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Game Changing Trade Regulations in US Shake Up Corporate Supply Chain Responsibility

31 May 2016
by Guest author

FORUM2016Roel Nieuwenkamp, Chair of the OECD Working Party on Responsible Business Conduct (@nieuwenkamp_csr)

In July 2015, The New York Times published an article about forced labor on Thai fishing boats. In the article they follow the story of Lang Long, a man who was shackled by the neck, working for 3 years as a slave at sea. He was one of the many Cambodian migrant boys and men working on Thai boats that supply fish to consumers worldwide. The men featured in the article are fortunately now free, but many slaves are still involved in the production of goods for global supply chains.

Indeed modern slavery is endemic within global supply chains. In recent conversations I had with some sourcing directors of large multinational enterprises, they admit that if you look closely and deeply enough, in every major global supply chain you are likely to find modern slavery. This has fuelled political moves to fight slavery in supply chains and also created serious challenges for companies dedicated to responsible sourcing.

In previous articles I have covered some of the innovative regulatory initiatives taken to promote supply chain responsibility (e.g. the UK Modern Slavery Act, the proposed law on due diligence in France, the Swiss referendum for a due diligence, and the EU non-financial reporting directive). Currently 8 Parliaments in the EU are calling on European Parliament to follow the French example.

Some recent developments in the United States may have even more impact on supply chain responsibility with global trade implications.

This February, President Obama signed in the Trade Facilitation and Trade Enforcement Act (H.R. 644). Section 910 of this law strengthened restrictions on the import of goods into the United States produced with forced labor, closing a loophole that existed in the Tariff Act of 1930 which allowed import of such goods if the product was not made in high enough quantities domestically to meet the U.S. demand.

This law accompanied two other moves to tackle modern slavery, particularly in the fishing industry, by the Obama administration. In addition to the new act, the administration has also enacted the Port State Measures Agreement which bars foreign vessels from accessing ports if suspected of illegal fishing. Furthermore the National Oceanic and Atmospheric Administration, which regulates fishing, announced new reporting requirements aimed at developing a better understanding among US companies of where seafood imports are sourced from.

While regulation is important, enforcement is arguably even more so. Indeed the Trade Enforcement Act is already being enforced. Recently the U.S. Customs authority issued two “withhold release” orders, preventing goods from entering the country because of suspicions that they were made using forced labor.

The first order came on March 29th against imported soda ash, calcium chloride, caustic soda, and viscose/rayon fiber that was manufactured or mined by Chinese company Tangshan Sunfar Silicon. U.S. Customs and Border Protection (US CBP) believes that these products were made by forced convict labor. The second order, on April 13th, was against imported potassium, potassium hydroxide, and potassium nitrate that is believed to be mined and manufactured by the same company using convict labor.

According to CBP Commissioner Kerlikowske: “CBP will do its part to ensure that products entering the United States were not made by exploiting those forced to work against their will, and to ensure that American businesses and workers do not have to compete with businesses profiting from forced labor.”  The Business & Human Rights Resource Center is tracking enforcement of the Act on their site.

These orders are an important part of enforcing the new ban and ensuring criminals that profit from human trafficking are not supported. Effective enforcement of this provision also provides incentives to business to protect their supply chains from forced labor to guarantee all of their imports are cleared for entry into the United States.

Recently Turkmenistan News (ATN) and International Labor Rights Forum (ILRF), partners in the Cotton Campaign, filed a complaint with the US CBP. The complaint concerns the import of cotton goods made using forced labor from Turkmenistan by companies, including retail giant IKEA. The government of Turkmenistan engages in a practice where annually farmers are forced to deliver cotton production quotas and thousands of citizens are required to pick cotton or are faced with a penalty. The complaint calls on U.S. Customs to classify cotton goods, such as the IKEA products, from Turkmenistan as illicit, issue a detention order on all imports of them, and direct port managers to block their release into the United States. CBP has yet to respond.

If the U.S. government and American businesses set a precedent that forced labor will not be tolerated, other countries are likely to follow suit. However, how U.S. government follows through on implementing the new ban, is essential to this effort.

child labor

Furthermore, given the extensive pervasiveness of modern slavery in global supply chains companies must be armed with tools to protect themselves and their supply chains from liabilities under these regulations.

