Noting that 2009 and 2010 provided an “extraordinary run” for master limited partnerships (MLPs), Wells Fargo Senior Energy MLP Analyst Michael Blum still sees plenty of potential, including strong business fundamentals, distribution growth and attractive yields. Learn what might take the wind out of an MLP’s sails, which sectors are positioned to run ahead of the wind and which MLPs have set their sights on achieving investment-grade status in this exclusive interview with The Energy Report.
The Energy Report: Michael, a recent Wells Fargo research report said that master limited partnership valuations looked “full, relative to historical valuations.” Does that mean there’s nowhere to go but down?
Michael Blum: Hopefully, there’s somewhere else to go. I think what the report is trying to say is that MLPs look fairly valued, relative to historical levels. Our outlook is for mid-single-digit total return, maybe 6% to 8%. We think investors will continue to receive an attractive yield, but that price performance is probably going to be choppy for a while. I don’t know if that’s necessarily a negative outlook.
On the face of it, relative to other investment alternatives, if you can get a 6%–8% return, along with the tax advantages MLPs afford, that’s a pretty decent investment. It’s not that MLPs are necessarily going to go down or trade down, but we do think that the upside in price is limited in the near term.
TER: Is it fair to say that you expect MLPs to go sideways this year after a relatively impressive 2010?
MB: That’s right. The last two years have been a pretty strong run. In 2010, MLPs generated a total return above 30%; in 2009, they were up over 50%. I think maybe we’ll take a breather this year.
TER: In that same report, you wrote about the two prevailing camps, in terms of MLP performance in 2011. One camp believes a new paradigm is being brought to bear that will revalue MLPs and drive down yields. You are in the other camp, which believes MLPs are just going through another cycle, that they are fairly valued and yields will grow slightly. What explains the different positions and why do you believe you’re right?
MB: There’s always been an argument that MLPs, on a risk-adjusted basis, are mispriced. That’s because, relative to their underlying fundamentals, one could argue that the yield is too high considering the growth rate. As an example, if you compare MLPs to real estate investment trusts (REITs)—another yield product—REITs typically have lower yields. But they also have lower growth rates in their dividends. Arguably, the fundamentals are less attractive than the MLP business model. Why shouldn’t an MLP yield less than a REIT, given that it has higher growth trajectory with better business fundamentals?
The other side of that argument is that MLPs trade at some discount to their intrinsic value because there are tax, liquidity and administrative burdens to owning MLPs. The pool of capital that can own MLPs is more limited because some investors can’t or don’t want to deal with the tax issues associated with owning them. In addition, it’s still a relatively small group. The market cap is right around $200 billion. That’s relatively small in the grand scheme of things. Liquidity for MLPs is not that great. And some funds won’t invest in the sector, simply from a liquidity standpoint. I think those two factors will limit how much capital can ultimately flow to the group. That’s why I think MLPs will continue to trade at healthy valuations, but perhaps not tighter than REITs.
TER: A chart in a recent Wells Fargo report showed Merrill Lynch high-yield, investment-grade bonds yielding 7.2%, whereas the Wells Fargo Securities MLP Index yielded only 6.1%. How do you convince an investor seeking yield securities to choose your offering?
MB: I think there are several reasons that an MLP investment could be more attractive than a high-yield bond. First, from a tax perspective, about 80% of the distributions received will be tax deferred until the security is sold. So, relative to the income received from a high-yield bond, more of that investment will go into the investor’s pocket on after-tax basis as an MLP. Secondly, because MLPs are equities, there is upside in the price. An investor may or may not have that with a bond, especially if it is held until maturity. Lastly, the distribution can grow with an MLP, but it is a fixed rate with a bond. We’re forecasting about 5% medium distribution growth for the MLP sector in 2011 and the next three years. In addition to the current yield, there is growth in that distribution rate.
TER: So, in addition to price upside there is also price downside.
