February 16, 2017: Low-income countries are often advised to prioritise investment in their trade infrastructure to better connect to international markets, and garner the benefits of a more open trade regime. The World Bank’s Trade Facilitation Support Program and the World Trade Organization (WTO)’s Trade Facilitation Agreement, for example, promote investment in trade infrastructure to boost development prospects by improving competitiveness and lowering trade costs.

In a recent ADB Institute working paper, I posed the question of whether too much emphasis may have been placed in recent years on international trade infrastructure, such as ports, customs, and international logistics that reduce international trade costs to the detriment of domestic infrastructure — internal roads and bridges that may reduce domestic trade costs.

Much of the empirical research shows that investment in trade infrastructure has a strong and positive impact on trade flows, and there is also a consensus that trade is an engine for economic growth. So, investment in trade infrastructure seems like a step in the right direction.

However, as anyone who has experienced rush hour traffic in an Asian megacity recently would know, the main infrastructure development challenges facing developing countries are not necessarily found at the border. Investment in domestic infrastructure is often lagging investment in trade infrastructure. This mismatch can hurt a country’s development prospects by undermining its potential to develop domestic as well as international trade.

Building on a location model developed by Martin and Rogers and using a new dataset on trade costs made available by Arvis et al., I demonstrate that in countries where domestic physical infrastructure is worse than the trade infrastructure, the additional dollar should be invested in domestic infrastructure before further investments are made in international infrastructure.

More specifically, in countries with relatively poor domestic infrastructure, I found that a 1% increase in the ratio of domestic to international trade costs — which can be achieved by curbing international trade costs by 1% — leads to 0.44% reduction in GDP per capita. In countries with relatively good domestic infrastructure, the same investment in international trade costs leads to a 0.33% increase in GDP per capita.

Benefits from open trade are not equal for all

Openness to international trade has, on average, had a positive impact on economic growth. But not all countries have benefited to the same degree. While investments in international trade facilitation no doubt lead to more trade, they can also result in a reallocation of investors away from countries with relatively poor domestic infrastructure.

The logic is straightforward. Firms deciding where to locate their production will choose countries with better domestic infrastructure, as it will be cheaper to produce goods and services there. Improved international trade infrastructure magnifies the opportunities for industrial relocation of firms to countries with decent domestic infrastructure.

This suggests that international mechanisms such as the WTO’s Trade Facilitation Agreement should make allowances for low-income countries to first develop their domestic infrastructure, so they can maximise the benefits to be had from more open trade.

Of course, there are many unanswered questions. The development impact of investment in national infrastructure as opposed to international trade infrastructure is unlikely to be linear, given that there’s more to development than just economic growth.

Further work should explore this question, as well as the impact of a range of possible trade-offs on investments in infrastructure. These include quality versus quantity, maintenance versus new infrastructure, financing with user fees versus subsidies, or universal services versus cost efficiency. The answers to these questions are likely to depend on the country, its development objectives, and the type of investment.

Marcelo Olarreaga is Professor of Economics, University of Geneva

This piece was first published as an ADB blog

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Dirk Schoenmaker & Charles Goodhart

October 25, 2016: The European banking system is downsizing. As a consequence, the big US investment banks are on the rise in Europe. This article argues that US investment banks are about to surpass their European counterparts in the European investment banking market. We discuss why leaving global investment banking to the big five American banks might be problematic and offer recommendations for a policy response.

1.        Introduction

Europe’s banks are in retreat from playing a global investment banking role. It is a consequence of the regulatory impositions of recent years, notably of the ring-fencing requirements of the Vickers Report (2011) and the ban on proprietary trading by Liikanen (2012). The main concern has been that a medium-sized European country, such as the United Kingdom or Switzerland, or even a larger country like Germany, would find a global investment bank to be too large and too dangerous to support, should it get into trouble. So, one of the intentions of the new set of regulations was to rein back the scale of European investment banking to a more supportable level.

The European Union, of course, has a much larger scale than its individual member countries. If the key issue is the relative scale of the global (investment) bank and state that might have to support it, could a Europe-based global investment bank be possible? We doubt it, primarily because the EU is not a state. It does not have sufficient fiscal competence. Even with the European banking union and European Stability Mechanism, the limits to the mutualisation of losses mean that the bulk of the losses would still fall on the home country. Moreover, there would be intense rivalry over which country should be its home country, and concerns about state aid and the establishment of a monopolistic institution. While the further unification of the euro area might, in due course, allow a Europe-based global investment bank to emerge endogenously, we do not expect it over the next half-decade or so.