Strong supply chain due diligence processes should in my opinion be an accepted defence under these new laws. This should include the notion that supply chain responsibility means often not ‘cut and run’ from risky suppliers, but ‘stay and improve’. Else these regulations could have devastating negative impacts on livelihoods of legitimate businesses operating in high risk areas. The OECD has provided guidance to companies in designing such due diligence processes. The OECD Guidelines for Multinational Enterprises (the OECD Guidelines) recommend that companies carry out supply chain due diligence to identify, prevent, mitigate and account for all adverse impacts that they cover, which include child labour and forced labour issues. For negative impacts arising within a company’s supply chain the Guidelines recommend that companies acting alone or in cooperation with others use their leverage to influence the entity causing the impacts to prevent or mitigate the harms.

The OECD Guidelines are referenced in the statutory guidance of the UK Modern Slavery Act, which note that “they provide principles and standards for responsible business conduct in areas such as employment and industrial relations and human rights which may help organisations when seeking to respond to or prevent modern slavery.’’

In addition to general recommendations the OECD has developed more detailed guidance on how these expectations can be responded to in specific sectors. For example the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas, the global standard on mineral supply chain responsibility, provides a 5 step framework for due diligence to manage risks in supply chains of minerals including forced and child labour in the context of artisanal mining. This Guidance is now the leading standard for avoiding child and forced labour in mineral supply chains and has been integrated as an operating requirement in the DRC, Rwanda and Burundi.

The FAO and OECD recently jointly developed a Due Diligence Guidance for Responsible Agricultural Supply Chains which also provides due diligence recommendations to manage risks related to forced labour and child labour in high risk agriculture sectors including palm oil and cocoa. Such approaches could be applied in the context of the Thai shrimping industry as well. Lastly the OECD is also developing a Due Diligence Guidance on Responsible Garment and Footwear Supply Chains, which provides specific recommendations for addressing risks of forced and child labor. This Guidance will be launched later this year and will be relevant to migrant workers in textiles factories

Regulation of global supply chains to combat forced labour is becoming increasingly common and impactful. Recent developments in the EU followed by new regulations and enforcement by the US customs authority are putting pressure on companies to monitor their supply chains more closely than ever. As the US and EU represent that world’s most important consumption markets these pressures will extend to companies globally, and have already been felt by Chinese and Swedish enterprises in the context of the recent US detention orders.

Supply chain due diligence and transparency will be increasingly important tools for global companies in safeguarding themselves from liability in light of these new regulations. The OECD has developed guidance on supply chain due diligence processes which address a range of issues including forced labour. In order to strengthen their global supply chains, companies would do well to step up and speed up implementation of due diligence in their global supply chains.

Useful links:

Global Forum on Responsible Business Conduct, 8-9 June

Roel Nieuwenkamp maintains a blog where all of his articles are archived. Please visit https://friendsoftheoecdguidelines.wordpress.com/

 

Productive Economies for Inclusive Societies: #OECD Forum 2016

30 May 2016
by Guest author

FORUM2016Anthony Gooch, Director of the OECD Forum and the Public Affairs & Communications Directorate of OECD

This time last year, the OECD Forum took place on the eve of an unprecedented series of UN and G20 international summits with the potential to shape global governance for decades to come.  In hindsight, 2015 proved to be an outstanding year for international collaboration, with governments around the world coming together to agree on ambitious goals to promote sustainable development, address climate change and deliver fairer more transparent international tax rules. On the eve of OECD Forum 2016, the focus shifts to the hard work of implementation , in the midst of slow and uneven recovery from the Crisis, an ongoing international refugee and migration crisis and an upsurge in acts of international terrorism.

We will be looking for answers to three overarching questions:

  • How can the positive momentum of international collaboration from 2015 be carried through to the tough task of implementing the noble undertakings embodied in the various agreements?
  • How can we kick start global productivity so as to deliver inclusive growth?
  • How should we address the need for a new societal contract and relevant policy frameworks for an era of digitalisation?

International Collaboration

Implementation of the SDGs, COP21 and G20 Tax Standards will require a holistic approach to inter-related economic, social and environmental issues from governments and non-governmental stakeholders alike. The Forum will address what will need to change given that the SDGs are now a global responsibility and targeted at countries at all levels of development. Civil society leaders such as Save the Children’s Helle Thorning-Schmidt, the former Danish Prime Minister are uniquely positioned to help map out what’s now required.

