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How competition cracks down on corruption

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saacartoon

For all the flack the private sector gets from both the left and the right, it has one redeeming feature that critics find difficult to avoid: competition. Take KPMG, the global auditing firm that has been at the center of the Gupta family scandal, in which South African taxpayers’ money was used to fund a wedding at Sun City in 2013. Upon the release of an internal report on the matter, KPMG CEO Trevor Hoole quit, as did the chair of the board and six other top staff. And in the weeks that followed, companies began to ditch KPMG as auditors, led by Magda Wierzycka’s Sygnia and followed by Hulisani, Munich Re, Sasfin, AVI, Telkom, and many others. Even that slowest moving of institutions – universities! – joined the KPMG culling. Sources within KMPG suggest that the mood is bleak.

KPMG is just one example. Bell Pottinger, the British public relations and reputations management firm, went into administration on 12 September after its Gupta-sponsored campaign to inflame racial discord in South Africa was exposed. And global consultancy McKinsey may be in even more trouble as the extent of its relations with Eskom and black-owned supplier Trillian (which was neither black-owned nor a legal supplier) becomes evident.

Market forces are at work. When companies built on trust and reputation lose it, clients will (and should) jump ship. It’s not personal, it’s business. Deloitte and PwC will benefit from their competitor’s indiscretion. But more than that, they would want to make sure that their own house is in order. Expect the quality of audits to increase significantly in future.

In contrast, those at the root of the problem are ensconced by the uncompetitiveness of government. The Gupta tentacles reach almost everywhere in the public sector, most notably in Treasury where minister Malusi Gigaba has suggested the Public Investment Corporation uses its considerable assets to support flailing state-owned enterprises like SAA. In wonderful irony, Cosatu threatening to replace the PIC with privately owned fund managers to oversee its members’ pension funds. Competition discourages bad behaviour.

Politics, of course, is competitive. Elections pit politicians and their parties against each other, with voters, presumably, electing that party which would serve their interests best. But elections are fuzzy reflections of voter preferences. (Brexit and the recent US elections are good examples.) And, most importantly, they only occur every five years. Had KPMG been subject to the same slow process of five-year elections, would anyone have remembered their misdemeanour two years from now?

Corruption, though, is a crime, and any politician found guilty should be punished accordingly. But as we have seen in South Africa, the rot can be so deep that those with the power to act against the rampant corruption – the National Prosecuting Authority, the Hawks, the Public Protector – can choose to stay quiet. And when the media lose their ability to fairly report on these matters – exactly what Bell Pottinger’s campaign against white monopoly capital tried to do – the corrupt actions of politicians will go uncensored by an oblivious public.

That is why impartial government audits are so important. Critics often claim government officials pay too much attention to ‘clean audits’, that it takes the focus away from what politicians should be doing. Helen Zille, Western Cape premier, admitted as much in 2015: ‘Trying to achieve a “clean audit” can actually become a stumbling block to service delivery. It also puts a brake on innovation in government.’

But audits matter because they change behaviour. A 2016 NBER Working Paper Eric Avis, Claudio Ferraz and Frederico Finan examined the extent to which government audits in Brazil reduced corruption. Brazil’s anti-corruption programme randomly audits municipalities for their use of federal funds, and this randomness allows the authors to test whether audits have a causal impact on corruption. They find that being audited in the past reduces future corruption by 8 percent, while also increasing the likelihood of experiencing a subsequent legal action by 20 percent. The reduction in corruption comes mostly from the ‘audits increasing the perceived threat of the non-electoral costs of engaging in corruption’. In other words, audits make politicians less likely to award government contracts to friends at inflated prices, which saves public resources and improves service delivery.

This is why KMPG’s actions are so despicable, and why it should be punished in the market place. It was the last line of defence, and it failed in its duty to uncover the misuse of public funds. If guilty, the same fate will hopefully befall McKinsey too.

But it might not be that easy. Many South African industries are concentrated, and the oligopolies in them are often deeply entwined. KPMG remains the auditors of Standard Bank and Investec. The fall of KMPG will also strengthen the dominance of Deloitte and PwC, which may render them, if a scandal was to hit them, too big to fail. With few obvious competitor, McKinsey has, so far, remained largely unscathed.

More competition, in both oligopolistic industries and the public sector, is how you ensure that corruption is identified and punished.

