SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION - Incubating the Future of Chile - Likonomics - Uncovering Key ASEAN Needs Vital to US Economic Legitimacy in ASEAN (Part 3)
The Fortnight In Brief (8th July to 2 1st July) US: CPI up, credit rating revised from negative to stable US data for June were largely positive with retail sales rising 0.4%, though m issing the 0.8% estimate by economists, and industrial production up 0.3%, the biggest since February. Julys Empire State Manufacturing Index was also up. June CPI rose 0.5%, also the largest since Feb, edging closer to the Feds 2% inflation target. In his testimony before Congress, Chairman Bernanke said the Fed expects to start scaling back on QE this year, and that the bond buying program does not follow a preset course. The USs Aaa credit rating was also revised from negative to stable by Moodys, on the back of the narrowing b udget deficit, which according to the CBO, is expected to be the smallest since 2008 this year. Asia: China reports slower growth; Attention shifts to election in Japan Chinas year-on-year home prices rose strongly in June. New home prices in 70 major cities saw a 0.8% increase in June from the previous m onth and a 6.8% increase from a year ago. The appreciation of home prices come as China reported a GDP growth of 7.5% growth in Q2, 0.2% lower than in Q1. In Japan, Shinzo Abes ruling coalition is expected to win the upper house of parliament. A victory would give the Liberal Democratic Party (LDP) a majority in b oth houses of parliament, allowing Abe more flexibility in implementing Abenomics. The Nikkei has seen a 41% increase year to date thanks to the aggressive monetary stimulus, increased fiscal spending and structural reform, dubbed the three arrows of Abenomics. EU: Japan advocates Britain to keep major role in EU PM David Cameron's promise to renegotiate Britain's role in the EU and hold a referendum on EU membership by 2017 has been greeted with concern by the United States among others. In addition, British Foreign Secretary William Hague has said that withdrawal from the EU would deter investors, undermine trade and damage Britain's global status. Meanwhile, Japan has mentioned "The advantage of the UK as a gateway to the European market has attracted Japanese investment. "The (Japanese) government is committed to making its relationship with the EU stronger than ever before. In this context, it expects that the UK will maintain a strong voice and continue to play a major role in the EU."
1710 1690 1670 1650 1630 302

ISSUE 42 22 JULY 2013

IN COLLABORATION WITH

PROUDLY SUPPORTED BY MSCI AC Asia Ex. Japan

S&P 500

STOXX Europe 600

520 515 510 505 500 495 490

300 298 296 294 292

Incubating the Future of Chile

By Lai Tze Wee, Singapore Management University
The author was on a Business Study Mission to Chile this summer to learn about entrepreneurship, as well as the interaction between politics, culture and the economy in Chile. Introduction In Economics, we learn of a phenomenon called the income trap where countries stagnate after years of spectacular growth. While Chile has the highest per capita income figures in Latin America (with a GNI per capita of PPP$1 21,000 in 2012), it is considered to be in an income trap. It is a country blessed with an abundance of resources, but this has become a curse as the institutions that arose focused more on resource extraction than encouraging productivity growth and innovation needed to drive sustainable growth. While promoting more innovation and entrepreneurship seems like a textbook prescription for Chile, the implementation of this strategy is far from simplistic. Enter CORFO (Chilean Economic Development Agency), an agency which mirrors the functions of Singapores very own EDB (Economic Development Board). Both Government agencies are synonymous with trying to create a competitive and innovative business environment in their respective countries as well as nurturing infant industries2. One of the flagship programmes from CORFO is Start-Up Chile, offering work visas and USD$40,000 in seed capital to attract and retain world class entrepreneurial talent. It is hoped that these entrepreneurs will create a thriving ecosystem in Chile by sharing ideas and networks in addition to inspiring Chileans to start their own Fortune 500 companies someday. This is similar to efforts in Singapore (such as the EntrePass immigration scheme and Global Entrepreneurial Executives scheme). A start-up bubble and why its alright If government funding and assistance are seen as inputs for growing start-ups in Chile, incubators3 could very well be the farmers which tend to these prospective multinational corporations. Incubators play an important role not only in selecting and allocating Government funds to entrepreneurs but also in offering a myriad of services such as cheap rental or entrepreneurial training and mentorship programmes. As we journeyed through Downtown Santiago and the financial district, Sanhattan (a portmanteau of Santiago and Manhattan), we visited a few of these incubators which now appear to be sprouting in larger cities across Chile. The business model and features of each incubator seemed nearly identical, differentiated only by industry focus or the company or organisation the incubator is affiliated with. At first glance, the growth of an ecosystem to support entrepreneurship was encouraging but further probing led to some uncomfortable discoveries. First, the business model of these incubators does not seem sustainable as most depend on the equity stake in the businesses they support. While incubators screen candidates and try to 2 Copyright 2012 SMU Economics Intelligence Club