Successful international collaboration means all stakeholders in society working together. The role of the business community is vital in itself, as is the way it works together with government to ensure a fair deal for all. This year marks the 40th anniversary of the OECD Guidelines for Multinational Enterprises, the most comprehensive set of recommendations by government to business on Responsible Business Conduct (RBC).  With the widening and deepening of globalisation, the Guidelines are more relevant than ever, but the role of business in society has evolved from the charitable and voluntary endeavours associated with Corporate Social Responsibly (CSR) to the more stringent expectations of RBC. Nobel Peace Prize Laureate Kailash Satyarthi will be sharing his insights of what can go wrong and why and how it can be corrected.

Tax is one of the clearest examples of how international collaboration is the only avenue to resolve major problems given that nationally-based tax systems are inadequate to deal with international financial flows.  The OECD-G20 BEPS project equips governments with the domestic and international instruments needed to tackle the issues. Effective exchange of information between countries, allows governments to better tax capital and capital income, and in turn raises issues about the effectiveness if the redistribution of wealth especially in countries where working-age benefits have not kept pace with real wages and taxes have become less progressive.

These discussions take place against the backdrop of the leak of the Panama Papers, revealing  the practices of the rich and powerful in hiding money offshore, a timely reminder of how much is still left to do to implement transparency when the gap between rich and poor is at its highest level for 30 years in most countries.

Productivity and inclusive growth

Clear and troubling evidence has emerged in recent years of the disappearance of productivity growth at a time of rising inequalities. It is natural that we should ask ourselves if these phenomena are interrelated.  We can no longer assume that technological and related innovations in processes and business models will automatically lead to better economic performance and stronger productivity growth. There is no guarantee that the benefits of higher levels of growth, or higher levels of productivity in certain sectors, will be shared across the population as a whole. Indeed, there is a risk of a vicious cycle developing, with the “bottom 40%” with fewer skills and poorer access to opportunities often confined to low productivity, precarious jobs, and the informal economy. At firm-level, too, a few big fish and cutting edge winners may leave the rest behind

The Forum will examine the nexus between productivity and inequality, identifying knowledge gaps, and seeking to chart policies that both boost productivity and tackle inequality. The role of corporate finance has also been examined both in entrenching the division between the haves and the have-nots and for its potential to unleash strong productivity gains.

To help us continue questioning assumptions about how the economy works and how we analyse these workings, we will welcome speakers such as Diane Coyle who asks whether traditional measures of productivity are suited to today’s “weightless” economy and César Hidalgo, who argues that understanding the nature of economic growth requires us to transcend the social sciences to include the natural sciences of information, networks, and complexity.  Award-winning author Paul Mason will present his vision a future of “Postcapitalism” and the internationally renowned Chilean architect Alejandro Aravena will open our eyes to the contribution to be made to productivity and inclusive growth by architecture.

The social sciences still provide a useful lens through which to address key issues, though, and we will be looking at access to quality jobs when the workforce is ageing but 75 million young people are unemployed worldwide. Similarly, tackling gender inequality is central to increasing productivity and inclusiveness, so we will focus on the role of women in the workplace, girls and women in Science, Technology, Engineering and Maths (STEM), and the social, cultural, legal, and political barriers to gender equality and the consequences of these. How appropriate then that Forum favourite, Michele Bachelet should  return in her capacity as President of Chile and Chair of the 2016 OECD Ministerial Meeting.

Migrants are another social group with specific needs and rights. The Forum will also tackle the sensitive issue of the economic, social and political impact of the sudden, large influx of immigrants and refugees into Europe and how best to meet the integration challenge.

Digitalisation of Society

The digitalisation of nearly every facet of the economy and society has become increasingly apparent in recent years. While this revolution holds many promises to spur innovation, increase productivity and improve services, it creates new dilemmas not least the fact that policy frameworks developed in a pre-digital era are not fit for digital purpose and that many people feel marginalised or threatened by accelerated change. It poses fundamental questions regarding the sort of society we want in this digital age and societal contract to deliver it.

