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The California Pension Crisis

 

The bankruptcy of Detroit in 2013 shocked the country due to its sheer size, but was also fairly expected given the decline of the American automotive industry in the 2000’s. Less commonly known is that in just a four year period from 2008 to 2012, three cities in California–San Bernardino, Stockton, and Vallejo–also filed for bankruptcy, with Stockton having held the record for the biggest city to file for bankruptcy prior to Detroit. While California was hit hard by the 2008 financial crisis, the three California cities that declared bankruptcy did so mainly because they found themselves unable to fund the pensions of their retired public sector workers. In fact, although California as a whole has not gone bankrupt like these cities, it is facing the same problem of pension payments. Every year, the State of California collects money for pensions from current employees and employers, but this amount is less than the amount they pay in pensions, thus are running a deficit. This has lead to CalPERS, the California Public Employees’ Retirement System, despite being one of the biggest investors in the world with over $300 billion in assets, being worth less than 68% of what it owes in pensions. California’s other main pension system, the California State Teachers’ Retirement System (CalSTRS), also has the same issue with unfunded liabilities of $97 billion, being worth only 64% of what it owes. These deficits are expected to continue growing if kept untouched, with spending on pensions rising each year as more public sector workers retire. This brings California in a very difficult spot of having to make several major decisions and having to do so quickly before these deficits snowball.

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Source : CalPERS

Explanation of the Issue:

While there are many reasons as to why California is in a pension crisis, it can be simplified into several key causes. The first cause is that California offered a far too generous pension plan to public sector workers around the Dot Com boom in the late 1990’s. One particular unsustainable pensions bill that was passed was the SB 400 in 1999. The bill offered most workers to have a higher percentage compensation at a lower retiring age. For example, highway patrol officers’ pension benefit formula changed from 2% at 50 to 3% at 50, which means that if they work for at least 30 years, they are able to retire as young as 50 years old and get the full yearly benefit of 3% multiplied by the number of years worked of their final salary. This is a significant change, with police officers who start working at age 20 retiring at age 65 with  a pension worth 135% of his salary at retirement. Another important factor is that this bill was retroactive, meaning it applies to all workers and not just workers who were hired after this bill, thus the increase in pensions immediately started taking effect.

Such a generous pension plan was set based on several incorrect assumptions. During the Dot Com boom the economy was in a strong bull market, leading CalPERS to expect a very high rate of return of 8.25% per year on average over the next 11 years. This assumption turned out to be wrong very quickly, with the return going negative in just one year as the Dot Com bubble burst in 2000. Even after recovering from this poor start, investment returns struggled yet again with the 2008 financial crisis. CalPERS has since then gradually lowered their expected investment return rate, the most recent decrease coming in 2016 to 7% by 2020 after not being able to meet their 7.5% target for 2 years consecutively.

Another factor CalPERS failed to assume was that life expectancy would increase by approximately 2 years from 76.6 in 1999 to 78.6 in 2017. Although this may seem like a small change, if the current 600,000 retirees live another 2 years than what was predicted, that means 1,200,000 more pension payments of approximately $35,000 per year, or $42 billion in total. With there being more state employees who retire each year than retirees who pass away, the number of people who get pension benefits keeps increasing every year. The number of retirees with pensions will also not decrease in the future because California is still increasing public employment despite these issues.

In addition to this, public sector wages have also been rising. With state worker labor unions becoming more organized and stronger, new wage increases have been negotiated every few years. These increases have been significant and persistent in recent years, and the total wages for California state workers excluding college, university or court employees has risen from around $15 billion in 2015 to $17.7 billion by the end of 2017. Due to the pension payments being a percentage of an employee’s wage, these raises also cause an increase in total payments.

For the aforementioned reasons, California now finds itself in a situation where it lacks funds in their investments and face increasing pension payments every year. While CalPERS spent $23 billion and CalSTRS spent over $14.5 billion in fiscal year ended June 2018, this spending is set to keep increasing. By 2023-2024, CalPERS is expected to have to pay approximately $34 billion annually, while only collecting $28 billion. The gap between the payments and contributions can be shown by this graph published by CalSTRS, in their 2017 auditors report. For more than a decade, benefits have exceeded contributions, with the 2016-2017’s contributions being almost $4 billion in deficit to benefits.

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Source: CalSTRS

The only difference between what goes into CalPERS and CalSTRS is that CalSTRS is funded through 3 sources–state contributions, employer contributions, and employee payments–while CalPERS uses investment earnings in place of employers contributions. For CalPERS, every dollar spent on pensions, 59 cents come from investment earnings, 28 cents from employer contributions, and 13 cents from employee payments. Keeping these factors into consideration, there are only two real solutions to this problem. Either to raise contributions or to lower benefits. There are approximately four options available in raising contributions: increasing investment earnings, state contributions, employer contributions, or employee contributions.

1. Investment earnings :

Increasing investment earnings if possible would be very convenient as it does not adversely affect other stakeholders, but it is not realistic for CalPERS. As discussed in previous paragraphs, California previously failed to meet its 8.25% target in 2015 and 2016, so it has lowered the target all the way to 7% for 2020. Attempting to readjust the target rate higher will result in having to invest in more risky investments, making the fund more susceptible to market fluctuations. Historical data shows that while 2016-17 did have a great return of 11.2%, which boosts the last 5 years’ average return to 8.8%, the investment return during this period was very volatile with 7.3% deviation. If we move track back further, investment return was 4.3% in the past 10 years, much lower than the current revised 7% target. Considering this past data, it is very unlikely that CalPERS will make riskier investments, since any further losses could jeopardize the pension fund.

CalPERS Historical Investment Returns and Volatility

Years 2016-17 2012-2017 2007-2017 1997-2017 1987-2017
Investment Return (%) 11.2 8.8 4.3 6.6 8.2
Volatility (%) – 7.3 13.4 11.5 10.1

Source: CalPERS

2. State Contributions :

State contributions are also difficult for California to increase, as state law prevents state contribution rates from rising more than 0.5% per year. With the current contribution rate of 9.828 %, CalSTRS can only rely on state contributions to a limited extent. There is also the option of directing more bills like SB 84, which made the state pay an extra $6 billion to CalPERS in 2017, but these bills are more of a special case. Raising state contributions leads to a further problem of the state having to use funds originally allocated to other purposes to pension payments, or raise the total fund size by taking measures such as increasing taxes. With California already having such a high tax rate, such a decision will be very difficult to push through.

3. Employer Contributions :

Employer contribution rates vary according to which sector the employer is in. For all sectors however, rates have been on the rise, the reason being from an increase in normal costs – costs theoretically required to pay pensions the current active employees, and not to pay the unfunded liabilities. Rates rose by about 1% in each sector from 2017-18 to 2018-19, and this trend is expected to continue in the near future.

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Source: CalPERS

While school employers have lower contributions rates to payrolls, they are also subject to increases, rates going up from 13.88% in 2016-2017 to 15.531% in 2017-18 and 18.062% in 2018-19. While raising these rates may seem to only hurt employers, all of these increases in employer contribution will in the long term spill over to users and employees of these services. State safety employees may face lower wages in order for the employers to cut costs and maintain profits, or prices could rise for state industrial related goods. Another example being potential decreases in salaries for professors at University of California schools and increases in tuition for students.

4. Employee Contributions :

Employee contributions vary similarly to employer contributions, with employee separated into 5 different groups, Miscellaneous tier 1 or 2 – state employees in administrative positions, industrial tier 1 or 2 – employees in California Department of Corrections and Rehabilitation or state hospitals, state safety – employees in correctional or forensic facilities at state hospitals or developmental centers with state safety named positions, peace officer/firefighter, and California highway patrols. These employees have contribution rates that correspond with their future pension benefits.

Contribution rates by Sector  

Misc. Tier 1 Misc. Tier 2 Industrial Tier 1 State Safety Peace Officer/Fire-fighter Patrol
8-10% 3.75 % 8-9 % 11 % 13 % 11.5 %

Source : Human Resources Manual

Provisions have been made to raise contribution rates, but have been difficult as it must be met with a corresponding increase in pension rates for it to be fair. Despite this, California did create a plan in 2013 called The Public Employees’ Pension Reform Act of 2013 (PEPRA) which has dramatically changed situations for employees hired after 2013. The act requires these employees to contribute 50 percent of the total annual normal cost of their pension benefit as determined by the actuary. Therefore, they have to contribute half of the normal cost of 12.91 %, 6.5%. This rate will continue to rise automatically as normal costs rise, the PEPRA members facing an contribution rate increase to 7% in 2018-19.

