Lagging electric vehicles

As if following up on the post about  Volkswagen and innovation, two brands of the group concluded their technological solution for electric vehicles is so relatively uncompetitive (to Tesla) that the brands’ electric vehicle rollout plans are significantly compromised.

These news follow an investment of more than €2 bn to build an electric vehicle platform for the VW Group with delivery scheduled for Q2 2019.

What is most worrying is how European vehicle manufacturers used the significant forewarn afforded by the European Commission’s White Paper on Transport. VW is the second wealthiest automobile manufacturer in the world and emissions in Europe are more restricted than in the US since… That’s it, they’re not

This may attest how the EU could reform competition and regulations to the benefit of the European economy. Notice that interfirm competition in the motor vehicle market meets requirements (the VW Group sells to 23% of the European market while DG COMP requires sets the antitrust threshold at 40%); but incentives to intrafirm competition are practically inexistent: low fungibility between assets in different Member-States and market standards as a by-product of the Single Market demand act as counterweights to concentration and crystallised industries.

As European firms become dominant, less competitive markets in labour and innovation present no incentive for investment in new skills or technologies. The capital market may somewhat increase gross operating surplus in some countries relative to others (see the recent post on Hungary and Czechia) because competition in input markets is impaired and thus gains accumulate only in capital – ie, research conditions in Czechia are hardly compared with those in Germany.

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China and the Europeans

The most significant outcome of the emergence of China as a foreign investor in Europe (rather than a market or a competitor) is the certainty that Europe is the way forward rather than a collaboration of Member-States.

The increase in multilateral inter-governmental political bargaining of the past decade, and its significant setback after Donald Trump, reached an hiatus just yesterday as Commissioner Vestager demonstrated the French-German ideology does not necessarily display the most adequate ideas for Europe.

Whereas European public good is a debatable concept amongst those that work on it past the political cycle, is it more obvious than in an exclusive competence of the European Commission – the guardian of the Treaties: Competition policy.

The request of Germany and France ignores two current facts and assumes the resumption of a trend that is, to a broad extent, past : multilateral economic stimulus.

What seems to elude the most fierce advocate of multilaterism is that its main beneficiary, China, is stepping back from its multilateral economic stance in reply to demands for a greater role of domestic consumption in economic growth.

Second order effects in raw materials (refusing to continue its role in recycling plastic), rural-urban inequality (the relentless Balassa-Samuelson/Podpiera effects, the politics upheaval), debt are signs that China is closing upon itself.

Not understanding that nursing conglomerates contributed to Japanese stagnation or that China can’t be both customer and supplier would be a significant mistake. The French-German offer shows precisely this misunderstanding: that Europe may grow past its size in just a few countries.
This same reasoning was very evident in previous years when negotiating Europe. An excessive focus on short-term growth and capital mobility (contrasting with people mobility, in upcoming work) shifted effective per capita growth (household wealth) to the center of Europe leading to the creation of a handful of Chinas in Europe.

The upheaval of values and firms, of production methods and private initiative in return for relatively low wages as technological dependence – that is the bargain presented to the Czech, Slovak, Polish and Hungarian voter and politician. A bargain that is very known from yesteryear.

The election of strongly conservative governments and workers’ demands of higher wages and more pay (Hungary’s extra work law and Audi wage increases) hints at this defensive posture that was aggravated through the past decade as wealthier Member-States, fuelled by media discourses despite the Barroso Commission, dismantled the Union’s principle of compensation to institute another principle of solidarity.

What becomes evident is that Europe won’t move forward by maintaining a Europe of yesterday, unproductive and broadly reliant on unfair pay elsewhere, nor by upholding a Europe of tomorrow, over-productive, out of ideas and broadly dependent on external technology and innovation.

Both must combine (RSA link here) but there’s little political thrust to do so in as much as the Commission does Member-States’ bidding. The Commission should not behave democratically because it is an institution.

That would be the same as saying we should give way in a queue just because fifty people say so – the Commission should hold its place, it upholds the Treaties and doesn’t swing to Governments (and its financiers, today firms tomorrow the people – cf Barrack Obama) but rather defends a higher interest, a more stable moral ground that goes beyond individual State power bargains.

