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What was the need for the invention of Bitcoin, and what is its future?

Bitcoin

Bitcoin was the first cryptocurrency introduced back in 2008 at the time of the financial crisis. It is a digital currency designed by a very famous but mysterious entity known as Satoshi Nakamoto. In 2008, a white paper was released by Satoshi stating about the new digital currency, Bitcoin, as an electronic cash system that is decentralized in nature. Suddenly, after one and a half years of bitcoin invention, Satoshi got disappearing leaving the bitcoin community in disguise. No one knows his real identity, and after his disappearance, many controversies were made about Bitcoin and its underlying technology.

Many events that were around the invention of bitcoin remain a mystery after the disappearance of its invention. He left the entire bitcoin network in the hands of the bitcoin community. What do you think about Bitcoin, and do you consider that it has any real value? You can contact with Immediate Edge here app to learn more about bitcoin.

Let us learn more about Bitcoin.

Why was Bitcoin invented?

The housing market collapsed in 2008 at the time of the financial crisis, and not only Satoshi Nakamoto but the entire market was upset to see the results of this. Some people distrusted the government or any central authority and thought that there should be a currency independent of government. Bitcoin becomes the first cryptocurrency that was introduced with a combination of decentralization and cryptographic principles.

Bitcoin is decentralized in nature, which means that it doesn’t involve any centralized organization and is not regulated by any central authority. The value and market of bitcoin are controlled according to its demand and supply in the market. When someone says that bitcoin is a store of value, yes, it is invented to introduce the general public to a medium of exchange that doesn’t involve any third-parties and in which no user has to rely on trust.

What were the trust issues with centralized organizations or authorities?

If you have read about the white paper introduced in 2008 or know about it, Satoshi Nakamoto stated that the reason behind the invention of Bitcoin is to overcome the weaknesses that traditional monetary systems had. No doubt that banks were doing their work accurately, but banks keep a check on money to know that money is spent reasonably, which means mediating all the transactions. This incurs a plethora of expenses that are passed to users that they have to pay as fees.

Satoshi overcame this weakness and made transactions of bitcoin irreversible. Irreversible transactions eliminated the need or involvement of banks or any other central organizations. This also prevented fraudulent funds, which means retailers or vendors weren’t required to prevaricate sales by taking their customers’ or clients’ personal information. There was also double-spending, which means spending the same money twice, and Satoshi even found a solution to this issue. He used cryptography which means an amalgamation of computer science and mathematical theory, which no longer required bank.

Is there any future for Bitcoin?

The invention and regulation of bitcoin have given rise to illegal trade. Even the users who learned first about the potential of bitcoin were the dark web users. Illegal trade was carried out with bitcoin because bitcoin is the only digital currency that provides the feature of refund-protection and anonymity. Only after few years since the invention of bitcoin was it associated with illegal activities.

There are bitcoin users across the world, and the value of bitcoin that is currently in circulation has exceeded $1 trillion value as bitcoin with the main goal of replacing the valuable asset, gold, to be the best store of value. Despite the arguments made on Bitcoin, bitcoin is a far better store of value than gold which also depicts that the market value of bitcoin will be greater than the market cap of gold in the future.

The Bottom Line

Bitcoin wasn’t expected to maintain its position in this highly competitive market. Still, bitcoin’s unique features impressed people worldwide and have now entered the mainstream even though crypto analysts believe that bitcoin is the monetary system’s future. However, it is still difficult to say anything as of now because of its volatile market.

Shall bitcoin be considered a good investment?

Bitcoin Investment

A lot of opinions and controversies are going around bitcoin since the last decade. Some consider bitcoin a valuable asset, some as a digital currency, and some consider it a wastage of time that doesn’t involve government or any other central authority. In reality, it is difficult to predict the future of cryptocurrencies. Over time, cryptocurrencies like bitcoin have made their way to the mainstream and prove to be the best investment. Do you think investing in bitcoin is profitable? For more information you can click here

Let us learn about bitcoin investment.

Does Bitcoin make a risky investment?

Like investing in bonds and shares makes a speculative investment, investing in bitcoin also comes with many risks and challenges. The bitcoin market is highly volatile, and its price could drop anytime, and online hacking can change the value and reputation of bitcoin in seconds. The journey of bitcoin has been quite dramatic because of the striking rise and fall in the price. Despite its volatile market, it has consistently impressed people and made people earn a profit by investing and trading in Bitcoin.

Since the introduction of Bitcoin, it has become the first digital currency that is ruling the cryptocurrency world’s ecosystem. Even crypto analysts often believe that Bitcoin has a bright future, which grew the bitcoin’s craze. People believe that Bitcoin will replace the traditional monetary systems shortly.

How and where to invest in Bitcoin?

Some people consider an online broker to make the process of investing in bitcoin a straightforward one. Similar to investing in stocks and shares, bitcoin is no different, but the only major difference is that bitcoin has a volatile market, and its price fluctuates a lot. We are mentioning some of the steps that investors need to follow while investing in bitcoin through an online broker.

  • A broker can either be a trading platform or an exchange. Investors need first to find the right broker to invest in bitcoin. After that, open an account with that platform or exchange, or company that allows users to make investments in cryptocurrencies.
  • Link your bank account or debit/credit card and deposit funds through your bank account to your brokerage account.
  • After depositing funds to your account, you can buy Bitcoins or any other cryptocurrencies you wish to invest in.
  • By observing the bitcoin market through technical analysis, you can sell your cryptocurrencies to earn gain or loss.

After knowing the steps to invest in Bitcoin, let us move forward and learn about some top-notch brokerages through which investors can invest in Bitcoin.

Coinbase

Coinbase is one of the best platforms that allow its users to easily and safely buy, sell and store bitcoins. Users can easily buy bitcoins or other cryptocurrencies without requiring an amount to maintain in their Coinbase account. By linking your bank accounts or debit/credit cards, users can easily pay for their purchases and withdraw money to sell crypto tokens. Users only need to create their account with Coinbase, verify their identity through some documents, and easily buy crypto tokens.

Coinbase mobile app is also available for users who trade bitcoin daily, and users can easily take their investment everywhere. You can transfer your cryptos and can convert them into fiat currencies anytime and from anywhere across the world.

eToro

eToro is another amazing trading platform that allows its users to trade a large number of cryptocurrencies, connect with traders across the world and allow users to explore portfolios that are managed professionally. Currently, eToro supports the sale and purchase of many crypto tokens, including Dash, Litecoin, Ethereum, Ethereum Classic, Bitcoin, Bitcoin Cash, EOS, TRON coin, Ripple, and many more.

BitcoinIRA

It is a proprietary platform that enables its users to trade cryptocurrencies by analyzing the market properly. Users have to follow some steps to trade cryptocurrencies with BitcoinIRA that include: creating an account, transferring funds, and then begin trading. Investors can get access to their digital wallets and customized dashboards by creating an account at BitcoinIRA. After that, they can link their bank accounts to wallets and can easily start trading in cryptocurrency they wish.

A Complete Guide to Learn About Bitcoin!

Guide to learn about Bitcoin

Bitcoin is a digital form of decentralized money in nature that doesn’t require any intermediaries like the government or banks to approve the transactions. Earlier in 2017, bitcoin’s price reached sky for the first time but after 2020, Bitcoin’s value broker all the records and become the most valuable currency.

Investors and traders have gained massive profits by investing in bitcoin because of its highly volatile market. Undoubtedly, investors have earned huge profits, but there are times when bitcoin’s value had fallen down, and people lost all their funds. Making an investment in bitcoin is the riskiest, but it can provide greater returns on your investments if done with proper knowledge and understanding.

Let us learn every single detail about Bitcoin in this article.

What is Bitcoin?

Bitcoin is the most contemporary form of digital cash or asset known as cryptocurrency. It was introduced in 2008 during the financial crisis and was created by a mastermind entity named Satoshi Nakamoto. Satoshi designed Bitcoin with an aim to provide the general public a digital form of cash that is decentralized. Bitcoin is decentralized in nature which makes it utterly different from fiat currencies that are centralized in nature. Decentralized currency means it doesn’t need any intermediaries to complete the financial transactions. For more information you can visit BitQT App

Bitcoin is a digital currency that follows peer-to-peer technology, which makes the individuals or users the volunteers complete their transactions without the approval of any central authority. This currency is wholly based on blockchain technology that uses cryptography to provide anonymity to both sender and receiver. Bitcoin currency is backed by code instead of being backed by any central authorities or valuable assets like gold.

In 2008, people lost trust in banks and government and wanted a system that is not based on trust, and this led to the invention of Bitcoin that is based on cryptographic proof and not on anyone’s faith. A peer-to-peer network means it enables two parties to transact directly without requiring the need of any third-party.

How does the Bitcoin network work?

Basically, the Bitcoin network is a computer code, and bitcoin is a computer file that is stored in digital wallets. There are three main bases of bitcoin currency that will help us to learn its working that includes:

  • Blockchain

Blockchain is a shared public ledger that records all the bitcoin transactions. Each bitcoin transaction is grouped with another transaction, and that comprises a block that is chained into a chain of blocks known as the blockchain. With bitcoin, the world was introduced with blockchain technology, and as of now, around 6000 cryptocurrencies are built on blockchain technology. This technology is known as the heart of cryptocurrencies.

  • Public and private keys

A bitcoin wallet is a digital wallet that contains two digital keys known as the public key and private key. These two keys are used to initiate a transaction and are used to sign the transactions digitally. The private key is a secret key that must be protected from unauthorized access.

  • Mining

Mining is the process of verifying the bitcoin transactions and recording them on the blockchain ledger. The miners are the individuals who do hard work and use computing power to verify the transactions given a time of 10 minutes. For their hard work and efforts, the miners are rewarded with bitcoins as an incentive.

Should you invest in Bitcoin?

Bitcoin is a speculative investment, and investing in it requires a complete understanding of the bitcoin market and factors that affect the price of bitcoin. Bitcoin is considered a risky investment, but sometimes its volatile market can help you in earning massive profits. Investing in bitcoin is definitely a thrilling experience as you learn so many things and experience many emotions because it is a roller coaster ride.

Despite investing in bitcoin, there are many ways through which you can make money. There are many money-making methods that can help you to make money by investing a little in it which include mining, trading, investing, staking, buying and HODLing, and more. Before you enter into the bitcoin market, you must gain complete knowledge of its market and learn the factors that affect bitcoin’s market and price.

The Future of Digital Currencies in India

digital currencies in India.

By Stefan Newhart

Bitcoin, the largest and most popular cryptocurrency in the world, continues its upward path, recently going past the $55,000 mark and on its way to reaching $60,000 by the end of February. This is a stunning rise by all accounts, especially when you consider that the token was at around $6,000 a year ago. Even if we go back to just a couple of months ago, Bitcoin was trading at $22,000 in mid-December, which shows how sharp and quick its price increase has been. However, even with this rally drawing more and more people to put their money into cryptocurrencies globally, there are some countries where the authorities are proving to be less receptive towards crypto, and looking to restrict or ban crypto trading and ownership. One such country is India, where the government recently introduced a bill in Parliament, which, if passed, would outlaw cryptocurrencies in the country.

