Articles from The Economist

Three articles from the subscription section of the current issue of The Economist are reproduced here and referenced in the next post - hopefully, the folks at The Economist won't mind as they are are generally spoken of highly here.

Decoupled
Companies' and countries' prosperity

Feb 23rd 2006
From The Economist print edition
The health of companies and the wealth of economies no longer go together
Ronald Grant

“NOTHING contributes so much to the prosperity and happiness of a country as high profits,” said David Ricardo, a British economist, in the early 19th century. Today, however, corporate profits are booming in economies, such as Germany's, which have been stagnating. And virtually everywhere, even as profits surge, workers' real incomes have been flat or even falling. In other words, the old relationship between corporate and national prosperity has broken down.

This observation has two sides to it. First, as Stephen King and Janet Henry, of the HSBC bank, point out, companies are no longer tied to the economic conditions and policies of the countries in which they are listed. Firms in Europe are delivering handsome profits that are more in line with the performance of the robust global economy than with that of their sclerotic homelands. In the past two years, the earnings per share of big listed companies have climbed by over 100% in Germany, 50% in France, 70% in Japan and 35% in America. No wonder Europe's and Japan's stockmarkets have outpaced those in America, despite the latter's faster GDP growth.

Second and more worrying, the success of companies no longer guarantees the prosperity of domestic economies or, more particularly, of domestic workers. Fatter profits are supposed to encourage firms to invest more, to offer higher wages and to hire more workers. Yet even though profits' share of national income in the G7 economies is close to an all-time high, corporate investment has been unusually weak in recent years. Companies have been reluctant to increase hiring or wages by as much as in previous recoveries. In America, a bigger slice of the increase in national income has gone to profits than in any recovery since 1945.
Home truths

The main reason why the health of companies and economies have become detached is that big firms have become more international. The world's 40 biggest multinationals now employ, on average, 55% of their workforces in foreign countries and earn 59% of their revenues abroad. According to an analysis by Patrick Artus, chief economist of IXIS, a French investment bank, only 53% of the staff of companies in the DAX 30 stockmarket index are based in Germany; and only one-third of those firms' total turnover comes from there. Only 43% of all the jobs at companies in France's CAC 40 are in France. With the profits of these firms so dependent on their global operations, it is not surprising that corporate prosperity has failed to spur “home” economies.

American and Japanese companies remain more closely tied to their domestic markets. Just one-fifth of the turnover of firms in Japan's Nikkei index comes from overseas. Foreign sales of America's S&P 500 companies amount to a modest 25% of the total. Even so, at the 50 biggest firms the figure is higher, at around 40%. The old saying, “What's good for General Motors is good for America”, no longer rings true: over one-third of GM's employees work outside the group's home country.

If a large part of the spurt in profits comes from foreign operations, it is less likely to be used to finance investment or extra job creation at home. If they reason that the recent past is a fair guide to the immediate future, companies are likely to plough their extra profit into further investment abroad. Alternatively, they may buy back shares or repay debt.

Globalisation has also shifted the balance of power in the labour market in favour of companies. It gives firms access to cheap labour abroad; and the threat that they will shift more production offshore also helps to keep a lid on wages at home. This is one reason why, despite record profits, real wages in Germany have fallen over the past two years. That in turn has depressed domestic spending and hence GDP growth.

Workers can still gain from rising profits if they own shares, either directly or through pension funds. There is reason to think that the share prices of large listed companies will fare better than their home economies. Economic theory and historical experience argue that, in the long run, profits grow at the same pace as GDP. However, if the profits of big companies are increasingly linked to global production, then the profits of listed companies in developed economies could rise faster than domestic GDP for many years.

In America, capital gains on shares have played a big role in supporting household spending over the past decade. But Mr Artus worries that workers in continental Europe are losing out, because a surprisingly high proportion of shares are held by foreigners: as much as 35% in France and 16% in Germany. This is partly because of the smaller role played by institutional investors, such as pension funds, in Europe compared with, say, America.

