A strategy to promote healthy globalisation

By Lawrence Summers

Last week, in this column, I argued that making the case that trade agreements improve economic welfare might no longer be sufficient to maintain political support for economic internationalism in the US and other countries. Instead, I suggested that opposition to trade agreements, and economic internationalism more generally, reflected a growing recognition by workers that what is good for the global economy and its business champions was not necessarily good for them, and that there were reasonable grounds for this belief.

The most important reason for doubting that an increasingly successful, integrated global economy will benefit US workers (and those in other industrial countries) is the weakening of the link between the success of a nation’s workers and the success of both its trading partners and its companies. This phenomenon was first emphasised years ago by Robert Reich, the former US labour secretary. The normal argument is that a more rapidly growing global economy benefits workers and companies in an individual country by expanding the market for exports. This is a valid consideration. But it is also true that the success of other countries, and greater global integration, places more competitive pressure on an individual economy. Workers are likely disproportionately to bear the brunt of this pressure.

Part of the reason why US workers (or those in Europe and Japan) enjoy high wages is that they are more highly skilled than most workers in the developing world. Yet they also earn higher wages because they can be more productive – their effort is complemented by capital, broadly defined to include equipment, managerial expertise, corporate culture, infrastructure and the capacity for innovation. In a closed economy anything that promotes investment in productive capital necessarily raises workers’ wages. In a closed economy, corporations have a huge stake in the quality of the national workforce and infrastructure.

The situation is very different in an open economy where investments in innovation, brands, a strong corporate culture or even in certain kinds of equipment can be combined with labour from anywhere in the world. Workers no longer have the same stake in productive investment by companies as it becomes easier for corporations to combine their capital with lower priced labour overseas. Companies, in turn, come to have less of a stake in the quality of the workforce and infrastructure in their home country when they can produce anywhere. Moreover businesses can use the threat of relocating as a lever to extract concessions regarding tax policy, regulations and specific subsidies. Inevitably the cost of these concessions is borne by labour.

The public policy response of withdrawing from the global economy, or reducing the pace of integration,is ultimately untenable. It would generate resentment abroad on a dangerous scale, hurt the economy as other countries retaliated, and make us less competitive as companies in rival countries continue to integrate their production lines with developing countries. As Bill Clinton said in his first major international economic speech as president, “the United States must compete not retreat”.

The domestic component of a strategy to promote healthy globalisation must rely on strengthening efforts to reduce inequality and insecurity. The international component must focus on the interests of working people in all countries, in addition to the current emphasis on the priorities of global ­corporations.

First, the US should take the lead in promoting global co-operation in the international tax arena. There has been a race to the bottom in the taxation of corporate income as nations lower their rates to entice business to issue more debt and invest in their jurisdictions. Closely related is the problem of tax havens that seek to lure wealthy citizens with promises that they can avoid paying taxes altogether on large parts of their fortunes. It might be inevitable that globalisation leads to some increases in inequality; it is not necessary that it also compromise the possibility of progressive taxation.

Second, an increased focus of international economic diplomacy should be to prevent harmful regulatory competition. In many areas it is appropriate that regulations differ between countries in response to local circumstances. But there is a reason why progressives in the early part of the 20th century sought to have the federal government take over many kinds of regulatory responsibility. They were concerned that competition for business across states, and their ease of being able to move, would lead to a race to the bottom. Financial regulation is only one example of where the mantra of needing to be “internationally competitive” has been invoked too often as a reason to cut back on regulation. There has not been enough serious consideration of the alternative – global co-operation to raise standards. While labour standards arguments have at times been invoked as a cover for protectionism, and this must be avoided, it is entirely appropriate that US policymakers seek to ensure that greater global integration does not become an excuse for eroding labour rights.

To benefit the interests of US citizens and command broad political support, US international economic policy will need to focus on the issues in which the largest number of Americans have the greatest stake. A decoupling of the interests of businesses and nations may be inevitable; a decoupling of international economic policies and the interests of American workers is not.

Bolivian province votes in favour of autonomy

By Andres Schipani in Santa Cruz

The opposition to President Evo Morales’ government in Bolivia’s gas-rich eastern region of Santa Cruz achieved a landslide victory of more than 85 per cent on Sunday night in an unofficial vote on autonomy.

