Author Archives: Stuart Burns

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It is a question we often see on the financial pages of newspapers or news sites, but rarely take time to seriously consider the consequences – why is the West apparently in a period of stagnant productivity growth?

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A recent article in The Telegraph explores the position for the U.K., but many of the trends observed — and, likely, reasons behind — Britain’s poor productivity growth are very similar to those in the U.S. and the rest of Europe.

For the sake of good order, we should define productivity growth. Simply put, it is a measure of the efficiency of production, usually measured as the ratio of inputs to outputs, or output per unit of input. Clearly, for workers to be paid more without a firm going bankrupt, just as for a country to raise living standards without living beyond its means, productivity per unit of labour has to increase over time. And so it has broadly over time, but not in a straight linear fashion, and therein lies a clue to our current malaise, the authors of the article suggest.

The article draws substantially on comments made and work done by Ben Broadbent, the Bank of England’s deputy governor. Broadbent fears Britain is past its peak and destined for a sustained period of poor growth in living standards due to stagnant productivity growth. Measuring productivity growth is far from easy, not least because “work” changes. In the days when most outputs were delivered by the manufacturing industry, it was easier to measure inputs and outputs; in today’s digital world, many services, like the internet, are largely free at the point of use.

Yet even so, the trend is clear: over the past decade, productivity has grown by just 2.1%, according to the Office for National Statistics as quoted by the news source. That is compared to before the financial crisis, when it typically grew by more than 2% every year. As a result, for much of the 2008-2014 period, real wages were in negative territory, a situation that was variously blamed on the financial crash, low interest rates perpetuating companies that would otherwise go bust, and lack of finance to allow firms to invest.

But Broadbent believes it is more deep-seated than those reasons, saying the wave of benefits seen from digitization we accrued in the 1990s and early 2000s has now passed. In addition, he argues, our position now is more akin to the industrial world’s lull between the age of steam and the onset of electricity – the big gains arising from steam had all been made yet and the benefits of electrification had not been felt, such that firms did not have a technological advantage encouraging investment, growth and expansion or face the threat of being left behind.

So far, there is limited evidence of new technologies like the mobile internet, artificial intelligence and mass automation transforming productivity. Broadbent believes it is simply too soon, but that given time and further technological progress, we could see these technologies having a transformational impact.

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Let’s hope so. Combined with the impact on traditional manufacturing jobs that globalization has had in mature markets and the growing disparity in incomes during this century, populist politics could have a destabilizing effect on Western societies, which will only be encouraged by a prolonged period of flat, or worse, negative growth in standards of living.

Does your company strategy call for a European manufacturing base but you worry you have missed the boat in terms of accessing lower-cost opportunities created when eastern European countries like Poland and the Czech Republic came into the E.U.?

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Lower land and labour costs, aligned with ample financial support from the E.U. to the poorer parts of Europe created a fertile investment environment for new business growth in these eastern European states. With a good standard of education, generally good rule of law and a high work ethic, it is not surprising eastern Europe has gone through something of an industrial revolution over the last 20 years.

But for firms looking to set up in those markets now, they are the Johnny-come-latelies to a maturing investment environment.

But fear not — a new wave of entrants may be on the horizon.

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(Editor’s Note: This is the first of two posts addressing the global trading system. Check back tomorrow for Part 2.)

The Economist asked the question in a debate that has been running over the last few weeks, stimulated in part by President Trump’s unprecedented actions on tariffs and quotas aimed at perceived cheaters of the global trading system.

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The article summarizing the debaters’ arguments (with contributions by guest contributors) makes fascinating and very appropriate contemporary reading for anyone interested in the topic. Few would argue that in its earliest guise the multilateral, rules-based system managed by the World Trade Organization (WTO), to lift the article’s words, has built up and delivered unprecedented prosperity across the world.

But even ardent supporters would also concede it has contributed to the decimation of the industrial base in many rich countries. Other factors have played a role, like automation and environmental policies, but the global trading system has played its part in this transfer for manufacturing capability and accompanying jobs.

