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Confronting The Entitlement Conundrum – Why Social Security May Be America’s Financial Weapon of Mass Destruction

April 18, 2010 67 comments

By Marquis Codjia

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Warren Buffett, the billionaire investor and long-time Chairman of conglomerate colossus Berkshire Hathaway, emphatically stated in 2002 that derivatives were “time bombs, both for the parties that deal in them and the economic system”. Given the deleterious role these securities had in the recent economic crisis, the “Oracle of Omaha” certainly evinces prescience in addition to his mythic business acumen.

Yet, what will likely choke off economic growth in the U.S., and by percolation, usher in global economic disequilibria, is managing mammoth entitlement benefits due to – or rather, promised to – millions of Americans over not only a year or two, but decades in their lifetimes, once they face thorny existential episodes such as illness, old age, disability, or loss of employment.

Of all government-steered social schemes, Social Security – the federal Old-Age, Survivors, and Disability Insurance (OASDI) program – is the largest, claiming 20% of the national budget in 2009 or $678 billion, right after defense (23%). Other known schemes are unemployment benefits, Medicare and Medicaid.

A conceptual understanding of Social Security is helpful to gauge the dynamics at work in the entitlement debate. Simply explained, Social Security allows retirees to earn pension income from contributions made by current workers – via specific payroll taxes. Understandably, the system remains balanced if contributions made exceed benefits paid – as is currently the case.

However, current projections posit a funding gap starting in 2016 – in other words, expenses will outrun revenues, thus coercing the country into seeking external funds (from new loans or cuts in other programs). Worse, successive governments have borrowed and used up over the years cumulative surpluses held in the Social Security Trust Fund.

The funding deficit is caused by a panoply of factors, the most important of which are the increase in life expectancy, the lowering birth rate, and aging baby-boomers (resulting in fewer workers paying for more retirees).

What’s flummoxing is that the current political elite – like their forerunners in both parties – seem to be voluntarily embroiled in partisan ramblings, and gladly enjoying esoteric rhetoric that renders the populace obtuse, and discredits the urgency and criticality of the social security debate. Consequently, our most intellectually dynamic citizens do not give this topic the socio-economic import it deserves.

The ensuing status quo threatens to turn a tractable conundrum into a veritable crisis – a “time bomb” into a “financial weapon of mass destruction” against America’s social fabric. Former and current Fed chairmen, fortunately, fathom the essence of the matter; thus, Alan Greenspan advocates a mix of measures to bring entitlement programs under control and ensure long-term economic prosperity, while Ben Bernanke warns that “Americans may have to accept higher taxes or changes in entitlements… to avoid staggering budget deficits.”

Several elements form the disquieting body of thoughts that justifies the hyperbolic, or apocalyptic, formulation used in this analysis.

First, the absence of a real, serious forum to gauge the merits of viewpoints engaged in the Social Security overhaul disputation. As noted earlier, this status quo seems to be furthered, at the very least, by consecutive administrations for the past three decades, because either the issue is thorny and politically unpalatable to constituents or elected officials deem it of lower priority. In sum, they dare not venture topics that may derail re-election prospects.

To fill the rhetorical void, snippets of partisan parlance are interjected here and there, mainly to polarize citizens and eschew a thorough debate. One such snippet is the notion that Social Security should be privatized and entrusted with professional portfolio managers because the government should let free-market decide and any form of public management of the behemoth fund is a type of communist intervention intolerable in capitalist America. In this article, the pros and cons of this argument cannot be evaluated with granularity but factual observations reveal the latter’s practical limits. It’s easy to wonder what financial devastation the country would have suffered had the Fund been invested in the stock market before the recent mini-crash. It’s also easy to observe how effective a manager the government can be by analyzing operational results at the Federal Employees Retirement System (FERS), the Army Medical Department, Medicare, and Medicaid, all of which remain sound programs.

Second, the much needed overhaul of the IRS and the country’s tax collection scheme is taking longer to occur, and this delay, coupled to the ongoing government waste at the federal, state, and legislative levels, annihilates any serious endeavour to cut budget deficits.

