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Women’s Empowerment in Japan: From Tokenism to Critical Mass?

April 19, 2024
By 21688

A decade ago, then Prime Minister Shinzo Abe announced a policy aimed at promoting more women to leadership positions in Japan—a country that has long ranked near the bottom in the Global Gender Gap Index. The pace of progress since then, though, has been embarrassingly slow. Thanh Nguyen (Waseda University, 2014) used an SRG award to analyze corporate data over the past decade to identify where improvements have been made and what more needs to be done to enhance women’s boardroom presence.[1]

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In spring 2014, then Prime Minister Shinzo Abe made a speech on “A New Vision from a New Japan” at the World Economic Forum, stating, “Japan must become a place where women shine. By 2020 we will make 30% of leading positions to be occupied by women.” This led to an increase in the number of female board directors, but Japan still failed to achieve the 30% target by 2020 and had to push back the target date by up to a decade.[2] The situation today is still not promising, as the Global Gender Gap Index in 2023 ranked Japan 125th out of 146 countries; the country has remained near the bottom of the list over the last 10 years. Will Japan be able to reach the 30% milestone by the revised deadline of 2030?

In my research, I gathered updated data about female leadership in Japan from 2012 to 2023. I first measured the impact of recent changes in Japanese policy and law aimed at promoting the appointment of women to management and leadership positions, focusing on Abe’s “Womenomics” policy launched in 2013 and the Act on Promotion of Women’s Participation and Advancement in the Workplace implemented in April 2016. I examined whether firms appointed more female directors during the policy period compared with earlier periods.

Second, I examined the critical mass of female directors and the firms that succeeded in increasing the number of female directors to this level. Critical mass is defined as the number of female directors needed to affect policy and induce real change. I identified firms as being successful in reaching critical mass if 30% or more of their board members were women—the target figure set by the Japanese government. My main research question was whether gender policies actually helped to increase the number of female directors, especially up to critical mass.

Scrutinizing Womenomics Policies

Many countries have introduced a mandatory or voluntary quota for female leaders to address gender inequality. For example, Norway has a 40% female board membership quota, while Britain maintains a 25% female board membership target. By contrast, the Japanese government promotes female leadership not with a quota but through its Womenomics policy package that encourages large corporations to promote gender- and employment-related policies. In particular, firms have been advised to establish and disclose their action plans to improve gender equality and to disclose relevant data.

To answer my research question, I collected data on the directors at listed firms in Japan from the Yakuin Shikiho (Executive Officers Handbook), published by Toyo Keizai Inc., which includes the name, age, position, gender, place of birth, education, and previous experience of each director. My final sample consisted of an unbalanced panel of more than 40,000 firm-year observations from 2012 to 2023. I then created a group of variables representing the characteristics of the board, including “total number of board members,” “total number of female board members,” “ratio of female board members,” “chairperson gender,” and “CEO gender.”

30% Target Reached by Only Small Minority of Firms

I found that only 9% of surveyed firms had at least one female board member in 2012 but that this figure increased gradually each year, climbing to 63.4% in 2023, with 2,482 out of 3,915 listed firms having at least one female board director (Figure 1). This indicates that many more firms appointed female board directors during the years of Womenomics. The steady uptrend was unaffected by the COVID-19 pandemic.

Policymakers may be happy with these changes in corporate governance and claim that the Womenomics policy package has been effective. The truth, though, may not be that rosy. When I calculated the share of female board members and grouped the firms according to this percentage, I found that the group claiming shares of 30% or higher accounted for only 0.59% of all firms in 2012 and a still very low 4.06% in 2023.

This figure has been increasing gradually each year, to be sure, but the pace has been very slow, and the spread is consequently very small. In 2023, among the 3,915 listed firms, only 159 met the 30% target for female board members. This means that although more firms appointed women to the board during the Womenomics years, the number of appointees has been minimal. If this situation continues, Japan will fail for the second time to reach its target of “30% of leading positions to be occupied by women.”

I also examined the number of women serving as the chair, the CEO, and a board member for each year from 2012 to 2023 and found that there has been no uptrend for either the chair or CEO. These figures fluctuated year on year with a very small change spread. Among the 31,520 board members in 2023, there were only 21 chairwomen and 54 female CEOs. In other words, of the 3,915 listed firms, only 54 firms were headed by women—hardly a robust picture of female leadership in Japan.

Figure 1. Share of Female Board Members, 2012–2023

 

As for board members, in 2012, only 374 of the 26,294 members were women, accounting for a mere 1.42% of the total. If chairwomen and female CEOs are deducted, the total number of female directors in 2012 was 335. Figure 2 shows that even with the jump in the number of female directors from 2012 to 2023, the ratio of female board members was still small. My data shows that in 2023, the percentage of female board members was 10.93% in 2023; in other words, males still occupy 89% of the boardroom. Without fundamental changes, the chances of Japan reaching the 30% target by 2030 appear bleak.

Figure 2: Number of Female Board Members, 2012–2023


I also examined the relative shares of outside and inside female directors. In 2023, outside directors made up 84.33% of the total, implying that firms have tried to increase the number of female directors by tapping human resources from outside the company, appointing such professionals as business consultants, university professors, and leaders of other firms. Indeed, it is easier for firms to appoint a female director from outside the company, since nurturing and promoting female employees to take on management responsibilities takes time.

This pattern highlights another challenge for Japanese corporations: the small pool of qualified female candidates for leadership positions, both inside and outside the firm. Appointing outside female directors is, at best, a short-term strategy, as even the external supply of qualified candidates is small. This is proven by the fact that outside female directors often serve on the boards of several firms. This situation will not fundamentally change until firms begin actively recruiting more female employees and providing them with opportunities for promotion to senior and leadership positions.

Need for Drastic Change

My research was an attempt to provide an overview of women empowerment efforts in Japan over the last decade and to present updated data about female leadership. It led to new findings on the number of female board directors during the twelve years of Womenomic policy (2012–2023).

During these years, corporate governance reforms resulted in more female directors, especially outside directors, being appointed to executive boardrooms, compared with the years before the policy’s implementation. Policies promoting female leadership thus appear to have been effective for listed firms. However, they have had no tangible impact on top positions, like corporate chairs and CEOs. And Japan may once again fail to reach its 30% target without drastic changes over the next six years.

These findings can serve as meaningful references for investors, corporate leaders, and policymakers. There have been calls for stronger measures to promote gender equality both inside and outside corporate settings so that this target can be reached by 2030. Policymakers need to do more than simply ask firms to hire more women and elevate them to leadership positions. And investors, especially institutional investors, must perform their stewardship duties by engaging directly with the companies in which they invest, persuading management teams and board directors to promote gender diversity, which can, in turn, create more sustainable, fairer, better-run, and faster-growing companies.

[1] This is a short English summary of a paper by the author that was originally published in Japanese. The full Japanese version can be found at: https://www.jsri.or.jp/publish/review/pdf/6402/05.pdf.

[2] https://mainichi.jp/english/articles/20200626/p2a/00m/0fp/014000c.


References

Kubo, K. and Nguyen, T. T. P. 2021. Female CEOs on Japanese corporate boards and firm performance. Journal of the Japanese and International Economies, 62, 101163.

Nguyen, T. T. P. 2021. Effects of board gender diversity on firm investment and performance. Waseda Commercial Review, 461, 47-92.

Nguyen, T. T. P. and Thai, H. M. 2022. Effects of female directors on gender diversity at lower organization levels and CSR performance: Evidence in Japan. Global Finance Journal, 53, 100749.

Nguyen, T. T. P. 2024. Nihon ni okeru josei no enpawamento: Tannaru shinboru kara kuritikaru masu e? Shoken Rebyu, 64(2), 115–129.

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How Hungary Came to “Accept” the Global Minimum Tax

March 5, 2024
By 31304

Hungary found itself isolated in the EU when it initially blocked the implementation of the OECD agreement on a minimum corporate tax rate for multinationals. In an article adapted from a paper that was submitted to Pázmány Péter Catholic University Budapest, Tamás Zoltán Wágner (Hungarian Academy of Sciences, 2022) writes that rather than stonewalling the agreement, the government wisely shifted its strategy, enabling it to embrace the deal while maintaining its tax sovereignty and competitiveness.

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Following the October 2021 agreement on a global minimum tax within the OECD framework on base erosion and profit shifting (BEPS), the focus in the European Union shifted to the question of how this should be implemented in national and EU legal systems. This became an issue because member states with low corporate tax rates, such as Ireland and Hungary, feared losing their competitiveness and were critical of the implementation efforts, triggering heated debate.

Hungary initially strongly opposed the implementation of the tax in the EU and anticipated vetoing it if necessary. Later, though, the Hungarian government adjusted its position and focused its efforts on how it could avoid implementing an actual tax increase. In the following, after briefly presenting the rules on the global minimum tax, I will examine whether Hungary’s fear was justified and then analyze the reasons for the change in the Hungarian position, which evolved from initial rejection to a search for a compromise.

Discouraging Tax Planning

Regarding the OECD agreement, it is important to point out that it is a two-pillar solution. The first pillar addresses the largest and most profitable multinational enterprises (MNEs) with a global turnover of more than €20 billion (€10 billion from 2028) and a pretax profitability ratio exceeding 10%. In countries where they sell their products and services and where they have consumers, these companies will need to pay 25% of their profits. By implementing this tax, countries that introduced or planned to introduce a digital tax will abandon it and commit to not introducing it in the future.

The second pillar is the global minimum tax, which aims to ensure that multinationals pay a minimum of 15% on all their profits in each jurisdiction where they have subsidiaries or establishments. According to pillar two rules, it is necessary to examine on a country-by-country basis whether the taxation of a given multinational reaches the effective tax rate. The global minimum tax applies to MNEs with an annual consolidated group revenue of €750 million operating in at least two of the four years preceding the current year and in two jurisdictions. States have the option of including for minimum taxation groups of companies operating in their own territories even if they do not have foreign subsidiaries or establishments. Not subject to the minimum tax, though, are government departments, international organizations, nonprofit organizations, pension or investment funds that are the ultimate parent companies of a group of companies, and the assets held by such entities.

The rate of the global minimum tax is not a nominal but an effective tax rate: only the taxes actually paid matter. Thus, if the effective tax rate of one of the subsidiaries in a given jurisdiction is less than 15%, then an additional tax is levied, to be paid by the parent company or the subsidiary. According to the three-element scheme developed by the OECD, the income inclusion rule (IIR) provides for the imposition of a top-up tax to make up for any difference in the taxes paid, or, if there is no IIR in the relevant jurisdiction, the undertaxed payments rule (UTPR) operates as a backstop to ensure that the tax rate for an MNE group is achieved by prohibiting cost deductions for group members or through similar mechanisms. The third element of the regulation is the subject to tax rule (STTR), a treaty-based rule that allows certain states to tax intra-group payments when the tax rate for such payments is below the minimum rate. This had been prohibited under the double taxation convention.

