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Abu Dhabi wants to make airplanes … and it has a sovereign fund available to help make it happen

by Brad Setser
August 7, 2008

Airbus is looking to source more parts (and produce more) in the dollar zone. Selling a product denominated in dollars with a euro cost structure isn’t currently a recipe for enormous profits.

China is part of the dollar zone, for better or for worse. It will soon be making A320s.

So is Abu Dhabi, though it is quite hard to see why an oil-exporter with a huge external surplus like Abu Dhabi should be in the dollar zone. Being a part of the dollar zone is a big reason why inflation is very high (and probably far higher than reported) in the Emirates.

Abu Dhabi could easily import all the airplanes and airplane parts it wants. $100 billion in export revenues split among a small population produces a lot of buying power. Abu Dhabi’s native-born residents are far too wealthy to spend their time building planes. They prefer flying them …

But Abu Dhabi aspires to do more than pump oil. And its proliferating sovereign funds have the resources to make most dreams come true. Or try too.

ADIA is Abu Dhabi’s best known fund, but it is far from alone. Over the past few years it has been joined by Mubadala, the Abu Dhabi Investment Council (a fund set up to manage ADIA’s regional investments) and perhaps Taqa (an ambitious state energy company that is investing in energy projects outside of the Gulf — and in effect doubling down on Abu Dhabi’s energy exposure rather than diversifying away from it). Wayne Arnold writes:

There are at least eight Government-owned or Government-controlled institutions now investing sovereign funds on behalf of Abu Dhabi. Far from just trying to drive up short-term gains, most share the goal of securing the long-term prosperity of the emirate, whether by providing nest eggs for retirement, securing long-term supplies of food and energy, promoting the development of new industries that create skilled jobs and reduce Abu Dhabi’s dependence on oil, or just amassing endowments.

While ADIA may have a portfolio that looks rather like a pension fund or a university endowment, Mubadala is more of a “sovereign economic development fund.” Its mandate goes beyond returns. It is also supposed to promote Abu Dhabi’s internal economic development.

Mubadala was, I think, set up in part to manage the “offsets” — basically contracts to produce parts — that came with the emirates purchases of military planes. Abu Dhabi’s ambitions to challenge Dubai in the airline business have made it a new force in civil aviation. Etihad is a big buyer of planes. Mubadala is willing to invest in parts production. Stefania Bianchi of the Wall Street Journal reported last week:

“Oil-rich Persian Gulf states, whose airlines have ordered billions of dollars worth of jetliners, now plan to leverage their financial clout into making parts for those planes.

As Airbus, Boeing Co. and General Electric Co. struggle with soaring oil prices, slowing economies and squeezed delivery dates, multibillion-dollar aircraft orders from airlines in Abu Dhabi and Dubai, in the United Arab Emirates, provide much-needed investment, cheap labor and state-of-the-art facilities …

Mubadala, which owns aviation maintenance, repair and overhaul firm Abu Dhabi Aircraft Technologies, in a statement said it wants to “work with the world’s very best partners to develop and operate businesses that generate outstanding financial returns.” European Aeronautic Defence & Space Co., of which Airbus is a part, and Rolls-Royce PLC struck similar deals to develop aircraft and engine manufacturing facilities in Abu Dhabi, Mubadala said earlier this month.

The EADS partnership, which Mubadala expects to generate more than $1 billion of revenue for Mubadala’s aerospace arm over 10 years, will see the Abu Dhabi company produce aircraft components for Airbus and, eventually, construct entire jets. EADS will meanwhile work with Mubadala to develop an engineering center and research-and-development facility in Abu Dhabi so it will eventually be able to design, develop and manufacture complete aircraft in the United Arab Emirates’ capital. Emphasis added.

Anyone who claims sovereign funds invest only for commercial returns hasn’t looked very hard. There are a host of funds in the Gulf that are designed to help their respective city state compete with Dubai as a financial center, and to otherwise their own economic development. That isn’t entirely non-commercial, but it isn’t fully commercial either.

Does it really make sense for a country as rich as Abu Dhabi to make airplane parts, let alone airplanes? Remember, all the labor will be imported, adding to pressure on rents and the like. An obvious alternative would be to move the factory closer to the labor pool that is expected to staff that factory?

Would Mubadala ever invest in a facility in a rival city state like Qatar? Qatar, remember, also aspires to be an airline hub and is building a huge new airport …

It is hard to see how Abu Dhabi’s plans pose much of a threat to the civil aviation industry in the US and Europe. Both Airbus and Boeing have long used parts contracts to help win business. Abu Dhabi simply isn’t big enough to become a major hub for high-tech manufacturing.

