State-owned enterprises, international investment and national security: The way forward

Frédéric Wehrlé and Hans Christiansen, OECD Directorate for Financial and Enterprise Affairs

For most of the past half century, countries around the world have gradually opened up to foreign investment, and with good effect. Investment from other countries has supported growth and development, created jobs and enhanced welfare. Today, as our data show, OECD economies retain only limited traditional regulatory restrictions to inward foreign investment in the form of foreign ownership ceilings and other discriminatory conditions. While many emerging economies are generally less open, they have made their legal regimes for foreign direct investment less restrictive. Ongoing monitoring by the OECD shows that these liberalisation efforts continued after the 2008 financial crisis.

However, since the 2000s, a new and opposing trend has emerged: the screening and review of foreign investment projects, particularly those by state-owned enterprises (SOEs), to mitigate risks to national security. In fact, a recent survey shows that more and more governments are introducing or enhancing screening mechanisms for inbound investment projects to identify and address perceived threats. A third of the 59 advanced and emerging economies that participate in our investment policy dialogue now operate such mechanisms. Several governments are now subjecting investment proposals involving SOEs to greater scrutiny, and at times prohibiting these investments. Some countries have established special rules for the review and admission of investments by SOEs or are considering new policies to address the issue.

Could the precedent offered by the Santiago Principles help to point a way forward? In 2008, following widely publicised concerns in some large OECD countries regarding high profile investment projects by non-OECD sovereign wealth funds (SWFs), the community of SWFs and their government owners adopted a code of good conduct, the Santiago Principles, that was motivated by a desire to ensure that countries would not use national security arguments as a cover for protectionism against foreign SWFs. A decade later, the upsurge of SOEs in global investment and related national security concerns expressed by recipient countries could motivate similar arrangements with respect to investment by foreign SOEs.

International investment by SOEs is a growing concern

The increasing participation of SOEs in the global marketplace, particularly as international investors, makes it all the more important to balance concerns about the good governance of SOEs and to maintain a level playing field. As bearers of state as well as commercial interests, SOEs may place their emphasis on strategic acquisitions, such as advanced technologies for example, on non-market terms. It is fitting therefore that the rise of SOEs should revive interest in investment policies related to national security.

Australia, for instance, screens all SOE investments, whereas it screens private investments only when they exceed a value threshold. Canada applies different trigger thresholds for the application of its net-benefit test if the investor is state-owned. The United States has established specific rules regarding SOEs as part of its national security review mechanism (CFIUS), which require investigation of all government-controlled investments concerning US businesses. Germany has just strengthened its review mechanism. France, Germany and Italy have called for EU policies to address the issue. Strengthening screening of foreign direct investment (FDI) on national security grounds is also under consideration in the Netherlands, the United Kingdom and the United States.

Heightened awareness of the implications of SOE investment has also been evident in more recent international investment agreements. The Trans-Pacific Partnership agreement (TPP), for example, dedicates an entire chapter to SOE investments, whereas in older agreements SOEs were effectively afforded a status broadly similar to that of private investors.

Governments have always been careful to secure policy space to safeguard national security needs. The OECD Codes of Liberalisation, for instance, just as many investment treaties, contain corresponding national security exceptions. These exceptions are typically self-judging, and the term “national security” is intentionally broad.

Because of the discretionary nature of invoking national security as a ground for restricting foreign investment, the OECD Guidelines for Recipient Country Investment Policies relating to National Security were issued as an OECD Recommendation in 2009. These guidelines offer a set of specific recommendations providing for non-discrimination, transparency and predictability, as well as regulatory proportionality and accountability, including effective safeguards against undue influence and conflict of interest.

Internationally agreed rules on SOEs would bring benefits

While concerns relating to SOE investments are legitimate–and many SOEs are less transparent than private firms–the imposition of outright or unqualified restrictions on SOE investments in recipient countries benefit neither host nor home countries as opportunities for mutually beneficial international investment are forgone.