Provisions like these will increase employee payments into the pension funding system and will help reduce the unfunded liability. However will need to be carefully implemented as state workers may feel discouraged from a deduction in real wage, causing risks such as more workers choosing the private sector over the public. In fact, labor unions hold a lot of power in California, just recently, the United Teachers Los Angeles, a labor union for public school teachers in LA, had a week long strike which lead to a 6% increase in wages and additional staffing. Due to the immense costs of public worker strikes, states are forced to negotiate.

 

Reducing Pensions:

While the CalPERS Actuarial Office has been using a 3% per year payroll increase rate, this number seems to be outdated, with the payroll growth being 3.7% in 2017.  In order to maintain the rate at 3%, the formula calculating pensions need to be updated. There are several methods, such as raising the retirement age by a few years, changing the wage from which a worker’s pension is calculated from, or reducing the cost of living escalators. However any change will have to be non-retroactive – it cannot affect any workers that have already been employed. This is because of the “California Rule” which states that workers are presented a pension benefit plan when they are employed, and that this pension can only be replaced by one that is equal to or increases benefits. This protection means that any change made now will take many years to actually cause any large change in the growing pension payrolls.

PERPA was an attempt to reduce pensions, along with getting more contributions from members, with it changing the benefit formula to 2% at 62, a lower percentage and a higher retirement age.  Former Governor Jerry Brown, who made this plan, also attempted to change the plan into a 401k style one, which is not defined benefit but rather defined contribution. However, this was rejected with huge opposition from labour unions, and Brown left office while still arguing with the state Supreme Court on changing the California Rule. Realistically, PERPA is a step forwards, but not significant enough to solve the problem. As long as the California Rule stands, solving the problem by reducing pensions will be a very long term plan.

 

Conclusion:

Analysis of the various methods of reducing CalPERS’ unfunded liabilities shows that most realistic methods will result in employees suffering. An increase in contributions by the state or employers will have spillover effects to all employees, and a plan like PEPRA will result in direct costs to future employees. Increase in contributions could also mean effects on unrelated California citizens who will have to face the decisions the state and employers make in order to maintain profits during rising costs.

The 401(k) style plan that Jerry Brown pushed for does seem reasonable when looking at how the burden of pensions is divided. A 401(k) plan would share the burden between the employees and employers, and could do so in a way in which benefits can automatically balance out employees’ own contributions. The current defined benefit system, on the other hand, puts too much burden on the employers, and the employees’ contributions are not what determine their pensions. However, it has been very difficult to implement this, as shown by the rejection of Senate Bill 1149 last year by labor unions. The biggest opponents of this bill, which simply offered an alternate 401(k)-style plan to new state workers, were K-12 teachers. This is because the current plan gives a higher benefit in comparison to the 401(k) alternative after one teaches for around 20 years, and 75% of current California teachers will serve 20 or more years before they retire. The biggest advantage of the 401(k) that makes it popular in the private sector is that there is no vesting period, one does not have to work in the same company for years to be allowed pensions, but this is not very attractive for California teachers. It can also be understood from the teacher union’s perspective that allowing an alternate plan could lead to the state attempting to make it the only available plan in the future, therefore wanting to reject it at all costs.

We can also learn several key lessons from the pension problem. We can see that when making decisions that will have a huge effect in the long run, it must be made with a lot of care for any risks. It must not be overly optimistic like SB 400, which was issued with an expectation for the economy to continue growing at a high speed and failed to consider economic fluctuations. We can also analyse that caution is especially necessary when the market is in a long bull market, like the years leading up to 1999 when SB 400 was issued, which coincidentally is very similar to what the stock market looks like right now. There is no such thing as a never-ending bull market, a recession no matter the size being inevitable. The fact that the US economy has looked so good in recent years, yet California has failed to meet investment return targets, also exemplifies just how poorly the funds have been managed.

This crisis is also an example of decisions that were made primarily for political gain, and without knowledge of long term economics. SB 400 was made partially because of the strong support and voting power of the public sector employees – short term gains being a factor that still affects many decisions in the government and state. The bill is especially bad because of the rigid nature of pensions, and the California rule which cements past plans through law. This California rule makes sense if the past benefits were reasonable, as it protects the state employees, but in a situation like this where it is causing a crisis, it is up to debate. As Governor Brown ended his term mid-negotiation, it will be up to the new governor, Gavin Newsom, to take his predecessor’s plans and set them into action without succumbing to the pressure of the labor unions.

 

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The Economics of Esports

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Ten years ago, few people believed that playing video games as a competitive professional sport could become a billion dollar industry. Yet this is precisely what has happened. Within just one decade, the esports industry has grown tremendously and is expected to make more than a billion dollars in revenue in 2019. Many investors are looking at the industry as a new investment opportunity and are establishing new esport teams to compete in official tournaments. To understand how these esport teams have achieved such financial success, this article will analyze the competitive online video game, League of Legends (LOL). This game’s success is remarkable–viewers recently spent a total of 10.65 million hours watching the games in just a span of 8 days during LOL’s biggest international tournament, the League of Legends World Championship. This is a result of both the game’s international popularity and an organized league structure that has made esports teams willing to compete.

The Revenue Side

Sponsorships

Many esports teams make a majority of their revenue, approximately 90%, from sponsorships and advertising. These revenue streams include sponsorships in exchange for advertisement on the player’s jerseys, similar to those of traditional sports. For example, the energy drink brand Red Bull and the smartphone company HTC have jersey sponsorships for Cloud 9, a legacy esports team. These sponsorships allow companies to gain nationwide recognition, and potentially international recognition as well if the esports team qualifies for international tournaments. While jersey sponsorships are not as effective as they would be in traditional sports since the camera is not centered around the players, the main reason why they still sponsor esports teams is due to the teams’ strong social media presence. In the digital age, esport teams allow sponsors to target demographics that have been traditionally difficult to reach through standard marketing tactics. Millennials typically watch less television and listen to the radio less often than older demographics, increasing the importance of social media marketing. Players and sponsors will typically collaborate on advertising campaigns; Grubhub, for example, recently posted several videos on their Youtube channel featuring Cloud9 players. Research has found that the average age of esports viewers is 29, with 39% of the total audience in the 25-34 age range, thus illustrating the effectiveness of marketing towards a young audience through esports.   

Prize Money

Prize money in esports is increasing at an incredible rate. While prize pools amounted to a mere couple thousand dollars at most in the past, they now reach several million dollars for large competitions. League of Legends for example distributed a total of $4.9 million for their World Championships last year to teams according to their final standings. This money does not go directly to the players, and most of it is absorbed by the organization as revenue. The esports team in this sense acts like a company, with the players as employees on yearly contracts. This meaning that the liability/ownership of any team related events are all held by the team owners. Domestically, teams in the North American League Championship Series (NALCS), after the franchising starting from 2018, are entitled to 32.5 percent of the league’s revenues. Half of this is evenly distributed, while the other half is allocated according to each team’s standings and viewer/fan engagement contribution. The way in which the last component is measured is not explicitly stated, but is predicted to be mainly related with the peak and average viewership of the team’s games throughout the season. The fan base growth incentive is a big priority for the League’s organizers, with several the questions they ask new teams being: How does the team plan to engage with and acquire fans? What’s their strategy for providing value to fans through merchandise, content and other opportunities? Why should fans support them? The league only allowing teams who plan to work on fan engagement to compete.

Merchandise Sales

Each esports team similar to traditional sports offers apparel and other related merchandise. These include jerseys to t-shirts, and also other gaming related goods such as mouse pads which target their unique audience. Teams take various approaches such as the 100 Thieves, a new team formed in 2018, which uses a “hypebeast” style of merchandising, with high prices and limited quantity. This has been very successful for them with apparel selling out within 20 minutes of release. This is not surprising considering the low elasticity of demand that a lot of these core fans have. By setting price high and quantity low, 100 Thieves also attempts to make team merchandise into a Veblen good, a good that is demanded more when prices are high, as the good has value as a status symbol. One issue stopping many teams from getting larger income from this sector is that esports stadiums are still very small compared to traditional professional sports. Since less fans can attend the actual games in person, it lacks incentive for fans to support teams at the stadium by wearing merchandise. A research paper,  “Comparison of eSports and Traditional Sports Consumption Motives” by Donghun Lee, Ball State University and Linda J. Schoenstedt, Xavier University, addresses this difference in esports and traditional sport fan behaviors . In their analysis, it is shown that compared to traditional sports, esport consumers spend relatively little on sport merchandise and attendance. Therefore it may be fair to assume that this is not an area of priority from the esports team’s perspective. Merchandise will most likely stay a smaller portion of the team’s revenue in the long run, even as the industry continues to mature, due to the fundamental differences in consumption and fan support as discussed. This fact further justifies 100 Thieves’ stance on team merchandise as a component that improves their team value rather than one that significant profits can be made through.

