Capital Flows

South Africa’s general malaise owes much to its very slow recovery from the international economic crisis that began in the United States in 2008. The country’s gross domestic product growth rate has declined from a usual 3 percent to 1.5 percent in 2014. Weaker commodities prices have also slowed an economy that still includes a large mineral export sector. Unemployment is a major cause of South African poverty. It peaked in the first quarter of 2015 at 26.4 percent, according to Statistics South Africa, the national statistical service of South Africa. The rate is even higher among blacks, who constitute about 80 percent of the population. It is estimated that unemployment among black youth in the townships is around 50 percent. It is also high in rural areas. Hence it is good news that in the second quarter of 2015, unemployment dropped to 25 percent, according to the latest reports by Statistics South Africa. Very high levels of unemployment are a characteristic of the South African economy. According to Bloomberg, South Africa has the second highest jobless rate of the 62 countries that it tracks. There are now 5.23 million South Africans without jobs, which marks a healthy decline of about 305,000. The South African government estimates that economic growth will be 2 percent in 2015. This is better than 2014, but still not at pre-2008 recession levels. The South African government’s aspirational National Development Plan looks to cut unemployment to 14 percent by 2020 and 6 percent by 2030. While slow economic growth certainly contributes to high unemployment, there are also important structural issues. Trade unions, allied to the governing African National Congress, keep wages high. Government policy has not promoted the creation of low-skilled, low-paying jobs. Yet, in part because of the shortcomings of the educational system, a large percentage of the population is unskilled. In many African countries, the informal sector of the economy absorbs unemployment. South Africa, however, appears to have the smallest informal sector of any large African country. This, in part, is the baleful heritage of apartheid, which restricted black enterprise and mobility. Moreover, there are numerous other structural and technical drivers of high unemployment. Measuring levels of poverty in South Africa (and elsewhere) is difficult given the variety of technical and definitional issues. However, the Daily Maverick, a respected South African publication, concludes that 21.7 percent of the population lives in extreme poverty. That means they do not have enough money to pay for the food necessary to meet their nutritional requirements. An additional 37 percent are unable the purchase both food and meet other necessities, such as transport and fuel. So, more than half of the country’s population is poor, and a high percentage of the poor are unemployed. Over the past decade, the percentage who are unemployed in South Africa has fluctuated in the mid-twenties. The most recent drop in unemployment is a welcome sign, but is unlikely to be the harbinger of long-term trends. Until the structural roots of high unemployment are addressed in South Africa, serious progress on reducing poverty cannot be made.

Mexico’s national GDP numbers remain lackluster. In 2014, the country grew 2.1 percent, and forecasts for 2015 predict a modest 3 percent increase. Yet these numbers mask the great diversity within and between the nation’s thirty-two federal entities. The Bajío region experienced Asian rates of growth last year—Queretaro up 14.3 percent, Aguascalientes 14.2 percent, Guanajuato 7.4 percent, and Jalisco 3.7 percent. Home to auto and aerospace hubs, these states receive increasing shares of foreign direct investment. Think tank México ¿Cómo Vamos? expects these states to continue to drive economic growth numbers going forward. Many of Mexico’s northern states saw strong upturns as well. Nuevo Leon, home to industrial city of Monterrey, grew 5.4 percent in 2014. In Chihuahua, Coahuila, and Tamaulipas close ties to a recovering United States seemed to outweigh continuing security challenges, with combined growth edging out the nation’s average. In contrast, Mexico City and the State of Mexico, comprising over a quarter of national GDP, grew just 1 percent. Southern states Chiapas and Oaxaca trailed the national rate as well. Guerrero and Michoacán were boosted temporarily by influxes of government funds for disaster relief and security respectively, but their longer term growth rates remains below average. These four states score the lowest on the United Nation’s human development index. And falling oil prices have hit the energy-rich southern states, in particular Tabasco and Campeche. These differing trends threaten to aggravate already deep economic divides, creating virtuous and vicious circles in terms of infrastructure, education, and opportunities. Federal efforts to redistribute wealth, specifically the Fondo Regional which provides grants for lesser developed states, maintains a MXN$6 billion budget (roughly US$400 million), not nearly enough to overcome ingrained disparities. These differential growth rates have the potential to shape regional and national politics. Economic expansion didn’t temper voter dissatisfaction this time—the Partido Revolucionario Institucional (PRI) lost the Queretaro governorship to the Partido Acción Nacional (PAN), and Nuevo Leon to the independent Jaime “El Bronco” Rodriguez. But as Mexico looks to twelve governor races in 2016, notably in Oaxaca, Puebla, Tamaulipas, and Veracruz, local economic growth rates will surely matter. So too will good governance—a dominant issue behind the 2015 results. And as the race for the 2018 presidency begins (already Margarita Zavala, Miguel Ángel Mancera, and Andrés Manuel López Obrador have publicly put forth their names), it needs to be a party, not just a candidate, who most convincingly promises to bring growth and governance to broader Mexico to stop the fragmentation of the political system.