It is telling that this bill would also at the same time create the framework for the Reserve Bank of India, the country’s central bank, to begin developing its own digital currency. Thus, it seems that the government is aware of the benefits that digital currencies can bring, but does not want so-called ‘private’ currencies such as Blockchain and Ethereum operating in the country. It is surprising since Bitcoin and other cryptocurrencies are not ‘private’ since they are not owned by any entity. Cryptocurrencies are decentralized, which is the biggest reason for their existence – to create currencies which are not controlled by a single entity such as a central bank. Thus, a central bank digital currency (CBDC) such as the digital rupee or other similar projects being worked on globally, would not fulfill one of the central reasons why cryptocurrencies were created in the first place, and therefore there are doubts as to whether they could have anywhere near the same kind of success that the likes of Bitcoin have had.

The rise of cryptocurrencies has also helped various other sectors, and the impact of this has been seen in India as well. For example, online gambling, although largely illegal, remains a very popular activity in the country. This has received a boost through the use of cryptocurrencies, with the creation of a live bitcoin casino in India, for example. Such online casinos allow users to place bets through cryptocurrencies, and therefore give crypto owners a place to spend their tokens if they wish. This move has increased the popularity of such sites even further, and shows how crypto can transform the prospects of a sector, especially if those sectors primarily operate online.

In India, there is currently a lack of regulation for the crypto sector, which has created a grey area. Most crypto operators and exchanges are calling for effective regulation, which would lay down a framework for operations, as well as protect investors and traders, rather than a blanket ban. A ban would lead to a huge loss of investment in the country, not to mention the loss of wealth for those Indians who have money invested in crypto, which would effectively get stuck if crypto is banned. The need is for regulation that allows innovation to thrive as well, while having enough measures to protect users and prosecute bad actors and those trying to conduct fraud. A ban would also make India one of the few countries in the world where crypto ownership and trading would be banned, putting it out of step with the rest of the world, and possibly creating a flight of capital as well as Indians look abroad to try and continue their crypto trading and investment.

Cryptocurrencies are here to stay, and so it makes sense to work with this innovation and create conditions for it to thrive.

A perfect guide to choose a bitcoin wallet!

bitcoin wallet

Bitcoin is the most valuable digital currency, which means it has no physical appearance. It can neither be seen nor touched, which is an excellent feature but creates several issues when it comes to storing it. There are special digital lockers termed bitcoin wallets that you can use to store bitcoins safely. If you are willing to buy and sell a cryptocurrency, there is no better platform than BitBolt. There are different types of bitcoin wallets, but you must choose the one that suits the most to your needs and requirements. Some of the tips you need to follow while selecting a wallet are as follows.

Focus on security

A bitcoin wallet is used to store bitcoins and make transactions. There are several features that you need to focus on while selecting a bitcoin wallet, but the most important one is safety. You can overlook other features for once, but you cannot compromise on safety at any cost. There are different types of bitcoin wallets, and in each one of them, you need to consider different things to ensures that it is safe and reliable. For instance, if you are using web wallets, you must check its URL and ensure that it has HTTPS instead of HTTP. HTTPS refers to secure protocol which means it safe to use that wallet.

There are some other security features also that you need to check and one of them is two-factor authentication. Two-factor authentication means if anyone tries to access your bitcoin wallet, you will receive an authentication code that will alert you that someone is trying to sign in to your wallet. It is a fantastic feature and can enhance the security of your wallet to a great extent.

Ownership

If you are trusting a wallet to store your bitcoins with it, you must check it provides you access to them. Some bitcoin wallets don’t offer access to the private keys to their users, which means they have no control over the funds they have stored in it. It is a crucial feature to consider while choosing a bitcoin wallet as a single mistake can make you lose your bitcoins forever. So, you must if the wallet offers you complete control over the private keys or not. It is important to have free access to the private keys so that you won’t have to ask for any permission before making a bitcoin transaction.Moreover, if you have control over the bitcoins, you will be able to create a backup for them outside of the wallet.

Type

Another crucial thing to focus on while choosing a bitcoin wallet is the type. There are mainly two types of bitcoin wallets; hot and cold wallets, and you need to have complete knowledge about them if you want to pick the right one. A hot wallet refers to online wallets which allow you to access bitcoins and make transactions over the Internet. It is highly convenient to use, but as it is online, it makes it easier for hackers to attack hot bitcoin wallets. If you are looking for excellent security, you must go for the cold wallets as they are offline and protects bitcoins from all kinds of online risks such as hacking, phishing, etc.

Both types of bitcoin wallets have their own benefits and drawbacks, and you need to consider all their features and choose the one that fits perfectly to all your needs and requirements. If you prefer accessibility and ease of use, you must choose a hot wallet as it can be accessed from anywhere. On the other side, if you store bitcoins in bulk and make a big transaction, a cold wallet is the right option for you.

Backup options

If you have some knowledge regarding bitcoins, you must know that bitcoins are irrecoverable. In simple words, if you lose the private keys to your wallet, you will lose the bitcoins forever. So, to avoid this risk, you must create some backups for your wallet and store them in a safe place. It is the primary reason that makes it important to choose a bitcoin wallet that allows you to create backups. Along with the backup options, you must check the restoration options too and ensure that it is easy and simple to restore the lost bitcoins using the backup. You must check these options beforehand so that you won’t have to face any hassle at the last moment.

Addressing the Pandemic in the Philippines Necessitates a New Economic Paradigm

President Rodrigo Duterte

By Bonn Juego 

In his late-night Talk to the Nation on COVID-19 on 6 April, Rodrigo Duterte, the populist President of the Philippines, echoed the affirmation of leaders from rich countries in North America, Europe, and Asia: to do “whatever it takes” for the economy to survive the pandemic. The problem, however, is that, on his own admission, Duterte is incompetent in economics. His stubbornly militaristic mindset and police-centric approach to governance is even more problematic when dealing with complex developmental causes and impacts of the coronavirus outbreak.

Yet the Philippine state’s inadequate institutional capacity to respond to the epidemic goes deeper. Given the national economy’s position in the hierarchical global economic system, its structural weaknesses impacts on how effective the government’s response can be. The current mainstream approaches to resolve the pandemic and the multiple crises of capitalism would fail to address the convoluted historical process of maldevelopment of the Philippines. Thus, a radical political strategy with a new economic paradigm for post-pandemic reconstruction is needed.    

The Neoclassical Economic Team and the Missing Keynesians

On economic affairs, Duterte has relied on the “bright boys” of his cabinet – notably, Finance Secretary Carlos Dominguez III, newly resigned Socio-Economic Planning Secretary Ernesto Pernia, and former Budget Secretary and incumbent Central Bank Governor Benjamin Diokno. Although they are competent technocrats, being trained in neoclassical economics, their faith in market-oriented solutions does not provide the appropriate policy framework to contain the health crisis and economic downturn.

While Duterte’s political style may be characterized as populism, his administration’s economic policies are “very conservative.” Hence, his instruction to the Secretary of Finance to generate funds through any means possible to sustain the beleaguered economy is to be carried out on the terms of neoclassical macroeconomic theory. A core operating tenet of this orthodox economic policy is that fiscal space (i.e. room in a government’s budget) is a prerequisite for government spending, even when an expenditure is on purposes such as securing the well-being of citizens during a pandemic. It undermines a basic Keynesian macroeconomic reality that the government generates income through spending — which, in turn, increases the state capacity to provide for the needs of the population. Neoclassical macroeconomics also claims that a government is constrained by revenues, and that the capability of a state is reduced to its financial position. It therefore disregards the possibilities for the state to exercise political will over economic policy instruments and the scope for a government to mobilize the country’s real resources. 

Unfortunately, voices from Filipino critical, heterodox, or post-Keynesian economists are hardly heard in public debates when their intervention is most urgently needed. 

MMT and Monetary Sovereignty

At this period of great uncertainty with a recession looming, the Philippine government may test Modern Monetary Theory (MMT) as a viable macroeconomic strategy to manage the pandemic crisis. MMT is applicable to a sovereign state like the Philippines with a central bank that issues the country’s own currency and a floating exchange rate regime that is fully integrated into the fiat monetary system of the contemporary world-economy. A fundamental principle of MMT is “monetary sovereignty,” which suggests that the state creates money. Hence, the Philippine peso is the creature of the Philippine state. 

The direct transfer of cash to the public and other targeted social support schemes are now being undertaken by state agencies, cities and municipalities across the Philippine archipelago on the basis of local ordinances and the Social Amelioration Program provided for under the Bayanihan to Heal as One Act. This may be construed as an implementation of MMT insofar as it shows that the government does not face financial constraints when printing and issuing its currency to distribute to the population for local consumption of goods and services.

Contrary to Duterte’s alarmist pronouncement, the government cannot run out of money for this purpose of transferring or handing out cash to the needy and insecure population simply because the Philippine state has sovereignty over the issuance of the peso and a national central bank (the BSP – Bangko Sentral ng Pilipinas) controlling monetary policy. At the moment, the Philippines also has a relatively stable credit rating and a sustainable level of external debt. Through legislation by the Senate and the House of Representatives, the Executive can instruct the BSP to issue money or credit bank accounts without draining the nation’s reserves. In today’s modern monetary system, this may be done digitally. 

By following the MMT, the Philippine government can take the perspective that the state issues — rather than merely spends — money. As such, the state is not like the typical private individual or household, whose spending is limited by its savings. Being the monopoly issuer of its own currency and the sole taxation authority, the state can always credit a bank account to make a domestic payment. The government cannot be insolvent; but it can default if it chooses to do so. An option for the government is to make a self-imposed debt limit, and for a developing country, in particular, it should be strategic with its foreign borrowings and avoid piling up external debt burden.  It is imperative not to deepen unnecessary external indebtedness of the government for expenditures and programs that can be covered in local currency during this expectedly protracted economic hardship. The substantial increase in government debt now due to deficit spending and external borrowings will still have to be addressed in the post-crisis management of the economy. There is a danger that these deficits and debts would be managed through austerity and deep cuts in state expenditures if neoliberal officials are elected in government or appointed in the bureaucracy in the future.

Mobilizing Finance, Real Resources and Labour

In addition to the macroeconomics of MMT, the Philippine government may also implement universal basic incomes and related social protection programmes, notably the provision of food and other needs for subsistence of households while on lockdown and community quarantine, to ensure cash flow for individuals and families, support reproductive life, and encourage both productive and creative work. But these financial assistance would not go far enough. In war-like economic conditions such as the COVID-19 pandemic, Keynes would remind us that the technical problem of finance (i.e., the making and issuance of money to spend for necessary expenditures) can be solved easily. The more crucial problem for the time being is the mobilization of resources, when not just the demand- and supply-side problems come in to play, but also where there is an organizational requirement for the government to deliver public services efficiently and effectively.