In the light of the above, it is clear that, contrary to the OECD BEPS Action Plan, adopted in 2013, the global minimum tax does not place emphasis on protecting the tax base but on eliminating the cause of tax planning: its basic philosophy assumes that MNEs will not use tax avoidance techniques if the tax advantage is taken away. It also aims to prevent a “race to the bottom” based on continuous decline in corporate tax rates and to reduce divergences between national tax systems, which also facilitate tax avoidance techniques.

An image generated by Craiyon (https://www.craiyon.com/).

Backlash from Hungarian Officials

Low-tax countries like Ireland and Hungary initially sharply criticized the concept because they feared losing their competitiveness and becoming less attractive to foreign investors. They also complained that the introduction of a global minimum tax would limit their tax policy, since it would essentially force them to raise their corporate tax rates: even if they apply lower tax rates, other states will collect the difference anyway. This fear seemed justified because, as Hindriks and Nishimura showed, the introduction of a global minimum tax would reduce the gap between high-tax and low-tax countries, which would also affect the ability to attract capital: large companies would be less likely to move their profits to low-tax countries.

Overall, countries with low tax rates can expect a decrease in tax revenues, while countries with high tax rates can expect an increase in tax revenues. In the longer term, the loss of a tax advantage could also jeopardize the very existence of tax havens and other preferential tax regimes. For this reason, these countries need to pursue one of the following strategies:

  • Maintain the status quo (for states that do not levy a corporate tax)
  • Raise the corporate tax rate to the level of the global minimum tax
  • Introduce a corporate tax system that applies to all companies
  • Introduce a threshold-based corporate tax system, which means that only companies subject to a global minimum tax must pay the higher corporate tax rate

Another strategy is for the state, in order to avoid an effective tax increase, to include as many types of tax as possible in the effective tax burden. This, in my view, is the best way forward, and it was, in fact, the choice made by Hungary.

Hungary, like other low-tax countries, was initially very skeptical about the global minimum tax. The proposed legislation triggered the following preliminary remarks from governmental officials:

  • “We should avoid a war of competition among tax systems in the global fight against harmful tax competition.”
  • “It is essential to respect the fiscal sovereignty of states regarding the taxation of income generated locally, and profits attributable to real economic activity shall be exempted to the greatest possible extent.”
  • “The situation should be avoided where the regulation penalizes differences between different methods of calculating the tax base instead of low taxation, which could substantially restrict the free movement of capital even between states applying tax rates close to the average.”
  • “A set of rules applicable only to subsidiaries would create a significant competitive disadvantage for capital-importing countries and, in many cases, lead to the relocation of headquarters to low-tax states.

These remarks were later supplemented by criticisms, such as:

  • “This reduces the sovereignty of the Hungarian tax system and would result in a competitive disadvantage for the European Union, which is unacceptable in the particularly sensitive economic situation caused by the Russo-Ukrainian war.”
  • “The Hungarian corporate tax rate (9%) is much lower than that of all our trading partners, which is the cornerstone of the Hungarian economic policy.”
  • “It would endanger hundreds of thousands of jobs in our country and would mean a return to the situation of 2010 in terms of corporate tax.

A Threat to Competitiveness

These comments indicate that the Hungarian government viewed the issue of the global minimum tax from a sovereigntist, tax competitiveness perspective. This was understandable, given the logic of Hungary’s economic policy: the implementation of an actual tax increase would endanger the competitiveness it had enjoyed thanks to low corporate tax rates. At the same time, the Hungarian government was under great pressure to support the adoption of the EU directive. After all, even if it did not introduce a global minimum tax, the tax difference would simply be collected by other governments. In other words, companies operating in Hungary will have to reckon with an increase in the tax burden no matter how Budapest decided, and moreover, by not implementing the tax, the government would be voluntarily forgoing sources of revenue that it could otherwise have claimed.

The situation of the Hungarian government became more difficult by the fact that on September 9, 2022, the EU’s largest economies—France, Germany, Italy, Spain, and the Netherlands—announced that if the EU directive was not adopted, they were ready to introduce the global minimum tax unilaterally. This step would have meant tens of billions of forints in additional tax liability just for German companies operating in Hungary, whose average effective corporate tax rate, due to various tax breaks, barely reached 3%. Hungary also faced concrete pressure owing to the termination of the US-Hungary double taxation avoidance treaty in early July 2022 and the decision of the European Parliament on national vetoes undermining the global tax agreement, also in early July.

Regarding the former, it is worth pointing out that this was not unexpected: even before the Ecofin (Economic and Financial Affairs Council) meeting in June 2022, US Treasury Secretary Janet Yellen warned Hungary to change its position on the global minimum tax or face the termination of the bilateral double taxation treaty. Although the treaty did not expire until January 2024, the United States showed no intention of concluding a new treaty with Hungary. In Tibor Pálszabó’s opinion, the potential implications for private individuals include the following:

  • If they become residents in both countries, their world income would become taxable in both states.
  • Even without multiple residence, they may become liable for taxation in the country of income in situations where they had previously been exempt, that is, a double taxation situation may arise.
  • The conventional exemptions that would have resolved such double taxation issues will be abolished.

In the case of businesses, there will be a negative change mainly in relation to the withholding tax: dividends, interest, and royalties will be subject to a withholding tax of 30% instead of the previous 5%. The Hungarian economy will experience the negative effects even in the short term (such as through a direct tax revenue loss of 70 billion to 80 billion forints due to the reorganization of the investment structure of US companies), but in the long term the situation is more serious: there could be a significant decline in the economy’s ability to attract capital and retain its labor force.

The European Parliament, meanwhile, criticized the unanimity requirement for decision-making in the field of taxation, calling on the European Commission and the Council to find alternative ways for the EU to fulfil its OECD/G20 commitments, such as through “enhanced cooperation,” unilateral implementation by member states, and transition to qualified majority voting. It also demanded that Hungary lift its veto and urged the Commission and member states to block approval of Hungary’s recovery and resilience plan unless all the criteria were fully complied with.

A Shift in Strategy

Based on the above, it was apparent that by the end of 2022 the Hungarian government found itself in a very difficult situation: it was isolated in the EU and risked being lumped together with conventional tax havens. The Hungarian position, which seemed rigid at first, thus gradually shifted to another strategy: including as many domestic taxes (such as the local business tax) as possible in the effective tax burden in order to avoid actually raising the corporate tax. In this respect, negotiations were successful, as Hungary achieved the following goals:

  • The inclusion of the local business tax in the global minimum tax
  • Exemption of real economic activity
  • Simultaneous introduction of rules in all countries adopting the global minimum tax (so that Hungary does not suffer a competitive disadvantage)
  • The likely collection of the tax difference from target MNE groups in the form of differentiated domestic taxes so that there is no need to change the corporate tax rate of 9%.

Subsequently, on December 12, 2022—after Hungary lifted its veto—EU member states reached an agreement on the directive submitted by the European Commission at the end of 2021 to ensure a global minimum level of taxation for MNEs, which entered into force on December 14, 2022.


The example of Hungary highlights that, contrary to initial fears, the introduction of the global minimum tax does not necessarily entail an increase in the corporate tax burden or restrict the tax sovereignty of low-tax countries if other types of domestic taxes (like the local business tax) are included in the effective tax burden. Therefore, the right strategy for the global minimum tax is not rigid resistance, as it can easily lead to international isolation and reputational loss (such as by being branded a tax haven), but to negotiate a compromise so that competitiveness can be maintained even after implementing the global minimum tax.

References

OECD/G20 Base Erosion and Profit Shifting Project. “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy.” https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf.

Czoboly, Gergely. “Globális minimumadó bevezetésének lehetséges hatásai a klasszikus adóstruktúrákra” [Possible Effects of the Introduction of a Global Minimum Tax on Classical Tax Structures]. Miskolci Jogi Szemle, 2021/5. (3. különszám).

Nobilis, Benedek. “Globális minimumadó: ez nem csak Magyarországnak fájhat” [Global Minimum Tax: This May Hurt Not Just Hungary]. Portfolio. https://www.portfolio.hu/gazdasag/20210413/globalis-minimumado-ez-nem-csak-magyarorszagnak-fajhat-477960.

Hindriks, Jean and Yukihiro Nishimura. “The Compliance Dilemma of the Global Minimum Tax.” LIDAM Discussion Paper CORE, 2022/13. https://dial.uclouvain.be/pr/boreal/object/boreal%3A259159/datastream/PDF_01/view.

Essid, Colleen. “The Global Minimum Tax Agreement: An End to Corporate Tax Havens?” SLU Law Journal Online, 73. https://scholarship.law.slu.edu/lawjournalonline/73.

Deloitte Insights. “Global Minimum Corporate Income Tax. How Might Countries with ‘Low’ or ‘No’ Taxation Respond?” https://www2.deloitte.com/xe/en/pages/tax/articles/global-minimum-corporate-income-tax.html.

Prinz, Dániel and Eszter Kabos. “Miért van szükség globális társasági minimumadóra?” [Why Do We Need a Global Minimum Tax?]. Qubit. https://qubit.hu/2021/08/02/miert-van-szukseg-globalis-tarsasagi-minimumadora.

Hungarian National Assembly. “Az Országgyűlés 24/2022. (VI. 21.) OGY határozata a globális minimumadó bevezetésére vonatkozó európai uniós irányelv elfogadásának elutasításáról” [24/2022 (VI. 21) Decision of the Hungarian National Assembly Rejecting the Adoption of an EU Directive Introducing a Global Minimum Tax].

Kiss, Rajmund. “Kerékbe tört versenyképesség? A globális minimumadó súlyos kockázatairól” [Competitiveness in Tatters? The Serious Risks of the Global Minimum Tax]. Mathias Corvinus Collegium. https://corvinak.hu/gazdasag/2021/05/19/kerekbe-tort-versenykepesseg-a-globalis-minimumado.

Government of Hungary. “A globális minimumadó jelentené a kegyelemdöfést az európai gazdaságnak” [A Global Minimum Tax Would be a Coup de Grâce for the European Economy]. https://kormany.hu/hirek/a-globalis-minimumado-jelentene-a-kegyelemdofest-az-europai-gazdasagnak.

Pardavi, László. “Néhány gondolat a globális minimumadó történetéről, bevezetésének okairól és lehetséges magyarországi hatásairól” [A Few Thoughts on the History of the Global Minimum Tax, the Reasons for Its Introduction, and Its Possible Impact on Hungary]. In Barna Arnold Keserű, Katalin Szoboszlai-Kiss, and Richárd Németh, eds., Salus Vocalis. Csegöldi indulás - Győri érkezés. Ünnepi tanulmányok Fazekas Judit tiszteletére. Győr, Universitas-Győr Nonprofit Kft, 2023.