*An edited version of this essay appeared on 2 November in Finweek magazine. Note that this essay was written before the Steinhoff debacle of the last week. My point stands, though. As details emerge of who is responsible for the Steinhoff mess, one thing remains clear: several members of the executive, including Marcus Jooste, CEO of Steinhoff, and Ben la Grange, chief executive of Steinhoff Africa Retail, have already lost their jobs. Where illegal actions have occurred, shareholders will make sure prosecutions follow. Compare Dudu Myeni, former boss of South African Airways, who, after finally being fired after years of mismanagement at SAA, landed a nice job as special adviser to the Minister of Transport.

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Written by Johan Fourie

December 11, 2017 at 09:53

Should South Africa host the 2023 Rugby World Cup?

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South Africa 2023

Tomorrow (Wednesday) we will know whether South Africa will host the 2023 Rugby World Cup. Here are my thoughts on hosting mega-events:

One of my aspirations when I was in high school was to bring the Olympic Games to Cape Town. Imagine a brand new athletics stadium and athlete village at Ysterplaat. Athlone Stadium could play host to sevens rugby, while the breathtaking Cape Town Stadium would host all football games. Newlands Rugby Stadium could be converted into a 20 000-seater indoor gymnastics stadium, Bellville velodrome would play host to cycling, Hartleyvale could host hockey, Camps Bay beach volleyball, Muizenberg surfing, the Waterfront sailing, and Langa could get a brand new boxing venue and swimming pool that could serve the community long after the Olympics is gone. And what better venue to launch the new Olympic code of T20 cricket than Newlands cricket stadium?

The sports stadia would, of course, be just one element of a much bigger infrastructure drive. The largest innovation will be in transportation: a new, world-class international airport, built on the N7 to Malmesbury, would allow Cape Town to lift international arrivals from 2 to 10 million. A new CapeRocket mass rapid rail network would connect the new airport with the city and neighbouring towns of Paarl, Stellenbosch, Somerset West and Simon’s Town, perhaps even Worcester through the Huguenot Tunnel. If a train could take you from Worcester to Cape Town City Center in less than an hour, imagine what that would do to the daily commute – and property prices in rural areas! (That is radical economic transformation, I can hear Cape politicians say.) And an Uber-like app for all city transport, including taxis, now electric, would allow spectators to seemingly move between the different transport modes.

In moments of weakness, these dreams return. But then reality kicks in, informed by several years of research on the impact of mega-events. The picture is not a positive one. In short, the Olympic Games is an expensive undertaking which rarely delivers on the promises of spectacular economic growth. Robert Baade and Victor Matheson, two experts in the field, summarises it best: ‘In most cases the Olympics are a money-losing proposition for host cities; they result in positive net benefits only under very specific and unusual circumstances.’ There are exceptions, of course. Los Angeles in 1984 was a financial success for two reasons: it built very few new stadia, and the costs that were incurred were mostly funded by the private sector. Barcelona in 1992, too, is considered a success, uplifting a city to global tourism status to the extent that Catalonians are now trying to curb tourism.

But these are the exceptions that prove the rule. Most cities that host the Summer Olympic Games continue paying for the event long after the closing ceremony. Montreal hosted the 1976 Olympic Games; Canadians finally repaid all of the debt in 2006, 30 years later. Many even argue that Greece’s economic woes of the last decade was a direct consequence of its 2004 Olympic Games expenditure. Most Olympic venues, built specifically for the event, are, at best, used for occasional events, much like the Cape Town stadium that was built for the 2010 World Cup. At worst, these venues fall into disrepair, and become a huge fiscal burden on the local government. Consider, as example, Rio’s Olympic venues only one year after the event!

Ex post studies of mega-events confirm the visual evidence. In a paper I co-wrote with Maria Santana-Gallego in 2011, we found that mega-events like the Olympic Games and Soccer World Cup boost a host country’s tourism by about 7%. This varies depending on whether the event was held during the off-season (like the 2010 World Cup in South Africa, and unlike the Olympics in Athens), the type of event (the Olympics is held within one city, the Soccer World Cup in several cities) and even who participates in the event.

Even if tourism increases substantially, as it did for South Africa before, during and after the 2010 World Cup, these advantages can easily be undone. In a back-of-the-envelope calculation, I have shown that all the tourism benefits South Africa derived from hosting the FIFA World Cup were undone by our ridiculous visa rules in 2015, a classic case of the negative unintended consequences of good intentions without sound analysis.