But the same forces that have pushed Abu Dhabi to create a sovereign economic development fund that invests at home and abroad in projects that sometimes seem motivated at least as much by Abu Dhabi’s internal plans as by a desire for financial returns are present in other, much larger countries. Abu Dhabi isn’t the only country with big plans.

That is one reason why I have criticized the decision to have the CIC manage the Chinese state’s controlling stakes in the state banks as well as an external portfolio. It suggests that the CIC isn’t purely a passive financial investor. I am not convinced that China can wall off the CIC from pressure to support China’s own firms as they go forth. I am pretty sure the state banks will face pressure to do so. And the CIC’s current ownership of these banks makes the state banks look a lot like the CIC’s fund managers — and perhaps the CIC’s own economic development funds. If the CIC is ADIA, is the CDB Mubadala?

The FT’s Lex notes that China’s various sovereign investors seem to be jostling with each other as they forth rather acting out a perfectly choreographed central plan. True enough. But they are competing to implement a government policy decision to invest more aggressively abroad. And so long as the State Council has to approve big investment abroad, it ultimately gets the final decision. Coordination may happen at a level above the CIC …

Addition references:

Wayne Arnold’s article on Abu Dhabi’s different investment funds provides a synopsis of the style of each fund.

33 Comments

  • Posted by Dave Chiang

    Well Airbus will build an A330 Assembly line in the United States for a $35 billion contract to build a new generation of aerial-refueling tankers for the U.S. Air Force. The US production line will also produce A330 commercial freighter aircraft for the world market. The Pentagon operates an US Industrial policy for defense acquisition that requires “made in the USA” production. Other countries including China have more commercially oriented Industrial policies. To entice foreign investment in a high technology industry, Airbus was permitted to retain 51% ownership in the Tianjin A320 production joint venture. In contrast to the usual Chinese government requirement of joint ventures with local partners, Intel was even permitted 100% ownership of the $2.5 billion Dalian semiconductor factory in a strategic technology industry.

    Abu Dhabi’s ambitions for its aerospace industry are no different than other Muslim developing nations. For Pakistan’s JF-17 Fighter program, China’s Chengdu AVIC Aircraft designed the aircraft, built a few dozen, and transferred the engineering design to Pakistan. Egypt also produces the K-8 Light Attack/Trainer aircraft under licence from China. Iran licenses QW-2 Air Defense missiles and C-802 Anti-ship missiles from the Chinese. In order to win global procurement contracts, the nature of the world economy is not only to export products, but to eventually transfer the engineering technology for local licensed production.

  • Posted by joe

    Brad, completely off topic but this article in the WSJ caught my eye today. Any thoughts on the impact the rule change may have?

    BEIJING — China announced changes to its foreign-exchange rules to address surging growth in its hard currency reserves, saying domestic companies can now keep their foreign-currency income overseas and pledging tougher penalties for illicit capital inflows.

    The changes remove a requirement that Chinese companies bring all of their foreign-exchange income into the local banking system. By allowing companies to keep more foreign currency offshore, the rules could reduce inflows into China and potentially lessen upward pressure on the value of the yuan.

    A Treasury Department spokeswoman welcomed the move, saying, “The removal of restrictions on holding foreign exchange and allowing foreigners to issue securities in China are both positive steps in the development of China’s foreign-exchange and domestic financial markets.”

    The revised rules will simplify approvals for Chinese companies seeking to invest overseas, the official said. At the same time, the government will step up monitoring of foreign-exchange fund flows, through measures such as on-site inspections and requiring banks to verify the legitimacy of currency transactions.

  • Posted by bsetser

    Right now Chinese companies generally want to get rid of their dollars and euros, not hold on to them — so I don’t think the rule change will have much of a practical impact. China also tightened controls on various inflows (more fines and the like if you are faking invoices to bring $ into China), so this is just the latest manifestation of the broader trend for China to loosen controls on outflows (fx held abroad is an outflow) while tightening controls on inflows to try to reduce reserve growth.

    But any Chinese company could reasonably ask why should I want to hold $ when the government doesn’t want them? what does the pboc know that I don’t?

  • Posted by bsetser

    DC — good point. Military contracting has always involved a commitment to produce something in the country buying the product (or often). All governments use their buying power in this way, to try to create jobs. Military contractors understand that their chances of getting the contract are helped if they increase the political constituencies that benefit. That tho introduces inefficiencies into the process.

    And I am not sure we want this process to be broadened from military contracting to include civil aircraft and a host of other products even more than is the case now rather than limited …

  • Posted by Scott

    Perhaps Chinese SWF’s could pick up some of the Las Vegas casino developments that are being foreclosed on. I don’t think that there would be much in the way of political repercussion from this. With deep pockets and a long investment horizon, these developments could work out.

  • Posted by Troll

    I agree with you Scott.