take in the best ideas, the fact remains that start-ups have a low probability of success and a high variance in potential payoffs. Without public money flooding this sector, it would be safe to say that there will not be as many incubators around. This was especially telling during interviews with the founders, who shared that most of them started out around 2009 or 2010. This was when the incumbent President, Sebastin Piera, took office and began a push for more entrepreneurship and pro-business reforms. Second, we were unconvinced of the unfeasibility of some of the business ideas we saw during the visits. It was uncertain if public funds used to spur entrepreneurship were being spent wisely. This concern was echoed by a few students, one of whom asked the director of an incubator if a start-up bubble was forming. Did the Governments enthusiasm at developing an entrepreneurship ecosystem cause a larger than optimal number of incubators and start- ups to thrive as they ride this boom? The Chilean Government may have been trying to grow roses, but they could have been cultivating too many weeds. Zombie start-ups and incubators supported by taxpayer funds could emerge, much like how aggressive monetary policy caused zombie banks and companies to proliferate in Japan and Europe. The entrepreneurs we spoke with were also uncertain if the next Government will continue to encourage entrepreneurship as much as the present one. When political winds change and Government support wanes, these incubators, start-ups and initiatives may go into limbo and crash, damaging the image that Chile had been trying to build. These fears were partially assuaged as long as spending is properly audited and the money did not leave the Chilean economy. The closed loop4 in the economy should ensure that at its worst, the spending will be no different from any traditional expansionary fiscal policy, except that entrepreneurs are spending the money on behalf of the Government. Even if these start- ups failed, the effects on the macroeconomy should be relatively benign. The objective of generating more productivity growth and entrepreneurship is much more important for the long term health of the economy. Our professor also explained that there were many intangible benefits which further strengthened the case for encouraging entrepreneurship and innovation. The spending was conspicuous enough that it attracted the attention of media agencies worldwide, strengthening Chiles image as a centre for entrepreneurs. This currency can later be exchanged for more Foreign Direct Investment (FDI), which would in turn attract more foreign start-ups to Chile. Even if the Start-Up Chile programme did not culminate in a Fortune 500 company, the long run effects may eventually result in one being created. Furthermore, another classmate explained that even if a bust were to occur in the short run, Darwinian natural selection will ensure that only the very best incubators and start-ups remain, allowing the ecosystem to grow more organically around a core of tested companies. Having more players in the ecosystem now may not necessarily be bad as there is a greater variety of investors, incubators, and start-ups. Less capable ones are then weeded out in the market, allowing a stronger core to form. Lastly, a participant from the first run of Start-Up Chile compiled a few statistics about the 22 start-ups in the programme after their first year to determine if the programme was a success. 3 Copyright 2012 SMU Economics Intelligence Club

