This is my Perspective column from this week’s Fund Strategy magazine.
Much of the debate on global financial markets in recent weeks, and indeed on economic prospects too, has focused on “tapering” by America’s Federal Reserve. Whenever such a term comes into vogue it usually repays examining in more detail.
It is clear what tapering means in principle. It simply refers to a reduction in monetary support by the Fed. Quantitative easing (QE) – or credit easing as the Fed prefers to call it – will be gradually phased out at some point. Much of the discussion so far has tried to ascertain when that point is likely to come.
The prospect of such tapering has certainly spooked the markets. Many equity markets have fallen from their recent highs and there has been a sell-off of bonds worldwide.
Yet central banks are notoriously cryptic about communicating messages about their intentions. Their preferred methods amount to a raised eyebrow here and half a wink there.
In retrospect the Fed’s discussion of tapering began to emerge with the Federal Open Market Committee (FOMC) in March. The statement released after the meeting referred to the Fed continuing to take account of the size, pace and composition of asset prices.
At the next FOMC meeting, as well as in subsequent congressional testimony by Ben Bernanke, the Fed chairman, the discussion became slightly clearer. In his statement he said that: “At its most recent meeting, the Committee made clear that it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes.”
Although the discussion was posed in symmetrical terms it is clear that a Fed reduction in asset purchases looks much more likely than an increase. Bernanke was not exactly shouting it from the rooftops but he was signaling the possibility of a reduction in QE in the next few months.
At this point it is worth remembering the scale of state support for the economy in recent years. Official interest rates have remained in a narrow band of 0-0.25 per cent since late 2008. There have also been three rounds of QE with the latest as recent as last autumn. The Fed’s balance sheet has increased enormously as a result.
These measures amount to almost five years of considerable monetary support for the American economy. Indirectly it has also helped to shore up the global economy.
But the monetary side of state support is only part of the story. America has allowed its fiscal deficit to widen at the same time as allowing the Fed has pursued QE. Both fiscal and monetary policy have played a central role in keeping the American economy afloat in these difficult times.
At present it looks like fiscal policy will start to shift sooner than monetary policy. The federal government has already started to reduce its borrowing and is likely to continue to do so in the coming years.
The importance of this fiscal tightening was recognised by Bernanke himself in his congressional testimony:
“The expiration of the payroll tax cut, the enactment of tax increases, the effects of the budget caps on discretionary spending, the onset of the sequestration, and the declines in defense spending for overseas military operations are expected, collectively, to exert a substantial drag on the economy this year.”
This fiscal pressure helps explain the Fed’s current preoccupation with tapering. With the reduction in fiscal support already starting to get underway the central bank is trying to divine how far it can go in reducing QE.
Every Fed statement is therefore examined scrupulously for hints of future action. Data release, particularly those on employment, are also watched closely. The assumption is that a recovery in the jobs market could be the sign of a more general upturn.
Such obsessive Fed-watching probably makes sense for those involved in short-term market trading. A reduction in QE could indeed cause sharp movements in asset prices in America and beyond.
However, for anyone who takes a longer-term view it constitutes a problem. Obsessing over Fed actions obscures the importance of broader developments.
In particular there is a widespread assumption that America’s economic problems are essentially cyclical. When the economy starts to turn upwards then, so the argument goes, fiscal and monetary support for the economy can be scaled back. Everything can then go back to normal for a few years until the next downturn in the cycle comes along.
The problem with this view is that the current crisis is not simply a cyclical one. The authorities have engaged in widespread support for the economy, with slight fluctuations here and there, for at least three decades.
As things stand the prognosis is for a prolonged period of economic atrophy. Substantial state support for the economy looks set to continue although its efficacy is likely to be reduced. Every dollar of support is likely to have less impact than it did in the past.
The obsession over tapering reveals the narrowing of economic debate and the lack of long-term thinking about how to tackle the economic challenges facing America.
Jacob Hacker of Yale attempts to explain the sometimes bewildering concept of predistribution on this BBC Radio 4 Analysis programme. I ask a question at about 14 minutes.
This is my cover story on the upcoming German elections for Fund Strategy magazine. The associated graphics can be found here.
The German elections on 22 September are likely to be important for the whole of Europe. Whatever the complexion of the new government, it will play a central role in deciding the future shape of reformed institutions in the European Union.
In that respect, the federal elections of 2005 or even 2009 were not nearly so notable. Although they were a democratic exercise for German citizens, they did not have substantial consequences beyond the country’s borders.
It is only in the last few years, with the emergence of the euro crisis, that Germany has come to the fore. For example, it was only in December 2009, more than two months after the last federal elections in Germany, that Greece conceded its debts had reached record levels. Since then, other eurozone member states – most notably Greece, Ireland, Portugal and Spain – have all suffered well-publicised difficulties.
Georg Grodzki, the head of credit research at Legal & General Investment Management, says: “You now have so many more initiatives, proposals and actions on the agenda which were simply taboo only four years ago.
“The whole arsenal of intra-eurozone crisis management tools – country bailouts, rescue mechanisms, guarantees, banking union, ECB [European Central Bank] bond market interventions – neither existed nor would it have been considered legal and possible.”
Germany has come to play a central role in tackling these problems. Andrew Milligan, the head of global strategy at Standard Life Investments, says: “Germany is now very clearly the paymaster-general for Europe. It is in charge of the speed with which the European project goes and to a certain extent it can determine the direction. European banking union will largely be determined by what the Germans want.” This is likely to be even more the case in the next few years as the eurozone attempts to move towards closer fiscal integration and banking union.
Paradoxically, it does not necessarily follow that the eurozone will be a central theme of the election itself. On the contrary, the last thing the main German political parties want is to have a heated public debate on the subject. From their perspective such a discussion could be highly divisive as it could expose deep divisions among the German population.
For that reason, the German establishment is doing all it can to quieten down discussion on the topic. Milligan says:
“Mrs Merkel will want a very quiet 2013 as that puts her in the best possible position to win the election.”
Seema Shah, a global bond strategist at Principal Global Investors, goes a step further. “If anything, 2013 has been a quiet year for the European bond markets precisely because of the German elections. If anything were to kick off this year Germany would not take a strong position for or against,” she says.
Other eurozone member states, as well as EU officials in Brussels, are happy to go along with the trend to keep quiet about the region’s structural problems. The last thing they want to do is to upset their paymaster in Berlin.
However, there is a chance that the eurozone will become a focus for debate despite all the efforts to keep quiet about it. A new political party, the Alliance for Germany (AfD), is campaigning on an anti-euro ticket. Although the established parties are doing all they can to play down its significance, there is a chance it could win a substantial protest vote. If it wins seats in the election, it will probably be harder for the incoming government to constrain discussion on the merits and demerits of the eurozone.
To assess the significance of the September elections, not only for Germany but, more broadly, this article will examine three key themes. First, the discussion of the eurozone and reform of the EU more generally. Second, the debate about what is often referred to as “social justice” or “social cohesion”. This brings in topics such as curbs on executive pay, raising income tax and even a possible wealth tax. Finally, it will consider the debate about financial institutions themselves. For those who are new to discussing German politics, there is also a guide to the main political parties and a piece on the German approach to economics.