    Last comment:

    Ricardo and Morality

    There is a nice Wikipedia article about “comparative advantage”. It even cites one of the newest works by Economist Ha-Joon Chang where he argues that this idea worked adversely for developing countries.

    I’ve decided, after seeing a lot of shoddy and self-serving economic research being passed off as science that we need to take a new approach. The era of the MBA and the bottom line has to come to an end.

    The golden rule does not state “do unto others…as long as it is cost effective”.

    Trade is based upon a theory that both parties will benefit if certain minimal conditions of fairness are maintained. These conditions are called the “free market”. One of the bitterest areas of disagreement is over exactly how “free” this market is. There are three schools of thought on this:

    EDITED — THE INITIAL COMMENT WAS TOO LONG

  • Posted by euro
  • Posted by asian

    USA politics at work:

    But then the McCain campaign should have guessed that you don’t mess with people who have enough money to bury you – as in the Hilton hotel family, which happens, irony of ironies, to vote Republican.

    Paris Hilton lost no time, simply hired better writers – Chris Henchley and former Saturday Night Live writer Adam McCay, a creative partner of the laugh-a-tonic Will Ferrell – and visibly got a tremendous kick delivering her response to the McCain ad. [1]

    Conveniently decked in swimsuit and high heels, looking totally hot, Paris in her video response not only whoops the old man – “really old, older than Yoda” – but offers her own energy policy to save America. She ends up looking more respectable than McCain. Additionally, fashionistas and the YouTube/Facebook hordes shrieked in delight as she also did promise to paint the White House pink.

    EDITED — TOO LONG, AND NOT GERMANE TO THE DISCUSSION

  • Posted by Ian Hurst

    How relevant! Thank you, asian, for your timely and insightful comments.

    Man, what was it about this post that so attracted the loonies?

  • Posted by mx jobless

    Maybe, the loonies are spreading like rabbits around the with lots of common sense, so lacking in corporate US of A.

    Relevance is very subjective to your job or taste?

    What do you want airbuses for, if you can’t afford a flight, made in china or in South Africa (nobody would complain, by the way)?

    If SWFs of Chavez pored tons of money to buy GM, the Dow Jones would jump without a sigh (those stupid southamericans are buying …).

    Relevance?

    EDITED — VEERED OFF TOPIC

  • Posted by bsetser

    Ian — good question. I would like to see a serious discussion of sovereign economic development funds — and how countries receiving investments tied to reciprical investment in the country making the investment should respond …

    abu dhabi is rich. a lot countries with tons of foreign assets are not — which suggests to me that there will be pressure to invest in ways intended to promote local development rather than to generate returns.

  • Posted by Prakash

    Brad – In the absence of rule of law in developing nations and investment opportunities in already developed ones, there is no contradiction between “promoting local development” and “generating returns in the long run”.

    One of the best ways to invest money in the long-term for a firm with such a view is develop the middle-east. Rule of law, order, stability is guaranteed by the Emir and in the long run, the returns would come in. It is better than Casinos, my humble view.

  • Posted by Dave Chiang

    Chinese win major Saudi Arabia military contract for self-propelled Artillery. A big boost to China’s defense industries. The Pentagon Neo-cons are upset. Well too bad.

    China wins key Saudi artillery contract
    http://www.upi.com/Security_Industry/2008/08/07/China_wins_key_Saudi_artillery_contract/UPI-74931218128855/

    HONG KONG, Aug. 7 (UPI) — China has signed a contract to provide Saudi Arabia with PLZ-45 155mm self-propelled howitzers for one battalion, according to an authoritative military industry source. One battalion normally would be armed with 27 such guns.

    This represents a second successful sale of PLZ-45s to the Middle East, following an earlier sale to Kuwait. In 2000 China exported 54 of the self-propelled guns to Kuwait, sufficient to arm two battalions.

    This latest batch of PLZ-45s is primarily to be used for testing purposes, according to the industry source. Once the Saudi military determines that the weapons meet its needs, it likely will import more of the howitzers.

    However, the United States has voiced objections to the Saudis’ procurement of Chinese-made howitzers, the source said.

    Kuwait also faced immense pressure from the United States when it decided to import PLZ-45s from China. The publisher of a military journal in Kuwait told the author during a meeting in Abu Dhabi the reason Kuwait chose to purchase the PLZ-45s was the weapons compared well with similar systems available from the West, including the U.S.-made M109A3 howitzer. The guns performed satisfactorily in live-fire tests, he said, and China’s price could not be beat.