MB: That’s correct. It’s an equity so the price can go up and down, but the same is true of a bond. High-yield bonds now are trading at spreads to the Treasury that are much tighter than the historical rates. So, you have the same risks as with high-yield bonds—interest rates go up or high-yield credit spreads widen.
TER: In a January 7, 2011 research report, you wrote: “We would continue to own MLPs but would wait for dips before adding positions.” How far off are those dips?
MB: It’s really hard to predict dips. If there was a good way to predict them, we’d all do it. There are always unforeseen events. You could have a large seller that decides to be in the market and puts pressure on the price. You could have a confluence of secondary equity offerings in a short time span that could create an oversupply or a situation where equity supply is greater than demand. That could create a pullback in the stock. You could have an exogenous event; for example, when Greece had sovereign credit issues last summer. That impacted credit markets and spreads, as well as MLPs, on a short-term basis. There’s a whole host of factors that could create these dips.
The reason we recommended continuing to own MLPs and to look for dips is that the underlying fundamentals for MLPs are quite good right now. Regardless of the macro factors that could push valuations up and down in the short term, we still think the MLP sector is very attractive on a long-term basis.
TER: MLPs depend heavily on lines of credit to borrow money for business expansion. The consensus is that interest rates are set to rise somewhat, which would increase the cost of capital for MLPs. Please tell us about that and some other potential headwinds that MLPs could be sailing into this year.
MB: Because MLPs pay out the majority of their cash flow every quarter, they do rely on access to capital markets. Because they invest significantly, either to acquire assets or to build new assets, they do have to access the debt and equity markets relatively frequently.
MLPs also are sensitive to interest rates, though not as much as one would imagine. The correlation between interest rates and MLP price performance is only about 0.4. When there is a sudden spike in interest rates or an unexpected increase in interest rates outside of consensus, MLPs will underperform much like other yield- or spread-based securities. That’s certainly a risk. I think a steadily rising interest rate environment will be manageable for MLPs. Those that can grow their distributions more quickly will probably better offset some of the increases in interest rates. For MLPs with limited or no growth in their distributions, you’d expect to see some erosion in price performance as interest rates rise.
Commodity price is another big risk. Oil is now over $90/barrel. To the extent that a number of MLPs have direct or indirect exposure to oil or natural gas liquids (NGLs), which are highly correlated to crude oil prices, a pullback in commodity prices would impact the cash flow. Right now, the correlation between MLP prices and crude oil prices is north of 0.7—the highest correlation of any product or commodity. Certainly that would be another potential headwind for the sector.
TER: MLP general partners (GPs) and gas processors were the best-performing subsectors in 2010. Are those subsectors likely to continue to perform in 2011? What other subsectors do you expect will do well?
MB: I’m not sure the gathering and processing subsector as a whole will outperform. I do think the gathering and processing MLPs that either have good exposure to shale-play development or very high growth rates will probably perform well. We’re thinking about the group more thematically. We think you want to own the higher-growth names, and then own the names that have exposure to crude oil and NGLs as opposed to natural gas. That’s because those subsectors have a lot of growth around them. Commodity prices are strong. The fundamentals are very good.
In terms of the general partners, I do think you could continue to see outperformance. There were six transactions this year in which an MLP acquired and eliminated a GP. That means there are now roughly half as many publicly traded GPs as there were a year ago. From a scarcity-value perspective, investors who want exposure to the GP asset class have a lot fewer choices. I think you could continue to see those move higher just from a scarcity-value perspective.
TER: What are some of those higher-growth names you mentioned?
MB: I would highlight El Paso Pipeline Partners, L.P. (NYSE:EPB), the pipeline MLP for El Paso Corporation (NYSE:EP), which has been selling pipeline assets into the MLP and will continue to do so as they fund development of its E&P business and other resources that it needs at the parent level. We are forecasting +10% growth per year for the next four or five years at El Paso Pipeline Partners. In 2010, the company grew the distribution 19% and sold assets to the MLP worth $2.1 billion. There’s a steady visible growth rate there.
