Jonathan Brooks, Head of Agro-food Trade and Markets Division, OECD Trade and Agriculture Directorate
What’s the difference between a Mississippi mud pie and a Haitian mud cake? The answer is mud. The mud pie is a dessert containing vast amounts of chocolate. The mud cake is literally that, mud with some salt and margarine mixed in. At one time, only pregnant women in poor areas ate mud cakes, in the hope of getting some calcium or other minerals. But following the sudden rise in food prices in 2008, mud cakes became a staple for thousands of Haitians who couldn’t afford anything else. Haiti is one of the poorest countries on Earth, but its hungry were not alone in their misery. Food riots broke out in Africa, Asia, the Middle East and Latin America and the Caribbean.
International crop prices of crop started falling in 2012. The OECD-FAO Agricultural Outlook 2016-2025 projects that over the next ten years, real prices of most agricultural products will decline slightly, but remain higher than they were prior to the 2007-08 price spike. Fundamentally, supply growth is expected to keep pace with demand growth, as population growth slows and the per capita demand for food staples becomes increasingly saturated in many emerging economies.
These projections assume continuing low oil prices and a sluggish recovery of the global economy, with abundant global food stocks to keep markets relatively stable. But merely a repetition of historic variability in oil prices, economic growth, and yields may well lead to another price spike within ten years. In addition, the uncertainties associated with climate change are starting to mount.
A major question is whether lower prices are to be welcomed, in particular whether they will benefit the world’s poor and hungry. Even before the food price crisis, when real food prices were lower than ever before, about 900 million people were not getting enough to eat (FAO). The 2007-2008 crisis was projected to add significantly to these numbers, given that the poor spend a relatively large share of their budgets on food, while the poorest farmers in the world are typically net buyers of food.
Fortunately, the worst fears were not realised and the total number of undernourished has continued to decline, to below 800 million in 2015. The impact of international price shocks was cushioned by three factors. First, domestic food markets in the poorest countries are often only partially integrated with international markets because they don’t have the ports, roads, storage facilities and other infrastructure required. This ultimately impedes development, but provides some isolation from international shocks. Second, many countries implemented policies to protect the incomes of the poor. The use of cash transfers seems to have been particularly effective at sheltering the worst off from the impact of price rises. Third, the recession of 2008-09 resulted in only mild slowdowns in most developing countries, and many of the poor could still afford to buy food.
There is an argument that while poor consumers suffer from food price rises in the short term, in the longer term farmer need higher prices for it to be profitable for them to engage with markets, while increased output generates further benefits in terms of increased employment and higher wages. However, this line or argument misrepresents the development process by failing to take account of the pressures imposed by market competition.
In developed countries, farmers who can continually reduce their costs, essentially thanks to technology such as adopting new crop varieties or exploiting economies of scale, will make profits. These profits will persist until other farmers catch up and prices fall from the cumulative impact on supply. Farmers who cannot adapt will of course be unprofitable at lower prices. This is no more than the competitive dynamic that we see in other sectors.
In developing countries, competitive pressures are mild or non-existent for subsistence farmers who are only weakly integrated with markets, but they kick in as infrastructure and local markets become more developed. Of course, few would suggest that the best way of helping developing country farmers is by failing to build rural roads, yet tariff walls and price protection can have just the same effect.
As farmers become more integrated with markets, higher long term prices reflect little more than the costs of productive factors (land, labour and capital), which means that the opportunities for profit are still confined to innovative farmers.
For farmers in both developed and developing countries, prices are therefore not the real issue. What matters is productivity. Higher rates of productivity growth lower prices in a way that is simultaneously good for consumers and beneficial for those farmers who are driving the productivity gains. “Laggards”, as Willard Cochrane termed them in 1958, face the choice of either improving their competitiveness or shifting into other economic activities.
Focusing on prices as the route towards higher incomes is in fact distracting because prices ultimately need to reflect the scarcity of natural resources. In many countries, for example, there is no pricing of water. That keeps costs low and contributes to lower prices, but also fosters unsustainable farming practices that will harm both producer and consumers in the longer run.
Lower prices are welcome to the extent that they derive from sustainable productivity growth. But from the standpoint of farmers, and the sector as a whole, prices are the wrong variable to focus on. As Paul Krugman put it: “Productivity isn’t everything, but in the long run it is almost everything”.
