This week, we talk a little about privatization and the role of governance before transitioning over to the Colombian economy.
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Last Week Briefing:
Argentinian bonds rose last week as their government beat the buzzer and successfully restructured $65B in sovereign debt.
The Turkish Lira continued to capitulate last week, falling to an all time low versus the dollar.
The People’s Republic of China announced a series of new tax incentives to attract capital towards the nation’s semiconductor industry. This new initiative continues the theme of China’s push towards self-sufficiency.
“East Asian Miracle”
For those of you who are new here, I’ve spent a great deal of time talking about the role of government, the process of privatization and how it benefits (or harms) budding economies. I do my best to keep politics down the middle on this newsletter — however, in today’s day-and-age, nothing is immune from political discourse.
Privatization is indubitably good for an economy. Private businesses have historically generated better returns for shareholders and have achieved elevated levels of efficiency unseen by government enterprises. Privatization, however, is not a silver bullet. Unfettered free markets have led to some pretty undesirable outcomes, as exhibited with John Rockefeller’s monolithic Standard Oil in the late 19th century. Standard Oil at the time was like Galactus from the Marvel Comics: swallowing up competitors or exterminating them through predatory pricing. At their peak, Standard Oil occupied over 90% of the U.S. oil patch. This, as you could probably guess, created diminishing marginal returns for the rest of the oil industry. As Standard Oil grew in scale, the American economy suffered over the long run. This isn’t to say that Rockefeller’s pursuit of dominating the oil industry is nefarious. Entrepreneurs are naturally consumed by the animal spirits of running a business. Rather, these emotions should be corralled and utilized as a tool by governments to achieve shared economic goals. Hence, the recipe for economic longevity is not to create competition between the state and entrepreneur. Rather, it is the harmonious overlap between the goals of a state and an entrepreneur that perpetuate economic prosperity.
I recently finished a book called How Asia Works: Success and Failure in the World’s Most Dynamic Region by Joe Studwell. Studwell talks about the emergence of several East Asian nations including Korea, Taiwan, Japan, among others, and how their governments succeeded in designing policy that would help them pivot from rural farming economies to major industrial hubs. Studwell blueprints the formula in which countries can achieve developed status through calculated government action, including privatization. While none of the countries mentioned in his book follow the same exact mold, there are three levers that a central government can pull to kickstart steady, sustainable economic growth:
1) Maximize agricultural output.
2) Prioritize manufacturing with respect to the country’s industrial output.
3) Foster those two industries (agribusiness and manufacturing) through a heavily-regulated financial sector.
I can unpack the merits of these pillars in a future newsletter but as you can see, a government can be inducive or obstructive when designing an economy. In the same vein, a government can guide the future of their economy by creating incentives that align with the goals of entrepreneurs.
Studwell emphatically stresses that this theory does not claim a political philosophy. For starters, he shows us the failures of state-planned economic policy, highlighting autocratic policy failures such as Mao Zedong’s Great Leap Forward and Sukarno’s “Guided Democracy.” In Mao’s case specifically, his regime attempted to maximize Chinese agriculture output through forced labor. Not only did he fail to achieve the crop yields he desired, but tens of millions of people died from famine and starvation.
Studwell then contrasts those failures with the blunders of Suharto’s and the Berkeley Mafia’s free market experiment. Suharto adequately masked his oppressive military regime with massive spending from oil revenues, debt reduction, and laissez-faire economic policies. Rather than using this newly created oil wealth to diversify their exports, he used it to pacify the middle class and enrich his cronies. When oil prices collapsed in the 1990’s, Suharto had nowhere to hide. Indonesia’s enormous deficit would ultimately bite the country in the back during the 1997 Asian Financial Crisis.
History also shows us that to some extent, protectionism is needed to protect nascent businesses in emerging economies. A multinational corporation can easily and effectively supplant national businesses through predatory pricing and an edge in economies of scale, thus reducing an emerging market’s GNP. Protectionism, however, is not a successful long-term strategy for a country’s growth. Protectionist countries are burdened by food shortages, stagflation, and high unemployment. Again, if you look at examples like Iraq now or Mao’s China, protectionism is a cure that is worse than the disease.
As you now know, there is plenty of nuance in cultivating accommodative economic policy.
Why are you telling us this?
