is remarkable.

Currently, it looks as if the focus of the government of Ghana is an inordinate reduction in inflation or the attainment of good GDP growth figures. Just last week, it was published that inflation was 15.97% in December which presupposes the current government has been able to bring it down presumably from above 20% at the beginning of the year to the current level of about 16%. This is commendable anyway. How be it, good inflation and GDP figures are only indicators of economic growth and sorry to say they are not good measurement for economic prosperity of the people of Ghana. It is not the fine inflation and GDP figures that can bring jobs to the people or improve upon their standard of living. Factually, what is the argument here? GDP is only a quantitative measure of the nation’s total economic activity. This definition suggests a missing qualitative dimension which I believe actually measures the standard of living and reveals the realities of the quality of life.

Economists employ the statistic GDP per capita when they would like to assess the standard of living in a country but this also presents erroneous analysis. GDP per capita by formula is the GDP value divided by the total number of people in a country. The concept here is that the higher the GDP per capita value, the better the standard of living. This is very interesting when one looks at some recent GDP per capita value analysis of 207 countries in the world. In that economic analysis Zimbabwe got a GDP per capita of $382.88 and is ranked 186/207 ahead of nations like Tanzania (GDP per capita $323.93 ,ranked 193/207), Togo (GDP per capita $350.60, ranked 190/207). It’s even more interesting when Haiti (GDP per capita $573.70, ranked 175/207) is ahead of Ghana (GDP per capita $572.77, ranked 176/207). Obviously, it can be deciphered that these statistics do not correlate with the standard of living or the quality of life in the respective countries. Perhaps, using the Gini index which is a quantitative measure of the income distribution of the people in a country could be a better statistic for measurement of the standard of living than GDP per capita. Next, inflation is a quantitative measure of the rate at which the general level of prices for goods and services is rising. It is measured by the Consumer Price Index (CPI) statistic. Inflation greatly impacts the purchasing power of incomes in the country. CPI measurements also have its lapses and consequently inflation is also not a perfect statistic. For your information, a lot of countries are trying to move away from the use of inflation, GDP and GDP per capita as means of assessing the health of their economy because of the inaccuracies associated with these statistics.

Again, I am not against the fact that the current government is trying to control inflation by adjusting its levels of spending, taxation and raising interest rates. As a matter of fact, inflation and GDP growth are good measures as they are reliable sources of information for foreign investors (both fixed income investors and stock investors). Fixed income investors are more interested in inflation as it can help them to know the worth of their money today after discounting their expected future returns by inflation. Stock investors would also factor inflation into their returns on investment in the hope of generating higher rates of return if inflation is low or moderate. Strangely, in spite of all these economic pursuits and jargons, the most important thing to Ghanaians is jobs and not what the GDP growth is or the inflation figures are. To the lame man, this is noise until the fruits are seen and experienced. The high unemployment rate is appalling and something needs to be done about it. Again, much as the government is pursuing fiscal and monetary policies to create a favorable business environment for investors to come, it must also pursue policies that are directed uniquely towards the attraction of more Direct Foreign Investment (DFI) and Portfolio investment which has the propensity to reduce the unemployment rate. Fixed income investors, stock investors are all potential investors for DFI and Portfolio investment respectively in Ghana. Also, it is true that the Ghana Stock Exchange is comparatively not well developed to attract more portfolio investment but the government must come up with policies that would improve its trade status internationally despite the current fiscal and monetary policies in place. For example, government policies should be in place for the crude oil exploration and mining companies in Ghana to start trading in crude oil stocks on Ghana Stock Exchange once oil production begins in 2010. The fact is Gold is traded on the exchange by companies such as AngloGold Ashanti so why not crude oil. All these can help in the elevation of the status of Ghana Stock Exchange internationally.