Some of this information can be seen in Figure 1 below. The figures show a low failure rate and significant benefits such as the media exposure and image created by the campaign have yet to be taken into account. Figure 1: Statistics from Start-Up Chile Participants Companies with at least cofounder living full time in Chile Companies with significant businesses still running in Chile Capital raised from angel investors and Venture Capitalists Companies still operating on own finances Companies which are profitable or raised significant capital Companies which have failed Companies which have been acquired Companies which still have business relationships in Chile Jobs created in Chile Companies which joined over the four subsequent rounds of Start-Up Chile Homeward bound The scales fell from our eyes during our stint away from home as we realised the opportunities and support in Singapore available for entrepreneurs. If not for the parallels we saw in a foreign land, many of these opportunities at home will have simply passed us unnoticed. If entrepreneurship can begin to take root and thrive in Chile, where the level of support and infrastructure is not as strong, Singaporeans can aspire to achieve much more. Lastly, to a brave friend who stayed behind for an internship in Chile and has plans to try for the Start-Up Chile programme, all the best! 6 (27%) 10 (45%) US$4,020,000 (Raised by 7 Startups) 16 (73%) 12 (55%) 3 (14%) 1 (5%) 19 (86%) 16 400

4 Copyright 2012 SMU Economics Intelligence Club

1 PPP$

Purchasing Power Parity Dollars is a hypothetical unit of currency derived by converting a countrys currency into a common international currency based on the relative price differences of a selection of goods across countries. 2 Infant Industries A new and usually promising industry which is not yet able to compete internationally and needs to be protected. 3 Incubators Programs designed to support the successful development of a start-up by providing business support resources and services such as cheap rental, education and training, networks and mentorship. 4 Closed Loop An economy with a closed loop is one which sees relatively little capital and trade outflows or leakages. Sources: 1. CORFO 2. E27 3. Janus Corporate Solutions 4. NathanLustig.com 5. OECD 6. The Guardian 7. The Next Web

5 Copyright 2012 SMU Economics Intelligence Club

Likonomics
By Henry Chan and Wang Haochen, Singapore Management University
After the June 10-12 Dragon Boat Festival holiday, the Chinese government engineered an unprecedented stress test on the nation's interbank market that saw overnight rates surge from the usual 2-4% to 13% on June 20th (Figure 1). Though subsequent intervention of the government had restored order to the market and moved the rate back to its usual range, most economists agreed that the episode had sent an unmistakable reform signal to the market and there is intense interest around the economic thinking of the new Premier Li Keqiang. Figure 1: Repo & Shibor (Shanghai Interbank offered rate) rate fixing

Despite the collective nature of Chinese leadership and the absence of definite policy pronouncement, Barclays Capital coined the word, Likonomics, to describe the economic philosophy of the new Chinese cabinet led by Premier Li. The market generally agreed that Barclays view is a fitting description of the economic directions of the administration. Barclays Likonomics has three major parts: no stimulus, de-leveraging and structural reform. They are internal measures aimed at correcting the existing imbalance of the Chinese economy and maintain the economic momentum to overcome the middle-income trap that the country will face in near future. The first two parts of Likonomics: no stimulus and de-leveraging are aimed at correcting the unintended economic imbalance of rapidly accumulated debt and high credit growth of the four trillion RMB stimulus package of 2008. A key feature of the 2008 stimulus package is that the local government takes the lead in the program implementation. The Chinese local government had limited taxation power and resources; their traditional way of funding capital expenditure is through bank loans and land sales. They undertook the assigned 2008 stimulus package by (1) setting up a local government financing vehicle (LGFV) and took out bank loans (2) expanding their participation in the real estate sector to raise funds and indirectly stimulate real estate prices (Figure 2). 6 Copyright 2012 SMU Economics Intelligence Club

Figure 2: Average land sale price & property sale price

The subsequent monetary expansion associated with the RMB four trillion stimulus package is many times over the original stimulus target (Figure 3). In this aspect, China was the first country to engage in Quantitative Easing (QE). Figure 3: China lending growth

Source: Economist When the government realized the problem in 2010 and tried to curtail credit, the medium & long term nature of the local government stimulus measures just moved the credit demand to shadow1 banking and credit expansion went unabated (Figure 4). Figure 4: Chinese credit growth with other channels gaining share over traditional bank loan after 2009

