PART ONE - COURSE INTRODUCTION
There is a great deal of pessimism in the non-Asian English-speaking capital markets right now. There is a great deal of optimism in the Portuguese, Mandarin-speaking, Indian capital markets right now. We are in the middle not of a recession but a global economic realignment with new rules, opportunities and economic paradigms.
Imagine a world in 2015 when a consortium of a Madagascar sovereign wealth fund, run on Norwegian standards of fund management and transparency based on Indian Ocean oil revenues combines with a Gujarati entrepreneur who has diversified from film investments into a digital services conglomerate and a syndicate of North American private equity funds purchases Canada’s leading agricultural technologies firm founded in 2011 with the profits from the sale of Potash Corporation to XXXXXX.
Imagine a world where CAT-fund (Canadian agricultural technologies fund) in 2015 backed by a consortium of Canadian institutional investors, Norwegian and Abu Dhabi sovereign wealth funds and the new Brazilian Heritage Protection SWF (formed in 2012 to pay for preservation of Amazon rainforest) invests with Novartis in an African health care company formed in 2011 by a group of Malian and Nigerian B-School students in London and Montreal.
Imagine a global economy in which there was a corruption-free Nigerian capital market. Atunma Oteh is not a household name in North America, and the Nigerian stock exchange is still a difficult place in which to frame an investment strategy, but just imagine if the petrodollars being turned into productive capital through that exchange were being invested productively.
The investment in next generation technologies and practices has driven capital markets for centuries. From the Suez Canal to the Baltimore and Ohio Railway, the political economy of new technologies will drive capital allocation in the next decade. Some of this is obvious, e.g. the investment in alternative energy technologies by institutional investors on a global scale. Some are less obvious: Unilever made a multimillion investor in Solarzyme, a company that produces palm oil substitutes from algae.
There are new rules and new strategies.
The reconnection of wealth and value creation suggests that there is a boom ahead in the global economy in 2011-2020. This may not be good news in Gary, Indiana where restructuring has been delayed by a profound misdiagnosis of the problems in the American economy. However, it is terrific news for globally oriented entrepreneurs in Silicon Valley, strategic hedge funds engaged in value-adding restructuring of organizational capacities in growing markets and well-governed political economies where intellectual capital is organized and focused on emerging growth opportunities.
These are Schumpeterian moments and economies which lag behind with poor educational systems or obsolete economic ideas will not be the most prosperous in the world in 2020. I don’t mean to be sanguine about this, but if you contrast the English-language media of Singapore with Toronto or New York and see the capacity of North American debate to be distracted by trivial and incorrect analysis, one sees what has to be done to change direction.
Let us start with the Stiglitz-Sen initiative on new measurements to replace GDP. We all know that quality of life is a significant component of all our personal measurement. The best days can be ones were we spend $2 on a Red Sea beach and some of the worst when we spend hundreds in an airport hotel. Great political economists have understood this. Great political economists remind us of that today.
We are moving away from “transactional” capitalism and moving towards “relationship” models of investing. But even if the so-called “Anglo-Saxon” model of market capitalism is replaced by a “Nordic model” in many visionaries, there remains a new issue for B-School to address as we try to imagine portfolios for the year 2020. How do we define value?
Gold has value because we accord it value. Real estate has value and is the underpinning of most capital markets. In the new global economy, arable land has a value because food security is a concern and agricultural productivity is a solution. In the new global economy open-source flexibility in managing the innovative potential for the digital age has value and the technique for validating the opinion of crowds suddenly has enormous value.
The global economy has some fundamental new features, which I will address today. It also requires that you design new instruments to create value and design efficient capital markets consistent with the new political economy of value creation. That will be the new leadership in B-Schools around the world and in the private equity firms and hedge funds that are invented to perform these tasks.
PART TWO ASIAN HEALTH CARE AND BRAZILIAN INFRASTRUCTURE
Khazanah is not a name familiar to most Canadian undergraduates. It is the Malaysian sovereign wealth fund. It has just transacted a $4.5 billion deal to create a regional health care company involving India’s Parkway.
Pernambuco is not a name familiar to most Canadian undergraduates. It is the Brazilian state whose infrastructure demands energize the development of northeastern Brazil.