Another fact about DFI and Portfolio investment is that they would serve as leading indicators for monitoring the growth of the economy of Ghana. As leading indicators, it presupposes that economic growth will be trailing the two entities DFI and Portfolio investment. Which also means changes in them would occur before economy growth changes occur. Consequently, as DFI and Portfolio investments go down it sends a signal that economic downturn or recession is on the way. Likewise, when they go up, it’s a signal that positive economic growth is at the corner. Also, unemployment is a lagging indicator which means it changes sometime after the economy has changed. Again, as a lagging indicator, it trails economic growth and this presupposes that changes in it occurs sometime later after the economy changes. It suggests that when the economy goes down, some time later unemployment would begin to go up. On the other hand, when economy goes up, sometime later unemployment begins to go down. In fact, the time when these things happen may be stochastic as they could be two quarters, one year, some business cycles and so on. In reality, there is a correlation between the leading indicators DFI, Portfolio investment and the lagging indicator unemployment. As DFI, Portfolio investment increases it reflects later in reduce unemployment. Also, I am of the view that the ruling government’s emphasis is on DFI but I am recommending a strong reconsideration of Portfolio investment. Next, in similar economics context, GDP growth and inflation are coincident indicators in that they change as the economy changes. That means as the economy moves up so they do. Remember that as GDP grows there is an attendant increase in prices and that is what causes inflation rate to go up. Also when the economy cools so does GDP goes down. In the second part of this article, I would continue with the policies that are needed and throw more light on portfolio investment and the invigoration of Ghana Stock Exchange.

Author: Charles Horace Ampong
Blog: http://www.charliepee.blogspot.com/

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Another Economic Bubble Burst Ahead – China? (Part 3)

In the second part of this article, the author elaborated on some of the negative and positive ramifications of China’s pace of economic growth. Now, in this final part of the article the author will continue with the implications of the economic growth, changes that needs to be made and the collaborative effort required to forestall any future economic failure.
Judiciously, to allay the fears of skeptics and expedite its strategic investments on the international scene, the Chinese government would have to deal with the political and economic freedom parameters especially corruption which is a real killer of economic growth as outlined in the second part of this article. Meanwhile, it is expected that China’s strategic investment in the developing and underdeveloped part of the world would increase because of its estranged relationship with the western world. Furthermore, with the Chinese government and investors loosing interest in investments in the low interest US treasuries and bond primarily due to the fiscal imbalance (that is massive U.S deficit) and the plummeting of the dollar, Chinese investors may be compelled to pursue a new sense of investment direction. Unfortunately, such a redirection of investment has negative impact on the U.S deficit whose source of funding is substantially through the sale of treasuries and bonds to these investors. As a matter of fact, a greater percentage of United States huge foreign debt is underwritten by China. Accordingly, a reduction in the purchases of the US securities would lead to a rise in interest rates which could partially affect the investment sector in the U.S exacerbating the unemployment situation. Moreover, it appears China is under pressure in the last few years to distance itself from the U.S its main trading partner and pursue its ambitious economic agenda. For example, in 2005, China decided to unpeg its currency the renminbi (whose basic unit is the yuan) from the dollar and to let it float followed by the revaluation of the currency. Also, in the past year China together with the BRIC countries (that is Brazil, Russia, India & China) tried to convince the world about the volatility and incompetency of the US dollar as a world’s reserved currency and the need for a switch to another currency. Supposedly, the dependence of the United States foreign debt on China must be an issue of concern for both countries because of its proclivity towards power transference from United States to China. All these developments are a foreboding of what is in the pipeline.
The next issue of concern is the effect of its population on the sustainability of its economic growth. There is a wide disparity in income distribution and purchasing power between the rural poor and the urban rich in China. Consequently, the urban rich percentage contribution towards domestic demand far exceeds that of the rural poor. These factors coupled with demographic and migration report from the United Nations predicting that by 2015, the percentage of the urban and the rural population would be almost equal ( 50% each) substantiates the need for strategies to bridge the purchasing power disparity. Thoughtfully, it would require initiating more projects in the rural areas to improve upon their lives so that their contribution towards domestic demand can parallel that of the urban folks. Remember, a prior analysis in the first part of this article revealed that a higher portion of the GDP growth emanates from domestic demand. That supports the notion that if China is to maintain its economic pace in the midst of the global slump in demand for exports then it would have to close the standard of living gap between the urban and rural folks.

Another subject worth deliberating on is the energy needs. Environmental pollution concerns are imminent when one considers China’s growing energy need. As matter of fact currently over 70% of its energy comes from coal and natural gas both non-renewable energy sources and potential contributors to acid-rain formation and global warming. The growing energy needs suggest an increase in dependence on oil and coal. However, the country cannot continue to depend on non-renewable sources energy for it supply and should consider stepping up its investment into the renewable energy source to obviate any future environmental disasters. The growing international pressure on countries to pursue environmental friendly industrial practices encompassing cost effective measures and accountability for carbon emissions should gravitate with the concerns of Chinese authorities. Truly, in the past environmental cost has been trivial and the contribution of the cost of damage to the environment on operational cost has been negligible. The story is expected to change after the just ended climate change conference in Copenhagen as several nations operational cost would increase due to the active inclusion of environmental cost in the cost of doing business. In the interim some austerity measures may be required from China. For example, the country would have to step up its regulatory framework in order to be able regulate effectively and efficiently its growing industrial and manufacturing sector. Remember, China is second to the US in the industrial and manufacturing sector of the world. Obviously, effective regulatory measures would increase cost but it’s worth it for the Chinese people and the rest of the world. Studies show that pollution cost forms about 7-10% of China’s GDP each year. That means if the country is to effectively pursue the UN regulations agree upon recently, this cost would definitely increase operational cost and reduce expected profits.

