Li Ka-Shing: When Shanghai Overtakes Hong Kong

Here's a nice illustration of a recurrent debate concerning Asian political economy that I will be able to use for classroom purposes. Hong Kong-based tycoon Li Ka-Shing, known as "Superman" for his business prowess, has offered a pointedly Asian opinion on the prospects of Shanghai overtaking his hometown as the world's gateway to China. While teaching development studies, I make it a point to differentiate the perceived utility of political and economic freedom. The Western view, of course, is that both go hand in hand. On the other hand, many Asian commentators believe that leaders have the right to withhold political freedom provided that economic freedom of the growth-promoting variety is given.
Hence Li Ka-Shing's very Asian point: As the Chinese megacity is granting more economic freedom of the sort Hong Kong enjoys--Shanghai is soon to become a free trade zone with looser capital controls, currency convertibility and so on that other PRC cities do not enjoy--Hong Kong's comparative advantage in those respects may be eroded. What's more, the clamor for too much political freedom among Hong Kong's residents is distracting it from the real task at hand of maintaining its economic preeminence. A card-carrying CCP member could not have said it any better:

Li Ka-shing, Asia’s richest man, said Hong Kong needs to raise its competitiveness if it wants to avoid losing out to Shanghai, where China is setting up a free trade zone, Radio Television Hong Kong reported. Li, the 85-year-old chairman of Hong Kong-based Cheung Kong Holdings Ltd. (1) and Hutchison Whampoa Ltd. (13), said the Shanghai free trade zone “will affect Hong Kong heavily,” RTHK reported on its website, citing comments Li made at a briefing yesterday.

The [Shanghai Free Trade Zone] may allow freer yuan convertibility, liberalize interest rates and relax restrictions on foreign investment, which may threaten Hong Kong’s status as China’s biggest financial center. The former British colony risks falling behind its rivals if citizens there don’t start rallying behind Chief Executive Leung Chun-ying, a Chinese official said yesterday.

“China is a big market and in the long term it can’t just rely on Hong Kong as its only hub,” said Kevin Lai, a Hong Kong-based economist at Daiwa Capital Markets Ltd. “I worry more about the deteriorating political environment in Hong Kong than about Shanghai establishing a free-trade zone.” Leung’s government has increasingly been drawn into a debate about the speed of electoral reform, as opposition lawmakers press for the open nomination of candidates for the election of Hong Kong’s next leader in 2017, rather than by committee as legislated.

Stupid politics, Li Ka-Shing is probably saying...what about making money, Hong Kong's real purpose? And what are we to make of those "Occupy," er, more-communist-than-mainland-self-styled-Communists?

Li said that Occupy Central, the movement proposed by some civic groups to pressure the Hong Kong government into accelerating the introduction of full democracy, may damage the economy and the city’s reputation as a financial center, according to the RTHK report.

Hong Kong residents should focus on the economy rather than politics, as Singapore leapfrogs the Chinese city as a financial center by many measures, the Standard newspaper reported today, citing remarks made to a business delegation by Wang Guangya, director of the Hong Kong and Macau Affairs Office. The city should give more support to Leung, he said.

He may be 85, but alike octogenarian Lee Kuan Yew, he's as sharp as tacks and unafraid to offer an unpopular opinion if it needs to be aired. For what it's worth, the various "Occupy" movements are closely associated with US-based protests. I think he missed an opportunity here to say, "Do you want to make Hong Kong's economy like America's?"

That should shut them up real good.

Taylor rules with assets and credit

One thing we have learned from the last recession is that the financial sector is quite important, that its dysfunction can have important consequences, and this can happen even in the most financially elaborate economy. Some thus call for the health of the financial sector to become a component of every policy maker's dashboard. From a dashboard it is only a small step to include the financial sector into a policy formula such as the Taylor Rule.