Although Germans are generally supportive of the EU, they are not universally favourable. A recent poll by Pew Global Research, a non-partisan American organisation, found 60% of Germans are in favour of the EU compared with 43% in Britain and 33% in Greece although 68% of Poles expressed a positive view. However, German support was substantially down on 2012, when 68% of those questioned were favourable.
If anything, the opinion among the mainstream parties differs less than among its citizens. As Kevin Lilley, the manager of the Old Mutual European Equity fund, noted in a written statement: “Germany has a consensus-driven political system and the left wing is even more pro-European than the right and has generally supported the current government’s actions.”
One area on which the parties have differed is eurobonds – that is bonds issued jointly by eurozone member states. In 2010, Peer Steinbrück, now the opposition Social Democrat (SPD) candidate for chancellor, co-wrote an article in the Financial Times in which he supported such instruments (“Germany must lead fightback” FT 14 December 2010). However, more recently, he has played down such initiatives. Clearly, they could potentially exacerbate German fears that it could end up paying a high price for bailing out others.
In contrast, the Free Democrats (FDP), the junior partner in the Christian Democrat- led coalition, is strongly against such debt mutualisation measures. It has resisted the idea of eurobonds as well as that of a common debt redemption fund.
Shah does not see any prospect of eurobonds being introduced in the foreseeable future. “I do not envisage anything such as a debt redemption fund or eurobonds coming in in the next few years at all,” she says. “It does not matter who wins.”
That is not to say that an SPD-led German government would necessarily be seen as a soft touch by other eurozone member states. It might be less strict on fiscal deficits but it could be more stringent in other ways. For instance, it was the SPD along with the Greens that first demanded a bail-in of bank depositors in Cyprus. They took this position on the grounds that they were against the bailing out of Russian oligarchs.
Perhaps the biggest wild card in the election is the AfD. If it becomes a vehicle for public discontent, as the Five Star Movement did in Italy, it could cross the 5% threshold and win seats in the lower house (Bundestag). However, even if it got, say, 2-3% of the popular votes, there is a chance it would take support disproportionately away from the current coalition parties.
Although the emergence of a eurosceptic party is a radical departure for Germany, the AfD is more technocratic than populist. Much of its core membership consists of fiftysomething economics professors rather than street protestors. It calls for an orderly break-up of the euro rather than the abolition of the EU.
On the face of it, the SPD and Greens should do well in the elections with their emphasis on social justice and maintaining social cohesion. According to the Pew Global Attitudes survey, no other Europeans place as much emphasis on reducing inequality as the Germans. Some 51% of Germans said it was their main concern in the poll.
This is perhaps strange given that the German economy and labour market are performing relatively well. According to a recent survey by the Organisation of Economic Cooperation and Development, a rich country think tank, earnings are increasing and poverty is falling. Germany’s unemployment rate is also low compared with other European countries. To the extent there is concern it focuses largely on such topics as sluggish economic growth and skyrocketing rents.
Nevertheless the SPD is committed to at least mitigating the extremes of inequality. In its election platform, it calls for an increase in the top rate of income tax as well as a statutory minimum wage. The Greens go even further in the direction of redistribution with support also for a wealth tax and increased inheritance tax.
Not that the CDU is entirely hostile to redistribution. Merkel has voiced support for measures to curb top manager salaries although she is opposed to any wealth tax.
It would also be a mistake to take the Spud’s apparently left wing rhetoric at face value. It was an SPD-led “red-green” government under Chancellor Gerhard Schröder that introduced the Agenda 2010 programme in 2003. The initiative made it easier for employers to fire workers as well as reducing entitlements to unemployment benefits.
This then is another area where the differences between the parties are not as great as they first appear. Although the SPD and Greens place more emphasis on redistribution than the conservative parties, they have taken a leading role in promoting a more flexible labour market. Meanwhile, the CDU is willing to criticise high executive pay when it is widely regarded as excessive.
The banking sector, and financial markets more generally, have both practical and symbolic value in the election.
As with social justice, it is the SPD that takes the lead in criticising the banks. What the party calls “taming financial capitalism” is central to its programme. As Sigmar Gabriel, the party chairman, wrote in the Guardian in March: “The real root of the [economic] crisis does not lie with profligate governments. Rather, it was excessive speculation and the resulting crash that forced many states to go massively into debt to bail out their banks.” (“German Social Democrats’ twin goals of social justice and banking reform”, Guardian, 14 March 2013 ).
This argument leads it to proposals for extensive reform of the banking system. It favours stricter capital adequacy requirements, a reduction of proprietary trading and the introduction of a financial transaction tax. It also supports the creation of a separation between commercial and investment banking.
The problem is that it did not attempt to introduce such measures when it was in office. To its critics its arguments can seem like opportunistic posturing.
It talks radical by criticising the conservatives when they are in office but is reluctant to take action itself.
Of course, this does not stop the SPD trying to take advantage of tax scandals. When Ulli Hoeness, the president of Bayern Munich Football Club and in Germany’s 1974 World Cup winning team, became embroiled in a tax scandal, both the CDU and the Christian Social Union (CSU), its Bavarian sister party, distanced themselves from him. The two parties had until then maintained friendly links with the football icon.
However, banking reform is hardly a theoretical topic in relation to the debate about the future of the eurozone. On the contrary, it is widely viewed as central to any programme of European economic integration.
As things stand, the plan is to introduce banking union in three stages. First, there will be the introduction of common supervision in which the ECB will take on responsibility for regulating banks across Europe. The plan is for this to start in July 2014 although it is still unclear how extensive the scope will ultimately be.
It could end up with the ECB directly supervising only a few large banks or it could go a lot further.
The next stage is a single resolution mechanism. This would provide a way to deal with banks that got into serious trouble. However, in April, the CDU finance minister Wolfgang Chasuble suddenly argued that introducing this step would require treaty change within the EU. If Germany holds to this line, it will inevitably mean slowing down the process of banking union.
Finally, there is the question of a common deposit guarantee scheme. In a truly integrated eurozone, a pan-European scheme would protect depositors from all member states. Yet it is hard to see this stage going ahead until the single resolution mechanism is sorted. On paper, the SPD and indeed the Greens too are more amenable to banking union. Both parties have expressed support for a European-wide resolution fund. But it would not be surprising if they toned down such support if they were elected into office. They are certainly sensitive to the charge that hard-working Germans should have to bail out allegedly lax southern Europeans.
Such concerns are part of what Ulrike Guérot, the senior policy fellow at the European Council on Foreign Relations in Berlin, refers to as the “paymaster victimisation discussion”.
Germany is keen on European integration in the abstract but is reluctant to pay the price. “Germany is not prepared for what needs to be done,” she says. “So it delays the whole thing.”
The most likely outcome of the Sept-ember elections is another CDU-led government. A grand coalition including both the CDU and the SPD is also a distinct possibility. But whoever is victorious could be facing tumultuous times in Europe in the years ahead.
