Job creation became focus in developed and developing world: Dr Lars Thunell
The crises started as a financial crisis on Wall Street, but it affected the whole world through a number of transmission mechanisms: foreign direct investment, remittances, portfolio investments where investors had to sell even good investments for liquidity reasons-- and especially trade. All went down dramatically.
“It is a great pleasure to be here and talk about the Private Sector’s Role in Development and the opportunities for India and for Indian companies. But let me start out with a few reflections on what is happening in the world. The last few years has seen some dramatic changes in the world economy. When Lehman Brothers crashed in September of 2008, a global boom came to an end. This boom was evident not only in the developed world, but also in the emerging markets led by China, India and the other BRICS. The crises started as a financial crisis on Wall Street, but it affected the whole world through a number of transmission mechanisms: foreign direct investment, remittances, portfolio investments where investors had to sell even good investments for liquidity reasons-- and especially trade. All went down dramatically.
High budget deficits, worsened by the high cost of government-funded bank bail-outs quickly created an economic crisis for governments. As companies were forced to reduce costs, they laid off workers and unemployment rose sharply. With government deficits and unemployment, the crisis became a political crisis and a jobs crisis. Job creation became the focus in the developed and developing world.
We have seen this in the US and in Europe where we still have the unresolved issues of government debt in southern Europe, political tensions and high unemployment. In Spain unemployment among youth is over 40 percent. In general, the developing world fared much better, since they had not had the excesses of the US and Europe. China’s stimulus package also helped the world economy get going again.
So what is happening now and what will the world look like over the next few years? What is the New Normal?
The World Bank coined the term MULTIPOLAR GROWTH, i.e. the world economy will no longer have one leader such as the U.S., but many different regions that will grow at different speeds. The IMF in October lowered its projections for the world economy to 3.6 percent. This is just a slight improvement from the 2012 growth rate of 3.3 percent, but a downward revision from what was previously expected. For the advanced economies the growth projection was reduced from 2 percent to 1.5 percent. For the emerging and developing countries the growth rate for 2013 was reduced from 6 percent to 5.6 percent. The U.S. is at least experiencing a weak recovery, even if it will be slow. Europe is likely to have another recession. This will, of course, have an impact also on the developing world. Further, there are huge uncertainties and downside risks; there are government changes in many countries, including China. Decision making seems to be stalled in the US with the fiscal cliff. So the FIRST trend in the New Normal is multi-polar, differentiated growth going forward with the emerging markets taking the lead.
The SECOND new trend is the almost universal acceptance of the PRIVATE SECTOR AS THE ENGINE OF GROWTH. With the pressure on government finances and the need to reduce unemployment, almost all governments are turning to the private sector and entrepreneurs. I will come back to this later.
The THIRD trend is scarcity of credit and FINANCIAL SECTOR CONSTRAINTS. Since the crisis, when many western banks had to be bailed out by their governments, banks have lacked capital and are concentrating their business on their home countries. Project finance and even trade finance are being curtailed. This trend is reinforced by increased regulation and Basel 3, which will have a major impact on banks’ capital positions.
The FOURTH trend in the new normal is the demographic contrast between developed and developing countries. In the Western world, and to some extent in China, the population is getting older. In the developing world, people are younger. In many developing countries, half of the population is younger than 25. This can be a great opportunity, with many young people coming into the workforce. But when young people cannot get a job then it becomes a source of frustration. Just look at what happened with the Arab Spring. Education, health care and jobs will be key to ensuring that young people are a source of economic and social dynamism and not instability.
The FIFTH factor is urbanization. 20 years ago around 40 percent of the world’s population lived in cities. Today, around half lives in cities; china just passed 50 percent. In 20 years, around 70 percent will live in cities. We will see many new large cities and many mega cities. Most of these will be in the developing world.
This brings me the SIXTH trend: the continuing demand for infrastructure, natural resources and food. To feed and house a population of 9 billion by 2050, we need massive investments in power plants, transportation, housing and farming. There will be scarcity of resources, including water, in many parts of the world
And overlying all of this we have changing weather patterns and the other environmental issues coming with climate change.
