Are we heading for a new era of nationalizations?

The Dutch government has just shelled out $775million and is now the proud owner of close to 13% of the Air France – KLM group, reflecting its determination to get back on an equal footing with the French government in the airline group. The Dutch government felt that KLM had recently been badly treated within the group when the new chairman was appointed…and the battle of wills is even more fierce and surprising when we realize that the Netherlands took its stake without informing the French government. More recently, Bloomberg announced the possible renationalization of EDF with the aim of better managing this strategic energy business in France, while Germany is willing to bail out Deutsche Bank if the bank gets into severe trouble.

There is very clearly a shift in government policy on the state’s role in companies’ shareholder structures, with a feeling of the re-emergence of the State as strategist. This idea had somewhat disappeared from our textbooks, but now seems to be coming back to the fore.

Over recent years, nationalizations have usually been temporary. This was the case for General Motors in the USA in 2009, as well as for UK banks at the height of the financial crisis. There is also the example of STX in France, and the matter is on the table again with Ford and Ascoval.

Globalization is no longer seen as the systematic solution

Globalization was set against a backdrop of an open world over the past twenty years, with resources allocated efficiently. This worked well as developing countries focused on industry, especially Asia, while developed countries concentrated on services and the intellectual resources required to supply the industrial sector. This allocation of resources can be immensely effective if all participants play by the rules and if each country feels it is benefiting from the arrangement.

One reason behind this change currently under way is that the world economy is no longer seen as cooperative. At the time of the Brexit referendum, the UK indicated that it would be better off outside the European framework than within, while at the same time elsewhere in the world, Trump and Xi Jinping are building a bilateral rather than a multilateral system.

This new world order does not fit with the globalization trend witnessed in a recent past. Trump has taken a more isolationist path than his predecessors, throwing a spanner in the mechanisms of globalization with his border duties and threats. In China, the Belt and Road Initiative demonstrates the country’s determination to build its own trade routes and set its own terms and conditions.

Against this backdrop, previous trends to globalization are changing, and if all participants no longer play by the joint rules of the game, then each country is free to make up its own. This could well be what is happening right now.

Growth is too sluggish

Alongside this explanation, there is also the issue of sluggish growth on developed markets. Some countries want to take matters into their own hands and set their economy back on a stronger trend, and each country wants to be able to do what it takes to get ahead. KLM’s move fits with this approach, as the Dutch government felt it was being excluded from decisions on its own airline KLM, which could potentially be bad for jobs and the Schiphol airport hub in Amsterdam.

Weaker productivity gains and shock on world trade My weekly column

The tricky economic outlook in developed markets is the result of a shock on economic activity due to a sharp slowdown in world trade, combined with insufficient productivity growth to trigger a swift recovery in economic activity. The risk of a long-lasting shock hampering both activity and the labor market is particularly high, as economic policy has little leeway to cushion these shocks and spread the cost out over time.

The decline in productivity gains is a real source of concern, especially for developed economies. In short, productivity is the surplus created by the production process, so when we talk about the production process, one plus one makes a little bit more than two: this “little bit more” equates to productivity gains. Depending on the time period and the efficiency of the production set-up, this “little bit more” can vary in size. In the past, productivity gains were vast, with growth of 5.8% per year in France on average in the 1960s, and this led to a downtrend in working time, an increase in wages and the implementation of an effective social security system (productivity gains = increase in production per hour worked in volume terms). The higher this surplus, the greater the production system’s leeway to redistribute these gains to all citizens.

Due to the very nature of the process, these gains drive self-sustaining momentum that helps cushion shocks and swiftly sets an economy back on the track to growth and jobs. The higher the gains, the more readily the economy can recover quickly and on a broad scale.

The current period since the crisis in 2008 has been characterized by a clear slowdown in production per hour worked across all developed countries. This is shown in the table below, which outlines average annual productivity growth across three time periods: an extended period between 1990 and 2007, the period since the US recovery in 2009 and the phase since the recovery in Europe in 2013.

