Friday, 18 November 2011

Bigger than Berlusconi

Up until now the crisis in Europe has involved plenty of Greece, large doses of Portugal and Ireland and a dash of Spain.  But seemingly from nowhere, Italy hit the headlines last week and took the unenvious position of centre stage.  The new focus on Italy changes the extent of the crisis. Greece makes up a mere 2.5% of GDP in the euro zone and Germany’s economy alone is more than 10 times larger.  On the other hand, Italy’s GDP is over 16% of the euro zone, and with government debt approaching 120% of GDP, any help for Italy is going to involve a considerable amount of funds.

A lot of fingers have been pointing at Silvio Berlusconi, the ex-Italian Prime Minister who resigned over the weekend, but Berlusconi was a symptom of a larger problem in Italy.  Italy is a country that is dominated by a range of different interest groups (be they unions, public sector workers, pensioners, Northerners, and so on) which makes the country difficult to govern (as any change to government policy is likely to annoy some group in society).  Berlusconi has made this worse by his own aversion to reform.   The lack of leadership and the control of the interest groups has dulled the dynamism of the economy and saddled Italy with its large debts.  One result of this is a lot of cumbersome regulations, which has Italy ranked 87th in the World Bank’s ease of doing business ranking (just below Mongolia).

As such, the economy in Italy has languished and others boomed.  Between 2000 and 2008, Italy grew at an average annual rate of 0.8%, the lowest in the Eurozone, compared to the Eurozone average of 1.8% and 3.8% in Greece.  Greece’s problems stemmed from too much debt at low interest rates after having joined the euro fuelling growth that was unsustainable.   But, in Italy, a stagnated economy meant the country missed out on the party in the good years but is still suffering from a hangover. 

Slow growth by itself would not have been a problem had it not been coupled with high levels of debt.  Unlike Greece, government debt has typically been high in Italy and has not been seen as a problem until Greece brought it to the forefront of investors’ minds.  Berlusconi has helped to make the situation worse by backing away from plans to rein in government spending and this is what ultimately prompted already jittery investors to sell off Italian government bonds and cost Berlusconi his job as Prime Minister.

While Berlusconi himself is not the main problem, removing him from power may open up the door to a solution.  But it depends on the governing powers in Italy being bold enough to put in place policies that will not only bring down its debt but also free up its economy and also on voters that recognize that this is necessary.  The markets seemed to have helped highlight the need for change and I think that this will put Italy back on track.

Sunday, 13 November 2011

US Jobs Data Puzzle

I once worked at a financial news service in Tokyo following the stock market in Japan and there were always certain bits of data that investors would watch out for.  One of these was the US non-farm payroll data which is released on the first Friday of every month and represents the number of jobs added or lost in the U.S. economy in the previous month.

This data was important to many firms not only in Japan but in much of Asia and elsewhere because strong growth in jobs would signal that consumers in the U.S. would be able to keep buying the goods these firms wanted to export to the U.S.  While American consumers are not the drivers of the global economy that they once were (which is a completely different topic on its own), I thought I would take a look at the jobs figures for October and see what insights we could gain from them.

The data shows that around 80,000 jobs were added to the U.S. economy in October which helped to nudge the unemployment rate down from 9.1% to 9.0%.  While the increase in jobs is positive, the jobs created in October are seen as insufficient in terms of making up for the jobs lost during the recession as shown by the graph (from the Financial Times website).  It is estimated that 6.6 million net jobs were lost in the U.S. during the past recession, and on top of this, that there are 100,000 new entrants to the job market every month.  As such, many economists believe that 200,000 jobs are necessary to make significant reductions in unemployment.

While a weak recovery in the U.S. economy is a major factor why unemployment remains so high, it is not the only issue.  The U.S. economy is in the midst of a massive shift of resources from the manufacturing sector to providing services such as health care, education, and business services such as those offered by lawyers and accountants.  These changes cause problems as workers have to move from sectors which are in decline to the expanding industries where the new jobs are being created but which may require completely different skills.  Therefore, some of the unemployment in the U.S. is cyclical unemployment which is caused by there being less work available.  But, there is also structural unemployment which is a mismatch between demand for certain skills from firms and the actual skills that workers have. 

