Monthly Archives: June 2013

Why Colonies Need Empires

On May 17th, 2013 the territory of French Polynesia…was reinscribed on the UN’s disapproving list of “non-self-governing territories”. The UN resolution requires France to move swiftly towards setting French Polynesia on the path to self-determination.   France boycotted the proceedings. But only 12 days earlier, elections in its scattered French Polynesian imperial outpost brought a heavy defeat for the territory’s long-standing pro-independence leader, Oscar Temaru, and victory for his arch-rival, Gaston Flosse, who vows never to let another flag fly over the presidential palace. Self-determination, the French government sniffed, “cannot be

The UN’s “non-self-governing” list dates back to 1946 and originally consisted of territories reported as dependencies by the colonial powers themselves. In the decades that followed, most became independent, or were annexed, or were officially acknowledged as, in effect, enjoying political autonomy. But 16 territories around the globe, mostly minute islands in the Caribbean, Atlantic or Pacific Oceans, remain officially in the queue for decolonisation. In the Pacific they include Tokelau, Pitcairn Islands, American Samoa, Guam and New Caledonia. Each year, a UN committee meets to deliberate on their status, and to pronounce its verdict on the appropriate steps towards decolonisation.

Yet, when consulted, independence has not been the preferred option for many Pacific islanders. In two UN-supervised referendums, held in 2006 and 2007, Tokelau (population: 1,411) narrowly failed to obtain the required two-thirds majority to end its status as a New Zealand dependency, though the results were close. The 47 inhabitants of Pitcairn, still home to descendants of the Bounty’s mutineers, have no desire to end British rule. Politicians from American Samoa repeatedly ask to be removed from the UN list.

The Pacific territory with the most realistic chance of decolonisation is nickel-rich New Caledonia, a French colony since 1853. In the 1980s indigenous Kanak leaders pushing for independence managed to get their islands relisted as “non-self-governing”. Violent conflict on the island, which has a substantial French settler population, ended in 1988 only after the authorities in Paris agreed to a referendum on independence to be held ten years later. When that time came, in 1998, Kanak leaders agreed to a further delay of 15-20 years, meaning that the scheduled referendum must be held at some point before 2019—and perhaps as early as next year. Many of the French settler politicians, who remain loyal to the motherland, hope that some further compromise can again avoid a potentially polarising electoral contest.

Mr Temaru’s successful bid to have French Polynesia officially listed as still a colony was inspired by the New Caledonian experience. In the past Paris has threatened to pull the economic plug on any territory that chooses independence, explaining why many Tahitians prefer some form of loose autonomy while remaining under the French umbrella. Yet at times the government in Paris has shown signs of growing weary of its costly Pacific dependencies.

The Pacific’s colonies: Ends of empire, Economist, May 25, 2013, at 41

The Art of Selling Weapons: offsets

[When governments buy weapons] it is standard to supplement the main deal with a side contract, usually undisclosed, that outlines additional investments that the winning bidder must make in local projects or else pay a penalty. Welcome to the murky world of “offsets”.

The practice came of age in the 1950s, when Dwight Eisenhower forced West Germany to buy American-made defence gear to compensate for the costs of stationing troops in Europe. Since then it has grown steadily and is now accepted practice in 120 countries. It has its own industry newsletter and feeds a lively conference circuit. The latest jamboree, hosted by the Global Offset and Countertrade Association, was held in Florida…. Yet its very structure serves to mask a build-up in the unrecognised financial liabilities of companies. It also, critics argue, fosters corruption, especially in poorer parts of the world.

Avascent, a consultancy, reckons that defence and aerospace contractors’ accrued offset “obligations”—investments they have promised but not yet made—are about $250 billion today and could be almost $450 billion by 2016. The industry’s own estimates are lower, but all agree the trajectory is upward.