Deep drop in world trade in December

World trade is slowing down sharply. In the last quarter of 2018 compared to the last quarter of 2017, trade is now up only 1.5% against 3.9% in October. The adjustment is not finished if we follow the Markit indicator of export orders in the USA, Japan and the Eurozone.

Asia is the region that contributes the most to this slowdown. Its 3-month contribution to global import growth was at + 4.8% in September and dropped to -5.3% in December. This persistent shock on trade is the result of the choices made in the White House. The brutality of the movement explains the change in outlook on activity since last summer but also the Fed’s new view on its monetary policy.

The German economy on the way to normalization

German growth stopped during the second half of 2018. During this period, the GDP was up by only +0.1% compared to the first six months (at annual rate).
It can be seen on the graph that the main source of growth inflection is external demand. Its contribution fell sharply in the second half of the year. The slowdown in trade with China and Asia (a consequence of a Trump effect on Chinese trade) explains the stagnation of exports. But imports are growing rapidly due to a strong private domestic demand.
This is the major point of the graph. Until 2015, the contributions of internal private demand and external demand were of the same order. This is no longer the case and private demand is now the main contributor to growth and with a certain margin. The weight of foreign trade is still important in Germany, but it’s no longer the main source of the German dynamics.
The German economy is normalizing its structure and it becomes comparable to other developed countries where the main source of the GDP growth is the private demand. This shows a greater dependence on its internal market. This is not bad news for the Eurozone.

Can a China / USA Agreement be credible?

Financial markets strongly value the possibility of a trade agreement between the United States and China. Such a situation would make it possible to reduce the constraints on global trade and to order them according to the framework defined by the agreement. Nothing would then stand in the way of the return of larger trade flows likely to bring global growth once again.

This idea is attractive because it would leave the area of concern that marks the global economy since last fall and for which we do not spontaneously see a way out.

Yet this possibility of an agreement seems to me to be totally illusory. Tensions between the US and China mainly reflect a problem of technological leadership. Which of these two countries will set the standard for developments like 5G or artificial intelligence or other technologies. Both countries are in fierce competition. I can’t imagine an agreement in which one of the two countries would agree to be subject to the developments of the other. Tensions between the two countries will remain strong even if minor agreements could be signed.

This will generate tension and volatility in the overall dynamics.

The Fed wants to remain agile

The end of the reduction of the Fed’s balance sheet is what we have to keep in mind after the publication of the minutes of the last FOMC meeting. It will take place during the second half of this year.

The US Central Bank does not want to be too constrained in the management of its monetary policy. The pace that was taken and the level targeted until then could add to the difficulty of the good calibrage of the monetary policy.

The Fed clearly does not want to be constrained in its choices because the global environment which is now more uncertain.

The way Yellen initiated the downsizing movement of the balance sheet was possibly compatible with a stable and predictable international environment. The arrival of Trump has created noise and spillover effects because of its policies. Now the Fed must take into account these noises and the risk of contagion which are attached to them.

The Fed does not yield to Trump by not raising rates, but it does not raise them in order to be able to intervene quickly to contain the negative effects of the policy pursued at the White House. She wants to be agile to limit risks. It’s well thought out.

Economic Policy Shocks

The desynchronization of economic policies, especially in the US, has caused negative shocks to the global economy, resulting in a downward synchronization of the economic cycle. Trade policies create breaks in value chains and all countries are affected (one product is manufactured in 3 countries A, B and C. If tariffs are put on the link between A and B reducing or modifying the activity on the product in A and B so C is affected). The dynamics of trade has been reduced in recent months in Asia (not just China) affecting exports in the Euro zone (see graph).

Productivity gains are no longer enough to cause an endogenous rebound in growth. Shocks therefore have persistence. Consequently, monetary policies will remain permanently accommodative and interest rates will remain very low for all maturities.
The economic model and the social model will have to adjust to this new pace. Hard challenge for European countries