Christian Democratic Union (CDU) The senior party in the current coalition government. Conservative in outlook. Leading figures include Angela Merkel and Wolfgang Schäuble, the finance minister. At the time of writing, the party was well ahead in the opinion polls.
Christian Social Union (CSU) More conservative Bavarian sister party of the CDU. Led by Horst Seehofer, who was previously a minister in Merkel’s cabinet and is now the premier of Bavaria.
Free Democratic Party (FDP) Also known as the Liberals. The junior coalition partner in the current CDU-CSU government. Own the centre-right and pro-business. There is a chance it will not receive the 5% of votes necessary to win seats in the Bundestag (lower house).
Social Democratic Party (SPD) The main opposition party. The centre left organisation recently celebrated its 150th anniversary although it has travelled far from its hard left roots. Its candidate for chancellor is Peer Steinbrück who served as finance minister from 2005 to 2009.
Greens (die Grunen) The most important green party in Europe. Served as part of the governing “Red-Green” coalition with the SPD from 1998-2005. However, it has formed coalition governments in regional states (Länder) with the CDU and the FDP. Led by Claudia Roth and Cem Özdemir.
Left Party (die Linke) Its roots can be traced back partly to the ruling party of the old Stalinist East Germany regime and partly to disgruntled former SPD members. Led jointly by Katia Kipping and Bernd Riexinger.
The Pirates (die Piraten) The party, founded in 2006, received about 2% of the votes in the 2009 national elections. Its main focus is on freedom of information. Appears to have passed its peak of support.
Alternative for Germany (Alternative für Deutschland – AfD) New eurosceptic party led by Bernd Lucke, an economics professor in Hamburg. Advocates a gradual dissolution of the eurozone although it does not call for a German exit from the European Union. Could appeal to protest voters who in the past might have voted for the Greens or the Pirates.
The composition of the Bundesrat (upper house) is determined by the 16 Länder governments so its composition changes with regional elections.
[BOX two] German economics
One reason for the frequent tension between Germany and other members of the eurozone is the significantly different economic outlook held in German governing circles. Germany tends to place more emphasis on monetary stability and balanced budgets than other European countries.
This difference is routinely explained as a hangover from Germany’s experience of hyperinflation in the early 1920s. Media discussion of German attitudes towards inflation is typically illustrated with old photographs of people carrying worthless piles of banknotes in wheelbarrows.
The problem with this explanation is that hardly anyone alive today can be old enough to remember events of 90 years ago. Although the experience of economic dislocation in Weimar Germany was undoubtedly traumatic, it was a long time ago.
Although there is a link between the current discussion and Germany’s economic past it is not as straightforward as a folk memory of hyperinflation. It is better understood in relation to the extreme fear of instability that imbues the German elite. The resultant emphasis on order applies as much to economics as other aspects of Germany life.
What is sometimes called Ordoliberalism emerged in German in the 1930s. It can be seen as a conservative response to the economic experience of the 1920s and the excesses that were already apparent in the early days of Nazism.
Its founders, including Franz Böhm, Walter Eucken, Hans Großmann-Doerth and Wilhelm Röpke, were wary both of excessive state power and unchecked markets. Like classical liberals they believed in the importance of markets but unlike them they saw the state as playing a key role. For instance, the role of the state was not just to ensure exchange could take place but also to prevent the emergence of powerful monopolies. It also had to create and police a framework of rules for economic actors to follow.
With the emergence of the Federal Republic after the Second World War, the ordoliberals came to play an important role in devising what came to be called the social market economy (Soziale Marktwirtschaft). They influenced the thinking of Ludwig Erhard (CDU), who was West Germany’s first finance minister and later became chancellor. Essentially a degree of income redistribution and social safety nets were added to the idea of a highly regulated market economy.
A link to my spiked review of The Great Gatsby appeared on the Real Clear Books portal site today.
They may not have the name recognition of Rihanna or Justin Bieber but central bankers have become high profile public figures.
Until perhaps the 1990s central bankers were dull technocrats who were hardly known outside government or financial circles. Since then they have become dull technocrats who are widely recognised by those who follow the news.
This was apparent earlier this month when Mervyn King, the outgoing governor of the Bank of England, appeared on BBC Radio 4’s Desert Island Discs. Not only did he appear on the show but it also received widespread media coverage.
Less well covered, at least in this country, was the speech given by Ben Bernanke, the chairman of America’s Federal Reserve, to this year’s graduating students at Princeton. He gave 10 suggestions to his audience of which the third, on meritocracy, attracted the most attention.
The Fed chairman made the obvious point that the people who do best in contemporary societies generally have a substantial amount of luck: “A meritocracy is a system in which the people who are the luckiest in their health and genetic endowment; luckiest in terms of family support, encouragement, and, probably, income; luckiest in their educational and career opportunities; and luckiest in so many other ways difficult to enumerate – these are the folks who reap the largest rewards.”
He then went on to argue that in a meritocracy those who do well have a moral obligation to contribute to society: “The only way for even a putative meritocracy to hope to pass ethical muster, to be considered fair, is if those who are the luckiest in all of those respects also have the greatest responsibility to work hard, to contribute to the betterment of the world, and to share their luck with others.”
Many commentators, including those sympathetic to Bernanke, saw his speech as a radical one. The Washington Post, for example, called it a “surprisingly excellent, radical speech”. Slate, an online magazine, said that Bernanke had given a “great talk” and the section on meritocracy was the best.
Paul Krugman, the New York Times columnist and Nobel laureate, also hailed Bernanke’s speech as excellent although he was judiciously cautious about calling it radical. For Krugman the speech simply showed where the evidence leads when it starts from what he regards as a sensible view of social justice.
Krugman is right to be wary of describing Bernanke’s argument about social responsibility as radical. On the contrary, it embodies the old aristocratic notion of Noblesse Oblige (nobility obliges) – in other words those who have wealth and power have corresponding responsibilities.
In that sense it is not a radical view but a conservative one. It justifies the privileges accorded to a technocratic elite on the grounds that its members will do right by the rest of us.
This is a view that is particularly important to challenge at a time when unelected officials have so much sway over the public. Whereas key economic decisions used to be made by elected politicians today they are often outsourced to central bank governors and the like.
Central bankers may have excellent academic qualifications, and in that sense be part of a meritocracy, but they have no democratic mandate to govern society.
This blog post first appeared today on Fundweb.
This article on the eurozone was written for the June issue of IPE (Investment & Pensions Europe) magazine. It is more technical than usual and, given that I quote several people, the views are not entirely my own.
In July 2012, the President of the European Central Bank (ECB), Mario Draghi, gave a landmark speech on the troubled eurozone. “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” he said.
The speech was welcomed by market participants. Alongside other measures announced afterwards it helped to settle what had become a profoundly jittery market. After months of muddling-through, the authorities seemed to have taken the decisive steps necessary to quell the possibility of a eurozone break-up.