Adó Online. “Niveus: Magyarország a globális minimumadóról szóló csatát hamarosan elveszítheti [Niveus: The Battle over the Global Minimum Tax Could Soon Be Lost for Hungary]. https://ado.hu/ado/niveus-magyarorszag-a-globalis-minimumadorol-szolo-csatat-hamarosan-elveszitheti/.

Government of Hungary. “Az Egyesült Államok nyomást akar gyakorolni Magyarországra” [The United States Wants to Put Pressure on Hungary]. https://kormany.hu/hirek/az-egyesult-allamok-nyomast-akar-gyakorolni-magyarorszagra.

Pálszabó, Tibor, Veronika Oláh, and Dániel Bajusz. “USA-magyar adóegyezmény felmondása: mi lesz veletek expatok?” [Termination of the US-Hungarian Tax Treaty: What Will Happen to Expats?]. EY. https://www.ey.com/hu_hu/tax/usa--magyar-adoegyezmeny-felmondasa--mi-lesz-veletek-expatok-.

Dajkó, Ferenc Dániel. “Sérülnek az amerikai-magyar kapcsolatok? – Szakértők a kettős adóztatás felmondásáról” [Are US-Hungarian Relations Damaged? Experts on the Termination of Double Taxation]. novekedes.hu. https://novekedes.hu/interju/serulnek-az-amerikai-magyar-gazdasagi-kapcsolatok-szakertoket-kerdeztunk-mi-varhato-a-kettos-adoztatas-egyezmeny-felmondasa-utan.

European Parliament. “European Parliament Resolution of 6 July 2022 on National Vetoes to Undermine the Global Tax Deal (2022/2734(RSP)).” https://www.europarl.europa.eu/doceo/document/TA-9-2022-0290_EN.html.

Mattiassich, Enikő and Károly Szóka. “Impact of the Introduction of A Global Minimum Tax.” In Mustafa Göktuğ Kaya and Haldun Soydal, eds., International Congress of Finance and Tax. March 10–11, 2023, Konya, Türkiye.

Council of the European Union. “Council Directive (EU) 2022/2523 of 14 December 2022 on Ensuring a Global Minimum Level of Taxation for Multinational Enterprise Groups and Large-Scale Domestic Groups in the Union.” Official Journal of the European Union, L 328, 22.12.2022, pp. 1–58. https://eur-lex.europa.eu/eli/dir/2022/2523/oj.

 

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Enhancing Immigrant Integration through Social Connections: An Experimental Study in Sweden

February 7, 2024
By 28006

Olle Hammar’s (Uppsala University, 2020) Sylff Research Grant focused on evaluating a program aimed at promoting social inclusion of immigrants and refugees in Sweden. The project, involving a randomized controlled trial in partnership with an NGO, assessed the impact of contact with natives on immigrants’ social, economic, and cultural integration. Preliminary results suggest potential benefits, including sustained relationships and increased job opportunities for immigrants.

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Introduction

My project on “Social Networks and Immigrant Integration: Experimental Evidence from Sweden,” conducted together with Mounir Karadja and Akib Khan at Uppsala University, seeks to understand and enhance immigrant integration in Sweden, a country known for its progressive social policies but which is now grappling with the challenges of integrating its growing foreign-born population (Statistics Sweden 2019). The project began with a deep interest in understanding immigrant integration in Sweden. Intrigued by the pivotal role social networks can play, we aim to explore the impact of social interactions between immigrants and native Swedes on the integration process.

The study is conducted in partnership with Nya Kompisbyrån (New Friend Agency), a Swedish nongovernmental organization facilitating informal meetings between immigrants and natives in Sweden. Immigrants, predominantly from low- and middle-income countries, are matched with native Swedes, fostering opportunities for language practice, cultural exchange, and network expansion. Through a randomized controlled trial, we assessed the effectiveness of this program.

 

Nya Kompisbyrån operations manager Mardin Baban, left, and Mounir Karadja of Uppsala University’s Department of Economics.

The COVID-19 pandemic posed significant challenges to this project, temporarily forcing participants to shift from direct, in-person interactions to digital meetings. Thankfully, solutions to these challenges were facilitated by the SRG, which allowed for the implementation of a more structured and sustainable survey data collection approach.

Background and Methodology

Sweden has experienced a significant influx of immigrants from diverse backgrounds, and their social and economic integration has become a key issue (Statistics Sweden 2019). Our research focuses on evaluating the effectiveness of social networks in facilitating this integration by working closely with Nya Kompisbyrån, one of the largest NGOs of its kind in Sweden.

In this project, we use a randomized controlled field experiment to evaluate a novel program administered by Nya Kompisbyrån.

The methodology is based on the observation that, since more immigrants than natives sign up for this program, not all immigrants can be matched with a native Swede. As such, our evaluation uses a randomization design where two immigrants are selected as potential matches for each native, based on common interests, gender, and age.

One of the immigrants is randomly assigned to meet with the native, while the other is placed in the control group. Individuals in both groups, as well as the participating native Swedes, were surveyed by an external survey company (co-financed by SRG) during the implementation period between October 2022 and September 2023. Using this data and methodology, we are able to assess the causal effects of contact with natives on immigrants’ social, economic, and cultural integration.

While the data collection phase is now finished, which was the aim of the SRG-funded part of the project, our next step will be to analyze the data and assess the final results. Preliminary findings suggest large potential benefits for the participating immigrants. Most matched pairs continue to meet after their first contact, indicating that a large share of matches results in meaningful and sustained relationships. In addition, many of the job-searching participants indicate that they have received a job or internship through their native Swedish contact. The interactions also seemed to facilitate stronger social networks for participating immigrants.

Adapting to COVID-19

The pandemic posed significant challenges to our original plan of studying in-person meetings between the participants. We adapted to these circumstances by shifting to a more sustainable format of long-term survey data collection, which allowed us to continue our research without compromising the integrity of the participants or the depth of our analysis. The project had to be temporarily suspended when COVID-19 made in-person meetings impracticable, but we were able to continue conducting fieldwork thanks to SRG.

The project will potentially have broad implications for Sweden’s approach to immigrant integration. It examines the importance of social connections and cultural exchange in breaking down barriers and fostering a more inclusive society (Allport 1954). The findings will offer valuable insights for policymakers, demonstrating how initiatives promoting direct social interactions between immigrants and natives can enhance the integration process.

Another contribution of this project is its experimental attempt to evaluate an NGO-driven intervention for immigrant integration. Many NGOs are active in the field of integration across the globe and often have innovative approaches based on voluntary participation, as well as low operating costs (Lundberg et al. 2011). In Sweden, the government identifies civil society as an important actor for integration. Yet, despite public and private investments, there is a lack of knowledge on the causal effects of civil society organizations in this domain (Osanami Törngren et al. 2018). As such, this project also contributes to evaluating civil society’ broader role in immigrant integration.

Both Academic and Practical Benefits

This journey has been both challenging and rewarding. Adapting to the unforeseen circumstances posed by the pandemic while maintaining the integrity of our research project was a significant learning experience. We are very grateful for support from the Sylff Association in helping us quickly adapt to these changed circumstances. The SRG funding was instrumental in the success of this project, enabling us to navigate unforeseen obstacles and contribute significantly to the field. It has also allowed me to continue my collaboration with my research colleagues and the NGO, as well as other actors in the area of immigrant integration in Sweden and abroad.

The project has been pre-accepted for publication in the Journal of Development Economics (Hammar, Karadja, and Khan 2023), based on a pre-results review. This, we believe, is a testament to its academic significance and practical relevance. The insights gained from this research will contribute not only to the academic understanding of immigrant integration but also offer practical insights for NGOs and policymakers on the potential of social networks and informal meetings. It strengthens our belief in the power of simple human connections to bridge cultural divides and enhance societal cohesion.

Our next step will be to analyze and disseminate the final results of this project. Going forward, we will further explore the dynamics of immigrant integration in different cultural and societal contexts. Our research also highlights the need for more innovative approaches to policymaking in the realm of migration and integration.

 

Social integration through coffee?

References

Allport, G.W. 1954. The Nature of Prejudice. Reading, MA: Addison-Wesley.

Hammar, O., Karadja, M., and Khan, A. 2023. “Social Networks and Immigrant Integration: Experimental Evidence from Sweden,” Journal of Development Economics, Accepted (Pre-Results Review).

Lundberg, E., Brundin, P., Amnå, E., and Bozzini, E. 2011. “European Civil Societies and the Promotion of Integration: Leading Practices from Sweden, Great Britain, the Netherlands and Italy.” In Social Rights, Active Citizenship and Governance in the EU. Baden-Baden: Nomos Verlagsgesellschaft.

Osanami Törngren, S., Öberg, K., and Righard, E. 2018. “The Role of Civil Society in the Integration of Newly Arrived Refugees in Sweden.” In Newcomer Integration in Europe: Best Practices and Innovations since 2015.

Statistics Sweden. 2019. “Integration: En beskrivning av läget i Sverige,” Integration 13.

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Performance of ESG Investment Strategies: Evidence from the 2015–2020 Bull Market and the Impact of COVID-19

June 2, 2023
By 30810

Máté Fain is a 2022 Sylff Fellow (Corvinus University of Budapest, Hungarian Academy of Sciences Group). For this dissertation, he explored whether environmental, social and governance (ESG) investment strategies are compatible with boosting the corporate “bottom line.” He concludes that good ESG may not always generate superior returns under adverse market conditions such as a pandemic. However, combined with traditional styles, it might yield positive outcomes.

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What do oil, soybean, gold, and water have in common? The answer, at first, may be surprising: in late 2020, water joined these well-known commodities on Wall Street: Californian farmers, hedge funds, and municipalities can now purchase water futures to hedge related risks. Besides water, weather derivatives are another type of commodity responds to environmental challenges but has a more mature market: the Chicago Mercantile Exchange introduced the first exchange-traded weather futures contracts and corresponding options in 1999, mostly tracking cooling or heating days. Some studies have gone even further and explored designing and pricing air-pollution derivatives.

More importantly, these market developments and scientific initiatives on risk management draw attention to sustainability. Sustainability challenges are getting more severe as life-sustaining natural resources become scarce worldwide.

Fostering environmental, social, and economic dimensions of sustainability is an urgent challenge to society. The Paris Agreement signed in 2016 to mitigate climate change or the United Nations Sustainable Development Goals (SDGs) established in 2015 with a broader scope on environmental and social concerns underscores the inevitability of addressing sustainability.

Stakeholder theory argues that dealing with stakeholder claims – from customers, employees, local communities, shareholders, and even the natural environment – is imperative for companies to fulfill their mission. Meanwhile, advocates of the trade-off hypothesis contend that resource reallocation to sustainability activities does not pay off; instead, such activities raise operating costs due to the internalization of externalities. Consequently, I examined if, it is possible to reconcile sustainability with companies’ financial objectives.

