Sustainablog

This blog will cover some news items related to Sustainability: Corporate Social Responsibility, Stewardship, Environmental management, etc.

21.5.05

The Chinese must act fast to conserve their country's shrinking water supply

Drying up
May 19th 2005 | BEIJING
From The Economist print edition

The Chinese must act fast to conserve their country's shrinking water
supply

AS A deputy prime minister in 1999, Wen Jiabao warned that the very
“survival of the Chinese nation” was threatened by looming water
shortages. Mr Wen has since taken over as prime minister, and earned
robust applause in parliament this spring when he promised “clean water
for the people”. To that end, his government says it will spend an extra
$240m this year. But this is a drop in the ocean. Never especially blessed
with water, in recent years China has seen its supplies fall to
dangerously low levels as it faces drought, rising demand and the combined
effects of decades of pollution and misguided policies. Senior officials
and international agencies are equally gloomy.
One in three country-dwellers in China lacks access to safe drinking
water. More than 100 big cities, of which half are deemed “seriously
threatened”, are short of water. Water tables are dropping by a metre or
more every year across much of northern China. Even in Beijing, supply per
head now stands at a perilously low 300 cubic metres (66,000 gallons) a
year. Reduced flow rates on China's greatest rivers have made hydro plants
reduce badly needed power output: many smelters, paper mills and
petrochemical plants are no longer sure of getting the huge amounts of
water they require. Droughts, historically more common in northern China,
are now hitting the south too. This year Guangdong province, home to 110m
people, has had a 40% drop in rainfall.
Misguided pricing policies have made matters a lot worse. Until 1985, most
users were not charged at all, so it made little sense for enterprises to
invest in treatment and recycling technology or for farmers to fret about
wasteful irrigation. Water prices in China have risen only slowly in the
past 20 years and are still among the world's lowest. Most Chinese water
is bought at around 40% below cost. Even in parched Beijing, city
officials are hesitating to press ahead with planned increases to the
break-even point of around six yuan ($0.72) a cubic metre. Nationwide,
prices are set at different levels for different sorts of users by a
jumble of local and central bureaucracies, all wary of slowing economic
growth.
John McAlister, head of AquaBioTronic.com, a water-recycling firm, says
China is committing “ecological suicide” with its current policies and
should put prices up to 20-40 yuan a cubic metre. He argues that
foreigners ought to take the lead in arguing for such increases if they
hope to continue to benefit from China's economic boom. Alas, he has had
as much trouble convincing foreign firms of the urgency of China's water
crisis as he has had convincing Chinese firms to invest in his technology.

19.5.05

Hola, governance: New stock exchange rules have put Spain on a faster track to better corporate governance

Hola, governance
Poulomi Mrinal Saha in London
16 May 05

New stock exchange rules have put Spain on a faster track to better
corporate governance
Juan Fernandes, a chief executive of a fictional Spanish public company,
decides to offer an ex-girlfriend’s firm a small consulting contract.
According to the board of the company this is a decision based on both
trust and the firm’s expertise, and Fernandes has not broken any company
rules.

But when first half financial results are filed this July in Spain,
directors of listed companies will have to divulge details of such company
transactions conducted on their own behalf or for those with whom they
share an “affectionate relationship”.

The Spanish stock market regulator, the Comisión Nacional del Mercado de
Valores, has told listed companies that all transactions involving
spouses, children, parents, siblings and other “persons with whom
directors hold analogous affectionate bonds” must now be disclosed every
six months, with immediate effect.

Tightening up definitions

This latest announcement by the CNMV spells out those categories of people
referred to as “related party” in Spain’s 2003 Transparency Act.

The Act, which prescribes various legal obligations for directors of
listed Spanish companies, also discusses the structure of shareholder
agreements and voting rights at shareholder meetings.

The Act says that directors have a duty to refrain from using the company
name or their position, in concluding any “transactions on their own
behalf or for related parties”. Company directors are also now not allowed
to take advantage of any transactions or investment on their own behalf or
for related parties that they know to have been offered to the company or
that the company is interested in.

The duties specified for directors of listed companies in the 2003
Transparency Act were aimed at cracking down on conflicts of interest. The
Act was based on recommendations made in the 2002 Report by the Special
Commission to Increase Transparency and Reliability in the Markets and
Listed Companies, popularly known as the ‘Aldama Report’.

The Aldama Report suggested that the climate of self-regulation in Spain
then was inadequate for the purpose of assuring investors and shareholders
that their money was in safe hands.

Investors were also, at the time, insufficiently protected from any
conflict between the “company’s interests and the interests of the parties
involved in managing it”, according to the report.

An agency problem

“Legal systems in continental Europe – and Spain is no exception – are
silent and even tolerant on the questions of conflict of interest and
other practices which are doubtful from the standpoint of the duty of
loyalty,” said the Aldama report.