Offsets come in two types. Direct offsets require investment in or partnerships with local defence firms. The idea is to develop self-sufficiency. Turkey, for instance, now meets half its own defence needs thanks to such arrangements. Indirect (non-defence) offsets include everything from backing new technologies or business parks to building hotels, donating to universities and even supporting condom-makers. Here the stated intention is to achieve more general economic or social goals.

Both types of offset are controversial. Economists view offsets as market-distorting. The World Trade Organisation bans their use as a criterion for contract evaluation in all industries except defence. Anti-corruption groups see them as a clever way to channel bribes. Even if many offset deals are clean, they are widely seen as a “dark art”, admits an industry executive. “Offset” has become a dirty word; the industry now prefers the euphemistic “industrial participation”.

The practice is frowned upon in some advanced economies. The European Commission is trying to impose a ban on all offsets in EU-to-EU contracts, and on indirect offsets when the supplier is from outside the union…

America has long been officially against offsets, though it practises something similar at home under the Buy American Act of 1933, which requires foreign arms-makers to source much of the work locally… And as embassy cables published by WikiLeaks make clear, America’s diplomats are sometimes closely involved in its firms’ discussions with foreign governments, including even squeaky-clean Norway’s, over proposed offsets.

In less developed countries, where defence spending is generally rising, offsets are booming. One appeal is that they can be recorded as foreign direct investment, boosting the government’s economic-management credentials. The two biggest arms-buyers in the Gulf, Saudi Arabia and the United Arab Emirates, have long-standing, sophisticated offset programs…Brazil and India are catching up…

This growth is fuelling a thriving offsets industry. At one end are dozens of small brokers who hawk ideas for offset projects to arms-makers and their clients. With the right contacts in government and the armed forces, even small outfits can service the largest defence firms. Take Dolin International Trade & Capital, a one-man operation run by Dov Hyman from his home in suburban New York. Mr Hyman cut his teeth as a textile trader in Nigeria. Today he advises African governments looking to use offsets while helping multinationals craft offset packages.

Further up the chain are a few sophisticated outfits that structure complex deals and arrange financing. The best known is London-based Blenheim Capital. These are assembling ever more creative packages, including, for instance, helping procuring countries to use contractors’ offset obligations as collateral for loans, backed by the “performance bonds” that firms set aside to cover unfulfilled obligations.

These middlemen are offsets’ most vocal defenders. Mr Hyman cites reams of examples of deals that he believes brought great benefits for purchasing countries’ economies. The best of them are “beautiful solutions”: for instance when arms-sellers satisfy offset obligations by guaranteeing credit lines for local manufacturers, thus reducing their financing costs. Using a multinational’s good standing in this way is “an efficient means of making possible transactions that otherwise wouldn’t be viable,” he argues.

However, some projects take contractors disconcertingly far away from their core competence. Take the shrimp farm set up in Saudi Arabia in 2006 with backing from Raytheon, a maker of radar systems and missiles. Praised at first as a model offset, it reportedly struggled to keep its pools properly maintained in searing temperatures and eventually went bust.

Moreover, the academic literature on offsets suggests that the promised benefits are elusive. There are some technology-transfer success stories: for instance, China has boosted its defence-manufacturing capability by requiring offsets when buying kit from Russia. However, research by Paul Dunne of Bristol Business School and Jurgen Brauer of Augusta State University has found that such deals are generally pricier than “off-the-shelf” arms purchases and create little new or sustainable employment. The offsets associated with the giant South African arms purchases of the late 1990s have created 28,000 direct jobs, claims the country’s government. Even if true, it is well below the 65,000 first envisaged. India’s auditor-general recently concluded that some offsets have produced no value for the country.

Judging performance is hard because of a lack of openness. Asked for confirmation of the fate of the shrimp farm, the Saudi offset authority said it kept “minimum information” on projects after their founding and suggested contacting its commercial backers. Raytheon declined to comment and suggested contacting the Saudis. DevCorp, another backer, did not respond. A study published in February by Transparency International, an anti-graft group, found that a third of governments that use offsets neither audit them nor impose due-diligence requirements on contractors.