The Research Question: Does "Doing Well While Doing Good" Prevail?

Alignment with sustainability goals might be assessed from as many angles as stakeholders exist. I focused on shareholder wealth and examined sustainability from an asset-owner perspective: is it possible to boost the bottom line by implementing sustainable corporate practices? Does the “doing well while doing good” concept prevail? If so, investors, as influential stakeholders, may drive sustainable economic growth.

Studying the impact of sustainability on shareholder value-added may manifest in several forms. Firstly, the analysis might cover accounting profitability, respond to how equity markets price sustainability, and identify the potential risk-adjusted excess returns for investors. My research intended to explore the last case.

In the investment literature, environmental, social and governance (ESG) is a broad umbrella term for firms’ sustainability . A wide range of ESG-conscious investment strategies exists, from exclusionary screening to direct shareholder engagement. My research concentrated on the ESG integration approach (applying ESG scores ranging from 0 to 100 of corporations to compile stock portfolios) and ESG-themed investing (equity portfolios that use megatrends such as energy efficiency, aging population, water scarcity, and cybersecurity). ESG integration is exceptionally popular, with US$25,000 billion in total assets under management, while thematic investing is the most significantly rising strategy, with a 2,250 per cent increase in 8 years.

Figure 1. Global growth of sustainable investing strategies
Note: AUM stands for “assets under management.” Source: GSIA (2020, p. 11)

For the ESG integration strategy, I applied separate environmental, social and governance ratings, and every stock belonged to one of the following portfolios: leaders, followers, loungers, laggards, and not rated. Thematic portfolios covered nine UN SDG-related challenges, such as water scarcity, aging population, and cybersecurity concerns. Each thematic portfolio fitted environmental, social and governance megatrends and encompassed firms with business models addressing critical sustainability challenges.

In compiling the ESG portfolio, more than 100 different investment styles, industries, and country exposures were controlled for to filter out secondary factor effects. Altogether the database included more than 15 million data points. The methodology followed a factor portfolio construction procedure: stock weights and returns were derived from extended Fama-MacBeth cross-sectional regressions (Fama, 1976; Fama and MacBeth, 1973). The time-series analysis of ESG factor portfolio returns applied the Fama and French (2018) right-hand-side approach.

Contribution

This research contributes to the existing investment literature on sustainability in several ways. Firstly, it complements the active debate about the role of ESG in general, which is far from settled (i.e., it is still an open question if it is possible to achieve significant extra returns with ESG, or, on the contrary, these investments are underperformers causing loss to investors). Secondly, to the best of my knowledge, no one has yet applied a stakeholder-based conceptual model that differentiates “organizational” and “global” sustainability. Originally Garvare and Johansson (2010) drew the distinction between organizational and global sustainability. ESG integration is consistent with organizational sustainability, while ESG-themed investing corresponds more to global sustainability.

The dissertation emphasizes the megatrend concept and integrates signaling theory into the stock selection processes. It also introduces a new mathematical formula for measuring megatrend exposures. Using the right-hand-side approach in the ESG framework is a novelty as well. Further, ESG-themed investing is a relatively new strategy, having shorter history than other strategies, such as negative screening, which was the pioneer sustainability investing strategy; hence, it is under-researched in the literature. Finally, the database used is unique and comprehensive, making the data suitable for measuring the pure performance of ESG factors.

Empirical Results in a Nutshell

The analyses revealed some remarkable findings. Investors allocating resources to ESG leaders and thematic portfolios achieved returns in the longer term commensurate with risk. Further, in the ESG integration strategy, a nonlinear relation prevailed, which contradicts the literature’s most common findings that there is either a positive, negative or neutral relationship between financial and ESG performance (non-linearity means that financial performance does not increase proportionally with ESG performance, as there is a “peak” after which increasing ESG performance does not come with significantly higher financial performance; sometimes financial performance even decreases, suggesting an inverted-U graphical representation of the ESG-financial performance relation), supporting diminishing marginal returns to ESG (law of diminishing returns: a firm will get less and less extra output – here, financial returns – when it adds additional units of an input – here, better ESG compliance). Next, during the exogenous shock of the COVID-19 pandemic, the figures did not corroborate the literature’s “flight to quality” concept (i.e., investors begin to shift their assets away from riskier investments into safer ones). Finally, no sufficient evidence was found for ESG factors to complement Fama and French models (Fama-French models detect factors such as firm size and investment policy that could explain stock returns; if a new factor is found, it could be added to the previous ones).

In summary, in most cases, investors could realize at least fair returns with sustainable investing. This finding is consistent with the efficient-market hypothesis, i.e., share prices reflect all public information, stocks trade at their fair market value. In other words, although there is only a slight chance for investors to gain superior risk-adjusted returns, they could contribute to the higher goals of sustainability without sacrificing returns.

Implications

The empirical results imply that most ESG portfolios yielded non-negative excess returns, even after accounting for transaction costs up to 25-50 basis points per annum. Higher transaction costs, as is the case for some exchange traded funds (frequently abbreviated ETFs) with expense ratios reaching 80-100 basis points per annum, may indicate two things: ESG-themed megatrend investors are willing to sacrifice approximately 25-50 basis points of annual return to remain aligned with sustainability targets, or the expense ratio may well decline in the future (nowadays, the average expense ratio is around 0.60 per cent).

Portfolio managers who integrate sustainability in their investment portfolios undertake a dual optimization process that combines ESG strategies with fundamental valuation. The proposed ESG pure factor portfolios might be utilized as smart beta indices to measure investment portfolios’ ESG factor exposure. This method is superior to calculating the overall ESG rating of investment portfolios currently commonly used by asset managers, as it separates the performance contribution of ESG from the secondary factors such as geographical, industry, or style effects.

ESG portfolios allow asset owners and managers to align their investment policies with the requirements and targets of international standards and regulations. According to a representative of the central bank of Hungary, whom I interviewed, both strategies are consistent with the EU Sustainable Finance Disclosure Regulation requirements. Thematic investing might be aligned with the Taxonomy Regulation and can be flexibly adapted to the SDGs and the climate goals of the Paris Agreement.

These results do not provide sufficient evidence for “flight to quality” during the first wave of the COVID-19 pandemic regarding ESG leaders, which contradicts Albuquerque et al. (2020), Broadstock et al. (2021), and Ding et al. (2021). One possible explanation might be that secondary factor effects substantially influence good ESG portfolios. Once these secondary effects are considered and filtered out, the otherwise observable outperformance disappears.

In summary, good ESG is not necessarily a panacea to generate superior returns during adverse market conditions such as a pandemic. However, combined with traditional styles or sectors, it might yield positive outcomes.

References

Albuquerque, R., Koskinen, Y., Yang, S., & Zhang, C. (2020). Resiliency of environmental and social stocks: An analysis of the exogenous COVID-19 market crash. The Review of Corporate Finance Studies, 9(3), 593-621. https://doi.org/10.1093/rcfs/cfaa011  

Broadstock, David C., Kalok Chan, Louis T. W. Cheng, and Xiaowei Wang. “The Role of ESG Performance During Times of Financial Crisis: Evidence from COVID-19 in China.” Finance Research Letters 38 (2021): 101716. https://doi.org/10.1016/j.frl.2020.101716.

Ding, Wenzhi, Ross Levine, Chen Lin, and Wensi Xie. “Corporate Immunity to the COVID-19 Pandemic.” Journal of Financial Economics 141, no. 2 (2021). https://doi.org/10.1016/j.jfineco.2021.03.005.

Dodd, E. Merrick, Jr. “For Whom Are Corporate Managers Trustees?” Harvard Law Review 45, no. 7 (1932): 1145–63. https://doi.org/10.2307/1331697.

Fama, Eugene F. Foundations of Finance: Portfolio Decisions and Securities Prices. New York: Basic Books, 1976.

Fama, Eugene F., and Kenneth R. French. “Choosing Factors.” Journal of Financial Economics 128 (2018): 234–52. https://doi.org/10.1016/j.jfineco.2018.02.012.

Fama, Eugene F., and James D. MacBeth. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy 81 (1973): 607–36. https://doi.org/10.1086/260061.

Garvare, Rickard, and Peter Johansson. “Management for Sustainability – A Stakeholder Theory.” Total Quality Management & Business Excellence 21 (2010): 737–44. https://doi.org/10.1080/14783363.2010.483095.

Global Sustainable Investment Alliance. Global Sustainable Investment Review 2020. GSIA, 2020. http://www.gsi-alliance.org/trends-report-2020/.

 

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The Role of Education on the Labor Market and Unequal Educational Opportunities: An Empirical Analysis for the CEE Countries

October 12, 2022
By 29630

Nemanja Vuksanovic, who received a Sylff Research Award grant in 2021, conducted an empirical analysis of the economic role of education in the labor market and unequal opportunities in education in the Central and Eastern European countries. While policy makers in these countries need to increase the availability of higher education, financial resources must be primarily directed to the poorer segments of society, notes Vuksanovic; over-subsidizing post-primary education could increase income inequality rather than reduce it.

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Subject, Aim, and Motivation

The subject of my research was the analysis of the economic role of education in the labor market, observed from the aspects of human capital theory and signaling theory, as well as the analysis of unequal opportunities in education in the Central and Eastern European (CEE) countries. The aim was to empirically determine the extent to which, in the CEE countries, education improves productivity or represents a characteristic that signals productive capabilities, as well as to empirically examine the degree to which selected countries are characterized by unequal educational opportunities.

There are several basic motivating factors for choosing the research topic.

Firstly, this research contributes to the development of scientific and professional literature related to the economics of education in the CEE region. It is pioneering research that addresses the economic role of education in the labor market and unequal educational opportunities among the CEE countries. No attempts have been made thus far to evaluate the premium on education, the effects of diplomas, and the influence of factors limiting the achievement of a certain educational level in this region by means of the proposed theoretical and methodological framework. I chose this topic because this research can contribute to a better understanding of the transition paths of Serbia and selected CEE countries in the segment related to the educational process.

Secondly, the research conducts a detailed and systematic overview of theoretical models developed to explain the economic role of education and unequal educational opportunities, by looking at the historical development of these models and the most significant results of previous research. Special emphasis is given to describing the problems that researchers encounter in empirical studies when assessing the rate of return on investment in education and the effects of diplomas. In a broader context, the significance of the research lies in general contribution to the development of scientific and professional literature in the field of economics of education. My intention was to present through the research an appropriate theoretical and methodological framework for future research on topics in the domain of this economic field.

Another scientific contribution of the research lies in the empirical results, which could help policy makers in the CEE region to create a more complete picture of the education system and, based on that, to develop guidelines for improving the education process. The findings of the research should make more visible the problem of inequality in income distribution, which arises from circumstances beyond the control of the individual. The study of unequal opportunities in education has gained in importance in recent years as a result of the increasing attention that researchers are paying to the problem of income inequality. The study of factors limiting equitable access to education is important because it can clarify the effects of education as a mechanism for reducing inequalities in income distribution. So my main motivating factor is that the research results can provide a better understanding of the segment of demand for education and distribution of education and be helpful to education policy makers among the CEE countries.

