The Economics of the German VAT Hike

I am very happy to be back here at AFOE, if not only, for a brief one-stop guest post about the economics of the German VAT hike and more specifically how market commentators and analists might just be reading the German economy somewhat falsely at the moment in the sense that they are not taking into account the implications of the sustained and evolving process of ageing in the German society. Indeed as Edward noted just a few days ago here at AFOE we might actually be talking about a clash of paradigms or at least a clash between two ways of looking at and interpreting the economic data coming out of Germany and indeed of the entire Eurozone. There are consequently many venues on which this diagreement is fielded and an important one of these is the German economy and more specifically the significance of the VAT hike and below the fold I will give my view on this topic.
Continue reading

Eurozone Economy: When Paradigms Collide

When scientific paradigms collide everyone should duck, at least that is the best advice I can offer at the present moment. The provisional German retail sales for January are now in, and they don’t make especially pleasant reading:

European retail sales dropped for the first time in 10 months in January as spending in Germany slumped, adding to signs economic growth is slowing, the Bloomberg purchasing managers index showed…..German retail sales had the biggest drop in two-and-a-half years, with its index declining to 43.9 from 55.2 in December

Now for those who have been following the German economy in recent months none of this should be particularly surprising, since as is reasonably well known Angela Merkel’s government has just upped VAT from 16% to 19% in an attempt to address the ongoing federal deficit problems. And of course, one months data never offer a complete picture. But this decline in retail consumption in Germany forms part of a much longer ongoing weakness in domestic consumption (and here), one which many were arguing had finally come to an end in 2006. Some of us, however, seriously doubted that this was the case, and hence the initial significance of today’s reading. In particular what we may be faced with are changing structural characteristics of economies as median population ages rise. In particular – and following the well-known life cycle pattern of saving and consumption – more elderly economies may have a higher rate of saving and a lower rate of consumption increase than their younger counterparts.

Some more evidence to back this point of view comes from Japan, where today we learn that household spending in December declined for a 12th straight month, dropping 1.9 percent from a year ago. Yet the Japanese economy is not in recession, and output is actually rising. As Bloomberg say:

Japan’s factory production rose to a record and household spending fell, underscoring the central bank’s concern that growth has bypassed consumers and left the economy dependent on exports.

So please note: growth appears to have by-passed consumers, and the economy is ever more dependent on exports. The same goes for Germany, and this is why I talk about paradigm collision, since the neo-classical theory of economic growth – with its core conception of ‘steady state’ growth – was never built to handle median age related changes in economic performance and structural characteristics. Something new is clearly needed.

Over the coming weeks I will undoubtedly have more to say about all this, as we get to see more of the 2007 Eurozone data, but for now let me point you in the direction of Claus Vistesen, who has been patiently toiling away trying to work through a hypothesis which, in terms of the data we are now seeing, certainly seems more in keeping with current economic realities than the view we currently see emanating from the ECB. His arguments on Japan can be found in depth here, and his latest piece on the eurozone is reproduced below the fold.
Continue reading

More Growth In The Eurozone

I think I’d better rephrase that: more overall growth, but a very mixed bag. In deriving aggregate numbers for the zone, four big economies really matter: Spain, France, Germany and Italy. Now each of these economies actually has different characteristics, so it is not clear what ‘the general picture’ means here.

Spain is the European economy whose current growth characteristic seem to resemble most those of the USA: above average growth (around 3.5% per annum), high dependency on housing and construction for the ‘extra growth’, high and rapidly growing private indebtedness (around 20% y-o-y) and a large current account deficit. Where Spain doesn’t resemble the US is in productivity, which has been more or less negative in recent years.

France is , as I’ve been suggesting, relatively ebullient despite the lack of all those labour reforms, and seems to be ‘on a roll’ at the moment. Driven by internal consumer demand and exports France managed an annualised 2.8% in the third quarter. Ironically, possibly France represents the big-four Eurozone economy with the most sustainable and balanced growth trajectory right now.

The German economy is growing at an unexpectedly high rate, but this extra-spurt is virtually all explained by the rapid increase in exports (helped of course by the fall in the euro).Investment, fuelled by the demand for all those exports, was also up. Meanhwile internal consumer demand is possibly even falling. (Growth in the third quarter was at an annual rate of 2.4% up from an annualised 0.8% in the second quarter).

And Italy, which as I keep mentioning is definitely now the ‘poor sister’ of the eurozone, with an identity crisis about what kind of economy it actually is, and a rapidly ageing population producing huge fiscal pressure. (On this see Morgan Stanley’s Vicenzo Guzzo yesterday). Italian growth actually bucked the trend in the third quarter and was lower than in the second quarter (dropping from a 2.8% annual rate to a 1.2% one).

All of this leaves me with the feeling: ‘Eurozone’ which eurozone?

Oil Demand Expected To Stay High

The International Energy Agency have just published their forecast for oil demand next year, and its more of the same, with the emphasis on more.

Global oil consumption is expected to increase by 1.75m barrels a day next year to total 85.2m b/d, suggesting that a recent fall-off in demand is temporary… For 2006, the IEA revised its forecast of non-Opec supply down 335,000 b/d to an average of 50.3m b/d.

Delays and declining production in Canada, the UK, Asia and Sudan are expected to damp production growth next year. The massive damage to platforms and rigs caused by Katrina and Rita will be felt outside the US as well, increasing costs and causing rig shortages in places such as the Middle East, where two of the rigs damaged by Rita had been scheduled to move this year.