Worse, accounting rulemakers have failed to impose any requirement to disclose offset liabilities. Companies can thus choose how, or whether, to put them on the balance-sheet. Defence firms have lobbied successfully for offsets to remain classified as “proprietary”, so they do not have to disclose their obligations. In some ways things have got worse: the Commerce Department’s annual report on American contractors’ offsets no longer even breaks out the numbers country-by-country.

This murkiness makes it hard to determine who really pays for offsets. On the face of it, the defence companies do. But Shana Marshall, an offsets-watcher at George Washington University, believes that they build the cost into their bids. Politicians and officials in procuring countries know that they are paying the bill through padded prices, but they accept this because offsets give them some grand projects to trumpet and sometimes provide palm-greasing opportunities.

A study in Belgium found that the country ended up paying 20-30% more for military gear when offsets were factored in. If the costs are largely borne by taxpayers, the benefits accrue to individuals and institutions chosen by the procuring government. This make offsets a good way to conceal delivery of public subsidies to interest groups, according to Ms Marshall.

A number of deals have been exposed as, or are suspected of being, corrupt. A commission has been set up to look into South African contracts dating back to 1999; the government has already conceded that offset credits changed hands at inflated prices. Since 2006 prosecutors in Portugal have been investigating offsets connected with a €1 billion ($1.3 billion) submarine contract with Germany’s Ferrostaal, HDW and ThyssenKrupp. Three Ferrostaal board members and seven Portuguese businessmen are on trial, charged with fraud and falsifying documents.  EADS, a large European contractor, is facing multiple inquiries over its sale of 15 Eurofighter planes to Austria. Prosecutors in Vienna and Munich are looking into allegations that millions of euros in kickbacks flowed through a web of offshore firms and side-deals, linked to offset agreements worth €3.5 billion, twice the value of the main contract. (In other words, EADS was supposed to generate €2 of business for Austrian firms for every euro it received for the planes—an unusually high ratio even in fiercely bid contracts.) Tom Enders, EADS’s chief executive, told Der Spiegel, a German magazine, that he “knew nothing about the shadowy world of dubious firms allegedly behind this.” The company says it is co-operating fully with prosecutors and that an internal investigation has so far found no evidence of punishable activity.

Prosecutors are also looking into whether AgustaWestland, part of Finmeccanica, an Italian defence firm, paid bribes to secure the sale of 12 helicopters to India in 2010. Finmeccanica’s former chief executive and the former head of AgustaWestland are due to go on trial next month. According to Italian court filings, suspicious payments allegedly flowed through a sham offset contract for software with help from a Swiss-based consultant. The helicopter-maker and the charged individuals deny wrongdoing.

Industry figures point out that all but the Indian case are at least five years old. They argue that corruption is harder to get away with today because of stricter anti-bribery laws and enforcement in America and Europe. Companies’ general counsels pay much more attention to offsets than they did a decade ago, says Grant Rogan, the head of Blenheim Capital.

Even if graft really is on the wane, offsets’ complexities make it hard to measure the true cost of defence deals. Procuring governments may apply generous “multipliers” to give extra credit to projects they deem exceptionally beneficial, especially if they are keen to buy the kit in question. As a result, defence contractors often find their liabilities turn out to be a lot less than their nominal obligations. A $5 billion sale of military kit might come with, say, $4 billion of gross offset requirements, but after multipliers it might only cost $500m to fulfil. A book on the arms trade, “The Shadow World”, by Andrew Feinstein, describes a contract Saab won in South Africa: to receive more than $200m in credits all the planemaker was required to do, the book says, was to spend $3m upgrading pools in Port Elizabeth and marketing the town to Swedish tourists. Saab says the tourism project cost much more, and suggested that it was up to the authorities to decide what value they put on what it achieved.

This sleight-of-hand helps to explain why industry executives are better disposed towards offsets in private than in public, says Ms Marshall. They say they could happily live without them, but they do not lobby to have them banned. Indeed, some big contractors see their ability to craft a package of attractive offsets as a “source of competitive advantage”, as Boeing’s boss, Jim McNerney, puts it.