Figure 1. Relationship between ratio of share of high-educated and share of low-educated population (x axis) and GDP per capita (y axis) among CEE countries

Education boosts the living standard of a country.

 

Basic Findings and Public Policy Implications

Seen from the social aspect the significance of the research results is manifold, since it can provide several guidelines for policy makers.

The results of my empirical study assessing the rate of return on investment in education indicate that in all CEE countries the positive return on investment in tertiary education is higher than the negative return on investment in primary education. That is, the link between education and earnings is convex, suggesting that in the CEE countries the highest rate of return is tied to the highest level of education. This tendency of the rate of return on investment in education—whereby the premium on education does not decrease with educational levels, so that it is highest in primary and lowest in tertiary education—has already been noted in a number of other studies.

In all CEE countries apart from Hungary, the positive premium on higher education is six to nine percentage points higher than the negative premium on primary education. points out that the relatively high rate of return for tertiary education may be because rates of return on investment in tertiary education are higher in those countries where the supply of more educated individuals grows at a slower pace than the demand for such individuals. Acemoglu (2008) argues that the gap in supply and demand for highly educated individuals may reflect the specificity of the country’s institutional framework or differences in changes in the openness of the economy and changes in the field of technological progress. Consequently, the present gap may have negative implications for the country’s economic development, as it leads to underutilized human resources. This implies that a country like Serbia, where the rate of return on investment in tertiary education is among the highest in the CEE region, is characterized by a significant gap in supply of and demand for highly educated individuals. This situation indicates the need for policy makers in Serbia to take appropriate measures to increase the supply of highly educated people.

Figure 2. Returns to high education in CEE countries

An investment in high education pays the best interest.

 

For policy makers, the observed pattern of returns on investment in education in CEE countries may also mean that a significant rise in the percentage of the population with lower levels of education will not greatly increase the earnings of individuals with these levels of education. The convex link between education and earnings suggests the possibility that over-subsidizing post-primary education may increase rather than reduce income inequality. Many international agendas, such as the Millennium Development Goals, have focused on increasing the share of the population with primary education. But when the link between education and earnings is convex, public investment aimed at increasing the coverage of the population with lower levels of education will not significantly increase the earnings of low-educated individuals. Moreover, Schulz (2003) points out that in countries where public subsidies in tertiary education are high—as is the case in many African countries—the convex link between education and earnings means that large amounts of public transfers to individuals in higher education, if not targeted, benefit most those whose families are of better socioeconomic status. In this case, such a public policy will not be very effective in reducing inequalities in income distribution. Both facts indicate that a successful public policy in Serbia must be directed toward more efficient allocation of educational investments; in other words, that special attention must be paid to distributing these investments by levels of education and targeting appropriate socioeconomic groups.

The results of the second empirical study show that every additional year of schooling over the years necessary for obtaining a university degree has a negative effect on earnings. This finding has significant implications for education policy. If some individuals benefit more from gaining a certain level of education, then policy makers need to recognize such different influences. This is especially important in the case of less developed countries of the CEE region, such as Serbia, where children from families of lower socioeconomic status face greater financial constraints. Namely, when education plays the role of a signal, it is important that highly gifted individuals be able to reach the highest levels of education to prevent the quality of the signaling role of education in the labor market from collapsing. Caplan (2018) points out that excessive public investments in education that are not directed toward appropriate groups devalue the importance of the role of education as a signal. Generous and untargeted public investment in the education system may jeopardize the importance of education as a means of overcoming the problem of information asymmetry between workers and employers. A nonselective policy of over-subsidizing higher education could lead to inflation of diplomas, which would greatly weaken the role of education as a signal. This is especially true in Serbia and Romania, where the signaling role of education is relatively weak among the CEE countries. Public policy makers in Serbia and Romania must therefore take care that financial resources are primarily directed to children from poorer families, with a focus on the talented ones, so that those children can reach the highest levels of education.

Improving the availability of higher levels of education through increased and well-targeted public investment is particularly important given the results of the third empirical study, which indicate the existence of unequal opportunities in education among the CEE countries. Increasing the proportion of the population with higher education may represent an appropriate public policy aimed at reducing income inequality, in line with the demonstrated link between education distribution and wage distribution. Pikkety et al. (2020) point out that this is important because the significance of implementing appropriate predistribution measures has recently been emphasized in the international agenda. Predistribution, which can influence the distribution of income before redistributive measures—taxes and social transfers—take effect, is based on the view that a country’s institutional framework through the legal and social system can contribute to reducing income inequality. Appropriate public policy in the CEE countries should be aimed at increasing the availability of higher education, while care must be taken to ensure that this coverage primarily affects individuals of lower socioeconomic status. A well-targeted predistribution policy oriented toward creating a fairer education system and a society characterized by equal opportunities can contribute to the country’s economic development and to the reduction of poverty and income inequality.

References

Acemoglu, D. 2002. “Technical Change, Inequality, and the Labor Market.” Journal of Economic Literature 40, no. 1 (March 2002): 7–72.

Caplan, B. 2018. The Case against Education: Why the Education System Is a Waste of Time and Money. Princeton: Princeton University Press.

Piketty, T., A. Bozio, B. Garbinti, J. Goupille-Lebret, and M. Guillot. 2020. “Predistribution vs. Redistribution: Evidence from France and the U.S.” WID.world Working Paper, 10.

Schultz, T. P. 2003. “Higher Education in Africa: Monitoring Efficiency and Improving Equity.” In African Higher Education: Implications for Development, 93. New Haven, CT: The Yale Center for International and Area Studies.

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Why Do We Need Vaccines Now?

August 4, 2021
By 29262

Drawing on the field of health economics, 2002 Sylff fellow Matheus Albergaria contemplates the consequences of the COVID-19 pandemic for collective health and possible solutions. Vaccines are one such solution, as well as social distancing and the wearing of masks in public places. But for these measures to be effective, it is key that individuals consider the impact that their actions may have on collective well-being.

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The first records of the so-called coronavirus 2019 disease (COVID-19) occurred in late 2019. As the name suggests, COVID-19 is caused by the severe acute respiratory syndrome coronavirus 2 (SARS-CoV-2), being generally associated with such symptoms as fever, dry cough, and tiredness, although other symptoms may also appear in more severe cases of the disease. Throughout the year 2020, the spread of the virus across numerous countries occurred at an astonishing speed; recent data from October 2020 suggest the confirmation of more than 190 million cases, as well as deaths in excess of 4 million worldwide.

An important aspect related to the COVID-19 pandemic concerns its consequences in terms of collective health. Few people outside the field of economics are aware of the existence of a field of study called “health economics,” in which scholars employ economic logic to evaluate health policy interventions, such as in the case of COVID-19. In this article, I will illustrate possible ways in which we can use the lessons from this field to understand some characteristics of the pandemic, as well as possible solutions related to it.

Since collective health can be seen as a special category of goods needed by a society—so-called public goods—it is important to take into account the potential implications derived from such a categorization. Specifically, public goods have two unique characteristics: they are (i) “non-excludable” and (ii) “non-rival.” That is, it is not possible to exclude anyone from their consumption (non-exclusionary property), while at the same time, the consumption of the goods by one person does not necessarily affect the consumption of other people in society (non-rivalry property). Examples of public goods—in addition to public health itself—are national security, maritime lighthouses, fireworks, public parks, and beaches. (It is worth noting that all these examples are non-excludable and non-rival goods.)

The main challenge related to public goods concerns the possible emergence of differences between individual interests and collective well-being. For example, in the case of public health issues, a person may wonder if it makes sense to comply with a period of quarantine at home, wear a mask in public places, or maintain social distance, as their actions may have seemingly insignificant impacts in social terms. In other words, in situations like this, a person may ask the following question: “Will my actions have any significant impact on the rest of society?” If the answer to this question is no, the person is likely to have little incentive to cooperate with collective well-being, since he views his individual actions as socially insignificant. One problem arising from thinking along these lines is that if many people think this way, it will be very difficult for society to achieve public health goals (as well as any goal involving collective action). Such situations are known as “social dilemmas”; actions that apparently make sense from an individual point of view do not necessarily lead to the best results from a social point of view. This fact has important implications for the current pandemic situation that we are experiencing in the world. Since collective health can be seen as a public good, a high degree of coordination between individual actions and society’s goals becomes necessary. The biggest challenge for a government in a context involving public goods is to coordinate individual actions so as to obtain results that are satisfactory for society as a whole.

Another important aspect related to the COVID-19 pandemic concerns the occurrence of a phenomenon known by economists as “externalities” (or “external effects”). Basically, externalities correspond to “market failures,” that is, situations in which the market system ceases to function properly, generating inefficient results from a societal point of view. In such situations, it would be possible to improve the situation of some people in society without necessarily harming others—that is, it would be possible to generate efficient solutions, economically speaking.

Externalities occur when the actions of an individual or firm have unplanned consequences on other parties (similar to the side effects of any action, which can be both positive and negative). For example, in the case of the COVID-19 pandemic, there is the possibility of negative externalities occurring, since some people may infect others without even knowing that they are infected with the coronavirus. (In fact, there are several reports of asymptomatic cases of the virus.) That is, even without having the intention of harming other people, an infected person can end up harming society as a whole.

An extreme example of the occurrence of negative externalities is the “Tragedy of the Commons,” a parable created in the nineteenth century to explain the potential adverse consequences of situations involving goods known as “common resources.” Although these goods are excluding as public goods, they are rivals—that is, the consumption of the good by an individual affects its availability to other individuals. Examples of common resources would be common property land, as well as fish in the sea and some animal species. (Not coincidentally, this parable has been used extensively in biology.) According to this “tragedy,” differences between individual interests and social interests could lead to a situation in which society ends up losing out as a whole. For example, a situation in which all people in a society have access to a common resource—such as the commons in England for a time—raises the possibility of the emergence of patterns of excessive consumption of that resource, which could lead to the society ending up in a worse situation in terms of social welfare. (The commons could become sterile, in this case.)

But what do these hypotheses say to us? First, the occurrence of market failures along the lines discussed here may suggest a more active role for governments around the globe. Since the market does not always result in efficient situations from a social point of view, there may be a role for government in the economy. For example, one way for governments to alleviate the pandemic’s adverse effects is by evaluating the occurrence of externalities between individuals in the current context. Additionally, the fact that the coronavirus displays patterns of complementarity with other sources of morbidity—such as obesity, diabetes, cancer, and heart problems—makes the case for the government to implement public policies focused on disseminating information related to possible forms of contagion.

