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09 June 2023

Germany's pro-cyclical policies are back

In our lead story we write about the return of pro-cyclical fiscal policies in Germany; we also have stories on yesterday's agreement in the EU on an asylum pact; on the geopolitics of natural resources; on why UK house prices are not really declining; on France nearing full employment; and, below, on what newspapers and smokestack industries have in common.

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Today's free story

How an industry declines

There is a lot of confusion about de-industrialisation. It does not necessarily mean less industry and fewer factories. It means less money - a falling share of industry in an economy's value-added. That has a lot of important consequences, but not necessarily the ones people expect, or discuss.

A good analogy is the decline of the newspaper business, an industry some of us know quite well. Newspapers have been in decline for a long time. Most of the titles from the 1990s are still around today. In the UK, several newspapers have stopped reporting circulation numbers because they have become so embarrassing. That is what happens when you lose an oligopoly. The old business model consisted of selling news to readers who had no alternative information sources, and then deliver those readers to the advertisers. Today, readers have many alternatives. The internet has given advertisers more direct and measurable ways to contact potential customers. The time when a publisher famously called newspapers a licence to print money are definitely over. The Telegraph group is now in receivership. That paper used to be the market leader. There are corner shops that make more money than some newspapers. A few papers are still doing ok, for all we know, but everybody is making less money than they used to.

The most important impact of the slowly creeping de-industrialisation is a loss of profits, not necessarily a loss of activity. That translates into relatively lower wages. Back in the 1980s, it was common for the older generation of journalists to own a house in fashionable neighbourhoods in central London. Nowadays, journalists often live in the distant outskirts. Salaries have been in secular decline. 

The salient characteristic of industrial decline is a rise in corporate crime. The telephone bugging scandals have killed the UK tabloids. The diesel scandal was the last hooray of the German car industry. 

They will still make cars in Germany in the future. But the industry will be dominated by other plays, it will employ fewer people, it will feed fewer suppliers, and its role in society will diminish. Spare a thought for the car fanboys in newspapers: a declining profession reporting on a declining industry. It is becoming a nostalgia business.

Another characteristic of declining industries is the celebrity phenomenon. The celebrity billionaire businessman with his space ventures is the mirror image of the celebrity journalist. In the media, the superstars currently work in television. The UK has been absorbed in a scandal involving two of its best-known TV presenters. Real-time soap opera is a business that is still booming. But Tiktok is fast becoming the next big thing.

De-industrialisation will go through similar phases. What will not happen is that we will wake up one day to a newspaper headline informing us that de-industralisation happened yesterday. 

8 June 2023

Meet the world's largest car exporter

This is a watershed moment for industry. China has surpassed Japan and Germany to become the world's largest exporter of cars. But as Greg Ip writes in the Wall Street Journal, what really shocked China's western competitors is not the sales numbers, but the sheer quality of Chinese cars. 

The arrival of China as a successful car exporter is of a different quality than, for example, the boom of the Koreans since the 1990s. They produced competitive cars, but this was essentially still a European/Japanese competition. An observation we have made is that the changeover from fuel-driven to electric cars is like the introduction of air bags. It is a step-change in the nature of the product. 

An electric BMW is still a BMW, with its clunky, over-engineered menu system. A Tesla is essentially a digital device: think of it as an iPad with a car built around it. Ip quotes an industry expert as making the point that 

"Manufacturers of gasoline cars are product-oriented, whereas EV manufacturers, like tech companies, are user-oriented."

They are tech companies. Ours are car companies.

Chinese EVs have entertainment systems inside the car, even microphones for karaoke, and several screens. It is the highest-end digital device, with wheels on it. The Europeans are absolutely hopeless at digital consumer products. They are up against something they don't understand. 

Sales of EVs in China did not take off until 2019, when the market started to explode. We have been reporting that German car makers, including VW and BMW, are not making much headway into the Chinese EV market. The Germans know how to build high quality EVs, but they are nowadays more focused on expensive cars. The problem is that Tesla is the undisputed market leader in that higher-end segment, and it is technologically ahead. The German car industry itself taught us that technology leadership has strong persistence effects. If you are the inventor of a new category, it is hard for the others to catch up.

Ip writes that much of the expansion of the Chinese car industry happened during the Covid lockdowns.