If this is the prophesied “Cold War 2” then we are entering a new protectionist/ privatized paradigm with respect to the role of private enterprise in diplomatic relations. Over the past few weeks, we’ve heard a ton of hype surrounding TikTok and the U.S. government’s pending ban of the popular video app. The ban also encapsulated WeChat, a popular Chinese app used primarily for messaging and digital payments. This string of bans isn’t anything new. Popular American websites such as Google*, Amazon, and Facebook aren’t allowed in China from the Great Firewall of China. Now, we’re seeing the U.S. government respond with bans of their own.
Similar to how the Space Race was born out of the Cold War, I’d anticipate the U.S. government will seek to incubate technology companies for diplomatic alliances. In response, the People’s Republic of China will likely continue to export their technologies to budding economies in Africa and Southeast Asia. Chinese and American companies will viciously try to outbid one another for technological dominance. A “Tech War”, if you will.
Looking forward, the American government will use their tech sector to strengthen diplomatic ties with strategic allies. We’re already seeing this with the marriage between Google and Reliance Technologies in India and Taiwan Semiconductor’s (TSMC) decision to open a plant in Arizona. Ultimately, I’d anticipate a stronger appetite for American corporations to venture overseas, specifically in African and East Asian markets with the goal of outcompeting Chinese firms. I would also anticipate a subsidized decoupling from China, like we’ve already seen in Japan and Korea.
As we discussed last week, a country’s success swings from the foundation of its institutions, particularly government. That means without a strong (or trustworthy) central authority, a country will not achieve sustainable economic growth. In China’s case, the government has marshaled their technology sector to catapult them into the upper echelon of developing economies. In our case, we must align the diplomatic goals of the United States with those of our largest tech companies. Given the global scale of these businesses, this will be a lot messier than expected.
Not Standard: Standard Oil was broken up by the U.S. Supreme Court in 1911. What companies were born out of its ‘trust-busting’? What are they known as today?
Answer at the bottom.
* Google, as we know it in the States is banned in China. However, Google’s subsidiary, Google China, is allowed.
For those who’ve seen Narcos on Netflix, you may not need a primer on why Colombia, despite being the third largest economy in South America, is shunned by international investors. While the 21st century has shown a change in pace for the South American nation, Colombia’s guerrilla dilemma has characterized the country for decades, extending far beyond the death of the infamous drug kingpin, Pablo Escobar. For my baseball fans out there, Escobar is the Tony Gwynn of drug money statistics. So before I continue, I want to highlight some absolutely surreal facts about Pablo Escobar:
Pablo Escobar spent an estimated $2,500 a month just on rubber bands for his cash.
Escobar would lose approximately 10% of his earnings due to rats literally eating his cash.
Escobar, at one point, offered to pay off Colombia’s sovereign debt ($10B at the time) so that they would protect him from being extradited to the States.
Escobar’s cultural impact cannot be ignored when discussing the Colombian economy. He was once referred to as “Robin Hood” given his philanthropic efforts and impact on the Colombian economy. In fact, Escobar was so beloved amongst the Colombian people he even ran for public office at one point. However, his impact on Colombia as a whole, was widely detrimental. Escobar’s extrajudicial wealth challenged the legitimacy of Colombia’s institutions, specifically its central government and legal system. It is this exact relationship that has capped Colombia’s true potential as an emerging market and economic powerhouse.
Hacienda Napoles — Escobar’s former estate. Today, it is a theme park.
Over/Under: What was Pablo Escobar’s estimated net worth at his peak? O/U: $40B
Answer at the bottom.
To understand Colombia’s drug prowess, we will have to rewind back to the early 1970’s when U.S. and Mexican authorities waged crop-eradication initiatives to smoke out (no pun intended) Mexican farmland. As U.S. and Mexican legislators antagonized Mexican drug smugglers, production was quietly shifted from Sinaloa, Mexico to Medellin, Colombia. Meanwhile, Colombia’s government was juggling multiple revolutionary groups such as M-19 (Movimiento 19 de Abril // 19th of April Movement) who were maintaining insurgencies in Colombian cities. At its peak, Colombia produced over 80% of the world’s narcotics. To this day, Colombia is still the largest producer of cocaine in the world.