Another factor that needs to be considered is the need for human capital the key to higher productivity and sustainability. The lagging behind of human capital can greatly retard productivity as is being experienced by a country like Denmark currently. In actuality, there is a causal relationship between productivity and human capital. Accordingly, if China is to keep up with its pace of economic growth then there is the need for revitalization of its educational sector to augment its human capital. It is true that China is advancing in technology ahead of the world but this is only sustainable with increasing level of human capital which is an integral part of the bedrock of productivity. Also, human capital is paramount to innovation, entrepreneurship, research and development all principal promoters of productivity. Innovation is needful in the energy and infrastructural sectors to meet its growing energy needs and its urbanization programs.

Now, in spite of some negative connotations associated with the economic growth, China should be commended for attainment of this high level of economic growth. Having the highest amount of foreign exchange reserves and recently overtaking Germany as the world’s largest exporter in 2009 is a laudable accomplishment which epitomizes China as an unprecedented economic super power and also an industrious nation. The fact is that no country can achieve such a distinctive status without infringement or petty international violations. Ultimately, much as the western world would want to see China comply with trade laws and the likes, they should also be ready to work with the country to ensure the sustainability of its economic growth. It is an indisputable fact that China is currently the locomotive engine of the world economy with worldwide strategic investments whose tentacles permeate even to the remotest parts of the world. So any expert in how a train operates would tell you what happens to the coaches when the engine derails or fails. In fact, there is a high probability of the coaches also derailing or failing if the engine derails or fails. Thus any failure of the Chinese economic system would spread pervasively to almost every economy of the world sending the world into another era of recession. By now, the world has learned from experience the repercussions of the failure of the United States economy plunging the world economy into recession and would not want a repeat of such an occurrence with China. Let’s not forget the fact that just as no economy was immune to the impact from the United States case, so be it for no economy in the world should the unexpected happen to China. Therefore, China would need the assistance and cooperation of the world especially the major economies to be able to control its macro-economic and political factors to ensure the sustainability of its economy and prevent economic super heating which is antecedent to an economic bubble burst. There are some who believe that all the pursuits of China have the objective of marginalizing United States and Europe and would want to be pessimistic about the future of the Chinese economy. However, united we stand divided we fall. Passivity is the key.

Finally, I would not want to complete this article without elucidating the fact that the attainment of such an economic status of leadership in manufacturing, technology and possibly the financial sector can be coupled with the attainment of superior military power. In reality, superior military power is primarily a result of the adoption of a superior military technology. Thus, the propensity by an economic super power to adopt and use its technological know-how leadership to create a superior military is inevitable. Another dimension of the technological leadership is the ability to infiltrate other country’s military system or security systems or better still hack the system.

Conclusion

Several economic empires have come and gone and unfortunately the demise of these empires termed economic bubble burst has often sent economic shock waves to the rest of the world. It is in the light of these developments that the world is wondering whether China the reigning economic empire would follow the same fate. Macro-economic factors describing the Chinese economy namely GDP, current account balance, CPI, inflation and foreign exchange reserves are currently favorable. Superficially, it is possible to think that China’s pace of economic growth is sustainable and there is no cause for alarm. However, a critical look at the economy reveals the need for a review of its policies that governs its economic freedom, political freedom and its international deliberations all of which can gravitate towards the initiation of an economic bubble burst. The long term absence of which could wreck the current pace of economic growth with reverberations to the rest of the world. Finally, it must be emphasized that China cannot do it alone and would need the cooperation of the world especially the major economies to ensure the sustainability of its economy and that of the world.