That is, for the Commission it should’ve been indifferent that the market net payers bought access to through the European Budget was not paying off and was now causing losses – the losses in itself are solidarity (pay for market access, suffer the consequences of overleveraging) and led to a deep rethinking of the Institutions rather than the institution of a guaranteed return for investment, a so-called solidarity. 

Make no mistake – EFTA countries pay for market access because the grand bargain of the budget is to compensate poorer countries for the nefarious effects of entering the customs and monetary Union.

“(The Werner Report) argued that compensation should be provided for the economic rigidities imposed on state budgets by the path of monetary unification.”
“Concerned about the competitive threat of the internal market to their economies, which already suffered from major regional (and national) development challenges, both countries (NB Portugal and Spain) had a strong case for demanding a revamped regional development policy, and were pivotal actors in altering the coalition of Community interests in favour of cohesion.”

The converse goes for net payers.

But it wasn’t. Either way, it’s clear today Germany and France are not indicating the way forward to Europe – it is doubtful they could, as do most economists. It must be a non-political Commission to do so not by punishing and restricting only but by planning and advancing.

We need new Stateswomen like Vestager (and Statesmen too) – not more nationalism, frankly.

More pay or better pay?

Workers in the Audi Hungarian factory of Györ closed the plant in protest for the lowest wages in the region.

Economics is prolific in theories useful to assess the merits of Hungarian workers’ demands. 

Economists Balassa and Samuelson concluded fast-paced export sectors such as motor vehicles in Hungary lead inflation elsewhere in the economy.

In those terms, the Producer Price Index for the automotive industry is significantly and positively correlated for two of the region’s three most dependent on vehicle exports.

The pass through is meeker than in the German economy but the positive sign leads to confirm the economists’ theorem. Although remarkable, the economics of Czechia’s motor vehicle manufacturing sector must be the subject of a different post.

Jirgi Podpiera documents the rapid qualitative improvement of exportable sector output as causing real exchange rate appreciation and explains sudden inflation increases.

The effect is somewhat equivalent to assuming competing inputs increase price pressure on complementary, fast growing sectors of exports economies. 

PPI to voth second export sectors in Czechia and Hungary, below plotted with each Member-State’s main export sectors (manufacturing of vehicles) evolve with similar cadence after 2008. More significantly, the main export sector’s PPI tracks price developments in the emerging sector on several occasions.

Both intra-sector and cross-sector growth effects impact broader and sectoral price indexes. To assess the merit of wage increases and hint at possible competitiveness losses, it is important to consider whether productivity has evolved with labour costs weighted by costs of other inputs such as energy. In fact, unit labour costs (a productivity measure) stand above labour costs even when weighted by the energy index. Further increasing wages should thus erode competitiveness as other inputs no longer compensate labour costs above productivity.

In fact, whereas the Producers Price Index for the  of vehicles  productivity has evolved with productivity, the trend is sustainable only as costs of other inputs such as energy have container the impact of relentlessly increasing wages in productivity.

The evident loss of competitiveness vis-a-vis a regional competitor (Czechia) merits a more refined analysis of its causes. To consider possible transition effects, the analysis is made for both the top and third most export-intensive sectors in both Hungary and Czechia (both charts in log).

Upon glance, it is noteworthy that Hungarian industry is both more capital intensive and less effective in producing value added.

The discrepancy suggests ineffective investment, lower input of labour to value added and thus the need to increase wages above cost of other inputs, inflation and productivity. Hungarian workers should strive for more efficient management and spending that converts relatively high value added per employee to higher value added.

Hungarian vehicle manufacturing industry is more capital intensive and invests more in tangibles than the Czech industry. Its lower labour input inflates gross operating surplus and profits per employee but still lags in total value added – hinting at capital inefficiency, possible the result of lower investment in high-value intangibles, as charted below.

    Technology Transfer and production costs

    US negotiations with China may set the standard for China’s requirements for foreign investing firms.

    Amongst US demands is the reduction of technology transfer agreements between Chinese and foreign investing firms. The chart below condenses American concerns: unit profits (blue plot) are increasingly less symmetric to firms’ investment in research as a percentage of profits (red plot).