Spain’s 20003 Transparency Act requires listed companies to produce annual
corporate governance reports with information regarding shareholding
structure; administrative structure; transactions with shareholders and
directors; and intra-group transactions; risk-control mechanisms;
procedure of the general shareholders’ meeting; and degree of fulfilment
of the recommendations on corporate governance.

But some market experts said then that the Act was not absolutely clear
about the definitions of some of the duties set out under it.

Transparency vs. privacy

The CNMV’s latest announcement is an attempt to clear the air on one of
these – the definition of ‘related party’.

But the announcement has not gone down well with some members of Spanish
business who have interpreted the term “affectionate relationship” to
include lovers as well. They believe this to be an infringement of
directors’ privacy.

A spokesman for a leading Spanish financial house says that the CNMV’s
definition of ‘related party’ was “stupid and ludicrous”. "If I had a
lover, which I don’t, would they expect me to admit it? What next? I get a
call from someone who has found out saying ‘pay me money or I tell your
wife’,” he told the Scotsman newspaper on condition of anonymity.

Ricard Fornesa, the president of La Caixa savings bank, described the new
rule as "laughable". Speaking to the Spanish press, he joked that
financial reports in Spain would now provide a sneak peak into directors’
private lives.

Not all at the receiving end of the CNMV’s new rule are as open about
their feelings as Mr Fornesa. Spanish bank, BBVA and telecommunications
giant, Telefonica preferred to maintain a silence over the new rule, when
contacted by Ethical Corporation. Both companies said that they would
oblige with “whatever the regulator asks” and already demanded complete
“integrity in conduct” from their directors.

Family legacies

Civil society groups campaigning for better corporate governance standards
in Spain have welcomed the announcement. “There is a thin line between
personal and corporate things but this is really important information
(that has to be disclosed),” says Maria Ferez, CSR analyst at Fundación
Ecología y Desarrollo (Foundation Ecology and Development), a group
campaigning to promote corporate responsibility in Spain.

Helena Vines, analyst at European ratings agency, CoreRatings explains
that most Spanish companies have only recently restructured themselves
from family-dominated businesses to those devoid of any such influence.

This, she says, makes it even necessary to have the CNMV pass strict
regulations in order to avoid any “possible conflicts of interest and push
the CSR agenda in Spain”.

Vines says that generally, Spain is doing well in its attempts to catch up
with the rest of Europe as far as corporate responsibility standards are
concerned.

In keeping with its recent focus on corporate governance in recent years,
the socialist-leaning government in Spain has now announced it will pass a
code of conduct for businesses early in 2006.

The corporate governance bandwagon rolling across Europe appears to be
gathering pace. Its biggest test will undoubtedly be in the newest member
states, where standards are often much lower. The EU Commission looks set
to pressure governments in these nations to catch up with those in the
west in the coming years.

18.5.05

'ecomagination': Inside GE?s Power Play -- GE seems to be doing several other things right in making ecomagination central to its strat

Strategic Thinking
by Joel Makower
May 2005
'ecomagination': Inside GE’s Power Play
General Electric, the 125-year-old behemoth born out of Thomas Edison's
electric light company, is casting a bright light on sustainability. Its
chairman and CEO, Jeffrey Immelt, has just announced that the $150 billion
company is hitching its future to the growth of clean energy, clean water,
and other clean technologies through a commitment to what GE is calling "
ecomagination."

Ecomagination, says Immelt, aims to "focus our unique energy, technology,
manufacturing, and infrastructure capabilities to develop tomorrow's
solutions such as solar energy, hybrid locomotives, fuel cells,
lower-emission aircraft engines, lighter and stronger materials, efficient
lighting, and water purification technology."

By almost any measure, it's a bold move. For GE, the fifth-largest U.S.
company, it represents a strategic shift that could catalyze competition
among some of the world's largest companies to accelerate the emerging
clean-tech economy.

Working with my colleagues at GreenOrder, a New York-based consultancy
specializing in sustainable business, I have helped GE prepare for this
day over the past year or so, working at both the strategic and ground
levels. Having had a front-row seat, I've watched "ecomagination" catch
fire at GE. I thought I'd share what I learned.

First, some background. In announcing ecomagination, GE is committing
itself to:
more than double its research investment in cleaner technologies, from
$700 million in 2004 to $1.5 billion in 2010;

introduce more clean-tech products annually, doubling its current $10
billion in annual revenues from ecomagination products and services to at
least $20 billion by 2010, "with more aggressive targets thereafter."
GE also is pledging to improve its own environmental performance by:
reducing its greenhouse gas emissions 1% by 2012 and the intensity of its
greenhouse gas emissions 30% by 2008, both compared to 2004 (based on the
company's projected growth, GE says its emissions would have otherwise
risen 40% by 2012 without further action);

reporting publicly on its progress in meeting these goals.
What's driving GE to do this? First and foremost, it's a huge business
opportunity. Clean Edge recently estimated that global markets for just
three technologies -- wind power, solar photovoltaics, and fuel cells --
will grow to more than $100 billion within 10 years, from about $16
billion today. That doesn't include clean-water technologies, in which GE
has invested heavily. (A study last year predicted that the market for
world water treatment technologies will reach $35 billion by 2007.) And it
doesn't include energy efficiency -- technologies that significantly
reduce energy use -- which is, arguably, the biggest market of all.