The largest such firms will employ dozens of offset specialists to give them an edge in bidding. Lockheed, another American contractor, has about 40. As long ago as 2005 the firm was touting its leadership in offsets to win Thai contracts, according to a leaked diplomatic cable.  A downside for the companies is that dealing with national offset agencies can be frustrating. And though the companies’ offset liabilities are smaller in reality than on paper, they can still be daunting: one American contractor, for instance, has $10 billion of nominal obligations in a single Gulf state that will cost $1 billion-2 billion to fulfil, according to a consultant (who will not say which firm or country)….

How long can the offsets boom last?  But in the shorter term, their growth will be fuelled by American and European contractors’ intensifying efforts to sell outside their shrinking home markets, to big developing countries whose defence budgets are growing…. Remarkably, offsets are now said to be the main criterion in contract evaluation in Turkey and some Asian countries—more important than the price or the technical capability of the defence equipment itself.

The defence industry: Guns and sugar, Economist,May 25, 2013, at 63

Deforestation: Rubber Barons and their Bankers

Along Route 7 in Cambodia’s remote north, dozens of small tractors known as “iron buffaloes” are plying a dilapidated piece of highway. Under cover of darkness, they transport freshly cut timber into nearby sawmills. The drivers wear masks, their tractors fitted with just one dim lamp at the front. Each carries between three and six logs which locals say were felled illegally on or near the Dong Nai rubber plantation, owned by Vietnam Rubber Group (VRG).

Illegal logging and land-grabbing have long been problems in Cambodia. A new report entitled “Rubber Barons” by Global Witness, a London-based environmental watchdog, has highlighted the issue once again. Dong Nai features prominently in the report, which claims that luxury timbers like rosewood, much in demand for furniture in China and guitars in the West, were culled as a 3,000-hectare (7,400-acre) section of forest was illegally cleared.

Global Witness says that local and foreign companies have amassed more than 3.7m hectares of land in Cambodia and Laos since 2000, as governments have handed out huge land concessions, many in opaque circumstances. Two-fifths of this was for rubber plantations, dominated by state companies from Vietnam, the world’s third-largest rubber producer.

The report claims that VRG and another Vietnamese company, HAGL, are among the biggest land-grabbers, and have been logging illegally in both Cambodia and Laos. It says that, through Vietnam-based funds, the two companies have received money from Deutsche Bank, while HAGL also has investment from the IFC, the private-sector arm of the World Bank. The two Vietnamese companies have denied any wrongdoing. Deutsche Bank and the IFC say they are studying the findings.

The report says that the two companies have failed to consult local communities or pay them compensation for land they formerly used. The companies routinely use armed security forces to guard plantations. Large areas of supposedly protected intact forest have been cleared, in violation of forest-protection laws and “apparently in collusion with Cambodia’s corrupt elite”.

Global Witness is urging authorities in Cambodia and Laos to revoke the two companies’ land concessions, which cover 200,000 hectares and are held through a network of subsidiaries. It thinks both companies should be prosecuted.

Logging in South-East Asia: Rubber barons, Economist, May 18, 2013

See also Bankers with Chainsaws

 

Business Models of Piracy – Somalia & Niger Delta

The decline in Somali piracy (which, according to a recent World Bank report, may at its peak have cost the world up to $18 billion a year in extra shipping expenses and lost trade) is partly the result of increasingly sophisticated co-ordination by international naval task-forces. Shipping companies are also making their vessels harder to attack thanks to a range of defensive measures, such as razor wire around decks, high-pressure hoses and maintaining speeds that make boarding hazardous. Armed security guards on many of the ships transiting pirate-infested waters have helped too.But the pirates could still make a comeback. The cost of deterring them is high. Shipping companies may lower their guard if they think the threat has passed, and patrolling naval forces could be needed elsewhere. And although Somali piracy has faded, west Africa has seen a surge in attacks on ships passing through the Gulf of Guinea.

