You are on page 1of 210

S.I.G. Economic growth reflects the long-term expansion of the productive potential of the economy.

It is generally
14 La collana Sviluppo, Innovazione e Governance ospita contributi scien-
accepted as a widespread measure of the population’s well-being. Nevertheless the rate of growth of a country tifici attinenti la Cooperazione Internazionale nei suoi diversi aspet-
1. Michela Lafratta, Maria Marano, Serena Saquella (a cura di), does not always represent the real improvement of the domestic behavior as it fails to capture key-aspects such Fondazione ti antropologici, economici, istituzionali, politici, sociali, storici,
Roma Sapienza

Roberto Pasca di Magliano


as the environmental sustainability and the benefits of digital transformation. A rapid growth of the GDP brings
Cooperazione allo Sviluppo e Diritti Umani, 2012 Sezione Cooperazione Internazionale
sanitari, tecnologici. Particolare attenzione viene rivolta a lavori che
benefits and costs as those deriving from the globalization and the impact of financial activities.
Short-term growth depends on the economic cycles. Even if the growth rates weaken, per-capita income keeps si ispirano ad approcci interdisciplinari capaci di affrontare in una
2. Roberto Pasca di Magliano, Percorsi dello sviluppo, 2013 growing. Roberto Pasca di Magliano prospettiva critica le sfide della globalizzazione.
3. Claudio Consalvo Corduas, Sostenibilità ambientale e qualità
Country Groups 2013 2014 2015 2016f
dello sviluppo, 2013
BRICS
Developing economies
5.7
5.3
5.1
4.9
3.9
4.3
4.6
4.8
GROWTH ECONOMICS Direttore Scientifico
Roberto Pasca di Magliano,
4. Roberto Pasca di Magliano, Laura Liguori (a cura di),
Cooperazione, Integrazione regionale e sostenibilità per lo sviluppo,
High-income economies
Low-income economies
1.2
6.4
1.7
6.1
1.6
5.1
2.1
6.2
AND Consiglio Scientifico Fondazione Roma Sapienza,
coordinatore sezione Cooperazione Internazionale
2015
World economy 2.4 2.6 2.4 2.9 GOVERNANCE
Regions / Developing Countries Segretario di Redazione

GROWTH ECONOMICS AND GOVERNANCE


5. Guglielmo Corduas, Sustainable development in urban transportation
Developing East Asia and Pacific 7.1 6.8 6.4 6.3 Andrea Billi, Sapienza Università di Roma
and cultural heritage, a look at Turkey, 2016
Developing Europe and Central Asia 3.9 2.3 2.1 3.0
Developing Latin America and the Caribbean 3.0 1.5 -0.7 0.1
6. Neno Gabelia, Decline of the Soviet Union, 2016 Comitato Scientifico
Developing Middle East and N. Africa 0.6 2.5 2.5 5.1
Antonello Folco Biagini, Presidente Fondazione Roma Sapienza
7. Daniele Terriaca, Fondi di ricchezza sovrana, 2016 Developing South Asia 6.2 6.8 7.0 7.3 Growth
Marta Albertini, esperta di letteratura russa e di storia dell’arte islamica, Roma
Developing Sub-Saharan Africa 4.9 4.6 3.4 4.2 Andrea Carteny, Sapienza Università di Roma
8. Aa. Vv., Microfinance Course, 2016 Theories Carlo Cereti, Sapienza Università di Roma
Angelo Chianese, Fondazione Roma Sapienza - Cooperazione Internazionale
The volume follows the main growth theories and then addresses current issues such as the impact of the digital Models Marco Cilento, Sapienza Università di Roma
9. Aa. Vv., The Uganda microinsurance contest, 2016 transformation of the society, the development aid policies as well as the contribution of the sovereign wealth Toni Concina, presidente Museo Faina, Orvieto
funds. The last part is devoted to the effects on institutions, the perspectives of the Italian economy and the need Fabrizio D’Ascenzo, Sapienza Università di Roma
10. Aa. Vv., The Impact of Microfinance, 2016 for changes in the European institutions.
Technology Cesare Imbriani, Unitelma Sapienza, Roma
Mario La Torre, Sapienza Università di Roma
11. Roberto Pasca di Magliano (a cura di), Economia e politica Roberto Pasca di Magliano is professor of Growth Economcs at Sapienza University of Rome, professor of Digital Transformation Gianfranco Lizza, Fondazione Roma Sapienza - Cooperazione Internazionale
Massimo Mamberti, segretario generale Comitato Leonardo, Roma
internazionale, 2017 Innovation Economics and Management and director of the Master “International Cooperation, Finance and Andrea Micangeli, Sapienza Università di Roma
Development” at Unitelma Sapienza, Rome. He is member of the Scientific Council of Fondazione Roma Sapienza Finance Salvatore Monni, Università di Roma Tre
12. Nabylah Abo Dehman, The evolving strategies of Sovereign Wealth and coordinator of the International Cooperation section. After the degree in Economcs at University of Naples Giovanna Motta, Fondazione Roma Sapienza
Funds, 2017 he specialised in economic studies at the Rossi Doria Center of University of Naples (1969), the London School Governance Luigi Paganetto, Presidente Fondazione Economia Tor Vergata, Roma
of Economcs and Political Science (1971-73), other British and American Universities (1977, 1978). He was Guido Pellegrini, Sapienza Università di Roma
invited as visiting professor at the University of California, Berkeley (1980). He won the competion for full profes- Beniamino Quintieri, Università di Roma Tor Vergata
13. Flavia Marucci, Privilegio e discriminazione razziale in Brasile, 2017 Italian growth model Francesco Renna, University of Akron, Ohio, USA
sor in Economics in 1980. During his career he obtained institutional engaments. He was apointed responsable
for the Development Cooperation at the Italian Ministry of Foreign Affairs 81985-87). He hold the position consul- Roberto Ridolfi, direttore Sustainable Development and Growth,
tant to Ministry of Agriculture (1991) and general director of business incentives policies at the Ministry of Aiming Social Europe Commissione Europea, Bruxelles
Marieli Ruini, Fondazione Ruini, Roma
Industry (2002-2005). In Sapienza University he promoted the establishment of the interdisciplinary graduate
Dominick Salvatore, Fordham University, New York, USA
degree course in Development Sciences and International Cooperation, of which he becaame president. He is Pasquale Lucio Scandizzo, Università di Roma Tor Vergata, Banca Mondiale
author of many publications concerning economic analysis, development economics, agricultural economics, Arnaud Sée, professore ordinario di diritto pubblico francese, Université de Picardie
international finance, innovation and governance. Ivana Tamai, Ministero Affari Esteri e della Cooperazione Internazionale,
Agenzia Italiana Cooperazione allo Sviluppo
ISSN 2282-5568 Luigi Toro, Sapienza Università di Roma
Anno VI, n. 14 - 2017 Lucio Ubertini, Fondazione Roma Sapienza
Fabrizio Vestroni, Fondazione Roma Sapienza
Giuliana Vinci, Sapienza Università di Roma

9788868129460_210_LN03
SEGUICI SUI SOCIAL NETWORK

34.00 EURO La collana si avvale della procedura di valutazione e accettazione


double blind peer review.
Roberto Pasca di Magliano

GROWTH ECONOMICS
and
GOVERNANCE

Edizioni Nuova Cultura


Collana Sviluppo, Innovazione e Governance

Direttore scientifico
Roberto Pasca di Magliano,
Fondazione Roma Sapienza-Cooperazione Internazionale

La collana adotta un sistema di valutazione dei testi


basato sulla revisione paritaria e anonima (peer-review).

Il comitato scientifico non risponde delle opinioni espresse dagli autori


nelle opere pubblicate in collana.

Copyright © 2017 Edizioni Nuova Cultura - Roma


ISBN: 9788868129620
DOI: 10.4458/9460

Copertina: Luigi Novelli


Composizione grafica: Luigi Novelli
Revisione a cura dell’Autore

È vietata la riproduzione non autorizzata, anche parziale,


realizzata con qualsiasi mezzo, compresa la fotocopia,
anche ad uso interno o didattico.
Index

Introductory remarks ............................................................................................... 7

1. Introduction to Growth Economics ............................................................... 11

2. Theories of economic growth: key-issues ....................................................... 21

3. Schumpeter: Role of the Entrepreneurs and Business cycles ...................... 39

4. Technology Transfer Frontiers:


Cooperation among Universities and Industries ........................................ 49

5. Digital Society and Sharing Economy ........................................................... 61

6. Policies for Development and Growth:


Microfinance towards Social Business ........................................................ 107

7. Sovereign Wealth Funds and World Capital Market ................................ 137

8. Democracy and Governance ........................................................................ 185

9. Italian Economic Perspectives ...................................................................... 191

10. Revive Europe Focusing on the Social ......................................................... 199

Bibliography .......................................................................................................... 205


Introductory Remarks

Does economic growth bring increased living standards?


Increasing the rates of economic growth has long been the holy grail of
conventional economics and politics. To a large extent, most developed
economies have been highly successful in increasing economic output.
But, has such an impressive increase in national output actually im-
proved people’s standard of living?
To decide whether economic growth has increased happiness is
highly subjective, and it is difficult for economists to make concrete ar-
guments. However, it is worth noting the various side effects of growth
and considering their impact on general living standards. Benefits of
economic growth are generally identified as follows:

i. Increased consumption
Consumers can benefit from consuming more goods and services.
An assumption of economics is that consumption is related to utility so,
in theory, with higher consumption levels, there is greater prosperity.

ii. Improved public services


Increased tax revenues allow governments to spend more on import-
ant public services such as health and education. Improved health care
can improve quality of life through the treatment of diseases and the
increase of life expectancy. Increased educational standards can give the
population a greater diversity of skills and literacy. This enables greater
opportunities and freedom. Education is seen as an important determi-
nant of welfare and happiness.
8 Growth Economics and Governance

iii. Reduced unemployment and poverty


Economic Growth helps to reduce unemployment by creating jobs.
This is significant because unemployment is a major source of social
problems such as crime and alienation. However, despite rapid increas-
es in economic growth since the Second World War, areas of high unem-
ployment are still present in the EU. For example, in France and Spain
there are currently high levels of structural unemployment. This kind
of unemployment may not be reduced by economic growth.

Why economic growth may not bring increased happiness?


Several reasons can be found, even if it is possible to concentrate the
attention on some of them.

i. Diminishing returns
If a section of the population is living in absolute poverty, economic
growth enables people to have higher incomes and therefore they will
be able to afford the basic necessities of life, such as food and shelter.
When economic growth can overcome this type of poverty, the link with
improved living standards is clear. However, when incomes increase
from e.g. $35,000 a year to $36,000 the improvement in living standards
is harder to justify. Diminishing marginal utility of income and wealth
is a basic economic concept, which suggests the tenth unit of a good
will give much less satisfaction than the first. If we already have 2 cars,
do our living standards really improve if we have the capacity to own
3 cars? Often, as economic growth provides additional incomes, people
increasingly save their money (higher marginal propensity to save): this
basically happens because they struggle to find anything meaningful to
spend their money on.

ii. Externalities of growth


Economic growth which involves increased output may cause ex-
ternal side effects, such as increased pollution. Global warming from
pollution is becoming a real problem for society. The economic and
social costs could potentially be greater than all the perceived benefits
of recent economic growth. However, it is worth noting that econom-
ic growth doesn’t necessarily have to cause pollution. The benefits of
growth could be used to develop better technologies that create less pol-
lution that is the priority at the moment.
Introductory Remarks 9

iii. Economic growth can cause increased inequality


It is perhaps a paradox that higher economic growth can cause an
increase in relative poverty. This is because those who benefit from
growth are often the highly educated and those who own wealth. In
1980s and 1990s higher growth in the UK and US has resulted in in-
creased inequality. (1) However, it depends on how growth is managed:
economic growth can be used to reduce inequality, for example the eco-
nomic growth which occurred in the 1950s and 1960s helped reducing
inequality.

iv. Increase in crime and social problems


We could mention another paradox: often, as incomes increase and
living standards improve, the level of crime increases as well. (2) This
suggests that crime is not motivated by poverty but perhaps envy. One
reason why crime rates increase is that quite simply there are more
things to steal. Back in the 1930s auto theft, mobile phone theft, etc. were
rare or non-existent. Economic Growth has created more goods to steal.
However the link isn’t absolute: for example, in recent years, crime rates
in US have reduced from their peak. But there has historically been a
general association between growth and crimes.

v. Higher economic growth has led to more hours worked


In the beginning of the industrial revolution, higher growth led to
people working lower hours.(3) However, in the past couple of decades
higher incomes have actually led to people working longer hours. It
seems people are unable to enjoy their higher incomes, feeling the ne-
cessity or preferring to work longer hours. This suggest people are valu-
ing earning money more than leisure. However, this trend may also be
due to companies wanting people to work longer hours.

vi. Diseases of affluence


Economic Growth has enabled improved health care treatments, but
at the same time there has been an unexpected rise in the number of
diseases and illnesses related to increased prosperity.(4) One example is
obesity. Modern lifestyles and modern diets have created an epidemic
of obesity, with significant proportions of the population expressing a
desire to lose weight. It could be argued that problems such as obesity
and stress related illnesses are not a direct consequence of growth. This
10 Growth Economics and Governance

is true, but, it is symbolic of the fact that increased prosperity has creat-
ed as many new problems as it has solved

Some conclusion
The benefits of economic growth are clear. These benefits are most vis-
ible for low income countries. Economic growth enables the possibility
to deal with many serious problems connected to poverty, homelessness
and lack of basic amenities. It is more interesting to comprehend wheth-
er economic growth in developed economies is actually increasing liv-
ing standards or not. Does rising incomes equal rising satisfaction? The
answer is not clear-cut. However there are clearly several issues which
suggest that economic growth has contributed to serious social, envi-
ronmental and economic problems by reducing the living standards.
This is not to say economic growth is doomed to bring unhappiness.
The challenge is to harness the potential of economic growth to make
sure it really increases sustainable living standards.
1
Introduction to Growth Economics

Economic growth concerns the increase in the amount of the goods and
services produced by an economy over time. It is conventionally mea-
sured as the percent rate of increase in real gross domestic product, or
real GDP.
GDP accumulated growth, in percent, constant prices

Growth is usually calculated in real terms – i.e., inflation-adjusted


terms – to eliminate the distorting effect of inflation on the price of
goods produced.
12 Growth Economics and Governance

Real GDP: Percent change from preceding quarter

In economics, “economic growth” or “economic growth theory” typ-


ically refers to growth of potential output, i.e., production at “full em-
ployment”.
Economic growth caused the production-possibility frontier to shift
outward.

As an area of study, economic growth is generally distinguished


from development economics:
 The former is primarily the study of how countries can advance
their economies.
 The latter is the study of the economic aspects of the develop-
ment process in low-income countries.
Since economic growth is measured as the annual percent change of
gross domestic product (GDP), it has all the advantages and drawbacks
of that measure.
Introduction to Growth Economics 13

1.1. Economic growth versus the business cycle

Economists distinguish between short-run economic changes in pro-


duction and long-run economic growth. Short-run variation in econom-
ic growth is termed the business cycle. The business cycle is made up of
booms and drops in production that occur over a period of months or
years. Generally, economists attribute the ups and downs in the busi-
ness cycle to fluctuations in aggregate demand.
In contrast, the topic of economic growth is concerned with the
long-run trend in production due to structural causes such as tech-
nological growth and factor accumulation. The business cycle moves
up and down, creating fluctuations around the long-run trend in eco-
nomic growth.

1.2. Historical sources of economic growth

Economic growth has traditionally been attributed to the accumulation


of human and physical capital, and increased productivity arising from
technological innovation.[2] Economic growth was also the result of de-
veloping new products and services, which have been described as “de-
mand creating”.[3]
Before industrialization, technological progress resulted in an in-
crease in population, which was kept in check by food supply and other
resources, which acted to limit per capita income, a condition known as
the Malthusian trap.[4] The rapid economic growth that occurred during
the Industrial Revolution was remarkable because it was in excess of
population growth, providing an escape from the Malthusian trap.[5]
Countries that industrialized eventually saw their population growth
slow, a condition called demographic transition.
Increases in productivity are a major factor responsible for per capita
economic growth – this has been especially evident since the mid-19th
century. Most of the economic growth in the 20th century was due to re-
duced inputs of labor, materials, energy, and land per unit of economic
output (less input per widget). The balance of growth has come from
using more inputs overall because of the growth in output (more wid-
gets or alternately more value added), including new kinds of goods
and services (innovations).[6]
14 Growth Economics and Governance

During colonial times, what ultimately mattered for economic growth


were the institutions and systems of government imported through col-
onization. There is a clear reversal of fortune between poor and wealthy
countries, which is evident when comparing the method of colonialism in
a region. Geography and endowments of natural resources are not the sole
determinants of GDP. In fact, those blessed with good factor endowments
experienced colonial extraction that provided only limited rapid growth
– whereas colonized countries that were less fortunate in their original en-
dowments experienced relative equality and demand for the rule of law.
These initially poor colonies end up developing an open franchise, equali-
ty, and broad public education, which helps them experience greater eco-
nomic growth than the colonies that had exploited their economies of scale.
During the Industrial Revolution, mechanization began to replace
hand methods in manufacturing, and new processes streamlined pro-
duction of chemicals, iron, steel, and other products. Machine tools
made the economical production of metal parts possible, so that parts
could be interchangeable.
During the Second Industrial Revolution, a major factor of produc-
tivity growth was the substitution of inaminate power for human and
animal labor, to water and wind power with electrification and internal
combustion. Since that replacement, the great expansion of total pow-
er was driven by continuous improvements in energy conversion effi-
ciency. Other major historical sources of productivity were automation,
transportation infrastructures (canals, railroads, and highways), new
materials (steel) and power, which includes steam and internal com-
bustion engines and electricity.
Other productivity improvements included mechanized agriculture
and scientific agriculture including chemical fertilizers and livestock
and poultry management, and the Green Revolution. Interchangeable
parts made with machine tools powered by electric motors evolved into
mass production, which is universally used today.
Productivity lowered the cost of most items in terms of work time re-
quired to purchase. Real food prices fell due to improvements in trans-
portation and trade, mechanized agriculture, fertilizers, scientific farm-
ing and the Green Revolution.
Great sources of productivity improvement in the late 19th century
were railroads, steam ships, horse-pulled reapers and combine harvest-
ers, and steam-powered factories.
Introduction to Growth Economics 15

The invention of processes for making cheap steel were important


for many forms of mechanization and transportation. By the late 19th
century prices, as well as weekly work hours, fell because less labor,
materials, and energy were required to produce and transport goods.
However, real wages rose, allowing workers to improve their diet, buy
consumer goods and afford better housing.
Mass production of the 1920s created overproduction, which was
arguably one of several causes of the Great Depression of the 1930s. Fol-
lowing the Great Depression, economic growth resumed, aided in part
by demand for entirely new goods and services, such as telephones,
radio, television, automobiles, and household appliances, air condition-
ing, and commercial aviation (after 1950), creating enough new demand
to stabilize the work week. The building of highway infrastructures also
contributed to post World War II growth, as did capital investments in
manufacturing and chemical industries. The post World War II econo-
my also benefited from the discovery of vast amounts of oil around the
world, particularly in the Middle East.
Economic growth in Western nations slowed down after 1973. In
contrast growth in Asia has been strong since then, starting with Japan
and spreading to Korea, China, the Indian subcontinent and other parts
of Asia. In 1957 South Korea had a lower per capita GDP than Ghana,
and by 2008 it was 17 times as high as Ghana’s. The Japanese economic
growth has slackened considerably since the late 1980s.

1.3. Economic growth per capita

The concern about economic growth often focuses on the desire to im-
prove a country’s standard of living – the level of goods and services
that, on average, individuals purchase or otherwise gain access to. It
should be noted that if the population grows along with economic pro-
duction, increases in GDP do not necessarily result in an improvement
in the standard of living. When the focus is on standard of living, eco-
nomic growth is expressed on a per capita basis.
A high savings rate is also linked to the standard of living. Increased
savings, in the long run, lead to a permanently higher output (income)
per capita, as capital accumulation per individual also increases.
16 Growth Economics and Governance

1.4. Measuring economic growth

Economic growth is measured as a percentage change in the Gross Do-


mestic Product (GDP) or Gross National Product (GNP). These two
measures, which are calculated slightly differently, total the amounts
paid for the goods and services that a country produced.
Real national output measures the market value (adjusted for infla-
tion) of all final goods and services produced in an economy over a year.
Producing a dollar’s worth of output generates an equivalent dollar’s
worth of income, so we can use real national output and real national
income interchangeably. Economic growth occurs with increases in real
national output and real national income per capita.
If we let Y be real national output (real national income) and P be
population, theny = Y/P is per capita real national output (per capita real
national income).
In order for economic growth to occur, real national output has to
increase faster than population. That is, differentiating per capita real
national output, and then dividing through by per capita output, we
obtain the economic growth rate dy/y as follows:

dy / y = dY/Y – dP/P

If real output increases faster than population, i. e., dY / Y > dP/P,


then we have positive economic growth with a rise in per capita in-
come, dy/y > 0. It is possible to have negative economic growth, or
economic decline, even with positive output growth, if the growth rate
of population exceeds the growth rate of output, i.e., if dP/P > dY/Y >
0, then dy/y < 0.
For example, from 2000 to 2009, the average annual growth rates in
real national output and population for Haiti were 0.7 percent and 1.7
percent, respectively, yielding approximately an average annual decline
in per capita income of 1.0 percent. This decline occurred even before
the devastating earthquake that hit Haiti in early 2010, setting the nation
back years, if not decades.
As an example of measuring economic growth, a country that cre-
ates $bln 9 in goods and services in 2014 and then creates $bln 9.090 in
2015, has a nominal economic growth rate of 1% for 2015.
To compare per capita economic growth among countries, the total
Introduction to Growth Economics 17

sales of the respected countries may be quoted in a single currency. This


requires converting the value of currencies of various countries into a
selected currency, for example U.S. dollars. One way to do this conver-
sion is to rely on exchange rates among currencies, for example how
many Mexican pesos buy a single U.S. dollar?
Another approach is to use the purchasing power parity method.
This method is based on how much consumers must pay for the same
“basket of goods” in each country.
Inflation or deflation can make it difficult to measure economic
growth. If GDP, for example, goes up in a country by 1% in a year, was
this due solely to rising prices (inflation), or because more goods and
services were produced and saved? To express real growth rather than
changes in prices for the same goods, statistics on economic growth are
often adjusted for inflation or deflation.
For example, a table may show changes in GDP in the period from
1990 to 2000, as expressed in 1990 U.S. dollars. This means that the sin-
gle currency being used is the U.S. dollar with the purchasing power it
had in the U.S. in 1990. The table might mention that the figures are “in-
flation-adjusted” or real. If no adjustment were made for inflation, the
table might make no mention of inflation-adjustment or might mention
that the prices are nominal.

1.5. The power of annual growth

Over long periods of time even small rates of growth, like a 2% annu-
al increase, have large effects. For example, the United Kingdom expe-
rienced a 1.97% average annual increase in its inflation-adjusted GDP
between 1830 and 2008. In 1830, the GDP was 41,373 million pounds. It
grew to 1,330,088 million pounds by 2008. (Figures are adjusted for in-
flation and stated in 2005 values for the pound.) A growth rate that aver-
aged 1.97% over 178 years resulted in a 32-fold increase in GDP by 2008.
18 Growth Economics and Governance

Projected change in real GDP in 2014-15


Annual average, per cent

The large impact of a relatively small growth rate over a long peri-
od of time is due to the power of compounding (also see exponential
growth). A growth rate of 2.5% per annum leads to a doubling of the
GDP within 29 years, whilst a growth rate of 8% per annum (an average
exceeded by China between 2000 and 2010) leads to a doubling of GDP
within 10 years. Thus, a small difference in economic growth rates be-
tween countries can result in very different standards of living for their
populations if this small difference continues for many years.

1.6. Development vs Growth

The concept of economic development started in the 1930s, when econo-


mists began to realize that most of humankind did not live in advanced
capitalist countries. This thinking/reexamination was sparked by Colin
Clark’s 1939 study, the first to make quantitatively evident the gulf be-
tween European countries and the rest of the world. Clark’s work was
responsible for initiating interest in the concept of development1.
The differences with the concept of growth would be introduced
in literature a decade after with the analysis of Roy Harrod and Evsey
Domar before and after the Second World War along the nascent
Keynesian theory, as well with the subsequent interest of Robert Solow
along the neoclassical theory.

1
Graboswski R., Self S., Shields P.M., Economic Development, Routledge, Lonndon
2015
Introduction to Growth Economics 19

Only in the late 1980s, “new” growth theory emphasized the role
of human capital in the growth process, rekindling interest in growth
theory. Paul Romer and Robert Lucas’s works on increasing returns to
scale and endogenous growth marked a new era of interest in growth.
Growth literature in the 1990s and early 2000s has refocused on the
concept of total factor productivity, embodied or endogenously deter-
mined technology, the direction of causality between human capital
and growth, and the role of institutions.
After the Second World War, many new indipendent countries arose
and immediately the gap between advanced and backward countries
appears in all its dramatic evidence.
The existing literature shows that the concept of economic develop-
ment is often confused with economic growth. But the evidence shows
that there a great difference between development and growth justifing
separate studies and empirical analysis.
Economic growth is the rise in national or per capita income or prod-
uct typically measured by gross domestic product (GDP) which refers to
the production of final goods and services within a country. An increase
in per-capita GDP, while characteristic of economic growth, does not
necessarily lead to a higher standard of living per capita, if the growth is
not evenly distributed. Economic development is a much broader con-
cept than economic growth as it give attention to situations where social
and institutional backwardness prevents the operation of the economy
and its rules.
In other words, it can be argued that growth refers to responsive
environments to economic measures, such as in advanced countries.
Development mainly concerns realities that, having not yet solved as-
pects such as the institutional set-up and the basic needs of the indi-
vidual, are poorly responsive to the economic variables. Sometimes,
confusion is made between the concepts of growth and development.
Typically, countries that are poor are also less developed, though a rich
country does not necessarily have to be a developed country. Consider
some of the oil-rich Middle Eastern countries that have experienced
large increases in per-capita GDP, yet lag far behind in other areas of
development.
20 Growth Economics and Governance

Development vs Growth in synthesis

Development con- Growth concerns Main aspects to be


cerns explained
• newly-born backward • mainly the historical • why is growth con-
countries after World richest countries centrated in few coun-
War II • tegions where the tries, while many oth-
• could be considered a reaction to economic ers are still waiting
four-leg chair where variables and to their along the road
institutional, social, change is effective • how did some de-
civil and economic as- • economic forces hav- veloping countries
pects are stabilized ing large effects over redeem themselves,
• need of an interdisci- the behavior of institu- crowding the group
plinary approach tions and individuals of the emerging
countries
• which are the dy-
namics that move the
transition countries
2
Theories of economic growth:
key-issues

2.1. Classical growth theory

The modern conception of economic growth began with the critique


of Mercantilists such as David Hume and especially by the Physiocrat
Francois Quesnay. The foundation of the modern discipline of Econom-
ics is due to the Classical Economists, above all Adam Smith with his
famous book The Wealth of Nations, published in 1776.
Adam Smith (1723-1790) noted the huge gains in productivity
achieved by the division of labor and the consequence role of capital
accumulation. He also pointed out the determinant role of the free mar-
ket, his working mechanism explaining by the famous definition of the
invisible hand.
David Ricardo (1772-1823) first analyzes the way in which income is
distributed among rent, profits and wages and the benefits of the inter-
national trade as each country can benefit from cheaper imports relative
to domestic production. His theory of comparative advantage became
the central basis for arguments in favor of free trade as an essential com-
ponent of growth.
Other authors gave important contributions to the analysis of the
economic relations as well to the reasons for development. Thomas
Malthus (17766-1834) stressed on the demographic constraints to de-
velopment, John Stuart Mill expected that the devolpment process will
22 Growth Economics and Governance

reach a situation of steady state. Karl Marx (1818-1883) investigated


the internal contradictions of the capitalist system itself that would
limit the possibilities of development by opening a crisis and revolu-
tionary event.

2.2. Schumpeterian growth

Schumpeterian growth is an economic theory named after the 20th-cen-


tury Austrian economist Joseph Schumpeter. Unlike other economic
growth theories, his approach explains growth by innovation as a pro-
cess of creative destruction that captures the dual nature of technologi-
cal progress: in terms of creation, entrepreneurs introduce new products
or processes in the hope that they will enjoy temporary monopoly-like
profits as they capture markets. In doing so, they make old technologies
or products obsolete.
This is the destruction referred to by Schumpeter, which could also
be referred to as the annulment of previous technologies, which makes
them obsolete, and “...destroys the rents generated by previous inno-
vations.” (Aghion 855). A major model that illustrates Schumpeterian
growth is the Aghion-Howitt model.

2.3. Keynesian approach to growth

John Maynard Keynes in The General Theory of Employment, Interest and


Money argued during the Great Depression that the loss of output by
the private sector was a result of a systemic shock (the Wall Street Crash
of 1929) which had to be filled by government spending.
 First, he argued that with a lower ‘effective aggregate demand’,
or the total amount of spending in the economy, the private
sector could subsist on a permanently reduced level of activi-
ty and involuntary unemployment, unless there was active in-
tervention. Business lost access to capital, so it had dismissed
workers. This meant workers had less to spend as consumers,
consumers bought less from business, which because of addi-
tionally reduced demand, had found the need to dismiss work-
ers. The downward spiral could only be halted, and rectified by
external action.
Theories of economic growth: key-issues 23

 Second, people with higher incomes have a lower marginal pro-


pensity to consume their incomes. Individuals with lower in-
comes are inclined to spend their earnings immediately to buy
housing, food, transport and so forth, while people with much
higher incomes cannot consume everything. They save instead,
which means that the money circulation of income through dif-
ferent hands in the economy is decreased. This lowered the rate
of growth. Spending should therefore target public works pro-
grammes on a large enough scale to speed up growth to its pre-
vious levels.
A central feature of Keynesian theory is the importance of entrepre-
neurial investment decisions that are assumed to be independent of
saving decisions, and to have a dominant influence on the economy. In
Keynes’s own work, they played a major role in the determination of ef-
fective demand and employment in the short run. It can be argued that
investment decisions will also play a major role in the determination of
the share of profits in the National Income, the rate of profit on capital,
the rate of technical progress and the rate of growth.
In the short run, during recession, economy is influenced by aggre-
gate demand that is not general equal di potential productive capacity.
In macroeconomics, aggregate demand (D) is the total demand for
final goods and services in the economy (Y) at a given time and price
level. It is the amount of goods and services in the economy that will be
purchased at all possible price levels. This is the demand for the gross
domestic product (Gdp) of a country when inventory levels are static. D
is often called ‘effective demand’.
An aggregate demand curve is the sum of individual demand curves
for different sectors of the economy. The aggregate demand is usually
described as a linear sum of four separable demand sources:

D = C + I + G + (X – M)

where:
 C is consumption (may also be known as consumer spending),
equal to the disposable income after tax.
 I is investment.
 G is government spending.
 X – M is net export,
24 Growth Economics and Governance

These four parts, which can be stated in either ‘nominal’ or ‘real’ terms,
are as follows:
 Personal consumption expenditures (C) or “consumption” de-
mand by households and unattached individuals; its determina-
tion is described by the consumption function and depends on
the propensity to consume.
 Gross private domestic investment (I), such as spending by busi-
ness firms on factory construction. This includes all private sector
spending aimed at the production of some future consumable. In-
vestment is affected by the output and the interest rate (i).
Consequently, we can write it as I(Y,i). Investment has positive
relationship with the output and negative relationship with the
interest rate. For example, an increase in the interest rate will
cause aggregate demand to decline. Interest costs are part of the
cost of borrowing and as they rise, both firms and households
will cut back on spending. This shifts the aggregate demand
curve to the left. This lowers equilibrium Gdp below its potential
level. As production falls for many firms, they begin to lay off
workers, and unemployment rises. The declining demand also
lowers the price level. The economy is in recession.
 G is the gross government investment and consumption expen-
ditures (G).
 (X-M) is the net exports representing the net demand by the rest
of the world for the country’s output.
These macrovariables are constructed from varying types of micro-
variables from the price of each, so these variables are denominated in
(real or nominal) currency terms.
Theories of economic growth: key-issues 25

Productive capacity is influenced by a host of factors and sometimes


behaves erratically, affecting production, employment, and inflation.
Keynesian Economists argue that private sector decisions sometimes
lead to inefficient macroeconomic outcomes which require active policy
responses by the public sector, in particular, monetary policy actions by
the central bank and fiscal policy actions by the government, in order
to stabilize output over the business cycle. Keynesian economics advo-
cates a mixed economy: predominantly private sector, but with a role
for government intervention during recessions.

2.4. Harrod-Domar model of growth: main issues

The modern theory of growth has been developed indipendently by


two the economists:
• Roy Harrod in his article “An Essay in Dynamic Theory” (1939),
• Evsey Domar in his article “Capital expansion, rate of growth
and employment” (1946)
Both have been inspired by the nascent Keynesian doctrine.
They developed what was then known as the Harrod-Domar model
of growth as dynamic extension of the Keynesian analysis of static equi-
librium. The model explain that growth rate is influenced by the level of
saving and the capital productivity
The Harrod-Domar model is the easiest way to start learning about
growth in the long run.
Main concepts used in the model are as follows:
1. Income, saving and consumption:
Y = C + S. as S = I -> Y = C + I
All income is either saved or consumed:
S = sY -> C = (1-s)Y
2. Capital accumulation:
K t+1 = It + K(1-d) where d -> depreciation
The model use the concept of capital-output ratio (efficiency of
the production system measured in term of capital):
cr = Kt / Yt
This to show that an economy can produce a lot of output with a
little capital (and viceversa).
26 Growth Economics and Governance

3. Rate of growth:
g = s / cr – d
In particular, three growth rates are developed:
i. Actual rate of growth (g) (i.e. the real income change):
g = s / c = (Y / Y) = D Y / Y where: s -> propensity to save
I/DY c -> quantity of capital need to
produce one unit of production
g is then equal to the ratio between the propensity to save and the
current capital-output ratio
ii. Warranted rate of growth (gw) (i.e. the growth that leaves every-
one satisfied with an increase in production (no more, no less)
needed to pursue better resource’s allocation, by impling a nec-
essary increase ininvestments)
gw = D Y / Y = s / cr where: s -> propensity to save
cr -> extra quantity of capital needed
gw is then equal to the ratio between planned and propensity to
save and the extra capital required per unit of product
iii. Natural growth rate (gn) (i.e. one that ensures growth that ab-
sorbs the available labor force in relation to its production ca-
pacity) as:
Y = L (Y / L)

2.5. Neoclassical growth model: main concepts

According to neoclassical theory (also called exogenous growth theory),


the main determinants of long-run economic growth are influenced by
production factors and a residual element reflecting technical progress.
Robert Solow, a Nobel Prize-winner, is the most relevant author in
the definition of the neoclassical growth model.
Solow found that technology progress has been in the Western Coun-
tries the most important input factor allowing long-run growth in real
wages and the standard of living. The growth is caused by capital accu-
mulation and autonomous technological change.
The technology progress has in Western Countries been the most im-
portant input factor allowing long-run growth in real wages and the
standard of living.
Solow postulated that the production function displays constant re-
Theories of economic growth: key-issues 27

turns to scale, so that doubling all inputs would double output. This
kind of simplifying assumption is the major weakness, since holding
one input constant (labor) and doubling capital will yield less than
double the amount of output. This is the famous law of diminishing
marginal returns. Solow’s model is a typical example of the ones of the
exogenous growth theories.
Through his residual analysis, Solow broke down changes in labor
productivity into two parts:
i. increase in the amount of capital per unit of labor;
ii. technological progress that includes improvements in the hu-
man factor.
The notion of growth as increased stocks of capital goods is known
as the Solow-Swan growth model (1950) by involving the relationship
between labor-time, capital goods, output, and investment. According
to this view, the role of technological change became crucial, even more
important than the accumulation of capital. This model assumes that
countries use their resources efficiently and that there are diminishing
returns to capital and labor increases.
From these two premises, the neoclassical model makes three im-
portant predictions:
i. the capital increase relative to labor creates economic growth,
since people can be more productive given more capital;
ii. poor countries with less capital per person grow faster because
each investment in capital produces an higher return than in the
advanced countries where the capital availability is very high;
iii. because of diminishing returns to capital, economies eventually
reach a point where any increase in capital no longer creates eco-
nomic growth. This point is called a steady state.
The model also notes that countries can overcome this steady state
and continue growing by inventing new technology. In the long run,
output per capita depends on the rate of saving, but the rate of output
growth should be equal for any saving rate. In this model, the process
by which countries continue growing despite the diminishing returns is
“exogenous” and represents the creation of new technology that allows
production with fewer resources. Technology improves, the steady state
level of capital increases, and the country invests and grows.
Statistical data does not support the model’s predictions, in partic-
ular, that all countries will converge to a same rate of growth in the
28 Growth Economics and Governance

long run, or that poorer countries should grow faster until they reach
their steady state.

2.6. Endogenous growth theory: main issues

One ubiquitous element of both theoretical and empirical analyses of


economic growth is the role of human capital. The skills of the popula-
tion enter into both neoclassical and endogenous growth models.
The most commonly used measure of human capital is the level of
school attainment in a country, building upon the data development of
Robert Barro and Jong-Wha Lee. This measure of human capital, how-
ever, requires the strong assumption that what is learned in a year of
schooling is the same across all countries.
It also presumes that human capital is only developed through for-
mal schooling, contrary to the extensive evidence that families, neigh-
borhoods, peers, and health also contribute to the development of hu-
man capital. Aiming at measuring human capital more accurately, Eric
Hanushek and Dennis Kimko introduced measures of mathematics and
science skills from international assessments into growth analysis.
They found that quality of human capital was very significantly re-
lated to economic growth. This approach has been extended by a vari-
ety of authors, and the evidence indicates that economic growth is very
closely related to the cognitive skills of the population.
Growth theory advanced again with theories of economist Paul
Romer and Robert Lucas, Jr. in the late 1980s and early 1990s.
World map of the 2008–2015 Global Competitiveness Index
Theories of economic growth: key-issues 29

Unsatisfied with Solow’s explanation, economists worked to “en-


dogenize” technology in the 1980s. They developed the endogenous
growth theory that includes a mathematical explanation of technologi-
cal advancement.
Endogenous growth theory holds that economic growth is pri-
marily the result of endogenous and not external forces. Endogenous
growth theory holds that investment in human capital, innovation,
and knowledge are significant contributors to economic growth. The
theory also focuses on positive externalities and spillover effects of
a knowledge-based economy which will lead to economic develop-
ment. The endogenous growth theory primarily holds that the long
run growth rate of an economy depends on policy measures. For ex-
ample, subsidies for research and development or education increase
the growth rate in some endogenous growth models by increasing the
incentive for innovation.
The endogenous growth model also incorporates a new concept of
Human capital: the skills and knowledge that make workers productive.
Unlike physical capital, human capital has increasing rates of return.
Therefore, there are constant returns to capital, and economies never
reach a steady state. Growth does not slow as capital accumulates, but
the rate of growth depends on the types of capital a country invests in.
Research done in this area has focused on what increases human capital
(e.g. education) or technological change (e.g. innovation).
In the mid-1980s, a group of growth theorists became increasingly
dissatisfied with common accounts of exogenous factors determining
long-run growth. They favored a model that replaced the exogenous
growth variable (unexplained technical progress) with a model in which
the key determinants of growth were explicit in the model.
Paul Romer (1986), Robert Lucas (1988), Sergio Rebelo (1991) and
Ortigueira and Santos (1997) omitted technological change; instead,
growth in these models is due to indefinite investment in human capital
which had spillover effect on economy and reduces the diminishing re-
turn to capital accumulation.
The simplest endogenous model assumes a constant-savings rate of
endogenous growth and a constant, exogenous, saving rate. The basic
assumption is that the production function does not exhibit diminishing
returns to scale to lead to endogenous growth. Various reasons for this
assumption have been given, such as positive spillovers from capital
30 Growth Economics and Governance

investment to the economy as a whole or improvements in technology


leading to further improvements (learning by doing).
The endogenous growth theory is further supported with models in
which agents determined the consumption and saving, optimizing the
resources allocation to research and development leading to technolog-
ical progress. Romer and other famous economists, Aghion and Howitt
(1992) and Grossman and Helpman (1991) incorporated imperfect mar-
kets and R&D to the growth model.