Applying internationally agreed commitments to SOEs and their government owners would help reassure recipient country regulators by offering greater transparency, addressing potential distortions that may arise from state ownership, and ensuring that the SOE owners also observe high standards of governance, disclosure and accountability. In turn, these regulators could be expected to apply the same conditions to SOEs that they apply to investment proposals by privately-owned companies.

A similar outcome to that agreed by SWFs can be achieved for SOE investments today. After all, recommendations on good practices for governance, disclosure accountability and transparency of SOEs have already been agreed under the OECD Guidelines on Corporate Governance of State-Owned Enterprises. These guidelines include specific provisions by which the legal and regulatory framework for SOEs, as well as their practices, should ensure a level playing field and fair competition in the marketplace when SOEs engage in economic activities. If translated to an international market context, and if fully implemented, these provisions could fully address the concerns of investment regulators. The last element required to emulate the “Santiago arrangement” would be to secure a commitment by SOEs to abide by these standards.

This could help convince recipient countries to keep their economies open and to uphold both the letter and the spirit of the principles of OECD guidance on national security.

The OECD stands ready to help forge a mutually beneficial and trusted arrangement for SOEs so that home and host societies can reap the benefits of international investment, while addressing important security concerns that inhibit certain investments proposed by SOEs today.

References and further reading

International Forum of Sovereign Wealth Funds (2008), the Santiago Principles

OECD (2016), State-Owned Enterprises as Global Competitors: A Challenge or an Opportunity?

OECD, OECD Codes of Liberalisation of Capital Movements and of Current Invisible Operations, 2012-2017

OECD, Corporate governance of SOEs: Guidance and research, 2011-2017

OECD, Monitoring investment and trade measures, 2008-2017

OECD, Freedom of investment at the OECD, 2007-2017

OECD (2015), OECD Guidelines on Corporate Governance of State-Owned Enterprises

OECD (2009), OECD Guidelines for Recipient Country Investment Policies Relating to National Security, Recommendation adopted by the OECD Council on 25 May 2009

OECD, FDI Regulatory Restrictiveness Index, 1997-2017

Shima, Y. (2015), The Policy Landscape for International Investment by Government-controlled Investors: A Fact Finding Survey, OECD Working Papers on International Investment, No. 2015/01, OECD Publishing, Paris.

Wehrlé, F. and J. Pohl (2016), Investment Policies Related to National Security: A Survey of Country Practices, OECD Working Papers on International Investment, No. 2016/02, OECD Publishing, Paris.

More private capital for infrastructure investment in Asia?

Jiaozhou Bay Bridge
Jiaozhou Bay Bridge

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[1].

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.

Useful links

Pension Fund Investment in Infrastructure Georg Inderst OECD Working Papers on Finance, Insurance and Private Pensions

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

OECD work on institutional investors and long-term investment

OECD Centre on Green Finance and Investment

[1] Inderst, G., Infrastructure Investment, Private Finance, and Institutional Investors: Asia from a Global Perspective, ADBI Working Paper Series, No. 555, January 2016

Social wealth funds: a key ingredient of a new pro-equality economic model

sharing-economyStewart Lansley, visiting fellow at Bristol  and City Universities. He is the author of  A Sharing Economy: How Social Wealth Funds Can Reduce Inequality and Help Balance the Books, Policy Press, 2016; the co-author (with Joanna Mack) of Breadline Britain, Oneworld, 2015, and the author of the Cost of Inequality, Gibson Square, 2011. 

Since 2008, the dominant model of capitalism – with its emphasis on markets, weak regulation and the concentration of private capital – has been fast losing friends.  It has fuelled rises in inequality, and far from delivering stable, long term growth, has brought growing economic turbulence. Even former cheerleaders, including the IMF, are questioning its sustainability.

