Focus On: Howard Pack

Saudi Arabia’s Slippery Future

Posted on October 3, 2012

It’s like Eskimos running out of ice: A recent report by Citigroup warns that Saudi Arabia — the world’s biggest crude exporter — may need to import oil by 2030.

How did Saudi Arabia allow its fortunes to slip, even as it supplies an eighth of the world’s oil and natural gas liquids? The country uses a quarter of its oil output domestically, and much of it is for power generation. Saudi power generating capacity has doubled in the past decade, partly because of the need for air conditioning, says a May 2012 story in The Economist. Aiding that consumption are high oil subsidies for Saudi power producers, which pay between $5 and $15 a barrel, compared to the export price of $116 for Brent oil in early September.

Howard Pack, a Wharton professor of business economics and public policy, says that while the notion of Saudi Arabia as a net oil importer is “conceivable,” it is unlikely. There are “many intervening factors” to consider when predicting such a scenario, he notes. For example, the Saudis could slowly raise the internal price of oil by reducing subsidies. This would reduce domestic consumption and increase exports, he says.

Second, the current energy market will be markedly changed if the U.S. and Canada continue to encourage fracking, the method increasingly used to release petroleum from rocks, including shale gas deposits. Shale gas extraction could make business sense if world oil prices stay above $54 a barrel, according to a fact sheet by the U.S. Department of Energy. In fact, shale gas could make up half of all U.S. natural gas production by 2035, the federal agency estimates. According to Pack, fracking will generate “significant additional supplies that will change the energy market,” but prices will still remain above Saudi Arabia’s cost to produce oil — meaning it would make little business sense for that country to become an energy importer.

Solar power could also alter the broader setting for the oil industry, Pack points out. “Over [the next] two decades, it’s likely that the cost of solar [energy] will drop dramatically, again complicating any predictions,” he says. Other imponderables include the impact of the green movement, and technological and social changes, he adds.

The Citigroup report notes that the Saudi situation could get worse if oil consumption grows in tandem with peak power demand. The country’s domestic oil consumption is growing at 8% annually, in line with rising per capita GDP and consumer spending. Already, its per capita oil consumption (per thousand people) is an estimated 100 barrels a day for 2012, compared to 61 for the U.S. and 26 for the U.K., according to the CIA World Factbook.

Oil accounts for 86% of revenues for the $600 billion Saudi Arabian economy, and the country cannot afford to put that income at risk. Among other measures to lower domestic oil consumption, the country is pushing to develop nuclear and solar power, and increased gas exploration.

Prominent Saudi Arabian economist Mohammad Al-Sabban told Bloomberg last month that he disagrees with the view that his country could become a net importer of oil. He faulted Citigroup’s estimate that future Saudi oil production will remain at 12.5 million barrels a day — the current level of production. “The kingdom’s production capacity [has] changed in the past, and it’s changing according to the needs of global demand,” he told the publication.

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Troubled Times Ahead for North Korea?

Posted on December 19, 2011

The death this weekend of North Korea’s Kim Jong-il, who ruled the country with an iron fist since his father’s death in 1994, had immediate repercussions throughout Asia and beyond.

The New York Times reports that South Korea — which has been at war with North Korea since the early 1950s — immediately put its military on alert, “boosting surveillance along the 155-mile border between the two countries, one of the world’s most heavily armed frontiers.” The tension between the two countries escalated during the past several years after North Korea demonstrated nuclear capability.

According to The Wall Street Journal, Asian stock markets took a dive in response to the news, “with South Korea’s stock market and the won tumbling to multiweek lows…. With markets already reeling from the European debt crisis and global growth concerns, Kim’s death has added a dangerous layer of instability to the Korean peninsula,” the Journal noted, adding that “many Asian neighbors [are] uneasy about the leadership transition phase in one of the world’s most reclusive regimes.”

That unease was further heightened by the announcement that Kim’s son, Kim Jong-un, has been named the country’s new leader, despite his youth (he is in his twenties), lack of experience and isolation from other governments.

Wharton faculty echoed the anxiety expressed in news reports. “Missiles have already been fired in the Sea of Japan” by North Korea, says Wharton management professor Witold Henisz. “This gesture demonstrates the internal uncertainty over succession, with Kim Jong-un or others trying to demonstrate their loyalty to the military or, perhaps, the military trying to demonstrate its independence. No one knows very much about the new potential ‘great successor.’ He will have to consolidate his power internally after having been raised in a two-generation cocoon [removed] from reality.”