TER: The yield for El Paso Pipeline Partners was 4.9% in 2010 and distributions were $1.64. What are your 2011 projections for El Paso?
MB: We’re forecasting a distribution rate of $1.89 and a yield of 5.3% for 2011.
TER: So, there is a little bit of growth on that one.
MB: Yes. The second name I would highlight is a stock we initiated today, Targa Resources Corp. (NYSE:TRGP). This is the general partner of Targa Resources Partners, L.P. (NYSE:NGLS). Due to where it is in its incentive distribution rights (IDRs), the growth rate at the GP is roughly three times that of the underlying MLP. We’re forecasting a three-year distribution growth target of about 23%. That robust growth comes from the underlying MLP, Targa Resources Partners. We’re forecasting about a 7%, three-year compounded annual growth rate at the MLP level. That’s driven by organic expansions of the natural gas liquids infrastructure. Targa is very well positioned in that business. The partnership has a large footprint in the Gulf Coast. As assets are being built to accommodate growing liquids production and demand, we think Targa will be able to grow the distribution at a pretty nice clip. That translates into a roughly 3:1 ratio of growth to the GP.
TER: You just published your top picks for 2011. What are some of those names?
MB: We’ve already talked about El Paso Pipeline Partners. I would also highlight Enterprise Products Partners, L.P. (NYSE:EPD). Enterprise is involved in the same market as Targa, the NGLs, natural gas pipeline and fractionation and infrastructure markets. The company has a market-leading position in NGL logistics. Based on those same trends in the NGL market, there is growth in liquids production, as well as growing demand for liquids from the petrochemical industry. Enterprise is building its asset base to handle that growing supply and demand. We think you could see distributions grow about 6% per year for the next several years with a yield of about 5.5%. Enterprise is also one of the most liquid names in the sector.
TER: Last year, Enterprise’s distributions were $2.33 and the yield was 5.6%. You’re saying it’s going to be about 5.5%. And what’s the distribution going to be?
MB: We’re looking for $2.45 for 2011.
TER: You said Enterprise’s distributions were going to grow. What are the catalysts for that growth?
MB: The catalysts really are the organic growth projects. As an example, fractionation capacity is very tight right now because NGL supply is up, and you need to fractionate the NGLs to get them to market. Enterprise has a dominant position at Mont Belvieu, Texas, which is the hub for NGL fractionation. As a result of all this pent-up demand, the company is building three new fractionation facilities in Mont Belvieu. Because there’s such demand, it’s been able to increase its rates by almost double what they have been historically. In addition, what used to be a spot business is turning into a long-term contract business. Shippers are now contracting for long-term agreements to reserve space in the fractionator. That affords Enterprise a long-term, fee-based cash flow stream.
TER: What are some other top picks?
MB: The other one I would highlight is Exterran Partners, L.P. (NASDAQ:EXLP). This one’s a little different; it owns compression assets. The general partner is Exterran Holdings Inc. (NYSE:EXH). The story here is that utilization of compression has stabilized and is starting to improve. On top of that, the parent company will be selling assets into the MLP over time to support growth. We think this will create very stable distribution and growth. Our three-year distribution prediction is 6.6%. The stock has a pretty healthy yield of 6.8%. This is a name that hasn’t run as much as others but has pretty good underlying fundamentals and should do well over time.
TER: My MLP chart shows a total return of 12.7% from early November to the end of December 2010. That’s quite phenomenal; such a return would have outperformed just about anything on the market, certainly in this type of investment. Are there any non-investment-grade MLPs poised to become investment-grade names in 2011?
MB: That’s a great question. I don’t know if there are any for 2011, but there are a couple of MLPs that have the potential to get there by 2012. One is Regency Energy Partners, L.P. (NASDAQ:RGNC). Its stated goal is to achieve an investment-grade credit rating. The company’s been transforming its business by adding pipeline and fee-based cash flows, to the extent that almost 80% of its cash flow will come from fee-based activities, and only 20% from commodity-price exposure. As it grows and achieves critical mass, you could see Regency Energy Partners achieve an investment-grade credit rating by 2012.
