DT article about re-balancing UK economy, innovation & investment

By Jeremy Warner

5:58PM BST 08 Sep 2015

102 Comments

Even the darkest of clouds will have some sort of silver lining. 

So when the financial crisis hit these shores, it was confidently predicted that despite its otherwise devastating consequences, it would at least force the UK economy to rebalance away from unsustainable-reliance on debt-fuelled consumption to a healthier form of growth based on investment and exports. The march of the financiers would be replaced by the “march of the makers”. 

Seven years after the event, the marchers are still struggling to get into their stride. This is not for want of cheerleading rhetoric from government ministers or the fantasy targets they have set themselves. It is hard to switch on the television these days without seeing the Chancellor in a high visibility jacket and hard hat striding the factory floor or construction site in some, generally northern, supposed centre of industrial activity and excellence. You certainly can’t fault him for his energy and enthusiasm. Back in 2012, he set a target of doubling British exports to £1 trillion by 2020. Regrettably, his chances of meeting it are zero. 

Full recovery in manufacturing output from the ravages of the crisis has proved equally elusive. Growth in industrial production and manufacturing has seriously lagged the recovery in services and consumption; factory output remains well below pre-crisis levels, and with a strengthening currency – which makes UK goods more expensive relative to foreign competitors – and the continued slump in Europe, actually begun to contract anew in the last quarter. Figures for July, due to be announced on Wednesday, are expected to show only a slight rebound; forward indicators for the remainder of the year give little reason for optimism. 

There is, of course, nothing new about de-industrialisation. Since 1978, the number of jobs in manufacturing has shrunk from 25pc of the UK workforce to around 8pc. Fewer than 3m people today work in UK manufacturing, against more than three times that number 40 years ago. Manufacturing output as a share of GDP has fallen by a similar order of magnitude. Surprisingly little of this displacement has ended up in financial services. The vast bulk of the outflow, at least in terms of jobs, has been into wholesale, retail, hospitality, government services, real estate, communications and transport. 

All very depressing. Yet we should also be careful not to overstate the nature of the problem. As Sir Richard Lapthorne, who chaired a government sponsored review of the future of manufacturing a few years back, points out, manufacturing is not what it was. Big changes are under way that put a whole new light on what we think of as the manufacturing sector. The bald statistics don’t yet properly reflect these changes. 

For a start, manufacturing is becoming very much more capital intensive. Developments in robotics and other forms of mechanisation are levelling the playing field and destroying the comparative advantage enjoyed by China and other low labour cost producers. This is already leading to some “onshoring” of production, particularly in textiles, an industry laid to waste by emerging market competition. However, these developments also mean that even if manufacturing were to make a big comeback in the UK, it would be unlikely in itself to create many jobs. Mass, production line employment is increasingly a thing of the past. 

But it is in so-called “factoryless” production that the more significant changes are taking place. This is partly about outsourcing. Dyson, for instance, produces nothing in the UK at all, but all its research and development, together with its engineering know-how, is based here. The high-end value creation resides in Britain, not Malaysia, where the vacuum cleaners are produced. The same is true of Apple, which is essentially just a product development, quality control and marketing company. It makes hardly anything itself. ARM is a British version of the same thing; it designs and sells computer chips for smartphones, but it doesn’t make them. 

It is in any case quite wrong to think of the modern manufacturer as solely about the process of turning base metal and biomass into saleable products. Most manufacturers today contain some service element. According to Sir Richard’s report, some 39pc of UK manufacturers with more than 100 employees now derive value from service activities. For Rolls-Royce, around half of revenues come from servicing and leasing its jet engines, rather than selling them. 

The so-called “shared”, or “circular”, economy promises further expansion of this service-based element. Having seen the future, both Ford and BMW have dipped their toes into the market for shared cars, even though this seems to be at odds with the priorities of the traditional “take, make, consume and dispose” manufacturing model.

Value is progressively shifting from traditional manufacturing to idea-intensive businesses and industries. These tend by their nature to be more service based.