Tom Patterson, a maritime security expert at Control Risks, a consultancy, says these pirates, who largely come from militant groups in the Niger Delta, have a different business model to their Somali counterparts. They tend to hold ships for about two to five days, removing as much of their cargo as possible (usually gas oil) and then auctioning it to the highest bidder. Hostages are taken if potentially valuable. This week five Poles and Russians, held since April 25th when pirates attacked the German-operated City of Xiamen container ship off Nigeria’s coast, were released, doubtless after a ransom payment.

International naval forces are unlikely to intervene. Nigeria has a decent navy of its own which claims to be upping its efforts to contain piracy. But foreign diplomats believe that some military officials turn a blind eye to thefts in return for a share of the spoils

Hijackings on the high seas: Westward Ho!, Economist, May 18, 2013, at 67

Tax Havens under Attack

[In] the Cayman Islands,  corruption would have been high on the list of election issues in a society where “everybody expects that you are going into politics to make your money”, as a former auditor-general recently put it. But there is plenty more to worry Caymanians and the inhabitants of Britain’s other remaining scraps of empire in the Caribbean: Anguilla, the British Virgin Islands (BVI), Montserrat and the Turks and Caicos Islands. Tourism and international finance have brought prosperity but the “twin pillars” are showing cracks. Fiscal fumbling has compounded the problem and has strained relations with Britain, which has long provided an economic backstop. The region’s two big tax havens, Cayman and the BVI, are under attack as never before.

The world economic slowdown hit these small, open economies hard…. In some cases Britain has pushed for income taxes to supplement the fees and indirect taxes that the territories rely on. But these do not go down well with footloose offshore types. Under pressure from the Foreign Office, Cayman’s government last year proposed a 10% levy for foreigners, who make up half the 38,000 workforce. This was scrapped when businesses squealed. Wary of scaring away business, the BVI has not raised the $350 fee for incorporation since 2004.

Avoiding fee rises is seen as important at a time when tax havens are under bombardment, especially from Europe. The five territories, Bermuda and others have been arm-twisted into backing a multilateral scheme for the automatic exchange of tax information. A longer-term threat is the growing international call for public registration of the “beneficial” (ie real) owners of companies and trusts. Standards must be applied evenly, says Orlando Smith, premier of the BVI, “otherwise, businesses will simply go to other jurisdictions.”

Offshore optimists note that China and Russia, whose citizens are big users of Caribbean havens, have not signed up to the information-sharing pact. But remaining attractive to clients while complying with ever more stringent international rules is “an increasingly difficult needle to thread”, says Andrew Morriss of the University of Alabama. No wonder the territories are trying to diversify away from finance, which in the BVI’s case accounts for 60% of government revenues. Anguilla is looking at fishing, Cayman toying with medical tourism. But hip replacements will not be as lucrative as hedge funds.

Britain is gently encouraging these efforts, while recognising that, as an official puts it, “There isn’t a long list of options.” It is trying to improve governance, too. After it threatened to veto a Cayman port project which had been awarded to a Chinese company without an open tender, bidding was restarted. Britain retains the power to block laws, suspend constitutions and dismiss governments. The Turks and Caicos constitution has been suspended twice, most recently in 2009 after an inquiry found “a high probability of systemic corruption”. This led to three years of direct rule by the British-appointed governor.

Putting your man in charge is one thing, putting money on the table quite another. To avoid it, Britain will have to play its hand carefully. It has to be seen to join the likes of France and Germany in taking a firm stand against offshore financial shenanigans, especially now that the prime minister, David Cameron, has made tax and transparency themes of this year’s G8 agenda. On May 20th he told Britain’s dependencies to “get [their] houses in order”. But if the havens lose their cash cow, they might have to go cap-in-hand to London. “Taxpayers Bail Out Tax Havens” is the last headline Mr Cameron wants to see.