The key to a strong economy has always been its productive capacity. During the pandemic, the mobilization of finance should come with shifting and mobilizing the country’s real resources. It is vital that the government’s pandemic response is comprehensive with a view to the action plan for economic and social changes over the immediate and long-term.

The greatest—yet underutilized—assets of the Philippines are the labour of its people. Acting as an employer-of-last-resort, the government should create jobs and facilitate employment in activities that are currently most strategic (e.g., in healthcare, scientific research, farming, education, information technology, retail and food sectors, construction and infrastructure, sanitation and other public services). Give jobs at a living wage up to a point of full employment and open opportunities for livelihood. Legislate labour laws to reduce working time to what is just and socially necessary so as to observe a natural balance between work and leisure.

In essence, this emphasis on the strategy of job creation even in a time of a pandemic comes from a particular sensibility of labour as a creative and productive source of social and economic value. Labour is the lifeblood of the human economy and society; whereas the capitalist system depends its survival and reproduction on the real subsumption of labour to capital and on the market exchange for profits. Here, Marx’s argument comes to mind: “Every child knows a nation which ceased to work, I will not say for a year, but even for a few weeks, would perish. Every child knows, too, that the masses of products corresponding to the different needs required different and quantitatively determined masses of the total labour of society.”

Paradigm Shift for a New Economy

The biggest constraint, however, to any progressive economic response to the pandemic is the longstanding hegemony of neoliberalism that has resulted in the tragic underdevelopment of and tremendous inequalities in the Philippines. From crony capitalism during the Marcos dictatorship in the 1970s–1980s to the succeeding 30 years under different administrations with essentially elitist liberal-democratic institutions, the neoliberalization process in the Philippines has favoured the ideology of trade liberalization over industrialization, localized agricultural innovation, agroecological transformation and food self-sufficiency. For decades, the country’s economic managers and free-market ideologues have made Filipinos consent to the idea that it is much cheaper to import manufactured goods, rice and other agricultural products than to protect and nurture the nation’s manufacturing industry, agriculture, farmers and food system.

The macroeconomic techniques offered by MMT and Keynesianism may prove effective for the Philippine government to keep the economy dynamic. But utilizing them requires strict adherence to the principles of democracy and integrity in governance.

On top of adopting the perspectives of state money, labour and democracy, there is need to redefine the role and restructure the responsibilities of the central bank in a way that contributes to a coordinated economic and social reform process—specifically to strengthen the domestic industry, manage the terms of trade, and institutionalize redistributive welfare programmes. To this end, “inflation targeting” should not be BSP’s primary regulatory function and monetary policy goal. Though central bank’s independence should be guaranteed, it must not be made immune from democratic accountability.

It is particularly important in the wake of the pandemic that economic policies be used as instruments of social justice to build conditions for a new economy, rather than the recovery of the grossly unjust and highly unequal existing order. The synergy of economic activities between rural and urban areas must be organized sustainably to attain the geographical development objectives of dynamism with equity. Importantly, to genuinely enforce progressive taxation, the government and the active citizenry have to collectively value every labourer’s contributions to the socio-economy, reassess the ethics of inherited wealth, and dismantle rentier capitalism.

Indeed, the ongoing health, economic and existential crises ought to be taken as an opportune moment to push for a shift in our thinking about the normative workings of the economy, the significance of addressing systemic inequalities, and the moral value of human dignity and every human life.

Paradigm shift now, and change shall come. 

The article was first published in the Developing Economics

About the Author

Bonn Juego teaches international development studies at the University of Jyväskylä, Finland. He has also held research fellowships and external lecturer appointments at the Universities of Aalborg, Copenhagen, Helsinki, and City of Hong Kong. He has authored numerous articles, recently including themes about authoritarian neoliberalism, populism, the political economy of Southeast Asia, sports capitalism, global justice movements, alternative futures and the social commons. @BonnJuego

Commentary: Lessons from Estonia, the world’s most digitally advanced nation

digital

By and

The digitalisation of public services saved the government more than 1,400 years of working time and allowed the nation to surpass the US in its struggle against election meddling, say observers.

People around the globe have been watching the build up to the US election with disbelief.

Particularly confusing to many is the furore over postal ballots, which the US president, Donald Trump is insisting will lead to large-scale voter fraud – despite a complete lack of evidence to back this.

And yet this issue has become a central feature of the debate.

Citizens of Estonia, a small nation in the Baltic region, will perhaps be particularly perplexed: Since 2005, Estonians have been able to vote online, from anywhere in the world. 

Estonians log on with their digital ID card and vote as many times as they want during the pre-voting period, with each vote cancelling the last. 

This unique technological solution has safeguarded Estonian voters against fraud, use of force and other manipulations of remote voting that many American voters are apprehensive about in the 2020 US election.

Voting online is just the start. Estonia offers the most comprehensive governmental online services in the world. 

Leading the World as a Digital First Nation

In the US, it takes an average taxpayer with no business income eight hours to file a tax return. In Estonia, it takes just five minutes. 

In the UK, billions of pounds have been spent on IT, yet the NHS still struggles to make patient data accessible across different health boards. 

In Estonia, despite having multiple private health service providers, doctors can collate and visualise patient records whenever and wherever necessary, with consent from patients – a real boon in the country’s fight against coronavirus.

Branding itself the first “digital republic” in the world, Estonia has digitised 99 per cent of its public services. 

And, in an era when trust in public services are declining across the globe, Estonia persistently achieves one of the highest ratings of trust in government in the EU. 

The Estonian government claims that this digitisation of public services saves more than 1,400 years of working time and 2 per cent of its GDP annually.

People prepare to vote in the 2019 Estonian parliamentary election, when 43.8 per cent of all participants voted over the internet.

Taxify
Taxify CEO Markus Villig shows a smartphone app at company’s headquarters in Tallinn, Estonia, June 13, 2017. Picture taken June 13, 2017. REUTERS/Ints Kalnins

The foundation of this digital republic dates back to 1997, a time when only 1.7 per cent of the world population had internet access, a start-up called Google had just registered its domain name and British prime minister John Major was celebrating the launch of 10 Downing Street’s official website.

Meanwhile, the government of the newly formed state of Estonia envisaged the creation of a digital society, where all citizens would be technologically literate and governance would be paperless, decentralised, transparent, efficient and equitable. 

Making the Internet a Human Right

The young post-Soviet government decided to ditch all communist-era legacy technologies and inefficient public service structure.

In a radical move, the government – which had an average age of 35 – also decided not to embrace western technologies. 

Neighbouring Finland offered an analogue telephone exchange as a gift and the Estonian government declined, envisaging communicating over the internet rather than analogue telephone.

Juri Ratas
FILE PHOTO: Estonia’s Prime Minister Juri Ratas leaves after a meeting with Britain’s Prime Minister Boris Johnson at Downing Street in London, Britain, August 6, 2019. REUTERS/Peter Nicholls/File Photo

The government of Estonia launched a project called Tiigrihüpe (Tiger Leap) in 1997, investing heavily in development and the expansion of internet networks and computer literacy. 

Within a year of its inception almost all (97 per cent) of Estonian schools had internet access and by 2000, Estonia was the first country to pass legislation declaring access to the internet a basic human right. 

Free Wi-Fi hotspots started being built in 2001, and now cover almost all populated areas of the country.

The government also understood that, in order to create a knowledge based society, information needs to be shared efficiently while maintaining privacy. 

This was a radical understanding, even in the context of today, when for most countries, data sharing among different organisations’ databases is still limited. 

It is predicted that by 2022, 93 per cent of the world’s total data collected or stored will be such “dark” or siloed data.

Bitcoin
Semiconductor giant TSMC says cryptocurrency mining, which requires a lot of computing power, will be key driver for growth (Photo: AFP/JACK GUEZ)

Two decades ago, in 2001, Estonia created an anti-silo data management system called X-Road through which public and private organisations can share data securely while maintaining data privacy through cryptography. 

Initially developed by Estonia, the project is now a joint collaboration between Estonia and Finland.

A large number of Estonian government and financial institutions using X-Road came under cyber-attack from Russian IP addresses in 2007. 

This attack made clear how vulnerable centralised data management systems are, and so Estonia required a distributed technology that is resistant to cyber-attack. 

Addressing this need, in 2012 Estonia became the first country to use blockchain technology for governance.

Deploying Blockchain Protection

Distributed ledger technology, commonly known as blockchain, is the underpinning technology of the cryptocurrency Bitcoin. 

The technology has moved on significantly since its inception in 2009 and is now used for a variety of applications, from supply chains to fighting injustice.

Blockchain is an open-source distributed ledger or database system in which an updated copy of the records is available to all stakeholders at all times. 

Due to this distributed nature, it is almost impossible for a single person or company to hack everybody’s ledger, ensuring security against cyberattacks.

Deploying blockchain technology not only ensures protection against any future attacks, but also poses many other benefits to Estonians. 

For example, in most countries citizens have to fill in many different forms with the same personal information (name, address) when they need to access public services from different government agencies. 

In Estonia, citizens only need to input their personal information once: The blockchain system enables the relevant data to be immediately accessible to the required department.

This might scare people worried about data privacy. But citizens, not the government, own their personal data in Estonia. 

Citizens have a digital ID card and approve which part of their information can be reused by which public service. 

A man holds a laptop computer as cyber code is projected on him in this illustration picture taken on May 13, 2017. (Photo: REUTERS/Kacper Pempel)

Estonians know that even government officials can’t access their personal data beyond what is approved by them for the required public service. 

Any unauthorised attempt to access personal data will be identified as invalid: Indeed, it is a criminal offence in Estonia for officials to gain unauthorised access to personal data. 

This transfer of ownership and control of personal data to individuals is facilitated by blockchain technology.

This should be an inspiration for the rest of the world. It is true that most countries do not have similar circumstances to post-Soviet Estonia when the Tiger Leap was introduced. 

But the same futuristic mindset is required to address the challenge of declining trust.

This commentary first appeared in The Conversation.

About the Authors

Dr Imitiaz Khan

is a Reader (Associate Professor) in Data Science at Cardiff Metropolitan University and leads the Data Science and Artificial Intelligence Lab, where he is currently supervising blockchain focused PhD studentships investigating different approaches of utilising blockchain technology – to ensure the data integrity of 4.5m VAT registered companies in UK (with Companies House); to identify fraudulent activities in cryptocurrency transaction using artificial intelligence (with Coincover); to establish a blockchain and smart contract based marketplace for digital health records (with Balsamee). Imtiaz also founded the Hub for Distributed Technologies and Future Societies at CardiffMet – a multidisciplinary research hub incorporating academics from four different schools to investigate the adaptation and impact of distributed technologies like blockchain on future society.