2.7. Energy efficiency theories: fundamentals of the sustainable


growth

The importance of energy to economic growth was emphasized by Wil-


liam Stanley Jevons in The Coal Question, in which he described the re-
bound effect based on the observation that increasing energy efficiency
resulted in more use of energy.
In 1865, he observed that technological improvements that increased
the efficiency of coal-use led to the increased consumption of coal in
a wide range of industries. He argued that, contrary to common intu-
ition, technological progress could not be relied upon to reduce fuel
consumption.
The Jevons paradox occurs when technological progress increases the
efficiency with which a resource is used (reducing the amount necessary
for any one use), but the rate of consumption of that resource rises because
of increasing demand. The Jevons paradox is perhaps the most widely
known paradox in environmental economics. However, governments
and environmentalists generally assume that efficiency gains will lower
resource consumption, ignoring the possibility of the paradox arising.
The issue has been re-examined by modern economists studying con-
sumption rebound effects from improved energy efficiency. In addition
to reducing the amount needed for a given use, improved efficiency also
lowers the relative cost of using a resource, which increases the quantity
demanded. This counteracts (to some extent) the reduction in use from
improved efficiency. Additionally, improved efficiency accelerates eco-
nomic growth, further increasing the demand for resources. The Jevons
paradox occurs when the effect from increased demand predominates,
and better efficiency leads to more resources being used.
Theories of economic growth: key-issues 31

Considerable debate exists about the size of the rebound in energy


efficiency and the relevance of Jevons paradox to energy conservation.
Some dismiss the paradox, while others worry that it may be self-de-
feating to pursue sustainability by increasing energy efficiency. Envi-
ronmental economists have proposed that efficiency gains be coupled
with conservation policies that keep the cost of use the same (or high-
er) to avoid the Jevons paradox. Conservation policies (such as cap
and trade) do not display the paradox, and can be used to control the
rebound effect.
In the 1980s, the economists Daniel Khazzoom and Leonard Brookes
independently put forward ideas about energy consumption and be-
havior that argue that increased energy efficiency paradoxically tends
to lead to increased energy consumption. In 1992, the US economist
Harry Saunders dubbed this hypothesis the Khazzoom–Brookes postulate,
and showed that it was true under neo-classical growth theory over a
wide range of assumptions.
The importance of electricity to economic growth has been recog-
nized by economists, prominent businessmen, economic historians and
various engineering, technical and science organizations and govern-
ment agencies. Conclusions of a report prepared for Los Alamos Na-
tional Laboratory for the United States Department of Energy and the
National Academy of Sciences stated: “Electricity use and gross nation-
al product have been, and probably will be, strongly correlated”.
The report’s conclusion went on to say that the energy intensity of
the U.S. economy (electricity consumed per dollar of GDP) had been
declining for a number of years.
All approaches to the inclusion energy into the theory of production
are known as the energy theory of value, which, nevertheless, does not
have an accurate and complete formulation. For example, Ayres and
Warr have presented a model that aims to address deficiencies in the
neo-classical and endogenous growth models. It claims that physical
and chemical work performed by energy, or more correctly exergy, has
historically been a very important driver of economic growth.
Key support for this theory is a mathematical model showing that
the efficiency of a composite indicator using electrical generation and
other energy efficiencies is a good proxy for the Solow residual, or tech-
nological progress, that is, the portion of economic growth that is not
attributable to capital or labor.
32 Growth Economics and Governance

The proper role of energy in production processes was elucidated by


the technological theory of social production.
Energy growth theory economists have criticized orthodox economics
for neglecting the role of energy and natural resources. Ayres and Warr’s
model relates the slowing of economic growth to energy conversion effi-
ciencies approaching thermodynamic limits, and cautions that declining
resource quality could bring an end to economic growth in a few decades.
Hall et al. 2001 state: “Although the first and second laws of ther-
modynamics are the most thoroughly tested and validated laws of na-
ture [..] the basic neoclassical economic model is a perpetual motion
machine, with no required inputs or limits.”

2.8. Unified growth theory and the bigh push

Unified growth theory was developed by Oded Galor and his co-au-
thors in order to address the inability of endogenous growth theory to
explain key empirical regularities in the growth processes of individual
economies and the world economy as a whole.
Endogenous growth theory was satisfied with accounting for em-
pirical regularities in the growth process of developed economies over
the last hundred years. As a consequence, it was not able to explain
the qualitatively different empirical regularities that characterized the
growth process over longer time horizons in both developed and less
developed economies.
Unified growth theories are endogenous growth theories that are
consistent with the entire process of development, and in particular the
transition from the epoch of Malthusian stagnation that had character-
ized most of the process of development to the contemporary era of
sustained economic growth.
In theories of economic growth, the mechanisms that let it take place
and its main determinants are abundant. One popular theory in the
1940s, for example, was that of the Big Push, which suggested that coun-
tries needed to jump from one stage of development to another through
a virtuous cycle, in which large investments in infrastructure and edu-
cation coupled with private investments would move the economy to a
more productive stage, breaking free from economic paradigms appro-
priate to a lower productivity stage.
Theories of economic growth: key-issues 33

2.9. Negative effects of economic growth

A number of arguments have been raised against economic growth. It


may be that economic growth improves the quality of life up to a point,
after which it doesn’t improve the quality of life, but rather obstructs
sustainable living.

i. Resource depletion
Many earlier predictions of resource depletion, such as Thomas Mal-
thus’ 1798 predictions about approaching famines in Europe, The Limits
to Growth (1972) did not materialize, nor has diminished production of
most resources occurred so far, one reason being that advancements in
technology and science have allowed some previously unavailable re-
sources to be produced.
In some cases, substitution of more abundant materials, such as plas-
tics for cast metals, lowered growth of usage for some metals. In the case
of the limited resource of land, famine was relieved firstly by the revo-
lution in transportation caused by railroads and steam ships, and later
by the Green Revolution and chemical fertilizers, especially the Haber
process for ammonia synthesis.
Virtually all economic sectors rely heavily on petroleum.
In the case of minerals, lower grades of mineral resources are being ex-
tracted, requiring higher inputs of capital and energy for both extraction
and processing. An example is natural gas from shale and other low per-
meability rock, which can be developed with much higher inputs of en-
ergy, capital, and materials than conventional gas in previous decades.
Another example is offshore oil and gas, which has exponentially
increasing cost as water depth increases.
Some Malthusians, such as William R. Catton, Jr., author of the 1980
book Overshoot, are skeptical of various technological advancements
that make previously inaccessible or lower grade resources more avail-
able. The counter-argument is that such advances and increases in effi-
ciency merely accelerate the drawing down of finite resources. Catton
refers to the contemporary increases in rates of resource extraction as,
“...stealing ravenously from the future.”
The apparent and temporary “increase” of resource extraction with
the use of new technology leads to the popular perception that resourc-
es are infinite or can be substituted without limit, but this perception
34 Growth Economics and Governance

fails to consider that ultimately, even lower quality resources are finite
and become uneconomic to extract when the ore quality is too low. Be-
cause of cultural lag, the perception of infinite resources and substitutes
may linger on for generations, and may not change, since the inevita-
ble resource bankruptcy is passed on to posterity. Catton has called
the faith in technology a form of “cargoism,” which takes its meaning
from various “Cargo Cults” in Melanesia and Micronesia. Furthermore,
Joseph Tainter, anthropologist, historian and author of the book “The
Collapse of Complex Societies,” has pointed out that each new addition
of complexity to technology can only be sustained if there is a good
enough return to justify the technology, and that over time, increases in
complexity have improved productivity at an ever decreasing rate.
As an example, in the early 20th century, when much of the world’s
oil was untapped, it was sufficient to drill a few metres into the ground
and install inexpensive rigs to extract oil at rapid rates. At the beginning
of the 21st century, achieving the same flowrates or less requires that oil
companies drill much deeper and apply sophisticated techniques and
equipment that costs hundreds of millions of dollars. If such trends con-
tinue, it may become uneconomic to increase complexity to access lower
grade resources with no net increase in productivity.

ii. Environmental impact


Some critics argue that a narrow view of economic growth, combined
with globalization, is creating a scenario where we could see a systemic
collapse of our planet’s natural resources.
Other critics draw on archaeology to cite examples of cultures they claim
have disappeared because they grew beyond the ability of their ecosystems
to support them.[68] Concerns about possible negative effects of growth on
the environment and society led some to advocate lower levels of growth.
This led to the ideas of uneconomic growth and de-growth – and Green
parties that argue that economies are part of a global society and global
ecology, and cannot outstrip their natural growth without damaging those.
Those more optimistic about the environmental impacts of growth
believe that, though localized environmental effects may occur, large-
scale ecological effects are minor. The argument, as stated by commen-
tator Julian Lincoln Simon, states that if these global-scale ecological
effects exist, human ingenuity will find ways to adapt to them.
Theories of economic growth: key-issues 35

iii. Equitable growth


While acknowledging the central role economic growth can poten-
tially play in human development, poverty reduction and the achieve-
ment of the Millennium Development Goals, it is becoming widely
understood amongst the development community that special efforts
must be made to ensure poorer sections of society are able to participate
in economic growth.
For instance, with low inequality a country with a growth rate of 2%
per head and 40% of its population living in poverty, can halve poverty
in ten years, but a country with high inequality would take nearly 60
years to achieve the same reduction. In the words of the Secretary Gen-
eral of the United Nations Ban Ki-Moon: “While economic growth is
necessary, it is not sufficient for progress on reducing poverty”.
Researchers at the Overseas Development Institute compares situ-
ations such as in Uganda, where during a period of annual growth of
2.5% between 2000 and 2003, the percentage of people living in poverty
actually increased by 3.8%. The ODI thus emphasises the need to ensure
social protection is extended to allow universal access and that policies
are introduced to encourage the private sector to create new jobs as the
economy grows (as opposed to jobless growth) and seek to employ peo-
ple from disadvantaged groups.[70]

iv. Implications of global warming


Up to the present there are close correlations of economic growth with
carbon dioxide emissions across nations, although there is also a consid-
erable divergence in carbon intensity (carbon emissions per GDP). The
Stern Review notes that the prediction that, “Under business as usual,
global emissions will be sufficient to propel greenhouse gas concentra-
tions to over 550ppm CO2e by 2050 and over 650–700ppm by the end of
this century is robust to a wide range of changes in model assumptions.”
The scientific consensus is that planetary ecosystem functioning without
incurring dangerous risks requires stabilization at 450–550 ppm.
As consequence, growth-oriented environmental economists pro-
pose massive government intervention into switching sources of ener-
gy production, favouring wind, solar, hydroelectric, and nuclear. This
would largely confine use of fossil fuels to either domestic cooking
needs (such as for kerosene burners) or where carbon capture and stor-
age technology can be cost-effective and reliable.
36 Growth Economics and Governance

The Stern Review, published by the United Kingdom Government in


2006, concluded that an investment of 1% of GDP (later changed to 2%)
would be sufficient to avoid the worst effects of climate change, and that
failure to do so could risk climate-related costs equal to 20% of GDP.
Because carbon capture and storage is as yet widely unproven, and its
long term effectiveness (such as in containing carbon dioxide ‘leaks’)
unknown, and because of current costs of alternative fuels, these policy
responses largely rest on faith of technological change.
On the other hand, Nigel Lawson claimed that people in a hun-
dred years’ time would be “seven times as well off as we are today”,
therefore it is not reasonable to impose sacrifices on the “much poorer
present generation”.

2.10. Frontiers of the digital transformation

In recent times we are seeing drastic changes increasingly influenced by


the mix of spread of digital technologies and the sharing economy that
will inevitably influence individual behavior and therefore the econom-
ic system and probably also political choices.
History shows that technological progress makes its way alone. Task
of an enlightened society is to direct it to the social and material well-be-
ing of populations.
Probably, as evidenced by indisputable trends, the sharing economy
will encourage these changes by adopting new ways of production and
consumption of goods and services. They will accordingly occur radical
changes in consumer welfare system, more oriented to the use of goods
and services and not the property.
To the extent that is spreading a culture of “possession” and less
owned, in societies grow the weight and significance of mutual trust and
thus the brotherhood between peoples of different cultures and traditions.
But if the sharing economy will continue to spread with the pace of
recent years will manifest itself in destructive innovation phenomena,
intuited by Schumpeter, who will penalize the traditional productive
systems than those leveled by digitization.
Not businesses but especially governments, if they want to meet the
challenges posed by the digital society, they must be able to drive the
new trends to reduce the inequalities created by globalization, reduce
Theories of economic growth: key-issues 37

areas of discomfort, fighting poverty with a view to steer the innova-


tion to society and, even more, to peaceful coexistence between different
peoples, cultures and religions.
The digital society, if well guided and oriented, can open up new
opportunities because of the weaker sections and pave the way for sus-
tainable growth routes.
The most advanced and sensitive entrepreneurship seems to react
very positively to the revolutionary opportunities offered by technol-
ogy, glimpsing new and profitable opportunities for potential growth.
In fact, the widespread dissemination of new knowledge and digital
technologies will stimulate the growth of new activities, and new job
types, capable of producing goods and services at affordable prices thus
favoring the expansion of in “sharing mode consumption”.
The spread of different forms of ownership of the property will prob-
ably rise consumption, through cost effectiveness, sometimes even de-
creasing due to the reduction of intermediaries and the greater techno-
logical content embedded in the goods.
Probably the axiom drive “more = more GDP growth” will be over-
come, because the digital society and the sharing economy will facilitate
access to new products / services at lower prices.
Lately a cooling of economic growth is observed in synthesizable
economy progressing at a “three zeros” (zero growth, zero rates and
zero inflation). But the stagnation of GDP do not always find correspon-
dence in the pattern of consumption that manifests in different realities
of slight growth signals.
In Italy, according to ISTAT, the average monthly expenditure per
household is about 2,500 euro, a slight upward trend. The expenditure
of Italian families began its gradual recovery from the middle of 2013,
but only in 2014 has chalked up a positive dynamic. In 2015, after the
interruption of growth in the first quarter, consumption continued re-
covery and grew in the second half of the year, supported by an im-
provement in consumer confidence, the recovery in the labor market,
the income growth available in real terms and the effect of towing large
events (Milan Expo). Strengthening spending has affected all sectors but
with different results in terms of dynamic reflecting the different de-
grees of compressibility of goods and services, their impact on the con-
sumption basket of families according to income classes, the degree of
technological innovation and changes in the purchasing choices of the
38 Growth Economics and Governance

Italians. The most buoyant regards spending on non-food goods and


services. In particular, the demand for durable goods showed a positive
trend far superior to 2014 both in volume (7.2%) and in value (7.0%).
Overall in 2015, household consumption rose by about 1% compared to
a growth of 0.8% GDP.
It seems that the GDP is not able to fully grasp the essence and qual-
ity of the economic well-being and that we must turn our attention to
other indicators which influence well-being.
The new economy of the partnership, based on the dissemination
of new knowledge, is almost upon us. The European Union must learn
to seize the opportunities beyond traditional targeted logical to GDP
growth to encourage, rather, the spread of digital innovations as a
means of improving knowledge and growth of new activities based on
sharing in this way promoting social welfare
3
Schumpeter: Role of the Entrepreneurs
and Business cycles

3.1. Introduction

At the beginning of the 20th century, when Joseph Alois Schumpeter, a


member of the German Historical School and later the father of entrepre-
neurship, started his academic career and, somewhat later, political career
in Vienna, the dominant doctrine of neoclassical economics was laid down.
Joseph Schumpeter wrote Theorie der wirtschaftlichen Entwicklung
in 1911 that was published as Theory of Economic Development in 1934.
Schumpeter tried to introduce the concept of entrepreneurs into the set-
up of neoclassical economics or the Walrasian System.
Schumpeter could easily define the function of his type of entrepre-
neurs in this manner, but the analysis of the overall process of evolution
required a radical reinterpretation of the system of general economic
equilibrium. He made clear that he could not accept the standard inter-
pretation of the quick Walrasian process of adaptation.
As most influential Harvard professor in the 1930s and 1940s Schum-
peter has been mentioned as the father of entrepreneurship and (irregu-
lar) growth theories, but he never received the Nobel Prize.
Schumpeter made clear that he could not accept the orthodox inter-
pretation of microeconomics. Although a general equilibrium system is
observationally equivalent to a system in which everyone is a complete-
ly rational optimizer, he declares this to be an illusion.
Schumpeter’s main contribution regards the fact that innovation is
function of the entrepreneur.
40 Growth Economics and Governance

Schumpeter is today more important than never earlier. Today,


clustered multinationals (MNCs) are powerful players in the global
markets. Because MNCs dominate the global markets of commodities,
they can collectively determine the rules of the game in the core mar-
ket segments.
The global economy is in expansion. New radical innovation are
needed to promote economic growth. There are one billion young
people (15-24 years old), 80% in developing countries, in the labor mar-
ket with few opportunities for productive work. According Schumpe-
terian theory, entrepreneurship is the key area of capacity-building to
resolve the global crisis.
Joseph Schumpeter proposed that an entrepreneur, as innovator,
creates profit opportunities by devising a new product, a production
process, or a marketing strategy. An entrepreneurial discovery occurs
when an entrepreneur makes the conjecture that a set of resources is not
allocated to its best use.
However he did not define what an entrepreneur looks like. Perhaps,
the reason to that was that Alfred Marshall focused the interest of neo-
classical economists on the concepts of representative firm instead of
innovative entrepreneur.
Marshall was a British economist at Cambridge, where he exerted
great influence on the development of economic thought of the time.
Marshall was concerned with theories of costs, value, and distribution
and developed a concept of marginal utility. His book Principles of Eco-
nomics from the year 1890 was for years the standard work.
In analizing business cycles, Schumpeter referred to the fundamen-
tal problem of economic change. He argued that entrepreneurs create
innovations in the face of competition and thereby generate (irregular)
economic growth.
Unlike Walras, Schumpeter gave much credit to human agency. Al-
though a general equilibrium system is observationally equivalent to a
system in which everyone is a completely rational optimizer, Schum-
peter declared this to be an illusion.
Three-cycle model of economic fluctuations or waves are proposed:
• Kitchin inventory cycle (3-5 years)
• Kuznets infrastructural investment cycle (15-25 years)
• Kondratieff long cycle (45-60 years)
What are the relevant waves of today in the emerging global economy?
Schumpeter: Role of the Entrepreneurs and Business cycles 41

What is evident is that all kinds of waves are much more shorter than
in the 30s when Schumpeter wrote his book.

3.2. The function of entrepreneurs in a society

An entrepreneur is motivated by the temporary monopoly profit that is


the return on the entrepreneur of the innovation that leads to increased
productivity and is the fundamental source of wealth in a society. Inno-
vations are considered as the major drivers of an economy.
Following Schumpeter, contributors to the scholarly literature on in-
novation typically distinguish between invention, an idea made man-
ifest, and innovation, ideas applied successfully in practice. Since the
social returns of innovations exceed the private returns, the factors that
facilitate innovativeness are considered to be critical to policy makers in
any of market economies.
The key to innovativeness is to allow firms to appropriate more of
the social benefits of their new products or processes, as through broad-
ening intellectual property rights or relaxing post-innovation antitrust
enforcement. This is what happened in the U.S. in the early 1980s.

3.3. Innovation distribution

Innovations are not continuously distributed in time but proceeds by


leaps which upset the existing equilibrium in markets and generate (ir-
regular) economic growth.
A parallel explanation of long waves in economics lies in the Kuhn’s
(1970) model of scientific development. Kuhn used the term paradigm
shift to refer to the mark of maturity of a science or techno-economic
paradigm that refers to an innovation or an innovation chain that affects
the whole economy, e.g. electric power or computers.
Schumpeter defined innovative transformation as a relatively slow
and conflict-ridden process and, thereby, distinguished innovation as the
function of entrepreneur that is separate from the administrative function
of manager. This reinterpretation helped him outline his theory of busi-
ness cycles as reflecting the wave-form process of economic evolution.
Schumpeter regards technological uncertainty as neither a suffi-
cient nor a necessary determinant of fluctuations but postulates that
42 Growth Economics and Governance

fluctuations are caused by supply shifts based on uneven technologi-


cal changes. He argued that entrepreneurs create radical innovations
in the face of competition and that business cycles are the major cata-
lyst of economic growth.
The problem of how business cycles come about is therefore insepa-
rable from the problem of how a capitalist economy functions.
Business cycles in the OECD countries after World War II have been
more restrained than the earlier business cycles. Economic stabilization
policy using fiscal policy and monetary policy has dampened the worst
fears of recession, and automatic stabilization due to the aspects of the
government’s budget also helped mitigate the cycle even without con-
scious action by policy-makers.
An exception is Russia that experienced prolonged depressions, fol-
lowing the end of the Soviet Union in 1991-1998. Business cycles are a
type of fluctuation found in the aggregate economic activity of nations
that organize their work mainly in business enterprises. Business cycles
are not merely fluctuations in aggregate economic activity. The critical
feature is that the fluctuations are widely diffused over the economy. The
economy of the Western world is a system of closely interrelated parts.
Although Schumpeter’s theory of business cycles is difficult to apply
to the global economy, there is no doubt that the ongoing technology rev-
olution will impact global markets, although we may not know the full
implications. Comparing the growth of Gnp with R&D statistics, Jensen
(1993) noticed that since the shock of the oil crisis in the mid 1970s, the
growth of R&D expenditures in the industrialized countries has been ap-
proximately double higher than the growth of Gnp. This trend has accel-
erated during the two decades of globalization, the 1990s and the 2000s.

3.5. Business cycle

The revolution of information technology (Ict) was the major source of


Schumpeterian dynamics in the industrialized countries in the 1990s.
The Schumpeterian market shock created new waves of innovative
growth firms, and destroyed the obsolete ones.
In the early 90s, Finland was hit by serious crisis in the bank indus-
try and about 20% of the firm population was lost. During the crisis
the positive entrepreneurial event was the unexpected global success
Schumpeter: Role of the Entrepreneurs and Business cycles 43

of Nokia. Two decades later Nokia is in a crisis signaling the new kind
of creative destruction of today. In the EU crisis countries (Greece, Ita-
ly, Spain, Portugal and Ireland) the Schumpeterian market shock may
be in full force. The negative end results are already known by econo-
mists. Hopefully, the positive end results are somewhere waiting for the
growth boom in the near future.
Schumpeter held two different approaches:
 He emphasized the role of entrepreneurs entering niches of
markets. By innovating, entrepreneurs challenged existing firms
through a process of “creative destruction”, which was regard-
ed as the engine of economic progress. Schumpeter (1942) paid
attention to the key role of large firms as engines for economic
growth by accumulating non-transferable knowledge in specific
technological areas and markets. There is a strong positive feed-
back loop from successful innovation to increased R&D activities
leading to renewed impulses to increased market concentration
 The neo-Schumpeterian approach analyses the generation, im-
plementation and diffusion of knowledge and technology, put-
ting emphasis on the decisive role and impacts of entrepreneur-
ship and innovation on dynamics and qualitative changes in
structures of industries or markets to which the innovation dy-
namics is targeted and thereby the society as the whole. Unfor-
tunately, Neo-Schumpeterian economists scarcely analyze the
“destructive” part of the “creative destruction” processes nor
consider the destinies of the people who are not lucky or able to
take advantage of innovation dynamics.
Looking at Schumpeter writings it is possible to distinguished two
different types of mechanisms underlying innovation by firms:
 Creative distruction
 Creative accumulation

i. Creative distruction
Schumpeter gave economists food for thought with the concept of
creative destruction. Creative destruction creates economic disconti-
nuities, and in doing so, an entrepreneurial environment for the intro-
duction of innovation, and earning monopoly profits. Competition is a
self-destructive mechanism that normalizes profits when the innovation
effect has been utilized. Creative destruction is associated with inno-
44 Growth Economics and Governance

vation of entrepreneurs (or small firms) entering unexplored market


where there are low entry barriers for new entrants utilizing the com-
mon pool of knowledge stock.
Creative destruction is a microeconomic process by its nature but has
considerable macroeconomic implication for economic growth. In cre-
ative destruction competition between firms and sectors is mainly driv-
en by technological factors when technological innovations overturn the
existing dominant technologies and shakes the status quo in the market.

ii. Creative accumulation


Creative accumulation is associated with institutionalized innova-
tion by MNCs that carry out innovation along established technological
trajectories and even try to prevent the entrance of newcomers.
MNCs dominate global commodity markets. By providing world-
class technologies and logistics, MNCs are important partners for local
entrepreneurs, MNCs are claimed to utilize monopoly power to create
high barriers to entry of new entrants, and impact on industry life cycles
and market structures.
When entrepreneurs under creative destruction draw from the pub-
lic domain only to place their own innovations within the reach of im-
itators, large firms under creative accumulation appropriate and build
on proprietary knowledge stocks through in-house R&D departments.
Thomas Edison (1847-1931) owned over a thousand U.S. patents. Edi-
son himself was a pioneer investor creating technological breakthroughs.
In the 1890s he established General Electric (GE). GE was among the first
ones organizing creative accumulation built on its proprietary knowl-
edge stocks through well-organized R&D departments, including light-
ing, transportation, power transmission, and medical equipment. GE is
still continuing the infinite quality-improvement process.

3.6. Influence of the R&D expenditure

The Schumpeterian analysis is confined to the influence of the degree


of concentration on R&D expenditure. The heterogeneity of industries
is the reason why the relation between concentration and innovative
output has often found to be non-significant or even negative.
Relying on historical analyses, Chandler (1962, 1990) claimed that the
Schumpeter: Role of the Entrepreneurs and Business cycles 45

strategy process is the key managerial innovation by which large firms


integrate the core elements of vertical production system or value chain.
Large firms with integrated manufacturing and R&D can be successful in
generating radical product and process innovations although the “escape
competition” strategy is common in the global patent race by MNCs.
As Buckley and Casson (1976, 1985) have noticed, internalizing, e.g.
vertical integration is the most valid strategy for MNCs. Schumpeter
argued for a positive relationship between the rate of R&D investments
and the firm size. According to the prediction of Schumpeter (1942), large
firms would inevitably gain dominance over small firms, and thus slow
the rate of radical inventions in the overall economy. His contradictory
claim was that monopolies favour innovations (Baldwin and Scott, 1987;
Baker, 2007). In broad terms, this is still true today. Big MNCs are the ma-
jor suppliers in global innovation and technology markets. The quality of
supply is, however, important to assess. The most common competitive
model for global commodities supplied by MNCs is oligopoly.
A market leader in oligopoly is not ready to take the risk of radical
or drastic innovations.
Referring to the neoclassical standard doctrine, Kenneth Arrow (1962)
claimed that a market leader in oligopoly is not ready to take the risk of
radical or drastic innovations since the firm might jeopardize its dominant
market position. Market leaders can earn profits by replacing itself (the
“Arrow effect”) what small firms in oligopoly, by definition, cannot do.
A market leaders inventing in new products or processes adopt strat-
egies as follows:
 pre-empting potential rivals;
 slowing down the diffusion of radical technological invention by
new entrants;
 maintaining a permanent leadership.
A classical case is Microsoft being the subject of antitrust investiga-
tions in the US and in the EU Microsoft, even if evidence of the misuse
of monopoly power was difficult to find.
Chandler (1990), the most influential economic historian since Schum-
peter, by comparing the history of corporate capitalism in the U.S., Brit-
ain, and Germany, noticed that the US managerial capitalism was the
winner for about one hundred years, from the 1880s to the 1980s. The
hated US trusts were the ones that succeeded to increase output, lower
costs, compete vigorously, and expand into more distant markets lead-
46 Growth Economics and Governance

ing to the growing population of MNCs that are able to develop prod-
ucts competitive in markets and so to become multiproduct enterprises.
Large vertically integrated firms replaced fragmented structures of pro-
duction and distribution and started to agglomerate their competitive
capabilities over industrial districts.
Schumpeter strongly believed in human incentive in innovation
dynamics.
Some writers have continued to deal with dynamic transformation
process in economies driven by the introduction of innovations. This
notion is well elaborated by Robert Lucas (1981, 1988).
Following the notion of increasing return, Romer (1989) claimed that
every generation has underestimated the potential for new recipes and
ideas. He argued that technology is not a mysterious outside force, as
economists thought in the past, but an internal one that can be culti-
vated to increase growth. His main slogan in terms of Schumpeter has
been: “The emerging economy is based on ideas more than objects”. The
greatest innovations are likely to occur from the cross-fertilization of
sectors and professions. For example, artists/scientists and businessmen
work models are interrelated but different. A major difference is that
artists/scientists are more likely to think laterally and holistically, busi-
nessmen are linkers of people and concepts whilst businessmen involve
a linear thinking pattern.

M-Commerce Development Model


Schumpeter: Role of the Entrepreneurs and Business cycles 47

3.7. Contribution of Keynesian school to business cycle

The Keynesian school argues for endogenous causes of fluctuations.


The main framework for explaining fluctuations is Keynesian eco-
nomics (Minsky, 2008). In the Keynesian view, business cycles reflect
the possibility that the economy may reach equilibrium at various lev-
els of employment. If the economy is in recession and unemployment
is high, the Keynesian theory states that monetary policy and fiscal
policy can have a positive role to play in smoothing the fluctuations of
the business cycle.
The neoclassical school is arguing for exogenous causes of busi-
ness cycles. Neoclassical economists, such as Paul Krugman and Jo-
seph Stiglitz, argue for minimal government regulations (laissez-faire)
since efficient markets and competition are the best ways to win a
recession. The Keynesian economists largely argue for larger gov-
ernment policy and regulation, as absent regulation, the market will
move from crisis to crisis.
4
Technology Transfer Frontiers:
Cooperation among Universities and Industries

4.1. Search for new innovation competitiveness: outline

Europe, Italy and the entire world are faced with a dramatic financial
crisis requiring innovative solutions, not limited to the economic field.
Returning to economic growth and higher levels of employment,
combating climate change and moving towards a low-carbon society
require urgent and coordinated actions. Challenges such as our ageing
population or our dependence on fossil fuels do, however, also provide
powerful opportunities to develop innovative products and services,
creating growth and jobs in Europe.
Moreover world economic growth has to deal with the impact of de-
mographic on the available natural resources which need to be used
more wisely.
Our societies are still facing security challenges which are growing in
scale and sophistication.
The emerging countries are moving from cost completion and tech-
nological imitation towards new strategies based on research and in-
novation, not only through technological collaboration with developed
countries, but also by making investments in high tech research centers
and industries abroad.
Italy in particular needs to meet the challenge of reinforcing its com-
petitive capabilities in the face of globalization:
 by increasing investments in R&D to improve innovative
components in its production;
50 Growth Economics and Governance

 by reaching a better coordination of the international license;


 by improving knowledge in project innovation and management.

4.2. World perspective

R&D large scale investments are growing in the US, while medium scale
investments are widespread in the EU and Japan.

Global share of R&D are stable in the EU and strongly increasing in


China. In the field of patent applications, it is growing the role of the
Brics countries and specially Japan.
The landscape of EU research and innovation programs has developed
over recent decades and now represents a significant share of the EU bud-
get (7,41% by 2013) making EU the second largest investor in R&D.
However the EU effort in R&D is still focused on medium R&D in-
tensity sectors (Automotive and Aerospace, Chemicals, Electronics)
while US R&D growth is dominated by the high-tech sector (ICT and
Pharma/BioTech).
The actual chance is to promote increasing collaboration between Uni-
versities and private research centre as well scientific parks, by linking
public and private research funding closer to specific policy objectives.
Technology Transfer Frontiers: Cooperation among Universities and Industries 51

Global share of total R&D (%) - 1996 to 2012, percentage Change in global share of total R&D (%) - 1996 and 2012, percentage

45 16

40 14

35 12

30 United States
10
EU-27
25 1996
Japan 8
20 2005
China 6
2012
15 India
4
Brazil
10
2
5
0
0 China Russian India Brazil South Africa
1996 1998 2000 2002 2004 2006 2008 2010 2012 Federation

Share in world PCT patent applications, selected countries, 2005-11,


PCT patent applications, index 2006=100, 2006-11
percentage

14,0 150

12,0 140

10,0 130
BRIICS
China Total OECD
8,0 120
Finland EU27
6,0 Germany 110 Japan
Korea United States
4,0 100
Sweden

2,0 90

0,0 80
2005 2006 2007 2008 2009 2010 2011 2012 2006 2007 2008 2009 2010 2011

4.3. Italian performance

Italy is reinforcing public effort in the direction of a better public-private


partnership in order to respond to the extreme budget constraints on
co-financed projects with high market perspectives.
The Italian R&D and innovation system shows positive and negative
aspects.
Looking at aggregate figures, the current Italian 2020 R&D target, set
at the value of 1.53% of Gdp, is not ambitious.
R&D intensity in Italy has increased around 2.3% annually over the
2000-2009 period, both public and private R&D have grown during the
period, but modestly. In 2012, industry funded 44% of the R&D invest-
ments; government accounted for 42%, and 9% was funded from abroad.
EU average R&D is at 1.9% almost 50% higher than the Italian one.
The modest Italian figures reflect the structural characteristics of its pro-
52 Growth Economics and Governance

duction system, which is based on traditional sectors with low R&D inten-
sities such as footwear, textiles and clothing and, to a lesser extent, other
machinery, basic metal products and non-metallic mineral products.
The business sector performs only around half of investments as a seg-
ment of innovative firms coexists with many non-innovative firms oper-
ating at low levels of productivity. Moreover, R&D and innovation capac-
ity is concentrated in Northern and Central regions of the country and
venture capital is in short supply and the patenting rate of young firms is
low. In general, Italy tends to perform better on indicators of non-R&D-
based innovation (for example, it leads in Community designs).
Public policy intervention in the R&D sector has opened many pos-
sibilities, which have not been completely exploited due to two types of
structural weaknesses. Italy is still ranked as a moderate innovator well
below the EU average even if significant improvement has been made.
The positive contribution of high-tech and medium-high-tech manufac-
tured goods to the trade balance demonstrates the potentiality of the
country to steer reforms of the R&D system and to derive economic
benefits from future efforts.
The National Research Plan (2011-13) aims to promote applied re-
search by strengthening business sector cooperation with the public
sector and supporting the internationalization of the research. Both the
Italian Mezzogiorno and the SMEs have attracted special attention in
technology and innovation strategies and policies. The National Strate-
gic Framework 2007-13 is co-financed by many EU plans: the National
Operational Programme (PON) Research and Competitiveness 2007-13
of the European Regional Development Fund (ERDF) and by the na-
tional Revolving Fund, which is of high importance for regional cohe-
sion and competitiveness.
Nevertheless the Italian performance in the field of gross domestic
expenditure in R&D is still at critical point as no change over time can
be recognized. The total factor productivity is stable over the time and
the country-competitivity will suffer in relation to a better dynamics of
most advanced European countries (The Netherlands, France, United
Kingdom, Germany).
Technology Transfer Frontiers: Cooperation among Universities and Industries 53

4.4. Strengthening competitiveness through innovation

Europe, and Italy in particular, needs to step up its performance in cre-


ating impact from research and innovation funding. Obstacles remain
in transferring research outcomes from the laboratory through the de-
velopment, commercialization and application phases. As pointed out
in the EU studies, it is essential the role of the industry in setting pri-
orities along public-private partnerships. It also involves broadening
support across the full innovation cycle, including covering issues such
as post-project follow-up, pre-normative research for standard setting,
support to patenting and to non-technological innovation.
In order to pursue the objectives of strengthening R&D investments
and innovation transfer to SMEs, a number of shortcomings and defi-
ciencies must be removed such as:
 the lack of a whole value chain approach to research and innovation,
 the complexity of using modern financial instruments,
 the over-bureaucratic rules and procedures,
 the lack of transparency.
In particular, improvements for future programs should focus on:
 Clarifying objectives and how they are translated into the
supported activities, while maintaining flexibility to respond to
emerging policy needs.
 Reducing complexity. Over time, research and innovation
programs have expanded the set of instruments leaving an
54 Growth Economics and Governance

impression of catering too many objectives by an higher fund


fragmentation. A lack of coordination between EU and Member
State funding adds to the complexity and leaves a potential
for overlap and duplication, for instance as regards State Aid
measures to support SMEs or to provide risk capital.
 Increasing added value and leverage and avoiding duplication.
Both national and European research and innovation funding
should provide more added value, should increase its leverage
effect on other public and private resources and have to be used
more effectively to support the strategic alignment and pooling
of national and regional funds to avoid duplication and achieve
critical mass.
 Simplifying participation by lowering administrative burdens,
reducing time to grant and time to payment and achieving a
better balance between cost and trust based approaches.
 Broadening participation in EU programs. A larger participation
of SMEs is needed and a stronger involvement of third countries
would offer opportunities to capture the benefits of knowledge
produced outside the EU.
 Increasing the firm-competitiveness impact from EU support.
This would require better uptake and use of results by
companies, investors, public authorities, other researchers and
policy makers. It also involves supporting broader innovations
(including non-technological and social innovation) which are
not the result of research activities. Better communication of our
objectives and the relevance of our actions to a wider audience is
also needed. The ultimate users of innovations (be they citizens,
businesses or the public sector) should be involved much earlier
in our actions to accelerate and broaden the exploitation of
results and to encourage greater public acceptance in sensitive
fields such as security or nanotechnology.
Securing a strong position in the key-enabling technologies such as
ICT, nanotechnology, advanced materials, manufacturing, space tech-
nology or biotechnology is of vital importance to Europe’s competitive-
ness as it enables the development of innovative goods and services
needed for addressing social challenges.
The European Technology Platforms (ETPs) helped define industry rel-
evant priorities. The Joint Technology Initiatives (JTIs) put industry in the
Technology Transfer Frontiers: Cooperation among Universities and Industries 55

driving seat through establishing formal public private partnerships. The


European Economic Recovery Plan introduced more informal public pri-
vate partnerships (PPPs) in key sectors. Experience shows that their success
is based on strong commitments from the stakeholders involved, as well
from simple and efficient governance and implementation structures.
Within the framework of its Strategic Innovation Agenda, the Eu-
ropean Industrial Initiative (EIT) will continue to strengthen its busi-
ness-driven approach through a focus on generating results as well on
the leverage capacity to getting funds from the private sector. In this
context relevant progress have been made in the SET-plan (energy re-
lated initiatives) and the ETAP-plan (green economy related initiatives).
All the programs are aiming to strengthen the competitiveness of the
Europe’s industry, with a particular focus on SMEs as they take into
account the fact that innovation requires many competences and activi-
ties other than research, which are non-technological in nature (such as
design, creativity, standard setting). Through their flexibility and agili-
ty, SMEs play a pivotal role in developing novel product and services.
Outstanding and fast growing SMEs have the potential to transform the
structure of Europe’s economy by growing into tomorrow’s multina-
tional companies. A strengthened approach to SMEs could be inspired
by the experience gained with the current SME actions and from the fact
that the needs of many SMEs are best served through support provided
at the regional level through the Cohesion Policy Funds.
Intellectual property rights governing EU research and innovation
funding are decisive for efficient exploitation and technology transfer,
while at the same time they need to ensure access to rapid dissemina-
tion of the scientific results. They are also of relevance for international
cooperation in areas of strategic interest. Nevertheless, attention must
be given to the growing change in the structure of industrial innovation:
new products and technologies are based on a set of patents rather than
a single invention. As the recent bid of Google for Motorola suggests,
companies are becoming integrators and are increasingly acquiring
ideas, also patented ones, from a wide range of sources. At the same
time, it is increasing the companies’ need to protect their inventions via
clusters of patents and no longer via a few major patents. These trends
cause a constant flow of knowledge between separate entities, such as
between public research bodies and enterprises, between major corpo-
rations and startups.
56 Growth Economics and Governance

In this development of the “knowledge transfer industry” an import-


ant role is played by the financial sector in order to ensure the pre-con-
ditions for the development of the idea to be transferred into an innova-
tion. In this respect, the European economy seems to be penalized when
compared with other technological area such as US, where new actors
and tools are emerging specifically to finance and support innovation
and where patents are considered a mere asset where to be invested in
and traded, by the limited involvement of financial institution in the
innovation process.
The low level of private financing to the research and innovation is a
major bottleneck in Europe as it represents the most significant gap with
the US in terms of venture capital funds investments as well as seed and
pre-seed small investments.
The new European research programs have demonstrated how the
EU budget in partnership with the European Investment Bank (EIB) can
succeed in overcoming market gaps in this area.
Building on this experience, future EU research and innovation pro-
grams should make full use of financial instruments (through the EU
Equity and Risk Sharing Platform mechanisms proposed in the Budget
Review) to support the commercialization of research results, the growth
of innovative businesses and investments in major infrastructures.

