World energy demand is forecasted to grow by nearly one-third between 2015 and 2040. A large share of this increase will be from the power sector, and the global demand for electricity is likely to increase by more than70%, leading to a 16% increase in energy-related carbon dioxide (CO2) emissions by 2040.

World energy demand is forecasted to grow by nearly one-third between 2015 and 2040. A large share of this increase will be from the power sector, and the global demand for electricity is likely to increase by more than70%, leading to a 16% increase in energy-related carbon dioxide (CO2) emissions by 2040. Despite the diplomatic success of the Conference of the Parties (COP) 21, it is clear that the current pledges by various countries in the form of Nationally Determined Contributions fall way short of the “well below 2-degrees Celsius” goal agreed to by world leaders in Paris.

Hence, lowering of greenhouse gas emissions beyond the current targets is essential if the global climate goal is to be met. In the last decade, global growth in renewable energy generation capacity has been significant. In line with this trend, energy modeling studies by the International Energy Agency indicate that renewable energy may reach up to 50% in the European Union by 2040, around 30% in the People’s Republic of China and Japan, and above 25% in the United States (US) and India. However, this may not be sufficient.

Solar photovoltaic (SPV), which currently contributes to a mere 2% of the global electricity generation, is the key for enabling this shift. The cost for generating electricity from SPV has fallen drastically due to a reduction of 75%–80% in the price of SPV modules from 2010 to 2015. This has led to a surge in the global installed capacity of SPV from approximately 39 gigawatts (GW) to 223 GW in the last 5 years (Figure 1).

Figure 1: Growth in Global Installed Capacity of Solar Photovoltaic

Source: Data are from International Renewable Energy Agency (IRENA). http://resourceirena.irena.org/gateway/dashboard/?topic=4&subTopic=16

The People’s Republic of China (43 GW), Germany (40 GW), Japan (33 GW), the US (25 GW), and Italy (19 GW) were the top-five countries by installed capacity of SPV, but Germany was the top producer of electricity from solar energy in 2015. Figure 2 shows electricity generation in gigawatt-hours (GWh) from solar energy in the top-10 countries of the world.

Figure 2: Electricity Generation from Solar Energy in Top-10 Countries (2014)

GWh = gigawatt-hour.
Source: Data are from International Renewable Energy Agency (IRENA). http://resourceirena.irena.org/gateway/dashboard/?topic=4&subTopic=18

Despite a large growth in installed capacity of SPV plants over the past few years, SPV still contributes a small share of the respective energy mix of countries due to low power density and the large amount of land required for scaling up production. One of the advantages of SPV is that large-scale plants can be set up quickly as panels are modular and require a short time for installation (around 1 year) as compared with other fossil fuel plants (5 years or more).

However, these plants need to be connected to the electricity grid for which dedicated power evacuation infrastructure (cables, towers, transformers) is required. Once connected to the grid, SPV can be distributed using the existing grid transmission and distribution infrastructure. SPV can also be set up as stand-alone plants that feed a dedicated load/consumer and are not connected to the grid. However, in such cases, it is essential that a storage system (such as batteries) be installed along with the plant to ensure supply of electricity to the consumer when the sun is not shining.

If scaled up aggressively, the International Renewable Energy Agency estimates that SPV capacity could reach between 1,760 GW and 2,500 GW by 2030, contributing up to 13% of the global electricity supply. This intended transition to a low-carbon energy system requires a major push from national governments in the form of favorable policies as well as technical and financial support from international agencies.

Although the levelized cost of SPV¹ has reduced from $0.285 to $0.126 per kilowatt-hour (kWh) (2015 prices) and is almost comparable to electricity generated from fossil fuels, the range of costs varies across countries of the world and depends on the scale of the plants. This reduction in cost is helping to make SPV technology more attractive, and investments in the sector have been increasing since the beginning of the decade.

Investment in solar energy has grown from $104 billion (2010) to $161 billion (2015) and 56% of the current global investment in renewable energy flows to solar energy technologies. However, it is estimated that $1 trillion in clean energy investment is needed per year in low-carbon power supply until 2030 compared with a business-as-usual scenario. The International Energy Agency predicts that in the new policies scenario, global investment in the energy sector will be around $68 trillion from 2015 to 2040. Of the investment in electricity-generation capacity, more than 60% is likely to be in renewables.

While developed countries committed to provide $100 billion a year to developing countries for mitigation and adaptation in the COP 21 agreement, a part of which would go to SPV, these funds may only be available from 2020 onward. Financing, both public and private, is therefore critical for deployment of SPV, and the gap between the current and required investments needs to be filled quickly. In fact, this can be compared with the proverbial “belling the cat” as growth in installed capacity hinges on the availability of finance.

Financing can be in the form of development aid, loans at reduced rates of interest, grants, and other innovative financing arrangements supported by market mechanisms. Lower costs of capital for financing clean energy also send the right signals for catalyzing private investment. Multilateral financial institutions, such as the World Bank, the Asian Development Bank, African Development Bank, Inter-American Development Bank, European Investment Bank, and the International Finance Cooperation, play a major role in financing clean energy initiatives.

In line with the increased focus of the World Bank Group (WBG) on climate-related issues, WBG President Jim Yong Kim committed to seek an increase in its climate-related financing from the current level of 21% to 28% by 2020. New development finance institutions, such as the Asian Infrastructure Investment Bank and the New Development Bank announced by the BRICS countries—Brazil, the Russian Federation, India, the People’s Republic of China, and South Africa—are also likely to have a large portfolio in renewable energy projects. The Global Commission on the Economy and Climate recommends that multilateral and national development banks need to scale up their collaboration with governments and the private sector as well as increase their own capital commitments to provide easy financing for renewable energy projects.

India, though a latecomer, is emerging as a big player on the solar scene. India announced a goal of obtaining 40% of its electricity from nonfossil fuels by 2030 at the Paris climate change summit and shepherded the international community to form an International Solar Alliance (ISA) of 121 countries that lie between the Tropics of Cancer and Capricorn.

To stimulate the growth of SPV, the WBG signed an agreement with ISA on 30 June 2016 on increasing solar energy use, with an end goal of mobilizing $1 trillion in investments by 2030. This agreement cements the role of the WBG as a financial partner for ISA. With the strengthening of this alliance, the WBG will support ISA by giving access to its global development network, specialized knowledge, and financing capacity, to promote the use of solar energy around the world.

The WBG also announced that it planned to provide more than $1 billion to support India’s ambitious target of installing 100 gigawatts (GW) of solar energy by 2022, an increase from the 5 GW of installed capacity in 2015. As a part of this commitment, the Board of the WBG approved a $625 million loan to support the Government of India’s program for installing rooftop SPV systems². The Board also approved a cofinancing loan of $120 million on concessional terms and a $5 million grant from the Climate Investment Fund’s Clean Technology Fund. These investments would be the WBG’s largest solar financing scheme in any country to date. Apart from putting money on the table, the WBG will also help develop a road map for mobilizing finance from other sources and would develop financing instruments to support solar energy development.