Next, the systemic spectre of a vicious cycle looms. If the ratio of retirees to active workers grows excessively, there will be fewer contributions to pay pension benefits, and such a reduced purchasing power will yield lower private consumption. Companies will then be forced to cut their workforce if sales are lethargic, and the smaller remaining workforce will contribute even less to the Social Security Fund, and so forth.

Fourth, the Fed – as the lender of last resort – can lend to the U.S. Treasury should public finances deteriorate but it can’t sustainably keep printing money via its quantitative easing tactic lest the dollar tumble on defiance from capital markets and heightened inflation.

Fifth, the country’s incapacity to lower its trade deficits will likely not be solved in the near future because the American industrial complex is currently unable or disinclined to produce superior goods affordably, and opening up U.S. markets to foreign suppliers serve as geostrategic levers in international discussions.

In the end, entitlement specialists and those well-versed in the Social Security issue ask the following: why aren’t authorities implementing the Social Security Trust Fund’s proposal (2009 Report) to marginally raise the tax rate or the salary cap on payroll tax in order to fix the funding gap? For example, raising the payroll tax rate to 14.4% in 2009 (from 12.4%) or cutting benefits by 13.3% would fix the program’s gap indefinitely, while these amounts increase to ca.16% and 24% if no changes are made until 2037.

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Obamanomics vs. Reaganomics – Which Can Save the Economy?

April 2, 2010 70 comments

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By Marquis Codjia

President Reagan in the Oval Office delivering his Tax Reduction televised address in July 1981 (Photo courtesy of the Reagan Library, Official government record)

In the 1980s, Ronald Reagan asserted emphatically that “government is not a solution to our problem,” but rather, “government is the problem.” Nowadays, many specialists revisit the soundness of such avowal in light of the mammoth government-engineered bailouts that questionably helped safeguard the global economic fabric.

Those experts are not alone. The current White House chief denizen, who uttered openly during the 2008 presidential campaign his admiration for Reagan’s political persona – much to the ire of some diehard Democrats – , has so far spearheaded policies overmuch adversative to Reaganomics.

Many Americans remember President Reagan for his debonair, articulate and Hollywoodian public posture; yet, the former leader had developed a sophistication in economic analysis that served him throughout the recession that hallmarked his presidency.

Faced with a dysfunctional economy at the onset of his mandate, President Reagan ingrained his policies in supply-side economics, advocating a quartet of measures that revolutionized America’s social dynamics and reignited its growth machine.

First, he proposed vast tax cuts on labor and capital to incentivize corporations and entrepreneurs to invest and innovate, whereas citizens, freshly cash awash due to increased savings, were heartened to spend. Next, deregulation in targeted economic sectors aimed at eschewing unnecessary costs to investors. Third, he steered a package of major budget cuts approximating – from 1981 onwards – a 5% reduction in government expenses (circa $150 billion today). Fourth, Reagan sought to tighten monetary policy to combat inflation.

The late president’s plan delivered mixed results.

Inflation experienced a spectacular fourfold decrease from 1980 to 1983 (13.2% vs. 3.2%), federal receipts grew higher than outlays (at an average rate of 8.2% vs. 7.1%), and the 16 million new jobs created helped shrink unemployment by 3 points (to 7.5% from a 1982 peak of 10.8%). Other accolades from the Cato Institute, a libertarian think thank, include a real median family income rise of $4,000 and a higher productivity.

This said, Reaganomics and its no holds-barred canons structurally devastated parts of America’s socio-economic fabric: fiscal cuts coupled with a surge in Cold War military spending created a yawning abyss in the nation’s finances (e.g.: large budget deficits, trade deficit expansion). In addition, some culpability can be attributed to the Republican leader vis-à-vis the 1987 stock market crash and the Savings and Loans crisis, merely because, at a minimum, both pandemonia occurred under his watch. In order to cover budget shortages, the administration then embarked on a borrowing spree that catapulted the national debt to $3 trillion from $700 billion, part of which (circa $125 billion) subsidized an S&L industry crippled by the failure of 747 thrifts.