    Profits are increasingly decoupled of investment in research, possibly implying low value added of research dissuades firms’ investment.  

    The symmetric growth of firm profits and GDP (outweighing investment in research) increasingly seems a past trend of the 1990s and early 2000s. Regardless of co-movement, the evident de-coupling coincides with China’s accession to WTO.

    Whether American research outputs lower value added dissuading firms or firms found ways to cut costs (eg, by delocalising production) instead of investing in research remains to be seen – even if US concern with research value added is warranted.

    Supply or demand?

    Is public spending supply or demand-side economics? 

    Although the ECB and the IMF argue that government spending impacts consumption and satiates demand, there is very little consensus amongst practitioners whether government implements supply or demand-side economics.

    At its rudiment, the question asked is whether government is the supplier of goods such that it may influence the Aggregate Supply (AS) curve.

    Typically, supply-side stimulus increases output without accelerating inflation by improving productivity; whereas demand-side stimulus increases output while accelerating inflation by increasing available income.

    The State supplies many goods that improve productivity such as education, R&D and infrastructure. When the State improves the supply of public goods affecting the production function, it is factually incurring in supply-side economics. Some improvements, such as a wage increase, are arguable (see below) whereas others, such as more seats or new courses, are incontestable.

    Conversely, when the State reduces consumption and personal income taxes, when it increases welfare spending or when it increases civil servants’ wages above productivity it is implementing demand-side economic policies.

    Research to the ECB and the IMF concluded government spending increases consumption while depressing investment and EU spending is demand-driven. Both assertions become debatable considering the helpful distinction above.

    The EU is seldom a direct supplier of public goods. The EU acquires public goods such as R&D from public and private contractors such as Higher Education institutions and firms. 

    Because the EU sets financing priorities, it affects the supply-side of the economy by lowering the cost of an R&D product if and only if the output is a public good – that is, unless the EU agrees with privatising profit from its investment. 

    With this distinction in mind, is the EU Budget delivering supply or demand-side stimulus?

    Education

    Loans to fund education and education-related living costs follow models typical of lending but atypical for assets with returns.

    In education, contrary to consumption, lenders expect a return on the funded asset, akin to lending on account receivables. Considering how individuals require income to repay their debt lenders would benefit from linking interest rate premia to risk and expected returns.

    The most costly education, that would require higher risk premium, produces the highest returns. Pupils borrowing to finance private studies are also typically those with better risk scores whereas those borrowing less to study in public schools are typically those with feeblest scores and relatively lower returns to education.

    Changing how guarantees cover banks’ risk premia remains the remit of the guarantors – the public sectorThe Brookings Institute suggests another solution.

    Hope

    The most significant difference between Socialism and liberalism (the political systems, this whole labour value added affair is very Socialist and we live by it) is hope.
    Socialism chastises Humanity, blames us for this great failure and injustice that is capitalism. Socialism lost hope in our self-guided improvement and increases wages today as if capitalism would not do it.

    Liberalism believes each of us shall make it – and opts to invest

    The productivity gap in Europe

    Martin Wolf, following Ray Dalio, writes today of productivity differentials in the world as a cause of significant challenges to growth.

    Following Mr Wolf, the gap represents widening inequality, the collapse of employment in manufacturing as the economy steers towards digital services and the savings glut.

    Whereas inequality is the topic of an upcoming post to this blog, both other trends were widely explored in previous posts. Member-States and other nations began shifting towards intangible value added in the 1980, partially as the result of lower returns to capital.

    The de-coupling of employment and physical capital implies a shift in labour market protection and taxation considering how firms are likely to capture more of labour’s value added in profits. Tax competition is perhaps the most significant hurdle to systemic change. 

    The savings glut increasingly seems the result of a preference for exports, the world divided between importing and exporting nations.

    Does debt lead to European prosperity?

    EU competition rules, an exclusive competence of the European Union, limit firm concentration with relevant implications to input and consumer markets alike.

    For instance, firms operating in  competitive markets benefit more from positive shocks to borrowing costs, particularly when leveraged. Firms operating in markets where competition is mute rely less on positive monetary supply shocks as higher profit margins make it indifferent to financing costs.
    Concurrently, firms in more competitive markets are more efficient, with firms competing in an international market implementing “cost minimisation” strategies. The EU’s competition framework, namely possible limits to concentration through acquisition, implies firms are often competing with intra- or extra-EU firms.