Leonardo Gambacorta and Federico Signoretti take that step by deriving from a DSGE model a Taylor Rule that includes asset prices and the amount of credit. So far so good, but why not also include the exchange rate? And more indicators? This is not the purpose of the Taylor Rule. It was devised to be a simple guide to policy, from which you want to deviate when circumstances call you to do so, for example with unconventional policies that cannot be captured with a Taylor Rule, simple or not. The best example is when the Taylor Rule calls for negative nominal interest rates. Would anybody blindly follow this? Of course not, and this is why we should stop thinking in terms of a single equation, especially when one has several policy goals. You needs at least as many instruments as goals. The policy interest rate cannot do everything.

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Japan's Trade Deficits & Halting Nuclear Power

Deficit-running Japanese are about as unnatural as surplus-running Americans, but we now have to reconsider this conventional wisdom. (Things change, my dear.) Recent years have witnessed an unwelcome turnaround in Japan's trade balance as it has swung from surplus to deficit in a fairly big way. While recent easy money "Abenomics" have lifted the general economic outlook there, there is a good reason why most analysts are less sanguine about the prospects for fixing the trade balance.

A contributing factor to this degradation in the external balance has, of course, been Japan's rising import bill from energy imports in the wake of the Fukushima nuclear power plant incident. With practically all of its nuclear powers shut, the nation's energy needs have been met largely by imports because Japan has few energy resources of its own. Not only do rising energy costs dent the spending power of Japanese consumers then as their electricity bills rise, but they also dent Japan's supposedly "mercantilist," export-oriented orientation:

So far, power companies have applied to restart about a dozen of Japan's 50 reactors. Prime Minister Shinzo Abe wants to see the reactors back on line, as they are a vital part of his plan to turn the economy around. Since the Fukushima disaster, Japan has been forced to import huge amounts of coal, liquid natural gas and other fuels.

Mr Abe's government blames these imports for the huge trade deficits posted by Japan since 2011. The average household electricity bill has risen by 30% since Fukushima, denting the government's attempts to boost consumer spending.

One of the Abe government's campaign promises was to bring these nuclear power plants back online. (His Liberal Democratic Party has long been supported by the energy industry for better or worse.) However, even if all fifty existing reactors were to come back in operation as they likely will in a few years' time, the interesting thing is that it is estimated that Japan would still run an external deficit:

After the 1979-1980 oil shock, Japan bounced back smartly, exporting millions of its cheap, durable and fuel-efficient cars and iconic electronic gadgets such as Sony Corp's Walkman. Today, however, there is no turnaround in sight.

Even though increased fuel imports since the March 2011 Fukushima disaster have been a major drag on trade, restarting all of Japan's nuclear reactors would not bring it back into the black, estimates suggest.

The only one of Japan's 50 reactors in operation was shut for planned maintenance on Sunday, with no firm date for bringing back an energy source that had covered about a third of the country's electricity needs.

The "real" culprit may be Japan offshoring production to nearby countries over the years to cope with rising production costs at home due to yen strength. This trend has only accelerated in recent times, causing a diminution of recorded Japanese export output:

That is because of the "hollowing out" of Japanese manufacturing as firms shift production and procurement overseas. Years of yen strength contributed to that shift, but the currency's retreat failed to reverse the trend as the desire to move closer to faster growing markets, tariffs, lower taxes and labor costs all played a role.

A Cabinet Office survey of manufacturers showed the share of overseas production of Japanese companies rose to 17.7 percent last year from just over 13 percent a decade ago and is seen reaching 21.3 percent in five years.

Japan temporarily shutting down its nuclear reactors that account for a third of its energy needs will likely be remembered as a short-lived, awkward moment in its postwar history. However, its shift to running trade deficits is probably becoming more structurally ingrained. As Don Henley once sang--here with admittedly unlikely regard to huge Japanese trade surpluses--those days are gone forever; it should just let them go.

Political connections pay off in the US

It is no secret that political connections help your business. The more more regulated or corrupt your economy, the more likely this is to be true. How much this helps is difficult to quantify. For one, political connections cannot be measured on some sort of scale, and gathering such data would be very difficult as people usually try to hide such connections from the public. And second, how would you measure the impact of of these connections.

