Thursday, September 27, 2007

Italy Retail Sales September 2007

Italian retail sales dropped in September at the steepest rate in more than two years as economic growth visibly slows.

A seasonally adjusted index of retail sales was at 44.1 in September, its seventh consecutive contraction, compared with 47.8 in August, according to a survey of 440 retail executives compiled for Bloomberg LP by NTC Economics Ltd. The reading has stayed below 50, the level that signals a contraction in sales, since February.

Finance Minister Tommaso Padoa-Schioppa this week said the government would cut its growth forecast for next year as the rising cost of credit triggered by the collapse of the U.S. subprime mortgage market damps growth across the eurozone. Italy's economy expanded at the slowest pace in 1 1/2 years in the second quarter and growth has lagged behind the euro-region average for 11 years.

Here's the retail PMI chart, and remember, any reading under 50 means contraction.

Euro Libor Rates

Basically, following up on this post earlier this month I wish to report that the 3 month euro libor rate is still stuck where it was, way above the ECB refi minimum bid rate. Here is a chart with the latest data we have from the BBA:

Also the FT reports this morning that the European Central Bank’s emergency lending fund, which attracts a penal interest rate, was tapped yesterday for €3.9bn – the largest sum asked for since October 2004.

The surge in demand for the ECB’s “marginal lending facility” pointed to the difficulties still being faced by European banks as a result of the global credit squeeze. The ECB revealed no details but it is likely that more than one borrower was involved. Use of the marginal lending facility attracts a 5 per cent interest rate – significantly higher than market rates.

Oh, Jean Claude, Jean Claude, wherefore art thou, my beloved?

Incidentally, the BBA link to the libor data is here.

Wednesday, September 26, 2007

And So It Begins ...

by Claus Vistesen

cross-posted from Alpha Sources

The dust has barely settled from Bernanke’s decision to lower the US Fed funds rate to 4.75% which has subsequently taken the EUR/USD to new heights in the +1.40 range before an all too common game has commenced in the Eurozone. Of course, there is nothing controversial about the falling Dollar as such regarding the immediate fundamentals of the Fed's decision but I still think it would be wise to notice what is going on in the Eurozone since after all this is not only a story of a falling greenback but also one of a rising Euro; currencies come in pairs you know. As such and as could perhaps have been expected the ECB is already under considerable fire. On the one hand the pressure is mouting from economic fundamentals themselves where news was dished up today that all measures of business and consumer confidence as well as real manufacturing growth are surely but steadily trending down. One the other hand and perhaps even more interesting is the fact that political interests are already positioning themselves according to the current environment which seems to have broken in a new ceiling for the EUR/USD. Of course and almost on queue the French President Nicolas Sarkozy was quick on the mark* …

``When the U.S. central bank lowers its rates, everything picks up; when we don't lower ours, we go down,'' Sarkozy said in an interview with TF1 and France 2 television stations. ``I'm telling Mr Trichet, `look at what others are doing'.''

Apart from Sarkozy we really also need to look towards poor Italy where the situation of course now is becoming somewhat of a desperate one since there is not a lot of slack to draw upon;

Luca Cordero di Montezemolo, chairman of Fiat SpA and leader of Italy's manufacturers, urged the European Central Bank to halt the euro's rise because it's hurting exports.

``The super euro worries us, we ask for the government and the ECB to do something,'' Montezemolo said late yesterday in Rome after employers' lobby Confindustria presented its latest growth forecasts. ``We don't want to give anyone any lessons but this could become a problem for exports.''

Now, the interesting thing here is not so much the fact that Sarkozy actually chose to pounce at this particular point in time since we all know that this is not the first time. The interesting thing however is that Angela Merkel (the German chancellor) chose to stay as the faithful squire (Sancho Panca perhaps?) to Trichet’s continous vigilance against inflation in exclaiming that …

``We will resist any attempt to challenge the central bank's independence,'' Merkel said at an event in Frankfurt last night to mark the German Bundesbank's 50th anniversary. The ``slightest suspicion'' that Europe is in two minds about the ECB's freedom from political interference ``would threaten the euro's stability,'' Merkel said.

Even the former Fed chairman Alan Greenspan who seems to have an awful lot of time on his hands at the moment weighed in on the debate;

Former Fed Chairman Alan Greenspan also weighed into the debate, saying Sarkozy will fail to persuade the ECB to cut interest rates. Sarkozy is ``wrong on this particular question,'' Greenspan, 81, said in an interview yesterday. ``I don't think he will succeed.''

This is where we then move into something of a peculiar situation. As a first and immediate point I couldn’t agree more with Angela Merkel and Alan Greenspan. The whole point with having a central bank is that it is independent and that it thus sets policy independently from national and regional interests. There can be absolutely no doubt about that and in this light alone Sarkozy’s and even Luca Cordero’s remarks are bridging a gap which is essentially un-bridgeable in a modern economy. However, this reservation, important as it may be, is also becoming something of a hollow chant at this point in time. In this light and dare I say it, Sarkozy’s advice that Trichet should ‘look at what others at doing’ seem to be a very sound piece of advice at this point. Alas, this then has the potential to become the situation which none of us wants it to be. As such and although I am sure Sarkozy’s and Cordero’s intentions are good they might end up solidifying the ECB on a path of rigidness and assertiveness regarding exogenous pressure and thus halt the making of decisions which, I am afraid, is becoming more and more clear as the economic data keeps on rolling in.

* All quotes above are taking from Bloomberg.

German Business And Consumer Confidence Tumbles

Well following hot on the heel of my German export driven economy post yesterday, events didn't take too long in bringing themselves home to roost.