A potential solution to the COVID-19 pandemic that has been widely publicized by the media and debated by society in recent times is the creation of vaccines capable of protecting individuals from the adverse effects of the virus. From an economic point of view, an effective vaccine in combating the virus must at least have two basic properties. First, the vaccine must have the characteristics of what economists call a “public good”: non-exclusiveness (no person should be excluded from its reach) and non-rivalry (the fact that a person receives the vaccine should not prevent other people from receiving it). Taken together, these two characteristics could justify a vaccine supply to be provided by the government in a pandemic context.

Second, unlike the virus, a vaccine must be associated with the occurrence of positive externalities. In the case of the current pandemic, an effective vaccine must be able to generate a kind of “spillover effect” in terms of immunization. Specifically, the fact that a person is vaccinated could prevent other people from being infected by the virus over time (a result that depends on the effectiveness of the vaccine in question). Ultimately, vaccines generate positive externalities.

One way to have a vaccine with these characteristics would be through its provision and free distribution by the government. Although there are substantial costs associated with such an undertaking, we must take into account the potential costs—of greater magnitude, probably—associated with the possible occurrence of a new wave of contagions in the world if an insufficient number of people are vaccinated.

Another way for governments to combat the adverse effects of the pandemic is through the introduction of public policies based on so-called merit goods, goods that the government obliges people to consume, assuming that they are not always able to make favorable choices for their own well-being. In the case of the current pandemic, two examples of such goods are the policy of social distancing and the wearing of masks in places such as supermarkets or sports gyms.

The situations described in this article point to the importance of considering differences between individual interests and collective well-being. In other words, what is best for an individual or group of individuals may not be better for society as a whole. A potential way to alleviate the harmful effects of the pandemic is through the collaboration of everyone in society: if one person collaborates—taking vaccines, following the quarantine regime, wearing masks in public places, and maintaining social distance—everyone benefits from it. Ultimately, it is important to consider the interaction between individual interests and collective well-being in an increasingly complex and diverse society where market failures may occur. From an economist’s point of view, possible solutions to the pandemic are not easy, although they are possible as long as each person considers the possible impacts of their actions on society as a whole.

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Is Egypt’s Economy Surviving Corona’s Bumpy Ride?

April 6, 2021
By 28847

Christine Guirguis, a 2020 Sylff fellow from the American University in Cairo, addresses the outlook for Egypt’s economy in the face of the coronavirus pandemic. Egypt was one of only three countries in the region to maintain positive growth in 2020, an impressive record given the difficulties it has experienced over the past decade, as Guirguis details.

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View of Cairo from the top of Cairo Tower, August 25, 2014.

Egypt’s economic condition in 2012–13 was dubbed the worst crisis since the 1930s. The severity of the economic troubles reached its peak in the first half of 2014 with a fall in the GDP growth rate to 1.2%—the lowest in about 50 years—as well as a rise of the inflation rate to 9%, a surge in the unemployment rate to 14%, a fall of eight places in tourism ranking, and a shortage in essential food products. As a result, Egypt’s economic status as of 2014, which was downgraded from emerging market to frontier market in Russell’s Annual Index, left the country scrambling to rescue its 86-million population at the time.

Before reluctantly resorting to the International Monetary Fund, Egypt—whose national security is a safety valve to the region—had received generous aid from the Arabian Gulf and Saudi Arabia totaling as much as $30 billion. While such aid breathed life into Egypt’s economy, the bill was far from paid.

In 2015, three-quarters of Egypt’s budget vanished into subsidies, government wages, interest payments, and capital loan repayments; only 5% of the budget was left for other purposes. In the same year, the crash of a Russian airplane due to an act of terrorism marked the Egyptian tourism’s clinical death before it was gradually resuscitated in 2019 by stricter security measures in airports. This was when Egypt decided, on November 3, 2016, to brace up for a $12 billion IMF loan by devaluing its currency by 48% and fulfilling the IMF’s requirements by way of cutting subsidies, increasing VAT, and floating the currency.

Luxor temple, Luxor, January 2015.

In a recent television interview, Mr. Tarek Amer, governor of the Central Bank of Egypt, talked about the Herculean responsibility he had in his hands in 2015. Egypt’s foreign cash reserves were only $800 million, an amount Egypt normally spends in a week. Consequently, its economy would have faced the risk of a total shutdown unless an urgent “surgery” of painful economic reform was done. The political and social sensitivity of the November 2016 decision, at a time when Egypt was craving for stability, rendered the proposal impossible from the point of view of almost all the cabinet members. No one was able to digest the unimaginable scenarios that could have taken place if the economic reform process had failed to meet its purposes, especially because its probability of success was estimated to be between only 10% and 30% at the time. With no alternatives on the horizon, President Sisi gave the green light for the execution of the economic reform proposal, a decision that signified a new, independent approach that enabled Egypt to skip the limitations that had long impeded its economic restructuring.

In a country where a quarter of the people live below the poverty line, the government wanted to ensure that its measures would not cause a humanitarian crisis or a social backlash. The government kept intact the cash transmission programs and subsidized food systems launched earlier.

Given the painful austerity measures, some envisioned a doomsday scenario taking place in Egypt. Yehia Hamed, a former investment minister in Mohamed Morsi’s 2012–13 government, wrote an article in the Foreign Policy in 2019 where he conjectured that Egypt was heading toward bankruptcy and warned Europe against a mass flocking across the Mediterranean of Egyptians fleeing an inevitable bleak fate.

In response Ahmed Shams El Din, an Egyptian capital markets professional and adjunct professor at the American University in Cairo, published an article on the same news site where he expressed his wonder at the former minister’s criticism of securing an IMF loan even though the government in which he served had approached the IMF in 2012 for a loan. He noted that Egypt’s economy is growing rather than collapsing, with the account and budget deficits cut in half and a 5.5% growth in 2019 compared to 2.2% in 2013.  

The current pandemic is already suffocating some of the biggest economies, supporting the IMF’s description of it as “the worst economic crisis since the 1930s depression.” For Egypt, the challenge is tougher due to losses in the main revenue sources, such as tourism, the Suez Canal, and remittances, which together constitute 15% of Egypt’s GDP. Therefore, in its June report the IMF initially expected a decline in Egypt’s GDP growth rate from 5.6% in 2019 to as low as 2% in 2020—a percentage it later changed to 3.5% in its October report. Given the global economic challenges, this relatively low growth rate makes Egypt one of three countries in the Middle East and Central Asia to maintain a positive figure in 2020.

Antique Bazaars, Aswan, January 2015.

During the apex of the global pandemic uncertainty in 2020, Egypt managed to pay $35 billion of its liabilities without suffering a severe decline in its foreign currency stockpile or any shortage of essential goods. This explained Egypt’s ability to maintain its credit ratings by Standard & Poor’s at “BB” in April 2020, by Fitch at “B+” with a Stable Outlook in July, and by Moody’s at “B2” in August. Based on these ratings, J.P. Morgan praised Egypt’s economic performance, stating that, thus far, its economy had successfully withstood the test of the pandemic and kept the trust of the international community. Hence, Egypt’s economy has been given well-grounded positive appraisals.To contain corona’s economic repercussions, the Egyptian government allocated 100 billion Egyptian pounds (EGP) as a stimulus package, including half to support the severely affected tourism sector, EGP 8 billion for the health sector, a 14% increase in pensions, energy cost relief for factories, fewer taxes on businesses, more cash transmissions, and financial support for irregular workers until the end of 2020.

Egypt’s top priorities in the economic agenda include augmenting domestic savings, as well as adopting a more liberal approach toward the market, revisiting tax penalties and exemptions, and laying the basis for a fairer accountability system.

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Empirical Research on Financial Crowdfunding at a Leading Research Organization for Alternative Finance

March 31, 2020
By 26667

Wanxiang Cai, who received a Sylff fellowship at Chongqing University in 2016 is currently enrolled in a PhD course at the School of Economics, Utrecht University, Netherlands. His research area is entrepreneurship. Using an SRA award, he visited the Cambridge Centre for Alternative Finance, a leading research center in the field of fintech.

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In recent years, crowdfunding has emerged as a source of online entrepreneurial finance. Although crowdfunding has attracted the attention of both researchers and policymakers, as an emerging form of entrepreneurial finance, we still have very limited information about its global pattern. My PhD research is about the governance of financial crowdfunding, and I suggest it is important to analyze the relationship among social capital, legal institutions, and financial crowdfunding at the macro (national), meso (platform), and micro (campaign) levels. It is essential for me to collect data about financial crowdfunding at the platform and national levels to finish my thesis.

Kings College of the University of Cambridge.

The Cambridge Centre for Alternative Finance (CCAF) is a leading research center in the field of fintech. It publishes several international industry reports every year. The center collects data from more than 1,000 fintech companies around the world and provides information about the development of the alternative finance market in different countries. These reports are the most comprehensive publications in this field and have been extensively cited in academic papers. Furthermore, the CCAF has established favorable relationships with policymakers around the world, including the Financial Conduct Authority (FCA) in Britain, the Inter-American Development Bank (IDB), and the World Bank. Thus, visiting the CCAF can not only help me collect essential data for my research, but also offer me a chance to have a deeper understanding of the industry and get more great insights from policymakers.

The author, left, with several members of the benchmarking report project.

After communicating with Tania Ziegler, the lead in Global Benchmarking at the CCAF, we reached the agreement that I would visit the CCAF and help them write the global benchmarking report, and in return, they would provide me with their survey data for my research. Furthermore, they would also give me a chance to discuss my research with several senior researchers at the University of Cambridge, including Professor Raghavendra Rau, who has a very high reputation in finance. Thanks to Sylff Research Aboard, I had the chance to visit the University of Cambridge and had a great time at the CCAF.

The Mathematical Bridge at the University of Cambridge.

I started my visits on September 1, 2019. I was shocked by the beauty of the city and the sacredness of the university. It was always sunny during my first two weeks in Cambridge, which is unusual in Britain, as it rains all the time. Several colleges are scattered along the banks of the River Cam, including Trinity College, where Issac Newton studied hundreds of years ago. An enormous number of visitors walked along the river, while the students in Cambridge shared with them the glories of the university, such as its history, famous alumni, and recent academic outcomes. These students looked very confident and felt so proud of their university, making me eager to start my research at Cambridge.

I began my research immediately. The first thing that I had to do was to collect data from a vast number of alternative finance platforms. The annual alternative finance report is based on these survey data. Thus, I contacted the founders of the platforms to see whether they were willing to get involved in our research. We collected data from more than 1,600 platforms around the world. Then we summarized how the market volume had changed over the last few years in major countries, as well as platform owners’ opinions about potential risks and regulatory changes. Based on this data, we also provided some preliminary analyses of what affects the growth of the alternative finance market. For example, we found a significant relationship between proper legal protections and the development of the alternative finance market. The information obtained in this way helps me to gain a deeper understanding of the global alternative finance market and is beneficial to my future research.

