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March/April 2003 Volume 5 Edition 1



In this issue:



(full-text Advisor below, or click on title for single article window)

Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Associate Editor: Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin,
Jonathan Lemco, Jean-Marc F. Blanchard, Barry Metzger, Russell Smith,
Ilissa A. Kabak, Andrew Novo, Jonathan Hopfner, C. H. Kwan, Dominic Scriven and Andrew Thorson

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U.S. Market Outlook – Uncertainty and the Market

By Scott B. MacDonald

The U.S. stock market remains in a stage of high volatility, reflecting a deep-seated degree of uncertainty over the future direction of global politics and the anemic nature of the U.S. economic recovery. While the prospects are good for a short-term equity rally based on the view that the war with Iraq will be short, there remain many dark clouds on the horizon. This threatens to bring dark days in the form of a plunging stock market, new terrorist attacks on U.S. soil, and the much-talked about double dip recession. With the Dow marching back and forth over the 8,000 mark, there is a good case to make that it could dip further, possibly below 7,000 before the end of the year.

Why all the gloom? At the end of the day, the fundamental issue is uncertainty. Markets hate uncertainty and we have plenty of it. Although we do not see a double dip recession and believe the U.S. economy is in a recovery mode, the pace and scope of that recovery is not strong nor is it convincing. As we have stated before, the U.S. economy is functioning like it did in the early 1990s. The actual recession, based on a contraction in GDP, is over, but there was a lag before sentiment changed for the better and recovery gained momentum. In 1991, the U.S. economy had a mild contraction, but expanded moderately in 1992 and 1993. The problem was that unemployment was high and for sectors of the economy, recessionary tendencies lagged.

We see the same pattern at work now, though corporate debt is higher. Although the U.S. technically did not have a recession (as there was not a back-to-back quarterly contraction in GDP), it has certainly felt like one and indeed the vast majority of Americans regard 2001 (and early 2002) as a recessionary period,. The problem is that the weak recovery is going to continue. The danger is that the U.S. economic expansion could glide lower, possibly stalling. The February uptick in U.S. unemployment from 5.7% in January to 5.8% should serve as a reminder that a very real downside scenario continues to sit on the horizon.

Our major worries are ongoing concerns about the Middle East and North Korea, the impact of higher oil prices (making itself felt at the gas pumps and in home heating bills), and the weakening consumer. Higher energy costs are certainly a negative for the already battered airline and auto companies. Added to that is the corporate sector’s reluctance to raise capital expenditures until there is greater clarity vis-à-vis the economy and geopolitical risks. Feeding on the uncertainty, banks and other financial institutions are nervously looking over their loan and credit card portfolios, though there has of yet been no major spike in non-performing assets. [In fact, many regional banks have reported non-performing assets of less than 1% of their loans in Q4 2002.]

Yet, for all the potential negatives in the market, not all is lost. Resolution of some of the geopolitical issues would go a long way in reducing uncertainty. With a few exceptions, corporate governance is improving. Sarbanes-Oxley is having a positive impact in making management clean up balance sheets. Although the problems at Ahold, the Dutch-owned supermarket giant were bad, it was the company that approached the Securities Exchange Commission to notify that agency that it had accounting problems. More significantly, the large debt overhang from the 1990s boom is being pared to more manageable levels and U.S. companies are much more cost-efficient than before. Finally, technical factors in the U.S. corporate bond market are strong – there is little new supply and a lot of money sitting on the sidelines wanting for the war scare to end and for companies to take advantage of very low interest rates to refinance. The few deals that came in February and early March were usually oversubscribed.

While we can be cautiously optimistic about the U.S. corporate bond market, we cannot say the same about the stock market. Equities have a long road ahead of them before we see another bull market. Some of these speed bumps include:

  1. Equity markets are no longer the source of cheap capital for industry as they were in the 1990s;
  2. Corporate problems will continue to have a quick and brutal echo in the stock market. Companies that get into trouble, be it with accounting or corporate governance issues, will be punished as investors will first flee the name and then shun it;
  3. Ongoing weakness in the U.S. and global economies undermines any extended rally. While the U.S. at least has a weak economy, with real GDP growth in excess of 2%, the same cannot be said of the world’s second largest economy, Japan, which is looking at 0.5-1.0% growth in 2003 and Germany, the world’s number three economy, which could slip back into recession.
  4. The tech sector continues to struggle, caught between the stark financial and economic realities and the need to push ahead for new innovations. Venture capital is hardly what it was in the 1990s and in most cases is being treated like spare silver bullets;
  5. While an Iraqi war may play out quickly, geopolitical issues are not going to be entirely eclipsed. North Korea remains an ongoing risk and al-Qaeda is hardly been eliminated; and
  6. It will take a long time for small investors to feel comfortable in investing in the stock market in a major fashion due to the billions of wealth lost in the market crash in 2001.
Consequently, we see the Dow as having another bear year in 2003, probably falling below 7,000 at some point, before recovering. The following year could see a recovery in stock prices, but that will depend on the ability of the economy to move at a faster pace than the 2.4-2.6% range and a decline in geopolitical uncertainties. Eventually the bulls will return, but at this juncture they remain out in the pasture, leaving the bears in charge of the street.

Interview with Dr. Marc Faber, lnvestment Advisor, Fund Manager and Author

By Keith W. Rabin

Marc Faber was born in Zurich, Switzerland. He went to school in Geneva and Zurich and finished high school with the Matura. He studied Economics at the University of Zurich and, at the age of 24, obtained a Ph.D. in Economics magna cum laude.  Between 1970 and 1978, Dr Faber worked for White Weld & Company Limited in New York, Zurich and Hong Kong. Since 1973, he has lived in Hong Kong. From 1978 to February 1990, he was the Managing Director of Drexel Burnham Lambert (HK) Ltd. In June 1990, he set up his own business, Marc Faber Limited, which acts as an investment advisor, fund manager and broker/dealer. Dr Faber publishes a widely read monthly investment newsletter "The Gloom, Boom & Doom" report which highlights unusual investment opportunities, and is the author of the recently released book "Tomorrow's Gold" and "The Great Money Illusion - The Confusions of the Confusions" which was on the best-seller list for several weeks in 1988 and has been translated into Chinese and Japanese. A book on Dr Faber, "Riding the Millennial Storm", by Nury Vittachi, was published in 1998.   A regular speaker at various investment seminars, Dr Faber is well known for his "contrarian" investment approach. He is also associated with a variety of funds including the Iconoclastic International Fund, The Baring Chrysalis Fund, The Baring Taiwan Fund, The Income Partners Global Strategy Fund, The Framlington Eastern Europe Fund, The Buchanan Special Emerging Markets Fund, The Hendale Asia Fund, The Indian Smaller Companies Fund, The Central and Southern Asian Fund and The Regent Magna Europa Fund plc and Tellus Advisors LLC.

Thank you Marc, for agreeing to speak with our readers. Can you tell us a little about your background and current activities?

I am Swiss and have worked in the investment field since 1970, first with White Weld & Co., later with Drexel Burnham Lambert Inc. I have lived since 1973 in Hong Kong and formed my own investment management and advisory company in 1990. I publish the Gloom Boom & Doom Report (www.gloomboomdoom.com ) and have written several books including the latest one entitled “Tomorrow’s Gold”, which is available through Amazon.com.

Until recently the U.S. was perceived as a safe haven and in many ways a beneficiary of global turmoil. This has been changing due to U.S. economic and corporate excesses and the 9/11 tragedy. As a result, investors have been enduring dramatic losses in dollar-denominated assets. This would seem to argue for greater international exposure, yet economists such as Joseph Quinlan argue that investor fear exceeds their desire for greater diversification and outflows from the U.S. -- have to date been minimal. Can you give your thoughts on this and whether this trend will be sustained?

Most investors seem to be brain-damaged. They buy high and sell low. They buy what is perceived to be safe or promising big returns, not what will provide big returns in future. In the late 1980s, they bought Japan and Asia and were negative about the US. In the late 1990s right up to now, they bought the US and shunned Asia, although Asia is following the crisis of 1997 relatively inexpensive.

Alan Greenspan and many analysts have expressed the view that current economic difficulties in the U.S. are largely the result of "global uncertainty" and that once problems with Iraq and other issues are resolved, positive growth and momentum will be restored in the U.S. Do you believe that is the case what is your outlook for the U.S. economy?

The problems of the US economy have nothing to do with “global uncertainty”. Greenspan messed it up so royally that he now has to find an excuse for his disastrous handling of the economy over the last 10 years or so. Now, we are paying the price for the ill-fated US belief that all problems can simply be solved by easing, printing money and expanding credit. Mr. Greenspan should never have been a Fed Chairman and future historians will judge him very negatively.

Throughout much of the 1990s, there was a lot of discussion about the "East Asian Miracle" and the coming "Pacific Century". This talk largely evaporated during the 1997 Asian financial crisis. Do you believe we were too quick to write off the "East Asian Miracle" and does the "Asian Way" represent a real alternative to Anglo-Saxon business and financial practices?

I do not believe so much in stereotype phrases like Asian miracle, the Asian way, etc. When it comes to money all people are of the same religion. In Asia, we have in theory looser controls over the economy than in the West, but recent events in the US and other western countries with respect to the terrible abuses that occurred throughout the economy, the business sector and the governments suggest that the Asian are small town thieves when it comes to plundering companies and ripping off shareholders.

During the Asian financial crisis, the U.S. was viewed by many as a "global economic locomotive" that needed to maintain its performance until Asia and/or Europe could regain its economic footing. Now the U.S. engine appears to have run out of steam and Europe or Japan do not seem ready to take on the load. Can the world regain positive momentum without a locomotive and what are the ramifications of continuing weakness in the U.S., Europe and Japan?

We have to distinguish between markets in terms of dollar sales and in terms of units. Today, many physical markets are already larger in China than in the US. I am thinking of steel, where the Chinese production is larger than the one of the US and Japan combined, with China still importing steel. Also the markets for refrigerators, TVs Radios, motorcycles, cellular phones are larger in China than in the US. Now add the markets of India, Japan, Indonesia, etc to the Chinese market and you actually see that Asia by itself is a huge economy in terms of units. I am a believer in a secular economic military and political decline of the US and a rise of China and other Asian countries. I think the US is today where the UK was at the beginning of the 20th century and that global growth in future will be driven by Asia.

For hundreds of years arguments have been made as to the potential of emerging markets and the potential they offer. What we have seen, however, is higher volatility and what you have termed "gloom boom doom" than one generally finds in more mature markets, especially over the long term. Would it then be fair to say that investing in emerging markets is more cyclically-oriented and a trading opportunity than a long term investment? What should investors who lack the resources of large institutions and ability to buy foreign listed securities watch out for?

I think this is a good point. However, I suppose that in many countries such as China and Russia, there will also be long-term opportunities. I am not sure that these companies already exist, but it is clear to me that China will also one day have a GE, an IBM, MMM, Coca Cola, etc. It is important to understand that rapidly growing economies have wild business fluctuations. In my book “Tomorrow’s Gold” I describe the life cycle of emerging economies and for an investor it is obviously important to time his purchases well. I may add that I include in “emerging markets” also “emerging economies” such as the Internet, the PC, and cellular phones. People who bought stocks in the TMT sector at the wrong time will probably never see their money back, as new players will displace the early leaders of these industries.

One is continually hearing now about the danger of deflation yet gold, oil and many other commodities are at, or approaching multi-year highs. Can you explain this phenomenon and its implications for investors? Are we beginning to see both forces exist simultaneously in a manner last seen during the "stagflation" years of the Carter administration?

Very few people understand the phenomena of inflation and deflation – both of which can occur at the same time. We have in many industries over-capacities and the opening of China and so many other countries is putting terrific pressure on the prices of manufactured goods. At the same time, these new countries will have a strong demand for commodities –especially oil and food products. Therefore, although prices of manufactured goods could continue to decline, prices of commodities may rise much further. In addition with Mr. Greenspan not hesitating to print money and expand credit and the prospect of Mr. Bernanke becoming Fed Chairman, and the possibility of a War, you have a favorable environment for commodities.

Technology and the Internet have had tremendous implications on our lifestyle and the way business is conducted around the world. After several bad years we are beginning to see investor interest in smaller Asian Internet companies such as SINA, PCNTF, REDF, SIFY, etc. and other such as IGLD in Israel. Is this a meaningful trend and what are your thoughts on technology in general?

Yes, I think that out of the ruins there will be some winners. I just don’t know which ones will really make a lot of money.

The Dollar has been weakening and most U.S. investors are unaware that even investments that have broken even are down double digits when measured against the Euro and many other currencies. Do you think this trend will continue and what are the trends that will arise as a result? Which currencies other than the Euro will be beneficiaries of this trend?

The dollar has been far too high considering the economic fundamentals of the US and considering the policies of its economic decision makers who don’t care at all about “sound money”. Therefore, I believe that the dollar has entered again a secular bear market, whereby it will lose in due course once again 90% of its value. The question, however, is against what the US dollar will lose value. Probably it will still decline against the Euro, as European fundamentals will improve with the inclusion of so many new countries into Euroland. However, I think the real weakness will occur against a basket of commodities and against hard assets.

Many of our readers represent corporations and governments in Asia and other markets that are seeking to position themselves to appeal to the international financial community. Do you have any thoughts or words of wisdom on steps they might take to make themselves more attractive in this regard?

The best way to get exposure to investors is to perform well and not to constantly lie to the investment community. Companies should spend more time running their businesses than talking to investors, while the executives would do better to read once a while something else than Newsweek and spend their time on the golf course.

For over a decade there has been a lot of talk about globalization and the integration of world financial markets. While this has perhaps slowed down in recent years, we are seeing increased after hours trading and firms seeking dual listings or even bypassing their national markets to list on foreign exchanges that they believe will deliver more attractive valuations. Can you comment on these developments and their implications for investors and public corporations?

We are moving towards a global market place where financial assets will be traded 24 hours a day. With this development it is clear that some shares will be more actively traded during European or NY hours than in Asia. After all, whereas the physical markets in Asia are huge, the financial markets are disproportionately large in the US compared to real economic activity. Thus, the high trading volume in the US compared to other countries.

The events of 9/11 have had a dramatic effect on corporate and political behavior. What are your thoughts on the implications of the "global war on terrorism"?

I am not so sure this statement is correct. 9/11 has given companies an excuse for poor performance and to cut travel and entertainment budgets. It has also given every dumb and totally uninterested expatriate wife, whose life consists of patronizing the local American Club, to force the husband to move back to the US for fear that he might find “something” more attractive in a foreign country.