While the resource potential of solar energy far exceeds global energy consumption, the market potential is limited due to higher capital cost of SPV. Apart from investment in infrastructure, distortion in electricity prices and non-targeted subsidies for electricity also act as barriers for growth of SPV. Nevertheless, SPV is a vital component of the future energy mix for a transition to a low-carbon economy, and financing SPV projects is a key ingredient in this recipe. With the latest commitment, the World Bank has “belled the cat,” which could catalyze private and public financing for the solar sector. This in turn could become the fundamental difference between success and failure of the global efforts to keep temperature rise well below 2-degrees Celsius at the turn of the century.
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¹ The levelized cost of electricity from other renewable energy sources (in US dollars per kWh, 2015 prices) are as follows: hydropower (0.046), biomass (0.055), geothermal (0.080), and onshore wind (0.060).

² “World Bank Approves $625 Million to Support Grid Connected Rooftop Solar Program in India,” The World Bank, 13 May 2016 (accessed 23 September 2016).

Belling the Cat: Financing Solar Renewable Energy Projects is republished with permission from Asia Pathways

The post If Solar is the Way Forward, Projects will need Financing appeared first on Economy Watch.

The ultra-low and negative interest rate environment in advanced economies and its implications for the rest of the world are currently among the top concerns of financial market participants and policy makers worldwide. Mark Carney, the governor of the Bank of England, recently said the low interest rate equilibrium¹ is one of the challenges in which the global economy risks becoming trapped.

The ultra-low and negative interest rate environment in advanced economies and its implications for the rest of the world are currently among the top concerns of financial market participants and policy makers worldwide. Mark Carney, the governor of the Bank of England, recently said the low interest rate equilibrium¹ is one of the challenges in which the global economy risks becoming trapped.

The phenomenon started when the central banks of the Eurozone, Switzerland, Sweden, and Denmark adopted negative interest rates from mid-2014 to early 2015. Japan followed in January 2016 and Hungary was the first emerging market to introduce negative rates in March 2016.

The motives behind the adoption of negative interest rates differed among these central banks. The European Central Bank moved first in mid-2014 to counter a subdued inflation outlook, with the objective of increasing inflation expectations. The central bank of Denmark followed three months later. It maintains a nearly fixed exchange rate with the euro and had to intervene heavily in the foreign exchange market because of a surge in demand for the Danish kroner.

Negative interest rates have had the beneficial effect of reducing capital inflows in Denmark. Similarly, in Switzerland, pressure on the currency led the Swiss National Bank to cut interest rates after abandoning its Swiss franc ceiling. The goal was to discourage capital inflows and counter the monetary tightening from the strong franc. Switzerland has traditionally maintained lower interest rates than the rest of Europe, partly because of lower inflation and partly to fend off excessive capital movements.

Central Banks with Negative Interest Rates

EM = emerging market.
Notes: * The date added in parentheses is when negative policy rates were introduced.
** The number in red is the policy rate as of 16 July 2016.
Source: National central banks.

Sweden, as a small open economy, faced growing risks from a slump in the housing market and deflation caused by the drop in the oil price and global commodity prices. Adopting negative interest rates helped house prices to rise and, eventually, inflation is expected to increase toward its 2% target. In Asia, the Bank of Japan cut rates on excess reserves parked at the central bank to –0.1%, to counteract the effects of falling oil prices and the economic slowdown in the People’s Republic of China. Finally, Hungary cut rates to revive economic growth and fight inflation.

The response to negative interest rates from academia, market participants, and international organizations has been mixed. Supporters of negative interest rates² suggest they can be considered as another type of unconventional monetary policy. It should help to relax financial conditions (lower interest rates charged on loans) and deliver additional monetary stimulus by boosting private consumption and investment. It should also benefit borrowers by reducing their debt obligations, resulting in lower non-performing loans held by banks. In addition, although many have expressed concerns about the impact of persistently negative interest rates on the profitability of the banking sector, such an impact would depend on banks’ capacity to pass on the costs of paying interest on the reserves parked at the central banks through re-pricing of loans and deposits and other liabilities.

Recently, some critics³ assert that the impact of persistently negative interest rates on the profitability of the baking sector has emerged as an important consideration in Europe and Japan. Evidently, large banks in Japan have started to report a decline in profit after the implementation of the negative interest rate policy⁴. Another concern is that the profitability and soundness of institutions with long-term liabilities such as insurance companies and pension funds may be weakened. Also of concern may be the long-term effects of ultra-easy monetary policy, such as an over-reliance on monetary policy to boost economic growth and the resulting decrease in productivity growth⁵.

So what would be the main effect of the negative interest rates, if the real sector fails to absorb the benefits mentioned above? In many cases, the main effect is through the exchange rate channel. Negative interest rates help to weaken currencies through the capital outflow. This can be an attractive option for an individual country, but for the world as a whole, it can be a zero-sum game. Central bank easing could push volatile capital flows around the world. To the extent that it pushes greater savings onto the global market, the global short- term equilibrium rate would fall further, leading the global economy closer to the liquidity trap.

What would be the implications of the negative interest rates for Asia? It has long been argued that asset prices in Asian financial markets are influenced more by the monetary policies of the advanced economies than by their own policies and fundamentals. The recent work by the World Bank suggests that the implications of negative interest rate policy for emerging markets are mostly similar to those of other unconventional monetary policy measures¹. The low or negative bond yield in Europe and Japan, and the expectation of a slower than previously expected rate hike in the United States, has encouraged the search-for-yield behavior.

The resulting return of international capital flows to Asian bonds has boosted Asian currencies and pushed down yields on Asian government bonds. Consequently, emerging Asia may be affected disproportionately by volatile swings in international capital flows, currencies, and increasing external debt levels. The yield curves in Thailand and the Philippines have flattened, providing clear examples. In addition, volatile currencies and international capital flows, and higher asset price, have been common in Asia since the global financial crisis.

To help Asia address its challenge and to maintain its good performance in the global economy of which it remains the most dynamic part, it needs to harness its growth potential. Firstly, structural reform should be directly addressed on the supply side of an economy. It can help to reorganize an economy, as can be seen in the People’s Republic of China. Secondly, no matter how innovative monetary policy is, it can only boost growth in the short run. Monetary easing would have provided limited support to the economy and inflation, given the role of structural problems in the current global economic slowdown.

However, policy makers need to use the time bought by monetary policy to maintain growth momentum in the short run and address the near term risks (including the risk from high foreign exchange rate volatility and deflationary shocks). A flexible and proactive monetary and exchange rate policy is needed. If businesses and households have confidence in the long-term growth of an economy, it can enhance the effectiveness of a monetary policy stimulus. Thirdly, emerging Asia has macroeconomic buffers in its stimulus policy (fiscal and monetary policy). However, this should not make policy makers complacent. Structural reform of infrastructure, education, research and development, support for female workers, income inequality reduction, broadening the coverage of social spending, etc., is much needed.

The article is based on our presentation at the 5th OECD–AMRO–ADB/ADBI–ERIA Asian Regional Roundtable on Macroeconomic and Structural Policy Challenges, held on 14–15 July 2016 at ADBI, Tokyo, Japan.

Possibility of Cross-Border Spillover to Asia

US = United States; EU = European Union.
Notes: German government bond yield represents EU government bond. Yield curves were retrieved at the following dates for each period: Pre-crisis = 31 January 2007; Easing = 31 January 2013; Fed Hike Speculation = 31 January 2014; Current = 4 July 2016.
Source: Bloomberg.