  • Posted by Rien Huizer

    Troll,

    Chang is one of the more sober representatives of the developmentalist school and I think his prescriptions are right if used within the limitations of the developmental state model, which is that it is OK to do the kinds of things that Korea became famous for, but only up to a point. That point is where the state loses its “disciplining power” vs the corporate sector AND the point where the country has caught up technologically to the point that the state can no longer issue investment directives without a grave risk of picking losers. You need a large supply of candidate workers (Lewis’ abundant labor model more or less) a few people who can organize business and very forgiving trade partners.(I am not doing justice to the model) When the WTO was gaining, that model became less viable, now with a world without much of multilateral set of institutions, perhaps.

    Brad,

    The UAE story looks ludicrous at first. A bit like me, a very experienced but unskilled and talentless golfer playing alongside a top ranked professional in a pro-am. We both play golf but I have to pay and the professional gets paid. It is unlikely that the pro and me will ever be part of the same profession. The aerospace industry is a bit like a pro-am: some pay and others get paid, but they all play and love the game.
    I would guess, if the Abu Dhabians want to pay for a parts plant somewhare in their country, to be staffed by migrnt workers (from top to bottom) with a few locals on the Board, why not. A bit like me hiring an ace youngster to caddy for me and occasionally coach, but in this case the caddy hits the shots as well, openly. Does it make sense to do that? Maybe. Singapore and Dubai both seem to have some success with an “industrial estate” approach where the state tries to earn increasing returns from its land and related resources, if necessary with imported labour, and develop a captive market for local services. And “clusters”. I guess Dubai does not have a lot of choice but do a Singaporean thing, the Abu Dhabians are in an entirely different situation. For the time being it looks pretty harmless. EADS would probably like to have plant in Brunei too.

    I would worry more about China. So far no country (OK Brazil has Embraer and Cnda Bombardier, but they are specilialists) outside the US and EU (sorry Brits for me the EU is a country that is 80% finished all it takes is completing the federal structure and getting rid of the toublemakers..) developed an alternative for the two national aircraft developers and builders. Parts are made all over the world, sometimes in strategig partnetship with one of the two.
    But China could (and probably wants to) have at least one designer/builder (and it does have an aerospace industry now). But even with EADS help (and watch them struggle with their new models) it may take several months before they can challenge Boeing. I guess that EADS looked at the alternative (selling fewer planes to China in the short term), the opportunity (no EU rules making technology transfer difficult like the defense-related US one)s, and said, what the heck, in the long run we’re all dead. Furthermore, the 320 is mature technology. Jet engines are different kettle of fish though. No chance one of the triopoly members will transfer much to China.

  • Posted by bsetser

    Rien — I also doubt Abu Dhabi will ever emerge as an independent aircraft producer that can compete with boeing and airbus. at the same time, there is little doubt that it is using its wealth to support what looks like an industrial policy. It has every right to do so within its own borders. But if it invests abroad with the intent of encouraging the firms it invests in to shift activity to Abu Dhabi, that strikes me as quite different — and it clearly means making investments that in my view have a somewhat strategic aim, i.e. they are motivated by more than commercial returns.

    my main point is that those arguing that SWFs are investors interested only in returns that never pursue strategic “state” goals need to look a little more closely at the investments of some funds.

  • Posted by Twofish

    bsetser: Right now Chinese companies generally want to get rid of their dollars and euros, not hold on to them — so I don’t think the rule change will have much of a practical impact.

    I think it will have a huge impact since once Chinese companies are allowed to hold dollars overseas, they are likely to do so in a form that will make it less likely that they will end up with currency losses. Keeping the money overseas means for example that you can fund the construction of a factory with revenue overseas without going pulling the money into then out of the firewall.

    bsetser: But any Chinese company could reasonably ask why should I want to hold $ when the government doesn’t want them?

    Because people in Kansas take dollars and not RMB, and if you are planning on opening a factory or buying a company in Kansas, you need dollars.

    The other problem is that there is “administrative risk.” If you convert your dollars to RMB, there is no assurance that SAFE will let you convert them back into dollars when you need to buy that factory in Kansas. This is a huge problem.

  • Posted by Dave Chiang

    “The other problem is that there is “administrative risk.” If you convert your dollars to RMB, there is no assurance that SAFE will let you convert them back into dollars when you need to buy that factory in Kansas. This is a huge problem.”

    As long as any company files the proper legal documentation, there is no risk that SAFE won’t let you convert back to US Dollars for legitimate purposes. For instance, there are hundreds of Chinese companies that list on the Hong Kong and New York stock exchanges. There has never been one incident that a Chinese company has missed payment of a dividend, or foreign bond interest.

    A brother in-law works for Minsheng banking corporation. While in Guangzhou, I asked him to cash a couple of thousand US dollars without any sweat. The Chinese yuan is now even openly exchangeable for US dollars at any Hong Kong bank or currency exchange dealer.

  • Posted by Twofish

    DC: As long as any company files the proper legal documentation, there is no risk that SAFE won’t let you convert back to US Dollars for legitimate purposes.