The changes we are seeing in the global capital markets reflect a new creation of value, the value of knowledge of tropic plants in medical treatment, the value of design in adding value to urban spaces increasing real estate valuation as well as increasing environmental sustainability, the value of microcredits-backed entrepreneurs creating thousands of new businesses commercializing appropriate local knowledge.
Even those who have been critical of globalization and the allocation of capital in the old period of Globalization 2.0 will have to recognize that we need disciplined capital markets allocating resources to the cornerstone enterprises of the 2020 portfolio.
The transfer of revenues to purchase extractive resources has to become part of this new global value-creation. The best minds of this new business generation have to design models for internet-coordinated venture capital that ensures entrepreneurs have access to mentoring and capital on their mobile phones. The best minds of this new business generation have to design institutional investors that convert resource wealth into productive investments.
The reform of the regulatory regime that had oversight on Globalization 2.0 is important. But the new global economy has to have financial instruments that smoothly allocate capital. The portfolio of 2015 will see some more Twitters, the investment in agricultural productivity in arable lands, the enhancement of real estate valuation through environmental design. But it will also see the transformation of resource wealth from an “oil curse” to a source of institutional investment payable as part of a global welfare state as pensions to the stakeholders of the region.
The best world of 2015 has a Madagascar pension fund ensuring investment in restructured Ontario assets. The best world of 2015 has a syndication of microcredits from Shenzhen, Bangalore and Johannesburg into a suite of new entrepreneurs in Kabul, Tikrit and La Paz.
The politics of this are already taking place in the thirty-somethings around the world who are sharing best practices in new entrepreneurial activities. The economics are more complicated. Some of the issues of Globalization 2.0 have to be remedied, i.e. transparency, accountability, disbursements of profits in a manner which ensures that globalization is not associated with the polarization of income distribution.
The intellectual tasks are defined in a business school. Ideas do matter. Norwegian and Chinese sovereign wealth funds backing new value creation in Brazil is the ideal. The profits are disbursed to the stakeholders, the depositors in the pension fund/SWF you will design.
Syndicated investments in new projects, a Kurdish film backed online by small investors who become the technological microcredits finance of the 21st Century is now a possibility. We can validate, perform due diligence.
The new global economy requires that two underlying principles be reaffirmed at every opportunity.
(a) The need for productive long-term capital investment through efficient capital markets trumps all other economic reforms. A Nigerian pension-fund, a Kazakh venture capital firm, the encouragement of Brazilian, Indian and Chinese investments in restructuring manufacturing assets are all achievable objectives if we take the Extractive Resources Transparency Initiative seriously and demand more of it. The Norwegian model, the model of the Alberta Heritage Fund for transforming resource wealth into longterm productive capital is the alchemy needed to make the global economy work. Without it, without global institutional investors, this new global economy will take a ragged form, marked by interruptions and idiosyncratic investment decisions. The goal is not just to change the way we look at GDP, but to look at the indicator of how much of the world’s capital market is invested by the standards of the best institutional investors.
(b) The “best” institutional investors also succumbed to the quantitative maladies of the 2000s. The second part of new global value-creation is to ensure that there is a global venture capital capacity. This is being done brilliantly by innovations in the microcredits market. But there is another challenge in the commercialization of global knowledge, the transformation of ideas into value. That is the question how we validate business models from Tunisia or Zambia, how we
syndicate investment in entrepreneurial efforts in smaller capital markets. The internet economy creates that opportunity as never before. “Bundled microcredits” becomes strategic venture capital. The fusion of the web economy and transformative economic development remains the most important part of the moment we are living through.
We are just at the beginning of a global expansion of growth. It will not happen (relatively) smoothly unless global political and financial leaders focus on the new pattern of global value-creation and escape the ancient categories of “state” and “market” for frameworks that reflect the new realities and the new opportunities. We have to measure quality of life in GDP, but we also have to measure capacities for long-term transformations.
The core problem with contemporary market economics is the disconnect between value creation and compensation. Capitalism works on a very simple moral principle: the creators of wealth should enjoy the benefit of their risk-taking. Across the world, phrases like “crony capitalism” and “casino economy” have come to reflect a cynicism about market economics.
