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Coffee, the miracle of poverty, and other wonders
By comparison, imagine if all wines were sold at a fixed price irrespective of the amount of work that a particular winery put into their product. Instead you are used to a wide range of prices, including a non-rated base price of cheap boxed wine if all you want is an alcoholic wine-flavoured beverage.
Poor people have no money. The measure of poverty is defined in terms of dollars-a-day earned. So we hear about “the number of people living below US$ 1 a day is 1.1 billion” without defining poverty or giving an indication of what the problem is. The real question should not be “why are people poor?” but rather: “why are people rich?”
Wealth is not a miracle; poverty is the real miracle here. If you consider that, despite the lack of concerts by Bob Geldof, or inspiring calls to action by Oprah Winfrey or Bono, European and US citizens are astonishingly wealthy (on average) by any measure you care to name. There are certainly pockets of poverty and deprivation – and these are just as curious. How does someone in the US – in the middle of one of the longest economic booms we have ever known, when more wealth has been created than ever – remain poor?
China too, despite super-star neglect, has over the past 20 years reduced the number of people suffering from absolute poverty from 268 million to 85 million.
The effects of poverty are clear to everyone: little money, little education, poor health, no jobs, and poor safety and security. The causes of these are less obvious since they are indirect. It is impossible for the rich to have become rich because of exploitation of the poor. The poor have nothing but their labour – and a large aspect of poverty is that the poor do not engage in productive work. If they’re not working then they can’t be producing anything that the rich can take – whether the rich pay for it or not.
Latin American producers introduced the Cup of Excellence competition to stimulate a market in fine coffees. The region has 25 million growers producing US$ 9 billion a year of beans. The Economist states: “Although the trade is profitable for importers and roasters, it has confounded governments and NGOs hoping to use the bean to stimulate developing economies. The collapse of trade barriers, a jump in production and a tendency by the largest roasters to treat coffee as a uniform commodity caused prices to fall to historic lows.”
The Cup of Excellence demonstrates that coffee is not uniform and that some coffees are truly outstanding, deserving of special treatment. The winner on January 16th – Fazenda Esperanca – sold their winning coffee online fetching 1 443 c / lb. A staggering 1 233% more than the “c” price.
It is frequently government interventions that result in mass hardship and poverty.
In Kenya coffee is traded in an open-cry warehouse similar to the New York Stock Exchange. All the coffee sellers get together. Their coffee is individually cupped and tasted by purchasers who are then able to decide for themselves the relative standards of the different producers. Prices are significantly higher than the “c” price and it would look as if the farmers get a good deal. But they don’t. Until very recently the entire sale process was controlled by the Kenyan government who took their cut, and then passed on the rest to the seller. The result is familiar to anyone in South Africa who has ever won a government tender; the process takes months. Farmers can be left without an income for almost a year after the crop has been sold. So Kenyan farmers have abandoned the open exchange for direct deals with buyers. Without the open comparison, though, prices have returned to “c” levels.
In Ethiopia the government buys the bulk of the coffee, sets a price, and then sells to international buyers. The price is fixed at “c” since purchasers are not allowed to taste in advance and have no means of evaluating what they buy. Farmers suffer accordingly.
There is some hope though. The most effective tool to ensure that farmers are not hurt by anti-competitive practice is in letting them know what the retail price of their product is. The most powerful tool working to farmers’ advantage has become one of the most rapidly deployed technological innovations of all time: the cell phone.
A number of SMS markets work to ensure that farmers know the latest auction prices for a range of products and are able to choose how to sell their own harvests. As governments and other controlled markets gradually lose control of being the single source of information it is hoped that more of the profits will go down to the producers.
South Africa and China, or why democracy isn't connected to economic growth
This was managed without external relief efforts or any heroic international "end poverty now" campaigns. Simply through the expedient of employing people in low-paying work to produce stuff that the rest of the world wants to buy. The workers don't have any of the labour protections or safety rights expected in the developed world. The Chinese - as a people - don't have any of the democratic representation or equality before the law expected by developed nations. So democracy is not a requirement for economic growth.