Bill Street, the head of investment at State Street Global Advisors (SSGA), no doubt speaks for many when he says he saw Draghi’s commitment as a “hugely positive step”. In Street’s view the ECB President “created a very positive environment for the markets”.
However, Street also argues that the goodwill won’t last forever. Draghi’s landmark commitment created a “window of opportunity”, he says, which could “close pretty quickly from a market and volatility perspective, if the policymakers don’t adhere to their commitments”.
Almost a year since “whatever it takes”, a review is timely. Before examining developments, it is worth reprising what Draghi said as well as recalling the associated policy initiatives. Then it will be possible to assess progress in relation to three key areas: fiscal, monetary and banking union.
With the benefit of hindsight, last July’s speech was relatively sanguine about fiscal policy.?At the time, Draghi said “the progress in undertaking deficit control, structural reforms has been remarkable”.
The official view was that these challenges were already being tackled. Eurozone member states signed a Fiscal Compact in March 2012 which came into effect until January 2013. The agreement created a framework for fiscal prudence by placing limits both on fiscal deficits and on levels of public debt relative to GDP.
It is also noteworthy that Draghi’s speech did not mention economic growth. Although the eurozone economy was performing poorly at the time this was viewed as a problem that?would pass.
Draghi’s main preoccupation in the summer of 2012 was what he referred to as “fragmentation”. The final, and most important, part of his speech focused on how the reassertion of national divisions was threatening the integrity of the eurozone. His most pressing concern was the banking sector.
“The short-term challenges in our view relate mostly to the financial fragmentation that has taken place in the eurozone,” he said. “Investors retreated within their national boundaries. The interbank market is not functioning.”
Another way of conceiving of the same problem is that sovereign debt and bank liabilities had become too entwined. For example, an otherwise healthy bank in a troubled eurozone member state could suffer a kind of ‘guilt by association’. Investors could withdraw capital simply because of where the bank was based. Conversely the collapse of troubled banks could also raise questions about financially sound nations.
A week after Draghi’s speech, the ECB announced its scheme for outright monetary transactions (OMT). Designed to provide official support for troubled member states, it gave the ECB the ability to buy unlimited amounts of sovereign debt in the secondary markets.
In mid-September, the European Commission adopted two proposals designed to tackle the longer-term challenge of banking union. It supported a Single Supervisory Mechanism (SSM) for banks as a first step towards full union. Later steps would include a single bank resolution mechanism and a common deposit protection scheme. If this programme were fully implemented it would create an integrated banking sector across the eurozone.
On one level, it is clear that last year’s initiatives have proved successful. The perceived risk of a eurozone breakup has receded. As a result, events that might have startled the markets last year – the disagreement over the Cyprus bailout and the uncertainty over the formation of an Italian government – have met with relative equanimity. For Cosimo Marasciulo, head of government bonds and foreign exchange at Pioneer, “from an investment perspective this is a remarkable result”.
In other respects progress is more mixed. One pressing concern is that, even according to official forecasts, the eurozone looks set to suffer a second consecutive year of economic contraction. Although financial markets have recovered the improvement has not spilled over into the real economy. Many voices are calling for more relaxed fiscal policy in selected countries to tackle the risk of a deflationary spiral.
Such calls were already apparent at the summit of EU leaders in March 2013, when France and Italy won support for a more flexible interpretation of the Fiscal Compact. Subsequently it has become widely accepted that France, Spain and even the Netherlands should be given more leeway in meeting their fiscal targets. José Manuel Barroso, the president of the European Commission, has also said in a speech that austerity has “reached its limits” – although he also emphasised the policy was fundamentally right.
Many fund managers accept that a measured loosening of fiscal policy makes sense in the current tough economic environment. For Léon Cornelissen, chief economist at Robeco, “it is clearly a positive as austerity is self-defeating”.
Similarly, for SSGA’s Bill Street, some fiscal relaxation is welcome as long as it does not go too far. “It’s not completely surprising that the fiscal tap turns on and off over these cycles,” he says. “It would be more worrying if there were a complete ideological leap.”
The degree of fiscal loosening should not be overstated. Several countries look set to meet their fiscal targets later than planned but the framework should remain intact. If this temporary leeway becomes permanent, it might not be so readily accepted in the markets. It is also notable that not all member states will either request, or be given, such room for manoeuvre. Germany seems certain to meet the fiscal targets while peripheral countries are likely to enjoy relaxation
There is broad consensus that monetary policy should be accommodative. In May, the ECB reduced its main interest rate to 0.5%. However, there is a substantial gap between the headline central bank rates and market rates. Many companies and households, especially in peripheral countries, have to pay substantially more for credit, than those in the core. In an attempt to help tackle this divergence the ECB was, at the time of writing, hinting at a scheme to bolster credit for small and medium-sized enterprises. There is also talk of additional extraordinary monetary measures but they are yet to materialise.
The ECB is generally seen as doing a good job under difficult circumstances. “The credibility of the eurozone has improved over the last few months thanks to the ECB,” says Eric Brard, global head of fixed income at Amundi.
Banes of banking union
The most fraught area remains, as it was last summer, banking union. That is because it raises the thorny issue of financial fragmentation and ultimately broader existential questions about the eurozone. The region is more than a loose association of nation states but less than a fully integrated economic bloc. As a result, it frequently has to negotiate tensions pulling it in either direction.
At present the eurozone is inching its way towards the first stage of banking union by creating a single supervisor. In the July 2014, the ECB will start directly supervising the region’s largest banks. Smaller banks will remain under the purview of national regulators, although the central bank will have overall responsibility.
One reason ECB supervision is important is because it is a pre-condition for the direct recapitalisation of banks by the European Stability Mechanism (ESM). Without it the eurozone’s permanent bailout fund, established in September 2012, will not be able to help rebuild the region’s battered banking sector – and thereby break the connection between banks and sovereigns.
However, some see the Cyprus rescue package as pointing towards a resolution of this problem. If, in the event of a bail-out, troubled banks have to accept a levy on deposits (and their senior bondholders have to accept default) this in a sense breaks the link with the sovereign. The so-called “bail-in” arrangement could, in this view, be more widely applicable.
Leigh Skene, an associate economist at Lombard Street Research, has argued that such bail-in arrangements have benefitted the stronger economies. In his view, the policy change means that bank failures can no longer bankrupt financially sound nations (unless they ignore the bail-in provisions agreed by G20 finance ministers and central bankers).?“The outlook for the sovereign debt in most countries has improved significantly, especially those with big financial sectors and/or too-big-to-fail banks,” he has written recently.
Nonetheless, the broader drive towards full banking union looks in danger of stalling. In April, the German finance minister, Wolfgang Schäuble, raised the objection that a bank resolution mechanism, the second stage of union, could require treaty change. If Germany holds to this line, it would make banking union an even more drawn-out and cumbersome process.
Part of this reluctance to go ahead with a single resolution mechanism relates to the tricky question of legacy assets. Core countries, including Germany, are anxious to avoid paying the cost of recapitalising banks that have historically got into trouble. Germany is in favour of a more integrated eurozone in principle, but feels it should not pay for the errant behaviour of others. The trickiest challenges are arguably political rather than financial or economic.