PART THREE SOME BACKGROUND ON GLOBALIZATION 1.0 AND GLOBALIZATION 2.0
For twenty years, there has been a debate about the relationship between value-creation and profits. It underlies much of the debate about Globalization 1:0 (from the end of the Cold War in 1989 to the Asian financial crisis in 1997). It is reflected in a number of issues about value investing and global economic growth in the 2001-2008 period (Globalization 2.0) and the misleading discussions of “corruption” which were most famously characterized in that period by the Enron collapse.
Twenty years ago, much of this was understood. Business Week had a cover story on “THE CASINO ECONOMY”; Richard Ellsworth wrote in the Harvard Business Review in 1989 about the dangers of “short-termism” and the short term characteristics of U.S. (Now Anglo-Saxon capital markets) were seen to be a liability in the competition with an Asian superpower (at that time Japan). But when the Japanese bubble collapsed and Japan ceased to be a threat, the trends towards short-termism and casino-driven quantitative “systems” went unchecked.
What people forget in that period was that it is easy to make money in a rapidly-growing market. Homesteading in Kansas did not require strategic skills, just as real estate development in central China does not require anything other than access to the property entitlement system of the day. There are many interesting questions that should be asking:
(i) how much money was made and by whom in underperforming the market in the 1991-2001 and 2001-2007 period. Please remember that the principle of a never-correcting market was the underlying rationale for the U.S. home ownership strategy that led to the precipitous 2008 mortgage-securitization trigger for what has happened to the global economy;
(ii) in globalization 1.0 and 2.0, how much wealth was created by simply allowing the Karachi or Jakarta stock exchanges to monetize positional goods in Pakistan and Indonesia?
The principles of the new global economy are being reshaped by decisions as we talk. I want to set the stage for some of these new principles by revisiting introductory lectures of 2008 and 2009 for this course on Global Capital Markets and New Trends in International Political Economy.
First, and above all else, we are living through not a recession, but a global economic realignment. China was already in international terms creating a banker-debtor relationship with the United States by 2004 and one of the great failings of our otherwise remarkable system of open democracy was that even though this issue was raised in that year’s Presidential Debates by Senator Kerry, most people were either indifferent or oblivious.
The move towards new sources of economic power has proven to be rapid. The Chinese buying binge on resources and the role of Temasek and the Abu Dhabi Investment Authority in the new world of sovereign wealth fund led capitalism has shown this realignment, In 2007, when former Treasury Secretary Bob Rubin negotiated ADIA’s bail-out of Citicorp, the relief-map of this global economic realignment were there for all who wanted to see to see.
Second, the models of Anglo-Saxon democracy were dubious in real time, but as with mediaeval theological rituals, when the sun continued to rise, many people assumed the incantations were working. The cumulative effect of these economic models was to create a profound cynicism about the agencies of capitalism. When the time came to reconnect value creation and compensation, pro-market economic actors were left with three visible functioning models for economic wealth-creation:
(a) the much discussed Nordic model, which is a combination of a well-managed welfare state that facilitates rapid adjustment and a capital market that is defined by being insulated from the wild fluctuations of globalization (massive capital import from China or Russia or any casino-winner. The model continues to be viable but the question as to how exportable it is remains a critical part of contemporary political debate;
(b) the Silicon Valley model of wealth-creation, one of the most successful economic models for creating value in human history, which succeeded by directly linking compensation to performance and for many years resisting strenuously the importation of east coast economic models into the venture capital and private equity led wealth-creation exercise that created Cisco, AOL, Google and a thousand other smaller varieties;
(c) the microfinance model of creating a billion entrepreneurs in Bangladesh, China, Morocco, which promoted a new pattern of growth incrementally but by aggregating millions of wealth creators. We see today in the oversubscription of the Indian microfinance firm SKS Microfinance the new global capital markets learning from this experience. From the Nobel PEACE Prize (not Economics Prize) to Mohamed Yunnus and the work of C.K. Prahalad, Iqbal Quadir as head of the MIT Global Entrepreneurship lab , Tarun Khanna’s A Billion New Entrepreneurs and the popularity that book has engendered in South Asia, we see a new model.