Emerging Voices features contributions from scholars and practitioners, highlighting new research, thinking, and approaches to development challenges. This article is by Elizabeth Littlefield, president and chief executive officer of the Overseas Private Investment Corporation, the U.S. government’s development finance institution. This month marks the 70th anniversary of Victory in Europe Day—when Nazi Germany surrendered to the allied powers and World War II ended in Europe. This occasion is an important opportunity to reflect on how the postwar reconstruction plan shapes our current model of economic engagement with the developing world and to consider expanding the role of the private sector in these efforts. The postwar consensus came together at Bretton Woods. To rehabilitate a ravaged Europe, representatives of the allied powers agreed on a few basic lessons from the war: (1) advanced nations, especially the United States, need to engage with the world; (2) economic instability breeds conflict; and (3) military and economic preparedness of individual nations alone can’t provide stability. These beliefs have informed U.S. post-war policies and led to the creation of the International Monetary Fund (IMF) and World Bank. For decades after, multilateral institutions and national governments led the investment in the developing world. In the early 1970s, official development assistance dwarfed private capital flows into emerging nations. The Bretton Woods consensus continues to shape the approach to economic development. Today, developing countries receive IMF and Bank loans as well as aid from donor governments. But development assistance is no longer the primary source of international capital. For every $1 in official flows, $7 in private investments flow into the developing world. (Official flows are $134 billion, while private flows are $778 billion). Yet, the need remains, and the private sector is well positioned to deliver where aid efforts have fallen short—in meeting immediate demands, especially creating jobs, building infrastructure, and stimulating the economy. The Overseas Private Investment Corporation (OPIC) was established in 1971 as a mechanism to help companies enter emerging markets. The U.S. government spun this development finance institution (DFI) out of the U.S. Agency for International Development. OPIC provides financing and political risk insurance to private investors seeking to work in emerging markets. By leveraging U.S. private sector capital and capacity to address critical needs in development countries, OPIC advances U.S. foreign policy and national security objectives. Today, OPIC’s global portfolio totals $18 billion in financing and insurance, supporting development projects in over 100 countries. Yet, OPIC’s capacity to support these investments doesn’t meet the scale needed today. Nearly $800 billion in global foreign direct investment (FDI) goes to developing economies, but the world’s least-developed countries receive less than 4 percent of global FDI flows. Aid will not satisfy the unmet needs of the world’s least developed regions. Currently, less than 1 percent of the U.S. budget is allocated to foreign assistance, and it is difficult to imagine this figure will drastically increase. Rather, increased private sector investment is the answer. Numerous U.S. companies are ready to invest their capital in emerging markets, but they need support to meet the business challenges and risk common to such environments. OPIC has already played an important role, providing loans and guarantees to mobilize investments and insurance to protect against unforeseen events But, the United States lags behind in economic engagement in developing countries. To expand U.S. private sector engagement, it will be necessary to redouble OPIC’s efforts. It is time for the United States to lead once more in the effort to spread peace and prosperity to the developing world—as we did post-World War II.