The portmanteau Obamanomics – used to depict economic policies espoused by current U.S. President Barack Obama – is a new concept, which understandably needs more time to develop before a studious analysis can be conducted on its merits.

Clearly, the current administration – also faced with a chaotic economy – has so far adopted, or is envisaging, policies diametrically opposed to Reagan’s precepts: higher taxes, increased regulation, more spending, and a loose monetary policy.

President Obama’s plan to save banks was the correct initiative for two reasons: decrepitude in capital markets would have metastasized into a more costly, general chaos, and the fact that banks are now relatively stable attests to the program’s effectiveness, notwithstanding the remaining work to be accomplished in the bank bailout’s scheme.

Even if the current economic recovery plan will take a while to reach its desired goals, preliminary results so far are altogether mixed: banks are loath to lend, the mortgage sector is still lethargic, the lackluster private consumption is hampering corporate investments and the global economic productivity. The economy is gradually adding thousands of jobs but the unemployment rate still stands at 9.7%.

So, which of Reaganomics or Obamanomics can save the economy today?

The answer is none.

No economy policy ingrained in political partisanship can save the economy; to be efficient, authorities must use a combination of ideologies, extirpating the best areas of each and amalgamating them into a coherent plan deep-rooted in sound economics.

First, the government must balance its budget by reining in bureaucratic waste at the federal and state levels, seeking higher efficiency in its social programs and maintaining a tax base able to provide sufficient inflows. The recent nomination of Jeffrey Zients as U.S. Chief Performance Officer is a welcome decision.

Second, the government and the legislative branch must agree to suppress or significantly reduce pork-barrel spending; even if some of the projects subsidized are valid, the lack of transparency and the fact that too much power lies in the hands of one lawmaker are troubling. Citizens Against Government Waste, a private, nonpartisan watchdog, estimated in its latest report that 2009 pork-barrel spending amounted to $19.6 billion, up from $17.2 billion the previous year.

Third, the government must invest in education, sciences, health, and recreation services to assure a productive labor force and educated populace. Every citizen appreciates a good local school system, an efficient police, and functional social services. Fourth, a gradual and well-balanced regulatory framework for critical sectors is needed to level the playing field for all economic agents and eschew the negative effects of systemic risks.

Finally, the tax code should be more efficient and easier to understand so more revenues are collected. Currently, it is estimated that it costs the IRS between 25 and 30 cents for every tax dollar collected, without counting the billions spent by citizens in tax compliance and planning. We have a simplified property tax code in our cities; why can’t we engineer a similar scheme at the federal level?

Can Google Live Without China?

March 25, 2010 72 comments

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By Marquis Codjia

Op-eds in prominent newspapers around the world are discussing profusely the latest decision by Google to disengage from China in a move that epitomizes the search engine’s level of camaraderie with communist censors.

While few viewpoints offer a holistic examination of a complex issue that goes beyond the business sphere, the majority applaud Google’s shift as salutary to enhancing democracy in the Asian country.

The query nowadays in the western hemisphere is whether China can live without Google.

Many respond by the negative, citing, among others, the infancy of the country’s technology infrastructure and its limited number of qualified engineers; some even posit metaphorically that Beijing will be “in the darkness” after such exit.

Truth be told, China needs Google far less than the opposite. Hence, to the inverse question – can Google live without China? – the reasonable answer becomes yes.

Strategically, there is a superfluity of arguments attesting that the Mountain View, California-based technology mammoth is following the wrong path in handling its Chinese conundrum. Some of these arguments are specifically endogenous to the firm, whereas others are more varied in nature and closely inherent to the macro-environment in which the firm evolves.

Google does not divulge the size nor the profitability of its China business but it can be inferred, from the country ca. 400 million internet users, that Google.cn – its local portal – contributes a hefty part of the overall bottom line.

Gauging the firm’s scope of business in Mao’s republic implies factoring not only core search revenues but also the ancillary business derived from joint-ventures in Asia and Google’s own commercial undertakings.