Despite the evidence against mega-events, cities and countries still line up to bid for them. It seems like an irrational thing to do, but there are very rational reasons cities and countries do so. These reasons are mostly political. The politician who hosts the event, will often not be the one who pays for it. There is an immense feel-good factor associated with hosting mega-events; having watched 8 games of the 2010 World Cup around South Africa, I know these emotions very well. And voters often vote for politicians not based on calculated policy statements, but on how they make them feel. A second reason is that cities can use a mega-event to get a larger share of the national budget.

South Africa 2023 stadiums.png

South Africa wants to host the 2023 Rugby World Cup. There are reasons for and against doing this. On the positive side, no new large infrastructure will be required. The event will also be held during the tourism ‘off-season’, meaning that rugby supporters would likely not displace other tourists. Its bid document projects an economic impact of R27 billion, with R5.7 billion to low-income households. A total of 39 000 temporary and permanent jobs is expected to be created. Sounds like a no-brainer.

But it’s not that simple; there are few things in life that are certain, but that these numbers are inflated is one of them. Cabinet has already approved a guarantee of R2.7 billion which was required World Rugby. The event will require public resources in an era when budgets are already under considerable stress. On the tourist side, South Africa have strong existing links with rugby-playing countries; tourism is therefore unlikely to see much of an increase before and after the event. And the feel-good factor of a tournament the size of the Rugby World Cup is limited if your team don’t win the finals; as a thought experiment, would 1995 have had such treasured memories were it not for Joel Stransky’s final drop goal?

Despite my childhood dreams, we were fortunate to escape the 2004 Cape Town Olympic bid, and even more fortunate to escape Durban’s Commonwealth Games disaster of 2022. Hosting mega-events are expensive parties, with inflated benefits and underestimated costs. (I should add: this is not only true for South Africa, but for Ireland and France, our competitors for the 2023 bid, as well.)

My heart wants us to win the bid; my head says it’s probably not the worst thing if we don’t. Let’s see what happens tomorrow!

*An edited version of this first appeared in Finweek magazine of 19 October 2017.

Written by Johan Fourie

November 14, 2017 at 07:05

The politics of infrastructure

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Cape Town railway historic

What type of infrastructure would be best for South Africa’s future? The answer, of course, depends on your point of view. If you live and work in Gauteng, your answer might well be to expand the Gautrain network. Or if you reside in Cape Town, you might prefer investments in desalinization plants. Your occupation may also be relevant. If you’re a miner, you are unlikely to support the expansion of renewable energies. A trained software engineer? Well, you’re likely to support large investments in telecommunications infrastructure.

An important – but often underappreciated – role of government is to choose the type of infrastructure that is destined to shape the country’s future development path. This choice is never neutral though: for every decision, there are winners and losers. Choose to build a new coal-fired power plant? That will benefit coal mine owners and workers, while the users of electricity, were the costs of alternative sources to fall rapidly, will pay. Choose to build a high-speed train network across the country (a hyperloop, perhaps!), then users of this network, likely to be high- or middle-income South Africans, will benefit, while long-distance bus services, taxi operators and rental cars will pay. The government’s job, in theory at least, is to choose the projects that will maximize the benefits and minimize the costs.

But things are never that simple. A research paper that will soon appear in the European Review of Economic History, written by Alfonso Herranz-Loncan and myself, investigate the infrastructure in the Cape Colony built during the second half of the nineteenth century. Before the discovery of diamonds in 1867, the few railways that existed (in and around Cape Town) were privately-owned and largely unprofitable. But the discovery of diamonds and the rush to the mines meant the demand for fast, affordable inland transport increased exponentially. The Cape government had to react.

They did. They bought the few existing lines, and then began to the process of connecting Cape Town to Kimberley, finally achieved in 1885. The connection to the booming diamond region brought huge economic benefits: we estimate that the railway may account for 22-25 percent of the increase in income per capita in the Cape during the diamond-mining period (1873-1905). This is a massive share for a single investment and a clear indicator of the transformative power of railways during the first era of globalisation.