Similarly, as Targa Resources Partners grows its business to achieve critical size and to add fee-based cash flow, as well as organic growth projects, you could see it hit investment grade in a couple of years.
TER: Any parting thoughts on the MLP sector as of mid-January 2011?
MB: It’s been an extraordinary run. Certainly, the MLP asset class has a higher profile than it probably ever has. You see articles in The Wall Street Journal, there are MLP ETFs, etc. A lot of new funds have been created to own MLPs. So, we still think there should be place in an investor’s portfolio for MLPs. Even after the strong run, they still offer a pretty attractive yield. MLPs have good, solid underlying business fundamentals, so we think the future is still very bright for the MLP sector.
TER: Michael, thank you for your time.
Michael J. Blum is a managing director and senior analyst at Wells Fargo Securities covering energy master limited partnerships. He began his Wall Street career in 2000 at First Albany Corp. as an associate analyst covering alternative energy securities, and joined Wells Fargo in 2001. Since 2003, he has been following MLPs and integrated natural gas securities at Wells Fargo. Before joining the sell side, he spent a year as the investor relations manager for a publicly traded Internet startup during the dot-com boom. Michael has been recognized twice as a Wall Street Journal “Best on the Street” winner, ranking in two categories in 2010: No. 3 for the oil and gas producers sector and No. 5 for oil equipment, service and distribution. He also ranked No. 4 for oil equipment, services and distribution in 2007. In 2010, Michael was ranked the No. 1 MLP analyst in the Greenwich Associates survey of institutional investors. In 2009, he was named the No. 1 oil and gas pipelines analyst by Forbes and was ranked as the No. 3 analyst for the master limited partnership sector in a survey conducted by Institutional Investor. Michael graduated magna cum laude from the University of Pennsylvania with a BA in English literature and a minor in economics.
The aim of main research agenda of development economics in the last century was to provide an evolving approach to curing the persistence of poverty and underdevelopment in world’s least developed and developing countries. High economic growth in developing countries in the last decades has changed many developing nations into middle-income countries. For instance, real economic growth rate in China and India from 1960 onwards averaged 6.67 percent and 3.49 percent, respectively. In 2010, China and India were already classified as lower middle-income countries, belonging to the same income group as El Salvador, Armenia and Philippines. In the recent year, China’s GDP per capita was higher than GDP per capita of many high-growing developing nations such as Ukraine, Nambia, Armenia and Bosnia and Herzegovina, and roughly at the same level as Algeria. Over the last decade, the economic growth in developing countries accelerated, driven by an increase in global commodity prices, robust investment rates, expansionary monetary policy and a growing domestic consumption. The economic growth in a majority of African states stagnated, consequently leading to a decrease in the overall standard of living. Between 1960 and 2009, average real GDP growth was negative in countries such as Congo, Democratic Republic (-2.26 percent), Liberia (-1.51 percent), Niger (-1.02 percent), Zambia (-0.52 percent) and Zimbabwe (-0.02 percent) with many other African countries with little or no growth in the second half of the 20th century. The stagnation of income per capita in countries such as Sierra Leone is largely the result of civil war and severe political instability, creating domestic violence and the persistence of poverty, malnutrition and AIDS/HIV prevalence. From the second half of the 20th century onwards, international aid donors have contributed significant amounts of foreign developmental assistance in various forms such as medical care and vaccination against polio, AIDS/HIV, measles and malaria, direct cash transfers and physical infrastructure. Despite significant official and unofficial developmental assitance from international aid donors, dispersion of real income per capita, measuring the level of cross-country convergence or divergence of income per capita, the gap in economic development widened in the course of the last century. In 2010, the percentage of countries with the level of real GDP per capita $1,500 or below equaled almost 20 percent (link).
