Kofi
Adjepong- Boateng is an investment banker and Senior
Associate Member
of St. Antony’s College, Oxford. Prior to co-founding First Africa in 1996,
he worked in the corporate
finance, trade finance and government advisory fields in Africa with
SG Warburg & Co., HSBC
Equator and
Price Waterhouse. In the late
1980s and early
1990s,
he was involved in a number of sovereign debt
buy-backs, corporate
restructurings
and commodity financings which occurred in Africa; and since
the late
1990s, he has advised on several of Africa’s largest
corporate transactions.
During 2003 and 2004, he served on the Africa Policy Advisory Panel, an advisory group mandated by the U.S. Congress, which reported
to Colin Powell,
the U.S. Secretary of State. He currently serves as a member of the Policy Committee
of The Centre
for the Study of African Economies (CSAE) and sits on CSAE’s Finance
Committee. He is also a member of the
Steering Committee of a research project at the Lauterpacht Centre for International
Law at the University of Cambridge which
is looking into the legal issues associated with accusations
of corporate complicity in human rights
abuse in resource rich countries. Since 2006, he has served on the International Advisory Board of ACE Ltd, the world’s largest
insurer of political
risk.
He is a Fellow of the Royal Society of Arts and Manufacturers in the UK and a Member of the UK’s Royal Economic Society.
Introductory remarks
I am
grateful to Paul, Stefan and
the Centre for inviting
me here this morning to give this opening address.
I suppose I ought to tell
you a bit about myself. I grew up in Ghana,
studied at this University many
years ago, and have spent my
entire career in investment
banking. I spent the early part of my career working
in London on corporate and sovereign restructurings
(including debt restructurings
and early privatisations). In
1993, I set up an investment
bank in Kenya called Loita Capital Partners
which I left
in 1995. In 1996, about 13 years
ago, a colleague and I established a joint venture investment bank
with S.G Warburg
& Co. which was
at the time the UK’s
largest
and
most
successful
investment
bank. That firm, First Africa, was recently acquired
by the Standard Chartered Bank group.
Standard
Chartered
has built one of the largest banking
operations in Africa over the last
150 years.
I should
state upfront that I don’t know very
much about what most
of you know a lot about. I am not a professional economist; nor am I
a civil servant active in policy formation. However, I
do know something about “money” and about why, from time to time, it moves from one place to another.. This is
probably
why I
have been asked by Stefan
to speak on “Africa and the banking crisis”. It
seems
to me there that are two
ways
to approach this subject.
One way is to discuss the likely effects on the continent’s growth of
the reduction in imports by Africa’s trading
partners
or the effects on Africa’s trade
finance of
either a contraction in, or rise
of the costs of, global trade finance
as
international banks come
under pressure to focus on their
home
markets1. I
could, for example, talk about the
effects
of a fall
in commodity prices on Africa’s growth. In his recent article
in this month’s edition of the UK’s Prospect magazine,
Paul Collier estimates
that over 200,000 jobs have been lost in the DRC as a result of
the collapse in cobalt prices
and that South Africa is
expecting to lose around
50,000 jobs in its mining
sector2.
Slow global
growth will
have implications for African
growth and there is quite a bit that one could say about this aspect of the global crisis. But, judging by the quality of this audience, you have probably forgotten more than I
will ever know about the inter-relationship between
global economic growth and
Africa’s
trade fortunes.
For
this reason, I
will not spend any time this morning
talking to you about this as I feel
I can add little to your understanding
of this
area of
international economics and trade.
Instead,
I have prepared a short
slide
presentation which is
available as a take away
and will be sent by Rose Page,
Paul’s assistant,
to each of you by email. It contains a number of
the statistics which
highlight the current global predicament. What these
statistics show
in summary is that we are
in a very deep global recession
comparable by economic historians to the 1930s Depression in certain
of its
characteristics and from which no
country in Africa is immune. No
matter how long I take to say
this that will be my conclusion
so it makes sense to state this conclusion
up front and move on.
The
second approach to tackling this topic
is to ask the question:
“What should we (and by that I mean “you and I”) focus on to prepare African
policy makers for a post-recession world knowing
the likely effects that this global slowdown
will have on African economies?” I’d
like to find a way in these opening remarks
to combine my experience as
an investment banker with yours
as central bankers and research
economists and to see whether there
are areas of mutual
interest
to which we should give attention in the next few months
and years in order to ensure
that some good comes
out of
the banking crisis for
the benefit of the poor, the middle class
and (dare I say it)
the rich who inhabit our continent.
One of the advantages about giving a talk to an academic
audience is the comfort
of knowing
that all the parties present
are here, not
only to share what
they know, but also to find
out what they don’t know.
“Not knowing” at conferences
like this is almost as
important as “knowing”. I want
to spend some
time this morning talking about what we do know,
but also, would like to invite you, the audience, at the
end of this session
to help, through questions, shape
a research agenda to address what we
“don’t know”
but should. In this context, the comment that what I have to
say “raises more
questions than
answers”
will be seen, by me at least, as
a compliment!
I suppose I ought to
say upfront
that I will be drawing on certain
aspects of the history of
economics to draw some of
my conclusions. This is an important point as, given the current
state of the world economy,
we are hearing
a lot about “history” in general
and the 1930s Depression
in particular. I recognise the importance
in the social sciences of
the separation nowadays between
“economic history” and “economic theory”.Unlike some, I
have always felt that this separation is
unfortunate
and one of the benefits, if
one can describe it as such, of
the current crisis is the fact
that a lot of the commentary
on the current state of affairs
is drawing somewhat liberally on economic history as
well
as the history of economic thought3.
3 Partha Dasgupta
draws attention to this unfortunate
separation between economic theory and econom ic history
in the
introduction to a paper presented in
1998. He writes: “You can emerge from your graduate studies in economics without
having
read any of the classics, or indeed, without having
anything other than a
vague notion of what the great thinkers of the
past had written. The modern
economist doesn’t even try to legitimize
his inquiry by linking it
to questions addressed
in the canon; he typically begins his article by referring to something in the literature a few months old.
He reads Ricardo no more than the contemporary physicist
reads James Clerk Maxwell.
What today’s economic student gets of the
classics are those bits that have survived the textbook treatment,
dressed in modern garb. The history
of economic ideas hasn’t
died; it has simply metamorphosed into a specialized
field.
3
I have been an investment
banker for over twenty years. In that period,
my career has been influenced
by:
- the “Third World
debt” crisis which had its origins in the Mexican
default in 1982. My career started in 1988
about 6 years after the onset
of the Mexican crisis. Not surprisingly, all of my assignments in the early
days were related in some way to the restructuring African sovereign debt;
- the stock market crash
of 1987;
- the US savings and loan
debacle; - the Asian crisis;
- the Russian crisis and the implosion of
LTCM; - the tech bubble of 2000; and now
- the current global financial
crisis.
That’s seven
events of global financial significance all of
which occurred in the last twenty-five or
so years. Each event
taught us important lessons
and gave rise to
academic research and a body of literature that is still
contributing to our understanding
today of how financial
markets work.
First Africa,
the firm I co-founded,
has been
fortunate
to have had a ring-side seat
during this in which the African
capital markets have grown
and evolved rapidly. We have had extraordinary people work with
the firm during this time,
all of whom were
involved in ground-breaking transactions.
Some of
the precedents in which the firm has
been involved include:
- The sale by Anglo American
Corporation in 1995 of JCI Limited to a Black Economic Empowerment consortium in South Africa. At the time, JCI was the world’s
sixth largest gold company and the
transaction was the
most
important of
the BEE mining transactions completed
in South Africa in that year;
- The sale by the Anglo American
Group in
1996 of its interest in First Merchant Bank of Zimbabwe. This
was
one of the first “empowerment” transactions in Zimbabwe and led to the creation of what has
become
one of Southern Africa’s
important regional banking
groups,
the African Banking Corporation;
- In 1999, we acted as
an adviser on the takeover of the Cotton Company of Zimbabwe by a private
equity consortium. This transaction involved the takeover
of what was
at the time Zimbabwe’s largest agricultural company;
It
is taught, but it is not compulsory for students, at least not in
the major economics departments. And just as most working economists today know little of the ideas that have
shaped their subject, your
average historian of economic
thought understands little
of what is currently going on in economics and
why. The separation is as complete as can be” Partha Dasgupta, Modern Economics and
its Critics I, St.
John’s College (February 1998) University of Cambridge, England.
4
- In 2003, we acted on
the sale of the Social Security
Bank in Ghana to France’s Societe
Generale. This transaction involved us in what
became the first takeover of
a listed bank anywhere in sub-Saharan
Africa;
- In
2004, the firm acted as an adviser to Anglogold
on its merger with
Ashanti Goldfields Company. This merger created Africa’s largest gold company. The
transaction was accompanied by the dual listing of the merged entity
in South Africa and Ghana and remains
to date, the largest
takeover of
a listed
West
African
company;
- In 2005, we acted on
the reverse takeover
of African
Gold by Mwana Resources
and the listing of Mwana
on AIM in London. Reversing predominantly Zimbabwean assets
in a London listed vehicle is difficult
at the best of times. To do so
at the height of the Zimbabwean crisis was ground breaking
in its own right;
- In 2006, we advised the MTN Group on its
acquisition of Investcom
LLC. This was one of the most
important cross-border
takovers by a South African
company and at the time,
was
the second
largest transaction
of its
kind in South Africa. It was also
the first
takeover of a company listed on the Dubai
Stock Exchange and is still the only successful transaction
of this
size completed by either of
the leading South Africa
telecoms companies;
- We acted on the conversion
of Equity
Building Society in East Africa
from
a mutual society
into a bank and the listing of Equity
Bank on the Nairobi Stock Exchange. This
transaction
was
the
first
of its
kind in East Africa and has since become
the precedent for those considering
transactions of
this
kind; and
- More recently,
we acted in 2008 and early this
year on the Rights Issue
and Placing undertaken by ETI, the West African
regional banking group. This
transaction
raised
a significant sum for the bank and was executed during the still
ongoing global financial crisis.
ETI raised what
amounted the largest
pool of capital raised by any
firm on the Ghana
Stock Exchange, which is one of the West African
exchanges on which the bank is listed.