The next days and weeks “are fraught with hazards such as Asia has not seen in years,” Henisz added. “Is China ready to step up and assume a position of international political authority? How will Japan, South Korea and others respond to provocations? Making the situation even worse, Europe is focused internally on the need to avoid the break-up of the euro, and the U.S. is increasingly turning inward as its election campaign heats up. In these circumstances, North Korea will have to act out even more to gain the international attention that it so craves. These are dangerous days.”

Wharton management professor Mauro Guillen points out that “leadership transitions in North Korea are a big deal because this is only the second one in half a century. The key issue is whether the youngest son has the support of the army or not, or whether the generals will use him as a puppet. His father alienated everyone, including China and the U.S., with his nuclear policy.”

Along with the country’s isolation is the fact that the North Korean people “are starving and are politically repressed,” Guillen adds. “Korean unification is still far away, and one can only hope that when it comes, it does not destabilize South Korea. Just think about how hard it was for West Germany to absorb East Germany. North Korea is much poorer and larger, and South Korea is not as resourceful as West Germany was. I think [U.S. President] Obama should go to the Demilitarized Zone separating the two Koreas and deliver a Reagan-style speech to [Chinese] President Hu, demanding that he ‘ cut off this barbed wire.’ China must seize the opportunity to put an end to this disaster.”

According to Howard Pack, Wharton professor of business and public policy, the death of Kim Jong-Il has been widely anticipated following rumors that he suffered from pancreatic cancer. Meanwhile, the succession issue “is very unclear – he favored his third son, but it is not [apparent] that [this son] is acceptable to the military. North Korea’s economy is very weak. While precise estimates of income per capita cannot be calculated, stories from emigrants both in China and in South Korea suggest a very low per capita income. [Yet] the country’s military capacity, especially in rocketry and atomic knowledge, is more than capable and has also been the only major source of foreign exchange.”

Pack adds that the “South Korean government has intensively explored the possibilities of an implosion of the North Korean economy and alternative policies to deal with it. South Korea is much larger, and its per capita income is probably 15 times greater. However, the government is well aware of the enormous costs to West Germany of absorbing East Germany. Except for the unlikely scenario that the new government would launch a war against the South, the death of Kim Jong-il has no obvious short-term implications for financial markets given its absence of exports, imports and financial interaction with the rest of the world.”

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Osama bin Laden: A Victim of His Own Success?

Posted on May 2, 2011

The biggest manhunt in history is over. U.S. President Barack Obama announced last night that American military operatives had raided Osama bin Laden’s compound outside Islamabad, Pakistan, killed bin Laden with a gunshot to the head and buried his body at sea. One of bin Laden’s sons was also killed, as were three other people.

Yet by the time the U.S. finally caught up with him, bin Laden was seen by many as more of a symbol of terrorism than a major threat. The political upheaval throughout the Arab world of the past few months is not associated with Al Qaeda, nor does it espouse the violence that is the hallmark of bin Laden and his followers.  

Osama bin Laden “could be described as a victim of his own success – providing that ‘success’ applies to getting star billing as the world’s most wanted terrorist,” says Ann Mayer, Wharton professor of legal studies and business ethics, and an expert on the Middle East. ”After attaining a high international profile with the 9/11 atrocity, he became so relentlessly hunted that he had to disappear from the international stage where he had enjoyed the spotlight.”

As bin Laden became more and more isolated in order to “minimize the chances of detection and capture, he increasingly lost real practical relevance for the cause that he ostensibly championed,” Mayer notes. He wound up “cowering behind the high walls of a villa in Abbottabad, far from the action and totally dependent on the services of an old-fashioned human courier to communicate with the outside world. [Global] events quickly outstripped his limited obscurantist vision, a vision that did not contemplate that youths dedicated to nonviolent protests would turn out to be far more powerful forces in changing the political environment than [he] had ever been.”

Mayer compares bin laden to Carlos the Jackal, “who became the world’s most notorious terrorist” in the 1970s after his attack on the OPEC headquarters in Vienna, “only to dwindle into a fugitive preoccupied with evading detection by intelligence operatives around the world…. For his diminished coterie of fervent followers, bin Laden may be a martyr whose death will incite revenge attacks, but for the Muslim world at large, there are much bigger issues on the agenda than the killing of a terrorist general who effectively abandoned his troops on the field for a luxury prison of his own making.”