Ali Shahaab

is a PhD candidate at Cardiff Metropolitan University. His research focuses on the feasibility of Distributed Ledgers (DLTs) and Blockchain Technology to guarantee the integrity of Companies House UK data. Key areas of his research are DLTs frameworks, security, privacy and immutability aspects of DLTs and Blockchain as well as legislative and deployment challenges. He also has a passionate interest in utilising blockchain technology to solve real world issues around trust, transparency and identity. Having MSc in advanced computer science from University of St. Andrews, UK and BS in Computer Engineering from Comsats Islamabad, Pakistan, Ali has a strong grip on software systems, distributed computing, cryptography and information systems.

The Importance of Industrialisation in Developing Countries

Industrialisation to Developing Countries

By Dr. Kalim Siddiqui

I. Introduction

This article also draws upon the East Asian economies’ abilities to allocate resources to stimulate industries and technological development. Despite differences in economic performance, East Asia including China has hugely transformed in the last mere four decades from being very poor, to achieving higher economic growth and incomes, and most of all reducing unemployment and poverty. The big question for academics and social scientists is how was this success achieved in such a short period?

The well-known, Ricardo’s trade theory of ‘comparative advantage’ is the primarily cost-based theory, but it ignores the historical development of industries in the developed countries. His trade theory explains very little about the factors behind the successful move towards industrialisation by some latecomer countries (Siddiqui, 2018d; see 2017c). More recent trade theories, for example, Krugman (1979) and Findlay (1978) acknowledge the important role of technological transfers in order to achieve higher incomes. They note that those developing countries, which have successfully been able to establish industries and advancements in technology thus catch-up with developed countries by adopting the latter’s technology. This is the same argument put forward by Vernon’s life cycle model (1966), which emphasises that the cost of production is a critical factor behind the choice of production moving to developing countries. It is claimed that the industries would shift at the later stages of the product life, from developed to developing countries, and then the developing countries could gain access to advanced technologies and know-how. As a result, this could trigger a process of expansion of manufacturing.

At present, China has emerged as the world’s second largest economy in gross domestic product terms.

It is argued here that the idea of industrialisation is still valid, feasible and relevant for developing countries. The state intervention policy attempted to improve the business environment or to alter the economic structure towards high-value manufacturing sectors. Soon after independence from the European powers, there was a general consensus among the developing countries until mid-1980s that industrialisation is associated with overall economic advancement and would improve the living conditions of their inhabitants. However, such policy aim became less important due to the debt crisis and pressures from transnational companies who were looking for global market integration to increase their profits (Siddiqui, 1996b).

At present, China has emerged as the world’s second-largest economy in gross domestic product terms. Only forty years ago, China was one of the poorest economies prior to its economic reforms. Understanding China’s policy direction can provide a deeper understanding of this rapid transformation and the lessons it offers to other former colonies or semi-colonial countries (Siddiqui, 2019b; see 2015d). In 1978, Deng Xiaoping launched gradual economic reforms in China to depart from a state-controlled economy. While until 1800, Imperial China was a dominant economic power, its economic growth started to stagnate and decline (Maddison, 2001). Marco Polo (1254-1324) was an Italian traveller, who travelled to Asia from 1271 to 1305 and stayed in China for 17 years, where he joined a diplomatic mission to the court of Kublai Khan, the Mongol leader whose grandfather, Genghis Khan, had conquered Northeast Asia. Marco Polo was the first European to publish a detailed account of Chinese society and its economy. He vividly described what he saw in Asia as a very highly developed civilisation. Others like North African traveller Ibn Battuta (1304-1368) and historian Ibn Khaldūn (1332-1406) also published a detailed account of their journey to Asia and South Europe during the fourteenth century. However, in China the Qing Dynasty was unable to industrialise like Britain and other West European countries and its power was further undermined by a lack of sovereignty to pursue independent economic development as a result of two opium wars and the imposition of unequal treaties by British and French armies (Siddiqui, 2020a; 2020b).

Apologists for the European Empire portray colonialism, the slave trade, European control over resources, and the undermining of sovereignty in Asia, Africa and Latin America as a positive development that transformed these societies and economies. Although defending colonialism is no longer popular, a few apologists still have nostalgia for the British Empire. For instance, Niall Ferguson (2003) tried to discover positive aspects of the British Empire. It seems to indicate a lack of knowledge and ignorance of what did in fact happen in the colonies during the colonial rule. The glorifying of colonial rule, and racial supremacy, is nothing new and was a widely spread myth during the Victorian period (Siddiqui, 2019a; 2009b).

During the reign of Aurangzeb, India was the world’s largest economy, worth over 27% of global GDP, and controlled nearly the entire Indian subcontinent. His rule lasted nearly 50 years (1658-1707), and he was the last great Mughal emperor of India. The British Raj in India was disastrous. In 1700 when a British trading company (i.e. the East India Company) was established in India, India’s share of the world’s GDP was 27% and the British share was merely 1.8%, but by the time the British left India after 200 years of the British Raj, India’s share had plummeted to as low as 3%, while Britain’s rose to 10% of the global GDP in 1947. (Siddiqui, 2017b; 2014) Hence Britain became a prosperous country by impoverishing India. Britain took over the richest country and in 200 years of her rule transformed India into one of the poorest countries in the world. Britain achieved this through a number of measures such as dismantling Indian handicraft industries, raising land rent, expropriating India’s wealth as so-called ‘tribute’ charges, and draining India’s resources to Britain (Siddiqui, 2019a). As a result, Britain became a world-leading economic and military power, and the exploitation of India financed the rise of Britain (Bairoch, 1993; Siddiqui, 2020c).

Economy of China

Indian textiles, for example, were one industry that was ruined. In 1800 India’s share of the world trade was 23%, but by the time British rule ended, trade was totally destroyed and India became specialised in the export of raw materials. The Indian market was flooded with British industrial goods and a tariff was imposed in Britain on Indian textiles, while the tariff on British goods coming into the Indian market was removed. Similarly, India’s steel and shipbuilding were destroyed to make way for imports from Britain. The building of railways was the biggest scam. The purpose of railways was to transport armies and bring raw materials from the interior regions to the coasts, and take British manufactured goods to the interior regions of India. The costs of building railways were very high and the British investors were given guaranteed the highest returns paid by Indian taxpayers. The de-industrialisation led to a rise in the rural population and at the same time, land rent charges were raised from pre-colonial rates of 15% to as high as 45% of the agricultural output, which resulted in increased rural indebtedness and occurrences of famines with greater velocity (Siddiqui, 1996a). By the end of the 19th century, India was Britain’s biggest source of revenue, the worlds’ biggest purchaser of British industrial goods, and the largest source of British high-paid employment at India’s cost.

During the 19th century, the rate of economic growth was very slow everywhere and the differences in living conditions and consumptions of the inhabitants in different countries were comparatively small. However, with the emergence of the industrial revolution, in particular, some countries began to grow exceptionally high in terms of GDP, while others were left behind. A further rise in growth rates was achieved with the establishment of large-scale manufacturing industries. Those who had accumulated more capital and could invest began to develop monopolies and thus could successfully charge higher prices. For example, by 1880, Britain produced two-thirds of the world’s total manufactured goods and was a global superpower. Commenting on the expansion factories in England, Kaldor (1977:196) notes: “For the very system of ‘factory production’ gave a continued and powerful incentive and installation of ‘bigger and better machines’, which were increasingly labour-saving and able to produce goods on an ever-increasing scale. It also gave a continuous incentive for the invention of new products, of new processes, and for increasing specialisation in the making of parts and components”.

Industrial growth also depends on the growth of ‘outside’ demand, which is partly the result of increased market penetration at the expense of other countries’ industries, or small scale pre-capitalist, and in the agriculture sector, partly due to a rise in farmers’ productivity and incomes so they could buy industrial products. The rate of industrial growth depends on the rise of markets for industrial goods outside the industrial sector. The rise in export markets of British manufactured goods from the beginning of the industrial revolution greatly contributed to its industrial development, which could also be called export-led growth. As Kaldor (1977:200) further emphasises: “Britain, being the first country to manufacture goods in factories on a large scale, was able to increase her exports at a fast rate, partly at the expense of other exporting countries (such as France), but largely by competing successfully with small local producers in other countries. The growth of exports of British-made cotton goods to India and China in the 19th century meant a severe shrinkage of local small-scale enterprise – the virtual disappearance of locally made hand-woven cloth – without any compensation in the form of alternative employment opportunities for the people displaced. With the transport revolution, vast areas became accessible to trade, and regions previously self-contained were increasingly drawn into the network of the world economy.”

The ‘forced specialisation’ during the British colonial period created mass poverty and ruined local handicrafts in the colonies to create markets for British industrial goods. Mainstream economists have failed to present the underlying causes of developed countries keeping some countries economically backwards. As Storm (2015: 669) notes: “Development economics appears to have fully come to circle, as interest in and concern for industrialization have made a comeback, echoing major concerns of the early development economists. However, when it comes to the practice of industrialization strategy and industrial policy, the default recommendation is still the market and static comparative advantage – the main task of governments is to impose institutional reforms and improve governance so as to allow markets to perform more efficiently.”

II. Literature Review

The neoclassical economists had nothing to say about the very pertinent questions which occupy the minds of economic historians: why do some countries or regions grow relatively fast while others remain backwards or stay poor? The division of the world into rich and poor countries is, I think, considerably important because it creates misunderstandings and prejudice about the poor countries. In fact, the division of the world into rich and poor countries as exist today is a recent phenomenon in our long human history. In the last three centuries, differences in rates of economic growth only emerged with industrial capitalism, first in England in the last decade of the 18th century, also known as the industrial revolution. The primary sources of capital were profits from the slave trade and colonisation. With the availability of huge capital accumulation, the country was able to invest in defence, education, technology, and thus could control global resources and markets.

Why did certain countries industrialise and become richly endowed with capital and technology and therefore move towards a higher standard of living? The answer is, in England by the 1780s traders and merchants became very powerful due to the development of overseas trade, following the colonisation of North America and Bengal province in India. The other crucial factor which contributed to the industrial revolution in England was agrarian changes i.e. in the form of new crops, the adoption of new methods of agricultural production, and ‘Enclosures Acts’ of Parliament, where the landlords were given possession of land by depriving the peasants of their traditional common lands. The ‘enclosed lands’ were cultivated as much larger units and by using new production techniques; this also cleared the way for increased commercialisation of agriculture. The increased agricultural surplus was sold in the market and those peasants and tenants who lost their traditional means of support were expelled from the land and forced to find employment outside in the cities, i.e. as Karl Marx described it ‘by selling their labour’ i.e. labour itself became a commodity.

Between 1845 and 1874 Britain experienced a dramatic rise in industrial production and this was also the period in which its share of the world’s trade in manufactured goods was at its highest. In fact, the birth of modern industries gave Britain a strong competitive edge over other countries in the first seventy years of the 19th century, as it faced virtually no real challenges to its supremacy in manufacturing and also in military strength after Napoleons’ defeat in 1815 at the battle of Waterloo.