    What you may consider a legitimate purpose may be different from what SAFE considers a legitimate purpose.

    DC: For instance, there are hundreds of Chinese companies that list on the Hong Kong and New York stock exchanges. There has never been one incident that a Chinese company has missed payment of a dividend, or foreign bond interest.

    But there have been some very close calls. There was one situation in which a major Chinese corporation had to basically get the State Council to overrule the decision of SAFE to not authorize a payment that was required for a major high profile deal.

    DC: While in Guangzhou, I asked him to cash a couple of thousand US dollars without any sweat.

    Try getting him to move US$100 million.

  • Posted by bsetser

    2fish — I am not with you on this. A chinese company that wants to expand abroad has a financial incentive to convert $ revenue into RMB (and lock in the current exchange rate/ get higher carry) and finance external investment with $ borrowing (backed by equity) not cash flow. that way it matches fx assets with fx liabilities and avoids to the extent possible a currency mismatch. the administrative risk has gone way way down in a world where China now wants firms to go forth and wants firms to invest abroad. the big risk is currency risk — and the hurdle for funding an offshore project in RMB (which you are if you giving up the option to convert $ into RMB) is a lot higher than funding a project in $, given the risk of RMB appreciation (which has fallen a bit for now, but it high over a longer term horizon)

    Both the US and chinese data indicate that there is basically no Chinese investment in US plant and equipment — look at FDI v total flows in the bilateral US current and capital account data with China. I don’t see that changing.

  • Posted by Dave Chiang

    Twofish,

    Noted Investor Jim Rogers is worth more than a $100 million and he states that he has not had a problem “legally” exchanging his money into Chinese yuan and equities. The point is that the Chinese yuan is moving in the direction of becoming a convertable reserve currency for “legal” transactions. In all bordering nations surrounding China, that includes Kyrgyzstan and especially Thailand, the Chinese yuan is legally exchangable at banks and foreign exchange dealers. And an equity investment in Citicorp was vetoed by the State Council not because of foreign exchange considerations, but because Citicorp’s “off-the-books SIV” is loaded with $1 trillion in subprime garbage.

  • Posted by Twofish

    bsetser: A chinese company that wants to expand abroad has a financial incentive to convert $ revenue into RMB (and lock in the current exchange rate/ get higher carry) and finance external investment with $ borrowing (backed by equity) not cash flow.

    The trouble is that without dollar assets outside the currency firewall, you are going to find it more difficult to borrow dollars. Suppose my assets are all RMB, someone lends me dollars, I default, the lender now has assets that are useless to them. If I have dollar cash flow and dollar assets, then I’m more likely to get much more external funding.

    Also, I think that a lot of these rules are designed for more long term goals. I don’t think that the RMB can stay undervalued for more than three years or so, and these regulations strike me as intended for the “post-appreciation” world. Corporate strategy typically looks ahead five to ten years.

    bsetser: the administrative risk has gone way way down in a world where China now wants firms to go forth and wants firms to invest abroad.

    Maybe. The trouble is that bureaucrats can be irrational, and you don’t want to be in a situation where you can’t fund something because some SAFE bureaucrat won’t rubber stamp something. If you can get SAFE to issue you some sort of license that promises that you can switch currency in three years, fine. You probably can’t.

    bsetser: Both the US and chinese data indicate that there is basically no Chinese investment in US plant and equipment

    Yet……..

    DC: Noted Investor Jim Rogers is worth more than a $100 million and he states that he has not had a problem “legally” exchanging his money into Chinese yuan and equities.

    USD->RMB no problem. Buying equities, no problem, you can buy H and B shares. RMB->USD big problems.

    Also I find Jim Rogers to be a little annoying since he really doesn’t say anything useful. China does have a lot of potential, but to make that potential amount to anything takes a lot of hard work, and that means focusing in on the problems and fixing them. At this point, I don’t think that Chinese economic growth can be stopped by external forces, and given that to be the situation, I don’t see the point of “cheerleaders.”

    DC: The point is that the Chinese yuan is moving in the direction of becoming a convertable reserve currency for “legal” transactions.

    You can’t have a reserve currency that isn’t capital convertible, and the RMB isn’t capital convertible, and in my opinion, it shouldn’t be capital convertible for a long, long time.

  • Posted by Twofish

    bsetser: Does it really make sense for a country as rich as Abu Dhabi to make airplane parts, let alone airplanes?

    Yes. Dubai is becoming something of a high-tech center in the Middle East.

    As far as cost….

    Also, would you feel comfortable knowing that you are six miles above the ground and the only thing that keeps you from a fiery painful death is a complex machine that was designed and manufactured by the cheapest labor the manufacturer could find?

    bsetser: Remember, all the labor will be imported, adding to pressure on rents and the like.