Meanwhile, I enrolled in an online course called Fintech and Regulatory Innovation. Through this course, I have gained new knowledge about fintech, especially from a regulatory perspective. More importantly, other students in this course are policymakers from around the world. During their discussions, I learned enormously from them. All the students come from central banks or other financial institutions, and they have great insights about the governance of fintech. They not only showed their expertise and experiences in the fintech topics but also raised questions about the future development of the market and potential research on these topics.

In addition to the above, we have discussed my research with several researchers. I have discussed one of my current papers with Wanxin Wang, a PhD candidate at Imperial College London. She also studies the topic of crowdfunding, and in fact, my paper is built on her recent paper published in a top journal. Her paper shares many similarities with mine, and she provided me with several suggestions for my research. I have also talked extensively with Dr. Rui Hao. She is very interested in my research, and she also helped me get a chance to interview policymakers worldwide. We decided to work together on a research project about how the regulations on equity crowdfunding will change. Unlike traditional entrepreneurial finance (e.g., venture capital and business angels), crowdfunding mainly consists of small investors who have limited knowledge about finance and investments, making it difficult to make proper regulations on financial crowdfunding. On one hand, overly strict legal protections on investors may harm small firms and entrepreneurial initiatives. On the other hand, legal protections can resolve extensive information asymmetry between investors and entrepreneurs. Thus, we have decided to conduct interviews on dozens of policymakers around the world. Using qualitative research methods, we would like to study how the regulations on financial crowdfunding will develop in the future.

Lastly, I conducted a study about how equity crowdfunding affects traditional entrepreneur finance. As an emerging form of entrepreneurial finance, we know less about the influence of equity crowdfunding compared to traditional entrepreneurial finance. First, equity crowdfunding may substitute traditional forms of entrepreneurial finance, such as venture capital, business angels, and private equity. Alternative, it may compensate traditional entrepreneurial finance, as it mainly supports small companies. This study contributes to my PhD research, as it explores under which legal conditions equity crowdfunding can contribute to the development of traditional entrepreneurial finance. Using the data from the CCAF and other databases, I have done some preliminary analyses. I have also discussed the idea and methods with Professor Raghavendra Rau. He gave me several comments, and I am improving this paper based his useful input.

In a nutshell, I have benefited extensively from this visiting. I have made friends, shared my research, got feedback, and gained a deeper understanding of my research. I appreciate that the Sylff Association has provided me with the scholarship to support my research at the CCAF. I am confident that other scholarship winners will also benefit from the Sylff.

Christmas dinner at the CCAF.

 

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Copycats and Patent Wars: The Effects of Quality Investment

December 13, 2019
By 22425

Qinquan Cui, a 2017 Sylff fellow at Sun Yat-sen University in China, is currently conducting research as a visiting PhD student at the University of California, Los Angeles (UCLA). Recently, he published his thesis “Quality investment, and the contract manufacturer’s encroachment” in one of the flagship research journals. In this article, he shares his analysis and perspectives on global business issues.

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Multinational cooperation has become increasingly popular in the manufacturing industry, including contract manufacturing and the setting up of joint ventures in emerging economies. In contrast to integrated business models in the past where the manufacturer had absolute control over material supply, manufacturing, assembling, and retailing, the core manufacturer in the new era has to face competition from business cooperators who can even be copycats. [1,2,3] This owes to the spillover and leakage of technology between different entities in a supply chain, which is a double-edged sword. [4] The positive side has been proven by Toyota’s knowledge-sharing network by learning product information. [5] However, product innovation can be imitated by local suppliers or contract manufacturers from the channel of foreign direct investment and product quality investment, leading to an emerging proliferation of supply chain encroachment. In such a situation, contract manufacturers (CMs) establish direct channels to compete with original equipment manufacturers (OEMs).

 

An Apple store opposite a Samsung store.
Wang Xiaofei — Visual China Group via Getty Images

The Patent Fights

This type of supply chain encroachment has induced a few intense fights - costly juristic activities. To stop such a practice of market entry, Apple Inc. (an OEM) fought with Samsung Electronics Co., Ltd. (a kind of CM), because the latter had been copying Apple’s product designs and patents for a long time. Recent years have witnessed a battle in which Apple took legal action against Samsung for product plagiarism, which has cost the former more than one billion dollars. [6] However, the United States Supreme Court appeared to be stuck in a dilemma over how to deal with the high-stakes battle between the two. [7] It indicated that it was uncertain how much money the South Korean electronics company owed for infringing patents on the iPhone’s design. Thus, it seems that filing a lawsuit has brought only a faint possibility of blocking Samsung’s encroachment and compensating for Apple’s losses caused by the former’s imitations. The complexity and uncertainty of the legal environment in different countries are mainly accountable for this dilemma.

 

Apple and Samsung’s legal fight over patents.
Peter Macdiarmid — Getty Images Europe

Strategic Quality Investment as a Weapon

To reduce the contract manufacturer’s incentive of encroachment by imitation, Apple has turned to a more attainable operational strategy—investing in product quality improvement. Accordingly, Apple’s investment in research and development (R&D) has increased significantly; for instance, the fiscal year 2016 saw a 25% increase from the previous year, which contrasted sharply with the 8% fall in revenue. [8]

One important point should be made clear: sometimes the upgrade of Apple’s products is not significant, and thus the differences between the two companies’ products are not distinct, while at other times the update is striking. In addition, the contract manufacturer does not always keep up with the pace of Apple’s product quality upgrade or compete with Apple by imitation. This makes people wonder under what conditions Apple would enhance investment for improvements in product quality and be highly cautious of the co-competitor’s imitations. A question then arises: is the CM’s threat of competition one of the motivations for the OEM to invest in product quality improvement?

The Multiple Effects of Quality Investment

When the collaborator is a copycat, there are two major concerns for the profit-maximizing OEM. First, enduring a CM’s imitation and encroachment without any costly deterrence is a conservative strategy, but the OEM has to share the retail revenue with the CM. Second, investing in quality improvement has multiple effects compared with the strategy of no investment: (1) it may stop the CM from encroaching and benefit the OEM; (2) if the CM’s encroachment cannot be prevented, the OEM’s profit may deteriorate, while the rival (CM) could obtain more retail revenue by imitation; and (3) a profit improvement might be induced by the OEM’s quality investment, regardless of whether the encroachment is prevented or not.

Besides, in order to enter the OEM’s final market, the CM would strategically adjust the wholesale price to affect the OEM’s sourcing quantity. The OEM may then benefit from the CM’s encroachment if the wholesale price becomes lower.

Research Questions

Motivated by the above discussions, my research “Quality investment, and the contract manufacturer’s encroachment,” published in the European Journal of Operational Research, aims to explore the following three questions by analyzing a game-theoretical model. (The main content of this article is based on the above published research.) First, under what economic conditions does the CM’s encroachment occur? Second, should the OEM invest in quality as a mechanism to deter—or encourage—the (potential copycat) CM’s encroachment? Third, under what conditions can the CM’s encroachment achieve a Pareto improvement instead of causing a loss to the OEM?

Main Findings

Without the OEM’s quality investment, the CM always has the incentive to encroach on the OEM’s market and will claim a higher wholesale price in contrast with the ideal scenario without encroachment, but the increase of the wholesale price will be mitigated by the CM’s higher imitating ability. Then the OEM’s profit will decline as the product demand decreases due to competition from the CM.

Furthermore, when there is an attainable quality investment opportunity for the OEM, once the investment is executed, the CM will prefer the irresponsible encroachment only if its imitating capability exceeds a certain threshold. Alternatively, the CM’s encroachment policy may depend on the characteristics of the OEM’s investment. In the latter scenario, the strategic interactions between the OEM and CM become more intricate, depending on the nature of the quality investment and the CM’s imitating capability.

Another key finding shows that the CM’s threat of encroachment can facilitate the OEM quality investment and that quality investment could be preferred if it can blockade the CM’s encroachment even though the quality investment per se is unprofitable. Overall, quality investment is partially effective in deterring the CM’s encroachment. Moreover, it is found that a win-win situation can be induced by the encroachment when quality investment is implemented by the OEM; in other words, if the CM’s imitating ability is not extremely strong, the OEM’s profit can be improved by the CM’s encroachment.

Managerial Insights

The motivations for the OEM’s quality improvement (investment) lie in two aspects. Firstly, it can stimulate market demand for the OEM’s original product, which can generate more retail revenue even as the CM acts as a free rider and copycat. Secondly, quality investment is also a powerful weapon to deter the competitive CM’s encroachment. Moreover, it is found that the CM’s encroachment is certain to happen when its imitating ability is strong, in which case the structure of quality investment no longer matters.    

Furthermore, research findings show that the CM’s imitation and encroachment can contribute to a win-win situation for both parties under certain conditions. In this scenario, the OEM’s profit increment is generated by an increased demand for the original product and a lower wholesale price, while the retail price of the original product falls compared with the situation without encroachment.

 

Quality investment at the crossing.
Lucas Jackson — REUTERS

However, quality investment is not always an effective solution to deterring the CM’s encroachment or helping encroachment improve the OEM’s profit. For instance, an encroachment by a CM with a strong imitating ability and an investment structure characterized by low investment cost and low quality improvement will certainly hurt the OEM’s profit.

This explains why, among those OEMs who established joint ventures (or other forms of cooperation) in developing countries, some would use quality improvement to deter their partners’ product imitation and encroachment, others prefer to invest in quality improvement and wink at the CM’s encroachment, and yet others complain about their CMs’ irresponsible imitation behavior.

As stated by the New York Times, the insights of this research are in line with the prediction that “Apple can find better ways of earning hundreds of millions of dollars than fighting a decade-long lawsuit.” [9] Then the courtroom is not always the place to try to get patent problems solved. Instead, the alternative operational strategy—quality (R&D) investment—would be a more efficient weapon that can deter copycats’ imitations and supply chain encroachments.  

 References

[1] Chen, Y.J., S. Shum, and W. Xiao. 2012. Should an OEM retain component procurement when the CM produces competing products? Production and Operations Management, 21 (5), 907–922.

[2] Cui, Q. (2019). Quality investment, and the contract manufacturer’s encroachment. European Journal of Operational Research, 279, 407–418.

[3] Cui, Q., C.H. Chiu, X. Dai, and Z. Li. 2016. Store brand introduction in a two-echelon logistics system with a risk-averse retailer. Transportation Research Part E: Logistics and Transportation Review, 90, 69–89.

[4] Aldieri, L., V. Sena, and C.P. Vinci. 2018. Domestic R&D spillovers and absorptive capacity: Some evidence for US, Europe and Japan. International Journal of Production Economics, 198, 38–49.

[5] Dyer, J.H., and N.W. Hatch. 2004. Using supplier networks to learn faster. MIT Sloan Management Review, 45 (3), 57.