The firm cannot ignore the potential cash-cow that Chinese internet users represent and the competitive pre-eminence that a local presence can proffer. The recent announcement from Google to move its local servers from the mainland to Hong Kong and end its censorship of searches does a disservice to the firm’s core business strategy because Google needs to be in China to win in the Chinese market, irrespective of the notorious practices of the nation’s economic climate.

Therefore, Ed Burnette is accurate in reiterating this viewpoint.

It is very momentous to acknowledge that China’s economic practices are far from fair and its socio-political system may at times be antithetical to paradigms experienced in other parts of the world. That China is not a democracy is commonplace rhetoric, yet many, if not all, Fortune 100 companies are keen to put basic tenets about free speech into oblivion and open a Chinese subsidiary.

Geostrategic factors at the macro-economic level are those that Google should pay thorough attention to. The firm is a leader in its industry and possesses reliable friends within the Obama administration – Andrew McLaughlin, its former head of global public policy, is currently the Deputy U.S. Chief Technology Officer in the Executive Office of the President. Yet, a company by itself cannot represent a major strategic player in the much larger and complex continuum of US – China relations.

Politicians are very economical with the truth when it comes to China. While they occasionally resort to rhetorical dissent vis-à-vis Beijing’s transgressions on democracy and issues relating to free speech, they all keep legendarily mum when it comes to coupling business with ethics.

They shouldn’t be necessarily blamed because there’s a variety of sibylline elements that make up transnational relations, and bi- or multi-lateral issues are not always simplistic with crystal clear solutions.

If Google pulls out of the mainland, it stands to lose billions of dollars in core revenues and collateral business. It will lose its dominance in the regional search business and such economic void will attract other rivals, which in the end will cripple the firm’s global market share.

This doom scenario is far from a Hollywood sci-fi episode. If Google exits, locals (such as Baidu) and major rivals like Microsoft’s Bing and Yahoo will doubtless grab the manna. Alternatively, new entrants may easily imitate the firm’s search model and take advantage of local authorities’ reprimand and develop their business.

There is a long list of Western multinationals operating in the mainland despite repeated protests from human rights activists. Think McDonald’s, Wal-Mart, Carrefour, Citibank, etc.

Collateral losses for Google are already reflecting China’s angry reaction after the search engine made its announcement; news media reported so far that Chinese mobile phone companies will drop Google or Android, its new mobile operating system.

Did The Bank Bailout Work?

March 18, 2010 63 comments

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By Marquis Codjia

A few months ago, the crumbling global economy was atop the agenda of many G20 leaders. Social unrest, banking sector meltdown, global growth conundrum, and stock market yo-yos were the main discussion topics among the planetary leadership.

Governments the world over addressed the most imperative issue, the banking pandemonium, with massive cash inflows into a sector that hitherto epitomized capitalism at its best (and worst), with a modus operandi more akin to central intervention in communist economies.

The global tab ranges from 4 to 5 trillion US dollars according to the most optimistic estimates, but the overall costs may run higher in the future.

The financial rescue of the ailing banking sector, in principle, was the right course of action and various experts across the political spectrum saw eye to eye on its criticality, including the staunchest free-market theorizers who routinely treat as leftist energumens out of the antediluvian era those who dare buck conventional wisdom regarding the role of government in social economics.

It was flummoxing, however, to observe how lenient authorities were vis-à-vis banks throughout the bailout process on top of the very favorable terms under which funds were disbursed. Hence, financial institutions that benefited from state largesse were able to quickly use monies received to regain profitability and reimburse their respective governments.

Other parts of the economy didn’t experience so swift a recovery. Unemployment is still high; the mortgage sector is still in a shambles. Banks have been reluctant to lend, creating an underperforming productive sector and a lethargic private consumption. The stock market may be up but, debatably, the “real economy” is still down.

Banks played a crucial role in the current economic malaise, but anti-bailout commentators were wrong to vilify them and to affirm that such guilt should have precluded public rescue. Financial intermediaries are an epochal pillar of our post-modern economies, and it would have been socio-economically ruinous and politically unpalatable to let them sink.

Admittedly, a majority of banks are today more cash awash and profitable than a year ago albeit some pockets of the industry are still comatose owing to the liquidity hemorrhage that has devastated them since the recession erupted.