Food Security and the Sustainable Development Goals Jonathan Brooks on OECD Insights
Florence Wolff, OECD Statistics Directorate
Economic growth (GDP) always gets a lot of attention, but when it comes to determining how people are doing it’s interesting to look at other indicators that focus more on the actual material conditions of households. Let’s focus on a few alternative indicators to see how households in the Netherlands are doing.
GDP and household income
Real household disposable income per capita increased at a slower pace than real GDP per capita in Q3 2016. Whereas real GDP per capita increased by 0.6 % from the previous quarter (the index increased from 102.2 in Q2 2016 to 102.8 in Q3 2016), real household income increased by 0.4% (the index increased from 97.1 in Q2 2016 to 97.5 in Q3 2016). The rise in household disposable income in Q3 2016 was driven by an increase in compensation of employees but this gain was somewhat offset by an increase in taxes, which explains the drop in the net cash transfers to households ratio (chart 2).
Chart 1 also provides a longer-term perspective and shows that Dutch households have yet to recover to their pre-crisis level of household income, which means that households have less purchasing power now than they had before the crisis. Also of note is that household income has been more volatile than GDP and has been trending upward since Q3 2014.
The divergent patterns between household disposable income and GDP are often related to changes in net cash transfers to households (chart 2), from government as well as from pension funds. For instance, government intervention that cushioned households’ material conditions in Q2 2009 resulted in a large increase in net cash transfers to households during that quarter (seen in chart 1 as a sharp increase in real household income in Q2 2009 compared with a slight drop in GDP). Since then, net transfers have been trending downwards slightly, mainly because of government acting to consolidate its finances.
Confidence, consumption and savings
Household disposable income is a meaningful way to assess material living standards, but to get a fuller picture of household material well-being one may also want to look at households’ consumption behaviour. Consumer confidence (chart 3) continued to rise in Q3 2016 (the index increased from 100.4 in Q2 2016 to 100.8 in Q3 2016). Coupled with a rise in real household income, this boosted real household consumption expenditure per capita by 0.7% in Q3 2016 (the index increased from 96.9 in Q2 2016 to 97.6 in Q3 2016) (chart 4). Real household consumption expenditures have been trending up since Q3 2014, in line with a similar trend in household income; however, Dutch households are still buying less goods and services per capita than they were before the crisis.
The households’ savings rate (chart 5), which shows the proportion that households are saving out of current income, was relatively stable at 12.3% in Q3 2016 indicating that Dutch households chose to spend the increase in their income in Q3 2016 on goods and services while preserving the level of their savings. Like in many other OECD countries, it is worth noting that Dutch households increased their savings during the economic crisis (with a peak at 16.9% in Q2 2009) – as a buffer to the deterioration in financial markets and the increased uncertainty over future income -, and that their savings rate has still not dropped back down to the levels observed before the crisis, indicating that Dutch households remain cautious.
Debt and net worth
The households’ indebtedness ratio, i.e. the total outstanding debt of households as a percentage of their disposable income, may reflect (changes in) financial vulnerabilities of the household sector and provides a useful yardstick to assess their debt sustainability. In Q3 2016, household indebtedness was 255 % of disposable income, slightly above the minimum reached in Q1 2016 (254.7%), yet remaining one of the highest levels among OECD countries. One reason for the high debt levels in the Netherlands relates to generous tax incentives on mortgage loans which constitute the bulk of household debt. Debt levels had been declining for several years because households redeemed relatively large amounts and took up fewer new mortgages. In the more recent period however, the decrease of the debt ratio has ended, mainly due to the revival of the housing market and the low interest rates.
When assessing households’ economic vulnerabilities, one should also look at the availability of assets, preferably taking into account both financial assets (saving deposits, shares, etc.) and non-financial assets (for households, predominantly dwellings). Because information on households’ non-financial assets is generally not available on a quarterly basis, financial net worth (i.e. the excess of financial assets over liabilities) is used as an indicator of the financial vulnerability of households.
In Q3 2016, financial net worth of households was at its highest level, at 477.4% of disposable income (chart 7) – an increase of 7 percentage points from the previous quarter, and of 214.1 percentage points since 2010. These levels are amongst the highest among the OECD. The increase in Dutch households’ financial net worth in Q3 2016 mainly reflects the increase of pension entitlements (a large proportion of Dutch households’ wealth). Not counting assets related to pensions, the financial net worth of Dutch households was 15.5% of disposable income in the third quarter of 2016. All in all, the increase in assets significantly outpaced the declining trend in households’ debt (chart 6).
