Africa and the Perversities of International Capital Flows

1. Africa and the Perversities of International Capital Flows By Howard Stein Professor, DAAS University of Michigan howstein@umich.edu

2. Introduction • Neoclassicals inside and outside of the IFIs in 80s and 90s pushed for unfettered movement of capital flows –funds would flow from rich countries with low marginal productivity to poor countries with high marginal productivity. • Promised gains in investment and production-African embraced financial globalization

3. Introduction • Removed restrictions on capital accounts • Open up to FDI • Privatized state assets including selling banks to foreigners • Built stock markets • Accumulated reserves • Under encouragement, supervision and financial support of IFIs

4. Introduction • Promised gains not realized • Opposite occurred-funds flowed from poor African countries to the rich • Mainstream Economists refer to this as the “Lucas Paradox” based on his 1990 article which pointed to this phenomenon. • Lucas and mainstream economists have used variety of explanations to explain away the paradox.

5. Introduction • Including differences in labor productivity countering differences in marginal productivity of capital, introducing human capital into total capital measures, differences in sovereign risk, property right issues, etc. • All have in common one belief-once an impediment or two are addressed then system will behave as neoclassical economics predicts

6. Introduction • This paper rejects that premise in favor of one that points to a systemic explanation that focuses on the power asymmetries inherent in the structure of international flows • We have witnessed a three decade project in creating a system I refer to as the global financialization imperative.

7. Introduction • First is the attempt to commodify all products or services that have any use value. • Second is financialization or the attempt to reduce all value that is exchanged (whether tangible, intangible, future or present promises, etc.) either into a financial instrument or a derivative of a financial instrument.

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

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

10. Introduction • Financial liberalization and its associated legitimizing theories have been embedded into the dictums and practices of the international aid community for decades. • They have used their power and resources to alter the terrain for global capital with perverse consequences.

11. Introduction • The idea of perversion is very different than a paradox which assumes that flows are contradictory to what we would expect. • In fact, the result is not surprising given the underlying structure of power.

12. Introduction • The idea of perversion here is ethical-where the poorest in the world are financially supporting the wealthiest • where capital flows have pushed African economies into perverse economic structures • where human needs become subservient to the whim of the accumulation strategies of hedge funds • where debt generation has fueled massive capital flight

13. Part I Financialization of Commodities

14. UNCTAD Study-2011 • “The mid-2000s marked the start of a trend of steeply rising commodity prices, accompanied by increasing volatility. The prices of a wide range of commodities reached historic highs in nominal terms in 2008 before falling sharply in the wake of the financial and economic crisis. Since mid-2009, and especially since the summer of 2010, global commodity prices have been rising again.” • http://www.unctad.org/en/docs/gds20111_en.pdf

15. Commodity Price Movements (IMF, 2011)

16. Commodity Price Volatility (IMF, 2011)

17. Possible Causes of Volatility • rapidly growing emerging economies • growing urbanization • growing middle class with changing dietary habits, including an increasing appetite for meat and dairy products • expansion of biofuels • conversion of land use from crops • impact of climate changeood to crops for biofuel production has also affected the

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

19. Financialization of Commodities • The term “financialization of commodity trading” indicates the increasing role of financial motives, financial markets and financial actors in the operation of commodity markets. • Heart of global finance-managing of vast amounts of wealth from rich people in hedge funds run by large global financial conglomerates

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

23. Implications • Also issue of herdism-the tendency of individuals to mimic the actions of a larger group, rather than acting independently and on the basis of their own information. • Rapid movements in and out of markets with terrible consequences to people

24. Not just oil!Food Prices 2011-2011 Index Mundi, 2011

27. The Ethics of Financialization • For Alan Knuckman, there is hardly a nicer place than the CBOT trading floor. "This is capitalism in its purest form," the commodities expert raves. "This is where millionaires are made.“ • How he makes money doesn't make any difference to Knuckman. He draws no distinctions among commodities like petroleum, silver or food products. "I don't believe in politics," he says. "I believe in the market, and the market is always right."

28. The Ethics of Financialization • How does he feel about exploding food prices? • The age of cheap food is over," predicts Knuckman, noting that this can't be such a bad thing for US citizens. "Most Americans eat too much, anyway." • http://www.spiegel.de/international/world/0,1518,783654,00.html-”How Global Investors Make Money Out of Hunger”

29. Part II Orthodoxy and African Liberalization

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

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

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

33. Mainstream Arguments • Thus, financial globalization is seen to ensure an efficient intermediation between saving and investment on a global scale (Rousseau and Sylla 2001). • An intertemporal borrowing/lending model as applied to cross-border trade in capital is popularly used as a theoretical model for showing welfare gains from net resource transfer arising from increased financial openness and free capital mobility.

34. Mainstream Arguments • With opening up to international borrowing, a capital-poor developing country is able to • a) divert resources to more future production by undertaking extra investment at a lower world interest rate; and • b) enjoy higher current consumption, as its saving-investment resource gap (and hence, the emerging current account deficit) is being filled by foreign saving (Obstfeld and Rogoff 1996).

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

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

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

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

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

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

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

42. Integrating Africa into Global Flows-Stock Markets • With these neoclassical formulations in mind, the IMF and other donors pursued an active agenda to build stock markets while removing capital account restrictions. • In1980, prior to the start of era of structural adjustment, there were only three stock exchanges in sub-Saharan Africa (Kenya, Nigeria and South Africa). • In 2011 there were 22 exchanges covering 31 countries in SSA.

43. Integrating Africa into Global Flows-Stock Markets • Most have been organized after the beginning of the Asian Crisis when the logic of capital account liberalization came into question even within the IMF. • In all exchanges covering 21 countries in Africa were established in 1997 and after many with the support of foreign assistance

44. Integrating Africa into Global Flows-Stock Markets • Few have any restrictions on the foreign purchase and sale of stocks. • For example T.Rowe Price’s Africa and Middle East Fund lists investments in stocks in a dozen SSA countries

45. Integrating Africa into Global Flows-FDI • The World Bank’s FDI project in Africa has deliberately pushed countries into privatization and a minimalist and uniform regulatory and legal framework aimed at encouraging countries to follow their comparative advantage in resource extraction. • A particular emphasis in the effort over the past two decades or more was on reforms aimed at attracting FDI to the mining sector in Africa

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

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

48. Integrating Africa into Global Flows-FDI • Closest to this was 1986 and 2006 mining acts of Ghana designed with assistance of the World Bank which becomes the standard pushed by the Bank in other African countries (Campbell, 2008)

49. Integrating Africa into Global Flows-FDI and Stock Exchanges • In African countries resource industries have a heavy representation on local stock exchanges which both opens up the resources to further financialization while also providing a mechanism for FDI to liquidate their assets.

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