When looked at this way, from Singapore, or Bamako, or Jakarta, or Saskatoon, the world financial crisis is not as portrayed in the short-termism and twitter-speed of media “analysis”. The U.S. is going through a long-delayed correction, wealth is being generated in many new places on the planet, well-managed economies are outperforming the marketplace, new growth is being created and Business School professors who talked about “markets” in which wealth is disconnected from value-creation are (with luck) unemployed.
PART FOUR A HISTORY OF THIS COURSE FROM LAST YEAR ARABLE LAND AND TWITTER
A year ago, I talked to this class about new value creation. I used the title “ARABLE LAND AND TWITTER”. In the intervening year, we have seen Canada’s Potash Corporation become the centerpiece of global capital market activity because of its unique capacities in value creation. We have seen Hewlett Packard and Dell compete for 3PAR to position their companies for a dominant position in cloud computing as the information economy restructuring. We are seeing an enormous expansion in the global economy as capital is redeployed to restructure the global economy. This is not a recession or a depression. It is a massive redeployment of capital. I used two case studies last year of DRIVERLESS SUBWAYS IN DUBAI and MOMBASA TEA EXCHANGES. Both show the rise of a Second World pattern of economic growth, where Dubai sets the standards (and despite its real estate correction, Dubai will remain a central part of the new global economy. As a friend of mine likes to say with charming simplicity “ just look at the map”) and Honey Farms in Kenya are a part of the new growth from microfinance-backed entrepreneurship which when aggregated creates a significant new asset category for global investors.
PART FIVE BIBLIOGRAPHY OF ARTICLES ATTACHED
For next week’s readings, I want to step back from these case studies and look at some of the analysis of contemporary political economy:
NEW ECONOMIC PARADIGM
Julie Creswell NYT on quant funds. Creswell’s reporting shows the decline of quant funds in the current economic environment and documents attempts to adapt them to new economic circumstances.
Julie Creswell also has an excellent piece on the surplus (sic) of cash in Wall Street hedge funds as investors look for different strategies in this post-GER (Global Economic Realignment) paradigm. The graphic is particularly useful.
Taleb’s pessimism lures CIC as an investor WSJ. Jenny Strasburg’s reporting of the CIC interest in Taleb’s Universa fund. Also look at Jane Kim’s reporting on Universa on how to profit from the next ‘black swan’, one of the most important investment metaphors in current jargon.
Landon Thomas’ assessment of the “economic pessimists” is an excellent overview.
Mohamed El-Erian of PIMCO’s piece on why the growth vs austerity debate is not relevant is essential reading for investment analysts and public policy makers.
Warren Buffett is looking for a successor. This could be someone like Li Lu according to
Susan Puliam’s reporting in the WSJ. As one is looking for models of new post-global economic realignment investment careers, this is an excellent article.
Alan Murray’s End of Management is essential reading for B-School students.
Sebastian Mallaby’s piece on Paul Romer in the Atlantic is a long, complicated article but may contain some of the most insightful thinking about new economic paradigms around today,
Khazanah trumps Fortis in bid for Parkway.
Rabobank invests in Asian agriculture. Rabobank, one of the world’s most innovative financial institutions and long a leader in agricultural investing demonstrates an strategy to operationalize of the ARABLE LAND investment thesis.
Chinese investment in Argentine infrastructure.
Jane Kim’s reporting in the WSJ on frontier investing is very well-done. Also, see
Renaissance and Africa. For the Russian fund, seeing Africa as a frontier market is a very interesting investment profile.
Syrian real estate and the transformation of Syria-Turkey-Iraq-Iran as an economic zone. The Hen-Tov and Haykel piece in the NYT on Turkey-Iran also sets a geopolitical framework.
Oil groups urge Indian sovereign wealth fund.
Gulf states leading on clean energy fund
A POSSIBLE 2020 PORTFOLIOARABLE LAND
WASTE TO ENERGY UTILITIES IN CITIES
REAL ESTATE (as always)
INFRASTRUCTURE (smart grids, water management)
One way to start thinking about the 2020 global economy is to ask what you would want in the portfolio. Moving forward from today, let’s look at some case studies of the current global economy:
New sources of value: DAEWOO INVESTS IN MADAGASCAR. The Madagascar coup of earlier this year was one of the most important underreported events of 2009. At a time when Canadian mining companies are investing billions of dollars in extractive industries, vanadium and rare earths, Madagascar became the template for a 21st Century crisis that also highlighted the emergence of the Indian Ocean zone. For Daewoo, this was a commercial play on arable land, like Chinese land purchases in Sudan and Abu Dhabi’s investment in Kyrgyzstan. The valuation of the deal produced such skepticism that it created a power struggle within the emerging Madagascar business elites.