The New Normal is a world with lots of challenges, but also opportunities. Over the last decades more than a billion people have been brought out of extreme poverty. This progress can continue with the right policy decisions, with smart regulation, an entrepreneurial private sector and the use of new technologies like internet, mobile phones, and new agriculture technologies such as drip irrigation.
So how do we meet these challenges and take these opportunities?
We must create more jobs through SMALL and MEDIUM SIZED COMPANIES.
As i said earlier JOBSs are the focus of politicians around the world, and everybody is realizing that the private sector is the creator of jobs. In most countries, small and medium sized companies constitute 60 to 80 percent of the economy. This sector is where a lot of attention is focused.
Improved BUSINESS CLIMATE for small companies is especially important in countries like India with a large and important informal sector. Studies by the World Bank show small companies entering the formal sector grow about 8 times faster than before. Plus, they pay taxes and can export. In the IFC report Doing Business, India ranks 132 out of 185 when it comes to Ease of Doing Business for SMEs. India ranks 173 for Starting a Business There are lots of opportunities for improvement. But Credit is relatively easy to get. India ranks 23.
FINANCING is an important factor for SMEs. We know that most banks prefer to lend to large companies. In addition, Basel 3 rules will make it harder for banks to lend to SMEs. Risk capital is also very scarce for SMEs even if counties like India are seeing more and more funds specializing in SMEs, often sponsored by multilaterals such as IFC. For the informal sector, micro finance is important and it is unfortunate that the private sector micro finance institutions have become a political issue in India. To be sustainable, these institutions need to have a profit so they can scale and grow without support from the government. When we studied this at IFC, we saw that the best way to bring down the interest rate for the borrower was competition and scale.
SMEs also need skills and TRAINING. Whether in the developed or developing world, a company is started by an entrepreneur with an idea. As the company grows, the entrepreneur needs new skills. So training is a key component in developing a vibrant private sector especially in developing countries.
Lastly, we need investment in INFRASTRUCTURE. This is critical to big and small companies alike. With power shredding, manufacturing facilities cannot run on full capacity. This makes even the best plants inefficient and makes new investments less profitable. Roads and logistics are essential for companies to be competitive. In fact, studies show that manufacturing plants in developing countries often reach world class competitiveness, but it is the cost of getting things in and out of the plant that makes them totally noncompetitive.
As mentioned earlier, massive amounts of investments in infrastructure are required in most countries around the world. The problem is that governments don't have the money to do it. The private sector has to be involved through so-called public private partnerships. But there are a number of problems of getting them going.
The private sector and the public sector often have different ideas of what PPPs should be. The private sector thinks the government should take the risks and they should have the profits. The politicians think the private sector should finance the projects but they should still have the decision power and decide things like tariffs. A lot of education is required of business people, the civil servants, the politicians and the general public. We have seen ambitious PPP programs become stalled in many countries including India. This is a critical issue for the world economic growth going forward, and that is why it is high up on the G20 agenda. We have to get this going!
Coming back to jobs and SMEs, I think it is important to note that they are very often part of a bigger ecosystem of firms. The smaller firms are suppliers to larger firms who have an important role in sharing best practices with their suppliers. These smaller firms often group themselves as clusters sharing vital infrastructure and learning from each other, even as they are competing. A good example of this is Socks City in China, producer of a major part of all socks for the world. Clustering becomes even more powerful when they are tied to a university, and you can get the combination of entrepreneurship and new technology. This is why many countries are trying to emulate Silicon Valley, and also have industrial parks which also can provide government subsidies through lower rents or tax holidays.
This will require new cooperation between the public and private sector.
This is often very complicated, as I mentioned above concerning PPPs in infrastructure. It can become even more complex when you talk about health care and education. But when the two sides can find ways to work together, it is a very strong formula. Public policy creates the right environment for entrepreneurship and competition. Public funds can help leverage the private sector, reduce risk and accelerate development.