Beyond that, Immelt believes the private sector needs to step up to the
plate in addressing environmental challenges, and to stop viewing the
environment as a no-win business proposition. Immelt doesn’t advocate
abandoning government action on the environment, but he sees an
alternative pathway for business, one in which the private sector embraces
today’s realities of environmental, national security, and other concerns
and invests in creating new markets for cleaner fuels and technologies.

True, GE still manufactures nuclear power plants (which are not part of
its ecomagination goals) and is investing heavily in "cleaner coal"
technologies (which are part of the goals) -- not everyone’s definition of
clean technology, though Immelt firmly believes they should be part of our
energy future.

Reasonable people can disagree on this, but it’s hard to argue with
Immelt’s willingness to put his company out front of the debate in a very
visible way. GE’s goal is not to promote one or two energy technologies
above the others, but to push them all aggressively. Washington could
learn a lot from that strategy.

GE seems to be doing several other things right in making ecomagination
central to its strategy. In many ways, it represents a textbook approach
to what a major corporate sustainability effort can look like. Here are
six specific reasons I believe GE is headed in the right direction:

1. It’s being viewed as a business opportunity. Few other large
companies -- BP, Dupont, and Interface are rare exceptions -- have set
their sights on making sustainability a cornerstone of topline business
growth -- new products, larger markets, stronger customer ties, etc. GE
sees ecomagination as an engine for creating new sources of business value
for years to come. That’s likely to make it sustainable within the
company, and not just the flavor of the month.

2. It’s got solid top-level commitment. Experts always talk about the
importance of having CEO buy-in to make sustainability more than just a
nice-to-do company initiative. (Again, BP’s John Browne, Dupont’s Chad
Holliday, and Interface’s Ray Anderson are among a handful of exemplars.)
Immelt seems to be making ecomagination a personal quest, from his
high-profile announcements this week all the way to his personal
appearance on the ecomagination Web site. I’m guessing you’ll be hearing
Immelt preach the ecomagination gospel for the foreseeable future.

3. It’s both aspirational and specific. GE’s ecomagination pledge
marries high-level strategy and vision with specific targets and
timetables. Both are critical for sustainability to succeed inside a
company, and having one without the other is a recipe for failure. In
providing both, GE has signaled its intention to be an environmental and
clean-tech leader, and has provided a road map of how they plan to get
there.

4. They’ve done their homework. GE has identified 17 products
representing about $10 billion in annual sales as part of the
ecomagination platform on which it plans to build. In doing so, the
company undertook an intensive process to identify and qualify current
ecomagination products, analyzing the environmental attributes of GE
products relative to benchmarks such as competitors’ best products, the
installed base of products, regulatory standards, and historical
performance. (Doing this analysis was one of the key roles played by
GreenOrder.) For each ecomagination product, GE created an extensive
"scorecard" quantifying the product’s environmental attributes, impacts,
and benefits relative to comparable products. The scorecards were used to
create the product claims that can be found in GE’s printed materials,
ads, and Web site.

5. It’s being integrated with the brand. GE says the ecomagination
"brand" will be integrated into its overall marketing -- at least for the
products that qualify. This is no small matter. Most companies have been
reluctant to play up their products’ environmental benefits (if you don’t
count those feel-good image ads that come primarily from energy, chemical,
and forestry companies), fearing that their green claims won’t stand up to
scrutiny when weighed against the company’s overall environmental
footprint. GE’s leaders seem willing to take the risk -- largely because
they’re making specific claims and are willing to back them up.

6. They’re in it for the long haul. Clearly, ecomagination -- like
sustainability itself -- is not a one-off campaign or short-term
proposition. GE seems determined to make ecomagination part of its
identity. It plans not just to market the brand aggressively to the world,
but also internally, to GE’s 300,000-employee base, to ensure that the
notion of leadership through clean technology is part of everyone’s job.
Time will tell, of course, how effective this strategy will be in helping
GE gain business -- and shareholder -- value. If it works, it may provide
a model for how a company can strike out as an environmental leader in
today’s cynical marketplace.

17.5.05

Regulation that's good for competition: Unfortunately, regulation often has a negative effect. What can governments do to get it right?

