The odds favour a difficult year ahead
by Richard Cluver
It is customary at this time for writers to try and probe the future, listing the hurdles and pitfalls that lie ahead and, hopefully the green shoots of promise that might offer better times than we have currently been experiencing.
So let us begin by noting that we are all weary of a lengthy period of sluggishness that began in October 2007 with the notorious sub-prime crisis when the New York Stock Exchange, bloated by excessive speculation that resulted from a property futures splurge that spectacularly collapsed and drove already dangerously over-borrowed world economies into a recession. Technically the recession has long been over but the majority of world economies have since struggled to achieve anything like the growth rates that are needed to create full employment and a general sense of well being among their citizens.
Happily though, the first green shoots of economic recovery have begun to sprout as evidenced by my graphs below that illustrate how the prices of basic commodities have begun to rise on the back of increasing industrial demand. There are approximately 28 KGs of copper in the average motor vehicle and so the 38.6 percent compound annual average rate at which the metal price is rising is proof of growing demand for cars and other consumer goods in the developed world. Much more dramatic, however, is the 112.5 percent compound annual growth rate of the crude oil price, this notwithstanding the fact that the fracking industry has resulted in the world’s largest oil consumer, the USA, becoming a net oil exporter.
These recoveries have been long overdue because the economic stimulation supplied by the world’s central banks mostly failed to trickle down to the poor because the tight lending clamps imposed upon private banks in the aftermath of the sub-prime crisis prevented them from lending to small businesses which are the engines of job-creation. Since whenever new money is generated it will always find an investment, the trillions of newly-created dollars inevitably flowed to the securities markets, driving down interest rates in the bond markets to such an extent that sovereign debt has attracted negative interests rates and share markets have soared. My graph below illustrates how South African Blue Chip shares have risen in value at compound 26.9 percent annually tripling the accumulated wealth of South Africa’s rich since the end of the 2007 to 2009 slump. So, notwithstanding the recession, investors who have followed my Prospects recommendations have done very well!
And just in case you should think that South Africa was alone in this phenomenon, I have depicted below the performance of New York Stock Exchange Blue Chip[s, similarly up rather more than three-fold since the 2007 crash:
At the same time, unemployment has soared all over the world creating a ticking time bomb that has brought about a tidal wave of political change everywhere of which the most significant in the past year were the shocks of Britain voting to exit the European Union and Donald Trump’s election victory in the US: both events that caught out all rational observers. Shockingly, however, there are few places on earth where unemployment is as great a problem as here in South Africa where corruption and maladministration has grossly exacerbated the problems of decimated global trade.
Add to this disturbing figure the fact that over 51% of South Africans — some 29,733,210 – live on less than R1,036.07 per month and it is clear why here and everywhere overseas our citizenry is desperate for change. So it is not surprising that the governing party in South Africa is reportedly riddled with dissent, and with every fresh scandal that erupts around the ANC’s failure to govern effectively the divisions become more sharply highlighted and so called “service delivery” protests are the inevitable consequence. In the circumstances it seems incomprehensible that President Jacob Zuma will be able to continue holding onto power in the new year. Increasingly, leadership of the party is coming to recognise that Zuma is a liability who is likely to cost them the next election
As more and more formerly loyal comrades break ranks and call for his dismissal, it would seem probable that within the next few months we might see a change of leadership. However, unless a change of leadership brings with it a change in the way the ANC operates – one that offers a material improvement in the day to day lives of ordinary South Africans, it is difficult to imagine how the ANC will be able to last in government even until the next elections which must be held before 2019.
Meanwhile, events overseas are likely to if anything heighten the pressure upon South Africa. The greatest single factor is likely to be accelerated capital flight as a consequence of two major factors. Firstly, the Government has run out of money and faces the immediate question of how to deliver on its promises to fund tertiary education. Expect increased taxes when the Budget is delivered early in the new year with most observers anticipating that Finance Minister Pravin Gordhan will significantly raise so-called wealth taxes. If these include major changes to things like Capital Gains and dividend taxation, then it is reasonable to expect that emigration of wealthy South Africans will increase from a steady trickle to a flood. Already, though I do not have figures to back up this statement, it is reported that South Africa has the world’s highest rate of wealth emigration and with each tax increase tax havens like Malta, Mauritius and the Caribbean become increasingly attractive.