South Africa, which does have a significant preponderance of laws that protect workers rights and democracy, has struggled with an official unemployment rate of 25.6% which has remained fairly consistent for more than a decade. Moodey's, the credit rating firm, recently issued a statement of concern regarding South Africa's skills deficit: "The risks facing Africa's largest economy in 2007 remain skewed to the downside due to a number of structural imbalances and sociopolitical tensions. One of the most pressing macroeconomic challenges ... is the ongoing battle with high unemployment and low skill levels, which pose a significant threat to economic growth while also fanning political and social unrest." They expect unemployment to drop slightly, but to remain stuck above 20% indefinitely.
There is a lot right in the new South Africa but there is also a lot wrong. Continued debate over racially motivated and discriminatory legislation has created a large number of obstacles to business efficiency. Without that efficiency South Africa has virtually no hope of being internationally competitive. The rest of the world may sympathise with South Africa's history but they will still buy their products from China. China concentrates on skills development to support businesses. South Africa concentrates on racial profiling of companies and arguing about definitions. A poll released at the World Economic Forum in Davos indicates that 63% of South Africans regard their political leaders as corrupt. Yet the ANC has a 70% parliamentary majority.
This is not to declare our democratic experiment a failure. Far from it; it has probably done more to releasing a lot of the frustration that the majority felt. China is still going to have to deal with that frustration and it may yet become extremely ugly - especially as their cities become large and diverse. Many cities are larger than the population of South Africa.
But South Africa is not going to achieve significant economic growth until people are told - in so many words - that the government cannot and will not provide jobs. That it will create opportunities to gain skills but that the onus is on individuals to become employable and then to accept terms acceptable to employers. Compromise is required and there has been precious little on offer.
The Europeans are already discovering the bitter lesson that expensive labour rights are wonderful for those who are lucky enough to have jobs, but those rights come at the cost of creating jobs for others. South Africa would do well to learn that lesson now before frustration over unemployment and government corruption undermines the very democratic institutions that so many fought for, for so long.
Enterprise Development and Employment: Experiences in South Africa and South Eastern Europe
The most recent program put in place by the South African government, spearheaded by the Deputy President, Phumzile Mlambo-Ngcuka, is the Accelerated and Sustainable Growth Initiative - South Africa (ASGISA). This initiative aims to eradicate unemployment in South Africa by focusing on three sectors; mainly bio-fuels, contact centres and office support services, and tourism. These sectors were chosen for their relative reliance on labour, and also for the belief that South Africa has a comparative advantage in them.
One of the major objectives of ASGISA is to increase the Gross Domestic Product (GDP) growth rate to 6% per annum by 2010. However, it is still a subject of contention whether this will achieve the underlying goal of halving unemployment by 2014.
Since the formal economy seems to be too slow in responding to the unemployment problem, the authorities in South Africa are now looking to the Small, Micro- and Medium Enterprises (SMME) sector to deliver. Perhaps this is the way to go, because it has been implemented with relative success in the South Eastern Europe (SEE) region.
Both the Stability Pact for South East Europe and the Investment Compact for South East Europe have been at the forefront of Enterprise Development in the region. From the Conference on Entrepreneurship and Employment in Bucharest, Romania to the Workshop on Training for Employability in Thessaloniki, the organisations focus on addressing the unemployment problem.
Some of the trends already emerging include issues surrounding access to finance, support for small business, and the impact of industrial restructuring.
As a general rule, large commercial banks are not enthusiastic about financing small business start-ups. Despite the fact that commercial banks in South Africa have committed about $ 700 million to small business loans, there are still requirements on track-record to assess creditworthiness. Similarly, the SEE region has commercial banks supporting large enterprises with a proven track-record of profitability. This is not where the similarities between the regions end.
Due to this gap in the SMME sector financing, a number of Micro Finance Banks and Institutions have sprung up. In the SEE region, Procredit bank has proven that it is profitable to lend to small enterprises at high interest rates. Similarly, South Africa has a number of micro lenders to cater for the SMME sector. In the same vein, commercial banks are starting to realise the importance of small business, in both regions.