None of this is to argue that manufacturing no longer matters. Germany this week announced another record trade surplus. Britain’s economic recovery has meanwhile become worryingly dependent on an equally sizeable current account deficit, which can only persist without mishap as long as foreign capital is prepared to fund it. More can and should be done to encourage Britain's tradable goods sectors. A good starting point would be to make all capital expenditure an immediate offset against revenue for tax purposes, thereby better aligning the incentives for capital investment with those of spending on labour. 

Introduction of a national living wage may help a little on this front. But to succeed like Germany in manufacturing, companies need to be thinking in terms of a continuous process of multiple product launches, requiring heavy upfront investment in development and retooling. Despite nascent signs of recovery in capital spending, British industry is still underinvesting on a destructive scale. 

Still, I began by referring to “silver linings”. As it happens, the terms of trade are once again moving quite dramatically in Britain’s favour, with the cost of energy, raw materials, food and many finished goods getting relatively cheaper, while the price of services is again rising fast. Pricing power significantly favours the UK’s areas of comparative advantage over those activities in which it is relatively weak. Certainly mass manufacturing no longer looks a good place to be. 

Many of Britain's service industries - particularly high-end business, financial and IT services - are in high demand the world over and can be easily exported. Britain might not produce very much any longer, but it is relatively well placed, possibly uniquely so, to benefit from these post-industrial trends, even as they apply to manufacturing.

Top10 international concepts - video revision

OK, this is an American version, so it brings in material in a different  way (Phillips Curve and trade - unnecessary, in my opinion). Still, some value in here, particularly explanation of the tariff diagram.

Free trade agreements

 asia.nikkei.com article - follow the link for more on free trade deals 

Vietnam-EU deal faces major obstacles

ROBERTO TOFANI, Contributing writer, asia.nikkei.com

ROME -- Vietnam Prime Minister Nguyen Tan Dung is hoping to sign a free trade agreement with the European Union before the end of his term in 2016 but that's looking a little optimistic.
     An FTA would bring substantial benefits. The EU is already Vietnam's second-largest trading partner after China but the trade deal could still boost the country's exports by 20%, according to the Konrad-Adenauer-Stiftung, a German political think tank. Europe would also get better access to Vietnam's market for selling its high-tech products. That might help to shrink its growing trade deficit with Vietnam, which grew steadily from 2.74 billion euros ($3.28 billion) in 2003 to 15.5 billion euros in 2013.
     Still, the two sides are unlikely to reach an agreement until Vietnam makes marked improvements in public procurement processes, intellectual property protection and state-owned enterprise reform, say those familiar with the negotiations.
     "From a European perspective, it is important for Vietnam to respect the exclusive rights to use Geographical Indications (GIs)," said Claudio Dordi, team leader of the EU's trade and investment support program for Vietnam. GIs is the name or sign used to show where goods, especially farm products, have originated. 
Trademark conflicts
The problem lies in the fact that Vietnam is also negotiating with the U.S. over the Trans-Pacific Partnership multilateral trade deal and Washington wants all signatories to adhere to its own trademark system that could conflict with European GIs. For example, the Europeans insist that only cheese produced in a certain part of Italy can be called Parmesan cheese, but in the U.S., Parmesan is considered a generic term for certain hard cheeses. The same problem exists for Parma ham. An American prosciutto maker operates under the registered name of Parma Brand even though it is based in Pittsburgh, not Parma.
     Vietnam will need to manage this kind of conflict between a U.S. trademark for "Parmesan cheese" and Europe's protected designation of the origin of "Parmesan cheese," said Dordi. Other countries in Asia face similar problems and there is no easy solution unless the EU and the U.S. agree to a compromise between themselves, he said.
     Another problem, at least from Vietnam's point of view, is that its inefficient SOEs will be hard-pressed to compete with European competitors if they open up service sectors such as ports, logistics and communications. Ludo Cuyvers, director of the Center for Asean Studies at the University of Antwerp, said Vietnam SOEs are already under pressure to reform as they will have to compete with regional rivals when the Asean Economic Community, due to come into effect at the end of 2015, opens up Vietnam's market to its neighbors. To open the gate to more competition from the west may be too much for the SOEs to cope.