The unemployment rate and the labour underutilisation rate (chart 8) also provide indications of potential vulnerabilities of the household sector. More generally, unemployment has a major impact on people’s well-being. In Q3 2016 the unemployment rate dropped to 5.8% confirming a downward trend observed since Q1 2014 when it reached a maximum of 7.8% in the period observed. The labour underutilisation rate, which takes into account underemployed workers and discouraged job seekers, is on average a little more than two times the size of the unemployment rate, indicating unmet aspirations among Dutch workers to work more. It is interesting to note that part-time employment is a long-standing characteristic of the labour market in the Netherlands: it is the OECD country with the highest part-time employment rate – with more than 35% of employed people working part-time – and where the share of involuntary part-timers (wanting full-time work) is low. This indicates the Dutch people’s preference for part-time work arrangements, in particular Dutch women, and therefore does not affect much the labour underutilisation rate.
One should keep in mind that households’ income, consumption and savings may differ considerably across various groups of households; the same holds for households’ indebtedness and (financial) net worth. The OECD is working on these distributional aspects and preliminary results can be found here and here. In addition, the Dutch Central Bureau of Statistics has information on income, consumption, and wealth broken down by household characteristics.
Like in many other countries, the economic crisis affected Dutch households who still haven’t recovered their pre-crisis income and consumption levels. Yet, overall, the third quarter of 2016 saw an increase of Dutch households’ material well-being, with expanding income and consumption per capita while their savings remain stable and unemployment continued to decrease.
However, to fully grasp people’s overall well-being, one should go beyond material conditions, and also look at a range of other dimensions of what shapes people’s lives, as is done in the OECD Better Life Initiative.
For many years, OECD has been focusing on people’s well-being and societal progress. To learn more on OECD’s work on measuring well-being, visit the Better Life Initiative.
Interested in how households are doing in other OECD countries? Visit our household’s economic well-being dashboard.
Alice Pittini, OECD Directorate for Employment, Labour and Social Affairs
A home is meant to be a safe and secure shelter for individuals and families, fulfilling the basic need to have a roof over your head. Yet a home is also a tradable asset, an investment from which there’s potentially big money to be made, or to be lost as the global financial crisis has shown us. Although the crisis led to a general drop in house prices in the short term, house prices have since picked up again in most countries and today they are growing faster than incomes in Austria, Canada, Germany, Luxembourg, New Zealand, Sweden, Switzerland, the United Kingdom and the United States.
Particularly in attractive metropolitan areas, house prices and rents are soaring, with a negative impact on access to opportunities and jobs, especially for people on low incomes. For example Auckland, New Zealand, has one of the most heated housing markets on the planet. Despite a recent reform increasing the taxation of housing property transfers, ‘flipping’ – i.e. the practice of buying properties and re-selling it at a much higher price over a short time span – has become increasingly common, with some properties reported as having been sold up to five times its initial value in four days. At the same time the capital is faced with an unprecedented housing affordability crisis, which led the Government to announce for the first time in its 2016 budget a four-year programme for emergency housing. Increasing house prices make it impossible for people to buy a home and step onto the property ladder, particularly young people. At the same time big cities and capitals are also faced with a shortage of affordable rental housing, and the spread of Airbnb and other short-term letting agencies is further aggravating the situation.
As a result, housing costs constitute the single highest expenditure item from the household budget, with an increase in the OECD average share of housing-related expenditure from 20.3% in 2000 to 22.9% in 2013. Housing costs represent a substantial financial burden for low-income households in many OECD and EU countries. For example, in Chile, Croatia, Greece, Portugal, Spain, the United Kingdom and the United States more than half of poor tenants (those in the bottom fifth of the income distribution) spend more than 40% of their disposable income on housing costs. Furthermore, in nearly all countries, the overcrowding rate increases as household income decreases, with countries like Hungary, Mexico, Poland and Romania experiencing overcrowding rates that are over 40% among poor households. Lack of sufficient living space for household members can significantly hamper wellbeing, with negative effects on health and on child outcomes. Worryingly, poor children are most prone to living in overcrowded dwellings, compounding their economic disadvantage and hurting their chances of succeeding in life compared with children from richer backgrounds.