So the withdrawal of European banks from a global investment banking role is likely to continue. That will leave the five US ‘bulge-bracket’ banks, (Goldman Sachs, Morgan Stanley, JP Morgan, Citigroup and Bank of America Merrill Lynch) as the sole global investment banks left standing. That leaves the European and Asian banks in the second tier, as strong regional players. Examples are Deutsche Bank, Barclays and Rothschild in Europe and CITIC in the Asia-Pacific region. HSBC is in between, with both European and Asia-Pacific roots.

2.       The rise of US and decline of European investment banks

While the US investment banks are the global leaders, what is their share in the European investment banking market? In a new paper (Goodhart and Schoenmaker, 2016), we use the Thomson Reuters investment bank league tables to calculate the investment banking proceeds of the top 20 players (see, for example, Thomson Reuters, 2016). Figure 1 shows that the market share of EU and Swiss investment banks has declined since 2010/11, while the share of US investment banks (the big five and Lazards) increased from 35 percent in 2011 to 45 percent in 2015. If the trend were to continue, US investment banks would take the prime spot from their EU counterparts soon, possibly already in 2016.

Figure 1: Investment banks by origin, European market shares (%)

Source: Goodhart and Schoenmaker (2016)

3.       Concerns for Europe

Why should it matter if in all the European countries, the local banks’ investment banking roles retrench to a more limited local role? There are three arguments why leaving global investment banking to the big five American banks might be problematic. The first is that this could leave Europe at greater risk from possibly ill-advised American political or regulatory intervention. A case in point is in the last crisis, when US banks came under pressure to reduce their foreign (including European) assets. While this danger exists, it was already present before the withdrawal of European banks from global investment banking. Since the US dollar and US financial markets play the central role in the financial system, the US is in a position to enforce its demands on acceptable counterparty transactions and to dominate, for good or ill, the international monetary policy scene.

The second argument is that this will leave global investment banking much more concentrated. Is this not potentially dangerous? Perhaps, but the five American investment banks still compete quite ferociously, so margins are not rising all that much.

Finally, the third argument is that current developments are inducing European banks more and more to concentrate on their national roles and clients in their investment banking operations, rather than taking a wider European stance. Deutsche Bank and Barclays are the only Europeans left in the top seven for the European market. But they are likely to lose their positions, because Deutsche Bank is currently undergoing a major reorganisation and Barclays is in the process of executing the Vickers split. In the investment banking field, the only pan-European banks will all soon be American.

There are concerns about US dominance in European investment banking. These are related to information advantages and soft relationships. The question arises whether US investment banks, as outsiders, are sufficiently knowledgeable about European corporates. Moreover, what is the loyalty of these US banks to European corporates in times of distress?

4.       Policy response

The European banking system is downsizing, partly because of on-going problems, partly because Europe is overbanked (Langfield and Pagano, 2016). That should run its course. The consequence is that the big US investment banks will be the sole leaders in the global investment banking market, as the Europeans, including the Swiss, are in retreat. Thus, the big five Americans are getting into pole position in the European investment banking market.

What should be the policy response? First, we look at the political side. With the decline of European banking (both in general and specifically investment banking), Europe’s hand in the EU-US Regulatory Dialogue is diminishing. Nevertheless, the European Commission is advised to strengthen its position in the EU-US bilateral negotiations and keep on viewing its banking industry as a strategic sector. The emerging role of the European Central Bank (ECB), on both the monetary and supervisory sides, can be used in these negotiations. The European Commission and the ECB should therefore jointly develop a strategic agenda with European priorities for their dealings with the US authorities. As in the US, this strategic agenda should be discussed with, and supported by, the industry.