Historically, the development of capitalism in Britain from the early 18th century as the merchant and bank capital had invested heavily in colonial and overseas operations, including slavery, which was backed by the state and the navy. And by the end of the 18th century, industries began to develop, and industrial capital emerged, which was detached from the City of London based on nexus of merchants, bankers, and aristocrats. However, this had disadvantaged manufacturing ever since and the bankers and traders were unwilling to lend to manufactures and these financiers always had been interested in overseas. In contrast to Germany and Japan, where there has been a close relationship between banks and industry. However, in Britain, the industries have had to rely their financial needs on the stock exchange and have had to pay high dividends to shareholders. From the late 19th century the rentiers and speculative capital were reinforced by the development of large urban property estates on high commercial rents and they were closely connected to banks. Also, the exchange rate and monetary policy have been geared in the interests of financial capital. In fact, the exchange rate has been kept at a high level for manufactured exports and interest rates tend to be set high, which produced a chronic deflationary bias, which undermines productive investments (Siddiqui, 2018a; 2015a).

The development of capitalism in Britain from the early 18th century as the merchant and bank capital had invested heavily in colonial and overseas operations, including slavery, which was backed by the state and the navy.

In 1900, nearly 50% of the total British capital was invested abroad, which still continues. As Norfield notes: “in 2013, Britain had the second-largest stock of foreign direct investments [after the US]… Among the top 500 global corporations in 2011…the UK was in second place behind the US, with 34 companies…Of the world’s top 100 non-financial corporations in 2013, ranked by the value of their foreign assets, 23 were US companies, 16 were British and 11 were French, while Germany and Japan each had ten.” (Cited in Calinicos, 2016) After, World War I, despite Britain’s imperial decline, but still it was able to maintain the power of the City of London. And after World War II, the country created tax havens for rich foreigners.

However, later on, due to the continuous loss of foreign markets caused by the growth of industries namely in France, Germany, the US and Japan, British export markets gradually not only declined but also faced increasing competition. These countries utilised the same protective tariffs and other forms of state support as Britain had adopted a century earlier. In the past, advanced economies relied heavily upon government intervention to promote manufacturing and adopted protections of their domestic industries. This included Japan, which escaped colonisation and thus was able to create a path towards industrialisation suited to its needs (Siddiqui, 2015a; 2009a).

In the US, soon after independence from Britain in 1776, there was a discussion among politicians and academics regarding whether the US should undergo industrialisation and produce locally, or buy manufactured goods from Britain. Those with large plantations and big landowners supported focusing on agricultural exports and importing manufactured goods from Britain and such views had also support in Britain. While the critics argued in favour of setting up manufacturing, which they saw as a difficult task in the short-term, but in the long-term, such a policy would provide long-term economic development. They argued that it would have a positive impact not only on industries but also on the agriculture sector and overall productivity, and moreover, industrialisation would make the US a sovereign and economically independent country.

For instance, in the early phase of the development of industries in England, in 1721, British Prime Minister Robert Walpole adopted a number of economic policies to transform the country from an exporter of raw materials into an industrially advanced nation. He brought in legislation to protect and support domestic industries from foreign competition and supported local industries through export subsidies. He also raised tariffs against manufactured imports and banned exports of raw materials and skilled workers leaving the country. Walpole’s economic policy then was not in support of an ‘open market’ and free trade but in support of the protection of domestic industries. However, once Britain’s manufacturing sector developed and became competitive, it had entirely different plans for its colonies in North America and India. As Girdner and Siddiqui (2008: 9-10) notes: “In India too, colonial authorities forced the country to specialise in the production of raw materials such as cotton, jute, opium, tea and so on, Britain banned cotton textile imports from India (calicoes) which were then superior to the British ones…. Successive British governments charted policies in the colonies so that the countries they ruled specialised in the production of raw materials and thus were unable to become competitors with British manufacturers”.

III. The Political Economy Approach

Those who study political economy seek to understand how history, culture, and politics impact economic performance and overall economic development. It also takes into account the international impacts on local economies. The international political economy is ultimately concerned with how political forces influence economic policy structures, and how institutions shape systems through global economic interactions and affect a country’s economic performance. The importance of economic, historical and international factors in attempts to build manufacturing, has been emphasised by researchers such as Myrdal, Baran, Kalecki, Hirschman and Kaldor. (Siddiqui, 2021a; 2018b)

Neoclassical economists explain the expansion of competition through markets and resource scarcity as integral points. Their theories ignore the global power structure and assume the existence of competitive markets in international trade, which is far from the truth. Thus, they are unable to present an explanation of why some countries are rich and powerful, while others remain poor and powerless. Why did the poor countries need to specialise in whatever they could produce at lower costs, which is known as ‘comparative advantage’, to correct their imbalances?

The classical developmental theory defined growth as ‘structural change’ which was backed by Prebisch and Singer’s thesis on the long-term deterioration of the terms of trade against developing countries, due to dynamic economies of scale being more prominent in the manufacturing sector (Siddiqui, 2012a; Siddiqui and Armstrong, 2017a). When manufacturing grows it also creates spill-over effect on other sectors and economic diversification becomes faster. Kaldor (1966) demonstrated the close relationship between long-term growth and structural change, which is known as ‘Verdoorn Law’. According to it, faster growth in output increases productivity due to increasing returns. Productivity growth is the key to economic development. Kaldor’s study on the relative stagnation in the British economy in the 1960s-70s, where he compared British economy to other developed economies and points out that the aggregate labour productivity depends largely on manufacturing output growth. He stresses that the relationship between labour productivity and output growth should be interpreted by the performance of the manufacturing sector. As Kaldor (1966: 106) noted: “productivity tends to grow faster, the faster output expands; it also means that the level of productivity is a function of cumulative output (from the beginning) rather than of the rate of production per unit.”

Economic development requires the transformation of the productive structure, which was mainly achieved in the past through industrialisation.

For the contemporary developing countries, the stimulus of industrialisation came after their independence, from state intervention in the forms of high tariffs or severe quantitative restrictions on imports. This policy made it profitable to develop home industries in substitution for imports, but by the mid-1970s and 1980s, the slow growth of either the export or agricultural sector put a constraint on markets, and thus the basis for the sustained growth of industrial production was missing, as a result the ‘Import Substitution Industrialisation’ possibility was exhausted (Siddiqui, 2018a).

Economic development requires a transformation of the productive structure, which was mainly achieved in the past through industrialisation. It means promoting structural change from the production of low-value to high-value commodities, and to achieve it, industries could play a vital role. Historically, rapid economic growth and improvement of economic conditions have been associated with the expansion of manufacturing. (Siddiqui, 2015b; 2015c) For example, past experience tells us that the economic development and creation of accumulation depends on the use of knowledge, technology and innovations to increase output and productivity per worker. It also depends on investment, particularly by the government through the use of fiscal policy, as happened during post-war Europe, when the state not only nationalised key industries but also increased funding in research and development of new technologies. It certainly did not leave these crucial aspects to the private sector only, as it is now advising to the developing countries.

IV. Industrialisation in East Asian and Latin American Countries

Why state intervention and the promotion of infant industries were successful in East Asian, but not Latin American countries? The development of the auto vehicle sector in the East Asian economies, for instance, had been strongly supported by the state. South Korea began with small-scale assembly plants and within less than two decades, the country was able to develop a competitive auto sector (Amsden, 2001). As Jenkins (1995: 627) notes: “The two key transactions in the development of the automobile industry have both (South Korea and Taiwan) involved a high degree of state intervention. The crucial form of state intervention in the transition to manufacturing in all countries was the setting of local content requirements for firms that wished to produce locally while giving them substantial protection from imports….. the state also intervened to limit the extent of foreign ownership in the industry. Government intervention also occurred at various times to attempt to rationalise the industry by preventing new entry, encouraging mergers, rationalising production or reducing the number of models in existence.”

Successful industrialisation in East Asian economies seems to have a clear vision where new combinations of productive resources, technology, and a favourable international climate successfully transformed the region during the Cold War. It appears that the state policy in East Asia shaped educational and skill development systems along with capital to generate R&D within increasingly productive enterprises (Siddiqui, 2012b; 2010).

In the 1960s, East Asian countries promoted labour-intensive industries such as footwear and textiles, and gradually shifted from agriculture to manufacturing with a strong potential for productivity growth (Economist, 2010).  Their governments realised the significance of the industrial sector for their economies, which continued to deepen over the period. By 2015, East Asia and China had a significantly higher share of manufacturing value-added than other regions (Siddiqui, 2019c). As the heterodox economist Fransman (1984:11) observed: “Technology and technological change are not autonomous forces exerting uni-directional effects on society and neither are they neutral … transcending existing social and theoretical circumstances. The recognition, however, that science and technology interact with important ways and that both are intimately affected by the prevailing social, political, theoretical and economic circumstances have extremely important implications for the way in which we examine technology and technological change.”

For instance, the economic policy adopted in Japan in the 1950s was also followed soon after by South Korea, Singapore and Taiwan. Researchers have found that companies in East Asia established productive linkages and interactions with state, private capital, and institutions that propelled innovations, along with value chains in electronics, chemicals, and auto vehicles in overseas markets (Siddiqui, 2016a; 2016b).

The success of the East Asian economies, particularly South Korea, developed its very competitive auto sector in the 1980s-90s. This policy is described as ‘developmental statist’, which acknowledges that the key factor in the success of East Asian economies is state intervention. (Siddiqui, 1995) There are a number of views such as structuralist and institutionalist economists, which argue that industrialisation requires active intervention. They argue that infant industries under capitalism, due to the problem of market failures, particularly in investment, technology and market coordination require state intervention, therefore, there is a need to ‘socialise risk’ as a means of enhancing the domestic economy and developing strategic assets. The neoclassical economists argue that infant industries do not mature and government incentives encourage unproductive activities.

The success of the East Asian economies, particularly South Korea, developed its very competitive auto sector in the 1980s-90s.

In Brazil, industries grew rapidly in the post-war period but faced a crisis in the mid-1980s due to a rise in external debts and inflation. Brazil’s economy in the last thirty-five years has adopted its short-terms macroeconomic policy while neglecting long-term industrial policy, which resulted in a decline in manufacturing and in catching-up with developed countries. Its manufacturing is still not fully developed and is ‘immature’ in Kaldorian terms i.e. where a large supply of labour still remains in low productive sectors. Countries can only attain the “maturity phase” when productivity levels become aligned between all sectors of the economy as a whole. As Nassif et al. (2018: 360) observe: “One case for premature deindustrialisation may occur when developing economies – which might have a rather diversified industrial base but have not yet completed their industrialisation process-are exposed to external competition without internal defence mechanisms of economic policy to continue the implementation of their structural change. This movement occurred in some Latin American economies in the 1990s and 2000s (especially Brazil and Argentina) following the economic opening according to recommendations of Washington Consensus. Since economies are deprived of defence mechanisms (such as tariff barriers, subsidies for exporting manufactured goods, capital controls, among others).”