As Ulrike Guérot, a senior policy fellow at the European Council on Foreign Relations in Berlin, says: “Germany is pretty structurally asymmetric to the rest of the eurozone”. In her view there are two dimensions to this asymmetry: demographic and economic.?Germany has a high median age, so elections tend to centre on the preoccupations of the middle-aged and elderly. In particular, there is a heavy emphasis on maintaining low inflation to protect savers. The southern European countries tend to be more focused on young people and the need to curb unemployment.
In addition, Germany’s interests are closely tied to manufacturing and exports than those of the more domestically-oriented economies of France or southern Europe. This is not to single out either the Germans or the southern Europeans for blame, but rather to explain the inertia in the system: fundamental differences result in a strong temptation to muddle through, unless an imminent threat forces the parties involved into action.
There are certainly no signs of decisive action arising from the German elections in September. Robeco’s Cornelissen expresses a common view when he says the current conservative-led government is not seeking to take the country in any clear direction.
Perhaps the greatest wild card in the election is the emergence of the new party Alternative für Deutschland (Alternative for Germany). The party is calling for a phased German withdrawal from the euro in a development that would have been unthinkable a short while ago. Many doubt it will exceed the 5% threshold needed to gain seats in the Bundestag but it could gain a significant protest vote.
The most likely scenario for the eurozone is that policymakers will continue to muddle through unless forced to do otherwise. Dario Perkins, an economist at Lombard Street Research, says that for this reason anxiety could return in a new form. “I don’t think the crisis is really over,” he says. “It’s a different type of crisis now”.
On balance the eurozone’s record since last summer is uneven. Policymakers have quelled the threat of a breakup, loosened fiscal policy for some countries and attempted to make monetary policy more accommodative. They have also taken the first step towards banking union.
On the negative side, the economic downturn has proved more protracted than expected and the forces of fragmentation have not disappeared entirely. Banking union, including the attempt to divorce sovereign risk from bank liabilities, has proved tough to take to a higher level.
Draghi’s “whatever it takes” speech in July 2012 did indeed provide a window of opportunity for the eurozone. However, if the markets come to believe that not enough is being done to resist fragmentation the window could still be slammed shut.
This is my Perspective column from this week’s Fund Strategy magazine.
The recent controversy over tax avoidance by the likes of Amazon, Google and Starbucks has revived old arguments about the power of global corporations. Such companies, it is argued, have become so big and pervasive that they can circumvent national governments.
Margaret Hodge, a Labour MP and chair of the Public Accounts Committee, is a high profile leader of the charge against such firms. She has accused them of immorality for avoiding tax even though she concedes they have not broken the law. For instance, she told Matt Brittin, the head of Google for northern Europe, that his company’s tax affairs were “devious, calculated and, in my view, unethical”.
Robert Reich, an American politician and academic, is one of the best-known corporate critics on the other side of the Atlantic. The former US Labour Secretary has argued that: “global capital, in the form of multinational corporations as well as wealthy individuals, is gaining enormous power over nation states”.
It should be readily apparent that politicians have a vested interest in making such claims. By focusing on the alleged misdeeds of corporations they can avoid their own culpability for problems. Railing against allegedly immoral tax practices by companies is a way of sidestepping awkward questions about the inadequacy of the legal framework created by legislators.
But just because politicians have a vested interest in criticising corporations it does not necessarily follow that the charges are entirely misplaced. It is true that many companies have become highly international. They trade overseas, invest abroad and have many other global connections.
It is also often said that about 70% of the earnings of FTSE 100 companies derive from business overseas. Admittedly the figure is skewed as it refers to the biggest companies rather than the whole corporate sector. Large companies tend to be, on average, more global than smaller ones. Nevertheless, it is striking that British companies lean so heavily on their international operations.
The mistake made by corporate critics is to assume that more international companies must mean less state power. In their view one necessarily takes power from the other.
This argument makes a false counter-position. Companies have become more international while, at the same time, states have become more extensive in their operations.
Probably the most graphic illustration of this trend relates to state spending. Public spending in Britain still accounts for about 40% of GDP despite all the talk of cuts. In other words government spending directly underpins a high proportion of economic activity.
Even this figure understates the true economic role of the state in contemporary economies. The state plays a key part in virtually every area of economic life. It transfers vast sums from some areas to others, enforces an extensive framework of rules and plays a key part in maintaining infrastructure. This extensive role in maintaining economic activity applies to supposedly free market economies, such as America and Britain, just as it does to continental European ones.
For better or worse, the world consists of both highly interventionist states and many international companies. It is misleading to assume the two are directly in competition with each other let alone to argue that corporations dwarf governments.
Although the debate on global capital has come to the fore recently it goes much further back than is generally assumed. Between about 1870 and the onset of the First World War in 1914, the world became highly internationalised. Back then cross-border trade and investment also accounted for a high proportion of economic output.
Against this backdrop many high profile figures argued that global capital was overwhelming nation states. John Hobson, an important influence on John Maynard Keynes, wrote a book called Imperialism (1902) that argued a unified international oligarchy was emerging. As a result, he concluded that nation states were becoming less important. In many respects, contemporary critics such as Robert Reich echo Hobson’s arguments.
A few years later, a prominent writer and Labour MP Norman Angell, wrote a book called The Great Illusion (1909). He put a positive spin on internationalisation by arguing that the world economy was so integrated that the great powers no longer had any interest in fighting each other.
Angell’s argument was discredited in the most brutal way possible when a few years later when the first world war erupted. As mainland Europe descended into bloody carnage it was no longer possible to maintain that nation states were becoming irrelevant.
It is only recently that the world economy has become as internationalised as it was before the first world war. In the decades following 1914 the economic ties between countries were weakened by two world wars, the Great Depression and the advent of the Cold War. The second period of globalisation only emerged in the 1970s after a gap of several decades.
None of this is to suggest that the world is on the brink of another world war. Thankfully this is not the case. But it does show that critics who counter-pose national states to international companies make a misleading argument. In the contemporary world powerful nation states co-exist with a high degree of international economic integration
This is my latest article for the Spiked Review of Books
The Great Gatsby has become a phenomenon. Not only is there a new blockbuster film, with Leonardo DiCaprio in the title role, but also plays, dance performances and even computer games. The novel sells hundreds of thousands of copies every year and is almost universally hailed as one of the great works of American literature.
This is strange, because when F Scott Fitzgerald’s work was first published, in 1926, the reception was muted. Sales were poor and the response by critics mixed. It was only in the early 1950s that the novel became popular, while what could be called the Gatsby obsession is of more recent origin.
To understand the shift, it is necessary to distinguish sharply between the way the character Jay Gatsby is seen nowadays and the way he was originally depicted. For the sake of simplicity, let us contrast Gatsby in Baz Luhrmann’s new film and the Gatsby of the actual novel. Despite the similarity of plot, there is a world of difference between these two versions of the same character.
