Keeping materials longer in the economy through reuse, re-purposing or recycling could reduce 33 per cent of the carbon dioxide emissions embedded in products.
Circularity requires a significant bridge between trade in goods and trade in services.
Increased recycling could reduce demand for primary resources, leading to both risks and opportunities in developing countries dependent on the extraction of natural resources.
CIRCULAR ECONOMY: THE NEW NORMAL?
Linear production is a familiar cycle. Resources are extracted and transformed into goods and services, sold and used, after which they are scrapped. This model has underpinned the expansion of the global economy since the industrial revolution.
It has linked material prosperity to the extraction of resources, yet has often overlooked the undue pressures placed on the environment and has rarely considered the cost of handling, scrapping and disposing of used materials, some of which are hazardous to human health. As the global population increases, incomes rise and nations strive to eradicate poverty, demand for goods and services will necessarily grow. The aim of achieving Sustainable Development Goal 12 on responsible consumption and production requires changing the linear production model. The concept of a circular economy and practice therefore merits close attention, as it can open new opportunities for trade and job creation, contribute to climate change mitigation and help reduce the costs of cleaning and scrapping in both developed and developing countries.
A circular economy entails markets that give incentives to reusing products, rather than scrapping them and then extracting new resources. In such an economy, all forms of waste, such as clothes, scrap metal and obsolete electronics, are returned to the economy or used more efficiently. This can provide a way to not only protect the environment, but use natural resources more wisely, develop new sectors, create jobs and develop new capabilities.
Each year, 1.3 billion tons of garbage are produced by 3 billion urban residents.1 This is the end point of a linear economic flow that starts with manufacturing, which uses 54 per cent of the world’s delivered energy, especially in energy-intensive industries such as petrochemicals, cement, metals and paper.2 Each year, 322 million tons of plastic, 240 million tons of paper and 59 million tons of aluminium are produced in the world, much of which goes to export markets and is not recycled.3
A rusty container or an obsolete mobile telephone are only two examples of the many products that end up being discarded, along with their transistors, metal structures and complex plastics. Each component requires a great deal of energy, time, land and capital to be produced and, even as the products become obsolete, their components often do not. The potential value of metals and plastics currently lost in electronic waste may be €55 billion annually.4
As the supply of recycled, reused and re-manufactured products increases, such products are maintained for longer in the economy, avoiding their loss to landfills. Food losses could be halved through food- sharing and discounting models that reduce fresh food waste. Access to efficient home appliances could be increased through leasing instead of sales. Organic waste could be recovered or transformed into high-value protein through the production of insect larvae.
Benefits such as these could be gained by both developed and developing countries; the potential economic gains are estimated at over $1 trillion per year in material cost savings.5 Several economies are already exploring circular strategies, including Brazil, China, India, Kenya, the Lao People’s Democratic Republic, Morocco, South Africa, Turkey, Uruguay, VietNam and the European Union.6 India and the European Union stand to gain savings of $624 billion and €320 billion, respectively.7
The effects of increased recycling on global value chains are an important area for research. For example, a circular model for metals implies an increase in the re-purposing, reuse and recycling of such materials. This can transform end points of the value chain, such as junkyards and dumping sites for metals, into new reprocessing hubs that supply metals to markets. This growth trend in recycling markets may be desirable from an environmental perspective, yet could reduce demand for primary resources, requiring an adjustment in employment, logistics and scal structures in countries dependent on the extraction of natural resources.8 At the same time, growth in the recycling, re-purposing and reuse of materials could support the emergence of regional reprocessing and recycling hubs and open new opportunities for the commodities and manufacturing sectors. Greater circularity could reduce the depreciation of physical capital in the economy, increasing overall wealth in societies. The specific benefits that developing countries could obtain by adopting formal circular economy strategies is a new subject for research, and further studies and data are needed.
Circularity can change trade patterns and improve the utilization of idle capacity
Circular models could help countries grow with resources already available in their territories. This may imply a reduction in international trade, yet the 140 million people joining the middle class each year guarantee growth in overall trade.9 Such growth may occur not in goods but in services such as access-over-ownership models.10 In addition, increased circularity can change production patterns, improving asset utilization rates and producing value chains based on recycling and re-manufacturing centres close to where products are used. This could lead to fewer transport-related losses, quicker turnarounds between orders and deliveries, lower levels of carbon dioxide emissions and the creation of jobs that cannot be offshored.
Some countries have trade surpluses in physical goods and others in immaterial services. Trade therefore results in a net transfer of materials from one region to another as seen, for example, in trade patterns between China and the United States. The United States imports many goods from China but does not export nearly as many finished goods in return. However, nearly 3,700 containers of recyclables per day are exported to China; in 2016, such exports amounted to 16.2 million tons of scrap metal, paper and plastics worth $5.2 billion.11
Cradle to Cradle
Closed Supply Chains
From Input to the European Commission from European EPAs about monitoring progress of the transition towards a circular economy in the European Union
Public traded companies are always under pressure to show earnings growth and sales revenue growth to enhance shareholder value.