Even before 9/11 we began to see a more vocal backlash against globalization, as seen in the disruption of the Seattle WTO meeting and the IMF/World Bank deciding to reschedule and scale down their annual meetings. Now we are beginning to see large-scale demonstrations around the world against U.S. policy toward Iraq and other international initiatives, which in many ways are similar to those we last saw during the Vietnam-war era. Do you think these are related and can you comment on this trend?

In the sixties, there was the saying about the “ugly American” because the world was afraid that America would take over the world economically. Now, we have anti American sentiment for the US arrogance and lack of sensitivity towards other views and customs. I admire in many ways the American way of life, but unfortunately American leaders know and understand what is going on in the world no better than my four Rottweiler dogs. Moreover, whereas my dogs only have one standard – to eat – the US has many different standards depending on their economic interests.

One economy that continues to defy gravity is China, and there seems to be a growing anxiety all over the world about its continuing strong growth and the displacement it is causing, particularly in the manufacturing sector. Can you talk a little about China, the role it will play in the world economy and what it means for investors, the U.S. and other countries in the region.

China today, is where the US was in the second half of the 19th century. At the time it became extremely competitive on world markets and its entry into the global economy led to a significant price fall between 1873 and 1900. The opening of China will depress prices for manufactured goods for a long time. At the same time China will become Asia’s largest customer for commodities and its tourists will be the largest group.

Similarly, Businessweek recently wrote an article comparing the movement of manufacturing jobs from the U.S. in the 1970-80s to a current displacement among service workers today. Given the improved communication and infrastructure that allows one to base an operation almost anywhere in the world, how will higher-wage and cost economies sustain their competitive advantage?

I don’t see how in the long run the US and Europe will be able to compete with tradable services from Asia. India will dominate the software industry and China the way China will dominate manufacturing. Research labs will also move to Asia as we have an endless supply of highly qualified and motivated people who can innovate and invent.

I notice you are more positive on Southeast Asian countries such as Indonesia, Thailand and the Philippines as opposed to markets such as Korea, Taiwan and Japan which possess superior infrastructure, more educated workforces, higher percapita consumption and a greater corporate and technological base. Can you tell us why this is the case?

I think that Korea, Taiwan and Japan will suffer to some extend from the competition of China. The resource based Asian economies will on the other hand benefit from the rise of China. This does not mean that stocks in Korea, Taiwan and Japan will not perform well, as companies can shift their production to China and, therefore, cut their costs.

What are your thoughts on Japan? What do you make of the debate between promoting inflation and demand vs. structural reform and industrial revitalization? Do you think we are at or near the bottom? Finally, do you think the best opportunities are with the export-oriented success stories such as Toyota or Hitachi or more the domestically-focused and/or distressed companies that will benefit from an economic turnaround?

I believe that in 2003, the Japanese stock market will bottom out and that good opportunities will arise. I am negative about Japanese bonds because I see a weaker Yen ahead and also the aggressive monetizing of the debt is likely to lead to higher inflation and interest rates.

Korea is viewed as one of the great "post IMF crisis" success stories. The country has shown a rapid willingness to reform and investor interest has grown to the point that companies such as Samsung now enjoy a larger market capitalization than Sony. It has also a rapid adapter of new technologies and leader in areas such as online trading, broadband and mobile telephony. At the same time, consumer debt is rising, unemployment is beginning to increase and troubles with the North are becoming a growing international concern. What are your views on Korea and it s economic prospects?

I think Korea will do just ok. I am not such a great believer in the success story of the last few years, which was built on excessive consumer debt. The stock market is somewhat over-sold and could rally from the present level by 20% to 30% this year.

Any thoughts on the emerging markets of Latin America, Central and Eastern Europe and the Newly Independent States and Africa you can leave with us?

I like some Latin American countries, because they are resource rich and will benefit in the environment I outlined. The price level of Argentina and Brazil is low and stocks may actually surprise on the up-side.

You recently authored a book named "Tomorrow's Gold" that has been attracting a lot of attention. Can you tell us about it?

Yes, it is doing very well and it will be translated into several foreign languages. Many people have written to me that the book is one of the most readable and interesting investment books. In my introduction to the book, I wrote that I owe all my knowledge to people from whom I learned a lot including Henry Kaufman. Sydney Homer, Charles Kindleberger, and all the classical and Austrian economists. I also learned a lot from Alan Greenspan, so if I am one day the head of the Zimbabwe Central Bank, I won’t repeat the same mistakes….

Thank you, Marc for a most informative discussion. Do you have any closing remarks for our readers.

"Follow the course opposite to custom and you will almost always do well"
J.J. Rousseau.

Click here to purchase "Tomorrow's Gold" directly from Amazon.com

Korea Needs to Address the Growing Uncertainty of International Investors

By Keith W. Rabin

Many analysts predicted a weakening Korean economy last year in the face of an emerging China, a slow growing Japan and continuing market turmoil in the United States. To the contrary, a revitalized Korea exhibited a strong performance. It attracted substantial investor interest -- and the Korean stock market registered one of the world’s strongest performances during the first six months of 2002.

This achievement began to erode, however, during the latter half of the year and has accelerated in recent months. The simple truth is that Korea -- no matter how competitive its economy, and how rapidly it implements reforms and expands its corporate capabilities -- is not large enough to act as an engine of world growth by itself.

In a nation seeking to establish itself as the "Dynamic Hub of Asia", the perceptions of foreign investors and business executives matter more than ever before. Without them, Korea cannot attract the physical, human and financial resources needed to position itself as a global technology and financial center or to enable its companies to develop the value-added strategies that are essential to maintaining the rapid development Korea has exhibited in the past.

Rising tensions in the North, increased media focus on Anti-Americanism, burgeoning consumer debt and this week's downgrade of Moody's outlook for Korea's sovereign credit rating all contribute to a growing discomfort among international investors and executives. Their uneasiness is compounded by the recent election of Korean President Roh Moo-hyun, who ran on a populist platform and is largely unknown -- not only outside of Korea -- but also among many Korean business leaders. The world therefore nervously watches to see whether Korea will continue to deserve its hard-earned reputation as the Asian country most eager to embrace reform after the IMF crisis and as a result offered some of the world's most attractive investment and business opportunities.

While Koreans tend to hunker down and turn inward when faced with adversity that is precisely the opposite of what is necessary at the present moment. Korean business and government leaders – if they are to maintain the good will and positive perception they been gained in recent years – must reach out and confront the problems they are facing. Investors are not seeking to punish Korea or to retreat from the peninsula. Like everyone else they are simply seeking the reassurances they need to justify their decisions.

For example, rising tensions in the North lead Moody's this week to change its outlook for Korea's sovereign credit rating from positive to negative. Their belief is based on the assumption that increased provocation by the North, which has resulted in an open resumption of its nuclear effort, heightens South Korea's security risk and the possibility of a military response from the United States.

This development surprised many investors and business and government leaders. It has raised their anxiety level, particularly after several months of media coverage depicting a growing "Anti-Americanism"in Korea. Several U.S. government leaders have even gone so far as to question whether it is wise to maintain American security forces in the nation. One might rightly ask if Moody's actions and the resulting uncertainty it created were a key factor leading to an intra-day decline of over 6% earlier this week off the five day KOPSI index average and whether this is a portent of things to come.

The answer largely depends on the actions of Korea's new government and its corporate community. The U.S. until recently was perceived as a safe haven and in many ways a beneficiary of global turmoil. This has been changing due to U.S. economic and corporate excesses as well as the loss of innocence following the 9/11 tragedy. As a result, international investors and executives, who have been enduring dramatic losses in dollar denominated assets, have by necessity begun to regain their appreciation for greater international diversification.

This theoretically creates a great opportunity for Korea-related projects and Korean companies who can position themselves as globally attractive investment opportunities -- yet it will not happen by itself. Rather than reach inward, Korea-related entities must reach out and explain current dynamics from their own perspective in a way that makes sense and which increases their attractiveness to the international investment community.

Korean opinion leaders need to emphasize while recent actions by the North are certainly important and need to be addressed, they do not represent a fundamental change from the security dynamics of the past fifty years. They might also point out the low historical correlation between economic growth in South Korea and changes in South-North relations. Furthermore, the rise in what is seen as Anti-American sentiment in the South might be interpreted more as the inevitable result of a young, maturing, empowered, growing democratic economy. Korea’s rising stature and educated workforce is giving rise to a truly dynamic human resource pool. It is seeking greater self expression – not only in its delivery of cutting edge products, technologies, corporate structures and a growing range of cultural exports – but also as a nation that seeks to independently determine its national destiny.

It is also worth noting that Korea represents an increasingly attractive consumer market in an of itself. This has helped to give additional depth and strength to its economy. While representing a highly positive and important trend over the long term, Korean leaders need to acknowledge investor concern over the rapid rise of consumer debt. Foreign media reports highlight alarming statistics such as the record 7% rise in the average credit card default ratio during the third quarter of 2002. Steps that the Financial Supervisory Service has taken to curb defaults, including the imposition of limits on cash advances and higher reserve ratios on lending institutions receive far less attention and need to be emphasized.

To maintain Korea’s continuing integration as a vital link in the global chain of commerce and finance, efforts must be made to communicate both the evolving growth of the Korean nation as well as the workings of individual entities on the firm level. By providing well thought out reasons why foreign investors and business partners would be wise -- not only to maintain -- but to expand their involvement with Korean enterprises; in addition to explaining the factors that drive their behavior, investors will be far more likely to understand that volatility moves in both directions.
This will help to lead them to the conclusion that current tensions with the North and other economic problems in the face of a global slowdown are only temporary interruptions in the long-term growth pattern that Korea has consistently exhibited for over half a century. Therefore, they will come to understand that any present trend downward, which may continue in the current incendiary environment, represents nothing more than a long term buying opportunity.

Interview on Japanese M&A Environment with Mr. Kiyoshi Goto, Director-General, Department of Business Development, Development Bank of Japan

By Keith W. Rabin

Mr. Kiyoshi Goto joined the Development Bank of Japan (DBJ) in 1978. His overseas experience and successful assignments in internationally related work are extensive, totaling fifteen of his 25-year experience at DBJ. He received his MBA from the Amos Tuck School at Dartmouth College in 1984. In 1987 he was dispatched to the International Energy Agency in Paris, the energy forum of the OECD, and worked as an energy economics analyst for three years. From 1995 to 1997 he was in DBJ’s International Department, in charge of extending loans to foreign companies investing in Japan. Then Mr. Goto was named Chief Representative of DBJ's Washington D.C. office, where he worked hard to provide a better understanding of DBJ's activities as well as the Japanese economy and society through thirty plus presentations and lectures in three years. Last April he was given a new mission, to lead a team providing M&A advisory service, a new business for DBJ.

Hello Goto-san, it is a pleasure to speak with you again. Can you tell our readers something about the Development Bank of Japan, its role and mission, as well as your own background and activities there?

The Development Bank of Japan (DBJ) is a governmental financial institution established in 1951. DBJ's mission is to contribute to the development of the Japanese economy and society via the provision of “quality” financial services that usually cannot be accommodated by private financial institutions. DBJ's contribution to Japan's wealth, I believe, has been widely acclaimed. Since readers of this newsletter mostly work outside Japan, I should emphasize that DBJ has made strenuous efforts to assist foreign firms wanting to enter the Japanese market. In 1984, DBJ crafted loan programs specifically designed for foreign companies investing in Japan, and those programs have been well received. In fact, the 1996 Economic Report of the President noted our efforts in this area. I have never heard of any Japanese institution other than DBJ being named in the Report.

I have devoted more than half of my career at DBJ to international-related business. After having assisted foreign companies for two years through the loan programs I mentioned, I went to Washington, D.C. and worked as a public relations officer for DBJ—and even for the Government of Japan—giving talks on a wide variety of issues including DBJ's loan programs and the state of the Japanese economy. You may recall that in the Business Opportunities in Japan symposium organized by the Japan External Trade Organization (JETRO) in November 1997, I gave a presentation titled, “Investing in Japan: A New Trend”, which pointed out the growing importance of M&A in Japan. Last April I was assigned to lead the newly established department in charge of M&A advisory services.

The development of M&A deals is a new area for DBJ. Can you tell us why DBJ is moving in this direction and how the "culture" of the institution is changing as you move to initiate this type of activity?

Yes, we are a Johnny-come-lately in this field. But we already realized how important M&A was for the Japanese economy a decade ago and carefully studied how DBJ, as a policy-implementing body, could supplement the market. We started this new service mainly for two reasons. First, M&A, once regarded in Japan as a malicious business conduct, is gradually becoming accepted as a useful business tool, but some distaste for M&A remains. We thought that an advisor whose mindset differed from that of private advisors was needed in order for M&A to become rooted in Japan, that is, an advisor who seeks a triple equilibrium. You may have heard talk of “win-win” deals, deals in which both the sellers and the buyers get fair shares of the value from the transactions. That, however, is easier said than done. The reality is that one side usually wins more than the other, sometimes unjustly. Being a governmental institution, we thought we should aim to assure that nobody goes overboard in an M&A transaction, and we do this by taking into account not only the benefits to the sellers and to the buyers, but also to the economy as a whole. I call this the “triple-win” approach. The second reason we started an M&A advisory service is that even though M&A has gradually become a business tool in Japan, only blue-chip companies have had the luxury to use it. Many small-to-medium-sized firms are ignored in this market because the deal size cannot generally justify the costs for professional services. We thought that we should give a helping hand to such companies to support the healthy development of the M&A market. Thus, we decided to jump into this new area.

This movement, adding M&A advisory services to DBJ's menu, meets the diversifying needs of corporate clients and increases the value of DBJ's financial services. This move also has a positive impact internally at DBJ in the sense that a solution-oriented approach is setting in; we should provide not only funds but also knowledge. Also this service offers DBJ a new avenue to a fee-based business.

Can you give us some specific examples of M&A deals you have completed or been working on and the type of deals you are targeting in the future?