The very likely response, in Europe at least, will be to protect domestic car makers through tariffs. Ip notes that the global south will still happily trade with China, and benefit from cheap cars. We noted that the Chinese are pursuing a high price strategy in Europe, cashing on the higher margins in the European market. Ultimately, the prices will fall, and this is when the crunch for the European car industry will happen.

We believe that industrial policy should be targeted at supply chain security, not the artificial preservation of competitiveness. The US energy department's latest critical materials assessment noted that Tesla was the first car company to change its reliance on neodymium iron boron, a rare earth magnet, whose exports China is now starting to restrict. This is also why we think the industrial policy, promoted by Jake Sullivan, the US national security adviser, is confused. It commingles legitimate concerns over national security and supply chain security with pork-barrel industrial interests. We are heading back to the old adage of what's good for GM is good for America. Except that this is no longer true.

7 June 2023

Bipolar à la française

This anger against the pension reform and the desire to move on seem to coexist in France. Labour unions staged another day of protests yesterday, where several dozen hard-left CGT trade union militants even stormed the headquarters of the Paris 2024 Olympics. But the turnout was significantly lower and protests in general less violent than previous ones. Traffic was mostly uninterrupted though some overseas flights had to be cancelled. The more moderate CFDT trade union already shifted its focus on employment issues such as minimum wage. It is on those issues the CFDT wants to see a quid-pro-quo compensation from the government for what they lost over the pension reform. Life goes on it seems.

Yet, this episode gives rise to two different political readings that could define the way forward post-Macron. One is that this public anger has not yet run its course, thus it needs to find its match politically. The other interprets it as the end of a violent cycle, where a time for appeasement has come.

These two different narratives also gives rise to different kinds of politicians coming forward. We already see some in the starting blocks for the 2027 presidential elections. Edouard Philippe surprised everyone this week when he came out forcefully on immigration. He showed himself not being afraid to talk about the link between immigration and crime, and how it clogs social systems. He calls Islamic communitarianism a threat, and came out in favour of more ambitious immigration reform. He said it is time to take back control and end the accord with Algeria from 1968, which gives the country particular advantages over others. All those themes are dear to the conservatives, and this rhetoric is his way of winning back an electorate tempted by the far-right. There is a red line for him, however, in his quest to take back control. He insists he would still respect France’s engagements inside the EU, thus excluding any Frexit over immigration.

On the left of the political spectrum, there is movement away from the loud and rebellious Jean-Luc Mélenchon. Bernard Cazeneuve, a former prime minister under Francois Hollande, founded his new movement La Convention and aims to break with the media-centred hyperactivity of the Mélenchon-led left. Instead, he appeals with a soft voice to reconcile apparent opposites on social justice and competitiveness, and on climate change and economic growth. His bet is that the French want to return to the more peaceful life, while Philippe concludes that the reason there is still anger is because the measures were not strong enough to respond to this discontent, writes Cecile Cornudet.

6 June 2023

Germany's seeping europhobia

Here is a graph from ARD television showing a survey about whether Germans identify with Europe. The blue bits indicate a very strong and a strong European identity. 

This is a better gauge than the usual Eurobarometer surveys, which in our view systematically overestimate support for the EU. Never allow an institution to judge itself. The question about whether people feel European is a better one because it separates current views on policies, which are subject to shift, from views on identity, which are persistent. We ourselves would be in the leftmost bar, but that would not stop us from vigorously disagreeing on policy.

It is a numerical coincidence, no doubt, that the 18% who totally disagree with the notion of a European identity are the same number as the current polling figures for the AfD. We see a polarisation of views. The proportion of those who strongly identify with Europe has actually gone up, as has the number of europhobes. It is the two middle categories that are down. But there is also an overall towards euroscepticism: the combined blue bits are down by 7 points to 41% compared to 20 years ago, whereas the grey ones are up by 4pp to 56%.

We see the EU in a trap. Low EU approval ratings make it harder for member states to agree to further integration. Yet further integration is needed to make the EU more successful, and more likely to meet higher approval ratings in the future. What we are seeing here is European integration through the backdoor meeting its inevitable fate.

5 June 2023

Decoupling from China

De-globalisation is starting to have real effects on the ground. Allianz's annual survey of German companies shows up some dramatic changes in German supply chains over the last three years. German companies are switching their supply chain partners from China to western European companies. Ludovic Subran, the chief economist of Allianz, writes in FAZ that only 10% of German companies are actively looking at China right now for their supply.