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¹ Two other challenges are low inflation and low growth. From Mark Carney, “Redeeming an Unforgiving World” (speech given at the 8th Annual Institute of International Finance G20 Conference, Shanghai, 26 February 2016).
² Jose Viñals, Simon Gray, and Kelly Eckhold, “The Broader View: The Positive Effects of Negative Nominal Interest Rates,” IMFdirect, 10 April 2016.
³ Leading critics include Claudio Borio, Leonardo Gambacorta and Boris Hofmann, “The Influence of Monetary Policy on Bank Profitability,” BIS Working Paper No. 514 (2015), Basel: Bank for International Settlements.
⁴ Atsuko Fukase, “Negative Rates Hit Mizuho Earnings,” The Wall Street Journal, 31 July 2016; and Zacks Equity Research, “Mitsubishi UFJ’s (MTU) Q1 Earnings Fall on Low Gross profits,” Nasdaq, 2 August 2016.
⁵ Lower interest rates may reduce productivity growth, by encouraging consumption booms and reducing incentives to improve resource allocation. See Gilbert Cette, John Fernald, and Benoît Mojon, “The Pre-Great Recession Slowdown in Productivity,” Document de Travail N.586 (2016), Paris: Banque De France.
⁶ Carlos Arteta, et.al., “Negative Interest Rate Policies: Sources and Implications,” Policy Research Working Paper No. 7791 (2016), Washington, D.C.: World Bank Group.

Implications of Negative Interest Rates for Asia is republished with permission from Asia Pathways

The post Can Negative Interest Rates be Beneficial? appeared first on Economy Watch.

Like other central banks in advanced countries, the Bank of Japan (BOJ) adopted an unconventional monetary policy after the 2007–2009 global financial crisis (GFC). After Prime Minister Abe advocated the new policy regime, Abenomics, the BOJ became highly aggressive in its unconventional policy (see, for example, Fukuda [2015] for details). On 4 April 2013, BOJ Governor Kuroda introduced quantitative and qualitative monetary easing (QQE) and committed to achieve a 2% inflation target in 2 years.

Like other central banks in advanced countries, the Bank of Japan (BOJ) adopted an unconventional monetary policy after the 2007–2009 global financial crisis (GFC). After Prime Minister Abe advocated the new policy regime, Abenomics, the BOJ became highly aggressive in its unconventional policy (see, for example, Fukuda [2015] for details). On 4 April 2013, BOJ Governor Kuroda introduced quantitative and qualitative monetary easing (QQE) and committed to achieve a 2% inflation target in 2 years.

The foreign exchange market reacted to the new policy regime very sensitively. The depreciation had positive effects on the Japanese economy. However, at the early phase of the QQE, several emerging Asian countries showed serious concern about the yen’s depreciation because it might have a beggar-thy-neighbor effect and would result in competitive devaluation in the region.

To what extent was their concern correct? To shed some light on this important policy issue, we investigated the spillover effects of the yen’s depreciation—because of Japan’s QQE—on stock prices in seven Asian economies: the Republic of Korea; Indonesia; Malaysia; Singapore; Thailand; Taipei, China; and Hong Kong, China. Specifically, we regressed the daily change of each Asian stock price on the intra-daily change of the yen–dollar exchange rates and on the daily changes in various control variables. The sample period of estimation is from 2 January 2012 to 31 December 2015.

The structural break tests show that in most of the East Asian stock markets, the estimated coefficients in the early phase of Abenomics were different from those in the following phases of Abenomics. In particular, we found that the stock markets in East Asia, which had first reacted to the yen’s depreciation negatively, responded positively as the QQE progressed.

The results were robust even if we included various control variables in the United States (US), the People’s Republic of China, and each Asian economy as explanatory variables. This implies that Japan’s QQE had much smaller beggar-thy-neighbor effects than originally anticipated.

However, when we allow the effect of Japan’s stock market recovery in the regressions, the yen’s depreciation no longer had large positive spillover effects on East Asian stock markets even in subsequent periods of Abenomics. In contrast, the effect of Japan’s stock price was significantly positive in all East Asian stock markets throughout the sample periods.

This implies that Japan’s QQE had no beggar-thy-neighbor effect because the positive spillover effect of Japan’s stock market recovery overshadowed the beggar-thy-neighbor effect of the yen’s depreciation. The QQE resulted in not only the substantial depreciation of the yen but also a significant stock price recovery in Japan. The QQE, therefore, had both negative and positive spillover effects on neighboring economies. In particular, as the QQE progressed, the positive spillover effect surpassed the beggar-thy-neighbor effect, so that the total effects of the QQE benefited neighboring economies despite the yen’s substantial depreciation.

The spillover effects of unconventional policy in advanced countries might not be symmetric across the countries. In East Asia, the US dollar is the dominant international currency. Thus, highly accommodative monetary policy in the US could have large impacts on the rest of the world, including emerging Asian economies.

In contrast, the internationalization of the Japanese yen has been limited even in the Asian region. Thus, unlike the US’ unconventional policy, Japan’s monetary policy had limited negative spillover effect on Asian economies. However, because of increased intraregional trade, Japan’s monetary policy, which had a positive impact on the Japanese economy, could have a beneficial effect on Asian economies.

Unfortunately, our sample period did not include the period after the BOJ introduced the negative interest rate policy in February 2016. Unlike the QQE, the BOJ’s negative interest rate policy did not result in the yen’s depreciation or stock price recovery in Japan. It is thus likely that the effects of the negative interest rate policy on Asian economies were quite different from those of the QQE. Exploring the different impacts of the BOJ’s two types of unconventional monetary policies would be an interesting future research agenda.

Spillover Effects of Japan’s Unconventional Monetary Policy on Emerging Asia is republished with permission from Asia Pathways

The post Mixed Results in the Rest of Asia over the BOJ’s Policy Decisions appeared first on Economy Watch.

Background

In February 2016, the Bank of Japan (BOJ), in order to reach a 2% inflation target, initiated a negative interest rate policy by increasing massive money supply through the purchase of long-term Japanese government bonds (JGBs).

This policy flattened the yield curve of JGBs. Banks started to purchase government bonds less frequently, because of the negative yield for both short-term government bonds and even for long-term government bonds up to 15 years.

Background

In February 2016, the Bank of Japan (BOJ), in order to reach a 2% inflation target, initiated a negative interest rate policy by increasing massive money supply through the purchase of long-term Japanese government bonds (JGBs).

This policy flattened the yield curve of JGBs. Banks started to purchase government bonds less frequently, because of the negative yield for both short-term government bonds and even for long-term government bonds up to 15 years.

On the other hand, a vertical investment–savings curve in the Japanese economy prevented the growth of corporate bank loans. Except for a few periods, the 2% inflation target could not be achieved. This paper examines this phenomenon, presents the reasons behind it, and offers solutions.

Recent Global Oil Price Movements

Oil prices dropped from over $100 per barrel in June 2014 to less than $30 per barrel in February 2016. Since early April 2016, prices started to increase again because of a fragile improvement in demand, but the priced reached was still less than half of 2014.

There are several reasons for this sharp drop, relating to the supply and demand conditions and expectations in the oil market (Yoshino and Taghizadeh-Hesary 2016b). Oil prices have a high impact on Japanese macroeconomic variables especially on price determination, because every year Japan spends almost $150 billion (23% of the country’s imports in 2015) on mineral fuels, including crude oil.