Content Creation

Although very small compared to the other sectors, esports teams also make money through content creation on platforms such as Youtube and Twitch. Popular teams like Team Solo Mid have regular videos on how the teams are doing, and these videos rack up above 100,000 views each. With advertisement revenues on each view, the teams can keep funding high quality videos. Teams like Team Liquid take this onto a higher level by partnering with 1 Up Studios, an esports production company, showing just how much care they put into this sector. The income from this sector is very small and for some teams is a loss, but its spillover effects are huge in terms of reaching new audiences and expanding their fan base. The fan base, as we can see, being the number one priority in attracting sponsors.

The Cost Side

Initial Investments

Many new Esport teams require significant investments on top of sponsorships in order to pay for the costs listed below. While raising cash for esport teams was very difficult in the past, this is becoming much easier with esports becoming more recognized. Cloud 9, recently raised $50 million through their series B funding round, led by Valor Equity Partners. They intend to use this money in constructing their training facility which they will also use as an office. Individuals are also investing large amounts of money into teams through these equity investments. Entrepreneur Scooter Braun and artist Drake recent became co-owners of the 100 Thieves through it’s Series A funding round. With this addition, this new team has had a total investments of more than $25 million in just one year.

Player and Staff Salaries

As esports becomes more major and accepted worldwide, player wages have increased significantly. While in the past, there were even cases where players were not paid any money other than prize money distributed, nowadays taking the example of LOL, players are paid more than an average first year undergraduate. The current minimum salary of players in the NA LCS is $75,000. Many of the more established players have higher wages, some rumored to go up to a million. This is very similar to traditional sports, where the high competition rewards “superstar” players, giving them significant negotiating power to demand high wages. Another factor for the bidding up of wages is the high labor mobility of esports players internationally, with many teams in the US having players from Europe or Korea. These players are attracted to the high wages and better job security North American teams offer, and are physically able to do so. On the other hand, there are also other costs related with labor, such as coaches and other staff. While these are smaller costs individually, they are larger in number. The number of non-technical staff is starting to increase in supply with the recognition of esports teams as a fairly stable company, so wage growth for these non-player employees is unlikely to match the pace of superstar player salaries.

Capital Costs

In order to increase productivity of the players, many of these teams have chosen to take a “gaming house” system, where players live in the same house and train up to 12 hours a day while other living issues are all sorted out by staff including chefs and cleaners. In order to reduce costs in this section, teams like 100 thieves have signed partnerships with housing related companies like Rocket Mortgage by Quicken Loans. On top of gaming houses, other teams have purchased training facilities such as Team Liquid’s Alienware training facility so that they can train in a setting specifically made for esports. This is another example of just how close esports is coming to traditional sports.

Advisement/Content Creation

As mentioned in the revenue section, while content creation is a source of revenue, it is also an area where teams invest a significant amount of capital and man power. Many teams have marketing teams working with the social media accounts of the team, and graphic design teams to make content such as posters of their players to advertise. The importance of content creation is almost equal to team performance as it is how the team can attempt to gain fan bases. For example, teams like Flyquest while lacking recent success, have managed to maintain popularity by producing content around their veteran players. Though players are the ones operating in the public spotlight, esports teams typically have dedicated teams operating behind-the-scenes to cultivate larger fan bases.

Franchising Costs

A recent big cost for NA LCS teams was franchising costs. The NA LCS changed the structure of the league by setting the team limit to 10 permanent teams, who will not face risks of relegation as they would have in the past. The cost in exchange for this right was $10 million, a sizable price tag for the organization. This cost is a fixed cost which could be amortized along the many years that the team competes in the league. The benefits of this $10 million is that they can expect to make long term projects around their esports teams, improving them from a mere short term investment. While there are concerns on the league’s level without relegation, it is a format that many major teams in the US use such as the MLB or NBA.

Outlook

Analysis of the revenue and costs of esports teams we can see that things are moving towards traditional sports with a lot of the costs becoming long term investments into the teams. It can also be seen that with 90% of revenues coming from sponsors, a lot of these costs go into the final goal of making the teams more popular. There are two main ways by which teams can do this, through better content creation and marketing, or by competitive success. The positives are that teams can meet these demands with long term planning now that traditional league structures such as franchising have been implemented. The franchising also incentivises teams to improve their competitiveness and viewership numbers through prize money distribution. The enthusiasm of new investors and the fact that is it in a small bubble phase right now will also contribute to making esports into a sustainable industry in the future.

A different concern is the demand side of esport, especially whether or not esports consumption will continue growing. Looking at the general trend, viewership seems like it will continue increasing exponentially as shown in the data provided by Newzoo. However it is necessary to understand the reasons for why these people view esports and if it will continue.

esportsgraph

Source: Statista 

An interesting study shows the differences in esports and traditional sports’ consumption. The report “What is eSports and why do people watch it?” by Juho Hamari, Max Sjöblom, attempts to explain the reasons for viewing esports through the Motivational Scale for Sport Consumption (MSSC). They found that from the components of MSSC, watching sports as a means to escape everyday life, knowledge acquisition related to the sport, novelty of new players and teams, enjoyment of aggression and the aggressive behaviors the athletes exhibit, were the four highest positively and statistically significantly associated factors with the frequency of watching eSports. What is particularly interesting is that this last factor, the aggression enjoyed by viewers is something that become less visible in traditional sports as they become modernised. For example, Major League Baseball has taken major steps to reduce injuries at the plate, with them implementing the collision rule in 2014 which penalises physical contacts on purpose at home base. Many sports are also implementing video replay systems in order to accurately penalize rough plays, this being emphasised most recently in the Soccer World Cup. This aggression on the other hand is automatically implemented in most video games in the form of kills or attacks. Famous esport games that build around aggression include shooting games like Counterstrike or more mild games like Fortnite. What this means in economics is that esports and traditional sports are not substitutes to each other from a consumption perspective. Therefore there will be no need for esports to steal consumers from traditional sports, reducing one of the huge potential obstacles to esports expansion. However this also means that esports will need to make conscious efforts to amass their own consumer base as it will not simply be able to attract the same consumers as traditional sports, one of the major issues the franchising of League of Legends is attempting to tackle.

In conclusion, the demand (viewers) and supply (esport teams) for esports seem to be moving towards a more sustainable growth model with the supply side understanding what their priorities should be – competitiveness and popularity, and incentivising it through methods such as franchising and prize money distribution. It should also be noted that while using the word “sports”, there are key differences in consumer behavior that push it into prioritising sectors such as content creation over merchandise. Performance may catapult esports players to initial fame, but it is personality that keeps viewers coming.

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Foreign Aid, Blessing or Bane: A Case Study of Foreign Aid’s Impact on Sub-Saharan Africa

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In August of 2018, the Trump administration introduced new conditions on billions of dollars in foreign aid spent through the UN and other multinational agencies. This decision revitalized the discussion of foreign aid, a hotly contested issue. According to Oxford Public International Law, foreign aid refers to the transfer of resources from a donor to a developing country. It comes either in the form of loans, which require repayment in the future, or in the form of grants. While foreign aid is often intended to help developing countries, some groups within donor governments use foreign aid as a tool to harm the economic independence of developing countries by creating dependency and other unfavorable political conditions in recipient countries.

Countries in Sub-Saharan Africa typically receive large amounts of foreign aid. According to New World Encyclopedia, Sub-Saharan Africa is the term used to describe the region of the African continent that lies south of the Sahara Desert. Although countries in this region posses vast amounts of natural resources, the region remains impoverished, and the continent of Africa as a whole has been identified as the world’s poorest inhabited continent. In recent years, however, countries in Africa have experienced significant improvements in infrastructure, education, and healthcare, and in 2017, the African Development Bank reported Africa to be the world’s second-fastest growing economic region. In some instances, this success can be attributed to foreign aid. While foreign aid has been playing an important role in this continent’s development, its real impact, true intention, and future effect, however, still remain controversial. This article will examine both the short-term and long-term impact of foreign aid in Sub-Saharan Africa.

One of the many types of foreign aid is emergency aid, which is rapid assistance given to countries suffering from immediate distresses, such as natural disasters. In Sub-Saharan African countries, where health-care related infrastructure remains underdeveloped, short-term emergency aid can be beneficial during a time of crisis such as natural disaster.

According to USAID, more than 13.1 million people in Sub-Saharan Africa face emergencies due to disasters such as drought and cyclones during the Lean Season. Among them, about 7.1 million people experience food shortages and 3 million experience water shortages. In such instances, foreign aid has proved remarkably effective: foreign aid assistance for cyclone-affected populations in Madagascar restored access to safe drinking water for 32,000 people in 2017.