Regulation that's good for competition
Unfortunately, regulation often has a negative effect. What can
governments do to get it right?
Scott C. Beardsley and Diana Farrell
The McKinsey Quarterly, 2005 Number 2

The aim of economic regulation should be the same in all sectors: to
facilitate fair competition among players or, where natural monopolies
exist, to ensure fair pricing and service levels. Greater competition
means stronger productivity growth, which in turn means a faster-growing
economy and more wealth to share. Yet governments everywhere struggle to
get regulation right.
Why regulate at all? First, market economies can't function properly
without rules: property rights (including trademarks and patents that
protect innovators) underpin transactions, and antitrust laws safeguard
fair competition. The painful transition away from Communism in the former
Soviet Union is a particularly vivid example of the need for a basic legal
framework. Second, regulation is necessary to mitigate broader market
failures in generally competitive industries—for example, to protect
consumers from abusive practices, to introduce and maintain safety
standards, to protect vulnerable workers, and to control environmental
pollution. Moreover, some forms of regulation (such as orphan-drug rules
for rare diseases) aim to force or encourage businesses to meet the vital
needs of unprofitable customers. Third, regulatory intervention is vital
in supporting competition and so promoting the welfare of consumers in
their dealings with electricity, telecommunications, and other network
industries that tend to monopoly because of huge infrastructure
requirements.
Regulation often runs into substantial difficulties, however. For
starters, there is no manual for implementing market-supporting
regulations. When regulators define rules of competition in areas such as
predatory pricing and intellectual property, they must constantly strike a
tricky balance. Rules and standards to protect consumers must be
sufficient, but not so costly as to discourage innovation and halt
progress. Governments are too inclined to frame policy through trial and
error, confusing economic goals with political and social ones. Although
such experiments often reflect genuine choices about the type of market
competition a society wishes to have, pressure from special interests for
state intervention may not be benign and may completely undermine the
economic rationale for regulation. Thus governments sometimes—and often
unintentionally—devise rules that hamper competition and create long-term
drags on growth.
The McKinsey Global Institute (MGI) believes that poor regulation is the
main factor limiting productivity and growth in economies throughout the
world, particularly developing ones. India, for example, could raise its
labor productivity by 61 percentage points if it removed harmful rules.
Brazil could raise its labor productivity by 43 percentage points (Exhibit
1). MGI research on Russia suggests that more effective regulation in that
country, principally to ensure fair competition, could raise its
structural economic growth rate to as much as 8 percent a year without
significant capital investment, which it now struggles to raise despite
current high oil prices.

In a recent study of 145 countries, the World Bank1 found that the
administrative cost of complying with regulations is three times higher
for businesses in poor countries than for those in rich ones. Yet
businesses in poor countries have less than half the protection for
property rights. Heavy regulation and weak property rights, moreover,
exclude the poor from business. Women, young, and low-skilled workers
suffer most.
Companies in both developing and developed economies are worried. A CEO
survey presented at the 2005 World Economic Forum, in Davos, identified
overregulation as the most important threat facing businesses. How can
governments craft more effective and balanced regulations? MGI studies of
17 economies, as well as McKinsey's long and deep experience working with
regulators and businesses, have helped us identify three common regulatory
traps and some basic principles to help rule makers avoid them.
Inappropriate regulation of factors of production
Governments sometimes restrict competition in a wide range of sectors by
inappropriately regulating markets for factors of production, such as
labor and property. They try to prevent abuses and correct market
failures, but their efforts frequently have unintended consequences.
Costly labor market regulations
Perversely, regulations that protect jobs often constrain employment.
Managers who have only a limited ability to reduce the workforce in a
downturn are hesitant to hire new workers. This reluctance makes it harder
for competitive companies to grow.
Furthermore, regulations guaranteeing decent wages for the most poorly
paid workers often limit the creation of new low-skill jobs in service
industries. France, for instance, sets its minimum wage at a level twice
that of the United States. As a result, US retailers employ 50 percent
more people per capita than do their French counterparts. Although not
plum jobs, these do boost the economy's overall ability to create wealth
while helping many low-skilled employees avoid social exclusion and giving
them an opportunity to move up the income ladder. Instead of raising the
minimum wage, with its possibly damaging secondary effects, governments
can provide assistance to low-income workers by using earned-income tax
credits to reduce their taxes.
Restrictive land and property regulations
Regulating land and property can slow growth by inhibiting capital
investment and industrial consolidation. Japan's zoning laws, for example,
protect mom-and-pop retail shops but prevent the expansion of more
productive large-scale discounters. Small shops account for more than 50
percent of the Japanese retailing sector, compared with less than a
quarter in the United States.
Unclear land titles and property rights also stifle growth. In the
Philippines, as Hernando de Soto shows in The Mystery of Capital: Why
Capitalism Triumphs in the West and Fails Everywhere Else,2 it can take 13
to 25 years and almost 170 steps and signatures to acquire a piece of land
legally. As a result, 60 to 70 percent of the country's people don't have
legal title to their land. This problem not only precludes the development
of a mortgage market and, hence, of a robust financial system but also
removes the main source of collateral for small-business owners and
entrepreneurs. It is also hard for bigger companies to obtain enough land.
Overregulation of competitive sectors
In most countries that MGI has studied, the biggest constraints on
economic growth result from inappropriate and unevenly enforced
regulations in naturally competitive manufacturing and service sectors,
such as consumer goods and construction.
Protectionist market entry regulations
To protect local industry and employment, governments create barriers such
as import tariffs and restrictions on foreign direct investment. But
protection of this kind insulates local companies from competition and so
removes their incentive to provide better and cheaper goods and services,
thereby harming the broader economy.
In India, for example, a small-scale-reservation law designates hundreds
of products that only companies below a certain size may manufacture. It
also restricts investments in fixed assets by companies that produce most
of their output for the domestic market. Both domestic and foreign
manufacturers therefore can't reach economies of scale.
Restrictive product market regulations
Governments rightly create safety standards to ensure that electrical
appliances are not a fire hazard and food standards to protect the
people's health. But some product market regulations make it harder for
companies to innovate and become more productive. In the long run,
consumers and the whole economy lose out.
Japan's regulations governing the materials and techniques used in home
construction, for example, aim to preserve the national character of the
country's building stock. They work: every house in Japan looks different
from other houses and is uniquely Japanese. But the construction industry
can't raise its productivity through standardization, which would make
housing cheaper. It would be better if consumers could decide for
themselves whether to pay an aesthetic premium.
Germany restricts the hours when retail stores can be open in order to
protect their workers and to make Sundays special. But these regulations,
combined with high minimum wages and with zoning laws limiting
hypermarkets, have helped keep the productivity of German retailing 15
percent below that of retailing in the United States.
Inflexible regulation of former monopoly industries
When governments liberalize utilities, railroads, and other network
industries, the potential productivity gains are enormous. Utilities
usually account for 10 percent or more of a nation's GDP, and their prices
affect the performance of companies throughout the economy.