How do they do it when markets have matured and economy has slowed?
Increase Market Share
How do then companies lower their costs?
Vertical Mergers and Acquisitions
Outsourcing (Sourcing parts and components / Intermediate Goods / Inputs from cross border)
Offshoring (Shifting Production cross border)
How do then companies increase their market share?
Horizontal Mergers and Acquisitions
Cross Border Markets Share (Sales in other countries)
In the last thirty years, this is exactly what has happened in US economy.
Macro Trends of increase in Outsourcing/Offshoring, Increase in Market Concentration, Oncrease in Inequality, Increase in Corporate Profits, Rising Equity Prices, Slower Productivity Growth, Lower Interest Rates, Low Labor Share, and Capital Share.
Please see my other posts expanding on these issues.
Please note that these forces are continuing and trends will remain on current trajectory.
Stakeholder vs Shareholder Capitalism
Slow Productivity Growth
Rising Market Concentration
Rising Equities Market
Dupont Ratio Analysis
Financial Planning (Micro – Firm Level)
Economic Planning (Macro- Aggregate Level)
From SHAREHOLDER CAPITALISM: A SYSTEM IN CRISIS
Our current, highly financialised, form of shareholder capitalism is not just failing to provide new capital for investment, it is actively undermining the ability of listed companies to reinvest their own profits. The stock market has become a vehicle for extracting value from companies, not for injecting it.
No wonder that Andy Haldane, Chief Economist of the Bank of England, recently suggested that shareholder capitalism is ‘eating itself.’1 Corporate governance has become dominated by the need to maximise short-term shareholder returns. At the same time, financial markets have grown more complex, highly intermediated, and similarly shorttermist, with shares increasingly seen as paper assets to be traded rather than long term investments in sound businesses.
This kind of trading is a zero-sum game with no new wealth, let alone social value, created. For one person to win, another must lose – and increasingly, the only real winners appear to be the army of financial intermediaries who control and perpetuate the merry-goround. There is nothing natural or inevitable about the shareholder-owned corporation as it currently exists. Like all economic institutions, it is a product of political and economic choices which can and should be remade if they no longer serve our economy, society, or environment.
Here’s the impact this shareholder model is currently having:
• Economy: Shareholder capitalism is holding back productive investment. Even the Chief Executive of BlackRock, the world’s largest asset manager, has admitted that pressure to keep the share price high means corporate leaders are ‘underinvesting in innovation, skilled workforces or essential capital expenditures.’ 2
• Society: Shareholder capitalism is driving inequality. There is growing evidence that attempts to align executive pay with shareholder value are largely responsible for the ballooning of salaries at the top. The prioritisation of shareholder interests has also contributed to a dramatic decline in UK wages relative to profits, helping to explain the failure of ordinary people’s living standards to rise in line with economic growth.
• Environment: Shareholder capitalism helps to drive environmental destruction. It does this by driving risky shortterm behaviour, such as fossil fuel extraction, which ignores long-term environmental risks.
The idea that shareholder capitalism is the most efficient way to mobilise large amounts of capital is no longer tenable.
We need both to create new models of companies, and implement new ways of organising investment that are fit for building an inclusive, equal, and sustainable economy.
Companies should be explicitly accountable to a mission and a set of interests beyond shareholder returns. Equally, investment must provide long-term capital for socially and environmentally useful projects, and damaging forms of speculation must be restricted.
For most people, our economy simply is not working, and the damaging aspects of shareholder capitalism are at least in part responsible. Reforming shareholder capitalism must not be dismissed as too difficult – the crisis is too urgent for that. We can take the first steps towards a better economic model right now. It’s time to act.
A Crash Course in Dupont Financial Ratio Analysis
What happens when economic growth slows ?
What happens when profit margins decline ?
What happens when Sales growth is limited ?
What does lead to Mergers and Acquisitions ?
What is the impact of Cost of Capital ?
What is EVA (Economic Value Added) ?
What is impact of Outsourcing/Offshoring on Financial Ratios ?
What is impact of Mergers and Acquisitions on Financial Ratios ?
What is impact of Stock Buy Backs on Financial Ratios ?
What is impact of Dividends on Financial Ratios ?
ROS (Return on Sales)
ROE (Return on Equities)
ROA (Return on Assets)
ROIC (Return on Invested Capital)
EVA (Economic Value Added)
MVA (Market Value Added)
From The DuPont Equation, ROE, ROA, and Growth
The DuPont Equation
The DuPont equation is an expression which breaks return on equity down into three parts: profit margin, asset turnover, and leverage.
Explain why splitting the return on equity calculation into its component parts may be helpful to an analyst
By splitting ROE into three parts, companies can more easily understand changes in their returns on equity over time.
As profit margin increases, every sale will bring more money to a company’s bottom line, resulting in a higher overall return on equity.