Yet despite the growing scepticism, the model of corporate capitalism remains intact, while proposals for change mostly involve tinkering with the existing pro-inequality model. A serious attempt at reform needs to build an alternative “sharing political economy”, one that disperses capital ownership, power and wealth, and ensures that the fruits of growth are more equally distributed. As the former lead economist at the World Bank, Branco Milanovic has argued, one of the principal drivers of inequality is the heavily private concentration of the ownership of capital. Central to a new, pro-equality economic model must be the de-concentration of such ownership.

To help achieve de-concentration, the French economist, Thomas Piketty, favours a global tax on wealth, while accepting it is a somewhat utopian idea. Encouraging the spread of alternative business models – from co-operatives to partnerships – that allow the greater sharing of economic gain – would also help disperse ownership.

As argued in a new book, The Sharing Economy, an especially powerful weapon for building more inclusive economies would be the creation of commonly-owned social wealth funds. These are publicly owned funds, created from the pooling of existing resources and used for the wider social benefit of society.  By helping to secure a more even economic balance between public and private ownership and ensuring that economic returns are more evenly shared, social wealth funds are a direct way of tackling inequality.

More than 60 countries have already introduced state-owned sovereign wealth funds, mostly resourced from oil revenues. While most of these are run in a non-transparent way as little more than the investment arm of the state, sometimes without obvious public benefit, several examples offer a blueprint for a model social fund. Since the early 1980s, Alaska has operated a highly popular fund which pays an annual dividend to all citizens. Perhaps the most successful and transparent of these funds is the $700 bn Norwegian Fund. Overseen by an independent ethics committee, it holds one per cent of global equities.

Many nations, including the UK, have been moving in the opposite direction, entrenching the private ownership of capital through the selling off of state owned enterprises and land.  An alternative strategy would have been to pool existing public assets (land, property and public companies)  into a ring-fenced fund to form a significant pool of commonly held wealth. Imagine the shape of the British economy today if, instead of rolling privatisation,  such a fund had been established in the mid-1980s.  It would have preserved the family silver, and by boosting the value of public assets in an era of growing liabilities, greatly strengthened the public finances. With part of the returns reinvested and part used to boost social spending, the fund would have grown to represent a very sizeable chunk of the economy. At least part of the returns could have been used to boost spending on vital infrastructure, thus strengthening the productive base of the economy.

Fifteen nations – in Europe, Asia and the Middle East – have already created “public ownership funds” which manage all state-owned commercial assets. Many of these – such as the Temasek fund in Singapore – have achieved impressive rates of return.

There are other ways one or more social wealth funds could be established.  Take the UK. Although it has already spent most of its oil revenue, such a fund could still be established using other sources of income including the dividends from other natural resources (that should be commonly shared) such as minerals, urban land and the electromagnetic spectrum. The occasional one-off taxes on windfall profits, such as those levied in the past on banks, energy companies and oil producers, could also be paid into such a dedicated fund, possibly in the form of shares.  Other options might include a direct charge on those financial and commercial transactions – such as merger and acquisition activity – which contain a high element of rentier activity.

In the 1960s, the British Nobel Laureate, James Meade, advocated just such a fund to help promote a ‘property owning democracy` in which all citizens have access to assets. He argued that such a fund should be financed by the dilution of existing capital ownership, through, for example, an additional, modest annual levy on share ownership.

Social wealth funds have the potential to become a new and powerful economic and social instrument that could play a key role in the search for ‘inclusive economies`. They would provide a powerful balance to private capital while the returns could be used to help build the productive and social base of economies.

Useful links

Inequality, the crash and the crisis Three articles by Stewart Lansley on OECD Insights

OECD work on inequality

Robo-Advisor fintechs are the new biotechs

panthera logoMarkus Schuller, founder of Panthera Solutions

The OECD Financial Roundtable on October 27 gathered together 20 representatives from the banking industry, fintech companies, and other financial services, as well as trade unions and other experts, in addition to the OECD delegations. The topic Fintech: Implications for the shape of the banking sector and challenges for policy makers allowed for an intense debate, especially among the 20 mostly private sector participants.