Firstly we have the IFO Business Climate Index:

The index for the Munich-based Ifo institute which is normally though to act as an early indicator of likely trends in German economic activity, fell for the fourth consecutive month from 105.8 in August to 104.2 for September. Expectations for the next six months were the gloomiest for almost two years, as the component measuring confidence in the economic outlook six months from now fell to 98.7, which was the lowest level recorded since November 2005, and down from 100.4 in August. Indeed this months general business climate reading was itself a 19-month low, and reflected growing concerns among German industrialists that the strength of the euro and the increasing cost of credit will sap economic growth. The IFO results are entirely in harmony with the Bank of Scotland PMI readings we saw earlier in the week.

German consumer confidence also fell - in this case to the lowest level in five months - according to the GfK AG's confidence index for October. The index fell to 6.8 from 7.4 in September, the market-research company said in Nuremberg today.

The general concern is the same as that being expressed in the IFO index, the fear that Germany's economy may lose momentum as a U.S. housing slump pushes up borrowing costs and at the same time the euro's appreciation to a record against the dollar weighs on exports.

The individual components of the index also make interesting reading:

The component measuring consumers' confidence in the economic outlook fell to 40.7 from 48.4, while the income expectations component dropped to 2.3 from 9.2 and the indicator of households' willingness to spend slipped to minus 2.4 from 6.4. These are quite substantial drops, and reflect a growing pessimism about the outlook for the coming winter.

In this climate it is hard to appreciate why people imagine that the dollar can quietly pulmb the bottoms while the euro scratches the ceiling. A correction is undoubtedly coming here, since the current narrative makes no sense at all. The first indication of the change, well haven't you noticed, M Jean-Claude Trichet has gone very quiet all of a sudden. Somehow I don't think he relishes courting the limelight too much right now.

Tuesday, September 25, 2007

The German Economy, Employment, Export Shares and Age Structure

Ok, well yesterday I gave a brief resumé and outline of the state of the German labour market, about why the recent drop in unemployment isn't everything it seems to be, about why German wages have deflated, rather than inflated, during the current economic expansion, etc etc. That post is a prerequisite for what now follows which will be an attempt to describe how the German economy actually works.

First off, and as is well known, German society is ageing, and the German population is declining. Here is a chart - thanks to Claus Vistesen who has been doing this part of the work (and see also this very important recent post from Claus on DM) - of the German population evolution:

As can be seen, after the late 1990s the rate of population growth in Germany began to decline rapidly, and then more recently the population actually started to decline.

This changing population pattern has also been accompanied, as is again well known, by an important ageing of the population. This can be seen clearly from a chart - again from Claus - for German median ages:

Now this rapid recent rise in the median age of the German population makes Germany a much older society than many other OECD countries. In particular the United States is much younger (as are the UK, France, Ireland, Iceland etc) as can be seen from a comparable chart for US median ages (again thanks to Claus).

As can be seen the US is an incredibly young society, having attained median ages during the 1970s and 1980s more typical of a developing than a developed society, and even today the US is only where - in median age terms - Germany was some 30 or so years ago. So when we talk about "ageing societies" we should remember that while all our societies are ageing, some of them (Japan, Italy, Germany) are doing so much more rapidly than others. This difference in fact has profound implications, ones which were never foreseen, and given what we now know it should not be surprising to see these age structure differences expressed - as we will see below - in very different core characteristics in each of the societies concerned.

Now, not only is Germany's median age rising, the proportion of the population in the key 25-49 age group is now falling. Let's look at the chart:

As can be seen from the chart this crucial age group touched its highpoint in 1997/98. This could be imagined as the moment of maximum capacity for the German economy. This is the case for two reasons. Firstly the 24 to 49 age group includes the crucial 25 to 49 household-former, first-time-homebuyer group. In terms of credit expansion, it is this group which drives a significant part of internal demand, since this is the group with the greatest propensity to borrow forward, and this is vital.

The 25 to 49 age group also includes another important group, the 35 to 50 one. It is this group which drives an economy in productive terms, since these are the prime age workers. So if you think of a society as a 100 metres sprint athlete, then there is an age when this athlete is at the maximum of his or her running potential, an age after which each time they can only run the 100 metres more slowly. Well a society is the same in terms of its collective economic potential, after the 25 to 49 age group peaks an economy can only move forward more slowly, and logically, since without addressing either fertility or immigration, every time more and more slowly, as this group declines inexorably as a % of the total population.

Is there any evidence for this kind of assertion. Well, yes, as it happens, there is actually.

Lets have a look at German GDP. First off a long term chart.

As we can see, and as is well known, German GDP growth has been very weak since the turn of the century. As is also well known 2006 was a very good year for the German economy, which is what lead all the commentators to cry - at last! There is a German recovery. But have they been too quick in drawing this conclusion? There are good reasons to think that they may well have been (and of course, in reality we are all about to find out as we go through the coming winter). Let's have a look at the evolution of the composition of German GDP over the years.

Now, as we can see, private consumption has hovered pretty close to the 60% mark for many years now, and government consumption has moved around the 19% of GDP mark pretty constantly, so the big difference has been in fixed capital formation which reached a peak around the 22 - 24% mark - guess when - yes you got it, just when the 25 to 49 age group was maxing out, in the 1992 to 1995 years. And why should this be significant, well quite simply since fixed capital formation includes the HOUSING share, and it is this component which has steadily declined as a share of German GDP since the mid 1990s, and which is why there is a "hole" in German (and Japanese, which is the same story, only told a little earlier) GDP, a hole which can only be compensated for by exports.