The other external factor putting pressure on South Africa is the advent of Donald Trump as President of the USA with his promise of massive infrastructure spending. Already in anticipation of this, US long bond rates have been climbing steeply.
Since South Africa is unable to live within its income, the Government is forced to borrow on the international market and rising US bond rates mean that we will be forced to pay more for our borrowings, inevitably putting pressure on our Prime Rate. Since the US Federal Reserve has just raised rates and is telegraphing another three rate increases in the coming year, it is inevitable that commensurate increases will happen in SA, putting upward pressure on our inflation rate as our over-borrowed citizens are forced to step up to the plate with increased mortgage and hire purchase payments. This will inevitably impact workers and so it would be fair to expect increased trade union demands, strikes and confrontations which will only make the role of government more difficult, particularly since the trade union movement has recently distanced itself from the ANC. So expect greater Rand weakness.
Events to the north of us will likely add to the pressure as Britain moves ahead with its “Brexit” plans with consequent re-negotiation of its multitude of trade pacts. Given, further, that the ANC recently shocked Europe by unilaterally ending many of our trade agreements and the system of payment guarantees, it is likely that our exporters will have to work that much harder to bring home vitally-needed foreign exchange.
Here, furthermore, it is reasonable to expect significant change to the complexion of the European Union. Following the failure of a referendum intended to force greater financial responsibility upon its citizenry, it is likely that in the short-term Italy will see significant bank failures which, in an extreme case, could trigger another Greece style crisis. Furthermore, expect significant political change in France, Belgium and Holland where disgruntled citizenry are likely to vote in right-wing politicians whose policies could greatly destabilise the European Union leading conceivably to France following Britain out of the EU and possibly thus precipitating the much heralded breakup of that unstable alliance.
The consequence of such change are all unlikely to be helpful for South Africa and are likely to massively heighten the already considerable pressure on Jacob Zuma’s administration, forcibly bringing about political change. Our fervent hope must thus be that such forces can be evenly handled within the democratic process rather than through revolutionary confrontation.
For investors, however, there is a silver lining to all this. Blue Chip shares have become the new gold and diamonds of traditional wealth preservation and they are likely to continually delivering growth in the foreseeable future. In the graph below I have reproduced my ShareFinder computer programme’s projection for the next two years in respect of the Blue Chips with the expectation that by next December such shares are likely to be standing around 20 percent higher than the present:
The wages of poor policy
By Brian Kantor, chief economist and strategist at Investec Wealth & Investment
Will a national minimum wage help the poor? We beg to disagree with the expert panel
It’s always salutary to be reminded just how dire the economic circumstances of the average South African are, and how slowly their economic conditions have been improving. Over 51% – some 29,733,210 of South Africans – live on less than R1,036.07 per month. These and many other shocking statistics are reported by the Panel of Experts, appointed to recommend the level of a National Minimum Wage (NMW) and on a process for its effective implementation (“Recommendations on policy and Implementation; National Minimum Wage Panel report to the Deputy President”).
The panel has no doubts about the helpfulness of an NMW in principle – only reservations about practiceThe panel seems to have no doubts that a NMW would be a very helpful policy intervention in principle. To quote selectively from its substantial report of 128 pages:“On its own it will not solve all of the challenges we face, but it is an implementable policy which is designed to have a measurable and concrete benefit on the poor. The minimum wage is therefore seen as one of the tools to close the wage gap, including between the genders, and thereby to overcome poverty.
“Furthermore, under the correct conditions and at the correct wage level, it is possible for minimum wage policies to contribute to improving economic growth. ……Given that the national minimum wage is essentially a policy to help the poor, it is generally accepted that exemptions and exclusions should be kept to an absolute minimum.”
Striking a balance – recognising employment dangers in scenario exercises.
The panel was required by the social partners in Nedlac, who agreed to an NMW, to recommend an appropriate level for the NMW. Since it recognised a relationship between wages and employment, the MNW had to strike a balance between the effects of increasing wages to a higher prescribed minimum level and its consequences for additional unemployment, of which South Africa already has a great abundance. Some 26% of the labour force is currently unemployed, while many more potential workers have been discouraged from looking for work and have fallen out of the labour force. Adding them to the work force would imply a more broadly defined national unemployment rate well into the 30% plus range.