Howard Pack, Wharton professor of business and public policy whose interests include Arab and Asian economies, suggests that the death of bin Laden helps “to restore American deterrence against terrorism but has few substantive implications. The evolution of the revolutions in Egypt, Tunisia, Libya and Syria will be affected only to a limited extent. Bin Laden was not a factor in any of these nations, and their political and economic futures will be determined by the strength of domestic interest groups. His death has no obvious implications for any of the contending political factions….”

Regarding the costs of protecting against future terrorist incidents, Pack notes that “no economic benefit can be anticipated, since the network that was put together presumably remains intact. Most analysts of the Middle East attribute strategic thinking for Al Qaeda to Ayman al-Zawahiri who presumably remains alive.”

Perhaps the most “jarring aspect of the operation,” Pack adds, was the close proximity “and conspicuousness of bin Laden’s compound to the Pakistani military facilities. This, of course, does not bode well for the future of Afghanistan and Pakistan. Thus, while it is a substantial symbolic and emotional victory and a testament of the abilities of the U.S. military and intelligence community, the impact [of bin Laden's death] will be limited.”

Howard Kunreuther, co-director of Wharton’s Risk Management and Decision Processes Center, suggests that people will feel both a “great sense of relief that we got bin Laden but also a great deal of concern in terms of what might happen” should Al Qaeda seek revenge for bin Laden’s death. “There is so much uncertainty; we don’t know what Al Qaeda can and cannot do; we don’t know whether they are well organized or if they will have an influence on other groups who don’t like the U.S.”

It was very important for President Obama to talk about the need for heightened security, Kunreuther notes, because the costs of not issuing that warning “could be extraordinarily high.” And yet, because the President did in fact issue that warning, “we all now think about things in a different way…. It stirs up emotions and feelings that are very hard to control.”

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Uprising in Egypt

Posted on January 31, 2011

As opposition to President Hosni Mubarak’s government enters its seventh day, it is far from clear what the future holds for Egypt, the Middle East, the U.S. and the global marketplace. Knowledge@Wharton asked two faculty members who have studied this region for their opinions on what led up to this crisis, and what will unfold in the days and weeks to come.

Mubarak’s grip on power seems tenuous, and given his age (82), it is almost certain that he will not be president much longer, says Wharton management professor Mauro Guillén, director of the Joseph H. Lauder Institute for Management & International Studies. “Another matter is the Mubarak regime. The middle class in Egypt does not want disorder. The upper class, needless to say, is eager to preserve the status quo. I very much hope that the opposition leaders can figure out a way of sharing power with the regime, and then perhaps organize open elections in two to three years.”

As for whether the protest movement in Egypt will spill over to other Arabic countries (besides Tunisia), “there are no true democracies in the region” — from Morocco in the West to Iraq in the East, Guillén notes. “It is a part of the world that has always been ruled either by benevolent monarchs or sheikhs, or by strongmen, frequently from the military. But the basic problem is not democracy; it’s unemployment, which is as high as 25% or 30% in many countries … and as high as 60% among young people. When you do not have a job, you want change. You also want change when you are oppressed, to be sure, but I do not think that is the factor that explains unrest right now.”

Guillén does not see Egypt becoming another Iran. “The Iranian revolution of 1979 was a popular-religious uprising with a clear leader– Khomeini. There is no such figure in Egypt. There is an Islamic political movement (the Muslim Brotherhood), but it does not have the support of the urban middle and upper classes in the country.”

The unrest is “primarily motivated by economic issues,” Guillén emphasizes. “If instead of a peaceful settlement with the opposition, what we see is bloodshed and chaos, then Egypt’s two most important sources of income will suffer: tourism and the Suez Canal. As the most important economy in the region, what happens in Egypt would affect neighboring countries. That’s why it is so important that the opposition play a constructive role, allowing the supporters of the regime to find a place in the new state of affairs that is created with this transition.”