Before 2008, there was almost no gap between credit and nominal GDP growth (Figure 5), but recent credit growth as measured by outstanding total social financing2 was 12% higher than nominal GDP growth. Although there is no economic theory or historical evidence that link a 7 Copyright 2012 SMU Economics Intelligence Club

widening gap between credit and GDP growth to a debt crisis. The mismatch raised enough concern among economists and very well reflects the losing productive edge of the economy. Coupled with the overheating of the property market, the surge of shadow banking and the rapidly accumulating debt by the local government and corporate sector, many economists have voiced danger of a possible Minsky moment3 in China. Figure 5: Recent gap between credit & nominal GDP growth

Source: PBOC (in trillion of RMB) The decision of having no stimulus and to de-leverage is indeed a prudent economic philosophy under the present circumstances. Figure 6: China growth

(note 2Q 2013 marked the fifth consecutive quarterly growth of below 8%) Infrastructure investment, export and manufacturing fueled the Chinese growth for much of the last 30 years. The model is running out of steam as the population is aging, and the labor force shrinking (Figure 7). Rising wages is also eroding Chinese exports competitive position (Figure 8). Premier Li asked the World Bank to conduct a study on China's middle-income trap challenge in 2010. Through the study, the need to continue reforms at the macro and micro level of the economy was emphasized, in order to sustain Chinas productivity gain. The 3rd pillar of structural reform is more important now as the whole world is moving into a low growth phase and China's old model cannot sustain its growth. Of all the three aspects of Likonomics, this particular aspect of structural reform is the most critical and carefully watched. 8 Copyright 2012 SMU Economics Intelligence Club

Figure 7: Chinas labor supply situation

Figure 8: China Wage Comparison

The Chinese incremental approach to reform is often construed as conservative and resisting changes. However, China has undergone more changes than most countries in recent years (sans Japan's Meiji restoration) and they have reaped the most benefit associated with reform in human economic history. The country's economic achievement really ties to reform. There are two major economic restructuring in China since opening up in 1978: the first is the agricultural liberalization and legitimizing of private property rights in the 1980s and the second is the state enterprises reform & WTO entry associated reform of the late 1990s. The second series of reforms in particular has laid the foundation of the rapid growth of the last decade. We noted the two reforms are all conducted in an incremental approach and done in a trial and adjustment basis. Goals are clear but not well stated and often move in a two-step backward, one-step forward fashion. It is often many years after a certain reform is implemented that people realize that it has been in place. Chinese leaders realized the value and necessity of reform. They have clearly identified the challenges they face and what they want to do. However, it is clear that they have no clear view on how to proceed and how long it will take them. On the future of Likonomics, they will probably move in the same fashion continuing with incremental steps to move forward with the objective of preserving stability and the stated objectives in their mind. In conclusion, we will not know whether Likonomics will work or not until a few years after.
1 Shadow Banking

Refers to loans extended through non-banking channels such as trust, wealth management products, insurance loans & bonds. A distinguishing feature of the Chinese shadow banking system is that banks are deeply involved in shadow banking. They serve as sales channels but keep those products out of the balance sheet and assume no legal obligation on credit quality. 2 Total Social Financing (TSF) Loans extended in China encompassing bank loans & shadow banking loans. 2 Minsky Moment A time of sudden collapse of asset values after an extended period of spiraling prices built on market speculation and unsustainable credit growth.