The panel recommended a NMW of R3500 per month, or R20 per hour, to be phased in by 2020, with 90% of the NMW to be applied in agriculture and 70% in the sector known as Domestic Service provided to Private Homes. It also recommended annual reviews of the NMW and a gradual move to uniformity across all sectors of the economy. It uses a so-called Computable General Equilibrium model of the South African labour market (as described and developed by Professor Haroon Bhorat of UCT) that included assumptions (not predictions based on past performance) about the trade-offs between percentage increases in minimum wages and percentage reductions in employment (in economic speak, this is known as “employment elasticity”).
The aggregate employment losses were estimated to be between 100,000 and 900,000 jobs lost in exchange for the recommended NMW. In the view of the Panel, the NMW had to be set high enough to make a significant contribution to poverty relief and yet low enough to be able to treat the extra unemployment as the acceptable price to the panel members, of them doing such good for society. This is another argument for “breaking eggs to make omelettes” from those unlikely to be harmed by the action, and who might even benefit from helping to give effect to a new dispensation.
However, the panel did qualify its judgment. It noted correctly:“…..that there is no research or data that can accurately predict the outcome of any policy intervention. It is for this reason that strong emphasis has been placed on the need for good solid research to support the work of the NMW institution into the future. Any future changes to the level of R3,500/R20 per hour should be based on solid evidence of the impact of the national minimum wage.”
Would it be unkind to recognise that this would also be more grist for the economist’s mill? The relationship between minimum wages and employment – what may be self-evident to the panel is not so to society at large. It would have been helpful had the panel used the report to explain more fully why employment offers are negatively related to employment benefits provided by employers in exchange for hours worked. The relationship is less self-evident than the panel may have presumed it to be – especially by members and leaders of trade unions who are inclined to attribute wage differences more to political forces and bargaining power (and even to race) than to the differences in skills and therefore of the contributions to output made by the well and poorly paid. The panel are also inclined to believe that the wage gaps can be easily closed, with little consequence for economic growth by taking more from the well paid and giving to the poor. And so for ever higher NMW.
The panel is well aware of an obviously important and highly consistent relationship that one observes in the South African labour market between measures of skills and wages earned. As statistically significant is the relationship between incomes and employment: the lowest income South Africans have the highest rates of unemployment. The full income and employment details are shown in the table below (Table 5: Household Indicators of the Panel Report). Other reports from Stats SA have demonstrated the links between educational attainments and income and employment.
It may be seen in the Table, that of the 16,306,000 people in Quintile 1, 31.2% of the population with the lowest share of income, only 15,9% are employed, 25% strictly unemployed and the broad unemployment rate of this group is estimated as 65.8%. The average wage of those employed in quintile 1 is only R1,017 per month. The second poorest quintile counts for a further 24.6% of the population, has a lower unemployment rate, a much higher participation rate in the economy and average wage incomes of R1,707 per month. This is a large improvement but is still a very low average wage.
The top income quintiles present very differently. Unemployment rates are much lower and participation rates and average incomes from work of the employed are much higher and well above the recommended NMW. It should be noted that the average wage income of those employed who fall into Quintile 3 of R2,651 per month is still well below the R3,500 per month recommended NMW.
The implications of an NMW set so far above average wages. Is there precedent that can help us predict the employment effects with any confidence? How can an NMW help the poor, who are now mostly not employed? This begs the question – is there any precedent for a NMW or a sectoral minimum wage determination to be set so far above average earnings and, if so, what were the consequences for employment? Or, put another way, is there reason, given the facts of the labour market, to think that the employment elasticities in South Africa are a lot more negative than the range of assumptions considered by the models. Time will tell much more about the consequences of the recommended NMW as the Panel complacently assumes and adjustments can then made to the model and the recommendations. But who will care for the unemployed and their dependents in the meanwhile?
It is very difficult to understand why the Panel should believe that the NMW can be helpful to the poor of South Africa or reduce inequality, because fundamentally the poorest South Africans – those in first and second quintiles – are mostly unemployed. And when they do find employment, they are able to only command wages far below those of the recommended NMW that still leave them objectively poor.