This is a guest post by Alex Dick-Godfrey, Assistant Director, Studies administration for the Council on Foreign Relations Studies Program. Last month, Soma Oil and Gas, a London based energy company, searching for hydrocarbon deposits off the coast of Somalia, announced that it had completed a seismic survey to ascertain the potential for recoverable oil and gas deposits. Although further details have yet to be released, chief executive Rob Sheppard announced that the results were encouraging. However, Somalia, and potential investors, should proceed with caution when considering entering this frontier market. East African oil exploration, and in Somalia specifically, is not a secret. Energy firms like Royal Dutch Shell and Exxonmobil operated in Somalia before the government collapsed in 1991. But recent gains against the insurgent group al Shabaab in the south and the decrease in piracy off the coast have sparked a regeneration of the industry. The Somali president, riding these positive evolutions, recently stated that the country is “open for business.” Although recent security developments are encouraging, substantial hurdles still exist. The Heritage Institute recently released “Oil in Somalia: Adding Fuel to the Fire?,” by Dominik Balthasar. The paper discusses how the oil industry in Somalia could have a promising future, but it also explores the risks facing Somalia if the development of its petroleum resources is not carefully managed. Balthasar rightly asks, “is Somalia ready for oil?” The historic challenges that have limited business opportunities in Somalia, domestic insurgency and piracy, have diminished for now, but these threats have not disappeared. Al Shabaab has been largely pushed out of southern Somalia by multinational forces, but has recently proven that it is still able to operate in the north of Kenya. As Kenya flexes to counter al Shabaab in its own country, it could provide an opportunity for al Shabaab to return to its previous strongholds in Somalia. And even as piracy has largely stopped, it is conceivable that al Shabaab or others could see oil tankers as opportunities to resurrect that practice as well. Beyond these security challenges there may be political disadvantages to developing the hydrocarbon sector in Somalia. Balthasar notes, among other things, that oil will likely exacerbate existing rifts and political tensions. In the context of the recent political turmoil and contentious federalism process, it is clear that any foreign oil companies would face a high degree of political instability and uncertainty. Balthasar also points out that the legal and constitutional conditions in Somalia are ambiguous in determining who can enter or negotiate contracts with oil companies. Without a well-defined regulatory environment for oil and gas resources, federal states, semi-autonomous regions, and the central government could all separately negotiate and enter into conflicting extraction agreements with private companies. The opaque regulatory nature of these resources has already proven problematic in the semi-autonomous regions of Puntland and Somaliland. Even with updated agreements on how to negotiate for and claim oil fields, Puntland and Somaliland have already leveraged their autonomy and granted their own licenses without the central government’s blessing. This is all likely to lead to further turmoil and maybe even conflict over profitable fields and the distribution of revenues. Somalia is probably not ready for oil development. With excellent access to shipping lanes and supposedly massive untapped wealth (perhaps as much as 110 billion barrels) it is no surprise that multinational oil companies are intrigued, but responsible investors would be wise to think twice. The underlying political instability and security challenges of Somalia will likely inhibit the long term feasibility and profitability of these projects. It could also cause backsliding for the hard fought improvements in Somalia’s government.

For the past century or so, big mining corporations have pursued their operations in Africa, but their senior management, marketing, and sales have been in Europe or North America. That is changing. The government of Botswana and De Beers Group, the diamond company, agreed in 2011 that the latter would sort, value, and sell diamonds produced by the company Debswana, a joint 50/50 business venture between Botswana and De Beers that accounts for a third of Botswana’s GDP. For its part De Beers agreed to transfer its London based rough diamond sales to Botswana. The move involves the transfer of professionals, equipment and technology from London to Botswana’s capital, Gaborone. In November 2013, De Beers started diamond sales in Gaborone in a state-of-the-art facility. Batswana, nationals of Botswana, are about 50 percent of the de Beers’ employees in the sales division. The outlook for the diamond industry is good, with new consumers from China, especially.  But few new diamond mines have come on stream over the past decade, raising the possibility of a shortage of supply.  The Botswana-De Beers deal appears to be win/win.  Botswana retains direct access to the world market for its diamonds while De Beers has long-term and uninterrupted access to one of the largest diamond supplies in the world. Over the long term, the De Beers move sets the stage for Botswana to emerge as a major participant in all aspects of the diamond industry, not just diamond mining.  That’s good for the continued development of the country, already one of Africa’s success stories.