The article questions whether the global trading system is broken, whether we should do away with it altogether, and whether a return to national tariffs and bilateral trade agreements is the solution to the perceived problems it has caused.

But the reality is that while the WTO and its rules-based system has significant faults, it is not bust in the way the world order of the 1930s, which was complete chaos and, as one of the arguments points out, fraught with government-imposed tariffs, quantitative limits on trade, discriminatory deals and foreign-exchange controls. It got so bad at times that some international commercial relationships even devolved into barter. This writer can remember his firm dealing with the Soviets in the 1980s, bartering ship loads of hot rolled coil steel from Russia and shipping back cold rolled steel coil from British Steel in the U.K.

But if the system is not busted it is certainly flawed, and those flaws have resulted in multiple problems.

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Rising oil prices were seen last year as a positive result of growing global growth and recovery, but a combination of factors are turning this benign view into a more sinister scenario.

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On the supply side, the combined efforts of OPEC and Russia, leaky as the agreement has been, have managed to reduce the global oil surplus in just 18 months to bring the market largely into balance. As a result, oil prices have gradually risen during the period. It’s a trend most observers have been sanguine about, believing the U.S.’s tight oil producers, encouraged by rising prices, will increase output to ensure ample supply and keep a lid on oil prices getting ahead of themselves.

But that benign view had not taken account of President Trump’s decision to rip up the Iran nuclear deal and, as a result, to reinstate sanctions, a move that will take place in two phases to give firms time to adjust.

According to The Telegraph, this will be done in two stages, on Aug. 6 and Nov. 4, allowing 90- and 180-day wind-down periods. In addition the Treasury is to re-list Iranian individuals and entities in the Specially Designated Nationals (SDN) list, thus revoking special licenses and exceptions previously granted to individuals and companies to deal with Iran, making it all but impossible for firms with a U.S. presence or needing dollar clearing to deal with them.

Lastly, Iran’s crude oil sales will be limited under the National Defense Authorization Act of 2012, as the U.S. departments of State, Energy and Treasury will allow ongoing but reduced purchases of oil from Iran, termed “significant reduction exceptions” on a country-by-country basis if they demonstrate a commitment to substantially decrease oil purchases (usually at least a 20% reduction).

As a result, Iran’s exports this year are likely to take a 500,000-barrel-per-day hit, from the country’s roughly 2,200,000 bpd current exports. The Telegraph speculates this could rise to 750,000 bpd next year as sanctions bite deeper.

Iran is not the only threat to supply. The ongoing implosion in Venezuela’s output, as spare parts run out and infrastructure collapses, also figures into the equation. So far, this has taken some 700,000 bpd out of global markets, the news source reports, with no sign of the trend slowing and no quick fix, even if a revolution overthrows the Maduro regime.

Meanwhile, the global oil industry investment collapse since 2014 following the plunge in oil prices has, like a juggernaut, taken time to impact output.

Output from conventional projects has until now been rising as projects started at the beginning of the decade have come onstream, but the cycle is turning — The Telegraph reports output will fall precipitously, by 1.5 million bpd in 2019.

So, what of all that replacement supply from the U.S. shale market?

Rig counts have predictably risen and output is up, but both U.S. tight oil and the Alberta tar sands are facing an infrastructure squeeze. Limited pipeline capacity and the failure to build new ones is holding back supply from the West Texas and Tar Sands regions. The U.S. is now becoming the world’s largest oil producer, on target to produce 12 million bpd next year by Energy Information Administration (EIA) estimates. However, that will not insulate the U.S. from higher oil prices, as the country is now exporting significant quantities of distillates and growing volumes of crude.

Saudi pledges to maintain stability in the oil markets should be taken with a pinch of salt. They have equally said they do not see any problem with a $100/barrel oil price and so are unlikely to raise their own production to ease the pain for everyone else until prices are well into triple digits.

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The Telegraph quotes Westbeck Capital, which says “We believe an oil price shock is looming as early as 2019 as several elements combine to form a ‘perfect storm’,” predicting $100 crude in short order, with $150 coming into sight, as the world faces a crunch all too reminiscent of July 2008.