Lower Oil Prices and the Negative Interest Rate Policy of the Bank of Japan

In 2013, the BOJ set a price stability target of 2% (year-on-year rate of change in the consumer price index). On 4 April 2013, the BOJ announced that, based on a decision at its monetary policy meeting, it would purchase Japanese government bonds, effective 5 April 2013.

This decision was taken at the first monetary policy meeting after Haruhiko Kuroda had taken up his post as the new governor of the BOJ.

Since 2013, the monetary base increased considerably with the implementation of the quantitative and qualitative easing policy after Prime Minister Abe came into power for the second time. On the liability side of the BOJ’s balance sheet, the monetary base increased from ¥155 trillion in April 2013 to ¥387 trillion in May 2016. In April 2013, the BOJ balance sheet indicated assets of ¥175 trillion, which expanded to ¥426 trillion by May 2016.

This amounts to almost a 2.5 times increase in the balance sheet in 3 years. The BOJ made a major purchase of Japanese government bonds (JGBs), which went up from ¥98 trillion to ¥319 trillion in the same period. In other words, these long-term government bonds comprised the major part of the assets.

As regards the BOJ’s target to keep to a 2% inflation rate, the Japanese economy experienced an inflation rate that was more than 2% only during certain periods, and mainly during 2014. One of the main reasons for this was an increase in the consumption tax and higher oil prices during that period. However, after the decline of oil prices, the consumer price index (CPI) and the inflation rate fell (Figure 1) to below 1% levels.

Figure 1: General Price Level and the Oil Price
(January 2005–March 2016)

CPI = consumer price index.
Source: NIKKEI NEEDS Database. 2016. http://www.nikkeieu.com/needs/ (accessed 5 August 2016).

Contrary to the BOJ’s expectations, the negative interest rate policy also affected the long-term interest rate of government bonds and caused the JGB yield curve to fall and flatten (Figure 2). This means it is not rational to hold government bonds until maturity, as the value of 100 at maturity will be less than 100 (i.e., 99, 98, 97, 96, or less).

Hence, investors—especially overseas investors—trade the bonds rather than keep them until maturity. While the nominal interest rate dropped, the volatility of the bond market increased because bonds were trading higher. Long-term bonds of over 15 years have a positive yield, but nobody wants to keep bonds that are shorter than 15 years until maturity because of the negative interest rate.

Figure 2: Japanese Government Bonds Yield Curves

Y = years.
Source: Ministry of Finance of Japan, Debt Management Bureau. 2016.

Policy Implications

In the low-oil-price era, the BOJ had to modify the 2% inflation target by lowering it. Secondly, Japan’s monetary policy and negative interest rate policy cannot hope to pull the country out of the current recession and deflationary situation over the long term. It is more important to make investment–savings (IS), curve downward sloping rather than vertical (Yoshino and Taghizadeh-Hesary 2016c), which means that the rate of return on investment must be positive and companies must be willing to invest if interest rates are set too low.

The recession in Japan is a result of structural problems (an aging population, a shrinking labor force, low participation of females in the labor force, a conservative banking system, a low level of technology development, slow growth in small and medium-sized enterprises and start-up businesses, low productive agricultural sector) that cannot be solved through the existing monetary policy.

The Japanese government needs to focus more on the growth strategies of Abenomics rather than on monetary policy. Yoshino and Taghizadeh-Hesary (2015) give more information on the growth strategies of Abenomics.

Decline of Oil Prices and the Negative Interest Rate Policy in Japan is republished with permission from Asia Pathways

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The local business community is upbeat with the passing into law of Republic Act 10744, otherwise known as the Credit Surety Fund Cooperative Act of 2015 on 6 February 2016. Essentially, the said law provides for the creation and organization of the Credit Surety Fund (CSF) cooperatives to manage and administer credit surety funds and to enhance the accessibility of micro, small, and medium-sized enterprises (MSMEs); cooperatives; and nongovernment organizations (NGOs) to bank credit facilities.

The local business community is upbeat with the passing into law of Republic Act 10744, otherwise known as the Credit Surety Fund Cooperative Act of 2015 on 6 February 2016. Essentially, the said law provides for the creation and organization of the Credit Surety Fund (CSF) cooperatives to manage and administer credit surety funds and to enhance the accessibility of micro, small, and medium-sized enterprises (MSMEs); cooperatives; and nongovernment organizations (NGOs) to bank credit facilities.

Since 2008, and until the implementation of this law, the CSF has remained a Bangko Sentral ng Pilipinas (BSP) program, the country’s central bank, in an effort to provide MSMEs easier and affordable access to credit.

In a way, this program compliments and strengthens the BSP’s policy objective of achieving inclusive finance. The BSP also considers the CSF as an economic stimulus by way of encouraging banks to lend to MSMEs, through accommodation and acceptance for rediscounting loans covered by the CSF.

Under the new CSF law, the Cooperative Development Authority (CDA), a government agency in charge of regulating cooperatives in the country, shall be tasked with registering, regulating, and supervising all present and future CSF cooperatives in the country.

On the other hand, the BSP spearheads the promotion, creation, and organizational development of CSF cooperatives, and facilitates the acquisition of technical assistance, such as training and seminars, in coordination with other public or private stakeholders.

The law has also put to rest one of the fundamental concerns and issues hounding the CSF, which is the lack of legal personality. Now it is not merely a program but a special type of cooperative with a separate juridical personality, capable of carrying out business transactions on its own. Another perk that can be found in the law is the CSF cooperative tax exemption, which seems superfluous considering that all cooperatives already enjoy tax exemptions as provided for in another law, the Cooperative Code of the Philippines.

At present, the different agencies concerned, including the BSP and the CDA are drafting the CSF law rules and regulations. This will be followed by a series of public consultations, hearings, and roadshows. The rules are expected to take effect and be in place before the end of the year.

Similar to other credit guarantee schemes, the CSF functions as an alternative to conventional collaterals, e.g., real estate and chattels, which enable MSMEs to gain easier access to credit.

But unlike most credit guarantee schemes that are usually funded and controlled by the government, the CSF pools contributions from the private sector, i.e., cooperatives and NGOs; and the public sector, i.e., local government units, and government financial institutions such as the Development Bank of the Philippines, the Land Bank of the Philippines, and the Industrial Guarantee and Loan Fund.

In the Philippines, the existing guarantee systems are publicly operated national schemes that are owned by the government and operated by a government agency or unit, or by a body with a separate juridical entity but managed by the government. The system requires periodic appropriations of public funds, such as continued subsidies or a fixed fund.

However, the CSF is a unique hybrid type of guarantee, as it combines the features of other schemes (mutual guarantee associations, corporate guarantee schemes, and public guarantee schemes). The CSF is based on partnership and cooperation among different stakeholders, both public and private, including cooperatives, NGOs, associations, and the MSMEs themselves. This broad membership makes the CSF more expansive and flexible in catering to the various needs of MSMEs.

As of the end of 2015, 45 CSFs were organized and launched in 30 provinces and 15 cities nationwide, with total membership of 630 cooperatives and 13 NGOs. In a span of 7 years, the CSF program benefited more than 15,000 MSMEs that were able to access loans from banks with aggregate loans of P2.28 billion, or approximately $50 million. With the institutionalization of the CSF, these figures are expected to increase remarkably.