The rise of development economics in the 20th century was a natural response to growing disparities in income per capita between rich and poor countries. In the framework of neoclassical theory, development economics emerged from a neoclassical growth theory, pioneered by the famous Solow-Swan model. In the simplest possible form, the growth of output per capita depends on the capital per worker and the initial level of output under stable rate of national saving and capital depreciation. Assuming diminishing returns to scale and constant rate of population growth, the increase in capital per worker would increase the output per worker that would, hence, approach its steady-state equilibrium. Theoretical notions of the Solow-Swan model were tested against the empirical data on economic growth. The key assumption of the neoclassical growth model is that poor countries would tend to catch-up rich countries, assuming higher output growth in poor countries. The convergence of income per capita would imply a neg relationship between the initial level of output per capita and output growth over time. Thus, countries with lower levels of output per capita in the initial period would experience faster rates of output growth. Consequently, the output per capita and the standard of living would approach to the level in rich countries. The empirical tests of the Solow-Swan model failed to confirm the theoretical hypothesis since economic growth rates in 20th century in developed countries were higher compared to developing countries. The divergence of income per capita led to the subsequent modifications of the Solow-Swan model. In fact, the main criticism of the model points out that the model itself failed to capture the role of technological progress in determining the level of output per worker. The mysterious growth episode in Japan and other East Asian nations posed a difficult question. How can a country with low initial level of output per worker at the end of the WW2, exceed the productivity level in rich countries? The obvious answer is that Solow-Swan growth model failed to capture the role of technology shocks which violate the assumption of diminishing capital returns, what could explain why initially poor countries subsequently converged to the level of productivity in rich countries and then exceeded the level. The phenomenon, known as growth residual, has subsequently reduced the predictive power of the Solow-Swan model since a considerable share of economic growth was not ascribed to capital and labor inputs but rather to the persistent role of technological change.
Policy implications from Solow-Swan model imply that the essential requirement to boost economic growth in a country with low initial level of output per capita is to increase the amount of capital per worker, namely by boosting public and private investment in infrastructure. From 1950s onwards, World Bank had repeatedly boosted the growth of infrastructure by facilitating developmental assistance into world’s least developed countries. According to the neoclassical growth theory, higher capital-labor ratio would provide additional investment stimulus, thereby increasing the employment-to-population ratio. Proponents of the foreign aid provided the rationale for higher foreign aid spending by the analogy of post-WW2 Europe when Marshall Plan provided $13 billion, or roughly $100 billion in today’s prices, to Western European economies to recover the physical infrastructure which had been destroyed during WW2. Marshall Plan intervention was rather short, quick and finite. The efficacy of foreign aid in Africa is questionable since little or no growth occured in many African states such as Burundi, Benin, Zimbabwe and Congo. Official forecasts from the United Nations from 1950s onwards, based on the famous Harrod-Domar growth model (link), often assumed a rapid increase in the level of GDP per capita in response to the increase in investment rates. The forecasts, based on the theoretical assumption of diminishing capital returns, predicted a persistent convergence of GDP per capita to the level sustained in richer countries. The fact that the launch of extensive investment in infrastructure resulted in further economic stagnation of many African states, has questioned both the validity and quality of prescriptions laid by the mainstream development economics.