In Brazil, the auto industry was dominated by foreign companies, in contrast to this; South Korea’s Hyundai Motor Company was a major part of the country’s conglomerate ‘Chaebols’ (industrial groups). The company’s growth is an interesting story. The company began by assembling Ford in 1966-67 but by 1972-73 the company developed a conflict with Ford over its joint venture plans and the production of the vehicle in South Korea. The joint venture talks ended in failure, and then it decided to develop its own model, which was known as Pony. The government then fully supported Hyundai against Ford and extended financial and technical support to the company to become a major car manufacturer. However, given the small size of domestic markets, it was difficult for Hyundai to increase production and achieve economies of scale, and hence exports became its major long-term objective in order to become a successful vehicle producer.

The difference between East Asia and Brazil as far as export promotion is concerned, is that in Brazil exports were promoted after the development of local markets, while in South Korea exports was promoted from the beginning. South Korea launched its auto manufacturing in the early 1970s, when the government closed various small unit industries and encouraged only four firms to produce vehicles. Effective intervention needs a higher degree of autonomy of the state from the dominant class, which allows the state to focus on key objectives rather than serving and protecting the narrow interests of small groups or short-term interests. In 1973, the government announced its prioritisation of the Heavy and Chemical Industry and its long-term industrialisation included promoting the auto vehicle sector. The aim was to achieve about 90% of local materials and contents for domestic car production and move towards a major exporter by 1982. Under this plan, only three companies were given a license to go ahead. By the mid-1980s, the government further rationalised the auto industry, by reducing it to only two producers.

This development strategy requires close coordination between the macroeconomic and industrial policies. We argue that consistency in the fiscal, monetary policy and exchange rate policy will be able to sustain price stability and low interest rates, which could mean higher profits for investors.

There was no doubt that by 1991, Brazil and South Korea became the world’s most successful and competitive auto producers. South Korea emerged as the worlds’ eighth largest vehicle producing country ahead of the UK, while Brazil was ranked as eleventh in 1991. However, in Brazil, the costs were reduced to approach international levels, but the economic crisis and macroeconomic policies during the 1980s were less favourable to the local auto industry. The domestic market had stagnated and foreign debts rose sharply, which led to a debt crisis and under pressure from the IMF and World Bank, the government had to adopt SAP, which resulted in adverse development of its auto sector. In South Korea, the state played a key role in the success of auto vehicle export promotion. The Amsden study (1989), and a later one by Wade (1990) documented that state intervention and support was an important policy measure. In fact, in South Korea, the state had shown a high degree of autonomy to undertake policy measures in favour of larger interests rather than fractional or narrow interests.

The long-term overvaluation trend of the real exchange rate in Brazil (i.e. in the last three decades) was to boost commodity exports. But the appreciation of the exchange rate of the Brazilian currency has adversely impacted the growth of manufactured goods. For example, in Brazil, the share of primary products and manufactured goods based on natural resources rose from 40.3% to 63% between 2000 and 2015. In the same period, there was a significant drop in the share of engineering, science and knowledge based products from 18.7% to 9.9%; manufacturing exports from 32.2% to 23.1%; and labour-intensive manufactured goods had a significant decline from 8.8% to 4.4% for the same period. The study by Nassif et al. (2018: 370) concludes: “With the rapid trade liberalisation in the 1990s and recurring trend of overvaluation of the Brazilian currency, Brazilian exports deepened her specialisation in primary products and natural resource-based industrial commodities… the Brazilian case of the Dutch disease explained by a sudden discovery of natural resources … nor by an exporter boom of tradable goods in the service sector… the new Dutch disease that has been hitting Brazil from the 2000s onwards with the dramatic deepening of an international specialisation pattern based on the exploitation of natural-resources based industries.”

Most of the East Asian countries by the early 1960s followed economic autonomy to pursue national development policies and at present re-emerge as important players in the world economy. The share of the East Asian economy of the global GDP rose six times from less than 4.0% to 25% between 1960 and 2018 (See Figure 1 and Figure 2). The faster economic growth of Asia was the result of the considerable structural transformation as is clear from Asia’s share in world industrial production (See Figure 3), increasing 10 times from a minuscule 4% to over 40% during the same period. (Siddiqui, 2021c) The transformation of East Asia from the most backward and impoverished region, to the growth locomotive of the world economy within forty years is unprecedented in human history and in fact, a positive development for other late-comer industrialising countries.

Figure 1

Figure 2

Figure 3

V. China’s Sources of Growth

Chinese economic reform approach differed from the Soviet Union and other East European countries. Its reforms were gradual and always remained under government control and were certainly not led by international financial institutions like the World Bank and IMF. China began slowly giving more incentives and freedoms to rural households. The government provided incentives to farmers by introducing the Household Responsibility System. The system was introduced to address two issues in agricultural policies; the introduction of a dual-track pricing system based on both the market and planned system, and providing autonomy to farmers as incentives to produce more output. The government did not establish private property, and the village community retained ownership of farmlands and provided equal land access to farm households. The policy for farmer households having ownership of the lands allowed the agricultural sector to improve as it retained labour in rural areas while keeping their rural migration to the cities under control.

During the 1980s, China focused on domestic industrialisation and to achieve this, the state intervention was seen a pre-condition, as was adopted a few decades earlier by Japan and South Korea. The government opened-up a few coastal areas for foreign investments in joint ventures in industries, where the focus was to encourage the transfer of technology, skills, know-how and exports. Moreover, rural reforms rapidly increased rural productivity and output. As Hazwan (2020:16) observes: “the productivity in the agricultural sector and the subsequent reallocation of labour to the non-state sector developed the rural economy. However, the productivity gains made began to level of as TFP (total factor productivity) rates remained constant between 4 to 5% during the 1990s…. the rural sector contributed to the economy more than the urban sector before it exhausted its productivity gains.” China’s cheap and abundant labour along with high domestic saving rates and also in the early 1990s China became one of the largest inflows of foreign capital in the developing world. The overseas investment initially has enabled the economy to benefit from capital accumulation through overseas investment and thus was able to absorb superior and deploy foreign technology and management skills, which resulted in rapid growth rates. Hazwan (2020:18) concludes: “many foreign firms have viewed China as a source of economical labour, while China has recognised the value of foreign firms, benefiting from capital inflow, managerial knowledge and superior foreign technology that can be absorbed, allowing the economy to benefit more than through simple capital formation… specialising in labour intensive and light manufacturing goods… .”

Production

Trade liberalisation resulted in a rise in regional inequality, because FDI was mostly focused in coastal regions (Siddiqui, 2019d). Moreover, credit-starved small businesses tapped into their friends and family as sources of credits, in the manner of the old cultural traditions of Chinese kinship-based networks known as Guanxi. This informal mechanism operated through the Chinese business culture of trust, based on Confucian philosophy. The state provided preferential treatment in order to attract more capital in special economic zone coastal areas. Initially most of the overseas investors and most of the entrepreneurs came from Taiwan, Hong Kong and Singapore.

In China, the growth of the technological capabilities of telecommunication and similarly the electronic industry in South Korea was not due to so much to the government role per se, but rather, the government was able to strengthen the capability of companies in very effective ways. Here we must take into account the important role of learning capability in technological development and overall industrial growth. South Korea relied on capability building as an important catch-up strategy. These policies in practice differ from country to country. For instance, the state has encouraged capability building in China in recent years, where state policy led to building large state-owned companies aimed at compensating for the poor presence of private companies. While in South Korea, joint ventures were adopted as a strategy to access foreign technologies along with huge public investments in education and technological research which enhanced domestic skills and productivity.

Trade liberalisation was a crucial part of China’s export-led strategy, in addition to the nation’s cheap and abundant labour and capital accumulation through the economy’s high-savings rate. China has become one of the nations that receive the most foreign direct investment, as compared to other developing countries, and such investment has enabled the economy to benefit from capital accumulation and to absorb and deploy superior foreign technologies, resulting in a higher growth rate. This approach echoes the Heckscher-Ohlin theory of specialising in labour-intensive and light manufacturing goods (Samuelson, 1949), as China had an abundance of labour. It was suggested that manufacturing goods accounted for the majority of goods exports due to China’s labour cost advantage and spare capacity in production.

VI. Conclusion

The protection of domestic industries was used in the past by the developed countries in their early stages of industrialisation such as in the UK, Germany, the US and Japan. In the US in the early 19th century, Hamilton argued in favour of ‘infant industry’ by extending support to nascent industries until they attained economies of scale and competitive advantage. In Germany, Friedrich List highlighted the importance of industries, and for him, the productive capability depended on the expansion of manufacturing (Chang, 2002). He saw that Britain’s advice to Germany to focus on agriculture was meant to keep Germany as a backward nation (List, 1909). Similar arguments were made by Lall (1992); the role of learning by doing encouraged the late developer countries to protect domestic industries until their companies had achieved sufficient capabilities to be competitive in overseas markets.

Industrial policy should be seen as an important policy to a country planning to accomplish industrialisation and which needs a long-term policy to reverse pre-mature industrial decline. The industrial policy could be to correct ‘market failure’ and to coordinate a set of state incentives such as subsidies and tariffs on imports. Therefore, state support is crucial in order to establish industries and relying alone on market forces and foreign corporations will be disastrous for the developing countries as shown by the recent experiences of the Latin American countries.

The study found that from the beginning, the East Asian countries began developing their manufacturing sectors by targeting the export markets, and also began for a brief period with ‘import substitution policy’. They realised that their domestic markets were limited and thus manufacturing could not achieve economies of scale. These countries opened their industries to foreign competition, welcomed foreign investment and technologies, and also focused on exports, which was used to stimulate economic development. Manufactured products soon became the principal exports of East Asian economies in contrast to other developing countries that largely focused on exports of agricultural commodities. Currently, East Asia has the second highest share of manufactured goods in total merchandise exports, after Europe.

The potential growth rate of an economy also depends on its productive structure, its degree of diversification, and its ability to generate higher value-added per capita.

China’s reforms are interesting as its growth path began with reforms in agriculture and only then focused its efforts in the industrial sector, demonstrating a sectoral shift. Furthermore, the level of openness has stimulated competition in the domestic economy, especially since the recognition of patent and protection law in the 1990s, as it encouraged Chinese firms to devote more resources to innovative activities leading to technological progress. The structural changes that China has experienced, however, altered its traditional sources of growth, as the economy reallocated inputs such as the labour workforce from various sectors in the economy, shifting the accumulation of capital through a repressed financial system. Furthermore, the study suggests that relatively poor countries would benefit from industrial expansion and catching up and converging with developed economies, as less developed economies benefit from economic backwardness and technological transfer, thus increasing the levels of economic development. However, the developed countries have opposed any attempt by the developing countries to industrialise and to follow sovereign industrial policy, which could be described ‘kicking away the ladder’, since they do not want to lose their dominant position in the global economic power structure.