If we come to look at exports we also find something interesting. While fixed capital formation declined as a share of GDP from 24% in 1991 to 17.76% of GDP in 2006 (ie a 6% drop), the German trade balance moved from a DEFICIT (yes, you heard right, deficit) in 1991 of 0.4% to a surplus of 5.44% of GDP in 2006, ie a rise of 6 percentage points. The two match exactly, incredible, isn't it? Here is the chart over time.

As I say, the correlation of these two since the mid 1990s is really quite striking.

Right two last charts just to finish up. Firstly annual private consumption growth in Germany (in percentage change terms):

As can be seen, this has been - barring the boom years of the mid 1990s - steadily declining in its ability to drive German growth, and it would be rather foolish to expect this to suddenly change now.

Lastly export growth and GDP growth:

As can be seen, since the mid ninetees, every time the German export performance flags GDP tanks. Claus and I haven't gotten round to doing the correlation coefficients yet (but we will do). But the relationship is pretty clear, so if the markets in the US and Eastern Europe slow noticeably this winter, just you watch what happens to German GDP.

So, as they say:

Quod Erat Demonstrandum

Or, if you prefer, "game, set, and bloody match". Anyone got some glasses handy, it's time to cork out the champagne I think. Or no, since this is Catalonia, a nice glass of Cava will do me fine. Have a nice day everyone. I will.

Employment and Unemployment in Germany

German unemployment fell for the 19th consecutive month in August according to figures released by the Nuremberg-based German Labor Agency earlier last week. The number of people out of work in Germany when adjusted for seasonal swings, declined 15,000 from July and hit the new recent low of 3.76 million.

Now, this seems like very good news indeed, doesn't. And of course it is. But is there more than just good news here? Perhaps there is, since, as we know, after 30 or so years of sub-replacement fertility the German population is now falling, so what about the labour force? Well maybe the first clue that all here isn't exactly as it should be can be found in this little admission tucked away in the press release from the German Federal Statistics Office:

Another positive impact on the labour market is exerted by a decrease in labour supply which, according to estimations of the Institute for Employment Research, will decline by 100 000 on an annual average in 2007.

Now fortunately the Federal Labour agency makes available monthly detailed statistics for the evolution of the German labour force, and it is to an analysis of this data that we will now turn.

Firstly the unemployment rate itself. Now there are various measures of this rate which you will find in current use, but whichever you look at it is plain that unemployment has been steadily coming down during the present expansion. In the chart below we illustrate this with the measure used by the Federal Labour Agency:

Now, if we come to look at the chart for the total numbers of those employed and unemployed (not seasonally adjusted) we can begin to notice some interesting details:

In the first place and clearly the number of unemployed has come steadily down. And the number of those employed has risen, although this is not such a clear picture, since the recent rise has only recovered the employment high-point which was achieved at the end of last year.

Now, if we come to look at a longer time series chart for the economically active and employed population in Germany, we will see immediately that - as indicated by the quote from the federal statistics office above, the economically active German population reached a high point in the third and fouth quarters of 2004, and since that time it has been trending down.

This is, of course, good news, if you work for the German Labour office (what is it they say - "Another positive impact on the labour market") and it is your job to find work for people since you will have less customers and hence less work to do, but it certainly isn't good news if your job is to generate a smoothly oiled economic machine capable of generating sufficient wealth to be able to sustain and support and adequate health and pensions system for all those members of that rapidly expanding over 65 age group. Also, and again as we can clearly see, the "massive job creation miracle" may have touched its ceiling sometime towards the end of last year. The German economy is now slowing, and it is not impossible that German employment will never again reach those giddy heights.

But there is another detail which should interest us here, and that is the type and quality of the work which is being created. Lets take a look at the data from the German Federal Labour Agency for those in work which is liable for the payment of social security contributions:

what we can see here is that the numbers of people in jobs which are liable to such payments reached a peak in 2001/02 and that subsequently it was declining up to the end of 2005. If we now take a look at a monthly chart since the start of 2006 we will get a clearer picture of the more recent situation:

What we will observe is that the trend has been rather upwards since the start of 2006, but that the total registered, at 26,880,000 is still significantly below the high point of 27,790,000.

I was in fact put on the track of all of this by an article a couple of months back in the Economist. They make the point in that article that Zeitarbeit, as temporary work is called in Germany, may only account for 1% of total jobs, but it does at the same time account for more than half of all those new jobs created in Germany the past year.

One example of the new breed of employers is time & more, which specialises in health care. It has around 400 people on its books, of whom 300 are nurses; two years ago it had 250. Its founder, Bernd Sydow, who sold his firm to Adecco in April, says that it supplies almost all Berlin's hospitals as well as hospitals in other big cities. Around three-fifths of time & more's nurses are called on for stints of one to three days, often at short notice. Having reduced permanent staffing levels and carrying no reserves, hospitals turn to the agency as their requirements fluctuate. Mr Sydow reckons that eventually about 5% of his clients' nurses will come from an external pool."

Now why is all this interesting. Well for two principal reasons. Firstly because of the most striking similarity with what has been happening in Japan (that other global leader in population ageing), and secondly for the light which all of this may throw on the evolution of domestic consumption in Germany. Basically the German jobs machine has been generating a large number of non-traditional and part time jobs, and these jobs are nothing like as remunerative as the traditional ones they have been replacing. There is nothing strange or even surprising in this, as Germany's workforce is ageing, and many of those in the over 50 age group who are seeking work may well find themselves working in just this sector.

As I say, the similarities with what has been happening in Japan are very striking here, and I do, of course, have a Japan blog, and you can find some of my arguments about what is happening to internal consumption, wages and the labour market in Japan on that blog.