    All the more reason to focus on aircraft design. The people that you import are likely to be extremely high skilled people.

    bsetser: Abu Dhabi simply isn’t big enough to become a major hub for high-tech manufacturing.

    Big doesn’t help and it might hurt. Ask Hong Kong and Singapore.

    bsetser: But they are competing to implement a government policy decision to invest more aggressively abroad.

    I think you are reversing things here. It’s not the state council that is forcing reluctant Chinese companies to invest abroad. Trying to convince a CEO to expand their company is like trying to convince an apple to fall to the ground. The bigger your company, the bigger your paycheck and the bigger your salary. Chinese companies (or American companies) don’t *need* convincing to expand. If you give the CEO of any company some cash, they will use it to expand.

    Where the State Council and CIC and the banks come in is not to *encourage* Chinese companies from expanding. They don’t need encouragement. What there job is, is to prevent companies from *stupidly expanding*. In every situation whose details we know about, it’s always CIC and the State Council that is saying “no.”

    The reason is obvious. If the CEO of CDB buys a huge US company, they get a big office and a huge salary. If the deal goes bad, nothing bad happens to them. They get fired and go off to enjoy the yacht that they bought while they were CEO. The people that get hurt are the investors, and you need powerful investors like CIC to curb the excesses of corporate management. You also need the State Council to make sure that the investments are in the national interest.

  • Posted by Twofish

    bsetser: And so long as the State Council has to approve big investment abroad, it ultimately gets the final decision. Coordination may happen at a level above the CIC …

    Coordination and veto are different things. State Council can say no, but it can’t (and doesn’t) force a company to make a deal that the company doesn’t think is profitable.

    Also this is going to break down with volume. As long as you have two or three deals, the state council can look at them, but I think the deal volume is going to very shortly be such that the state council can’t look at every one of them.

  • Posted by bsetser

    re: “USD –> RMB = No problem … ”

    Please tell me how? I wouldn’t mind getting paid interest on Chinese RMB rather than losing money if nothing happens by buying NDFs.

    China tightening controls on inflows, and USD to RMB is an inflow … so I am bit surprised by this statement.

  • Posted by Twofish

    bsetser: Please tell me how? I wouldn’t mind getting paid interest on Chinese RMB.

    If you want to convert large amounts of USD->RMB, all you have to do is to start a factory in China. You can convert as much USD->RMB as you want to pay for the expenses for that factory.

    bsetser: China tightening controls on inflows, and USD to RMB is an inflow…

    They are tightening things up in the sense that now if you say that you want to convert lots of USD->RMB to start a factory, they’ll make sure that you really are starting a factory.

  • Posted by Rien Huizer

    Brad,

    Belatedly, yr #15. You are entirely right and if you are looking for evidence in an American context that SWF activities can result in cross border trade intervention, you are entirely right as well.

    But most probably, no democratic (or at least no public governed by a government not openly predatory) (educated or not) will consent to politicians who do not try to gain a “free” (i.e. one without costs caused by retaliation of other costs for the local taxpayer) unfair advantage for their constituents. In the EU there are many rules that the local police is supposed to enforce (for instance fishing quota). The thing to do as local politician (to get votes) is to enforce only weakly (not t all would not do) and signal to the public that you deserve credit for that. All you lose is the green vote, which is necssary only incidentally, and then only for social democrats, a movement in decline. Not very different from what the people in Mississippi expect their local reps to do.

    The point is, free trade or rather universal absence of discriminatory economic intervention (to include absence of “strategic” investment by states in other countries) is investment ) is a theoretical concept that requires a set of enforcable international rules. That was the environment we were looking forward to some 15 yrs ago and it has simply not materialized. Too many locals not believing in the growth of the pie and too many wanting a bigger share nor. Plus national prestige, plus proper work for the
    elite etc. Plus a lot of poor who expect their government to do things hat are impossible.

    The SWF world is the one that is finally replacing the post WWII consensus, consisting of Bretton Woods international finance, decolonization, UN, GATT, plus the stability of a bipolar international system and the non-aligned countries economically irrelevant or captive. Unfortunately, the US could not behave in a Wilsonian fashion due to its political system (predictable from the aftermath of WWI), the USSR committed suicide and various technologies (containers, communication, jet engines) combined with the greed of western workers to make high cost low tech western workers redundant, now finally resulting in a draconian choice between protecting Michigan or Pommeranian workers and accepting lower growth with more inflation (after a while), or having large groups of voters without the financial resources and status (the dole does not replace earned income psychologically) for whom the labor market does not provide space, except if they move to the Pearl Delta or Shenyang. I do not believe that FX adjustments (market- or administrative) are the best way to overcome this situation. What they do is get the politicians in the affected countries off the hook, a bit like central bank credibility does with the policy space of politicians historically associated with intervention and keynesianism.