Coca Production & Eradication — Production hit an all time high in 2017
Put yourself in the shoes of a Chief Executive of a multinational corporation. What could possibly incentivize you to invest into the Colombian economy? Surely, no amount of grease payments would justify the political and social risks incurred in doing business in Colombia. Colombia struggled following the 1970’s because unlike developed nations, their cardinal institutions had failed to earn the trust of their citizens. Legislators were frequently bribed, sometimes killed if they threatened to inhibit the operations of the cartel. Similarly, economic policy reforms were stale in comparison to the exuberant projects undertaken by Escobar and his associates. You see, while the rest of the country suffered from a weak manufacturing sector, those in the cocaine trade were channeling their wealth throughout Colombia, constructing buildings, refineries and storage facilities, enriching other Colombians. However, as we touched upon earlier with Standard Oil, this kind of monopolistic entity has diminishing effect on the Colombian economy. Over the long run, Colombia struggled to knock down unemployment, hyperinflation, and adequately monetize their oil reserves. Although, recently, there have been reasons to get excited about Colombia’s economic prospects.
The 2010’s sing a much more upbeat tone for our friends in Colombia. The Cali and Medellin cartels would dissolve in the late 1990’s, ushering in an era of law and order. In 2002, Álvaro Uribe Vélez was elected president on the basis of returning security to Colombia. Fast forward to 2016, Colombia’s central government made headways in suppressing violence and mending peace agreements with the revolutionary insurgent group, FARC. In that same year, homicide rates hit a 40-year low. In 2017, Bogota, Colombia — the nation’s capital — had lower crime rates than Miami, Florida. The country’s success in tackling this issue has invigorated the Colombian tourism industry. Tourism spending eclipsed $6 billion in 2018 as over three million tourists visited the South American nation. Overall, aggregate foreign direct investment has eclipsed $1.7 trillion since 1994.
Foreign Direct Investment in Colombia — Since 1994
Economically speaking, Colombia has maintained an ‘Investment Grade’ rating on its sovereign debt since 2013. Inflation has dropped significantly from the double-digit readings of the 1990’s to a pedestrian 3.7% annual average, trailing three years. Colombia is also home to the fastest growing technology sector in South America. TV Azteca, a South American telecom company, recently built the longest fibre-optic cable in all of Latin America, right in Colombia. Also, SoftBank committed US$1 billion to Rappi, a Colombian delivery app. The strength of Colombia’s rebound can be traced back towards the public-private partnerships brokered between the Colombian government and it’s industrial sector. In addition, new government programs have enabled English-speaking Colombians to find competitive jobs in business process outsourcing for multinational companies.
Colombian Coffee Bean Farmer
Colombia’s economy is characterized by their strength in exports. Bananas, coffee beans, and cocoa are just a few of the goods that dominate Colombian trade. Looking forward, Colombia would be prudent to diversify their economy away from their dependence on commodity exports. That said, the proliferation of legalized marijuana could prove to be a cash cow for the country. I’m interested in this phenomenon because 1) the marijuana industry is extremely adolescent and market share is concentrated in a handful of companies and 2) marijuana has resilient demand, as exhibited with soaring sales during the coronavirus pandemic.
Colombia, with an edge in geography, can maintain an edge in global cannabis production. In other words, what Saudi Arabia is to oil, Colombia can be to cannabis. For starters, the infrastructure is already there. There are skilled individuals who are familiar with the marijuana harvest and will likely capitalize on those skills when recreational use is legalized. Also, Colombian weed producers can harvest the flower for $0.50/gram compared to the Canadian $2.00/gram. Colombia legalized public use of marijuana in 2019, although they will be betting on a wave of legalizations as they hope to become the de facto producer of marijuana around the world.
Estimated Cost per Gram — Barrons
Colombia in the age of COVID-19 find themselves struggling to shore up their tax base. Petroleum goods dominate Colombian trade, comprising over 45% of Colombian exports. Like the other petro-states I’ve mentioned in this newsletter, Colombia has been strained in trying to diversify its exports as the price of oil has waned over recent years, damaging the value of the Colombian peso. This problem has not be any easier to solve as oil prices have plummeted in 2020 from the economic effects of the coronavirus. Colombia was forced to extend its shutdown until August 30th as they’ve recently rocketed past 400,000 total coronavirus cases, the third most in South America. The Bank of the Republic, Colombia’s central bank, is confident in their ability to rebound from the shutdown, forecasting a 4% bump in GDP for 2021.
I guess on a comparative basis, that shouldn’t be too hard.
In case you were curious about the title of this section… Click here!
Not Standard: Standard Oil was broken up into seven different components following the Sherman Antitrust Act. See the graphic below:
Over/Under: UNDER. Pablo Escobar’s estimated net worth was $30B. However, some reports have it as high as $50B.
Thankfully, the house always wins.
The Global Capitalist
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**None of this should be perceived as investment advice. Speak with your advisor before investing in emerging markets.**