Yen-Teik Lee, Bang Dang Nguyen and Quoc-Anh Do find a way by first looking at the university networks among CEOs and candidates to US state governor races and then looking at the stock valuation of firms around the time of close gubernatorial contests. Firms connected to the right candidate gain 1.36% right after the election, and the bump persists. Imagine how large this can become in countries where such patronage is less scrutinized and where regulation is more prevalent.

Third World Solidarity? Petronas Ditches PDVSA

Just when you thought things could not get worse for Venezuela's economic situation, they do. In recent times, Venezuela has sought to partner with other developing countries for exploiting its energy reserves in the likely belief that they would be more understanding of its political-economic situation. Having offended American oil giants through forced nationalization, it arguably had little choice but to look East.

Today's case in point is Malaysia. Just as Venezuela uses its control over a state-owned oil firm to further national objectives, so does Malaysia. Alike that of Venezuela, Malaysian leadership has also been accused of despotic tendencies--especially its perennial party in power UMNO. Allegations of electoral irregularities? Check that too. Despite similarly relaxed attitudes towards Western-style platitudes about good governance, however, it appears Malaysia has its limits and is now fed up with Venezuela. As a result, Malaysia's state-owned oil firm Petronas wants to sell its stake in a partnership with Venezuela's counterpart PDVSA:

Malaysian oil company Petronas said it is exiting one of the biggest petroleum projects in Venezuela's Orinoco belt, after what sources close to the venture and within the firm said were disagreements with Venezuelan authorities and state-run PDVSA. The flagship project, called Petrocarabobo, has planned investments of about $20 billion over 25 years and calls for building a 200,000 barrel per day upgrader to convert heavy crude into light crude oil.

When the venture was formed in 2010, Venezuela touted it as a sign that oil companies were willing to put up with demanding fiscal conditions in exchange for access to the world's largest oil reserves. Petroleos de Venezuela (PDVSA) has 60 percent of the project. Petronas belongs to a consortium that holds 40 percent. Its other partners are Spain's Repsol, India's ONGC and two smaller Indian firms, Oil India and Indian Oil Corp. Petronas holds an 11 percent stake. Sources close to ONGC and Oil India said on Wednesday they were unlikely to buy the stake being shed by Petronas. 

I wonder why there are no takers. To begin with, Venezuelan crude in the Orinoco is heavy and sour, which makes it difficult to refine unlike light, sweet crude oil. On top of this challenge, you have the Venezuelans constantly changing revenue-sharing arrangements adding to the confusion:

"This should not come as a surprise. We have not been excited about this project for the past two years because of the dealings with the government," said the source, who requested not to be identified as he was not authorized to speak to media [...]

One source close to the project told Reuters that frequent changes in the fiscal framework, disagreements with the government of Chavez's successor - Nicolas Maduro - about the business terms, and long delays led to the decision to withdraw. 

So much for third world solidarity since even Malaysians are no longer willing to put up with the arbitrariness of Chavez's successor Maduro. If even the Chinese withdraw next given their unconcern over Western conceits alike transparency and good governance, who will be left to provide the technical capabilities to extract this heavy and sour crude? 

Does US Discourage PRC FDI? Uncle Sam Sez No

This is a follow-up to a recent post about the Chinese food conglomerate Shuanghui International attempting to purchase US pork producer Smithfield. If it pushes through, this deal will be the largest Chinese acquisition of an American firm to date. However, as I mentioned earlier, there are all sorts of dubious "national security" concerns which many believe the US deploys as an excuse for blatantly discriminatory attitudes towards China. I have called it "hog farm protectionism" in this case. Recently, Greg Gilligan, chairman of the American Chamber of Commerce in China, weighed in on these goings-on back in the US of A prior to the completion of the CFIUS process for this acquisition. He too believes that making pork a "national security" issue is, well, hogwash at a time when the United States needs job-creating FDI...even from [gasp, choke!] China:

American policy makers need to ask why the U.S. is not attracting more job-creating Chinese investment. While weakness in European economies has certainly played a role in this recent trend by offering Chinese investors bargain asset prices, we can't ignore the perception that the U.S. harbors an underlying hostility to Chinese investment. Recent political opposition to Shuanghui's acquisition of Smithfield reinforces this perception. Indeed, the response to this deal is representative of several worrying trends.