9 Copyright 2012 SMU Economics Intelligence Club

Sources: 1. Bloomberg 2. BofA Merrill Lynch Research 3. CEIC 4. Nomura Global Economics 5. Trading Economics 6. The Economist

10 Copyright 2012 SMU Economics Intelligence Club

Uncovering Key ASEAN Needs Vital to US Economic Legitimacy in ASEAN (Part 3)

By Tan Kwan Hong, Singapore Management University
Previously, Kwan Hong discussed the US economic legitimacy with ASEAN. This week he continues to unveil an initiative that would help in formulating a vibrant US-ASEAN economic engagement. Institutionalization Creating new and novel economic institutions will be crucial to jointly cater to the specific yet changing needs of ASEAN and the US. One emerging need is the rebalancing of efforts through the support of consumption and investment functions for an integrated ASEAN. Cross-border financial reforms are thus paramount. The Obama Administration can therefore help to foster the institutionalization of key and novel market mechanisms and economic institutes that serves this function. For example, an ASEAN Economic Development Fund can be instituted with an initial injection of US funds, supplemented by fund contributions by ASEAN governments. Funds from ASEAN sources will then make up the largest proportion of funds in the long run. The benefits are multiple. First, this initiative will allow governments of ASEAN states a readily accessible pool of funds vital for their economic and social developmental projects. Such a cross-border financial mechanism that improves the access of credit could help households and the government sector in reducing dependence on precautionary savings1, in turn freeing up savings for investments. Figure 9: ASEAN countries save far more than the US

Source: CEIC Second, through a reduced dependence on precautionary savings, only then can the imbalance between ASEAN as a surplus entity and the US as a deficit entity be reduced. The savings rates 11 Copyright 2012 SMU Economics Intelligence Club

of major ASEAN countries far exceed that of the US (Figure 9), and these savings can be better channelled to projects and investments that derive higher returns. Figure 10: Net bilateral aid flows from US to Myanmar (USD)

Source: Trading Economics Third, with this cross-border financial institute acting as a substitute to US aid, the US might also benefit from the reduced reliance on any one ASEAN member on future US funds and aid. For example, US net bilateral aid2 flows to Myanmar alone amounted to about US$ 31 million in 2010 and to more than US$70 million in 2007 (Figure 10). Figure 11: Asian bond market breakdown by country

Source: Asian Development Bank Finally, through the maturity of such a cross-border financial institute, further modes of fund raising, such as the issuance of bonds in the support of these institutes, can also be implemented. This will pave the way for a more mature equity and debt-trading market in which ASEAN currently lacks. The collective bond market size of major ASEAN countries are at present, paling in comparison with the bond market size of China and South Korea (Figure 11). The maturity of such financial markets will in turn pave the way for a joint ASEAN currency, if it ever desires so. Incentivization The US can also have a hand in incentivizing regional institutions and US businesses to invest in ASEAN. Grants or special economic arrangements can be granted to ASEAN-US business 12 Copyright 2012 SMU Economics Intelligence Club

activities within specific sectors of focused, thereby encouraging US investments in ASEAN and even vice versa. Figure 12: Exports of goods and services as a % of GDP

Source: UN Statistics Division The goods and services export sector is a viable place to start. With most major ASEAN countries (except Singapore) facing a less-than-100 percent of total exports of goods and services as a percentage of GDP (Figure 12), such sectors are potential growth areas. The time is also ripe for the US and foreign investors to participate in such opportunities. Via the ASEAN Economic Community (AEC) 2015, foreign investors will be able to enjoy up to a massive 70% of foreign ownership in ASEAN businesses. Also, in order to incentivize ASEAN businesses to adopt US patents and trademarks, further grants can be given to ASEAN businesses to incentivize such behaviour. A lower cost of patent adoption will increase the utilization-rate of US patents, and reduce the need for patent theft, amounting to a benefit to all parties involved. Figure 13: US exports of goods to ASEAN, 2001-2011