There are some exceptions, like BASF and Mercedes, who have over-invested in China and will struggle to extricate themselves. While the media is focused on those companies, they do not reflect the national trend. The Munich security index, published by the Munich security conference, lists perceived risks in various countries. Russia tops that list almost everywhere. When it comes to China, Germany has a higher risk perception than any other country except Japan. In Italy, for example, China is way down on the list. We don't think this is due to particular anti-Chinese sentiments in Germany, but more to a realisation of Germany's supply chain vulnerability. 

The macro data tell us that China remains Germany's largest trading partner, but there is a lot going on under the hood. 60% of the companies that reported concerns over their supply chains during the Covid pandemic in the Allianz survey have since reported that they have changed suppliers and production facilities. Subran expects this trend to accelerate in the next few years. By the end of the decade there will be a big transformation of German supply chains. 

We agree with his assessment that this will come with welfare losses, though we think this expression is a bit of a euphemism. We are not talking about hypothetical small welfare losses like those caused by Brexit. We are talking about macro shocks, like persistent inflation. The west benefitted from the release of poor rural workers into the industrial labour markets of south-east Asia, and especially China. This trend has now reversed in those countries. Now we are decoupling our supply chains at a time when our own populations are ageing. The right strategy in our view would be a renewed focus on productivity, through technology and market regulation that facilitate these kinds of improvements. This is not the direction in which European policy is headed right now - to put this mildly.


2 June 2023

How not to discredit Le Pen

Marine Le Pen is the second most popular politician in France, according to an Elabe poll. The French government seems powerless in its response. In a radio interview Élisabeth Borne had called Le Pen's Rassemblement National an heir of Marshal Pétain, whose Vichy regime collaborated with the Nazis. This provided RN with a great opportunity to call on Borne for an apology.

Emmanuel Macron himself reprimanded his prime minister in a council meeting: the opposition is to be discredited by pointing to their own inconsistencies and over concrete measures and not via moral posturing, according to Macron. The strategies of the 1990s do no longer work, he reasons.

But Macron’s strategy to win through facts does not seem to be working either. His remarkable record on unemployment, his whatever-it-takes measures to get the people through the pandemic, and the energy crisis did nothing to win the confidence of the people. Those same people were ready to turn against him at the first occasion over the pension reform.

Le Pen, by contrast, has developed a teflon quality. Nothing seems to hamper her popularity, not even her links to Vladimir Putin, nor her completely unrealistic pension reform proposal. She was first to identify the cost-of-living crisis as a theme in her campaign, and the surge in inflation has thus helped her a lot, without her needing to do much. Compared with a disruptive Nupes on the left, and an internally divided Les Republicains, her party looks like the responsible opposition, not obfuscating the work in parliament but also united behind a common position.

The focus is instead on the government. After this Pétain remark, the French media is speculating about whether Borne needs to go earlier, forcing Macron in Bratislava to express his full confidence in her. Usually, a sentence like this is the beginning of the end. But we don’t think it is likely to happen now. Macron would contradict himself if he were to let her go over moral posturing rather than substance. He already set the time frame: he gave Borne until mid-July to work out his reform agenda, only then he will make a decision on whether she is to stay or not.

If Borne were to go over this incident, it would further cement Le Pen’s power to shake and shift politics. This episode shows how difficult it is for Macron and his government to discredit Le Pen and her party in a post-truth world, and to stop her on the launch path towards becoming the next French president.

1 June 2023

Living in yesterday's world, literally

The graphic below is from FAZ based on a research report by a business group in Germany, and it depicts the relationship between the net and the gross value of the national capital stock as a measure of its age. This broadly concords with anecdotal experience. Germany and Italy have the oldest capital stock in a group of western countries. There are still fax machines in German police stations, and doctor's office. Of the Europeans, France and the UK fare better. 

We previously wrote of another survey showing that the austerity period had led to a shortfall of investment in Germany by about €550bn. You see the decrepit state of the public sector in many areas of life, especially in the Bundeswehr. Commuters have been experiencing long delays in their rail journeys and traffic congestion on motorways for the same reason. An example is the closure of a critical motorway in the west of Germany after the discovery that a bridge was unsafe. That, too, was a consequence of Wolfgang Schäuble's austerity policy. 