Now, if we turn to the impact of all of this on German wages and salaries, then we will find that, naturally enough, and under the circumstances, they have not been rising anything like as fast as some imagined they would be, given the supposed "tightening" which was taking place in the labour market.

As we can see, the response of German wages and salaries to the "new economic revival" has been extremely muted, and this should not surprise us in the least if we think about the changing age composition of the German Workforce.

Italian Consumer and Business Confidence September 2007

Well today it is very much "una de cal y otra de arena" as we say here in Spain (we could say "un pugno e una carezza" in Italian, but it isn't quite the same). First, the "carezza": Italian September consumer confidence unexpectedly rose this week.

The Rome-based Isae Institute's index rose to 107.3 from 106.6 in August. But I don't think we can eak out too much pleasure from this single data point, since the reading is still well down on earlier in the year, and most of the other indicators are going in exactly the opposite direction, except unemployment, of course, but I have already addressed this apparent anomaly here.

A more realistic sign of the times is to be found in the fact that the Italian government raised its debt forecast for next year at the same time as cutting its outlook for economic growth. Italy's debt is now projected to remain at 103.5 percent of gross domestic product next year, revised up from the original forecast of 103.2 percent. The figure was announced by Finance Minister Tommaso Padoa-Schioppa during a parliamentary session in Rome yesterday. He also suggested that he now expected the Italian economy to expand between 1.3 percent and 1.6 percent next year, lower than the original forecast of 1.9 percent. And from where I am sitting even this figure may well be too high, we need to see what happens this winter first.

Italy's debt is still expected to fall to 105.1 percent of GDP this year, and the deficit to 2.5 percent of GDP, at least on Padoa-Schioppa's reading it is. But we still need to see the final actual growth performance this year before we can accept this type os assertion as realistic I think. Downside risk is everywhere right now, and the growth estimates have been dropping steadily since the spring.

Now for the real shovel full of sand: Italian business confidence fell to the lowest in almost two years in September The Isae Institute's business confidence index fell to 92.2 from a revised 93.8 the last month.

In fact the whole business sector seems to be taking a very differnt view of the situation from the official government one. The euro is at record highs, and everyone, with the horourable exception of Jean Claude Trichet it seems, is crying "ouch"

The Rome-based Eurispes research institute were already saying back at the end of August that the then 2 percent GDP growth forecast of the government was way too high and that growth - and remember that was then, not now - would be more like 1.7 percent this year. As I note above Finance Minister Tommaso Padoa-Schioppa yesterday said next year's growth will not top 1.6 percent, but we have yet to see a realistic complete 2007 GDP forecast from the Italian government (realistic I say, we can all try and pretend that what is happening isn't).

To add more sand to sand, a measure of total orders in the ISAE index fell to minus 7 from minus 1 in August. Also a sub-index measuring domestic orders dropped to minus 9 from minus 4, while a measure of foreign orders remained stable at minus 7.

Changing languages for a moment, and going back to the "pugno" (what was it Casius Clay said, "float like a butterfly, sting like a bee"?) is this all now ending up as a case of sauve qui peut?

Monday, September 24, 2007

Eurozone Economies Slow Visibly

Well the FTs Frank Atkins may be going a bit far in make comparisons with the aftermath of 09/11, but the fact of the matter is that there does seem to be a significant slowdown in progress.

The eurozone economy has this month suffered its biggest jolt since the aftermath of the September 2001 terrorist attacks, with global financial turmoil hitting the services sector particularly hard, according to a closely watched survey.

The unexpectedly steep fall on Friday in the eurozone purchasing managers’ index – the third consecutive monthly drop – could knock policymakers’ previous confidence that the 13-country eurozone economy would escape largely unscathed from the US subprime mortgage crisis.

Here is the chart for the Bank of Scotland PMI for the last few months:

Manufacturing seems to have peaked out in mid summer, but services do seem to have started to screech towards a halt (in the sense that 50 marks the neutral, non-expansionary, reading) since mid-August. This would be consistent with other reading we have in the sense that Germany and Italy have been slowing prior to the sub-prime issue, but now - from everything I can see around me here in Barcelona - the construction component of the key Spanish economy is also rapidly grinding to a halt. The reason is obvious I think : banks simply aren't so ready to lend money, and certainly not such a large proportion of the asking price as has been the case hitherto. Conclusion: young people will now have to start to save, and this saving will be noticed in Spanish consumption. And it won't be a one day wonder. Spain will be living with the aftermath of the boom for some years, I think.

German ZEW Economic Sentiment Index September

German investor sentiment on the outlook for the German economy worsened more than expected in September on worries about market turmoil and the strong euro.

The Mannheim-based ZEW economic research institute said its economic sentiment indicator, based on a monthly survey of 304 analysts and institutional investors, fell to -18.1 this month from -6.9 in August. The figure was the lowest since December 2006.

This report adds to growing concern that the collapse of the U.S. housing market will only push further down growth which was already slowing in some of Europe's core economies, Germany and Italy in particular. The European Commission on Sept. 11 lowered its forecast for German growth this year to 2.4 percent from 2.5 percent, adding that the fallout from defaults in the U.S. on mortgages aimed at people with a poor credit history had ``tilted the balance of risks to the downside.''

Friday, September 21, 2007

Italy Second Quarter 2007 Unemployment and Employment

According to Bloomberg this morning:

Italy's unemployment rate unexpectedly dropped to a record low in the three months through June as the economy expanded for a second year, prompting companies to step up hiring.