Diamonds are associated with glamour and South Africa. The Cullinan Mine, east of Pretoria, is famous for diamonds of the huge variety, including the ‘Cullinan Diamond,’ at 3,106 carets, the largest gem quality diamond ever found. The owner presented it to King Edward VII in 1905, and the Great Star of Africa, which was cut from it, is in the scepter of the royal regalia used at the coronation of British monarchs. The British press is reporting that another huge diamond has just been mined at Cullinane. Though only 232 carets, the British media is estimating that it “could” be worth up to ten million pounds sterling, or U.S. $16,205,000. Other estimates go as high as fifteen million pounds sterling. Cullinan Mine is now owned by Petra Diamonds, a corporation registered in Jersey in the Channel Islands, and its shares are traded on the London Stock Exchange. Its shares rose about 7 percent on September 9 with the announcement of the big diamond. The Cullinan Mine was long owned by the diamond conglomerate de Beers, associated with the Oppenheimer family. In 2011, the Oppenheimers sold their 40 percent share in de Beers to Anglo-American, a giant mining company headquartered in London. Previously, de Beers had sold the Cullinan Mine to Petra Diamonds, a relatively new mining company. Petra Diamonds is subject to the provisions of the South African governments Broad Based Black Economic Empowerment (BBBEE) program. According to its website, Petra’s BBBEE partner is Thembinkosi Mining Investments, with a 14 percent share in the Cullinan Mine. The report of the mining of a huge diamond may make the press but, mining as a whole is now only about 18 percent of South Africa’s gross domestic product, according to the CIA Factbook. Drivers of economic growth now are not so much diamonds and gold as telecommunications (including cell phones), financial services, and real estate.

This is a guest post by Greg Mendoza, an MA student at The Fletcher School, Tufts University. He previously was an intern in the Latin America Studies program at the Council on Foreign Relations. Last year, Mexico passed a historic energy reform to end over seventy years of exclusive state control of the energy sector. Some analysts estimate drastic changes in the sector—with upwards of twenty billion dollars in foreign direct investment a year that could boost GDP 2 percent annually by 2025. On August 11, President Peña Nieto signed into law the secondary legislation that dealt with issues ranging from the distribution of oil rents to the reorganization of the electricity sector. One important but less discussed aspect for the nation’s future will be the Mexican Fund for Stabilization and Development, designed to help the Ministry of Finance mitigate the negative effects of volatile energy prices. Oil and commodity price fluctuations have buffeted Latin American economies for decades. Governments exacerbated the damage by maintaining procyclical fiscal regimes—increasing spending during booms and slashing budgets when prices fell. These policies are dangerous for states such as Mexico given that last year oil revenues accounted for sixty-six billion dollars, or one-third of the government’s annual budget. The new Mexican Fund for Stabilization and Development will manage government energy revenues. Controlled by the Bank of Mexico, the country’s independent central bank, the fund will disburse an estimated sixty-three billion dollars to the federal budget (based on current receipts from Pemex). Assuming additional revenues, some of the monies will be saved while others will be allocated to programs such as the universal pension system and local development projects. A technical committee that consists of the Ministers of Finance and Energy, the Governor of the Central Bank, and four independent parties will recommend to congress the amounts given to each of these programs. This structure contrasts with Mexico’s previous Oil Revenues Stabilization Fund. The previous fund could never save enough revenue to make a difference in downturns because of the balanced budget rule, which annually withdrew money from the old oil fund when there was a budget deficit. Under the new law, the technical committee limits transfers to the federal budget at 4.7 percent of GDP, and bigger outlays for economic emergencies require a two-thirds vote in the Mexican lower house. In creating this new fund, Mexico hopes to replicate the success of other sovereign wealth funds. Chile’s Economic and Social Stabilization Fund is the best known in Latin America, credited with bailing the country out in the wake of the 2008 world financial crisis. With copper representing 20 percent of the country’s GDP, the fund saves surplus copper revenues during booms, and spends the reserves during economic downturns. The central bank manages the fund and is valued at almost $16 billion, a large sum for a country whose GDP was $277 billion in 2013. The government’s adherence to saving copper surpluses proved successful in 2008, when funds were quickly transferred to the federal budget to mitigate the effects of the Great Recession. The success of Mexico’s new stabilization fund will depend on whether the new fiscal rules work. Saving money for a rainy day is not easy. Oil bounty could also push up the currency (the dreaded resource curse) hitting Mexico’s robust manufacturing sector, which represents three-fourths of its exports. However, the new stabilization fund addresses these concerns and removes the old restrictions on its savings, limits monetary transfers to the federal budget, and is managed by the independent central bank to minimize political interference. The new rules should insulate the economy from the negative effects of oil revenue variability and provide resources for future development. The fund’s success will be determined by the upcoming implementation, and although there are still challenges institutionalizing these reforms, the new laws are a positive first step in modernizing Mexico’s energy sector.