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Full disclosure – I am an owner of an iPhone, iPad and Macbook — and I don’t mind admitting it, a  longtime fan of Apple’s products — but even I cringe when the firm claims to have “worked with other metal companies to develop the proprietary technique, which allows for the generation of ‘green’ aluminium for the first ever time.”

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The claim follows the announcement late last week that at its Pittsburgh research center, Alcoa has developed a replacement for the carbon anodes used in the smelting of alumina to aluminium.

The carbon anode has the important role of delivering a strong electric current through the melt, but in the process carbon is converted to carbon dioxide and considerable levels of greenhouse gas emissions are produced.

But although Apple is said to be investing C$13 million (U.S. $10 million) in the joint venture called Elysis, it is a drop in the ocean compared to the C$120 million of funding from the governments of Canada and Quebec and, further, the C$55 million invested by Alcoa and Rio Tinto in order to achieve commercialization of the technology over the next five years.

Indeed, Alcoa and Rio each have a 48% stake in the JV, with the rest owned by the government of Quebec, so quite how Apple can claim any fame in this venture is hard to see.

OK, Apple’s hubris aside: is this a step forward in lowering aluminum’s carbon footprint?

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India has over-promised and under-delivered on so many fronts over the decades.

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Home of the world’s largest and, despite its young age and huge diversity, still thriving democracy, it has promised growth to rival China. Apart from brief bursts of activity, it has generally failed to live up to its plaudits expectations.

One reason often cited, apart from chromic infrastructure and the legacy of a British love of bureaucracy, is endemic corruption.

Graft had become so deeply engrained in Indian business culture that many had written the country off from delivering sustainable long-term growth for its hundreds of millions of poor. The relatively very few rich got richer while the miserably small middle class grew so painfully slowly compared to China that many thought India would never haul itself out of its emerging-market status.

But critics had not factored in Narendra Modi. While not everyone would support his Hindu-biased populism, he has brought immense progress to India, overcoming entrenched interests with a politically astute skill and dynamism.

There is still a long way to go, but a recent Economist article describes how he has taken the fight to the ruling business elites in a blitzkrieg campaign to dismantle tycoons’ practices of personalizing gains and socializing losses.

Founding shareholders of Indian companies have long made use of a loophole of Indian corporate law that prevents banks from seizing companies in default on their loans, so owners of companies can run their organizations badly or, worse, suck out funds for personal gain with little fear of losing their money-making enterprise.

The system has actively perpetuated this system with a bunged up judicial system that takes months, if not years, to hear cases and state banks’ lending to firms on the basis of personal connections rather than sound business-lending principles. This cronyism was almost encouraged by officials not wanting banks to post losses, such that state banks are kept afloat by the government yet are carrying massive debts which will never be repaid.

Modi’s government new bankruptcy code came into force in May 2016. After almost two years of preparation, the first big cases have hit the headlines last month, The Economist reports. The fate of 12 troubled large concerns amounting to 2.2 trillion rupees ($33.4 billion) of non-performing debts is due to be settled within weeks. Another 28 cases worth a further 2 trillion rupees are set to be resolved by September. Between them, these firms account for about 40% of loans that banks themselves think are unlikely to be ever be repaid. In total some 1,500 companies are said to be insolvent, according to The Economist.

A new set of dedicated courts, backed by a cadre of insolvency professionals, is on hand to help banks seize assets and sell them to fresh owners, the article states. To focus the minds of both bankers and borrowers, if no deal can be cut within nine months the firm is shut down and its equipment sold for scrap.

As a result, those looking for cheap, distressed assets are already circling for pickings from the current 12 and 28. Such turmoil on this scale will create a short-term drop in investment as firms hold off to see what becomes available. In the longer term, the process of death and renewal will probably be highly dynamic for the economy.

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It will also focus the minds of today’s Indian tycoons on running their businesses better and courting political favor less. Indian business is shifting focus from “who you know” to “what you know,” which is definitely a good thing for the health of the country in the future.