To create competition in sectors such as telephony and electricity,
regulators often try to lessen the market power of incumbent former
monopolists. One common approach involves requiring them to let new
retailers use their networks at a favorable wholesale price while still
insisting that they provide universal coverage for profitable and
unprofitable customers alike. Competition is vibrant in such former
monopoly industries of most developed economies. The transfer of profits
away from the incumbents has been substantial, and prices have tumbled in
some sectors: from 1990 to 2002, for example, the cost of fixed-line
telephone calls fell by almost 50 percent in the countries of the
Organisation for Economic Co-operation and Development (Exhibit 2). The
granting of licenses to a host of new mobile-telephony operators has also
increased competition and demand, improved the infrastructure, and cut
prices.
Governments, however, often struggle to create flexible frameworks that
anticipate and respond to conditions as markets evolve. In
telecommunications, for example, regulators in developed markets are
struggling to take account of new technologies that, along with existing
regulations, are changing the balance of power between incumbents and
attackers. Although alternative platforms such as cable, wireless, and
VoIP (Voice over Internet Protocol) are substitutes for traditional
fixed-line telephony, they tend to be regulated separately and, in some
cases, circumvent regulation altogether.
As a result, the challengers are gradually eroding fixed-line telephony,
which still generally accounts for a majority of the revenues and profits
of the incumbents. Under current cost structures, if such regulatory
asymmetries are not adjusted to reflect the new reality they will severely
reduce the returns of the incumbents' fixed-line business. That will in
turn undermine the incumbents' ability to invest in new infrastructures
and technologies (such as a national broadband network) that would benefit
consumers and the overall economy in the long term.
Getting regulation right
Regulators should keep certain guidelines in mind as they tackle the
difficult task of making their rules more effective.
Make regulation fact based and transparent
A fact-based approach and a transparent process are the keys to making
optimal regulatory decisions and controlling special-interest groups.
Regulators should understand not only how different options will affect
the economics of competition in a sector but also their social and
political implications. Detailed modeling and analysis are required to
clarify the trade-offs and to judge whether the goals of regulation will
be met.
Some governments that formerly failed to undertake this kind of analysis
are now changing their ways. Until now, for example, India's government
has banned foreign direct investment in the retail sector in the belief
that modern formats favor the rich and that greater competition wouldn't
drive substantial growth elsewhere in the economy. But having undertaken a
microeconomic analysis showing that modern-format discounters offer lower
prices and that a competitive retail sector would generate productivity
growth in one-third of the total economy, the government may lift the ban.
Making regulatory barriers more transparent—for example, by measuring
levels of regulation against international benchmarks—helps a country
develop a community of support for regulatory reform and therefore puts
pressure on the special interests behind the status quo. A community of
this kind often includes academics, international organizations (such as
the World Bank and the Asian Development Bank), the global media,
influential private foundations, private individuals, and, of course,
representatives of the one group likely to benefit most: consumers.
Make regulation dynamic
Dynamic rule making is particularly important in heavily regulated
sectors. A regulator should continually assess not only the kinds of rules
each of them requires but also, if competition is already established,
whether fewer rules might make sense. Like taxes, regulations are hard to
remove or reduce, but doing so may be necessary to stimulate growth and
innovation.
Regulators can make rules more malleable by adopting a "sunset" clause
that requires regular reviews of how well regulations fulfill their
purpose and either extends their sunset dates or automatically terminates
them at a particular time. The US Civil Aeronautics Board Sunset Act of
1984, for example, ended nearly 40 years of close regulation of airline
routes and fares by the CAB. This move led to intense competition and to
lower prices that helped consumers and the US economy at large.
Today many regulatory laws are also subject to impact assessments:
systematic examinations of the advantages and disadvantages of ways to
achieve an objective. Most OECD countries have adopted this approach, but
they don't use it to the same extent, and many developing countries don't
use it at all. Some governments have also established independent
consultative bodies, such as the United Kingdom's Better Regulation Task
Force.
Regulate factor markets with care