The philosophy of the mainstream development economics was sharply criticized in the light of the fact that foreign aid failed to alleviate poverty and made the growth of African economies slower. The efforts by the World Bank have been diverted from correct diagnosis of the developmental issues in African states to repeated initiatives such as the commitment of the international community to increase the share of foreign aid to least-developed countries to at least 1 percent of the GDP. The criticism of the mainstream development economics was already formulated in 1958 when Mont Pelerin Society organized the 9th meeting and development economics seminar where professor Herbert Frankel of the Nuttfield College put forth the criticism of foreign aid and the failure of development economics:
“The lesson that flows from it is that it does pay to go to these remote areas and find out what the problem is, instead of assuming that one knows the problem before one begins. Until recent years, people have simply assumed in many of these territories in Africa, that there were no real, positive signs of enterprise among the indigenous population, which was supposed to be so uninstructed or inert that it was not able to fend for itself, experiment for itself, or improve itself. It was not realised that a reason why there was this apparent lack of initiative in the population was that there were serious customary or legal obstacles to the exercise of ordinary enterprise, even on a small scale.“
Given the lack of the comprehensive diagnosis of the causes of underdevelopment in African countries, the mainstream development economics failed to capture the appropriate assumptions in the theoretical models of economic development, upon which developmental assistance was justified. A more reasonable theoretical solution to the economic stagnation and social conflict in Africa has been put forth by the human capital theory. In its broadest and most general form, the theory stated that the economic stagnation of African countries is a consequence of the lack of skills and investment in education that could provide the necessary input to increase the economic growth and, subsequently, alleviate the issues of AIDS/HIV, malaria, child malnutrition and domestic violence. There is no doubt that the growth of education initiatives in Africa has sent many children to school. In addition, many universities in Western Europe and the United States have expanded the initiative and offered students from African states preferential admission criteria in various forms such as graduate fellowships, student grants and lower required standardized test scores, to boost admission rates of African nationals at U.S. universities. The efforts of developed countries to bring educational initiatives to Africa encouraged school participation as well as international opportunities of African citizens to study abroad, even at world’s most prestigious and highly-ranked universities. Notwithstanding the importance of education in creating the stock of human capital for the wealth of nations, educational initiatives should address the essential obstacles that creates the failure of African expatriates to return to home countries, hence, bring skills, knowledge and various other forms of human capital, which are essential to the process of long-run growth, the issues of labor market distortions in African countries. These distortions crucially impede the ability of young African graduates to matching jobs in regional labor market.
What the mainstream development economics failed to take into account is the institutional paralysis which prevails in a majority of African countries, plagued by the destructive tribal institutions based on widespread corruption, bribes and domestic violence as means of achieving political power. The prevalence of hybrid institutions, marred by the complete absence of the rule of law and judicial institutions that could facilitate efficient contract enforcement and the protection of private property rights, is not only a severe obstacle to higher economic growth but also the apparent mechanism that captures the set of explanatory features that could possibly account for what caused the misdiagnosis of the African development dilemma. Back in 2002, African Union estimated that each year, corruption costs African economies more than $148 billion or 25 percent of Africa’s GDP. The significance of corruption in state structures in Africa manifests itself in poor quality and provision of public services, the absence of judicial independence from political regimes, cumbersome contract enforcement and unprotected private property rights. Such distortions impede the level of trust and provide evolving incentives to subvert the institutional independence into political cronyism, in which corruption substitutes the tax system through bribes and extortion as methods of lowering transaction costs in overcoming the malfunctioning of the judicial system. In 1978, Erwin Blumenthal of the central bank of the Federal Republic of Germany, warned the international community that “Zaire’s political system is so corrupt that there’s no prospect for Zaire’s creditors to get their money back.” (link)
The advancement of country’s economic prospects requires not only transparent, sound and efficient regulations but, more importantly, highly efficient civil service. In 2010, Transparency International published Corruption Perception Index (link) by measuring the persistence of corruption in public sectors across the world. The findings showed that the vast majority of poor African countries were plagued by extensive and extortionate corruption and ranked in the bottom 20 percent of the distribution. Comparing the level bureaucracy against GDP per capita reveals the amplified evidence of the negative correlation between the efficiency of civil service and the GDP per capita. The ease of doing business in Africa in countries such as Botswana, Ghana, Mauritius and South Africa is remarkably easier with predictable, stable and efficient regulation, compared to countries such as Burundi, Burkina Faso, Côte d’Ivoire etc. where highly burdensome administrative procedures in doing business hamper capital formation and restrain productive investment in health-care, education and private-sector infrastructure that could provide the impetus to economic growth.