A sectoral analysis suggests that in Germany the car industry, mechanical engineering and the pharmaceutical industry were the only ones to maintain their capital stock levels during that period. The economic consequence of underinvestment is low growth. The current government has been trying to reverse this trend, by making some money available for green investments and repairs of military equipment. But the fiscal rules are starting to kick in again.

As an aside, this graph should serve as a warning to those who confidently keep forecasting that post-Brexit UK will forever underperform the EU. We think it is in general not a good idea to judge economic performance in relationship to other countries. But if you do, you are likely to be disappointed.

31 May 2023

Why the west doesn't get Erdogan

Why did western commentators and analysts get Turkey’s elections so wrong? Kemal Kilicdaroglu was predicted to win only weeks before the first round. The US and Europe quietly, or overtly, backed Kilicdaroglu and hoped that he would turn Turkey’s fate around and towards the west. What we are likely to see is the opposite.

There was a lot of bias and ignorance in the commentary. The western media focussed on the democratic credentials of Kilicdaroglu and his promise of returning to economic orthodoxy. Western commentators warned of Recep Tayyip Erdogan’s victory as a step further towards autocracy and a calamity for the Turkish economy. But there is a blindspot in western thinking. As David Hearst, editor of the Middle East Eye, wrote, Erdogan was elected with an overall turnout that western democracies can only dream of, close to 90%. Turkey always had high turnout rates, and Turkish citizens trust their democratic system. Erdogan is thus in another league compared to many European countries: even Emmanuel Macron’s recent run off against Marine Le Pen only mobilised 74% of voters. Also western commentators also cannot easily compare Turkey to countries like Egypt or Tunisia, where participation was 41% and 11% respectively.

The opposition’s U-turn after the shock of the first round only cemented Erdogan’s credibility. Kilicdaroglu and his team played on fears and resentments against Syrian refugees, putting off Kurdish voters. The image of Kilicdaroglu as a Turkish version of Gandhi who cooks in his kitchen were gone. His campaign sharpened and promised that he would send Syrian refugees back home. But when it comes to the manifestation of power, Kilicdaroglu, a civil servant who never won an election since 2010 and who is a member of the Alevi minority faith, was no match for Erdogan. The Turkish president shaped modern Turkey like no other person in nearly every aspect of life, and won every election he has contested since he became mayor of Istanbul in the 1990s.

On Syrian refugees, Erdogan also appeared milder in his rhetoric. Even though promising to repatriate Syrian refugees is part of Erdogan’s toolbox, he refrained from talking about forceful repatriation, which is considered unethical under Islam. Another argument that worked in Erdogan's favour comes from Turkey’s democratic system itself. Turkish voters do not like the idea of cohabitation. When parliament was won by Erdogan’s AKP alliance with 45% of the votes, it gave a strong argument to vote for Erdogan in the second round.

The fact that the election results are so close makes Erdogan’s victory appear even more precious. It is not a weakness but a strength for him that he has been seen as struggling and emerged from this victoriously. People can relate to this. There is thus no doubt that Erdogan is now the strongest leader in the region. The fact that the west got it so wrong also adds some spice to his new power. The west, however, will have to find a different way to look at Turkey. We may not understand their culture, but politics is nothing but an expression of culture. We certainly cannot claim that he is an undemocratic leader. US President Joe Biden’s declared support for the Turkish opposition was thus not only meaningless, but could also prove to be counterproductive eventually, warns Hearst. A congratulatory message may not do the trick.

30 May 2023

Value of hope

The UK Labour Party has not put a lot of deep thought into a post-Brexit economic model. Sir Keir Starmer's hope of a better deal from the EU is delusional. Not to speak of his silly macro policy target to outgrow the G7.  

But there is one big policy shift that is worth noting. It is the plan to end land speculation and, indirectly, the rentier financial model on which England has become over-reliant for its wealth. The Conservatives did not tackle the housing crisis. Nor did previous Labour governments. This is a big shift. 

Yesterday the UK media reported on Labour plans legislation that would make it economically viable for local councils to issue compulsory purchase orders (CPO) of land owned by developers.