Our IdeaFactory on the Digitalisation of Society will provide valuable impetus to a new OECD project on the Digitalisation of the Economy & Society. We will address the changing role of the State as well as the ethical, social and technical dilemmas digitalisation provokes. In the context of  “The Digital World & the Future of Work” we will explore strategies to adapt the skills taught in education and training systems to the changing needs of today’s and tomorrow’s employees and employers,  providing input to our project on the Future of Work. With the help of humanoid robot Pepper, we will look closely at the future role of robots, artificial intelligence and increasing reliance on algorithms in transforming daily life, work, and social interaction.

Innovation is not just about technologies. It also includes new ways of doing things, and the “circular economy” can play a crucial role in delivering on COP21 by decoupling economic growth and job creation from the exploitation of natural resources.  Key actors such as Nick Stern will examine how to reduce pressure on precious finite resources from a global population that will reach 9 billion by 2030, a third of whom will be middle-class consumers.

Better Life Index & Economic Outlook

Wellbeing has been at the heart of the Forum since we first presented the OECD Better Life Index in 2011.  The latest edition of the Index that empowers people to compare countries’ performance in wellbeing according to what is most important to them, unveiled on 31 May,  will feature 38 countries including 2 newcomers, South Africa and Latvia, our newest member. Now in its 5th year, the Index has well over 8 million visitors from all corners of the globe, who are responding with their wellbeing priorities in ever greater numbers: in 2016 the top 3 priorities are Life Satisfaction, Health and Education. Income is ranked 9th out of our 11 dimensions of wellbeing. Analysis for those countries where citizens have shared their preferences with us most is available here.

Whilst the Index promotes our aspiration to measure our future development in a more holistic way, the OECD will be the focus of attention of the world’s media when we present our latest Economic Outlook, forecasting the prospects for the global economy on 1 June.

Join the debate

The rational, evidence-based discussion and compromise needed to define and implement the best ways to improve our societies and economies is often lacking in political discourse, whether in the context of the elections, the reforms or the referenda that will shape the future for generations to come. Against this backdrop, the Forum will challenge the world’s policymakers and policy-shapers to imagine and help realise a future where far more “Productive Economies” deliver in such a way as to effect far more “Inclusive Societies”.  We also extend this challenge to you. Join the debate!

Useful links

Forum programme

Forum speakers

Watch the Forum from the comfort of your own home

Take part in the debate through social media

 

Asia growth pessimism is not warranted

29 May 2016
by Guest author

ado2016Juzhong Zhuang, Deputy Chief Economist and Deputy Director General, and Ganeshan Wignaraja,  Advisor in the Economic Research and Regional Cooperation Department, Asian Development Bank

A gloomy outlook is enveloping the world’s economies. There are concerns too that countries are failing to sufficiently focus on long term policy responses to reverse the decline in global growth. Some argue that the global growth slowdown may be permanent, highlighting the danger of a period of chronically low growth, or what economists term “secular stagnation.”

While secular stagnation for the global economy is still a debated hypothesis, for developing Asia, a downbeat view of its economies and policies is clearly overdone. While the growth has slowed, it is still robust. At 6.5% annually over the last 5 years, it remained the fastest growing region in the world. By comparison, developing countries outside Asia grew 3.4% and advanced countries only 1.6% annually during the same period.

Yes, developing Asia’s growth is noticeably slower. In the decade up to 2010, annual average growth reached 7.6%. Our most recent forecasts project regional growth to edge down to 5.7% over the next two years.

This, however, does not portend a secular decline in the region’s growth rates.

Lingering crisis-related factors partly explain this slowdown. Weak global demand has reduced exports from the region’s open economies including those with strong links in global value chains. Furthermore, the flagging global recovery and growth moderation in the People’s Republic of China’s (PRC) have softened global commodity prices and constrained the growth of commodity-exporters including many Central Asian countries.

There are important structural factors too. A recent ADB study shows that developing Asia’s potential growth – or growth consistent with stable inflation – slowed from 7.4% annually in the seven years before the global financial crisis to 7.1% in the seven years after the crisis, due to a combination of falling growth in the size of labour force – related to demographics – and in labour productivity.

The reality is that when we look at Asian economies today we see several reasons for optimism.