Because we are a latecomer in this field, we do not yet have many completed deals to prove the effectiveness of DBJ's “triple-win” approach to M&A advisory services. However, a deal we completed last November may illustrate DBJ's approach. We served as an advisor for Meidensha Corporation, a heavy electric machinery manufacturer, on a deal between its affiliate, Meiden Hoist System, and KCI Konecranes, a world leader in the crane market. Meiden Hoist System had been struggling in the depressed and over-crowded market, and KCI Konecranes, though long aspiring to enter Japan, had not found a suitable arrangement. This strategic alliance not only benefited Meidensha and KCI Konecranes, both of whom received a fair share of the value, but also achieved national policy objectives, namely, business restructuring and promotion of foreign direct investment, thus significantly contributing to the Japanese economy. KCI Konecranes included DBJ's name in its press release on this alliance, which, I believe, is quite remarkable since an advisor is not usually mentioned in this kind of release and furthermore we served as an advisor for Meidensha -- not for KCI Konecranes. This deal clearly demonstrates that our aim is truly for “win-win” transactions. Perhaps one might wonder if KCI’s praise was earned at Meidensha’s expense—that is, some might think that Meidensha was underrepresented and the notion of triple equilibrium is a joke. One thing is evident: Meidensha could have terminated the contract with us anytime they wanted and would have done so if they had not been satisfied with our services.

seatedLet me tell you how I understand M&A. M&A is an economic transaction that really does create value that did not formerly exist. The seller provides a platform for value creation and the buyer offers managerial, technical and other expertise. Unless the buyer and seller get fair shares of value created, the deal won’t close and nobody will gain. Yes, an advisor works for a client, either the buyer or the seller, and gets fees. However, if you regard M&A as a game of win or lose, you are quite likely to lose fees you could otherwise have earned. The fact that more than half of M&A deals end up as failures, according to various surveys and studies, may back up my notion. We at DBJ have a mindset to make a project as feasible as possible in the long run, which we have done through our financings since the bank’s establishment. As part of our implementing policy, we have to make sure that the projects we finance will have positive impacts on the Japanese economy and society. This approach is also the backbone of our M&A activities. On the other hand, take an example whereby a client comes to us and says that it is looking for an M&A opportunity simply to boost its earnings per share by acquiring a company with a low price-earnings ratio. We do not provide advisory service for such clients. I hope this will help explain our M&A advisory policy. We are targeting deals that will contribute to corporate/business restructuring, revitalization of local economies, and promotion of foreign direct investment.

Substantial wealth has been created in the U.S. by investor groups who assume possession of distressed or underperforming assets and then move to reduce costs and introduce other "re-engineering" techniques to restore profitability. One might imagine there are many opportunities of this kind in Japan given the depressed economic environment it has experienced over the past decade, yet we have yet to see this become a defining trend. Can you give us some of the reasons why and whether this might change in the future? Additionally, what is the likelihood that virtually bankrupt corporates or financial institutions will be allowed to fail?

An active market for distressed assets in Japan cannot be created overnight. But one is developing. Evidence is that the number of MBOs increased significantly in Japan, from thirteen transactions in 2000 to forty-two in 2002. Recently, UK-based 3i withdrew from the market. However, major foreign funds are still in Japan and Japanese players are becoming active in the distressed-asset market. Unison Capital, Advantage Partners and MKS Partners have been quite visible. DBJ also plays an important role in this regard. DBJ put equity into Nippon Mirai Capital, a new entrant in this field and we have been investors in several corporate restructuring and turnaround funds. Our loan function also supports the activities of turnaround private equity. For example, Unison Capital made equity investment in ASCII, a publisher of PC-related magazines and books, which had been in serious trouble for so many years despite twice changing management. DBJ appreciated Unison’s turnaround scheme and, together with other commercial banks, provided funds necessary for its smooth turnaround. ASCII made a surprisingly speedy and dramatic comeback. In Japan I expect those “hands-on” style investors—in your words, those introducing “re-engineering” techniques—to be the key for Japan’s recovery.

About the George Romero question, by that I mean the question about “zombie” companies, I would like to respond with a quote from Charles Darwin’s The Origin of Species: “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.” This is the philosophy behind Unison Capital, which I heard from its founder, Ehara-san. According to Darwin’s law, the answer is crystal clear.

With the Nikkei at twenty year lows, many investors have been ignoring Japan in favor of China and other Asian markets that they believe offer more dramatic growth and potential. Can you tell us why they should devote more attention to Japan and about some of the opportunities they may be missing?

China is regarded as the country of the future by many. China’s entry into the WTO indicates that an immense market is finally opening. But I think there is still a rocky road ahead. Risks in China’s financial sector alone could ruin the economic potential. Since the stakes for prosperity coming from China are so huge, every multilateral and bilateral effort should be made to ensure her healthy growth. Still you should keep in mind that your love for China might sometimes blind you to her faults. Talking about Japan, it is, no doubt, saddled with numerous problems. However, according to World Economic Forum's Global Competitiveness Report 2002, Japan's position improved considerably, from 21st in 2001 to 13th in 2002. Technology represents the key driver for this improvement. The report points out that the country’s innovative power has remained very strong, which compensates for drops in the macroeconomic index and public institutions index. This implies that once the macroeconomic situation improves and the governance problems can be addressed properly, which admittedly are not easy tasks, “the sun should also rise.” Investors should follow Japan carefully, that’s for sure; I see no reason to ignore Japan.

Many analysts view the primary economic problem in Japan as being the need to deal with non-performing loans, and they maintain that little can be done until this problem is addressed in a definitive manner. Furthermore there is also a common perception that there is little or no demand for commercial loans among borrowers. Do you share the view that no progress can be achieved in Japan without resolving the NPL issue? Furthermore do you believe that there is little or no demand for new commercial loans?

Oh, boy! This has been extensively discussed among high-profile economists and I may not be the right person to answer this. My opinion is that the NPL problem should be properly addressed. However, I think we should distinguish between two types of NPLs: NPLs stemming from the burst of the bubble and NPLs stemming from the deepening deflation. The former had long been left disregarded partly because banks thought they could be disposed anytime as unrealized gains on securities but most of them have been written off. The latter is a new pile of bad loans springing up like mushrooms due to worsening deflation. Since the problem we now face is the latter, what is most needed, I think, is comprehensive counter-deflationary measures. I will leave what the measures should be to policy-makers and economists, though. A lot should be done to address the NPL problem properly.

Regarding the demand for commercial loans, if you look at some macro statistics on liquidity or free cash flow of non-financial firms, you see that in aggregate firms have excess cash. Demand for commercial bank loans has been weak because of the slack economy. Banks themselves have changed their lending policies, leaning toward charging premiums applicable to the risks involved, which I think is the right direction. These two factors have caused the decrease in commercial bank loans.


When talking about direct investment in Japan, much of the emphasis has been on greenfield rather than M&A projects. Part of the problem has been the dichotomy between, one, domestic constituencies and management who want to maximize valuations and/or are resistant to change and, two, foreign investors who seek to introduce efficiencies and achieve maximum gain. This adversarial relationship is standard practice in the U.S., but is often perceived to cause excessive tension in a consensus-driven Japan. Is it simply a matter of time before Japan takes more fully to U.S.-style M&A as a corporate finance tool?

I do not fully share your view. First, even the Japanese government (the Japan Investment Council headed by the prime minister) a long time ago realized the importance of promoting foreign direct investment via M&A and in 1996 made an official statement “On the Preparation of an M&A Environment in Japan.” It was so epoch-making that the media bashed it, claiming the government was selling off Japanese firms. Secondly, although Japanese have been highly allergic to M&As because of negative aspects such as greenmailers and hostile takeovers in the U.S. in the 1980's, their attitude has been changing. Carlos Ghosn of the French company Renault successfully revived Nissan Motor and French coach Philippe Troussier energized the Japanese soccer team. Is Mr. Ghosn still a public enemy in Japan? Definitely, not. We all know that we need foreign management know-how to rejuvenate the Japanese economy. When I was studying at Amos Tuck in 1982–1984, the U.S. was eager to learn from Japan, and you guys did it right. You benchmarked Japan and adjusted the Japanese model to meet the U.S. context. It’s our turn, isn’t it? M&A has become recognized in Japan as a common corporate finance tool; there is no doubt about it. Looking from North America, it may seem a snail's pace. But our team has been working hard to assist Japanese firms to benefit from M&A, especially cross-border M&A, and hope to change that perception.

In the U.S., many business owners and entrepreneurs look to sell all or part of their companies for the right price, even when they are doing well, for either strategic reasons or to realize some of the underlying equity, and these transactions when properly executed are perceived as positive achievements. In Japan, however, they are often viewed as failure. For that reason, it has been rare to see healthy Japanese firms turn to M&A as a means to realize value or to enhance their competitiveness. Do you think this is a fair statement, and, if so, what can be done to change this perception in Japan?

Well, since corporate/business restructuring has been the single most important issue in Corporate Japan recently and M&A has been used as a restructuring tool, you might have such an impression. But Japanese blue-chip companies have become focused on corporate value creation and have used M&A to increase the value-based metric, best known as “economic profit” or “economic value added.” In short, we are too busy restructuring. But you should note that restructuring also increases corporate value and that, usually, the more ambitious the restructuring the more the growth. You may have in mind something like Jack Welch's 1987 swap of GE's consumer electronics business for the medical systems interests of Thomson of France. If that's the case, I admit it may take a decade for Japanese to see such a deal. But didn’t the GE-Thomson deal frighten even the U.S. people to death?

Even though one can make a good argument as to why Japan offers an attractive investment opportunity, many companies and investors we deal with find it extremely difficult to identify attractive companies that possess a sufficient understanding and appreciation of the investment process -- despite a professed desire to attract foreign investment. Furthermore, business practices and sensibilities can be very different. As an ivy-league MBA graduate, can you give any advice to foreign investors on how they might identify specific investment opportunities in Japan and not only go about facilitating transactions but also to maintain good relations with their Japanese counterparts after they are consummated?

To expedite successful M&A in Japan, I would advise them to choose an advisor who has expertise in cross-border transactions as well as a good understanding of Japanese corporate culture. Marriage between two different parts of the world can never be easy and there are a lot of difficulties to overcome. An advisor who is well-versed in cultural differences could successfully build a bridge between the two. Our team has strong competence in cross-border deals since DBJ has for almost twenty years accumulated vast know-how in cross-border transactions through its financial assistance to foreign firms entering the Japanese market. The Meidensha–KCI Konecranes deal I introduced earlier demonstrates our capabilities.

Part of the problem in initiating M&A deals is the complexity of, and large amount of time that must be devoted to, individual transactions. Many people point to the scarcity of qualified service professionals in Japan, even in large-scale transactions. This can be even more problematic within the smaller scale transactions you are focusing on as they lack the scale needed to amortize the costs needed to allow successful closure. Can you comment on this problem and how if might be addressed?

Japan’s M&A market is very young, relative to that in the U.S., and an overemphasis on lending activities by Japanese banks accounts for the lack of qualified M&A advisors here. However, competence in this business is quite different from the one in the derivatives house. You do not have to know the Black and Scholes model to be a good advisor. The weapons you should have are basic tools in valuation and some of the buzzwords in this world. What makes you an excellent advisor are an analytical capability to formulate corporate strategy and communication skills, which can be cultivated through work experience. Therefore, Japanese advisors could sooner or later be parallel to their U.S. counterparts. Regarding the cost recovery issue in smaller deals, a clear-cut answer cannot be expected. The amount of work required for an M&A transaction, unfortunately, hardly changes with deal size. Therefore, an institution like us should contribute for the time being, subsidizing smaller deals. Since DBJ alone cannot support smaller M&A deals, a more comprehensive approach should be devised: by giving technical assistance to the M&A sections of local banks, for example.

waveWhen foreign investors talk about investing in Japan, they are largely talking about Tokyo and perhaps Osaka. Can you talk a little about other geographic areas of Japan and the potential that they offer?

Yes, the only city in Japan that many foreign investors can name may be Tokyo—outside of, perhaps, Osaka, because of its international airport and Universal Studios Japan—so, it’s no wonder that most foreign direct investment and M&A has focused there. However, this should not be construed to mean there is a lack of opportunities in other parts of Japan. It is just difficult for foreign investors to find the hidden jewels in areas other than Tokyo. I can name some of the areas which may appeal to foreign investors: Sapporo City in Hokkaido, where high technology companies cluster together; the northern Kyushu area, as a gateway to East Asian countries; and the Nagano area, where Japan’s manufacturing prowess can be found. As for how to mine these mother lodes, DBJ can assist in many ways. As I mentioned, DBJ has assisted foreign companies investing in Japan for more than twenty years using our network all around Japan: our branch offices, local governments and other related institutions, such as JETRO and the Japan Industrial Location Center. In terms of M&A, we have a network with forty local banks and regularly exchange information. We think it would be prudent for your readers to keep us in mind.

Thank you Goto-san for sharing your thoughts with our readers. Do you have any closing thoughts or comments you would like to leave with us?

Let me close by borrowing from the final scene of the 1985 movie Rambo: First Blood II:

"Kiyoshi, non-performing loans, deflation, everything that happened here may have been wrong. But, damn it, Kiyoshi, you can't hate your country for it."

"Hate? I'll die for it."

Yes, our team will serve the country via M&A to the death

CAN ANYONE TELL US WHY JAPAN'S TECH ECONOMY IS BROKEN? Is Japan's high-tech economy broken? We don't think so. Derailed perhaps. But if you understand the mechanics, you can gain access to amazing opportunities for business and technology in Japan. Nobody else knows Japan like we do. Find out what's going on, direct from Tokyo, weekly and free. Four great newsletters at http://www.japaninc.com.

Investing in Japan via Tax Efficient Silent Partnerships

By Andrew H. Thorson
Partner, Dorsey & Whitney LLP (Tokyo)

Companies investing, acquiring or operating subsidiaries in Japan should consider using the “silent partnership” or “TK” (known in Japan as a Commercial Code tokumei kumiaia) as a tax efficient vehicle for their transactions. By using the TK vehicle, in certain circumstances investors can realize substantially reduced Japan-side tax burdens which would otherwise set up a road block to viable returns on an investment.

In the typical scenario, the sole-shareholder of a Japanese company might fund the company solely via additional share purchases. In such cases, the shareholder could be paying an effective tax rate of up to 47.8% including combined Japanese local and national taxes plus the 10% withholding tax on dividends paid to the U.S. shareholder. What if the shareholder could reduce the tax burden in Japan to 20%? Depending upon the circumstances, financing the Japanese company via a TK could result in such a reduction.

What is a TK? A TK is not a business entity. TKs are contracts between silent “investors” and business “operators”. The investor contracts to provide an asset (cash or other property) for use by the operator in its business. In exchange, the operator pays the investor an agreed percentage of the business’s pre-tax profits.

Under the TK contract, the investor receives no ownership right in the business. The investor receives only a right to profits. Furthermore, while the TK contract may provide the investor with certain investigatory and informational rights, the investor receives no management rights. TK contracts are simple and often require little more than an agreement upon scope of the subject business, the allocation of profits and losses, and terms relating to termination/expiration.

A TK is not a loan agreement or a leasing agreement. However, the operator deducts payments to the investor on a pre-tax basis. Usury limitations do not apply on payments of profits to the investor. This is one advantage of the TK when contrasted to inter-company loan financing.