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We normally associate Cornwall in England with scones and cream teas … or, if we are really metal nerds, we associate the sometimes sunny southeast country of the British Isles with mining (particularly with tin mining).

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The area dominated with igneous morphology has been mined since Roman times for tin, copper and a number of other metals.

But one metal, not surprisingly, that has never featured is lithium. I say “not surprisingly” because up to the end of the last century, it barely featured as a metal of value.

Nickel metal hydride batteries dominated the small appliance world and lead acid still served the rest. This century has seen an exponential growth in the use of lithium-ion batteries, from iPhones to electric cars to massive storage barns. The growth has been such that fears are mounting of a market shortage in the next decade, fueled in no small part by state support for electric vehicles (EVs) in Asia.

In fact, so urgent has the situation become that Chinese and Japanese battery makers are quietly buying into or buying up lithium deposits around the world to ensure they have secure supplies.  Currently, Europe consumes around 25% of the world’s lithium, but is dependent on imports from Australia, Chile, Argentina and China.

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Be assured there will be a next crisis — there always is, sooner or later.

It is the nature of economic cycles that markets get out of balance and have to readjust. That sounds like rather a benign process, but of course we all know there is plenty of pain and many casualties when it happens.

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An interesting article in The Economist analyzes the reasons why market crises arise and, from that, where it believes the next one is developing.

To quote the report, financial crises tend to involve one or more of these three ingredients: excessive borrowing, concentrated bets, and a mismatch between assets and liabilities.

The crisis of 2008 was so serious because it involved all three — big bets on structured products linked to the housing market, and bank-balance sheets that were both overstretched and dependent on short-term funding.

The Asian crisis of the late 1990s was the result of companies borrowing too much in dollars when their revenues were in local currency. The dotcom bubble had less serious consequences than either of these because the concentrated bets were in equities; debt did not play a significant part.

As for the next crisis? The Economist report indicates the cause of the next one is probably lurking in corporate debt.

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Following intense lobbying by French President Emmanuel Macron and German Chancellor Angela Merkel — plus, it must be said, the whole European steel industry and many consumers in the U.S. — U.S. President Donald Trump has announced a delay in the imposition of steel and aluminium tariffs on Canada, Mexico and, crucially, the European Union until June 1.

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The temporary exemptions from tariffs on these countries were set to expire today. At the same time, agreements for permanent exemptions for Argentina, Australia and Brazil have been made.

According to The Telegraph, the U.S. granted temporary relief to European producers from 25% tariffs on steel and 10% levies on aluminium only up to May 1but has now extended by a further 30 days while it tries to ring concessions out of its partners in NAFTA and with the E.U.

Specifically, the article suggests automobiles are high on the list of things on which Trump wants to see movement. The E.U. charges 10% import duty on U.S. cars but currently incurs only 2.5% on the import of E.U.-made cars into the U.S.

Tariffs would hit steelmakers this side of the Atlantic hard, the article states, with the industry only just recovering from the 2015 crisis, which cost tens of thousands of jobs. Closure of the U.S. market creates the potential for a “double whammy” to the European industry. Not only is America a major market for Germany, the U.K. and Italy, but Chinese producers are likely to flood Europe with excess output, which was a major cause of the crisis of three years ago.

China remains broadly the U.S. main target, but the steel and aluminium tariffs are part of a wider bid to renegotiate the terms of trade with a number of countries, from close to home with NAFTA to far-flung producers on the other side of the globe.

The president seems to have a bone to pick with most of them. The threat of sanctions is a blunt but effective tool to bring countries to the negotiating table. As a tactic, it does seem to have some merit.

No breakthroughs have been made, but many discussions are now ongoing that were being avoided a year ago. China’s steel imports have dwindled markedly into the U.S. over recent years, but aluminum remains significant. The threat of such has already drawn the ire of Beijing, but also the willingness to make conciliatory gestures, such as freeing up the domestic market for foreign investments.

But on two key trade demands, The New York Times reports Beijing is not willing to give ground.