The
above list illustrates
the breadth of work carried out by firms such
as mine
in Africa. There are many
other transactions
which could be added to this list
but I believe the short
list above illustrates the extent
to which financial services companies such
as ours play an important role
in facilitating the corporate activity in Africa. The question worth
considering is the extent to which this
level of corporate
activity took place primarily
because of financial innovations in Africa
and elsewhere. Innovations such
as the introduction of stock
markets, the role
played by private equity and hedge funds in investing in African companies and the emergence of
cross-border financial players who have been able to help ensure that standardised and good quality financial information becomes available outside of
national borders are all important
5
financial innovations whose role
in spawning cross-border corporate activity should not be underestimated.
Over
time,
today’s crisis will give rise to robust debate
amongst professional economists such
as
you about the policy prescriptions
for
a post-recession world and I
would like to use these opening
remarks
to ask that you start thinking about
areas for further research
which
will make more
robust about our
approach to policy. That’s
my objective this morning.
So, “What are Bankers for…(in theory!)
Many economists,
and I hope the majority of
you here, view freely operating markets in which
free exchange occurs as the best mechanism for
allocating scarce resources. From the point of view of allocating
capital, the most important markets in this
respect
are the commercial
banking market, stock exchange (or stock market)
and other capital markets,
such as
the bond
market
or the markets in other
financial securities.
I share the view
that the capital markets
are crucial
for
the allocation of resources in a modern
economy. Household
savings
are channelled through the capital markets
to the corporate sector and investment funds are
allocated, again through
the markets, among companies. Markets allow
both companies and households
to share
risks, or
so we
believe. I am conscious that there
have been recent lessons learnt
about risk sharing as
a result
of the predicament in
which giant global financial services companies
such
as AIG find
themselves. But for
now, I
will
restate
my belief that well
functioning capital markets
enable both firms and households to share risks.
However, having
said this, it seems to me
on reading the literature that
there
are at least four important limitations
to the efficiency with
which capital markets
operate, particularly in Africa and other emerging
markets:
1. Firstly,
in most countries, such
as those
in Africa, stock markets are
not that large or important. The financial markets
in Africa and other emerging markets are
primarily
markets for
government
debt. Often, the external
capital that industry
requires for investment is
obtained in the form of loans
directly from commercial
banks;
2. Secondly, in all countries, including the US and UK,
internally generated funds tend to be more important than is frequently acknowledged.
In most African
countries these
internally
generated funds are
far
more
important than the external finance raised through the
capital markets and commercial banks.
This has certain implications which I
will come back to;
3. Thirdly,
the ideal of a frictionless capital market is rarely, if
ever, achieved in practice. Financial intermediaries,
such as
stock brokers, investment
and merchant banks like ours,
are needed to overcome the
barriers
to information and to market
participation. Reducing these informational
barriers is important if
firms
and investors are to exploit
markets
effectively;
and
6
4. Finally, we
should not underestimate how important
it is to well functioning capital markets
that there is also an effective
market
in corporate control (in
other words, a market in takeovers or
mergers).
Most of my career has been spent
in the market for
corporate control. This
is an important aspect
of the role played by the
capital markets which
must
not be forgotten. Corporate
takeovers are not as common in Africa
as they
are elsewhere
in the world, but they are becoming more common. The possibility of takeovers
is assumed to be a device for disciplining managers.
An acquirer can buy up the shares of
a badly managed target,
replace the incumbent management, better utilise the
company’s assets
and make a capital gain.
The capital markets are meant
to play an important oversight
role,
but we should not ignore the equal importance
of the role played in asset allocation
by the threat and presence of
corporate
takovers.
Despite the limitations
listed above, there is almost universal
popularity of capital markets
across
the world4. To date, several African countries have introduced
legislation to encourage the emergence of
stock exchanges and a number
of African
countries have recently
tapped the international
bond markets. One
of First
Africa’s board
directors, Walter Kansteiner,
put in place a program when
he was
President
Bush’s
Assistant
Secretary
of State
for Africa
to encourage the rating of
African sovereign bonds. Between March 2004 and February 2009, eight African countries, all of
which benefited under the
Kansteiner program and secured ratings, raised over
US$16 billion in the international
bond markets.
There
are two important
reasons why
there is
almost universal popularity of capital markets
across
the world. One reason is
what I
call the “push” factor and the other,
the “pull” factor:
1. Firstly,
government
intervention has become discredited.
The appeal of government intervention
in the 1950s and 1960s had its origins in the market failures associated
with the 1929 Wall Street crash and the Great
Depression of the 1930s.
This is
an important point as it serves
as a reminder
that this is not the
first
time that a global financial crisis has
led to calls for greater government
intervention and regulation.
Prior
to the onset of the current global financial
crisis, it
appeared to many people that government failures are at least as important, if not more
important, a problem as market failures. This is what
I would
call the “push” factor underpinning the popularity of the free market in general,
and of capital markets in particular.
The current crisis may have damped the public’s enthusiasm for free
markets. Bank nationalisation in the West
has been taken in its stride;
2. The second reason for the universal popularity of
capital markets is that policy makers have been persuaded by economic theorists
to promote
free markets.
Economic theory, particularly that
pertaining to financial markets, has
stressed the effectiveness of
markets
in allocating resources. This is
what I
would
call
the “pull factor”. The general acceptance by policy makers of
free markets
as “efficient” markets
was predominately
a backlash against the views
of Keynes which
had initially dominated the post-war
era.
The intellectual attractiveness
of efficient markets
had a lot to do with the works of Milton
Friedman, Robert
Lucas and
Eugene Fama. Works with
which
I’m
sure you are all
familiar.5
As economists, you are
looking to understand the role
that financial markets
play in different national economies.
As economists, you
bring to your task an intellectual training that
places markets at the
very centre of the study
of economics. Some of
you might even go so far as to argue
that markets define
the very subject matter of
economics and that complete
and competitive markets
represent the ideal allocation system backed
up by the fundamental theorems of welfare economics.
Having said this, I
am sure that most of
you will recognise that there
are a number of areas of study and research
that have become an increasingly
important part
of economics in the past few decades.
The current global crisis reminds
us of
how important
these areas of study are:
1. Firstly,
there
are the incentive problems that arise between
agents and principals, employers and employees,
managers and shareholders, financial
institutions and their customers;
2. Secondly, there are difficulties
that arise in financial markets when
information is
asymmetrically distributed. The early
work of
Joe Stiglitz and Andrew Weiss helped formulate
our early
understanding of these
issues6;
3. Thirdly, there
are always transaction costs.
That’s how I have earned my living for several years. It
is these
transaction
costs
which prevent the existence
of more
than a small fraction
of the
number of possible
5 For a discussion on the emergence of Chicago
economics and the role
that this school played in the providing the theoretical underpinnings
to deregulation see Johan Van Overtveldt,
The Chicago School
– How the
University of Chicago Assembled
the Thinkers who Revolutionized Economics and Business (Agate, 2007)
and Craig F. Freedman, Chicago Fundamentalism – Ideology and Methodology
in Economics (World Scientific Publishing Co. (2008)).
The views of the Chicago School
differed radically from those
of Keynes which had dominated the post-War era.
Peter Clark’s review of
Robert Skidelsky’s biographies
of Keynes reminds us how different these two schools actually were” “Skidelsky
is against the “single-book” interpretation of Keynesianism, and thus demands due attention
for the Treatise [on Money]. Its message is that savings and investment,
being different activities carried on by
different people, could not
simply be presumed identical.
It took interest rate to
bring them into equilibrium. …What
Skidelsky …. chooses to emphasize is the
Treatise’s preoccupation
with the economics of disequilibrium, when the economy is in a position
of sub-optimal output and hence unemployment. If the …”Bank
rate” …is what restores equilibrium, it follows that
banking policy plays a crucial role
in stabilizing the system. “Order has to
be created”, is Skidelsky’s gloss; “it
is not natural”. Put like this…the Treatise carries us a long way into the world disclosed by the
General Theory,
in which
the absence of any self-righting
forces in the economy is affirmed” – Peter Clark, Keynes rediscovered, Times
Literary Supplement (November 20, 1992) pg 4. This is a point
on which Clark had elaborated upon in his earlier and more extensive work: The Keynesian Revolution in the Making 1924-1936 (Oxford
University Press (1988)) See for example
pages 22-24.
6 See, for example, J.
Stiglitz and A. Weiss, Credit Rationing
in Markets with
Imperfect Information,
(American
Economic Review, 71 (3) (June) 1981;
8
markets envisaged by
the Arrow-Debreu-Mackenzie
general equilibrium models7;
4. Finally,
there
are the
long-term relationships
between financial institutions
and our customers
which, from time to time,
stifle
competition and almost
certainly
counter any view that “perfect competition” exists.
The four areas of study
listed above are central to
our
understanding of finance today,
since much
of financial
practice
and theory deals with the attempt to overcome agency problems, incomplete
markets, transaction
costs, and lack of information.
Work done by two of CSAE’s
Directors, Stefan Dercon
on insurance markets
and Marcel
Fafchamps
on market institutions, both highlight
the shortcomings of markets and how
these
limitations influence
institutional
developments8.
Despite
the above limitations, the
classical theory makes a powerful case
for
the role
that markets play in national
economies whenever
the imperfections
caused by market power, asymmetric information, and
incentive problems are
not too overbearing. However, the fact
that we are living through a global crisis which
has largely
been caused by a wide range
of market failures (particularly as they relate
to the incentive problems
in the banking industry) is
a very
rude reminder
of the
limitations of markets.
So, why
is understanding these limitations
important
to understanding the likely impact
of the global recession on Africa’s growth?
To begin to understand the likely impact of the global crisis on Africa, one must start with
an understanding of the relationship between
the financial system of
a country and the real economy
and in particular the corporate
sector.
Companies
are the issuers of
all of the securities traded in the capital markets outside of
government
paper and the investment return
on these securities depend on the performance of the issuers that
make up the corporate sector.
The financial sector
plays an important role
in corporate governance because
it allocates control rights
(including rights over cash
flows)
and assists in the design of
the securities that
are issued.