The new regulation: Norway to monitor Asia Investments The Financial Times report by Lamont and Ward shows how the Norwegian sovereign wealth fund is trying to monitor corruption and correlate investing with social responsibility. Norwegians are deliberately trying to develop best practices for the management of sovereign wealth funds and to help other countries develop the ability to turn revenues from resource extraction into productive capital. In addition, they are assuming a leadership role in global social responsibility.
New patterns of investment CHINESE-AUSTRALIAN-CANADIAN RARE EARTH MARKETS Chinese investors and the Chinese sovereign wealth fund have become significant players in the global economy. Rick Carew and Tom Wright excellently review this in the September 24th, 2009 Wall Street Journal article “China Sovereign Fund Bets Big on Resources“. The case study of China and the global rare earths market is particularly interesting about new patterns of global extractive resource strategies. Keith Bradsher’s reporting in the New York Times in the September 25th New York Times shows the intricacy of the Chinese mutual dependence on western markets as well as any other single case.
New “stimulus” packages THE $36 TRILLION GLOBAL INFRASTRUCTURE MARKET - WHO PAYS? The Booz Allen report in Strategy and Business in 2007 raised some fundamental questions about how governments “stimulate” economies in a post-Keynesian world even before this global economic realignment. The development of financial mechanisms for infrastructural redesign remains a fundamental driver of the new global economy, in the U.S. stimulus package, in the Chinese domestic investment strategy and as a global pull the building of infrastructure in emerging markets. Infrastructure remains a key driver to the global economy, creating wealth through enhanced real estate valuations and opening up markets (canals, ports, railroads). How this is financed in a world of structural deficits remains a key investment banking challenge.
The constant challenge of valuation – where is the new “value” in the post-internet mobile global economy or put differently TWITTER IS WORTH HOW MUCH? The global economy is being driven by social media and new sources of value unimaginable even a few years ago. The obvious answer is we don’t know how much Twitter is worth, but smart investors think there is a value proposition which makes it worth a speculative investment. It is a bet on a business model and a management team and this becomes a cornerstone of the restructured global economy, trying to link productive capital with emerging entrepreneurial opportunities.
New players KHAZANAH HAS A ROLE NOW, HOW IMPORTANT ARE SOVEREIGN WEALTH FUNDS AND IS THE INDIAN OCEAN A NEW ZONE OF GROWTH? There are some discussions about sovereign wealth funds and SWF strategies generally. They constitute a significant new market driver in the global economy. Khazanah, the Malaysian sovereign wealth fund, is an important case study. Its involvement with Saudi Arabian financial investments and Malaysian involvement in Gulf Arab investors highlights the rise of the Indian Ocean zone (once described as the new Dubai-Singapore network, now seen as more broad than that as Chinese investment enters the Indian Ocean). There are interesting observations on this by Ben Simpfendorfer, a China analyst with the Royal bank of Scotland.
New sources of entrepreneurially created wealth. From Microcredits to new economic players, the emerging markets, there is a process of wealth creation branded as the bottom of the Pyramid by C.K. Prahalad. While some exaggerate the impact of these new sources of wealth-creation, the reality is that entrepreneurially led growth (e.g. Silicon Valley, the U.S. automotive industry in the 1920s, the economic geography of southern China, the mittelstand companies of Germany) has created demand in previous eras of economic restructuring. One can only imagine the impact of thousands of entrepreneurs from Sao Paolo and Hyderabad will create new patterns of growth in the global economy.
In the first class, I briefly talked about driverless subways in Dubai and tea markets in Mombasa. "Driverless subways" is a case study of new infrastructure investment and fundamental innovation in the global economy. . "Mombasa tea markets" is a case study of the rise of new financial innovations in the “South”. If we navigate through these seven current themes, we can try to define the vectors of the new global economy.