While foreign aid does provide short-term relief in face of natural disasters, the long-term impact of this politically tied aid is detrimental. Foreign aid, especially food aid, often results in massive influx of cheap goods. Though intending to help consumers in recipient nations, donor countries often floods recipient markets with cheap or even free goods. In the case of Sub-Saharan Africa, countries’ local businesses are subject to being squeezed out of the market, thereby undermining local industries. This is what happened in Costa Rica in 1980s after cheap imported grain flooded into local market. From 1984 to 1989, the number of farmers growing corn, beans, and rice fell from 70,000 to 27,000, amounting to loss of approximately 42,300 livelihoods. The same also happened in Kenya. In 1993, European Union (EU) wheat was sold in Kenya at a price level that was 50 percent cheaper the domestic level with the hope of relieving the damage in agriculture after severe drought in 1992. As a result, in 1995, Kenyan wheat prices collapsed through oversupply, damaging local agricultural and food production, and creating severe poverty for this country in which 80 percent of its exports are accounted for by agriculture. While the motives behind foreign aid are ostensibly benevolent, these instances show how easily the intention can be twisted and turned against recipient countries.

The essence of neo-colonialism is that the state which is subject to it is, in theory, independent and has all the outward trappings of international sovereignty. In reality, its economic system and thus its political policy is directed from outside.

The loss of sovereignty by neo-colonialism occurs through a variety of mechanisms. First, foreign aid, when misused, can cause substantial harm  in recipient countries. While the initial purpose of development aid is to help boost overall social stability and economic performance in developing countries, recipient countries often divert a large percentage of development aid into military development that is directly used to repress domestic dissent. For example, in the Arab Spring of 2011, governments across Africa used their armed forces to hinder the democratic process. Reports showed that around 40% of African military spending is financed by OECD aid due to aid fungibility, which refers to the possibility that aid is used in ways not intended by donors. The vague restrictions on foreign aid enabled donors to  use aid, especially bilateral aid, for their own purposes. Take the Economic Support Funds (ESF) in US bilateral economic assistance as an example. Although it is officially listed as economic aid, ESF is considered as a form of military assistance since it is used to financially support countries that are deemed politically and strategically important to US. In more extreme cases, donor countries even directly aid local regimes to suppress dissent. For instance, Britain provided the government of Sierra Leone with tanks, which were then used to attack dissidents during a civil war in 1990s. For decades, African countries’ failure to independently operate their own governments gives colonialism a chance to return in a more subtle form and harms the already established social and economic orders.

Recognizing the dilemma brought by foreign aid, Sub-Saharan African countries must reconsider the types of aid that are permitted to flow into their countries. While the short-term benefits brought by foreign aid to Sub-Saharan African countries are necessary and significant especially during times of emergency, the recipient countries must be aware of the potential harm, long-term reliance, and other political implications that come with it. At the end of the day, achieving economic advancement is necessary to fulfill greater political and economic independence, a major goal for Sub-Saharan African countries that relies on their own ability to develop skilled and educated labors, reduce corruption in political institutions, and reinforce capitals of production through technology development and infrastructure improvement.

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Jadarite, Kosovo’s Threat, and Political Instability: Foreign Direct Investment in Serbia

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In 2004, reports surfaced of a new mineral in Serbia. Analysis from the Museum of Natural History in London confirmed that the mineral was previously unknown to geologists. The discovery of this new mineral, jadarite, in Serbia’s Jadar region has garnered the attention of a variety of foreign industrial and mining firms, like Rio Tinto Mining, a leading investor in Serbia.

The discovery of jadarite also sparked further interest from investors around the world, leading to a rapid increase in foreign direct investment (FDI) in Serbia. This past year, Serbia rose to the top of IBM’s Global Locations Trends Report because of the large number of jobs created by FDI relative to the country’s population.  FDI inflows have expanded beyond the mining and processing of jadarite to a variety of other industries throughout the Serbian economy. The report states that Serbia “continues to receive significant inward investment in key sectors such as textiles, transport equipment, chemicals and electronics,” noting that manufacturing jobs in particular accounted for “almost 80% of all jobs created from FDI.”

According to the National Bank of Serbia, the gross inflow of foreign money has been consistently increasing since 2014, reaching €2.1 billion in 2016 and peaking at €2.5 billion euros in 2017. Goran Knežević, Serbia’s Ministry of Economy, attributes these influxes to the government’s persistent effort to make the region more attractive to foreign investors, particularly through corporate reforms and job training policies.

If Serbia hopes to continue reaping the gains from foreign investment, however, it must continue working to provide a stable investing environment through improvements in both its domestic policies and its interactions with neighboring nations. Continual tension with Kosovo not only threatens the tepid peace in the region, but also investors’ faith in the country as political conflict is both risky and costly. Further, investors question Serbia’s ties with Russia given Russia’s oil investment in the region. As such, many Western investors feel uneasy investing in a state with such close ties to an adverse country.

Political questions aside, Serbia has been working toward more corporate-friendly policies since 2010. This effort has included the creation of a specialized office for company registration, eliminating minimum capital investment requirements, and expediting corporate registration processes by reducing paperwork requirements. Serbia’s government has seemingly recognized the importance of FDI in the rebuilding of the economy and has consistently worked toward making it more appealing. To date, it takes on average less than 12 days to register and begin operating a corporation in Serbia. Any reductions in bureaucratic red tape significantly improve the region’s attractiveness to corporate interests.

To further appeal to investors, the Serbian government has allocated greater resources to its vocational training programs. Such policies are appealing to investors looking to minimize labor and training costs and as well, providing a vast labor force that accommodates the growing manufacturing and industrial operations from foreign companies. However, brain drain continues to plague the country, as many highly skilled workers left during the 1991 wars in Yugoslavia, and many young people continue to leave the country to pursue professional opportunities or attend university in the EU.

Though Serbia’s economy has been growing consistently over the past couple of years, such growth has done little to retain Serbia’s young professionals, leading investors to question whether projects in the region are sustainable for the long-term.

Serbia still struggles with government corruption and political instability, particularly regarding Kosovo. The two countries have been at odds since the 1990s, and especially since Kosovo’s independence in 2008. Peace processes have continually failed between the two countries, and most recently, a potential land deal between the two countries has gone sour after a nationalist speech from Serbian president Aleksandar Vučić. Though his speech was well-received by Western leaders, Kosovo President Hashim Thaçi claims Vučić has no intention of compromise with Kosovo after his comments about a “long road of thorns and problems” where he sees no opportunity to “implement [Vučić’s] ideas.”

On top of political tensions, it is extremely costly and difficult to import into the country. It costs more than $1600 and requires seven documents for each transaction, a policy that is designed to minimize capital outflows. Last year, more than half of Serbia’s output was in exports, indicating a trade surplus, but companies remain frustrated in their manufacturing efforts.

Serbia’s economy has also struggled since the breakup of Yugoslavia, largely due to the destruction of agricultural resources and political corruption. However, the country seems to be getting back on its feet. The European Commission expects Serbia’s economy will grow by around 3.5% by 2019 and for unemployment to drop to around or below 10% in the same time. Such improvements are likely due to FDI and the stability it has brought to the region.

Further, most of the wealth in Serbia comes from outside sources. Serbia’s GDP per capita peaked in 2017 at $5,899, roughly 47% of the world’s average. Fiscal instability and low levels of local wealth put local, grass-roots type projects at a significant disadvantage given that few individuals have the ability or capital to run a business at the scale that other investors are able to.

FDI is absolutely central to Serbia’s long-term economic development. Should FDI to Serbia recede, it is unlikely they would be able to sustain their current levels of growth.  As such, the Serbian government should perhaps be more willing to cooperate with Kosovo and in resolving their ongoing disputes, if only for the optics—appearing to be more diplomatic only eases investor apprehension.  

Though there are significant profits to be made, its political condition makes investing in Serbia high-risk. Given other investment opportunities in countries with less political tension and similar economic status, in Central Asia, for example, diplomatic efforts would be a powerful signal from Serbia to investors who may be uncertain. For a country that has struggled economically and politically since the early 90s, ameliorating relations with Kosovo is more necessary now than ever as Serbia hopes to appear less-risky and retain investor interest and capital.

China’s Remarkable Recovery From the Great Recession, and Implications For Its Future

Although China was hit hard by the Great Recession, its economy rebounded very quickly. Why?

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The Great Recession was a period marked by a sharp decline in economic activity, beginning in December 2007 and lasting officially until June 2009. It started in the United States when the housing market crashed, but contagion effects spread to the United States’ trading partners, one of the biggest of which was China. China’s economy relies hugely on exporting their goods overseas, and when American households lost about $16 trillion of net worth in the recession, they couldn’t afford to buy as many imported goods from China. Despite China’s permanent level of exports falling by 45%–a staggering amount–its economy rebounded incredibly fast, faring much better than that of any developed country. The crisis even affected countries without close financial links to the United States, such as Russia and South Africa, with these nations also decreasing their demand for Chinese products. Why did China recover so fast, given its export-driven growth model, while the rest of the world didn’t? The answer lies in the response of the Chinese government and a party system with the control necessary to push through stringent domestic policies, even if they caused short-term pain for its already struggling firms.