Once securities are
issued, it is the financial intermediaries who provide information
on company performance that investors utilise to make
decisions on
whether
to buy or sell securities.
9
As mentioned earlier,
the market for corporate
control simply does not exist in most African
countries, and the evidence for the
monitoring
role of
banks over African corporates
is weak. In
addition, the reliance on internal finance
by African corporates means that managers are
largely autonomous of
outside sources of capital. African
firms,
particularly the large diversified companies such as Dangote
Industries
in Nigeria or the Anglo
American
Group in South Africa can act as financial institutions to compensate for the limitations
of
financial markets and financial
intermediaries. I have not as yet seen
any research from you or
your peers on the efficiency of capital allocation decisions
made
by our African conglomerates
either historically (as
companies such as Anglo
can no longer be called conglomerates
in the classical sense
of the word) or presently (and
here I’m
thinking of the likes of Dangote
in Nigeria, Press Holdings in Malawi or
the various East African groups). Perhaps,
this is
one of the research takeaways that will
come out of this conference9. I hope so.
Where capital
markets are
robust and deep,
it is
reasonable
to assume that companies pay all their earnings to their
shareholders and that the capital markets
and the banking sector provide
firms with
the capital required for investment. In
practice, however,
features such
as asymmetric
information
and agency costs restrict
the role of external finance.
This makes raising
external capital
a costly alternative to internally generated
funds.
In several markets,
including those in Africa, the development of
the capital markets
was
stunted by the frequency with which governments print
money. By printing money, governments avoided the need to issue
paper which
is an important component in the development of
any capital markets.
The inflationary effects of
excesses in money supply also discouraged the purchase of
long term securities. For this
reason,
companies operating in Africa have historically been forced to rely on
internal
finance as a more important
source of
funds
than debt or equity for
long term investment as the issue
of long dated securities
simply does not happen. The problem with
this state
of affairs is
that there does not seem to me to be a robust reason
for believing that the allocation of
funds
for
investment that results from
the use of
internally generated
capital is optimal. Firms that are
cash rich may
be poor in opportunities for investment
and vice versa and so the external
finance constraint (in other
words,
the absence of properly functioning
capital markets) appears to be a source of inefficiency.
As credit becomes
scarce, this
problem is exacerbated. An efficient
market in corporate control reduces this constraint by enabling
cash rich firms to buy firms
with
little cash and cash
poor firms to sell
themselves to those with
more cash. My point here is
that the fact that we
are beginning
to see a rise in corporate
takeovers and merger
activity in Africa supported by the role
played by investment bankers means
that some of
the limitations our
countries face as a result of not having very deep capital markets may
now start to be addressed. Research done in this area in Africa
may also give rise
to some
interesting results
and I would encourage this as
another takeaway from this
conference.
So what do Bankers do…(in practice!)?
The
points
made above highlight the importance of
the role played by financial intermediaries. Despite
what you might read about investment bankers,
we actually do serve a useful
purpose,
once in a while. Financial intermediaries, (people like me), are becoming
increasingly essential to the
efficient exploitation of complex
capital markets.
The role of
financial
intermediaries such
as investment bankers is to make it possible for individuals to gain some of
the benefits of complex financial markets
without bearing all of the prohibitive costs that come
with a high level of sophistication. These benefits in part
arise by economizing on the costs of
acquiring information. This is the
traditional advising
role of intermediaries such
as investment bankers.
The
intermediary
acquires information
at a fixed cost and shares it with
its customers
at a nominal marginal cost.
Without intermediaries,
the full benefits of financial innovation will not flow through
to the economy at large, either globally
or locally.
The analysis of
the benefits to economic growth
of a well-functioning financing system has a long history
with a growing body of academic
research arguing
that the development of financial
markets and institutions within countries and across borders is
a critical part of the growth process and not simply
an inconsequential spill over responding passively to economic growth
and industrialization. Research
in this area can be traced back to
Walter Bagehot whose seminal work was published
in 187310. The work done by Sir John
Hicks
in interpreting various aspects of
economic history11 and by Ronald McKinnon12 on the role of
capital in economic development follows this tradition.
More recent
research work has
been carried out by several
others13. This literature
describes the way financial systems reduce
information
and
transaction
costs
and in so doing influence savings rates, investment decisions, technological innovations, long-run growth rates and the
rate of industrialization.
Economists
hold very divergent opinions on the importance of
the financial system
for
economic growth. Walter Bagehot
(1873) and Sir John
Hicks
(1969)
argue that it played a critical role
in igniting industrialisation
in England by facilitating the mobilisation of
capital for (what John Hicks called)
“immense works”.
Sir John
argued
that the capital market improvements
that mitigated liquidity
risk
were
the primary causes of
the industrial revolution
in England14. With liquid capital
markets, savers
can hold assets – such as equities or
bonds – that they can sell quickly and easily if they want
access
to their savings. Simultaneously, capital markets transform these
liquid financial assets into long-term capital
investments in illiquid production processes.
John
Hicks
believed that because the industrial revolution
required large
commitments
of capital for long periods, the transformation in industry in England may not have occurred without this
liquidity transformation brought
about by financial innovation.
Another economist
of old, Joseph Schumpeter
made the point in 1912 that a well-functioning
capital market spurs technological innovation by identifying and funding
those ideas with the best chance of
successfully
implementing innovative products
and/or production processes.
In contrast, Joan
Robinson at Cambridge wrote in 1952 that she believed that “where enterprise leads finance
follows”. According to
this
view, economic development creates demands
for
particular types of financial
arrangements, and the financial
system responds
automatically to these
demands. From what
I have witnessed in
my career, I am more persuaded by the views of
John Hicks on the role
of financial
intermediaries than
I am by those
of Joan
Robinson on this subject15. This is a point to which I will return in
my conclusion.
Money,
Credit, Banking, August 1988
pp 559-88; and Franklin Allen
and Douglas Gale, Comparing Financial Systems,
MIT Press (2000).
14 Hicks tells readers
that: “My Theory of
Economic History
is largely an attempt
to see the main lines of economic development
as a matter of the evolution of the merchant-intermediary, and its consequences”;
John Hicks: The Formation
of an Economist. Banca Nazionale del Lavoro
Quarterly Review, September, 1979.
15 Joan Robinson’s own views
on Hick’s work are perhaps partly summarised
in the following quote: “Whenever equilibrium theory is breached, economists rush like bees whose comb has been broken
to patch up the damage. J.
R. Hicks was one of the
first, with his IS/LM, to
try to reduce the General
Theory to a system of
equilibrium. This had a wide
success and has distorted teaching for many generations
of students. J.R.Hicks used to
be fond of quoting a
letter from Keynes which, because
of its friendly tone, seemed to approve
of IS/LM, but it
contained a clear objection to a
system that leaves out expectations of the future from the inducements to invest…Forty years
later, John Hicks noticed
the difference between the future and the past and became dissatisfied with IS/LM but (presumably to save face
for his predecessor, J.R.) he argued that Keynes’s analysis was only
half in time and
half in equilibrium” Joan Robinson, Further
Contributions to Modern
Economics (Basil
Blackwell (1980)) pg 79.
12
Where to from here?
To
my mind,
taking the points I have made this morning,
the current global crisis does
give us a firm basis for thinking
about a research agenda into the
functioning of the banking and broader financial markets
in Africa. It is towards this
research agenda
that I would like to make some
suggestions.
I will
make a number of points
in summary form and I trust
that as I do so,
you remember my earlier plea for the
compliment that “I have raised
more
questions than answers”!:
1. Firstly, the current global crisis has
given rise to significant state ownership of,
or investment
in, a number of the leading global banks which
are active in trade and corporate
finance in Africa. The likes of
Citibank, Royal Bank of Scotland and Fortis will
find that they come under pressure
to focus on their home markets
in the US, UK and Europe. Any
expansion of their
activities in emerging markets such
as Africa will be curtailed. The likes of Barclays
may not have taken state aid to date, but I expect them and those of
the other banks which may
also not have taken state aid to nonetheless come under pressure
from their respective governments to focus on business in their home
markets. For the past
two centuries, much of
the flow of investment
capital into Africa and other emerging markets has been dominated
by international merchant
banks. It is these
banks which
shaped the early pattern of global investment
into Africa. A fair amount
of research
exists
at present
on the nature of, and mechanisms for, investment
made through the British capital
markets into Argentina,
Australia,
Canada, and the United States16 but less so in the
case of Africa. The four countries
mentioned above are estimated
to account for about one-half
of British overseas finance,
were
frontier
territories whose development depended
on their ability to bring new lands
and natural resources within the
scope
of the international market. In this respect,
these colonies were no different from those in Africa.
To facilitate the economic development of
the Americas and Australia,
it was necessary to invest
in transport, mining, land development, agriculture,
agricultural and mineral processing, as well as
services and products which supported colonial
development. While research into these four territories exists, there
has been very little research on the
nature of investment
into Africa
during the colonial period. In
this regard, it is
worthwhile
drawing attention to the similar historical role
that the merchant banks17, such as
16 See Lance E. Davis and Robert
E. Gallman: Evolving Financial
Markets and International Capital Flows- Britain, The Americas,
and Australia,
1865-1914. Cambridge University
Press. (2001).
17 The definition of what
constituted a “merchant bank” during the 19th Century is itself
an area of some debate. Geoffrey
Jones, writing on this
subject, notes as follows:
“The relationship between
trading companies and banks
was both multifaceted and highly significant for both parties. …[I]n
their origins merchants
and bankers were virtually indistinguishable,
and it was only slowly over the
course of the nineteenth century that
a clearer separation occurred.
In several cases, such as Anthony Gibbs,
Wallace Brothers, and Mathesons, merchant banking remained
part of the business
portfolio. Matheson & Co. regarded its legal status in a
13
Baring Brothers
& Co., N.M. Rothschild & Sons
and J. Henry Schroder & Co18., played
in the colonial era in facilitating capital flows into Africa
as well
as the role played by other
members of the London
Stock Exchange19. The flow of capital
into Africa and other
colonial territories
facilitated
by the London firms was
the building block for today’s
global financial architecture and an
important component of
global financial flows
which continues to remain
in place today20.