First, while the PRC’s growth deceleration may continue, it is likely to be gradual. The key to sustain PRC’s growth at a robust pace is to maintain solid productivity growth through a greater focus on innovation and industrial upgrading, to offset the impact of declining working-age population. This is indeed among priorities of PRC’s new Five-Year Plan (2016-2020). Its on-going shift in growth model from heavy reliance on manufacturing exports and investment towards domestic consumption and the service sector will make growth more balanced and therefore more sustainable. ADB projects the PRC to grow 6.5% in 2016 compared with 6.9% in 2015.

Second, many other Asian economies continue to grow strongly, benefiting from reform efforts. Over time, developing Asia’s growth is likely to be driven by multiple growth centers. Across South and Southeast Asia we have upgraded recent growth forecasts, including major economies such as Bangladesh, India, Indonesia, Pakistan, and the Philippines. India, for example, is the fastest growing major economy and has developed a comparative advantage in services particularly information technology services. The country is presently attempting to foster manufacturing development and linkages to global value chains through a Make in India Program. Likewise, Indonesia is attempting to shift away from a dependence on natural resources into manufacturing development. Growing at 7-8% annually, Cambodia, Lao People’s Democratic Republic, and Myanmar continue to catch up with the rest of the Association of Southeast Asian Nations (ASEAN).

The PRC’s structural transformation also offers new opportunities to other economies, as the country gradually withdraws from low-cost, labor-intensive manufacturing industries and its growing middle class demands more quality consumer goods.

Third, regional economies have learnt valuable lessons from the Asian financial crisis and taken steps to reduce financial vulnerability and bolster resilience to external shocks. Across developing Asia, macroeconomic management has improved, and authorities have intensified the use of macroprudential policies and strengthened the oversight of corporates and financial institutions. Regional integration is increasingly linking markets and production through the spread of global value chains, free trade agreements, foreign direct investment, and greater mobility of skills.

Fourth, the region still has large room for catch-up with advanced countries. In 2015, developing Asia’s average per capita GDP was only $4,796, compared with the global average of $10,139 and an OECD average of $35,768. Indeed, most of the economies in the Asia-Pacific region are still classified as low- and lower-middle-income economies. Notably, Singapore; the Republic of Korea; Taipei, China; and Hong Kong, China grew at about 7-9% in the 1960s to the 1980s before they became newly-industrialized economies.

Last but not the least, many Asian countries—PRC, India, Indonesia, and many more—are scaling up reform efforts in trade and investment regimes, macroeconomic management and public finance, financial regulation, and public sector governance. These reforms will continue to reduce impediments to efficient resource allocation, improve technical and managerial efficiency, enhance an economy’s ability to respond to shocks, and lay the foundations for greater private investment and innovation.

In recent decades, structural reforms that addressed specific domestic constraints have been key drivers of rapid economic growth in developing Asia, and they will remain so in the years ahead. ADB’s research concludes that policies that close half of the gaps with globally best practices in tertiary education, labour market flexibility, institutional quality, and trade openness and financial integration could raise developing Asia’s potential growth by nearly 1 percentage point annually over the next ten years.

Undue pessimism about developing Asia’s growth is misplaced. With reforms and their effective implementation, the region can and will continue to drive global growth.

Useful links

OECD Economic Outlook for Southeast Asia, China and India 2016: Enhancing Regional Ties

Antimicrobial resistance: millions of lives and trillions of dollars?

28 May 2016
by Guest author

AMR reportJim O’Neill, Commercial Secretary to the UK Treasury

After I was appointed chair of the Review on Antimicrobial Resistance, one of the first questions I set out to answer was what would be the impact if no steps are taken to tackle rising resistance. While we can never know exactly what would happen in the future, I felt that any debates about the cost or difficulty of dealing with resistance should be informed by the far greater costs of inaction. Already resistant infections are estimated to kill at least 700,000 people a year, and in the United States alone they cost 20 billion USD in additional healthcare costs. We hired the consultants KPMG and RAND to examine what would the world look like in 2050 if we did not control resistance and to compare this to what would happen if resistance was tackled properly.

They both took current levels of hospital acquired infections for klebsiella pneumoniae, e. coli and  staph aureus, as well as total infection rates for TB, HIV and Malaria, and examined what would happen if resistance rates in these areas rose to 40 percent. This would mean that the first line treatment would fail 40% of the time. This figure was chosen as it was similar to the rates of k. pneumoniae that are resistant to carbapenems in parts of southern Europe, it is also similar to rates found for methicillin resistant staph aureus (MRSA) and multidrug-resistant TB (MDR-TB) in some parts of the world. As part of their research they presumed that a person with a resistant infection in the future would have the same outcome chances as someone today who gets a resistant infection, the levels of resistance would simply rise. They also presumed that rates of hospital acquired infections would double as people would carry the infections for longer making it easier for them to spread.