Global annual venture capital investment, 2005-11


Technology Transfer Frontiers: Cooperation among Universities and Industries 57

France has recently established France Brevets, a €100 million in-


vestment fund (split between the State, €50 million and the Caisse des
Dépôts et Consignations, €50 million). The fund is intended to enable
universities, schools of engineering and research bodies, as well do-
mestic firms, to exploit their patents more effectively, through the
exploitation of patent clusters, and by framing strategies in order to
leverage their market potential by promoting cross-fertilization in the
management of public and private-sector patents. The France Brevets
fund will try to get to the experience the same success of much larger
foreign investment funds in innovation, such as the Intellectual Ven-
tures Fund in the United States (€5 billion and 30,000 families of pat-
ents acquired); the Innovation Network Corp of Japan ($ 1 billion); the
South Korea innovation fund ($350 million).
The relevance of a solid innovation fund system enhancing the diffu-
sion of the outputs of R&D investments and their commercial exploita-
tion is clearly supported by the evidence that a large share of firms de-
velop their process, product, organizational and marketing innovations
without carrying out any direct investment on R&D.

4.5. Turning research into innovation transfer for higher val-


ue added and new occupation: the role of the University
research center in Italy

In Italy there are several research center that can be classified as center
of excellence.
Many Italian Universities have developed an efficient system to im-
prove technology transfer to industry, to SMEs in particular. Among the
most important centers, the following are the notable for their activities
as incubators or technology transfer: Politecnico of Turin University,
which provides also facilities for financial support to new born high
tech enterprises, Politecnico e Bicocca of Milan University, University of
Trento research center, Sant’Anna University of Pisa, Sapienza Univer-
sity of Rome.
Sapienza University is one of the largest Universities in the world
(more than 130 thousand student, 4,500 professors and researchers, 1,500
administrative staff, 11 Faculties in all sectors a part from Agriculture, 66
Departments). Its technological activities are arranged as follows:
58 Growth Economics and Governance

 Research and Innovation Commission, which provides the main


strategies for applying patents to innovations;
 Patent Department, which provides all the facilities for new
inventions;
 Spin off Commission, which provides the evaluation and
the approval of new projects suitable for the participation of
Sapienza in the risk capital.

4.6. Concluding remarks

“Capitalism is based on a process of continuous change coming from tech-


nological innovation through progressive phases which create new structures
while the old ones are eliminated. This process of ‘creative destruction’ is the
core of capitalism”. (Joseph Schumpeter)

By taking these pioneer’s suggestions, let us make some strategic con-


clusive remarks:
 Innovation is the way to transform new research ideas into the
process of technological transfer to new high tech enterprises.
 Innovation means the creation of new processes or new
products, which provide an increasing added value and new
jobs opportunities for specialized workers.
 Innovation must be supported by a selective and efficient
incentivizing system.
 Both innovation and technology transfer are strategic activities
for enterprises (SMEs in particular) to gain competitiveness in
the world market by reducing costs, diversify products, creating
new retail network and managing patents.
 Innovation capacity is the most important way to attract
investments and specialized jobs.
 Innovation has to be supported by strengthening the public-
private partnership through credit facilities and venture capital
participation, as well by creating private research centers
supporting groups of SMEs.
 Innovation has to be accompanied by advanced professional
education and training on the job.
An efficient funding system is crucial to create a suitable environ-
Technology Transfer Frontiers: Cooperation among Universities and Industries 59

ment for the proliferation of innovative ideas. It has to be devoted to


finance specific items, such as:
 selected research projects suitable for technology transfer to
SMEs;
 laboratories to host new-born activities;
 scientific parks to locate spin offs, start-ups and high tech small
enterprises;
 international network among academic and private excellent
research centers;
 commercialization of research results;
 investments in major infrastructures;
 creation of a joint license among start-ups
5
Digital Society and Sharing Economy*

5.1. Meaning of the sharing economy

Although sharing economy (also called shared, collaborative, peer or


access economy) does not have a single definition, it has been explained
in several analyses.
In 2000, the economist Jeremy Rifkin2 prophesized the advent of a
new economy enabled by digital technologies, in which a server has
property of a good while a client can have a temporary access to it by
sharing, lending or renting it.
Alex Stephany, the CEO of JustPark and one of the world’s leading
experts of sharing economy, describes the phenomenon as “the value
in taking underutilized assets and making them accessible online to a
community”3.
Another fundamental author in shaping the public and academic
analysis around this phenomenon is Russel Belk, a professor of York
University. He tries to define the concept of sharing by differentiating
its meaning from other similar concepts. He says: “Sharing is a funda-
mental consumer behaviour that we have either tended to overlook or
to confuse with commodity exchange and gift giving. Sharing is a dis-
tinct, ancient, and increasingly vital consumer research topic that bears

* in collaboration with Margherita Ghidini, graduated in Cooperation and Develop-


ment, Sapienza 2016.
2
Rifkin, Jeremy, 2000, The Age of Access: The New Culture of Hypercapitalism, Where All
of Life is a Paid for Experience, Jeremy P Tarcher.
3
Stephany, Alex, 2015, The Business of Sharing: Making It in the New Sharing Economy,
Palgrave Macmillan.
62 Growth Economics and Governance

on a broad array of consumption issues ranging from sharing house-


hold resources versus atomized family possessions to file sharing ver-
sus intellectual property rights4.”
Botsman and Rogers describe the sharing economy as an economic
model driven by network technologies that enable things and skills to
be shared or exchanged in ways and on a scale not possible before.
Another way to analyze the sharing economy is by comparing it with
the ‘traditional’ economy. Dervojeda et al. explain that, in traditional
markets, consumers buy products (which they later own) and services,
whereas in the sharing economy suppliers share their resources tempo-
rarily with consumers, either free or for a return (financial or non-finan-
cial). Virtually anyone can share almost anything, from products and
property (e.g. an apartment, a car, a bicycle, a travel equipment) to time,
skills and competencies (e.g. cooking and photography skills, knowl-
edge of a town, places to see).
This type of sharing or exchange services facilitated platforms de-
mand and supply of goods.
In many cases, these platforms are created and managed by private
companies, also referred to as peer-to-peer companies or sharing econ-
omy companies.
The most commonly known sharing economy model is a peer-to-
peer model in which peers (mostly individuals) offer and request goods
and services.

Peer-to-peer model

4
Belk, Russell, Sharing, 2010, The Journal of Consumer Research, Vol. 36, No. 5 pp. 715-
734, The University of Chicago Press.
Digital Society and Sharing Economy 63

The platform then acts as an intermediary between them.


Other authors refuse to use the term “sharing economy”, preferring
to adopt other terms.
This is the case of Rachel Botsman and Roger Roo, two important
experts of the sector. They prefer using “collaborative consumption”
to indicate the reinvention and the fast growth of traditional concepts
of sharing, trading, bartering, landing, gifting, renting and swapping
through digital technologies. They define the “collaborative consump-
tion” as a new business model that disrupts, goes ahead and reinvents
what and how individuals consume. In other words, the collaborative
consumption is an economy model enabling access over ownership, a
new era in which “what is mine is yours”5.
Lisa Gansky, entrepreneur and writer, prefer the concept of “mesh”
as a metaphor of our new phase of information-based services. She
wrote: “a Mesh describes a type of network that allows any node to
link in any direction with any other nodes in the system. Every part
is connected to every other part, and they move in tandem.6” The
metaphor helps to outline the shift occurring in human relationship
with things. According to Lisa Gansky, sharing is as old as human
being. People have always shared things and services, transportation
and public parks just to make some example. She defines sharing an
“old-fashion neighbourliness”, but she adds that our time represents
a new era of sharing.
Following the author, this new phase of sharing is arisen for the fol-
lowing drivers: recession, population growth and density into the cities,
climate change, disruption of big brands (a phenomenon occurred from
the inception of the Web which has forced the old companies to adapt or
die), the increasingly connection between people and things.
As Lisa Gansky, Marta Rainieri, author of Collaboriamo! Come i social
media ci aiutano a lavorare e a vivere bene in tempo di crisi, strongly outlines
the drivers of the ignition of the sharing economy. She wrote that eco-
nomic, social and environmental crisis, side-by-side with digital tech-
nologies, have amplified the possibilities of goods, services spare time

5
Botsman, Rachel and Rogers, Roo, 2010, What’s Mine Is Yours: The Rise of Collabora-
tive Consumption Harperbusiness.
6
Gansky, Lisa, 2012, The Mesh: Why the Future of Business is Sharing, Portfolio
Penguin.
64 Growth Economics and Governance

and so on. Consequently, a great number of businesses have been cre-


ated with a “sharing purpose”. However, she does not provide a defi-
nition of the term in question, but she cites the definition provided by
Rachel Botsman and Roger Roo, writers of What’s mine is yours: The Rise
of Collaborative Consumption.
In fact, the best framework to break down these complex concepts is
given by Botsman on the web site Co.exist7. She writes a definition for
each of the main concepts proposed to define the phenomenon.
 Starting with “sharing economy”, defined as “an economic mod-
el based on sharing underutilized assets from spaces to skills
to stuff for monetary or non-monetary benefits. It is currently
largely talked about in relation to peer-to-peer marketplaces but
equal opportunity lies in the business to consumer models”.
 Then, she explains the meaning of “collaborative economy”: “An
economy built on distributed networks of connected individuals
and communities versus centralized institutions, transforming
how we can produce, consume, finance, and learn.” She says that
the collaborative economy has four components: production, con-
sumption, finance and education.
She also provides the definition of “collaborative consumption” as
“an economic model based on sharing, swapping, trading, or renting
products and services, enabling access over ownership. It is reinventing
not just what we consume but how we consume.” In her opinion, this
concept is composed by three distinct systems that she defines as follow:
1. The first one is the Redistribution Markets, based on unwanted or
underused goods redistributed.
2. The second system is the so-called Collaborative Lifestyles. It is
based on the idea that non-product assets such as space, skills
and money are exchanged and traded in new ways.
3. The third one is the Product Service Systems that consist on pay-
ing to access the benefit of a product versus needing to own it
outright.
In conclusion, the most suitable approach to the phenomenon is not
beginning with a definition of it.
Whereas the best approach consist is to analyse the common charac-

7
Botsman, Rachel, 2013, The Sharing Economy Lacks A Shared Definition, http://www.
fastcoexist.com/
Digital Society and Sharing Economy 65

teristics of the “sharing businesses”, on which the authors cited above


mostly agree.
Using Lisa Gansky’s approach8, the common characteristics of the
sharing businesses can be explain in four elements, as follows:
1. The first is indubitably sharing. Sharing businesses offer some-
thing that can be shared, including products, services and raw
materials, within a community, market or value chain.
2. The second element is the use of advanced Web and mobile data
networks to track products and aggregate usage, customer and
product information. The phenomenon is made possible by the
way in which people are all increasingly connected to everything
else, with other people and things.
3. The third one focus on shareable physical goods, including the
material used, which makes local delivery of products and ser-
vices valuable and relevant.
4. Last, the transmission through word of mouth of offers, news
and recommendations is augmented by social networks services.
Not every sharing business or organization contains every elements
described above.
Indeed, according to Botsman, in the near future we will assist to the
sharing economy sitting side-by-side or going head-to-head with old
consumerism model.
This is the case of hybridization: in this sense, Airbnb is the most fa-
mous hybrid business model. It represents both a model for traditional
commerce and a for collaborative commerce.

5.2. Sustainability

Julian Agyeman originates the concept of “just sustainabilities”, the full


integration of social justice and sustainability, defined as “the need to
ensure a better quality of life for all, now and into the future, in a just and eq-
uitable manner, whilst living within the limits of supporting ecosystems”. The
idea is that there is no a universal “green” pathway to sustainability,
that sustainability is context-specific but justice is an intrinsic element9.

8
Gansky, Lisa, 2012, The Mesh: Why the Future of Business is Sharing, Portfolio
Penguin.
9
Agyeman, Julian, 2012, Just sustainabilities, www.julianagyeman.com.
66 Growth Economics and Governance

This concept focuses on four condition for sustainability as such:


1. improving quality of well-being and, more generally, of life;
2. meeting the needs of future generations besides of the contem-
porary generation;
3. equity and justice in terms of recognition, procedure, process,
and outcome;
4. living according to the ecosystem’s limits.
The concept of sharing represents one of the expression of “just sus-
tainabilities”. Indeed, many sharing businesses deliver benefits to poor-
er and enables people to have access resources and experiences from
which otherwise they will be excluded on grounds of income10.
In conclusion, it is still too early to assess how much the sharing econ-
omy will influence the sustainability of our future, but it is showing
clearly good premises.

5.3. Socio-cultural elements

It can be useful to focus on the socio-cultural elements that enabled the


sharing economy to grow.
1. First of all, it is necessary to analyse the impact of the financial
crisis of 2008 and of the consequent loss of confidence in inter-
mediaries will be described with the aim of creating a general
framework of the current society.
2. Then, the shift from owning to sharing will be clarified, as well
as the concept of global commons.
3. After that, it will be explained why the feeling of empathy is
increasing.
4. Following this, the focus will be on human beings and on the
changes on human’s behaviour.
Finally, the analysis will be on the three factors that allow the sharing
businesses to work: trust, reputation, and the logic of reciprocity.

i. Effects of the financial crisis of 2008


We are still experiencing the biggest economic and financial crisis
since the 30s of the last century (the Great Depression). The crisis, ini-

10
McLaren, Duncan and Agyeman, Julian, 2016, Sharing citier. A case for Truly Smart
and Sustainable cities, The MIT Press.
Digital Society and Sharing Economy 67

tially only financial, has turned into a global crisis, involving nearly all
the global financial system.
The financial crisis of 2007-2009 has exposed the structural weak-
nesses and shortcomings of the international financial system: excessive
financial risk in connection with a high use of debt; lack of transparency
and complexity of the investment business; the presence of institutions
that were not the capacity of controlling and regulating.
In general, it is alleged that the crisis began because of the collapse of
subprime mortgages in the US11. The bank grants a mortgage to people
with a low and or uncertain income. The subprime mortgage is risky for
the bank, as it is not certain that borrowers will repay the debt.
This credit intermediation system was based around what economists
call a “shadow banking” sector. Shadow banking is characterized by a
lengthening of the series of steps between savers and borrowers, steps
more complex and less transparent. This sector may involve not only tra-
ditional banks, but also non-banking institutes functioning as a bank.
Losses due to the collapse of the subprime mortgages, as these were
originally assessed by the rating agencies as safe securities, generated a
crisis of confidence in the entire financial system.
Unfortunately, the sharp decline in the US housing market has made
impossible for many owners meet their financial commitments. In this
context, many of the major institutions that gave subprime loans had
had to cease trading or started bankruptcy proceedings.
The uncertainty has made the world markets extremely cautious and
volatile, with the result that it is now much harder to get loans.
However, consumers cannot disclaim any responsibilities for the
crisis. The social analyst and columnist John Gerzema calls the phe-
nomenon “the 50-20 paradox”12. According to John Gerzema, it took
us 50 years to reach annual savings ratings of almost 10 per cent. This
process started with the World War II and the savings were so high
because there was nothing to buy. On the other way, over the course
of approximately the last 20 years, consumers went from a 10 per cent
savings rate to a negative savings rate. Those 20 years coincide with
the beginning and development of the “hyper-consumerism era”. The

11
Gramlich, Edward, 2007, Booms and Busts: The Case of Subprime Mortgages, Federal
Reserve Bank of Kansas City Economic Review.
12
Gerzema, John, 2009, The Post-Crisis Consumer, www.ted.com.
68 Growth Economics and Governance

personal debt-to-income ratio basically increases from 65 per cent to


135 per cent in the span of about 15 years. So consumers got overlev-
eraged and the banks did as well.
Nonetheless, consumer’s behaviour is changing. In The Disruption of
Sharing Olson and Connor define this phenomenon as follow: “Although
the sharing economy was still in an embryonic stage in 2009, the psychology of
the consumer was clearly undergoing a profound transformation. A new par-
adigm had emerged wherein consumers were owning less stuff and spending
less, but still finding creative ways to travel, commute to work, host dinner
parties and have memorable experiences.13”
The young people born between 1980 and 2000, the so-called Mil-
lennials, are the perfect example of this changing in consumer’s be-
haviour. By being the biggest cohort in a country, Millennials set glob-
al cultural trends14.
According to Goldman Sachs, Millennials hold different values than
the previous generations did at their age, including the hierarchy of
needs15. The must-haves for previous generations are not as important
for Millennials. Indeed, they are putting off major purchases, or avoid-
ing them entirely.

ii. Loss of confidence in the existing institutions and intermediaries


We are still assisting to a “financialization” period: a growth of the fi-
nancial sector, its increased power over the real economy, the explosion
in the power of wealth and the reduction of all of society to the realm
of finance16. The size of the financial sector peaked around 7.6 per cent
of GDP and, after a brief decline during the central years of the crisis,
returned to 7.3 per cent in 201417.
Thus, the above-mentioned financial crisis does not mean the death
of consumerism or the financial sector. Data, on the contrary, show that
the crisis had no discernible long-term impact on consumer trust, but it
has lowered for a period.

13
Olson, Michael and Connor, Andrew, 2013, The Disruption of Sharing, www.share-
ble.net.
14
U.S. Chamber of Commerce Foundation, 2012, Millennials Report, www.uscham-
berfoundation.org
15
Goldman Sachs, 2016, Data story Millennials.
16
Konczal, Mike and Abernathy, Nell, 2016, Financialization.
17
Konczal, Mike and Abernathy, Nell, 2016, Financialization.
Digital Society and Sharing Economy 69

Even though, the experience suggest that people’s behaviour is


changing: they are moving from mindless to mindful consumption.
The strong appetite of consumers in regards of sharing economy is a
manifestation of this changing.
In fact, the key defining characteristic of the sharing economy is the
existence of a platform connecting buyers and sellers and reducing
transactions costs.
This transaction cost is made up of search and information costs, bar-
gaining and decision costs and policing and enforcement costs. In some
cases, mutually beneficial transactions that could occur do not because
transaction costs are too high. Essentially, sharing economy emerged
because developments in information and communications technology
have significantly lowered transactions costs.
Reducing the transaction costs is also a way to reduce the distance
between buyers and sellers, cutting out inefficient intermediaries.
After the beginning of the crisis, there was an uptake in the savings
rate. Visa reports that less people are using credit card, by preferring
debit cards. This means that the consumers are starting to pay with
money that they own. It is, in part, a reaction to economic hard times.
But it is also closely related to the civic dissatisfaction that is rocking the
political establishment, and additionally has some roots in environmen-
tal awareness and changing aspirations.
In fact, a research proposed on Psychological Science shows that con-
fidence in institutions hit an all-time low in 2012 for both adults and
high school seniors18.
In this context, the sharing economy is not just a manifestation of our time,
but also a powerful tool in the hands of consumers for savings purposes.
This is happening because crisis has encouraged people to reconsid-
er what is valuable to them and how they want to get what they want.
Taking the United States as an example, the recession may be over,
but the values that emerged during it appear to be staying put—and the
sharing economy is giving new weight to the axiom “less is more.” 7 per
cent of consumers surveyed by PwC19 agreed that the sharing economy
reduces clutter and waste.

18
Twenge, Jean et al., 2014, Declines in Trust in Others and Confidence in Institutions
Among American Adults and Late Adolescents, 1972–2012, Psychological Science.
19
PwC, 2016, The Sharing economy, Consumer Intelligence series.
70 Growth Economics and Governance

Returning to savings, many of the users of these new services are


driven by price. More than half of North Americans consider switch-
ing from buying to sharing if it lets them save 25 per cent. Established
brands often compete with sharing startups on price when they launch
a marketplace of used goods or enable a marketplace of lower cost ser-
vice workers.

iii. Owning vs. sharing


On Why not share rather own? Russell Belk defines sharing as: “… an
alternative form of distribution to commodity exchange and gift giving. Com-
pared to these alternative modes, sharing can foster community, save resources,
and create certain synergies. Yet outside of our immediate families, we do little
sharing. Even within the family, there is increased privatization. Two recent
developments, the Internet and intellectual property rights doctrines, are locked
in a battle that will do much to determine the future of sharing. Businesses may
lead the way with virtual corporations outsourcing the bulk of their operations.
Whether virtual consumers sharing some of their major possessions are a viable
counterpart remains an open question”20.
Everybody can share, from individuals to nations. People may share
for individual or collectives purposes. It is possible to share for a pre-
scribed period or for a defined period.
But, “owning” and “sharing” are also concepts with the ability of
shape how human beings can define themselves.
As Zygmunt Bauman explains, in the hyper-consumerism human
beings are defined by what they owned, while in the sharing system
they are defined by community, by reputation, by what they can access
and how they share21.
According to the analysis concluded by PwC on the report The Shar-
ing economy, 43 per cent of consumers agree that owning today feels
like a burden. In addition, sharing economy alleviates the burden—the
burden of cost, of maintenance, of choice (or lack thereof) and countless
other variables22.
Goldman Sachs’ researches show that new generations are embrac-

20
Belk, Russell, 2007, Why Not Share Rather Than Own?, the ANNALS of the Ameri-
can Academy of Political and Social Science.
21
Bauman, Zygmunt, 2000, Liquid modernity, Polity Pr.
22
PwC, 2016, The Sharing economy, Consumer Intelligence series.
Digital Society and Sharing Economy 71

ing this wave, having a different approach on goods and services. In


fact, Millennials have been reluctant to buy items such as cars (only
15% believe that owning a car is extremely important), music and lux-
ury goods (only 10% define owning a luxury bag to be extremely im-
portant)23.
Derek Thompson and Jordan Weissmann define Millennials as the
“cheapest generation”24, because they are not buying cars or homes at
the rate the previous generations did. Instead, they are turning to a new
set of services that provide access to products without the burdens of
ownership, giving rise to what has being called a “sharing economy”.
Indeed, their comfort with technology concern for environmental
problems and the shift in consumption preferences make Millennials
receptive for the sharing.
Those changes do not necessarily imply to pick between owning or
sharing. In fact, this may mark the beginning of a permanent genera-
tional shift in consumption preferences and spending habits. However,
more likely, in the next future, most people will have the feet in both
camps, just as successful business models such as Airbnb may become a
hybrid of both traditional commerce and collaboration.

iv. Global commons


On The Global Idea of the Commons, Donald Nonini, defines the glob-
al commons: “…The great variety of natural, physical, social, intellectual,
and cultural resources that make human survival possible. By ‘the commons’ I
mean those assemblages and ensembles of resources that human beings hold in
common or in trust to use on behalf of themselves, other living human beings,
and past and future generations of human beings, and which are essential to
their biological, cultural, and social reproduction. Various kinds of commons
have long existed as viable and durable arrangements for providing for the
needs of human survival.”
According to this definition, the global commons goods can not be
circumscribed in the domains of private or public goods, but they exist
at the intersection of both of them.

23
Goldman Sachs, 2016, Data story Millennials.
24
Thompson, Derek and Weissmann, Jordan, 2012, The Cheapest Generation. Why
Millennials aren’t buying cars or houses, and what that means for the economy, www.the-
atlantic.com.
72 Growth Economics and Governance

There are three approaches to the global common and its preservation:
1. The first can be summarized as the “Leviathan coercion”. In this
position the political solution of the tragedy of the commons is
seen in a central government with control over the global com-
mon goods.
2. The other possibility is to grant private rights for using global
commons. On 1968, Garrett Hardin, biology and ecologist, wrote
The Tragedy of the Commons. He argues that, if a good belongs to
everybody, men have a natural tendency to exploit it according to
their own needs, by bringing the common to the deterioration25.
By taking the example of England during the Industrial era,
Hardin develops the theory that a private owner, as owner of
the surplus, would have had the interest of improving the land,
not just its exploitation.
3. Conversely, the third approach was find out by Elinor Ostrom,
winner of the Nobel Prize in 2009. She identifies the possibility
of a community management of global commons, which can en-
dure in time. The cases studies analysed by the author (commu-
nal tenure in high mountain meadows and forests in Switzerland
and Japan; irrigation institutions in Spain and the Philippines)
show that to cope with complex environmental conditions, peo-
ple usually decide to share what they own, according to rules
and agreements, giving value to what is shared26. Substantial
evidence has accrued that human actors are able to solve some
(but definitely not all) collective-action problems on their own
without external rules and enforcement imposed from the out-
side. Indeed, communities had always made up their own rules
for creating and maintaining local resources, ensuring equitable
ways of sharing their use and benefits.
This position can be-called the Co-governance approach27, which of-
fers a way to put the sharing paradigm into practice. Co-governance
implies taking decisions at the lowest possible level of authority, with

25
Hardin, Garrett, 1968, The Tragedy of the Commons: American Association for the Ad-
vancement of Science.
26
Ostrom, Elinor, 1990, Governing the Commons: The Evolution of Institutions for Col-
lective Action Cambridge University Press
27
Quillingan, James Bernard, 2008, People Sharing Resources: Toward a New Multilate-
ralism of the Global Commons, Kosmos journal.
Digital Society and Sharing Economy 73

the purpose of including in the decisions the people that directly affect
them. There is a real sharing of duties and decision-making over the
use and protection of the resources. Co-governance enables the devel-
opment of non-centralized rules and institutions with the function of
giving use, control, access and wealth generated on a commons.
In sum, Ostrom highlights that self-organized sustainable use can
emerge from collective effort among relatively equal users of global
commons goods where they are enabled to play a central role.

v. Empathic civilization
The Enlightenment has taught us to imagine human beings’ nature
as rational, autonomous, detached and utilitarian.
By taking Hobbes’ theory as an example, he defined individual as
selfish, concerned with self-preservation, searching for power andwar
with others. Consequently, in the state of nature, men are in a war of
all against all28. The solution proposed by enlightenment thinkers is a
nation-state with the aim of protecting property relations and stimulate
market forces and, like individuals, in an incessant battle with other
state in the pursuit of material gains.
However, recent discoveries in brain science have changed this vi-
sion, discovering mirror-neurons – the so-called empathy neurons29.
Men are not born with a bad inclination by nature. Indeed, the human
being comes to life ready to share, to feel and to empathize with the
state of mind of other men.
Mirror-neurons allow feeling and experiencing another’s situation as
if it were one’s own.
Starting from the discovery of mirror-neurons, James Rifkin wrote
his famous book The empatic civilization. In his book, Rifkin asks himself
about the mechanism to allow emphatic sensitivity to mature and ex-
pand through history30. The growth of empathy has been made possible
only by an increase in consumption of energy and natural resources,
which led to a drastic deterioration of the planet’s health.
Rifkin believes that we are assisting to a third industrial revolu-

28
Hobbes, Thomas, CreateSpace Independent Publishing Platform.
29
Rizzolatti Giacomo, 2004, The Mirror-Neuron System, Annual Rev. Neurosci.
30
Rifkin, Jeremy, 2009, The Empathic Civilization: The Race to Global Consciousness in a
World in Crisis.
74 Growth Economics and Governance

tion, thanks to the historic convergence of energy and communication.


During the Forum of the Public Administration held in Rome on 2016,
Rifkin reiterated the necessity to embrace the third revolution, even be-
cause everybody are already part of this revolution.
The distribution of renewable energies is coming together with the
Internet revolution, making possible an increase in empathy for the
Earth’s health.
The convergence of new technologies and renewable energy lies
in the dissemination and sharing. Facebook, Wikipedia, Twitter and
other Internet applications are typically born from below, with diffu-
sion-based systems, sharing, and participation. Rifkin wishes to apply
this system to the renewable resources. According to the author, every
home will be able to produce energy from the sun, the wind and so on.
The surplus not consumed by single house will be shared and made
available to the other and in accordance with the sharing model.
With just one glance to contemporary society, it is possible to con-
clude that empathy has been discouraged by consumerism. Human
beings are able to learn by imitation, and this faculty is at the basis of
human culture. The mirror-neuron mechanism appears to play a fun-
damental role in both understanding and imitation. However, consum-
erism disrupts this mechanism by distinguishing people from others
through consumption choices.
In addition, commercial capitalism tends to replace person-to-person
trust with trust in the market.
Notwithstanding, Rifkin believes that new technologies are challeng-
ing the consumerism mechanism. Press, radio, television and Internet
have developed stronger and broader forms of empathic consciousness.
In this sense, empathy is the first sharing form: a sharing of identity
and individuality.

vi. Human being


Yuval Noah Harari, the famous Israeli professor of history and writ-
er, in his bestseller Sapiens: A Brief History of Humankind tried to under-
stand what made humankind the most successful species on the planet.
He concluded that the real difference between humans and other an-
imals is on the collective level: people is able to cooperate on a regular
basis with complete strangers. Mankind is the only specie that can co-
operate in very large number and in a flexible way, thanks to the ability
Digital Society and Sharing Economy 75

of imagination. Indeed, only humans can create and, then, believe in


stories created by themselves.
Harari argues that all forms of mass-social human cooperation
works because people imagines that the rules, ideas and values im-
plied in these forms are real. Religion is an example of a mass-social
human form of cooperation. Religious people, believing in the same
fiction (God), can come together to build a place of worship or to fight
like in the case of crusades.
Consequently, all forms of cooperation have always played a funda-
mental part in human history and in its development.
However, there is just one fiction, invented by mankind, in which
everybody believes: money.
According to the author : “Money is accordingly a system of mutual
trust, and not just any system of mutual trust: Money is the most universal
and most efficient system of mutual trust ever devised” and “Money is more
open-minded than language, state laws, cultural codes, religious beliefs, and
social habits. Money is the only trust system created by humans that can bridge
almost any cultural gap, and that does not discriminate on the basis of religion,
gender, race, age, or sexual orientation.”
At a certain time in human history, money has been invested in order
to get more money than there was at the start. This is the so-called The-
ory of Primitive Accumulation31 created by Marx for explaining the rise
of capitalism. Capitalism is not just an economical phenomenon, but it
embraces all aspects of human lives.
With capitalism, the ideology of individualism took place32. At the
core of this ideology, there is the idea that all human beings are unique
and they should be free to pursue their own interests, without any out-
side input, in a framework of rules equal for all. Capitalism is set on the
basis of an individual utility maximizer - a selfish individual who goes
after what he or she wants.
According to Classical Economists33, the society is the sum of indi-
viduals who are able to achieve the general interest by following their
natural inclination to get the highest satisfaction. Consequently, market

31
Marx, Karl, 1867, Capital: Critique of Political Economy.
32
Weber, Max, 1922, Economy and Society.
33
Smith, Adam, 1776, The Wealth of Nations. Ricardo, David, 1817, Principles of Politi-
cal Economy and Taxation.
76 Growth Economics and Governance

relations are based on the freedom of everyone to make decision about


what to buy and to sell.
Adam Smith’s revolutionary theory is based on the idea that the self-
ish human urge to increase profits creates collective wealth and hap-
piness. In accordance with this theory, an individual becomes rich by
increasing the overall system, not by despoiling the others.
However, Adam Smith did not take into account the relation and con-
tradictions between morality and wealth. Individuals are not equal in the
market, coming in to it with different products and services to sell, dif-
ferent assets and different amount of money. As consequence, the market
does not bring freedom to all individuals, but it creates a subordination to
the richer. Furthermore, in a system built on individualism there is little
space for cooperation has intended by Yuval Noah Harari.
Capitalism thrives just in a consumer culture, because if no one is
buying product the system fail and breaks down.
The social consequences of this phenomenon are well described by Zy-
gmunt Bauman’s concept of “liquid modernity”34. Liquid modernity indi-
cates the impossibility of transforming the choices of individual in collec-
tive projects, due to the liquefying of social ties. In the liquid society, the
consumption is the parameter through which all other activities are judged,
by giving order to social priorities and by organizing social integration.
So, the liquid society draws the triumph of individualism, narcissism
and marketing.
In this context, the idea of “sharing” takes an important place, being
an alternative to consumerism and private ownership. “Sharing” is en-
able to stress and highlight that cooperation behaviour which, accord-
ingly to Yuval Noah Harari’s theory, makes humankind controlling the
world over the other species. Its impact is so fundamental in our society
because it is not just linked to a transformation in how we consume and
own, but it embraces also the way we produce, learn and interact with
each other and relate to natural resources and money. It represents a
breaking point in respect of the hyper-fast, hyper-modern consumerism
system of our time.
Moreover, in the sharing economy, people represent the earth; it is a
people’s economy, meaning that people are active citizens and partici-
pants of their communities and the wider society. The participants of a

34
Bauman, Zygmunt, 2000, Liquid modernity, Polity Pr.
Digital Society and Sharing Economy 77

sharing economy are individuals, communities, companies, organisa-


tions and associations. In the sharing system human being are like the
bees. The honeybee knows that it must protect and sustain bees of the
colony because every of them is important to the survival of the hive.
Human beings are also suppliers of goods and services; they are creators,
collaborators, producers, co-producers, distributors and re-distributors.
In a sharing economy, people create, collaborate, and produce.
Human beings are no longer passive consumers but “homepre-
neurs”35.
The “homepreneur” is a new class, both producer and consumer
who creates value at the same time as getting what he want from those
around. Micro-entrepreneurship is celebrated, where people can enter
into binding contracts with one another and trade peer-to-peer.
Within business, people – both co-owners, employees and customers
– are highly valued, with their opinions and ideas respected and inte-
grated into the business at all levels of the supply chain, organisation
and development.

vii. Trust and reputation: the new money


Rachel Botsman’s speech at Ted conference in 2012 is the most use-
ful explanation to understand the relevance played by trust and rep-
utation in the sharing economy36. She said: “…But the real magic and
the secret source behind collaborative consumption marketplaces like Airbnb
isn’t the inventory or the money. It’s using the power of technology to build
trust between strangers.” And “Reputation is the measurement of how much
a community trusts you.”
There is no control in the sharing system. Between consumers and
producers, there is no someone with the purpose of controlling the
transaction. Platforms are simple facilitators enabling peer-to-peer
transactions. What make these transactions possible is trust.
Businesses have always known the importance of earning and
maintaining the customer’s trust. However, social and mobile net-
works have changed the way it is possible to obtain trust. In fact, in the
contemporary highly connected world, a business is defined more by

35
Stephany, Alex, 2015, The Bussiness of Sharing. Making it in the New Sharing Eco-
nomy, Palgrave Macmillan.
36
Botsman, Rachel, 2012, The currency of the new economy is trust, TEDGlobal.
78 Growth Economics and Governance

how people experience it, and their opinion on it, more than by what
the brand say about itself37. In other words, technology is reinventing
the old forms of trust.
Brian Kramer, writer of the book Shareology, interviewed more than
one hundred people to understand why they share. He concluded that
there is only one core reason: self-perception38.
Technology has empowered people to share with global tribes and,
in the marketing world, has never more important to treat ourselves as
a sort of “personal brand”. Kramer argues that is through the creation
and the sharing of people’s personal brands that people perceive and
connect each others. He adds that personal brand, meaning also per-
sonal reputation, is equal to the perceived reputation of the content or
source that has being shared. This means that people only share some-
thing with others that is in line with how they perceive themselves or
they want to be perceived.
Like in the case of “personal brand” cited above, successful busi-
nesses, for instance Airbnb and BlaBlaCar, Uber etc. are able to build
a brand around a set of core values that reflect what is important for
their users. In fact, according to the author, people share on a platform
if they trust the company or identify with the content proposed by the
company.
Kramer concluded that business can earn people’s trust working
on humanizing every single interaction; empathizing with the users
by knowing exactly what they care about; knowing what the company
stand for as a brand; creating content that is shareable.
People relying on a business if the business can truly deliver on its
promise. Customers want be sure that their information will not be
shared with anyone.
According to Lisa Gansky too, trust is fundamental to any business,
but in the sharing businesses is even more important. Trust is social,
which makes business social; consequently, sharing businesses are hy-
persocial. In fact, sharing businesses create a myriad of relationships
and social connectivity, in which a high degree of trust is often required

37
Gansky, Lisa, 2012, The Mesh: Why the Future of Business is Sharing, Portfolio
Penguin.
38
Kramer, Brand,2016. Shareology, How sharing is powering the human economy, Mor-
gan James.
Digital Society and Sharing Economy 79

because human-to-human interaction, not a physical product, is often


the focus of the exchange39.
In practice, businesses construct trust on their platforms through
some tools: online reputational checks based in social networks. Through
these tools, strangers turn into real people with online identities and a
verifiable reputation. Once customer’s trust is earned, businesses are
constantly alert to the customer’s evolving needs with the purpose to
retain their loyalty anew with each interaction.
Turning back to Rachel Botsman’s speech, she describes reputation
as the “socioeconomic lubricant that makes collaborative consumption work
and scale”. Then, she underlines that people are starting to realize that
the reputation they generate in one place has value beyond the environ-
ments from which it was built.
So, Botsman suggests a sort of collection of an individual’s personal
reputation, with the aim of controlling it more; shaping it, and extract-
ing the immense value that will flow from it.
By creating a system like this, reputation turns into the currency that
says that you can trust me.
Moreover, reputation will be easier to shape that people’s credit his-
tory, with the ability of changing who has power, trust and influence.
In fact, Botsman concluded her speech by saying that the invention of
traditional credit transformed the consumer system, and in many ways
controlled who had access to what. Meanwhile in the 21st century, new
trust networks, and the reputation capital they generate, will reinvent
how we think about wealth, markets, power and personal identity, in
ways that people can not yet even imagine.

viii. Logic of the reciprocity


The theory of logic reciprocity is the alternative to the rational choice
theory of collective action, which holds that individuals can be expected
to contribute to societal goods only if pushed by material incentives. In
contrast, the logic of reciprocity holds that individuals will often con-
tribute voluntarily to collective goods though they believe that most
other individuals are willing to do the same.
The reciprocity theory is based on the perception that if others are be-

39
Botsman, Rachel and Rogers, Roo, 2010, What’s Mine Is Yours: The Rise of Collabora-
tive Consumption Harperbusiness.
80 Growth Economics and Governance

having cooperatively, individuals will be moved by altruism and they


will contribute to public goods. In contrast, when individuals perceive
that others are taking advantage of them, they will be moved by resent-
ment and pride.
The logic of reciprocity is strictly linked to the issues of trust pro-
posed above.
In this self-sustaining atmosphere, promoting trust acquire a central
role, being an alternative to costly incentive schemes for solving societal
collective action problems40.
Moreover, such incentives may well undermine the conditions of
trust necessary to hold collective action problems in check. Rewards
and punishments can imply that others have not the desire of coop-
erating voluntarily, a message that could indicate weaken individuals’
commitment to contributing to public goods.
Thus, material incentives may not only be an inefficient regulatory strat-
egy for solving collective action problems; it may often be self-defeating.
The experiments proposed by Boaz Keysar, Benjamin Converse, Ji-
unwen Wang, and Nicholas Epley show the asymmetry between pos-
itive and negative actions41. Positive actions, such as giving, should
elicit reciprocity in equivalent measure, whereas negative actions,
such as taking, should produce more selfish reciprocity. They con-
cluded that social exchange is based largely on the meaning of social
actions, rather than on the objective value of those actions. Positive
actions of giving are reciprocated in comparable measure, whereas
negative actions of taking are reciprocated more selfishly, and may be
followed by escalation.
The asymmetry demonstrated in this study represents “a basic el-
ement of reciprocity that occurs more generally for positive versus negative
actions, from compliments versus insults, to rewards versus punishments, to
helping versus hurting”.
Reciprocity is not new in the economic field. Since the classics of the
discipline, political economy has been associated with acts of exchange,
and exchange implies necessarily some form of reciprocity. An econom-

40
Kahan, Dan, 2002, The Logic of Reciprocity: Trust, Collective Action, and Law, Yale
Law School.
41
Keysar, Boaz, Converse, Benjamin, Wang, Jiunwen and Epley, Nicholas, Recipro-
city Is Not Give and Take Asymmetric Reciprocity to Positive and Negative Acts, University
of Chicago.
Digital Society and Sharing Economy 81

ic exchange a mutual relationship where two or more subjects give and


receive either simultaneously or sequentially.
Applying the logic of reciprocity to the sharing economy is not so
easy as it seems.
According to Russell Belk, sharing does not include reciprocity in
the classical sense, as it occurs in gift giving or commodity exchange42.
On the other hand, reciprocity seems to be ubiquitous in the sharing
economy, where we find plenty of business models comprising sharing,
swapping, bartering, commercial renting, leasing as well as buying.
An interesting research for understanding how important reciproc-
ity is for sharing and whether differences in balance of reciprocity per-
ception may lead to different outcomes is the one conducted in Couch-
surfing by Alina Geiger and Claas Christian Germelmann 43.
The findings of the studies shows that hosts generally welcome and
accept reciprocal behaviour, but that there is a different understanding
of what kind and how much reciprocity is appropriate. What is con-
sidered to be a sufficient, appropriate, and valuable compensation fur-
ther depends on the nature of the relationship between host and surfer.
For instance, during short-term stays, the host either gladly accepts any
kind of compensation offered by the surfer, or even expects the surfer
to reciprocate directly in order to achieve a balanced reciprocity imma-
terial compensation.
Couchsurfing is a peer-to-peer reality. A peer-to-peer economy is a
decentralized model whereby two individuals interact to buy or sell
goods and services directly with each other, without intermediation by
a third-party, or even business men. The buyer and the seller have direct
transactions with each other. Because of this, the producer owns both
their tools (or means of production) and their finished product.
Since a third party is removed from the transaction, there is a greater
risk that the provider may fail to deliver, that the product will not be of
the quality expected, or that the buyer may not pay.
In this situation, the logic of reciprocity plays a fundamental role for
controlling behaviour and building trust.
In other terms, it is possible to say that what move individuals’ be-

42
Belk, Russell, 2010, Sharing, The Journal of Consumer Research, Chicago Press.
43
Geiger, Alina, Germelmann, Claas Christian, Thank Me for Hosting:” The Role of
Reciprocity in Sharing, www.researchgate.net
82 Growth Economics and Governance

haviour towards a smooth exchange of a good or a service through shar-


ing, swapping, bartering, commercial renting, leasing or buying is the
logic of reciprocity.
Might it be reasonable to asserts, as in the case of collective goods,
that individuals who share will often act in a proper way if they believe
that most other individuals are willing to the same. In this context, the
system of reputation become the tool through which the logic of reci-
procity takes place.