The interesting thing is that this is not only happening at the country level. It is also happening at the global G20 level and at multilateral organizations such as the World Bank Group. I was in Busan Korea at the OECD biannual conference on aid effectiveness. For the first time the private sector was acknowledged as the engine for development and growth. But we must be careful to ensure that subsidies are used to correct market failures and not to destroy markets. There are many examples in the developed world where subsidies and old type of industrial polices have slowed down growth rather than creating a vibrant private sector. That is why IFC set up some rules for the combination of public and private funds. Subsidies should help create markets, be limited in time and amount and have special governance. But as I said, if this is done right it can be a winning formula
Seizing the opportunities requires us to keep trade relationships open.
Since the second world war, globalization has become a major factor in and driver of development. Trade has increased dramatically. In particular, China’s development has been based on an export driven model. India is a leader in trade in services with its outsourcing industry, This has created wealth and jobs in India and China and other export driven economies. It has also been very beneficial to consumers in the West who have gotten access to goods and services at cheaper prices. But this also created some of the global imbalances that we now need to correct, the U.S. trade deficit and budget deficit for example.
There have been strong flows of FDI and portfolio investments into the emerging markets, as these stock markets for many years were the top performers in the world.
This of course allowed many developing countries to invest in new manufacturing facilities and infrastructure. It was a very positive spiral, but imbalances continued to build up.
With jobs being the focus for most politicians, we now have a debate about protectionism. This had already started before the crises with food shortages and the run up in food prices. At that time, several countries instituted export controls for wheat and rice.
On the manufacturing side, many countries are bound by the WTO rules. But they can manage their currencies. This is what China and many other countries have been doing for a long time. Lately the problems in the US and Europe, combined with the success of many developing countries, have made some emerging market currencies appreciate and make them less competitive. It was at this point the Brazilian finance minister started talking about currency wars. This has become a very hot political issue in many countries. I believe this could be a major threat to a global economic recovery.
Job creation through SMEs , public private partnerships and continued globalization and free flow of trade and capital will be crucial factors going forward.
Where will the major opportunities be?
Some of the sector areas I already indicated: infrastructure and natural resources, logistics, agriculture and food processing, housing.
To a large extent, this will be driven by the new middle class that is emerging in many developing countries. They don't just want the basics. They want cars, nice furniture and brand clothing. They want luxury goods. No wonder that China is now the largest market for many super brands such as Porche.
To serve all these new customers is a major business opportunity going forward. We see these new middle classes not only in India and China. We see them in other parts of Asia such as Indonesia and the Philippines. Latin America has also made great strides in development with not only Brazil and Mexico expanding but countries such as Colombia and Panama. Chile is on the verge of becoming a developed country.
Perhaps the most exciting opportunity is in sub-Saharan Africa. This is a continent of about 875 million people (World Bank number) and the economies have been growing fast. This year sub-Saharan Africa is estimated to grow 5 percent, and 6 or 7 of the world’s fastest growing economies are in Africa. Africa has fewer wars that any time since independence. Governance and corruption are still issues, but it is improving. When I meet business people from around the world, they are asking how to increase their business in Africa.
Natural resources are, of course, a big driver. More than 40 of the sub-Saharan countries have oil, gas or minerals. The latest are Mozambique and Tanzania, where they have found massive amounts of gas that will totally transform these economies the way Ghana is being transformed right now. This will be a challenge. We have seen in many countries how natural resources can be a curse instead of a blessing. Corruption can increase with wealth and making countries can become less competitive in other sectors. There is a movement now against corruption and for more transparency, led by the Extractive Industries Transparency Initiative and the World Bank.
There are also more companies getting involved in the manufacturing and agricultural sector, especially food processing and logistics. This includes Chinese firms. I was recently in Ethiopia where IFC had identified 200 registered Chinese companies, including one major footwear manufacturing company. It had moved there when wages became too high in China, and to be closer to their customers.