Source: United States Census Bureau

13 Copyright 2012 SMU Economics Intelligence Club

Finally, as ASEAN seeks to industrialize, technology exports and the exports of high end manufacturing tools and machinery from the US to ASEAN might also see a rise. Currently, Singapore is the biggest receiver of these exports, but such exports are vital to other developing ASEAN countries as they seek to industrialization and move up the value chain. Grants and special economic arrangements that incentivize ASEAN countries to enter into contracts for these highly valued products can therefore be viable. US total exports to ASEAN have seen an overall rising trend over from 2001 to 2011 (Figure 13). Integration To foster economic integration that will lead to the fulfilment of objectives as stated by the AEC, and for trade and investment facilitation between ASEAN and US, a range of principles and procedures will have to be aligned and integrated. For example, investment policies, investor protection regimes, policies on non-discrimination, transparency and self- disclosure, market access rules and regulations all requires integration into a common set of rules and procedures unwaveringly abided by all. Integrating each countrys previous procedures into a simplified set of customs procedures, while simultaneously enhancing the transparency of the groups entire customs administrations, will bode well to enhance the overall economic integration with ASEAN and the US. Also, an integrated set of principles governing the use of information and communication technology is vital. It will help assist policymakers and enforcement agencies on contemporary issues such as cross border information flow and local content requirements. Finally, the US, in pursuing an integrated set of principles governing environmental protection, and on the safeguarding of small and medium enterprises (SMEs) which generates the majority of all jobs in ASEAN and the US can potentially utilize these avenues to extend its engagements to non-state actors, such as the various chamber of commerce, trade associations, non-governmental organizations (NGOs) and research institutes throughout ASEAN.
1 Precautionary Savings

To avoid future income fluctuations and retain a smooth consumption, individuals set aside a precautionary reserve, by consuming less in the current period, and resort to precautionary savings in case the bad state is realized in the future. 2 Bilateral Aid A voluntary transfer of resources from one government to another. This contrasts with multilateral aid where aid is pooled from one or more sources and dispersed among recipients. Sources: 1. CEIC 2. Trading Economics 3. Asian Development Bank 4. UN Statistics Division 5. United States Census Bureau

14

Copyright 2012 SMU Economics Intelligence Club

The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents : Vera Soh (Vice President, Publication) vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Samuel Ong (Publications Director/ Editor) samuel.ong.2010@business.smu.edu.sg Singapore Management University Singapore Ng Yongxiang (Marketing Director) yx.ng.2011@accountancy.smu.edu.sg Singapore Management University Singapore Tan Kwan Hong (Writer) Undergraduate School of Economics Singapore Management University kwanhongtan.2009@economics.smu.edu.sg Lai Tze Wee (Writer) Undergraduate School of Economics Singapore Management University tw.lai.2010@economics.smu.edu.sg

Ng Jia Wei (Vice President, Operations) jiawei.ng.2012@economics.smu.edu.sg Singapore Management University Singapore Yingyu Zeng (Liaison Officer) yingyu.zeng.2010@economics.smu.edu.sg Singapore Management University Singapore Darren Goh Xian Yong (Editor) darren.goh.2010@business.smu.edu.sg Singapore Management University Singapore Henry Chan (Writer) Postgraduate Lee Kong Chian School of Business Singapore Management University henry.chan.2012@phdgm.smu.edu.sg Wang Haochen (Writer) Postgraduate Lee Kong Chian School of Business Singapore Management University hc.wang.2012@maf.smu.edu.sg

Everything in this document and/or in this website is copyrighted by law and cannot be used without the written permission of its owner/publisher. It is forbidden to make digital copies or reproductions, however you may however use the information as reference material and it may be physically printed for personal use. You may also quote parts of the content of this publication, digitally or physically, if the source and author is clearly stated, together with the copyright information. All views expressed in this publication are the personal opinion of the researcher(s), do not constitute a buy or sell recommendation on any instruments, and in no way reflect the opinions, views, or thoughts of SMU and other abovementioned universities, and unless specified, of any other student clubs. All logos and/or images on these pages belong to SMU and the respective third party copyright and trademark owners. SPEX, affiliated clubs and the covering researcher accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or further communication given in relation to this document. SPEX is the brainchild of current New York University undergraduate Mr. John Ang, further developed by SMU students for the benefit of both SMU and non-SMU students.

15 Copyright 2012 SMU Economics Intelligence Club