The recommended NMW will surely make it even more difficult for some, especially young workers, to find work that might provide them with a path out of poverty. Thus the NMW is very likely to increase further the unemployment of low skilled potential workers in SA, and to widen the gap between the average incomes of the high earners and the low earners (most of them non-earners) of the population. The poor of South Africa deserve better opportunities to work and more so the opportunity for their children to acquire the education and skills that would help them qualify for and find well-paid work. They do not need further interference in their search for work.
Employers will make the adjustments that will confuse the observers and the evidence. To complicate the numerical outcomes to be observed in due course, structural adjustments to employment practice will be made by employers in response to higher minimum wages. The adjustments will include more reliance on mechanisation and automation, requiring more carefully selected and skilled employees – forces that substitute capital for labour (especially less skilled labour) that are already at work in the economy.
Other adjustments employers will make will be to offer fewer hours of work and significantly less by way of other important employment benefits. These include food, accommodation and contributions to pension and medical aid for example. The panel appears not to recognise these in its money wage-only determination. Evidence of such reactions that are so unhelpful to low income workers comes from previous minimum wage adjudications in the agricultural sector. Fewer workers were employed permanently – less accommodation was offered on the farm – and higher transport costs were incurred by workers bussing in from informal settlements. There is also bound to be less compliance with the law given the availability of cheaper labour and additional employment offered to illegal immigrants.
Why does the labour market only work well for the higher income earners? Is it because they are much less encumbered by regulations and collective bargaining?
A further observation of the inconvenient and uncomfortable truths of the South African labour market is that the supply and demand for labour are very well matched for the well paid and very poorly matched for the low paid. A very high unemployment rate – a large number of potential workers unemployed at current wages – is surely evidence of wage levels that are too high rather than too low for the important purpose of providing work for those who would wish to work at prevailing wage rates.
These are not considerations that receive much attention from the panel, other than a presumption of “structural imbalances” or why these structural forces that discourage employment do not apply to the most expensive of workers in South Africa who are so readily employed. One has to concede that employment at low wages for those with limited skills cannot overcome the poverty of the working poor. But then what can, other than them acquiring the valuable skills that are in short supply and well worth hiring? Wishful thinking or waving magic wands in the form of unaffordable high minimum wages will not solve their problem.
However, unemployment makes their condition more onerous and denies them the employment and low wage benefits that they would be willing to accept, demonstrated by them seeking work. Also, being unemployed prevents the potential worker from acquiring skills on the job and the opportunity to demonstrate their capabilities that add to their employment credentials. These opportunities are particularly important to young, unskilled entry-level workers whose unemployment rates are regrettably but understandably well above average unemployment rates as is well recognised by the panel.
The panel might have sought an explanation of the high rates of unemployment of low income South Africans in the structural impediments to their employment in the country. Barriers to employment offered or accepted in the existing highly pervasive regulations of their employment contracts. It is not as if minimum wages have not been tried in South Africa: they are widely practised and have surely had their effect on the employment of the lowest paid and least skilled. There are in fact 124 separate such sectoral minimum wage determinations. They cover approximately 5 million workers and 33% of those employed, leaving only 35% of workers uncovered, including presumably many of the better paid also without union representation. The lowest such monthly determinations in 2015 ranged from R1,813 for domestic workers to R2,844 per month per contract cleaner in the lowest grades. The highest sectoral minimum determinations – for more skilled work – were R6,155 for workers in private security and R6,506 per month in retail and wholesale businesses.
The newly fashioned NMW is intended to remove all this administrative complexity – and presumably also the possibility of recognising very different labour market conditions (supply and demand) that may apply in the different sectors and regions of the economy. These are conditions that participants in specific labour markets, unencumbered by regulations, would be much better informed about than even diligent officials.The case for best leaving the determination of an employment contract to willing buyers and sellers of labour does not get any hearing from the panel. The collective bargaining process in South Africa can easily be shown to protect the established interests of employees and their employers at the expense of the employment opportunities of the outsiders. This process receives nothing but uncritical approval from the panel, and an appeal for the wider application of collective bargaining arrangements.