Regrettably, nothing has changed. These institutions are resorting again to the erstwhile practices that wrought havoc to the economy in the first place, under the aegis of a regulatory body eerily blind, deaf and tongue-tied.

Banks, evidently, should be encouraged to pursue and make profits as any private concern. But when such a financial quest comes at the expense of an entire system or poses a systemic threat to the productive sector of the economy, the argument in favor of tougher regulation becomes of preeminent import.

Companies need to utilize hedging for exposure control; yet, speculators lately seem to use derivatives to bet against their very benefactors. Although outrageous to vast swaths of the populace, such practices are explicable if one considers that the speculating camp only furthers private interests of elites (their investors) who seldom factor morality into the profitability equation.

Case in point: Greece. The Hellenic government bailed out its banking sector with billions of dollars only to see their country downgraded a few months later because of a perceived default risk.

At this moment, elected officials and central bankers should ponder the following question: did the bailout work? Or, stated differently, did the mammoth cash infusion into banks and the associated supplemental initiatives reach the initial goals?

Seasoned economists and social scientists will grapple amply with issues regarding program effectiveness and efficiency in the future, but prominent experts currently believe the answers to such interrogations are negative. George Mason University economist Peter Boettke posited that bank bailouts have created a “cycle of debt, deficits and government expansion” that in the end “will be economically crippling” to major economies, whereas Barry Ritholtz, famed author of Bailout Nation and CEO of research firm FusionIQ, thinks the rescue programs could have been conducted better.

It can be argued that the initial rescue phase of the bailout program was effectual in that it helped avert a domestic and global banking hubbub. But, contrary to popular credence, that was the easiest part. The courageous headship of political leaders and regulators cannot be underrated in the process, but it is indisputably far facile for a powerful central bank, like the US Federal Reserve, to make journal entries to the credit of targeted institutions and replenish their corporate coffers via the much celebrated “quantitative easing”.

The Fed, just like other G8 central banks, is in an enviable position because it can create money ‘out of nothing’ by increasing the credit in its own bank account. Ask current Greek Central Bank governor George Provopoulous whether he’d like to have such latitude.

Regulation is where actual political bravery need be shown from authorities, and so far the lack of sweeping reforms in the financial sector may obliterate the latter’s plodding recovery.

At present, there are five distinct reasons explicating the mediocre results obtained so far from the bailout scheme.

First, the much needed financial overhaul is taking longer to move up the legislative ladder and reach US President Barack Obama’s desk because not only financial lobbies – such as the über-powerful American Bankers Association – are exerting strong pressure,  the political agenda is also crowded out with the pressing healthcare reform and the geostrategic concerns linked to conflicts in Afghanistan and Iraq.

The fact that Senate Banking chief Chris Dodd, D-Conn., wants to introduce reform in the sector will probably change little in the short-term.

Second, President Obama’s own senior level financial staff is composed of former Wall Street alumni and lobbyists, and many skeptics are incredulous that a clique so tied to financial interests can spearhead true reforms in an industry that was previously munificent to them.

The next two factors are endogenous to the banking industry. One is the past experience of regulation and deregulation cycles that usually make laws dissipate over time, and the other stems from the idiosyncratic ability of financial engineers and investment bankers to design new products and techniques to counter existing laws.

Finally, the regulatory endeavor should be global in scope, and the present lack of geographic cooperation and the practical difficulty to track systemic risk within the industry are currently handicapping further advances.

Can Tiger Woods Come Back?

March 12, 2010 100 comments

By Marquis Codjia

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After his über-publicized apology ceremony a few weeks ago, many sport commentators and golf enthusiasts over the world were wondering what Tiger Woods would do next.

The legendary golf champion seemed genuinely remorseful for the immense tort he’d wrought upon his family and vowed to do everything in his power to reconnect the “trust dots” with his loved ones.

Although Woods clearly avouched that the sport wasn’t his immediate priority and that his career would be put on hold for a certain period, it makes sense to speculate that the golfer would certainly resume competition sooner rather than later.