In spite of allegations of fraud from the side of the government, voting throughout the day across the province’s 700 polling stations was peaceful with no international observers present.

Bolivia's senate president and a leading opposition figure told the Financial Times that “after May 4, Santa Cruz would not allow anymore of its resources to go where the Movement Towards Socialism [Morales' political party] wants.”

“This will be the first electoral process that is not only outside the law, off the margins of the electoral institutions, but also without any international observers that can certify its transparency', Jose Luis Exeni, head of the National Electoral Court says. “This is threatening the constitutional order and the nation's unity', he added.

Sporadic violent incidents such as road blockades, burnt ballots boxes and clashes with demonstrators impeded voting earlier in the day in some of Mr Morales’ strongholds, leaving one dead and about 20 wounded.

Santa Cruz leaders are pushing for a statute of autonomy with what they call a 'democratic mandate' opposed to the government's 'totalitarian centralism'. This could give them more control over land, taxes and hydrocarbons revenues.

On Sunday night, the rhythmic chant of 'Autonomy! Autonomy!' spread through a crowd of thousands that filled the Santa Cruz's main square in Santa Cruz with a sea of green and white flags.

“The only possible, democratic and prosperous Bolivia is a decentralised, autonomous one', claims Carlos Dabdoub, secretary of Autonomy of the Santa Cruz regional government seen as masterminding the autonomy project.

Yet for many Bolivians, including Mr Morales, approval of the Santa Cruz plans would lead to a de facto declaration of independence from the central government in La Paz. For him the push for autonomy is an attempt by the rich minority to keep their long-held privileges, and to undermine his policies of granting greater powers and a greater share of Bolivia's land and resources to the poor indigenous majority, mostly located in the western highlands.

“The conservative and oligarchic sector sees the current transformations coming from the social and indigenous sector as a threat and they have to stop that at all costs', explains Gabriela Montaño, the president's delegate in Santa Cruz. But opponents in the eastern lowlands say Mr Morales' reforms - outlined in a draft constitution yet to be approved - would unfairly favour some indigenous groups mean greater central control and an unfair distribution of the regions' resources.

After Santa Cruz, five more out of Bolivia's nine departments are expected to approve similar measures in referenda during the next few months.

For the man who might style himself as governor of Santa Cruz, incumbent prefect Ruben Costas, this autonomy process is 'contagious': “this is unstoppable and will redefine Bolivia”.

Up against the Citi limits

By Henny Sender

Wall Street’s finest were on the edge of their seats last December when at least two of China’s most important financiers paid separate visits to New York. Leading US commercial and investment banks were facing huge losses as the year-end approached and were in urgent need of a capital infusion, preferably one that could be announced at the same time as their annual results.

One visitor was Chen Yuan, head of China Development Bank and the son of a Communist revolutionary icon. Mr Chen, a bold and ambitious man, had once been a deputy governor of China’s central bank. Now he presided over an institution that was transforming itself from a lender with a development mandate to a commercial institution with plans to list.

Another was Gao Xiqing, who as president of China Investment Corporation, has responsibility for $200bn (£101bn, €130bn) of China’s massive foreign reserves. When he met senior executives at banks including Citigroup, UBS, Merrill Lynch and Morgan Stanley, the welcome they accorded him was understandably warm. All those banks were engaged in intensive discussions with sovereign wealth funds, the world’s largest pools of investment capital – of which CIC was among the newest.

Sovereign wealth funds turned out to be crucial in shoring up some of the proudest names in a financial world once they were beset by the credit crisis. SWF investments in Citi, Merrill and Morgan Stanley, struck in December and January, “were an act of faith in America”, says Stephen Schwarzman, founder of Blackstone Group, the private equity house in which CIC had also become an investor.

To their critics, and indeed to some officials at the US Treasury, SWFs represent a potentially sinister force – opaque monoliths with hidden agendas and mysterious abilities. But as the story of Citi and the Chinese reveals, SWFs have a lot in common with other big funds in the financial world – the same need to keep their investors happy and meet their returns criteria, giving their negotiations a flavour entirely familiar to the bankers and lawyers around the table.