An initial impact evaluation survey conducted for the period 2009 to 2012 showed that the program facilitated credit access to previously unbankable borrowers. This was confirmed by a follow-up survey in March 2014, which also showed that the MSME beneficiaries notched a 27 percent increase in jobs generated, with 55 percent of the surveyed respondents realizing growth in terms of sales and income. Moreover, respondents claimed they are now able to fund their children’s education more appropriately.

The proponents of the new CSF law and stakeholders concerned have all recognized the need to foster national development and reduce poverty through the MSMEs that facilitate local job creation, production, and trade in the country.

Through the CSF, MSMEs will have easier access to credit and to formal financing at significantly lower costs than those charged by informal lenders. The increase in MSMEs will lead the Philippine economy to grow in a more sustainable, balanced, and inclusive way.

The Institutionalization of the Credit Surety Fund in the Philippines is republished with permission from Asia Pathways

The post Stabilizing Philippine Economic Growth from the Bottom Up appeared first on Economy Watch.

The countries comprising the South Asian Association for Regional Cooperation (SAARC) region (India, Pakistan, Bangladesh, Nepal, Bhutan, Afghanistan, Sri Lanka, and the Maldives) commonly known as South Asia face serious healthcare affordability and accessibility challenges.

The countries comprising the South Asian Association for Regional Cooperation (SAARC) region (India, Pakistan, Bangladesh, Nepal, Bhutan, Afghanistan, Sri Lanka, and the Maldives) commonly known as South Asia face serious healthcare affordability and accessibility challenges.

According to World Bank national estimates, South Asian countries houses more than 390 million poor people and a very significant percentage of total population lies below national poverty line (Figure 1). This large number of population is quite unlikely to afford private healthcare services and heavily dependent on the public healthcare facilities.

Figure 1: % of population below nationally determined poverty line

Source: World Bank

Apart from just high poverty levels, the availability of doctors is another critical challenge. As per World Bank data except Maldives, every SAARC country has less than 1:1000 doctor to population ratio, which is an area of concern (Figure 2). The availability of qualified doctors in the rural areas is dismal and people often tend to self-medicate or take treatment from self-proclaimed doctors who often have no formal education in practicing medicine. It is also important to note that more than 50% South Asian population amounts to approximately 1.17 billion lives in rural areas that often has to travel to cities to access secondary and tertiary care raising tough accessibility barriers.

The high cost of travel to urban health centers coupled with a lack of awareness make the situation worse. Hence, it can be argued that the basic health care demography for these South Asian countries is reasonably identical, and the problem of health care can therefore be looked at from a regional level rather than in the context of an individual country.

Figure 2: Number of doctors (physicians) per 1000 people

Source: World Health Organization

These severe affordability and accessibility barriers to universal quality healthcare demands for innovation in the way care in being delivered to both the poor and people living in rural areas. To understand innovation in South Asia, things need to be put into right perspective. Innovation in health care is not only about technological innovation or new systems of health care financing or upcoming health care delivery models targeting a vulnerable population. Health care innovation is a mix of all the abovementioned elements, which covers all aspects from diagnosis to delivery of service to the end customer, which is the patient in this case.

Often, the misconception is that technological innovation is confined to the sophisticated labs of developed nations. The increasing adoption of frugal innovation by many technological firms has changed this notion dramatically in the past few years especially in the area of health care diagnosis. Intel in India launched a device in 2015 called Lifephoneplus, which enable people to take an ECG and monitor glucose levels by themselves. This device uses the existing bluetooth and wireless network to transfer the health information record by phone, from which it can then be sent to the doctor directly.

Since 2007, GE Healthcare, one of the biggest providers of health care systems, has been developing portable and battery-operated ECG systems out of India’s labs, and these are already being used in rural areas in the developing world. The company has recently claimed to launch the first CT scanner made out of its India facility in 2015 for the developing market, keeping in mind the twin big challenges of affordability and accessibility. The challenges of the developing world are very unique and therefore the technological innovation needs to be tinkered in a way that it takes care of local needs and challenges.

South Asian countries have witnessed nearly a wind of various telemedicine initiatives and, of late, mobile apps operating at different levels and scale. Some examples include Apollo Telemedicine and iClinics in India, mPower in Bangladesh, and Aman Telehealth in Pakistan, among many others. The telemedicine-based business models leverage the information and communication technologies to act as a bridge connecting rural patients with qualified doctors in the urban areas and could be effective in improving the outcomes especially in primary care. What is more interesting is the acceptance that telemedicine seems to have generated among the governments of the South Asian countries.

India has recently announced that an e-Health authority will be set up in 2015, while the Maldives and Nepal and have national telemedicine helplines in place since 2011. However, Telemedicine alone has limited capacity to address the vast healthcare needs in South Asia. There is certainly a need for fostering effective partnerships to increase the geographical reach, impact and service offerings.

So what are the prospects for health care innovation in South Asia? One possibility is that the next wave of innovation in health care will be defined by increasing partnerships, such as those being implemented on a PPP model, where PPP stands for public, private, and people. For instance, the coupling of telemedicine and other innovative health care delivery models with public insurance schemes could be very effective in addressing the huge unmet need of quality rural health care in developing nations. The pairing of the low-cost surgery center, Narayana Health, with state government–supported micro insurance schemes in which poor people pay a premium of only $4–$6 annually in India is one such great success story.

The immediate need is for not only stand-alone frugal innovations or new delivery mechanisms, but also devising a way to better integrate the various actors across the health care delivery value chain. The governments in South Asian countries need to upgrade their role from being merely a support provider to that of being a key enabler to bring all stakeholders on a single platform. If low-cost medical devices and technology-based frugal innovation are not being implemented in public health care systems then the potential impact of these advancements will be very limited.

The health care delivery services could also be contracted to the innovative and effective private health care providers by the different governments so that the much-needed quality primary care services are provided in the rural areas. The public insurance schemes supported by the government can be used as payment for these services. The health care innovation driven by the private sector brings in expertise and ideas but the scalability can only be achieved from active government participation in it, and not merely support.

Therefore, this may be the right time for both the government and the private sector to reconsider the current innovation ecosystem in the health care sector in South Asia from the lens of active collaboration and setting the clear standards for service delivery.

Given that both of the challenges and solutions to healthcare look similar for South Asian countries, it may also be a good idea to form a regional cooperation model to foster innovation in healthcare. Different countries can both share and learn from each other experiences in adopting innovative healthcare delivery practices. The lessons learned from the establishment of SAARC as a regional multilateral institution could also be leveraged in this regard.

Innovation in Health Care in South Asia is republished with permission from Asia Pathways

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Small and medium-sized enterprises (SMEs) play a vital role in the economic growth of a country. Specifically, in developing countries where poverty, unemployment, low income per capita, low literacy rate, and high inflation and interest rates can hinder economic growth, SMEs contribute significantly to the national income and provide employment opportunities (Moktan 2007).

Small and medium-sized enterprises (SMEs) play a vital role in the economic growth of a country. Specifically, in developing countries where poverty, unemployment, low income per capita, low literacy rate, and high inflation and interest rates can hinder economic growth, SMEs contribute significantly to the national income and provide employment opportunities (Moktan 2007).

However, SMEs have low survival rates than large firms because of resource constraints. Innovation is an important resource for a firm’s competitive advantage; it improves the firms’ knowledge-learning abilities. From the perspective of input resources, one of the most common indicators used to measure firm innovation is research and development (R&D) expenditure.