Author: Charles Horace Ampong
GLG Councils Consultant
Blog: http://charliepee.blogspot.com

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Another Economic Bubble Burst Ahead – China? (Part 2)

In the first part of this article, the author provided the striking details of the need to be mindful of the economic pace of development of China. The suggestion was based on an exclusive analysis of economic growth characteristics of economic super powers from a phase of economic miracle to the phase of economic malaise. The author advocated for the need for policies that would mollify the negative impact on the world economy should there be any failure of the Chinese economy.
In this second part of the article, the author would like to start with a prefatory discussion of what an economic bubble burst is and the controversies surrounding it. Next, the article would discuss some future precautionary changes China is expected to initiate in order to sustain its economy avoiding any economic quake and reducing the impact of any failure on the world economy. In fact, this ensuing discussion is not a panacea for any future expectant economic frailties but rather a perspective analysis of reality and what needs to be done. Again, it is not a vitriolic censure of China’s economic achievements but rather a meticulous assessment of the current situation which can serve as a harbinger to any future eventuality of economic fiasco.

Now, an economic bubble burst in simple terms occur when an economy experiences huge accumulation of bad debts (bankruptcies) and deterioration of asset values. Deterioration of assets occurs because both good and bad assets appreciate excessively beyond their intrinsic value. This is prevalent when interest rates are low and investors borrow from banks to invest in financial assets resulting in more money in the system as against few assets. Ultimately, the increase in demand of assets culminates in over-valuation of their market value as against their intrinsic value. Furthermore, inappropriate monetary policies that enable unscrupulous lending practices by banks can lead to the formation of asset price “bubbles”. To explicate this point, it is possible that indiscriminate lending practices will result in unredeemable loans and consequently the accumulation of bad debts. So two financial mishaps are inevitable here that is the creation of bad debts and huge losses in asset values. Such situations actuate an economic chain reaction called economic bubble burst which spreads to other parts of the economy. A recent example is what occurred in the U.S housing sector in 2007 when bad debts were maximal and home sale lost value dramatically. The negative situation created spread to other parts of the U.S economy because the housing sector is an integral part of the greater economy. Now, there are a lot of controversies surrounding the formation of economic bubble burst. There are those who argue that the phenomenon can occur in times when prices are correctly price and market seems efficient. And that the time of occurrence is very uncertain and that makes it very difficult to decipher accurately it causes. Despite the hullabaloo, the net effect of the bubble burst is loss of great wealth and possible failure of the economic system. A remedial measure for economic bubble burst is for governments to increase interest rate or bank reserves requirement so as to reduce the availability of loanable funds and also the amount of money in the system. As at now, it is known that the Chinese government is putting in place monetary and fiscal policies that can prevent the creation of bad debts and subsequently an economic bubble burst. This is very commendable. However, there are other factors that gravitate indirectly towards an economic bubble burst which needs to be addressed. In this context, to ensure the sustainability of China’s economy and prevent any economic quake which would resonate with the world economy, it is imperative that much consideration is given to the ensuing propositions which address these factors.

The country will have to review the factors that compositely control its economic freedom and political freedom locally and internationally. The factors to consider are investment freedom, financial freedom, property rights freedom, freedom from corruption and invariably civil rights freedom. There is the need to remove restrictions on investment freedom especially the caps and delineation of certain sectors for foreign investors. Furthermore, the state inordinate control of its financial systems predominantly the banks needs to be revised. The revision should be focused on the current regulatory framework which limits foreign investors in capital markets and also curtails the expansion of financial services to the locals and foreigners alike. In fact, revisions of this sort in the financial sector would increase the contribution of the financial system to GDP growth in addition to providing jobs in the sector. There is also the need to enforce intellectual property rights protection to curb copyright activities and associated fraudulent deals on patents, trademarks and the likes. Next, pragmatic eradication of any corruption is essential to promote regulatory transparency in the financial sector as well as government activities and projects at the state and local level. As matter of fact, in any progressive economy corruption at the governmental and individual level is a set back to direct foreign investment. Unfortunately, if not controlled can adulterate the decency of economic growth gradually bringing it to a halt. Also corruption at this level can lead to creation of bad debts as it has the tendency to promote indiscriminate and vague transactions (including lending practices) consequently initiating an economic bubble burst. Indiscriminate transactions also include unplanned spending practices promoting the scramble for assets which could result in assets over-valuation. In reality, corruption from this perspective is a potential “land mine” for initiation and causation of an economic bubble burst. Generally, the influence of the ruling communist party on the market economy is inhibiting investment, financial and property rights freedom besides indirectly enhancing corruption. Also, China is presumed to have a very low tolerance for political freedom with particular reference to human rights. Truly, a proper reformation of these components of its economic freedom and political freedom would enhance its reputation on the international scene fomenting the prosperity of its strategic investments in places like Africa, South America and the developed world. Rumors have it that China’s investment in places like Africa is a form of neo-colonialism and this is expected to impede the pace of strategic investments (mergers and acquisitions) in these foreign countries. Only time would tell if China’s activities are pro neo-colonialist. For there is a proverbial saying that fire is a good servant but a bad master and it remains to be known if the activities of China would conform to this saying. China must prove its critics wrong! The critics argue that Africa has become a fertile ground for China for doing business primarily because China is more interested in doing business than in conforming to moral and ethical standards of detesting corruption, human rights abuses and probably environmental pollution impacts. Substantiating their claim is the assertion that the country is aggressively doing business in places like Sudan, Zimbabwe, Democratic Republic of Congo where human rights abuse, genocide and corruption are at their zenith and also in countries like Ghana and Zambia where environmental pollution is on the ascendency but a secondary issue. The western world sees the violation here and is agitating for adherence to ethical standards and unfortunately African governments seem not to welcome the western world utterances. Nevertheless, with a record trade surplus of $35.2 billion as at September 2008, China has the capability to invest any where even though the trade surplus is expected to dwindle in the face of sluggish exports and domestic demand. The growing raw material needs for its industrial and manufacturing sector also adds to the urgency to invest. Currently, China has managed to secure several oil projects and investments in Africa because China is the second largest consumer of oil after United States and so it needs these oil sources to sustain its economy. For your information, the continent of Africa holds about 8% of the world’s oil reserves besides several potential undiscovered reserves. Additionally, China is supplying technical assistance and loans to some African countries that it deems as viable business partners. It has also inundated the continent with its low cost goods creating competition in respective country markets. These are positive developments for Africa and the world though some degree of skepticism surrounds these international business transactions because of the possibility of default loans. China would have to review its foreign policy in this wise.