But these benefits were not equally shared by everyone. Surprisingly, the government itself earned a meager 3.7% average return on its capital. Had a private firm built the railways, far fewer branch lines would probably have been built. As Stellenbosch PhD student Abel Gwaindepi now shows, the government incurred huge debt to build this infrastructure, and although the government did benefit through customs duties and other tariffs, the main beneficiaries were the owners of the diamond fields. The railway link between Cape Town and Kimberley could now transport the machinery and foodstuffs required to feed the growing Kimberley population. Western Cape wheat farmers, who supplied the mines with food, was another group of beneficiaries. It is not entirely coincidental that it was also these two groups – mine owners and Western Cape farmers – who had formed a political alliance in Cape parliament.

Of course, it was not only mine owners and Cape farmers that benefited. As detailed reports of passengers show, Cape Colony residents from all walks of life used the railways. But, ultimately, it was tax payers who had to foot the debt that were incurred, and often these tax payers were spread across the entire colony (far from the direct benefits of the railways) – and after unification in 1910, the rest of the country. And the location of the railways meant that those with less political influence – like Basotho farmers, who were of course producing wheat much closer to the diamond fields – lost out. Here is one missionary report from 1886, the year after the railway line was completed: ‘Basutoland, we must admit, is a poor country… Last year’s abundant harvest has found no outlet for, since the building of the railway, colonial, and foreign wheat have competed disastrously with the local produce.’

The nineteenth-century Cape railways contributed significantly to economic growth, but it inadvertently also had distributional consequences: some benefited more than others, and some even suffered as a result of its construction.

The lessons for today? Politics shapes the type of infrastructure that’s built. And infrastructure shapes the direction of economic development. So the key question is this: Are we building the type of infrastructure that will put South Africa on a path of broad-based economic development, or is the choice of infrastructure determined by the self-interest of those with decision-making power, much like Cecil John Rhodes and his cronies during the late nineteenth-century?

Put differently, when we choose a new power-generating facility or national air carrier or telecommunications license, do we consider the benefits for society as a whole or the benefits for a specific interest group?

*An edited version of this first appeared in Finweek magazine of 5 October 2017.

Policy uncertainty is killing investment in what matters

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microscope

Much has already been said about South Africa’s inefficient public sector. Not only has the public sector wage bill escalated beyond the realms of the sustainable, but this has come at almost zero public sector productivity growth. In other words, we are paying more for government to do less. Add to that the poor performances of state-owned enterprises like Eskom, the SABC and most notoriously, South African Airways, and it seems that there is little more that the South African government can do to hurt the prospects for economic growth.

But there is. A new NBER working paper, published by Jose Maria Barrero, Nicholas Bloom and Ian Wright, uses new data on about 4000 US firms to investigate the sources of uncertainty in the US economy. They first distinguish between short-term and long-term uncertainty, identifying the factors that cause each type of uncertainty. They then ask how each type of uncertainty affect firms’ behaviour.

Short-term uncertainty, they find, is caused by oil price volatility. In contrast, economic variables like the oil price has less of an effect on long-term uncertainty where political risk, like policy uncertainty, has a much larger effect. The important result is that short-term and long-term uncertainty have different consequences for firm behaviour. Short-term uncertainty affects employment; long-term uncertainty affects investment in research and development.

If we assume this is true for South Africa too, how would it play out? Volatility of several macroeconomic variables, like the oil price and exchange rate, cause higher short-term uncertainty. This would likely make firms unwilling to hire new workers, or make managers unwilling to offer higher wages. These are the consequences economic commentators typically cite when referring to an unstable macroeconomic environment.

But employment and wages are not the only variables affected by uncertainty. One of the key indicators of a thriving economy is businesses’ willingness to invest in research and development. Take R&D as a percentage of GDP, shown in the Figure below. There is large variation in the share that countries spend on research and development: Israel and South Korea, for example, spend more than 4% of their GDP on R&D. South Africa spend less than 0.8%. (This figure almost reached 0.9% in the 2006-2008 period, a period not surprisingly correlated with high growth rates.)

RDspending

There is a strong positive correlation between countries that grow fast and those that invest in research and development. South Africa, unfortunately, significantly lags those countries at the technological frontier. It is important, though, to understand why this is the case. It is not only government that invests in R&D; in fact, more than half of all R&D investment in South Africa comes from the private sector.

So what will encourage businesses to invest more in R&D? Well, according to Barrero, Bloom and Wright, political risk and policy uncertainty is the biggest determinant of private sector investment in R&D. In a political environment with little policy coherence, business are unlikely to make investments where the returns can only be realized in the long-run. Even if the possible returns are substantial, a rational investment response to a murky policy environment would be to sit back and see what happens. Lower investment in R&D means falling further behind international competitors.

