China Research

This is just a brief note I write in the last minutes before the publication of this blog. I feel strongly to point at a paper that very recently has been published by two economists from the Bank of International Settlements (BIS, which is the central bank of the central banks). Contrary to what could be read in some articles in the press, the paper – written by Dong He and Robert N McCauley – is not an official statement by the BIS. (“The views expressed are those of the authors and not necessarily the views by the BIS”).

But I am sure that many experts within the BIS share the views and the warning of the two authors.  Their concern is taking up the fact that some East Asian countries – or rather companies in these countries – more recently have been too strongly attracted by the U.S. dollar and the low-interest rate environment for private credits in USD. In other words: corporate (private) indebtedness in foreign currency (USD) has been increasing too rapidly in some Asian countries, particularly in China.

I myself take the warnings from the BIS very seriously. The BIS has a good record of giving warning signals in time, mostly expressed in the kind of working papers quoted above. Economists like E P  Davis or William White can serve as good examples.

Even if you do not believe in the concerns that are expressed above, I would like to recommend reading the analysis mentioned above. You get at least better insight into the usually not very transparent Chinese (East Asian) financial markets.

Dong He/Robert N Cauley. “Transmitting global liquidity to East Asia: policy rates, bond yields, currencies and dollar credit”. 2013. BIS Working Paper. No 431.

Furthermore, if you want to read more about the negative Swedish experience with private borrowing in foreign currency, you can look at an article of mine from last year published by the National Association for Business Economics (NABE). In this article, I also refer to the important impact of psychology on exaggerating financial markets. For this reason, I feel particularly glad that Robert Shiller this year is one of the three Nobel Prize Winners in economics. Behavioral finance can be very much applied to Chinese financial markets, too.

Fromlet, Hubert. “Predictibility of Financial Crises: Lessons from Sweden for Other Countries”. 2012. Business Economics. Vol 47. No 4, pp 262-273.

Hubert Fromlet
Visiting Professor of International Economics, Linnaeus University
Editorial board

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In 2007 the world economy faltered. The economic crisis that struck the globalised economy spread rapidly across country borders and caused the most severe and globally spread recession witnessed in almost a century. This global recession affected international business all over the world. Empirical reports have shown that small and medium-sized enterprises (SMEs) in general and those with international operations in particular were most affected by the recession. One reason for this might be that SMEs in general possess fewer resources and have more limited international experience and managerial resources compared to large multinational corporations.
In a recent publication of mine at the Center for International Business Research in Emerging Markets (CIBEM), Linnaeus University, interest was turned to the performance of SMEs and to examine whether the internationalisation strategies of SMEs can contribute to explaining the firms’ performance in the market turbulence caused by the recession.
The article addresses three shortcomings in the existing literature on the relationship between firms’ internationalisation strategies and their performance.

First, the main body of research reported has focused on MNCs, thus our knowledge is still limited when it comes to SMEs. This is an intriguing shortcoming as SMEs, in comparison with their larger counterparts, have to be more conscious, careful and selective when making decisions about their international or global activities. This is because SMEs are generally constrained by a limited resource base and hampered by a limited pool of international experience.

Second, most studies have examined the effects of a firm’s degree of internationalisation; in contrast, this study seeks to separate the scope and the scale of internationalisation while at the same time including the dynamic speed dimension.

Third, and most importantly, the reported studies have been undertaken in times of market stability. Less is known about the validity of these findings under market turbulence.In light of this background, the article addresses these shortcomings by seeking an answer to the research question: In times of market turbulence, what are the performance effects of a SME’s scale of internationalisation, scope of internationalisation and speed of internationalisation?

To answer the research question, the research model is theoretically derived from international business and strategy literature.
The research model is confronted with a unique dataset integrating data collected in an on-site survey covering the firms’ internationalisation strategies until 2007 with objective and publicly available performance data for the period 2007-2011. This strategy allows us to test whether the internationalisation strategies in place prior to the recession have an effect on firm performance during times of market turbulence. Three hypotheses are posited:

The greater the scale of SME internationalisation, the stronger the firm performance in times of market turbulence.

The broader the scope of SME internationalisation, the stronger the firm performance in times of market turbulence.

The higher the speed of SME internationalisation, the stronger the firm performance in times of market turbulence.

From the analysis and discussion it can be concluded that the strategy of firm internationalisation is a relevant predictor of performance in times of market turbulence. In this research it is shown that the scope as well as the speed of firm internationalisation positively influences performance in times of market turbulence. Thus, firms that are able to balance their sales between different markets as well as to establish first mover advantages internationally will experience a positive performance in times of market turbulence. Conflicting the hypothesised model, however, the analysis revealed that the scale of internationalisation did not significantly affect SME performance in times of market turbulence. Thereby it seems as if the share of the sales exported is less important than the number of markets exported to in order to be resilient in times of market turbulence.