The
withdrawal of
the global banks from building their business
aggressively in Africa
and
other
emerging markets will make
room for local banks to expand and capture market share. How local firms behave in the face of less competition from foreign firms will
be important in
determining
how deep the provision of financial
services in Africa
continues to become.. Will the less
competitive landscape locally
for
both management talent and customers mean that we will
see local
banks
expand into disciplines like project finance
and corporate finance which have been
the
domain of foreign banks? Will
they attempt to expand their
product offering to the unbanked market on the back of the rising profitability
of their core businesses?
How
prepared
are our
central banks to regulate the movement
by our local banks into areas such as project
and acquisition finance and securities
(margin) lending? All
these areas of banking have in the past been dominated
by foreign
firms.
2. Secondly,
there will
be a decline in the overseas interest in acquiring
African
corporate
assets
as a result of the crisis. Over
the past few years, my firm and others
have seen an increase
in cross-border acquisitions.
The slides you will be receiving after this
presentation set
out data on mergers
and acquisitions. Interest
has been led by Asian buyers. For example,
following
the withdrawal of Anglo
American from the Zambian Copperbelt in the early 1990s, we saw the fortunes
of the Copperbelt transformed by the likes of First
Quantum,
Equinox and Vadanta all junior
mining companies with
origins
in Australasia. As
I explained earlier, mergers and acquisitions play
an important role in unlocking corporate
assets and
from
time to time play the
efficiency role that the lack of depth in the capital markets leaves unfilled. If, as expected, the global slowdown
reduces the ability
of financial intermediaries to facilitate
activity in Africa’s corporate
sector
by overseas buyers, will
our capital markets respond with enough acumen to support acquisitions by our
local players as they look
to take advantage lower prices
for
corporate
assets due to lower foreign interest? Again,
are our
regulators sufficiently tuned into the benefits
of corporate consolidation
and the role that our local financial
services companies
are to play in this area? The ties
between international investment, economic
growth
and the role of financial intermediaries
in the 19th and early 20th centuries
is well
documented21.
These functions include facilitating
the trading of risk, allocating capital between Great
Britain and its colonies in Africa, monitoring managers such
as Cecil John Rhodes and the United
Africa
Company, mobilizing savings in
Britain for investment overseas, and easing
the trading of goods, services, and financial
contracts across borders22. In understanding
these ties, it is
important to point out that academic economists
and historians have
highlighted some of the shortcomings associated with
the role played by banks in resource
allocation. The potential for
banks to extract oligopolistic rents from industry
is already
the subject of research23.Nonetheless, the role
played by investment banks is central to a well
functioning
M&A market and it
will
be important to see whether
as there
is a reduction
in the number of foreign buyers
active in Africa’s corporate
market,
the large local and regional players become more active,
with support
from the local
African
financial markets.
3. Thirdly,
the global slowdown will limit
the growth by Africa’s local corporates
of internally generated earnings.
As mentioned
earlier, retained
earnings are
an important, though not perfect, substitute for a deep capital market. Because
of this,
my expectation is that
the effects of slower corporate earnings
growth will translate into
slower long term investment.
Our
financial markets
are not yet deep enough to step
into this gap and in the absence
of alternatives, we should expect the current crisis to lead to a slow down in the very forms of
long term investment that Africa needs.
This need not be the case and
before
I conclude these opening remarks, I would like to spend a few minutes
talking about one of the financial innovations that arose out of
the 1930s Depression. It
is a good guide to the influence
that economists and Central Bankers
can have on a post-recession
world.,
My comments are
on a company called Industrial
and Commercial Finance Corporation (otherwise
known as “ICFC”).
It was formed in the UK after
the 1930s depression. I have a soft spot for ICFC as
my father worked there after his undergraduate degree
at Wharton.
ICFC,
was,
in essence,
what we would
today call a “venture capital fund”.
It has since
evolved into 3i, a “private equity fund” and although I recognise the
difference
between the two types of institutions, the points that I
would
like to make in this presentation
are common to both “venture
capital” and “private equity” and so, for this reason, I will
refer
to the whole asset class
as “private equity”.
Private Equity consists of
equity investments in companies
that are not listed on a stock
exchange. For Africa,
this constitutes
the bulk of our corporate
sector.
Investment vehicles in the private equity sector tend to
be structured as limited partnerships
with a fixed life agreed upfront
(this is
typically seven to ten years, although allowing for possible
roll-over
(extension
periods)).
The partnerships comprise of
investors – typically
pension
funds,
university and family endowments
23 In this context, Ash Demiriguc-Kunt
and Ross Levine make the point that “Powerful banks frequently stymie innovation and competition.
Banks may extract
information rents from firms
and thereby reduce the incentives
of firms to undertake profitable
projects… Furthermore, powerful bankers may
collude with managers against other outside
investors and thereby thwart competition,
efficient resource allocation, and
growth.” Ash Demiriguc-Kunt and Ross Levine, Financial Structure and Economic Growth, pg 8. Also
see Raghuram G. Rajan, Insiders and outsiders:
The choice between informed and arms
length debt, (Journal of Finance 47 (4) (September 1992):
pgs 1367-1400.
16
and
rich
individuals – who are the “limited
partners” (LPs) and a fund manager,
referred to in the industry as the “General Partner”.
ICFC
was
an early predecessor
of today’s PE funds.
It carried out a function
of national
significance, intermediating between small-
and medium-sized business, the capital markets and the British
government.
When it was founded,
ICFC was envisaged
as a
long overdue response to the
1931 Report of the Committee
on Finance and Industry which
had been chaired by Lord Macmillan.24. The Macmillan
Report (as it was
known) highlighted what
it saw
as
the persistent failure of
the financial
markets and the banking system in Britain
to provide long-term investment
funds to smaller- and medium-sized companies.
This
market
failure
became known as the “Macmillan
Gap”. and there are parallels
to be drawn between the Report’s analysis of
post-1930s Britain and today. For me, the question is whether
the financial innovations which
arose
out of these debates
in the 1930s are relevant
and applicable today, particularly
across
Africa where the level of support that
the capital markets
give to industry is still in its
infancy.
The
years 2008 and 2009 are not the first time
that bankers have come under
criticism for the absence
of support to industry. Richard
Coopey and Donald Clarke
in their 1995 history of 3i make
the following observation:
“ The
relationship between the finance sector
and British industry has
come under a great deal of scrutiny
during the twentieth century.
As the British economy,
pre-eminent in the nineteenth century, has
been overtaken by successive
rivals, so
questions about
the role of the banks
and capital market in this relative
decline have been repeatedly posed.
There
are,
to be sure, a range of
other candidates for
the post of chief scapegoat
– including a growing anti-industrial
culture, the costs of being the first industrial power [etc] and a general
demise of scientific
and technical literacy. Nevertheless the City, which has become
colloquial shorthand for the financial
system in
Britain, remains one of the most
prominent
targets for
criticism”25.
What
was
the solution to this? Well,
interestingly,
government
intervention in the financial
sector
was contemplated
in a manner that sounds very contemporary –
very
2009! Again,
Coopey and Clarke make the point:
“ As the depression had deepened in the early 1930s, so
debate had intensified
over the causes of, and possible remedies for, protracted
economic
failure.
This debate included the fundamental
question of market forces
versus
some
form of state
intervention, and in this context attention began to be focused
upon the working of the financial
system in
Britain”.26
The Committee on Finance and Industry was set
up in November 1929, five months
after
the election of MacDonald’s Labour government, to inquire into “banking, finance
and credit” in Britain. The Macmillan Committee,
as
it came to be known, was chaired
by Lord Macmillan and included John Maynard Keynes27 and Ernest
Bevin. In spite of the wide-ranging remit of the Committee
and the breadth of its final
report, it became principally remembered
for
its identification of the Macmillan gap – a chronic shortage
of long-term investment
capital for Britain’s small-
and medium-sized enterprises28. What
the Macmillan Committee identified
as being
a capital
market
failure
in the UK is no different
from what we
should
expect to find across Africa
as a result
of the withdrawal of
different
forms of
capital from our industries. This
is further
exacerbated by the decline in internally
generated funds brought about by slower growth.
We
should not underestimate
the effect of the above on long term investment which
brings
me to my last and final point:
4.
I hope that one of the lasting
post-recession innovations in Africa is
a renewed
focus
on innovations which strengthen the capabilities within our
financial
sector
for long term investments. I
know a number of
you are Central Bankers and Although
you may
be focused on questions of disclosure
and regulation, I encourage
you to also look into the role that the Bank of England played in the
emergence
of ICFC29 and the problems that Economists such as Keynes addressed
through the deliberations of the Macmillan Committee. I
hope that you, and other professional
economists, will
look deeper into the role that the UK’s Central Bank played in encouraging the emergence
of this
important institution after the 1930s
Depression as a way
of addressing
market
failures
and the persistant lack of support
for
industry by the financial sector in Africa. An
institution similar
to ICFC
is an
important financial innovation.
Today, ICFC has evolved into 3i and plays a role well
beyond that confined to providing
finance to small and medium sized enterprises. The origins of
this institution, born out of the debates amongst
economists and policy makers in the 1930s should be of immediate interest to us as we think through
the post-recession innovations for today’s
world30. Will the 2008/2009 recession
lead
to
the creation of similar institutions, underpinned
by sound economics and by a clear understanding
of how
markets work? If so,
what role
can those of you here
play through your respective central banks
in encouraging the emergence of
these institutions
across Africa? I have a fear
that this recession will see
the re-emergence
of the
Development Banks
and an increase in the influence of the DFIs
with all the anti-market
practices associated with “development financing”. This
will be
the wrong response and I
hope that some of you will
do your best to see that this does
not happen.
The four points that
I have made in these concluding remarks will, I
hope
stimulate
some
thought. It is important that our Central Bankers31 and professional
economists don’t
sit on the sidelines as
observers during this
most challenging of times. I encourage you to use your
time at this conference to
think about the post
recession
world
and about your role in it. It is
an important role
which, to quote President Bush, should
not be “mis-underestimated”.
Thank
you.
21
“What are Bankers
for…..?”