The jobless rate fell to 6 percent from 6.2 percent in the first quarter, the Rome-based national statistics office Istat said today. That is the lowest since 1992, when Istat began to record the figures.

This growth-driven stepping-up hiring picture - which is by no means unique to Bloomberg - unfortunately isn't quite the whole Italian labour market dynamics story, as the latest complete data set from ISTAT reveal. Let's have a look at why it isn't.

First off, Italy's unemployment rate has been declining, there is no doubt about that. Here's the chart from Q1 2004 onwards.

But how do we interpret this drop in employment? That is the question. Is there more going on here than meets the eye at first glance?

Well, if we look at the next chart for the size of the Italian labour force and the numbers of those employed, then we can see that the Italian labour force does now seem to have "maxed out" (in terms of reaching its ceiling), and may possibly even be slightly declining. At the same time the new employment creation element is very small indeed:

This position becomes even clearer if we look at the year on year changes, where we can see that the size of the labour force turned negative at the end of 2006:

The situation is particularly dramatic and preoccupying in the Italian south (the mezzogiorno), as can be seen from the following chart, the labour force actually went into decline after the second quarter of 2006:

And again, if we look at the unemployment data, we can see that the drop in the south is particularly dramatic:

This situation is extremely preoccupying, especially since the South has been receiving comparatively little immigration. It is preoccupying since it is quite simply unsustainable.

If we look at the migrant presence in Italy, we will see that this has increased considerably in the last few years:

But we will also see that the presence is very unevenly distributed, with proportionately few migrants being in the south, although, as we have noted, the active labour force in the south is contracting more rapidly:

Also, as we can see below, migrants, due to their demographic profile (the age ranges, more being male, etc), tend to have a much higher labour force participation rate than native Italians:

And again, while the economically active migrant population do have a slightly higher unemployment rate than the native Italian equivalent, the order of magnitude is not large, especially given their very high participation rates.

One of the principal problems Italy is now facing is that the number of workers in the most productive age groups is now starting to decline as a % of the total population. If we take a look at the chart for the 25 to 49 age group, we will see that this group rose steadily as a share of the total till the early years of this century. Then the proportion started to level off, and now it is just begining to turn down. 25 to 49 isn't necessarily and exact measure of the most productive group, probably 35 to 50 would be better, but it is the data we have from Eurostat, and it is a good enough measure of the extent of the problem.

If we look at part-time employment as a proportion of total employment, we will see that this has also been on the rise in Italy in recent years, and again this is not surprising in the light of the population ageing which is taking place, and what we know about the impact of this on the functioning of labour markets.

So, far from the Bloomberg story of lots of job creation and healthy economic performance being the case, if we look at the quarterly year on year chart for GDP we will see that the Italian economy has been slowing visibly since the last quarter of 2006 and may well be now heading for a recession this winter:

The position is even clearly when we come to look at the rates of growth from one quater to the next:

An examination of the retail sales chart tends to confirm this prognosis, after a spike at the end of last year, sales dropped back, and there is now virtually NO change year on year over the previous corresponding months in 2006.

The industrial output trend seems to be very similar, which a spike at the end of 2006, and output actually turning down after May 2007.

At the end of the day all I can really say about the more complete picture we can get from this data, is that it is now well past time that people stopped selling themselves pipedreams that everything is running smoothly and that the need to address the real structural ageing-related issues which Italy actually faces is getting to be more urgent by the day.

Wednesday, September 19, 2007

The Greek Economy Under The Microscope

Well, as was widely predicted Costas Karamanlis has now been re-elected prime minister of Greece. He was helped in this, some say, by the recent strong performance of the Greek economy.

According to an impressive array of economic data assembled by the Economist he deserves the applause:

During his first term, George Alogoskoufis, the canny finance minister, got public finances back in order and removed bureaucratic obstacles that were preventing Greece from receiving its full share of EU funding. The economy is growing by more than 4% a year. Tourism is headed for a record year, with more than 16m visitors expected. Unemployment fell at the start of the tourist season to 7.7%, the lowest rate in memory.

But does he? Is the Greek economy really so sound as some pretend. And will there be enough meat in the traditional diet of institutional reforms to really get to grips with the underlying issues which confront the Greek economy. It is fashionable in economic circles to talk about imbalances and twin deficits. Well if ever there was a text book example of such problems it is certainly the case of Greece, as we will see.

So the purpose of this post is to dig a little below the surface and take a detailed look at that "other" Greek economy, the one lurking out there just behind all the recent glowing headlines. Let's see if we can try and discern some of the longer run tendencies which may be at work in Greece, tendencies which, if we can identify them accurately, may actually help us to determine the general outline of Greece's economic future in the medium and longer term.

Since I want to put this post up today, and given that time is at the moment is a really precious commodity, since, among other things, the growing emerging market credit crunch seems now to be steadily closing in on the Romanian Leu (as predicted here in this post)and it now seems to be in danger of entering into some kind of free-fall, I will, just for a change, try to be a man of few words. Lets see if, in this case, the charts don't largely speak for themselves.