That’s at least what traders believe at Intrade.com, an online prediction markets operator, with 80% of participants wagering that the golfer will play in a PGA Tour event before April 30th, 2010.

Understanding the dynamics, both external and internal, at work in Tiger Woods’ sport empire is crucial to corroborating such forecast.

First, the athlete possesses solid internal strengths stemming from his game and his family. He has a highly supportive mother, whose bonding grew even more intimate after her husband died a few years ago, and a loving (?) wife, Erin, who most likely will remain by her estranged husband once the sentimental pain dissipates.

Second, Woods is debatably the most popular athlete on earth. His popularity spans on and off golf courts since he’s also prominent in philanthropy via his foundation. Albeit his communication was deplorable at the onset of this conjugal melodrama, he has a solid organization to withstand the crisis.

Third, and most important, strength in Woods’ favor: us.

Fans constitute the biggest asset in the sportsman’s coffer. The public relishes offering a second chance to contrite celebrities who concede poor judgment and apologize for it. Cases vary from one individual to the other, but current and past headlines offer a plethora of stories involving politicians, religious leaders, sportsmen and other celebrities who regained prominence after an adulterous episode.

Fourth advantage to Woods: fellow golfers. Oddly, this group needs his quick comeback more than any other even if some rivals may secretly fancy his premature retirement to reach stardom. Some voiced outrage in the media after the infidelity surfaced back in December, but admittedly the industry as a whole has benefited tremendously from Woods’ clout.

Players can’t refute that Woods’ presence in the game has helped fatten their individual paychecks and endorsement deals owing to the increased audience the golf genius drew to a sport previously touted as elitist.

Last but not least, sponsors and major news outlets, especially visual media (TV and internet), stand to lose billions of dollars if the athlete pauses or halts his career. The golf industry has experienced a momentous sales growth in the last decade and no firm wants that manna to evaporate. This is especially true for key players such as Nike and Adidas, or small apparel dealers and internet portals devoted to the sport.

It becomes then pretty clear that external factors favor a Woods’ return but the question now remains whether he will use this difficult period to solidify his morale and come back or sink into oblivion. Wait and see!

From Wall Street to Dubai – The Lucrative Idiosyncrasies of Islamic Banking

March 4, 2010 59 comments

Religious limitations within Islamic jurisprudence have kept Islamic banks more cash awash than their risk-taking Western counterparts after the recent economic hubbub, but gradual reforms need to take place for the industry as a whole to experience a structurally sustained positive growth in the future.

By Marquis Codjia

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A supranational symposium of key financial players took place recently (March 2nd and 3rd, 2010) at the posh King Hussein Bin Talal Convention Center on the shores of the Dead Sea, circa 25 miles southwest from Amman, Jordan.

The event received trifling media interest from major western news outlets; however, behemoths in the global banking industry were closely eyeing pivotal decisions that may be announced in the final communiqué.

They were right to do so.

The gathering, the first Islamic Finance and Investment Forum for the Middle East, occurred in economically healthy and politically stable Jordan – a prominent ally of the West in a geostrategically susceptible region, – which enjoys the highest quality of life in the Middle East and North Africa Region, according to the 2010 Quality of Life Index prepared by International Living Magazine.

Another essential factor to heed lies in the fact that participants were among the crème de la crème of the Islamic financial marketplace, a group of over 350 bankers and experts from 15 countries that are spearheading transformational shifts in an economic sector likely to experience solid growth in the foreseeable future.

A bird’s eye view of Islamic banking is utile to fathom the industry’s core dynamics.

Islamic banking – and to a larger extent, Islamic finance – is deeply rooted in Islamic economics and quintessentially governed by Sharia, a legislative corpus that encapsulates the religious precepts of Islam.

Sharia or its financial section known as Fiqh al-Muamalat (Islamic rules on transactions) allows financial intermediaries to engage in any form of economic activity so long as they don’t charge interest (Riba) and shun businesses implicated in forbidden (Haraam) undertakings.

Sharia strongly furthers risk sharing among investors and economic transactions collateralized by tangible assets such as land or machinery but outlaw derivative financial instruments.