  There's also the problem of non-tariff barriers that the Europeans are unwilling to drop. Vietnam considers the EU's rigid health, safety and environmental requirements as the greatest impediment to its exports. Some Vietnamese food exports have regularly been found to violate EU hygiene requirements and in October, the Vietnamese ministry of agriculture chose to suspend the export of certain types of vegetables to Europe after banned bacteria were found on samples. The EU also has discretionary power to ban the import of products that have violated the rules five times in a year.

     There has been some progress with the FTA negotiations. At the end of November, Vietnam's National Assembly passed the amended Enterprise Law and Investment Law, which are intended to provide more favorable conditions for foreign investment in Vietnam. Vietnam has also indicated it is ready to drop import duties on European products such as alcoholic beverages, according to an EU internal report that was written last March and seen by the Nikkei Asian Review.
Less emphasis on China
Politically, the Vietnamese government is keen to diversify its imports and buy less from China, with which it has maritime and territorial disputes in the South China Sea. In fact, Vietnam is courting stronger diplomatic support from the EU to back its claims against China. The prime minister raised the issue during his European tour in mid-October, when he also met European Commission President Jose Manuel Barroso for talks on the FTA.
     Vietnam has a growing trade deficit with China. The latest figures from the Vietnamese statistics office shows Vietnam imported $39.9 billion worth of goods and services from China from January to November, up 18.9% year-on-year. That left Vietnam with a trade deficit of $26.4 billion, 22.1% more than the previous year.
     As a result, Vietnam has been keen to negotiate FTA agreements with other countries in the region. One was sealed with South Korea on December 10.
     The 11th round of FTA talks will take place this month in Vietnam and there is another round scheduled for early March in Brussels. If real progress is made at these talks, Prime Minister Nguyen may still see his dream come true, but there is certainly a lot more work to be done.  

Resources for International Trade

International Trade

Review the following....

T2U international trade presentation
http://www.slideshare.net/tutor2u/international-trade-25962434

T2U protectionism presentation
http://www.slideshare.net/tutor2u/protectionism-26223566

Learn Liberty videos
http://www.youtube.com/watch?v=y0gGyeA-8C4
http://www.youtube.com/watch?v=7yOHjRThM_o
http://www.youtube.com/watch?v=qdcQLWGaJoM

Global trade resources

TTIP links

global manufacturing competitiveness:

Boston Consulting Group interactive charts

Article with graphics and explanations of this:

https://www.bcgperspectives.com/content/articles/lean_manufacturing_globalization_shifting_economics_global_manufacturing/

What the future holds - essay material

When you have made all your points, explained them clearly and done full evaluation, then you might want some big-picture material to impress the examiner with your knowledge of the wider context. I sent you this last September, but it is still very current:

When the money runs out?

Stephen King, group chief economist of HSBC, a banking giant, has written a book, 'When the Money Runs Out: The End of Western Affluence,' that was published in the early summer. It raises relevant issues and of course, a bank economist has to avoid some sensitive ones.

The author acknowledges that in a paper currency system, the money in a narrow  sense may never run out but he argues that the ability of the developed world to generate significant economic growth, and thus wealth, has declined. He highlights that in the first four decades of his own life real British incomes per head almost tripled; in his fifth decade, they rose just 4%.

In an op-ed piece in The New York Times on Monday (the reader comments are also interesting), he wrote:

"The underlying reason for the stagnation is that a half-century of remarkable one-off developments in the industrialized world will not be repeated.

First was the unleashing of global trade, after a period of protectionism and isolationism between the world wars, enabling manufacturing to take off across Western Europe, North America and East Asia. A boom that great is unlikely to be repeated in advanced economies.

Second, financial innovations that first appeared in the 1920s, notably consumer credit, spread in the postwar decades. Post-crisis, the pace of such borrowing is muted, and likely to stay that way.