Greek GDP

Lets start with a look at recent performance of Greek GDP. As we can see this has been growing pretty strongly in recent years. Although one thing that can be seen immediately from the charts is that Greek GDP certainly is extremely volatile.

and here what it all looks like when you iron out some of that volatility. The quaterly year on year growth rates:

This volatility in Greek GDP growth can be observed stretching all the way back across the years:

However this examination of Greece's GDP growth since the late 60s, also reveals another highly characteristic feature, very high levels of growth with then slowly and steadily begin to drop. Thus we can see that despite the relatively strong growth rates of recent years things have slowed a lot since the heady days of the 60s and 70s. This evolution is of course reasonably normal, and for two reasons. Firstly developing economies tend to experience quite rapid rates of "catch up growth" (you can see this process at work now in Turkey or China) as they converge on the more developed economies. This catch up growth is largely technologically and efficiency driven. But there is another component at work here, a demographic one. As societies develop they move through a series of age structure changes. Initially these changes are almost all favourable - this is the so called demographic dividend period, which as we can see was more or less to be found in Greece in the 1960s and 1970s. Then comes the mature - peak performance - stage, when participation rates are high, dependency ratios are low, and a high proportion of the workforce are in the prime age 30 to 50 group. This has been the Greek case since the early 1990s.

But then comes the mature demographic phase, with life expectancy at birth over 80, and median ages moving up through the 40 to 50 range. This is the stage that Greece is now entering, and this stage presents particular features and problems as we will now see.

Components of GDP Growth

One of the areas in which this changing age structure of a population can be monitored and studied at the economic level is in the evolution of the relative shares of the different components of GDP.

And, as could be expected, if we take a closer look at the composition of Greek GDP in recent years we can see some interesting lines of development. In the first place if we look at private domestic consumption we can see that this has been growing quite steadily over the years.

But if we dig a little bit deeper and take a look at private domestic consumption as a share of GDP we will notice something very interesting and potentially significant, since we we will see that in recent years this has been falling, slowly but steadily:

Now those of you who are regular readers of this blog should not in fact be surprised by this discovery, since Greece, like many other European societies is in the process of ageing, and one of the characteristics that Claus Vistesen and I have been trying to draw attention to in those societies who have moved up through the 40 year median age frontier is that the consumption share steadily starts to drop off as a component in GDP growth. This process seems to be constant, relentless and irreversible. It is, at the end of the day, one of the principal drivers of the growing problem of global imbalances.

So if we now take a quick look at Greece's median age, we will see, not surprisingly, that this has now started slowly but steadily to nudge up over the 40 frontier:

So Greeece is now, it would seem, like other ageing societies - and most notably in this context Germany and Japan - destined to have to live increasingly from increasing exports as a share of GDP, and getting growth from leveraging its export potential. But this is just where the problem arises. Let's look at the chart for export share:

Now as we can see, Greece is a long way from being where Germany and Japan are. Indeed it looks like a much worse case - on the surface at least - of where Italy is. Exports are if anything also trending down very slightly in terms of GDP share, and they are certainly not picking up the slack left by the gap in domestic consumption.

So if exports and private consumption are trending down, and if government spending given the huge debt which has been accumulated (more on this later) is now being tightly reined in, just where exactly has Greece been getting all that GDP growth from in recent years. Well that question isn't too difficult to answer, it comes from fixed capital formation, that's where it comes from.

And what exactly does fixed capital formation mean in the Greek context? Well that can be summed up in just one word - yes you guessed it - cement. Tha is the economy has been increasingly driven by construction activity.

(A curious detail here, the Greek statistical office, in constructing its construction activity index, actually uses the cement volume as a key proxy measure for activity).

So now lets take a look at the evolution of Greek construction activity in recent years:

As we can see, the high point in recent construction activity was in 2002 (not too surprising really, what with the Olympics and all that). Since 2004 the level of activity has clearly been well below the level attained in 2002 and 2003. This becomes even clearer if we look at the chart for the year on year changes in the activity level:

What we can see is that since the end of 2006 there has been some recovery in the civil engineering sector, but housebuilding has not recovered dramatically, despite a generally favourable environment in 2006.

Now lets look at house prices. Firstly if we look at the recent annual data we will see that prices rose significantly in 2001 and 2002, and then subsequently slowed.

So obviously Greece has been living from some sort of construction boom or other. But just how much of a boom has Greece "enjoyed" in recent years. Well, one measure of this would be the rate of change in house prices, so lets take a look. Looking at the quarterly data for 2003 to 2005 what we can see is that the rate of price growth dropped to a low in 2003/04 and then subsequently recovered to some extent in 2005.

If we now look (see below)at the more recent data for urban areas ex-Athens (which is the only data we have for this period at this point. All of this comes from the Bank of Greece, Bulletin of Conjunctural Indicators) we can see that the rate of price increase seems to have peaked in the last quarter of 2005, and since that time it has been steadily slowing, and of course this evolution is consistent with the steady tightening of interest rates from the ECB. So what we can discern here is that while - post 2000 - Greek house prices have not been exactly stationary - they have averaged increases of what, something in the 10% range - these rates of increase are well below the levels attained in the main EU housing boom economies - Ireland, the UK, Spain - and this should not surprise us if we take demography seriously, and compare Greece's median age with that of the other countries involved. Greece may now have touched base just on the other side of the "partage des Eaux" in the median age sense, and housing booms may be effectively "done" as a future driver of growth.

Indeed if we look at the latest data on the national construction index which is posted on the Greek Statistical Institute website we will find that construction posted an annual drop year on year in June 2007 of 7.9%. Given what we know about the global market for credit for construction activity, and given the constraints on the Greek government debt, it is extremely unlikely that this situation is going to improve greatly in the coming months, and to this whole topic we will return at the end of this post.

Greek Demography

Now one of the points I am highlighting here is just how the economic activity of a society changes as the age structure changes. As median ages of societies pass the critical 40 mark, as we are seeing in the Greek case two things happen. The domestic consumption share starts to decline, and the role of private construction activity (ie housing) as a driver of economic growth starts to decline. Thus the society starts to depend increasingly on exports to be able to achieve economic growth. And if there are weaknesses in the export capacity, then there are weaknesses in the whole structural profile of the economy, and this, of course, is the Greek case.