To start with, China introduced a RMB¥ 4 trillion (equal to $584 billion) stimulus package in 2008, to be put into infrastructure and social welfare programs by 2010. This stimulus was comparable in size to the United States’ own stimulus packages, but it came from an economy about one-third the size at the time, so the effect was more drastic and the initiative much bolder than any other country dared to enact. With its packages, China hoped to spur economic activity and increase its citizens’ total demand for goods and services, or aggregate demand, through the creation of jobs and welfare initiatives. If consumers use the money from these support policies to purchase more goods and services, their spent money circulates and get re-spent on new goods and services, bolstering the economy otherwise weakened from the recession. All of this went superbly for China: “total industrial production in China nearly doubled between 2007 and 2013 despite the crisis and an extremely weak international demand for Chinese goods, whereas the United States has experienced zero growth in industrial production and that in the European Union and Japan has declined by 9.3% and 17.1%, respectively.”

The United States enacted programs with similar goals, so why did China’s work while the United States’ didn’t? The difference was largely influenced by the Chinese government’s control of the economy. China has a market authoritarian system, where the government can keep a much closer handle on any economic activity in their country. In the United States, there is a much less restrictive free market system, and firms are under less pressure to do anything for the good of the country, instead focusing on minimizing profit loss. Once the Great Recession hit, American firms were hesitant to borrow and invest in expanding operations when aggregate demand was still low, and consumers weren’t willing to spend when firms weren’t hiring. In China, this wasn’t the case; they had things like state-owned enterprises (SOEs) run by the government, and the government took rapid steps to help the country even though they incurred debt and loss in the short run.  

China’s state-owned enterprises also acted as a sort of automatic stabilizer for their economy. Automatic stabilizers are policies and programs designed to balance fluctuations in a nation’s economic activity without needing intervention by policymakers. This stands in contrast to the pro-cyclicality of typical, privately-operated firms, which tend to restrict their operations in times of recession. While this minimizes the risks they take during a downturn, it also means firms are less eager to do business, dragging out the length of economic recovery. Normally SOEs are supposed to maximize profit just like privately owned enterprises, but beginning in 2008, they consented to increased production and investment spending, which provided major benefits to the economy and helped the economy start to grow again. Favorably for China, almost 20% of industrial employment following the 2008 crisis came from SOEs; with so many jobs remaining active during and after the recession, their economy was able to recover much more quickly and effectively in a manner not possible in countries without SOEs or similar programs.

While China’s policy actions involving SOEs worked out in the short run, risks posed by its Keynesian approach should be addressed. The timeline for the recovery of demand can vary greatly, so Chinese firms that stepped up production post-recession would be in an even worse position if their increased output went unpurchased. Past efforts by the Chinese government to influence demand have been notoriously unsuccessful, especially thanks to its people’s strong propensity to save. Data also show that from 2008 to 2015, China’s M2 measure of money (total cash and checking deposits plus savings deposits, money market securities, mutual funds, etc) increased by 16 percent annually, but during the same period, China’s economy expanded at a rate less than half that. Domestic inflation, as well as expectations of inflation, has been high since 2008. Taken as a whole, China’s success should be taken with a grain of salt and under different circumstances may have even damaged the economy more.

Beyond these unrealized risks, China also created several other hazards for itself set to materialize in the coming years, including increases in its already dangerous levels pollution and higher inequality among Chinese citizens. It has overproduced steel thanks to government subsidies and tax breaks, drawing the ire of competing steel-producing nations. Its debt has risen to approximately 50% of its GDP in part because of its post-recession policy actions, and it’s uncertain how easily they can repay it. Furthermore, with demand for Chinese exports unlikely to return to pre-recession levels, and because investment already accounts for almost half of its economic activity, China should look to do things like boost household incomes through higher wages and lower social security contributions, put in place fairer resource prices, interest rates, and distribute dividends from state-owned enterprises, or increase spending on pensions and healthcare if it wants to continue its economic growth and achieve its promise for the future.

The Rough Road to Reunification: Germany’s Struggles Toward Economic Convergence

The political reunification of Germany in 1990 moved at an astounding pace. Integrating the two regions economically, however, has proven to be far more difficult, and this process will certainly be ongoing for years to come.

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Image Description: This image, painted on a section of the Berlin Wall, depicts an East German Trabant (“Trabi”) driving through the Wall into the Western side, with the date of the fall of the Wall on the license plate. This little car, with an engine akin to that of a lawn mower, was a prized possession for East Germans (it took approximately 15 years of saving to get one) and has become an iconic symbol of East German culture.

Travelers arriving in Berlin are bound to notice that memories of the Cold War still linger in the city. A succession of stones marking the location of the Berlin Wall bisects the city, just as the Wall itself once did. The famous “Fernsehturm” (“TV Tower”) still stands in the eastern part of the city, although it no longer blocks television signals from Western Europe, as it was designed to do when half of Berlin belonged to the communist German Democratic Republic (GDR, also known as “East Germany”). Yet when the Cold War ended, the GDR ceased to exist and became part of the unified Germany that we see in Europe today. In many ways, eastern and western Germany are now one–they share the same political system, for example, and citizens on both sides of the former Iron Curtain enjoy freedom of movement within Germany and within the European Union as a whole. Economically, however, the two continue to be vastly different, leading some to wonder if the Iron Curtain was ever truly lifted.

The political process of German reunification moved at an astounding pace. By the end of 1990, a reunified Germany existed on the European landscape, a Germany that now included the five “new federal states” of Mecklenburg-Vorpommern, Brandenburg, Saxony, Saxony-Anhalt, and Thuringia, as well as the entirety of Berlin. Integrating the two regions economically, however, has proven to be far more difficult, and this process will certainly be ongoing for years to come. Remnants of the Soviet-style command economy used by East Germany have hindered the region’s development, leading Germany’s new federal states to trail the rest of Germany in almost every measure of economic prosperity. And although German taxpayers have poured more than $2 trillion into helping the former GDR develop, Germany’s new federal states continue to experience significantly lower labor productivity and significantly weaker private sectors than their western neighbors, which in turn has contributed to chronic high unemployment and lower average incomes. Furthermore, despite large investments in the new federal states, the former GDR has lacked opportunity relative to Germany’s western states, and a steady stream of outward migration has caused the region to lose almost two million people since the fall of the Iron Curtain. This large outflow of workers and their families has exacerbated the region’s demographic challenges, and the outflow of human capital dampened economic prospects for the region and for the East Germans who decided to stay.

Labor productivity in the former GDR (and in eastern Europe in general) has been, and continues to be, significantly lower than labor productivity in western European countries. In 1990, East German labor productivity was just two-fifths that of West Germany, despite the fact that education levels in the GDR were similar to those of western Germany, and perhaps even higher. This is largely because the GDR used outdated technology and capital stock, which prevented East Germans from producing as much per capita as their West German peers. This also required firms to take on a large labor force whose sole purpose was to service the equipment and keep it running. In the 1990s, funding from the German government allowed these firms to upgrade their capital stock, a much needed reform for a region whose firms would be competing on the global market. However, the presence of such funding eliminated the need for large service teams, ultimately costing many East Germans their jobs.

East Germany’s low labor productivity also meant that East German labor became quickly overvalued following reunification. During reunification, then-chancellor Helmut Kohl offered the East a monetary union in which East German marks could be exchanged for West German marks on a 1:1 basis. While the move was politically popular, it proved to be an economic disaster as firms in the former GDR quickly found themselves with a labor force that they could no longer afford. “Instead of one to one,” former German Interior Minister Thomas de Maizière recalled, “the exchange rate should have been one to three or one to four, to reflect the economic reality….” The shock that came from the 1:1 exchange rate forced eastern firms to lay off workers en masse–in the industrial sector, two-thirds of all employees were laid off in a short period of time.

It is important to note that over the past 28 years, the former GDR has made tremendous strides in improving labor productivity, and has fared far better than Germany’s eastern European neighbors. The benefits of Germany’s $2.34 trillion investment in the former GDR are certainly visible–in 2014, the productivity gap between eastern and western Germany hovered around 20 percent, whereas the productivity gap between eastern European countries and western Germany hovered around 60 percent. High labor productivity is crucial for any economy, without it, it becomes very hard for that economy’s workers to be competitive in a global market. Thus, the reforms that were made to increase labor productivity in the former GDR, while painful, have been necessary.