The concept of structural unemployment helps explain a strange occurrence in the U.S. labour market.  A recent survey showed that the number of vacant jobs in the U.S. was 3.4 million in September which is the highest in two years.  One reason for this is that workers no longer have the skills that companies are looking for.  Another reason is to do with the housing market.  The slump in house prices means that around one quarter of all mortgage borrowers in the U.S. owe more to the bank than their house is worth.  The result being that people in this predicament are less likely to sell their home to move to take a job elsewhere.

Apart from the immediate hardships that unemployment causes, long spells of unemployment often result in skills that workers have becoming out-dated or people losing contact with the job market and not returning.  This may slow the recovery in the U.S. economy as there will not be the right type of workers for the jobs that firms want to fill and the workers will tend to be less productive than they otherwise would have been.  The problem may be all the greater due to the lack of resources provided to educate and retrain workers and could be one factor that could weaken the dominant economic position of the U.S.

Tuesday, 8 November 2011

So what is going on…???

Last week saw a couple of growth forecasts being cut as the lingering effects of the financial crisis continue to weigh on the economies of developed countries. 

The OECD, an organization which counts many of the richer countries as its members, downgraded its expectations for growth and now predicts 1.8% growth in the U.S. economy next year compared to 3.1% it forecast in May.  The euro zone is only expected to manage a 0.3% increase in GDP in 2012 opposed to a prediction of 2.0% growth just six months earlier.  The OECD points to factors such as firms putting off investment due to uncertainty over the direction of the economy as well as households spending less as they worry about jobs and weak returns on investments in stocks and property.  Deeper cuts in government spending are also seen as having a negative effect as many governments rush to lower their levels of spending.

The Federal Reserve, the central bank of the U.S., also published a lower forecast for U.S. growth.  The U.S. economy is predicted to expand by around 2.7% rather than the forecast centred around 3.5% growth which was released in June.  Unemployment had been expected to fall more quickly from its current level of 9.1% to near 8.0% next year, but is now forecast to only edge down to near 8.6%.  The forecast had been changed due to underestimation of the lingering effects from the financial crisis and the weak housing market.The weakness in the economy has prompted the Federal Reserve to state that it expects to keep interest rates close to zero until the middle of 2013.

The release of the lower forecasts suggests that even economists are struggling to come to terms with the impact of the financial crisis.  These effects are difficult to come to grips with due to the scale of the problems built up during the boom years when the easy availability of debt propelled asset prices (i.e. prices of stocks and property) to exorbitant levels.  It will continue to take time for these imbalances to work themselves out and for asset prices to adjust to suitable levels (i.e. fall).  The inability of politicians in both Europe and the U.S. to work constructively toward a solution is further compounding the problem.  But there may be little that the politicians could do anyway.  The typical tools for perking up the economy are either not available (high government debt means that politicians can’t spend to create growth) or are not proving that useful (options in terms of monetary policy have already been exhausted with interest rates near zero and central banks unable to print enough money).

So the answer is that no one really knows for sure how much this period of weak growth will continue for.  Economist tend to have faith in the market to create a setting where growth is possible but a return to a steady expansion may still be a way off due to the problems mentioned above.

The recent economic turmoil raises many issues, some of which I will try and deal with in this blog.  But if there are any particular topics you would like me to deal with or questions you may have, please let me know.

Hello all...

Hello all.

First, let me explain a little bit about this blog and what I am trying to achieve with it.

The motivation for this blog is to take a step back from the news and take a look at the bigger picture.  I have maintained an interest in economics over a long period but I still find it a little overwhelming to follow what is happening with regard to the economy and this blog is an attempt to give more background to issues that are in the news to help build a clearer picture of what is going on. 

So please let me know any questions you may have on things that are happening in the economy, any comments you may have on what has been written in the blog, and any advice on how to explain things better.  

Most of all, I hope that you make the most of what this blog is trying to achieve and help me to do the same.