There are some in the South African government who realise this. Minister of Science and Technology, Naledi Pandor, has committed to doubling R&D expenditure as a percentage of GDP by 2020. This is commendable, but in the current budgetary environment, unlikely to get the support from the Minister of Finance. Other initiatives to get the private sector investing in R&D, like a refundable tax credit that will benefit small businesses, have not been implemented.

These problems are not unique to South Africa. As the authors argue: ‘Our findings are significant in the wake of recent events like Britain’s vote to leave the European Union and Donald Trump’s assumption of the US Presidency, which have generated considerable uncertainty over future economic policy around the world. As we have shown, such policy uncertainty is particularly linked with long-run uncertainty and in turn with low rates of investment and R&D that can have significant consequences for the global economic outlook in years to come.’

R&D is the bedrock of future prosperity. Political risk that leads to policy uncertainty hurts not only economic growth and employment creation, but also deters firms from investing in the one thing that can create prosperity for all. If the ruling party is serious about its slogan, it better start by enacting more coherent economic policy.

*An edited version of this first appeared in Finweek magazine of 21 September 2017.

Writing a biography of an uncharted people

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Biography

Two weeks ago, early on the Tuesday morning while still in bed, I opened my laptop to start the day. I was staying in a guest house in Guelph, Canada, where I was on a short visit before heading off to the Economic History Association meetings in San José at the end of that week. Scanning through my mails, my eyes came to rest on an address I had expected – an email from our Development and Alumni Relations officer. It read only: ‘Geluk Johan!’ – ‘Congratulations Johan!’ Our Mellon application was successful. The Biography of an Uncharted People project had begun.

The idea for the Mellon project had started roughly a year earlier. South Africa’s individual-level census data for much of the period before 1948 has not been preserved, and economic history is increasingly moving towards understanding ‘history from below’, using large datasets to investigate the social, demographic and economic aspects of human behaviour in the past. Fortunately, large numbers of other types of individual-level records have been preserved in South Africa’s archives, and are increasingly being digitised by institutions such as FamilySearch.org. These records include things like marriage records, death notices, voters’ rolls, tax censuses and slave emancipation records. Using such source material, I believe, would have two main benefits: firstly, it would open many new avenues for historical inquiry and, secondly, it would help equip history students with the skills of the data revolution, something I’ve written about before.

Dyanti Ngcita

An example of a Cape province death certificate

But transcription is expensive. The Andrew W. Mellon Foundation, however, is a generous supporter of research in the humanities, and after a rigorous internal and external application process, with many excellent competing project bids, we received, on that wonderful Tuesday morning, the happy news of success – starting in January 2018, the project will be funded for five years.

This will not only be a South African project. We have brought together an impressive team of scholars, with a wide range of expertise. Now we are scouting for academically dedicated and enthusiastic students to join us in writing this new biography. We offer bursaries from postdoc to Honours level. More information is available on the project website.

I am excited about what the newly transcribed information, currently hidden away in millions of unused documents, can reveal. I am excited about building a team of dedicated and brilliant young scholars, a team that can continue long after the five years funding term. And I am also excited to join a new faculty and department, encouraging inter-disciplinary research that will, hopefully, provide new insights into the lives of South Africans, present and past.

How finance evolves

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Evolve

Why is it that stock markets tend to be depressed during winter months? Or that investors with too little emotional response (or too much) tend to be less profitable than those with just the right amount of emotion? Or that traders tend to make more money on days when their levels of testosterone are higher than average?

In a fascinating new book, Andrew Lo builds on the corpus of behavioural science research to outline a new theory of financial markets. His basic point: homo economicus is dead. The hyper-rational human that always optimized every decision, most famously portrayed in the Efficient Markets Hypothesis of Eugene Fama that has ruled the field of finance at least since the 1980s, does not exist. His new book, Adaptive Markets: Financial Evolution at the Speed of Thought, explicates his Adaptive Markets Hypothesis, first proposed in 2004 as a substitute for the Efficient Markets Hypothesis.