Third, social safety nets became widespread, reducing the need for households to save for unforeseen emergencies. Those nets are fraying now, meaning that consumers will have to save more for ever longer periods of retirement.

Fourth, reduced discrimination flooded the labor market with the pent-up human capital of women. Women now make up a majority of the American labor force; that proportion can rise only a little bit more, if at all.

Finally, the quality of education improved: in 1950, only 15 percent of American men and 4 percent of American women between ages 20 and 24 were enrolled in college. The proportions for both sexes are now over 30 percent, but with graduates no longer guaranteed substantial wage increases, the costs of education may come to outweigh the benefits."

King makes a plea for "economic honesty, to recognise that promises made during good times can no longer be easily kept."

He proposes reforms such as raising pension ages, increasing immigration in ageing societies and a social pact where an older population does not cannibalise benefits at the expense of the young.

The economist also recognises that rising inequality is part of a process that feeds mistrust within nations.

Stephen King writes in his book:

"Based on our collective belief in ever-rising living standards, we have spent the last half-century watching our financial wealth and our political and economic 'rights' accumulate at an incredible pace. We all, directly or indirectly, own pieces of paper or rely on political promises that make claims on future economic prosperity. Only a handful of years ago, we were so confident in continued economic progress that we could be educated yesterday, consume today, retire tomorrow, have excellent healthcare the next day and create a better life for our children while, at the same time, saving very little. We hadn’t just mastered our economies. We had mastered time itself.

What happens, however, if the future is worse than we hoped it would be? What happens if, collectively, the claims incorporated in our pieces of paper and our political promises cannot be honoured?"

Broadening your understanding of currency management

This article has some quite complex material; it does explain how the Swiss tried to hold the CHF down, and the implications of all those francs sloshing around the global financial system. You don't need to read all of it, but you should try to glean:

1. Why they pegged;
2. What forced them to drop the peg, and the impact for the SNB and the economy;
3. Where all the francs they sold to keep the peg ended up, and the implications of a rising franc (similar to the rising $);
4. About two thirds of the way down, in italics, a quote from a John Mauldin newsletter (love that guy!) with a tongue in cheek analysis of fiscal probity a la Switzerland.

It also makes the point that the euro is less like the deutchmark and more like the lira... an interesting point, now I think about it.

The Swiss National Bank won't go bust

Exchange rate management:

Two contrasting articles to show you how exchange rate management has to evolve to fit in with circumstances, plus an article from 2006 explaining why countries pegged themselves to the $. The first was written back in 2010; the second is from December 2014. Compare & contrast:

ARTICLE 1

China is letting the yuan “off the leash”, says Ian King in The Times. Since July 2008, the government has pegged its currency to the dollar in order to shield its crucial export sector from the impact of the global downturn.

This has caused a spat with US lawmakers. They point to China’s hefty current-account surplus (and the US deficit) as evidence that it is gaining an unfair trade advantage by not allowing its currency to appreciate against the dollar. Now China has moved back to a ‘crawling peg’ system introduced in 2005. The currency is allowed to rise (or fall), but it can only move in a band of 0.5% around a point set by the central bank every day.

Risk assets bounced so sharply you’d have thought the news signalled “a cure for male pattern baldness”, says FT.com. Analysts cited plenty of reasons to be impressed. The move will forestall US protectionism. It suggests that China has gained confidence in the strength of the global recovery. A dearer currency boosts Chinese companies’ and households’ purchasing power, which should underpin exports elsewhere. Meanwhile, cheaper imports should temper inflation, helping China achieve a soft landing. This marks the beginning of a shift away from China’s dependence on exporting, helping to rebalance the world economy.

Yet the move is hardly a “game changer”, as Capital Economics puts it. This isn’t a shift to a freely floating regime as the daily trading band is staying. And China won’t countenance a major rise in the yuan-dollar rate, given the yuan’s appreciation against the euro, says Rom Badilla on Bondsquawk. It can’t spur consumption overnight, given the “culture built on savers and under-investment”.
In any case, there’s more to global imbalances than currencies, as Economist.com points out. From 2005 to 2008, for instance, the yuan rose by 20% against the dollar, yet the Chinese current-account surplus, and the US deficit, kept rising.