What the researchers found, using the above assumptions, is that if we do not take the appropriate steps to stop drug-resistant infections, the death toll could rise from 700,000 today to 10 million by 2050. This would mean that a person would die every three seconds from these six drug-resistant infections, and more people would die than are currently killed by cancer. The consequences of inaction would therefore be huge. KPMG and RAND, then fed these deaths into an economic model for what the world would look like by 2050; similar to the model that I used to make my BRICs prediction 15 years ago. The only change they made in their standard assumptions was that people who would die of AMR would no longer be able to work and consume goods. They ignored the impact of people being sick for longer, the indirect costs such as surgery being more complicated, the healthcare costs on society, the disruption to a family that can be caused by illness, and anything else that could cause productivity to change from resistant infections. Despite these conservative assumptions they found that over the next 35 years resistance would knock 100 trillion USD off the world’s production if we do not act to stop AMR. To put that in context that is more than the UK is expected to produce between now and 2050, and more importantly is far greater than the cost of tackling the problem.

Last week I had the pleasure of releasing the Review on AMR’s final report, where I highlighted ten interventions that the world needs to take to tackle resistance. The most important four being: first, to introduce rapid diagnostics so that doctors know whether or not a patient needs an antibiotic before prescribing them. Second, we need public awareness campaigns so that people know what resistant infections are and how to prevent them. Third, we need to find better incentives for people who come up with new drugs so that it is profitable; there has not been a new class of antibiotics since the 1980s. In order to tackle drug resistant infections we need to change that. Finally, we need reduce the amount of antibiotics we give out in agriculture. At the moment some farmers give out antibiotics to healthy animals so that they grow faster, and the whole of society picks up the cost of this though resistance. This is not acceptable; I am therefore delighted to see that the OECD is taking the lead on research into how to curb unnecessary antibiotic use in agriculture. More needs to be done to prevent this.

When costing our interventions my team and I estimated that it would cost up to 4 billion USD a year to avert this global catastrophe. I no longer work in investments, but spending  4 billion USD to prevent a crisis that will cost trillions and kill 10 million people a year is excellent value for money. From pharmaceutical companies to farmers, and from states to individuals, we all need to start acting now before it is too late.

Useful links

Antimicrobial Resistance in G7 Countries and Beyond G7 Health Ministers Meeting, Berlin, 8 October 2015

OECD Workshop: Economics of Antimicrobial Use and Resistance in the Livestock Sector 12 October 2015

Jim O’Neill will be participating in the Meeting of the OECD Council at Ministerial Level (MCM) on 1 and 2 June 2016, under the chairmanship of Chile, with Finland, Hungary and Japan as Vice-Chairs.

The size of the reversal of the supercycle is bigger than you think: And too big to be dealt with by monetary policy in advanced economies

27 May 2016
by Guest author

2016-BFO-cover-350Adrian Blundell-Wignall, Director, OECD Directorate for Financial and Enterprise Affairs, Special Advisor to the Secretary-General on Financial Markets

The real economy will always seem to be disconnected from the financial economy during periods when the need for structural change is so overwhelming that it can hardly be otherwise. We have had the easiest monetary policy of any historical era outside of hyperinflations, and productivity fails to grow, economic activity is weak (particularly in Europe and China) and there is no sign of inflation. The 2016 edition of the OECD Business and Finance Outlook addresses the three main causes of this:

  1. The size and impact of the reversal of the supercycle centred on emerging economies.
  2. The problems with company productivity and growth in a global excess capacity situation.
  3. Forcing a zero time value for money onto investors distorts financial investment and works against long-term investment.

We focus on the first of these in this first taste of the 2016 Outlook to be released on 9 June 2016.

Many commentators simply do not seem to understand the sheer size of the supercycle now in reversal.