In short, the Adaptive Markets Hypothesis accepts that humans are biological beings, and that our biology limits our ability to optimize every decision as the Efficient Markets Hypothesis predicts. Most importantly, though, our ‘irrationality’ is not random. This means that we consistently make the same ‘mistakes’, something that behavioural scientists have known for quite some time. One of these mistakes, for example, is that we often link events together because they happen to occur close to each other. As Lo puts it: ‘We humans are not so much the “rational animal” as we are the rationalizing animal. We interpret the world not in terms of objects and events, but in sequences of objects and events, preferably leading to some conclusion, as they do in a story.’

Telling stories is one way we try to make sense of the world, even if those stories are sometimes false. We do this because, given the environments that we encountered, this was the most evolutionary successful behaviour. But that has consequences: If our environment change, our biological decision-making processes might not be equipped to deal with the new environment. In Lo’s words: ‘“Rational” responses by homo sapiens to physical threats on the plains of the African savannah may not be effective in dealing with financial threats on the floor of the New York Stock Exchange’.

Often the real world is not very different from the survival-of-the-fittest world our ancestors encountered on the African plains. Many times, humans do optimize their behaviour. This is why the Efficient Markets Hypothesis could hold for so long, treating ‘irrational’ behaviour as random outliers that will be averaged out in the marketplace. But as Low demonstrates in countless examples, often humans (and by implication traders) behave ‘predictably irrational’, reacting to fear systematically different than to reward, for example, and opening opportunities for windfall profits on the financial markets. That is why some famous investors, accounting for these predictably irrational heuristics of humans, can be consistently successful.

The good news, though, is that we are not like other animals. We do not have to wait for evolution to take its course, molding us to our environment through natural selection. We have the ability to learn and adjust through trial and error. High-frequency trading is a great example: speed is everything in financial markets, and automated trading programmes have replaced specialist human traders who are just too slow to recognize and respond to the predictably irrational human errors. But even this is changing, as Lo explains: ‘At first, these high-frequency traders made windfall profits, since human specialists were sluggish and inefficient in comparison. However, there ultimately came a point where high-frequency traders were mainly competing with each other. To succeed in this financial arms race, high-frequency trading firms had to invest in faster and more expensive hardware. At the same time, however, these firms were scouring the market for any trace of “juice” that might be left. In a very short amount of time, high-frequency trading was pushing against its natural evolutionary limits. It had unexpectedly become a mature industry, with low margins on trades and low overall profits.’ High-frequency trading is now on the decline, as more and more exchanges start implementing ‘no high-frequency trading zones’. The environment is changing, and those high-frequency traders that do not adapt, will perish.

The book presents not only a fascinating new theory that can explain why some investors continue to be successful despite the prediction of the Efficient Markets Hypothesis, but it also situates this theory within the context of broader developments in finance. We learn why the Efficient Markets Hypothesis was so appealing, why earlier attempts to use evolutionary thinking in finance never caught on, and what this new theory might say about the future of finance. It also has a cautionary word about how we train the next generation of finance gurus: ‘For the mathematically trained economist, it’s sometimes difficult to think in evolutionary or ecological terms, but sooner or later, this way of thinking will be domesticated (another biological metaphor), and will become another standard tool for economists to use, just as molecular biologists use it today.’

Just like the finance industry employed mathematically-inclined engineers and physicists in the last few decades, perhaps biology will be the training-of-choice for the next generation of investment firms. Perhaps. What we do know is that the environment is changing, and that means that traders will have to adapt too if they are to survive, and thrive. As Lo explains: ‘An evolutionarily successful adaptation doesn’t have to be the best; it only needs to be better than the rest.’ Let the games begin!

*An edited version of this first appeared in Finweek magazine of 7 September 2017.

What explains the rise of populism?

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Donald Trump

Consider the following thought experiment: Sibusiso and Thulani each own a firm that competes with the other. In each of the following scenarios, Sibusiso’s firm outcompetes Thulani’s. Which of the four do you consider unfair competition?

  • Sibusiso works hard, saves and invests his profits, and invents new techniques and products, while Thulani’s products change little and he loses market share.
  • Sibusiso finds a higher quality input supplier in the US, which makes his products better and he therefore takes market share from Thulani.
  • Sibusiso outsources some of his services to Bangladesh, where workers work 12-hour shifts under hazardous conditions, earning very low wages.
  • Sibusiso brings Bangladeshi workers into South Africa under temporary contracts, and puts them to work at lower than minimum wages.