The relationship between the amount of foreign aid, received by the least-developed countries, and the scope of corruption as a rough approximation of the institutional quality in the least-developed states, could provide the answer to the question whether international donors consider the scope and significance of corruption in allocating the amount of foreign aid. The experience from the last century of development policy, suggest that international donors actually allocated more foreign aid to the countries, suffering from severe state failure, widespread corruption, government failure and the complete absence of judicial independence that could provide a system of checks and balances and the necessary restraint on the violiation of private property rights, extortion and violence by the political elites. In 1999, Alberto Alesina and Beatrice Weder (see “Do Corrupt Governments Receive Less Foreign Aid,” American Economic Review, 92(4), pp. 1126-1137) found that, contrary to arguments of aid supporters, foreign aid is not used to reward good governments since more corrupt governments received more foreign aid and official development assistance from international donors. The most striking evidence, presented by Alesina and Weder, suggests that U.S donors seem to neglect the persistence of corruption in allocating foreign aid to poor countries while, on the other hand, Scandinavian donors deem the persistence of corruption as highly important, hence, rewarding governments with lower extent of corruption.
In the following graph, I estimated the impact of corruption on official development assistance in the sample of 41 least-developed countries in 2008. In the model, I set the official development assistance to be determined by the scope of corruption in least-developed countries. The official development assistance is expressed as a share of representative country’s gross national income (GNI) for it provides a better measure of aid dependence than foreign aid per capita since the size of population is controlled by the main assumptions of the model. The data on official development assistance were download from World Bank’s World Development Indicators (link). The data on the extent of corruption in least-developed countries were provided by Transparency International’s 2008 Corruption Perception Index (link). The extent of corruption varies from 1 to 10, where lower values indicate more persistent corruption. I estimated whether countries with more corrupt governments receive a higher share of foreign aid from international donors. On the basis of 41 least-developed countries, sample estimates suggest that a 1 point improvement in corruption perception index tends to decrease, on average, the share of foreign aid in gross national income, on average, by 2.37 percentage points. Sample estimate of the slope coefficient is statistically significant at 5 percent level. Even though, the variation in corruption perception index accounts for 5.51 percent of the variation in official development assistance, the influence of the extent of corruption on the share of foreign aid in gross national income is not spurious but systematic and persistent.
Corruption and official development assistance
Source: World Bank, World Development Indicators, 2010. Transparency International, Corruption Perception Index, 2008.
The estimate suggests that international donors indeed reward more corrupt governments by increasing the share of official development assistance. In 2002, African Union estimated that corruption was costing the African continent $150 billion per year. The estimates of the total cost of corruption provide an ample evidence that, over the last century, international donors consistently allocated foreign aid to more corrupt governments, creating aid-dependent economies, prone to bloated bureaucracies and extractive institutions which subsequently led to the stagnation of income per capita in the last decades. An ample criticism of foreign aid initiative was put forth by Dambisa Moyo (link) in the WSJ two years ago: “The most obvious criticism of aid is its links to rampant corruption. Aid flows destined to help the average African end up supporting bloated bureaucracies in the form of the poor-country governments and donor-funded non-governmental organizations.“
The consequence of rootedness of corruption and extractive political institutions in African tribal cultures can be, in a considerable part, drawn upon the colonial heritage that spread throughout the African continent from 19th century onwards. The colonial experience across the African continent (link) served not only as a conquest of newly discovered areas but, moreover, also as an experiment of developing political and economic institutions on the basis of European influence. The colonial heritage in Africa was mainly derived from the European occupation of African lands. Hereto, the presence of European colonizers in Africa provided a long-lasting foundation of the institutional lessons from which the African states went forth.
Given the heterogenity of the European perspectives on institutional development, the colonial period in Africa left a long-lasting impact on the economic and political development in Africa. Africa’s richest countries, namely Botswana, South Africa and Mauritius, were influenced tremendously by the colonial heritage. In Botswana and South Africa, the colonial influence of English and Dutch on further economic development was mainly derived from setting strong institutional foundations of economic development such as the rule of law, judicial independence and limited government compared to other African states. Apart from the setting of formal institutions, fostering contract enforcement and the integrity of the political institutions, English and Dutch colonizers provided the establishment of cultural setting not prone to fraud, extortion and extractive institutions. Favorable institutional conditions furthered the advertance of trust and institutional efficiency, which are deemed essential in fostering the development of financial markets. Even the German presence in Namibia from 1884 to 1915 during Deutsch-Südwestafrika (link) fostered, to a certain extent, independent judiciary, relatively sound institutions and cohesive framework of the rule of law. As a result, Nambia retained the status of one of the least corrupt countries in Africa, known for relatively high degree of economic freedom in a regional comparison with other African states.