Potential Tax Efficiencies. As indicated above, if properly established and monitored, use of a TK structure for a Japan investment could reduce the effective Japanese tax rates for certain Japan investments.

Take the simple example of financing a wholly-owned subsidiary. When a U.S. investor purchases or establishes a wholly-owned corporation in Tokyo the effective tax rate on profits can be estimated at 47.8% (approximate combined corporate tax rate of 42% plus a 10% withholding on dividends to U.S. companies under the Japan – United States tax treaty).

If properly structured, the tax burden in Japan could be reduced to a 20% withholding tax on TK profits paid to the U.S. investor. TK structures have been used in more complicated structures as well, for example in aircraft and other asset leasing arrangements wherein they lawfully reduce tax burdens in Japan.

Freedom of Contract and Limitations on TK Uses. The Commercial Code of Japan prescribes the fundamental legal foundation of the TK structure but TK structures are generally subject to the principle of “freedom of contract”.

The TK structure is, however, not without limitations. An investor is at risk and does not receive fixed payments as a lender might. The investor also has no right to payment when the business has no profits. If the asset is fully consumed by the business, then the investor receives nothing upon termination or expiration of the TK.

Furthermore, a silent investor may enjoy certain contractual rights of investigation and access to information, but participation in the management of the entrepreneur’s business could result in the silent investor being treated as an ordinary shareholder for tax purposes. Such participation could also result in joint and several liability, or the nullification of the legal validity of the TK. For this reason, the TK investor should not be a shareholder of the TK business, but could be an affiliate of the TK business’s shareholder – and could be an affiliate domiciled in a tax haven.

Potential scrutiny by Japanese tax authorities is perhaps the material concern in structuring a TK. Generally speaking, however, the material concern of tax authorities relates to treaty shopping.

Consider, for example, the case in which US Parent Inc., a U.S. corporation, establishes an entity, X Inc., in country X where the tax treaty between country X and Japan provides that TK profit distributions to companies of X are entirely free from Japanese taxation. If X Inc. was established for the sole purpose of taking profits from Japan Sub K.K. via a TK to avoid Japanese taxes, then this is the type of case wherein Japanese tax authorities might consider issuing an assessment notice. Under such circumstances, X Inc. lacks real substance and could be considered a treaty shopping vehicle established to avoid Japanese taxes otherwise payable by a U.S. corporation. Some commentators indicate generally the importance of being able to demonstrate to Japanese tax authorities a rational basis for entering into a TK before taking into account associated tax benefits.

Scrutiny of TKs. The TK is a typified form of commercial code contract, which is used by some well-known Japanese corporations in various capacities. Use of a TK in and of itself is not generally considered suspect activity or harmful to the reputation of an investor.

In recent years the tax authorities have found TKs widely used in business practice, yet until somewhat recently, aircraft leasing has been perhaps the only major transaction in which TKs were regularly utilized. We understand that rumors of a disallowance of TK tax benefits have been surfacing annually for several years now, but based upon informal discussions with officers of related authorities, believe there is no impending move within the tax authorities to eliminate such benefits. There have been quasi-governmental study groups formed to research the current uses of the TK structure in Japan, however, a change in law to prohibit the use of TKs could be difficult for the government. Tax authorities are perhaps more likely to crack down on misuses of the form (such as in treaty shopping) rather than abolish it.

As discussed above, a TK must be used appropriately. In structuring a TK for a Japan investment, particular care must be taken to ensure that the intended benefits are supported by sound commercial rationale and will achieve the intended benefits. The ultimate decision of whether or not a TK is suitable for a Japan investment will rest upon the results of a comprehensive review of all of the relevant facts and associated tax concerns

ANCIENT HISTORY: Thailand and Cambodia make peace – but for how long?

By Jonathan Hopfner

While the war on Iraq is in the early stages, another, a less prominent conflict drew to a close March 22, when checkpoints on the Thai-Cambodia border were officially reopened after remaining shut for nearly three months in response to the torching of the Thai embassy in Phnom Penh.

The Thai-Cambodia dispute registered as little more than a blip on the global radar, but despite both governments’ insistence that they consider the matter resolved, could yet have serious implications for relations between the two countries and the fragile unity of the 10-member Association of Southeast Asian Nations (ASEAN).

The conflict was also a potent reminder that in Southeast Asia, ancient history continues to exert a forceful, if often unnoticed, influence on present events. The furor was sparked when a Thai actress popular in both her native country and Cambodia, Suwanan Khonying, allegedly commented that she would not visit Cambodia until it returned the 1100 year-old Angkor temple complex to Thailand. While Khonying insisted she uttered these lines in a role on a soap opera that aired in Thailand two years ago, her words appeared in the Khmer press early this year, prompting Cambodian Prime Minister Hun Sen to comment at a rally in January that Khonying was “not worth a blade of the grass that surrounds Angkor.”

What happened next stunned even those well accustomed to Cambodia’s political instability. On January 29, bands of protesters that had gathered in front of the Thai embassy in Phnom Penh broke into the compound and set the building alight. Having exhausted government targets they next turned their attention to the private sector, burning and looting Thai-owned businesses throughout the capital. By the time order was restored over 30 firms, including hotels, restaurants and airline offices, were damaged or destroyed; Thai Prime Minister Thaksin Shinawatra had sent five planes to the capital to evacuate Thai nationals and the Cambodian ambassador to Bangkok was expelled. Future tallies estimated the riots cost Thai companies at over 2 billion baht, but it is more difficult to gauge the fiasco’s effect on the already tenuous relations between the two nations.

Theories as to the true causes of the incident abound; Thai Ambassador to Phnom Penh Chatchawed Chartsuwan implied upon his return to Bangkok that the riots were not spontaneous and that the Cambodian police were slow to respond to his requests for assistance. Many observers accused Hun Sen of deliberately whipping up nationalist sentiment ahead of nationwide elections in July; a time-honored tactic of Cambodia’s current administration. The Cambodian government itself accused opposition leader Sam Rainsy of fomenting disorder to discredit Hun Sen and his party; a charge Rainsy has hotly denied.

More insightful analysts have suggested that the Cambodian unrest had been brewing for some time. Thailand and Cambodia have been trading salvos for years over two other temple complexes on the Thai-Cambodian border that both countries lay claim to. More of a factor may have been Cambodians’ increasing resentment over what they see as Thailand’s economic colonization of their country; trade along the border reached 18.7 billion baht (US$420 million) last year, with Thailand recording a surplus of a whopping 17.76 billion (US$396 million). Much of Cambodia’s nascent infrastructure, including its mobile phone network, is wholly or partially owned by Thai firms. Even tourism, which the Cambodian government has upheld as a key engine to the country’s development, has grown under Thai auspices; three of the largest hotels in Phnom Penh are Thai-owned and Bangkok Airways enjoys a virtual monopoly on the lucrative route from Bangkok to Siem Reap and the temples of Angkor. Thai music and television is so favored among Cambodian youth that Senior Minister Sok An last May asked local television producers to impose a moratorium on Thai films, soap operas and game shows.

The aftermath of the riots only highlighted to many Cambodians the extent to which they are dependent on their wealthier neighbor. As border posts closed, the economies of towns in Cambodia that rely heavily on cross-border trade and traffic such as Poipet were devastated.

With the border situation returning to normal on March 21 after Hun Sen paid 252 million baht (US$5.8 million) in compensation to Thailand for the destruction of the embassy, relations between the two countries look set to steadily improve. But several thorny issues remain unresolved. Though the Cambodian government has agreed in principle to pay an additional 2 billion baht (US$46.6 million) to businesses affected by the incident, trust between Phnom Penh and Bangkok remains at an all-time low, as evidenced by Shinawatra’s insistence that Cambodia compensate at least one business before the checkpoints were opened. Hun Sen may also have some difficulty persuading his largely impoverished people – many of whom, correctly or not, believe too much Cambodian money already ends up in Thai coffers – that settling the outstanding bill is in the nation’s best interests.

This is to say nothing of the conflict’s wider implications, especially for the investment climate of Cambodia itself and ASEAN as a whole. Many of the grouping’s nations are locked in an uneasy coexistence. Disputed areas exist between Thailand and Myanmar, Thailand and Laos, and the Philippines and Vietnam; Singapore and Malaysia frequently lock horns over issues such as waste and water supply, and Malaysia regularly accuses Indonesia of failing to control illegal logging and immigration along their border on the island of Borneo. The shared history of Thailand, Myanmar, Laos, Cambodia and Vietnam is one of war and conquest; foreign investors may rightly wonder now whether the nationalist tendencies that crop up in all these countries could once again give rise to events like those that took place in Phnom Penh. Business and trade will soon recover, but the real casualty of the Thai-Cambodia spat may be the image of stability and unity that ASEAN has been struggling to project to investors in the face of increasing competition from China. At the very least the incident is a powerful reminder that in Asia, old habits die hard.

The Global War on Poverty: An American Foreign Aid Revolution

By Barry Metzger, Senior Partner, Coudert Brothers, LLP

The 1990s were marked by growing domestic and international criticism of American foreign aid to the developing world. While the largest donor at approximately $10 billion per annum, the United States contributed the smallest proportion of its national wealth to such assistance (approximately 0.1% of America’s Gross National Product). It has also been chronically delinquent in Congressional funding of commitments to the soft loan windows at the multinational development banks which aid the poorest nations. In the buoyant optimism of America’s boom economy through most of the decade, America’s wealth stood in dramatic contrast to poverty and human suffering in the developing world. The unrestrained devastation of the AIDS pandemic in parts of Africa painted most starkly that contrast between the wealth and poverty of nations.

With the inauguration of the George W. Bush in 2001, there seemed little objective reason for optimism about the emergence of enhanced development assistance as a major theme of the Bush Administration’s foreign policy. Senior members of the Administration, most notably Treasury Secretary Paul O’Neill, were openly critical of what they termed to be a long history of ineffective foreign aid. Criticism of United Nations organizations and the World Bank were common. The Administration’s discomfort with multilateral approaches to international issues seemed unlikely to yield strong support for programs to achieve the United Nations-sponsored Millennium Development Goals or to implement the World Bank’s Comprehensive Development Framework in its developing member countries.

Yet within the past year the Bush Administration has undertaken two bold initiatives that promise dramatically to increase America’s foreign aid for development and which embody a new paradigm for America's development assistance.

In March of last year, immediately prior to the United Nations-sponsored International Conference on Financing for Development in Monterey, Mexico, President Bush made an American commitment to a 50% increase in its development assistance over the next three years – to $15 billion a year. The incremental funds would be channeled through a Millennium Challenge Account to those developing countries which, in President Bush's words:

"…root out corruption, respect human rights, and adhere to the rule of law… invest in better health care, better schools and broader immunization… [and] have more open markets and sustainable budget policies…"

The eligibility of countries for funds from the Millennium Challenge Account is to be determined through a remarkably "metric" approach. To determine eligibility, a country must score above the medium on sixteen indicators or indexes that measure the extent to which a country "governs justly, invests in its people, and encourages economic freedom." The indicators include the: Freedom House indexes of Civil Liberties and Political Rights, Rule of Law index created by the World Bank Institute, a country's credit rating, various measures of public expenditures on primary education and healthcare, Heritage Foundation's Trade Policy index, IMF's statistics on a country's inflation rate and its government's budget deficit.

The Millennium Challenge Account is to be administered by a small, new government corporation, the Millennium Challenge Corporation. Countries determined by their "metric" scores and by the Corporation's board of directors to be eligible, are to submit proposals for assistance to the Corporation. If approved, the programs funded will be administered directly by such governments or by such governments in cooperation with non-governmental organizations, with a minimum of prudential oversight by the Corporation. None of such assistance is to be channeled through the traditional screening and administrative processes of the United States Agency for International Development (USAID) or made available through increased American contributions to multilateral organizations such as the United Nations Development Programme or the World Bank.

A similarly bold initiative was recently promised by President Bush in his 2003 State of the Union Message, in which he announced a $15 billion American commitment -- including $10 billion of new funds -- to fight AIDS in Africa and the Caribbean over a five year period. The Emergency Plan for AIDS Relief is intended to prevent seven million new AIDS infections, to treat at least two million people with life-extending drugs, and to provide humane care for millions of people suffering from AIDS and for children orphaned by AIDS. The Emergency Plan will be based on a "network model" being employed in countries such as Uganda. This involves a layered network of central medical centers that support satellite centers and mobile units, with varying levels of medical expertise as treatment moves from urban to rural communities. It will build directly on clinics, sites and programs established through USAID, the U.S. Department of Health and Human Services, non-governmental organizations, faith-based groups, and the host governments. Only a small portion of the funds will be channeled through the multilateral Global Fund to Fight HIV, Tuberculosis and Malaria recently established as a Swiss foundation. This is so despite the fact that the Secretary of the U.S. Department of Health and Human Services is being appointed chairperson of the Global Fund and that the Global Fund takes a comparable approach to that of the Emergency Plan (in supporting proposals from both governments and from partnerships between governments and non-governmental organizations and in operating outside of traditional development assistance delivery channels).

The dramatic increase in development assistance embodied in the Millennium Challenge Account and the Emergency Plan reflects a new domestic political consensus or, maybe more accurately, a new political coalition in the United States supporting development assistance. These new initiatives have not had their origin in the traditional support for expanded development assistance from within the liberal community or from U.S. businesses that are internationally active. These new initiatives reflect powerful support from the conservative community and, in particular, from the Christian right. Such support is largely based on the religious and moral case for assisting the poor and on the view that such righteous assistance also serves the U. S. national interest. This new consensus or coalition was first seen in the Jubilee 2000 Campaign for debt relief. Foreign aid activists such as the rock star Bono and health activists such as Professor Jeffrey Sachs have played an important role, probably more so than professional politicians. Yet the role of professional politicians should not be underestimated, since the Republican majorities in Congress ultimately will reinforce Presidential leadership and should ensure Congressional endorsement of these initiatives.

The Millennium Challenge Account and the Emergency Plan are far more than mere money; they also represent a dramatic departure from traditional development assistance. Their approach is more unilateralist than multilateral, with a very sharp focus on development effectiveness. Millennium Challenge Account funds are not to go automatically to allies of strategic importance to the United States, but only to those countries with "passing grades" on governance, economic freedom, and investments in education and healthcare. There is a dramatic turning away from development assistance viewed as a country's "entitlement" as a poor nation. Instead, these initiatives are intended to provide assistance only for those countries that demonstrate a willingness to help themselves. In the case of the Millennium Challenge Account this will be achieved through open markets, open political dialogue and human capital investments -- and in the case of the Emergency Plan through credible and accountable project proposals.