    Probably we should accept that there is a conflict between China and India (for instance) gaining big improvements in their standards of living via labor cost arbitrage (by shipping embodied low labor costs) and western countries maintaining their existing standards or even aspiring to improvement. Since there is no conflict resolution mechanism and the power that could have created a global order (or benevolent empire, whatever you like) has failed to do so (and may not get a second chance, but who knows), we are exposed to the world becoming increasingly anarchic.
    In such a world, dealing with SWFs becomes primarily a domestic problem. For a New Yorker working for Goldman, there should be no protection. For a Californian aerospace worker, there might be a dire need. May the best man win!

  • Posted by ST

    “able to design, develop and manufacture complete aircraft in the United Arab Emirates’ capital”

    As Airbus and Boeing will tell you from extensive experience, it won’t happen. You simply cannot encapsulate the entire effort in any one country. For one thing the technology is far more complex than people estimate. No one does this today, no one. Malaysia learned a costly lesson and China is going to learn an $800 billion lesson on this as well. Ultimately they will contract out crucial and large pieces like the avionics (brain of the aircraft).

    I have been in this industry for 10 years. The Economist recently had a good article on this subject making the exact same point wrt China’s planned effort.

  • Posted by Twofish

    ST: As Airbus and Boeing will tell you from extensive experience, it won’t happen. You simply cannot encapsulate the entire effort in any one country.

    So don’t even try, What you really want to do is not do everything in one country, but set up an environment so that lots of key parts and people end up in your country.

    The hard part about aerospace is that everything has to work right or else really, really bad things happen. It’s different from things like consumer software, where if you have a bug in a program, people get mildly annoyed. If you have a bug in an avonics system, then things just start blowing up.

    ST: ltimately they will contract out crucial and large pieces like the avionics (brain of the aircraft).

    Or alternatively, they can develop expertise in a crucial bit and contract in.

    ST: I have been in this industry for 10 years. The Economist recently had a good article on this subject making the exact same point wrt China’s planned effort.

    But then you have to ask “what are the alternatives?” and “what are they really trying to do?” In the case of China, China is just not going to make better planes than Boeing in the next twenty years. It’s just not going to happen. However, given that reality, what should China do? Boeing is just not going to provide China with the latest fighter jets or critical project management and technology. So should China just give up and do nothing? I don’t think so.

    I think that China should just try to do its best with what it has. It’s not going to beat Boeing in the next decade. But if it can get *something* up and flying, that will be in China’s national interest since it means that some of the key people and technology are going to be Chinese.

    One other thing is that aerospace is as far from your standard concept of “free markets” as you can get, since the whole entire system is basically government run.

  • Posted by Twofish

    Huizer: The SWF world is the one that is finally replacing the post WWII consensus.

    I don’t think that there was very much of a post-WWII economic consensus. Bretton Woods didn’t break up in 2008, it broke up in 1973. ITO failed in 1950, and we didn’t have a World Trade Organization until the 1990′s. The “Washington Consensus” happened in 1990 rather than in 1950. Throughout the 1970′s the prevailing economic ideas were either “social democratic” in Western Europe, “Marxist” in the Soviet bloc, and the “developmental state” in much of the third world.

    The “free market consensus” really didn’t happen until Reagan-Thatcher in the 1980′s, and it wasn’t until the 1990′s that you have that consensus being accepted by the Clinton-Blair group.

    So what people talk about “consensus” and “agreed rules of international trade”, my response is “what consensus?” “what agreed rules?”

    Huizer: The point is, free trade or rather universal absence of discriminatory economic intervention (to include absence of “strategic” investment by states in other countries) is investment ) is a theoretical concept that requires a set of enforcable international rules.

    It actually doesn’t. The thing about trade is that it by definition leaves both sides better off, because if it didn’t, they wouldn’t trade. The thing that is tricky is defining exactly who the “sides” are, and making sure that the “sides” that are making the no-trade/trade decision have the “right motiviations.”

    Huizer: That was the environment we were looking forward to some 15 yrs ago and it has simply not materialized.

    I think it has. It’s not a glass half-empty/glass half-full situation. It’s 90% full. I think that most of the stated objectives that people interested in freer trade in 1993 were looking at have been achieved, and it is in *dealing with success* that we have the issues of today. The issues that we are looking at today are consequences (in many cases unforeseen consequences) of the success of globalization.

    In any case, it’s not 1993, it’s 2008 and the world is a very different place.