The influence of South Africa’s extensive welfare system on poverty and employment hasn’t received much more than perfunctory and rather condescending attention from the Panel as shown below. One can only wonder how panel members could have argued that social wage spending could not have some offsetting effects on consumption and, more arguably perhaps, on employment via the willingness to supply labour services at low hourly rates on offer – a consideration taken up below.
5.43. “While wages are low relative to living levels, there are arguably (our emphasis) some offsetting effects from the social wage spending by Government. About 35% of South Africa’s budget is spent on programmes targeted at the poor, including free basic education, health care, water and electricity, and income support grants for children and the elderly”.
They may, as did the Davis Committee on Tax Reforms, have referred to a report by the World Bank on the influence on incomes and their distribution of South Africa of its welfare system, as quoted below: “But while incomes earned in South Africa may well be the most unequally distributed in the world – the distribution of expenditure is much less unequal. The World Bank shows, in a recent study, that South Africa does more to redistribute income in cash and kind to the poor than its developing economy peers with similar average incomes , Armenia, Brazil, Bolivia, Costa Rica, El Salvador, Ethiopia, Guatemala, Indonesia, Mexico, Peru, and Uruguay (South Africa Economic Update Fiscal Policy and Redistribution in an Unequal Society, World Bank, November 2014).”
As this study also reports: “South Africa ranks as one of the most unequal countries of CEQ (Commitment to Equality Methodologies applied by official statisticians in income measurement) participant countries, if not among all middle-income countries, given its Gini coefficient of 0.69. The proportion of the population living in poverty at 33.4 percent measured by the international benchmark of $2.50 a day(purchasing power parity, PPP, adjusted) — is also higher than in many other middle income countries with similar levels of GNI per capita. For example, the poverty rate is 11 percent in Brazil and 4 percent in Costa Rica”
To quote further from the World Bank report: “Briefly, this Update has two main findings. First, the burden of taxes falls on the richest in South Africa, and social spending results in sizable increases in the incomes of the poor. In other words, the tax and social spending system is overall progressive. Second, fiscal policy in South Africa achieves appreciable reductions in poverty and income inequality, and these reductions are in fact the largest achieved in the emerging market countries that have so far been included in the CEQ. Yet despite fiscal policy being both progressive and equalizing, the levels of poverty and inequality that remain are unacceptably high. South Africa is currently grappling with slowing economic growth, a high fiscal deficit, and a rising debt burden. In this context, addressing the twin challenges of poverty and inequality will require not only much-improved quality and efficiency of public services but also higher and more-inclusive economic growth to help create jobs and lift incomes.” (p22)
These income transfers and benefits in kind may moreover influence the willingness to supply labour services at prevailing wages – especially when wages on offer are very low. By providing an alternative source of benefits welfare raises the reservation wage – the wage at which it makes good sense to work or to seek work, work that may well be physically demanding and less than enjoyable for its own sake. The panel might have paid more attention to the supply side of the SA economy to help explain low rates of labour force participation, also to help explain why immigrants from Africa are much more likely to be employed – at market related wages. They clearly have a lower reservation wage given their limited access to SA welfare and the dependence their families left behind may have on cash remitted to them.
The panel remarks somewhat self-evidently that, “An additional problem faced by the country is that there is evidence that the growth in the demand for labour in South Africa has not been sufficient to keep up with the much larger growth in labour supply.”The panel quotes with seeming approval a study that apparently shows growth and job creation are not well correlated. To quote the Panel: “Recent empirical work by Mkhize (2016) finds that the economy’s capital intensity undermines its ability to generate jobs in times of economic growth. He finds that, in the long run, growth and job creation are not correlated, although there is some sectoral variation. This points to the broader economic policy challenge facing South Africa, which is that there are structural barriers that exacerbate unemployment, the solutions to which require more than economic growth”.
This is a surprising conclusion, given the fact that in the developed world, incomes (GDP), population and the size of the labour force have grown together, as indeed they have in South Africa, as our own work has shown (see below graph??? ). It should be noted though that such work on the relationship in SA between GDP and numbers employed is complicated by the absence of an official, continuous and long-time series of numbers employed. As may be seen, the employment intensity of GDP fell significantly after 1985 but then picked up very strongly after 2003 as the economy regained momentum.