Of course, given the nature of the two media, film versions of novels tend to be highly simplified. It is almost impossible for a movie of two to three hours to do justice to the nuances of a complex novel. But the differences between the new film and the novel go much further than that.
It is not that the film is untrue to the plot of the novel. On the contrary, it is quite faithful, although, as would be expected, it leaves important elements out. It is rather that the film lacks the ambivalent sense of possibility that is central to Fitzgerald’s novel.
For contemporary audiences, the point of the film is much more readily accessible than the book. The movie gives a voyeuristic glimpse of what life was supposedly like for younger members of what is nowadays referred to as ‘the 1%’. In that sense, it is true to Fitzgerald’s famous dictum that the rich ‘are different from you and me’. In contrast, the novel is not simply about Gatsby’s desire to become wealthy but is also about his drive to reinvent himself – it is a wider allegory for the American dream.
The themes of the film are therefore familiar to anyone who follows the news, reads contemporary novels, or indeed watches movies. It depicts the supposed greed and excesses of the super-rich, or, as some would call them, the filthy rich, in New York in the 1920s. Much of the focus is on almost orgy-like dance scenes in Gatsby’s mansion – more akin to Ibiza 2013 than Long Island 1922 – and car chases that would befit an action movie. Ironically, given the plot, it is also a showcase for designer brands, with Prada and Miu Miu figuring prominently.
The outline of The Great Gatsby is so well known that it is easy to view it as a simply morality tale: however hard most people try to move on, the 1% will keep them down. This is how the film tells the story. Jay Gatsby’s rise from poverty and his subsequent fall are easily read as an endorsement of the view that social mobility in America is a myth. Despite his initial success in achieving wealth, the established rich – Old Money – refuse to accept Gatsby as one of their own. Ultimately, they have no qualms about engineering his downfall.
To understand the differences with the novel, it helps to look at the historical context. Fitzgerald was one of a ‘lost generation’ of artists who came of age during the First World War and included the likes of TS Eliot, Ernest Hemingway, John Dos Passos, Erich Maria Remarque and John Steinbeck. Following the carnage of the war, it is hardly surprising that such artists tended to be imbued with a deep cultural pessimism. Fitzgerald himself referred to the period following the war as the Jazz Age, with ‘a generation all grown up to find all Gods dead, all wars fought, all faiths in man shaken’.
It was also an era of tremendous tumult. Most notably the Russian Revolution of 1917 had generated both enormous hope and hostility around the world. It also triggered failed uprisings in many other countries, most notably Germany. By the early 1920s, the situation had started to stabilise, but there were still important events such as the establishment of the Irish Free State and hyperinflation raging in Weimar Germany.
America underwent big shifts, too. It had become a more centralised society – with the federal government gaining pre-eminence over local states – and a much less agrarian one. Two key developments provided part of the backdrop to Fitzgerald’s novel. It had become more acceptable for women to have a degree of freedom, with female suffrage being granted in America in 1920. And there was the emergence of an era of mass consumption. This is partly reflected by the role of cars and advertising in the novel. It is easy for us to take these aspects of the book for granted, but in the 1920s they were innovations.
So while the 1920s were pessimistic compared with what had come before, in America there was still some sense of possibility. Women were becoming freer; new economic opportunities were emerging; and mass consumption was becoming a reality. The sense of possibility was more muted in Europe, which had suffered the direct brunt of the war and social dislocation and was more troubled economically.
Jay Gatsby in many respects reflects the sense of possibility that was strongest in America. As a 17-year-old farm boy in North Dakota, he had conceived of a ‘Platonic conception of himself’, to which he was faithful until his demise. He is described by Nick Carraway, the narrator of the novel, as a ‘son of God’ who ‘must be about His Father’s business, the service of a vast, vulgar and meretricious beauty’.
This degree of hope remains alive, not rejected by the narrator, in the book’s famous final paragraph. It describes how ‘Gatsby believed in the green light, the orgastic future that year by year recedes before us. It eluded us then, but that’s no matter – tomorrow we will run faster, stretch out our arms further…’
Admittedly, Jay Gatsby’s dreams are ruthlessly beaten down by Old Money. Carraway describes the representatives of Old Money as ‘careless people’ who ‘smashed up things and creatures and then retreated back into their money or their vast carelessness, or whatever it was that kept them together, and let other people clean up the mess they had made’.
Contemporary liberals one-sidedly grasp this pessimistic side of the story. It confirms their prejudice that progress is a forlorn hope and wealth will always remain the privilege of the elite. Such tellings transform a great novel into a simple tale of greed and excess.
Yet despite its pessimism, the novel retains much hope. It raises the possibility of humanity remaking itself for the better, of running faster and stretching our arms further. Unfortunately, Gatsby’s ‘green light’ does not feature in the recent retelling of his tale by Baz Luhrmann, but anyone who has high hopes for humanity may find something inspiring in the more complex novel.
This is my cover story from last week’s Fund Strategy magazine. Note that, since I quote many people, not all opinions included in this article are mine.
In his March 2011 budget speech the chancellor of the Exchequer, George Osborne, put forward a vivid vision of how the British economy could return to growth. The new prosperity would be driven by the manufacturing sector and the export of goods abroad:
“We want the words: ‘Made in Britain’, ‘Created in Britain’, ‘Designed in Britain’ and ‘Invented in Britain’ to drive our nation forward—a Britain carried aloft by the march of the makers. That is how we will create jobs and support families.”
Osborne was echoing a call made by all of Britain’s main political parties since the emergence of the economic crisis in 2007-8. There is a broad consensus that the economy should be rebalanced away from financial services and towards the industrial sector.
That of course is not to contend that services, which account for about 77% of output, should disappear. The idea is that the British economy had become too heavily weighted towards financial services in particular. From this it follows that more emphasis should be placed on rebuilding manufacturing. An industrial renaissance is seen as key to the fortunes of the whole British economy.
Yet the economy has confounded this hope by going in the opposite direction since the crisis started to become apparent in early 2008. According to figures released in April by the Office for National Statistics the service sector was 0.8% above its pre-recession peak. Manufacturing, in contrast, was 10% below its high point.
These figures point to a peculiar paradox. The sector that was meant to lead the recovery is still languishing while the sector in which the crisis emerged has surpassed its previous best. If anything it is the servers who are marching forwards while the makers are in retreat.
Recent trade statistics underline this point. British still has a strong positive balance in its external trade in services. However, this is more than offset by a large deficit of its trade in goods, with no sign of recovery. Overall this leaves Britain with a yawning trade deficit.
This abject failure to bring about a manufacturing revival raises awkward questions about the British economy and its corporate sector. What is the character of the relative decline of manufacturing? Does it matter for the British economy as a whole and for its corporate sector? If so what can be done about it? The rest of this article will examine each question in turn.
Decline is a deceptively slippery concept to pin down. It always begs the question of decline relative to what. There can be decline relative to some measures but increases relative to others. The tricky thing to work out is which metrics matter.