The unilateralism of these initiatives is, to an extent, a reflection of the Bush Administration's discomfort with multilateral institutions and multilateral solutions. It is also, however, a reflection of more broadly based domestic and international criticism of the failings of traditional foreign aid and development assistance agencies. Such criticism has targeted the United Nations, the World Bank as well as USAID and its sister, bilateral donor institutions in other countries. Such criticism takes these institutions to particular task for the slowness of their own movement from an "entitlement" perspective to more performance-based grounds for the award of their largess. Too many projects at these institutions are viewed as having been unsuccessful, and the weight of their own bureaucracies is viewed as placing too heavy a burden on program administration. The Global Fund -- a non-American initiative -- evidences a comparable preference to that of the Millennium Challenge Account in its desire to work outside of the traditional foreign aid agencies (both multilateral and bilateral). Troubling and ironic is the Emergency Plan's preference to work largely outside the framework which the Global Fund has itself established outside the traditional multilateral and bilateral healthcare bureaucracies.

The path ahead is uncertain. Congressional approval of the Millennium Challenge Account and the Emergency Plan seems assured. Yet budget appropriations could be scaled back in light of America’s worsening budget deficit, the persistent weakness in its domestic economy and the costs of America's defense. Geopolitical factors could also skew development assistance priorities in favor of allies rather than those countries that can demonstrate their ability to use such money best as development capital.

Another uncertainty, particularly in relation to the Millennium Challenge Account, is the nature of the proposals which eligible countries will submit for funding. Since great weight is to be placed upon responding to the priorities of emerging democracies with market economies, it may be that the funded proposals have less of a focus on poverty reduction, environmental protection and the other priorities that currently animate America’s and multilateral development programs. Such countries may well place greater weight on programs for purely economic development.

Most likely, both the Millennium Challenge Account and the Emergency Plan will be implemented largely as they have been proposed. They can be expected to have a significant influence in reshaping the paradigm for development assistance. That influence will not be limited to America’s development assistance programs, but can be expected over time to spread to the program design and priorities of other bilateral donors and of the multilateral development banks.


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Consoling Progress: How September 11 Affected U.S. Trade Policy

By Russell L. Smith, Willkie Farr & Gallagher

Once the shock and sadness of the September 11, 2001 attacks had subsided, Americans, and particularly decision makers and opinion leaders in Washington, began to try to understand the profound ramifications of a foreign terrorist attack on American soil. Trade and global economic policy emerged very quickly as a vitally important area. USTR Zoellick almost immediately made it clear that there was a direct link between trade, economic development, and the circumstances responsible for the frustration and hoplessness, and extremism that breed terrorism. Initially, Zoellick's point was to emphasize the need to pass Trade Promotion Authority legislation. While there were those in Congress and the press who criticized Zoellick strongly for allegedly using a national tragedy for political purposes, events belied that accusation. First, Congress passed TPA relatively quickly, and second, the Doha Ministerial that launched a new round of global trade negotiations was marked by a unity and determination to reach consensus on an agenda that could not have been more different from that of the disaster in Seattle two years before. Zoellick was proven both correct and pragmatic--events provided him with a principled goal, and he used the opportunity to achieve an agenda that ultimately help realize those goals.

The ultimate realization of a balanced multilateral agenda that encourages global economic growth and especially benefits the poorest nations is, however, encountering the practical hurdles of national self-interest. Differences over every substantive area of the Doha Agenda are for the time standing in the way of progress at the multilateral level. The knowledge this would happen and the understanding it was vital to continue to link economic development to the struggle against terrorism at all levels, has led to the other major trade policy initiative generated by the September 11 attacks--the U.S. effort to achieve a wide range of bilateral and regional trade agreements. One need simply review the list of nations and regions with whom the United States has or seeks to conclude agreements to understand the strategic and political motives of Ambassador Zoellick in undertaking this initiative.

Again, Zoellick is being criticized this effort. The criticism is especially harsh from WTO officials, who see bilateral negoations as a threat to the Doha Agenda and the WTO itself. This allegation is basically not justified. While bilateral and regional negotiations have their own problems, if conducted with a measure of sensitivity to mulitlateral impacts, they can make a positive contribution to WTO-related objectives. Certainly, to give just one example, breakthroughs on agriculture issues at the bilateral level can only be helpful to the Doha negotiations on that issue, which are essentially at a standstill. Just as importantly, bilateral and regional negotiations are clearly vital to post-September 11 U.S. geopolitical interests. There is no need to detail the very obvious reasons for many of the nations chosen to receive the benefit of U.S. bilateral and regional attention, from key allies like Australia, to key targets like Morocco. Singapore and Chile were ripe for quick success and thereby established precedents for more difficult, but ultimately more deeply beneficial agreements.

The progress that has been made in all trade negotiating fora, given the meager prospects post-Seattle, is in large part attributable to U.S. initiatives driven by the understanding that the September 11 attacks and the abiding presence of global terrorism demand a dramatic, long-term, and positive economic response. This will help to rebuild confidence in international relationships and to diminish the opportunities for such tragedies in the future.

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International Trade After September 11 - Port Security Initiatives and International Business

By Russell L. Smith and Ilissa A. Kabak of Willkie Farr & Gallagher

The terrorist attacks of September 11, 2001 have changed the way Americans live and work. Security measures that were unheard of just over one year ago are now commonplace as Congress and the Bush Administration strive to prevent future terrorist attacks. This trend is especially true for the transportation sector. While we are familiar with the security measures implemented at U.S. airports, many of us are unaware of the profound changes affecting U.S. maritime ports and foreign ports of origin as well as the manner in which companies conduct international trade. All of this will ultimately have a significant impact on the U.S. economy.

Since the September 11 attacks, U.S. ports have been operating under heightened security to prevent the smuggling of weapons of mass destruction into the United States. The Bush Administration has been working to develop a more far-reaching, permanent security plan to deter such potentially disastrous activity. As part of this effort, the U.S. Customs Service has developed new programs to address the threat that terrorism poses to U.S. ports. These programs have forced companies with imports at any point in their supply chain to understand the ramifications of the various Customs programs, changes to import processing activities, and ongoing efforts to increase potential port security, and to align their operations accordingly.

While Customs has developed, and is in the process of implementing, various security-related programs, this article discusses one program, the Container Security Initiative (“CSI”), and regulations developed under CSI that have a profound effect on how U.S.-based businesses reliant upon imports operate in this new environment.

CSI and the 24-Hour Rule

As part of the effort to address the threat of terrorism to U.S. ports, Customs launched the CSI in January 2002. CSI is designed to deter terrorists from utilizing international shipping lines to smuggle weapons of mass destruction. According to Customs, the key elements of CSI are to establish security criteria for identifying high-risk containers based on advance information, prescreen containerized cargo at the earliest possible point in the shipping process, use technology to quickly prescreen containers deemed to be high-risk, and develop secure shipping containers.

Under CSI, upon agreement with foreign governments, U.S. Customs agents will be stationed at foreign ports to identify and inspect high-risk shipments for smuggled goods or weapons at those ports of lading. To date, the governments of Canada, Singapore, the Netherlands, Belgium, France, Germany, Sweden, Italy, United Kingdom, Spain, China, Hong Kong, Japan, and South Korea have agreed to participate in CSI. As of this writing, the CSI program is already operational at the ports of Antwerp, Bremerhaven, Hamburg, Rotterdam, LeHavre, Montreal, Halifax, and Vancouver.

To enhance the effectiveness of CSI, Customs developed the 24-hour Advance Vessel Manifest Rule (“24-hour Rule”). The Rule, which Customs began to enforce on February 2, 2003, requires parties to transmit to Customs specific and detailed cargo declarations for ocean freight on vessels that call on U.S. ports at least 24 hours prior to lading at the foreign port. Carriers and eligible Non-Vessel Operating Common Carriers (“NVOCCs”) must submit such information to Customs either electronically through the vessel Automated Manifest System (“AMS”) or in paper form. If Customs does not receive the required manifest information 24 hours prior to lading, Customs will instruct a shipping line not to load the cargo on the intended vessel, thus stopping the shipment at the foreign port. Customs has already issued such “No Load” directives to various shipping companies since the agency began enforcing the rule.

Customs’ 24-hour Rule exempts bulk cargo (homogenous cargo that is stowed in bulk, is loose in the vessel hold, and is not enclosed in any container such as boxes, bales, bags, cases, etc.) and break bulk cargo (cargo that is not containerized but is otherwise packaged or bundled ) on a case by case basis. To apply for an exemption, carriers must submit a written request to Customs. Unless and until an application for exemption is granted, companies are required to comply with the 24-hour Rule. Companies that are exempt from the 24-hour Rule must submit cargo declaration information to Customs 24 hours prior to arrival in the United States if they participate in the vessel AMS, or upon arrival if they are non-automated carriers.

Implications of 24-Hour Rule

Prior to the implementation of the 24-hour Rule, Customs Regulations stipulated only that parties have a cargo manifest available upon entry into the United States and upon request by a Customs agent. By requiring the presentation of vessel manifest information 24 hours prior to the loading of cargo onto the vessel at the foreign port, Customs is insisting that such information be transmitted days, or in some cases weeks, earlier than what had been required of carriers under prior Customs Regulations. Thus, exporting companies will be required to provide their carriers with detailed shipment information at an even earlier stage in the shipping process to ensure that the carriers can properly, and promptly, submit the manifest information to Customs according to the requirements set forth in the 24-hour Rule. This, in turn, will likely force U.S. importers, especially those that maintain facilities dependent upon just-in-time deliveries, to implement a system that will allow for the early identification of their need for imported products.

Given the necessary changes companies must make to comply with these new regulations, Customs’ 24-hour Rule is changing significantly the manner in which importing parties, their suppliers, and their ocean carriers, arrange and account for ocean shipments. This has the potential to place substantial burdens on parties who must comply with the Rule.

The Canadian Tiger is Still Roaring

By Jonathan Lemco

In 2002, the Canadian economy was the best performer within the G-7 group of industrialized nations. Despite the global downturn, Canada was the only major industrialized nation with a budget surplus, and it registered a decent GDP growth level of 3.3%. In 2003, the Canadian dollar has improved relative to its US counterpart from 63 cents in January 2002 to 67 cents in March 2003, a 30 month high. In fact, Canada’s GDP growth will again average over 3% to outperform its rivals.

The reasons for this success are easily identified. Canada’s industrial structure has been less exposed to the bursting of the technology bubble. Also, Canada has benefited from its status as a net exporter of energy. In addition, the 67-cent dollar (in US terms) is still attractive to international investors and tourists alike. In addition, there is some evidence to suggest that Canadian productivity levels have improved. Policy makers have also played an important positive role in addressing Canada’s fiscal and monetary policy challenges.

In February 2003, the Canadian Federal government introduced its 2003 fiscal budget, which calls again for a balanced budget. There will be increased spending on health care, defense and other items, but the ethic of fiscal prudence has taken firm hold. Also, the balanced budget is backed by a Can $3 billion contingency reserve. The fiscal consolidation and debt reduction undertaken since the mid-1990s have provided room to further ease tax burdens and introduce modest discretionary spending stimulus. We think that tax cuts should be a priority, for the array of taxes imposed on Canadians, which despite the health and social services that are available to them as a consequence, is far greater than those imposed on their US counterparts. Tax cuts could be a vehicle to boost employment and economic production.

Canada’s flexible exchange rate regime has served the country well, as it has been effective in cushioning the economy from external shocks. Also, since the early 1990s, Canada has been one of the world’s strongest advocates for liberalized trade. Canada has been a substantial economic beneficiary of the North American Free Trade Agreement and its predecessor, the Canada-US Free Trade Agreement. The agreements have resulted in investment and job creation and have contributed to a falling national unemployment rate from 9.6% in 1996 to 7.4% in February 2003. This compares favorably to the United States where unemployment is increasing. Further, Canada is virtually unique among industrialized nations with a 2002 current account surplus of 2.8%.

On the monetary policy side, the Bank of Canada has implemented a successful inflation-targeting framework that has anchored expectations and permitted timely monetary policy responses. Going forward, we expect the Central Bank to increase interest rates in 2003 to reduce the inflation risk, which was 4.5% in January 2003. Thus far in 2003, Canada is the only G-7 nations to increase borrowing costs at all -- by 25 basis points in March 2003.

There are built-in constraints on this success story however. The most important of these are the uncertainties associated with the strength of the US economic recovery. Over 85% of Canada’s trade is with the United States, and its financial and economic health is intimately tied to the prospects of the US. In addition, uncertainty associated with a potential war in Iraq could reduce investment and diminish national growth prospects.

But we think these risks will be outweighed by the fundamental strengths of the economy. In March 2004, Prime Minister Jean Chretien will retire and federal elections will be held. At the moment, former Finance Minister Paul Martin is the strong favorite to be elected Prime Minister. Should that occur, investors should expect continued market-friendly policies from the government of Canada.

Vietnam’s Roaring Private Sector

By Dominic Scriven

One of the more hackneyed laments of recent years has focused on the moribund state of Vietnam’s economy, and the absence of a serious private sector. A closer look is merited, however, not least since Vietnam is now established as Asia’s second fastest economy. The following comments address the power of the private sector; its problems; and a confident prognosis for the future.

First, the last few years have established a firm, and uncontested legal basis for private business: the landmark Enterprise law of 1999, the country’s first Banking law in 2000, Decree 48 on the stockmarket, and upgraded privatization legislation last year. The Constitution, reviewed in 2001, unambiguously leveled the playing field with the State-owned economy.

The effect has been dramatic: 55,000 new businesses have been registered, including more than 20,000 in 2002 alone. There now more than 1,000 privatized companies; 21 listed companies; and 40 private sector banks. This does not include more than 2,000 foreign businesses.

The private sector is the principal source of new job creation (at 1.4m school leavers per year, this dwarfs the total state-enterprise workforce of 1.8m); and is responsible for more than half of non-oil exports – including world-beating performers rice, cashews, coffee, and pepper; garments, footwear, and housewares. The private sector invests more than either the state, state enterprises, or foreign investors, equivalent to more than 6% of GDP per year; and churns out a quarter of industrial production. The private sector is the principal motor behind a doubling of bank deposits and 50% increase in bank credit in the last three years. There can be little doubt who is the pied piper in this robust economy.