5.4. Contribution of growth theories to Sharing Economy

i. Entrepreneurs, creative distruction and the Sharing Economy


Schumpeter’s description of entrepreneur perfectly fits with the fig-
ure of entrepreneurs in the sharing economy field.
With just one glance to the successful stories behind the rise of busi-
ness such as Airbnb and BlaBlaCar, it is possible to notice how funda-
mental the role of their funders is.
No one more than “sharing entrepreneurs” is a taker of risks and
nobody introduces innovative products and new technology into the
economy than them.
A start-up is a company just beginning to develop. Usually, they
are small and initially financed and operated by few founders or one
individual. They offer a product or a service not currently being offered
elsewhere in the market, or that is being offered in an inferior manner.
The figure of entrepreneur proposed by Schumpeter is the only who
could have success in the market by creating a start-up.
According to Daniel Goleman, writer of “What Makes a Leader” 44, five com-
ponents allow the best leaders to maximize their performances: self-aware-
ness, self-regulation, motivation, empathy, social skills as follows:
1. Self-awareness is the ability to recognize and understand the
moods, emotions, and drivers of their clients.
2. Self-regulation is the ability to control or redirect disruptive im-
pulses and moods; the ability to think before act.
3. Motivation is the passion to work for reasons that go beyond
remuneration.

44
Goleman, Daniel, 2004, What Makes a Leader, Emotional Intelligence, Harvard Busi-
ness Review.
Digital Society and Sharing Economy 83

4. Empathy is the ability to treat people according to their emotion-


al reactions.
5. Social skill is the ability of managing relationships and building
networks.
Regulatory system and, more in general, governments could draw
important lesson from this theory and apply it to sharing economy and
“sharing entrepreneurs”.
If entrepreneurs are drivers of economic growth, the regulatory sys-
tems and governments should not limit their activities; in contrast, they
should provide different tools to aid them to develop.
Many cities have already grasped Schumpeter’s exhortation, by build-
ing up a virtuous system of infrastructure and regulatory system enabling
entrepreneurs to be the force of innovation that Schumpeter’s hoped45.
In respect of another aspect sharing economy is linked to the concept
of “creative deconstruction”.
By applying innovative technologies, entrepreneurs inevitably de-
construct long-standing arrangements and frees resources.
Sharing businesses are one the main example of disruptors in economy.
Due to Internet and technological progresses, current time is the time
when an entire industry can be disrupted by one revolutionary idea46.
Many start-ups are changing the rules of the game, forcing everyone
else to play along or disappear from existence.
Sharing businesses create disruptive products, which are able to
transforms a market, sometimes to the point of upending previously
dominant companies.
A disruptive product will generally underperform with regards to
former products in the market, but they will offer a distinct set of ben-
efits, typically focused around being cheaper, more convenient, or sim-
pler. Consequently, the disruptive product appeals to the low-end of
the market or creates a completely new market47.
A cardinal principle of economics is that efficiency focused innova-
tions drive away all inefficiencies from the system.

45
Driessen, Martyn, The role of the entrepreneur in small business success: the Entrepre-
neurship Scan, University of Groningen.
46
Owyang, Jeremiah and Samuel, Alexandra, 2015, The New Rules of the Collaborative
Economy, www.visioncritical.com
47
Guttentag, Daniel, 2013, Airbnb: disruptive innovation and the rise of an informal touri-
sm accommodation sector, Current Issues in Tourism
84 Growth Economics and Governance

The example of Airbnb is the best way to clarify how sharing busi-
nesses are creative destructors.
Traditionally, in the tourist market individuals who are booking an
accommodation use renting rooms from formal businesses, such as ho-
tels. Airbnb has disrupted this model by providing an online market-
place that permits the large-scale rental of spaces from one ordinary
person to another – the so-called peer-to-peer accommodation system.
By exploiting the potential of internet technologies, Airbnb overcame
the two main difficulties for building up a peer-to-peer accommodation
system: trust between providers and users, and making known the ac-
commodations of guests.
For the trust’s issue, as many people will understandably be wary of
hosting a stranger or sleeping in a stranger’s home, Airbnb’s key trust
mechanism is its review feature, which allows hosts and guests to post
public reviews about one another48.
In addition, Airbnb has made it simple for hosts to post descriptions
and photographs of their spaces, communicate with guests, and take
reservations and payments.
All the features described above have permitted Airbnb’s innovative
business model, but for actually being disruptive there must be demand
for a product. The characteristic that creates a huge demand for Airb-
nb’s services is that accommodation is typically cheaper than tradition-
al accommodation, and that introduces additional benefits associated
with staying in a residence.
The cost is so low because the primary fixed costs (i.e. electricity) are
already covered, the hosts generally have minimal or no labour costs,
the hosts are generally not fully dependent on their Airbnb revenue,
and the hosts generally do not charge taxes.
Moreover, there are other benefits that push guests to prefer Airbnb
to a traditional hotel.
For example, some tourists may prefer the feeling of being in a home,
and Airbnb hosts may be able to provide useful advice. Airbnb guests
also will often have access to practical residential amenities, such as the
possibility of using a kitchen.
In short, innovative technologies, cost-saving, household amenities,

48
Guttentag, Daniel, 2013, Airbnb: disruptive innovation and the rise of an informal touri-
sm accommodation sector, Current Issues in Tourism
Digital Society and Sharing Economy 85

and the potential for an authentic local experience make Airbnb a pow-
erful example of “creative deconstruction.
Understanding the reasons - in particular how it uses internet tech-
nologies- of the striking growth of Airbnb could also be a model for
other start-ups and, more in general, to whoever desires to become an
entrepreneur.
Furthermore, sharing economy is a creative destructor in another
sense. It is not just disrupting in regards of economic sectors or prod-
ucts, but it is changing the way individual perceive consumerism.
In other words, sharing economy is even change individuals’ way of
consumption.
Adjusting to a consumer who does not necessarily buy, but rather
rents, it would necessitate a shift in production, sales, and even employ-
ment structures.
In fact, the mainstream thought that owning property is fundamen-
tal for individual identity has been changed by Millennials who have
forced the markets to make way for social networks building a steady
replacement of ownership by access49.

ii. The Harrod-Domar model and the Sharing Economy


Sharing businesses could learn important lessons through the Har-
rod-Domar model. In fact, most of the accomplishments of the model
could play as essential part to these businesses, too.
To begin with, the model highlights the most important factor for the
economic growth: the process of capital accumulation.
Looking at the model is clear the central role of investment for achiev-
ing growth. Indeed, net additions to the capital stock in the form of in-
vestments will bring about a corresponding increase in output.
Lot of sharing businesses focus on investment, because many new
technologies are inherently capital-intensive. To build a company such
as Airbnb and BlaBlaCar, entrepreneurs need lots of investment.
Another lesson could be drawn by the warranted growth rate, which
it should keep in mind by entrepreneurs because it is the rate at which
they will be satisfied of their investment.
Moreover, the Harrod-Domar model underlines that to achieve full
employment of capital and labour the actual growth rate should be

49
Sethi, Rajat, 2014, Sharing economy: A Case for Creative Destruction,www.medium.com
86 Growth Economics and Governance

equal to the warranted growth rate that, in turn, should be equal to the
natural growth rate.
Finally, it is through the divergence of the rates cited above that the
so-called “Smart cities” (for “Smart Cities”, see chapter 6), wishing to
apply the sharing economy system, should take into account the Har-
rod- Domar model.
In many cities, natural growth rate exceeds the warranted growth
and this will lead to depression.
In fact, due to growing urbanization in the cities, it should happen
that the effective labour force is increasing faster than capital accu-
mulation, leading to a rise of unemployment. Moreover, the diver-
gence between the rates implies greater plans to invest than plans to
save, which, in turn, lead to inflationary pressure. In order to cope
with inflationary pressure and unemployment there are different
possibilities:
 Firstly, it is possible to reduce the rate of growth of the labour
force; measures to control population growth are an example.
 Second, it could be useful a reduction in the rate of growth of
labour productivity.
 Third, there is the possibility of an increase in the saving ratio.
Finally, the use of more labour-intensive techniques with the pur-
pose of reducing the capital-output ratio.
Labour-intensive techniques are those techniques that use compar-
atively lesser amount of capital and greater amount of labour. In other
words, the term indicates that less of capital and more of labour is re-
quired for the process of production.50
Some synergies between sharing economy and the concept of la-
bour-intensive techniques could be noticed.
It is not the case of companies as AirBnb and BlaBlaCar, which re-
quire a huge amount of capital.
However, many of the newly born start-ups use this type of tech-
niques, thanks to technologies.
Internet technologies are much less capital-intensive than important
technologies of ages past.
For instance, building or renting a factory needs a greater amount of
capital.

50
Das, Shiti, Labour and Capital Intensive Techniques, www.yourarticlelibrary.com.
Digital Society and Sharing Economy 87

In contrast, creating a platform on Internet is easier and, undoubted-


ly, cheaper.
Moreover, many of these Internet-based platforms imply the use of
skilled or unskilled workers: idle capacities now can be shared and of-
ten monetized.
It is still too early to predict the impacts on employment and on la-
bour conditions. For instance, critics see the sharing businesses as re-
sponsible of creating a class of “precariat51”.
In short, sharing economy contains good premises, but the effects of
the phenomenon will be assess in the next future.

iii. Human capital and the Sharing Economy


Growth theories outline also the fundamental role played by hu-
man capital in businesses’ growth, and this applies to sharing busi-
nesses, too.
Investment in human capital is strictly linked to technological prog-
ress and it embeds all the improvements in the education, health and
skills of the labour force52.
Taking another time Airbnb as example, it is not surprising that in
the current year, Airbnb results, on the website Glassdoor53, the best
place to work in.
Innovative products require prepared and motivated people and
many sharing businesses understood and apply investments in capital.
Some of the benefits provided by Airbnb to its workers are health, vi-
sion and dental insurance; maternity and paternity leave; the possibility
of working from home; free lunch or snacks, a pet friendly workplace;
employee discount; company social event; job training.
Concerning the job training, and more in general, education, the
growth theories strongly highlight the impact of it on human capital.
In fact, they assess three main ways in which education can improve
growth performance, which are true also for sharing businesses;
 Firstly, education improves the quality of labour, and also the
quality of physical capital through the application of knowledge.

51
Roose, Kevin, 2014, The Sharing Economy Isn’t About Trust. It’s About Desperation,
New York Magazine.
52
Thirlwall, 2011, Economics of Development, Palgrave.
53
Airbnb Benefits, www.glassdoor.com.
88 Growth Economics and Governance

 Secondly, education has spillover effects on other sectors of a


company.
 Last, education is one of the most important inputs into research
and development field and for attracting investment.

5.5. The relevant economic aspects of sharing economy: some


conclusion

Now, the core problem concerns the main economic aspects proposed
by the rise of the sharing economy.
For this purpose, the first paragraph will be dedicated to the theory
of prosperity without growth as proposed by Tim Jackson.
Following this, the exam will be on sustainable consumption and pro-
duction and, more in details, the focus will be on the analysis proposed
by Jeremy Rifkin on the necessary path for achieving sustainability.
Then, there will be an analysis of the concept of co-production and
how it is embraced by many sharing businesses.
In conclusion, a brief description on the most efficient ways to fi-
nance sharing businesses will end the paragraph.

i. Prosperity without growth


For the purpose of the sharing economy analysis, the theory of
prosperity without growth, proposed by Tim Jackson, deserves a spe-
cific description54.
Tim Jackson, professor at the University of Surrey, proposes a deep
analysis of the concept of prosperity, starting from the prediction that a
new era of high growth is inconceivable.
To begin with, Tim Jackson tries to understand the real meaning of
prosperity.
He argues that prosperity has been often compared and assimilated
in the concept of GDP.
Neoliberal economists, for instance, tend to see the economy and,
more in general, society depending on continued growth achieved by
attracting capital to invest in new development and infrastructure, and
on attracting skilled entrepreneurs by offering masses of consumer and
cultural choice. This is could be true, but it is just one side of the coin.

54
Jackson, Tim, 2009, Prosperity Without Growth, Earthscan.
Digital Society and Sharing Economy 89

Indeed, Jackson states that by focusing on GDP, the annual marketed


flow of final goods and services, the analysis does not take into account
the so-called throughput, which he defines as “the metabolic flow of useful
matter and energy from environmental sources, through the economic subsys-
tem (production and consumption), and back to environmental sinks as waste.”
One of the aims of Jackson’s work is to teach humanity that the world
should stop before the extra social and environmental costs that it caus-
es exceed the extra production benefits that it produces.
In addition, Jackson strongly believes that a new era of high growth
is inconceivable, as the economic system has reached the limits of land
availability, climate change, and energy prices.
Thus, the definition provided by the author of prosperity consists in
the people’s ability to flourish as human beings within the ecological
limits of a finite planet. In fact, prosperity is about things going well, in
accordance with hopes and expectations.
The idea proposed by the author is a prosperity in which it is possi-
ble for human beings to flourish, to achieve greater social cohesion, to
find higher level of well-being without increase the material impact on
the environment.
Jackson uses the terms capability to flourish following the analysis
and definition proposed by Amartya Sen on “living standard”. Capa-
bility to flourish means that in a liberal society, people should have
the right to choose whether or not to participate in society, to live a
healthy live, to work.
Jackson adds that prosperity is often inextricably linked to the pros-
perity of those around. In this case, prosperity is a shared vision, which
translates itself into a vision of human progress.
Prosperity, in this sense, speaks of the elimination of all the con-
straints (i.e. hunger) to enjoy a good life for all the humanity.
According to the author, the legitimacy of the means to live well is
part of the glue that keeps society together. Therefore, the collective
meaning could extinguish, when the hope of translating prosperity into
reality is lost.
Jackson’s analysis highlights that humanity is failing in the task of
reaching a sharing and lasting prosperity. Indeed, he argues that peo-
ple’s reality is mis-aligned with any meaningful expression of prosperi-
ty and that the vision of social progress that drives people is fundamen-
tal untenable.
90 Growth Economics and Governance

Capabilities for flourishing means also that people have the freedom
of choice. However, in a finite planet, certain kind of freedom are im-
possible or immoral.
For this reason, Jackson defines the capabilities of flourishing as a
“range of bounded capabilities” to live well within certain limits.
The limits are established in relation to two critical points and, with-
out the respect of these conditions, it is impossible to reach a fair and
lasting prosperity:
 The first limit is the finite nature of the planet.
 The second is in relation of the scale of the increase of global
population.
To solve the dilemma of growth, Jackson proposes the concept of
“decoupling”.
According to “decoupling” approach, economic output becomes
progressively less dependent on material throughput. In other words,
through decoupling, economy can continue to grow without breaking
ecological limits.
Jacksons distinguishes between “relative” and “absolute” decoupling.
Relative decoupling means a decline in the ecological intensity per
unit of economic output. Resource impacts decrease relative to the GDP.
However, they do not necessarily decline in absolute terms. Simply stat-
ed, it is doing more with less. More economic activity with less environ-
mental damage.
Conversely, absolute decoupling means that resource impacts de-
cline in absolute terms. It is in this latter situation that economic activity
is to remain within ecological limits.
According to Jackson, decoupling has a clear appeal for business-
es because is about doing things more efficiently. Resources inputs
in fact represents a cost to producers. Thus, the profit motive should
stimulate a continuing search for efficiency improvement in industry
to reduce input costs.
Turning back to the dilemma of growth, for solving the problem,
resource efficiencies must increase at least as fast as economic output
does. And, they must continue to improve as the economy grows.
This is the case of absolute decoupling.
Following Jackson thought, it is possible to argue that the sharing
economy can enter in the framework of the decoupling approach.
Indeed, the sharing of resources is part of the fabric and eco-system
Digital Society and Sharing Economy 91

of a sharing society, in which externalities are always considered and


integrated.
Sharing, swapping, and so on have the impacts of producing a cer-
tain amount of output by avoiding the exploitation of natural resources.
In fact, the products implied in those exchanges already exist and they
do not need other inputs to be created or modified.
These are all results of the advances in technology, which in turn are
the basis for enabling the sharing economy.
Taking Airbnb as example, it is clear how hosts can obtain money
without implying any impacts for the environment. The good is the
home, apartment, or bedroom, which already existed and are shared
with guests, giving hosts an economic gain.
In addition, the author presents, as useful path to reach prosperity as
described above, a change in the social logic. This is exactly the change
in consumer’s behaviour that is happening through the rise of the shar-
ing economy.
In the sense of cutting economic impacts, the decoupling approach
and, more generally, the prosperity without growth proposed by Tim
Jackson, are closely linked to the concepts of sustainable consumption
and production, which, in turn, could be easily link to another famous
theory: the Third Industrial Revolution proposed by the economist Jer-
emy Rifkin.

ii. Sustainable consumption and production


Sustainable consumption and sustainable production are two con-
cepts closely linked with one another. They have been defined during
the Conference of Oslo in 1994 as “the use of services and related products,
which respond to basic needs and bring a better quality of life while minimizing
the use of natural resources and toxic materials as well as the emissions of waste
and pollutants over the life cycle of the service or product so as not to jeopardize
the needs of further generations.”
How the concepts of sustainable consumption and production are
closely linked to the sharing economy could be well explained through
Jeremy Rifkin’s thought.
It has been already mentioned the so-called Third Industrial Revolu-
tion prophesized by Jeremy Rifkin.
However, it is necessary a deeper analysis of his thought which is the
best and more complete overview on reaching sustainability.
92 Growth Economics and Governance

Rifkin highlights that the laws of thermodynamics govern all eco-


nomic activity, and the so-called “entropic bill” for the First and Second
Industrial Revolution has already arrived.
Stated simply, the first and second laws of thermodynamics state that
the amount of energy in the universe remains the same, fixed. However,
energy is continuously changing form: from available to unavailable.
Therefore, no energy is lost, but the dispersed energy is no longer ca-
pable of being used for any type of work. The term to call the no-lon-
ger-usable energy is entropy.
According to Rifkin, this happens also in the economic activities. The
energy embedded in the production of goods and services is always
used and lost in moving the economic activity along the value chain.
Thus, the “entropic bill” can be defined as the loss in the energy used
to convert natural resources into economic value.
According to the economist, the bill has now came due. Climate
change, destruction of the Earth’s biosphere, and biodiversity are just
some of the emanations of the exhaustion of this economic model55.
For this reason, Rifkin prophesizes and hopes a shift towards a Third
Industrial Revolution and, consequently, to a new economic model.
To begin with, Rifkin analyses the elements that are required for ev-
ery rise of a great economic paradigm56.
The elements found out by Rifkin are three, each of which inter-
acts with the others to enable the system to operate as a whole: new
communication technologies to manage more efficiently economic ac-
tivity; new source of energy to empower more efficiently economic
activity; and new modes of transportation to more efficiently move
economic activity57.
For instance, Rifkin explains that the First Industrial Revolution had
all the three elements, having the convergence of the rise of the tele-
graph and steam-powered printing (new communication), abundant

55
Rifkin, Jeremy, 2016, One Belt, One Road: Ushering in a Green Internet Plus Third
Industrial Revolution in China, the European Union and across Eurasia, speech at Foru-
mPA conference, Palazzo dei Congressi, Roma.
56
Rifkin, Jeremy, 2016, One Belt, One Road:Ushering in a Green Internet Plus Third
Industrial Revolution in China, the European Union and across Eurasia, speech at Foru-
mPA conference, Palazzo dei Congressi, Roma.
57
Rifkin, Jeremy, 2013, The Third Industrial Revolution: How Lateral Power is Trasfor-
ming Energy, the Economy and The World, Griffin
Digital Society and Sharing Economy 93

coal (new energy), and locomotive on national rail systems (new modes
of transportation).
According to Rifkin, the European Union and China are now laying
the ground work for the Third Industrial Revolution.
He argues that China and European Union are trying to build up a
new high-tech Eurasian Silk Road to connect the Eurasian land mass in an
integrated market, fostering the transition to a Third Industrial Revolu-
tion and an ecological, sustainable civilization.
This adaptation of the historical Silk Road, which is commonly called
One Belt, One Road, is in fact an attempt to create an economic land belt
that includes countries on the original Silk Road58.
Rifkin outlines that the three elements are putting in place by both
the European Union and China, thanks to the digitalization. Indeed, he
says “the digitalized communication Internet is converging with a digitalized
renewable Energy Internet, and a digitalized automated Transportation and
Logistic Internet, to create a super-Internet of Things (IoT) infrastructure”59.
According to Rifkin’s analysis, it is through the evolution of the Inter-
net of Things that the Third Industrial Revolution is on its path.
The Internet of Things represents the first element for reaching the
Third Industrial Revolution. Indeed through the rise and implementa-
tion of the Internet of Things - as we already argued - every device will
be able to communicate with each other and Internet users, moving eco-
nomic activity in a smart digital society.
Turning to the element regarding the new source of energy, he
analyses that millions of people in Europe have transformed their
homes and businesses into micro-power plants to harvest renewable
energy onsite, and the Internet of Things will enable the adopters to
monitor their electricity usage in their buildings, and share their sur-
plus green electricity with others across nations and continents on a
smart Energy Internet.
This process is defined by Rifkin as the democratization of energy, a
phenomenon that is forcing electricitycompanies to rethink their activ-
ities, because they are not anymore the exclusive producers of energy.

58
A Brilliant plan One Belt, One Road, 2015, www.clsa.com
59
Rifkin, Jeremy, 2016, One Belt, One Road: Ushering in a Green Internet Plus Third
Industrial Revolution in China, the European Union and across Eurasia, speech at Foru-
mPA conference, Palazzo dei Congressi, Roma.
94 Growth Economics and Governance

Consequently, many electricity companies are changing their busi-


ness model to survive in the new Energy Internet Era. Moreover, the
process described above will lead power companies to manage energy
in a more efficiently way, and to sell less rather than more.
Following Rifkin’s theory, the functioning of the “Energy Internet”
is based on five foundations pillars, enabling the transformation to a
distributed electricity system and to renewable energy:
 First, buildings and infrastructures will need to become more
energy efficient for installing renewable energy technologies.
 Second, it is necessary to set ambitious targets to replace tra-
ditional sources with renewable resources, by encouraging
feed-in tariffs.
 Third, for managing energy, the storage technologies will need
to be embedded at local generation sites.
 Fourth, digital technologies will need to be installed in every
building to transform the system in to digital connectivity in or-
der to manage multiple sources of energy.
 Fifth, every parking space will need to be equipped with a
charging station to allow vehicles to charge.
The Communication Internet and Energy Internet also affect trans-
portation and logistics fields, turning them in what Rifkin calls the au-
tomated Transportation and Logistics Internet.
In the Transportation and Logistics Internet era, through the In-
ternet of Things, people will have real-time logistical data, traffic
flows and weather conditions, and information on warehouse stor-
age capacities on route. Moreover, the impact on shipment will be
great, by using Big Data and analytics to create applications for the
optimization of the efficiency.
Transportation and Logistics Internet impacts also the very way peo-
ple view mobility.
Data on Millennials proposed by Goldman and Sachs show how
young people prefer having access to mobility rather than ownership
of vehicles60.
Rifkin foresees a transition from ownership of vehicles to access to
mobility in driverless vehicle on smart road systems. Indeed, he prophe-
sizes that by 2025, some of the shipment will be carried out by driverless

60
Goldman Sachs, 2016, Data story Millennials.
Digital Society and Sharing Economy 95

electric, powered by nearly zero marginal cost renewable energies, and


operated by sophisticated algorithms and analytics61.
As in the case of the Energy Internet, the Transportation and Logis-
tics Internet have some fundamental pillars to operate efficiently that
can be summarised as follows:
 First, Rifkin outlines again the need for charging stations for ve-
hicles.
 In order to collect data on logistical flows sensors will need to be
embedded in devices across logistics networks.
 Then, the storage and transit of all physical goods will need to
be standardized to make the process easier and more efficient.
 Finally, all logistical operators need to bring all their assets into
a logistical space to take advantage of lateral economies of scale
and to make more efficient the shipment of goods.
As it has been argued above, the three elements of the Internet of
Things, the Energy Internet, and the Transportation and Logistics Inter-
net enable the rise of a new economic system.
Indubitably, they are forcing to a reassessment of the nature of pro-
ductivity and a new understanding of ecological sustainability in pro-
duction and consumption, leading to a wholesale rethinking of econom-
ic theory and practice.
Following Rifkin, the result of a fully-digitalized economy leads to a
more ecological sustainability by decreasing the amount of information,
energy, material resources, labour, and logistics necessary for the pro-
duction, storage, distribution, consumption, and recycle of goods and
services toward near zero marginal cost. Moreover, he argues that the
rise of sharing economy has influenced the amount of products. In fact,
more people are sharing fewer items, resulting in fewer resources being
used up and less gas emitted into the atmosphere.
For this reason, Rifkin highlights that the sharing economy is the
most ecologically efficient economy achievable.
In fact, the products in the sharing economy succeed in grasping the
core ideas of the concepts of sustainable consumption and production.
In a sharing economy the use of natural resources and toxic materi-

61
Rifkin, Jeremy, 2016, One Belt, One Road: Ushering in a Green Internet Plus Third
Industrial Revolution in China, the European Union and across Eurasia, speech at Foru-
mPA conference, Palazzo dei Congressi, Roma.
96 Growth Economics and Governance

als are minimized because of the sharing nearly free green energy and
redistribution of goods and services in the system. Reselling, giving,
swapping, lending and renting are all ways to increase the usage dura-
tion of resource-consuming goods.
This is exactly what Tim Jackson hoped through his theory of pros-
perity without growth.
Few could disagree that many sharing businesses have environmen-
tal benefits, such as potential energy saving and resources efficiency
that result, for instance, from car sharing and bike sharing.
The shift in consumer’s behaviour from ownership to access is one of
main advances toward sustainable consumption.
Indeed, Rifkin says that millions of people are already transferring
part of their economic life to the sharing economy.
Moreover, in the sharing economy, changes in behaviour are hap-
pening also between entrepreneurs, which propose goods and services
designed for sustainability rather than obsolescence, promoting not
only the re-use of resources, but also models that have a positive impact
on the planet62.

iii. Co-production and core economy


Another fundamental economic aspect of the sharing economy is
represented by “co-production”.
The term was coined in 1970 by Elinor Ostrom, professor at the Uni-
versity of Indiana, in relation to the situation of the Chicago police. She
used co-production as a way of explaining why the police needs the
community as much as the community needs the police. In other word,
the public safety is a jointly product by the community and the police.
And, at that time, this process was undermined by the removal of the
police from the beat, into patrol cars.
Stated simply, the concept indicates that public services are co-pro-
duced by both paid and unpaid labour. Each help the other to do their
work effectively, and jointly they produce the service that is needed63.
It was used again by Anna Coote and others at the Institute for Public
Policy Research and the King’s Fund to explain why it is necessary an

62
Motofska, Benita, 2016, What is the Sharing Economy, www.peoplewhoshare.com
63
Peterson, Paul, 2009, Nobel Prize Winner Elinor Ostrom and Her Theory of Co-Pro-
duction, www.educationnext.org.
Digital Society and Sharing Economy 97

outcome of co-production between doctors, their patients, and families


and communities supporting those patients. Indeed, when that relation-
ship is forgotten, both sides fail64.
Then, the concept has been developed and deepened by Professor
Edgar Cahn, the Washington civil rights lawyer, who recognised how
important neighbourhood level support systems are, and that these are
economic activity, but in the broadest sense.
Co-production challenges the assumption that service users are pas-
sive recipients and recognises their contribution in the successful de-
livery of a service. At the same time, it involves the empowerment of
front-line staff in everyday dealings with customers.
In sum, co-production means growing communal forms of collabo-
ration and sharing in social infrastructure and services. More broadly, it
consists in the production and delivering goods and services in a recip-
rocal way between users and producers.
From the time of ancient Greek philosophers, family and community
relationships were defined as a second economy, originally called oe-
konomika. In more recent time, economists have demoted it by calling
it the non-market economy.
It was through the analysis of the environmental economist Neva
Goodwin that the hierarchy has been reversed by calling it the ‘core
economy’65.
The core economy is an operating system consisting of family, com-
munity, civil society, and neighbourhood which rely on the specialised
services of a society, such as healthcare, education and crime.
The core economy is vast, both in its range of activities and its eco-
nomic impact.
Poverty, low levels of trust or social infrastructures, isolation and so
on are all manifestations of free-riding on the core economy.
Considering this, the aim of co-production approach is to rebuild
and reinvigorate this operating system, by realising its potential.
The focus is to encourage people to use the human skills and experi-
ence they have to help deliver public or voluntary services.
In order to make the engine work, it is necessary to: treat people as

64
Coote, Anna, 2011, The Great Transition: Social justice and the core economy,
www.neweconomics.org.
65
Stephens, Lucie et al., 2008, Co-production, www.neweconomics.org.
98 Growth Economics and Governance

assets, not burdens, by providing opportunities for personal growth


and development; invest in strategies that develop the emotional intelli-
gence and capacity of local communities; use peer support networks in-
stead of just professionals as the best means of transferring knowledge
and capabilities.
It goes without saying that sharing economy models have helped
accelerating and uptaking co-production in many fields.
To begin with, it has already been noticed the ability of sharing par-
adigm in enhancing trust between strangers, which is one of the funda-
mental points proposed by the co-production approach.
Moreover, many sharing businesses have the purpose of aggregating
users to collectively invest in a good or a service useful for all.
Taking the healthcare sector as example. There are different plat-
forms, such as Patients Like Me that have a sharing soul. Indeed, Pa-
tients Like Me (PLM) is an online community where patients share their
personal experiences with a disease, find other patients like them, and
learn from each other. This platform has the capacity of co-producing a
“second opinion” on a disease, psychological support, reinforcement of
preventive initiatives, being able of reduce isolation of a patient66.
In the education field, the co-production appears to have a massive
potential. Thus, many entrepreneurs have already built up peer-to-peer
learning platforms.
Tandem, a community of language learners, is an example. Tandem
is a mediated commercial peer-to-peer language-sharing marketplace,
where people can share their language knowledge thanks the platform.
In the education sector, whether face-to-face or online, students learn
to be proactive and co-produce with their peers67.
Finally, in the energy sector, it is possible to find a lot of sharing
businesses (and traditional businesses, too) aggregating householders
who want solar on their own roofs, and others offering the opportunity
to collectively invest in solar gardens68.
In this framework, the sharing model looks like an emerging and
innovative production model in which the creative energy of citizens

66
Gupta, Sunil and Riis, Jason, 2011, PatientsLikeMe: An Online Community of Patients,
Harvard Business Review.
67
About Tandem, www.tandem.net
68
McLaren, Duncan and Agyeman, Julian, 2016, Sharing cities. A case for Truly Smart
and Sustainable cities, The MIT Press.
Digital Society and Sharing Economy 99

is coordinated, through a digital platform, outside of the parameters of


the traditionally hierarchical and mercantile organization resulting in
the public provision of common resources.

iv. “Venture capital”, “business angel”, “crowd-funding”


Now, the analysis will be on how sharing businesses finance
themselves.
These enterprises can be financed at three levels. First, pre-seed
financing is typically involved in the analysis and evaluation of the
idea. Secondly, seed financing intervenes in the testing phase of the in-
novative idea. Thirdly, start up financing occurs at an advanced stage
of the idea. The idea became a prototype that must be checked for
commercial validity.
Start-ups – as newly born companies or ventures with limited op-
erating history – lack access to capital markets and thus to traditional
source of financing.
Furthermore, they cannot raise funds by issuing debt.
For this reasons, entrepreneurs face the lower risk for financing their
companies through “Venture capital” or through “Business angel”.
Not all venture capital investments take place when a company is
first being founded. Venture capitalists can provide funding throughout
the three stages of a company’s progression69.
Venture capital is a type of funding for a new or growing business.
It usually comes from venture capital firms that specialize in building
high risk financial portfolios. In this system, the venture capital firm
gives funding to the start-up company in exchange for equity in the
startup. This is most commonly found in high growth technology in-
dustries like biotech and software70.
A business angel or business investor can be defined as a former en-
trepreneur or professional who provides starting or growth capital in
promising ventures, and helps with advice and contacts. Unlike ven-
ture capitalists, angel investors usually operate alone (or in very small
groups) and play only an indirect role as advisors in the operations of
the investee firm. They are deemed to be ‘angels’ in comparison with
grasping investors who are termed ‘vulture capitalists.’

69
Brooks, Chad, 2013, What is Venture Capital?, www.businessnewsdaily.com.
70
Venture Capital, www.businessdictionary.comm
100 Growth Economics and Governance

Primary differences between these two types of investment rely on


timing, monetary size, and deal structure.
Generally, if the business is at an early stage business angels are the
most likely source of funding.
Venture capital, by being usually involved with companies that
are slightly more mature, with higher valuations, and higher funding
amounts, often invest more money - usually millions, tens of millions,
or even hundreds of millions of dollars. In contrast, funding amounts in
angel investors typically range from a couple thousand USD through to
one million USD.
The deal structure for venture capital requires seat on board. Indeed,
in exchange for their funding, venture capitalists expect a high return
on their investment as well as shares of the company. Meanwhile, angel
investors do not always require a hands-on role in the running of the
company, as venture capitalists do.
There is another difference between them: venture capitalists will
generally invest in any startup they feel has the potential to make them
money, while angel investors generally like to make investments in
firms that work in industries they are personally familiar with.
Another way to finance a start-up requires at least a brief description:
crowd-funding.
Crowd-funding is another alternative financial instrument outside
of the traditional financial system as the other two proposed above. It
concerns the use of small amounts of capital from a large number of
individuals to finance a new business activity. It makes use of the easy
accessibility of vast networks of people through social media and web-
sites to bring investors and entrepreneurs together. Crowd-funding has
the potential to increase entrepreneurship by expanding the pool of in-
vestors from whom funds can be raised beyond the traditional circle of
owners, relatives and venture capitalists71.
There are two types of crowd-funding that can be taken into consid-
eration:
 donation crowd-funding;
 debt crowd-funding.
In the first case, people invest simply because they believe in the
cause, without any reward.

71
What is the crowdfunding? www.investopedia.com.
Digital Society and Sharing Economy 101

The second case is also called peer-to-peer lending or lend-to-save.


Here, investors receive their money back with interest. It is preferable
for new businesses because it allows for the lending of money while
bypassing traditional banks.

5.6. Regulating the Sharing Economy

The analysis proposed in this paragraph enters in the realm of one of


the most complex field in relation of the sharing economy: regulation.
Both proponents and critics recognise the necessity of a fair regula-
tion of the sharing paradigm.
However, there could be a real threat to the sharing economy if
the government regulation is driven by the incumbent industries chal-
lenged by sharing businesses. This is due to the disruptive nature of
sharing for existing powerful businesses -as it has been already de-
scribed- that could lead to regulations to protect private, rather than
the public interest.
The danger is that excessive legislation and regulation will absorb
the gains yielded by technology improvements, preventing mutually
beneficial trade and stiffling economic growth72.
The relationship between regulation and innovation brought by
sharing businesses can have three different outcomes as follows:
 First, regulation can hinder innovation by placing excessive bur-
dens on entrepreneurs. Like the case of licenses on industries or
entry requirements or by forbidding, often on a precautionary ba-
sis, the production of new products due to their potential risks.
 Second, regulation may facilitate the introduction of innovations
in the market, notably by waiving requirements or the obser-
vance of standards, granting exemptions, or authorizing compa-
nies to develop novel activities and projects on a temporary or
permanent basis.
 Third, regulation can have no direct effect on innovation and
only accidentally foster it73.