R&D performs two major functions: it generates new knowledge through product/process innovation and increases the firm’s absorptive capacity (learning effect) and, hence, innovative performance (product/process innovation).

However, internal R&D alone is not sufficient and SMEs’ use of external R&D (R&D collaborations) is equally important to achieve higher levels of innovation (Bergman 2010). A recent study investigates the impact of internal and external R&D on the innovation performance of SMEs in India and Pakistan.

SMEs in India contribute 17% to total gross domestic product (GDP) while the figure for Pakistan is around 40%. India’s SMEs employ nearly 15% of the national workforce (about 60 million people), account for 26 million enterprises, and contribute 45% of manufacturing output. In comparison, SMEs in Pakistan employ 75% of the non-agricultural workforce, account for 3.2 million enterprises, and contribute 30% of manufacturing output.

In R&D investment, India has the edge over Pakistan in overall R&D expenditure, which is equal to 1.0% of GDP compared with 0.3% for Pakistan. For cross-country comparison, micro-level data from the World Bank’s Enterprise Survey were obtained for 3,492 SMEs in India and 696 SMEs in Pakistan.

Regarding the comparison of innovation activities in Indian and Pakistan SMEs, a graphical assessment is provided. Figure 1 shows that approximately 46% of India’s SMEs undertook internal R&D compared with just over 9% of Pakistan firms. This suggests that Pakistan’s SMEs are much less engaged in internal R&D.

The level of external R&D undertaking is very low in both countries, suggesting poor alliances or collaboration with other firms and research institutions. Further, most (65%) of India’s SMEs were engaged in product innovation compared with only 22% of Pakistan’s SMEs. This information suggests that the low level of R&D by Pakistan’s enterprises results in low innovation output. A similar trend is found for process innovation. However, the patent and license output is low in both countries. This outcome could indicate that SMEs in both countries predominantly introduce incremental innovations.

Figure 1: Innovation Activities in Small and Medium-Sized Enterprises in India and Pakistan (%)

NGO = nongovernment organization, R&D = research and development.
Source: Author’s Own Calculations

SMEs in both countries rely mainly (over 70%) on internal sources of financing for their innovation activities (Figure 1), while Pakistan’s SMEs have substantially less access to external finance than India’s SMEs. Similarly, public support for innovation activities (R&D grants, subsidies, and tax credits) is low in both countries.

Similarly, Figure 2 provides information on R&D and product and process innovation by firm size. Approximately 31% of small firms in India are engaged in R&D and nearly 46% of medium-sized firms. A much higher share of large firms, 63%, are engaged in R&D. In Pakistan, only 3% of small firms undertake R&D compared with 20% of large firms. Overall, the link between R&D and firm size indicates that large firms in both countries undertake more R&D than do SMEs.

Figure 2: Research and Development, and Product and Process Innovation by Firm Size, India and Pakistan (%)

Source: Author’s Own Calculation

In India, 63% of SMEs have introduced product innovations. In Pakistan, only 18% of small firms have introduced product innovations. Overall, large firms are more engaged in innovation activities in both countries, which suggests they have better financial and knowledge resources. Pakistan’s SMEs have lower innovation capabilities than those in India.

Concerning the estimation analysis, this study reveals that SMEs engaged in both internal and external R&D may have significantly better innovation performance. In addition, the positive relationship between internal and external R&D implies a complementary relationship between these two types of R&D.

This suggests the likelihood that investing in internal R&D would increase the probability of also engaging in external R&D, and vice versa. This result confirms the findings of other researchers. Meanwhile, the negative association between a firm’s size and innovation output suggests that SMEs in both countries may be facing resource constraints.

Does internal and external research and development affect innovation of small and medium-sized enterprises? Evidence from India and Pakistan is republished with permission from Asia Pathways

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Since trade started being emphasized as a locomotive of growth, export promotion trade policies have become a popular option for countries in search of higher economic growth rates. East Asian countries in particular have witnessed a distinct success in terms of rapid economic growth after the adoption of outward-looking trade policies.

Since trade started being emphasized as a locomotive of growth, export promotion trade policies have become a popular option for countries in search of higher economic growth rates. East Asian countries in particular have witnessed a distinct success in terms of rapid economic growth after the adoption of outward-looking trade policies.

There are two main hypotheses regarding the relationship between trade and economic growth.  One is the export-led growth (ELG) hypothesis that postulates countries can attain rapid economic growth through adoption of outward-oriented trade policies (see Golub and Hsieh 2000) and the import-led growth (ILG) hypothesis, which instead accentuates the role of imports in increasing economic growth.  The other is in channeling technology and innovations, supplying capital and intermediate goods, and improving competition to enhance efficient resource allocation (Thangavelu and Rajaguru 2004).

The Republic of Korea adopted different trade policies at different times, ranging from the inward-looking to the outward-oriented outlook. Looking deeper into the growth–trade nexus in the case of the Republic of Korea can shed more light on this ongoing debate.

Trade and growth nexus in the Republic of Korea

The history of the country before the 1960s is marked by two key episodes: independence from Japanese annexation (1949) and the Korean War (1950–1953). Both events have an important place in the history of the Republic of Korea, a country that has transformed itself from one of the poorest countries in the world to a high-income country (and from an aid recipient to a donor) within a very short period of time. Krueger (1997) correctly argues that, compared with the other “three tigers” (Hong Kong, China; Singapore; and Taipei, China), the economic miracle recorded in the Republic of Korea has been at once extraordinary and exceptional, for two main reasons.

First, the economic implications of the Japanese occupation and the Korean War were devastating; political turmoil, social unrest, and low initial capital were rampant. Additionally, the size of the country’s economy relative to other East Asian countries was smaller, and the size alone could hardly guarantee promising economic development prospects.

Trade played a significant role in this scenario, despite the contentious views among scholars on whether it promotes economic growth in general. As can be seen from the figure below, trade openness (exports and imports in sum as a share of gross domestic product) was only 4% in 1961, but reached about 50% in 1995, jumping over 100% in 2010. In addition, the share of imports in total trade had also been higher than that of exports, up until early 2000, which indicates the considerable dependence of the Republic of Korea on imported raw material.

Interestingly, the share of exports to total trade overtook those of imports in the post-2000 period, and this might be attributable to increased exports of value-added products and/or the world commodity price hike. Although the evidence regarding causality between trade and economic growth is debated, the irrefutable fact is that trade has a significant share in the economy and has played a vital role in the rapid economic growth achieved in the Republic of Korea. This is true even if authors who credit the collective efforts of the government in designing appropriate policy, and the people of the Republic of Korea, who have worked hard to overthrow the yoke of poverty, are correct in their arguments (Krueger 1997; Connolly and Yi 2009).

Gross Domestic Product, Exports, Imports, and Trade Openness

TO = trade openness.
Source: Author’s illustration, based on data collected from World Bank (2012) and International Monetary Fund (2009, 2012).

Empirical Evidences

In a recent study, we estimated a vector error correction (VEC) model for cointegrated variables based on annual data from 1960 to 2010 to examine the short-run and long-run causal relationship between cointegrating variables. According to table below, we find that the long-run relationship, as verified by the significance of the error correction (EC) term, unidirectional causality between exports and economic growth, running from exports to economic growth, while it is bi-directional for imports.