As asset turnover increases, a company will generate more sales per asset owned, resulting in a higher overall return on equity.
Increased financial leverage will also lead to an increase in return on equity, since using more debt financing brings on higher interest payments, which are tax deductible.
competitive advantage: something that places a company or a person above the competition
The DuPont Equation
The DuPont equation is an expression which breaks return on equity down into three parts. The name comes from the DuPont Corporation, which created and implemented this formula into their business operations in the 1920s. This formula is known by many other names, including DuPont analysis, DuPont identity, the DuPont model, the DuPont method, or the strategic profit model.
The DuPont Equation: In the DuPont equation, ROE is equal to profit margin multiplied by asset turnover multiplied by financial leverage.
Under DuPont analysis, return on equity is equal to the profit margin multiplied by asset turnover multiplied by financial leverage. By splitting ROE (return on equity) into three parts, companies can more easily understand changes in their ROE over time.
Components of the DuPont Equation: Profit Margin
Profit margin is a measure of profitability. It is an indicator of a company’s pricing strategies and how well the company controls costs. Profit margin is calculated by finding the net profit as a percentage of the total revenue. As one feature of the DuPont equation, if the profit margin of a company increases, every sale will bring more money to a company’s bottom line, resulting in a higher overall return on equity.
Components of the DuPont Equation: Asset Turnover
Asset turnover is a financial ratio that measures how efficiently a company uses its assets to generate sales revenue or sales income for the company. Companies with low profit margins tend to have high asset turnover, while those with high profit margins tend to have low asset turnover. Similar to profit margin, if asset turnover increases, a company will generate more sales per asset owned, once again resulting in a higher overall return on equity.
Components of the DuPont Equation: Financial Leverage
Financial leverage refers to the amount of debt that a company utilizes to finance its operations, as compared with the amount of equity that the company utilizes. As was the case with asset turnover and profit margin, Increased financial leverage will also lead to an increase in return on equity. This is because the increased use of debt as financing will cause a company to have higher interest payments, which are tax deductible. Because dividend payments are not tax deductible, maintaining a high proportion of debt in a company’s capital structure leads to a higher return on equity.
The DuPont Equation in Relation to Industries
The DuPont equation is less useful for some industries, that do not use certain concepts or for which the concepts are less meaningful. On the other hand, some industries may rely on a single factor of the DuPont equation more than others. Thus, the equation allows analysts to determine which of the factors is dominant in relation to a company’s return on equity. For example, certain types of high turnover industries, such as retail stores, may have very low profit margins on sales and relatively low financial leverage. In industries such as these, the measure of asset turnover is much more important.
High margin industries, on the other hand, such as fashion, may derive a substantial portion of their competitive advantage from selling at a higher margin. For high end fashion and other luxury brands, increasing sales without sacrificing margin may be critical. Finally, some industries, such as those in the financial sector, chiefly rely on high leverage to generate an acceptable return on equity. While a high level of leverage could be seen as too risky from some perspectives, DuPont analysis enables third parties to compare that leverage with other financial elements that can determine a company’s return on equity.
ROE and Potential Limitations
Return on equity measures the rate of return on the ownership interest of a business and is irrelevant if earnings are not reinvested or distributed.
Calculate a company’s return on equity
Return on equity is an indication of how well a company uses investment funds to generate earnings growth.
Returns on equity between 15% and 20% are generally considered to be acceptable.
Return on equity is equal to net income (after preferred stock dividends but before common stock dividends) divided by total shareholder equity (excluding preferred shares ).
Stock prices are most strongly determined by earnings per share (EPS) as opposed to return on equity.
fundamental analysis: An analysis of a business with the goal of financial projections in terms of income statement, financial statements and health, management and competitive advantages, and competitors and markets.
Return On Equity
Return on equity (ROE) measures the rate of return on the ownership interest or shareholders’ equity of the common stock owners. It is a measure of a company’s efficiency at generating profits using the shareholders’ stake of equity in the business. In other words, return on equity is an indication of how well a company uses investment funds to generate earnings growth. It is also commonly used as a target for executive compensation, since ratios such as ROE tend to give management an incentive to perform better. Returns on equity between 15% and 20% are generally considered to be acceptable.
Return on equity is equal to net income, after preferred stock dividends but before common stock dividends, divided by total shareholder equity and excluding preferred shares.
Return On Equity: ROE is equal to after-tax net income divided by total shareholder equity.
Expressed as a percentage, return on equity is best used to compare companies in the same industry. The decomposition of return on equity into its various factors presents various ratios useful to companies in fundamental analysis.
ROE Broken Down: This is an expression of return on equity decomposed into its various factors.
The practice of decomposing return on equity is sometimes referred to as the “DuPont System. ”
Potential Limitations of ROE
Just because a high return on equity is calculated does not mean that a company will see immediate benefits. Stock prices are most strongly determined by earnings per share (EPS) as opposed to return on equity. Earnings per share is the amount of earnings per each outstanding share of a company’s stock. EPS is equal to profit divided by the weighted average of common shares.