Ironically, both Fintechs and big banks lobbied for level playing fields, arguing that the respective “other” benefits from a regulatory advantage. It also became evident that the big banks try to justify their existence by highlighting their large capital and client base, expressing interest in cooperating with Fintechs by offering scalability. The latter is claiming to add a moment of disruption to financial services, opening it to a wider audience by democratising financial services. Whether the race is decided through competition or cooperation, regulatory “sandboxes” were presented as appreciated tools to level the playing field for both.

At Panthera, we are asset allocation specialists. As such, the Fintechs named Robo-Advisors in the field of asset management are of most interest for us. Inspired by the OECD FRT, we looked at whether Robo-Advisors deliver on the promise of adding a disruptive moment to our market segment. For that purpose we introduce two asset allocation penalties as indicators of disruption.

As we concluded in our article “Man at the centre of the investment decision”, the underperformance of professional investors versus the market portfolio is dominated by two structural factors, cost penalty and behavior gap penalty. Cost penalty is defined as the amount of under-performance caused by transaction costs, management fees, distribution fees, etc. Behavior gap penalty is the contribution of the human factor to a biased perception of reality caused by cognitive dissonances. Indicators of the penalty along the investment process can be certain market timing techniques, the application of flawed portfolio optimisation techniques, minimising career-risk as primary objective, and other expressions of cognitive biases.

As highlighted in a previous article, professionals managing other people´s money like regional banks, private banks, wealth managers, investment companies, (multi-) family offices, etc. are confronted for the first time in decades with a situation that forces them to:

  1. either grow aggressively in size to play a shaping role in the industry´s concentration process
  2. take on the competition with Robo-Advisor Fintechs in offering low-cost, fully automated wealth management solutions
  3. position themselves as leaders in an investment management niche via an innovation-driven competitive edge
  4. or accept to be squeezed out of the market.

Options 1 and 2 are out of reach for most of the investment service providers listed above as they are too small, too conservative, and/or too loaded with overhead costs. Assuming they want to survive, Option 3 is the only one left for the vast majority of professional money managers.

If Option 3 it is, getting trapped in pseudo-innovations like risk parity will be insufficient. Consequently, a learning organisation with a continuous improvement cycle is a prerequisite for establishing and maintaining the innovation-driven competitive edge of an investment process in the chosen niche. Many will not manage to reinvent themselves.

Like Big Pharma during the 2000s, which benefitted of windfall profits due to rent-seeking oligopolies, the asset management industry is increasingly dominated by a handful of multi-trillion-dollar players like Vanguard, BlackRock or State Street. Big Pharma was compensating its lack of innovation ability by re-investing its windfall profits into biotechs, refilling its product pipeline with the ideas of promising start-ups.

We see similar patterns occurring in the asset management industry, where Robo- Advisors convert from stand-alone B2C (business to consumer) providers to either white-label B2B2C providers or useful take-over candidates for the big players. With Vanguard launching its Personal Adviser Service already mid 2014, Charles Schwab following with its Schwab Intelligent Portfolios in 2015 and BlackRock taking over FutureAdvisor shortly after, the big players benefit from the momentum of digitalisation.

Here, the weakness of the Robo-Advisory start-ups become obvious. Their offering is lacking the disruptive element. All they offer is a more compelling user interface as improved distribution channel, lower production, and end-consumer costs compared to traditional money managers. In that, they are powerful enough to put pressure on the small-to-medium sized money managers, but have no leverage on disrupting the industry’s oligopoly. The explanation lies in four reasons:

  1. Robo-Advisors help investors to minimise their cost penalty. By still relying on traditional portfolio construction techniques of the first generation (Mean-Variance Optimization, MVO, etc.), they are offering identical services like thousands of established money managers. As such, they don’t offer disruptive innovation at the head of the asset management industry, but simply an evolution of presenting those methods – user interface – and distributing them differently – cheaper fee-model and no intermediaries along the distribution channel. Having talked to several Robo-Advisor executives, their responses can be summarized as: “we definitely have other issues than the portfolio construction methods used”. They consciously ignore, that, although their traditional techniques have been performing well since 2009 through a historical anomaly, they failed in raising significant assets under management because they lack competitive edge in portfolio construction.
  2. Related to reason 1 – neither the big players nor their emerging rivals are significantly reducing the behaviour gap penalty. Their rebalancing and cost average techniques are helping investors to apply some self-discipline. Though this does not hold investors back from overruling those techniques in times of turmoil, when the pro-cyclical temptation is shown to be the highest. This blind spot on the behaviour gap penalty is explained by the first generation portfolio construction models used, as for those, the human factor in investing does not exist. Unsurprisingly, this is less of a problem for the big players, given that the start-ups are not challenging them with taking the lead.
  3. The big players remain more competitive than Robo-Advisors because, while applying identical portfolio construction techniques, they can offer their advisory services even cheaper by still making money on the investment products chosen or through transaction fees. Charles Schwab, for instance, manages to charge zero fees for their Robo-Advisory service. It cannot get cheaper than that. Furthermore, the big players can scale their Robo-Advisory business through their enormous asset base.
  4. Both the big players with their Robo-Advisory front-end and the Robo-Advisor start-ups acknowledge in the meanwhile that retail and institutional investors need to have a human client advisor as back-up. By responding to that need, both are either hiring client advisors themselves or offering white label solutions of their platforms to RIAs/IFAs (registered investment advisors/independent financial advisers). Given the stronger balance sheets and better scalability of brand and existing customer base, the big players with Robo-Advisory front-ends enjoy a competitive edge.

In short, Robo-Advisor Fintechs are currently not revolutionising the asset management industry as they lack a disruptive element, but are helping accelerate the concentration process to produce even larger players.

Useful links

OECD work on finance

Aligning Investment with Development Goals in Central America

siecaJavier A Gutiérrez, Executive Director, Secretariat for Central American Economic Integration (SIECA)

Central America has an important opportunity over the next few years to build inclusive and sustainable development through deepening regional economic integration, both to further the development of its internal market at sufficient scale, and to present the region as more attractive for investment. At the Secretariat for Central American Economic Integration (SIECA), we view coordinated regional integration as crucial to the implementation of the 2030 Agenda for Sustainable Development and its Sustainable Development Goals (SDGs). Key priorities are facilitating trade, promoting sustainable, resilient infrastructure and ensuring the integration of small-scale enterprises into value chains and markets (SDG 9), as well as promoting gender equality through women’s economic empowerment (SDG 5).

Regional action to support trade

Central America has made considerable progress in fostering trade openness and economic integration. The majority of trade within the region is now conducted under a free trade regime – tariffs apply to only 1.8 percent of originating products. Because of this progress, intraregional trade went from accounting for 16 percent of total exports in 1960 to 32 percent in 2015.

However, the World Bank estimates that around 12 percent of the value of consumer goods in Central American countries is still associated with the burdensome procedures and out-dated infrastructure in borders. It also takes an average of 13 days to export and 14 days to import products, and freight moves at an average speed of only 17 km per hour. Costs associated with road transportation are particularly high in the region. In advanced economies, freight transport prices are as low as 2-5 US cents per ton-kilometre, but they average 17 US cents per ton-kilometre on main Central American routes; prices stand out even against other developing economies. This is why trade facilitation has become one of the region’s priorities.