Moreover, there are many people who have no permanent roof over their heads at all. Even though the homeless make up less than 1% of the total population in OECD countries surveyed, that is still a significant number of people without a home. The United States reports 564 708 homeless people, and Australia, Canada and France all report having over 100 000 in their most recent surveys. Progress on this front has been uneven in recent years, with the number falling in Finland and the United States, but increasing in Denmark, England, France, Ireland, the Netherlands and New Zealand.
Improving access to affordable housing, particularly for low-income households and those in need, is an important policy objective across OECD countries. What can countries do to meet this goal? There is no one-size-fits-all solution, but countries are implementing a range of different instruments. Most countries have housing allowances and/or social housing arrangements as well as different kinds of financial support towards homeownership. Indeed, housing allowances are now one of the most widely used instruments of housing support. At 1.4% of GDP, public spending on housing allowances in OECD countries is by far the highest in the United Kingdom, followed by France and Finland. Most countries also provide social rental housing (either directly or increasingly through supporting not-for-profit housing organisations). However, in a number of countries there has been a decline in the amount of social rental housing available, partly due to the slowdown in construction and privatisation of social housing, such as in Germany and the United Kingdom. That being said, social rental accommodation still represents over 20% of total housing in Austria, Denmark, and the Netherlands.
Grants, subsidised mortgages and mortgage guarantees are common ways to help low- and middle-income people buy homes. Chile is the country with the largest share of support to home buyers through grants, and most other countries are aiming to ease access to mortgage credit. Tax relief is another frequently used instrument for homeownership support: mortgage interest deductibility alone costs 0.5% of GDP in the United States and 2.1% of GDP in the Netherlands. However, the extent that measures supporting home buyers really target those in need varies across countries and schemes. The OECD’s new Affordable Housing Database helps countries monitor access to good-quality housing and provides governments with clear evidence to design the best combination of policy options to tackle homelessness, unaffordable housing, and overcrowding.
The perennial curmudgeon H.L. Mencken is famously misquoted as saying: “For every complex problem there is an answer that is clear, simple, and wrong.” The ability to simplify is of course one of our strengths as humans. As a species, we might just as well have been called homo reductor—after all, to think is to find patterns and organize complexity, to reduce it to actionable options or spin it into purposeful things. Behavioural economists have identified a multitude of short-cuts we use to reduce complex situations into actionable information. These hard-wired tricks, or heuristics, allow us to make decisions on the fly, providing quick answers to questions such as ‘should I trust you?’, or ‘Is it better to cash in now, or hold out for more later?’ Are these tricks reliable? Not always. A little due diligence never hurts when listening to one’s gut instincts, and the value of identifying heuristics is in part to understand the limits of their usefulness and the potential blind spots they create. The point is, there is no shortage of solutions to problems, whether we generate them ourselves or receive them from experts. And there’s no dearth of action plans and policies built on them. So, the issue isn’t so much how do we find answers?—we seem to have little trouble doing that. The real question is, how do we get to the right answers, particularly in the face of unrelenting complexity?
There’s a nomenclature in the hierarchy of complexity as well as proper and improper ways of going about problem solving at each level. This is presented in the new publication “From Transactional to Strategic: Systems Approaches to Public Challenges” (OECD, 2017), a survey of strategic systems thinking in the public sector. Developed by IBM in the 2000s, the Cynefin Framework posits four levels of systems complexity: obvious, complicated, complex and chaotic. Obvious challenges imply obvious answers. But the next two levels are less obvious. While we tend to use the adjectives ‘complicated’ and ‘complex’ interchangeably, the framework imposes a formal distinction. Complicated systems/issues have at least one answer and are characterised by causal relationships (although sometimes hidden at first). Complex systems are in constant flux. In complicated systems, we know what we don’t know (known unknowns) and apply our expertise to fill in the gaps. In complex systems, we don’t know what we don’t know (unknown unknowns) and cause and effect relations can only be deduced after the fact. That doesn’t mean one can’t make inroads into understanding and even shaping a complex system, but you need to use methods adapted to the challenge. A common bias is to mistake complexity for mere complication. The result is overconfidence that a solution is just around the corner and the wrong choice of tools.