At the same time, the world’s thirst for oil shows few signs of abating, despite high prices. The IEA said that weakening of demand this month was likely to be a short-lived side effect of bottlenecks in distribution caused by the US hurricanes.

Katrina and the Waves

As Edward suggests below, the macroeconomic effects of Katrina are just now becoming known, much less felt or sorted out.

One item that will be much more widely reported is that in addition to all of the petrochemical industry located there, New Orleans was the linchpin of the Port of South Louisiana. The port is the largest in the United States by tonnage, and the fifth largest in the world. Only Rotterdam, Singapore, Shanghai and Hong Kong are larger.

Stratfor reports, “Fifteen percent of all US exports by value go through the port. Nearly half of the exports go to Europe.” Anything from Montana to Ohio that’s sent to the world in bulk passes down the Mississippi River and past New Orleans. Virtually all of it is loaded onto oceangoing vessels at the PoSL. The port is expected to be closed for at least three months. This is a significant disruption in world trade.

The refinery outage is a serious issue. Even if they were not damaged by the storm, their staffs are probably scattered throughout the region, and not all will have survived. The refineries are also built to be run continuously and brought offline rather slowly. The rapid shutdown and long-term power outage may have done more damage than the storm itself. And they were all running flat-out before the storm to meet high demand.

The big question is consumer spending and demand. If gas prices take enough household income to cause cutbacks in other areas, what will that mean for the American economy? How sharp a drop in growth should we expect? And can the global economy run without the great engine of American consumer demand?

We may be about to find out.

The Emerging Global Labour Market

Opening my McKinseyQuarterly Newsletter today, I find an interesting link to the McKinsey Global Institute’s latest contribution (free, but registration required) to the question whether Globalization is actually civilizing, destructive, or feeble – as Wharton’s Mauro Guillen put it in this paper with reference to Albert Hirschman’s analysis of the shifting social value attributed to markets.

Actually, the analysis is not so much concerned with moral evaluations but – as one of the study’s authors, Diana Farrell, put it in the preface, with providing

“… a fact base to the public debate on offshoring and
the emerging global labor market to enable policy makers and business leaders
to make more informed and better decisions.”

Even if the study only projects trends up to 2008, it is still apparent that any conclusions drawn from an attempt to analyse something as vast and complicated as the global labour market will always depend on far too many assumptions that may or may not turn out to be true. After all, McKinsey also managed to present a model for rationlising stock market valuations for non-cash-flow-generating companies before and after the crash in 2000 – the variable that changed was… expectations.

Still, I think it is a valuable contribution to raise the quality of the public debate by actually attempting to quantify some variables determining demand and supply. While the study – as far as I can tell from looking at the executive summary – does not support the “feeble” view of globalization, when reading the results it is probably still helpful not to forget that McKinsey is unlikely to be interested in increasing their clients’ employees fear of being outsourced any further (the study deals only with white collar offshoring) –

  • Offshoring will probably continue to create a relatively small global labor market?one that threatens no sudden discontinuities in
    overall levels of employment and wages in developed countries.
  • Demand for offshore labor by companies in the developed world will increasingly push up wage rates for some occupations in low wage countries, but not as high as current wage levels for those occupations in developed ones.
  • Potential global supply and likely demand for offshore talent are matched inefficiently, with demand outstripping supply in some locations and supply outstripping demand in others.

No Answers Only Questions

One person who could rightly claim to know more about global ageing and its possible consequences than anyone else in the business is the German Director of the Manheim Research Institute for the Economics of Ageing Axel B?rsch-Supan. If there’s a conference being organised, he seems to be there. Actually his comments at both these meet-ups are well worth reading in and of themselves (here, and here).

In a sense B?rsch-Supan is almost uniquely qualified to express opinions on the topic since he has both devoted a large part of his professional career to studying the question, and he lives and works in a society which is already reeling under the impact. As he says:

“Today?s Germany has essentially the demographic structure that the United States will reach in a quarter of a century. The dependency ratio (the ratio of persons aged 65 and over to those aged from 20 to 59) is at 28 percent, and it will reach 75 percent in 2075, if we dare project that far. Almost one-fifth of the German population today are aged 65 and over. One quarter are aged 60 and over, which is relevant because the average retirement age in Germany is 59.5 years. Thus, in this sense the United States is not ?entering largely uncharted territory,? …. Rather, they can look to Europe?in particular to Germany and Italy?to see what will happen in the United States.”

I mention B?rsch-Supan because he serves as a good pretext for going over where we are to date with the issue. As he says himself. watching demography change is rather like watching a glacier melt, on a day-to-day basis it’s hard to see that anything is happening, but over time the impact is important.

One of his recent papers has the intriguing title: “Global Ageing: Issues, Answers, More Questions“. It is a good up-to-date review of the ‘state of the art’, and a quick examination of the points he makes probably serves as a good starting point, since I can’t help thinking, in the case of global ageing, it isn’t so much what we know that matters, it’s what we don’t know.

So here we go, a review of what we “know”, what we think we know, and what we don’t know:
Continue reading

The World As Optimum Currency Area?

I was a little surprised to read in the Christmas edition of the Frankfurter Allgemeine Sonntagszeitung (not yet online, subscription wall, in German) that Robert Mundell seems to have changed his mind. In his seminal 1961 paper about monetary integration, he famously stated that “the optimum currency area is not the world”. Now it appears he favors a sort-of worldwide currency union, initially comprising Dollar, Euro, and Yen (apparently, he’s also made that point earlier this year in Lib?ration (subscription wall, in French)).
Continue reading