There is no doubt that Britain has suffered a long-term decline in its productive capacity relative to the rest of the world. As far back as 1860, at the height of the Victorian era, Britain accounted for about 20% of global manufacturing output. Today it accounts for a little over 2%.
Although Britain is still the ninth largest manufacturer, which makes it a sizeable player, it was once number one. It is also likely to be overtaken by several emerging economies in the coming years.
This shift away from a leading position does matter in relation to global politics. Historically economic power, particularly industrial might, has been closely tied to military and political influence. It is therefore not surprising that Britain long ago relinquished its record as the world’s pre-eminent power.
However, the particular form of decline does not necessarily matter in relation to economics. On the contrary, the world economy today, including the manufacturing sector, is vastly bigger than it was in the mid-nineteenth century.
Indeed in real terms Britain produces a lot more than it did back in then. It is just that Britain was the first country to industrialise and many have followed its path since. Britain is certainly a far more prosperous place than when it was the workshop of the world and Britannia ruled the waves.
Other forms of relative economic decline are more recent. Manufacturing has fallen sharply as a share both of employment and GDP over the decades.
Perhaps the most striking employment statistics relate to coal mining – strictly speaking not part of manufacturing although classified as industry. According to figures gathered by the National Coal Museum there were over 1.2m coal miners in Britain in 1920. These men were digging out coal with relatively primitive technology to fuel Britain’s manufacturing sector as well as associated areas such as transport. By 2004, in contrast, only 6,000 people were employed in coal mining.
Yet coal digging has become vastly more efficient over that period. Back in 1920 each employee dug up an average of 183 tons of coal compared with 4,500 tons per person in 2004.
There are no doubt several reasons for this shift including the closure of smaller and less efficient pits. But a key factor was the application of technology to make coal mining more efficient. Each individual can be vastly more productive thanks to the introduction of machinery. On top of that are the considerable health and safety benefits of not having to send vast armies of men underground.
This dramatic change points to a broader shift in British industry. It has become much more productive and capital intensive. Where there were once large armies of manual workers at many plants today there are far fewer. The number of people employed in manufacturing fell from about 5.7m in 1981 to 2.5m in 2011. In percentage terms that represents a drop from 22% of the workforce to 8%.
That is a substantial shift but it does not necessarily constitute an economic problem. Production can increase even though the number of employees falls. Indeed this rise in productivity – output per employee or per hour – is central to economic progress.
The shift away from manual work is more significant in social than economic terms. More people are involved in the services sector and far fewer are involved in producing goods. Arguably this change can also be associated with a cultural shift. It helps explain why nowadays people typically view the world from a consumer’s perspective rather than that of a producer. For most people the world of production is distant from their lives.
Another striking area of relative decline is in relation to output. Manufacturing output has fallen from about 25% of the economy in 1980 to 11% today according to World Bank figures. By this measure manufacturing has also become a lot less important relative to the economy as a whole.
The vast majority of British firms are not involved in manufacturing directly. They no doubt use manufactured goods, and perhaps supply manufacturing companies, but they are not goods producers.
It is therefore possible to identify at least three key areas in which British manufacturing has suffered a sharp relative decline. Its share of global output has fallen, far fewer people are employed in the sector and it accounts for a shrinking share of GDP.
These trends are common across the developed world. Britain, once the workshop of the world, has perhaps fallen further than others but it is not unique. Even mighty America does not enjoy the pre-eminence it had not that long ago. In 2010 China became the world’s largest producer of manufactured goods. Although American products were still, on average, more sophisticated the America lost the leading position it had since overtaking Britain to capture industrial pre-eminence.
This all begs the question of whether the relative decline of the Britain’s manufacturing sector matters. Perhaps it is only the economy as a whole that counts. All the talk of the “march of the makers” might simply be a panic reaction to the financial crisis.
It might even be possible, in principle at least, for Britain to offshore all of its industrial production to the rest of the world. In any case it seems at least debate-able that there is a need for manufacturing to be any particular size.
Such conclusions should not be drawn too readily. Some indicators suggest that manufacturing is more important than its relative share in output and employment suggest. It is more than just another small niche.
For a start, manufacturing itself is fairly narrowly defined. Once production is defined more broadly, to include the likes of mining and infrastructure, its share of the economy becomes larger.
The boundaries between manufacturing can also be blurred. In many cases the division between manufacturing and services is not clear-cut. Rolls Royce, the power systems company, provides a classic example of what are sometimes called manu-services. A large part of its revenues comes from the services it provides as well as spare parts. For instance, it receives payments for engine maintenance and remotely diagnosing problems that occur.
But manufacturing is not just larger in size than the headline figures might suggest. It is also different in character. Typically manufacturing, at least in its modern high technology component, is far more capital intensive than the average services firm.
Despite the relatively small size of the manufacturing sector it accounts for over 70% of spending on business research and development. Manufacturing also accounts for a disproportionate share of trade with about 46% of exports and 55% of imports in 2011.
So far this article has talked as if manufacturing is one homogenous sector. Naturally the reality is more complex. It is widely accepted that the sector itself includes diverse types of firms.
Alastair Gunn, a UK equity fund manager at Jupiter, has extensive experience of visiting such firms. In broad terms he distinguishes between advanced engineering companies and firms that are trying to squeeze the most out of old facilities. The former are usually in the quoted sector – including listed companies such as Melrose, Rotork, Spectris and Weir – while the latter are generally privately held.
Gunn says that the manufacturing firms he invests in typically “have pricing power and what they are producing is incredibly valuable for the end customer”. Much of what they do cannot be easily replicated as it demands a high degree of skill and knowledge. Often such firms perform some of the more basic parts of the production process overseas.
Many industrial firms, in contrast, are not in such a fortunate position. “An awful lot of companies in this country are using 25-year old equipment in old buildings,” he says. For such firms, which are often competing with Chinese companies on price, there is little incentive for them to invest. “It does not make sense for them to do anything else as they are living in a world of constantly downward pricing”.
That is not to deny that such operations can be impressive in their own terms. But they are constrained in what they can do. “The live in a world without pricing power,” says Gunn.
The debate about whether sizeable economies always need a manufacturing sector remains to be resolved. But it is certainly the case that the headline figures about output and employment understate its continuing importance. Manufacturing remains an important area for the development of high technology and international trade.
The coalition government, and indeed the Labour opposition too, are keen on initiatives to promote the manufacturing sector. Although the days of “picking winners” have long gone there is a consensus that high technology production should be supported. Whether such initiatives will work is another matter.
This government has made several high profile announcements and launched numerous initiatives to support manufacturing. These include schemes for increasing university support for high technology, promoting training in manufacturing, support for regional growth funds and tax incentives.
Several government-backed bodies play a key role in attempting to promote the manufacturing sector. The Manufacturing Advisory Service, established in 2004, gives expert support to manufacturing firms to help them improves their competitiveness. The Technology Strategy Board, founded in 2007, overseas innovation centres and helps companies improve their supply chains.
However, there is a debate to be had about how much impact such initiatives can have. Many experts put much of the blame for the recent sluggish performance of British manufacturing on a lack of demand. This applies both to domestic demand, where households are clearly stretched, and exports.