72
Allen, Darcy and Berg, Chris, 2014, The sharing economy. How over-regulation could
destroy an economic revolution, Institute of Public Affairs.
73
Ranchordas, Sofia, 2014, Does Sharing Mean Caring? Regulating Innovation in the
Sharing Economy, Minnesota Journal of Law.
102 Growth Economics and Governance

For the complexity of this matter, we will show only a sum of the rec-
ommendations for regulating the sharing economy that the vast literature
has proposed for facilitating the implementation of the sharing paradigm.
It has already been mentioned that there are many risks in case of
excessive regulation.
Moreover, the sharing economy faces already numerous regulatory
burdens even without a specific regulation for sharing businesses.
Those regulatory burdens are particularly in the areas of consumer
protection, taxation, safety, employment practices, contracting legiti-
macy, liability, insurance, and the existing industry specific law and
regulation.
To avoid useless limitations to the widespread benefits sharing
platforms potentially yield over traditional markets, it is really im-
portant to highlight which are the main good practices for regulating
the phenomenon.
It is possible to summarize in five points the main recommendations
for legislators and regulators to refer to when thinking about how to
regulate the sharing economy.
 The first recommendation is based on encouraging and imple-
menting bottom up self-regulation rather than rigid top-down
government control, and tread lightly.
As argued above, the reaction in relation to the disruptive nature
of sharing could be to control or limit the innovations to pro-
tect from some hypothetical harm. Unless and until there can be
demonstrated specific and direct harm to consumers for which
no market solution exists or seems likely to emerge, there is the
need to treat sharing lightly.
Solutions to the problems mentioned above should be crafted as
close as possible to the individuals facing the problem at hand.
In fact, individuals within a particular scenario have the unique
local knowledge to develop a solution, from the inside.
According to Adam Thierer, author of Permissionless Innovation ar-
gues that the best thing to do it should be to permit technologies by
default, rather than to constrain, regulate and control by default74.
Moreover, he argues that usually the best solutions to complex

74
Thierer, Adam, 2016, Permissionless Innovation: The Continuing Case for Comprehensi-
ve Technological Freedom, Mercatus Center at George Mason University.
Digital Society and Sharing Economy 103

problems are the “bottom-up” regulations, which are dynamic,


flexible and cost-effective solution, rather than costly, slow and
rigid top-down government regulations.
The sharing economy has already begun to implement a number
of bottom-up governance mechanisms, by utilising and making
available information that only consumers can provide, such as
the use of rating and reputation systems.
In conclusion, in order to follow this first recommendation, mar-
kets should be left free to experiment, to fail, and to undertake
evolutionary trial-and-error. They will develop, test and im-
plement effective institutional governance mechanisms. These
mechanisms should be left free to test in the market so that they
may iterate, improve and focus on the safety and certainty levels
required by markets75.
 The second recommendation is to reduce occupational licens-
ing. Occupational licensing is a form of government regulation
requiring individuals to obtain a license before pursuing a par-
ticular profession or vocation. In other words, those particular
professions require the permission of the government.
The logic behind the occupational licensing is to protect consum-
ers or users of a service, and, more generally, for the quality of
services and public safety. However, they can prevent the emer-
gence of new technologies and services by creating barriers to
entry. In fact, the hurdles to receive a license tend to grow more
stringent and expensive as time goes on.
According to the research conducted by Andrew Moylan and
R.J. Lehmann, “occupational licensing laws are estimated to cost the
U.S. economy roughly $100 billion annually in lost economic output,
despite the fact that licensing has been shown to have either no impact
or even a negative impact on the quality of services provided by licensed
practitioners”76. Moreover, the authors added that licensing lim-
its consumers’ choices. When issues of occupational licensing
emerge in sharing economy debates, the initial reaction should

75
Allen, Darcy and Berg, Chris, 2014, The sharing economy. How over-regulation could
destroy an economic revolution, Institute of Public Affairs
76
Moylan, Andrew and Lehmann, 2014, Five Principles for Regulating The Peer Pro-
duction Economy, R Street Policy Study no. 26.
104 Growth Economics and Governance

be to decrease existing licensing, rather than increasing the shar-


ing economy models up to current levels.
In addition, and conversely, it could be noted that peer produc-
tion should reduce the need for specific licensing in many pro-
fessional categories. Indeed, peer production services offer a jus-
tification to reduce, rather than increase, reliance on licensure,
because new tools allow for easier exchange of information and
eliminate many information asymmetries.
Darcy Allen and Chris Berg, in the research The sharing economy.
How over-regulation could destroy an economic revolution propose
the alternative approach of certification, which provides the
right of all potential practitioners to enter the occupation77. Cer-
tification allows consumers or employers to choose to pay some-
one with greater state-documented skills or someone with fewer
job characteristics. In this context, certification lets the market
decide whether the benefit of the certification outweighs the cost
of obtaining it.
 The third recommendation is in relation to the need of reducing
industry specific controls.
Whether someone tries to enter in an industry, he could face in-
dustry-specific controls, which tend to define the structure, and
who may operate within it. This is no so risky for consumers as
someone can think, in fact, consumers and companies alike will
remain protected under the broader and stronger set of gener-
al common and criminal laws. On this matter, Darcy Allen and
Chris Berg argue that where there are serious risks to consum-
ers, it is best to use existing market instruments to protect con-
sumers, like insurance contracts and surety and fidelity bonds,
rather than specific industry control or prescriptive regulation78.
 However, Moylan and Lehmann as fourth recommendation
highlight the necessity of creating a suitable environment for
platforms to develop new and more efficient contracting solu-
tions for further improving their business models. As for all

77
Allen, Darcy and Berg, Chris, 2014, The sharing economy. How over-regulation could
destroy an economic revolution, Institute of Public Affairs.
78
Allen, Darcy and Berg, Chris, 2014, The sharing economy. How over-regulation could
destroy an economic revolution, Institute of Public Affairs.
Digital Society and Sharing Economy 105

emerging business, sharing models are already facing market


uncertainty and, in such a case, the role of government in this
process is to step back.
 Last, the fifth recommendation is a sort of sum of the others and
it consists on encouraging entrepreneurship, innovation and
emerging industries through deregulation of labour markets.
Those five recommendations do not aim to be exhaustive, but try to
outline the main point to implement as possible the potential of enor-
mous economic benefits to people all over the world, through the shar-
ing model. In fact, it is clear that with a sensible, minimal regulatory
structure, it can and will create enormous new wealth, generate jobs
and put previously underutilized resources to work79.

79
Moylan, Andrew and Lehmann, 2014, Five Principles for Regulating The Peer Pro-
duction Economy, R Street Policy Study no. 26.
6
Policies for Development and Growth:
Microfinance towards Social Business

6.1. Introduction

Finance for development and growth is the part of the economy that stud-
ies particularly the problems of the economic trap, trying to find a feasible
way to alleviate them. Analysing in particular the economy of the poorest
countries, it seemed clear that the traditional approach to underdevelop-
ment was effective to countries that had already achieved a reasonable
economic level, but risked to be ineffective for the real deprived countries.
Cooperation aid, investments, globalization were all factors that
could play a positive role in fostering development in a country, but in
the poorer ones the structural problems were obstacles that inhibited
the inclusion of the mass of the population into the economic process.
In other words, the main problem was not the lack of resources or the
extremely backwardness of the country, but rather the fact that, even in
presence of massive foreign aids, didn’t exist any mean to foster eco-
nomic inclusion of the lowest layers of the population.
Simply, international aid managed to reach the poor people in term
of relief from hunger, but could not be effective as a multiplier of eco-
nomic activities. It worked as top-down intervention, but could not give
a real stimulation from the bottom.
It was a fact that the percentage of the population effectively cut off
from economic activities in the very poor countries reached levels very
close to 80%, and that the solutions had to be found in encouraging “en-
dogenous” activities.
108 Growth Economics and Governance

Finance for development therefore started to study the economic


structure – or, rather, the de-structure – of the poorer countries, and tried
to find other ways to achieve a better inclusion of the population. Formal
systems had obvious operational limits, the interventions from interna-
tional partners were mostly addressed towards achieving a reasonable
framework of modern infrastructures or provide educational opportuni-
ties for the people; even in a more recent approach, all provisions exclud-
ed any form of facilitation of credit to the non-active population.
These were considerations that regarded in general all developing
countries. Starting from that, the theory of Financial exclusion was
elaborated.
The Financial exclusion theory is relatively recent in economy. Its
proper definition is ‘the difficulty encountered by a class of population
in accessing to appropriate financial services and products in the finan-
cial service market’.
The financial system of a country is, with no doubts, an essential
component of the development process, and is a key element to reduce
poverty. It is not only a mean to address resources to more produc-
tive forms of investments, but also to achieve a better distribution of the
same resources to a larger part of the population.
The key factor of success for a financial system in a developing coun-
try is definitely its accessibility to the poorest part of the population.
Economic theories in the 1950’s assumed that the main problem of the
underdeveloped countries lied in the lack of internal saving. Contrary
to this, the contemporary theories identify the financial exclusion as one
of the main causes of underdevelopment.
Coherently, we could mention the assumption that since foreign
aids, flows of external money, grants etc. are definitely not sufficient to
stimulate economic development, there should be an internal mecha-
nism of economic stimulation to create savers and consumers. Besides,
many critics object that, missing real mechanisms of redistribution of
income, aids creates in the years further dependency that, in the case of
very low income countries, risks to increase the economic gaps and to
be a permanent obstacle to economic growth.
Nevertheless, the following question remains absolutely current:
how much is a financial exclusion due to the low economic condition of
the subjects, and how much is instead a consequence of the rigidity of
the financial system itself?
Policies for Development and Growth: Microfinance towards Social Business 109

6.2. Microfinance

Starting from the early 1980’s it became clear that it was necessary to
identify new forms of finance that could be more efficient against finan-
cial exclusion and in the fight against poverty. All theories elaborated
by the Finance for Development therefore concentrated mainly on the
problems of the access to credit and on the procedures to concede loans
by institutions outside the informal system.
Microfinance went exactly in this direction: its objective was the cre-
ation of new mechanisms that would allow people, henceforth excluded
from the financial system, to participate, even marginally, to the eco-
nomic process of development. Particularly, to give instruments – not
just economic – to people till then totally cut away from any form of
productive activity, rescuing them from a life of mere survival.
The first approach of microfinance aimed to create an availability of
small credit to the most deprived part of the population, with a totally
different logic from the traditional ‘moneylenders’. It was the starting
point of the so-called ‘social business’: an intelligent mix of the formal
system and of the informal one. It started with the consideration that
formal credit was not available to the poor because of the various dif-
ficulties – internal, external, formal, physical etc. –, and informal credit
was often available only at an exorbitant cost and created situations of
utter dependence of the borrower on the creditor.
The original core business of microfinance was to give access to credit
to a layer of population with an extremely low income and no possibility
to give collateral guarantee. With the increase of demand and the need
to introduce more sophistication in the offer of services, in the years it
diversified into a wide range of activities, which can be listed as follows:
 Microcredit to individuals: addressed mostly to families of very
low income, to enable them to buy first need goods and services;
 Microcredit to enterprises: loans granted to small entrepreneurs
to start/develop a business. To this objective, there is often a col-
lateral service of technical assistance and support;
 Real estate microfinance: loans granted to cover real estate
operations;
 Micro-savings: collection of small deposits through microfi-
nance institutions in order to contrast usury. To this there is also
the possibility to have credit cards and bancomat services.
110 Growth Economics and Governance

 Micro-insurance: insurance services, mostly life insurance or


weather insurance, granted at low premium and low rate of
covering;
 Micro-leasing: it is the most advanced form of microfinance, and
goes towards the need of small enterprises that have to mod-
ernize the plants but don’t want to get into loans that would be
difficult to repay. By this service, the enterprises get the use, but
not the property, of the leased machineries, with lesser expenses
and fixed charges for the company.
Amongst all the new services offered by modern microfinance, the
following two are proving particularly effective in this thrive to break
the poverty cage that has entrapped for so many years the poorer pop-
ulations of the developing countries as well the newly backward areas
od the advanced countries:
i. The micro-saving. In the poor societies, there is a natural mistrust
against all form of saving through a financial institution (Banks,
cooperatives etc.), favouring rather forms of under-the-pillow
treasuring. Encouraging forms of formal saving make available
to the financial circuits money otherwise non fruitful, assure the
return of interest to the savers and give a better degree of stabi-
lization to the market. There are two forms of savings: the com-
pulsory one, and the voluntary saving. In the case of compulsory
saving, the borrowers have to divert part of the lent money to a
fund that acts as collateral to the financing; normally, at the end
of the reimbursements the borrower can utilize the full amount
of the savings.
ii. The micro-assurances. This form of microfinance has been first
introduced in the 90’s, still with huge difficulties considering the
economic reality of the concerned countries. A factor that makes
this service very difficult lies on the fact that it is relatively ex-
pensive, and that – amongst all –most of the subjects have a pre-
carious, on-the-verge-of-poverty life, and have little sensitivity
on this matter. There is however a growing demand for services
of insurance, particularly on the sanitary and life. On this, the so-
called ‘communitarian’ model seems to be the most appropriate,
with local communities that create small assurance companies,
profit-free, that provide a set of pre-defined services. Other in-
teresting forms of insurance are the ‘weather insurances’, with a
Policies for Development and Growth: Microfinance towards Social Business 111

further and more complex declination of the index-based insur-


ance, which ties the repayment to a set of pre-figured indexes of
climate conditions, such as floods, droughts
Even with these forms of higher sophistication, the fundamental as-
pects of microfinance are the following:
 the characteristic of being ‘loans’;- the vocation of being ‘social’
and not profitable.
 the will to address to the poorest layer of the population, other-
wise cut off from any form of economic activity.
All forms of microfinance present also some common peculiarities:
 they account always for small amounts of money, usually lent at
a very short and repayable term;
 there is always a very high flexibility in dealing with the indi-
vidual clients;
 particular attention is given to the poor rural population, often
strangled by moneylenders and other forms of informal financing;
 self-management of borrowed money is highly incentivized, in
order to develop also a transfer of knowledge;
 great encouragement is given towards the constitution of sta-
ble participative structures, that could steer the poorest towards
acquiring more responsibility and better management capacity.
As far as allocations of loans are concerned, the interest rate in av-
eraging in the underdeveloped regions could reach the 35% per year
(compared to the interests practiced in the informal banking, which al-
most always exceed 10% per month), while in developed countries it
does not exceed 7-8%.

6.3. Micro-Financing Institutions

The institutions that are active in micro-financing are the so-called MFI
(Micro-Financing Institutions), and have the peculiarity to be active not
only in the financial field, but also in non-financial activities, such as ed-
ucational training, technical assistance, even social services. This helps
to create a network of relationships based on mutual confidence, and
also to encourage a correct behaviour from the customers.
Microfinance is having a sharp increase in all its forms: it has been
estimated that, in 2015, the total figure of the poor population who are
112 Growth Economics and Governance

likely to be touched by services of microcredit should exceed 175 mil-


lion. It is therefore natural that, with the sharp growth in the demand
of financial opportunities, there is also a parallel diversification by the
MFI’s of the offered services.
The most famous example of microfinance institution (MFI) is repre-
sented by Grameen Bank, founded in 1976 by Dr. Muhammad Yunus,
who was awarded, for the particular achievements of his organization,
with the Nobel Price for peace in 2006. Dr. Yunus, who in 1970 was an
economist teaching in the Chittagong University, foresaw that the best
way to foster development was to open the market of credit to the poor-
er part of the population: his definition was that “the poor remains that
because the financial institutions don’t worry to help him enlarging his
economic base”. Poverty, in other words, doesn’t depend on the lack of
capacity by the poor to manage capitals, but the lack of opportunity to
have access to credit.
Yunus’ intuition was that very small loans could make a dispropor-
tionate difference to a poor person. Women in the villages that made
bamboo furniture had to take out usurious loans for buying bamboo,
ending by paying their profits to the moneylenders. His first loan was of
$27 from his own pocket to a group of 47 women who, by that, managed
to get each one a net profit. Encouraged by this extraordinary result, he
managed to establish a pilot project, called Grameen Bank Project, by
securing a small loan from the government Janata Bank.
On October 1983 the pilot project started to operate as a full-fledged
bank, and was finally renamed simply Grameen Bank. The core busi-
ness remained offering credits to the poor: it created access to credit on
reasonable terms, through group lending system, weekly-installment
payments and long term loans.
Grameen Bank in the years has become a huge reality. It accounts on
over 2,600 branches nationwide, has served over 8 million people, and
has distributed over 13 billion US$. A peculiar aspect to note is that over
96% of borrowers are women, and the rate of repayment exceeds 98%
of the total.
On the example of Grameen Bank, a lot of other MFI proliferated
around the world. In the year 2000 about 1,500 MFIs were censed, serv-
ing 30,7 million customers. In 2015 the number of MFI increased to over
5,000, with a number of borrower over 200 million person.
Certainly, the most evident effect has been the capacity to stimulate
Policies for Development and Growth: Microfinance towards Social Business 113

mechanisms of social promotion on populations often deprived even of


the more basic rights. In fact, microfinance impacted in three different
ways, economic, socio-political and psychological:
 The economic impact is evident if we consider that microfinance
obtained the financial inclusion of a number of subjects previ-
ously cut off from any economic circuit, unless under extreme-
ly unfair conditions that would annul completely any form of
profit and relegate the same subjects to a state of continuous,
hopeless poverty.
 The socio-political aspect concerns the impact that the access to
an economic activity had to static societies, limited and tied to
ancestral traditions. Notably, the role of women – who are the
major recipients of microcredits – was changed a lot in the com-
munities.
 The psychological impact relates to the perception that your life
can change, that there is a hope to sort out of poverty.
The financial crisis opened new ways for microfinance:
i. Credit crunch is the main impact of the world-wide financial crises;
ii. Small enterprises and poor individuals will suffer from this sit-
uation as both of them cannot offer guarantees that are need to
borrow money in the traditional credit market;
iii. Since there is evidence, both from development theory and from
the experience, that development is better stimulated from the
growth of human capital than from physical capital, microfinance
activities (in particular microcredit) can offer an effective solution,
out of traditional aid policies. These considerations help to under-
stand why microcredit has progressively emerged as one of the
most important and innovating tools to promote human dignity
and sustainable development. Its fundamental role has been that
of devising financial instruments, which make access to credit and
financial facilities possible for poor borrowers lacking of collateral
resources. Microcredit institutions play an important role in the
development process as they give priority to loans with long-term
profitability, unless directed by the government. On the other
side, standard commercial banks have short-term perspectives as
they are interested in the short term cash flows and have no inter-
est in the so-called social profitability.
It follows that:
114 Growth Economics and Governance

 Because the main objective of development is poverty reduction


and because poverty reduction processes imply investment in
human capital, it is of main importance to finance small projects
carried on by poor people, who can give relevant contribution to
local production in the long-term horizon.
 In doing so contemporary microcredit institutions revitalize and
adapt to a modified economic framework the instruments and the
historical experience of many financial institutions born with soli-
darity and mutualistic principles in the last century in Italy and in
the rest of Europe (Savings banks, Cooperative credit banks, etc.).
Microcredit is only a part of the financing activities that can be per-
formed to stimulate development, even if the most important. Many
other financing services (insurance, production of nutritive goods,
transportation and communication facilities) can be arranged in order
to create a suitable environment to host human capital. The entire group
of these financing services is included in the microfinance.
In this perspective microfinance is realizing part of the fundamental
mission of the financial system (matching those with productive ideas
and those with the financial resources needed to operate them) which
traditional financial institutions were not able to realize.
From another perspective, microfinance represents an important in-
novation in development policies and in the principles which inspire
them. Microfinance schemes go beyond the logic of the grant, which
represents a unilateral transfer which does not stimulate the sense of
responsibility of the receiver. While under many circumstances a grant
can be the only way to help those in need which cannot give anymore
their productive contribution to the society, the same approach may be
even humiliating for those who still retain their working potential and
want their dignity to be restored by an act of confidence of their coun-
terparts. In this respect microfinance schemes are bilateral and involve
a principle of reciprocity in which the receiver is asked to reciprocate
the trust received with his productive contribution to the society. Under
this angle, microfinance programs may represent one of the most effec-
tive channels of solidarity. By stimulating and enacting capacity build-
ing of the share of the poor who are potentially productive they funda-
mentally contribute to a creation of economic value, which can finally
benefit also the remaining share of their no more productive neighbors.
The same banking mechanisms are such that the amount of money de-
Policies for Development and Growth: Microfinance towards Social Business 115

posited in microfinance institutions may be multiplied in terms of mi-


crofinance loans contributing to develop projects for an amount that is
superior to the one initially invested.
By promoting reciprocity, responsibility and involvement of the re-
ceiver, microfinance has revealed itself as an important instrument to
promote human dignity (in itself a fundamental prerequisite for capac-
ity building), enhance capabilities and functionalities and increase indi-
vidual happiness beyond its direct economic impact.
Several success experiences, such as the Tonga Development Bank,
the Grameen Bank (village-bank), the Banca del Sol in Bolivia and the
Reinke in South Africa, show the crucial role of the microcredit institu-
tions in promoting development.
It can be said that, if well-administrated, small loans given to poor
people has a very low default-rate, lower than that of many ordinary
commercial credit.
The Grameen Bank system is based on specific elements such as:
 Loans are given to those people or enterprises that cannot insure
real guarantees;
 Help poor people to go out from illegal credit systems;
 Support endogenous local initiatives that enable poor people to
produce a surplus to bring to the market;
 Support a saving mentality as well as simple accounting system
within the small enterprise;
 Give poor people the possibility to participate to the profit of the
bank;
 Increase the responsibility toward a productive result;
 Support the crucial role of the women.
Actually the Bank gives credits for a total amount of $30 million (95%
women). Contributions are received from main organizations such as
UNCDF, UNIFAD, UNDP, UNESCO, UNICEF, World Bank and many
States (EU members, USA private foundations).

6.4. Perspectives towards social business

Microfinance institutions are currently engaged in a process of gradual


innovation in the adoption of new techniques to cope with the limits
emerged and the lessons learned from more and less successful experi-
116 Growth Economics and Governance

ences, in order to improve the profitability of the financed projects, as


well their repayment rate.
Innovation concerns also crucial areas such as the impact of subsidies
and donors’ funds and the comparative advantages of the different mech-
anisms which ensure high repayment rates in spite of the lack of borrow-
ers’ individual collateral (group lending, notional collaterals, progressive
loans with dynamic incentives, etc.). A crucial problem in this develop-
ment is represented by the lack of applied work on survey or bank loans
data aimed to provide rigorous impact analyses. Without them, the differ-
ent hypotheses on the comparative advantage of one or another mecha-
nism cannot be tested and do not help to proceed forward and implement
the existing mechanism. Empirical evidence on the specific determinants
of success or failure in different contexts, even though not to be consid-
ered as a dogma, should greatly contribute to the knowledge in this field.
Another incredible potential for microcredit today comes from the op-
portunity of linking directly individual investors’ willingness to pay for
inclusion and microfinance institutions. So far, the main source of micro-
credit funding has been institutional or intermediated. Recent inquiries
demonstrate that global market integration and the increasing awareness
of world interdependences and inequalities have significantly increased
the number of individuals with social preferences and willingness to pay
for inclusion of the poor. Similar studies performed in different countries
identify a share of 30-40 percent of respondents, which are willing to pay
for this cause. On the rationales of this significant growth is that environ-
mental degradation and poverty in some regions of the world are clearly
emerging as regional problems with global consequences. As a conse-
quence, social responsibility is gradually emerging not just as an altruistic
but also as a longsighted self- interested response to them.
This becomes evident when individuals come to understand that
environmental degradation has negative consequences on individual
health and on the likelihood of: environmental disasters; degradation
of human and working conditions in underdeveloped countries are a
threat both in terms of security and cost competition.
In this respect, the new role of governments and financial institu-
tions may be that of increasing information on the available opportu-
nities that “concerned” individuals have in order to channel efficiently
resources to promote human dignity, inclusion of the poor and sustain-
able development.
Policies for Development and Growth: Microfinance towards Social Business 117

To be effective, the microcredit instruments need a proper institution-


al framework, good governance and good international development
policies. Even though they are complementary and do not substitute the
engagement of international institution for sustainable development,
they may become fundamental catalysts of resources, which the civil
society is willing to provide for the solution of global imbalances.
In the light of the above-mentioned consideration and the initiatives,
which can implement and enhance the role and effectiveness of microfi-
nance initiatives, we propose to work in the following directions:
 information campaigns on microcredit from government and
international institutions to promote the participation of indi-
vidual (socially concerned) savers to microcredit programs giv-
ing them the option to address a share of their savings to micro-
credit initiatives. These activities should be accompanied by the
creation of a formal committee in which institutions, banks and
members of civil society can discuss about related social respon-
sibility and information initiatives;
 creation of a “Microfinance Research Institute” in Rome, co-fi-
nanced by private banks, government, financial institutions
and individuals in order to: implement available databases and
perform impact analyses on microcredit projects and evaluate
advantages and opportunities for their development in differ-
ent world area where poverty is increasing. Given the growing
willingness to pay for the social value of microcredit projects,
these studies should include not just economic but also social
performance analysis. Such research activity should not be lim-
ited to impact analyses on the individual borrower but should
extend to the evaluation of the impact of the microcredit initia-
tive at the aggregate level (externalities, spillovers, multipliers
effects) and to the effects and consequences of the interaction
between microcredit institutions and the rest of the traditional
financial system;
 provide research and financial support to the creation of local
microcredit officers with screening and monitoring skills;
 evaluating the best techniques to reduce risk linked to small
project financing, by using insurance and derivatives;
 evaluating the complementary intervention to reduce poverty
and to promote human capital in specific territories;
118 Growth Economics and Governance

 defying all the steps in the operation of credit to the poor and
“non bankable” individuals;
 creation of a “Microcredit Start-up and risk insurance guaran-
tee fund” co-financed by private banks, governments and finan-
cial institutions and individuals in order to: support start-ups,
capacity building and upsizing of microcredit institutions ans
well extend insurance from various types of risk (exchange rate
volatility, political instability, natural disasters) in order to cre-
ate conditions for access to credit also for borrowers leaving in
difficult economic environments.

6.5. The Grameen Bank experience

Founded in 1976, Grameen Bank has both pioneered the development


of micro-finance, and created nearly 30 businesses designed to alleviate
poverty. The article traces the gradual development of Grameen’s ex-
pertise in formulating social business models, which require new val-
ue propositions, value constellations and profit equations, and as such,
resembles business model innovation. The article presents five lessons
learned from this experience: three are similar to those of conventional
business model innovation andchallenging conventional thinking, find-
ing complementary partners and undertaking continuous experimen-
tation; two are specific to social business models: recruiting social-prof-
it-oriented shareholders, and specifying social profit objectives clearly
and early. We suggest that these new business models – where stake-
holders replace shareholders as the focus of value maximization – could
empower capitalism to address overwhelming global concerns.
The Grameen Group is a network of nearly 30 sister organizations
linked to the Bangladeshi Grameen Bank, the microcredit pioneer and
(together with its founder, Muhammad Yunus, one of this article’s
co-authors) 2006 Nobel Peace Prize winner. This group was established
in 1983 with the creation of the Grameen Bank (‘Grameen’ means vil-
lage), within the framework of a new law drafted specifically for the
purpose. Yunus, at that time a professor in economics, had already
started to lend money to people trapped into poverty by greedy mon-
eylenders. He had discovered that entrepreneurship was by no means a
rare quality among poor people – but that traditional banks refused to
Policies for Development and Growth: Microfinance towards Social Business 119

grant loans without collateral. Grameen Bank now gives loans to over
7.5 million poor people - 97 percent of whom are women – helping them
to lift themselves out of poverty: 68 percent of the families of Grameen
Bank borrowers have crossed the poverty line. Motivation towards re-
payment is high, with rates currently running at 98.4 percent, and the
bank has been profitable in every year of its existence except 1983, 1991
and 1992. The socially-oriented organizations in the Grameen Group
now range from the country’s largest phone company to one supplying
affordable healthcare. The Group’s on-going experience (over almost 30
years) of building firms whose purpose is to alleviate poverty has led to
the emergence of the concept of ‘social business’, which can be viewed
as still being under construction.
Established multinational companies (MNC) have recently shown
some interest in the Grameen experience and in its fight against poverty
as part of a more general emphasis on corporate social responsibility
(CSR). However shareholder value maximization remains the rule in
the capitalist system, and – clearly – the reconciliation of this with social
objectives is often problematic. Thus, although advocates of CSR like to
propose that companies should be measured by a ‘triple bottom line’ of
financial, social and environmental benefits, ultimately only one bottom
line usually matters: financial profit.
However, research has shown that, if managed strategically, CSR
projects can indeed pay off, both socially and financially. In the midst of
the current financial and economic crisis, some companies have begun
to question their role more fundamentally and seem to be awakening
to social change issues. Some pioneering established companies have
sought to implement more pro-active CSR policies that anticipate so-
cial trends and go beyond the minimum required, and this impetus has
led to the rise of the number of ‘social businesses’. Many of these have
turned to Grameen to benefit from its experience to help them achieve
these goals, and partnered with it in a range of social business ventures.
We report on three of these as our case studies:
 Grameen Phone, a partnership with Telenor (the Norwegian
telecommunications company), has become one of the largest
tax payers in Bangladesh. The success is based on the Grameen
‘telephone ladies’, who provide a phone service in their villages
by lending users a phone for just a couple of minutes e avoiding
them having to make costly handset purchases;
120 Growth Economics and Governance

 GrameenVeolia is a co creation with Veolia Water (one of the


world’s leading water service providers) designed to use sim-
plified surface-water treatment systems to provide rural popula-
tions with affordable access to drinking water, distributed at vil-
lage drinking fountains or via cans, using prepaid card systems;
 Grameen Danone is a collaboration with Danone (one of the
world’s leading healthy food companies) that offers an afford-
able and easily available dairy product developed to fulfill the
nutritional needs of Bangladeshi children. The yoghurt is pro-
duced locally and distributed door-to-door by Grameen ladies.
The story behind each of these ventures is of the gradual emergence
of the social business concept: a self-sustaining company that sells
goods or services and repays its owners’ investments, but whose prima-
ry purpose is to serve society and improve the living standards of the
lot of the poor. Building on these recent Grameen experiments, our goal
in this article is to delineate the lessons learned so as to provide detailed
guidance for companies wishing to create social businesses. We analyze
these cases (which are described in more detail in the Appendix) not in
chronological order, but in the sequence that fits our main purpose of
studying the building of social business models. As the social business
idea borrows some concepts from the capitalist economy, social busi-
ness implementation can likewise borrow conventional business liter-
ature concepts. Our idea is to investigate whether the business model
concept and in particular the business model innovation literature can
help us propose a framework for setting up social businesses. The re-
search into business model innovation, which considers business mod-
els as the locus of innovation (rather than products, processes or tech-
nologies), while it doesn’t always use the same terminology, has led to
a growing body of academic literature over recent years. This literature
suggests that business model innovation is facilitated by three major
strategic moves: challenging conventional wisdom; setting up appropri-
ate partnerships; and undertaking experimentation. We reviewed these
recommendations in the Grameen experience, and found that they were
also relevant for creating social business models. However, the case
studies show that building social busi nesses also requires two addi-
tional passages: the needs to involve social-oriented shareholders and
to state the intended social profit explicitly. Hence, overall, five lessons
can be learned from the Grameen experience.
Policies for Development and Growth: Microfinance towards Social Business 121

The structure of this article follows our research path. First, we pres-
ent the social business model concept, and highlight how building so-
cial businesses resembles business model innovation. Then we describe
the five lessons learned through the Grameen experience noted above.
This leads us to develop a specific social business model framework
conceived to help managers seeking to set up businesses conceived to
fulfill a social goal.

6.6. Meaning of the social business

In the capitalist system, two extreme types of corporate bodies can be


distinguished. On the one hand, companies can be seen as profit-max-
imizing businesses, whose purpose is to create share- holder value. On
the other, non-profit organizations exist to fulfill social objectives. Fig-
ure 1 shows how a social business borrows from both these entities: it
has to cover the full costs of its operations, and its owners are entitled to
recover their invested money, but it is more cause- than profit-driven.
Its position in the lower right quadrant shows that it has both the poten-
tial to act as a change agent for the world, and sufficient business-like
characteristics to ensure it survives to do so.
In organizational structure, this new form of business is basically the
same as profit-maximizing businesses: it is not a charity, but a busi-
ness in every sense. The managerial mindset must be the same as in a
business: when you are running a social business, you think and work
differently than if you were running a charity, even though your objec-
tive is different from a profit-maximizing company. At the same time
as trying to achieve their social objective, social businesses need to re-
cover their full costs so they can be self-sustainable. Their owners nev-
er intend to make profits for themselves (there are no dividends), but
they are entitled to get their money back if they wish. Rather than being
passed on to investors, surpluses generated by the social business are
reinvested in the business, and thus, ultimately, passed on to the target
group of beneficiaries in such forms as lower prices, better service or
greater accessibility.
Thus, a social business is designed and operated just like a ‘regular’
business enterprise, with products, services, customers, markets, ex-
penses and revenues. It is a no-loss, no-dividend, self-sustaining com-
122 Growth Economics and Governance

pany that sells goods or services and repays investments to its owners,
but whose primary purpose is to serve society and improve the lot of the
poor. Here it differs from non governative institutions, most of which
are not designed to recover their total costs from their operations, and
are therefore obliged to devote part of their time and energy to raising
money. As it seeks self-sustainability, a social business only relies on its
investors at the beginning of a development project.

Fig. 1 Social business vs Profit maximizing business and


not-for-profitorganisations
This is close to the concept of ‘social entrepreneurship’, defined by
Mair and Marti as ‘a process involving the innovative use and combina-
tion of resources to pursue opportunities to catalyze social change and/or
address social needs’. Social businesses can be seen as a subset of social
entrepreneurship, which includes both profit and not-for-profit initia-
tives, and which can be distinguished from conventional entrepreneur-
ship through the ‘relative priority given to social wealth creation vs.
economic wealth creation. In business entrepreneurship, social wealth
is a by-product of the economic value created’. All those who design
and run social businesses are social entrepreneurs - but not all social
entrepreneurs are engaged in social businesses (some models, for in-
stance, still include conventional dividend payments to profit oriented
shareholders).
Hence, a social business is a new form of business that can be located
somewhere between a profit-maximizing and a non-profit organization.
Policies for Development and Growth: Microfinance towards Social Business 123

But why should investors put money into such a business? The many
billions of dollars that people around the world donated to charitable
causes every year demonstrate that people want to give money in a way
that benefits other human beings. However, as noted above, investing
in a social business is different from philanthropy in several ways e the
social business is self-sustaining and investors get their money back:
people who donate to charity do not. The investor also remains the
owner of the company and can thus decide its future course of action,
so that, as well as a chance to provide money, the social business offers
businesspeople an exciting opportunity to leverage their own business
skills and creativity to solve social problems.

6.7. Social business as business model innovation

The business model concept is currently attracting much attention from


researchers, and seems useful in offering guidance on how to create so-
cial businesses. However, despite ever-growing literature on the busi-
ness model concept, there is no consensus regarding its definition. An
in-depth analysis of business model components in academic literature
shows that, among the plethora of definitions, three elements are usu-
ally distinguished: the product/service proposed to customers, the way
the company is organized so as to deliver this product and service to its
customers, and the revenue model. Some authors, however, focus on
Chesbrough and Rosembloom for example, focus on the revenue mod-
el, whereas Zott and Amit focus on transactions between the firm and
its external constituents. We suggest that a business model has three
components.

Fig. 2 The three components of a conventional business model


124 Growth Economics and Governance

Business model innovation is about generating new sources of prof-


it by finding novel value proposition/value constellation combinations.
Hence, we wondered what the literature on this phenomenon offers to
our understanding of building social businesses. As mentioned before,
five lessons can be learned about the Grameen experiences: three are
similar to those involved in conventional business model innovation;
two are more specific, as highlighted by Table 2.

6.8. Similarities between social and conventional business mo-


del innovation

Lesson 1: Challenging conventional wisdom


Most research on business model innovation underlines the radicalism
of this type of innovation, which is defined as the capacity to create
new strategies which modify the rules of the competitive game in an
industry. This represents a major challenge for companies, as it entails
questioning the models that have previously led them to success. This
in turn requires revisiting a number of basic assumptions, and resem-
bles what Argyris and Schon have described as ‘double loop’ learning.
In contrast to ‘single loop’ learning which confines itself to changing
strategies within an existing framework e double-loop learning forces the
organization to transform its fundamental references and adopt new ones.
The creation of Grameen Bank offers an insightful illustration on how con-
ventional wisdom can be challenged: indeed, the questioning of the current
rules of the game was at the very heart of the bank’s foundation.

Table 2. Five lessons in building social businesses

Similarities with conventional business model innovation


1. Challenging conventional wisdom and basic assumptions
2. Finding complementary partners
3. Undertaking a continuous experimentation process
Specificities of social business models
4. Favoring social profit-oriented shareholders
5. Clearly specifying the social profit objective

It was Sufiya Begum, a woman from a village called Jobra, who


taught Yunus (then an economics professor) about the problem she
Policies for Development and Growth: Microfinance towards Social Business 125

encountered. Like many others in her village, she relied on the local
moneylender for the cash she needed to buy the bamboo for the stools
she crafted. But he would only give her the money if she agreed to sell
him all she produced, and at a price he would decide e which was ridic-
ulously low. Thus, though hardworking, she was trapped in poverty,
altogether forty-two people in the village, who had borrowed a total
amount of less than $27 from the moneylender, faced the same desper-
ate situation. They could not borrow money from conventional bankers
since they had no credit histories and no collateral to offer, and could
not even fill out the necessary paperwork because they were illiterate.
In the event Yunus lent them the $27 from his own pocket: he recovered
it within a week. But despite evidence provided by several other simi-
lar experiences, conventional bankers continued to be reluctant to con-
sider poor people as potential customers. They found it impossible to
challenge their conventional wisdom e that loans could not be granted
without collateral: so a dedicated bank had to be set up.
Grameen Bank’s business model reinvented the rules of the game.
First, the value proposition of the bank aims at lifting the poor out of
poverty by making small loans sufficient to finance income-generating
businesses and rice-husking, machine repairing, purchasing rickshaws,
buying milk cows, goats, cloth, pottery and so on. Except in very ex-
treme circumstances, interest is charged on all loans. Second, the value
constellation breaks away from bureaucratic control. Local Grameen
branch managers (a branch, typically, covers 15 to 22 villages) first visit
the villages and identify the prospective clientele, who are dealt with
in groups of five. Only if the first two borrowers in a group begin to
repay the principal plus interest within six weeks the other group mem-
bers become eligible for loans. Group support, peer pressure, self-inter-
est and the motivation of bor- rowers ensure that repayment rates on
Grameen Bank loans remain high.
Grameen Bank’s business model therefore challenges several stan-
dard banking assumptions, including the beliefs that loans cannot
be granted without collateral and that ‘entrepreneurship’ is a rare
quality among the poor. Conventional banks were unable to enter
the double loop learning process involved in adopting new frames
of reference e but it is challenge that awaits all MNC’s wanting to set
up social businesses.
126 Growth Economics and Governance

Lessons 2: Finding complementary partners


The second step in building social business models is to leverage ex-
pertise and resources by setting up partnerships. Again, the need to be
open to other players in the industry, and to players in other industries,
is covered in the business model innovation literature. The idea was de-
veloped by Chesbrough, who called for businesses in technological en-
vironments to open up their own business models to partner companies
so that the benefit from new resources can be applied to the context of
poverty. On a theoretical level, in contrast to the competitive paradigm,
the cooperative paradigm places most of its emphasis on collaboration,
which allows organizations to gain access to new resources they would
otherwise have needed to either develop alone or purchase. The main
advantage of collaborative agreements lies in the pooling of resources
and knowledge leveraged by the partners, which may in turn lead to
the development of a broader portfolio of resources for firms in the net-
work. Cooperation is considered as a major factor of success for pro-ac-
tive CSR strategies, and research stresses the importance of long-term
relationships among such actors.
As the specific literature on business model innovation which aims at
social benefits has already shown, the Telenor example illustrates how
setting up a collaborative partnership is a major step in building social
business models. The advantages are clear: Grameen had no experience
in building a wireless phone network, while, for its part, Telenor had
no experience of developing world markets. Telenor benefited from
Grameen’s knowledge of the country and the network of people the
bank had already built. This created a strong barrier against new en-
trants. The combination of the two partners’ resources and skills led
this successful venture, which offered a useful value proposition to cus-
tomers while also helping poor people become entrepreneurs and lift
themselves out of poverty.
These partnerships between businesses and not-for-profit organiza-
tions can be highly productive and low in risk, as they take place be-
tween actors who are not in direct competition with each other. Having
learned from past failures, the Grameen Group encourages partnerships
with established and skilled companies whenever possible. For exam-
ple, several years ago the Group had undertaken an experimental proj-
ect to develop locally-produced weaning food to compete with import-
ed baby food. The product Cerevit was trial-marketed at a much lower
Policies for Development and Growth: Microfinance towards Social Business 127

price than that of imported products, but did not succeed. One reason
was that the project lacked the right kind of partners to make it happen,
a type of problem that was overcome in the Grameen Danone case by
partnering with an organization that could offer such knowledge.