Earnings Per Share: EPS is equal to profit divided by the weighted average of common shares.
The true benefit of a high return on equity comes from a company’s earnings being reinvested into the business or distributed as a dividend. In fact, return on equity is presumably irrelevant if earnings are not reinvested or distributed.
Assessing Internal Growth and Sustainability
Sustainable– as opposed to internal– growth gives a company a better idea of its growth rate while keeping in line with financial policy.
Calculate a company’s internal growth and sustainability ratios
The internal growth rate is a formula for calculating the maximum growth rate a firm can achieve without resorting to external financing.
Sustainable growth is defined as the annual percentage of increase in sales that is consistent with a defined financial policy.
Another measure of growth, the optimal growth rate, assesses sustainable growth from a total shareholder return creation and profitability perspective, independent of a given financial strategy.
retention: The act of retaining; something retained
retention ratio: retained earnings divided by net income
sustainable growth rate: the optimal growth from a financial perspective assuming a given strategy with clear defined financial frame conditions/ limitations
Internal Growth and Sustainability
The true benefit of a high return on equity arises when retained earnings are reinvested into the company’s operations. Such reinvestment should, in turn, lead to a high rate of growth for the company. The internal growth rate is a formula for calculating maximum growth rate that a firm can achieve without resorting to external financing. It’s essentially the growth that a firm can supply by reinvesting its earnings. This can be described as (retained earnings)/(total assets ), or conceptually as the total amount of internal capital available compared to the current size of the organization.
We find the internal growth rate by dividing net income by the amount of total assets (or finding return on assets ) and subtracting the rate of earnings retention. However, growth is not necessarily favorable. Expansion may strain managers’ capacity to monitor and handle the company’s operations. Therefore, a more commonly used measure is the sustainable growth rate.
Sustainable growth is defined as the annual percentage of increase in sales that is consistent with a defined financial policy, such as target debt to equity ratio, target dividend payout ratio, target profit margin, or target ratio of total assets to net sales.
We find the sustainable growth rate by dividing net income by shareholder equity (or finding return on equity) and subtracting the rate of earnings retention. While the internal growth rate assumes no financing, the sustainable growth rate assumes you will make some use of outside financing that will be consistent with whatever financial policy being followed. In fact, in order to achieve a higher growth rate, the company would have to invest more equity capital, increase its financial leverage, or increase the target profit margin.
Optimal Growth Rate
Another measure of growth, the optimal growth rate, assesses sustainable growth from a total shareholder return creation and profitability perspective, independent of a given financial strategy. The concept of optimal growth rate was originally studied by Martin Handschuh, Hannes Lösch, and Björn Heyden. Their study was based on assessments on the performance of more than 3,500 stock-listed companies with an initial revenue of greater than 250 million Euro globally, across industries, over a period of 12 years from 1997 to 2009.
Due to the span of time included in the study, the authors considered their findings to be, for the most part, independent of specific economic cycles. The study found that return on assets, return on sales and return on equity do in fact rise with increasing revenue growth of between 10% to 25%, and then fall with further increasing revenue growth rates. Furthermore, the authors attributed this profitability increase to the following facts:
Companies with substantial profitability have the opportunity to invest more in additional growth, and
Substantial growth may be a driver for additional profitability, whether by attracting high performing young professionals, providing motivation for current employees, attracting better business partners, or simply leading to more self-confidence.
However, according to the study, growth rates beyond the “profitability maximum” rate could bring about circumstances that reduce overall profitability because of the efforts necessary to handle additional growth (i.e., integrating new staff, controlling quality, etc).
Dividend Payments and Earnings Retention
The dividend payout and retention ratios offer insight into how much of a firm’s profit is distributed to shareholders versus retained.
Calculate a company’s dividend payout and retention ratios
Many corporations retain a portion of their earnings and pay the remainder as a dividend.
Dividends are usually paid in the form of cash, store credits, or shares in the company.
Cash dividends are a form of investment income and are usually taxable to the recipient in the year that they are paid.
Dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends.
Retained earnings can be expressed in the retention ratio.
stock split: To issue a higher number of new shares to replace old shares. This effectively increases the number of shares outstanding without changing the market capitalization of the company.
Dividend Payments and Earnings Retention
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. On the other hand, retained earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends. Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or accumulated deficit. Retained earnings and losses are cumulative from year to year with losses offsetting earnings. Many corporations retain a portion of their earnings and pay the remainder as a dividend.
A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. Retained earnings are shown in the shareholder equity section in the company’s balance sheet –the same as its issued share capital.
Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a “special dividend” to distinguish it from the fixed schedule dividends. Dividends are usually paid in the form of cash, store credits (common among retail consumers’ cooperatives), or shares in the company (either newly created shares or existing shares bought in the market). Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.