But before we go on to look at this, let's stop for a moment and examine the drivers of the upward movement in median ages. Essentially there are three key parameters here: fertility, life expectancy, and immigration.

Lets take fertility first. As can be seen from the following chart, Greek fertility (in terms of TFR) dropped below replacement in the early 1980s, and has subsequently fallen to the lowest-low level (the 1.2 - 1.3 range) where it has stubbornly remained.

Basically sustained low level fertility impacts on the economic system via its influence on the labour suppply and via the demand related influence on population age structure (ie the relations between savers and borrowers). With less people being born, and increasing numbers of people in the older age groups, the ration between births and deaths steadily changes until a point is reached where more people die are being born (ie the natural rate of increase in population turns negative). Greece reached this stage in the mid ninetees, as can be seen from the next chart.

As I say though, fertility is only one of the factors which influences age structure and median ages, life expectancy is also important, and, as we all know, life expectancy has been increasing steadily in recent decades across the developed world. In this Greece is no exception to the general picture, as can be seen from the next graph.

The third factor is immigration. Really due to the extensive operation of the informal sector in the Greek economy it is very difficult to get accurate information on the scale of immigration in Greece in recent years. The information we do have is provided by the Greek Statistical institute, and such as it is I present in the chart below:

As can be seen, there has been a steady rise in the level of immigration into Greece in recent years, pulled essentially by the relatively strong level of economic growth. As can also be seen the vast majority of the migrants come from Albania (and a good chunk of the rest come from the Balkans I could add) and I mention this as significant since in the main inward migration into Greece has been of ethnic relatives. This detail is significant, since it gives us a cultural measure of societal flexibility, a measure which may be important when we come to think about the issues of reform and change which inevitably face Greece as a rapidly ageing society. In this sense the Greek migration model seems to follow a pattern which is to be observed in Japan, Germany and Russia, where the temporary availability of culturally close "diaspora" groups may serve to postpone the longer term opening towards a more culturally diverse environment. This could be regarded as a rather key institutional structural indicator.

Eurostat also provide information on annual migration into Greece, and I have made an additional chart based on this information. As I say, migrant data need to be handled with care, and it isn't really clear why, if the Greek statistical agency can provide such systematic and accurate information to Eurostat they have such shabby data on their own site, but still, such is the nature of things, and it is not for us mere mortals to ask why. Anyway, here is the chart:

What is quite revealing about this graph is the fact that there seems to have been far more migration into Greece in the early ninetees than there was in the first years of this century. As I say, I wouldn't want to make too much of this data, since I am not sure of its level of reliability, but if it is at all accurate then it is very consistent with the story Claus and I are trying to tell, since it would seem that Greece did not have the kind of housing-driven pull, migrant-arrival push between 2001-2006 that say the UK, Ireland and Spain did, and the general situation begins to look increasingly more like the Italian profile, but this really awaits further investigation and confirmation before I personally would want to jump to any hard and fast conclusion.

Coming back to the general issue of inward migration into Greece in recent years, really there is no big mystery as to why Greece should be receiving migrants. Basically, and as can be seen below, the rate of increase in Greece's working age population has started to slow dramatically in recent years. It is too early at this point to say when this number will turn negative, since essentially it depends on the rate of inward migration, and since the rate of inward migration depends essentially on the rate of economic growth we are in danger of going round and round in circles here.

Obviously there is another key factor to be taken into account at this point, and that is the age structure of the workforce. Essentially in the Greek case this has been largely positive in recent years (and hence the reasonably good productivity statistics) as the share of the population in the 35 to 50 age group has risen steadily.

This situation, however, is not set to continue. If we look at the down trend shown in the following chart in each of the key younger groups, then it is obviously only a matter of time before the share of the 35 to 50 group starts to fall, and with it Greek collective productivity.

Now going back to the stagnating working age data, as we can see below the Greek economy has been steadily generating employment in recent years:

So, with the total population in the relevant age group stagnating, and new jobs being created, three things tend to happen: unemployment goes down, immigration goes up, and participation rates go up. The second of these we have already looked at. Here is the unemployment data:

Basically It is pretty much what we would expect. It is important to remember though that this drop in unemployment has two components, an economic growth "feelgood" one, and a demographic, ageing society, one. The impact of each of these components is quite distinct.

As might have been expected participation rates in Greece have also increased over the years, but it is important to continually bear in mind that in the context of an ageing society this process has limits, since there must both be an upper ceiling to the aggregate level of labour market participation, and the human capital (or value added) component of those who enter in the higher age ranges (or re-enter, as in Japan, after an initial retirement) is well below that of workers in the prime age categories.

Finally, going back to the 35 to 50 age group for a minute we can see from the floowing chart that this group has been steadily growing as a proportion of the working population in recent years, but that recently the rate of increase has slowed, and must be now near its peak:

This very favourable demographic situation is, of course, reflected in the Greek productivity figures, which have been pretty good:

The point of all the demogrphics, however, is that, in productivity terms, Greece is now near its peak potential, and this is why the longer term outlook has to be preoccupying, since if you reach such as structurally distorted position, and accumulate so much public debt during your "heyday", then it is hard to see how you can easily correct and "sweat off all those extra kilos" of debt later.

Returning to our main topic which is perhaps where we might expect growth to come from in the Greek economy in the coming future - given that domestic consumption is now unlikely to be a driver, and for the same reason construction activity is now unlikely to be the engine that pulls the train, we are left with two possibilities, government consumption, and exports.