The Caribbean: Treasure islands in trouble, Economist, May25, 2013, at 35

Blackstone, China, Secrecy: Guyana

The government of Guyana wants to move forward with an $840m project at Amaila Falls, deep in the forested interior. At full capacity of 165MW, it could supply more power than Guyana’s present needs.  The lead developer is Sithe Global, part of the Blackstone Group. Sithe wants a guaranteed 19% return on its equity stake, and plans to start construction this year. China Railway First Group signed an engineering contract in September. The China Development Bank will lend most of the money. The Inter-American Development Bank has been asked to chip in $175m; the World Bank was initially involved, but has pulled out.

Amaila’s supporters point out that it will flood less than 55 square km (21 square miles). No villages will be displaced and little wildlife will be disturbed. Guyana would no longer rely on fossil fuels for electricity. After two decades, ownership would pass to the government, construction costs paid off.

Opponents worry that clean electricity will not come cheap. Guyana Power and Light (GPL), the state-owned electricity company, will pay about $100m a year to the Amaila consortium. Electricity bills are unlikely to fall (three people were killed last year in protests over electricity charges). And Amaila’s power may not be reliable. The El Niño weather pattern can bring a year-long drought. In normal years, the plant will run below capacity between October and April. GPL will have to pay for backup thermal power. The IMF has urged “careful consideration of the [financial] risks”.

Plans to build Amaila date from 1997, though Sithe only got involved in 2009. The estimated cost has risen steadily. An access road is unfinished. There is as yet no economic feasibility study for the project; when completed, the study will remain confidential, as is GPL’s outline power-purchase agreement. Opposition parties complain that the government is being “secretive” about Amaila. On April 24th they blocked funds for a government equity-stake in the project. If Amaila is as beneficial as its backers claim, an open debate might generate broader support for the project, and cut its $56m bill for political risk insurance.

Hydropower in Guyana: Shrouded in secrecy, Economist, May, 4, 2013, at 39

Mining Companies Love Least Developed Countries

An expert panel led by Kofi Annan, a former UN secretary-general, looked at five deals struck between 2010 and 2012, and compared the sums for which government-owned mines were sold with independent assessments of their value. It found a gap of $1.36 billion, double the state’s annual budget for health and education. And these deals are just a small subset of all the bargains struck, says the report, which Mr Annan presented in Cape Town, South Africa, on May 10th.

The report highlights some puzzling details. For instance ENRC, a London-listed Kazakh mining firm, waived its rights to buy out a stake in a mining enterprise owned by Gécamines, Congo’s state miner, only to acquire it for $75m from a company owned by Dan Gertler, an Israeli businessman, which had paid $15m for it just months earlier. Mr Gertler is close to Joseph Kabila, Congo’s president. ENRC, which is being investigated by the Serious Fraud Office in Britain, was Congo’s third-largest copper producer last year. Both ENRC and Mr Gertler deny wrongdoing.

African countries often fail to collect reasonable taxes on mining, says Mr Annan’s panel. For example, Zambia’s copper exports were worth $10 billion in 2011, but its tax receipts from mining were a meagre $240m. The widespread use by mining firms of offshore investment vehicles as conduits for profits creates scope for tax avoidance. Their use is not restricted to rich-world companies. Much of the oil that Angola ships to China is via a company called the China International Fund. Its trading prices are not made public…

Congo’s prime minister, Matata Ponyo Mapon, promises change. In January 2013… Mr Ponyo said he would rein in the state-owned mining companies and increase transparency in the industry. “We must avoid situations where we’re not publishing our mining contracts, where our state assets are undervalued, and where the government doesn’t know what its state mining companies are doing,” he told miners and officials at a conference in January….

Last year miners in Congo, which include Freeport-McMoRan and Glencore Xstrata, shipped $6.7 billion-worth of copper and cobalt from the country.

Business in the Democratic Republic of Congo: Murky minerals, Economist, May 18, 2013, at 74