In addition to taking part in the implementation of the World Trade Organization (WTO)’s Trade Facilitation Agreement (TFA) – El Salvador, Honduras, Nicaragua and Panama have already notified the WTO of its ratification, and the rest of countries are in the process of doing so –, Central America adopted its Strategy for Trade Facilitation and Competitiveness (STFC) in October 2015. The Strategy will involve the implementation of five short-term measures to streamline border management procedures, and a medium and long term plan to consolidate a Coordinated Border Management (CBM) system in Central America, following the guidelines and best practices from the World Customs Organization (WCO). Successful implementation of the Strategy could enable an increase of between 1.4 and 3 percent in the region’s GNP and a surge in exports between 4.2 and 11.9 percent, according to the UN Economic Commission for Latin America and the Caribbean (ECLAC). The STFC, moreover, is conceived only as a step towards deeper economic integration. A roadmap to be implemented from now to 2024 has also been approved with the aim of establishing a Central American Customs Union (CACU).

Investment priorities

Besides trade and integration, Central America is seeking to improve its infrastructure. Panama is the most ambitious; having recently invested US$5.58 billion in the expansion of the Panama Canal; they’re also creating a second metro line, and have already announced a third one valued in US$2300 million. Meanwhile, Honduras has focused in infrastructure supportive of trade facilitation, and Guatemala and El Salvador have devoted resources to energy-related projects.

Despite this the region still faces a sizeable investment gap. According to ECLAC estimates, Latin America needs to spend some 6.2 percent of GDP per year on average to fund infrastructure investment needs in transport, energy, telecommunications, and drinking water and sanitation, but spending is currently below 3 percent of GDP in Central America. The region also needs to revamp its existing infrastructure, building resilience to the effects of climate change, and improving adaptive capacity to face climate-related hazards and natural disasters, reflecting the targets under SDG 13 on climate change.

Just as crucial is investment in boosting micro, small and medium enterprises (MSMEs). Around 96 percent of Central America’s companies are MSMEs, which support 54 percent of employment and contribute to 34 percent of the region’s GDP. It is thus crucial to harness the potential of the regional market – which is large, with similar cultural background and a shared language – to offer small firms the opportunity to engage in international trade. SIECA has intervened to bolster MSME participation in value chains for key export products, including bovine meat, natural honey, foliage, cardamom, tilapia and shrimp, through the Regional Programme for Quality Support of Sanitary and Phytosanitary Measures in Central America (PRACAMS), which operates with funds from the European Union.

Moving forward, the region is looking to support MSMEs in other sectors of industry, creating a path for entrepreneurs to join the formal economy, create better jobs, and – because 46 percent of micro enterprises are owned by women – boost women’s participation in regional and global value chains and their economic empowerment.  A recent SIECA study shows that the sectors with the most potential for participation in value chains include food preparations, vegetables, cardamom, coffee, and cattle.

Addressing financing gaps

All these efforts require a substantial amount of support. Overall, SIECA managed US$9.3 million in cooperation funds in 2014 and US$11.7 million in 2015, including for the work on MSMEs and GVCs above. As the sustainable development agenda moves forward, however, regional efforts will also require improved monitoring and evaluation mechanisms to ensure effective allocation of funds and an overarching strategy that ensures resources are aligned with the region’s own development goals.

Preventing overlaps or contradictions between each countries’ fund allocation will be crucial. To achieve this, the Council of Ministers of Economic Integration is expected to soon approve the Central American Aid for Trade Programme (AfTP), and later submit it to the Summit of Presidents for its adoption, a systematic investment plan to address regional trade-related investment needs in a coordinated way.

In SIECA’s experience, aid is more effective when there is a close collaboration between countries and donors. Clear communication and feedback mechanisms have helped us enhance the effectiveness of our collective actions. We’ve also learned the importance of coordinating the execution of projects at the regional level, to avoid redundancies and ensure regional efforts are coherent. Instruments to assist leaders in identifying financing gaps and seek investment and funds to cover them are also crucial.  Applying these lessons will be crucial for success as Central America moves ahead with the implementation of the 2030 Agenda.

Useful links

The OECD and Latin America and the Caribbean

OECD Latin America Economic Outlook 2016: Towards a New Partnership with China

Doing good business, for profits, people and the planet

DCR 2016Erik Solheim, Former Chair of the OECD Development Assistance Committee (DAC), based on the editorial of the 2016 OECD Development Co-operation Report: The Sustainable Development Goals as Business Opportunities.