Reforming the rules covering the factors of production can have a major
impact. Because of the complex and sensitive trade-offs between economic
and social objectives, however, reform must be handled with great care if
it is both to win broad support and create economic value.
Spain achieved both goals in the 1990s, when it introduced more flexible
labor laws that helped cut unemployment by 40 percent in only six years.
Among other things, the reforms let employers and employees negotiate
contracts (rather than having labor laws dictate the terms) and created a
new type of permanent contract, which reduced the employers' payouts to
laid-off workers by 60 percent, for youths and other groups that have
unusual difficulty finding jobs.
Belgium, by contrast, maintains generous early-retirement schemes intended
to promote corporate restructuring and to keep the peace with labor. But
they have generated huge costs for the government and given the country
one of Europe's lowest employment rates. Only one in four Belgians aged 55
to 64 works.3
Let the market pick the winners
Regulations governing competitive markets should be neutral in their
impact on different players. Leveling the field for new entrants, whether
at home or abroad, spurs competition by pressing incumbents to match or
surpass their productivity. When governments take this perspective, they
avoid the regulatory trap of trying to protect enterprises of every scale,
from mom-and-pop stores to national airlines.
Regulators clearly have a role in developing national technological
standards. But with rare exceptions, they should avoid favoring one
product or technology over another, since doing so often reduces
incentives to compete and innovate. Europe's decision to deploy the Global
System for Mobile Communications (GSM) and to allow roaming and
interoperability across borders was effective because these moves helped
mobile technology to penetrate European markets more quickly than it did
elsewhere. But European telecom ministries had previously urged (and
sometimes forced) operators to buy telecom equipment made in the home
country—a decision that drove costs much higher than they would otherwise
have been.
Enforce regulations evenly
Allowing some players to gain advantage by disregarding the rules also
distorts competition. When regulators fail to tackle the gray (informal)
economy, in which companies underreport employment, avoid paying taxes,
and ignore product quality and safety regulations, the market can't pick
the winning products and services. Companies operating partially or wholly
outside the law gain substantial cost advantages, which more than offset
their low productivity and small scale and help them stay in business.
Larger, more productive, and law-abiding companies therefore can't gain
market share—a huge problem in low-income nations, where the informal
economy generates an estimated 40 percent of GNP. It is widespread in some
developed nations too.4
To address the problem, governments must devote enough resources to pay
for adequate enforcement of tax and other regulations. Many developing
countries in particular will have to improve their tax collection and
audit capabilities and to increase penalties for those flouting the law.
To avoid massive social repercussions in the transitional stage and to
increase the chances of success, governments should address the informal
economy one sector at a time.
Protect people, not jobs
When regulators try to save employment in a particular sector, they may
succeed for a period, but at the expense of job creation elsewhere in the
economy. In the United States, for example, anxiety about losing service
jobs to offshore providers is widespread. But MGI research indicates that
the US economy as a whole gains sizable benefits from offshoring, through
corporate savings, additional exports, repatriated profits, and greater
productivity.
Rather than seeking to prevent the loss of jobs eliminated through the
search for higher productivity, regulators should focus on cushioning the
blow for workers who become unemployed and on easing their transition to
new jobs. Such assistance could include retraining programs and
company-sponsored insurance to offset lower wages. From 1979 to 1999,
however, 69 percent of the US workers who lost their jobs through the
offshoring of services found new work within six months, and roughly half
moved to higher-value-added activities.5
In many Western European countries, regulators should also facilitate the
creation of new jobs by making labor and product market rules more
flexible so that they don't stifle competition and innovation.
Don't regulate business processes
In naturally competitive and liberalized sectors, businesses should be
free to decide how best to meet any standards for the health and safety of
their products and for protecting the environment. If governments use
restrictive regulations to control the operations, organizational
structure, and practices of companies—including the way they satisfy their
demand for labor—their ability to innovate in pursuit of greater
productivity will suffer.
Consider the 1990 US Clean Air Act amendments, which established a