This is a guest post by Stephanie Leutert, who is beginning an MA in Global Affairs at Yale University in the fall. She previously was my research associate in the Latin America Studies program at the Council on Foreign Relations. Mexican manufacturing is perhaps best symbolized by the infamous maquiladoras in the border region. Yet, in states from Chihuahua to the Yucatán, Mexican engineers are changing the narrative. Alongside more established auto and medical equipment manufacturing, Mexico is growing its aerospace industry, attracting investment, creating jobs, and changing its economic identity. But many challenges remain if the benefits are to be felt widely. For now, Mexico’s aerospace industry is the world’s fourteenth largest. Some 287 aerospace companies operate in eighteen states, with five major clusters in Baja California (59 companies), Sonora (45 companies), Querétaro (33 companies), Nuevo León (32 companies), and Chihuahua (32 companies). And the sector is growing exponentially. From 2009 to 2012, Mexico’s aerospace industry received more foreign direct investment than any other aerospace sector in the world—boosting its exports to $5.5 billion in 2013. Driving the sector’s explosion is its integral role in the North American aerospace production platform. “The United States is the market, Mexico is the low cost manufacturing, and Canada is the partner for production,” explained Marcelo López Sánchez, the secretary of sustainable development for Querétaro. In the sector’s continental supply chains, “aircraft are designed in Canada, set up in Mexico, and final production takes place in the United States.” This role—along with Mexico’s macroeconomic stability, low wages, few if any tariffs for exports to the United States and Canada, protection of intellectual property rights, and growing number of aerospace engineers—have propelled the sector onto the global map. Mexico’s federal and state governments have also cleared the way—offering companies enticing tax incentives, cutting through bureaucratic red tape, and signing bilateral aviation agreements with forty countries to waive the inspections of pieces and parts before they are packed for export. Still, Mexico’s aerospace industry employs only about 43,000 Mexicans, a tiny portion of the country’s 50 million strong workforce and even small within the advanced manufacturing sector. But the real importance lies in the spillover effects. Every $1 million invested in engineering intensive manufacturing is estimated to create an average of four jobs. And every one high tech manufacturing job supports at least two jobs elsewhere (though some estimates are as high as fifteen jobs)—both directly (in the companies that supply the aerospace industry) and indirectly (in construction, transportation, and other service industries). However, for Mexico to reap the full benefits of its aerospace clusters, the sector will need to continue building out its local companies and employee base. The majority of aerospace companies operating in Mexico are foreign, limiting the economic effects for host regions. This stands in contrast to other advanced manufacturing industries where Mexican companies have a much larger presence. In Querétaro alone, Mexican companies make up almost a third of the state’s automobile manufacturing, and expanding into the burgeoning aerospace industry would appear to be a logical next step. But the transition has been slow. Part of the problem, according to Luis Lizcano, director general of the Mexican Federation of Aerospace Industry (FEMIA), is the different business model. “In the automotive industry, [production] is high volume, low mix, in aerospace it is low volume, high mix.” A company may get an order for 250 parts, many of which are different—and all must be of the highest quality. “It requires a different mindset.” For those companies already shifting mindsets and moving into aerospace, there is also the challenge of becoming certified. Compared to other advanced manufacturing industries, aerospace certifications are stricter and more expensive, and navigating the process can be tough for companies just entering the sector. “You have to be technically savvy to understand the industry and the certifications,” says Lizcano. To provide support, state governments have taken the lead—counseling Mexican companies on how to obtain the appropriate certifications necessary to break into global supply chains. But none of this matters without the human talent necessary for