While the influence of German, English and Dutch colonizers was largely beneficial to African countries from the perspective of economic growth and development over the last century, the presence of French, Italian and Belgian colonizers arises serious concerns over the prospects of economic development across the African continent. The myraid of violence, in countries such as Congo Dem. Rep. and Somalia, which ultimately led to civil wars and the settlement of extractive institutions, largely reflects the innate ability of the colonial policies to provide the necessary conditions for the institutional integrity, the rule of law and stringent property rights that could underline the basis of economic development by restraining the power and domination of political elites and their ability to expropriate private property rights in pursuit of extractive monopoly rents from natural resources. That easily explains why countries such as Congo, Zambia, Nigeria and Zimbabwe, in spite of vast reserves of natural resources, were seized by the state capture of political elites. The colonial presence largely determined the size and scope of aid dependency in African states. The most plausible and persuasive explanation of the impact of European colonial policies in African countries was presented by Daron Acemoglu, Simon Johnson and David Robinson (see “Disease and Development” Journal of European Economic Association, 1(2/3), pp. 397-405):
“European colonists were much more likely to develop institutions of private property, encouraging economic and social development, in places where they settled. In contrast, in places where they did not settle, they were more likely to opt for extractive institutions, designed to extract resources without investing in institutional development. In these places, institutions were highly centralized, with political power concentrated in the hands of small elites and with almost no checks on this elite. The property rights and more general rights of the majority of the population were not protected.“
The political and economic circumstances of the European institutional legacy in African states imparted aid dependency on those countries where the combination of tribal institutions, hostile to free enterprise and judicial restraint of political dictatorships, and unequivocally detrimental colonial policies dominated the development of political and economic institutions, setting the rules of the game. Therefore, the inability of many African societies to establish sensible and effective institutions resulted in the political capture of the state by the elites. The monopoly power of the political elites, enforcing anti-growth public policies, led to consistently poor economic outcomes, plagued by high rates of poverty and infectious diseases such as polio, malaria and measles.
The challenge of development economics is not to design aid schemes, which inevitably lead to aid dependency, marred by persistent corruption and political fraud, but to ascertain correct diagnosis of why foreign aid repeatedly resulted in the poor economic outcomes and the consequent stagnation of income per capita in many African states in 20th century. The failure of African societies to establish a rigorous system of incentives, which could significantly improve economic outcomes, is not a response to market failures (which deemed highly of early development economics) but a result of severe government failure to establish effective institutions of the rule of law, contract enforcement and stringent property rights. These institutions are the broadest foundations of economic development and the only viable alternative to political nepotism and the power of elites which, as poor development outcomes in Africa show, ultimately impose extractive institutions, causing the persistence of poverty and underdevelopment.
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It seems that JCT showed that he and the ECB are not completely blind and deaf when it comes to the reality of a stronger currency in a world where everyone is scrambling to devalue.
As I have noted before, stranger things have happended than the ECB raising into a an impending downturn, but it seems that the ECB has lifted off a little bit in terms of the vigilance against inflation.
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The Monster Employment Index for January was released today, and the index moved down 8 points to a value of 122, but is 7% higher than last January’s value.
At 8:30 AM EST, the Employment Situation report for January will be announced, and the consensus for non-farm payrolls is an increase of 150,000 jobs compared to a gain of 103,000 in the previous month, the consensus for the unemployment rate is that it will increase by 0.1% to 9.5%, the consensus average hourly earnings rate is expected to increase 0.2%, and the consensus for the average workweek is 34.3 hours.
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