"cap-and-trade" system to reduce sulfur dioxide emissions from
coal-powered electricity plants. By setting a cap while giving companies
the option of trading their rights, regulators encouraged utilities to
explore innovative ways of reducing emissions. Companies had an incentive
to cut their emissions costs to levels below the market price for the
rights and to sell their excess rights to other companies. The scheme
achieved its targets more cheaply than expected: experts predicted that
the cost of reducing sulfur dioxide emissions would range from $700 to
$1,500 a ton, but the final market price of the rights reflected a cost of
only $350.
Tailor regulation to national markets
Regulation must reflect the legal and institutional background of specific
countries as well as their stage of economic and infrastructure
development; copying foreign regulations is rarely appropriate and can be
downright harmful. Although benchmarks help to increase transparency, they
must be comparable. Factors such as the cost of capital, labor rates,
population density, demand patterns, the competitiveness of the industrial
structure, and the stage of liberalization vary widely by country.
Benchmarks should thus be tailored to the local environment, since they
can drive very different regulatory outcomes.
Many developed economies that moved quickly to privatize
telecommunications were acting logically when they based their regulatory
regimes on the role of the fixed-line incumbents that then dominated the
industry. But in some developing countries (including the Czech Republic,
Jordan, Malaysia, and Russia), the incumbents' fixed-line networks already
have far fewer users than new mobile networks do. In such cases, mobile
may be a much more efficient way to provide universal service. It might be
appropriate to regulate both kinds of networks in a similar way to ensure
the widespread development of a mobile data infrastructure at generally
accessible prices.
Remember the need for infrastructure
Rail and telecom networks, water and gas pipelines, and distribution grids
are all capital intensive, with long payback periods. Regulators should
consider ways to promote and reward investment in these networks. One way
might be to let prices for network access be higher than its actual cost
so that incumbents can reinvest in or upgrade networks and new players
find it worthwhile to build their own. Another possibility is
"ring-fencing" new investments by, say, guaranteeing that a new telephony
network investment won't be available to other players for a period of
time.
Make natural-monopoly trade-offs explicit
Clearly, some cases will involve natural monopolies (or temporary ones in
industries such as pharmaceuticals) as well as many types of rail and
power infrastructures. Here regulators should make explicit trade-offs
between the tight regulation of pricing and the interests of consumers, on
the one hand, and the effects of regulation on employment, investments in
infrastructures, business models, innovation, quality, universal service,
and the like—elements that competition usually drives—on the other. Rural
mail, telephony, and rail service, as well as the pricing of orphan drugs
for rare diseases, are just a few such questions. The key is to analyze
facts and objectives so that their implications become clear and to make
explicit trade-offs among the interests of diverse groups of stakeholders.
Issues such as cross-subsidies, the protection of intellectual property,
and predatory pricing must constantly be evaluated and addressed in these
kinds of environments.
Crafting regulations that encourage rather than hinder competition and
growth is increasingly tough at a time of accelerating technological
change and economic uncertainty. Politicians are under pressure to protect
troubled industries and to safeguard jobs. The work of regulators is ever
more complex—which makes it ever more vital that they make wise choices.
About the Authors
Scott Beardsley is a director in McKinsey's Brussels office, and Diana
Farrell is director of the McKinsey Global Institute.
Notes
1International Finance Corporation and World Bank, Doing Business in 2005:
Removing Obstacles to Growth, Oxford University Press, September 2005; and
World Bank, World Development Report 2005: A Better Investment Climate for
Everyone, Oxford University Press, September 2004.
2New York: Basic Books, 2000.
3Prospero: A New Momentum to Economic Prosperity in Belgium (2004) is
available online. The work is based on data from established Belgian
sources, such as the Federal Planning Bureau, the National Bank of
Belgium, and the National Institute of Statistics; from international
organizations, including the European Commission and the Organisation for
Economic Co–operation and Development (OECD); and from discussions with
union leaders, politicians, academics, and top executives at Belgium's
private and public institutions.
4Diana Farrell, "The hidden dangers of the informal economy," The McKinsey
Quarterly, 2004 Number 3, pp. 26–37.
5Lori G. Kletzer, Job Loss from Imports: Measuring the Costs, Institute
for International Economics, Washington, DC, September 2001.