    Both observations combined imply European firms compete to minimise costs and rely more significantly on capital. Only when the economic cycle implies capital shortage do firms engage in “cost reduction—particularly labour cost reduction through the adjustment of quantities rather than prices”.

    As more productive firms pay higher wages, indebtedness exhibits a positive correlation with household wealth as visible in the chart reproduced below.

    This trend is also visible elsewhere in the world.

    European unemployment insurance

    The insurance is in fact, as President Juncker clearly presents, a contribution to national unemployment benefit costs made by the EU Budget’s redistribution mechanism to mitigate asymmetric shocks and by the reform reform compensation mechanism (presented in the tabled regulation as an “incentive” to reform).

    I’m in favour of the latter, having suggested it months before it was proposed by the European Commission. The asymmetric shock absorber also makes sense in a Europe prone to asymmetric shock.

    As previously explored on this blog and a post to the RSA, asymmetries in Europe prevail as long as interindustry integration, that is Member-States’ propensity to produce certain goods and services and not others, prevails.

    Asymmetric shocks (say, in Germany where firms are excessively concentrated in production goods exported to extra-EU markets) resulting from exogenous conditions (say, a slowdown in China’s economy, German firms’ most significant customer) shall happen in a Union where regional productivity asymmetries uphold Member-States decision to produce more substantially some but not other varieties of goods.

    Firms preferences evolve considering, amongst other factors, a Member-State’s comparative advantage in terms of capital (physical, human) and technology, institutional framework and financing conditions, and the economic cycle. 

    A country’s prosperity is somewhat protected by tariffs and a Central Bank-issued currency that mitigate comparatively less productive goods such as agricultural goods. For instance, “food industries also have little incentive to export: their value added would be 18% lower [NB with no tariffs] than the benchmark (14% with draw-backs)”, as reported by the WTO that also computed the following table:

    Most Member-States have eschewed both mechanisms when joining the Single Market and later the Euro, prompting Member-States to crystalise production preferences.

    Consider Portugal and the Netherlands, two economies of similar size. The chart below plots two 5-year moving averages of the weight of the agriculture sector in employment: the gap between paces of change and the gap between the weight of the agricultural sector in each country. Both stabilise significantly after the introduction of the ERM II in 1997.

    The following chart plots the rate of structural change (that is, the average of yearly changes of the 5-year average of employment weights in Agriculture, Industry and Services) in both Member-States and Denmark between 1992 and 2008.

    Notice the significant slowdown in both Member-States in 1997 and more significantly in Portugal after the introduction of the Euro in 2002.  Conversely, the pace of structural change in Denmark does not seem significantly affected by the introduction of either ERM or Euro.

    [NB There are numerous other plausible reasons for this observation besides the introduction of the Euro – while the impact was indeed asymmetric.]

    That in itself isn’t necessarily negative except for those Member-States where lower value-added goods are produced and where the compensation afforded by tariffs and monetary policy were eschewed. Formally, “agglomeration advantages lock business activity in relatively prosperous core regions, even though wages – and thus production costs – tend to be higher there.”

    Consider how Spanish exports are increasingly of low value-added:

    The European Budget’s objectives of Cohesion and Convergence are achieved through investments in capital and technology precisely to diversify production in those Member-States where lower value-added is produced.

    As low value-added sectors typically include less foreign inputs, firms operating in these sectors are less prone to benefit from competitiveness gains of foreign suppliers when their currency appreciates. Member-States where low value-added activities prevailed were thus disproportionately affected by the introduction of the Single Currency.

    Amongst the adjustment mechanisms necessary to improve lower value-added economies is the labour market when workers in low value-added activities migrate to those Member-States where their work is highly remunerated. Disparities between relative wages happen as workers in high value-added economies increase human capital to access high value-added, high paying jobs that are more plentiful than elsewhere.

    Hence an unemployment insurance only benefits the structure of the European Union if it enables workers to relocate across Member-States, adjusting wages in both economies and stimulating convergence. This is furthermore justified by the local nature of wages.