As for protectionism, China’s announcement has defused tension before the G20 meeting this weekend. But with elections looming, China remains a “convenient economic scapegoat” for misguided legislators, says James Pethokoukis on Breakingviews. “The risk,”
says Capital Economics, is that China is “criticised for moving too slowly and that trade tensions escalate again.”

ARTICLE 2

At the start of this year, “investors thought there was next to no chance” that the Swiss central bank would stop artificially weakening the Swiss franc against the euro, says The Daily Telegraph’s

Peter Spence. “They do not want to be burned a second time.” So after last week’s Swiss shocker, everyone is wondering – which country might be next to abandon a long-held currency peg?

Denmark’s currency peg is under pressure

The spotlight has fallen first on Denmark, which is now the last major economy to peg its currency to the euro. Denmark’s Nationalbank (DNB) targets a value of 7.46 Danish krone to the euro. The currency is allowed to fluctuate in a band of 2.25% around this target.

The authorities are in a similar position to the Swiss. Concerned investors have moved money from euros to krone, which has forced the DNB to buy foreign currencies to prevent the krone from rising too far. When the European Central Bank (ECB) launched quantitative easing (QE) this week, the DNB had to slash interest rates twice and buy more foreign currency to keep the krone weak.

Markets expect the DNB to be far more committed to the euro peg, which is over 30 years old – the Swiss National Bank had only been holding the Swiss franc back for three. Moreover, the DNB’s balance sheet has only swollen to 20% of GDP following its foreign-exchange purchases, compared to 70% in Switzerland. So there should be some way to go before fears over a bloated money supply or major future losses on currency holdings begin to rattle the Danes.

Even so, given the money flowing out of Europe, the DNB may have to be more radical, says Capital Economics. It has already imitated unconventional ECB measures, such as generous three-year bank loans, but the Danes may yet have to turn to QE of their own.

Hong Kong’s will endure…

Like Switzerland, Hong Kong has also amassed a huge pile of foreign-exchange reserves. Its aim is to hold the Hong Kong dollar (HKD) steady at 7.80 to the US dollar. But this is one peg that looks likely to last for some time. It has been in place for the past 32 years, and unlike the Swiss one, enjoys widespread credibility and popularity. It is recognised as “the cornerstone of Hong Kong’s… stability”, say John Tsang and John Greenwood in the South China Morning Post.

The main advantage is predictability and stability for businesses’ costs and pricing: Hong Kong’s economy is completely dependent on exports, so there would be huge uncertainty if the currency were to float freely. The link to the dollar, the world’s reserve currency, has also shored up the financial sector during bouts of emerging-market panic, when capital tends to flee to the developed world.

These factors are widely deemed to outweigh any disadvantages, such as having to import US monetary policy. This problem is mitigated by Hong Kong’s extremely flexible labour market, which has tempered both inflationary booms and slumps in demand.

…but will China’s?

Another potential “fault line on the global currency map” is the Chinese yuan, says Craig Stephen on Marketwatch.com. Its “crawling peg” – the yuan is allowed to move within a band that is gradually shifted upwards – is becoming “increasingly painful to maintain”. China’s economy is slowing and deflation spreading, with producer prices having fallen for three years. Falling prices make the real value of the country’s huge debt load, around 250% of GDP, even heavier.

A stronger currency fuels these trends. To make matters worse, major trading partners are printing money to make their exports more competitive. Japan’s aggressive QE has been a particular headache, says Société Générale’s Albert Edwards – and Europe’s won’t help either. Devaluation of the yuan is “an inevitability”. Capital flows out of China suggest investors may agree.