Finally, African leaders may be celebrating their new found supposed “win-win” relationship with China just because they believe the strategic investments would provide the much needed long awaited jobs. However, these governments should do the math well to ascertain whether Chinese foreign policies and investments have the capability to do just that without a future price to pay. Furthermore, whether these investments are sustainable from the view point of geopolitical risk (that is policy changes in investments and labor) encompassing China and host countries.
Watch out for Part 3 of this article!!

Author: Charles Horace Ampong

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Another Economic Bubble Burst Ahead – China? (Part 1)

Most economists would agree that just as there is much euphoria surrounding an economic boost for a country, there is also an implicit economic phobia with regards to its authenticity and sustainability in the longer term. Historical analyses of economic empires depict a cyclical trend of economic mayhem and plummeting after attainment of the pinnacle of distinctive economic super power status.

As a matter of fact, the demise of these economic empires has been observed to occur immediately after certain macro-economic factors characterizing “super heating” of these economic icons becomes evident.
In actuality, the epoch of economic cataclysm of the empires dates as far back as the time of the Persian empire to now a period of time during which the world has witnessed the downfall of many economic empires including but not limited to the Roman empire, U.K, Japan and possibly U.S.A. Apparently, there is a high degree of consecutiveness between the emergence of economic empires and their subsequent economic debacle. That means the world continues to see the rise of economic empires as well as their demise in fulfillment of biblical prophecy and also in conformity with one of the sayings of King Solomon which states that “To everything there is a season, a time for every purpose under heaven”.

Now, the objective of this article is not to explain the rational behind the prophetic and proverbial tendencies but to assess and enlighten the world about the need to be wary of the emerging economic super power China and the possibility and ramifications of its demise in the near future. China according to analyst is expected to overtake the U.S in economic output based on GDP in the early years of 2020. China currently has managed to increase its market share of the world market economy with leading economic indicators all pointing to a positive outlook. For example, China has comparatively higher range of GDP figures such as from a value of 13.0% (2007) to a value of 8.4 %( 2009 forecast) in spite of the fact that U.S still maintains its position as having the largest economy in the world. In 2006, the Chinese economy was about $2.68 trillion worth and this was about a fifth of the size of the US economy [OECD 2009]. Also, its current account balance as percentage of GDP has changed from 11.0 %( 2007) to 5.6 %( 2009 forecast); fiscal balance as percentage of GDP from 0.7 %( 2007) to -3.3 %( 2009 forecast); consumer price index from 4.8(2007) to -0.8(2009 forecast) and changes in inflation from 7.4(2007) to -3.1(2009 forecast). The country also experienced increase in foreign exchange rate reserves from $1528 billion (2007) to $2392 billion (2009 forecast) [China Economic Report, 2009] . The current account balance which comprises of balance of trade, factor income payments and transfer payments experienced a drop due probably to the worldwide recession. Balance of trade covers payments for export and import of goods and services whilst factor payments encompass income from foreign investments in financial assets or securities. Transfer payment is the net worth of grants, aids given and received internationally. In fact, a major part of the country’s current account is dependent on the net exports (balance of trade) and this is likely to have a ripple effect on its GDP as that also depends greatly on net exports. Ultimately, the drop in balance of trade presupposes that much of the GDP growth is coming from domestic or consumer spending just like it happens in the United States economy. In addition, it is likely that the country exported goods and service as much as it imported with a resultant minimal change in balance of trade. Nevertheless, the good news is that at least the current account is a surplus and not a deficit which means the revenue from trade, income and transfer payments at least exceeds the expenditure from these transactions. Consequently, this is a cash inflow for China’s economy.