We are dealing with a global economic realignment right now. In trying to figure out the financial events of the last year and the contours of the global restructuring which this black swan has brought us, we need to put out a few markers. Much of the discussion is driven by either focus on regulatory failure or concerns about short-term financial market performance:
(a) The first analytical framework perceives a regulatory failure that brought about the crash of the global economy (“the patient was healthy before the accident”). While I think there is an exceptionally important discussion about regulatory failures, I often think that this debate serves to create an illusion of control in the United States in particular. If only “we” had regulated more efficiently, we wouldn’t be in this mess. The regulatory issues are real and compounded the crisis, but the underlying problem was the failure to recognize the shifting of tectonic plates in the global economy.
(b) The second analytical framework focuses on current stock market performances, whether or not recovery looks like a “w” curve or looks like a traditional recession. This too is obviously very important, because we all live in the short term and are trying to calculate portfolio strategies, availability of expansion capital in capital markets and domestic economic confidence. However, this discussion all too often takes place within the same economic paradigm which failed to predict or understand the events of last year, economic modeling of recessions and market corrections. The realization of this is the reason so much economic analysis sounds tentative at this time.
What we need to do is understand that there is a very different process of value-creation in the world coming from this global economic realignment (GER). The point is not to understand it, but to design it. So the purpose of this lecture is to (a) provide a relief map of the realigned global economy and (b) look at the role of B-Schools in designing new models of wealth creation within this relief map and (c) briefly address some of the questions of global governance within this realigned global economy.
First, let us look at some of markers in the new global economy. We should have known, and some did, look at the hedge fund managers who shorted U.S. banks between December 2007 and the collapse of Lehman brothers in September 2008, that the combination of U.S. indebtedness to China as a result of the mismanagement of the U.S. economy during the tax-free prosecution of the Afghan and Iraqi wars and the development of significant new pools of capital as a result of Globalization 2.0 (1997-2008) had led us into a number of high risk activities. When Bob Rubin successfully negotiated in December 2007 the $7.5 billion Abu Dhabi Investment Authority investment in a restructured Citigroup, we should have known.
Second, the global economic realignment does require new rules of governance. That is what the Pittsburgh summit was all about. The challenges ahead for it are how to finance infrastructural changes globally (driverless subways) and coordinate the new economic realities (Mombasa tea markets) with international rule of law? I think that if you hold these two challenges in mind, the next few years look more comprehensible and the agency required to create the preconditions for a different form of global prosperity seem more attainable. (In writing this lecture, I reviewed Brad Setser’s blog from his days at the Council of Foreign Relations before becoming joining President Obama’s National Economic Council. It remains helpful background reading).
New sources of wealth are created by designing new forms of digital media, by commercializing our medical histories, by improving the productivity of agricultural lands. The tectonic plates that have started to shift in the last year show the need for new financial architecture to reflect new patterns of growth. This architecture will evolve in ways we are just starting to understand. Some of it will fit into categories that are familiar to us: harmonization of securities law, compliance with tax-enforcement. Some of them will be completely new: the validation of entrepreneurs through some form of social media like Kiva. It is possible to imagine a model of entrepreneurial growth where microcredits are allocated via mobile telephony and validated by a social media network attached to a Twitter like business model. There will be new businesses around rare earth mining (scandium, vanadium are not household words, but they transform our concept of usable materials). In other words, innovation will take place as it always has once we decided on the new sources of value.
The geopolitics of this will challenge us as we realign capital markets with new political realities. By simply Googling “China String of Pearls Map”, I came up with an interesting blog from a PhD student at Durham in the U.K. The focus on the Indian Ocean zone is obvious to anyone looking at global politics today. From Somalia to Indonesia, Indian, Chinese, European and American interests are being redefined and the new players in the zone create a very different global capital market, because this is where much of the new global wealth is being created and traded .Bob Rubin could have asked for $7.2 billon from the Chinese, but they would have had a very complicated decision-making process on whether they would have been interested. If the Citigroup restructuring had been done that way, we would have been more quickly aware of this shift of power to the emerging markets, the BRIC countries and more (Malaysia, Indonesia).
ASIAN HEALTH CARE AND BRAZILIAN DIGITAL INFRASTRUCTURE
Growth in the Global Economy in 2011