The way Wall Street reached out to these funds and how they responded suggests there is nothing sinister about this two-way courtship. It has instead been a process marked by competition, calculation and miscalculation on both sides. Indeed, its very messiness might provide some reassurance that the sovereign wealth funds hardly seem to have nefarious agendas.

“The SWFs have tried to help – often on a very expedited basis – troubled western financial institutions and, unfortunately, they have been rewarded so far with losses as well as criticisms over their lack of transparency,” says David Rubenstein, co-founder of Carlyle Group. “Going back to that well may be harder.”

But even without that wariness on the western side, deals with sovereign wealth funds are by no means automatic, as Citi was to discover last year.

As the end of the year approached, ailing Wall Street banks were competing with each other to attract capital from potential investors. By December, Citi’s situation was looking more dire than anyone anticipated when the bank announced an investment from the Abu Dhabi Investment Authority back in November. Management was untried. The business model was flawed. The losses were both huge and unquantifiable. Citi needed to raise more capital before it announced results in mid-January or its share price could collapse.

But to many sovereign wealth fund executives, Citi is America – and they say they believe the authorities would never let Citi go down. So CIC’s Mr Gao and Mr Chen of CDB were greeted enthusiastically in December when each came calling. At his meeting with Citi’s top brass including Vikram Pandit, newly installed as chief executive, Mr Chen committed himself to giving Citi $5bn and pledged to be the bank’s anchor investor, one CDB adviser on the deal says.

Although Citi declines to comment, people familiar with the US bank say it was more or less steered to CDB as the proper counterparty for a dialogue with the Chinese. Just why that was the case is not clear, though. While CIC is supposed to be the premier investor of China’s reserves, it faces competition at home both from CDB and the State Administration of Foreign Exchange (Safe).

Even after CIC was created last year – under the umbrella of the People’s Bank of China, the country’s central bank – Safe continued to take a portion of China’s reserves (now more than $1,600bn) and invest in stocks, property, private equity and stakes in companies including ANZ Bank in Australia and Total, the French energy group.

Of the three possible Chinese investors – CIC, Safe and CDB – CDB was arguably in the weakest position, especially since Mr Chen had already spent some of CDB’s money – government reserves rather than deposits – on a stake in Barclays of the UK.

Ultimate authority in Beijing resides in the State Council, which acts as the arbiter among competing interests in China. No matter which organisation Citi approached, the fate of the Citi request for cash would come to be decided behind closed doors there.

CDB’s Mr Chen returned to Beijing from New York and began making telephone calls. He had two tasks: to convince the authorities in Beijing to approve his ambitious plans; and to do some rapid due diligence checks on Citi.

“Citi needed a good story on why this deal made sense for China,” says the head of the Hong Kong office of one leading private equity firm and a former investment banker with intimate knowledge of China. “The story is very important for the Chinese government.” That wisdom is echoed by others. “It is important that there be a story,” says one person familiar with the thinking at the Kuwait Investment Authority (KIA). “It shouldn’t be just that it is cheap.”

(By way of example, the “story” at Merrill Lynch was that under John Thain, its new chief executive who had previously been a Goldman Sachs partner, Merrill could set its troubles behind it and be another Goldman Sachs in the making. Goldman weathered the credit squeeze better than its main rivals and was not among those needing a cash injection.)

The “story” was particularly important at the turn of the year, as the Chinese authorities were becoming apprehensive about overseas investments. CIC’s maiden investment in May had been a $3bn stake in Blackstone on the eve of that group’s listing – an investment in common shares that was struck without any discount or influence, while barring the new fund from selling for four years or making similar investments for a year. By the time the Chinese were talking to Citi, the Blackstone investment had nearly halved in value.

Moreover, CIC was already investing in Morgan Stanley. CIC executives were concerned both that they already had enough exposure to US financial groups and that, if they took a stake in Citi as well, they would trigger a political backlash in the US, according to Jesse Wang, the number three at CIC.

CDB had meanwhile not fared well with the stake it took in Barclays of the UK. There was also a competitive dynamic at work – officials at Safe were arguing to the State Council that only their organisation had the experience to invest sensibly, many people with knowledge of the matter say.

The Chinese feared they were beginning to seem like dumb money in the eyes of the rest of the world. “Bureaucrats everywhere fear to look stupid,” says a top executive at one Chinese investment arm. “That is especially the case in China, where the cadres are supposed to be the elite. They are perceived, and perceive themselves, as smart.”