In terms of support for the SMME sector, the SEE region has started a process of simplifying business start-ups. These include reducing the administrative obstacles, and establishing “one-stop” business help-centres. In South Africa, this process involves eliminating the bureaucratic red tape that entrepreneurs have to go through before starting a business.
The last pillar of the efforts to stimulate enterprise development involves education and training. In the SEE region, the emphasis is on developing an enterprise culture in society, which is the key to job creation and competitiveness. By contrast, South Africa places a greater emphasis on formal education and reducing illiteracy. It is for this reason that the South African government spends close to 20% of the general public expenditure on education in 2003 (SA Reserve Bank Quarterly Bulletin ). This basically means that South Africa chooses to first educate the population, before promoting an enterprising culture.
In the SEE region, the challenge is to incorporate entrepreneurship into the formal educational system.
Most of the job creation initiatives in South Africa are modelled on economically advanced nations, with very limited impact. If more of the experiences of regions like the SEE were analysed in South Africa there would be more relevant factors that could be applied.
Bringing Capital to Small Enterprise
Written by Hermann JeuschenakThe predicament lies in balancing the risk and reward in an environment where the perceived risk of lending demands a premium the borrower cannot afford. Solutions therefore must see risk reduced to a level where the credit seeker can afford the interest charges while the credit grantor is adequately compensated.
In 1980, the US Congress and the Federal Home Loan Bank, under vastly differing circumstances and acting in a different environment, increased guarantees to lenders. This intervention was ill-considered, led to unprecedented credit extension and soon led to period described as "the largest and costliest venture in public misfeasance, malfeasance and larceny of all time". The lesson – non-intervention purists aside – is that financial guarantees must only facilitate and no more; the bulk of the credit risk must remain with the lender and the borrower, in aggregate, must remain obliged.
And here we can borrow, intellectually, from capital markets: specifically, from financial structures in the collateralised debt obligations (CDO) market.
Imagine we create a loan fund of R100m, administered by a special purpose vehicle (SPV), that has as its purpose the granting of loans to prospective entrepreneurs. The fund would have as its contributors a commercial bank (R60m), private investors (R20m) and national government (R20m). For their contributions each would receive from the SPV a credit linked note (CLN) that pays the holder interest amounts and, on maturity, repays the capital – all of which is based on the overall performance of the loans the SPV has made to the SMMEs. However, each note would carry different terms and offer different payouts.
The government, net contributor (or investor deriving returns from a growing SMME sector) would own the equity tranche; so called because this CLN would carry the initial default risk – up to its initial investment of R20m. That is to say, government's CLN would (in this simple form) carry zero interest return and, if all the borrowers repay all of the borrowed capital, will receive 100% of its capital back. If, however, any one of the borrowers defaults, government's capital repayment would be adjusted downward accordingly (limited to R0m).
This CLN offers limited, but adequate, protection to the holders of the tranche 1 and tranche 2 CLNs from default. Now consider the R20m investment by private investors (tranche 2). They would stand next in line in absorbing default (again limited to R20m) and, as private investors, would demand a return on their investment that reflects this risk. Tranche 1, the R60m invested by the commercial bank, being the least risky and protected by R40m of default, would offer a low return. As a combination, the SPV - not having to pay interest on R20m, paying a low interest rate on R60m and paying a high interest rate on R20m – only needs a moderate interest return on the loans made to the SMMEs to service its CLN obligations.
The result; SMMEs gain access to cheaper (subsidized) financing, government has limited exposure while leveraging up the total funds advanced to SMMEs, commercial banks on an investment that better suits their lending and risk appetite profiles, and, because its easier for everyone, we bring responsiveness to an environment plagued by red tape and policy.
Key to this proposal – default rates and rates of return aside – is encouraging normal capital markets behaviour.
While government's provision of collateral to a sector typically unable to do so on a substantial basis makes such a transaction economically feasible, we must remain cognizant of the need for accountability and cautious of moral hazard.