A derivative instrument is a product that derives its value from other financial instruments (known as the underlying), events or conditions. It is mostly utilized for hedging risk or speculating for profit. The recent turmoil in global capital markets and the ensuing socio-economic pandemonium owe much of their existence to a type of derivative called Credit Default Swap (CDS).

Viewpoints alien to the Muslim world may find Sharia restrictions deleterious for sustained economic development because what Muslim jurisprudence defines as vice (gambling, adult filmography, alcohol, etc.) not only plays a vital role in many countries’ GDPs but is also an arguable social and temporal concept.     

Notwithstanding, a plethora of observers now contend that constraints within Islamic finance have successfully shielded Sharia-compliant institutions from the recent economic meltdown while keeping their coffers cash awash.

Several factors support a potential Islamic finance boom, including skyrocketing deposits from denizens of oil-rich populated countries, numerous infrastructure projects and the emergence of a large middle class.

UK-based International Financial Services London estimates that Sharia-abiding assets have grown by 35% to $951 billion between 2007 and 2008, even though the industry “paused for breath” in 2009 amid the ongoing economic lethargy.

According to Mohammad Abu Hammour, Jordan’s minister of finance, the Islamic banking sector witnesses an annual growth rate of 10-15 % and there are currently over 300 Islamic banks in more than 50 countries, with large concentrations noted in Iran, Saudi Arabia and Malaysia.

Most of those banks and financial intermediaries are owned by native shareholders but growing swaths of the Islamic banking sphere are being populated by specialized sections of “ordinary” full-service Western banks.

HSBC Amanah, the Islamic finance arm of HSBC, is an illustration of that trend.

Islamic banking is highly profitable and the heightened foreign interest conspicuously corroborates the notion that the industry is bound to expand once emerging nations within the Muslim world are willing and able to use their gigantic cash reserves to structurally develop core sectors of their economies.

Nonetheless, many pending issues are still crippling the Islamic finance sector and prevent it from exceeding the 1% share it currently holds in global banking business.

The first relates to the need for Islamic banks to devise risk-hedging strategies – especially those engaging in cross-currency transactions – and instruments that are compliant with regulatory precepts. Specialists within the industry have to be creative because derivatives, a major hedging tool, are prohibited by Sharia. Progress in that area is still timid.

Second, Islamic scholars need to devise and inculcate a homogenous body of legislation to financial agents to avoid asymmetric disadvantage in the marketplace. The immensity of such a task cannot be underrated because Islam has multiple schools of thought and divergent interpretations of certain religious precepts can often turn out to be insurmountable stumbling blocks.

Sunni Islam is the largest branch of Islam with at least 85% of the world’s 1.5 billion Muslims although the endogenous variety of schools of thoughts often creates a diversity of views.

If a bank located in Sunni Saudi Arabia finds itself at a regulatory disadvantage versus an Iranian bank ruled by the precepts of Shiite Islam or a financial institution in Kharijite Oman, then evidently fundamental market disequilibria will emerge.

Third, the sector needs to harmonize practices to grow. Uniformity is needed not only in regulatory oversight but also in accounting and risk standards, both internally (within the Islamic world) and externally (vis-à-vis Western or other regional financial zones). A practical example will be to seek compliance with I.F.R.S. (International Financial Reporting Standards) and Basel II Banking Accords.

Finally, Islamic banks will need to engage in a sophisticated, well-targeted communication campaign aimed at educating skeptical U.S. and E.U. regulators (primarily), as well as prospective clients in the Western hemisphere. This effort will be pivotal in shifting public perception of the quality and positioning of their products and services and in expunging the stigma that erstwhile (and current) geopolitical happenings may have placed on the “Islamic brand”.


Dr. Abu Ameenah Bilal Philips on Interest and Islamic Banking

Competitive Asymmetry vs. Corporate Strategy: The Perilous Nexus in a Treacherous Chasm

February 19, 2010 64 comments

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by Marquis Codjia



In the past, corporate strategists sought to maximize overall firm profitability by devising the best modus operandi that will help achieve results efficiently and effectively. Such a strategy routinely took advantage of the endogenous analogies of a homogenous market or geographic zone, such as culture, regulatory landscape, uniformity in fiscal or monetary policies, and socio-political affinity.