These conclusions should be of interest to managers of SMEs. The findings suggest that managers of internationalising SMEs should spread their risk between different countries in order to reduce sales fluctuations and gain flexibility of market activities in times of market turbulence. This research shows that the geographical scope of the international activities of the firm is a more important predictor of SME performance in times of market turbulence than the scale of internationalisation. Furthermore, this study has shown that managers in firms starting to internationalise their activities should seek to exploit potential first-mover advantages in different countries by realising a strategy of internationalisation at a high speed.

Thus, it has been shown that SMEs should not put all their eggs into one basket. When market turbulence arises, as witnessed in the last five years, firms that have spread their risks have experienced stronger performance. This analysis shows that it is not the share of the eggs that are put into the home market basket in relation to the international one that is the main predictor of performance in times of turbulence. Instead, it shows that what matters is the number of baskets used for the eggs and the speed at which the eggs are spread between the baskets. Thus, it has been shown that the number of baskets used renders a positive performance effect. The same holds true for the speed at which the eggs are spread. Based on this research, it is argued that we should drop the assumption that internationalisation is a risky strategy. This research has shown that it might be more risky for firms not to internationalise activities than it is for them to do so. In times of market turbulence, internationalisation should be seen as a risk-reducing strategy rather than an instance of risk taking.

Thus, we are confident to suggest for managers of SMEs to spread your eggs, and to do it quickly!

The full version of the paper can be accessed online at the website of International Small Business Journal: http://isb.sagepub.com/content/early/recent

Mikael Hilmersson
PhD, Assistant Professor of International Business, Linnaeus University
Editorial board

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Many private households and financial institutions in our part of the world do not know anymore where and how to invest their money. Saving accounts may even give a negative real return. The German insurance giant Allianz refrains from new investments in bonds because of the low yields. More examples could be mentioned.

Investing in stocks?  Yes – or maybe. But the mood on a number of stock exchanges may be better than the outlook for the real economy. China gives some doubt even what regards the short-term prospects of the economy. So do other emerging economies with working stock markets such as Indonesia, Brazil and Russia.

What about investments in real estate? There is (still) an increasing demand in a number of industrial countries since credits are cheap at many places (e.g. Germany, Sweden). However, not many investors have the resources to be active on this kind of market. The risk of a (new) bubble may emerge in the future.

Could “safe” bonds be something to invest in? In the past, government bonds in many mature countries were regarded as fundamentally safe. The European debt crisis tells us now a different or modified story. For this reason, nobody can be surprised that bonds in emerging markets increasingly are promoted by financial institutions at the expense of bonds in OECD countries. What about the emerging-market alternative?

We know from stock markets that investments in mature economies can fail from a country risk perspective, too. Failures are not an issue that are exclusively related to emerging markets. Despite – normally – major institutional shortcomings, stock market investments in emerging countries may be successful at least in the shorter perspective. But there is, of course, no guarantee for good (trend) developments. Negative turnarounds may show up very suddenly on emerging capital markets. Certain negative events may lead to massive sales by (mainly?) Western investors, and – consequently – to sharp falls of stock prices.

Bond markets in emerging markets usually have even larger structural weaknesses. Normally, bond markets in these countries are institutionally lagging behind modern and transparent models even more than stock markets. China may serve as an illustrative example. It should be kept in mind that most emerging countries do not even have a bond market.

Furthermore, the volume of tradable bonds in emerging countries – if such trading conditions exist at all – tends to be very limited. Before investing in emerging market bonds, it should be a good idea to further analyze the institutional conditions of the relevant country very carefully – turnover/liquidity and transparency of bond markets included. These shortcomings may counteract – on average – more healthy fiscal numbers in many emerging countries compared to traditional OECD countries.  Exactly these favorable fiscal indicators in quite a number of emerging economies serve nowadays frequently as arguments for purchasing emerging market bonds.

Sure, there may be more promising bond alternatives on emerging bond markets I do not know about. In general terms, however, question marks what concerns investments in emerging market bonds should be very large. Macroeconomic indicators do not tell the whole truth. Microeconomic and institutional conditions must be considered as well.

Thus, the run for somewhat higher yields – for instance to emerging economies – is not all in financial life. Memory on financial markets is usually quite short – as the heavy involvement of Swedish banks in the recent Baltic disaster clearly shows – just 15 years after the severe banking crisis in the first half of the 1990s!

And we also get these days reminded again that very low interest rates during a longer period of time many times provoke increasingly risky investments. This may be the main reason for the current strengthening marketing of emerging market bonds.

But have we already forgotten the origins of the American subprime crisis just a few years ago?

Hubert Fromlet
Professor of International Economics
Editorial board

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