Diversification, combined with a bottom up approach to default risk can tempt the SPV into the lacks allocation of funding. To address this concern a second SPV (SPV2), tasked with the long-term management of the loans to SMMEs and also owned by the commercial bank, stands between the first SPV (SPV1) and the holder of the tranche 1 CLN.
The purpose of this SPV is two-fold. In the first instance it isolates the long-term responsibility for the management of the loan portfolio, thereby creating a specialized entity with the requisite resources required for the administration and a vehicle that can be paid by SPV1 for this function. In the second instance, by paying the SPV a percentage of the interest collected from the SMME portfolio (starting with the initial R100m), the commercial bank stands to gain from effective administration – a carrot well understood by these entities. This way too, since the fee is paid by SPV1, all role-players contribute and benefit.
Regards the long-term administration, the intention is for SPV2 to take part of the fees received from SPV1 to pay enterprise development consultants for mentoring the SMMEs – such consultants having been rated by Whythawk Ratings. Again, all CLN holders pay and all SMMEs and CLN holders stand to gain. The approach encourages accountability and obviates moral hazard.
This leaves us with the purpose of SPV1 and the responsibility for the initial loan allocations. Surely there's an unnecessary duplication an certainly SPV2 would complain that it suffers the decisions of SPV1 in the allocation process. This could well be argued, and this proposal is not set in stone, but what this duplication allows is the rapid allocation of funding.
SPV1 would specialize in the assessment of business plans and loan approvals and own the loan obligations. Owned by the commercial bank, it would have the expertise to deliver on its mandate but its board would allow for representation by all CLN holders (while limiting their administrative input).
The final consideration of this piece is the extent of the collateral or equity tranche and the likelihood of enticing private investors. Here we can turn to the corporate social investment funds. With many corporates keen to support SMME development, the equity tranche could be enlarged, with the proviso that the repaid loans remain in the fund for recycling to new SMMEs.
How do we prepare nonprofit organisations for the long term?
Written by Hermann Jeuschenak
Importantly, this statement does not suggest that the underlying needs will forever disappear but supports the view that successful development will give rise to societies and individuals capable of attending to their own needs; societies that will have their own capacity to address causes of moderate and manageable proportions.
To achieve this, two processes must follow. In the first instance, limited funding must be efficiently allocated to those that demonstrate the capacity and will to deliver on social needs – a process to which Whythawk Ratings aims to contribute through our ratings. The second process is to ensure that skills and capacity developed during the first process remain – for every society will forever require education and health-care, skills development and the nurturing of talented aspirants or hapless victims of fate; and, undeniably, because zero to low return social funding is, in every instance, finite.
The risk, and the current mind-set, is not to keep a sharp focus on the sustainability of funding and long term capacity – perhaps a consequence of magnitude and the seemingly insatiable demand global inequality suggests. But we, as a global society, involve ourselves because we believe that a distant solution or parity exists.
By encouraging best practices in NGOs we not only stand to improve the reach and effectiveness of our collective interventions but also prepare these organizations for self-sufficiency in the future – a cornerstone of capitalism; our best system for economic sustainability and growth so far.
And it is these best practices, amongst others, which any ratings system should encourage. Financial controls engender discipline and awareness and client feedback encourages a level of service delivery that creates its own demand. How so? Enterprise development consultants with proven track records and successful clients will, with time, attract paying clients eager to enter the economy. Adult learnership programmes, where learners with enhanced skills are able to demand higher wages, will soon attract individuals that are prepared to pay today for greater incomes tomorrow. And, for other sectors, where total independence from donors is an impossibility, their surrogate for self-sufficiency is the success they attain through the adoption of best practices. Throughout history the wealthy have supported causes, only the number of wealthy and the level of support have varied. Highly rated orphanages, for example, will attract the limited funding during leaner times and they, through this, will, in a way, be self-sufficient.
Social development is also for the long term and we must be brave and disciplined enough today if we are to succeed.
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