In addition, exports, imports, and economic growth in Korea display unidirectional short-run causal relationships. The direction of causality runs from exports and imports to economic growth both in the long and in the short run, which signals the validity of both ELG and ILG hypothesis for Korea. Remarkably, the absence of long-run causality from GDP to exports has an important implication: enhanced export growth in Korea did not track increased economic growth.

Estimates of Vector Error Correction Model

Notes: Values in the table are summed regression coefficients and F-statistic in parenthesis. R2 is the coefficient of determination, S.D. is the standard error of the dependent variable, σ is the standard error of regression, and D.W. is the Durbin Watson statistic. *, **, and *** show significance at the 10%, 5%, and 1% level, respectively.
Source: Author’s computation, based on data collected from World Bank (2012) and International Monetary Fund (2009, 2012).

Moreover, according to the Granger causality test and based on the VEC model in the Republic of Korea, both the exports and imports show unidirectional causal relationships with economic growth in the short run. The unidirectional causality that runs from exports to GDP—thus, absence of reverse causality—might be attributable to the fact that the Republic of Korea diverted exportable items toward its domestic market and away from export markets.

This assertion could be conceivable because of the fact that economic growth, which is ultimately followed by expansion of the industrial sector, but not necessarily, might be expected to lead towards improved performance of the export sector. However, this causality from economic growth to exports has not been evident in this study.

Policy implications

Interestingly, the results imply that a singular trade policy that focuses only on exports might not be effective to enhance economic growth. The absence of causality between economic growth and exports in the Republic of Korea is a consequential finding. Perhaps a major policy lesson stemming from the Republic of Korea’s trade and growth experience is the importance of production for domestic consumption and partial absorption of exports in the domestic market.

This assertion is plausible because we might expect that the industrial expansion associated with economic growth would improve export performance. However, this study does not show any causality from economic growth to exports, thus conforming to “vent-for-surplus” theory. As a consequence of the ensuing increase in aggregate demand, growth may create a situation whereby more national output is absorbed domestically leaving relatively less for exports (Dolado 1993).

The underlying implications are far-reaching: as an economy booms, domestic markets play a vital role in sustaining growth. The outward-oriented trade policy adopted in the early 1960s, together with infrastructure development, laid the foundation for the “miracle” economy recorded in the Republic of Korea. Furthermore, the import-substitution policy in the 1950s contributed to a twofold higher economic growth than what the export promotion policy contributed during the same period in the Republic of Korea (Kim and Roemer 1979, as cited in Kim 1991).

Similarly, the authors found that the export promotion policy between the periods from 1963 to 1973 contributed threefold to economic growth over what import substitution contributed during the same period. This evidence also reinforces the fact that both the import substitution and export promotion policies implemented from the early 1950s to 1970s played an important role in boosting economic growth. Most importantly, it appears that there was a feedback effect from import substitution to export promotion that augmented the total gains from trade in the Republic of Korea.

What can we learn from the trade and growth nexus in the Republic of Korea? is republished with permission from Asia Pathways

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Twenty-first century competition is centered on the knowledge economy, with Europe and North America inexorably charting the course of development in the international arena. In calculated steps, Latin America and Asia have been asserting the need for enhanced knowledge economy strategies in their own pursuits of national and regional development. The historic pattern formulated by Japan has set the course for the People’s Republic of China (PRC), Malaysia, and the newly industrialized economies of Asia.

Twenty-first century competition is centered on the knowledge economy, with Europe and North America inexorably charting the course of development in the international arena. In calculated steps, Latin America and Asia have been asserting the need for enhanced knowledge economy strategies in their own pursuits of national and regional development. The historic pattern formulated by Japan has set the course for the People’s Republic of China (PRC), Malaysia, and the newly industrialized economies of Asia.

These nations have been witnessing a remarkable march from post-industrialization era product-based economies to knowledge-based economies. In essence, developing countries that have succeeded in making a development leap appear to have leveraged opportunities offered by the knowledge economy, and the Republic of Korea is a perfect example. Africa, instead, has been experiencing an overall fall in terms of the World Bank’s Knowledge Economy Index (KEI).

Africa: Lagging Behind

On average, Africa’s KEI has been low and falling since the beginning of the third millennium. If the continent has much to catch up on, this alone does not explain the current scenario. Countries like the Republic of Korea accomplished one of the most spectacular development miracles of the 20th century, transforming from a low-income nation in the 1950s to an industrialized economy by the turn of the century.

Yet, in the post-independence era, most countries on the continent were comparatively more developed than the Republic of Korea. Drawing on this reflection, broad consensus has emerged in academic and policy circles that (i) the Republic of Korea’s economic miracle has been centered on knowledge economy policies and (ii) African countries in their current pursuit of knowledge-based economies can learn valuable lessons from the Republic of Korea. A recent award-winning study (Asongu 2015) addresses this question by looking at patterns and trends in the KEI and its components.

Examining knowledge economy gaps

Using the four dimensions of the World Bank’s KEI from the World Development Indicators for the period 1996–2010, the study presents some knowledge economy lessons from the Republic of Korea for Africa. It examines knowledge economy gaps, diagnoses “policy syndromes,” and prescribes catch-up strategies.

The study used the Republic of Korea as the frontier or benchmark nation, decomposing 53 peripheral African countries into fundamental characteristics of wealth, legal origins, regional proximity, oil wealth, political stability, and landlockedness. The four components of the World Bank’s KEI used are education, innovation, information and communication technology (ICT), and economic incentives and institutional regime.

Diagnosing policy syndromes

A policy syndrome within the study’s context refers to the gap between the Republic of Korea and Africa in their knowledge economies, for a given knowledge economy dimension and a specific fundamental feature of African development. In other words, policy syndromes are negative tendencies of differences in knowledge economy dimensions between African peripheral countries and the frontier Republic of Korea economy.

Increasing differences in a given knowledge economy dimension denotes policy syndromes (PS) whereas decreasing differences reflect a syndrome-free (SF) tendency. Hence, PS represents higher deviations from the frontier or the Republic of Korea.

The table below shows the potential of this approach, with the left-hand-side showing PS (or panels with high differences) and the right-hand-side presenting SF (or panels with low differences). The need for more policy intervention decreases consistently from left to right. This analysis shows, for example, that landlockedness (LL), low income (Low I), and political instability (Con) are high PS fundamental characteristics with regard to the three top KEI components.

Policy Syndrome and Syndrome-Free Information Criteria

Con = conflict-affected countries, Eng = English common law countries, Frch = French civil law countries, ICT = information and communication technology, LL= landlocked countries, Low I = low-income countries, Mid I = middle-income countries, NA = North Africa, NCon = non-conflict-affected countries, NLL = not landlocked countries, NOil = non-petroleum exporting countries, Oil = petroleum exporting countries, SSA = sub-Saharan Africa.

So what?

The relevance of catch-up strategies increases with the importance of policy syndromes identified in the table above. The study suggests the importance of planning efforts on five different fronts as part of a coordinated knowledge economy catch-up strategy.

First, in education, African economies need to take bold steps on this front, including for example increasing college enrolment and the ratio of research and development (R&D) expenditure as a proportion of gross domestic product (GDP). For workers to cope with changing technological conditions, African governments also need to provide technical and vocational training as well as take the necessary steps toward encouraging training at workplaces. While the Republic of Korea continues to import a substantial portion of its technology from more advanced nations, it has developed a solid indigenous R&D platform, allocating about 3% of its GDP to R&D.