Cash dividends (most common) are those paid out in currency, usually via electronic funds transfer or a printed paper check. Such dividends are a form of investment income and are usually taxable to the recipient in the year they are paid. This is the most common method of sharing corporate profits with the shareholders of the company. For each share owned, a declared amount of money is distributed. Thus, if a person owns 100 shares and the cash dividend is $0.50 per share, the holder of the stock will be paid $50. Dividends paid are not classified as an expense but rather a deduction of retained earnings. Dividends paid do not show up on an income statement but do appear on the balance sheet.
Stock dividends are those paid out in the form of additional stock shares of the issuing corporation or another corporation (such as its subsidiary corporation). They are usually issued in proportion to shares owned (for example, for every 100 shares of stock owned, a 5% stock dividend will yield five extra shares). If the payment involves the issue of new shares, it is similar to a stock split in that it increases the total number of shares while lowering the price of each share without changing the market capitalization, or total value, of the shares held.
Dividend Payout and Retention Ratios
Dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends:
The part of the earnings not paid to investors is left for investment to provide for future earnings growth. These retained earnings can be expressed in the retention ratio. Retention ratio can be found by subtracting the dividend payout ratio from one, or by dividing retained earnings by net income.
Dividend Payout Ratio: The dividend payout ratio is equal to dividend payments divided by net income for the same period.
Relationships between ROA, ROE, and Growth
Return on assets is a component of return on equity, both of which can be used to calculate a company’s rate of growth.
Discuss the different uses of the Return on Assets and Return on Assets ratios
Return on equity measures the rate of return on the shareholders ‘ equity of common stockholders.
Return on assets shows how profitable a company’s assets are in generating revenue.
In other words, return on assets makes up two-thirds of the DuPont equation measuring return on equity.
Capital intensity is the term for the amount of fixed or real capital present in relation to other factors of production. Rising capital intensity pushes up the productivity of labor.
return on common stockholders’ equity: a fiscal year’s net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage
quantitatively: With respect to quantity rather than quality.
Return On Assets Versus Return On Equity
In review, return on equity measures the rate of return on the ownership interest (shareholders’ equity) of common stockholders. Therefore, it shows how well a company uses investment funds to generate earnings growth. Return on assets shows how profitable a company’s assets are in generating revenue. Return on assets is equal to net income divided by total assets.
Return On Assets: Return on assets is equal to net income divided by total assets.
This percentage shows what the company can do with what it has (i.e., how many dollars of earnings they derive from each dollar of assets they control). This is in contrast to return on equity, which measures a firm’s efficiency at generating profits from every unit of shareholders’ equity. Return on assets is, however, a vital component of return on equity, being an indicator of how profitable a company is before leverage is considered. In other words, return on assets makes up two-thirds of the DuPont equation measuring return on equity.
ROA, ROE, and Growth
In terms of growth rates, we use the value known as return on assets to determine a company’s internal growth rate. This is the maximum growth rate a firm can achieve without resorting to external financing. We use the value for return on equity, however, in determining a company’s sustainable growth rate, which is the maximum growth rate a firm can achieve without issuing new equity or changing its debt-to-equity ratio.
Capital Intensity and Growth
Return on assets gives us an indication of the capital intensity of the company. “Capital intensity” is the term for the amount of fixed or real capital present in relation to other factors of production, especially labor. The underlying concept here is how much output can be procured from a given input (assets!). The formula for capital intensity is below:
Capital Intensity=Total AssetsSales
The use of tools and machinery makes labor more effective, so rising capital intensity pushes up the productivity of labor. While companies that require large initial investments will generally have lower return on assets, it is possible that increased productivity will provide a higher growth rate for the company. Capital intensity can be stated quantitatively as the ratio of the total money value of capital equipment to the total potential output. However, when we adjust capital intensity for real market situations, such as the discounting of future cash flows, we find that it is not independent of the distribution of income. In other words, changes in the retention or dividend payout ratios can lead to changes in measured capital intensity.
This document was prepared by the OECD Secretariat to serve as an issues paper for the hearing on market concentration taking place at the 129th meeting of the OECD Competition Committee on 6-8 June 2018
Rising Market Concentration and Declining Business Investments in the USA – Update June 2018
Since my last posts in August/September 2017 on the subject of
Declining Business Investments
several new studies have been published. In addition, several important hearings and conferences have been organized by OECD, Brookings Institution, Boston University School of Law. Please see my list of references for details of each one of them.
This topic now is getting good attention in media also.
The Peterson Institute for International Economics (PIIE) held a major research conference on the “Policy Implications of Sustained Low Productivity Growth” on November 9, 2017. Jeromin Zettelmeyer, PIIE, moderates panel 4, “Wages and Inequality.” Presenters include Jason Furman, Harvard University and PIIE, and Lawrence H. Summers, Harvard University. I have given the link to Video of the session 4 in the references.
OECD on June 7-8, 2018 held hearings on Market Concentration at Paris, France. Several presentations were given by experts in the field. I have given link to the conference webpage in the references.