From this perspective the weak performance of continental Europe, a key customer for British goods, inevitably caused trouble for exporters. Lucy O’Carroll, the chief economist at Swip, says: “The countries with which we do most of our export trade have been in a state of quite subdued demand since 2008. Giving them more of what we produce has been challenging.”
Azad Zangana, an economist at Schroders, shares this view. It follows, if the argument about demand is right, that a eurozone recovery should boost manufacturing. “Later this year, and certainly next year, we should see better growth coming out of the eurozone,” he says. “That should feed through into better export performance and better numbers for the manufacturing sector in the UK”.
But arguably a dynamic manufacturing sector should be able to prosper even with a poorly performing eurozone. Strong firms should be able to take advantage of rapidly growing emerging economies to find new customers. German firms, for instance, are shifting the balance of their exports away from the region. Three of Germany’s top five export destinations – America, Britain and China – are outside the eurozone.
Swip’s O’Carroll recognises the potential of shifting more towards emerging economies but argues it is a difficult task. “It is not an easy thing to do”, she says. “The challenge was perhaps underestimated.”
Schroder’s Azanga agrees that such a shift is starting to happen. He says success by British exporters to China constitutes a “phenomenal story”.
An alternative, although also complementary, explanation of relative decline is that a structural change is underway. Western firms are retaining the most sophisticated elements of their operations at home while outsourcing routine operations abroad. This can take the form of setting up lower technology manufacturing facilities overseas.
Some companies, including the likes of Apple and Nike, outsource manufacturing to other firms. The American firms are responsible for design and marketing but others generally carry out production.
Such arrangements do not show up clearly in the national trade statistics. If a British firm produces goods overseas they are not counted as British exports.
Low levels of investment are perhaps the final part of the puzzle. Manufacturing investment accounted for only 12% of business investment in 2011 compared with 22% in 1997.
The difficulty here is untangling cause and effect. For Andrew Milligan, the head of global strategy at Standard Life Investments, low investment levels are mainly a response to the low levels of demand.
Even those companies that are performing well are not generally close to full capacity. As a result they have little incentive to invest to increase their output.
Despite the frequent complaints about access to finance it is not generally a problem for sizeable firms. Milligan, who is also an adviser to the TSB, says: “Large companies have no difficulty in accessing finance.”
Britain’s manufacturing sector looks set to become smaller still as its less efficient firms struggle to deal with ever-fiercer competition. The big question is whether its engineering champions can retain their edge against existing players and ambitious newcomers. A tough fight lies ahead.
Except for a handful of seasoned fund managers, few have had such privileged access to manufacturing firms as Peter Marsh. The former manufacturing editor of the Financial Times estimates that in 29 years on the newspaper he visited about 5,000 companies in 30 countries.
He pulled together the results of his research in The New Industrial Revolution, published last year. As an international study covering more than 250 years of industrial history, the book has enormous scope. According to Marsh, the new industrial revolution, which he says started in about 2005, has some defining characteristics:
Technology. The more technology there is in the world the greater the scope for yet more new ideas to emerge. Technological development should be seen as an ongoing process with one breakthrough making future innovations ever more likely.
Choice. For Marsh the new era will be one of “mass personalisation”. While the mass production of the early 20th century was based on standard products the current trend is towards providing enormous variety. Standard components can be combined in numerous ways to provide an almost bewildering range of choices for consumers.
Value chains. Companies will be linked to each other in new and innovative ways. Those firms that are most adept at developing such connections will have an advantage.
Niches. The global scale of production gives more scope than ever for companies that inhabit highly specialised niches.
New manufacturing nations. Connections with China in particular will play a key role in shaping the new industrial landscape.
Clusters. Regional concentrations of expertise will be able to prosper by exploiting global connections.
Not everyone agrees that combining these developments, even if each transpires, will constitute a genuine revolution. James Woudhuysen, professor of forecasting and innovation at De Montfort University, Leicester, points out that the industrial revolutions that occurred after 1750 and in the decades preceding 1914, were made of more substantive and more obviously interlocking innovations. The late nineteenth century department store was revolutionary in that it combined safety lifts, plate glass and electric lighting. It also made the most of the refrigerated railroad car, the telegraph and the mail-order catalogue.
He adds that in the two earlier epochs, society had every confidence in future progress, giving it the will to introduce radical innovations. Today, he says, “that can-do attitude towards the future is notable by its absence”.
Indeed negative attitudes towards industry are widespread. It goes much further than a failure to embrace production. Industry is presented as guzzling scarce resources, generating harmful waste and even threatening the future of the planet. The aspiration to use industrial development to help create a better and more prosperous world is, sadly, lacking.
One of the most pervasive and damaging misconceptions in public debate is that economics can be understood from the perspective of the consumer. The acceptance of this blinkered worldview makes a balanced understanding of the economy impossible.
Take the idea that the economy is suffering from a lack of confidence or “animal spirits” as the most obvious example. This is an all too common explanation for the West’s economic plight.
The implication is that the reason for the mess we are in is essentially psychological. If only we would buck up and, Nike-style, “just do it” everything would be OK. Consumers would start consuming again and businesses would quickly return to normal.
Such an approach ignores the economy’s structural weaknesses. For example, it fails to consider the lack of investment in productive activity. It also confuses “confidence”, seen as a loss of nerve, with the culture of caution that has enveloped contemporary society. The latter has itself to be explained since it is a relatively new phenomenon.
A more sophisticated version of the consumerist viewpoint is the idea that the economy is essentially suffering from a lack of aggregate demand. This argument was on show in a particularly polished form when Robert Reich, the American labour secretary under president Bill Clinton, spoke at the TUC in London recently.
Reich argued rightly that high deficits and the burgeoning levels of public debt are not problems in themselves. They are instead symptoms of a more fundamental weakness.
The Berkeley professor pointed to falling wages and unemployment as the underlying causes of high public debt. This ugly duo means that there is a lack of demand.
However, he failed to address the possibility that weak demand is itself a symptom of problems on what economists sometimes call the supply side. From this perspective the financial bubble did not simply burst in about 2008 with a resultant hit to demand. It is first necessary to work out why the bubble inflated.
In both America and Britain the authorities maintained relatively high public spending and loose monetary policy from the 1980s onwards. This approach was itself an attempt to offset the effects of a weakening economy. Rather than promote a new round of productive investment the authorities preferred to make easy credit available.
This was not just a case of government being misguided or cowardly. It essentially decided it was easier to muddle through than to tackle underlying economic weaknesses in a decisive way.
None of this is meant suggest that mainstream economic thinking does not consider the productive economy at all. But when it does it tends to be from the perspective of consumption.
Productive economic activity is too often see as squandering scarce resources, generating waste and even threatening the planet. The role that productive activity plays in generating more resources, innovation and raising living standards is downplayed or forgotten completely.
The economy can only be understood properly in the round. There can be no consumption without production.
This blog post first appeared yesterday on Fundweb.
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