But there are issues, principally as a result of growing pains. First among these is modest scale: few businesses are more than first generation, and family ownership is the norm. This leads to inexperienced management, most visible in an unwillingness to plan for the long term, and a ruthless focus on near-term profitability. Partly due to this, businesses suffer from a lack of transparency, though much of this reflects an outdated allergy to tax payment. Clearly this, in turn, impacts on the valuations that such companies attract and almost all business sales are transacted at close to book value. And lastly, all of the above lead to much distorted capital structures, over-high real interest rates, and a dysfunctional financial system: the largest listed company has not one dong of medium term debt, while half the deposits of the banking system are kept in dollars, and lent offshore at minimal margins. Vietnam is not the poor country that many believe – rather it suffers from a misallocation of resources.
They say that nothing is impossible in Vietnam, but anything can happen. Here’s a few cheerful, and entirely achievable predictions for the future:

The number of privatizations will treble in three years; the number of listed companies will double in each of the next five years; both money supply and bank credit will double in the next three years; real interest rates will halve; and asset markets will boom.

Dominic Scriven is a director and co-founder of Dragon Capital, and manager of Vietnam’s largest investment fund, Vietnam Enterprise Investments Limited.

The Political Economy of a Stronger Yuan

By C. H. Kwan, Senior Fellow, Research Institute of Economy, Trade and Industry

As symbolized by the rapid rise in China's foreign exchange reserves, the yuan is facing upward pressure. Although a gradual appreciation of the yuan both greatly benefits China itself and responds to the wishes of the international community, there are many political hurdles to be cleared both at home and abroad before this can be realized.

Led by rising inflow of foreign direct investment and exports, China's balance of payments surplus has widened further following WTO entry in late 2001. As a result, the county's foreign exchange reserves rose by $74.2 billion (equivalent to 6% of GDP) in 2002 to reach $286.4 billion by the end of the year. This figure ranks second in the world behind Japan, and is equivalent to roughly one year's worth of China's imports.

Officially, China has a managed floating system, but ever since the Asian financial crisis of 1997, the yuan has remained stable against the dollar, and is virtually pegged to the greenback. If, as is the case now, the yuan's value is set at a level that is too low compared to its actual strength, dollar supply exceeds demand. When monetary authorities absorb excess dollars from the market, the nation's foreign exchange reserves increase as a result. If China were to adopt a floating system and authorities did not intervene at all in currency markets, its foreign exchange reserves would not have grown and the yuan would have appreciated instead.

If the authorities continue to keep the yuan at its prevailing level, China's trade imbalance and foreign exchange reserves will further increase, causing much harm to the Chinese economy. First, the surge in foreign exchange reserves will make it difficult to control money supply, and exacerbate the real estate bubble. In addition, China has already surpassed Japan as the country with which the United States has the largest trade deficit, and should the deficit widen further, it could lead to trade frictions. Finally, most of China's foreign exchange reserves have been invested in US Treasuries, and since the return on those investments is much lower than that of investments made at home, it is clear that the savings of Chinese citizens are not being effectively invested. The yuan should appreciate in order to correct such distortions.

In addition to adjusting exchange rates, reforms are also needed in the exchange system itself. First, against the backdrop of the sharp fluctuations in the yen-dollar rate and the fact that most Asian nations have shifted to a managed floating system, the yuan's stability vis-a-vis the dollar under the peg system causes large fluctuations in the exchange rate between the yuan and the currencies of its trading partners. This is a destabilizing factor for China's trade and its economy as a whole. At the same time, rising mobility of capital is making it more difficult to control money supply and interest rates, and the current de facto fixed exchange rate system should also be abandoned from the viewpoint of maintaining the independence of monetary policy.

Exiting from the dollar peg system is preferably done at a time when economic fundamentals including external balances are good, and when there is some upward pressure on the yuan. The stage is almost set, as these preconditions have practically been met. When doing so, it is probably more realistic to condone a gradual appreciation spreading over a few years rather than implementing a steep appreciation in one step. Yet, authorities so far have remained cautious over a yuan appreciation partly because the leaders newly appointed during the latest Communist Party Congress and National People’s Congress will take time to consolidate their power.

Meanwhile, major industrial countries like Japan are calling for the yuan's appreciation, saying it would help combat global deflation and correct their trade imbalances with China. While it is true that there is room for the yuan to rise, given the reasons cited above, it is likely that the new Chinese leadership would want to avoid by all means possible a scenario in which it allows the yuan to appreciate due to external pressure. In this sense, recent remarks by Japanese financial authorities calling for a stronger yuan, such as the opinion piece that Haruhiko Kuroda and Masahiro Kawai, the vice minister and deputy vice minister of finance for international affairs, jointly penned in the Dec. 2 edition of The Financial Times, can only delay, rather than accelerate, the yuan's appreciation. Their hopes for a sharp rise in the yuan, similar to that of the yen in the wake of the Plaza Accord, must be viewed as unrealistic.

As this shows, the appreciation of the yuan is both desirable for China itself, and can also meet the demand of the international community. Nevertheless, the dilemma is that there is little prospect of this materializing because of a lack of trust among the countries concerned. In terms of its GDP and trade volume, China is now on a par with Britain, and as can be seen in the current calls for a stronger yuan, it can no longer be ignored when discussing such issues as industrial adjustments, deflation, and trade imbalances in major industrialized countries. There are limits to the extent to which current international economic policies can be effectively harmonized so long as China is left out in the cold. The time may have arrived to construct a system under which mutual trust can be further developed, such as considering China's entry into the Group of Seven.

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China’s Other Economic Agenda: Priorities, Progress, and Policies

By Jean-Marc F. Blanchard, Ph.D.

China’s troubled state-owned enterprises (SOEs) and state banks, its unemployment woes, and the pressures unleashed by its World Trade Organization (WTO) accession tend to dominate conversation when China’s economic difficulties are discussed. These problems present genuine threats to the country’s economic prosperity and political stability. They are, however, only three of the many economic challenges that China confronts as it moves to a market-based and globally integrated urban economy.
The interlinked nature of China’s economic problems means that the leadership cannot deal with the more visible economic threats in isolation from lesser-known problems. A recapitalization of the banking system, for instance, will not spur growth unless the government succeeds in fostering a more favorable business environment for private firms. China’s less familiar economic difficulties include private sector constraints, rural underdevelopment, and public finance problems.

The private sector is a ray of light on China’s contemporary economic landscape. It produces about one-third of China’s GDP, dominates the service sector, and, more importantly, is a major source of job creation. Yet private enterprises operating in China face substantial obstacles. These include a lack of access to capital, underdeveloped markets, too little or too much market supervision and regulation, restrictions on market entry and access to government resources, inadequate infrastructure, and corrupt officials. Currently, many SOEs that are trying to become normally functioning private businesses cannot get the investment they need, the managerial training they require, or the asset divestment powers they seek.

In rural areas, underdevelopment has many facets: poverty, high levels of income inequality, inadequate health and education, energy shortages, and ecological crises. If rural areas cannot provide adequate opportunities, rural residents will migrate to urban areas. This places great strains on local governments, job markets, and the urban infrastructure. Additionally, rural underdevelopment implies a lack of money to support education, health care, and environmental programs. Either this money will come from higher government levels or these programs will remain underfunded. This will make it extremely difficult to create an educated workforce, to deal with costly health problems like HIV/AIDS, and to reduce air pollution, water shortages and farmland losses.

We should not forget that rural underdevelopment has provoked political unrest in recent years. This is one reason decision makers gave it great attention in the 10th Five-Year Plan (2001-2006) and last November’s 16th Party Congress, and repeatedly mentioned it at the ongoing National People’s Congress. It would be farfetched to assume that just because rural areas served as the base for the 1949 Revolution that rural problems will once again become the wellspring of another revolution. Many of the conditions present in 1949 are simply are not there today. Nevertheless, severe problems exist. Ironically, development programs may fuel the fire if they cause rural inhabitants to feel they are entitled to more, but fail to deliver and do not furnish political channels for them to pursue any resulting grievances peacefully.

It is not well known that government units beneath the national level account for almost three-quarters of public expenditures in China. Furthermore, government units below the provincial level account for more than half of all public spending. Unfortunately, these sub-national units are spending far in excess of their resources. To restore balance, they need to cut spending, raise taxes/fees, or draw more money from an already hard-pressed central government. Aside from their adverse consequences in terms of social spending, cuts could diminish spending on the infrastructure that promotes growth and sustains the creation of a national market. Moreover, tax and fee hikes may stifle business creation, causing corruption, and encouraging wasteful efforts to evade taxes and fees.

Cognizant of these problems and the risks of inaction, Chinese leaders have embraced numerous initiatives. They have worked to establish a functioning legal and judicial system, to create additional financing options for small and medium enterprises, to open previously closed sectors like energy, and to improve transportation and logistics. They also have striven to increase access to education, to encourage the production of higher-value crops, to produce better socio-economic indicators, and to protect natural resources. Finally, they have endeavored to stabilize the financial situation of the country’s subnational units through increases in general and project specific transfers, new revenue sharing arrangements, and shifts in expenditure obligations.

Going forward, the economic agenda remains packed. The government needs to improve the business environment by eliminating internal trade barriers, reducing government monopolies, and increasing import and export privileges. On the public finance front, policymakers must balance subnational spending obligations with subnational resources, improve information and management systems, and establish more effective tax systems. In the realm of rural underdevelopment, officials need to do more with respect to health and education spending, the creation of non-farm employment opportunities, and the protection of individual property rights.

To address these outstanding items, the government is pursuing various options. For instance, it is giving space to private financial institutions in the insurance, banking, and securities industries and considering reforms in the tax laws applied to financial institutions. It also is reducing the footprint of SOEs in many markets. It is also accepting market prices for energy and transport, which reduces government subsidy burdens and creates new opportunities for private entrepreneurs. Furthermore, it is curbing special fees and user charges and strengthening land-use rights. Moreover, it is dramatically streamlining the bureaucracy and allocating more resources to infrastructure, environmental, and education. Finally, it is enacting additional business and environmental laws and creating more transparent regulations and guidelines.

There is no reason to doubt the new Communist Party leadership’s commitment to these and other reform initiatives. Past economic crises have discredited administrative economic solutions. The internal and external pressures for continued economic reforms are great. The new leadership and China’s power brokers are pragmatic and uniformly support a reformist agenda. And these elites have the support of powerful patrons including Jiang Zemin and Zhu Rongji. Nevertheless, their reformist zeal will be tempered by government fiscal constraints and their wariness of potentially destabilizing change.

Successful progress on China’s other economic issues could offer many opportunities to businesses that operate in, or want to conduct business with, China. First, it should create new buyers and suppliers. Second, it should increase investment opportunities, either individually or in partnership with domestic companies. Third, it should increase the country’s overall rate of economic growth. Fourth, it should stabilize the rural, ecological, and government fiscal situation. Fifth, it should allow progress on the country’s more visible economic problems. Where China is concerned, then, 2+2 indeed may make 5.

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Intellectual Property Rights, Pharmaceuticals, and East Asia: Turning Gold into Lead?

By Jean-Marc F. Blanchard, Ph.D.

The Trade-Related Aspects of Intellectual Property Rights Agreement (“TRIPS”), one of the many agreements that established the World Trade Organization (WTO), sets forth international norms and legal standards with respect a variety of intellectual property rights (IPR) such as copyrights, trademarks, and trade secrets. In recent years, government budgetary woes and endemics and epidemics such as the HIV/AIDS crisis have put severe pressures on countries to violate or tepidly support the provisions of TRIPS relating to drug patents. Drug patents are important because they limit the sale, use, and manufacture of patented products, and, where appropriate, the use of patented drug manufacturing processes.

East Asia is no stranger to the aforementioned pressures. Furthermore, the national development objectives of East Asian governments provide them with incentives to interpret TRIPS in a self-serving manner.

Last April, the Office of the United States Trade Representative (USTR) issued its annual Special 301 Report on global IPR protection. The report shows that East Asian countries do not always protect drug patents. Taiwan suffers from some trademark counterfeiting while South Korea does not take adequate steps to prevent patent-infringing products from obtaining marketing approval. Furthermore, certain U.S. pharmaceuticals continue to experience difficulties in obtaining administrative protection for their products in China.

Although the situation with respect to drug patents in East Asia is not dire, there are a number of trends that threaten it. The first trend is the deteriorating public finance situation in East Asia. Relatively slow economic growth is producing pressure on many governments to tighten their budgets, which have been in deficit as a result of fiscal stimulus programs undertaken to stabilize or increase economic growth over the past few years. A second is the growing number of infectious diseases needing attention. These diseases raise not only budgetary issues, but also huge politico-economic issues because of their effect on family structures and the workforce. A third trend is the need for countries to find new sources of economic development. One noteworthy source that East Asian governments are currently emphasizing is the biotech sector.

Despite their acknowledgement that patent rights can provide an incentive for drug research and development, the preceding trends are leading East Asian countries to adopt a variety of ameliorative tactics vis-à-vis their pharmaceutical burdens. These tactics include price controls, cuts in drug reimbursement rates, and parallel importation. Moreover, East Asian and other countries are lobbying for the ability to use confidential drug test data, for the transfer of technology to support the development of domestic pharmaceuticals, and for more time to comply with TRIPS.

To the pharmaceutical industry’s dismay, these pressures are also leading East Asian countries (as well as other developing countries) to use compulsory licensing in a liberal fashion, to authorize compulsory licensing for production abroad, and to move slowly in establishing the enforcement systems that TRIPS requires. Although the specific justifications advanced by governments for such measures are often questionable, their general right to authorize compulsory licensing for domestic production is not. Article 31 of TRIPS specifically allows compulsory licensing for government use, or in a “national emergency” or “circumstance of extreme urgency.”

Looking ahead, the East Asian environment for IPR will worsen the greater the benefit that each country derives from exploiting drug patents and the lower the cost that it will incur from exploiting them. Benefit is a function of each country’s health care requirements, its drug manufacturing capabilities, its economic development needs, and its financial situation. Cost is a function of each country’s bargaining power versus patent holders. Factors increasing a country’s bargaining power include abundant financial and political resources, allies with financial and political clout, and a friendly normative environment. Factors increasing the patent holder’s position include financial and political might and powerful allies. Its power also is enhanced to the extent that an adversary country has its own medical products whose IPR it needs to protect.

Historically, the pharmaceutical industry has dealt with threats to its IPR by attempting to exercise power. This is changing, however, as shown by the industry’s creation of various drug subsidy programs such as the Together-Rx prescription savings program and its contributions to various global disease initiatives. Of course, pharmaceutical companies have not given up entirely on using their muscle. The industry, however, must be careful about emphasizing a realpolitik strategy because it can backfire in the court of public opinion. Moreover, pressure against developing countries has led them to undertake a counteroffensive in the WTO regarding the “proper” interpretation of TRIPS provisions.