The Hamilton Project/Brookings Institution had a Conference on June 13, 2018 in Washington DC on the subject of Market Concentration. Please see the link to the conference video and papers in the references below.
From The State of Competition and Dynamism: Facts about Concentration, Start-Ups, and Related Policies
From The State of Competition and Dynamism: Facts about Concentration, Start-Ups, and Related Policies
From The hidden hyperbolic geometry of international trade: World Trade Atlas 1870–2013
Regional Trading Blocks
Free Trade Agreements
Metabolism of a City
Metabolism of a Nation
Metabolism of the World
Growth and Form
From The hidden hyperbolic geometry of international trade: World Trade Atlas 1870–2013
Here, we present the World Trade Atlas 1870–2013, a collection of annual world trade maps in which distance combines economic size and the different dimensions that affect international trade beyond mere geography. Trade distances, based on a gravity model predicting the existence of significant trade channels, are such that the closer countries are in trade space, the greater their chance of becoming connected. The atlas provides us with information regarding the long-term evolution of the international trade system and demonstrates that, in terms of trade, the world is not flat but hyperbolic, as a reflection of its complex architecture. The departure from flatness has been increasing since World War I, meaning that differences in trade distances are growing and trade networks are becoming more hierarchical. Smaller-scale economies are moving away from other countries except for the largest economies; meanwhile those large economies are increasing their chances of becoming connected worldwide. At the same time, Preferential Trade Agreements do not fit in perfectly with natural communities within the trade space and have not necessarily reduced internal trade barriers. We discuss an interpretation in terms of globalization, hierarchization, and localization; three simultaneous forces that shape the international trade system.
From The hidden hyperbolic geometry of international trade: World Trade Atlas 1870–2013
When it comes to international trade, the evidence suggests that we are far from a distance-free world. Distance still matters1 and in many dimensions: cultural, administrative or political, economic, and geographic. This is widely supported by empirical evidence concerning the magnitude of bilateral trade flows. The gravity model of trade2–4, in analogy to Newton’s law of gravitation, accurately predicts that the volume of trade exchanged between two countries increases with their economic sizes and decreases with their geographical separation. The precision of that model improves when it is supplemented with other factors, such as colony–colonizer relationships, a shared common language, or the effects of political borders and a common currency5–7. Despite the success of the gravity model at replicating trade volumes, it performs very poorly at predicting the existence of a trade connection between a given pair of countries8; an obvious limitation that prevents it from explaining the striking regularities observed in the complex architecture of the world trade web9–13. One of the reasons for this flaw is that the gravity model focuses on detached bilateral relationships and so overlooks multilateral trade resistance and other network effects14.
Another drawback of the classical gravity model is that geography is not the only factor that defines distance in international trade. Here, we use a systems approach based on network science methodologies15,16 to propose a gravity model for the existence of significant trade channels between pairs of countries in the world. The gravity model is based on economic sizes and on an effective distance which incorporates different dimensions that affect international trade, not only geography, implicitly encoded on the complex patterns of trade interactions. Our gravity model is based on the connectivity law proposed for complex networks with underlying metric spaces17,18 and it can be represented in a pure geometric approach using a hyperbolic space, which has been conjectured as the natural geometry underlying complex networks19–22. In the hyperbolic trade space, distance combines economic size and effective distance into a sole distance metric, such that the closer countries are in hyperbolic trade space, the greater their chance of becoming connected. We estimate this trade distance from empirical data using adapted statistical inference techniques23,24, which allow us to represent international trade through World Trade Maps (WTMs). These define a coordinate system in which countries are located in relative positions according to the aggregate trade barriers between them. The maps are annual and cover a time span of fourteen decades. The collection as a whole, referred to as the World Trade Atlas 1870–2013, is presented via spatial projections25, Table S5, and trade distance matrices, Table S6. Beyond the obvious advantages of visualization, the World Trade Atlas 1870–2013 significantly increases our understanding of the long-term evolution of the international trade system and helps us to address a number of important and challenging questions. In particular: How far, in terms of trade, have countries traveled in recent history? What role does each country play in the maps and how have those roles evolved over time? Are Preferential Trade Agreements (PTAs) consistent with natural communities as measured by trade distances? Has the formation of PTAs led to lesser or greater barriers to trade within blocs? Is trade distance becoming increasingly irrelevant?
The answers to these questions can be summarized by asserting that, in terms of trade, the world is not flat; it is hyperbolic. Differences in trade distances are growing and becoming more heterogeneous and hierarchical; at the same time as they define natural trade communities—not fully consistent with PTAs. Countries are becoming more interconnected and clustered into hierarchical trade blocs than ever before.
There have been several developments in economics in last 20 years. Although these have been developed by different groups of economists, there are common relations among all of them. Because of Institutional silos, many of these developments are not shared. My attempt is to compile them here in this post and other previous related posts.
