Sunday, 26 October 2014

FRANCE....SOLVING THE PROBLEMS OF THE EUROZONE’S SECOND BIGGEST ECONOMY

I attended a conference last week that looked at France’s domestic economic situation and at the impact that has on France’s global and European role.

According to budgets they published this month, France and Italy are failing to meet the Euro area requirements for reducing Government debts and deficits to sustainable levels.

If France, as a big country making up 20% of the Euro area’s  GDP, were to be exempted from the EU debt and deficit rules, in ways that were not open to smaller  euro area countries, this would do great damage to the credibility of the euro, and potentially this could drive up to the interest rate euro area governments must pay to borrow. It is thus very important to Ireland that France overcome it’s problems.

In recent years, France has lost competitiveness, and it is consequently running a balance of payments deficit. In other words its people are spending more abroad, that than they are earning from abroad.

The French economy is projected to grow by only 1% in 2015, as against a projected growth of 2% in Germany and Spain, 2.7% in the UK, and almost 3% in Greece and Sweden.

The loss of competitiveness of France is due to several factors

+  Fewer people  are working fewer hours. For example, of people between 55 and 64 years of age, only 44% are working in France, as against 73% in Sweden, 65% in Japan, 60% in the US and  58% in the UK.
+  There is substantial youth unemployment, because young people find it hard to get on the career ladder because of an over regulated labour market that protects existing jobs at the cost of discouraging the creation of new ones. Last year 80% of all new jobs created in France were on temporary contracts.
+ The bigger a company grows, the more rigid are the rules that apply to it in terms of the right to hire and fire.  So, while France has some of the most successful big companies in the world, it lacks a large corps of middle sized export oriented companies, like Germany has.  90% of all French companies have fewer than 10 employees and they have strong incentives to stay small.
+ Monopolistic practices exist in a number of sectors controlled by the state and in some private professions. The vested interests protecting these monopolistic practices are very strong. These inefficiencies contribute to the loss of exports by French companies.

There was a strong sense among the participants at the conference that the current Socialist Government of Manuel Valls was making a serious effort to tackle these underlying weaknesses, but that the dividends of some the reforms, while very substantial, would be slow in coming, perhaps not in time for the 2017 elections.

There is a risk Prime Minister Valls will lose his majority because of defections in his own party. Meanwhile the opposition UMP is split on personality questions. The Front National is making huge strides in the polls, but its economic policy would break up the EU and introduce heavy state controls which would be incompatible with France’s global economic success.

Faster growth is crucial, and the margin between success and disaster is very narrow.  If the French economy grows at only 1% per annum over coming years, France could be on the road to default and a social crisis, but if it can manage a growth rate of 1.6% or better, it will work its way out of its difficulties. 

The stimulus for French growth will have to come to come both from inside and  outside France. French people save a lot, and if they could get the confidence to spend a little more of their savings, that would help. Likewise if Germany, which has been neglecting its infrastructure, stated to invest more that would help French exports.

The trouble is that French and Germany economists and politicians have very different intellectual assumptions, and dialogue between them can become a dialogue of the deaf.

Meanwhile, partly because it was wise enough to stay out of the Iraq debacle in 2003, France alone of the western powers, has the confidence to intervene directly in places like Mali, Libya and the Central African Republic.

France retains a strong nuclear deterrent and a civil nuclear industry that does not do the sort of climate damage that other  EU countries’ energy industries do.

Politics are important. Its Presidential system enables France to be strong and decisive in international affairs.

But that strength does not extend to domestic economic policymaking, where factionalism and introspective thinking are preventing the creation of any kind of “Grand Coalition for Reform”, of the kind that has enabled countries like Germany and Mexico to deal decisively with long standing blockages to growth.

Sunday, 19 October 2014

HANGZHOU, CHINA

I  have been in Hangzhou in the past week attending a Global Investment Conference organised by Euromoney. Hangzhou was for a time the capital of China and the biggest city in the world. It is about 200 km from Shanghai, or an hour’s journey on the high speed train, a trip that I was told costs only 10 euros.

Hangzhou was a centre of the silk business and was visited by Marco Polo. Silk from Hangzhou went along the ancient Silk Road all the way to Europe, thereby making Hangzhou one of world’s first globalised economies.

I spoke in Hangzhou just as the Asia Europe Economic Meeting (ASEM) of heads of Government was taking place in Milan. As the President of the European Council, I attended the first ever ASEM meeting  in Bangkok in 1996. I met the Mayor  of Hangzhou and key commercial and political figures.

Since 2010 there has been a huge surge in outward investment from China in the rest of the world, jumping from 6.1 billion euros to 27 billion euros in just three years. This investment is going into  buying high tech companies, companies with globally known brands, and tourist resorts (like Fota in Cork). Just as China’s export drive enabled it, not only to gain income but also to gain market knowledge, this wave of investment is also designed to strengthen China’s global competitiveness and sophistication. 

Children in the Shanghai are getting the highest test results in Maths, Science and Reading comprehension in the global PISA tests, which shows that they will provide strong competition for European and Irish children in the global economy. Irish Universities are accepting Chinese students and also investing in developing University facilities in China. This will help China to become a high income economy, its people enjoying lifestyles that will make similarly exorbitant demands on global resources, to the ones already being made by  European and American lifestyles consumers.