Second, we turn to the supervisory side. While Europe may lose some political clout, the supervisory implications are not a problem for Europe. With the move to capital markets union, the European supervisory architecture can handle the gatekeepers, which are becoming more US-dominated. The European Securities and Markets Authority (ESMA) has powers under the Regulation on Credit Rating Agencies to licence and supervise the European operations of the primarily US-based credit rating agencies. Similarly, the relevant directives (Capital Requirements Directive and Markets in Financial Instruments Directive) give the relevant supervisors in Europe (in this case the Prudential Regulatory Authority and the Financial Conduct Authority in the UK) powers over the London-based European operations of the US investment banks. After Brexit, the US investment banks might move (part of) their business to Frankfurt and Paris. In that case, the ECB – the new supervisor in the banking union – would become the supervisor of these continental European operations.

Third, the large corporates could themselves take precautions. For the bigger financing operations, a corporate typically hires a banking syndicate, which is a group of investment banks that jointly underwrite and distribute a new security offering, or jointly lend money to the corporate. European corporates would be well advised to include at least one (large) European investment bank in this syndicate, also in good times when they do not need them. That could help them in bad times, when US banks might be reluctant for whatever reason (including more detached decision-making). The involvement of a (local) European investment bank in the syndicate is not only useful for loyalty but also information reasons. Because of their local roots, the European banks have an information advantage over their US peers, which keep offices in New York and London (and after Brexit, Frankfurt or Paris). The practice of giving a European investment bank at least one place in further US-dominated banking syndicates could help to avoid complete dependence on the whims of the big US investment banks.

Dirk Schoenmaker is Professor of Banking and Finance at Rotterdam School of Management, Erasmus University and Charles Goodhart is Emeritus Professor of Banking and Finance at London School of Economics

References

Goodhart, C. and D. Schoenmaker (2016), ‘The United States dominates global investment banking: Does it matter for Europe?’, Policy Contribution 2016/06, Bruegel.

Langfield, S. and M. Pagano (2016) ‘Bank bias in Europe: effects on systemic risk and growth’, Economic Policy 31(85): 51-106.

Liikanen Report (2012) High-level Expert Group on Reforming the Structure of the EU Banking Sector, Final Report, Brussels.

Thomson Reuters (2016) ‘Global Investment Banking Review, Full Year 2015’, Thomson Reuters Deals Business Intelligence, New York.

Vickers Report (2011) Final Report: Recommendations, Independent Commission on Banking, London.

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Kamilia Lahrichi

Oct 27,2014: The two contenders who won Uruguay’s first round of the presidential election on October 26 will not bring about any radical economic change for this small country wedged between two regional heavyweights – Argentina and Brazil.

This nation of 3.4 million people earned the sobriquet “Switzerland of South America” because of its democratic tradition and strong economic growth, a model for its unstable neighbours.

Leandro Zipitría, an Economic Consultant and Professor at the University of Montevideo in Uruguay, explained that Tabare Vazquez, the leftish Broad Front contestant and Lacalle Pou, from the conservative National Party, do not have economic programs notably different than President Jose “Pepe” Mujica’s.

Their political platforms diverge in respect to social policies, namely education and crime reduction.

Mr. Vazquez led the country from 2005 to 2010. He expanded the welfare system to reform the education system and improve working conditions.

Mr. Pou is the son of former president Luis Lacalle. Under the banner “New Hope”, he has reached out mainly to the Uruguayan youth with a focus on education, culture and agriculture.

Following the footsteps of “the most humble” leader

Despite his popularity, President Mujica cannot run for a second mandate because Uruguay’s constitution bars consecutive presidential terms.

He will be remembered as “the poorest” and “the most humble” president due to his austere lifestyle. “Pepe” shunned the lavish presidential mansion and lives in a modest farmhouse on the outskirts of the capital Montevideo with his wife and his three-legged dog.

He gained international renown as he gives away 90% of his salary to charity. He also drives a 25-year-old Volkswagen Beetle.

This 79-year old ex-guerilla was tortured and isolated during 14 years in jail. He was freed in 1985 when Uruguay returned to democracy after more than a decade of dictatorship.

Notwithstanding that the economy has grown significantly during his mandate, the truculent head of state has lambasted rampant consumerism in international summits.

At the United Nations General Assembly in New York in 2013, he said: “it seems that we have been born only to consume, and to consume”.

At the Rio+20 conference in 2012, he asked: “what would happen to this planet if Indians would have the same proportion of cars per household as Germans? How much oxygen would we have left?”

Standing out in Latin America

Despite slowing growth in neighboring countries, affluent Uruguay grew on average by 6.2% from 2004 to 2011, compared to a global average of 2.9% and a Latin American average of 4.5%.