In the short-run, pharmaceuticals should adopt a three-pronged strategy, which reduces the benefits that countries derive from infringing upon patents and increases the costs of such infringements. First, they should seek to partner not only with global health organizations, but also multilateral and bilateral development agencies. Such partnerships will leverage their charitable activities and deal directly with some of the root causes of the global health care crisis. Second, they should undertake public relations initiatives that reach wider audiences. Third, they should support developing country efforts to nurture industries using traditional medicines and indigenous biological endowments. In the long run, it is to the advantage of the pharmaceutical industry to assist global efforts to facilitate economic development. This is due to the fact that development can reduce the incentives for governments to break drug patents and can create a more hostile environment for patent violators.

Although the pharmaceutical industry always will be under a modicum of pressure given government budgetary pressures, rising health care burdens, and economic development objectives, more effective strategies can help to prevent the current situation from degenerating into an unending bad TRIP(s)

Global Credit Solutions Limited provides a top-level service in the collection of commercial and consumer accounts, skip tracing, asset and fraud investigations and credit information on companies and individuals, globally. Visit them on the web at http://www.gcs-group.com or join their free monthly newsletter specially designed for credit professional and managers.

Malta and Slovenia – A Growth of European Momentum?

By Scott B. MacDonald

On March 9, 2003 the island-state of Malta voted in favor of joining the European Union in a referendum. This was the first popular test among 10 nations invited to become EU members next year. According to official results, 53.65% or 143,094 Maltese, voted "yes," The “no” vote won 46.35% or 123,628. This was a relatively narrow margin mirroring worries that membership in the EU could compromise the island-state’s tradition of highly prized independence.

The vote was important for the EU. Clearly EU headquarters in Brussels and the other nine EU candidates were watching closely due to concerns that enthusiasm for an expanded Europe was weakening. European Commission President Romano Prodi said the result boded well for ratification in other countries. "This is a choice for stability and growth, as well as for the peaceful reunification of Europe and the European people," Mr. Prodi said in a statement from Brussels.

One of the reasons for the possibility of waning excitement over EU membership has been the seemingly heavy-handed approach to developing a common European foreign policy, led by France and followed by Germany. Indeed, the Paris-Berlin bid at leadership in regard to policy over Iraq ultimately resulted in French President Jacques Chirac talking down to a number of potential EU members, in particular, Poland, Bulgaria and Romania. Other concerns have been in surrounding policy independence to Brussels in a number of areas, despite obvious gains in terms of the EU’s generous assistance.

The vote was a victory for Malta's pro-membership Prime Minister, Eddie Fenech Adami, though the opposition challenged him to call elections soon for another test of voter sentiment. But Labour party leader Alfred Sant said that with 270,000 ballots cast, the 20,000 people who didn't vote meant the "yes" total amounted to less than half the eligible electorate. Voter turnout was roughly 90 per cent.

The Prime Minister’s Nationalist government met soon thereafter and decided to make an "opportune decision" on Mr. Sant's demand by calling for a general election on April 12. This was not a shock to the public as it was widely expected that the cabinet would call for elections in a few weeks, possibly to be held just before Malta is to sign its EU accession treaty in an April 16 ceremony in Athens.

Doubts about EU expansion have been growing across the continent, and the people of Malta — proud of decades of independence and policies of non-alignment — went to the polls divided over whether their Mediterranean archipelago should join the bloc.

A spat between Paris and EU-candidate nations over Washington's tough stance on Iraq only aggravated unease among smaller, less-developed countries that they would be dwarfed politically by bloc members such as France, Germany and the UK. New EU members will receive billions of dollars in aid, but they will also have to open their markets. Many workers in Malta worry that the price of membership would be slashed jobs as protectionist barriers come down.

Slovenia's referendum is next, on March 23. Other candidates with referendums pending include Poland, where a strong farming lobby fears agriculture will suffer from EU membership, as well as the Czech Republic, Estonia, Latvia, Lithuania, Hungary and Slovakia. Cyprus is to ratify its bid with a parliamentary vote

Buyside Magazine reaches active institutional investors monthly with news and analysis of the equities markets. Buyside takes readers beyond news of the current business climate to report industry and market trends that are crucial for investors to understand -- not simply the latest business trends or product releases. Buyside and BuysideCanada are available in print, and online at www.buyside.com. Subscriber information is available on Buyside's home page.

KWR Viewpoints

The Return of Spheres of Influence?

By Scott B. MacDonald


For all the discussion about the split between the United States and Europe over Iraq, the fundamental issue is that the international political system is heading back into spheres of influence. The Western alliance is becoming history. This was bound to happen. We sometimes forget that nature abhors a vacuum. Perhaps having a single superpower is a little bit like a vacuum – so many places to play policemen and not enough soldiers to go around. Now, we see the drift away from uni-polarity back to multi-polarity, with President Jacques Chirac of France, backed by Germany’s Chancellor Gerhard Schroeder and, to a lesser extent, Russia’s Vladimir Putin, leading the way to asserting Europe’s independence vis-à-vis the United States. We also see a more self-confident China, willing to defy the U.S. on Iraq and quietly asserting itself in Southeast Asia.

The main indicator of the return of spheres of influence foreign policy is evident in recent encounters between the United States and Europeans. The United States is now in the process of seeking to re-write the Middle Eastern map to its advantage – by invading Iraq and seeking to create a new democratic-capitalist government in the place of Saddam Hussein’s regime. From this point, U.S. power can be easily projected throughout the region, including those states that have long track records of supporting international terrorism – Iran, Syria and Saudi Arabia. Simply stated, the hope is that bad regimes will be replaced with governments that share the same values as the West – democracy, elective government, equal rights for men and women, secular rule of law, and capitalism. Through this process, beginning with Iraq, even the Palestinian-Israeli issue can be resolved. Everyone will benefit, in particular, the United States, which will clearly be dominant in the region for a long time. While oil is part of the equation, it is only a small part.

President Jacques Chirac is actively re-asserting France’s sphere of influence – in Europe, the Middle East and Africa. By opposing war against Iraq -- as opposed to standing up for Saddam Hussein -- France is standing tall among the Arab world, a longstanding French constituency based on history, economic and political ties, and France’s own Muslim population of about 6 million individuals. President Chirac in March also visited Algeria, where he was given a hero’s welcome from estatic crowds. France considers Algeria important and has been a strong base of support for the embattled quasi-authoritarian, yet secular government. France also carries considerable clout in relations with its former North African colonies of Morocco and Tunisia. At the same time, French troops have been sent to the Ivory Coast, where they helped to impose a peace plan. French troops are based elsewhere in sub-Saharan Africa, clearly representing France’s national interest in what was traditionally its sphere of influence.

While France and Germany are asserting their sphere of influence in Europe, Africa and the Middle East, Russia remains the dominant player in parts of Central Asia. However, the projection of U.S. power in the region, in particular, in the former Soviet republics around Afghanistan, is a point of concern in Moscow. On one hand the Russians are happy to have the U.S. as an ally in the fight against global radical Islam. They also like foreign investment in their economy. However, the Russians do not like U.S. forces in the region and there is come jockeying for influence. This explains the recent thaw in relations between Russia and the European Union, in particular, with France. Whereas French and German governments were vocal over Russia’s heavy-handed actions in Chenynia, those criticisms have become far more muted over recent months. Closer ties with France and Germany also provide Russia with some leverage over the United States.

The other two major players in the regional spheres of influence game are China and India. China clearly looks to Southeast Asia and the South China Sea as zones of influence, where its economic and military power are evident. Beijing also has influence in Korea, though would rather have the United States bear the costs of North Korea’s failed economy. China also has a good relationship with Pakistan, which it uses to counterbalance India. For its part, India is the major regional power in South Asia. It is also seeking to play a more active role in Southeast Asia, standing up for Malaysia’s Indian population and seeking to develop a closer military relationship with Singapore.

The return to spheres of influence is a hardly finished development. The United States has not surrendered being the dominant and sole superpower or its option of going it alone when it observes its national interests at risk. U.S. military power remains a major factor in Asia, Europe, and the Middle East. And economically speaking no other economy can come close in sheer size and ability to generate world growth. At the same time, the Franco-German gambit to make Europe stand tall vis-à-vis the Americans has not gone well with many other European nations. Certainly the UK, Spain and Italy have taken a different Iraqi policy path from that dictated from Paris and Berlin. In addition, prospective Central and Eastern European members to the European Union have a greater sense of unease with Paris-Berlin leadership, especially after French President Jacques Chirac’s recent comments of their “immaturity”, which recalls similar hegemonic behavior reminiscent of the Soviet Union and the eastern bloc. In Asia, China’s “influence” is hardly bringing North Korea to heel. India cannot control the violence in Nepal that is creeping toward civil war. Russia is still not able to stop acts of terrorism in the Caucasus.

What does this mean for those countries without spheres of influence? A major concern of this trend is that globalization is likely to be curtailed. Political spheres of influence also have an economic component. Political tensions in other areas are likely to creep into trade talks or further efforts for financial liberalization. This poises significant risks for countries, such as Japan, Korea and Chile that have placed an emphasis on international trade and export-led economic growth. Japan, long a free rider in military power agreements, will increasingly be forced to compete with China in maintaining an economic sphere of influence in the rest of Asia. This raises the tough questions of the durability of the U.S. alliance and how far Japan wants to go in upgrading its military.

If the current drift into spheres of influence continues, prospects for political tensions are likely to increase. Multi-polar world political systems are more unstable than uni-polar or bi-polar ones. Competing spheres of influence usually lead to confrontation. Prior to both World Wars, the global political system was decidedly multi-polar - and inherently unstable as proved by the two following bloodbaths. We are left with the words of Lord Palmerston, a British prime minister during the Victorian era, who observed: “There are no permanent alliances, only permanent interests.”

French Foreign Policy: A Perspective from History

By Andrew Novo

Maybe it’s something in the wine from Bordeaux. Maybe it’s something in the Roquefort cheese. Maybe it’s a desire to imitate the Scottish salmon that generations of French rulers after William the Conqueror were unable to acquire. Whatever it is, historically, France seems committed to swimming against the current of foreign policy, opposing the world’s most powerful state, and pushing itself forward as the champion of unlikely causes. At face value, it might be expected that France, one of the most respected and long-lived democracies in the world, would support the American led campaign to disarm Iraqi dictator Saddam Hussein of his weapons of mass destruction, and to prevent him from supporting terrorists, and remove him from power. After all, France is, and has been for two-hundred years, an important American ally. In this case, however, France and the United States do not see eye to eye. In fact, France has aligned itself squarely against the United States, Britain, Spain, Italy, and almost all of Eastern Europe, and shoulder to shoulder with Germany and Russia. Now, it is no surprise that Germany and Russia should oppose American policy, but France’s opposition is troubling and bears some explanation.

There’s no doubt that every nation acts almost exclusively out of self-interest in international affairs. France, however, has taken this principle to new levels of contrarian action that betray her position in the world. Yet, the stalwart opposition -- so much more resolute than that against Germany during twenty-seven days in 1940 -- to the attempts of the United States to enforce the mandate of the United Nations Security Council in disarming Iraq, is only the most recent example of how France has stymied other nations with its actions.

The root cause of France’s actions can possibly be found in its egotistical pretensions. Pushed from the limelight of the international stage, France has made it its duty to reign in the burgeoning power of the world’s only remaining superpower – the United States. France aspires to be the watchdog of the world, a nation that can hold back the tide of American hegemony and keep the world a healthy and balanced conglomeration of more or less equal nations. France is no longer an imposing world power and perhaps thinks that no one else should be either. The mirage of French greatness was shattered on the battlefields of WWI and finally put to sleep during the above mentioned seventy-seven days in 1940. The French star is likely to remain in the eclipse for the present and the foreseeable future. Interestingly enough, this is not the first time that France has pursued an unorthodox course following a fall from conspicuous power. Three significant examples stand out from history to demonstrate how France, deprived of open dominance, has attempted to alter the world’s balance of power through its diplomatic positioning.

During the first half of the sixteenth century, after her imperial ambitions were foiled in Northern Italy, France found herself in a difficult strategic situation. The possessions of Holy Roman Emperor Charles V in Spain, Burgundy, the Netherlands, and Germany, effectively surrounded the country. To counter the Hapsburg threat, France found a shocking ally. In 1536, King Francis I became the first Christian ruler to sign an alliance with the Ottoman Turks. This was a momentous occasion, while many powers had previously signed treaties of peace with the Sultan no one had become an ally. The Turks, hitherto regarded as the greatest threat to European liberty since the Mongol hordes of the thirteenth century, now became the partners of one Christendom’s most powerful rulers. Nevertheless, Francis was intent on the move in order to contain the ambitions of Charles V, the most powerful ruler in Europe. Granted, the French have not become an ally of Saddam Hussein, but they have become his advocate, insisting he is cooperating with UN weapons inspectors and poses less of a threat to peace than the loose cannons directing American foreign policy.

Less than a hundred years after the Franco-Turkish alliance, with Europe shuddering under the strain of the Thirty Years War, France once again chose an unexpected but politically expedient side. The country itself was recently emerging from decades of civil and religious strife. Instead of allying itself, as a Catholic country, with the Catholic Emperor Ferdinand II, France decided to fight on the side of the Protestant German, Swedish, and Dutch forces. This course was pursued not out of devout belief in the Protestant cause, but mainly to counter the resurgent power of the empire, and the dominant power of Spain. France had no real affinity for the Protestant cause, but the desire to maintain the balance of power in Europe drove the fleur-de-lis onto the side of the “heretics.”

Finally, we must not forget that France supported the revolution of thirteen British colonies in North America. Bourbon France was one of the bastions of Europe’s “Old Order” of empires. Despite this position, the bait of revenge against a British Empire that had so recently taken over France’s large holdings in North America and pushed it out of the Indian sub-continent proved too strong. Holding its aristocratic nose against the progressive doctrines of liberty, equality, and justice, France allied itself against Britain, the most powerful state in the world. Men, arms, and ships were sent across the Atlantic to help America win its freedom. This, in the end, of course had the odd result of pushing an already shaky French economy into dire straits and sparking a new, exclusively French Revolution with “liberty, equality, and fraternity” as its (borrowed) by-words.

Now in the present, France has once more aligned herself against the greatest power in the world in an effort to stem that nation’s attempts to deal with international problems as it sees fit. It is important for America to recognize the lessons of history and to realize how far France may go to deny the United States what she denied Charles V in the sixteenth century, Ferdinand II in the seventeenth, and (soon to be mad) George III in the eighteenth. France, whether rich or poor, powerful or weak, cannot accept a secondary role in world affairs and will use every means at its disposal to push forward into the limelight. In light of the track record, “the actions of our so-called ally, France”* are not as surprising as they seem on the surface.