When It Comes to Replacing Oil Imports, Nuclear Is No Easy Option: reactors make electricity, not oil. And oil does not make much electricity.

When It Comes to Replacing Oil Imports, Nuclear Is No Easy Option, Experts
Say
The New York Times, 9 May 2005 - President Bush has proposed reducing oil
imports by increasing the use of nuclear power, which he said in a recent
speech was ''one of the most promising sources of energy.''
There is a problem, though: reactors make electricity, not oil. And oil
does not make much electricity.
Nuclear reactors produce about 20 percent of the electricity used in the
United States and about 8 percent of the total energy consumed. Oil
accounts for 41 percent of energy consumption.
Could a few dozen more reactors, in addition to the 103 running now, cut
into oil's share of the energy market?
''Indirectly, but very indirectly,'' said Lawrence J. Goldstein, president
of the Petroleum Industry Research Foundation, a nonprofit group that
studies the economics of oil. People who think nuclear power is a way to
reduce oil imports are ''confusing several issues,'' he said.
Peter A. Bradford, a former member of the Nuclear Regulatory Commission,
added, ''No one knowledgeable about energy policy would link nuclear power
and gasoline prices.''
In the puzzle of energy consumption and production, however, experts point
to three intersections of oil and nuclear power that would offer
opportunities to cut demand for oil, pushing down its price and strategic
significance. But all are limited, clumsy, expensive or dependent on new
technologies whose success is not guaranteed, the experts say.
The first option is to replace the oil used to make electricity with new
nuclear reactors. But most of the oil in the electric sector has already
been replaced, by coal.
According to the Energy Department, last year the electric utilities used
about 207 million barrels of oil, or less than 600,000 barrels a day.
(Total American consumption of oil is about 20.5 million barrels a day.)
Even the 600,000-barrel figure is higher than what nuclear reactors could
replace, because some of that oil is used in generators that run only a
few hundred hours a year. Reactors must run continuously, so they could
not replace the oil-fired plants that are used only intermittently.
The electric system consumes another fuel that nuclear power could
replace: natural gas. Last year, American utilities burned just under 5.4
trillion cubic feet of natural gas, out of total consumption of 22.3
trillion cubic feet.
''You can get a scenario where nuclear would free the gas to go to other
things,'' replacing oil and gasoline, said Thomas Capps, the chairman of
Dominion, one of several electric companies that have expressed interest
in building new nuclear reactors. ''You can run cars on natural gas,'' he
said.
The technology for that is available, but not many people use it.
According to the Natural Gas Vehicle Coalition, a lobbying group, about
130,000 such vehicles are on American roads today, out of more than 200
million. After decades of promoting natural gas, federal and state
governments have made some headway in persuading commercial fleets to
switch. But they have essentially given up on selling natural gas to
ordinary consumers, who have been unwilling to convert their vehicles to
use it.
There is also little economic incentive behind using natural gas. Mr.
Goldstein noted that the current wholesale price of gas, about $7 per
million B.T.U. (the standard unit by which gas is sold), is the equivalent
of $42 per barrel for oil. But oil now sells for about $50 a barrel, which
means the price difference is not enough to induce a switch.
Gas must also be pressurized for a car to hold enough to travel more than
a few miles; pressurizing it and distributing it to service stations would
add expense.
But there is another way that nuclear reactors could influence the oil
supply, one that bypasses electricity completely. Nuclear engineers are
working on designs and materials for a new class of reactors -- which
could be ready in about 20 years -- whose main product would be heat.
The Idaho National Laboratory in Idaho Falls, which is owned by the
Department of Energy, is working on ways to take very hot steam from a
nuclear reactor, then run a small electric current through it to separate
the water molecules into hydrogen and oxygen. If that can be done more
cheaply than the current method of producing hydrogen, which uses natural
gas, the hydrogen could be used at refineries to make components of
gasoline.
Gasoline is made of molecules with a certain ratio of carbon to hydrogen.
Part of each barrel of oil consists of molecules with too much carbon to
be useful in gasoline; instead, those molecules are used only in low-value
products like asphalt and tar.
The technology exists for refineries to break up those molecules and add
hydrogen, until the hydrogen-carbon ratio is suitable for making gasoline
or diesel.
David Lifschultz, chief executive of Genoil, a company that makes systems
for using hydrogen at refineries, says the oil supply being exhausted
first is light oil, which has many components that can be used in
gasoline. Heavy oil, with components high in carbon, is far more abundant
and often sells at a discount of $20 or $25 a barrel, he said.
Available technology could convert 16 million barrels a day of heavy oil,
about a sixth of the world supply, into gasoline components, Mr.
Lifschultz said, driving down the price of light oil.
J. Stephen Herring, a consulting engineer at the Idaho lab, explained two
other ways for reactors to make motor fuel.
Canada has vast reserves of shale oil, now being converted to ingredients
of motor fuel by using natural gas. The gas is used to heat the shale to
make its oil flow more easily, and hydrogen, also obtained from the
natural gas, is incorporated into the oil to make it suitable for use in
gasoline. But a nuclear reactor could do those jobs, delivering both
hydrogen and steam for cooking the oil out of the rock, Mr. Herring said.
Another strategy, he said, would be to break down coal, shale oil or other
hydrogen fuels into a gas comprising hydrogen and carbon monoxide. At high
pressure, these materials could form molecules suitable for making
gasoline or diesel. A reactor could provide the energy required.
But using a reactor to make the ingredients of gasoline is many years
away; the new reactors being considered by utilities are similar to the
ones running now. The experts say that only after several of those have
been built and have run for a few years is a private company likely to try
something more adventurous.
Mr. Herring did not fault that strategy. ''If I were responsible for
spending the billion dollars,'' he said, ''I'd be conservative, too.''