Keynote
speech – CSAE Annual Conference
Africa
and the Banking Crisis
St. Catherine’s College, Oxford March
2009
Kofi
Adjepong- Boateng*
* A version of this presentation was made to conference participants and has been amended following discussions at the conference. The author is an investment banker and Senior
Associate Member
of St. Antony’s College, Oxford. Prior to co-founding First Africa in 1996,
he worked in the corporate
finance, trade finance and government advisory fields in Africa with
SG Warburg & Co., HSBC
Equator and
Price Waterhouse. In the late
1980s and early
1990s,
he was involved in a number of sovereign debt
buy-backs, corporate
restructurings
and commodity financings which occurred in Africa; and since
the late
1990s, he has advised on several of Africa’s largest
corporate transactions.
During 2003 and 2004, he served on the Africa Policy Advisory Panel, an advisory group mandated by the U.S. Congress, which reported
to Colin Powell,
the U.S. Secretary of State. He currently serves as a member of the Policy Committee
of The Centre
for the Study of African Economies (CSAE) and sits on CSAE’s Finance
Committee. He is also a member of the
Steering Committee of a research project at the Lauterpacht Centre for International
Law at the University of Cambridge which
is looking into the legal issues associated with accusations
of corporate complicity in human rights
abuse in resource rich countries. Since 2006, he has served on the International Advisory Board of ACE Ltd, the world’s largest
insurer of political
risk.
He is a Fellow of the Royal Society of Arts and Manufacturers in the UK and a Member of the UK’s Royal Economic Society.
1
Introductory remarks
I am
grateful to Paul, Stefan and
the Centre for inviting
me here this morning to give this opening address.
I suppose I ought to tell
you a bit about myself. I grew up in Ghana,
studied at this University many
years ago, and have spent my
entire career in investment
banking. I spent the early part of my career working
in London on corporate and sovereign restructurings
(including debt restructurings
and early privatisations). In
1993, I set up an investment
bank in Kenya called Loita Capital Partners
which I left
in 1995. In 1996, about 13 years
ago, a colleague and I established a joint venture investment bank
with S.G Warburg
& Co. which was
at the time the UK’s
largest
and
most
successful
investment
bank. That firm, First Africa, was recently acquired
by the Standard Chartered Bank group.
Standard
Chartered
has built one of the largest banking
operations in Africa over the last
150 years.
I should
state upfront that I don’t know very
much about what most
of you know a lot about. I am not a professional economist; nor am I
a civil servant active in policy formation. However, I
do know something about “money” and about why, from time to time, it moves from one place to another.. This is
probably
why I
have been asked by Stefan
to speak on “Africa and the banking crisis”. It
seems
to me there that are two
ways
to approach this subject.
One way is to discuss the likely effects on the continent’s growth of
the reduction in imports by Africa’s trading
partners
or the effects on Africa’s trade
finance of
either a contraction in, or rise
of the costs of, global trade finance
as
international banks come
under pressure to focus on their
home
markets1. I
could, for example, talk about the
effects
of a fall
in commodity prices on Africa’s growth. In his recent article
in this month’s edition of the UK’s Prospect magazine,
Paul Collier estimates
that over 200,000 jobs have been lost in the DRC as a result of
the collapse in cobalt prices
and that South Africa is
expecting to lose around
50,000 jobs in its mining
sector2. Slow
2
global
growth will
have implications for African
growth and there is quite a bit that one could say about this aspect of the global crisis. But, judging by the quality of this audience, you have probably forgotten more than I
will ever know about the inter-relationship between
global economic growth and
Africa’s
trade fortunes.
For
this reason, I
will not spend any time this morning
talking to you about this as I feel
I can add little to your understanding
of this
area of
international economics and trade.
Instead,
I have prepared a short
slide
presentation which is
available as a take away
and will be sent by Rose Page,
Paul’s assistant,
to each of you by email. It contains a number of
the statistics which
highlight the current global predicament. What these
statistics show
in summary is that we are
in a very deep global recession
comparable by economic historians to the 1930s Depression in certain
of its
characteristics and from which no
country in Africa is immune. No
matter how long I take to say
this that will be my conclusion
so it makes sense to state this conclusion
up front and move on.
The
second approach to tackling this topic
is to ask the question:
“What should we (and by that I mean “you and I”) focus on to prepare African
policy makers for a post-recession world knowing
the likely effects that this global slowdown
will have on African economies?” I’d
like to find a way in these opening remarks
to combine my experience as
an investment banker with yours
as central bankers and research
economists and to see whether there
are areas of mutual
interest
to which we should give attention in the next few months
and years in order to ensure
that some good comes
out of
the banking crisis for
the benefit of the poor, the middle class
and (dare I say it)
the rich who inhabit our continent.
One of the advantages about giving a talk to an academic
audience is the comfort
of knowing
that all the parties present
are here, not
only to share what
they know, but also to find
out what they don’t know.
“Not knowing” at conferences
like this is almost as
important as “knowing”. I want
to spend some
time this morning talking about what we do know,
but also, would like to invite you, the audience, at the
end of this session
to help, through questions, shape
a research agenda to address what we
“don’t know”
but should. In this context, the comment that what I have to
say “raises more
questions than
answers”
will be seen, by me at least, as
a compliment!
I suppose I ought to
say upfront
that I will be drawing on certain
aspects of the history of
economics to draw some of
my conclusions. This is an important point as, given the current
state of the world economy,
we are hearing
a lot about “history” in general
and the 1930s Depression
in particular. I recognise the importance
in the social sciences of
the separation nowadays between
“economic history” and “economic theory”.Unlike some, I
have always felt that this separation is
unfortunate
and one of the benefits, if
one can describe it as such, of
the current crisis is the fact
that a lot of the commentary
on the current state of affairs
is drawing somewhat liberally on economic history as
well
as the history of economic thought3.
3 Partha Dasgupta
draws attention to this unfortunate
separation between economic theory and econom ic history
in the
introduction to a paper presented in
1998. He writes: “You can emerge from your graduate studies in economics without
having
read any of the classics, or indeed, without having
anything other than a
vague notion of what the great thinkers of the
past had written. The modern
economist doesn’t even try to legitimize
his inquiry by linking it
to questions addressed
in the canon; he typically begins his article by referring to something in the literature a few months old.
He reads Ricardo no more than the contemporary physicist
reads James Clerk Maxwell.
What today’s economic student gets of the
classics are those bits that have survived the textbook treatment,
dressed in modern garb. The history
of economic ideas hasn’t
died; it has simply metamorphosed into a specialized
field.
3
I have been an investment
banker for over twenty years. In that period,
my career has been influenced
by:
- the “Third World
debt” crisis which had its origins in the Mexican
default in 1982. My career started in 1988
about 6 years after the onset
of the Mexican crisis. Not surprisingly, all of my assignments in the early
days were related in some way to the restructuring African sovereign debt;
- the stock market crash
of 1987;
- the US savings and loan
debacle; - the Asian crisis;
- the Russian crisis and the implosion of
LTCM; - the tech bubble of 2000; and now
- the current global financial
crisis.
That’s seven
events of global financial significance all of
which occurred in the last twenty-five or
so years. Each event
taught us important lessons
and gave rise to
academic research and a body of literature that is still
contributing to our understanding
today of how financial
markets work.
First Africa,
the firm I co-founded,
has been
fortunate
to have had a ring-side seat
during this in which the African
capital markets have grown
and evolved rapidly. We have had extraordinary people work with
the firm during this time,
all of whom were
involved in ground-breaking transactions.
Some of
the precedents in which the firm has
been involved include:
- The sale by Anglo American
Corporation in 1995 of JCI Limited to a Black Economic Empowerment consortium in South Africa. At the time, JCI was the world’s
sixth largest gold company and the
transaction was the
most
important of
the BEE mining transactions completed
in South Africa in that year;
- The sale by the Anglo American
Group in
1996 of its interest in First Merchant Bank of Zimbabwe. This
was
one of the first “empowerment” transactions in Zimbabwe and led to the creation of what has
become
one of Southern Africa’s
important regional banking
groups,
the African Banking Corporation;
- In 1999, we acted as
an adviser on the takeover of the Cotton Company of Zimbabwe by a private
equity consortium. This transaction involved the takeover
of what was
at the time Zimbabwe’s largest agricultural company;
It
is taught, but it is not compulsory for students, at least not in
the major economics departments. And just as most working economists today know little of the ideas that have
shaped their subject, your
average historian of economic
thought understands little
of what is currently going on in economics and
why. The separation is as complete as can be” Partha Dasgupta, Modern Economics and
its Critics I, St.
John’s College (February 1998) University of Cambridge, England.
4
- In 2003, we acted on
the sale of the Social Security
Bank in Ghana to France’s Societe
Generale. This transaction involved us in what
became the first takeover of
a listed bank anywhere in sub-Saharan
Africa;
- In
2004, the firm acted as an adviser to Anglogold
on its merger with
Ashanti Goldfields Company. This merger created Africa’s largest gold company. The
transaction was accompanied by the dual listing of the merged entity
in South Africa and Ghana and remains
to date, the largest
takeover of
a listed
West
African
company;
- In 2005, we acted on
the reverse takeover
of African
Gold by Mwana Resources
and the listing of Mwana
on AIM in London. Reversing predominantly Zimbabwean assets
in a London listed vehicle is difficult
at the best of times. To do so
at the height of the Zimbabwean crisis was ground breaking
in its own right;
- In 2006, we advised the MTN Group on its
acquisition of Investcom
LLC. This was one of the most
important cross-border
takovers by a South African
company and at the time,
was
the second
largest transaction
of its
kind in South Africa. It was also
the first
takeover of a company listed on the Dubai
Stock Exchange and is still the only successful transaction
of this
size completed by either of
the leading South Africa
telecoms companies;
- We acted on the conversion
of Equity
Building Society in East Africa
from
a mutual society
into a bank and the listing of Equity
Bank on the Nairobi Stock Exchange. This
transaction
was
the
first
of its
kind in East Africa and has since become
the precedent for those considering
transactions of
this
kind; and
- More recently,
we acted in 2008 and early this
year on the Rights Issue
and Placing undertaken by ETI, the West African
regional banking group. This
transaction
raised
a significant sum for the bank and was executed during the still
ongoing global financial crisis.