Since 1990, the former GDR has experienced significantly higher unemployment rates than Germany as a whole, largely due to the layoffs spurred by increases in labor productivity. The new federal states struggled with double digit unemployment figures throughout the 1990s and into the early 2000s, with unemployment peaking at 18.5 percent in 2005. In some states, the figures were even worse–throughout the 1990s, around 49 percent of the working-age population of the eastern state of Saxony-Anhalt was either registered as unemployed or participating in an employment initiative. Significant progress has been made in decreasing eastern Germany’s unemployment rate. Yet even in 2016, western Germany had an unemployment rate of 5.6 percent, while eastern Germany had a rate of 8.5 percent, a gap of 2.9 percentage points.

Despite the extensive financial support that the former GDR has received since 1990, eastern Germany also continues to experience structural weakness due to an underdeveloped private sector. Eastern German firms are typically half the size of the average western German firms, and out of Germany’s 500 largest firms, only 34 have their headquarters in former East Germany. None of those 34 are part of Germany’s authoritative DAX stock index. Large firms bring many benefits to the regions where they are headquartered by attracting skilled labor,  providing a variety of employment opportunities, and by crucially stimulating innovation. The lack of a large business presence in eastern Germany has thus caused the region to miss out on all of these benefits.

One side effect of eastern Germany’s weak private sector includes lower levels of research and development (R&D) funding, particularly from private sources. In western Germany, more than half of R&D funds come from private sources, whereas in eastern Germany, more than half of R&D funds come from universities and government grants. Although research funding as a whole has been increasing in the former GDR, private R&D investment has not increased at the same rate. In 2013, for example, the former GDR had reached 86 percent of the western German level of overall R&D spending, but only 50 percent of the western German level of R&D spending funded by private sources. Eastern Germany also sees relatively few patentable innovations, compared to western German states, producing only one-third as many patents as western Germany in 2010.

Much has been achieved thus far in the process of unifying Germany’s eastern and western regions. Standards of living in eastern Germany are approaching those of western Germany. Workers in eastern Germany have become much more productive since 1990, and the East’s GDP per capita has risen considerably as well. Average levels of life satisfaction, which dropped sharply in the early 1990s in eastern Germany, are now the highest that they have been in both regions since reunification. Even so, reunification has not been without its painful side effects.

The story of Germany’s reunification, while unique, offers lessons for countries, politicians, and individuals around the world, extending far beyond the boundaries of Germany itself. The experience of East Germans and the transition of eastern Germany is interesting because it offers guidance as to how to help countries formerly ruled by dictatorships succeed in the global market economy. Today, the European Union contains many countries that were formerly behind the Iron Curtain–Poland, Hungary, Slovakia, the Czech Republic, to name a few, who still have a long way to go to catch up to their Western European neighbors in the economic sense. Furthermore, given the planned accession of countries in the Western Balkans to the European Union, the story of German economic reunification could not be more relevant.

 

 

 

 

The Market for Citizenship

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Every country has a comparative advantage, the ability to produce some sort of good or service and produce it well. The United States, for example, has a thriving airplane industry, France is known for its cheese, and Saudi Arabia is a major oil producer. Some countries, however, have found more unusual niches. In the case of some, especially smaller island nations such as Dominica, that comparative advantage appears to be purchasing citizenship.

The number of “Economic Citizenship Programs” (ECPs or Citizenship by Investment Programs) worldwide has surged in recent years. Such programs allow wealthy individuals to legally obtain citizenship and a passport in return for a large contribution to a national development fund or a sizable real estate investment in that country. What’s more, many of these programs don’t require individuals to relinquish their existing citizenship, and instead allow them to hold multiple citizenships simultaneously. The concept of the ECP is not new; St. Kitts and Nevis’ program dates back to 1984, and Dominica introduced its Citizenship by Investment program in 1993. Today, between 30 and 40 countries have such programs, offering either immediate citizenship in exchange for an investment or a faster track to obtain citizenship for those who make a large investment in that country.

Worldwide, several thousand individuals spend around $2 billion per year to obtain citizenship and passports through ECPs. The market for citizenship is growing, with most investors coming from China, Russia or the Middle East, places where political circumstances at home make international travel difficult. ECPs tend to target wealthy individuals from developing countries who may have the means to travel internationally, but lack a passport that will enable them to do so. A wealthy executive from the Middle East, for example, will likely be able to travel to many more countries visa-free with a Caribbean passport than he would be able to with a passport issued by a country such as Iraq. For wealthy individuals from poor or otherwise unstable countries who love to travel, going through the process to buy a second passport, while often time-consuming and expensive, is entirely worth it.

Particularly for those countries that are smaller and less affluent, ECPs generate large revenue streams with little hassle. Frequently, when a national government needs money, it will resort to either raising taxes, cutting spending, or issuing sovereign debt. Raising taxes and cutting spending can be politically unpopular, especially during a recession. Sovereign debt, while a popular option, does require governments to pay interest to investors, thus introducing a financial obligation. Legally selling passports, however, imposes no additional costs on the taxpayer base and does not require a national government to pay back investors. Instead, a national government can capitalize on the appeal of citizenship and use these earnings to finance other debts, development programs, and disaster recovery programs. (Disaster recovery programs are especially important for hurricane-prone Caribbean nations).

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A street in Malta’s capital, Valletta. While Malta’s ECP is pricier than many, it does offer investors easy access to continental Europe via Malta’s EU membership.

Take the case of Dominica’s Citizenship by Investment Program, one of the world’s most lenient ECPs, allowing individuals to receive almost immediate citizenship and a passport in exchange for either a $100,000 donation to the country’s Economic Diversification Fund or a $200,000 investment in a government-approved real estate development project. It only requires that the investor hold on to the property for at least three years. Furthermore, Dominica’s program has no residency requirement whatsoever. In other words, it is possible to become a citizen of Dominica with no intention of ever going there.

Dominica’s Citizenship by Investment Program has had remarkable success, with the tiny island nation selling around 2,000 passports per year. Dominica is not an affluent country — its GDP per capita was $7,144 in 2016 — and its main industries, namely tourism, agriculture, and light manufacturing, are not especially lucrative. Recruiting foreign investment through citizenship, therefore, allows Dominica to capitalize on its status as a small country with a benign presence on the world stage. Dominican citizenship is especially attractive to wealthy individuals from unstable regions of the world, as Dominican passport holders can travel to over 120 countries without a visa. Furthermore, the Dominican government has gone to great lengths to make the island a business-friendly place. In Dominica, there are no capital gains, inheritance, foreign income, or wealth taxes, and qualifying entities can be exempted from import duties.

One of the oldest ECPs, that of St. Kitts and Nevis, began as a means to cope with the withdrawal of European sugar subsidies, which destroyed the local economy. Today, anyone interested in obtaining citizenship from the tiny nation of 55,000 can do so either by contributing $250,000 to St. Kitts and Nevis’ Sugar Diversification Industry Fund, which is tasked with diversifying the sugar-dominated economy, or by investing $400,000 in a government-approved real estate project. So far, St. Kitts and Nevis has sold over 10,000 passports for at least $250,000 each, and earnings from its program now account for around 25 percent of its GDP. These inflows have also benefited St. Kitts and Nevis’ real estate, tourism, and construction industries.

Small Caribbean nations are not the only countries to have citizenship by investment programs. Approximately half of European Union member states have immigrant investor programs, and those who buy in benefit from the freedom of mobility throughout the EU under the Schengen Agreement. Typically, these programs cost more than programs in the Caribbean and have stricter residency requirements, but those who do buy in are able to live and work anywhere in the EU. Even the United States has an immigrant investor route: the EB-5 (Employment-Based Fifth Preference Immigrant Investor) visa program reserves around 10,000 visas per year for immigrants who invest at least $1 million to create or preserve jobs in the United States (or $500,000, if the investment is made in a high-unemployment or rural area). A qualifying immigrant investor, plus a spouse and children, then receive 2-year conditional green cards that can potentially be converted into permanent resident status, and eventually, citizenship.

ECPs, however, have come under criticism, and have been exploited for purposes of criminal activity. Italian businessman Francesco Corallo, for example, managed to purchase a Dominican diplomatic passport despite being on Interpol’s most-wanted list for tax evasion and bribing politicians. When confronted, Corallo tried to claim diplomatic immunity by saying that he was Dominica’s permanent representative to the UN’s Food and Agriculture Organization (his claim failed to sway the authorities, however, and he is now being held in St. Maarten). Similarly, St. Kitts and Nevis’ program has drawn criticism from around the world for its lax controls, and in November 2014, Canada revoked St. Kitts and Nevis citizens’ visa-free travel privileges, thus diminishing the power of the St. Kitts and Nevis passport. The United States’ program has also drawn criticism and has been accused of “selling American citizenship” as opposed to merely attracting foreign investment. Furthermore, it is very difficult to measure the impact that immigrant investors have had on the American economy, leading many to question the EB-5 program’s effectiveness and efficiency.