From an economic perspective, each of these scenarios have a similar result: there are winners as well as losers as they expand the economy. But people generally react very differently to them. Most people are happy with scenario 1 and 2: even if someone loses (Thulani and his employees), this comes through what is perceived as fair competition from Sibusiso. It is scenario 3 and 4 that creates problems: when Sibusiso ‘breaks’ local laws (even though it may be perfectly legal in the foreign country), his competitive advantage, and by implication international trade, is viewed as unfair.

In a provocative new NBER Working Paper, Harvard University economist Dani Rodrik use this example to argue that too-rapid globalisation – the increasing use of scenarios 3 and 4, of outsourcing production to the developing world or of employing immigrants – is the underlying cause for the rise of populism across the developed world. The ‘losers’ from globalisation feel that foreigners – abroad or as immigrants in their own countries – have taken unfair advantage of then, stealing their jobs. They have chosen the politics of populism as a way to ‘punish’ this rapidly globalising world.

Economists know that free trade creates both winners and losers, and that the winners almost always gain more than what the losers lose. If the winners could perfectly compensate the losers, everyone would be better off from a free-trading world.

But Rodrik argues that such compensation is not always easy, and rarely happens. Aside from Europe, where an extensive social safety net was institutionalized to support ‘losers’, most countries failed to find a way to sufficiently compensate those that suffered the consequences of open borders. Make no mistake: open borders resulted in massive global gains, notably for the poor of China and India. But in each country, as trade theory predicts, there were losers. In Rodrik’s words: “People thought they were losing ground not because they had taken an unkind draw from the lottery of market competition, but because the rules were unfair and others – financiers, large corporations, foreigners – were taking advantage of a rigged playing field.”

There are many new studies to back up this claim. In a 2016 paper, David Autor and his co-authors show, for example, that the trade shock of China joining the World Trade Organisation aggravated political polarisation in the United States: districts affected by the shock moved further to the right or left politically, depending which way they were leaning in the first place. Analysing the Brexit vote, Italo Colantone and Piero Stanig show that regions with larger import penetration from China had a higher Leave vote share. They repeat the study for fifteen European countries, showing that China’s entry into the WTO had similar political consequences across Europe. In a 2017 working paper, Luigi Guiso and his co-authors use European survey data to draw even more precise conclusions: the more individuals are exposed to competition from imports and immigrants (the higher their economic insecurity), the more they vote for populist parties.

To summarise: because there were uncompensated losers from global free trade, argues Rodrik, there were political consequences. Rodrik then constructs a model to explain this populist rise on both the left and the right. According to the model, there are three different groups in society: the elite, the majority, and the minority. Says Rodrik: “The elite are separated from the rest of society by their wealth. The minority is separated by particular identity markers (ethnicity, religion, immigrant status). Hence there are two cleavages: an ethno-national/cultural cleavage and an income/social class cleavage. An important implication of this reasoning is that even when the underlying shock is fundamentally economic the political manifestations can be cultural and nativist. What may look like a racist or xenophobic backlash may have its roots in economic anxieties and dislocations.”

Populists who emphasize the identity cleavage target foreigners or minorities, and this produces right-wing populism. Those who emphasize the income cleavage target the wealthy and large corporations, producing left-wing populism. The large numbers of immigrants into Western Europe has resulted in the rise of right-wing populists, for example, while Latin America, because of large disparities between rich and poor, has seen more left-wing populism. The United States, argues Rodrik, falls somewhere in the middle – with Donald Trump on the right and Bernie Sanders on the left.

These findings have important implications for South Africa too. South Africa joined the WTO in 1995 and liberalised our complicated tariff schedule, opening our borders to foreign competition. There were many winners from cheaper imports, notably consumers, but some firms and industries struggled, leading to job losses, often concentrated in certain regions. And although South Africa rolled out an impressively comprehensive social safety net for a middle-income country, they could not compensate all the losers, especially as the global financial crisis hit in 2007 and unemployment began to worsen. It is not entirely coincidental that the first large-scale xenophobic attacks on foreigners happened in 2008 (what Rodrik would call right-wing populism) and that the ANC shifted left with the election of Jacob Zuma as South African president in 2009.

Even if globalisation creates more winners than losers, the losers, like Thulani and his employees, may feel that the system is rigged, and retaliate by voting for more populist parties. As South Africa stumbles into another recession, this may have profound consequences for the ANC’s December elective conference – and the national election in 2019.

*An edited version of this first appeared in Finweek magazine of 10 August 2017.

Written by Johan Fourie

August 14, 2017 at 16:47