Finally, the study concludes that the potential growth rate of an economy also depends on its productive structure, its degree of diversification, and its ability to generate higher value-added per capita. The East Asian industrialisation presents a very useful experience for others for economic transformation, bringing out the diversity of experiences, and analysing the factors explaining their stunning success that have rich lessons for latecomers and other developing countries. Here for late developers, the expansion of the manufacturing sector could play a major role in the transformation of the economy and it seems that economic growth and the development of the productive structure are both connected. Therefore, there is a need in the developing countries to reconsider the role of the state and also to create a favourable macroeconomic environment for capital accumulation, investment, innovation, structural change, overall economic development, and catching-up.

About the Author

Kalim Siddiqui Dr. Kalim Siddiqui is an economist, specialising in International Political Economy, Development Economics, International Trade, and International Economics. His work, which combines elements of international political economy and development economics, economic policy, economic history and international trade, often challenges prevailing orthodoxy about which policies promote overall development in less developed countries. Kalim teaches international economics at the Department of Accounting, Finance and Economics, University of Huddersfield, U.K. He has taught economics since 1989 at various universities in Norway and U.K.

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Foreign direct investment – trends and developments in France, Germany and the United Kingdom

Foreign direct investment

By Kurt Ma, Christian Sauer and Tonio Sadoni at global law firm Bryan Cave Leighton Paisner

Introduction

2020 was a trying year for dealmakers and cross-border M&A. Foreign direct investment (“FDI”) has been one of the more notable casualties in the pandemic. Companies are approaching transactions with greater caution, and dealmakers have been reassessing investment decisions, particularly where they involve other countries.

At the same time, there has been a general trend towards greater FDI regulation in some places. The Committee on Foreign Investment in the United States, or CFIUS, continues to see its jurisdiction expand and its funding increase. In the EU, a regulation and mechanisms have been introduced that apply directly in member states and that allow one member state to make submissions where foreign investments in another member state are likely to have an impact on national security in that member state. While Asia and, in particular, Southeast Asia seem to be bucking the trend and continue to attract FDI from China and Japan, the pandemic is expected to suppress some of that early promise.

In France, Germany and the United Kingdom, we are seeing a growing emphasis on investment control and, consequently, a need to navigate related legal and regulatory challenges.

France

Since its introduction in 2005, the FDI regime in France has expanded and developed apace, especially in relation to sensitive sectors and in respect of transactions and investors falling within the scope of the regime. The evolution of the French FDI regime has often echoed wider economic or technical developments, e.g. the inclusion of artificial intelligence and cloud computing in the list of relevant sectors in 2018. Several changes to the regime were implemented following major foreign investments in the country, e.g. the acquisition of Alstom by General Electric in 2014. Decisions have also often had a political component, as in the proposed takeover of supermarket chain Carrefour by the Canadian group Couche-Tard. The Ministry of Economy and Finance rejected it in January 2021, even before a formal filing for approval had been made.

The French FDI regime was fully reformed in 2019, consolidating the amendments made since 2005, as well as additional modifications recently introduced in response to the Covid-19 pandemic. The key aspects of the reformed regime are set out below.

First, the former distinction between EU and non-EU foreign investors (whether persons or entities) was abolished and entities in the chain of control included in the definition. This amendment, together with the requirement that investors disclose any interest held by or financial support received from a state outside of the EU or its agencies in the preceding five years, have significantly increased the information to be provided in an FDI filing.

Second, the reform harmonised the list of transactions that qualify as investments under the regulation. These are the acquisition of control of a French entity, the acquisition of a business unit of a French entity or, except for EU investors, the acquisition of 25% of the voting rights of a French entity. Since the pandemic, the threshold was temporarily lowered to 10% for listed companies until the end of 2021, thereby mirroring the applicable rules in Germany and Spain.

Finally, the reform clarified the list of sectors considered sensitive and into which an investment by a foreign investor would require prior approval. The list covers not only activities directly related to defence and national security, but also infrastructure, goods and services in ten economic sectors considered vital to the national interest. Research and development activities in critical sectors are on the list as is the biotechnology sector which was added during the pandemic.

Unlike the rules for merger control filings and similar to the reforms proposed in the UK, the FDI regulation in France does not set any economic or financial conditions for its application. The size of the target will, however, be taken into consideration when a filing is reviewed.

The decisions of the Ministry on FDI filings are not made public. When reviewing a request for approval, the Ministry may require the investor to make certain commitments, including reporting, operations, or divestments. Such commitments can be negotiated with the Ministry, therefore, outright refusals are rare. The investor will generally prefer to abandon a transaction before a formal refusal is issued (as was the case with the proposed acquisition by Couche-Tard for Carrefour). However, the Ministry does not consider itself bound by its own precedent decisions, notably as regards its definition of the precise scope of the sectors covered by the regulations. In light of the continuous move towards greater protectionism, thorough preparation and anticipation of FDI restrictions are key for the success of transactions in any of the protected sectors.

Germany

Recent amendments to German foreign trade laws (the Foreign Trade and Payments Act (Außenwirtschaftsgesetz, “AWG”) as well as the Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung, “AWV”) have imposed on foreign investors a new layer of bureaucratic requirements and restrictions. In general, under the new rules, if a foreign investor directly or indirectly acquires at least 10% of the voting rights in a German company, the Federal Ministry of Economics may determine the acquisition to represent a threat to public order and security and, if necessary, restrict or prohibit the acquisition.

The main changes to the AWG and AWV introduce a significantly broader screening standard. The key question now is whether an acquisition or investment leads to an “expected impairment of public order or security”. Before this amendment, a “genuine threat” was required before any intervention. The change is therefore likely to lead to greater scrutiny of FDI transactions. In addition, the Ministry will consider whether the transaction affects other EU member states or EU programs and projects, thus introducing a further layer of complexity and uncertainty to the review process. During the screening period, any acquisition subject to reporting requirements will be provisionally invalid until approval is obtained.

Like its counterparts in France and the UK, German government introduced new FDI restrictions in response to the pandemic. The 15th regulation amending the AWV is directed at the healthcare sector, introducing stricter regulations on companies that develop or produce goods that are essential for the long-term maintenance of a functioning health care system. For this purpose, manufacturers of vaccines, antibiotics, medical protective equipment and medical goods for the treatment of highly infectious diseases have been added to the list of protected companies.

To safeguard German know-how and technology in critical areas, the Ministry has also proposed an updated regulation which will either further restrict investment in the areas of artificial intelligence, robotics, biotechnology and quantum technology or extend the scope of investment control to these areas.

The extended scope of regulation and the need to consider EU interests are likely to have significant impacts on FDI in this country. We expect the changes in German foreign trade law to lead to longer examination phases of up to several months to account for EU considerations. This is likely to have a deterrent effect on FDI transactions as investors consider the pros and cons of investing in Germany (and other EU countries). Some commentators suggest that there will be a slight decline of about 6.6% in FDI volumes for 2020 (from EUR 64.7 billion in 2019), but the effect of the new regulations, as well as the government’s efforts to promote the country as an investment-friendly jurisdiction, remain to be seen.

Given the new legal standards for FDI transactions, dealmakers should plan ahead, conduct any appropriate risk analyses and prepare to engage with the EU Commission and other EU member states. For M&A transactions, parties will have to examine closely the reporting obligations under foreign trade law and whether the transaction should be reported or an application made for a clearance certificate. Parties may also wish to consider the inclusion of a condition precedent in the transaction documents that the Ministry approves the transaction. Contractual amendments to account for the possibly more intensive and longer examination of the acquisition by the authorities might also be a good idea.

United Kingdom

The United Kingdom remains one of the top destinations for FDI globally and has historically shied away from policing FDI in the way that some other countries have. Indeed, existing FDI controls have been addressed as part of the UK’s voluntary merger control regime for years. The UK government has the power to intervene in transactions on certain specified public interest grounds.

In November last year, the government published draft legislation to reform the current FDI screening regime, introducing a framework similar to CFIUS and closer to those adopted in France and Germany. These measures are expected to give the government increased powers to block, impose conditions to, delay the closing of, or unwind FDI transactions, including joint ventures, in 17 key sectors, including communications, defence, data, energy, transport, artificial intelligence, computing hardware and robotics.

The National and Security Investment Bill introduces a broad package of reforms to the existing FDI framework. The Bill contemplates a hybrid system of mandatory and voluntary notifications. The former would apply when a transaction occurs in relation to any of the 17 key sectors. The latter would be deployed when parties observe any defined “trigger event” which may be of interest from a national security perspective. This hybrid system is supplemented with a “call-in” ability that allows the government to review any transaction that has completed but that has not been notified to the authorities. As with the FDI regulations in France, the Bill envisages that certain transactions would, regardless of market share or sales thresholds, fall within the scope of review.

The lack of safe harbours and the danger of having completed transactions being unwound means that a greater number of transactions are now susceptible to either intervention or pre-emptive and voluntary notification. Failure to make notifications where required will void a transaction. Non-compliance could attract fines of up to 5% of worldwide turnover or £10 million (whichever is higher) and up to five years imprisonment for directors.

Whilst seeking to maintain its reputation for being open for business, the UK is clearly moving towards engagement with FDI on levels and in ways more akin to its US and European counterparts. Dealmakers and companies looking to invest in British companies, particularly in the sectors described above, will need to focus on early due diligence, careful transaction structuring and pre-emptive engagement with advisers and the government.

Deal structure and timetable will be affected, as well as the way in which a target company is controlled. The use of commitments, e.g. as to the safeguarding of intellectual property rights, or divestments of certain assets, will continue to be relevant. We expect issues like persons with significant control or influence, board rights, director appointments, shareholder voting rights, and reserved matters to come to the fore. With careful transaction management and deal structuring, we believe investors can successfully navigate many of these regulatory and legal challenges. The alternative is the very real risk of having a transaction blocked from closing or, worse, unwound after closing.

Conclusion

These developments reflect the general approach taken in other countries as part of a global trend towards greater protectionism. Despite the role that FDI could play in supporting business and economic recovery, we are likely to see increasing government intervention in areas of strategic value and sensitivity. We believe these new FDI regimes will survive and continue to be relevant regardless of COVID-19 and any near-term outcomes. Investors and dealmakers would be well-advised to plan their transactions accordingly, particularly where there are concerns around the identity of the acquiring or investing entity or where the target operates in a sector of national or strategic importance.

About the Authors

Kurt Ma

Kurt Ma is a London-based corporate partner at global law firm Bryan Cave Leighton Paisner with particular expertise in mergers and acquisitions, strategic cross-border transactions, private equity, corporate insurance and joint ventures. His clients include entrepreneurs, listed companies, regulated firms and institutions, and governments.