ETI raised what
amounted the largest
pool of capital raised by any
firm on the Ghana
Stock Exchange, which is one of the West African
exchanges on which the bank is listed.
The
above list illustrates
the breadth of work carried out by firms such
as mine
in Africa. There are many
other transactions
which could be added to this list
but I believe the short
list above illustrates the extent
to which financial services companies such
as ours play an important role
in facilitating the corporate activity in Africa. The question worth
considering is the extent to which this
level of corporate
activity took place primarily
because of financial innovations in Africa
and elsewhere. Innovations such
as the introduction of stock
markets, the role
played by private equity and hedge funds in investing in African companies and the emergence of
cross-border financial players who have been able to help ensure that standardised and good quality financial information becomes available outside of
national borders are all important
5
financial innovations whose role
in spawning cross-border corporate activity should not be underestimated.
Over
time,
today’s crisis will give rise to robust debate
amongst professional economists such
as
you about the policy prescriptions
for
a post-recession world and I
would like to use these opening
remarks
to ask that you start thinking about
areas for further research
which
will make more
robust about our
approach to policy. That’s
my objective this morning.
So, “What are Bankers for…(in theory!)
Many economists,
and I hope the majority of
you here, view freely operating markets in which
free exchange occurs as the best mechanism for
allocating scarce resources. From the point of view of allocating
capital, the most important markets in this
respect
are the commercial
banking market, stock exchange (or stock market)
and other capital markets,
such as
the bond
market
or the markets in other
financial securities.
I share the view
that the capital markets
are crucial
for
the allocation of resources in a modern
economy. Household
savings
are channelled through the capital markets
to the corporate sector and investment funds are
allocated, again through
the markets, among companies. Markets allow
both companies and households
to share
risks, or
so we
believe. I am conscious that there
have been recent lessons learnt
about risk sharing as
a result
of the predicament in
which giant global financial services companies
such
as AIG find
themselves. But for
now, I
will
restate
my belief that well
functioning capital markets
enable both firms and households to share risks.
However, having
said this, it seems to me
on reading the literature that
there
are at least four important limitations
to the efficiency with
which capital markets
operate, particularly in Africa and other emerging
markets:
1. Firstly,
in most countries, such
as those
in Africa, stock markets are
not that large or important. The financial markets
in Africa and other emerging markets are
primarily
markets for
government
debt. Often, the external
capital that industry
requires for investment is
obtained in the form of loans
directly from commercial
banks;
2. Secondly, in all countries, including the US and UK,
internally generated funds tend to be more important than is frequently acknowledged.
In most African
countries these
internally
generated funds are
far
more
important than the external finance raised through the
capital markets and commercial banks.
This has certain implications which I
will come back to;
3. Thirdly,
the ideal of a frictionless capital market is rarely, if
ever, achieved in practice. Financial intermediaries,
such as
stock brokers, investment
and merchant banks like ours,
are needed to overcome the
barriers
to information and to market
participation. Reducing these informational
barriers is important if
firms
and investors are to exploit
markets
effectively;
and
6
4. Finally, we
should not underestimate how important
it is to well functioning capital markets
that there is also an effective
market
in corporate control (in
other words, a market in takeovers or
mergers).
Most of my career has been spent
in the market for
corporate control. This
is an important aspect
of the role played by the
capital markets which
must
not be forgotten. Corporate
takeovers are not as common in Africa
as they
are elsewhere
in the world, but they are becoming more common. The possibility of takeovers
is assumed to be a device for disciplining managers.
An acquirer can buy up the shares of
a badly managed target,
replace the incumbent management, better utilise the
company’s assets
and make a capital gain.
The capital markets are meant
to play an important oversight
role,
but we should not ignore the equal importance
of the role played in asset allocation
by the threat and presence of
corporate
takovers.
Despite the limitations
listed above, there is almost universal
popularity of capital markets
across
the world4. To date, several African countries have introduced
legislation to encourage the emergence of
stock exchanges and a number
of African
countries have recently
tapped the international
bond markets. One
of First
Africa’s board
directors, Walter Kansteiner,
put in place a program when
he was
President
Bush’s
Assistant
Secretary
of State
for Africa
to encourage the rating of
African sovereign bonds. Between March 2004 and February 2009, eight African countries, all of
which benefited under the
Kansteiner program and secured ratings, raised over
US$16 billion in the international
bond markets.
There
are two important
reasons why
there is
almost universal popularity of capital markets
across
the world. One reason is
what I
call the “push” factor and the other,
the “pull” factor:
1. Firstly,
government
intervention has become discredited.
The appeal of government intervention
in the 1950s and 1960s had its origins in the market failures associated
with the 1929 Wall Street crash and the Great
Depression of the 1930s.
This is
an important point as it serves
as a reminder
that this is not the
first
time that a global financial crisis has
led to calls for greater government
intervention and regulation.
Prior
to the onset of the current global financial
crisis, it
appeared to many people that government failures are at least as important, if not more
important, a problem as market failures. This is what
I would
call the “push” factor underpinning the popularity of the free market in general,
and of capital markets in particular.
The current crisis may have damped the public’s enthusiasm for free
markets. Bank nationalisation in the West
has been taken in its stride;
2. The second reason for the universal popularity of
capital markets is that policy makers have been persuaded by economic theorists
to promote
free markets.
Economic theory, particularly that
pertaining to financial markets, has
stressed the effectiveness of
markets
in allocating resources. This is
what I
would
call
the “pull factor”. The general acceptance by policy makers of
free markets
as “efficient” markets
was predominately
a backlash against the views
of Keynes which
had initially dominated the post-war
era.
The intellectual attractiveness
of efficient markets
had a lot to do with the works of Milton
Friedman, Robert
Lucas and
Eugene Fama. Works with
which
I’m
sure you are all
familiar.5
As economists, you are
looking to understand the role
that financial markets
play in different national economies.
As economists, you
bring to your task an intellectual training that
places markets at the
very centre of the study
of economics. Some of
you might even go so far as to argue
that markets define
the very subject matter of
economics and that complete
and competitive markets
represent the ideal allocation system backed
up by the fundamental theorems of welfare economics.
Having said this, I
am sure that most of
you will recognise that there
are a number of areas of study and research
that have become an increasingly
important part
of economics in the past few decades.
The current global crisis reminds
us of
how important
these areas of study are:
1. Firstly,
there
are the incentive problems that arise between
agents and principals, employers and employees,
managers and shareholders, financial
institutions and their customers;
2. Secondly, there are difficulties
that arise in financial markets when
information is
asymmetrically distributed. The early
work of
Joe Stiglitz and Andrew Weiss helped formulate
our early
understanding of these
issues6;
3. Thirdly, there
are always transaction costs.
That’s how I have earned my living for several years. It
is these
transaction
costs
which prevent the existence
of more
than a small fraction
of the
number of possible
5 For a discussion on the emergence of Chicago
economics and the role
that this school played in the providing the theoretical underpinnings
to deregulation see Johan Van Overtveldt,
The Chicago School
– How the
University of Chicago Assembled
the Thinkers who Revolutionized Economics and Business (Agate, 2007)
and Craig F. Freedman, Chicago Fundamentalism – Ideology and Methodology
in Economics (World Scientific Publishing Co. (2008)).
The views of the Chicago School
differed radically from those
of Keynes which had dominated the post-War era.
Peter Clark’s review of
Robert Skidelsky’s biographies
of Keynes reminds us how different these two schools actually were” “Skidelsky
is against the “single-book” interpretation of Keynesianism, and thus demands due attention
for the Treatise [on Money]. Its message is that savings and investment,
being different activities carried on by
different people, could not
simply be presumed identical.
It took interest rate to
bring them into equilibrium. …What
Skidelsky …. chooses to emphasize is the
Treatise’s preoccupation
with the economics of disequilibrium, when the economy is in a position
of sub-optimal output and hence unemployment. If the …”Bank
rate” …is what restores equilibrium, it follows that
banking policy plays a crucial role
in stabilizing the system. “Order has to
be created”, is Skidelsky’s gloss; “it
is not natural”. Put like this…the Treatise carries us a long way into the world disclosed by the
General Theory,
in which
the absence of any self-righting
forces in the economy is affirmed” – Peter Clark, Keynes rediscovered, Times
Literary Supplement (November 20, 1992) pg 4. This is a point
on which Clark had elaborated upon in his earlier and more extensive work: The Keynesian Revolution in the Making 1924-1936 (Oxford
University Press (1988)) See for example
pages 22-24.
6 See, for example, J.
Stiglitz and A. Weiss, Credit Rationing
in Markets with
Imperfect Information,
(American
Economic Review, 71 (3) (June) 1981;
8
markets envisaged by
the Arrow-Debreu-Mackenzie
general equilibrium models7;
4. Finally,
there
are the
long-term relationships
between financial institutions
and our customers
which, from time to time,
stifle
competition and almost
certainly
counter any view that “perfect competition” exists.
The four areas of study
listed above are central to
our
understanding of finance today,
since much
of financial
practice
and theory deals with the attempt to overcome agency problems, incomplete
markets, transaction
costs, and lack of information.
Work done by two of CSAE’s
Directors, Stefan Dercon
on insurance markets
and Marcel
Fafchamps
on market institutions, both highlight
the shortcomings of markets and how
these
limitations influence
institutional
developments8.
Despite
the above limitations, the
classical theory makes a powerful case
for
the role
that markets play in national
economies whenever
the imperfections
caused by market power, asymmetric information, and
incentive problems are
not too overbearing. However, the fact
that we are living through a global crisis which
has largely
been caused by a wide range
of market failures (particularly as they relate
to the incentive problems
in the banking industry) is
a very
rude reminder
of the
limitations of markets.
So, why
is understanding these limitations
important
to understanding the likely impact
of the global recession on Africa’s growth?
To begin to understand the likely impact of the global crisis on Africa, one must start with
an understanding of the relationship between
the financial system of
a country and the real economy
and in particular the corporate
sector.
Companies
are the issuers of
all of the securities traded in the capital markets outside of
government
paper and the investment return
on these securities depend on the performance of the issuers that
make up the corporate sector.