Employment and Output (Real GDP) in South Africa (1967-2015
Source: SA Reserve Bank, Investec Wealth and Investment
Such econometric work on the relationship in South Africa between GDP and numbers employed is complicated by the absence of a continuous long time series of numbers employed. Reserve Bank employment series data used to calculate the figure above dates only from 1967 and refers to employment outside of agriculture and to formal employment only. The numbers employed in these categories amounted to 9.17 million employees in 2015.
A single equation regression equation can be applied to confirm the strength of the GDP influence on numbers employed between 1967 and 2015. The log of the GDP co-efficient has a highly significant value of 0.715 (t stat=18.66) and the equation has a very good fit with an R squared of 0.88. The predictions of this model are compared to the employment outcomes below. As can be seen, the model overestimates employment after 1990 and underestimates employment more recently.
Employment and Output in South Africa (1967-2015) Actual and predicted by GDP
Source: SA Reserve Bank, Investec Wealth and Investment
Using earlier sources of information on employment before 1967, we have estimated an employment series going back to 1940. The predicted relationship with GDP (available from 1946) is shown below. The relationship between GDP and employment over this longer period remains highly significant, while the GDP influence is somewhat less so. The GDP has a co-efficient of 0.54 while the R squared rises to 0.93, indicating an even better statistical fit between GDP and employment. (See below)
The evidence strongly suggests that the relationship between GDP and employment in South Africa remains as highly significant as economic theory and history would predict. Clearly there is more to employment than GDP; any increase in GDP growth can be confidently predicted to increase employment, as it did through the boom years of 2004- 2008 when GDP growth averaged over 5 per cent per annum.
The Mkhize study to which the Panel refers is in reality nothing like a long run study. The data to which it refers extends only to 2000. Furthermore, the study reveals a statistically significant positive relationship between output (GDP) and employment at the aggregate level with a positive output co-efficient of 0.45. The output influence on employment is particularly strong for the service sectors.
Employment and Output in South Africa (1940-2015) Actual and as predicted by GDP
Source: SA Reserve Bank, Investec Wealth and Investment
Clearly the relationship between population growth and growth in employment has weakened over the long run, as evidenced by a declining rate of participation of the adult population in the labour force. The reasons for this may include a technological bias in favour of capital substituted for labour. But further reasons worthy of serious consideration, in addition to a welfare enhanced higher reservation wage, are surely the plethora of interventions in the labour market including the role played by trade unions willing to trade off less employment for improved benefits for those who retain their jobs.
The recommended NMW represents more of the same lack of faith in market forces that encourage further regulation of the labour market in South Africa, rather than a very different recommendation to introduce less interference in the market place to generate faster growth and employment. It represents another example of economists, like the governments they usually serve, as being part of the economic problem rather than the solution.
Six factors that will shape the future
by Marius Oosthuizen
1. Economic Disruption
The first can be described as ”economic disruption”. It is increasingly clear that the convergence of communication and digital technology with that of automation and robotics, will altar business and economic processes at a fundamental level. The welcome efficiencies to be enjoyed from the employment of these so-called disruptors, will place pressure on the capacity of old economic systems to deliver on the social good of gainful employment, the societal value that they have dependably delivered for the last half- century. European institutions that have increasingly thought of themselves largely as custodians of a “single market” which requires ever-more regulatory and eventually legal standardisation, will now be under pressure to provide enabling frameworks and targeted projects that unlock new economic and societal value to be created in this era of disruption. EU institutions will need to ensure that creative destruction occurs instead of the mere destruction of value through this and other forces.
2. Technological Acceleration
The second force, which is related to the first, is that of “technological acceleration”. While not a new phenomena, given the known accelerating effects of global interconnectedness through the likes of cellular telecommunications, the new reality of ubiquitous connection, big data and artificial intelligence combined with the inherent flexibility of the services and knowledge economy, will result in change driven by technology continuing to accelerate apace. Political institutions, structured both in their formal design and procedural culture, around long-run political cycles and terms of office, rather than being responsive and adaptive to new information, will struggle to navigate this tumult. EU institutions will need to enable the reintegration of unemployed citizens, through innovation and training in the wake of the effects of the two forces mentioned above.