Christian Sauer

Christian Sauer is a Paris-based corporate partner at global law firm Bryan Cave Leighton Paisner with extensive experience in complex and cross-border transactions, strategic alliances, joint ventures and partnerships. His French and international clients mainly come from the telecommunications, media, technology, energy and biotech sectors.

Tonio Sadoni

Tonio Sadoni is a Hamburg-based corporate partner at global law firm Bryan Cave Leighton Paisner whose practice encompasses mergers and acquisitions, joint ventures and other corporate or private equity transactions. He has vast experience representing clients from the life sciences/healthcare, nutrition and hotel industries.

The Rise of ESG Financial Products

The Rise of ESG Financial Products

By Victoria Judd and Henrietta Worthington

ESG finance continues to gain traction globally, with an increasing variety of financial products becoming available under the ESG umbrella.  Bonds, loans, non-bank lending and even mortgage products can be converted to include ESG compliant characteristics.  This article considers the advantages and disadvantages which exist across the financing spectrum as these financial products gain momentum and evolve. 

Amid a looming global economic recession, there is one area that looks poised to continue to grow: ESG finance.  ESG finance has gained traction since the first green bond principles were issued in 2014 and it has come into its own since the adoption of the Paris Agreement in 2015.  The subsequent issuance and updating of green bond principles, and green- and sustainability-linked loan principles, have sought to add documentary and process consistency to this rapidly growing and developing market.  In numbers, the global green and ESG loan volume has grown by over 15 times in four years and is expected to increase further in 2021.

Looking at this evolution from a high level paints the picture of the global trend, without however considering the elements that make up the sum.  There are many different financial products that have come together to bolster the growth of this sector.  The vocabulary includes words such as Green Loans, ESG Loans, Green Bonds, ESG Bonds, Social Bonds, Sustainable Bonds, Green Schuldscheine and Green US Private Placements.  This article investigates these products in further detail.

What are the main drivers for ESG financial products?

Investing in ESG financial products is beneficial to society, investors and the development of the financial markets.  Funding projects that have social or environmental benefits is valuable to our society by improving governance or directly impacting environmental or social improvement goals.  It is broadly reported that companies that are conscious of their ESG performance and seeking ESG improvements outperform other market participants who are not; a fact that attracts investors to the ESG space.

The development of ESG financial products is encouraging transparency and consistency in reporting, while concurrently raising awareness and building the expertise of investors in relation to these topical issues.   

However, there remains a lack of consensus regarding what constitutes “green” or “social” for the purpose of ESG financial products and there is still a panoply of different criteria that are measured and reported on across the market, from eliminating use of coal to increasing indigenous cultural awareness.  Transparency of reporting also still relies on voluntary reporting. 

The most common form of ESG lending

ESG bonds, whether described as such, or as “green” or “social” bonds, are the most common form of ESG lending in the market.  Such bonds allow for money to be directed towards specific uses or projects, which are geared towards environmental, climate or social outcomes. 

ESG bonds, whether described as such, or as “green” or “social” bonds, are the most common form of ESG lending in the market.

A large swathe of projects may fit under this umbrella: green projects could include climate adaptation, renewables or other environmentally friendly projects. Eligible projects for social bonds run the gamut from building affordable basic infrastructure (such as clean drinking water), to access to essential services, affordable housing, employment generation, food security or socio-economic advancement and empowerment.

As a longer-term investment compared to a green or sustainability linked loan (which we examine below), the initial investment towards a specific “use of proceeds” ensures that minimal oversight is needed on an ongoing basis.  The financial risk and return characteristics are the same as traditional bonds, but the added ESG characterisation may help reduce the interest rates and thereby help raise more capital. 

External ratings are sought for the purpose of these characterisations and there is a marginal further cost of due diligence to validate green credentials early on (typically between £20,000 and £100,000), which means that ESG bonds tend to be cost-neutral at best.  Of course, the additional profile raising for ESG projects is an added benefit that is harder to quantify in monetary terms. 

The main downside for participants in the bond markets is that there is no real ongoing scrutiny, making it difficult to control how capital is applied to projects, and without such scrutiny, the bond issuer can make investments into projects to hit management targets rather than ensuring that the chosen project will have a genuine positive effect.

As these bonds become more integrated into mainstream funds, indices and other products, it is expected that the cost of issuance may further decrease as additional interest from retail investors augments.

Green Loans and Sustainability Linked Loans (SLLs)

In the loan market, the Green Loan and the Sustainability-Linked Loan are proving popular.  Companies are estimated to have raised in excess of USD 180 billion of green and sustainability linked loans globally in 2020.  This is up from roughly USD 5 billion in 2017.  The large majority of this financing is currently taking place in Europe, however, its popularity is growing across the globe.

In the UK, the Loan Market Association (LMA) published principles for Green Loans in 2018 and for SLLs (also known as ESG Loans or KPI Loans) in 2019. These principles were supplemented by further guidance in 2020. Whilst Green Loans must be used to finance a specific green purpose, an SLL helps borrowers to improve their sustainability profiles by establishing sustainability linked performance metrics. In both cases, borrowers are able to benefit from cheaper funds when they successfully hit certain prescribed green and/or sustainable targets and face rising ratchets where these targets are not met (often in the region of 5-10 bps).

Green Loans and Sustainability Linked Loans (SLLs)

The weakness in relation to this form of financing is linked to the robustness of the structure. Green and sustainability washing is a genuine concern with regard to borrowers who are looking to enhance their reputation and benefit from cheaper loans and lenders who have not developed systems to appropriately audit these metrics.

Other ESG alternatives are gaining traction

The issuance and evolution of the Green Bond Principles, the LMA’s Green Loan Principles and SLL Principles have greatly helped to create guidelines of how to structure ESG bonds and the loan products.  As these become more commonplace, they are also continuing to evolve and influence other financial products.

For instance, the Sustainability-Linked Bond, which combines reported characteristics from SLLs with a fixed income product is gaining momentum.  ICMA published principles for this market in June 2020, and it is expected that the market size for these issuances will be about $125 billion by the end of 2021.  These vehicles do not need a clear purpose for expenditure as with a green or social bond but instead align closer with SLLs and Green Loans by reporting on key performance indicators (KPIs).  External parties are sought to assess and review changes to the main KPIs.

Other financial products like Schuldscheine, a medium to long-term bond-like product that does not need to be registered at a stock exchange, and private placements also exist in an ESG format.  These debt products are characteristically cheaper to enter into than a publicly listed bond, which can offset some of the costs associated with sustainability reporting.  Borrowers also benefit, as with other ESG products, from the reduction in the cost of capital through the ESG characterisation.

Schuldscheine exist in a green “purpose” format and in a “sustainability linked” format, with reporting akin to the Green Loan and SLL respectively and at the current time between 10 and 15% of Schuldscheine issued follow an ESG format. 

The private placement market is also steadily evolving and at the start of 2020, already represented 9% of all sustainability labelled debt. As with other products, the US lags behind Europe in respect of private placement issuances.  This could be because the longer-term maturities of seven to 12 years for US private placements make it more difficult to compile sensible key performance indicators to track a company’s performance.  It could also be because without the relationship building aspect that comes with bank lending, concentrating efforts on a borrower’s ESG efforts is an indulgence for institutional investors.  Such investors may be less interested in giving up some of their return where there is less market pressure.  In time, it seems a fair prediction that US private placements will grow in numbers.

As investors become more interested in ESG products, CLOs are also expected to become more commonplace.  At the current time, negative screening against oil and gas companies, big tobacco and gambling companies tend to differentiate products that fill ESG criteria from those that do not, though it is expected that the market will become more sophisticated.

What about consumer facing financial products?

No financial products are immune from the ESG trend.  Some green mortgages are already available to homebuyers in Europe and the US. Customers obtain better borrowing rates in return for purchasing more energy efficient homes or implementing energy saving works.  Further work is required though to allow energy performance to be included in the calculation of mortgage affordability calculations, so as to increase the market opportunity.  In Europe, over 40 banks are already participating in the Energy Efficiency Mortgages Action Plan and, in the US, green mortgages are issued by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), and some banks.

Reporting

ESG finance is still a relatively nascent market, and as a result, there are significant inconsistencies and gaps in current reporting systems which threaten to undermine the efficacy of many of these products.  There is no established market approach to reporting, with different methodologies and conventions creating confusion for market participants.  Specific reporting obligations will typically depend on the size and nature of a transaction, the relevant parties, and the financing structure.

By way of example, in relation to green financial products, companies will commonly report an external ESG rating, CO2 emissions and/or consumption of green energy.  However, corporates could also set targets to demonstrate their interest in sustainability and may therefore report on bespoke KPIs, such as reductions in food waste for a large supermarket chain or flying with a sustainable fuel for an airline company.  The factors that are reported are still very much led by the borrower, who is best able to set its own sustainability ambitions. Whilst the flexibility of these products is a clear advantage, it makes the task of standardising reporting extremely challenging.

Certain bodies have taken steps to address these issues, for example, the LMA’s guidance on Green and Sustainability Linked Loans suggests annual reporting and encourages borrowers to increase transparency with regard to their reporting methodology.

There are also signs that regulators will start stepping in to standardise ESG disclosure metrics and reporting.  Again, the EU is leading the charge in this area with the Sustainability-Related Disclosure Regulation due to come into effect in part on 10 March 2021. The regulation will require that certain regulated entities in the EU make ESG related investment disclosures.  Similarly, unregulated businesses that are seeking investment will need to show that they meet the criteria to be categorised as “sustainable” under the Sustainability-Related Disclosure Regulation.

Conclusion

From a reporting perspective, there is clearly work to be done. However, the lack of uniformity does not seem to have stemmed from the growth of ESG financial products, which continue to soar in popularity.

Given palpable social pressures (from the climate crisis to the Black Lives Matter movement, to name but a few) this is an area that companies and investors are increasingly looking to, and whose strength lies in its flexibility. As external agencies and financiers advise on how to provide consistent information, and regulators consider standardisation, the challenge will be in providing clarity whilst maintaining the integrity of a flexible model which provides for a broad definition of what falls within “ESG”.

After all, this will ensure that we are more open to progress in ESG matters, whatever form they may take.

About the Authors

Victoria Judd

Victoria Judd is a multispecialist financing counsel at Pillsbury Winthrop Shaw Pittman LLP who advises borrowers and financial institutions on a broad range of transactions, with a focus on sustainability, the energy transition and project development.  She advises on diverse structures including project finance, acquisition finance, leverage finance, restructurings, sustainable finance and corporate finance.

Henrietta WorthingtonHenrietta Worthington is a counsel at Pillsbury Winthrop Shaw Pittman LLP who focuses her practice on a broad range of international transactions including sustainable lending, energy and infrastructure projects, international trade, export finance, restructurings, acquisition finance, general corporate finance and fintech. Henrietta also has extensive experience advising clients on regulatory, sanctions and ESG compliance requirements.

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