Firstly, the president’s headline-grabbing $100 billion cut in the U.S.’s trade deficit with China and probably even more sensitive is a curb on a $300 billion Chinese plan to invest in advanced tech like A.I. and electric cars. China will almost certainly sweat it out if the president sticks to demands to row back on what China sees as its strategic future.

The row with Europe is far from settled. The postponement has only bought 30 days, so the pressure is on to find a solution.

Europe has more to lose than the U.S., so you have to think some form of settlement will be found that will, to some extent, meet the president’s objectives.

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If not, the pain Europe’s steel industry has gone through in the last 10 years will be nothing compared to what is to come.

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Editor’s Note: Check out Part 1 here

The option of European Economic Area (EEA) membership like Norway — which is not in the European Union (E.U.) but has open borders with the bloc and accepts some of its laws and regulations — seems strangely to have not been an option debated (at least publicly).

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The reason may be a hysterical backlash from those in favour of Brexit whenever a compromise position is mooted, so wedded are they to total exit.

The fact remains, however, the U.K. is making compromises on all fronts as it becomes increasingly clear it has no cards to play that the E.U. values. At risk of revolt or not, it may yet try to stay in the customs union as negotiations reach a head during the summer.

Should Britain leave the E.U. without an agreement, the worst that would happen would likely be World Trade Organization (WTO) rules on tariffs. That means the U.K. could end up with a deal like the U.S., where tariffs rates reflect the various parties’ home vested interests.

By the Numbers

The E.U. charges 10% on imports of U.S. cars, for example, compared with the only 2.5% the U.S. charges E.U. car makers, that would be a serious obstacle for major U.K. exporters like Jaguar Land Rover, Nissan, and BMW-owned Mini. The U.S., on the other hand, charges 130% duty on peanuts and 350% on tobacco, effectively cutting off trade in those areas.

Without an existing template to adopt, the U.K. would have a prolonged negotiation and an uncertain couple of years while the details were hammered out during which some firms inevitably would hedge their bets and move some facilities abroad as Rolls Royce aero engines announced it was considering this week, The Telegraph reported.

Everyone has an opinion, and frequently they are at odds.

Sir Lockwood Smith, New Zealand’s former high commissioner to the U.K., issued a warning as the government comes under pressure to stay in the customs union. He warned against remining locked into the E.U. system, saying failing to leave the customs union would be “awful for Britain and for the world,” The Telegraph reported last week.

But the commonwealth country’s experiences of free trade have not been to exit a major trading bloc on their doorstep in return for the tenuous opportunities further afield.

New Zealand has done very well from removing tariff barriers and opening up its economy. Prior to that, however, it was clearly stifled by restrictive barriers; that is not the case with the U.K., as trade with Europe is flourishing.

Life After the E.U.

Few now can be found who still cling to the notion the U.K.’s economy will expand faster or living standards will rise faster if the U.K. leaves the E.U. Even Brexiteers are notable for calling for a return of national sovereignty and immigration controls rather than the economic benefits.

But despite the gloomy outlook, both sides of parliament remain enthralled by the notion that “the people have spoken” and are unable to have a reasonable debate about whether it remains the best course of action.

As a result, Britain will almost certainly leave in some form, either soft or hard. It will probably fudge, compromise and capitulate to remain in the customs union, but there remains a chance – as a result of political revolt, rather than policy – that it could have a hard exit.

If that happens, manufacturing and services will both experience a systemic shock that could take years to overcome. British exporters will be forced to look for opportunities outside of Europe as markets within the bloc become less viable. Likewise, importers will look further afield if the imposition of tariffs and border controls puts European suppliers on the same footing as those from the rest of the world.

U.K. manufacturing and service industries will, to some extent, be forced to relocate plants and offices into Europe. New car plant investment, for example, would make more sense in eastern Europe than the U.K., should the U.K. leave the trading bloc without a free trade deal. Likewise, banking and insurance will need an E.U. presence to secure the licenses necessary to continue to operate within the E.U.

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It’s hard to see how the outcome can be good for anyone. The objective now is to hope for the least bad of options.