Wage levels are rising fast in China, as demand for workers is beginning to exceed supply, partly thanks to the one child policy.  China is losing low cost jobs to Vietnam and Mexico, so it has no choice but move higher up the value chain.

There is a shift in the allocation of credit away from big, relatively inefficient, state owned heavy(and often polluting) industries, towards privately owned businesses in the consumer goods sector. While the raw GDP growth rates in China may decline as a result, the life style enhancing quality of future GDP will improve.

China is becoming a middle class country, with middle class tastes and material aspirations. With wealth has come anxiety, with many Chinese wanting to invest some of their savings overseas. This provides opportunities for the Irish international financial services industry.

While I was in Hangzhou, the protests in Hong Kong were still under way. The protesters wanted anybody to be eligible for election, not just candidates approved by a single nomination committee. I read an article on this controversy in the “China Daily”, by an Indian Professor, M D Nalapat,  entitled  “Hong Kong must avoid the democracy trap”, which challenged the notion that, at every level of economic development, democracy is a guarantor of economic success.

He said
“Political chaos can act as a speed breaker for rising Asian economies, dampening the challenge they pose to western counties. Iraq, Egypt, Libya and Ukraine are examples of countries where hundreds of thousands of youths believed that replacing of existing structures through street protest would result in a better life. Instead what they have got are deteriorating living standards and  increasing insecurity.”

This is unfortunately a fair comment, and demonstrates the danger of making exaggerated claims of automatic economic advantages from any change of governmental system. Democracy requires patience and self restraint, sometimes absent in recently liberated societies.

Professor Nalapat went on
“Hong Kong is still moving upward, when the present generation in the US and the EU are worse off than the generations preceding it”

This  is a  superficial comment. Mature economies will never have, or need to have, the same rates of economic growth as economies, like China, which are in the “catch up” phase. Indeed, there is a case to be made that, beyond a certain level of economic development, diminishing returns in human wellbeing and environmental quality set in. 5% plus annual growth rates cannot continue to infinity.....anywhere in the world.

It is not surprising that an article like Professor Nalapats’ should appear in the “China Daily”, but is troubling that it should be written by an Indian, an inhabitant of the world’s largest democracy, a country in which there are 3 million freely elected  legislators at differing levels of government, with real competition between parties unlike the tightly controlled system obtaining in China.

But Professor Nalapat is showing that people in the developing world are watching European and North American democracies, as we squabble about how to restore dynamism and optimism in the wake of the 2008 economic crisis, and are drawing conclusions about our systems of government, and the capacity of those systems to enable us to get our economic act together, and democratically to reconcile citizens expectations with economic realities.

Sunday, 12 October 2014

THE EU’S SYSTEM FOR KEEPING EURO STATE BUDGETS ON TRACK IS AS IMPORTANT AS EVER NOW.....ESPECIALLY WHEN INTEREST RATES ARE LOW

Bond markets are notoriously fickle. They often seem to be driven by sentiment rather than deep analysis. The experience of 2006-2008 shows that they are not infallible. They are not a good guide to long term economic prospects. Rating agencies seem to follow sentiment rather than lead it. They are like a bus driver who is looking out the back window of the bus rather that at the road in front.

This is the context in which France and Italy should be assessing the wisdom of submitting draft budgets this month to the European Commission, in accordance with the Stability and Growth Pact,  that go back on commitments they had previously given to reduce their budget deficits to below 3% of GDP.

The low rate of interest at which most European governments can borrow at the moment can be explained by two factors, which are not necessarily permanent

1.) Sovereign bonds, that is bonds issued to allow governments to borrow, are treated as entirely risk free assets in the balance sheets of banks under the rules the EU has set for calculating the solvency and adequacy of capital of banks.  This is a somewhat artificial assumption, in that it implies that there is a ZERO risk that a European Government will ever default on its bonds ie. fail to pay all the interest due and repay the bond in full and on time. The scale of debt relative to income of some European countries might lead some to question this assumption, unless of course there is a big surge in either inflation or economic growth

2.) Prevailing interest rates are now so low, the amount of money seeking a home is so great, and high yielding investments are so scarce, that it is not surprising that investors are turning to government bonds, and thus driving down their interest rate. But if the flow of funds slowed, or if the availability alternative better yielding investments were to increase, the demand for government bonds would immediately slow. Then the interest on government bonds would have to increase, if governments were to sustain their borrowing levels.

It is against this background that the budget plans to be submitted by member governments of the euro  on 15 October will have to be assessed. The European Commission, in assessing the draft budgets of member states, would be unwise to assume that present low interest rates on government bonds are a permanent condition.

Ironically, while governments may defy the European Commission, they would not be able to defy the bond markets, if, for any reason, bond markets were to change their minds about sovereign bonds, and look for a higher interest rate. Bond markets can be less forgiving and less attentive to rhetoric or political argument than the European Commission or Ministerial colleagues in the European Council of Ministers.

That could happen quickly, leaving little time for adjustment. 

It is less likely to happen if the EU’s system for coordinating the budget policies of the 18 euro area states (the Two Pack and the Six Pack) are seen to be respected, especially by the big countries like France and Italy. This is backed up in a very specific way by Article 126 of the European Treaties.

If the system is defied, or reinterpreted in a way that removes its meaning, the fickle bond markets could get nervous again.

Ireland knows, better than most, how difficult that can be for a state that needs to borrow to fund services, or repay maturing debts.