Unfortunately, mismatches between organisational structures and problem structures are common. For example, in medicine, without proper coordination, two specialists can work at cross-purposes on a single client. While the endocrinologist treats the patient’s hyperglycaemia (a complicated system) with pharmaceuticals and diet, the nephrologist might treat her kidney failure (also a complicated system) through a separate set of pharmaceuticals and dietary recommendations. Not only can these two pursuits be at odds (what may be good for the kidneys may be bad for blood sugar, for example), but both treatments can have effects on other systems of the body that may go unmonitored. Understanding these interactions and those of each treatment on the body’s individual systems as well as on the body as a joined up, holistic entity (which it certainly is) would be the broader, complex and more desirable goal.
The body politic may not be so different. Institutions have specific and sometimes rather narrow remits and often act without a broader vision of what other institutions are doing or planning. Each institution may have its specific expertise yet few opportunities for sustained, trans-agency approaches to solving complex issues.
Thus, top-down, command-and-control institutional structures breed their own resistance to the kind of holistic, whole-of-government approach that complex problems and systems thinking require. This may be an artefact of the need for structures that adapt efficiently to new mandates in the form of political appointees overseeing a stable core of professional civil servants. Also, the presence of elected or appointed officials at the top of clearly defined government institutions may be emblematic of the will of the people being heard. Structural resistance may also stem from competitive political cycles, discouraging candidates to engage in cycle-spanning, intertemporal trade-offs or commit to projects with complex milestones. In a world of sound-bites, fake news and scorched earth tactics, a reasoned, methodical and open-ended systems approach can be a large, slow-moving political target.
And that’s the challenge of approaching complex, ‘wicked’ problems with the appropriate institutional support and scale—there must be fewer sweeping revolutions or cries of total failure by the opposition. Disruption gives way to continuous progress as the complex system evolves from within. It is a kind of third way that eschews polarization and favors collaboration, that blends market principles with what might be called ‘state guidance’ rather than top-down intervention.
Global warming, policies for ageing populations, child protection services and transportation management are all examples of complex systems and challenges. To take the last example, in the US, traffic congestion is estimated to cost households USD 120 billion per year and 30 billion to businesses (OECD, 2016). But where to start? With a massive infrastructure building spree? Where would you add additional capacity? How much would you invest in roads, and how much in pubic transportation? What are the relative advantages of toll roads vs increases in gas or vehicle taxes? What are the likely effects of gas price fluctuations and the onset of fleets of electric, self-driving cars? What about the technologies that have yet to be invented? And what will be the impact of policies on income inequality, gender equality, the environment and well-being? Finally, how do you efficiently join up levels of government and all the stakeholders potentially involved?
Complex systems are hard to define at the outset and open ended in scope. They can only be gradually altered, component by component, sub-system by sub-system, by learning from multiple feedback loops, measuring what works and evaluating how much closer it takes you to your goals.
General Systems Theory (GST), that is, thinking about what is characteristic of systems themselves, sprang from a bold new technological era in which individual fields of engineering were no longer sufficient to master the breathtaking range of knowledge and skills required by emerging systems integration. That know-how gave us complex entities as fearful as the Intercontinental Ballistic Missile and as inspiring as manned space flight. Today, the world seems to be suffering from complexity fatigue, whose symptoms are a longing for simple answers and a world free of interdependencies, with clear good guys and bad guys and brash, unyielding voices that ‘tell it like it is’, a world with lines drawn, walls built and borders closed. Bringing back a sense of excitement and purpose in mastering complexity may be the first ‘wicked’ problem we should tackle.
In the meantime, we need to find a way to stop approaching complex challenges through the limits of our institutions and start approaching them through the contours of the challenges themselves. Otherwise too many important decisions will be clear, simple and wrong.
The rapid increase in global value chains (GVCs) in the last two decades, in response to falling communication costs and reductions in trade barriers, has in large part been fuelled by large and multinational enterprises. But across the OECD, 99.8% of enterprises are classified as SMEs, very few of which engage in international trade. Yet collectively, SMEs are responsible for two-thirds of employment and over half of economic activity in the OECD. This has raised policy concerns about the inclusive nature of globalisation and more specifically whether SMEs, and their employees, are less able to benefit from GVCs. While it is clear that SMEs face particular and more significant challenges to exporting compared to larger firms (see for example the OECD Statistical Insights Who’s Who in International Trade) it is also true that direct export channels are not the only mechanism available to SMEs for integration into GVCs. A new report by the OECD, Nordic Countries in Global Value Chains, developed in collaboration with national statistical offices in the Nordic countries, shows that SMEs play an important role in GVCs as suppliers of larger exporting enterprises. In particular, it highlights that in the Nordics, more than half of the domestic value added of exports originates in SMEs.