Generally, the country rely more on trade to boost its economic growth and any global slump is likely to affect its economy seriously unlike the U.S that relies on consumer spending. The repercussion in the decreased current account balance is likely to retard the investment climate in the country and subsequently the GDP growth. The negative fiscal imbalance (predominantly vertical imbalance) suggests the negative impact of fiscal decentralization and the monetary imbalance between the Chinese federal government and the provincial governments from the perspective of expenditure and revenue disbursements. Again, it implies an increase in transfer payments from governments to provinces because of less revenue available from the provinces coffers to meet its expenditure. China also experienced a reduction in consumer price index to a near zero value of 0.8 in 2009 forecast signaling technically a decrease in demand or in other words deflation. The deflation is yet again reflected in the negative inflation in 2009. Also, the country has the largest amount of foreign exchanges reserves (more than $2000 billion) in the world which makes it assume the status of the largest exporter of capital in the world. This also means that in terms of hot cash inflow into a country, China is ahead of the world.

Analytically, these comparatively stunning economic figures suggest the prospect and inevitability of China becoming the epicenter of the world economy. Added to these fact is that the country is playing a leading role in manufacturing, technology and financial sector of the world as it is fast spreading its tentacles in these sectors into almost every part of the world from Africa to Asia. Much as this is encouraging for the world, disappointments are plausible should any economic quake occur at this epicenter. Such a quake would definitely spread to every part of the world starting from Asia and spreading all the way to America. In fact, a lot of financial redeployment has occurred in the last few years for China. For example due to the low interest rate in the U.S and other western countries, a lot of Chinese investors have borrowed funds from these places where interest rate are low and reinvested it in the Chinese economy where interest rates are comparatively high. Some of these funds have also been used to buy US securities predominantly bonds and bills. In addition, there has been a massive government fiscal and monetary stimulus in support of its economy. A greater percentage of this stimulus found itself in the infrastructural sector and in the pockets of domestic consumers boosting domestic demand including the housing sector. Also recently, China embarked on the depreciation of its floating currency the renminbi (whose basic unit is the yuan) as a means to increasing net exports in the midst of the global recession.
Next, in spite of these encouraging developments, what is non-trivial is whether China would be able to implement and maintain appropriate effective fiscal and monetary policies to erase any imbalances in its economy and explicitly imbalances with the rest of the world. This calls for policies that can prevent the creation of bad debts and an “economic bubble burst” with spill overs to the rest of the world. Furthermore, policies that would incorporate the cost of a better environment in its industrialization to ensure compliance with the targets set at the recent climate change conference in Copenhagen. Also of significance are policies that would promote political freedom, investment freedom, labor freedom and freedom from corruption. Frankly, what the world needs from China in future are policies that can produce a cooling effect on its “heating” economy and a breaking effect which provides safe landing with avoidance of worldwide economic catastrophe. Optimist may argue that the expected slow recovery of the world’s economy in the next few years would produce a breaking effect on the Chinese economy as global demand for goods, services and raw materials would barely increase stabilizing prices and keeping inflation low. Unfortunately, such economic figures analyses with respect to economic growth of economies have been continuously revised substantiating the degree of uncertainty surrounding its veracity.

Finally, the question that needs to be asked is whether China is susceptible to an economic bubble burst now or in future and should the world be worried about that. In the next part of this article the author would give some reasons why the world should be wary of the pace of economic growth for China and the amendment the country needs to make to reduce the negative impact on the world should there be any failure. Watch out for part 2 of this article!!

Author: Charles Horace Ampong [MSc(Eng), MBA(Finance)]
GLG Councils Consultant
Blog: http://charliepee.blogspot.com

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