In theory, this is already possible, but it comes at a steep price. Developers often buy cheap land in the hope that it will later be granted planning permission. If a local government issues a CPO for the land, it must compensate the owner not only for the fair-value price, but also for what is known as the hope value, which is what the land would be worth should it receive planning permission in the future. 

The new promised legislation will allow local councils to sequester land without the hope value attached. In other words, at a fraction of the price. If enacted, this policy will end land speculation at a stroke. 

The rise in UK land and property prices has been due to a combination of strict planning laws and a steady influx of immigrants, which has led to an increase in demand for housing. The total UK population is now 69m. In 2000, it was 59m. Successive Labour and Conservative governments, however, have shied away from increasing housebuilding. This is due in part to prevent falls in house values that would naturally arise once supply is increased. But even when governments promised to build more housing, as Boris Johnson did, they could not deliver. There is only so much land available for new construction.

Sir Keir has already broken a taboo by promising, or threatening, depending on your perspective, to build on greenfield sites surrounding urban areas, in what are known in the UK as greenbelts. Despite its high population density, England has nature reserves even in the direct vicinity of cities. The opening up of greenbelts to development is a taboo that Labour is now willing to break.

We see the main effect as creating more affordable housing for young people, with a slow drag-down effect on the rest of the housing market. It won't lead to a collapse in house prices, but it will be one of several factors that could dampen future house price growth. The other is higher interest rates, which ends demand-led bubbles like buy-to-let schemes. 

This is an important policy shift, but we think not enough. EU membership was highly conducive to the rentier economy model, boosting the role of the City of London as the euro area's financial centre and the world's money-laundering capital, and facilitating immigration that kept wages low and house prices high. Without these factors, the UK needs to focus on old-fashioned productivity growth, and harness future growth industries. On the latter, it is quite possible that the Tories will come up with more convincing answers than Labour once the Sunak government enacts the recommendations of the pro-innovation regulation of technologies review, by Sir Patrick Vallance, the government's former chief scientific adviser. In the long-run, this is the stuff that matters the most. It is also the reason why we are not as downbeat on the UK economy as other commentators. Herein lies a potential niche for the UK, one that a technophobic EU is unlikely to match. 

But Labour's land use policies, and the concomitant shifting of finances from central to local government, matter too. Something is moving in the UK, after a long lull.

26 May 2023

Forget EU's green role model

Clean air is a public good that everyone enjoys, or lacks, at the same time.

The EU’s fit-for-55 agenda is full of goals and aspirations. It wants to set an example and lead the world to decarbonisation. But what if other countries won’t follow? We already reduced our carbon footprint by 25% over the past 20 years to 2.7 gigatons of CO2, which is half of the US's and a quarter of China's emissions. But without the efforts of others, this is a competition that is not worth winning.

In his op-ed for Les Echos, Eric Le Boucher made two important points: First, our strategy is inflationary. Second, we are not a role model for the world. 

The first point is related to whether we should pursue the green agenda through the supply or the demand side. The US puts all its efforts on the supply side with massive investments that eventually yield lower prices for green technologies which are then affordable to the consumer. The EU puts most of its efforts on the demand side by regulating what green energy sources are to be used and limiting imports from countries that are less regulated. The heat pump is a massive investment German house owners will have to shoulder with significant knock-on effects on their budget, consumption and house values. The demand side focus will cause an inflation shock similar to the oil price shock in the 1970s, according to Jean Pisani-Ferry. It comes in a time when Europe needs the opposite, a slowdown in prices and higher productivity. He calculated in his report that it will cost another 3-4% of GDP to finance this green transition. It is thus far from being neutral, as the initial strategy was set out to be.

The second point is our ideological blind spot. The EU no longer serves as a role model for others in other areas. Why would we think this to be any different when it comes to decarbonisation? The EU, by being completely engulfed with its own green agenda, seemed to have forgotten that there is another world out there that needs to partake in those efforts for it to be effective at the global level. Instead of subsidies to households so that they can switch over to heat pumps or regulating imports in our region that is already less carbon-intensive, would it not make more sense to invest that money in reducing emissions in Africa or India? Would this not constitute real leadership rather than the introspective, self-righteous way of how we go about right now?

We agree with Le Boucher in his conclusion that we need to let go of these sacrifice-based ideologies. They are too expensive for our economies. Instead we need more innovation and more finance to realise those. Most of all, we have to stop seeing ourselves as a role model for the world.