[6] Eichenwald, K. 2014. The great smartphone war. Vanity Fair, May 3, 2014.

[7] Kendall, B. 2016. Supreme court hears Apple-Samsung patent case. The Wall Street Journal, October 12, 2016.

[8] Gallagher, D. 2016. What does Apple get for $10 billion of R&D? The Wall Street Journal, October 28, 2016.

[9] Nicas, J. 2018. Apple and Samsung end smartphone patent wars. The New York Times, June 27, 2018.

 

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Insights into the Economic and Legal Dimensions of Public Contractual Relationships in Europe

December 5, 2019
By 27004

The aim of my doctoral dissertation research—carried out with the support of a Sylff fellowship—is the examination of contracts concluded by the state and other public bodies in Europe. Particular attention is given to concessions and the interplay between various national legal traditions and the law of the European Union. My work focuses on the legal specificities of these contracts and seeks to understand important socioeconomic connections of this field of law, such as the different modes of the state’s involvement in the economy and the different ways public services are organized, and where the boundaries between the state and market are set. In the following, I would like to give a brief introduction to this topic.

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In the evolution of the law of public contracts at the national and European level, the organization of public services has always played an important part.

Many services that are now considered public services first appeared as private initiatives. As capitalism developed, urbanization and population growth resulted in an ever-increasing number of tasks that public administrations needed to organize for the smooth functioning of society. The state’s involvement in the economy became more active in the first half of the twentieth century owing to two world wars, economic crises, the growing need for public services, and the bankruptcy of private-sector service providers. As welfare states flourished in Europe in the 1960s and the first half of the 1970s, the provision of public services came to be carried out mainly in the public sphere, either by state bodies, local authorities, or by organizations closely related to them.[1]

The Chain Bridge, one of the iconic monuments of Budapest, Hungary, is an example of a private initiative taking the lead in building public infrastructure in the nineteenth century. Its construction was funded and carried out by the Chain Bridge Joint Stock Company, owned by private shareholders. (Photo by Gyurika, CC-BY-SA-2.5, https://commons.wikimedia.org/wiki/File:Lanchid-budaipiller.jpg)

Challenges to the concept of the European welfare state emerged in the 1970s, as the oil crises of 1973 and 1979 triggered a new way of thinking about economic policy. The organization of public services according to market principles, outsourcing, and the involvement of the private sector became widespread, accompanied, in certain cases, by the privatization of assets serving as the basis of a public service. An important factor encouraging these processes was the law of the European Union. The most intensive period of regulation in the European Union to build up an internal market of undistorted competition started in the early the 1990s. An important part of this was the liberalization of network-based public services and the regulation of public procurement, which became more detailed and effective through the adoption of new directives.[2]

The reform of public services and the growing importance of contracting out became a general trend in Europe, but they unfolded differently in the individual member states of the EU, influenced by the respective traditional approaches to delivering public services.

In Germany, public services of an economic nature are traditionally provided by so-called Stadtwerke. These are companies of local authorities (earlier organized also by public law) that provide the population of a geographical area with different utilities. In the field of social services, cooperations of charitable organizations were a traditional form of service provision. The trend of privatization has affected these long-established structures, and private operators now play an important role in the delivery of public services. As a result of EU-led liberalization, these markets also had to be opened up to competition—or at least adjusted to a competition-driven legal system. However, certain sensitive areas, such as water supply and ambulance services, were protected by public policy from the encroachment of market forces by the EU.

Unlike Germany, France did not develop a strong utilities’ sector at the local level. The system of French local authorities was very fragmented, and their scarce resources encouraged the delegation of public services—mainly in the form of concessions—to private providers from as early as the middle of the nineteenth century.[3] The French state’s interference in the economy was particularly strong after World War II; extensive nationalization took place ,which largely affected the utilities, but state involvement was significant even in the competitive parts of industry and in the banking and insurance sectors.[4] Due to this composition of public property and the historic guiding theory of service public in public administration, the privatization of the 1980s and 1990s affected primarily the competitive sectors of the economy, not the utilities. The French constitution of 1946 expressly stated that monopolies and companies providing national public services and the assets necessary to run these services must remain state property.[5] A characteristic of the French model is that the utilities market is dominated by a few large companies, which are also important participants in the EU-wide market of service concessions.

The Channel Tunnel links Great Britain with continental Europe. The infrastructure project, negotiated in the middle of the 1980s, was a pioneer of large-scale, concession-type contracts using the project finance technique relying on the proceeds of the project. (Photo by Florian Févre from Mobilys, CC BY-SA 4.0, https://en.wikipedia.org/wiki/File:TGV_TMST_3011-2_-_Sortie_Tunnel_sous_la_Manche_%C3%A0_Coquelles.jpg)

In Britain, the common law legal system (which follows a different concept than the legal systems of continental Europe) evolved in parallel with another type of economic development. From the outset, capitalism developed with much less state involvement than in Germany or France. Margaret Thatcher, who became prime minister in 1979, was a pioneer of a neoliberal economic policy. She implemented reforms to achieve a more economic and effective public sector, encouraging contracting-out, private-sector involvement in public projects, privatization, and the liberalization of monopolies in utilities. The British administration also developed innovative legal concepts like unbundling and public-private partnerships (PPPs) that later spread to the rest of Europe and beyond.

Nowadays, EU law has a decisive impact on how member states can organize public services. Although there is undoubtedly a push toward more competition and privatization, there are also elements of EU law that try to seek a balance between the principle of undistorted competition and the will of member states to preserve their ability to decide on the most appropriate way to provide public services with different degrees of state involvement and to protect certain traditional elements of their systems.

The Law of Public Contracts

The law governing the contracts of public bodies is also shaped by changing economic circumstances, the increasing recourse to contracting-out, and the impact of EU law. There is a general trend towards unification, mainly deriving from EU public procurement law, whose focus is to sustain undistorted competition in public purchases through transparent procedural rules. But this process also accommodates different legal traditions in national laws.

PPP contracts were widely used from the 1990s to develop different types of public infrastructure, such as motorways. However, there were always concerns whether PPPs could deliver value for money for the public sector. (Photo by Kroock74, CC BY-SA 3.0, https://commons.wikimedia.org/wiki/File:Toll_booths_in_the_UK.jpg)

The most developed legal tradition relating to public contracts can be found in the French legal system in the concept of administrative contracts. What sets this legal regime apart is that contract rules of public authorities must also reflect the public interest and guarantee the proper functioning of public services. Administrative contracts form a distinct category apart from private law contracts, and legal disputes relating to them fall within the jurisdiction of administrative courts. Special rules are applicable to these contracts besides the underlying law of the French Civil Code. The main feature of administrative contracts is that the parties to the contract are not in an equal position and that the law acknowledges certain prerogatives for public authorities (e.g., a unilateral power of modification in case it is so required in the light of the public interest). However, the rules of administrative contracts must also fairly protect the interests of the contracting party by sustaining the economic balance in case of unforeseen circumstances and by compensating the private party in case the administration exercises its special rights.

The German legal system has traditionally been based on a strict distinction between private and public law. Its main approach to the contracts of public authorities is that public administration is also subject to private law when it takes part in economic relationships. This way of thinking has not impeded the acknowledgement of certain specificities of public contracts in connection with the public interest. The emphasis in German law is on the requirement that public authorities give due consideration to human rights even if they are acting under contract. In order to apply public law requirements to private law contracts, German courts incorporated these public law principles into general private law clauses. This solution of taking into account public principles in the interpretation of private law is called Verwaltungsprivatrecht in legal literature.[6]

One difference we can observe in English law is that its evolution is much more based on the needs arising from private economic activity than in continental contract laws. In the system of common law, it follows from the principle of the rule of law that the same law applies to both the state and private parties when they take part in economic relationships. As a result, even the existence of administrative law was recognized much later in England than in Germany or France. The specificities of public contracts appear in the principles elaborated by the courts and in codified laws, but there is no general legal concept or theory on how the public interest is considered in relation to public contracts.  

In spite of the conceptual divergences, common features can also be observed in the main European legal systems.[7] These elements all relate to the public interest and represent two main aspects of public contracts. On the one hand, public bodies need more freedom to act in order to decide on public matters and keep their competence to act as the public interest requires. However, when public interest warrants a derogation from contractual obligations, the private party must be compensated fairly. On the other hand, the administration cannot circumvent its public law obligations—such as respect for human rights—even if it acts in accordance with contractual provisions.

EU law also affects significantly how the traditional principles of public contracts can be applied in the member states. It is possible to maintain different approaches to public contracts in individual legal systems, but their special points of view can only apply within the boundaries set by EU law.

 

[1] Hellmut Wollmann and Gérard Marcou, “Introduction,” in Wollmann and Marcou (eds), The Provision of Public Services in Europe: Between State, Local Government and Market, Edward Elgar Publishing, Cheltenham, 2010, p. 5.

[2] Council Directive 89/440/EEC of July 18, 1989, amending Directive 71/305/EEC concerning the coordination of procedures for the award of public works contracts; Council Directive 88/295/EEC of March 22, 1988, amending Directive 77/62/EEC relating to the coordination of procedures on the award of public supply contracts and repealing certain provisions of Directive 80/767/EEC; Council Directive 92/50/EEC of June 18, 1992, relating to the coordination of procedures for the award of public service contracts; Council Directive 93/36/EEC of June 14, 1993, coordinating procedures for the award of public supply contracts; Council Directive 93/37/EEC of June 14, 1993, concerning the coordination of procedures for the award of public works contracts; Council Directive 93/38/EEC of June 14, 1993, coordinating the procurement procedures of entities operating in the water, energy, transport, and telecommunications sectors.

[3] Attila Harmathy, Szerződés, közigazgatás, gazdaságirányítás, Akadémiai Kiadó, Budapest, 1983, p. 29.

[4] For a detailed account of the different approaches to public ownership in the economy after 1945, see Leigh Hancher, “The Public Sector as Object and Instrument of Economic Policy,” in Terence Daintith (ed), Law as an Instrument of Economic Policy: Comparative and Critical Approaches, Walter de Gruyter, Berlin, 1987, pp. 165–236. 

[5] Ninth paragraph in the preamble of the Constitution of 1946: “Tout bien, toute entreprise, dont l’exploitation a ou acquiert les caractères d’un service public national ou d’un monopole de fait, doit devenir la propriété de la collectivité.”

[6] For a comprehensive analysis of Verwaltungsprivatrecht, see Ulrich Stelkens, Verwaltungsprivatrecht—Zur Privatrechtsbindung der Verwaltung, deren Reichweite und Konsequenzen, Duncker & Humblot, 2005.

[7] See also Rozen Noguellou and Ulrich Stelkens (eds), Droit Comparé des Contrats Publics / Comparative Law on Public Contracts, Bruylant, 2010.