One is Washington's tendency to define American national security interests unreasonably broadly. Some opponents of the Smithfield deal have suggested that pork production is a national security issue. It's hard to credit that argument in an economy where Americans already have access to an unimaginable array of foods, including a wide range of meats. Another is Washington's lack of transparency in its approach to vetting these deals. Politicians and policy makers are starting to move the goal posts with each deal. One example of this is the CFIUS process itself, the results of which aren't published. Earlier this year, a U.S. district court judge refused to throw out a claim by Chinese-invested Ralls Corporation that it had been denied due process when, without adequate explanation, regulators demanded that it divest its interests in four wind farms. The lack of clarity about how Washington will decide investment issues is a problem.

Meanwhile, back in DC, the folks at the US Treasury replied to what they believed to be a mischaracterization of Committee on Foreign Investment in the US (CFIUS) procedures by Mr. Gilligan. Assistant Secretary for International Markets Marisa Lago counters:

Greg Gilligan, in "America Needs the Smithfield Deal" (Sept. 4) mischaracterizes the role and processes of the Committee on Foreign Investment in the United States (CFIUS) and inaccurately describes the U.S.' policy on foreign investment.Contrary to Gilligan's claims, the CFIUS review process is non-discriminatory and transparent in its rules and procedures [...]

Unlike other countries that place restrictions on investments in broad swaths of the economy, impose ownership caps, or review foreign investment for economic and other considerations unrelated to national security, CFIUS applies the same rules to each transaction that it reviews, regardless of the country of the investor or the economic sector of the investment. We welcome investment in our entire economy and from all countries, and from private and state-owned investors alike. Unless a transaction presents a national security risk, we welcome it.

And while we are required by law to keep information filed with CFIUS confidential, the rules that govern the CFIUS process, including its governing statute and regulations, are publicly available and fully disclosed online. It is a process that enables us to protect national security in a manner fully consistent with our policy to encourage foreign investment.

Her response reminds me of Robert S. McNamara's: answer the question that you wish to answer, not what was actually asked. Many discussions that make or break PRC investment are conducted in backroom, informal meetings and not in public deliberations. So, saying that the rules are disclosed does not necessarily mean that the investors-to-be have a fair opportunity to air their views during deliberations. More importantly, she skirts the problem that "national security" is made to cover pretty much everything they can think of: If the Chinese purchase is unpopular with the political classes, they will find a way to relate it somehow to "national security."

Going back to Gilligan, the evidence he cites for Chinese contempt is that the PRC is increasingly resorting to similarly vague and open-ended reasons that may be used to discourage US investment in the future:

Rules passed in 2011 allow the Ministry of Commerce to review a transaction's national security impact based on considerations of "economic stability" and "social order," without defining what these terms mean. Beijing also imposes an opaque and unpredictable review process on many foreign investments. It is hard for American businesses, or our government officials, to persuade Beijing to change such rules when Washington increasingly behaves in the same way.

At any rate, the CFIUS has since cleared the way for the Shuanghui-Smithfield deal. Whether through embarrassment if it went ahead with "hog farm protectionism," do remember that past years have witnessed US opposition over what I would argue are similarly specious "national security" grounds. Consider the cases of Huawei-3Com and CNOOC-Unocal where the prospective Chinese investors pulled out knowing they would be turned down anyway.

Still, the Smithfield deal shows improvement on the part of the US, but keep in mind that the more relaxed Canadians have permitted far larger deals with the Chinese in industries supposedly subject to "national security" concerns. Me? I will reserve judgment until a larger mooted purchase of an American firm in energy or high-technology sectors by a Chinese one comes around.