In 2015, when world leaders adopted the Sustainable Development Goals, we committed to the most inclusive, diverse and comprehensive and ambitious development agenda ever. By doing so, we acknowledged that development challenges are global challenges. The new global goals represent a universal agenda, applying equally to all countries in the world.

The year 2015 was the best in history for many people. We are taller, and better nourished and educated than ever. We live longer. There is less violence than at any other point in history. Over the past decades many countries, spearheaded by the Asian “miracles” – such as in Korea, the People’s Republic of China and Singapore – have had enormous development success. By believing in the market and the private sector, these nations have experienced strong economic growth and several hundred million people have been brought out of poverty. The debate within the development community on the importance of markets and the private sector is a thing of the past. The debate is won.

But based on astonishing success, we need to bring everyone on board. The 2030 aim is to eradicate extreme poverty, but to do it in an environmentally sustainable way. Luckily – for the first time in history – humanity has the capacity, knowledge and resources needed to achieve this. Never before was this the case. The leaders of the past have never set such goals, nor did they have at their disposal the policies and the resources to reach them. The Sustainable Development Goals cover the economic, social and environmental dimensions of life. And they emphasise that increased co-operation between the public and the private sector is vital to reach them.

Implementing the new Sustainable Development Goals will require all hands on deck, working in concert to build on each other’s strengths. In this report we look at the opportunities for businesses both to make money and do good for people and the environment. We must go beyond traditional thinking that business revenues depend on destroying the environment. Smart investment in sustainable development is not charity – it is good business and it opens up opportunities.

In developing countries, small and medium enterprises are considered the engine of growth. In Asia, they make up to 98% of all enterprises and employ 66% of the workforce. Especially for green growth, small and medium businesses can play an important role by acting as suppliers of and investors in affordable and local green technologies. For instance, in Africa several businesses offer “pay-as-you-go” solar energy to low-income households that do not have access to central resources.

Over the next 15 years, billions will be invested annually by the public and private sectors. We need to make sure that this money creates jobs, boosts productive capacity and enables local firms to access new international markets in a sustainable way. What’s more, these flows are often coupled with transfer of technology that has positive and long-term effects.

This report cites the results of interviews with executives from 40 companies that had performed above the industry average in terms of both financial and sustainability-performance metrics in various sectors – including oil and mining, gym shoes, soup, cosmetics and telecommunications. The research demonstrates that sustainable action can contribute to increased efficiency and profits, gains above and beyond their social and environmental benefits. The returns on capital include reduced risk, market and portfolio diversification, increased revenue, reduced costs, and improved products.

We need to take these experiences further. The 17 Sustainable Development Goals represent a pipeline of sustainable investment opportunities for responsible business. But fulfilling that potential will mean ensuring that business does good – for people and the planet – while doing well economically.

Although some countries are making progress, no country has achieved environmental sustainability. The worse things get, the more difficult it will be to find solutions. We need to take action now. There is more bang for every buck when profits are combined with bringing people out of poverty, improving environmental sustainability and ensuring gender equality. For example:

  • Ethiopia’s growth has benefited the poor and the country aims to become a middle-income country without increasing its carbon emissions.
  • Brazil has reduced poverty and equality while cutting deforestation by 80%.
  • Costa Rica has revolutionised conservation by providing cash payments for people who maintain natural resources. Forests now cover more than 50% of the country’s land, compared to 21% in the 1980s.
  • The Indonesian rainforests, the largest in Asia, are doing much better than recently. Deforestation decreased for the first time in 2013 and the positive trend is continuing. The main palm oil companies have made a no new deforestation pledge.

Poverty reduction can be green and fair. But we need to remember that neither developing nor developed countries will sacrifice development for the environment. But development comes to a stop if natural resources are exhausted, water continues to be polluted and soils are degraded beyond manageable levels.