IMF Balance Sheet Approach (BSA) – From-Who-To-Whom
Balance Sheet Economics/Asset Liability Matrices (ALM) of Tsujimura
Financial Input-Output Analysis (F-IO Tables)
F-SAM ( Financial Social Accounting Matrix)
Interrelated Balance Sheet Approach of Perry Mehrling and Zoltan Pozsar
Stock Flow Consistent Modeling – Marc Lavoie, G Zezza, W Godley
Extended Supply and Use Tables (E-SUT)/UN SEIGA Initiative
Supply Chain Finance/Financial Supply Chain Management/Operations and Finance
Trade Finance/Global Value Chains/Accounting for Global Value Chains
Integrated Macroeconomic Accounts – NIPAs and Financial Accounts
From Balance Sheets, Transaction Matrices and the Monetary Circuit
Chapter 2 of book Monetary Economics by M Lavoie and W Godley 2007
The lack of integration between the flows of the real economy and its financial side greatly annoyed a few economists, such as Denizet and Copeland. For Denizet, J.M. Keynes’s major contribution was his questioning of the classical dichotomy between the real and the monetary sides of the economy. The post-Keynesian approach, which prolongs Keynes’s contribution on this, underlines the need for integration between financial and income accounting, and thus constitutes a radical departure from the mainstream. 1
Denizet found paradoxical that standard national accounting, as was initially developed by Richard Stone, reproduced the very dichotomy that Keynes had himself attempted to destroy. This was surprising because Stone was a good friend of Keynes, having provided him with the national accounts data that Keynes needed to make his forecasts and recommendations to the British Treasury during the Second World War, but of course it reflected the initial difficulties in gathering enough good financial data, as Stone himself later got involved in setting up a proper framework for financial flows and balance sheet data (Stone 1966).2
In trade relations, if goods flow from X to Y, then Money (Payments) flows from Y to X.
Intra Firm amd Inter Firm relations between Accounts Receivables and Accounts Payable
UNITED NATIONS STATISTICS DIVISION SEIGA Initiative
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From What is Regional Trade Blocs or Free Trade Agreements?
As trade integration across countries is intensifying, we hear more and more about Free Trade Agreements (FTAs) and Regional Trade Blocs (RTBs). As their name suggests these RTBs/FTAs are arrangements aimed for faster trade liberalisation at regional levels.
Countries are convinced that trade is an engine of growth and they are searching for arrangements that promote trade.
The WTO that contains 162 countries is the most popular one; a truly multilateral forum for trade liberalisation. But the history of WTO led trade liberalisation shows that the organisation is facing difficulty in bringing further trade liberalisation because of conflicting interest among large number of countries.
This has led to interest in trade liberalisation within a limited number of countries that may be regionally close together. These regional trade promoting arrangements advocate more tariff cuts and removal of other restrictions within the group while maintaining restrictions against the rest of the world.
Though many regional trade agreements like the EU, NAFTA and ASEAN were established before or around the time of WTO’s formation, there is mushrooming of RTBs in recent years. Recently formed Trans Pacific Partnership (TPP) shows this increasing affinity towards RTBs. Many RTBs like the TPP would like to make advanced level trade liberalisation and hence they are not satisfied with the slow pace of trade liberalisation within the WTO.
What are Regional Trade Blocs (RTBs)?
Regional Trade Blocs or Regional Trade Agreements (or Free Trade Agreements) are a type of regional intergovernmental arrangement, where the participating countries agree to reduce or eliminate barriers to trade like tariffs and non-tariff barriers. The RTBs are thus historically known for promoting trade within a region by reducing or eliminating tariff among the member countries.
Over the last few decades, international trade liberalisations are taking place in a serious manner through the formation of RTBs. They are getting wide attention because of many important international developments. First, now the world is trying hard to escape from the ongoing great recession phase. Second is the failure of the WTO to take further liberalisation measures on the trade liberalisation front.
The EU, NAFTA, ASEAN, SAFTA etc are all examples for regional integration. The triad of North America, Western Europe, and Asia Pacific have the most successful trade blocs. Recently signed Trans Pacific Partnership is a powerful RTB. Similarly, another one called RCEP is in negotiation round. India has signed an FTA with the ASEAN in 2009. Simultaneously, the country has signed many bilateral FTAs.
Different types of RTBs
All regional trade blocs don’t have the same degree of trade liberalisation. They may differ in terms of the extent of tariff cutting, coverage of goods and services, treatment of cross border investment among them, agreement on movement of labour etc.
The simple form of regional trade bloc is the Free Trade Area. The Free Trade Area is a type of trade bloc, a designated group of countries that have agreed to eliminate tariffs, quotas and preferences on most (if not all)goods and services traded between them.
From the lowest to the highest, regional trade integration may vary from just tariff reduction arrangement to adoption of a single currency. The most common type of regional trade bloc is the free trade agreement where the members abolish tariffs within the region. Following are the main types of regional economic integrations.
Classification of RTBs
Preferential trading union: Here, two or more countries form a trading club or a union and reduce tariffs on imports of each other ie, when they exchange tariff preferences and concessions.