The financial sector
plays an important role
in corporate governance because
it allocates control rights
(including rights over cash
flows)
and assists in the design of
the securities that
are issued.
Once securities are
issued, it is the financial intermediaries who provide information
on company performance that investors utilise to make
decisions on
whether
to buy or sell securities.
9
As mentioned earlier,
the market for corporate
control simply does not exist in most African
countries, and the evidence for the
monitoring
role of
banks over African corporates
is weak. In
addition, the reliance on internal finance
by African corporates means that managers are
largely autonomous of
outside sources of capital. African
firms,
particularly the large diversified companies such as Dangote
Industries
in Nigeria or the Anglo
American
Group in South Africa can act as financial institutions to compensate for the limitations
of
financial markets and financial
intermediaries. I have not as yet seen
any research from you or
your peers on the efficiency of capital allocation decisions
made
by our African conglomerates
either historically (as
companies such as Anglo
can no longer be called conglomerates
in the classical sense
of the word) or presently (and
here I’m
thinking of the likes of Dangote
in Nigeria, Press Holdings in Malawi or
the various East African groups). Perhaps,
this is
one of the research takeaways that will
come out of this conference9. I hope so.
Where capital
markets are
robust and deep,
it is
reasonable
to assume that companies pay all their earnings to their
shareholders and that the capital markets
and the banking sector provide
firms with
the capital required for investment. In
practice, however,
features such
as asymmetric
information
and agency costs restrict
the role of external finance.
This makes raising
external capital
a costly alternative to internally generated
funds.
In several markets,
including those in Africa, the development of
the capital markets
was
stunted by the frequency with which governments print
money. By printing money, governments avoided the need to issue
paper which
is an important component in the development of
any capital markets.
The inflationary effects of
excesses in money supply also discouraged the purchase of
long term securities. For this
reason,
companies operating in Africa have historically been forced to rely on
internal
finance as a more important
source of
funds
than debt or equity for
long term investment as the issue
of long dated securities
simply does not happen. The problem with
this state
of affairs is
that there does not seem to me to be a robust reason
for believing that the allocation of
funds
for
investment that results from
the use of
internally generated
capital is optimal. Firms that are
cash rich may
be poor in opportunities for investment
and vice versa and so the external
finance constraint (in other
words,
the absence of properly functioning
capital markets) appears to be a source of inefficiency.
As credit becomes
scarce, this
problem is exacerbated. An efficient
market in corporate control reduces this constraint by enabling
cash rich firms to buy firms
with
little cash and cash
poor firms to sell
themselves to those with
more cash. My point here is
that the fact that we
are beginning
to see a rise in corporate
takeovers and merger
activity in Africa supported by the role
played by investment bankers means
that some of
the limitations our
countries face as a result of not having very deep capital markets may
now start to be addressed. Research done in this area in Africa
may also give rise
to some
interesting results
and I would encourage this as
another takeaway from this
conference.
So what do Bankers do…(in practice!)?
The
points
made above highlight the importance of
the role played by financial intermediaries. Despite
what you might read about investment bankers,
we actually do serve a useful
purpose,
once in a while. Financial intermediaries, (people like me), are becoming
increasingly essential to the
efficient exploitation of complex
capital markets.
The role of
financial
intermediaries such
as investment bankers is to make it possible for individuals to gain some of
the benefits of complex financial markets
without bearing all of the prohibitive costs that come
with a high level of sophistication. These benefits in part
arise by economizing on the costs of
acquiring information. This is the
traditional advising
role of intermediaries such
as investment bankers.
The
intermediary
acquires information
at a fixed cost and shares it with
its customers
at a nominal marginal cost.
Without intermediaries,
the full benefits of financial innovation will not flow through
to the economy at large, either globally
or locally.
The analysis of
the benefits to economic growth
of a well-functioning financing system has a long history
with a growing body of academic
research arguing
that the development of financial
markets and institutions within countries and across borders is
a critical part of the growth process and not simply
an inconsequential spill over responding passively to economic growth
and industrialization. Research
in this area can be traced back to
Walter Bagehot whose seminal work was published
in 187310. The work done by Sir John
Hicks
in interpreting various aspects of
economic history11 and by Ronald McKinnon12 on the role of
capital in economic development follows this tradition.
More recent
research work has
been carried out by several
others13. This literature
describes the way financial systems reduce
information
and
transaction
costs
and in so doing influence savings rates, investment decisions, technological innovations, long-run growth rates and the
rate of industrialization.
Economists
hold very divergent opinions on the importance of
the financial system
for
economic growth. Walter Bagehot
(1873) and Sir John
Hicks
(1969)
argue that it played a critical role
in igniting industrialisation
in England by facilitating the mobilisation of
capital for (what John Hicks called)
“immense works”.
Sir John
argued
that the capital market improvements
that mitigated liquidity
risk
were
the primary causes of
the industrial revolution
in England14. With liquid capital
markets, savers
can hold assets – such as equities or
bonds – that they can sell quickly and easily if they want
access
to their savings. Simultaneously, capital markets transform these
liquid financial assets into long-term capital
investments in illiquid production processes.
John
Hicks
believed that because the industrial revolution
required large
commitments
of capital for long periods, the transformation in industry in England may not have occurred without this
liquidity transformation brought
about by financial innovation.
Another economist
of old, Joseph Schumpeter
made the point in 1912 that a well-functioning
capital market spurs technological innovation by identifying and funding
those ideas with the best chance of
successfully
implementing innovative products
and/or production processes.
In contrast, Joan
Robinson at Cambridge wrote in 1952 that she believed that “where enterprise leads finance
follows”. According to
this
view, economic development creates demands
for
particular types of financial
arrangements, and the financial
system responds
automatically to these
demands. From what
I have witnessed in
my career, I am more persuaded by the views of
John Hicks on the role
of financial
intermediaries than
I am by those
of Joan
Robinson on this subject15. This is a point to which I will return in
my conclusion.
Money,
Credit, Banking, August 1988
pp 559-88; and Franklin Allen
and Douglas Gale, Comparing Financial Systems,
MIT Press (2000).
14 Hicks tells readers
that: “My Theory of
Economic History
is largely an attempt
to see the main lines of economic development
as a matter of the evolution of the merchant-intermediary, and its consequences”;
John Hicks: The Formation
of an Economist. Banca Nazionale del Lavoro
Quarterly Review, September, 1979.
15 Joan Robinson’s own views
on Hick’s work are perhaps partly summarised
in the following quote: “Whenever equilibrium theory is breached, economists rush like bees whose comb has been broken
to patch up the damage. J.
R. Hicks was one of the
first, with his IS/LM, to
try to reduce the General
Theory to a system of
equilibrium. This had a wide
success and has distorted teaching for many generations
of students. J.R.Hicks used to
be fond of quoting a
letter from Keynes which, because
of its friendly tone, seemed to approve
of IS/LM, but it
contained a clear objection to a
system that leaves out expectations of the future from the inducements to invest…Forty years
later, John Hicks noticed
the difference between the future and the past and became dissatisfied with IS/LM but (presumably to save face
for his predecessor, J.R.) he argued that Keynes’s analysis was only
half in time and
half in equilibrium” Joan Robinson, Further
Contributions to Modern
Economics (Basil
Blackwell (1980)) pg 79.
12
Where to from here?
To
my mind,
taking the points I have made this morning,
the current global crisis does
give us a firm basis for thinking
about a research agenda into the
functioning of the banking and broader financial markets
in Africa. It is towards this
research agenda
that I would like to make some
suggestions.
I will
make a number of points
in summary form and I trust
that as I do so,
you remember my earlier plea for the
compliment that “I have raised
more
questions than answers”!:
1. Firstly, the current global crisis has
given rise to significant state ownership of,
or investment
in, a number of the leading global banks which
are active in trade and corporate
finance in Africa. The likes of
Citibank, Royal Bank of Scotland and Fortis will
find that they come under pressure
to focus on their home markets
in the US, UK and Europe. Any
expansion of their
activities in emerging markets such
as Africa will be curtailed. The likes of Barclays
may not have taken state aid to date, but I expect them and those of
the other banks which may
also not have taken state aid to nonetheless come under pressure
from their respective governments to focus on business in their home
markets. For the past
two centuries, much of
the flow of investment
capital into Africa and other emerging markets has been dominated
by international merchant
banks. It is these
banks which
shaped the early pattern of global investment
into Africa. A fair amount
of research
exists
at present
on the nature of, and mechanisms for, investment
made through the British capital
markets into Argentina,
Australia,
Canada, and the United States16 but less so in the
case of Africa. The four countries
mentioned above are estimated
to account for about one-half
of British overseas finance,
were
frontier
territories whose development depended
on their ability to bring new lands
and natural resources within the
scope
of the international market. In this respect,
these colonies were no different from those in Africa.
To facilitate the economic development of
the Americas and Australia,
it was necessary to invest
in transport, mining, land development, agriculture,
agricultural and mineral processing, as well as
services and products which supported colonial
development. While research into these four territories exists, there
has been very little research on the
nature of investment
into Africa
during the colonial period. In
this regard, it is
worthwhile
drawing attention to the similar historical role
that the merchant banks17, such as
16 See Lance E. Davis and Robert
E. Gallman: Evolving Financial
Markets and International Capital Flows- Britain, The Americas,
and Australia,
1865-1914. Cambridge University
Press. (2001).
17 The definition of what
constituted a “merchant bank” during the 19th Century is itself
an area of some debate. Geoffrey
Jones, writing on this
subject, notes as follows:
“The relationship between
trading companies and banks
was both multifaceted and highly significant for both parties. …[I]n
their origins merchants
and bankers were virtually indistinguishable,
and it was only slowly over the
course of the nineteenth century that
a clearer separation occurred.
In several cases, such as Anthony Gibbs,
Wallace Brothers, and Mathesons, merchant banking remained
part of the business
portfolio. Matheson & Co. regarded its legal status in a
13
Baring Brothers
& Co., N.M. Rothschild & Sons
and J. Henry Schroder & Co18., played
in the colonial era in facilitating capital flows into Africa
as well
as the role played by other
members of the London
Stock Exchange19. The flow of capital
into Africa and other
colonial territories
facilitated
by the London firms was
the building block for today’s
global financial architecture and an
important component of
global financial flows
which continues to remain
in place today20.