  • Posted by Judy Yeo

    Brad

    Twofish is right in a sense; had a real easy time getting from US$ to RMB, but the other way round was a complete nightmare and was just getting my money back. the only unofficial way was to carry all in cash out of the country (praying that counterfeits weren’t any significant part of the cash) and exchanging in your local friendly currency exchange…

    the first signs of trouble will be where transfers of profit (eg transfers to HQ ) accelerate in amount and frequency, probably will guarantee you a visit from all the local bureaucrats though, why? are you thinking of the ‘ole factory sideline?

    twofish

    think rien may be referring to bretton woods II though that reference has always seemed hazy, help anyone?

    as for the consequences, probably not so unforeseen. Just that the key flows and direction were going in (some cases) opposite directions. My university years included continual “harassment” by conscientious parties/individuals hoping to rope in more fellow protestors for demos against globalization amongst other causes; and that was in the mid 90s.

    The world is a very different place, in part because globalization has turned out to be more of cerberus than the friendly golden retriever. Would Adam Smith have approved of trade as seen today? Fair trade – does it exist and fair to who or what?

    totally beyond my brain capacity…

  • Posted by zero

    Twofish – given your comments about the importance of aerospace from a strategic standpoint you are banished from the comparative advantage club. But seriously, what is wrong with countries keeping an industry for strategic purposes? One area economists really miss the mark on is food supply. Most citizens of any country want a secure food supply and comparative advantage be dammed. Couple this with most people think the work farmers do adds dignity to their society and are happy with farmers as custodians of rural areas and you get countries not wanting to gut their agriculture industries despite what any economist says.

    But to the point at hand – building airplanes really makes no sense for Abu Dhabi. They should dust off Micheal Porter and try things like oilfield services and construction. Value add in your particular area is the way to go. As a Canadian We have seen way to much export of raw logs and importing furniture, exporting pulp and importing paper. And even more galling for a Canadian is most of the technology involved in a sector like Forestry is Scandinavian, or more importantly not Canadian.

    So if it was me. I would buy Schlumberger and a host of smaller oilfield service firms and start to quietly corner a few niche markets here and there, transferring technology the whole time. Use connections in the Gulf to squeeze out competitors, and use that as a base to start dominating other oil and gas producing areas.

    This might be a bit too mundane for the big thinkers on this board, but it is the sort of hard work that is needed to create a value add cluster. Paying Hollywood to produce a few movies will not make Abu Dhabi into the Hollywood of the Gulf.

    But best of luck to them.

  • Posted by Twofish

    zero: But seriously, what is wrong with countries keeping an industry for strategic purposes?

    I don’t have anything ideologically against it, but it turns out that in many, perhaps most, cases, trying to keep an industry closed for strategic reasons turns out not to be in the national interest. What tends to happen is that you end up with a heavily subsidized industry producing products that no one wants to buy that does nothing real except eat up resources that could be used for other things.

    zero: But to the point at hand – building airplanes really makes no sense for Abu Dhabi. They should dust off Micheal Porter and try things like oilfield services and construction.

    UAE is a hub for oilfield services and construction. Halliburton just moved their world headquarters from Houston to Dubai.

    The trouble with oil services is that the oil is going to run out in about 20-30 years, and you have to have a strategy for what to do then. I agree with ST’s point that creating an aerospace industry is hugely complex, which is why if the UAE or China wants to have something in place by 2040, it has to start investments now.

    Part of the reason I think that aerospace is a good fit for UAE is that it can take some of the expertise it has in oil services. Oil services is an extremely high technology, government regulated, high capital industry with large parts that are safety-critical. Some of that expertise can rub off on aerospace.

  • Posted by zero

    Twofish – as a Canadian I understand the practical implications of keeping industries closed. However, there is a political element to the strategy that overrides economic concerns. For example, in Canada most Canadians don’t care if we pay a few extra $$ for milk to keep our diary farmers off welfare. The costs here just aren’t that great. Now when the diary farmers start buying Aspen ski villa’s, opinions might change.

    From my experience in Industry the transition from oilfield services to aerospace will not be practical. Sure, engineers from both disciplines study fluid mechanics, but the transference of skills is just not there. Oilfield services makes sense because it is a sunset industry in the west so no one will care if some foreigners overpay for a coiled tubing outfit in Moose Pasture Alberta. Second, oil will still be around for a couple of hundred years just in decline. There will be enough demand for oilfield to make huge rewards.

    Another factor to look at is cultural. Given the lack of interest in actually doing physical work (why Saudi Arabia has guest workers with high unemployment is bad policy) maybe the Gulf states should pick industries that are culturally acceptable, like baking and trading. Buying up the back offices of every City and Wall street firm and next Main street firms looks like a better fit to me.

    Don’t get me wrong – i understand and respect Abu Dhabi’s goal to diversify. I just hope they do it right. There are plenty of good examples of failures for what not to do and I feel they are picking the wrong road.

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