If profits (and hence executive pay) continue on their merry way, while ordinary employees' real wages stand still and their health benefits and pensions are eroded, workers might well expect their governments to do something to close the gap. It's not hard to think of ideas that would be popular—higher taxes on profits, restrictions on overseas investment, import barriers, or making it harder to lay off workers. The trouble is, in a globalised economy such measures would also be suicidal. Firms would simply move operations' head offices to friendlier countries.

A more promising way of allowing workers to share in companies' prosperity is to encourage firms to introduce profit-sharing schemes for employees. But perhaps the most useful thing that governments can do is to ensure that consumers (ie, workers) benefit from lower prices as a result of the shifting of production to low-cost countries. The prices of consumer goods have fallen by much more in America in recent years than in the euro area, where retailers are shielded from competition and have not passed on cost reductions. Greater competition in Europe would allow workers to share in the gains of globalisation through lower prices.

The clear lesson is that policies aimed at penalising companies will fail to spread the rewards of corporate success to the wider economy. The only sure way to boost national economic prosperity is to make labour and product markets work more efficiently and to improve education, to make the home country a more attractive production base.

The growing internationalisation of companies also makes a nonsense of the paranoia, in both America and Europe, about foreigners buying “our” companies. It has always been foolish for governments to block foreign takeovers which make good economic sense. It is even more so today. When over half of the workforce of many big companies is based abroad, the distinction between foreign and domestic firms has become increasingly blurred. There was patriotic outrage in France at the hostile bid for Arcelor by Mittal, a global steel giant. Yet although Arcelor is a member of the CAC 40 and viewed in France as a national corporate jewel, it is actually the product of a three-way European merger. It is incorporated in Luxembourg and only one-third of its employees are in France. In future the notion of “our” companies will become even more elusive.

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Out, damned D word
Japan's Economy

Feb 23rd 2006
From The Economist print edition
The battle against deflation seems to have been won

A LOT of nasty words begin with the letter D: disease, death, devastation and danger. In comparison, deflation might seem a relatively mild affliction. Yet Japan, the first economy to suffer prolonged deflation since the 1930s, has lived with its painful economic consequences. Falling prices mean that real interest rates cannot be negative when required to reflate a sick economy. Falling prices also inflate the real burden of debt. This, in turn, depresses spending, which further intensifies deflation. And so on, in a vicious spiral.

Central bankers have long known how to fight inflation, but have been flummoxed by deflation. Five years ago the Bank of Japan launched a monetary experiment—its so-called “quantitative easing” policy, which basically means printing lots of money. The economy seems to be responding: figures last week showed that Japan's real GDP grew by 4.2% in the year to the fourth quarter (and by a stunning 5.5% annual rate in the same quarter). On that measure, it is currently the fastest-growing rich-country economy (see article).

Before declaring deflation dead, however, policy-makers need to hack through a statistical tangle. According to the Bank of Japan's preferred measure, core consumer prices (which excludes fresh food) showed a year-on-year increase (albeit only 0.1%) in November and December: two small nails in deflation's coffin. But Japan's national accountants, who compiled last week's surprising growth figures, have a more dispiriting view of deflation. By their measure, prices appeared to fall by 1.6% in the year to the last quarter: the deflationary monster is still alive and well.

In fact, both measures are flawed and give a misleading picture of what is really happening in the economy. Japan's core rate overstates inflation, because unlike in other countries, it includes energy prices, which are surging. Equally, in an economy undergoing profound structural change and suffering from deflation, it is a particularly daunting task to know how much of a change in spending is due to a change in real output, as opposed to a change in prices.