The fear was stoked by the process Citi ran. Potential investors had little time and were not given a detailed look at the heart of the problem at Citi – its fixed-income trading book. Moreover, Citi barred CDB (and other potential investors) from employing top investment banks as advisers, since Citi regarded them as competition. That left potential buyers depending on boutiques such as Lazard Frères that lacked a significant presence in China.

Concerned at the magnitude of the challenge and their own ignorance, the team at CDB appealed to Goldman Sachs to advise it on valuing Citi. Operating with great secrecy, Goldman sent a group of bankers to Beijing over Christmas.

At the same time, Mr Chen began the long process of selling his deal to both the government and regulators at the China Banking Regulatory Commission. He also sought counsel from CIC, which in addition to its investment mandate held shares in CDB and had recently given it a $20bn capital infusion. CIC warned Mr Chen about the extent of Citi’s exposure to problems in its subprime loan book but refrained from telling CDB what to do, according to people familiar with the matter.

Some arms of the government were impressed by the image of a Chinese entity helping what was seen as America’s mightiest bank now it was on its knees. The foreign ministry was highly supportive and offered to move its accounts to Citi. “They thought of it as legitimising China,” says one CDB adviser.

The banking regulators were less impressed. Liu Mingkang, a former deputy of Mr Chen at the central bank and head of the CBRC, criticised CDB for its money-losing investment in Barclays, advisers to CDB say. Mr Liu also noted that the investment was reactive rather than part of a well thought-out strategy. Others voiced doubts as to the wisdom of the investment as well as dismay at the prospect of competing arms making big investments in similar areas.

In early January, the CDB team held at least a dozen conference calls with Citi executives. Citi officials told the Chinese that Government of Singapore Investment Corporation (GIC) was interested in providing all the money Citi sought.

“We thought they were bluffing,” says one adviser to CDB. “If [the investment by] GIC was going to be that large, it would trigger reporting requirements for GIC and they would need clearance from the Fed. But the message was [that] we may not be the anchor investor and would probably be scaled back.”

The money CDB realistically could hope to put to work went from $5bn to under $3bn. Nevertheless, Mr Chen remained interested, these advisers say.

On the weekend of January 12-13, as the deadline for the financing approached, the CDB team was tense. Still, when the news came that Wen Jiabao, China’s prime minister, and the State Council had decided to withhold approval in the absence of consensus among all the interested parties consulted in Beijing, CDB officials were stunned.

The fear of incurring losses on an investment in Citi – and a resulting loss of face – was a big part of the reason for that outcome. But the opposition of the banking regulators led by Mr Liu and concerns over competing investment arms were other factors, the advisers to CDB say.

The following day, Citi announced that it had raised $6.88bn, largely from GIC, though with Kia providing an additional $3bn. The ultimate deal gave investors plenty of downside protection. “Of course Kia is concerned if the share price is down,” says the person familiar with the thinking at Kia. “But Kia is a long-term investor and there is less concern because of the structure. As long as Kia has guarantees about returns, that is all that matters.”

Abu Dhabi’s Adia, meanwhile, had structured its November investment in Citi in a way that gave it the right to go back and strike better terms on its deal, heightening its downside protection to match the terms GIC and Kia struck with Citi. But whatever the ultimate success or otherwise of the deal, it was too late for Mr Chen and CDB.

Tranquil pools of capital

In previous decades, much sovereign wealth, particularly from commodity booms, was squandered or merely parked in low-yielding debt, mostly US Treasury securities. Now, governments with large surpluses set up funds to ensure that this wealth is invested profitably and professionally. These sovereign funds are today viewed, by those who need it, as the most desirable source of capital in the world.

For a start, they are less demanding than the private equity firms and hedge funds – sometimes their partners, occasionally their rivals – that are the world’s other great pools of capital. These largely western groups demand higher returns as well as the right to have some say in management issues.

Whereas the Kuwait Investment Authority (Kia), for example, seeks to double its money every 10 years, private equity firms would regard that as a relatively modest target. That is a big reason why the only serious dialogue between a Wall Street bank seeking money and a potential private equity investor took place between TPG and Merrill Lynch.