ECPs provide an innovative way for countries to raise revenue without having to raise taxes or take on more sovereign debt, often providing revenue for development projects, and sometimes disaster recovery that would not have been available otherwise. Yet the success of these programs relies on a solid design that promotes the efficient use of investor funds and that prevents criminals from exploiting the system. If designed well, these programs are a lifeline; if not, they can become pipelines for international crime.

 

 

 

Economics of Happiness: An Interview with Richard Easterlin

USC Professor Richard Easterlin

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“There’s a fair proportion of economists that will dismiss this out of hand as heresy,” Richard Easterlin, renowned “father” of the economics of happiness and namesake of the controversial Easterlin Paradox, told me. “But on the other hand, as you know, the Sarkozy Report came out about 2008.”

The Report by the Commission on the Measurement of Economic Performance and Social Progress (2008), or, as Easterlin put it, the “Sarkozy Report,” was a speculative paper commissioned by Nicolas Sarkozy, then-president of France, “to identify the limits of GDP as an indicator of economic performance and social progress … [and] assess the feasibility of alternative measurement tools.” Tasked with reporting on these initiatives was Nobel laureate Joseph Stiglitz, with close advisement from fellow Nobel laureate Amartya Sen and Neo-Keynesian economist Jean-Paul Fitoussi.

Easterlin best articulated the significance of the Sarkozy Report in his widely popular response paper “Policy Implications of the Sarkozy Report” (2010). The paper delineated four primary economic measurements contained in the report:

  1. Production (GDP)
  2. Economic well-being (material living level)
  3. Overall well-being (of which economic well-being is one of eight components)
  4. Well-being of current vs. future generations (“sustainability”)

It should come as no surprise that Easterlin, who has dedicated the greater part of his academic career to the economics of happiness, would mark the third item as the Sarkozy Report’s most substantive contribution. In fact, this report is a familiar document to students of his economics of happiness course at USC due to its significance as a milestone for the happiness and well-being branches of behavioral economics.

Having begun research on the topic of subjective well-being (SWB) in the early 1970s, Easterlin found true validation in an international effort to explore policy implications of the economics of happiness.

“It was indicative of the fact that there really has been a major paradigm shift where economists increasingly are willing to listen to what people say. Sometimes it’s just political attitudes,” said Easterlin. “But as I said, it has taken off. So it’s really been, from my point of view, quite surprising, but at the same time rewarding because it makes me feel like people are paying attention to this, and this is very important.”

Throughout his academic career, Easterlin has faced criticism from voices across mainstream economics, informed by the disciplinary dictum that “economists don’t care about what people say, [they] only observe what people do.” For example, unemployment data – which Easterlin views as a self-reported, falsifiable metric – remains unimpeachable in the established paradigm of economics.

“You inherit it, and you don’t question it,” Easterlin said. “But new things come along, and you question them pretty severely if they run counter to the paradigm as happiness did. Not just in terms of its relationship to economic growth, which made it doubly hard to understand, but simply because it was accepting what people had to say about their well-being.”

Easterlin’s rejection of the academic status quo manifested itself in his declaration of the Easterlin Paradox, which challenged one of the fundamental tenets of economics: that more money leads to higher happiness. In the short run, Easterlin found that higher income does indeed correlate to a higher level of happiness; however, after acknowledging available data on the long-run relationship between happiness and income, he found no significant positive correlation. Easterlin’s explication of the inconsistency between cross-sectional and long-run time series data brought him fame and put his research at the center of charged debates between economists, behavioral and classical.

The research that Easterlin has conducted is highly empirical, constructed with data compiled over decades from multinational populations. For example, Easterlin has challenged notions that transitions from Soviet-style socialism to capitalism increases life satisfaction. While data from social scientist Hadley Cantril, author of “Soviet Leaders and Mastery over Man,” showed that there is a massive decline in life satisfaction following the collapse of a socialist nation, his research failed to include later-released data showing that life satisfaction existed at “fairly high happiness” leading up to the collapse. This suggests that it was not the socialist system per se that decreased life satisfaction, but rather political factors that compromised the stable period of high happiness. Of course, political factors are related to economic systems, but in Easterlin’s reckoning, whichever economic system maximizes the dimensions of SWB should be pursued.

“I didn’t start out with the view that socialism had any redeeming features or that the welfare state was a superior situation. As the evidence has accumulated, it’s becoming increasingly meaningful,” Easterlin said. “At the individual level, evidence seems to suggest at the extent you sacrifice your family and your health to make money, intuitively it’s not going to do much for your happiness. Whereas to the extent you try to achieve a reasonable balance, you know, put a lot more weight on your family life, exercise … the happier you’re going to be. But what we can do is have economic growth in which the incremental resources, instead of being left to the individual via consumer sovereignty as to how they are used, are determined much more by governmental intervention. Healthcare policy, schooling, maternity leave, paternity leave, provisions for old people – that is sort of a cradle-to-grave welfare policy you have in Scandinavia. They have high rates of growth as the Western world goes – Scandinavia is as good or better than most countries, including the U.S.”

Fiscal policies and fundamental beliefs in theories of government clearly divide those aligned with Easterlin and those who fare libertarian or right-of-center. But to Easterlin, there’s no mistaking it: a healthy work-life balance determines high quality of life, and Scandinavian economic systems provide the healthiest work-life balance recordings, and thus, the happiest reported populations.

When asked which measures could be taken to foster research conducted in his field, Easterlin focused on empirics.

“We still need a lot more specifics and data about policies that are conducive to happiness, [like] family policies,” said Easterlin. “So my feeling is that [the future] is trying to get better insight into those things, and probably also into broader questions on civil rights. And I think it’s interdisciplinary. I think you need to know something about political science, and that’s where the commodification of labor comes in.”

Easterlin concluded: “You know I think with all these studies, people need to be attuned to them and educated [on them] in order to make holistic statements about what happiness and welfare are about, and I feel we are progressing.”

____________

To read more about welfare economics, Easterlin suggests:

The Oxford Handbook of the Welfare State

Edited by Francis G. Castles, Stephan Leibfried, Jane Lewis, Herbert Obinger and Christopher Pierson

“Produced entirely by political scientists. Not one economist in that one or sociologist. But it’s indicative that the study of the welfare state is much more a private thing in the field of political science. [Additionally, it addresses] the political socialization process, and other psychological mechanisms.”

I would also suggest:

Happiness, Growth, and the Life Cycle

by Richard Easterlin

The Argentine Inflation Problem

argentina

In the final week of 2017, Argentina’s Merval index, the most important index of Argentina’s stock exchange, hit the 30,000 point mark for the first time in history, surging 77 percent in 2017 alone. Economic growth within Argentina appears to be strengthening, and the Organization for Economic Cooperation and Development (OECD) is optimistic that Argentina will continue to experience growth in its agriculture, manufacturing, retail and construction sectors in the near future. All of this is welcome news, both for Argentina’s president, Mauricio Macri, and for the people of Argentina, as the country appears to be emerging from recession. Yet despite this welcome news, the Argentinian economy remains beleaguered by one particularly insidious force: high inflation.

According to Argentine daily newspaper La Nación, Argentina had the second highest rate of inflation in the entirety of Latin America in 2017, ending the year with an inflation rate of 24.8 percent. The only Latin American country with an inflation rate higher than that of Argentina was the catastrophic Venezuela, which experienced an inflation rate of 2,616 percent in 2017. Argentina’s high inflation rate has plagued the country, leading to the deterioration of the Argentine peso vis-à-vis other currencies while causing prices to soar, and must be brought under control if Argentina and its industries are to succeed on a global scale.

High inflation wreaks havoc on economies via a rapid rise in prices, the erosion of the purchasing power of an individual’s income, and the deterioration of the value of an individual’s savings. An extremely high rate of inflation (a rate of 1,000 percent or more) is known as a hyperinflation, which cripples economies and can be very difficult to recover from. Zimbabwe’s inflation rate, for example, hit 500 billion percent in 2008, marking the worst hyperinflation event in global history. When billions, even trillions, of Zimbabwe dollars became less valuable than the paper they were printed on, the country was forced to give up its national currency. Today, Zimbabweans conduct transactions using foreign currencies such as the U.S. dollar, the British pound and the Indian rupee.

Argentina’s inflation woes stretch back decades. In the mid-1970s, Argentina’s inflation rate shot up and averaged 300 percent per year for the next 15 years. In 1989, the inflation rate in Argentina hit a whopping 3,079 percent. In an attempt to cure the hyperinflation of the late 1980s, Argentina introduced a currency board in 1991, under which the peso was pegged one-to-one with the U.S. dollar. In other words, as the dollar appreciated and depreciated in relation to other currencies, the value of the peso would move with it. For a short period of time, the currency board was successful and tamed Argentina’s high inflation levels. However, over the course of the 1990s, as the dollar appreciated, Argentina’s currency board became overvalued, harming the country’s competitiveness globally and plunging the country into recession. With the collapse of the dollar peg also came elevated inflation, and the currency board was abandoned in 2001.

