Tag Archives: European Economies

Central and Eastern European (CEE) economies costs and benefits from Covid-19

The impact of Covid-19 on countries like China, and other parts of Asia, has meant that firms in the large economies of Germany and France might not be keen to outsource work to Asia. Although the infrastructure and the resources are available in these countries the Covid-19 risks associated with them means some European companies are looking at options closer to home – also referred to as “nearshoring” (moves by China-wary western European manufacturers to bring production closer to home). CEE countries especially Czech Republic, Hungary, Poland, Slovakia and Romania are particularly strong in the manufacturing sector whilst Estonia, Latvia, and Lithuania (Baltic states) have a comparative advantage in services. Although outsourcing will help these economies it will take a bit of time before there is any significant change.

This is an optimistic view but for some Eastern European countries the GDP forecast has been worse than that experienced after the GFC.

With the fall of the Berlin Wall, the transition from command to market systems led to severe recessions within countries – accelerating inflation and very high levels of unemployment – GDP fell by over 40% in the old Soviet-bloc countries. The present recession is proving to be much worse and these Eastern European countries are particularly vulnerable. The Economist came up with three reasons:

  • These economies are exported dependent – as a % of GDP exports are 96% in Slovakia, 85% in Hungary.
  • Eastern European countries will find it hard to fund deficits as their credit rating tends to be a lot lower than other countries wishing to borrow money. Bulgaria’s rating is BBB compared to say Austria which is AA+
  • A lot of these countries rely on tourism as part of GDP therefore with Covid-19 the tourist industry has all but disappeared. For Croatia that is about 25% of GDP.

The outlook looks especially bleak for economies that were in a poor economic condition before Covid-19. Even though there have been radical steps taken to nullify the economic impact of the virus it will take a strong and coordinated response at EU level to steer countries out of their economic hardship.

Source: The Economist – Eastern Europe’s covid-19 recession could match its post-communist one. 28th May 2020

EU’s uncommon Common Agricultural Policy

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector known as the common agricultural policy – CAP. Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU. The EU’s seven year budget (2021-2027), also known as the ‘multi-annual financial framework (MFF) is currently being discussed and agricultural subsidies are once again a controversial issue although have been reduced from previous years – 70% of the EU budget in 1980 to 37% in 2018 – see graph right from The Economist.

The aim of discussions is to reduce the amount to between 28% and 31% of the MFF. EU support levels are very high when compared to other countries. The graph below shows the support that other countries receive – producer support estimate (PSE), as a share of total farm income. EU is 20.% (2018) above the OECD average and well ahead of China, USA, Russia, Canada, Brazil, and Australia. Norway is at 62.36% whilst New Zealand is 0.48%.

Source: https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy

Who gets what from EU farm subsidies?

Source: https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy

There is wide variation in the support provided to agriculture within the “Common” agriculture policy. Latvia does the best of any country in the EU with a lot of other more recent eastern European entrants into the EU – of the top 10 Greece and Finland are the only non East European countries. The Netherlands gets a mere 7% of their income from EU support and traditional supporters of agriculture spend like Ireland, Luxembourg, Italy, and Poland are all below the EU average

  • Despite being a vocal critic of the CAP (and receiving a separate rebate) UK support is broadly the same as the EU average
  • France’s support is only just above average, while Germany’s is in the bottom quarter
  • In terms of the “market price support” element—which inflates EU food prices—Belgium, Hungary, Malta, Poland, and UK producers benefit most

The variation seen here reflects a combination of factors, few of which relate to a policy objective. Most payments are distributed on the basis of a farm’s size in hectares—though per hectare rates vary and were often based on the historical value of production. Other payments relate to sustainability of farming methods, numbers of young farmers, or how much farms produce. With agriculture seen as a significant contributor to global emissions should subsidies be tied to those farmers reducing their impact on climate change?

The economics behind CAP intervention price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

  1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
  2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
  3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
  4. There is a contraction in domestic consumption to 0Qd1
    Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Sources:

  • https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy
  • The Economist: 23-11-19 – Milking taxpayers

Brexit and ‘Yes Minister’?

In light of what has been happening regarding Brexit here is a very amusing clip from the BBC series “Yes Minister” in which Sir Humphrey and Jim Hacker discuss Brussels and the notion of the UK trying to pretend that they are European. Also discusses why other European nations joined the common market in the first place.

I am off to the beach and out of internet range – will be back around 6th January. Merry Christmas and a Happy New Year.

Brexit and the EU explained

No doubt you are aware of the what is happening in the UK with regard to leaving the European Union – Brexit. Below is a very informative video from CNBC which explains the history of the UK when it entered the EEC (as it was formerly known) in 1973 under Ted Heath’s government to today where there is chaos as to the process of leaving the EU.