“Uruguay has become a small diamond in a rocky landscape,” noted Claudio Loser, visiting senior fellow at the Inter-American Dialogue, a centre for policy analysis in Washington D.C.

The World Bank sets out that Uruguay’s gross domestic product (GDP) grew by 4.4% in 2013. In comparison, the economy of Brazil – Latin America’s largest with 200.4 million people – grew by only 2.5% in 2013.

The South American giant’s GDP reached US$2.246 trillion in 2013 – 40 times Uruguay’s.

While the Argentine and Brazilian economies are highly protectionist, Uruguay is a   “mostly free” marketplace, according to the 2014 Index of Economic Freedom. It assesses the level of economic freedom based on the rule of law, regulatory efficiency, state intervention and open markets.

The Index indicates that Argentina is “repressed” since 2000 – the lowest level of economic freedom. Brazil became “moderately free” for the first time in 2014.

Hence, “Uruguay appears to be the logistical and financial centre of Mercosur,” said Nestor Pablo Aleksink, Executive Director of the Program Argentina Export, an organisation promoting exports, during a press conference in Buenos Aires on October 21.

The Common Market of the South (Mercado Comun del Sur in Spanish) is a free trade bloc and customs union including Brazil, Argentina, Uruguay, Paraguay and Venezuela. It has a combined GDP of about US$3 trillion.

Uruguayan government officials argue that the country could become a regional door to Asia as China is its biggest export market.

A March 2012 report titled “Uruguay: Economy and Institutions, the Key to Success” released by the Ministry of Economy and Finance points out that the country has the only deep harbours of South America. They operate under a free port regime.

Thanks to its 45 kilometres of paved roads per 1,000 square kilometre, Uruguay has also the most dense highway network in the region.

Sound macroeconomic and investment policies  

Although Uruguay’s economy expanded by only 3.9% in 2012, Mr. Zipitría pointed out to three factors that boosted economic growth in the past decade.

“First, Uruguay has seen an important increase in the price of commodities it exports,” he noted. Exports of soybeans, meat, rice, sulfate chemical wood pulp and wheat more than tripled in the last decade.

In addition, investment increased fivefold in the last 10 years mainly due to massive foreign investment in paper pulp.

“Thirdly, the government has had a pragmatic approach to economics, propelling some important reforms like a new bankruptcy law, a new tax law [and] a non-discretionary tax reduction decree to foster investment,” he concluded.

Uruguay offers a positive investment environment as the tax system is neutral with respect to foreign investors. Also, there are no limits for foreign capital in companies. A 2007 decree incentivises local and foreign investors with income tax cuts for businesses.

Uruguay, hence, regained investment grade status by Fitch Ratings, Standard and Poor’s and Moody’s Investors Service.

A May 2014 Moody’s Investors Service’s Global Credit Research notes “moderate credit risks, and the country’s reduced vulnerabilities to regional and commodity shocks”. The rating agency forecasts a “steady increase in the investment ratio and productivity gains.”

Yet, a high inflation rate remains a challenge for policy-makers. It stands at 9.1% – well above the central bank’s target of 5% plus to minus 2%.

Slamming the door of Mercosur?

The saying goes: when Brazil or Argentina sneezes, Uruguay catches a cold.

In 2001-2002, Uruguay followed Argentina into crisis because it was commercially tied to the fortune of its ailing neighbour. Uruguay was hit hard: poverty reached 40% and the unemployment rate 20%.

This was caused, in part, by the boom-bust cycle of Argentina’s massive 2001 default, which significantly affected trade flows with its neighbour. The county ran out of cash and faced difficulties in production capacity.

Unlike Argentine, Uruguay handled its recovery efficiently. It achieved macroeconomic stability while tackling its population’s social needs. In fact, it was able to access international credit markets quickly and secured US$1.5 billion from the United States Treasury in 2002.

Uruguay, which today depends less on trade with Argentina, has a robust economy with a well-regulated banking system. It thereby lives up to its reputation as “el país corajudo” (the plucky country in Spanish). Exports to Argentina have fallen from 25% to 4% in a decade.

Uruguay does not rely exclusively on Brazil either so that if the South American giant reduces its demand, Uruguay can strategically reorient its market, explained Minister of Commerce Mario Bergara in September 2014. Uruguay now exports commodities to 140 countries, such as the Netherlands, China and Russia.