In the Nordic countries, indirect exports through GVCs by Independent SMEs are around twice as important as their direct exports…
A significant share of total value-added (and hence employment) generated by SMEs is dependent on foreign markets, with the contribution of exports provided via indirect channels rising the smaller the firm. For example, while only 5% of value added generated by independent micro SMEs (SMEs with less than 10 employees) in Sweden is exported directly, an additional 24% of their value added is generated through value chains of downstream exporters, highlighting the significant dependencies of these firms on foreign markets. Figure 1 further illustrates this by separating dependent SMEs (firms with fewer than 250 employees which are part of a larger enterprise group) from independent SMEs (similar firms that do not have such ties). It shows that for the latter category, indirect exports are more than twice as important as direct exports.
Figure 1. Share of domestically produced value added that is exported
….reflecting the important channels provided by larger firms and MNEs…
Larger enterprises provide important channels for SMEs to access foreign markets and benefit from international growth, in particular in emerging economies where barriers to direct exports may be onerous for SMEs. Figure 2 illustrates that 28% of all SME’s exports are channelled through larger firms, with a significant share reflecting MNEs (both foreign and domestically owned).
Figure 2. Channels through which SMEs link to foreign markets
….which generate significant spillovers for jobs and income…
In turn, a quarter of every dollar of GDP created by exports of large firms reflects the value of goods and services provided by upstream SMEs (Figure 3), thus highlighting the important role larger firms can play in generating upstream spillovers in the form of income and employment. Indeed, in the Nordic countries, on average, each unit of value added by large exporting firms generates an additional 0.66 units of value-added in upstream (large and small) suppliers. This partly reflects the stronger focus of large firms on their core business functions. In this respect, it is also useful to mention that larger firms also typically include a larger share of imports in their exports: in other words, a higher import content of exports can go hand in hand with strong domestic supply chains.
Figure 3. Upstream contribution to exports of large enterprises: per cent of total domestic value added
..…particularly for SMEs in the services sector.
Upstream spillovers generated by larger firms are especially important for SME services providers. As Figure 4 illustrates, around 20% of the domestic value added exported by large manufacturing firms consists of services provided by upstream SMEs. Overall, services account for over 4o% of the gross exports of the main manufacturing industries. This shows the importance of e.g. efficient logistic services providers, and specialised business services such as accounting and legal services, for manufacturing exports.
Figure 4. SME services providers’ contribution to exports of large manufacturers
The findings in the report Nordic Countries in Global Value Chains summarised above highlight the importance of policy measures (e.g. improved access to finance, skills and technology transfers that recognise the upstream role of SMEs in driving competitiveness of downstream exporters, as well as their ability to disperse the benefits of trade more widely), as complements to more ‘traditional’ measures that focus on direct exporters, such as removing red tape, special (export) financing schemes, and facilitating match-making with business partners abroad.
The measure explained
The indicators on the role of SMEs in GVCs have been developed via a unique and innovative collaboration between the OECD and the Statistical Offices in Denmark, Finland, Norway and Sweden. This cooperation allowed for the linking and integration of detailed and harmonised micro data into the Inter-Country Input-Output (ICIO) table that underpins the OECD-WTO Trade in Value Added (TiVA) indicators. Building upon standardised national linked micro datasets in all four countries, a shared SAS program ensured that identical calculations were performed in all countries without the microdata having to leave National Statistical Offices. The full report includes a detailed methodological annex that describes how data were combined and indicators derived.
The domestic value added in exports reflects the value of exports that is domestically produced (i.e. not imported), either by the exporting firm itself, or by its upstream suppliers (i.e. value that is indirectly exported).
This Statistics Insights accompanies the report “Nordic Countries in Global Value Chains”, which examines the role of SMEs, MNEs and trading enterprises Nordic Global Value Chains. The report can be downloaded here.
More information on Trade in Value Added (TiVA), the indicators and the ICIO table can be found at http://oe.cd/tiva.
Georg Inderst, Independent Adviser, Inderst Advisory
Since the financial crisis, infrastructure investment has moved up the political agenda in most countries – now also including the USA. Asia is often seen as the world’s infrastructure laboratory, with massive construction of transport and energy projects.