This is why the only sensible measure of Japan's economic performance is nominal GDP, ie, total national output measured in money not volume terms. When inflation is high, only changes in real output offer any sensible guidance to how the economy is performing. But in a period of deflation, nominal changes matter much more: growing real GDP means little if the economy is contracting in money terms. Between 1997 and 2004 Japan's nominal GDP shrank by 5%, while America's spurted by 42%. The good news is that in the year to the fourth quarter of 2005 Japan's nominal GDP grew by 2.6%, its fastest annual growth for almost nine years. (Even so, nominal GDP still remains below its level in 1997.)
No nominal matter

Shrinking nominal GDP created a vicious circle by causing Japan's huge ratio of government-debt-to-GDP to rise further. Rising nominal GDP will now help to reduce that, and by boosting tax revenues it will slim the budget deficit. Faster nominal GDP growth also means that zero interest rates become more reflationary, since the gap between interest rates and nominal GDP growth is a good gauge of the tightness of monetary policy.

This underlines a big difference between today and August 2000 when the Bank of Japan briefly and prematurely abandoned its zero interest-rate policy. Real GDP growth was then running at an apparently healthy 2.5%, but nominal GDP was barely growing. Soon after the bank raised interest rates, deflation intensified and real GDP growth slowed sharply again. The Bank will be more cautious about raising rates this time, but sooner or later it will need to withdraw its unprecedented injection of liquidity if it is to prevent a future asset bubble. As Japan's economy becomes more normal, it is natural to expect a more conventional monetary policy. In economics, a bit more normalcy can be a jolly good thing.

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Self-inflicted wound
Gold and the Bundesbank

Feb 23rd 2006 | FRANKFURT
From The Economist print edition
Germany's central bank cuts off its nose to spite its face

A TRUCE was called last week in a battle between Germany's Bundesbank and federal government over the country's 3,400 tonnes of gold reserves. The central bank is proud of having stood up to the finance minister. However, it is hard to see what it has gained.

The gold is worth about €50 billion ($60 billion) according to the Bundesbank (valuing its stash at recent market prices). Every finance minister for the past two decades has been trying to coax the central bank into selling some. Although an agreement between central banks, sealed in 2004, would allow it to unload 120 tonnes a year until 2009, the Bundesbank won't budge.

Most Bundesbankers see themselves as custodians of the people's wealth. Selling some of it, especially to fill part of the gaping hole in the public finances, would both erode that wealth and damage the central bank's fiercely guarded independence. So when Peer Steinbrück, the new finance minister, proposed that the Bundesbank should keep the capital proceeds of any gold sales but that the interest should go to the budget, he was sent away with a flea in his ear. The Bundesbankers were especially miffed by a veiled threat that if they did not co-operate, their special pay supplement, which adds up to 19% to their basic salaries, would be removed.

The days when journalists would invariably describe the Bundesbank as “mighty” are long gone. With other euro-zone central banks, it handed monetary policy over to the European Central Bank when the euro was born in 1999. In the past four years the Bundesbank's staff has been reduced by over 20%, to 12,300. It will fall to 11,100 by the end of 2007. That is still too many for what is now merely one member, albeit the biggest, of the euro club. And its eight-man board is too big, a concession to regional politics. Nevertheless, it is a founding principle of the euro area that national central banks be independent of their governments. This gives Axel Weber, the Bundesbank's president, a strong hand in any disputes with ministers.

Although Mr Steinbrück was seen off, the Bundesbank looks a little ridiculous. Under last week's truce, Bundesbankers' supplement will be phased out, but gradually, to be replaced with increases in basic pay; the bank's top officials in Frankfurt will still get a 9% top-up. But under the existing Bundesbank law the proceeds of any gold sales go to the government anyway, as do all the central bank's profits. This week Mr Steinbrück unveiled a budget which foresees that €3 billion will come in from the Bundesbank this year. Meanwhile, one parliamentarian has proposed putting Mr Steinbrück's proposal into law anyway.

So, to spite Mr Steinbrück, the once-mighty Bundesbank has simply robbed itself of flexibility. It risks hoots of derision if it now sells an ounce of gold.