Lesson 3: Undertaking continuous experimentation


Strategic experimentation is another recommendation from the
business model innovation literature, where it is viewed as a specific
type of knowledge acquisition. In effect, an existing firm implement-
ing this type of innovation is forced to imagine and learn new ways
of doing business. For this the changes need to be radical, questioning
the firm’s conventional way of doing business. In the ‘classical’ strate-
gic approach, most learning occurs in the preliminary phase of diag-
nosis through analyses and studies. However, the fundamental nature
of business model innovation means that simple market studies or cli-
ent surveys are inefficient and not very useful: the people surveyed
are unable to project themselves into this ‘radical newness’. Strategic
experimentation offers another route towards the required learning,
and can be fundamental to solving problems where solutions are un-
certain, or when critical information sources are non-existent or un-
available. Launching a series of small experiments helps minimize risk
and maximize the firm’s rate of learning, making it possible to identify
a strategy’s potential for success most efficiently.
Thus, as for conventional business model innovation, social busi-
ness models can start small, be refined and then rolled out. Corpo-
rate world experts can provide the relevant tools for analyzing the
market and finding new outcomes, but analysis alone is not sufficient:
only experimentation can determine whether new business model will
work out. Experimentation does not mean intuition, but involves the
ability (and intention) to make changes if the path first chosen turns
out unsuccessful. (This resembles the concept of ‘redirection’ noted
in Thompson and MacMillan’s article in this issue on building busi-
ness models for generating societal wealth) The development of the
Veolia Grameen business model provides an interesting illustration.
During the first stage of operation, the factory will supply water to
approximately 25,000 people, and its facilities will be extended during
a second stage, raising this figure to around 100,000, after which oth-
er factories will be built throughout Bangladesh. This social business
128 Growth Economics and Governance

model is still under construction, and as with earlier Grameen trials


will need to be fine-tuned as it is implemented.
Table 3 provides a summary analysis of our three cases, emphasiz-
ing the first three lessons from business model innovation: how con-
ventional wisdom needs to be challenged, how partnerships pay off,
and how experimentation helps create a good road map for rolling out
the concept. The story behind each of our cases is of the gradual emer-
gence of the social business concept: a self-sustaining company that
sells goods or services and repays its owners for their investments, but
whose primary purpose is to serve society and improve the lot of the
poor. Such lessons lead to the identification of the specificities of social
business models.
Grameen Danone is considered to be the world’s first conscious-
ly-designed multinational social business, an international business
with a social mission but run as a for-profit organization e so special
lessons can be learned from this case. As noted earlier, building so-
cial business models relies on some of the same strategic moves as
conventional business model innovation. However, the Grameen Da-
none example also illustrates the specificities of this type of business
model: the need to take all stakeholders (not just shareholders) into
account and the need to define the social profit expected from the
social business.

Lesson 4: Favoring social profit-oriented shareholders


As noted above, more and more corporate managers are keen to
launch CSR projects that seek to help developing countries. But they
face the problem that, even if such projects are small in terms of the
overall scale of the company, they still require resources. In the Da-
none case these resources included both asset expenditure (for the
factory) and valuable top management time. Since business manag-
ers report to owners or shareholders, they must give profit the high-
est priority, since reducing profits to promote social welfare might
leave owners and/or shareholders feeling cheated. Corporate social
responsibility could be viewed as corporate financial irresponsibility
unless financial profit-oriented shareholders can be shown that the
incurred costs will turn into a positive cash flow in the medium or
long term.
Policies for Development and Growth: Microfinance towards Social Business 129

Despite the ever growing number of studies trying to measure the


impact of CSR on financial performance over the past thirty years (some
list 52 such studies, others 127), researchers still argue about the exis-
tence of a positive, negative or neutral link. These unclear outcomes
stem from different shortcomings, including inappropriate constructs,
methodological flaws or problems in the definition of ‘performance’.
More recent studies have taken these shortcomings into account and
attempted to correct them e but, as Barnett observes, ‘the link between
CSR and financial performance has become only murkier’.
Even if we claim a positive link between CSR initiatives and corpo-
rate financial performance, another debate remains, as Friedman’s ad-
vocates would argue that such a positive financial contribution is not
necessarily consistent with maximizing shareholders’ wealth. As the
CEO of a pub- licly-held company, Riboud is answerable to his Danone’s
shareholders, but he risked being unable to provide clear evidence of
how the resources used in the Grameen Danone experiment maximize
value for them. So, in order to avoid alienating skeptical shareholders,
Danone developed another innovation by disconnecting the funding of
Grameen Danone from the stock market. The company created a public-
ly-trade mutual fund with a special mission to give investors social ben-
efits rather than financial benefits e and gave Danone’s shareholders
130 Growth Economics and Governance

the option of joining if they wished. V765 M have been raised so far, of
which 20 has came from Danone. Over 25 percent of Danone’s 8,000 em-
ployees in France have opted to invest part of their profit-share income
into the fund. 90% of the mutual fund’s assets will be invested in mon-
ey-market instruments yielding a predictable market rate of return; the
remaining 10 percent will be invested in social businesses, which will
pay no return. Taken together, these two pools of money will provide
investors with a near-market yield on their money, while at the same
time supporting businesses that are bringing specific social benefits to
people in need. Although in theory a social business should provide no
annual return, this mutual fund is an acceptable and innovative way of
financing social businesses through the existing stock market.
This leads us to refine the social business model framework so it in-
cludes not only customers, suppliers and other partners, but also share-
holders who understand and accept the social mission of the experi-
ment. In building social business models, the value proposition and the
value constellation must be constructed through innovative links be-
tween all stakeholders, including shareholders.

Lesson 5: Specifying social profit objectives clearly


As is often the case in partnerships, cooperation can uncover con-
flicts between partners over time. For example, the Grameen Group’s
idea was to convert Grameen Phone into a complete social business by
giving the poor the majority of shares in the company so as to let them
benefit from its soaring profits e but Telenor refused to sell its shares. To
avoid such problems, the mission of Grameen Danone was established
in detail at the beginning of the project.
When the objective is to build a social business, its business model
must be shifted from traditional financial profit generation towards so-
cial profit generation. This is possible where only social profit-oriented
shareholders are involved in the project, but it makes the design of the
business model more difficult, since it must focus not only on financial
profit, but on profit for all stake-holders. Hence, while financial profit
is implicit in conventional business model innovation, social business
models need to define their objectives clearly.
So Grameen Danone’s mission statement is very explicit: ‘to bring
daily healthy nutrition to low income, nutritionally deprived popula-
tions in Bangladesh and alleviate poverty through the implementation
Policies for Development and Growth: Microfinance towards Social Business 131

of a unique proximity business model’. Several sources of social profit


were targeted, with two constraints: the need to limit the environmen-
tal impact of the operation, and the need for it to become economical-
ly viable (full cost recovery constraint). Nutritional profit was the first
source. Shoktidoi yoghourt naturally contains calcium and proteins,
and is expected to have a strong nutritional impact on children aged 3
to 15 who eat it on a regular basis. There is also an employment profit:
jobs were created locally on the (one-person) micro-farms, at the facto-
ry, and in the distribution channels. Grameen Danone plans to create
3,000 micro-farms, while the Bogra factory was conceived with the aim
of creating local employment rather than using so- phisticated machin-
ery, so also avoiding recurrent equipment maintenance problems. The
Grameen ladies andlocal entrepreneurs already involved in collecting
loan interest payments for local Grameen Bank branches and selling
Grameen Phone calls have increased their income by distributing the
product. By developing local employment without competing with ex-
isting networks, Grameen Danone is also helping fight against rural ex-
odus, which is at the root of many problems in developing countries.
It is also important to add that these ‘profits’ have not been achieved
at the cost of compromising on the third ‘bottom line’ e environmental
issues e in fact, quite the opposite. Grameen Danone is particularly vig-
ilant in implementing its environmental policy, which focuses on eco-
logical packaging and reduced energy use. Although the cup in which
the yogurt is contained is not (yet) edible, it is made out of PLA (Poly
Lactic Acid) which is elaborated from corn starch, and is designed to be
completely biodegradable in local climate conditions. Furthermore, the
rickshaw vans used to distribute the product use no natural gas or oil.
The example of Grameen Danone shows that social and environ-
mental goals do not necessarily conflict with long-term economic goals.
However, conflicts can appear at any point. As just one example: in 2008
the rise in milk prices made it difficult for Grameen Danone to break-
even, posing the problem of which objective e the economic or the social
profit e should be favored in such a situation. Such questions highlight
‘facts of life’ for those designing or managing social business models:
conflicts of this type are inherent and ongoing, and represent yet an-
other specificity of social as compared to conventional business models.
132 Growth Economics and Governance

6.8. The social business model framework

Drawing from these Grameen Group experiences, we can highlight the


adjustments needed in switching from a traditional to a social business
model framework. The first change is the specification of targeted stake-
holders, and the provision that the value proposition and constellation
are not focused solely on the customer, but are expanded to encompass
all stakeholders. The second is the definition of desired social profits
through a comprehensive eco-system view, resulting in a social profit
equation. The third is that the economic profit equation targets only full
recovery of cost and of capital, and not financial profit maximization.
These changes are illustrated by Figure 3.
Our topic here has been limited to the social impact of social busi-
nesses; however it is important to stress that the social business mod-
el can also be applied to environmental issues. Problems ranging from
climate change and water shortages to industrial pollution and high-
priced energy, which are mere nuisances to people in the North, pose
life-and-death difficulties for those in the South. These problems could
also be addressed by social businesses using specific new social busi-
ness models.

Fig. 3 The fouor components of a social business model

By comparing the business model innovation literature and the


Grameen experience, we have shown five lessons that can be learned
about building social business models and also designed a general
Policies for Development and Growth: Microfinance towards Social Business 133

framework, demonstrating its value for our understanding of social


businesses. We believe these findings do not only concern MNC’s wish-
ing to engage in pro-active CSR policies, but can also be generalized to
all entrepreneurs seeking to create social businesses.
We consider this paper as a first step in shaping the concept of the so-
cial business model, and further field experiment and research are need-
ed for researchers and practitioners to study and develop this self-sus-
taining type of business. Indeed, many questions remain unsolved. For
instance, how should the performance of social businesses be assessed?
While return on capital employed is an accepted measure for conven-
tional business models, social profit is difficult to measure with such
standard ratios. Relevant indicators will probably suffer from greater
time lags than those used in financial performance management: the
impact of Shoktidoi yoghurt on children’s health, for instance, will not
become measurable for a couple of years. Certification procedures, such
as the one developed by the Global Reporting Initiative, might be help-
ful, but are still under construction. However, we believe strongly there
will be a growing interest in building social business models for three
main reasons. First, humans have an instinctive, natural desire to make
life better for their fellows if they can. Given the chance, people would
rather live in a world without poverty, disease, ignorance and needless
suffering. These are the causes that lead people to donate billions of dol-
lars to charity every year, to launch NGOs and non-profit organizations,
to volunteer countless hours to community service, and (in some cases)
to devote their careers to relatively low-paid work in the social sector.
The same drivers will lead many to create social businesses, once this
new path is widely recognized and understood.
Second, unlike conventional businesses, social businesses are not en-
gaged in a contest. Their objectives are social, so they can learn from one
another and best practices should spread rapidly. The effort involved in
creating and refining social business models is, in a sense, a ‘donation’:
they are unlikely to be seen as intellectual property in any sense, and so
can be easily copied and rolled out by other global partners e and may
even merge to become a stronger social force in the world.
Last but not least, there is another set of reasons why these cases
studies should encourage businesses to engage in this type of initiative.
We believe that, although small, these new ventures can play promi-
nent roles within MNCs. While disagreement remains as to their effects
134 Growth Economics and Governance

on firm performance, several studies have found a positive relationship


between CSR and firm reputation, while research has also consistent-
ly demonstrated the advantageous effect of CSR initiatives on current
and prospective employees. Building social businesses could be seen as
a ‘learning lab’, offering an arena where managers can challenge their
conventional wisdom and develop dynamic capabilities that could in
turn be helpful to an MNC’s main business.
All these arguments speak in favor of the development of social
business initiatives within established companies, and suggest that
there should be a proliferation of social businesses through new or du-
plicated business models. Research on this topic needs to go on, since it
does inot only enhance our understanding of pro-active CSR policies,
but it also challenges our conventional approach to business thinking.
Indeed, introducing it into the capitalist system may save the system
altogether, by empowering it to address the overwhelming global con-
cerns that currently remain outside mainstream business thinking. In
addition, as we highlight in this article, building social businesses re-
quires taking all stakeholders into account, a lesson that might also be
usefully transferred to multuinationals conventional businesses, so as
to contribute to a ‘post-crisis system’ where stakeholder value maxi-
mization replaces shareholder value maximization. Taken altogether,
research on social business could be a factor in changing the capitalist
system, by helping both academics and practitioners to challenge the
current dominant shareholder paradigm.
The findings in this article have emerged from the field, and in the
specific context of shaping current experiments at Grameen. So far, our
findings cannot be generalized to theory: further empirical inquiries
need to be made into more social businesses, within and beyond the
Grameen Group. However, we hope our lessons and framework will
become a vehicle for examining new cases, so as to ultimately become a
definitive contribution to theory.

6.9. Countertrade

A typical international contract is the one in which the parties will pro-
vide each other with goods and/or services, relegating the payment of
a sum of money to a residual role.
Policies for Development and Growth: Microfinance towards Social Business 135

This type of operation is conventionally referred to as countertrade.


The payment in cash being replaced by the transfer of another good
or asset. In practice, and depending on the case, a form of exchange,
compensation or retrocession takes place. This type of contract is born
to compensate for the limited financial resources one of the parties
might have at his disposal. Such contracts thus essentially regard ex-
changes being made with enterprises in developing countries. In the
contractual proceedings either central banks or banking institutions
are also involved to provide a guarantee to the performing party from
any default of the other party.
There are several contractual sub-types that are fully described in
the weighty “Legal Guide on International Countertrade Transaction” of the
UNCITRAL, a UN agency: the Barter, the Switch trading, the Counter pur-
chase, the Buy back and Offset.
These contracts differ only with regards to the specific operations
they are meant to regulate, although the various types of contract pres-
ent sometimes only minor differences between them as follows:
 the Barter implements the direct exchange of goods or services
for other goods or services without using money as a means of
purchase or payment, except for any eventual balance;
 the Switch trading implements a practice in which a company
transfers the obligations of another company to make a purchase
in a particular country;
 the Counter purchase realizes the sale of goods or services to a
country by a company that agrees to purchase a specific product
or receive services of that country;
 the Buy back is used when a company builds a factory in a coun-
try - or provides technology, equipment, training, or other ser-
vices for the same country - and accepts a certain percentage of
the products of the establishment concerned as partial payment
for the contract;
 the Offset is generally used for the procurement of goods of high
technology and includes both the transfer of sophisticated tech-
nologies, and of know-how, including in the military field, and
the promotion of investment and easier access to certain mar-
kets ; with the “direct offset” one of the parties proceeds to the
provision of technological systems in one country and the other
party shall provide compensation in the form of raw material of
136 Growth Economics and Governance

the same or another country, or the finished product; the ‘”indi-


rect offset” refers to a transaction in which a government agen-
cy procures or allows for the supply of goods of high value, re-
quiring from the supplier that counter-purchases operations be
made with the purchasing country and that the economic value
of exchange is secured by forms of investment, technology or
assistance in third markets.
All these contracts have a common problem caused by the frequent
non-simultaneity of the exchange of goods, whether they have or lack
market affinity. The things to be exchanged can indeed also be future
things.
Frequently, therefore, the first performing party must protect itself
with a bank guarantee waiting for the obligations of the second party to
be fulfilled later.
Another important problem is linked to the value of the traded goods:
value of sales of goods supplied or counter-value based on the price lists
at the time of transfer of the assets, up to compensation. Clearly, in this
respect, there is also a “risk” that will be assessed each time to know
which of the two parties will be affected.
Finally, the law applicable to countertrade operations must also be
defined, where it is freely desirable by the parties, where this is permit-
ted by the legal systems that are applied to the same parties.
7
Sovereign Wealth Funds and
World Capital Market*

7.1. Introduction

Sovereign Wealth Funds (SWF) act as agencies supporting mergers


and acquisition operations (M&A) in the international capital market
with a particular interest in Western companies that are “hungry” for
new capital. Indirectly they also act as investment actors in fields like
renewable energy and development projects.
On the international capital market more than 70 Sovereign Funds
are acting, having a financial power estimated at more than 7 trillion
dollars. Relevant financial power if compared with the hedge funds
who count for 1,9 trillion dollars (in decline), the pension funds for
18 trillion, the private equity funds and the merchant banking for
21 trillion. Unlike major investment companies, the capital of SWFs
is owned and controlled by governmental agencies. They act in the
investment market as private groups/actors even if their resources
are publicly owned.
Sovereign Funds multiplied themselves in recent years by receiv-
ing increasing financial resources from rich emerging countries aimed
at gaining higher yields than from the conservative investments in
State bonds. There are funds of very high dimensions and with wide-

* In collaboration with Daniele Terriaca, Phd in Cooperation and Development, Sapi-


enza University of Rome and Nabylah abo Dehman, Phd in Cooperation and Develop-
ment, Sapienza University of Rome.
138 Growth Economics and Governance

spread holdings: The Government Pension Fund of Norway and the


Abu Dhabi Investment Authority are the largest respectively with
activities/assets under management of 838 and 773 billion dollars.
In 2007, a Chinese fund was established and has since reached 575
billion dollars. One year later, in 2008, the Russian Federation also
created two sovereign funds that amount to 170 billion dollars. Glob-
al investments are significantly influenced by Sovereign Funds: it is
estimated that for each additional unit of the allocated fund, foreign
direct investments (Fdi) increase by 12%.
Other than macroeconomic stabilization, savings and pension,
SWFs started by investing in low-risk assets (such as bonds), then
gradually diversified into equities before focusing on alternative as-
set classes (real estate, hedge funds, private equity, or infrastructure)
and more recently moving towards sustainable and renewable allo-
cation. These new strategies following the oil crisis seem to be influ-
encing positively their investment allocation policy towards respon-
sible and development projects.
Some SWFs are pursuing responsible and development goals by
allocating resources in long-term socio-economic projects with a stra-
tegic importance for the local economy or even for strategic foreign
countries. This is the case of the Norwegian fund, the Emirati fund
(Mubadala), the Iran National Development Fund, the New Zealand,
Australian and Singapore funds that manage a part of the national
wealth and seeks to encourage responsible investment in the absence
of a developed local financial market. Increasing interest for financial
allocation in development project is increasing in other SWFs, both at
national and international level.

7.2. The role of the SWF in the international capital markets

Sovereign Wealth Funds (SWF) can be defined as instruments of pub-


lic investments financed by capitals coming from different sources
(official reserves, oil revenues, trade surpluses, pension reserves, de-
velopment projects).
Rozanov coined the term “SWF” (2005) in order to distinguish
these agencies from the activities of the Central Bank and of that of
Hedge Funds.
Sovereign Wealth Funds and the World Capital Market 139

The financial allocations of SWFs are fed by the massive trade sur-
pluses which led the official reserves up to 9 billion $/US (a 140% in-
crease in the last 5 years, 25% of the world GNP). More than 5 billion
dollars are owned by China and Japan.
Official reserves largely exceed the level needed to insure domes-
tic monetary stability for several Central Banks: the financial surplus-
es can be devoted to investment agencies. There is no doubt that the
growth of SWFs’ capital assets has been directly influenced by the
impressive increase of the official reserves detained by the owner
countries.
The SWFs (7 billion US dollars) account for far more than half of
the world official reserves. Today SWFs have a dimension similar
to the gold reserves (which, however, are not invested), exceed the
Hedge Funds (approximately 1.9 billion US$), and it is expected that,
by 2015, they will count for a 10% of global financial assets.
Gross Official Reserves

Source: IMF, FIS, 2013


140 Growth Economics and Governance

Capital assets of the SWF (billion US dollars)

Source: SWF Institute

SWF’s capital sources

Source: SWF Institute, Preqin, 2012


Sovereign Wealth Funds and the World Capital Market 141

SWFs are managed by independent agencies and their goals respond


to several aims such as macroeconomic stability, investment diversifica-
tion, and strategic participation.

SWF’s portfolio composition

Source: IMF “Global Financial Stability Report” 2015

Sovereign Wealth Funds are playing an increasingly important role


in international finance, with regards particularly to both merger and
acquisitions and foreign direct investments.
While for a long time, capitals moved from industrialized countries
towards developing areas; today, Western economies are facing capi-
tal flows from the oil-rich countries and from the emerging countries
towards the more secure and stable developed markets. They are con-
fronted with both opportunities and concerns:
 Elements such as a stable institutional and legal framework,
the high technology industries’ structure, modern services, the
availability of relatively good infrastructure, etc. attract the new
comers’ interest.
 The depth of the financial crisis emphasized the lack of fresh
142 Growth Economics and Governance

capitals and brought the advanced countries and their weak


companies to open their door to new actors.
 Nevertheless, the State-owned capitals of the SWF do not fit with
the private nature of the market economy.
 Moreover, the countries that run this new state-capitalism are
more often than not ruled by undemocratic regimes.
Thus, the OCDE countries are attempting to find a proper balance be-
tween the need for fresh capitals and the risk of both dangerous political
influence and management control.
In a context characterized by the deep structural financial instability
that emerged with disruptive force in the American crisis, the SWFs,
who played for a long time the role of “silent” investors, are now attract-
ing the interest of researchers, of private and public companies as well
as that of policy makers, who are all seeking new sources of funding to
compensate for the lack of liquidity. Questions such as that of transpar-
ency, accountability and reciprocity emerge as the main issues for gov-
ernance rules to better regulate capital flows in a balanced way that does
not disincentive investments and that at the same time prevent from the
risk of political pressure.
The need for a regulatory framework that meets the requirement of
free capital movement and transparency of foreign investors pushed
main players in the international financial system to look for a common
proposal. The recent setting-up of the International Working Group on
SWF, which brings together the representatives of the Sovereign Wealth
Funds and of the main multilateral financial institutions (IMF, OECD,
EU), is the concrete demonstration of this necessity. The working group,
directed by Jaime Caruana, Director of the Money Markets and Capital
of the International Monetary Fund Department, and Hamad al Suwaid,
Chairman of the powerful sovereign fund of Abu Dhabi and Undersec-
retary of State, has launched a proposal for a voluntary code of conduct
in 24 principles, which China has already adopted.
Among the members of the EU, there are different attitudes: from the
liberal position of the United Kingdom down to the more conservative
and protectionist view of France and Germany, even if there are some
differences between them as well. The Italian attitude would seem to be
more open to capital inflows as the need to attract FDI is greater.
In the international capital market more than 70 Sovereign Funds are
now operating, armed with financial resources of 6,3 trillion dollars, the
Sovereign Wealth Funds and the World Capital Market 143

Hedge Funds (1,9 trillion $ declining), the Pension Funds (approximate-


ly 18 trillion) and finally the Private Equity Funds and the Merchant
Banking (21 trillion)80. A great number of these funds are concentrated
in Asia and in the Middle East; while other countries account for only
15% of the total asset value.
Sovereign Funds stimulate both increasing flows of investments
and of Mergers and Acquisitions (M&A) to Western companies that are
“hungry” for new capital.
The SWFs’ financial dimension in recent years is increasing due to
greater capital flows from rich countries (oil producers and emerging
economies) aimed at gaining higher profits in the world capital market
with respect to the conservative investments in State bonds.
SWFs include funds of very high dimensions and with widespread
holdings, such as:
• Government Pension Fund of Norway whose financial activities
reach 838 bill. US/$
• Abu Dhabi Investment Authority, the largest one, with financial
activities of 1 bill. US/$ circa
• Saudi Arabia Monetary Authority with a dimension of 675.9 bill.
US/$
• SAFE Investment Company of China, recently established, that
has already reached 600 bill. US/$
• Kuwait Investment Authority with financial assets of 410 bill.
US/$
• Government of Singapore Investment Corporation with finan-
cial assets of 320 bill. US/$
• Temasek Holdings whose financial assets amount to 174 bill.
US/$
• Qatar Investment Authority whose financial assets amount to
170 bill. US/$
• The Russian Federation created two sovereign funds in 2008 that
now amount to 170 bill. US/$
• China National Social Security Fund whose financial assets
amount to 161 bill. US/$
Unlike major investment companies, SWFs’ capital is owned and
controlled by governmental agencies. They act in investments’ market

80
Deutsche Bank
144 Growth Economics and Governance

as private groups but the resources are public. Officially their purpos-
es concern macroeconomic stabilization, the inter-generational transfer
of wealth, and the creation of sources of new investment opportunities
other than oil.

7.3. SWF in the World Capital Market

The extreme volatility of the financial markets, due by the expansive


monetary policies pursued by the major world’s central banks, could
give at the Sovereign wealth funds (SWFs) greater opportunities in
moving capitals towards most profitable investments.
Actually their role in the international financial market is increasing,
particularly regarding both merger and acquisitions (M&A) and foreign
direct investments (Fdi), thanks at the extraordinary accumulation of
financial resources reached by the emerging economies and of the oil
producer countries that would need to manage this capital amount in a
most profitable way. For these reason, the SWFs represent the better in-
strument to manage the excess capital trough the investments activities
in the global market.
If during the last century the capital accumulation was a character-
istic of the Western industrialized countries, nowadays the emerging
phenomena are shifting the SWFs location and ownership but not their
investment allocation choice that still prefer the more secure and stable
advanced markets.
The expression Sovereign Wealth Fund was coined the first time by
Rozanov in 2005, even if the creation of the first fund (Kuwait Invest-
ment Authority, KIA) was in 1953, describing funds as instruments with
the aim to “insulate the domestic economy from excessive volatility,
support the sterilization of excess liquidity, accumulate savings for fu-
ture generations and use the monetary surplus for economic and social
development”. In 2009, the International Working Group of Sovereign
Wealth Funds (Iwg) has given a more precise definition describing the
SWFs like “investment State vehicles using capital flows in excess to be man-
aged separately by the central banks”.
Sovereign Wealth Funds and the World Capital Market 145

Sovereign Wealth Funds by year of establishment (%)

Source: Preqin, 2015

Large part of the SWFs have been created since the beginning of the
third Millennium (table 5), due to the increasing surplus of the balance
of payments (Ocampo e Griffith-Jones, 2010), and at the end of 2015
there are about 80 active funds worldwide (whose main ones are listed
in the Annex 1) who manage assets of more than $ 7 billion.
The SWFs are operating as private agencies searching a profitable
capital allocation, through the investment diversification that could
open new opportunities for the mono-sector economies (ex. oil produc-
ers) or even for the poor technology countries.
Actually, they are confronted with opportunities and concerns that
can be synthesize as follows:
• The depth of the financial crisis and the increasing State debts
emphasized the lack of fresh capitals in the advanced countries
by inducing their companies to open the door to new actors;
• New actors (investors) are attracted by stable institutional and
legal framework, efficient public administration, high technolo-
gy industries, modern services, infrastructure, etc.;
• The State-owned structure of the SWFs do not always fit with the
private nature of the market economy, i.e. the portfolio strategy
of SWFs could be influenced by political choice.
• Moreover, a great part of SWFs is run by countries often ruled by
undemocratic regimes.
146 Growth Economics and Governance

In an economic context characterized by the deep structural finan-


cial instability, the SWF, operating as silent investors, are attracting
the interest of private and public companies as well of policy makers,
who are seeking new sources of funding to compensate for the do-
mestic lack of capital.
Questions such as that of transparency, accountability and reci-
procity emerge as the main issues for governance rules. Capital flows
need balanced international regulations to promote investments and,
at the same time, prevent from the risk of political pressure.
Following these guidelines, the OECD countries are attempting to
find a proper balance between the need for capitals and the risk of
political influence or management control.

7.4. Macroeconomic power

Despite the repeated financial crises and the recent tensions in Eu-
ropean markets, the SWFs assets under management (AuM) recor-
ded a steady growth path since 2009 and, after suffering losses of
an average of between 5% and 15% (with tips to 30%) for those with
a riskier portfolio (Jen, 2010), have increased significantly between
2013 and 2014.
The table XXX shows that this AuM is not equally distributed; the
first five sovereign wealth funds hold more than 50% of the total, va-
lue who reach the 76% considering the top ten in the league.
With reference to the strategic objectives identified by Kunzel
et all. (2011) and Chiarlone and Miceli (2013) 81, the most relevant
Swfs are the Savings funds (about 25% of the total of AuM) and, al-
beit with a lower number, are the Reserve investment funds that hold
most of the wealth 82.

81
The authors outline five categories of SWFs: Saving funds (distribute wealth be-
tween generations by diversifying their assets into more profitable activities), Stabiliza-
tion Funds (pursue the aim to isolate the households by commodity fluctuations), Pension
reserve funds (pension purposes), Reserve investment funds (using excess liquidity to max-
imize profits) and Development funds (allocate resources for activities aimed at national
socio-economic development).
82
These classifications, however, should not be used in a rigid manner, in fact many
SWFs could pursue several objectives simultaneously or change it over time, depending
on the national needs. Usually, as evidenced by Kimmitt (2008), the commodity funds
Sovereign Wealth Funds and the World Capital Market 147

In addition, the total assets of 20 funds classified as commodity


(or that derive their financing from natural resources) reach about
3.7 trillion dollars (table 6); given this particular composition, it is
evident that the evolution of AuM is strongly related to the evolution
of oil prices.

Top SWFs operating in the international market

The following Table suggests that in the seven years that followed the
2007-2008 financial crisis, the assets under management of SWFs is more
than doubled. At the same time it’s possible observe that, while in 2008
the commodity SWFs managed more than two thirds total assets, the
non-commodity SWFs now account for a greater share of these assets,
that is roughly 40%.

are characterized by many strategic changes over time.


148 Growth Economics and Governance

SWFs asset under management ($bln)

Source: SWF Institute; The City UK estimates, 2016

The forecast for the next years indicate the maintenance of this
expansion trend, the only uncertainties could be linked to the future
evolution of crude oil prices. If the sharp decline in crude oil, which
began towards the end of 2014, should also continue in the long-term,
the countries holders a commodity funds would be more oriented to use
part of the AuM to compensate the revenues reduction avoiding pressu-
res on the external debt exposure.

7.5. Regulatory framework

The great asset amount managed by SWFs over the years has triggered
a broad debate, academic and political, on the potential impacts of such
investors and their portfolio management so as to increase a protectio-
nist approach, by the target countries, over the SWFs acquisitions.
According to Beck and Fidora (2008; 2009), most of these fears stem
from the fact that the SWFs objectives may not only be stimulated by
economics reasons or oriented at maximizing the value of investments,
but also supported by political reasons or linked to the possession of
advanced technologies.
Sovereign Wealth Funds and the World Capital Market 149

These elements of concern are amplified by the fact that, as previously


underlined, the most SWFs are active within non-OECD countries, ma-
naged by non-democratic regimes, with a less degree of institutional
development.
Referring to the first 10 countries who hold the greatest SWFs, the chart
XX collects information not only on the amount of the AuM managed
(over 85% of the total) but also the so called Rule of Law (proxy of the de-
gree of institutional development)83 and the ability of the State to ensure
the efficiency of its regulatory framework (summarized by the Freedom
from Corruption and Property Rights)84.

Swf and the Rule of Law

Source: elaboration on SWF Institute data, 2016

83
Edit by the Heritage Foundation and summarized in the Index of Economic Freedom
(2015). A high index values is associated at the degree of a democratic system.
84
The horizontal and the vertical axis represent respectively the Freedom from Corrup-
tion (FC) and the Property Rights (PR) while the bubble size is proportional at the total
Aum.
150 Growth Economics and Governance

The Table shows how only three countries (Norway, Singapore and
Hong Kong) are located in the upper part of the dial and present si-
gnificant values for the indicators considered, demonstrating an high
efficiency of the State apparatus.
The rest of the sample, where the assets hold reaches a value clo-
se to $ 3 trillion, are characterized by a weak governance structure. In
particular, in three cases (China, Russian Federation and Kazakhstan)
there is a widespread state control on the economic management. These
assumptions, which derive from a simple descriptive analysis, might
confirm the thesis about the opacity these financial instruments althou-
gh there are no confirmations regarding the danger of their financial
transactions on the markets stability.
On the contrary, some empirical investigations (Chiarlone, 2010)
showed how the SWFs acquisitions could generate greater liquidity in
financial markets and, considering their nature of long-term investors,
there are low probability that they effect massive divestment tran-
sactions, impacting adversely on stock prices. At the same way, despite
widespread concerns, academic studies (Bortolotti and Fotak, 2009; Bal-
ding, 2009) have shown that is no evidence of any SWFs influence on the
strategies of the target companies and on the fund investment decisions
from the reference countries.
In support of SWFs is possible find some positive aspects related also
to the greater liquidity managed that could supporting the growth of
target enterprises, reducing both the cost of risk capital and the financial
market volatility during financial storms (Lesmond, 2005).
Furthermore, it could be argued that SWFs constitute an opportunity
for States to regain authority over financial markets that globalization
seemingly had taken away, leaving them at the mercy of the risks and
volatility that characterize markets; the SWFs represent in a way the re-
turn of the State and of politics within the financial world, phenomenon
that was more evident during the economic turn down.
So SWFs, if well conceived and properly managed, could be consid-
ered as efficient instruments to preserve local economies from the vicis-
situdes of economic scenario. But, because their sovereign structure and
because most of them originate from countries that still face important
infrastructure gaps and economic inequalities, it can reasonably expect-
ed that they can be more than simple stabilizing or saving funds, but
instruments to generate positive change from a developmental stand-
Sovereign Wealth Funds and the World Capital Market 151

point, both in their home country and abroad85.


It has been argued, in effect, that SWFs have been and could be more
relevant in financing development as they dispose of significant re-
sources and because their horizon tends to be much longer than that of
other investment vehicles. Increasingly confronted with a lack of fund-
ing, companies have for instance expressed a growing interest for the
SWFs investments that can accompany the firms in their development
and open up new commercial alleys.
In order to maximize the positive role of SWFs, it’s need a regulatory
framework that meets the requirements of free capital movement and
transparency of foreign investors.
The recent setting-up of the International Working Group on Swf,
which brings together the representatives of the Sovereign Wealth
Funds and of the main multilateral financial institutions (IMF, OECD,
EU), is the concrete demonstration of the necessity to seek a common
proposal86.
Within the European countries, there are different attitudes: from the
liberal position of the United Kingdom to the more conservative and
protectionist strategy of France and Germany, even if there are some
differences between them as well. The Italian attitude would seem to
be more open at the capital inflows, due at the great need to collect Fdi.

7.6. Relationship between Foreign Direct Investments and the


SWFs

Market integration pushes companies to partially delocalize their pro-


duction in a worldwide perspective by searching the most convenient
location in term of labor cost per unit of product.
At the same time, multinational companies are benefiting from many
innovative financial instruments to support investment projects, also
through minority shareholdings, even moved by speculative choices.

85
One of the main SWFs objective is linked at developmental purpose, for these rea-
sons a certain number of them are described as Sovereign Development Funds.
86
The working group, directed by Jaime Caruana, Director of the Money Markets
and Capital of the International Monetary Fund Department, and Hamad al Suwaid,
Chairman of the powerful sovereign fund of Abu Dhabi and Undersecretary of State,
has launched a proposal for a voluntary disclosure code (24 principles), which China
has already adopted.
152 Growth Economics and Governance

The growth of the foreign direct investments (FDI) seems to depend


not only on a single country’s economic growth (GDP, export flows)
but also mainly on the financial actors’ dynamism (Investment Funds,
Pension Funds, Hedge Funds, Sovereign Wealth Funds).

i. Fdi outflows
Fdi flows are mainly influenced by developed countries, even if in the
last decade we have been witnessing an increasing role of the emerging
countries. These new economies count for at least ¼ of global Fdi out-
flows due to the investment activities of their SWFs in strategic sectors
such as commodities, finance and communication (UNCTAD, 2012).
Global outflow Fdi trend (1980-2011)

(Grey areas concern the depression periods)


Source: elaboration on Unctad e Nber data

According to the World Investment Prospect Survey 2012-2014 (WIPS),


Fdi outflows are estimated at 1.8 trillion US/$ by the end of 2013 with
an increasing trend in 2014. Greater interest has been devoted to invest-
ment in manufacture and in real estate.
Observing the geographical characterization, the industrialized coun-
tries (NAFTA and other OECD countries) represent the absolute major-
ity of the global Fdi-outward while their share is considerably lower in
Fdi-inward. The United States hold the leader position, followed by the
United Kingdom and France.
Sovereign Wealth Funds and the World Capital Market 153

Capital flows towards developing countries are directed towards


China, Singapore and Hong Kong and the transition economies such
as that of the Russian Federation. The emerging countries are slowly
acquiring capacity and strength as important investors. They are no lon-
ger solely FDI-recipient countries as they used to be in the past.

ii. Fdi inflows


The Fdi-inward trend in the world is growing: in 2005, it increased
by 29% (916 billion), 38% in 2006 (1,306 billion) and even more in 2007
(approximately 40% - 2,002 billion).
However, as the negative effects of the financial crisis pushed down the
real economy, the FDI flows decreased to 1,819 billion in 2008 and to
1,221 in 2009 before slowly regaining strength in 2010 and 2011 (respec-
tively 1,412 and 1,691 billion) and decreasing again in 2012 to 1,317 bil-
lion. The FDI inflows of 2013 show some sign of slight recovery as they
reached 1,461 billion.
Global Fdi inflows, average 2005-2007, 2007-2013 (bn US dollars)
154 Growth Economics and Governance

Fdi inflows by region, 2010-2013 (bn US Dollars)

Source: UNCTAD, 2013

Source: UNCTAD, 2013


Sovereign Wealth Funds and the World Capital Market 155

Around 10% of the global FDI on average is due to the SWFs’ invest-
ments activities. SWFs’ investments reach the maximum level of 108 billion
US/$ in the 2008 (pre-crisis). The preferred destination of the investments
remains the OECD countries (55% of total value in 2012), half of which are
attracted by the more advanced European countries (UK, CH, F). BRICS
countries are the recipients of less than a third of these investments.
As a consequence of the financial crisis, new investment strategies
were adopted by the SWFs with regards not only to the geographical
distribution but also to the sector allocation. SWFs are moving toward
less risky activities such as real estate. Real Estate allocations represent,
in 2012, 23,7% of the global assets.

SWF - sector distribution 2011-12 (% global value)

Source: Sovereign InvestmentLab

iii. Impact of the SWF’s strategy on the Fdi


It is interesting to analyze which kind of relationship (if any) exists
between the dynamics of Fdi and the investment strategies of the SWFs.
An estimate has been computed through a simple one-equation regres-
sion model by using a “cross-section analysis” among countries grouped
in representative areas87.

87
The geographical areas are: USA, EU, rest of the OECD, OPEC, BRIC (Brazil, India,
China), Low income countries, other developing countries, rest of the world.
156 Growth Economics and Governance

The model is structured as follows:


• dependent variable: total Fdi inflows in all the countries of the
world,
• independent variables as follows:
• Gdp = Gdp of each countries units by areas
• Ris = official reserves
• fondInv = investment fund (private equity)
• fondPen = pension fund
• fondHedge = hedge fund
• SWF = Sovereign Wealth Funds
The result of the regression is as follows:
Fdi worldIn=-32,36 + 0,026gdp -0,009ris + 1,663fonInv -0,606fondPen -1,095fondHedge +0,122SWF
(t-student index = 0,85; Durbin-Watson index = 3,2)

The regression shows a very small impact of the GDP on FDI (as pre-
dicted), while the only positive impacts on the FDI dynamics are due
to Private Equity Funds and Sovereign Wealth Funds whose influence
is estimated at around 10% of the Private Equity Funds. On the other
hand, there is no relationship with official reserves as it could have been
expected because of the independent structure of the SWFs.