Output Gap in Eastern European Countries

Output GapThe Economist had a very good graphic showing the difference between the actual and potential GDP in central and eastern European countries. In Romania a 16% rise in the minimum wage is likely to lift domestic demand and inflation whilst the Ukraine and Bosnia have problems with big negative output gaps where their GDP is well below their potential GDP.

Remember to mention the output gap when doing an essay that involves the business cycle. The output gap is the difference between demand and the economy’s capacity to supply. This is the difference between the ‘actual’ level of output (GDP) and the economy’s ‘potential’ level of output (potential GDP).

  • If the economy is running above capacity (GDP > potential GDP) the output gap is positive.
  • If the economy is running below its full capacity (GDP < potential GDP) the output gap will be negative.
  • There is a sweet spot which is where the level of output is consistent with stable inflation and full employment.

Remember that ‘potential’ output is not an upper limit on the level of output. Rather, think of potential GDP as the economy’s efficient level of output. Running the economy below potential GDP is inefficient because there are some resources that are not employed. Running the economy above potential GDP is also inefficient because resources are over-utilised (eg, machinery is being made to work too hard causing it to wear out too quickly).

While it is efficient to have the economy running at potential, quite often it does not. Resources can be over- or under-utilised, which will translate into inflationary or disinflationary pressure (over-utilisation will push future inflation up, while under-utilisation pushes future inflation down).

Business Cycle.png

European Structural Unemployment

Here is a great graphic from the Wall Street Journal which identifies the structural unemployment, productivity levels and the unemployment rate. Structural unemployment refers to unemployment arising from changes in demand or technology which lead to an oversupply of labour with particular skills or in particular locations. Structural unemployment does not result from an overall deficiency of demand and therefore cannot be cured by reflation, but only by retraining or relocation of the affected work-force, some of which may find work at low wages in unskilled occupations. Structural unemployment is distinct from frictional unemployment, which is essentially a short-term phenomenon.

* Spain and Greece have been highlighted as economies with significant unemployment problems.
* Ireland although has high unemployment does have encouraging productivity levels compared to other EU countries
* Norway seems to have things right – low unemployment and high productivity
* Eastern bloc countries tend to have lower productivity levels.

Structural Unemp Euro

% Change – GDP per person – 1999 – 2014

Useful graphic from The Economist that shows the % change in GDP from 1999 – 2014.
1999 was when the Euro currency was introduced and with Latvia joining the currency bloc at the start of this year that makes 18 members. Spain, Greece, Portugal and Italy have struggled since the GFC especially Italy – negative GDP. Germany’s GDP per person has increased by over 20% since 1999. Benefitting from export revenue in recent times with a weak euro.

GDP by country 1999-2014

CAP reforms unlikely to benefit New Zealand farmers.

A move by the European Union to slash subsidies to farmers isn’t as big a deal as it sounds. The EU has announced cut to the subsidies it pays industrial scale farmers of up to 30% – this is part of the Common Agricultural Policy (CAP) which costs the EU tax payers 50bn a year and is 40% of the whole EU budget. This will be of little benefit to NZ farmers as they will still be denied access through tariffs and quotas on sheep, butter, cheese etc.

Objectives of CAP

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

CAP Int Price
Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.

Spain tries the German method to reduce unemployment

If you look at the labour market in Spain you would think that it resembles the German economy 10 years ago when Gerhard Schroder was its leader. Schroder was responsible for labour reforms that ignited the German economy into one of the strongest in Europe.

Spain is relaxing labour laws and cutting public spending and there are some positive signs here in that labour unit costs are falling as result of greater productivity. However German’s vocational education sector was a significant factor in its improved performance as the education and training system is more job orientated. Furthermore, with austerity measures in place and more to follow – pressure from the EU to introduce yet another sales-tax rise – Spain will find it hard to generate any sort of growth. But if it does grow will it generate any reduction in unemployment? Because of labour reforms some economists now believe that only 1.5% growth is required to bring about net job creation rather than 2.5% as previous.

Spain Unem

Credit Rating Agencies – how countries stack up.

Rating Agencies Feb 2013Here is a list of the latest ratings by the three main rating agencies. Notice that Australia and the three Scandinavian countries have top ratings. The UK lost its top rating from Moody’s but maintained the top rating from the other two. New Zealand comes in further down with a top rating from Moody’s but has lost its top grade from the other two. When you get to B status your are talking high risk or junk status and this is quite evident with the PIGS counties.

If you have watched the movie documnetary ‘Inside Job’ you will remember that these 3 credit rating agencies also rated high risk investments – sub-prime mortgages – as AAA, up to a week before they failed. The same could be said about their rating of investment company Bear Stearns.

Ultimately they could have ‘stopped the party’ but delayed ratings reports and made junk status investments AAA rated. But as they testified in front of congress their advice to clients are opinions ‘just opinions’ – I wonder do they share the opinions of those that lost huge amounts of money, including sovereign investments. Recently they downgraded Greece and Spain in the knowledge that the servicing of the debt would now become more costly for those countries and stifle any sort of recovery in the near future.