Japan and China have spent 5% and over 8% of GDP, respectively, on infrastructure over the last 20 years while the Western developed world has been trending down to about 2.5% of GDP. The impact is clearly visible, especially in East Asia. At the same time, the “old world” is struggling even to maintain existing infrastructure.
Is there an “Asian model” of infrastructure finance? It is worth taking a closer look before jumping to conclusions, as argued in our recent working paper for the ADBI.
The first thing to note is that the picture is not uniform across the Asian continent. South Asia (4%) and South-East Asia (2-3%) invest well below the required levels of 6-7% of GDP.
Secondly, Asia’s infrastructure investment and finance is primarily driven by the state. The ratio of public to private finance is 2:1 to 3:1 or higher, compared to a ratio of roughly 1:2 in Europe and North America. The private sector still plays a subdued role, often supported by substantial government subsidies and guarantees. Both privatizations and public-private partnerships (PPPs) are below the global average.
Thirdly, Asia’s project finance is very dependent on bank loans, especially from state-owned banks and development institutions. There is scope for more securitization in this field. The use of project bonds or US-style revenue bonds is still tiny overall, although interest is rising in some places.
A fourth point is of growing interest: institutional investors are traditionally not much involved in infrastructure. Faced with budgetary and banking problems, many Asian governments are now trying to find new sources of infrastructure finance. However, the local investor scene is rather concentrated, with a predominance of public reserve funds, social security funds and sovereign wealth funds (SWF). The Asian private pension systems are comparatively small.
Most Asian investors traditionally run very conservative investment policies with a high allocation to domestic government bonds and deposits. Investor regulation tends to keep insurers and pension funds away from riskier and less liquid assets such as infrastructure debt and equity. However, some change is underway. For example, the world’s largest pension scheme, Japan’s Government Pension Investment Fund, started to move into infrastructure in 2015.
But higher commitments to real assets do not necessarily mean more finance for Asian infrastructure. Singaporean and Chinese SWFs, for example, have been very active in European real estate and infrastructure markets in recent years, and so has the Korean National Pensions Service, in line with many other large Asian funds.
Finally, Asia’s attractiveness has so far been sub-par for international investors. There are widespread restrictions on foreign direct investment in infrastructure sectors not only in China but also in most ASEAN and South Asian countries. Other factors that make life difficult for potential foreign investors include cryptic regulations and land laws, bureaucracy, and judicial processes.
In summary, there are certain commonalities across Asia but is there an “Asian model”? If any, it would apply to East Asia’s massive public expenditure programs from abundant state budgets on the back of strong export revenues. This also drives the construction, engineering, and related industries to the extent they can be exported worldwide. It is also remarkable that, at the same time, China has managed to become the largest producer of renewable energies. But not many countries are in such a position.
Nor should other countries necessarily follow the “East Asian model”, at least not fully. Japan ended up with expensive overcapacities and a massive debt burden. Even China is trying to change its reliance on heavy state spending at all levels and on easy credit from domestic public banks and local government financing vehicles. Public money is eventually limited everywhere.
Asia can build on the existing diversity of “infrastructure financing cultures”. Different approaches work in different places. Korea, Taiwan, Singapore and Hong Kong, for example, are following a more open model with capital markets that attract private and international investors. India has seen substantial domestic private activity in project finance, PPP and private equity funds. Corporate bonds have been widely used in Thailand and elsewhere. Malaysia has developed the world’s biggest market for sukuk, including Islamic infrastructure bonds. Indonesia and the Philippines have been experimenting with new PPP institutions to “crowd in” more private capital.
Furthermore, in terms of institutional investor involvement, it is worth looking across the Pacific to places like Australia, New Zealand and Canada. Good long-term savings institution can help rebalance the wide maturity mismatch between short-term bank deposits and long-term project financing.
So, what lessons can be learned from Asia? There is probably more to learn about political determination than about infrastructure finance or setting the framework for private investment. Political leadership and consensus-building are most needed for cross-border projects such as intercontinental railway, or large distribution networks for energy, water, and communication.
With the “Belt and Road” initiative, the $40bn Silk Road Fund, the fast establishment of the Asian Infrastructure Investment Bank, the construction of ports and railways in Africa and elsewhere, and by pushing green energy, China has marched forward in in impressive way.