7.7. Governance implications

The historical foreign attitude of the OECD countries was to invest in the
Arabic countries and not much in the emerging countries such as China
and Russia for questions related to stability and risk aversion. In the
last decades, Western companies’ strategies are changing and show a
more positive interests towards the emerging countries both in order to
exploit natural resources (oil) and to gain from lower production costs.
Regarding the BRICS’ investment strategies major concerns upset the
advanced economies as the recent acquisitions in strategic sectors could
affect companies’ control and profit distribution. The ongoing financial
crisis could further amplify these effects.
Main concerns can be formulated as follow:
• M&A operations in strategic sectors such as banks and finance,
communications, energy, defense, infrastructure and high-tech
could have negative impact to national security.
Sovereign Wealth Funds and the World Capital Market 157

• Lack of transparency, accountability and reciprocity of many


SWFs make it difficult to understand their investment philo-
sophies and strategies.
• Risk profiles could involve both source and recipient countries.
By promoting a voluntary global agreement to adopt common
self-regulating rules on the basis of the IMF working group and OECD
declaration (September 3rd 2008, Santiago Conference), could improve
the international acceptance of the SWFs’ investment policies.
Nevertheless, there are still too many conflicting interests and it is like-
ly that these declarations will be adopted in principle and will not be
translated into best practices that could help build up good governance.
Two philosophies could influence the search for global governance:

i. Liberal view
Countries with a more liberal approach, like the United States and
the United Kingdom, would delegate to the international organization,
such as the IMF or the World Bank, the task of drafting appropriate
governance rules on SWFs’ management and transparency. They could
be considered long-term reliable investors since they have to “sterilize”
currency surpluses in emerging economies. Several economists (Jeffrey
Garten, Lawrence Summers) suggest that a soft governance approach
has to be adopted with a few fundamental principles, such as trans-
parency of choices and the publication of reports on owned portfolios,
under the surveillance of both the IMF and the World Bank.

ii. State- intervention view


This view is mostly favored in several EU countries. It would fix a
maximum level of equity participation, by introducing a golden share
system or even further restrictions, in order to safeguard strategic sec-
tors and companies from the acquisitions of the SWFs.
The EU has set up a working group to define some common rules on
transparency and investment to move towards more restrictive posi-
tions. But the wider international consensus is in favor of the “soft liber-
al” approach of the IMF, which has been developed by the International
Working Group on SWFs.

iii. The Italian view


Italy is one of the most internationalized economies due to their
158 Growth Economics and Governance

SMEs’ competitiveness in the world markets. Exports are increasing de-


spite the strength of the euro and its position is expanding in foreign
markets. In terms of increasing rate, Italy is second only to Germany.
Nevertheless its capacity to attract FDI and M&A is insufficient be-
cause of its weak domestic competitiveness, administrative inefficiency,
and legal uncertainty.
In order to attract more investments, the Italian position on the
SWFs’ governance should be closer to the liberal solution, even if it
is not reflecting the tradition based on the Central Bank control on fi-
nancial activities. It should be in favor of the introduction of a limited
set of best practices (good governance) to improve the transparency of
the SWFs. The use of fiscal policy could help to attract foreign invest-
ments by giving fiscal advantages to the SWFs who agree to abide to
the transparency rules.
Italy has a political interest to support the need for greater trans-
parency and accountability, as it would make the SWFs investments’
choices clearer, with particular regards to strategic sectors (infrastruc-
ture, energy, utilities services). Furthermore, Italian foreign invest-
ment strategy could support the adoption of reciprocity rules from the
SWFs in order to open the way for more external investments in the
emerging countries.

7.8. Propensity for responsible investments

We will attempt to construe the propensity of SWFs to adopt responsible


practices in terms of investment. Such tendency will be analyzed ac-
cording to whether SWFs include in their investment decision-making
process environmental, social and governance (ESG) criteria and if not
whether and why it would make sense for them to do so from both a
commercial and ethical standpoint. The ESG criteria are not set in stone
and they continuously evolve so as to include new factors in order to
better tailor responsible investment strategies to ever-changing condi-
tions. Examples of ESG factors can be found in the table below.
Sovereign Wealth Funds and the World Capital Market 159

Tab. 9.13 - Examples of ESG factors88

Environmental Social Governance


- Climate change - Working conditions, - Executive pay
- Greenhouse gas including slavery and - Bribery and
(GHG) emissions child labor corruption
- Resource depletion, - Local communities, - Political lobbying
including water including indigenous and donations
- Waste and pollution communities - Board diversity
- Deforestation - Conflict and structure
- Health and safety - Tax strategy
- Employee relations
and diversity

Indeed, while at the inception of the socially responsible investing


movement in the 1960s, the latter was considered a marginal segment
in the investment world as it appeared to be rather a value-based ap-
proach rather than a properly thought out and sound financial strate-
gy, it became an object of interest and study and recent developments
have shown that it might be in some cases shielding more yields than
unsustainable approaches have so far – at least on the longer term89. We
will solely consider responsible investment as defined by the Principles
for Responsible Investment (PRI), a global network of investors who
created in 2006 a list of six principles for responsible investment90 that
investors around the world can voluntarily choose to adhere to. The
list of signatories has grown considerably since 2006 and now counts
over 1,500 entities from over 50 countries with assets amounting to more
than $60 trillion91. Therein, RI is defined as “an approach to investing
that aims to incorporate environmental, social and governance (ESG)
factors into investment decisions, to better manage risk and generate

89
What is Responsible Investment?
https://www.unpri.org/about/what-is-responsible-investment
89
See Kempf, A. and Osthoff, P. :“The Effect of Socially Responsible Investing on Port-
folio Performance” https://drupal.financite.be/sites/default/files/references/files/2184.pdf
90
The list of the six principles can be found in annex I
91
About the PRI – Principles for Responsible Investment
https://www.unpri.org/about
160 Growth Economics and Governance

sustainable, long-term returns.”92 RI is to be distinguished from other


value-based investing approaches such as socially responsible invest-
ment (SRI), green, sustainable or impact investment for instance. These
approaches might intersect with RI but the main point of rupture is that
the said approaches aim at promoting dual return structures on invest-
ments: both financial and social/green etc. Conversely, RI does not ad-
vocate for social returns per se. Rather it insists on the importance of
having a holistic approach to investment by including ESG factors in the
evaluation process of returns and risks insofar as not doing so would
eventually affect the investments’ financial performance.
The example of Norway’s Government Pension Fund Global (GPFG)
will be put forward as it stands out from both the literature and among
its peers as the clear leader in terms of responsible investment practic-
es. While the ethical argument for the adoption of a responsible invest-
ment strategy for SWFs is rather clear but needs to be restated – con-
sidering its liabilities, its lack of direct and legally binding fiduciary
responsibility, its public character etc. – the hypothesis we depart from
is that it is also sound from a financial point of view and that returns
over the long-term could only be improved by integrating ESG criteria
into investment choices.
As institutional investors, SWFs evolve in a world that is in constant
mutation and where new challenges come forth every day. They are
required, like other institutions and other investors, to adapt to these
changes and to meet these challenges to remain relevant and to insure
they are able to meet the mandates they were set up for. In this light, it
is interesting to look into whether SWFs behave rather as trend-setters
in terms of investment practices or whether they follow on the trends
set by other investing vehicles: be them of other public investors (pen-
sion funds) or private investors (hedge funds) as a SWF is considered
to be a public institution behaving like a private entity on the market. It
is also relevant to ponder upon the influence that norms-setting inter-
national institutions might have on the behavior of SWFs and to what
extent SWFs might act hand in hand with these institutions and assist
them in setting up new principles and standards by which to abide in
terms of responsible investment. We will attempt to fathom where SWFs

92
What is responsible investment?
https://www.unpri.org/about/what-is-responsible-investment
Sovereign Wealth Funds and the World Capital Market 161

stand in terms of putting responsible investment on the agenda of other


investors and whether they can act as leaders in making the financial
world more responsible and more acutely aware of the problems that
stem from inconsiderate investment practices be it at the environmental,
social or governance level.
Subsequently, in the following part, the potential inclination of SWFs
towards financing domestic and foreign development projects will be
scrutinized in order to fathom whether they may or may not play an ac-
tive role in financing development along with fulfilling their other man-
dates (intergenerational redistribution of resources’ revenues – macro-
economic stability and so forth) or whether these different mandates
might clash or supersede/impede one another. On the other hand we
will try to construe the challenges and barriers encountered by foreign
investors – such as SWFs – when trying to invest in assets based in de-
veloping countries and the financing partnership schemes that may be
engineered in order to overcome these difficulties and find new alleys
for financing development.
Both the integration of ESG criteria in the investment choices of SWFs
in this section and the latters’ potential participation in financing de-
velopment at home and abroad in the next, will be addressed in light
of the megatrends put forward by PwC93 that have been at play in the
global economy and that will continue to disrupt and shape the global
economic landscape for decades to come, as they surely influence the in-
vestment decisions of all investors, and not least of sovereign investors
among which the SWFs find themselves.
1. Reshaping of the global economic order: the shift of economic
power towards the East/South is crucial for sovereign investors
insofar as they must therefore now grant greater importance to
developing markets that tend to be more dynamic all the while
offering more numerous investment opportunities as they often
still suffer from a lack of infrastructures and services. Javier San-
tiso insists on the necessity to “reload our cognitive maps”94 in the
sense that “not only is the center of gravity of the world shifting

93
“Global megatrends”: PwC, http://www.pwc.com/gx/en/issues/megatrends.html
94
Santiso, Javier: “Sovereign Wealth Funds and the shifting wealth of nations”, in
Sovereign Wealth Funds and Long-term investing, edited by P. Bolton, F. Samama and
J. E. Stiglitz, p.127
162 Growth Economics and Governance

but traditional concepts also need to be reset”95. There is indeed


a blatant need to rethink the world in other terms that the tra-
ditional center/periphery and developed/emerging dichotomies
as the latter no longer reflect the current state of affairs. Indeed
according to the IMF, while during the 1980s, emerging and de-
veloping economies accounted for around 36 percent of global
GDP (measured in purchasing power parity, or PPP, terms) and
some 43 percent of global GDP growth (with PPP weights), for
the 2010-2015 period, the numbers were 56 percent and 79 per-
cent, respectively96. This trend was surely enough accentuated
by the financial and economic crises that have also discouraged
many institutional investors to risk investing in what used to be
known as safe securities in developed markets, bringing them to
start considering other alternative assets to diversify their port-
folio and alleviate their risk level. Also worth mentioning is that
most SWFs originate from the East and the South as evidenced
by the graph below. This contributes to reinforce their inclina-
tion towards investing their assets in countries that are closer to
them. This can be justified by direct geographical proximity as
the latter presents clear advantages in terms of information net-
works in the sense that countries have a greater historical knowl-
edge of their neighbors thus bearing lesser costs in dealing with
these markets and optimizing the positive externalities.

Number of SWFs by region97

95
Ibid.
96
“IMF Survey: The Global Economy in 2016”, http://www.imf.org/external/pubs/ft/
survey/so/2016/INT010416A.htm
97
Institutional Investor Profiles, SWFs, Sovereign Wealth Funds Institute,
http://www.swfinstitute.org/sovereign-wealth-fund-profiles/
Sovereign Wealth Funds and the World Capital Market 163

2. Demographic shift: the shift in demographics with some coun-


tries having to cope with ageing population and others doted of a
large, growing young active workforce will inevitably draw a line
between SWFs and pension funds whose fiduciary responsibility
will become more significant and pressing in the coming years.
Unless open migration policies are enacted to overcome the short-
age in workers, pension funds of States with ageing populations
like Canada or Japan will face much heavier pension obligations
that may force them to revise their investment decisions and risk
aversions levels. This might sharply modify the sovereign invest-
ing landscape of these institutions, affecting their traditional long-
term span and shifting the priority to investment in more liquid
assets (you might want to back that with a quote).

Level of concern about ageing of the population98

Another phenomenon of importance for the sovereign investing


landscape in terms of demographic shifts is the growth of the
middle class in the said emerging economies as in Asia for in-
stance where it now accounts for over 60% of the total popula-

98
United Nations, World Population Policies Database, https://esa.un.org/PopPoli-
cy/charting/worldmaps.aspx
164 Growth Economics and Governance

tion99. This should contribute to emphasize an already ongoing


phenomenon: that of the emerging markets capturing a growing
share of the totality of global foreign direct investments. There
is no reason why SWFs should derogate from the rule and sulk
these investment opportunities as the expansion of the middle
class and sustained growth in emerging countries seem to be
trends that will persist over the long-term while the recovery in
the so-called advanced countries is still lagging behind.
3. Accelerating urbanization: the accelerated urbanization of the
BRICS countries among others which has been characterized
by the appearance of megalopolis in India or China for instance
will surely call for large infrastructure needs and thus for sig-
nificantly increased financing. Needless to say that this rapid
urbanization phenomenon will contribute to put the issues of
sustainability and responsible investment even higher on the
agenda. Urbanization is often accompanied by the rise of a
middle class that quickly translates into a higher demand for
goods and services along with an overall increase in per capita
purchasing power. As mentioned above, this will surely only
reinforce the attraction of foreign sovereign investors for these
new markets. It might also fuel the temptation for developing
countries with resource revenues or exceeding commercial bal-
ance to set up a SWF in order to manage these extra earnings
to cope with the infrastructure-financing gap. Indeed, this last
decade has been characterized by a decrease in available funds
from international organizations and developed countries
through the traditional aid channels forcing developing coun-
tries to find other sources of financing. Apart from more tradi-
tional private investors, sovereign ones might be the right ones
to point at given their long-term investment span. The phenom-
enon of rapid urbanization also represents a challenge in terms
of urban-planning. Every year, the world’s urban population
grows of an extra 75 million people: between 2005 and 2015, the
urban population swelled by around 750 million people, four

99
Santiso, Javier: “Sovereign Wealth Funds and the shifting wealth of nations”, in
Sovereign Wealth Funds and Long-term investing, edited by P. Bolton, F. Samama and J. E.
Stiglitz, p.128
Sovereign Wealth Funds and the World Capital Market 165

fifth of which in Asia and Africa. Most cities in the developing


world are already very densely populated and there are real
and lingering problems regarding urban infrastructures such
as roads and public spaces. Indeed cities are expanding without
letting the adequate space for road construction for instance100.
The questions raised by this rapid growth should be addressed
by adequate funding but most importantly by sound planning
and a securing of property rights that would entice otherwise
reluctant professional developers to step in101.
4. Climate change and resource scarcity: while climate change
stands out as one of the biggest challenges of our times and that
it is expected to have dramatic consequences in particular for
populations of the least developed countries, the internation-
al community has been failing to address it with the urgency
and commitment necessary. To tackle climate change requires
an effort that involves both mitigation – to avoid the unman-
ageable – and adaptation – to manage the unavoidable. So far,
the steps taken by the international community fall short in the
face of the gravity of the current situation. Moreover, the issue
of food scarcity and the prediction of a growth in population
worldwide are inherently intertwined with the challenges posed
by climate change. These developments have been inspiring a
number of cross-border acquisitions in a move by import-depen-
dent countries to insure their own food security. Concerns over
food security thus drives foreign arable land acquisitions and
investments in agribusinesses abroad (China and the Gulf Co-
operation Council – GCC – countries have already set in motion
such investment schemes) in order to rely ever less on imports
and to be less vulnerable to the volatility of prices of food prod-
ucts. Indeed the 2008 crisis of food prices made those countries
that heavily rely on imports to feed their population realize the
extent to which they were exposed to such price surges. How-

100
In a study on seven African cities (Accra, Addis Ababa, Arusha, Ibadan, Johannes-
burg, Lagos and Luanda), Shlomo Angel of NYU calculates that only 16% of the land
was set aside for roads in the newly residential areas built since 1990. Urban planners
usually recommend reserving twice this figure for road space.
101
“The right kind of sprawl” and “Bourgeois shanty towns”, The Economist, July
2nd 2016
166 Growth Economics and Governance

ever, it is crucial to look closer at the impact that these invest-


ments have had and are having on the local populations of the
countries in which they are made. Indeed, China’s investments
in Africa have been pointed the finger at insofar as some have
described them as plain ‘land-grabbing’. The lack of regulation
and the difficulty to gather data due to very low levels of trans-
parency in the operations of most SWFs make these issues even
more relevant and worth scrutinizing.
5. Technological breakthroughs: some sovereign investors have
been sensible to the recent and upcoming innovations in the
field of new technologies and start ups choosing to put increased
focus on venture capital and incipient Internet companies.
Southeast Asian funds for one have been the first to open up
offices in San Francisco Bay for instance to locally monitor their
investments in the companies and startups of the Silicon Valley.
In June 2016, the sovereign fund of Saudi Arabia invested $3.5
billion in the capital of Uber, Silicon valley’s most highly valued
private company102. Southeast Asian and Middle Eastern funds
are not the only ones to have started invested in these tech com-
panies as both the Alaskan and New Zealand funds also came
through with investments in digital healthcare and in clean
technology business respectively. Sovereign funds have indeed
made investments in venture capital and start ups for a total of
$10 billion through 93 deals, 63% of which during the year 2014
and 2015103. Javier Santiso who had come up with the term Sov-
ereign Development Funds in a 2008 OECD working paper104 to
designate these funds enclined to invest in development proj-
ects both in their home country and abroad, now refers to these

102
“Sovereign wealth funds throw funding lifeline to tech ventures”, E. Auchard and
S. Ahzar, Reuters
http://www.reuters.com/article/us-wealthfunds-tech-idUSKCN0YT1OC
103
Data from the Sovereign investment lab presented in the 2015 report of the Sov-
ereign Investment Lab of the Bocconi University: “The sky did not fall”, in “The rise
of sovereign venture funds”, D. Lopez, p65 https://www.unibocconi.eu/wps/wcm/
connect/961cda94-6412-4d5b-93e9-12af00ac8bb9/DEF_report_SIL+2016_low.pdf?-
MOD=AJPERES
104
Santiso, J. “Sovereign Development funds, Key financial actors of the shifting
wealth of nations” http://www.oecd.org/dev/41944381.pdf
Sovereign Wealth Funds and the World Capital Market 167

funds undertaking such investments in tech firms and start ups,


as Sovereign Venture Funds105.
Today, socially responsible investors encourage an array of corporate
practices that promote consumer and worker protection, human rights,
and environmental stewardship among other things. As sovereign in-
vestors, SWFs have a responsibility as they are managing assets that
are by essence public assets. While they have to fulfill a commitment
of yielding financial returns, they also have to do with a more implicit
commitment to respect international legal requirements and thus find
themselves at the heart of a non-negligible dilemma, which is to find
the adequate balance between their financial and ethical commitment.
As Anna Gelpern puts it: “How do we reconcile diverse accountabili-
ty demands on SWFs when such demands do not necessarily stand in
a hierarchical relationship to one another?”106 According to her, there
are four dimensions along which demands for accountability behoove
SWFs: public, private, internal and external although as she points out
“there is no stable ex ante ordering saying which dimension comes out
on top.”107 The challenges that arise from these various layers of account-
ability translate mostly into ordeals in terms of governance, transparen-
cy and in some ways in the choice of investment strategies and the type
of management of existing investment in equities for instance.
It makes perfect sense for sovereign investors to seek both financial
returns and positive societal impact, as their ultimate shareholders
could be considered to be the citizens of their countries108 although
their fiduciary responsibility is not as clear-cut and direct as that of
pension funds for instance. However they do belong to states and are
associated to governments given their ownership status. As such, the
actions taken up by SWFs and their being associated with firms that
have unsustainable practices might tarnish the reputation of the state
in question and stand in contrast with its international legal obliga-

105
Santiso, J. Forthcoming, Cambridge University Press, as mentioned in “The rise of
sovereign venture funds”, D. Lopez, p63 in the 2015 report of the Sovereign Investment
Lab of the Bocconi University: “The sky did not fall”
106
Gelpern, A. “Reconciling sovereignty, accountability and transparency in sover-
eign wealth funds” in Sovereign Wealth Funds and long-term investing, edited by Bolton,
P., Samama, F. and Stiglitz, J.E. p205
107
Ibid. p206
108
Lo Turco, Cecilia
168 Growth Economics and Governance

tions. Besides, many SWFs share the common objective of providing


for future generations. This commitment entails a greater sense of re-
sponsibility when deciding upon portfolio strategy and evaluating the
various investment opportunities along with taking risk-measurement
seriously. With assets under management of $7 trillion and counting,
SWFs have a say in the corporate practices of the companies they in-
vest in and taking a more active ownership approach seems evermore
necessary and justified. Richardson indeed argues that the next log-
ical step in the evolution of SWFs would be for them to take it upon
themselves to invest in a more sustainable fashion. He points out in his
comparative study of Norway’s GPFG and of the New Zealand SF that
neither of these funds yet manage their portfolio comprehensively to
actively promote sustainable development109.

i. Norway’s Government Pension Fund Global


Among all SWFs, Norway’s Government Pension Fund Global
(GPFG) is often pointed out to as the most transparent, most ethical
and overall most deserving of praise of its peers. Unlike its name
would have one believes, the GPFG is not a pension fund insofar
as it does not have designated beneficiaries, as it is not ruled by the
principle of fiduciary duty and does not have a set time horizon over
which to realize its commitment110. Its stated objective is to turn pe-
troleum revenue into financial wealth, aiming for the highest possi-
ble returns bearing an acceptable level of risk. It was created after the
discovery of oil under the waterbeds of the North Sea was made at
the end the 1960s. It took the government of Norway twenty years to
design a structure that would allow them to manage oil revenues and
have it benefit living and future generations. While one of the main
goals was to avoid the effects of the Dutch disease, the underlying
assumption was that should the oil reserves finish, the fund would
be a substantial resource from which the future generations could
still avail themselves from. While in the first decades after the dis-
covery of the oil and gas fields, the revenue derived from their sale

109
Richardson, B.J. “Sovereign Wealth Funds and the Quest for Sustainability: In-
sights from Norway and New Zealand”, Nordic Journal of Commercial Law issue
2011#2, p1
110
Clark, Dixon and Monk. Sovereign Wealth Funds: Legitimacy, Governance, and Global
Power, Princeton University Press, 2013, p.67
Sovereign Wealth Funds and the World Capital Market 169

was used to develop the local petroleum industry and to develop the
country, it became clear quickly enough that the increasing revenues
due to the rise the price of oil would soon exceed the local needs and
risked destabilizing the economy if they were injected as such. To
avoid overheating the Norwegian economy, it was decided that all
investments of the fund would thus be made outside of Norway. The
ethical guidelines were established in 2004 and it is important to note
that while governments have changed and different parties and thus
different Ministers of Finance have been in charge, the consensus
over the role of the fund has been maintained and respected by pol-
iticians across the spectrum. While observers in the early days of the
fund might have been worried to see such a substantial cash flow fall
in the hands of a sovereign government, Norway’s politicians have
proven that they were not only able to manage it but also to allow for
a gradual diversification of the portfolio of the fund both geographi-
cally and across sectors. It is important to note as often governments
fail to implement long-term policies insofar as they are constrained
by the electoral cycles and often fall prey to the temptation of giving
into them at the expense of the need for long-term commitments.
The engagement of the GPFG with regards to socially responsible
investment is both a translation and a consequence of its obligation
and dedication to have its operations subject to both transparency
and accountability requirements. It is accountable to the Norwegian
people through the Ministry of Finance and publishes yearly reports,
highlighting its investment strategy and activities. The Ministry of
Finance which is charged with the management of the fund, sets the
bar in terms of investment strategy but also gets involved in ethical
matters as it defines the ethical guidelines to be followed. In its task,
it is assisted by two advisory bodies part of the Minister of Finance:
the Council of Ethics and the Strategy Council on Investment. How-
ever, operationally, it is the Norges Bank through the Norges Bank
Investment Management (NBIM) that manages the GPFG. The two
following organograms illustrate the links between the different ac-
tors involved in the management of the GPFG and the type of re-
sponsibilities incumbent upon each of them:
170 Growth Economics and Governance

The management model of the GPFG111

The Governance structure of the GPFG112

111 Governance Framework, Government of Norway website, https://www.reg-


jeringen.no/en/topics/the-economy/the-government-pension-fund/government-pen-
sion-fund-global-gpfg/governance-framework-for-the-government-/id696848/
112 Governance Framework, Government of Norway website, https://www.reg-
jeringen.no/en/topics/the-economy/the-government-pension-fund/government-pen-
sion-fund-global-gpfg/governance-framework-for-the-government-/id696848/
Sovereign Wealth Funds and the World Capital Market 171

Considered in general to be both an ethical and responsible sovereign


investor, the GPFG has doted itself of various tools to support responsible
investment practices. It expresses expectations as an investor and exercis-
es active ownership through voting in companies’ board meetings and
by engaging with the board and the management to encourage socially
responsible investments and good corporate governance. However, as it
currently invests in over nine thousand companies113, engaging pro-ac-
tively with each of them is clearly challenging. It has also started since
2008 to include particular areas of focus dear to SRI into its investment
and risk monitoring and management processes. In 2008, it chose to focus
first on children’ rights to later come in 2010 to both climate change and
water management. These three areas fall under the broader umbrella of
topics inherent to sustainable development as defined by the United Na-
tions in 1987 as “development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.”
The GPFG thus sees its involvement in the promotion of responsible in-
vestment as part of an overarching strategy to act for sustainable devel-
opment. It is reflective of Norway’s standing in the international com-
munity as pointed out by Clark, Dixon and Monk that see the GPFG as
both “an instrument of long-term national welfare and as an expression
of Norway’s commitment to global justice.” They regard the GPFG as “a
moralist sovereign wealth fund.” This characterization is true, to the ex-
tent that the GPFG uses divestment and a naming and shaming approach
to deter other financial entities from investing in companies that carry
out unsustainable practices. Indeed every year, it publishes a list of the
companies that it chooses to divest from along with the reason motivating
their choice. But that is not all it does. Indeed, the GPFG has contribut-
ed to improving industry standards by participating to both institutional
discussions on the topic and private companies roundtables. A telling ex-
ample is the crucial role it took on in the proceedings that led to the draft-
ing of the Santiago principles. It has also enhanced its own legitimacy by
insisting that its own activities be reported transparently to the public.
Furthermore, the GPFG has recently set an acclaimed precedent
when it conducted a major divestment operation excluding companies
– and their subsidiaries – that it had assets in on the basis that they

113
The GPFG invests in 1.3% of all companies listed worlwide and 2.3% of listed
companies in Europe.
172 Growth Economics and Governance

were producing coal or coal-based energy. Indeed the Storting took a


historic decision in 2015 to divest massively from companies involved
in the thermal coal business. So far, the GPFG divested from 52 coal
producing companies – including some subsidiaries in what they have
termed a ‘first’ wave of exclusion in April 2016, that should be followed
by further exclusions before the end of the year 2016114. The criteria upon
which the decision was made was that if a company made 30% or more
of its revenues from thermal coal or whether 30% or more of their ac-
tivities was dedicated to thermal coal it would be excluded. The basis
for such a sizeable divestment was that investments in coal-producing
companies represent a risk for global warming but also a financial risk.
It was a great achievement for the fossil fuel divestment campaign that
argues that the current reserves of oil, gas and coal are already exceed-
ing the quantity of what could be safely burned and who thus tries to
convince investors to dump stocks in the said companies115. Howev-
er, Urgewald, a German NGO has conducted a research together with
Greenpeace Norway to evaluate the weight of the divestment made in
April 2016 to measure it against the announced amount a year earlier
and it has come to the conclusion that until now only 1/5th of the NOK
55 million had actually been divested – that is to say that the divestment
from the 52 companies in April 2016 only amount to NOK 11 million out
of the NOK 55 million announced116. This assessment has led the two
non-governmental organizations to call upon the Norwegian govern-
ment to fulfill its promise by the end of the year.
By 2014, the GPFG had divested from 49 companies and the list of
the latters was published on its website with a joint justification that
mentioned the reason behind the divestment117. The same year, it con-

114
Observation and exclusion of companies, NBIM website
https://www.nbim.no/en/responsibility/exclusion-of-companies/
and “Oil Fund aims to cut 40 new coal companies”, Dagens Næringsliv, April 29, 2016
http://www.dn.no/nyheter/2016/04/29/1008/oljefondet-vurderer--kutte-40-nye-kullsel-
skaper
115
Fossil fuel divestment campaign
http://gofossilfree.org
116
Divestment done and divestment to do: the Norwegian Global Pension Fund and
Coal, 2016 https://www.urgewald.org/sites/default/files/typ_download/divestment_
done_and_divestment_to_do_2016.compressed.pdf
117
The list of all the companies the GPFG divested from can be found on their website
https://www.nbim.no/en/responsibility/exclusion-of-companies/
Sovereign Wealth Funds and the World Capital Market 173

ducted an analysis of greenhouse gases emissions from the companies


in their equity portfolio in order to get an idea of their portfolio emis-
sions’ intensity. Their contribution to research is part of their dedication
to SRI insofar as it also allows for a better-informed active ownership in
the companies they invest in.
NBIM’s market value as of July 2016 is of $847 billion. With such
important assets under management, the decisions and operations of
the fund are scrutinized by other investors and companies around the
world as it clearly has the potential have a substantial impact on the
places it chooses to invest or divest from. . While it is relevant to scruti-
nize the operations of SWFs with regards to responsible investment, it
is nonetheless crucial to ponder upon the reasons that might motivate
these operations or that might hinder their being carried out.
In this light, Landier and Nair’s classification of socially responsible
investors is useful as it points out to three types of investors in the realm
of responsible investments as follows:
• Yellow investors: feel morally obliged to exclude from their hol-
dings companies that are not compatible with their values. Histori-
cally, this is where SRI is born with the Quakers (religious group).
Yellow investors do not care whether their action is going to change
the world or whether it will have a cost on their portfolio.
• Red investors: not motivated by moral concerns but rather belie-
ve that information on governance of companies or how respon-
sible they are in terms of social and environmental values can
help them create financial returns.
• Blue investors: more pragmatic – focused on impact and intere-
sted in SRI only if it does not have too much of a financial cost.
Blue investors want to be convinced that SRI is changing the
behavior of companies in a significant manner. They are concer-
ned about the objectivity of the criteria that are used to rate com-
panies as responsible or not and very suspicious of lip service,
“green washing” and marketing.
Landier argues that a number of potential blue investors are wait-
ing on the sideline and that they want to be convinced of the actual
impact of SRI. Furthermore he sustains that SWFs could potentially act
as catalysts of these hesitating investors because of the amount of as-
sets they hold under management and given their ability to coordinate
on new information standards. To him, it is clear that the participation
174 Growth Economics and Governance

of SWFs could rally a number of these potential blue investors to the


cause of SRI and thus increase the numbers of responsible investors
considerably. This would in turn increase the pressure on companies
to abide by ESG standards and would have the wrongdoers feel ever
more concerned about the expectations and demands of responsible
investors and civil society in general. Dag Dyrdal elaborates on Land-
ier and Nair classification of responsible investors to try and position
Norway’s GPFG on the responsible investors’ spectrum. According to
his view, the GPFG acts both as a yellow investor and as a red inves-
tor. On the one hand, it qualifies as a yellow investor in its divestment
operations insofar as the exclusion mechanism derives from a political
decision and that the negative financial returns that may result from it
are not taken into account in the decision making process making it a
purely morally/ethically motivated move. On the other hand, in terms
of the fund’s management, the starting point is quite surely as a red in-
vestor in that decisions must eventually pay off over time to insure the
sustainability of the said fund over the long-term and the fulfillment
of its obligations towards the people of Norway be them present or
future generations. Therefore, Dyrdal suggests that the GPFG be seen
as an orange investor – that is partly yellow and partly red – rather
than as a blue investor. Nonetheless, its weight on the international
capital market and its well-established legitimacy makes it a poten-
tially strong rallying force for all these blue investors still standing
on the sideline. And to a great extent, the GPFG is conscious of its
widespread influence as pointed out by the council of ethics: “Our ex-
perience shows that there is a keen interest in our activities, both in
Norway and abroad. The contact with various research institutions,
non-governmental organizations, and media representatives are im-
portant to our work.”

ii. Investing in development responsibly


The SWFs, who originate for the most from emerging econ-
omies, have gained in exposure for various reasons, one of which
being their pivotal contribution to the bailout of the traditional
Western banking institutions in the midst of the 2008 financial crisis.
Notwithstanding the suspicions with regards to the motives behind
SWFs’ investment choices and the overall lack of transparency that
characterize their governance – as most SWF are owned by non-dem-
Sovereign Wealth Funds and the World Capital Market 175

ocratic states – there is a growing sense that these long-term investors


could be key in financing development both in their home country
and abroad. While the objectives behind their set up are multifold,
one of them is indeed developmental and some have even referred to
them as Sovereign Development Funds118. Not only did the economic
crisis brought about a shift in the perception of SWFs but it also en-
couraged a shift in the direction of their investments. As SWFs typi-
cally originate in emerging economies – even if Javier Santiso argues
that dichotomies “such as OECD/emerging economies have grown to
reflect historical baggage more than economic reality119” – they have a
propensity to invest in development both locally and in other emerg-
ing economies although it is undeniable that the prime objective of
their investment strategies remains before all the prospect of prom-
ising returns. The crisis reinforced that tendency in the sense that
emerging economies have had sustained growth even after the crisis
hit, while most of the countries in the West have found themselves lag-
ging behind and offering ever less attractive markets to invest in. An
important feature that is worth noting with regards to SWFs and their
potential as financer of development is the tendency of most of them
towards long-term investments. Indeed for development projects to be
effective, the investments have to be sustained over the long run.
According to the IMF, “a development fund can make investments
that support, if implicitly, wider socio-economic projects and industrial
development that help raise a country’s potential output.” As mentioned
earlier, most SWFs are to be found in emerging/developing countries
and the discrepancy between the amount of reserves accumulated and
the living conditions in the SWF’s sponsor country – be it with regards
to infrastructure, telecommunications, health conditions and the educa-
tion sector– has brought some countries to allow and even to encourage
their SWFs to invest domestically.
As of 2012, thirteen SWFs had domestic investment mandates, as re-
ported in the Table to be found below. It can be observed that eleven out
of these thirteen are indeed emerging or developing countries whose

118
See Javier Santiso, Sovereign Development Funds: Key financial actors of the
shifting wealth of nations, OECD Emerging Markets Network Working Paper, Oct. 2008,
http://www.oecd.org/dev/41944381.pdf
119
p3, Javier Santiso, “Sovereign Development Funds: Key financial actors of the
shifting wealth of nations”, EmNet Working paper, OECD, October 2008
176 Growth Economics and Governance

SWFs’ domestic investments aim at supporting sustainable growth for


their countries and provide the population – and future generations –
with sustained returns. While these domestic investments could be key
in financing development locally, to be effective the SWFs’ quality of
management is paramount as dealing with financial assets is nothing
short of an arduous task and neither is insuring that the outcomes for
the country be constructive.
Moreover the state of governance in some developing countries
might make it difficult for even an internally well-managed fund to
have concrete positive fallouts on the real economy. Indeed, a SWF
while it offers some hope and real opportunities can substitute neither
a well-functioning government with sound monetary and fiscal poli-
cies nor the application of the rule of law. The example of the Nigeria
Excess Crude Account (ECA) that was set up in 2003 by the govern-
ment of then President Olusegun Obasanjo is telling although it was
not clearly designed as a SWF. While the fund started off well as the
rise of oil prices allowed it to set aside a considerable amount of mon-
ey (20billion dollars), it soon became clear that the ECA would not
fulfill quite what it had been set out for. Indeed as reported by Dixon
and Monk, over a relatively short period of time government and state
officials withdrew 17 billion dollars: “withdrawals that did nothing to
improve the quality and quantity of infrastructure even though a ma-
jority of the outflows were designated for this purpose120.” The failure
of the ECA shows how important it is for a fund to be able to function
aside from the political play lest it performances may be hindered by
corruption, and malpractices of all kinds.

120
Adam Dixon and Ashby H. B. Monk, “What role for Sovereign Wealth Funds
in Africa’s development?”, Oil-to-Cash Initiative background paper, Center for Global
Development, October 2011
Sovereign Wealth Funds and the World Capital Market 177

SWFs with domestic investment mandates

Development can be financed locally by SWFs in their home country but


not only. Indeed foreign SWFs have been seen to invest in developing coun-
tries. Some have gone as far as creating funds that make explicit reference
to their developmental investment objective or to their regional orientation
such as CAD Fund – the China Africa Development Fund, Norfund – the
Norwegian fund for development and the Dubai World Africa. The Chinese
government’s involvement in Africa has often been criticized in the Western
178 Growth Economics and Governance

press and accused of grab-landing and of colluding with local officials and
non, regardless of their record – unlike Western governments who often at-
tach political conditions to their aid. But much of the fuss has no truth to it:
what is certain is that China entertains a different conception of development
as the one put forward by the West, but that does not make it less valid or
efficient. CAD Fund has invested mostly in infrastructure, heavy industry
and agricultural projects in Africa because the Chinese drew from their own
experience the lesson that these sectors are at the core of development. Chi-
nese FDIs towards Africa have grown from 30 million of dollars in 2009 to
82,5 million in 2012 and these direct investments have allowed to better the
quality of the cereal offers in the 18 African countries associated with CAD
Fund121. Besides the investments that have been made in terms of infrastruc-
ture and heavy industries have brought more dynamism to the economy of
countries such as Tanzania, Zambia and Ethiopia. The map below shows the
variety of investments that have been made by China in Africa since 2010.
CAD Fund is often compared to what appears to be a benchmark in
terms of Development Finance Institutions: Norfund. The Norwegian in-
vestment fund for developing countries was created back in 1997 and
has a larger mandate than its Chinese counterpart. Indeed, while around
50% of its portfolio is invested in African States, it also pursues projects in
South/ South-East Asia and in Central America. It provides investments, as
would a traditional commercial investor with this difference that it accepts
higher risks and lower returns. It provides equity, risk capital and loans to
companies in countries where they are typically lacking and its principal
objectives are economic growth and poverty reduction through partner-
ships with companies or organizations focusing on agri-business, renew-
able energies or financial institutions. Norway’s concern for transparency
reflects with the operating of Norfund whose activities and achievements
are reported in annual reports and whose projects are regularly evaluated.
Although Norfund and CAD Fund function in a distinct manner, they both
contribute to financing development in LDCs and both achieve to obtain
sustainable returns on their respective investments. These experiences are
full of promises for those who believe in financing development through
investment rather than through the typical canal of aid.

121
Tsirisoa Rakotondravoavy, “Le fonds public chinois CAD Fund lorgne sur les res-
sources africaines et malgaches”, Journal de l’économie, January 5th 2014, http://www.
journaldeleconomie.com/2014/01/le-fonds-public-chinois-cad-fund-lorgne.html
Sovereign Wealth Funds and the World Capital Market 179

Development has become of crucial importance not only for social rea-
sons but also for political and geopolitical ones. It is of pivotal significance
that development be taken seriously and financing it through investments
is one way of doing just that. The interests of the SWFs in financing devel-
opment are manifold. Not only do they wish to stabilize the economies of
their home country but also of foreign ones as they see in these investments
the possibility to tame long-lasting turmoil and to end social malaise while
contemporarily opening new investment opportunities. The international
community should be expected to contribute to the framing of the funds’
operations in order to assist them in achieving their full potential while
making sure they remain within the boundaries of their mandates and do
not infringe on the sovereignty of foreign countries.