Howard Pack, Wharton professor of business and public policy, is co-author of a book entitled, The Arab Economies in a Changing World, written with Marcus Noland, a senior fellow at The Peterson Institute for International Economics. In a blog written today, Pack suggests that “the immediate response to the revolutions sweeping the Middle East is to blame poverty, unemployment, and rising food prices…. Yet per capita economic growth in the high population nations such as Egypt [is] comparable to many other middle income countries, poverty [is] not high by international standards such as the percentage of population living on less than two dollars a day, and progress in indicators such as life expectancy, infant mortality, and years of education has been quite remarkable, especially in Egypt. Tunisia’s standard of living and other indicators are even better.”

While the major problem that countries in the Middle East face is “providing employment for the growing labor force,” the causes for the discontent are many, Pack adds. These include governments’ failure to pay attention to unrest among their populations, lack of job opportunities specifically for young people — “Indeed, many of the leaders of the current unrest are university graduates” — corruption and nepotism. Yet Pack sees several ways out of this political, social and economic morass. One is to increase exports of labor intensive manufactured goods to the European Union because, as Pack notes, exporting is a “major route to generating jobs,” and Egypt’s proximity to the EU means relatively low transportation costs.

To encourage exporting, Pack suggests improved road and port facilities, the establishment of special economic zones, and efforts to improve productivity. Higher-quality education and more advanced technology are also needed. “It needs to be emphasized,” he points out, “that a move towards an Iranian style government will hardly address these issues as it is likely to be accompanied, as in Iran, by a Soviet style command economy with all its attendant failures. The rest of the world has little leverage [over] the outcomes of the current movements. But whoever emerges on top will face the same labor unrest and the need to implement changes ranging from education reform to economic policy. Americans need [no] reminder of how difficult such changes are. Given the history of recent revolutionary governments from Cuba to Iran, there is little room for optimism.”

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Chinese Checkers: The U.S. Jumps China on Trade

Posted on January 19, 2011

China’s president Hu Jintao is meeting with President Obama in Washington, D.C., this week. Trade relations and currency valuations are no doubt on the agenda. The U.S. has long wanted China to increase the value of the renminbi to provide some balance to the U.S. trade deficit, and China is viewed by the U.S. as dragging its feet endlessly to avoid any meaningful changes that could disrupt its export-led economy. The U.S., meantime, relies on China to help finance its deficit through large Chinese purchases of U.S. Treasury securities.

Given this mutual dependence, direct confrontations over currency or trade will likely remain off the table for now. Still, it looks as though there is new room for an escalation in skirmishes around the periphery.

Case in point: Last week, the U.S. announced it will match the export financing discounts that China is offering on bids for the sale of 150 diesel-electric locomotives to Pakistan, according to a story in the Financial Times. The U.S. is offering the cut-rate financing through the U.S. Export-Import Bank to help General Electric win the US$477 million contract. In order to match the Chinese offer, the U.S. will be violating some international trade rules under the Organization for Economic Cooperation and Development by financing the deal for 12 years (vs. the allowable 10 years.)

“This is a leading indicator of what appears likely to be a contentious period,” says Wharton business and public policy professor Howard Pack. The U.S. move is designed to send a warning message to Chinese officials. A key issue, Pack adds, is whether the company, GE in this case, is internationally competitive, leaving the only cost difference between the two bids the value of the Chinese subsidy. “If it is, the subsidy may be justified.”

Stephen J. Kobrin, a management professor at Wharton, notes that China does not play by the same rulebook and their financing policies can give Chinese firms an advantage in export markets. China’s “state-supported, authoritarian capitalist system makes it difficult to integrate that country into the ‘Western,’ rule-based liberal international order.” If the U.S. plays by the rules and China does not, China gains significant advantages. Yet, if the U.S. matches China’s financing offer — “as we are doing in this case, by violating the rules ourselves, we risk compromising the entire international framework.”

The optimal solution: Getting agreement from all parties on international transaction rules, “or less optimally, to bring effective pressure on China to conform,” Kobrin says. If those possibilities prove unrealistic, then the U.S. may have to compromise to compete. ”However, if we go down that road we should do so in full knowledge of the risks to the rule-based international order.”

Pack points out that the U.S. could also turn to the World Trade Organization to help sort out such trade issues, but that process is usually cumbersome and typically decisions come “long after projects are implemented.” Such issues “should be viewed within the context of a still-fragile world economy — a trade war could tilt the international economy back into recession but the temptation to retaliate by the U.S. is very understandable.”

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