Two different economic systems butting are up against each other. The group of emerging economies, now comprising around half of the world economy, is not open and (via financial repression) has built up massive savings over a short period of time. These savings have been forced into investment with a heavy role of state industrial policy. Indeed, some very large economies are behaving as though they too can develop just like the small Asian Tigers in the post–1945 period. The other group of more open market based economies is responding to the reversal of the supercycle and other structural factors (such as the failure in some regions to deal with huge bank non-performing loan problems up front) mainly with monetary policy. But little is happening.

This is not so surprising. How big was this saving and investment rise? The sum of the world’s national saving (and investment) since the early 2000s has risen a startling 225%. Most of this occurred in a single country, China.

This investment in emerging market economies (EMEs) has created massive overcapacity in the supercyle sectors, like steel, aluminium, cement, energy (particularly fossil fuels), transport (especially shipping), utilities and similar.

How do we know this other than by industry anecdotes and anti-dumping duties being imposed on emerging country’s exports, such as steel and aluminium?

Well, let’s have a look at the return on equity (ROE) based on 11,000 non-financial companies versus their cost of equity (COE) and their cost of capital (COK):

Excess capacity: ROE-COE and ROE-COK in advanced and emerging economies.
Declining in advanced economies; out of control in emerging economies.

ABW-blog-Fig1Note: See Chapter 2 of the OECD Business and Finance Outlook 2016 for lists of advanced and emerging economies.
Source: OECD calculations, Bloomberg.

The ROE-COK is negative in EME companies, and spectacularly so versus the COE (which means managers can’t add value for shareholders). This is pulling down ROEs in advanced countries too.

Just how big is this supercycle investment? If only one point is to be taken from this year’s Outlook, let it be this: the size of investment related to the supercycle is much bigger than you think and its reversal is having an impact that monetary policy in advanced countries cannot hope to cope with.

Let’s look at the facts from the world’s largest companies. The figure below shows global capital expenditure by sector. The energy and materials sectors alone account for 40% of the total. This is now in decline with links to many other sectors.

ABW-blog-Fig2

Source: OECD calculations, Bloomberg.

The energy and materials sectors alone rose to 40% of capital spending of the 11,000 biggest global companies (shown in blue and grey). These are huge sectors. Energy consists of oil, gas, drilling, oil and gas equipment and services, exploration, refining, storage, transportation, coal and consumable fuels. Materials consists of chemicals, fertilisers, industrial gases, construction materials, metal and glass containers, paper packaging, aluminium, diversified materials and mining, gold, precious metals and minerals, forest products and paper products.

If industrials and utilities (for the energy to drive all this) are added, the numbers rise to 60%. The supercycle sectors have a huge derived demand for inputs and services from other sectors, so that the linkages go even further than this.

Now, capital spending in all of these sectors and their demand for goods and services from other sectors is in decline. Chinese growth collapsed in 2014-2015, and, from late 2015, it is repeating the mistakes of 2009; it is embarking on a new real estate shantytown rebuild funded by state-owned enterprise bank credit.

What does this do? Once more it raises demand in the supercycle sectors and delays the much needed creative destruction phase. Local government steel, cement, aluminium and other factories in each province (all too big to fail) have no incentive to exit.

The reversal of the supercycle and the sheer size of what is happening is such a massive headwind that it is overpowering easy monetary policy.

Monetary policy has nothing to say about the sectoral misallocation of resources and excess capacity in the global industrial sectors; and certainly not in countries largely cut off from the discipline of openness and market forces.

The Outlook analyses this in some detail and then delves into the problems with company productivity in the excess capacity world since the crisis. It looks at what the companies that adjusted to the shock of the crisis did in terms of key corporate finance decisions, which helped them to negotiate this difficult post-crisis world. These companies are compared to those that didn’t adjust and are now part of the problem. It then looks at the portfolio consequences of setting a zero time value for money.

Watch out for the next blogs on these topics, but above all come and discuss the full publication being launched on the 9th of June.

Useful links

Business-Finance-Outlook-20126-callout-350The launch of the 2016 OECD Business and Finance Outlook takes place at 9.30am CET on 9 June 2016. Register to participate or watch the live webcast www.oecd.org/daf/oecd-business-finance-outlook.htm

 

 

The 2016 OECD Forum on 31 May – 1 June, is entitled “Productive economies, Inclusive societies”. The Forum is organised around the three cross-cutting themes of OECD Week: inclusive growth and productivity, innovation and the digital economy, and international collaboration for implementing international agreements and standards.

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