aerospace manufacturing. Mexico graduates an impressive number of engineers, but given the aerospace industry’s recent arrival, most are specialized in other sectors. Some communities are working hard to change this. In 2006, Bombardier arrived in Querétaro after the state agreed to build a National Aeronautics University to train aerospace engineers. Today, the university provides two-thirds of Bombardier’s workforce for its Querétaro plant and sets up specialized training programs when needed. Other universities and technical programs are also popping up across the country, and are increasingly partnering with schools in the United States. The goal for workers, says Lizcano, is to have a “higher knowledge base, higher skills, and then higher value added per job,” making the sector more competitive and hopefully pushing up wages. Today, Mexico’s aerospace industry employees continue to earn low salaries by international standards. An operational worker (the majority of the sector’s employees) earns an average of US$1,000 a month, and a technical job brings in about US$1,500 a month—limiting the upsides for families and communities. Fully addressing any of these challenges will take time, even given the current efforts among industry leaders and policymakers. Yet, the industry is already a powerful symbol of the country’s expanding economic identity. As the domestic suppliers and workforce continue to develop, Mexico’s aerospace sector has the potential to change the country’s economic narrative and ultimately its reality.

This is a guest post by Allen Grane, former intern for the Council on Foreign Relations Africa Studies program. Allen is currently an officer in the Army National Guard. His interests are in Africa, conflict, and conflict resolution. On July 8, 2014, former NBA star Dikembe Mutombo and Innovation: Africa, an Israeli non-profit, launched a new program in the Democratic Republic of the Congo (DRC) to provide clean and sustainable energy to people in need. The program will serve people in Mutombo’s hometown of Kinshasa and neighboring villages. Mutombo reached out to Innovation: Africa after hearing of the organization’s success in developing solar energy projects in Uganda, Malawi, Tanzania, Ethiopia, and South Africa. Innovation: Africa will provide solar power to four facilities in the DRC. The organization uses the solar power to administer a number of electric services, such as lighting a school that serves over 740 students and providing water to a Kinshasa orphanage with 150 children. In conjunction with the Christian Broadcast Network, Innovation: Africa has drilled down over fifty meters into an aquifer that can provide the orphanage with its own source of clean water. Using solar energy, this water can be brought up to the surface. The projects are varied. The group is also setting up a light installation that will allow for more efficient energy use at the Biamba Marie Mutombo Hospital in Kinshasa. Another major project provides energy to a medical clinic in Bu Village, which serves a community of over eleven thousand people. By providing energy to these facilities, Innovation: Africa is offering communities hope. The energy that is provided through solar power allows the medical facilities to operate at night and to refrigerate medicines and vaccines. Medicine and access to clean water offer children a better chance of survival in a country where the under-five mortality rate is three times higher than the global average. Sivan Ya’ari, founder and president of Innovation: Africa, is proud that these projects are developed to be self-sustaining. The organization encourages participating schools, orphanages, and clinics to use the access to energy in order to develop their own businesses.  Innovation: Africa provides oversight to ensure that the businesses are sustainable. One of the organization’s business models is to set up cellular phone charging stations where customers pay a fee to charge their phones. The profits of these businesses are managed by a board and overseen by Innovation: Africa’s field managers in order to ensure that the money is used to repair and maintain the solar panels. In just five years, Innovation: Africa has helped over 450,000 people in six countries and is now running seventy-eight solar power projects. According to a 2011 World Bank report, only 6 percent of the population of the DRC has electricity. Innovation: Africa has the opportunity to help a great deal of people through its work.