Well, if we look at the government angle, we will rapidly see that the goose is already pretty much cooked, in the sense that a massive debt has been run up during what were the rather favourable years, and that now, as the going gets tougher the room to maneuver will be much less (as is also the case in, for example, Italy and Japan). If we look at the evolution of the Greek government deficit over the years, we will see that it has been substantial:

As a result of this, the Greek government debt has climbed steadily as a % of GDP.

It might be worthwhile addressing at this point a standard argument that arises in these cases that societies like Greece and Italy are much richer than actually appears due to the existence of a large informal sector. I have to reply to this in advance by saying that in terms of government debt dynamics this is essentially irrelevant, since this sector, by definition, does not pay taxes. The only road to go down is to formalise the sector. But formalising involves adding non-direct wage costs to output, and is thus likely to reduce total activity, and, of course, that activity which is formalised also brings new contributors into the social security system, who at some stage also have a claim on government outgoings, so two points are clear. Firstly the situation is much more complicated than some imagine, and secondly, the informal economy is unlikely to be able to rescue the formal economy in its ability to maintain government solvency.

Lastly, let's take a look at exports and the trade balance. The first chart shows the evolution (in value trems) of Greek exports and imports in recent years.

As is obvious, there has been a significant trade deficit. This is not the point for an in-depth analysis of the Greek current account situation, but let us say that, in the short term at least, the export sector is unlikely to rescue Greece from a looming growth slowdown.

Greek Inflation and Monetary Policy

One of the points which has not received any attention so far in this review is the impact on Greece of participation in the eurozone system. A brief examination of some of the imbalances - in trade, in the government deficit etc - we have identified here should be sufficient to illustrate the superficiality of those approaches which focus on eurozone wide aggregate data, and lose all the little devils (of which there are many) lying around just waiting to be uncovered in the details.

Now as of the turn of the century the Bank of Greece effectively lost control over monetary policy, as a zone-wide rate of interest was applied from the ECB. One of the impacts of this policy has been - as we can see in the chart below - that Greece has not for a single year since the introduction of the common currency had an inflation rate which falls within the ECBs much vaunted 2% target.

Actually if we now come to look at recent inflation, we will see that, as the ECB has tightened, so the rate of inflation has gradually started to come down, although it is still however stubbornly stuck around 50bps above the 2% target:

This situation seems to suggest that the Greek economy has for some years now been growing at somewhat over domestic capacity. This process is also reflected in the steady ongoing wage cost push pressure, since wages as can be seen in the chart below, have been consistently rising at well above the rate of productivity increase:

This situation, however, does seem to be rather inbuilt into a one size fits all monetary policy. I reproduce below, courtesy of the kind data collection efforts of the bank of Greece, a chart comparing the overnight Eonia loans rate offered by the bank (which is effectively the ECB refi rate plus a few BPs) with the Greek CPI on a monthly basis since January 2001. As will be seen the rate dropped below the Greek CPI in early 2002(hardly an advisable state of affairs for a country with an inflation problem and a twin deficits one) and effectively remained there till the late summer of 2006. The big question is, what is the long term consequence of such a long period of above capacity growth?

Obviously capital inflows, and inward movements of migrants can help offset the limitations of the domestic economy, and the inward movement of migrants can help slow down the upward march of the Greek median age (as might a substantial pro-natality policy Scandinavian or French style, if Greece only had one). It is hard to say at this point, but it would seem the monocultural characteristics of the inward flows into Greece and the relatively lower levels than those achieved in say Spain or the UK or Ireland may well mean that migration is not slowing ageing sufficiently in Greece, and that the danger of an "italian" evolution is now a real one. We basically need more data and more analysis on this process, and more detail on the connection between excess economic growth fuelled by ultra-low eurozone interest rates and inward migration rates (a work in progress).

Short Term Prospects

Well, as we have already noted Greek GDP growth in the second quarter of 2007 slowed down considerably, and indeed turned negative. It is difficult, as has been said above, to draw any hard and fast conclusions from this given the long term volatility of Greek GDP output. However the June and July building index data point should already serve as an initial warning. Other data tend which we do have to hand only serve to confirm this slightly uncertain and mildly preoccupying outlook.

First off, let's look at retail sales. Here's the most up to date version we have of the short term index:

if we now look at the year on year changes since Jan 2006, then I think it is clear that there are definite signs of a slowdown since the middle of 2006.

If we come to industrial output it is clear that Greek industry was ramping up production again quite nicely in the first six months of this year after the slowdown in the second half of 2006, although since April the rate of growth seems to have slowed considerably:

But if we come to examine year-on-year rates of change, then we can see that the real expansion took place in the first six months of 2006, and since then things have obviously been slowing considerably:

So, to return to where we started, and Mr Karamanlis, and his recent election victory, can we agree with the verdict of Economist that the handling of the economy has been more or less what Greece needed? I'm afraid we can't. Severe problems seem to be lying out there just waiting to be addressed, and unfortunately, whether we like it or not, these problems are going to make their presence felt. Worse, people don't even seem to be thinking about the right sort of problems. Certainly pension reform is urgently needed, but so too are other reforms to felxibilise migration and to try and encourage an increase in fertility, topics not normally found on the hitlist of the institutional reformers whether these be staff journalists of the Economist, or economists at the world bank. Meantime the global headwinds are turning. Next year is already looking to be a difficult and complicated one. The Greeks - who to some extent still live from shipping - have long been renowned mariners, so lets just hope they can learn some of the key lessons, and sail these choppy seas with out taking on-board too much water. Unlike the Presige, they will be well advised to deck themselves out a double and well re-inforced hull to try to get themselves through the coming storm.