Chinese investment offers in Africa since 2010


180 Growth Economics and Governance

7.8. Concluding remarks

• Reversing the historical trend that saw capital moving from deve-
loped countries to developing areas, as today capital flows come
from the oil-rich and new emerging countries.
• SWFs’ M&A strategies are seeking greater participation in capi-
tal-risk of strategic companies with no apparent influence on the
top management
• In the case in which the companies are publicly owned, the risk of
political constraints grows.
• The financial power of emerging countries is well represented
by the share between their currency reserves and the debt, that
account for the credibility of a country, equal to 16,7 points on
average for all of the emerging countries (14,5 for India and 6
for China). The financial reliability of these countries is increa-
sing dramatically. China with its China Investment Corporation
blows up by investing in Blackstone, an American Private Equity
company recently listed. The Russian financial power is creating
a stabilization fund, Gazprom.
• A reliable estimate shows the extent to which global invest-
ments are significantly influenced by Sovereign Wealth Funds:
for each unit of growth of the Sovereign Wealth Funds, Fdi in-
crease by 12%, while the Hedge Funds and Pension Funds lose
importance, because of their bigger interests in the financial
speculation market.
Sovereign Wealth Funds and the World Capital Market 181

Appendix: List of SWFs (SWF Institute, updated to August


2015)
Country Fund Billion $ Date of Source
creation
Norway Government Pension Fund – Global 882 1990 Oil
UAE – Abu Dhabi Investment Authority 773 1976 Oil
Abu Dhabi
China China Investment Corporation 746.7 2007 Non-Commodity
Saudi Ara- SAMA Foreign Holdings 671.8 n/a Oil
bia
Kuwait Kuwait Investment Authority 592 1953 Oil
China SAFE Investment Company 547 1997 Non-Commodity
China – Hong Kong Monetary Authority Invest- 400.2 1993 Non-Commodity
Hong Kong ment Portfolio
Singapore Government of Singapore Investment 344 1981 Non-Commodity
Corporation
Qatar Qatar Investment Authority 256 2005 Oil & Gas

China National Social Security Fund 236 2000 Non-Commodity

Singapore Temasek Holdings 193.6 1974 Non-Commodity


UAE – Investment Corporation of Dubai 183 2006 Oil
Dubai
UAE – Abu Dhabi Investment Council 110 2007 Oil
Abu Dhabi
Australia Australian Future Fund 95 2006 Non-Commodity
Russia Reserve Fund 88.9 2008 Oil
South Korea Korea Investment Corporation 84.7 2005 Non-Commodity
Russia National Welfare Fund 79.9 2008 Oil
Kazakhstan Samruk-Kazyna JSC 77.5 2008 Non-Commodity
Kazakhstan Kazakhstan National Fund 77 2000 Oil
UAE – International Petroleum Investment 66.3 1984 Oil
Abu Dhabi Company
UAE – Mubadala Development Company 66.3 2002 Oil
Abu Dhabi
Libya Libyan Investment Authority 66 2006 Oil
Iran National Development Fund of Iran 62 2011 Oil & Gas
US – Alaska Alaska Permanent Fund 53.9 1976 Oil
Algeria Revenue Regulation Fund 50 2000 Oil & Gas
182 Growth Economics and Governance

Malaysia Khazanah Nasional 41.6 1993 Non-Commodity


Brunei Brunei Investment Agency 40 1983 Oil
US – Texas Texas Permanent School Fund 37.7 1854 Oil & Other
Azerbaijan State Oil Fund 37.3 1999 Oil
Ireland National Pensions Reserve Fund 27.4 2001 Non-Commodity
France Strategic Investment Fund 25.5 2008 Non-Commodity
New New Zealand Superannuation Fund 21.8 2003 Non-Commodity
Zealand
US – New Mexico State Investment Council 19.8 1958 Oil & Gas
New Mexico
Iraq Development Fund for Iraq 18 2003 Oil
Canada Alberta’s Heritage Fund 17.5 1976 Oil
US – Texas Permanent University Fund 17.2 1876 Oil & Gas
East Timor Timor-Leste Petroleum Fund 14.6 2005 Oil & Gas
Chile Social and Economic Stabilization Fund 15.2 2007 Copper
UAE – Emirates Investment Authority 15 2007 Oil
Federal
Russia Russian Direct Investment Fund 13 2011 Non-Commodity
Oman State General Reserve Fund 13 1980 Oil & Gas
Bahrain Mumtalakat Holding Company 10.5 2006 Non-Commodity
Peru Fiscal Stabilization Fund 9.2 1999 Non-Commodity
Chile Pension Reserve Fund 7.9 2006 Copper
Mexico Oil Revenues Stabilization Fund of Mex- 6.0 2000 Oil
ico
Oman Oman Investment Fund 6.0 2006 Oil
Italy Italian Strategic Fund 6.0 2011 Non-Commodity
Botswana Pula Fund 5.7 1994 Diamonds &
Minerals
US – Permanent Wyoming Mineral Trust Fund 5.6 1974 Minerals
Wyoming
Trinidad & Heritage and Stabilization Fund 5.5 2000 Oil
Tobago
Brazil Sovereign Fund of Brazil 5.3 2008 Non-Commodity
Saudi Public Investment Fund 5.3 2008 Oil
Arabia
China China-Africa Development Fund 5.0 2007 Non-Commodity
Angola Fundo Soberano de Angola 5.0 2012 Oil
Sovereign Wealth Funds and the World Capital Market 183

US – North North Dakota Legacy Fund 3.2 2011 Oil & Gas
Dakota
US – Alabama Trust Fund 2.5 1985 Oil & Gas
Alabama
Kazakhstan National Investment Corporation 2 2012 Oil
Nigeria – Bayelsea Development and Investment 1.5 2012 Non-Commodity
Bayelsea Corporation
Nigeria Nigerian Sovereign Investment Authority 1.4 2012 Oil
US – Louisiana Education Quality Trust Fund 1.3 1986 Oil & Gas
Louisiana
Panama Fondo de Ahorro de Panamà 1.2 2012 Non-Commodity
UAE – Ras al RAK Investment Authority 1.2 2005 Oil
Khaimah
Bolivia FINPRO 1.2 2012 Non-Commodity

Palestine Palestine Investment Fund 0.8 2003 Non-Commodity


Venezuela FEM 0.8 1998 Oil
Kiribati Revenue Equalization Reserve Fund 0.6 1956 Phosphates
Vietnam State Capital Investment Corporation 0.5 2006 Non-Commodity
Gabon Gabon Sovereign Wealth Fund 0.4 1998 Oil
Ghana Ghana Petroleum Funds 0.4 2011 Oil
Indonesia Government Invesment Unit 0.3 2006 Non-Commodity
Mauritania National Fund for Hydrocarbon Reserves 0.3 2006 Oil & Gas

Australia Western Australian Future Fund 0.3 2012 Minerals


Mongolia Fiscal Stability Fund 0.3 2012 Minerals
Equatorial Fund for Future Generations 0.08 2002 Oil
Guinea
Papua Papua New Guinea Sovereign Wealth n/a 2011 Gas
New Guinea Fund
Turkme- Turkmenistan Stabilization Fund n/a 2008 Oil & Gas
nistan
US – West West Virginia Future Fund n/a 2014 Oil & Gas
Virginia
Mexico Fondo Mexicano del Petroleo n/a 2014 Oil & Gas
Total Oil & Gas Related 4,168.6
Total Other 3,115.1
TOTAL 7,283.7
8
Democracy and Governance

According to Acemoğlu, Simon Johnson and James Robinson, the pos-


itive correlation between high income and cold climate is a by-prod-
uct of history. Europeans adopted very different colonization policies
in different colonies, with different associated institutions. In places
where these colonizers faced high mortality rates (e.g., due to the pres-
ence of tropical diseases), they could not settle permanently and they
were thus more likely to establish extractive institutions, which per-
sisted after independence. In places where they could settle perma-
nently (e.g. those with temperate climates), they established institu-
tions with this objective in mind and modeled them after those in their
European homelands.
In these ‘neo-Europes’ better institutions in turn produced better
development outcomes. Thus, although other economists focus on the
identity or type of legal system of the colonizers to explain institutions,
these authors look at the environmental conditions in the colonies to
explain institutions. For instance, former colonies have inherited cor-
rupt governments and geo-political boundaries (set by the colonizers)
that are not properly placed regarding the geographical locations of
different ethnic groups, creating internal disputes and conflicts that
hinder development. In another example, societies that emerged in
colonies without solid native populations established better property
rights and incentives for long-term investment than those where na-
tive populations were large.
186 Growth Economics and Governance

8.1. Inequality and economic growth

Income distribution is measured by the Gini coefficient. Exchange rate


competitiveness is measured by rate deviation from purchasing power
parity adjusted for per capita income.
Initial theories incorrectly stated that inequality had a positive ef-
fect on economic development. The marginal propensity to save was
thought to increase with wealth and inequality increases savings and
capital accumulation. However, it was determined much later that the
analysis based on comparing yearly equality figures to yearly growth
rates was flawed and misleading because it takes several years for the
effects of equality changes to manifest in economic growth changes.

Percentage changes in GDP growth spell length as each factor moves


from 50th to 60th percentile and all other factors are held constant

The credit market imperfection approach, developed by Galor and


Zeira (1993), demonstrates that inequality in the presence of credit mar-
ket imperfections has a long lasting detrimental effect on human capital
formation and economic development.
The political economy approach, developed by Alesian and Rodrik
(1994) and Persson and Tabellini (1994), argues that inequality is harm-
ful for economic development because inequality generates a pressure
to adopt redistributive policies that have an adverse effect on invest-
ment and economic growth.
Democracy and Governance 187

8.2. Evidence

A study by Perotti (1996) examines the channels through which inequal-


ity may affect economic growth. He shows that, in accordance with the
credit market imperfection approach, inequality is associated with low-
er level of human capital formation (education, experience, apprentice-
ship) and a higher level of fertility, while lower level of human capital
is associated with lower growth and lower levels of economic growth.
In contrast, his examination of the political economy channel refutes the
political economy mechanism. He demonstrates that inequality is asso-
ciated with lower levels of taxation, while lower levels of taxation, con-
trary to the theories, are associated with lower level of economic growth.
A 2011 note for the International Monetary Fund by Andrew G. Berg
and Jonathan D. Ostry found a strong association between lower levels
of inequality in developing countries and sustained periods of economic
growth. Developing countries with high inequality have “succeeded in
initiating growth at high rates for a few years” but “longer growth spells
are robustly associated with more equality in the income distribution.”
Disputing the claim of a Washington Post editorialist that “Western Eu-
rope’s recent history suggests that flat income distribution accompanies
flat economic growth,” journalist Timothy Noah, points out that redistri-
bution policies in Europe do not seem correlated to economic problems of
the late twenty-oughts. With the exception of Ireland, the countries at risk
of default in 2011 (Greece, Italy, Spain, Portugal) were notable for their
high Gini-measured levels of income inequality compared to other Eu-
ropean countries. As measured by the Gini index, Greece as of 2008 had
more income inequality than the economically healthy Germany.

8.3. Quality of life

It has been shown that happiness tents to increase with a higher GDP
per capita, at least up to a level of $15,000 per person.
Economic growth has the indirect potential to alleviate poverty, as
a result of a simultaneous increase in employment opportunities and
increase labour productivity. A study by researchers at the Overseas
Development Institute (ODI) of 24 countries that experienced growth
found that in 18 cases, poverty was alleviated. However, employment
188 Growth Economics and Governance

is no guarantee of escaping poverty, the International Labour Organisa-


tion (ILO) estimates that as many as 40% of workers as poor, not earning
enough to keep their families above the $2 a day poverty line. For in-
stance, in India most of the chronically poor are wage earners in formal
employment, because their jobs are insecure and low paid and offer no
chance to accumulate wealth to avoid risks. This appears to be the result
of a negative relationship between employment creation and increased
productivity, when a simultaneous positive increase is required to re-
duced poverty. According to the UNRISD, increasing labour productiv-
ity appears to have a negative impact on job creation: in the 1960s, a 1%
increase in output per worker was associated with a reduction in em-
ployment growth of 0.07%, by the first decade of this century the same
productivity increase implies reduced employment growth by 0.54%.
Increases in employment without increases in productivity lead to a rise
in the number of working poor, which is why some experts are now promot-
ing the creation of “quality” and not “quantity” in labour market policies.
This approach highlights how higher productivity has helped to re-
duce poverty in East Asia, but the negative impact is beginning to show.
In Vietnam, for example, employment growth has slowed while produc-
tivity growth has continued. Furthermore, productivity increases do not
always lead to increased wages, as can be seen in the United States, where
the gap between productivity and wages has been rising since the 1980s.
The ODI study showed that other sectors were just as important in reduc-
ing unemployment, as manufacturing. The services sector is most effec-
tive at translating productivity growth into employment growth. Agricul-
ture provides a safety net for jobs and economic buffer when other sectors
are struggling. This study suggests a more nuanced understanding of
economic growth, quality of life and poverty alleviation.

8.4. Relationships between democracy, education and virtuous


rules

A definition of the democracy has been formulated by Abraham Lincoln


in his Gettysburg address in 1863: government of the people, by the peo-
ple, and for the people
He also explored how the interaction between democracy and educa-
tion affects the quality of government.
Democracy and Governance 189

Democratic elections do not foster the quality of government in


countries with largely uneducated populations. The standard argument
advanced in political science and economics in favor of democratic in-
stitutions suggests that democracy gives the right incentives to elected
officials because free elections provide to the voters an instrument to
defend themselves from corruption and excess in the use of power.
The following issues try to reconcile discordant literature on the
influence of both democracy and education in promoting good gover-
nance and economic development:
• the interaction between democracy and education is positively
correlated with the quality of government;
• the correlation between democracy and the quality of govern-
ment is not statistically significant in countries with low levels of
education and is positive and statistically significant in countries
with high levels of education;
• nevertheless we assume that there is a significant effect of educa-
tion on governance only in democratic governance (Hirschman);
• Democracy and education rather complement each other and
put into perspective the predictions of Glaeser et al. (2006) who
suggest that stable democratic institutions cannot flourish in the
absence of educated population.

The values and the objectives of democratic governance can be sum-


marized as follows:
190 Growth Economics and Governance

There is a widespread consensus on the need to reinforce institution-


al credibility as a coordinated and unitarily governed system but some
contrasts among the various political and economic approaches persist.
Different opinions concerning the modalities to realize reforms to reach
selected objectives:
• top-down rules, generally following the application of laws, im-
plying controls and administrative sanctions
• bottom-up rules, generally based on administrative procedures
only, implying the use of self-regulating measures which re-eval-
uate individual’s responsibility.
In conclusion, it can be said that virtuous rules are the best ways to
implement radical reforms intended to modify socio-economic distor-
tions within society in some main sectors, through:
• The improvement of credibility and public effectiveness;
• The reduction of public debt and budget expenditure;
• The fight against fiscal evasion and black economy;
• Best way to increase individual’s confidence in the future and
thus to promote development.
9
Italian Economic Perspectives

The recovery is consolidating in Europe and in Italy, even if at mod-


erate and different rates. Positive signals are reflected in GDP growth,
employment growth and, conversely, in the reduction of the unemploy-
ment rate among young people, as well as in the sharp reduction in the
use of social divergent (-58% compared to 2016). The progress keeps
going on in 2017, demonstrating how the season of reforms started with
so many difficulties and contrasts is producing its own results.
However, in recent times, anxiety arises as consequence of an inva-
sive globalization, rapid technological change and impetuous migratory
flows , causing destabilizing effects on the life-style of the people, on
their welfare as well on social behaviors.
Social disadvantages raise a dramatic anti-system feeling in Europe,
whose manifestations are widespread all over the world. Brexit in UK,
the presidential election in US, the rise of populist parties all over in Eu-
rope, the push towards local autonomies, reflect a climate of uncertain-
ty that manifests itself in skepticism towards institutions. Democracy
by absurdity facilitates the crushing of political systems and weakens
its government’s capacity with imprecise consequences on the stability
and credibility of the states. In the meanwhile, the major international
financial powers have a growing share of world economy in their hands,
exerting a growing control on the domains of politics and society.

9.1. Consequences of international turmoil

Labor deceleration (albeit unequal between countries) coupled with the


192 Growth Economics and Governance

disruptive effects of technological change on income distribution have


led to slower growth in income for low and middle income households.
Globalization and automation have weakened the position of workers
and their ability to strive for wage growth.
Yet capitalism has been the greatest rider of prosperity and opportu-
nities the world has ever known. Over the past 25 years, people living
in extreme poverty in the world have declined from 40% to below 10%.
The opening of the markets, due to the so much disputed globalization,
has contributed to narrowing the gaps between the various countries in
the world. And despite the allegations of unfair competition, trade has
helped economic growth far more than it has damaged. Exports stim-
ulated competitiveness and contributed to the exit from the recession;
the export companies pay their workers up to 18% more than average.
But capitalism, if not well-guided, can become a threat to more be-
cause of the over-benefits it has to the few. A world where 1% of human-
ity controls more wealth than the remaining 99% will never be stable.
Information and Communication Technologies (Ict) have enabled
businesses to partially relocate production processes by promoting mar-
ket integration.
But, by itself, this has not brought prosperity to everyone and broad-
ly shared growth. Economists have long recognized that markets, left
alone, may fail. And companies, who are without guidance, failed to
take into account the impact of their decisions on pollution, vulnerabil-
ity of dangerous products, or rising health costs.
The financial crisis has redesigned the map of world powers beyond na-
tionalities. New international finance actors act on a global scale with quick
and cynical choices and decisions, which are totally disconnected from the
manufacturing economy, with negative consequences in terms of credit
restrictions and falls in investment. The International Monetary Fund esti-
mates that annual financial wealth exceeds at least 8/10 times the real value,
that is the value of production of goods and services. If the global GDP,
between 1997 and 2016, has almost doubled from $ 40 trillion to more than
75, financial assets are estimated to have increased more than 250%. Finan-
cial crises have heightened the isolation of the political class, managers and
elites who enjoy privileges excluded from ordinary citizens.
The world is more prosperous than ever, but our societies are
marked by growing uncertainty and discomfort. This is the paradox
that slams our epoque. The reason for this is in the different source
Italian Economic Perspectives 193

of profits: for finance, they come from rising or falling speculations


through derivative products; for the real economy, profits depend on
turnover. It is obvious therefore that finance is pushing to exacerbate
crises and weaknesses in states and also banks, insurance companies
or listed companies to create profit opportunities through the prolifer-
ation of different types of derivatives totally unconnected with manu-
facturing. The characteristic values of market economies are squeezed
to the benefit of the unbridled pursuit of profits no longer derived
from the production and sale of goods and services but by the trading
of financial products. The consequence is that crisis situations are ex-
aggerated and exacerbated beyond their actual size.
New unsustainable scenarios are emerging together with the spread
of disadvantages that undermine the ethics of individual behaviors by
damaging economic growth and destroying jobs.

9.2. Italy: growth signals

Among the 27 EU member States, Italy is a country where productivity


has grown less in the last decade: about 1.4%, against a European aver-
age of almost 12%. There is an objective correspondence between lack
of GDP growth, retirement of the employment rate and inadequate in-
crease in productivity, which requires reflection and strong reform and
development support.
Comparisons with other countries are not comforting: in spite of an
increase in Italian GDP of 4% since 2009, French GDP grew by 12%, En-
glish by 17%, German by 22% and US by 26%.
The impact of the 2008 crisis has severely damaged the performance
of the Italian labor and economy: the weak state of production and the
overall financial situation have resulted in negative multipliers. This is
mainly due to the fact that Italian productivity over the last decade has
grown ten times less than the German one and eight times less than the
European average. This is the rehearsal of how Italy has in the past years
failed to challenge the quality of work and innovation that is at the heart
of any development strategy, following the red thread of training.
However, recently, extremely difficult reforms have given positive
effects. Following the contraction in the last three years, Italy’s GDP vol-
ume was up 0.9% in 2016. Final consumption (+0.7 percent), sustained
194 Growth Economics and Governance

by the increase in purchasing power, and gross fixed capital formation


(+0.9 percent) recorded moderately positive variations, while exports
marked a robust growth and translated into a significant trade surplus,
effect of the increase in available income.
The dynamics of economic activity are satisfactory, especially in the ser-
vices and transport sectors (+ 19.7%). The index of industrial production
recorded a significant increase in January (+ 1.7% compared with the end
of 2015). Additional signs of recovery come from the construction industry.
Inflation is slightly accelerating up to 1.6% due to rising food prices
and the moderate rise in international energy product quotations.
Employment shows signs of moderate growth: on an annual basis, it
mainly affected employees, both at end-of-life (+ 5% compared to 2015),
while the number of employees continued to decline, especially among
the employees (-7.8 percent). The unemployment rate is declining: from
12.7% in 2014 to 11.7% in 2016. The number of people seeking employ-
ment has also decreased by 7%. The inactivity rate fell to 32%.
But Italy remains the second largest country in the EU after Greece
having a debt that stood at 2,250 billion at the end of 2016, 132.3 percent
of GDP, with a two-tenth compared with the previous year (slightly
above 2.136 billion or 132.5 percent of GDP), two tenths higher than the
target set out in the Stability Program last year.
The primary balance, i.e. not considering the charges for paying in-
terest on debt, is substantially constant from 2014 at around 5% of GDP.
Debt service spending declined in 2016 to 6 billion (4 tenths of a per-
centage point in GDP). The weight of total revenue on GDP fell from 48.2
to 47.9 percent and that of total outflows from 51.2 to 50.5 percent. Among
charges other than interest expense, strong write-downs were record-
ed for the other current income (-4.6 billion) and for employee income
(-1.9 billion). Investment expenditures, falling sharply from 2010 to 2015,
amounted to 37.3 billion, slightly above the previous year (36.9 billion).
Revenues increase direct taxes and social contributions, while indi-
rect taxes have fallen by more than a billion. In the presence of moderate
growth in economic activity, fiscal pressure dropped by three tenths of
a point, from 43.6 in 2014 to 43.3 in 2016.
The serious problem of the submerged economy remains, which, to-
gether with illegal activities, amounts to 203 billion lire, accounting for
a 12.9% increase in GDP, up from the previous year, demonstrating the
ineffectiveness of contrast policies.
Italian Economic Perspectives 195

Overall, competitive capacity appears to be improving, reflecting on


international markets, is still a determining factor in the performance of
businesses and manufacturing sectors. As has been documented on sev-
eral occasions, Italy is distinguished among the European countries for
the large number of companies operating in foreign markets: 88 thou-
sand in industry alone (a value only according to Germany), which ex-
plains more than ‘80% of the total Italian exports. However, the degree
of concentration of Italian companies’ exports is amongst the lowest in
Europe: the first five industrial export companies account for about 6%
of total sales abroad, half of that of Spanish and French, and less than
a third of the German. The first twenty Italian exporters explain a low-
er national export quota than that of the top five exporters in the EU.
Moreover, the majority of Italian exporters are of a small size: 2/3 em-
ploys fewer than ten, while 95% fewer than 50.
Looking at 2017, expectations about the trend in the economic cycle
are better and more robust, albeit with signs of uncertainty. The slow-
down in emerging markets and the stability of commodity prices overlap
with the growing turbulence in the financial markets. Forward-looking
indicators, however, suggest a moderate cyclical recovery. In particu-
lar, in advanced countries, economic activity should continue to benefit
from the drag on the components of domestic demand and on the con-
tinuation of the stimulus action by monetary policy.
Alongside the characteristics mentioned here, there are other factors
relevant to the competitiveness of the Italian production system in the
knowledge economy sector, which is of great importance in the im-
provement of the well-being of the weakest part of the population. Italy
lacks delays compared to the EU average. Investments in research and
development, although rising, still lag behind relative to the EU aver-
age: Italian firms still invest little in R & D (0.7% of GDP vs. 1.3% of the
average EU) and employ fewer workers (4.1 per thousand inhabitants
vs. 5.4). Patent capacity is still limited: patents per million inhabitants
are 73.7 against 112.8 Europeans. However, the degree of dissemination
of innovative activity is not modest: the indicators on enterprise innova-
tion detection point to greater Italian propensity for product or process
innovation. However, they make relatively limited use of e-commerce,
in particular online sales (it makes up 7 percent of businesses against 17
in the European average). Looking at the spread of new technologies,
in terms of broadband usage, Italy is in line with the European average
196 Growth Economics and Governance

(92% against 94% in the case of sole business); when considering other
aspects, such as the speed of the connection, the degree of connectivity
of Italy is, however, among the lowest in Europe.
In the context of investments aimed at achieving the objectives of Eu-
rope 2020, the Italian strategy for the development of the ultra-wide band
provides for significant infrastructural interventions to increase territorial
coverage in order to increase the spread of Ict technologies among eco-
nomic operators. From the extension of broadband coverage, added value
increases and productivity are expected in the territorial areas concerned.
At the beginning of 2017, a warm climate improvement in our coun-
try emerges business confidence, unmatched by consumers who seem to
suffer from the situation of institutional uncertainty and social discom-
fort, particularly difficult in Italy. Industry turnover, net of seasonality,
continues to show positive economic trends, thanks to the liveliness of
instrumental goods and intermediate goods.

9.3. Limits of conventional policies and opportunities for diffe-


rent models of action

As incapable of governing and stiffling excesses in finance, States react


by tightening their rigor by dismissing the burden of recovery on the
real economy and not even on financial activities; thus accusing a grow-
ing dependency on finance to meet the needs of financing its growing
debt exposures.
Faced with these worrying situations, which overwhelm not only eco-
nomic but also social equilibrium and the entire system of values ac-
quired in advanced societies, conventional economic policies, inspired
to the austerity, seem to completely inadequate to faster the growth of
the economy. Budget-oriented measures and fiscal tightening, in the ab-
sence of a drastic reduction in spending, create recession and end up
affecting the same remediation possibilities.
Instead, new proposals and new organizational models are needed to
revitalize economic democracy and restore right and sustainable ethical
values within the society. In particular, it is necessary to devise innova-
tive pathways oriented to:
 modernize public institutions by increasing their efficiency and
reducing their costs;
Italian Economic Perspectives 197

 increase social measures by focusing on the protection of the in-


dividual and on the enhancement of human capital;
 reduce unproductive public spending and tax burden (especial-
ly on less-skilled classes) and to replace them with tax incentives
for private investment;
 support investment in innovation;
 find the way to control the speculative irresponsibility of finan-
cial powers.
Yet, a successful economy is such that it provides significant job op-
portunities in a sustainable economic growth perspective, capable of
containing climate change and ensuring a more prosperous future for
generations to come.
An “innovative project” that must be based on an overall design able
to rebalance the powers and scope of the public sphere so as to increase
the people’s responsibility for the development of their country. The
essential tools of the new strategy are the strengthening of the govern-
ment and the implementation of cost-free growth measures. An alterna-
tive reform path to the one that follows is based on the introduction of a
set of “virtuous rules”, i.e. on reforms capable of inducing collaborative
(and non-collusive) behaviors in the subjects and institutions to pursue
remedial goals and growth.
Italy needs to continue the reform season to increase productivity and
competitiveness, reduce flooding, contain public debt, spread techno-
logical innovation, increase investment in human capital, and introduce
virtuous rules in order to promote non-collusive behavior. Objectives
not easy to pursue because of the strong resistance that consolidated
conservatism and corporatism opposed to any change that is seen as a
means of eradicating acquired powers.
Difficulties that are widespread in our country and therefore explain
the need to maintain close cohesion at European level and avoid dema-
gogic controversy over or against the euro.
In this context new alliances can be created to reinvent European pol-
icies in three important areas: social measures aimed at protecting the in-
dividual and enhancing human capital, fiscal support for innovation and
gradual tax harmonization. This will require a firm commitment from the
Italian side to the revision of the Fiscal Compact and especially to the
launch of a process of democratization of the European institutions.
10
Revive Europe Focusing on the Social

The same type of populist discontent that fueled Brexit is on the rise
throughout Europe, suggesting that policymakers have lost sight of the
European project’s central objective: to ensure the wellbeing of all Euro-
peans by increasing both integration and cohesion. People are the real
wealth of a nation.
The best way to improve the human capital of a country or region
is through social equity. However, this outlook hasn’t yet taken place
in the EU’s elite policymaking circles, where well-meaning economists
and politicians believe they are doing the right thing by balancing bud-
gets and reducing in spending in health, education, and infrastructure.
These policymakers, with little empirical evidence, believe that fiscal
prudence today will lead to a stronger economy tomorrow.
This is the thinking behind the current policy mix in Europe, where
fiscal austerity is combined with structural reform, meaning less spend-
ing on the social safety net and less regulation to protect workers.
The costs of these policies are mostly on the shoulders of the poor
and the middle class:
 Who benefits from growth: the many or the few? If an economy
is said to be growing when a small minority receives most of the
gains while the wealth of the majority stays the same or decreas-
es, the concept of economic growth loses much of its meaning.
 Since gross domestic product is the preferred gauge of any econ-
omy’s value, many factors that contribute to human wellbeing
are ignored, and spending on fundamental needs, such as health
and education, is seen as an expense rather than an investment.
200 Growth Economics and Governance

Otherwise, rather than funneling economic benefits to the rich,


policymakers should assess whether investing in opportunities
for the poor actually does more for economic growth.
The main factors that are shaking the EU founding values seems to
be as follows:
 the surge in inequality that occurred anywhere in terms of new
forms of poverty among the most vulnerable social classes;
 the uncontrolled growth of migratory flows that weighs on tran-
sit countries (and not only), producing unbearable social and
economic costs.
Concerns about the social consequences of these phenomena create
confusion in the minds of many Europeans, also due to the inability
of Europe to correct the distortions. It is time for the EU to return to
the macroeconomic expansive policies, recognizing the benefits of full
employment in fostering social stability and sustainable growth. As the
Nordic model shows, high employment is good for the economy be-
cause it ensures adequate tax revenues to finance high levels of social
investment, creating a virtuous cycle.
Many European countries are now in a vicious cycle instead, with
austerity policies worsening the problem of youth unemployment and
creating a generation that will not be equipped to drive future growth.
In the current slump, European countries should be investing in their
human capital to spur their economies’ potential growth.
European countries’ fiscal policies give little importance to the pur-
chasing power of the middle class, not emphasizing creativity and inno-
vation, which benefits from high-quality education and infrastructure.
The revival of the values of cohesion and integration among European
nations is the real challenge facing the Union choices, firmly refocus-
ing the set of policies designed from top to concrete measures, simple,
transparent that can better improve the welfare the lower classes. When
the needs of citizens and their expectations will be taken into account,
UE will be benefit from a confidence increase in the institutions.
Over the past twenty years, economic rigor, austerity at all costs pre-
vailed, for everyone, regardless of the well-known diversity.
For too long, social options have been neglected, albeit supported
by treaties and official documents, fueling anxiety about credibility and
trust in the institutions, their choices and the way they operate. This
is often the case when policies are drawn from above and imposed on
Revive Europe Focusing on the Social 201

citizens and in particular when drastic choices do not generate the ex-
pected effects.
One should certainly not overlook the fact that in some countries
the rise in public debt and the slowdown in growth have weighed on
the budget deficit target. Nevertheless the social imbalances caused by
globalization and uncontrolled immigration have crippled confidence,
giving room to demagogues.
The mistake is to persevere on austerity by giving up the exploration
of all the useful spaces to combine rigor with growth to bring institu-
tions and policies closer to citizens. The costs of the current policy mix in
Europe, inspired by fiscal austerity combined with structural reforms,
mostly affect the poor and the middle class.
It is necessary for the European Union to return to expansive macro-
economic policies, recognizing the great benefits of full employment for
social stability and sustainable growth. As the Nordic model shows, a
high employment rate is good for the economy.
Assuming that:
 the proposals coming from anti-system movements (when and if
any) must be understood and taken into account;
 on a general level, the EU must link debt reduction (in heavily
indebted countries) to cutting unproductive spending and the
mobilization of socially co-financed EU measures, allowing for
temporary deficit increases (never made);
 the single currency in the Eurozone must be defended, as the
bargain of a monetary autonomy reached with difficulty but still
necessary; this may lead to avoid perverse consequences that its
dismantling would produce on the income of the less wealthy
and on the capital market;
 the procedures and methods of redeployment by re-budgeting
the European budget must be semplified.
There is the possibility as welle the need to combat the disruptive ef-
fects of globalization by adopting direct social measures on recipients
such as:
i. Gradual harmonization of the European tax system, at least in
terms of value added tax, labor taxation and income of the less
wealthy;
ii. Introduction of a unemployment insurance, proposed by Italy
since 2014 and also supported by successive meetings between
202 Growth Economics and Governance

Labor and Economy Ministers. Among the various proposals for


advanced policies in this area, the European Benefit Scheme, a
European minimum protection scheme, based on a mix of basic
EU protection and top-up protection provided by the national
institutions of each member country. The European system of
unemployment insurance would be an important step towards
greater social cohesion. It would provide a short-term basic sup-
port that would allow individual countries to better measure
and manage unemployment benefits.
iii. Harmonization of social security systems. Another challenge
for Europe is to put pressure on increasingly hypertrophic social
spending in situations where the population is rapidly aging, by
making subsidies available to the contributing capacity, in order
to arrest the increase of public debt.
iv. Harmonization of school and university education systems.
Harmonization of education at every rank and grade, promoting
professional training and internships at companies. A project of
great social significance, which does not cost overtime and can
trigger a gradual and comprehensive process of integration at
the service of Europe. Its purpose is to foster the rebalancing of
the initial endowments and training opportunities offered to in-
dividuals by coordinating national models to allow access to job
opportunities in other countries. Union intervention in the field
of continuing education is conceived as an active inclusion pol-
icy, which should necessarily be accompanied by national mea-
sures aimed at introducing flexibility in the labor market. The
introduction of active employment policies does not exclude the
use by individual States of measures to support the income of
the kindergarten.
v. Civic Education for Citizenship. In order to promote citizen-
ship education, primary, secondary and university education
systems are intended to prepare students to become active cit-
izens by providing them with access to knowledge of the struc-
ture of society, social and political movements, the content of the
integration process and the role of the European institutions to
which it is attached.
vi. Control of immigration and revival of development cooper-
ation. The European institutions have reacted in an alarming
Revive Europe Focusing on the Social 203

way to migration, highlighting the lack of a common strategy for


dealing with internal and external flows. Four actions have to
be taken to avoid the suffering and, in many cases, the deaths of
thousands of people traveling to Europe: a) Common European
Union law on asylum; b) Legal humanitarian channels for refu-
gees; c) Legislation on the issuance of visas for work, study and
reunification: d) Protection of the external borders of the Union.
Europe must shift its attention to the social values of integration
among different peoples and traditions, rediscovering and adapting to
the modern times the goals of the founding fathers.
If we want to avoid the decline towards nationalist and populist
drifts, it is necessary to lay solid foundations to build a true political and
social integration on which a sovereign euro may be found its legitimi-
zation. In other words, the relaunch of the integration process must be
able to identify new perspectives on which to reconstruct Europeanism
and rediscover the interest of citizens, who are more aware of monetary
integration or budgetary rigors.
To conclude, we will remember an amazing statement from Amartya
Sen. In the The Idea of Justice, he affirms that:
 Real social equity does not require equal treatment for all but
rather better treatments for the poor and the most disadvan-
taged.
 Demanding greater equity in public finance is not enough unless
you consider the different starting points for individuals in the
different societies in which they live and work.
Bibliography

Anderson M., Warner V., Technolgy Transfer, 2010


Andreasen A. R., Profits for nonprofits: find a corporate partner, Harvard
Business Review 74(6), 47e59 (1996).
Baharumshah A.Z., Thanoon M., (2006) “Foreign capital flows and eco-
nomic growth in East Asian countries” in China Economic Review,
vol. 17, pp. 70– 83.
Barba Navaretti G., J. Venables A., (2006) Le multinazionali nell’econo-
mia mondiale, Il Mulino, Bologna.
Barnett M.L., Stakeholder influence capacity and the variability of financial
returns to corporate social responsibility, Academy of Management Re-
view 32(3), 794e816 (2007).
Basu P., Guariglia A., (2007) “Foreign Direct Investment, inequality,
and growth” in Journal of Macroeconomics.
Becattini G., Rullani E., (1993) “Sistema locale e mercato globale” in
Economia e Politica, n. 80, pp. 25-48.
Becattini G. (1993), Sistema locale e mercato globale, in Fuà G., Zacchia
C. (a cura di), Industrializzazione senza fratture, Il Mulino, Bologna.
Brammer S. and Pavelin S., Corporate reputation and an insurance motiva-
tion for corporate social investment, The Journal of Corporate Citizen-
ship 20, 39e51 (2005).
Brugmann and C.K. Prahalad, Co-creating Business’s New Social Com-
pact, Harvard Business Review 85(2), 80e90 (2007).
Bianchi M., Piccalunga A., La sfida del trasferimento tecnologico, Le Uni-
versità italiane si raccontano, Springer, 2012
Brainard S.L., (1997) “An empirical assessment of the proximity-con-
centration trade-off between multinational sales and trade” in Amer-
206 Bibliography

ican Economic Review, vol. 87, pp. 520-544


Burtless G., Has Income inequality really increased in US? The Brookings
Institution, January 11, 2007
Chakrabarti A., (2003) “A theory of the spatial distribution of foreign
direct investment” in International Review of Economics and Fi-
nance, pp. 149 – 169
Deutsche Bank, “Sovereign Wealth Funds, State investment on the rise”,
Deutsche Bank Research , September 10th 2007
Doh J., Ramamurtia R., (2004) “Rethinking foreign infrastructure in-
vestment in developing countries” in Journal of World Business, pp.
151 – 167
Eggera P., Winnerb H., (2005) “Evidence on corruption as an incentive
for foreign direct investment” in European Journal of Political Econ-
omy, pp. 932 – 952
Eichengreen B., Tong H., (2007) “Is China’s FDI coming at the expense
of other countries?” in Journal of Japanese International Economies,
pp. 153 – 172
EU, Improving knowledge transfer between research institutions and industry
across Europe, 2010
EU, Innovation Union Competitiveness Report, 2012
EU, Can Public Private Partnerships (PPPs) lever investment to get Europe
out of economic crisis?, 2012
European Pantent Office: Annual Report, 2012
Fernandez-Ariasa E., Hausmannb R., (2001) “Is foreign direct invest-
ment a safer form of financing?” in Emerging Markets Review, pp.
34 – 49
IMF, Sovereign Wealth Funds—A Work Agenda, prepared by the Mon-
etary and Capital Markets and Policy Development and Review
Departments in collaboration with other departments, approved by
Mark Allen and Jaime Caruana, February 29th, 2008
JP Morgan, Sovereign Wealth Funds: A Bottom-up Primer, May 22nd
2008
Global Economics (2007), October 5th
Goldstein I., Razin A., (2006) “An information-based trade off between
foreign direct investment and foreign portfolio investment” in Jour-
nal of International Economics, vol. 70, pp. 271–295.
Grogan L., Moers L., (2001) “Growth empirics with institutional mea-
sures for transition countries” in Economic Systems, pp. 323 – 344
Bibliography 207

IL SOLE 24 ORE, (2007) various articles, (Bortolotti, Cristalli, Debene-


detti, Garten, Merli, Pasca di Magliano, Riveda, Summers)
ISIAE (2007), Rapporto sui Fondi di Ricchezza Sovrana, Roma
Higino Schneider P., (2005) “International trade, economic growth and
intellectual property rights: A panel data study of developed and de-
veloping countries” in Journal of Development Economics, pp. 529
– 540
Hines J.R., (1999) “Lessons from behavioural responses to international
taxation” in National Tax Journal, vol. 52, pp. 305-322
Hooper V., Kim S.J., (2007) “The determinants of capital inflows: Does
opacity of recipient country explain the flows?” in Economic Sys-
tems, vol. 31, pp. 35– 48.
Jen S., (2007) “Russia the Newest Member of the “SWF club”, Morgan
Stanley Research Global.
Jenkins R., Edwards C., (2006) “The economic impacts of China and In-
dia on sub-Saharan Africa: Trends and prospects” in Journal of Asian
Economics, vol. 17, pp. 207–225.
Kurman M., Tech Transfer 2.0, Triple Helix Press, 2013MIUR, Program-
ma Nazionale della Ricerca 2011- 2013, 2011
OECD, Innovation Strategy, 2012
OECD, Sme’s entrepreneurship and innovation, 2012
Li X., Liu X., (2005) “Foreign Direct Investment and Economic Growth:
An Increasingly Endogenous Relationship” in World Development,
pp. 393 – 407
Markusen J.R., Maskus K., (2001) “Discriminating among alternative
theories of the multinational enterprise” in Review of International
Economics, vol. 10, pp. 694-707
Merril Lynch (2007), The overflowing bathtub, the running tap and
SWFs Noy I., Vu T., (2007) “Capital account liberalization and for-
eign direct investment” in North American Journal of Economics and
Finance
Piccalunga A., Granieri M., Conti G., La gestione del trasferimento tecno-
logico:, strategie, modelli, strumenti, 2015.
Russ K.N., (2007) “The endogeneity of the exchange rate as a determi-
nant of FDI: A model of entry and multinational firms” in Journal of
International Economics, vol. 71, pp. 344–372.
The Economist (2008), “The Invasion of the Sovereign wealth-funds”,
January
208 Bibliography

Thompson J.D. and MacMillan I.C., Business models: creating new mar-
kets an societal wealth, Long Range Planning 43(2e3), 291e307 (2010).
Truman E.M., (2007) “SWF: the need for greater transparency and ac-
countability”, Peterson Institute for International Economics Policy
Brief.
UNCTAD, (2006) WIR 2006 FDI From Developing And Transition Econ-
omies: Implication For Development, United Nations, New York and
Geneva
UNCTAD, (2007) WIR 2007 Transnational Corporations, Extractive In-
dustries And Development, United Nations, New York and Geneva
Yeaple S., (2003) “The role of skill endowments in the structure of US
outward foreign investments” in Review of Economics and Statistics
Finito di stampare nel novembre 2017
con tecnologia print on demand
presso il Centro Stampa “Nuova Cultura”
p.le Aldo Moro, 5 - 00185 Roma
www.nuovacultura.it

Per ordini: ordini@nuovacultura.it

[Int_9788868129460_17x24col_LN03]