The
withdrawal of
the global banks from building their business
aggressively in Africa
and
other
emerging markets will make
room for local banks to expand and capture market share. How local firms behave in the face of less competition from foreign firms will
be important in
determining
how deep the provision of financial
services in Africa
continues to become.. Will the less
competitive landscape locally
for
both management talent and customers mean that we will
see local
banks
expand into disciplines like project finance
and corporate finance which have been
the
domain of foreign banks? Will
they attempt to expand their
product offering to the unbanked market on the back of the rising profitability
of their core businesses?
How
prepared
are our
central banks to regulate the movement
by our local banks into areas such as project
and acquisition finance and securities
(margin) lending? All
these areas of banking have in the past been dominated
by foreign
firms.
2. Secondly,
there will
be a decline in the overseas interest in acquiring
African
corporate
assets
as a result of the crisis. Over
the past few years, my firm and others
have seen an increase
in cross-border acquisitions.
The slides you will be receiving after this
presentation set
out data on mergers
and acquisitions. Interest
has been led by Asian buyers. For example,
following
the withdrawal of Anglo
American from the Zambian Copperbelt in the early 1990s, we saw the fortunes
of the Copperbelt transformed by the likes of First
Quantum,
Equinox and Vadanta all junior
mining companies with
origins
in Australasia. As
I explained earlier, mergers and acquisitions play
an important role in unlocking corporate
assets and
from
time to time play the
efficiency role that the lack of depth in the capital markets leaves unfilled. If, as expected, the global slowdown
reduces the ability
of financial intermediaries to facilitate
activity in Africa’s corporate
sector
by overseas buyers, will
our capital markets respond with enough acumen to support acquisitions by our
local players as they look
to take advantage lower prices
for
corporate
assets due to lower foreign interest? Again,
are our
regulators sufficiently tuned into the benefits
of corporate consolidation
and the role that our local financial
services companies
are to play in this area? The ties
between international investment, economic
growth
and the role of financial intermediaries
in the 19th and early 20th centuries
is well
documented21.
These functions include facilitating
the trading of risk, allocating capital between Great
Britain and its colonies in Africa, monitoring managers such
as Cecil John Rhodes and the United
Africa
Company, mobilizing savings in
Britain for investment overseas, and easing
the trading of goods, services, and financial
contracts across borders22. In understanding
these ties, it is
important to point out that academic economists
and historians have
highlighted some of the shortcomings associated with
the role played by banks in resource
allocation. The potential for
banks to extract oligopolistic rents from industry
is already
the subject of research23.Nonetheless, the role
played by investment banks is central to a well
functioning
M&A market and it
will
be important to see whether
as there
is a reduction
in the number of foreign buyers
active in Africa’s corporate
market,
the large local and regional players become more active,
with support
from the local
African
financial markets.
3. Thirdly,
the global slowdown will limit
the growth by Africa’s local corporates
of internally generated earnings.
As mentioned
earlier, retained
earnings are
an important, though not perfect, substitute for a deep capital market. Because
of this,
my expectation is that
the effects of slower corporate earnings
growth will translate into
slower long term investment.
Our
financial markets
are not yet deep enough to step
into this gap and in the absence
of alternatives, we should expect the current crisis to lead to a slow down in the very forms of
long term investment that Africa needs.
This need not be the case and
before
I conclude these opening remarks, I would like to spend a few minutes
talking about one of the financial innovations that arose out of
the 1930s Depression. It
is a good guide to the influence
that economists and Central Bankers
can have on a post-recession
world.,
My comments are
on a company called Industrial
and Commercial Finance Corporation (otherwise
known as “ICFC”).
It was formed in the UK after
the 1930s depression. I have a soft spot for ICFC as
my father worked there after his undergraduate degree
at Wharton.
ICFC,
was,
in essence,
what we would
today call a “venture capital fund”.
It has since
evolved into 3i, a “private equity fund” and although I recognise the
difference
between the two types of institutions, the points that I
would
like to make in this presentation
are common to both “venture
capital” and “private equity” and so, for this reason, I will
refer
to the whole asset class
as “private equity”.
Private Equity consists of
equity investments in companies
that are not listed on a stock
exchange. For Africa,
this constitutes
the bulk of our corporate
sector.
Investment vehicles in the private equity sector tend to
be structured as limited partnerships
with a fixed life agreed upfront
(this is
typically seven to ten years, although allowing for possible
roll-over
(extension
periods)).
The partnerships comprise of
investors – typically
pension
funds,
university and family endowments
23 In this context, Ash Demiriguc-Kunt
and Ross Levine make the point that “Powerful banks frequently stymie innovation and competition.
Banks may extract
information rents from firms
and thereby reduce the incentives
of firms to undertake profitable
projects… Furthermore, powerful bankers may
collude with managers against other outside
investors and thereby thwart competition,
efficient resource allocation, and
growth.” Ash Demiriguc-Kunt and Ross Levine, Financial Structure and Economic Growth, pg 8. Also
see Raghuram G. Rajan, Insiders and outsiders:
The choice between informed and arms
length debt, (Journal of Finance 47 (4) (September 1992):
pgs 1367-1400.
16
and
rich
individuals – who are the “limited
partners” (LPs) and a fund manager,
referred to in the industry as the “General Partner”.
ICFC
was
an early predecessor
of today’s PE funds.
It carried out a function
of national
significance, intermediating between small-
and medium-sized business, the capital markets and the British
government.
When it was founded,
ICFC was envisaged
as a
long overdue response to the
1931 Report of the Committee
on Finance and Industry which
had been chaired by Lord Macmillan.24. The Macmillan
Report (as it was
known) highlighted what
it saw
as
the persistent failure of
the financial
markets and the banking system in Britain
to provide long-term investment
funds to smaller- and medium-sized companies.
This
market
failure
became known as the “Macmillan
Gap”. and there are parallels
to be drawn between the Report’s analysis of
post-1930s Britain and today. For me, the question is whether
the financial innovations which
arose
out of these debates
in the 1930s are relevant
and applicable today, particularly
across
Africa where the level of support that
the capital markets
give to industry is still in its
infancy.
The
years 2008 and 2009 are not the first time
that bankers have come under
criticism for the absence
of support to industry. Richard
Coopey and Donald Clarke
in their 1995 history of 3i make
the following observation:
“ The
relationship between the finance sector
and British industry has
come under a great deal of scrutiny
during the twentieth century.
As the British economy,
pre-eminent in the nineteenth century, has
been overtaken by successive
rivals, so
questions about
the role of the banks
and capital market in this relative
decline have been repeatedly posed.
There
are,
to be sure, a range of
other candidates for
the post of chief scapegoat
– including a growing anti-industrial
culture, the costs of being the first industrial power [etc] and a general
demise of scientific
and technical literacy. Nevertheless the City, which has become
colloquial shorthand for the financial
system in
Britain, remains one of the most
prominent
targets for
criticism”25.
What
was
the solution to this? Well,
interestingly,
government
intervention in the financial
sector
was contemplated
in a manner that sounds very contemporary –
very
2009! Again,
Coopey and Clarke make the point:
“ As the depression had deepened in the early 1930s, so
debate had intensified
over the causes of, and possible remedies for, protracted
economic
failure.
This debate included the fundamental
question of market forces
versus
some
form of state
intervention, and in this context attention began to be focused
upon the working of the financial
system in
Britain”.26
The Committee on Finance and Industry was set
up in November 1929, five months
after
the election of MacDonald’s Labour government, to inquire into “banking, finance
and credit” in Britain. The Macmillan Committee,
as
it came to be known, was chaired
by Lord Macmillan and included John Maynard Keynes27 and Ernest
Bevin. In spite of the wide-ranging remit of the Committee
and the breadth of its final
report, it became principally remembered
for
its identification of the Macmillan gap – a chronic shortage
of long-term investment
capital for Britain’s small-
and medium-sized enterprises28. What
the Macmillan Committee identified
as being
a capital
market
failure
in the UK is no different
from what we
should
expect to find across Africa
as a result
of the withdrawal of
different
forms of
capital from our industries. This
is further
exacerbated by the decline in internally
generated funds brought about by slower growth.
We
should not underestimate
the effect of the above on long term investment which
brings
me to my last and final point:
4.
I hope that one of the lasting
post-recession innovations in Africa is
a renewed
focus
on innovations which strengthen the capabilities within our
financial
sector
for long term investments. I
know a number of
you are Central Bankers and Although
you may
be focused on questions of disclosure
and regulation, I encourage
you to also look into the role that the Bank of England played in the
emergence
of ICFC29 and the problems that Economists such as Keynes addressed
through the deliberations of the Macmillan Committee. I
hope that you, and other professional
economists, will
look deeper into the role that the UK’s Central Bank played in encouraging the emergence
of this
important institution after the 1930s
Depression as a way
of addressing
market
failures
and the persistant lack of support
for
industry by the financial sector in Africa. An
institution similar
to ICFC
is an
important financial innovation.
Today, ICFC has evolved into 3i and plays a role well
beyond that confined to providing
finance to small and medium sized enterprises. The origins of
this institution, born out of the debates amongst
economists and policy makers in the 1930s should be of immediate interest to us as we think through
the post-recession innovations for today’s
world30. Will the 2008/2009 recession
lead
to
the creation of similar institutions, underpinned
by sound economics and by a clear understanding
of how
markets work? If so,
what role
can those of you here
play through your respective central banks
in encouraging the emergence of
these institutions
across Africa? I have a fear
that this recession will see
the re-emergence
of the
Development Banks
and an increase in the influence of the DFIs
with all the anti-market
practices associated with “development financing”. This
will be
the wrong response and I
hope that some of you will
do your best to see that this does
not happen.
The four points that
I have made in these concluding remarks will, I
hope
stimulate
some
thought. It is important that our Central Bankers31 and professional
economists don’t
sit on the sidelines as
observers during this
most challenging of times. I encourage you to use your
time at this conference to
think about the post
recession
world
and about your role in it. It is
an important role
which, to quote President Bush, should
not be “mis-underestimated”.
Thank
you.
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