In addition to keeping itself safe from unstable neighbors, Uruguay has diversified its goods exports with new segments, namely paper pulp and soybeans.

Thus, “Mercosur has lost its path,” said Mr. Zipitría.

Notwithstanding that the regional free trade zone has sought to boost commerce, discord among member states has stymied economic progress.

“The politics that Argentina is applying today does not favour the process of [regional] integration,” said Mr. Aleksink, in reference to heavy-handed policies to protect the local economy.

Besides, the union of leftist governments in Mercosur appears more ideological than practical.

“Although Uruguay has managed to attract foreign investment, there are some tensions within [the Broad Front] in the government that tends to evaluate international interests in ideological terms, and less in pragmatic terms,” explained Mr. Zipitría.

The political coalition deems trading with foreign countries a “heresy towards Mercosur.”

“If the political direction changes in any of these countries [Argentina, Brazil and Venezuela], maybe the winds could change in Uruguay too,” he added before the presidential election in Brazil on October 26.

Left-leaning president Dilma Rousseff came first before centrist economist Aécio Neves in the race in Brazil

A unique model

Thanks to advanced education and social security systems as well as the legalisation of abortion and gay marriage, Uruguay has pioneered a unique social model in the region.

It was coined “The Netherlands of Latin America” too because of its progressive social laws: Uruguay is the first country on the planet to legalise the production, selling and consumption of marijuana, as part of a groundbreaking experiment.

President Mujica declared that drugs are an “economic power”: drug trafficking exists because there is demand.

Besides, along with its Argentine neighbour, Uruguay has achieved gender development parity. In contrast to most Latin American countries, the nation has one of the lowest perceived levels of corruption in the world.

More stories:

Brazil’s President Rousseff stays in power

Bolivia’s Evo Morales wins a third consecutive term

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Suparna Goswami Bhattacharya  

October 7, 2014: While the technology sector is struggling to shrug off the gender-bias tag from its name, there is another industry — the financial services sector — which is also finding it tough to do away with this infamous tag.

And unlike the technology sector, the problem is not confined to the top executives. Even at the entry level, investment bank employees are mainly men, according to a report titled ‘2014 Investment Banking Analyst Class’ by Vettery, a recruiting firm based out of New York, US.

Sample these statistics. In this year’s list of bankers who graduated to enter the industry, about 77.5% are males.

Also, of the total US investment banking analysts, only 23% are women. This is a 2% drop from the year 2012.

Vettery collected data of about 1,00,000 financial workers, through its proprietary data techniques, who have signed up with the site. Though it is no news that there is a dearth of women leaders at the higher echelons, the findings are important as most banks do not release any demographic information about their junior workers.

According to a research by University of Exeter, there are a number of barriers to diversity which need to be addressed before the benefits of improved gender equality can be felt. These include lack of work-life balance, paucity of role models and mentors, stereotypes and unconscious bias, among others.

Professor Diane Perrons of the Gender Institute at the London School of Economics and Political Science, in a study, said that there is a culture of long working hours in the sector. It becomes difficult for women to fit into this “masculine work culture”, as they usually have an important role to play at home as well.

Of course, there is the issue of supply as well. Supply in terms of candidates with the prerequisite background (finance/economics majors) and an interest in working in high finance for 80-100 hours a week.

Further, many women in the financial services sector cite a lack of role models and mentors in the industry as one of the barriers to their own career progression. Academic research, such as that conducted by Dr Ruth Sealy from the Cranfield School of Management and Professor David Gray from the University of Surrey, emphasises the key function that role models play in facilitating career progression. It was found that one-third of women leave the job after only eight months because of lack of role models.

Though, most banks refused to comment on the findings, one of the banks in the US said that they are making all efforts possible to improve the gender diversity, but much more needs to be done. “Managers need to reward output and not number of hours spent in office. Also, work from home should be included in a holistic manner rather than making it an exception for some employees,” says the HR manager of the US-based bank.

However, there seems to be some light at the end of the tunnel. “We’ve seen all banks make attempts to improve diversity, especially at the entry-level ranks. We are working on a number of searches for investment banking, private equity and hedge fund clients, and there is a demand for female employees,” says Alex Orn, CFO, director of analytics, Vettery.

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