Second, in order to facilitate innovation, reverse engineering is preferable to investment in new commodities because the technologies on the continent are more imitative and adaptive in nature. Korean industrialization progressed from imitation to innovation. In the Republic of Korea, industrialization and education complemented one another to accelerate and sustain development: education produced technological learning and industrialization, and the latter boosted the return rate on educational investment, which further promoted demand for education.

Third, in the same vein, reverse engineering in ICT would consolidate the continent’s base in ICT, drive down the cost of technological acquisition, and reduce dependence on business operations. In essence, the Republic of Korea’s ICT success has hinged on the exercise of soundly integrated approaches entailing an industrial policy, an active informatization policy, and competitive and regulatory policies that are well enforced. Africa too can follow this path.

Fourth, the institutional regime of African economies can be consolidated, among other things, by supporting institutions to

(i) be market-focused with the adoption of a development strategy that completely liberates the competitive forces essential for the knowledge economy;

(ii) foster an industrialization strategy that is export-led, exposing African corporations to global competition and compelling domestic industries to invest in innovation and technology assimilation;

(iii) assert credibility in times of crises; and

(iv) co-opting elites to invest in long-term continental goals. The Republic of Korea’s leader Park’s pragmatic approach to thwarting elite corruption seems enlightened in retrospect. Instead of cracking down on them (and some businessmen), as the USA urged, he expropriated their bank shares and obliged them to invest in industries that encouraged import-substitution. The Korean government’s solution to its 1997 crisis sheds light on the advantages of having a credible institutional regime. The government was able to issue new bonds to finance reforms and increase its public debt because of its history of financial credibility and fiscal prudence.

Fifth, concerning economic incentives, whereas an extensive development strategy would expose African industries to more competition and hence induce intensive R&D programs, fiscal incentives from governments remain essential. Protectionist measures are only necessary at initial stages of development in a given industry and should be eventually curtailed to discourage complacency in innovation.

Moreover, incentives to private credit should be provided by African governments to reduce the substantially documented issues of surplus liquidity. This would stimulate private sector development and respond to the growing stream of literature on the need for investment in the continent. The Korean government’s research institutes helped small & medium-size enterprises (a sector with more risk or greater capital requirements), with new “know how” through collaborative R&D.

African governments can learn from the long-term fiscal prudence of the Korean government in establishing post-1997 reforms. Measures such as recapitalization of financial institutions, removal of non-performing loans, provision of financial support to low-income families, and creation of social programs such as unemployment insurance, helped boost the Korean economy.

Some knowledge economy lessons from the Republic of Korea for Africa is republished with permission from Asia Pathways

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Over 31 million consumers in Vietnam researched or purchased a product online in 2015. Just ten years ago, internet connectivity was only starting to become common. Digitization is changing how people trade. There are even more dramatic changes happening under the hood. The way trade is financed, processed and regulated has entered a period of disruption. We take this opportunity to consider the short and long-term implications of digitization of the trade process.

Over 31 million consumers in Vietnam researched or purchased a product online in 2015. Just ten years ago, internet connectivity was only starting to become common. Digitization is changing how people trade. There are even more dramatic changes happening under the hood. The way trade is financed, processed and regulated has entered a period of disruption. We take this opportunity to consider the short and long-term implications of digitization of the trade process. They’re not what you’d expect.

Loosening infrastructure constraints

Digitization and related technologies have already improved development outcomes, even where existing infrastructure appeared to be a binding constraint. For instance, biometric IDs enable 1.009 million Indians to access social services. The number of digital finance users in Asia doubled from 2011 to 2014, despite bank density remaining below the global average.

Simplifying documentation

Trade is a document-intensive process, which slows processing time. Digitization is simplifying the workflow, pushing down costs and reducing risk. Replacing physical documents with electronic versions streamlines time-consuming activities related to the physical movement, recoding and storing of documentation. This also increases accuracy, reduces documentary risk and the likelihood of disputes between parties.

Transparency in risk analysis

Financing trade requires credit and risk analysis, and it is in this step where the disengagement of small and medium-sized enterprises (SMEs) often occurs. SME financial records and collateral are often insufficient, so to assess risk financial institutions must perform more in-depth, and therefore more costly, due diligence on SMEs borrowing small amounts compared with larger firms borrowing much larger amounts.

One novel way to address this problem is an open public online trading system that companies and financial institutions could use to settle transactions. It would enable lenders to see the verified history of a firm’s transactions, including credit history, commercial disputes, and performance risk along the entire supply chain. Such a system would generate the records that SMEs struggle to maintain, and the verified set of transactions would enable banks to assess SME lending risk in a cost effective way. Several consortia of banks are already piloting projects to work through the technical issues. As this goes forward, there is a need for leadership to ensure interoperability.

Standard legal identities

To fully take advantage of online trading systems, SMEs should use a standardized identification number. This is already in progress, and the use of legal entity identifiers (LEIs) has been expanding globally to 448,354 today. A standardized identifier directly reduces the cost of conducting due diligence, and facilitates the collection and tracking of credit, performance and commercial dispute data. The importance of legal identification has already been recognized in the Sustainable Development Goals (SDGs), as SDG 16.9 aims to provide every person on the planet with a legal identity by 2030. LEIs extend the concept to firms.

Total LEIs issued globally. Source: Global LEI Foundation. Note: measure is total LEI as of June of each year.

Total LEIs issued in Asia and the Pacific. Source: Global LEI Foundation. Note: measure is total LEI as of June of each year.

Speeding up the supply chain by modernizing the legal process

The processing of trade is slowed down at multiple stages in the supply chain by an analog legal process. Legal processes could be moved into hyper drive by using smart contracts, which encode and execute the workflow associated with a traditional contract. The contracts are self-executing using ‘if-then’ commands. For example, once an electronic payment is made, the smart contract automatically triggers the associated result, which might be that a shipment is released. Or if a payment is not received on time, a piece of equipment will be remotely decommissioned. As this technology gains ground, it has the potential to increase productivity.

Government-backed e-currency

Cross-border currency settlement is costly. Even though trade is typically processed through an electronic payments system, it is backed by physical money in a central bank, which needs to be verified to avoid counterfeiting and double counting. The current payments system is inefficient, prone to errors, expensive and is therefore ripe for disruption. As consumers all over the world have moved away from cash, central banks are also exploring the potential of issuing electronic currency. The idea is that e-currency would function not as a replacement to physical money, but as an addition to it.

Mobile money accounts (total registered). Source: IMF Financial Access Survey 2015.

Before they launch e-currencies, central banks must consider factors such as implementation details, the capacity of commercial banks to manage the product, and the impact on the financial services industry. However, the trend is inevitable. The Bank of England is exploring its options and both the People’s Bank of China and the Bank of Canada have publicly stated their intention to issue e-currency, although this may be a few years away.

Skepticism around the possibility of creating public open trading windows, smart contracts, government-issued e-currency is understandable given the technical, legal, and regulatory challenges. Yet banks, technology firms and governments have already made significant progress in these areas. The next step is to coordinate various groups involved in trade – bankers, regulators, legislators and companies to agree a compelling vision of the future.

Digitizing trade – how changing the process is changing development is republished with permission from Asia Pathways

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