ARTICLE 3

Try and imagine you live in a country where you can borrow at 6-7% per annum for a return of about 15% – obviously not guaranteed but pretty good odds. Would you do it? Of course you would.  Now, imagine that country is China.  Hold your horses, you may argue. The cost of borrowing is higher than 6-7% in China. More like 10-12% for the average entrepreneur. Well, don’t bet on it. As the world increasingly becomes one big open market place, and the Chinese authorities stubbornly maintain their view that the best recipe for China is a Yuan which closely follows the US dollar – albeit with a couple of percentage points of annual revaluation thrown in for good measure – borrowing in US dollars to invest in China carries little or no perceived currency risk.

In a recent article in the FT fm2, some interesting observations were made in terms of the implications of large emerging economies such as China deciding to shadow the US dollar. In fact, the dynamics are not terribly different from those of the EU, where several countries have enjoyed an unprecedented boom in recent years as a result of the “one size fits all” monetary policy forced upon us after the introduction of the euro.

Had countries such as Denmark, Ireland and Spain been able to determine their own independent monetary policy, interest rates would most likely be higher in those countries today. However, these countries, and more, have benefited from the fact that ECB’s policy has largely been dictated by the sicklings of Europe, i.e. Germany, France and Italy.

When credit is cheap relative to expected returns, it encourages increased borrowing. It is as simple as that. There are obviously other measures available, should your government be keen to slow down the economy, but with monetary policy outsourced to the eggheads in Frankfurt, membership of the euro club has effectively stripped its members of the most effective tool available.

Now, let’s go back to the Chinese example.  Access to cheap capital has a number of implications – positive as well as negative. One of the most obvious ones is asset inflation, in recent years manifesting itself through higher property prices and buoyant equity markets all over the world. It should also be noted that China is not the only country linking its currency to the US dollar, although some tie ups are more formally established than others. The currency peg approach has been fashionable in Asia for years and is now spreading to other parts of the world.

The dollar peg: effect on current account deficits

This also helps to explain why so few emerging economies are running current account deficits –contrary to economic theory which suggests otherwise. Normally, when a country runs a large surplus, currency appreciation will, over time, reduce the level of competitiveness and thereby reduce the surplus. However, when the currency is artificially held down, as is the case with China and certain other countries, no such mechanism is in place to address the imbalance.  Another, and potentially positive, side effect from the Dollar Club phenomenon is the effect an American slowdown may have on the other members of the club. It is an almost universally accepted view today that a meaningful US slowdown will have negative implications for growth in other parts of the world, as many emerging economies are export driven.

However, this argument fails to address the rebalance of economic growth which may happen as a result of lower US dollar borrowing costs.  Let’s assume for a second that the US economy were to go into recession at some point in 2007 (for the record, we do not expect this to happen).  The Fed would almost certainly lower the Fed funds rate in order to stimulate domestic demand. Meanwhile, as a result of even cheaper credit amongst the other Dollar Club members, growth in these countries could in fact accelerate.  So far so good.

Why currencies should be allowed to float freely

More worryingly, the long term implications for inflation are not encouraging.  Eventually, excessive levels of liquidity will not only feed into asset inflation but will also put upward pressure on consumer price inflation.  How long it will take before this problem becomes apparent is difficult to say. What we can say, though, is that when the problem is there for everyone to see, it will be a difficult one to handle for the local monetary authorities, as they will find that they have lost the ability to effectively control monetary policy, just as it has been the case in Europe.

How markets will react to that situation is anyone’s guess. One thing is sure, though. The only lasting solution is to allow all currencies to float freely. Only then will the imbalances we are currently experiencing be addressed once and forever. However, as long as the Chinese (and others) show a complete disrespect for fair play, the chances of that happening are probably quite remote.

By Niels C. Jensen, chief executive partner at Absolute Return Partners LLP. To contact Niels, email: njensen@arpllp.com

The impact of a $ bull market - John Mauldin

As promised, a link to the article that covered the impact of a $ bull market in depth - before anyone really noticed the rising $. This change is an undercurrent of huge significance for the global economy; it will unfold as we approach the exam. If some of the content is inaccessible, ask me. Most of it is very clear and accessible.

A Scary Story for Emerging Markets