This system of similarities was observed in North America between Canada and the United States, in Western Europe prior to the Schengen Accords that led to higher economic integration within the European federation, and Japan within its Asian economic and geopolitical fiefdom. It has proven very fruitful for many a company because the strategic proximity afforded them lower implementation costs and higher profitability.

Nowadays, globalization along with its cohort of uncertainties is rebalancing the economic landscape and swinging the strategic pendulum in unlikely whereabouts. Globalization forces companies to review their tactical practices because of inherent execution difficulties in cross-cultural environments.

Tactics ought not to be mixed up with strategy. The former deals with detailed maneuvers to achieve aims set by the latter.

The need to control and instill a grain of homogeneity in the global marketplace has forced Western governments – mainly – to found organizations that will promote anti-protectionist measures and greater legislative coordination in world’s business. World Trade Organizations (WTC), North American Free Trade Agreement (NAFTA), and Eurozone are examples of such institutions or zones.

Though these international bodies have help catapult capitalistic free-trade as the preferred ethos, they have proven ineffective at creating a common economic environment in which corporations can engineer the same strategy to achieve their goals across geographical zones or markets.

This failure is due to the complex continuum of events taking place daily in the global arena that forces corporate leaders to include new factors in their strategy matrices.

A strategy matrix indicates how effectively a business entity can achieve profitability by juxtaposing such factors as store location, operating procedures, goods/services offered, pricing tactics, store atmosphere and customer services, and promotional methods.

New factors to be added to the mix are diverse and intricate; hence, an exhaustive analytical list cannot be within the purview of this paper. Some emerging trends relate to online marketing, higher government intervention, shareholder activism, military deals with domestic or foreign vendors, terrorism and war effects, and intellectual property theft.

Business leaders usually lump some of these issues in several corporate functions: risk management, government relations, regulatory, marketing, human resources, etc., and address them at higher echelons only when their magnitude dictates executive decision-making.

This approach is erroneous because it fails to recognize the systemic pedigree of corporate strategy and the notion that it must include all risks and objectives across the organization to be successful. The threats cited earlier are complex and diverse, and they usually change market equilibria by permitting, for instance, small firms to compete against larger rivals in markets they once couldn’t have penetrated.

This is the reason why I ascribe the concept of “competitive asymmetry” to this new phenomenon.

Numerous news headlines illustrate competitive asymmetry in the market. Western luxury brands are nowadays faced with fierce competition from “made in China” faked items, while American pharmaceutical mammoths like Pfizer and Johnson & Johnson observe powerlessly patent-protected pills being fraudulently transformed into generics in India. Another example is activist investor Carl Icahn confronting Time Warner’s management and demanding a change in corporate strategy or organizational structure (segment divestiture, merger, acquisition, etc.).

Other instances include Boeing filing a contract protest with the US Government Accountability Office after it lost a military deal to Northrop Grumman Corp and Europe’s EADS or fast-food giant McDonald losing an eight-year trademark battle to stop Malaysian Indian McCurry Restaurant from using the “Mc” trademark.

These trends are obviously deleterious for most firms within the western hemisphere because that asymmetric rivalry deprives them of the profits their R&D investment must have normally secured over a large time span. The threat is coming principally from emerging and underdeveloped countries because now mature European, American and Japanese markets no longer offer maximal growth prospects and enjoy a legal environment that disincentivizes intellectual property malpractice.

Major companies cannot underestimate the criticality of these emerging trends because they not only stand to lose market share at home but also see their profits eroded in those international markets where growth rates are healthier.

I’ll end with some geoeconomics questions: how will Google’s recent infuriation at China affect the firm’s country strategy given that the current 300 million Chinese computer users constitute a less ignorable niche? What about its overall Asia strategy? Will business prevail over politics? Will Google’s potential exit from the Chinese market propel rival Baidu to domestic and global supremacy? How will that affect the firm strategy with respect to launching other products in a country with 1.3 billion customers? How will this affect Google’s overall profit line?