Andrew Novo is an independent foreign policy analyst based in New York. His opinions may not necessarily reflect those of KWR International

Emerging Market Briefs

By Scott B. MacDonald

Brazil – Trends in the Right Direction: Credit conditions for Brazil are gradually improving. In mid-March Fitch changed the outlook on its B sovereign ratings from negative to stable. The rating agency indicated the change was due to “a marked turnaround in international trade performance and signs the new government is committed to economic policies that could place Brazil’s public and external finances on a sustainable path.” Looking ahead, Fitch “believes that maintenance of sizable primary surpluses, a trend toward declining real interest rates, and critically, a resumption of reasonable economic growth rates will be critical to further improvements in Brazil’s international credit standing.”

Colombia – Coca Down: There is some good news on the war on drugs. According to United Nations data, Colombia’s coca harvest was down by 30% in 2002. This data was derived from satellite imaging, comparing the prior year’s data to 2002’s. Most of the 105,600 acre (42,736 hectare) fall in coca production was due to the forced eradication campaign undertaken by the Uribe government. The acreage removed from production is estimated to cover an area more than double the size of Washington, D.C. The Uribe government attack on drugs is a major weapon for the government in its war against leftist guerrillas and far-right paramilitaries who sell coca to buy weapons.

Israel – Israel Elect Goes Down: Standard & Poor's downgraded in February Israel Electric, from A- to BBB+, with a negative outlook. The agency cited uncertainties in the company’s operations and investment program and its weak financial profile.

Malaysia – Positive Growth Numbers: Real GDP grew 5.6% in Q4 2002, slightly ahead of the consensus and slightly lower than the previous quarter’s growth rate, which was revised up to 5.8%.

Peru – 2002’s GDP Faster Than Expected: Good news is always welcome, even in the form of a surprise. Expectations for real GDP growth in 2002 were around 4.8%. However, the final number was 5.2%, making 2002 the fastest year of growth since 1997. The key drivers for growth were improved performances by the mining and construction sectors. The Peruvian government has made a forecast of 4% growth for 2003. Mining benefited from the opening of the Compania Minera Antamina copper-zinc mine, which is owned by BHP Billiton (33.75%), Noranda (33.75%), Teck Cominco (22.5%), and Mitisubishi Corp (10%).

South Africa – Upgrades Coming: At the end of February 2003, Moody’s revised South Africa’s Baa2 outlook from stable to positive. The agency cited declining debt ratios, improved external liquidity and careful macroeconomic management. Shortly following that, Finance Minister Trevor Manuel presented his 2003/04 budget. The government revised its budget deficit to 1.4% of GDP in fiscal 2002/03 (from 1.6% of GDP) and is forecasting a deficit of 2.4% of GDP in 2003/04 (allowing for a little more room in social spending). In addition, the government signaled it was loosening foreign exchange controls, long urged by the IMF. In March, Fitch placed its BBB- rating on review for a possible upgrade. We suspect that S&P, which rates South Africa at BBB-, with a positive outlook, will soon be upgrading the country as well

Book Reviews

Corbin, Jane, Al-Qaeda: The Terror Network that Threatens the World, (New York: Thunder’s Mouth Press, 2002). 315 pages. $24.95

Reviewed by Robert Windorf




coverClick here to purchase "Al-Qaeda: The Terror Network that Threatens the World" directly from Amazon.com

Although al-Qaeda has faded from the daily headlines focus on Iraq, the terrorist organization is hardly dead and buried. Indeed, there is a good chance that the organization will strike again against the West, in particular, the United States. For anyone looking for a well-written and researched book on this radical Islamic organization, Jane Corbin’s Al-Qaeda: The Terror Network that Threatens the World makes for a comprehensive read. Corbin is a senior reporter for the BBC’s flagship current affairs program, Panorama and has become an expert on Middle Eastern terrorist movements. She also did a Panorama Special “Towards Zero Hour”, following 9/11, which revealed in considerable detail how the hijackers plotted their assault on the United States.

The fundamental thrust of Al-Qaeda is to reveal who and what al-Qaeda is and what are its objectives. It is also about the West’s response to the threat of this particular terrorist group. As to al-Qaeda’s objectives, Corbin quotes Osama bin-Laden (1998): “Every grown-up Muslim hates Americans, Jews and Christians. It is part of our belief and our religion. Since I was a boy I have been at war with and harboring hatred of Americans.” Simply stated, al-Qaeda’s objectives are to free the Middle East, in particular, Saudi Arabia (the home of the two holy cities of Mecca and Medina) from being “occupied” by American troops and being dominated by the West. This means overthrowing local, pro-Western governments and striking at the West and Israel.

Corbin traces the roots of al-Qaeda back to the Soviet occupation of Afghanistan and follows the adventures of bin-Laden as he became involved in the anti-Soviet war effort. She also notes his growing hostility to the Saudi regime and the United States. At the close of the failed Soviet occupation of Afghanistan, bin-Laden has emerged as a key international personality in what was soon to grow into a truly international organization of terror.

One of the strong points of Corbin’s book is her examination of how the West failed to fully detect the growing threat from al-Qaeda. As she notes, the West’s political correctness and very openness was adeptly used against it, even after the bombings in East Africa in 1998. Corbin states of the Western response:

“It is a tale of weakness and exploitation and a failure of imagination. Al-Qaeda, fundamentally a product of the Arab world, could only flourish in a free and forgiving climate, unlike that of many Middle Eastern countries, where harsh regimes stick to the only form of rule recognized and respected by militant Islamic organizations. Bin Laden’s group turned instead to the softer underbelly of the West; to democracies with respect for human rights, more open immigration policies and laws that restricted intelligence and law enforcement agencies. Bureaucratic turf wars, complacency, military timidity and political weakness, not to mention political correctness, contributed to our inability to deal with these extremists, until it was too late to save the lives of thousands.”

Corbin also offers insights into Allied military operations against al-Qaeda and Taliban forces, following the end of the Afghan war. Operation Tora Bora, which ended the first round of fighting, probably let Osama bin Laden out of the country and into Pakistan, in part due to relying on inept local forces. Operation Anaconda, which followed, was also not the raging success the U.S. military portrayed it. Rather, Corbin suggests Afghanistan will not be a story of quick military victories, but will have to be a long-term commitment, considering the country’s complex political realities and the porous nature of the borders with Pakistan, itself divided with cleavages between more secular and fundamentalist Muslims as well as a myriad of tribal and regional loyalties.

Corbin offers a sobering, journalistic account of a major problem facing the West –something destined to be around for a long time. She believes that Western governments must continue to reassess terrorist laws and what political correctness means – both from a societal stance and from a security viewpoint. Corbin concludes with this warning: “It is not a question of whether we will see another terrorist outrage but when and where – and how many innocent lives it will claim.”

Con Coughlin, Saddam – King of Terror (New York: Harper Collins, 2002). 350 pages. $26.95


Click here to purchase "Saddam – King of Terror directly from Amazon.com

By Scott B. MacDonald

It has become popular to write about Saddam Hussein. Indeed, a small sea of ink is now dedicated to explaining how a man who became one of the most powerful Arab leaders in modern times emerged from a hard and deprived childhood. Yet, Saddam is now well-known through the world for presiding over a near-totalitarian regime and for bringing the world down the path of another Middle Eastern war. One of the books that stands out from the pack is Con Coughlin’s Saddam – King of Terror, which in some ways harkens back to Samir al-Khalil’s Republic of Fear (1989) in terms of chronicling the brutish, but methodical nature of Saddam’s Ba’athist regime.

Coughlin sets the tone of his book in the very beginning by stating: “Writing a biography of Saddam Hussein is like trying to assemble the prosecution case against a notorious criminal gangster. Most of the key witnesses have either been murdered, or are too afraid to talk.” To Coughlin, Saddam is a creation of his roots, much like Hitler and Stalin, who also overcome their less auspicious starts in life to take absolute control of their respective nations. As he notes, “The shame of his humble origins was to become the driving force of his ambition, while the deep sense of insecurity that he developed as a consequence of his peripatetic childhood left him pathologically incapable in later life of trusting anyone -- including his immediate family.”

Saddam began his political career as a political thug, gradually climbing up the ranks of the Baathist party, especially following the 1968 coup that brought them to power. The climb to power was one marked by ruthlessness and tenacity. Much like Stalin, Saddam focused on the machinery of the state, quietly assuming power. By July 1979, Saddam officially became the president of Iraq, then one of the more developed and wealthiest Arab nations. He followed this by purges of the Baath party, the military and the bureaucracy. In the place of many of the fallen, Saddam placed his family and trusted cohorts.

What makes Saddam such an interesting historical figure is that he was not content with ruling just Iraq. Bigger dreams beckoned. In many regards, he saw himself as a modern-day Saladin, being the man to re-unify the Arab world and re-take Jerusalem. In this, he sought to carve up his bigger neighbor Iran, which had incited Iraq’s local Shitte population. The ensuing war was to last from 1980 to 1988, result in wrecking the Iraqi economy and leaving thousands dead or wounded from the brutal, yet inconclusive conflict. Only a couple of years later, Saddam launched the invasion of Kuwait. That was to end up with the near-destruction of the Saddam regime.

What Coughlin finds the most interesting is Saddam Hussein’s ability to survive. Despite major setbacks, numerous coups and assassination attempts, and the hostility of the United States, the “bully of Baghdad” has managed to cling to power. He attributes this to Saddam’s ability to maintain control over the security apparatus, rely on only a very small group of people, and the regime’s manipulation of the country’s oil wealth. The last always allowed Saddam to buy the necessary weapons from the outside world and to have some degree of largesse for keeping the key troops happy.

Coughlin’s book is certainly timely and informative. It paints a picture of a man who is clearly an over-achiever in the most bizarre sense – a dictator willing and ready to eliminate, though continuous purges anyone that remotely resembled a threat. At the same time, Coughlin is certain that Saddam has been active in seeking to re-arm Iraq, including with weapons of mass destruction. As he noted: ‘even the medical supplies shipped in by the U.N. were exploited by the regime, and ended up being sold on the black market in Jordan, the profits being channeled back to the Presidential Palace in Baghdad. The lion’s share of the substantial income Saddam received from these various illicit activities was spent on arms.” Most of the arms came from China, North Korea, Russia and Serbia.

Whether or not one agrees with the Bush administration’s decision to pursue war with Iraq, anyone reading Coughlin’s book comes off not wishing Saddam Hussein well. At the same time, it also makes one wonder about difficult nature of the rocky soil that Iraq will offer for any attempt to create a democratic government in a post-Saddam society

Robert Beaumont, The Railway King: A Biography of George Hudson, Railway Pioneer and Fraudster, (London: Review, 2002). 274 pages UK Pounds 14.99

Reviewed by Scott B. MacDonald


Click here to purchase The Railway King: A Biography of George Hudson, Railway Pioneer and Fraudster directly from Amazon.com

In a world currently marked by corporate scandals and the controversial figures behind them, it is often instructive to remember that we have been on this stage before. History is filled with scoundrels, rouges, and hucksters. Despite being labeled as such, not all scandal-linked individuals are necessarily “evil” and, indeed, in a warped way, some good has come out of their efforts. One such individual that has been much vilified, but arguably did some good was George Hudson, known in the 19th century as the “railway king”. In his well-researched and easily readable The Railway King, Robert Beaumont, a journalist for the York-based Yorkshire Evening Press, undertakes the challenge of a man who “led a turbulent and mould-breaking existence”. According to Beaumont, Hudson was many things, probably the most significant of which was his role in Great Britain’s industrial revolution, in particular, with the development of railways.

Hudson began life in 1800 in relatively poor surroundings in Yorkshire. He was apparently kicked out of his home for fathering an illegitimate child. From those humble beginnings, Hudson was to work his way up at a drapers firm. However, in 1827, fortune smiled on him as a distant relative died and left him a small fortune. He took part of that inheritance and bought shares of the North Midland Railway. Over time, he came to control over a third of Britain’s rail network, which mostly hubbed out of York. Indeed, Hudson made York a commercial hub as he quickly grasped, ahead of many others, that rail travel was the wave of the future. In this, he was similar to those that understood that the Internet was a revolutionary breakthrough. He was also an excellent salesman, which helped him sway many to put their money into his company’s shares. At his high point, Hudson employed tens of thousands of workers, was a leading member of the Conservative Party, and laid hundreds of miles of virgin track.

Yet, for all the positives of Hudson’s life, there was a downside. As did the Internet in its time, rail in its time was a major force in financial markets, capable of creating and destroying great fortunes through speculation. In this Hudson was a primary force. He was a man of vision and an excellent salesman. He was also a polarizer – people tended to either really like and trust him or hate him. Part of the reason for this Beaumont notes, was that his subject was “a mass of contradictions: immensely hard-working, yet dangerous self-indulgent; tremendously generous, yet a purveyor of the sharpest financial practices; poorly educated and roughly spoken, but a quick-witted visionary; and unbearably arrogant, yet strongly humble at the end.”

What did Hudson in was his financial practices – sloppy at best, intentional at worst, he offered investors big dividends, but eventually questionable profits. In a sense, the finances behind Hudson’s many railway companies were like so many ponzi-schemes, with new money in, new money to old investors, while the newest contributors waited for their profits. At the same time, Beaumont notes: “The problem was that he had difficulty in differentiating between his own interests and those of his companies, but that is a failing common to autocratic businessmen.” (Look at the former heads of Tyco International, WorldCom and Adelphia). He further elaborates: “It is essential that George Hudson was simply behaving in exactly the same manner as the other managers and directors of Britain’s railway companies across the country. They were making up the rules as they went along, as occasionally happens in fast-growing new industries.”

Hudson was eventually voted out of the House of Commons, saddled with large debts from failed companies, hounded by creditors and angry company boards, and viciously attacked by his detractors. At one stage, he fled to France, where he lived well below his former splendor. Hudson finally was able to return from exile and be re-united with his wife, who he had left behind. He was to die in 1871, though his name was to remain considerably tarnished until recently.

Considering the current round of fascination with business scandals and the key personalities involved, Beaumont’s book about George Hudson reminds us that these figures are far more complex than being transfixed between simple faces of good and evil. At the end of the day, they must be seen as simply individuals, forced to make decisions about how to conduct their business – for the better or the worse. However, for this reviewer, Hudson remains a far more sympathetic figure than the top management at Enron, WorldCom or Qwest. Rules and regulations concerning corporate governance were rudimentary during Hudson’s day; today the rules and regulations are far more clear-cut. While Hudson is perhaps entitled to a fair shake in the historical sense, it is likely that Bernie Ebbers, Kenneth Lay and Ralph Nuccio will have to wait much longer. We strongly recommend Beaumont’s The Railway King.


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