TPG wanted returns that were at least double that which sovereign wealth funds seek and the right to nominate at least one board member in exchange for an investment of $2bn (£1bn, €1.3bn) to $3bn. With the terms more onerous than any a sovereign fund would demand, the talks between TPG and Merrill did not get very far.

So Merrill turned to Temasek, one of Singapore’s two main state investment vehicles, for the bulk of its recapitalisation. “We want them to be strategic partners and not just investors,” says Greg Fleming, chief operating officer of Merrill.

Yet as they look for the most attractive investments, the sovereign funds also find themselves competing ever more fiercely with each other. In November, Citi received its first, $7.5bn capital injection from Kia’s great rival, the Abu Dhabi Investment Authority (Adia), a deal Adia committed to in a matter of days. Bader Al-Sa’ad, the head of Kia, says he asked himself enviously at the time: “How can I change Kia so we can move that quickly?”

Funds such as Adia and Kia have a long history as responsive and sophisticated investors. But Chinese money is perhaps the most desirable, largely because of the centuries-old siren song of the Chinese market. Senior executives at supplicant banks say they like Chinese capital because they can present their China deals to the rest of the world as great strategic initiatives rather than merely a form of rescue finance.

Yahoo under pressure after deal collapse

By Richard Waters in San Francisco

An expected realignment of the consumer internet sector was thrown into doubt over the weekend after Microsoft’s surprise abandonment of its $46.5bn offer for Yahoo.

The move is set to put pressure on senior executives of both companies, as one of Yahoo’s largest shareholders criticised both sides for failing to agree a deal that would have left Yahoo shareholders with a big gain and given Microsoft a boost in its attempt to compete with Google.

It will also trigger fresh rounds of talks between some of the biggest players in the internet industry as both companies now look for other ways to boost their flagging online businesses, analysts and investors said.

Steve Ballmer, Microsoft’s chief executive, called off his company’s three-month pursuit of Yahoo in a letter - released publicly on Saturday - to Yahoo founder and chief executive Jerry Yang.

Mr Ballmer said Microsoft had raised its bid to $33 a share, from an original offer of $31, but that Yahoo had continued to hold out for at least $37.

Mr Yang is likely to face the most heated questions from shareholders over his refusal to do more to reach an agreement, with his company’s shares expected to drop sharply from their bid-inflated price of $28.67 at the end of last week.

Bill Miller, portfolio manager at Legg Mason, which owns 6 per cent of Yahoo’s stock, yesterday called on the internet company to mount an immediate stock buy-back worth at least $4bn to demonstrate its confidence in its shares, after turning down an offer that represented a 70 per cent premium to the share price before Microsoft made its offer.

“They had the opportunity to do this, and both sides missed it,” said Mr Miller.

“Yahoo’s management now is in a really difficult position – they have to prove they can get that value back to $37.”

However, Mr Miller reserved his strongest criticism for Microsoft, which he said now faced a position as “a distant number three online” over its refusal to increase its offer by a relatively small amount, at least by the standards of its own financial resources.

“To miss out on a major strategic opportunity that was worth 2 per cent of your market [value] doesn’t make sense,” he said.

Some observers speculated yesterday that Microsoft had taken a tough line on price in the hope that pressure from shareholders would force Mr Yang back to the negotiating table.

Microsoft’s apparent withdrawal “could be tactical”, said Morton Pierce, a New York mergers and acquisitions lawyer, though he added: “In deals of this magnitude, you assume they’ve really thought about it and they’re really walking away.”

Yahoo sought to present the weekend’s events as a chance to return to business as usual, and one person close to the company said it would push ahead and try to complete deals it has discussed in recent weeks with both Google and AOL.

AOL, meanwhile, has also been holding talks with Microsoft, a person close to the situation said at the weekend. Time Warner, AOL’s parent, could ultimately be one of the biggest beneficiaries of the latest turn of events if it leads to a fight between Microsoft and Yahoo for AOL, one investor said. Microsoft has also held talks with News Corp about combining its internet operations with MySpace.

The expected flurry of discussions follows the failure of a deal that would have reshaped the internet landscape, and reflects the pressure on both Mr Yang and Mr Ballmer to show that they have alternatives as they try to narrow the lead of runaway internet leader Google.