For those who do not benefit from all the success stories, it is necessary to identify and replicate good policies that actually improve lives. Official development assistance is important for the least developed nations and countries in conflict. Aid remains at a record high at USD 132 billion in 2015, but private investments are more than 100 times greater than aid and more important for poverty reduction and economic growth.

In order to make the most of private investments for sustainable development, it is fundamental to know more about how much is being mobilised from the private sector as a result of public sector interventions. In this report the OECD describes how it monitors and measures the amounts being invested. The European Union found in 2014 that by blending public and private investments, EU countries used EUR 2 billion in public finance grants to mobilise around EUR 40 billion for things like constructing electricity networks, financing major road projects, and building water and sanitation infrastructure in recipient countries. We should be inspired by this example to do more. Business prospers when society prospers.

Each and every decision we take today related to private investment will have historic implications. We must learn that more and better investment is possible. Balancing economic growth with environmental sustainability is not only feasible – it is fundamental.

In this report we look at the opportunities the new Sustainable Development Goals offer for doing good business, for profits, people and the planet. It offers guidelines and practical examples of how all sectors of society can work together to deliver the 2030 Agenda. Investing in sustainable development is not charity, it is smart. We just need to go ahead and do it.

Useful links

Communicating trade and investment responsibly

biacBernhard Welschke, Secretary General, Business and Industry Advisory Committee to the OECD (BIAC)

The OECD offers a wealth of data and analysis illustrating that investment and trade can strongly support the competitiveness of our economies, the efficiency of markets for consumers, the potential for innovation, and—yes—the quality of employment. Of course, open markets raise the stakes for companies and their workers in a competitive environment. But policies that enforce rules for multilateral trade and that encourage governments and social partners to invest in education, training, and skills will ultimately enable our economies to trade up, and not down. In fact, OECD research shows that companies that are involved in international trade offer better working conditions, better salaries, and can reduce informality.

We also know that trade and investment are questioned by some, and unfortunately the arguments are increasingly emotional, if not irrational. And in spite of some modest improvements, barriers to market for trade and “foreign” direct investment exist in abundance, with significant adverse effects on growth and productivity. We often forget that trade and investment have pulled hundreds of millions of people out of poverty and are responsible for much of the convergence we see between living standards globally across countries.

Protectionism remains a real threat, and not many understand the severe consequences for productivity if global value chains are or compromised or even interrupted. In fact, the OECD can exactly show this for individual countries and even sectors.

We are all challenged to communicate responsibly on the opportunities that come with open markets. Clearly, it is counterproductive to vilify trade and to use it for campaigns of all sorts. We need both, a strong and reliable multilateral trade regime, and a drive to reap the benefits of regional integration—including TPP and TTIP. If done right, these goals should be compatible and enforce themselves mutually. And the great potential of trade in services is still to be developed, with important tools such as the OECD Trade in Services Restrictiveness Index pointing to the cost of the many barriers in this sector.

One more word on investment: there is a rambling debate on investor protection, and some question if International Investment Agreements—along with Investor State Dispute Settlement schemes—compromise “the right to regulate”. This is another example how an important debate can be hijacked for populism. Of course, states should have the right to regulate, but not expropriate. It should surprise nobody that high-standards for the protection of investors against measures that contradict earlier agreements are essential for a pro-growth policy environment—and in particular for long term investment in infrastructure. It is important that that these discussions are put back on a factual basis and that misinterpretations are effectively addressed. The OECD is in a unique place to explain why international investment agreements matter, and how they contribute to economic prosperity worldwide. Governments and business, with support and evidence from the OECD, must step up in their efforts to explain the virtues of trade and investment more convincingly to the public.

Useful links

BIAC Policy Group on Trade and Investment

OECD work on trade

OECD Conference on investment treaties: The quest for balance between investor protection and governments’ right to regulate 14 March, 2016, OECD Paris

International trade: Free, fair and open? OECD Insights

BIAC stands for business