You all know the opportunities for Indian companies in Asia and the Middle East. I think Africa also offers a great opportunity for Indian companies. East Africa is relatively close, and there has been an historic strong trade relationship between India and Africa. There are also many people in Africa who originally came from India. In many countries they have been the leading business people.
But Indian companies have another advantage. That is what I would call the INDIAN BUSINESS MODEL. Given the huge market in India, with over a billion people, companies have developed business models that are volume based.
We talked earlier about the new middle class in emerging markets. These are people who earn between 3000 and 20000 dollars per year. With 2 billion people, that is a market of over 12 billion dollars. This is where most companies focus their strategies.
There are 4 billion people earning less than $3000 per year. That is 5 trillion dollar market. With highly specialized business models, companies are now able to address this market in a profitable way. They are doing this with new technology, like Fino, that use biometrics and telecommunications to address the financial needs of the poor. Eye operations are done in India at a fraction of the cost in the West, often with better quality. Apollo Hospitals is asking how to bring good health care to a billion people. Packaging and design, especially for the base of the pyramid, can be very successful. Several companies are packaging shampoo and food in single use units. Gillette designed a razor for the Indian poor by asking what they could afford, and then designing the best razor for that cost.
Here I think Indian companies have unique competitive knowledge that could be used in many other emerging markets including Africa.
Indian companies have increased their business in Africa. Trade has increase from 5 billion dollars to close to 60 billion in 2011. India is Africa's fourth largest trading partner after the E.U., China and the US, but it is still only less than 6 percent of Africa's trade. There are significant investment flows from India into Africa, but those are mainly driven by state related companies. So there are significant possibilities for private Indian companies to expand into Africa.
- We live in a world with a lot of uncertainty. Europe is in recession and will have deal with its debt burden resulting in slow growth and high unemployment for quite some time. The US is slowly coming back, based on the improving housing situation, and a better competitive situation with lower energy prices. The emerging markets are where we will see real growth. China seems to have reached bottom and we will probably see stimulative actions from the new leadership. The new middle class, newly found natural resources and demographics will continue to be drivers of growth in these countries. Africa seems to be the new opportunity.
- However many of the imbalances remain in the world, so we can easily see another dip in the world economy. Risks are very high.
- The political uncertainties are also high with the very strained situation in Europe, where governments have to take very unpopular decisions. The re-election of president Obama came with with no real change to the balance of power in Congress. There is new leadership in China and a struggle with reforms in India. The Middle East is going through a major transformation. Inequality is increasing in most countries and that will be another source of tensions and increased criminality.
The new normal will be based on this multipolar world with differentiated growth. Financing will be scarce resource due risk aversion and the lack of capital in the banks. Cooperation between the public and private side will be needed. PPPs will be key.
Demographics will make the west (and China) grayer while in most countries in the emerging market the people are younger. Soon 70 percent of the world’s population will live in cities. We will see new mega cities especially in the emerging markets
Natural resources will be scarce and the need for infrastructure will be immense. On top of that, we have climate change where major investments will be needed to adapt to the changing weather patterns.
But it is an exciting world where we have the chance to bring billions of people out of poverty.
- To do this, governments have to look at the private sector as part of the solution and not the problem.
- To create jobs we need to rely on the private sector, especially small and medium financing. These companies need a good investment climate with smart regulation a fair tax system. They need financing and infrastructure and they need training. Governments also need to promote trade and that is where an institution like Exim Bank of India plays a very important role.
- Companies, large and small, should take these opportunities and grow and develop their businesses. They should look for new markets in terms of new segments, such as the base of the pyramid. They should look at new geographical areas such as the low- income states in India or sub-Saharan Africa. And they should do so in an environmentally and socially responsible way. Indian companies are ideally positioned to do this.
Thank you all for listening. Again thanks to the Exim Bank of India who invited me to come here and thanks to all of you for listening.”
India Infoline Research Team / 08:44, Jun 26, 2015
IIFL is hosting 10 companies at a Management Roadshow in Mumbai today. The opening is a subdued start. US market saw minor losses with Dow, S&P 500 and Nasdaq closing marginally lower.