Finding more private finance and attracting more long-term investors to Asian infrastructure is a new and different challenge. The focus needs to shift towards increasing efficiency and quality of infrastructure. Private and social returns need to be properly assessed. Environmental, social and health considerations will feature more prominently in the future, also in emerging markets. The OECD with other organizations can surely help in enhancing governance standards and international collaboration.
Pension Fund Investment in Infrastructure: A Comparison Between Australia and Canada Georg Inderst, Raffaele Della Croce OECD Working Papers on Finance, Insurance and Private Pensions
 Inderst, G., Infrastructure Investment, Private Finance, and Institutional Investors: Asia from a Global Perspective, ADBI Working Paper Series, No. 555, January 2016
Adam Corlett, Economic Analyst and Stephen Clarke, Research and Policy Analyst, Resolution Foundation
The UK economy has, in many respects, performed well recently. Last week it was revealed that GDP grew by 2 per cent in 2016, above the OECD average, and higher than forecasters expected when the country voted to leave the European Union. Employment is at a record high and average wages, although still 4 per cent below their pre-crisis peak, have been growing at a rate of around 2 per cent a year in real terms. Yet dark clouds are forming on the horizon, particularly for those on low and middle incomes.
Our annual audit of Living Standards across the UK, which uses the macroeconomic forecasts of the independent Office for Budget Responsibility as well as expected tax and benefit rates, shows that growth in typical household incomes will slow sharply in the next few years.
Indeed, the strong income growth of the past few years has likely already ended. Very low inflation – driven by oil price falls – and rising employment could not have been expected to last forever, and inflation has picked up quickly since the EU referendum vote cut the value of Sterling. Looking at the next four years as a whole we project cumulative growth in average working-age incomes of only 1.7 per cent (or 0.4 per cent a year). This is the result of forecasts of above-target inflation, poor wage growth, no employment growth, and tightening fiscal policy.
But even more worrying is how this meagre growth is likely to be shared. While incomes are projected to stagnate for those in the middle, they are expected to rise (albeit weakly) for those at the top and fall significantly for those at the bottom – as shown in the figure below. The poorest quarter of working-age households are projected to be around 5-15 per cent worse off in 2020-21 than this year. In contrast, the highest income quarter would rise by 4-5 per cent.
The result is the worst period of household income growth for the poorest half of households since records began in the mid-1960s. The skewed growth would also represent the largest increase in inequality since the premiership of Margaret Thatcher, and would take inequality (measured here after housing costs) to new heights. This is illustrated below for three common inequality measures, with the most dramatic rise being in terms of the ratio of household income of the 90th percentile compared to the 10th, reflecting the extremely large fall in income at the bottom.
The large inequality increases of the 1980s – which until now have never really been repeated in the UK – can also clearly be seen. However, that was a period when incomes generally rose across the distribution – and significantly faster at the top. The current period is therefore unprecedented in combining weak overall growth with rising inequality and falling incomes at the bottom. To put it another way the next few years could be like the 1980s but without the feel-good factor.
Notes: The 80/20 ratio is the income of a household richer than eight out of ten households divided by that of one richer than only two in ten households; the 90/10 ratio is similarly constructed; and the Palma ratio is the income share of the top 10 per cent divided by the income share of the bottom 40 per cent.
So why does this projection look so bad and what can be done to change it?
The UK’s anaemic wage growth is linked to poor productivity growth, which has dogged the UK for a decade now. The OECD has drawn attention to the low levels of infrastructure spending in the UK and a lack of investment in human capital. Greater public and corporate investment could help spur greater productivity growth. Reducing the cost of housing could make a big difference too. Current mortgagors are benefiting from continued low borrowing costs but we can’t rely on record low interest rates forever.
There is also scope to continue the remarkable employment growth of recent years. Despite the record high, many parts of the country and many groups still have much lower labour market engagement. Our research suggests that addressing such disparities could put around 2 million more people in work by 2020-21.
But, beyond the rate of growth, how that growth is shared is in many ways a simple policy choice. The dismal projection for poorer working-age households (and those with children especially) is in large part due to welfare cuts of over £12 billion inherited by the new PM. These include a freeze in almost all working-age benefits until 2020, despite rising and higher-than-expected inflation; cuts to the generosity of in-work support; and large reductions in support for new families with more than two children. At the other end of the spectrum, the government is introducing tax cuts that will predominantly benefit middle to higher income households. While the government is seeking to bring down its fiscal deficit, how this burden falls – and what level of inequality it wants to see in this country – is entirely its own choice.