Inflation dropped to 10 percent in 2003, but it began to rise again during the presidential administrations of Nestor Kirchner and his wife and successor, Cristina Fernández de Kirchner. Yet as the inflation rate became worse and worse, Argentina’s government chose to deny it: when told in 2012 that the inflation rate in Argentina was 27 percent, Ms. Kirchner scoffed. “If it were as high as they say it is,” the then-president retorted, “the country would explode.” During Cristina Kirchner’s presidency, INDEC, the government statistical office in Argentina, began producing doctored inflation statistics that grossly underestimated the true inflation rate and nearly destroyed the country’s relationship with the International Monetary Fund. The Economist stopped printing the inflation statistics published by INDEC in its weekly issues.

Persistent high inflation has pushed up market interest rates, forcing Argentina’s government to pay an interest rate of around 25 percent to borrow in pesos. It has also destroyed Argentina’s mortgage market, forcing many Argentinians to pay upfront (and often in dollars, given the peso’s volatility), in addition to diminishing private sector lending overall by causing interest rates to skyrocket. Across low and middle-income economies, private sector lending constituted around 97 percent of GDP in 2016, and in Latin America, that number was approximately 49 percent. In Argentina, private sector lending constituted a mere 14 percent of GDP in 2016, giving Argentina one of the lowest rates in the entire world. This rate is on par with rates seen in deeply impoverished countries, such as Zimbabwe (12 percent) and Haiti (18.3 percent).

Confidence in the Argentine peso faltered, and over the next few years, it dramatically dropped in value vis-à-vis the dollar. Argentinians dumped the pesos they had and poured their wealth into U.S. dollars before their savings would wither away any further – a practice that soon became largely illegal. President Cristina Kirchner instituted currency controls that made it nearly impossible for Argentinians to purchase dollar assets. These currency controls had the unintended consequence of making Argentinians poorer compared to savers in other countries, as they were being forced to invest in an asset that was rapidly losing value. Upon the implementation of the currency controls, a black market for U.S. dollars quickly emerged in Argentina. Known as the “blue market,” it enabled Argentinians to purchase dollars against the law, albeit at exorbitant prices. In Buenos Aires, cuevas, or caves, popped up across the city to facilitate dollar purchases, and even the smallest cuevas would handle $50,000 to $75,000 in transactions per day.

When Mauricio Macri was elected president in November of 2015, he soon embarked on a variety of much needed, albeit painful, reforms to rehabilitate the Argentine economy. The former mayor of Buenos Aires quickly restored the independence of INDEC, charging the agency with creating a new and accurate inflation rate. While the move restored credibility to INDEC (The Economist began to publish INDEC’s inflation statistics again in 2017), it revealed how uncomfortably high Argentina’s inflation rate actually was. Under President Cristina Kirchner, inflation in Argentina averaged around 10 percent per year according to INDEC. Upon the election of Mauricio Macri, INDEC found that number to be closer to 25 percent.

President Macri also ended the Kirchner-era currency controls, once again allowing the peso to float freely. While this allowed Argentinians to invest in more stable assets and freed Argentina’s exporters from the burden of an overvalued peso, it also caused the value of the peso to decline further, and pushed inflation up to 40 percent in 2016. The day that the end to the currency controls was announced, the Argentine peso fell by 29 percent against the dollar. 

President Macri’s economic reforms initially eroded his popularity, and by metaphorically “biting the bullet” and pushing through the economic reforms that Argentina desperately needed, President Macri put himself and his party at great political risk. In 2017, however, Argentina’s fortunes began to turn around. In July, the Argentine economy expanded by 4.9 percent, and salaries began to rise. Furthermore, business confidence rose, the percentage of Argentinians living under the poverty line fell, and inflation began to fall as well. President Macri and his “Let’s Change” coalition experienced a much-needed popularity boost as well, with the coalition winning 41 percent of the vote in Argentina’s October 2017 midterm elections. This electoral mandate encouraged the president to go ahead with work on reforming the tax code and reducing Argentina’s budget deficit.
Overall, Argentina’s prospects are looking up. Argentina’s stock market had a banner year in 2017, and on February 20, Forbes published an article titled “Is Argentina The New Darling Of Emerging Markets?” Yet persistent high inflation threatens to derail Argentina’s economic recovery. The sooner its inflation rate can be brought back to a low, stable and predictable level, the better.

Will Trump Tariff Solar Panels at the Cost of American Service Jobs?

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One of President Trump’s main promises on the campaign trail was to crack down on free trade in the name of protecting American businesses, particularly the manufacturing sector. Despite the charged rhetoric during his campaign, President Trump has been a relatively traditional Republican when it comes to trade policy, outside of withdrawing from the Trans-Pacific Partnership (TPP). Last month, however, the Trump administration announced the imposition of new tariffs on imported solar panels and washing machines, a move designed to protect domestic manufacturers against a market flooded with cheap foreign goods, mainly from Asia. The tariffs on solar panels, which start at 30 percent and decline by 5 percent each year until 2021, have particularly profound implications for the expanding market of solar panels and solar energy.

As the cost of producing and installing photovoltaic solar cells has fallen drastically, the market for solar energy has grown rapidly, transforming the idea of widespread adoption of solar energy from an environmentalist’s pipe dream to a practical source of power. According to Bloomberg’s New Energy Finance Team, the price of solar energy has fallen from $350 per megawatt hour in 2009 to about $100 in 2018, with some projections estimating that average solar costs will fall below those of coal in the next decade. The International Energy Agency reported that 2016 saw solar grow faster than any other source of energy, with most of the activity coming from China, whose governmental support has enabled its producers to capture almost half of the entire market.

In many ways, China is on the forefront of the solar energy boom; the country alone added more solar capacity this past year than the total energy capacity of Germany and is responsible for driving much of the innovation that has caused the price of solar energy to fall so drastically. However, Chinese dominance in the solar sector has not been a blessing to American manufacturers struggling to compete with low-cost Chinese panels. Two companies, Suniva and SolarWorld Americas, complained to the White House and the International Trade Commission that they could not compete with the cheap photovoltaic cells imported from China without government intervention to “restore fair competition in the U.S. market.”

The complaints made by Suniva and SolarWorld are not unfounded. Suniva, a Chinese-owned company based in Georgia, filed for Chapter 11 bankruptcy last spring as a direct result of the influx of foreign panels. The International Trade Commission recommended a tariff of 35 percent on imported solar panels, and the Trump administration delivered with last month’s decision. Domestic producers of solar cells, such as Suniva, SolarWorld, First Solar and Tesla, stand to win as they will be able to sell their panels tariff-free and face less competition from their Chinese rivals. The possible benefits that these firms may receive from the tariff were reflected in their stock prices, as both SolarWorld AG’s and First Solar’s stock prices jumped shortly after the decision was made public. There is also no doubt that the creditors of struggling U.S. solar manufacturing firms have a positive view of the tariff, as the value of their investments will appreciate as a result. As far the U.S. solar manufacturing sector is concerned, the tariff does what it is supposed to do.

Proponents of the tariff overlook one crucial fact about the solar industry in America: the vast majority of jobs in the solar industry are not in manufacturing. In 2016, there were about 260,000 people employed in the solar industry (twice that of coal), but only 38,000 of those jobs were in manufacturing (14 percent) and only 2,000 were involved in the direct production of solar cells. Most of the jobs in solar are involved in the development and installation of residential and utility-level solar projects. The Bureau of Labor projects growth of 105 percent in the number of solar installers in the next 10 years, which would make it one of the fastest growing occupations in the country. The tariff will restrict the supply of panels available in the United States and thus raise their prices; in turn, higher panel prices will lead to fewer installations, forcing layoffs. The Solar Energy Industries Association estimates that as many as 23,000 jobs could be lost as a result of the tariff, and Green Tech Media estimates that the tariff could reduce solar installations by as much as 11 percent, setting the United States back in the adoption of clean energy. While some proponents of the tariff may point to the fact that Chinese companies like Jinko Solar have announced plans to build factories in America, the relatively few jobs that these highly automated factories would produce likely wouldn’t make up for the loss of jobs caused by the tariff itself.

Considering the net job loss that will result from this trade decision, it is hard to justify the implementation of the tariff. This decision seems to not result from economic analysis alone, but rather from a desire to maintain congruence between campaign trail rhetoric and public policy. President Trump promised to bring manufacturing jobs back to the United States, and this tariff might do just that – albeit relatively few. The fact that the tariff might slow the adoption of solar energy and bolster other forms of energy may also be a deliberate strategy to play to his base of support. “America First” intentions aside, the tariff’s economic ramifications will harm the livelihoods of many Americans, which should be the preeminent consideration on any policymaker’s mind.