Free trade union or association: Member countries abolish all tariffs within the union, but maintain their individual tariffs against the rest of the world.
Customs union: countries abolish all tariffs within and adopt a common external tariff against the rest of the world.
Common market: in addition to the customs union, unrestricted movement of all factors of production including labour between the member countries. In the case of European Common Market, once a visa is obtained one can get employed in France or Germany or in any other member country with limited restrictions.
Economic union: The Economic Union is the highest form of economic co-operation. In addition to the common market, there is common currency, common fiscal and monetary policies and exchange rate policies etc. European Union is the example for an Economic Union. Under the European Monetary Union, there is only one currency- the Euro.
At present, out of the total regional trade arrangements FTAs are the most common, accounting for nearly 90 per cent.
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From Asia’s Rise in the New World Trade Order
From The world’s free trade areas – and all you need to know about them
International trade is a driving force behind economic growth, and two so-called “mega-regional” trade deals are dominating public debate on the issue: the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP).
But there are around 420 regional trade agreements already in force around the world, according to the World Trade Organization. Although not all are free trade agreements (FTAs), they still shape global trade as we know it.
What exactly are free trade areas?
The OECD defines a free trade area as a group of “countries within which tariffs and non-tariff trade barriers between the members are generally abolished but with no common trade policy toward non-members”.
The free movement of goods and services, both in the sense of geography and price, is the foundation of these trading agreements. However, tariffs are not necessarily completely abolished for all products.
Which are the world’s major free trade areas?
The North American Free Trade Agreement (NAFTA)
Free trade between the three member nations, Canada, the US and Mexico, has been in place since January 1994. Although tariffs weren’t fully abolished until 2008, by 2014 total trilateral merchandise trade exceeded US$1.12 trillion.
According to the US government, trade with Canada and Mexico supports more than 140,000 small and medium-size businesses and over 3 million jobs in the US. Gains in Canada are reportedly even higher, with 4.7 million new jobs added since 1993. The country is also the largest exporter of goods to the US.
However, the Council on Foreign Relations suggests that the impact on Mexico is harder to assess. Per capita income has not risen as fast as expected; nor has it slowed Mexican emigration to the US. However, farm exports to the US have tripled since 1994, and the cost of goods in Mexico has declined. The cost of basic household goods has halved since NAFTA came into force, according to estimates by GEA, a Mexican economic consulting firm.
Association of Southeast Asian Nations Free Trade Area (AFTA)
The AFTA was signed in January 1992 in Singapore. The original members were Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. Four countries have subsequently joined: Vietnam, Laos, Myanmar and Cambodia.
The bloc has largely removed all export and import duties on items traded between the nations. It has also entered into agreements with a number of other nations, including China, eliminating tariffs on around 90% of imported goods.
The AFTA nations had a combined GDP of US$2.3 trillion in 2012, and they’re home to 600 million people. The agreement has therefore helped to dramatically reduce the cost of trade for a huge number of businesses and people.
Southern Common Market (MERCOSUR)
Although MERCOSUR was envisaged as a Latin American single market, enabling the free movement of people, goods, capitals and services, this vision is yet to become reality. Internal disputes have slowed progress towards removing tariffs and the free movement of people and goods.
But MERCOSUR is still one of the world’s leading economic blocs, and has a major influence on South American trade and the global economy.
Common Market of Eastern and Southern Africa (COMESA)
Formed in December 1994, the organization aims to develop natural and human resources to benefit the region’s population. Its primary focus, according to the United Nations, is to establish a large economic and unit to overcome barriers to trade.
With 19 member states, and an annual export bill in excess of $80 billion, the organization is a significant market place, both within Africa and globally.
COMESA utlimately aims to remove all barriers to intra-regional trade, starting with preferential tariffs and working towards a tariff-free common market and economic union.
What about the European Union?
The EU is a single market, which is similar to a free trade area in that it has no tariffs, quotas or taxes on trade; but a single market allows the free movement of goods, services, capital and people.
The EU strives to remove non-tariff barriers to trade by applying the same rules and regulations to all of its member states. The region-wide regulations on everything from working hours to packaging are an attempt to create a level playing field. This is not necessarily the case in a free trade area.
The creation of the single market was a slow process. In 1957, the Treaty of Rome established the European Economic Community (EEC) or Common Market. However, it was not until 1986 that the Single European Act was signed. This treaty formed the basis of the single market as we know it, as it aimed to establish the free-flow of trade across EU borders. By 1993 this process was largely complete, although work on a single market for services is still ongoing.
Today, the EU is the world’s largest economy, and the biggest exporter and importer. The EU itself has free trade agreements with other nations, including South Korea, Mexico and South Africa.
What about the TPP and TTIP?
Once fully ratified, the Trans-Pacific Partnership is set to become the world’s largest trade agreement. The TPP already covers 40% of global GDP, and trade between member nations is already significant.
However, by removing tariffs and other barriers to trade, the agreement hopes to further develop economic ties and boost economic growth.