3. Rising Social Expectations and Demands
The third and perhaps least understood force will be that of “rising social expectations and demands”. In a world of hi-tech healthcare, mass production and distribution of basic necessities and unprecedented advances in communication and transportation technologies, populations will clamor for access to a more equitable distribution of the benefits of post-industrial modernisation. Given the direct causal relationship between these social demands and the political climate they produce, and the bearing thereof on the role of EU institutions, the capacity to remain directly attuned and proactively engaged with the hopes and aspirations of EU member-state citizens, will controversially become a crucial institutional competence.
4. Extreme Climate
The fourth force will be that of “extreme climate”. While climate related threats already test the capacity for responsiveness of national governments, it remains the case that only at an international level can the mammoth task of addressing climate change be undertaken. The difficulty of maintaining economic progress, which addresses the aforementioned social demands, while bringing climate related threats to the top of the agenda, will be accentuated. In this regard, technology has a significant role to play in reforming old extractive systems and replacing them with new eco-friendly alternatives. EU institutions are uniquely and well placed to take on the challenge of creating the frameworks within which inter-state partnership can be forged within which climate related projects can be undertaken.
5. Institutional Decay
There is no guarantee that the political will, that brought about the creation of the EU institutions, will be sustained into the future. It is this fifth force, that of “institutional decay”, that must be proactively arrested through a concerted effort to embed a long-term, broad-based European vision as a backdrop to providing the narrative of why EU institutions remain vital. In the short-term, as populist rebalancing occurs within EU member states, EU institutions will be confronted with the difficult task of crafting and reinforcing values-based perspectives as they relate to the threats to- and opportunities before those nations who share a common destiny in Europe.
Read also: ‘Liberal’ intolerance – making sense of anti-Brexit, pro-Clinton, #FeesMustFall protests.
6. Changing Power Dynamics
Finally, the sixth force, which will have a crosscutting affect on all of the above, is that of “changing power dynamics”. Whereas the dominant power regime in the region has been that of a free-market social economy within a law-based framework, presided over by elected political power – the impact of social media, the proliferation of digital forms of communication and the long-term prospects of insecurity for Europe’s neighbors to the south and east, create a setting where power will increasingly dissipate to the margins and remain fractured. Coalition politics and coalition activism will contend in a dual for control of the public square.
All of these forces necessitate rapid institutional reforms of EU institutions. The era of the “global village” is all but gone. A more appropriate picture is that of a global network of city-states, united in trade but divided culturally and politically by local demands. The world is again coming to terms with not only the advances bought about by human ingenuity but also the excesses of the anthropocene – mankind’s extractive effects on the ecology and society itself. It remains to be seen if the politics of personality and fear will outwit that of institutionalised democratic norms. The social cohesion of Europe, so vital to the global democratic order, depends on it.
Read also: The West’s uneasy experiment: Trump, Brexit fuel rising tide of Nationalism
· Marius Oosthuizen is a member of faculty at the Gordon Institute of Business Science, University of Pretoria, South Africa. He teaches leadership, strategy and ethics. He oversees the Future of Business in SA project that uses strategic foresight and scenario planning to explore the future of South Arica, Africa and BRICS.
Tough decisions lie ahead for the US
by John Mauldin
The highest-rated soap opera ever, at least among those with an economic and investment approach to life, is the show put on by the US Federal Reserve. I’m going to have a few things to say about the recent FOMC meeting, and we’ll use it as a springboard to chew the fat about the new season and upcoming episodes of our very own soap opera: As the Fed Turns. Just as devotees of As the World Turns used to speculate about what their favorite characters were up to, we can have a little fun opining about the Fed’s next moves. Now, a Trump presidency offers a lot of potentially juicy drama, too, and we’ll certainly want to chat about it. And of course, we won’t be forgetting that this is soap opera with real-world implications for the markets and our investment portfolios.
Very few things are certain in financial markets these days. We used to be certain, for instance, that interest rates would always be positive. Now we know that’s not so! But last week we experienced a moment of near-certainty when federal funds futures contracts said the odds of an interest rate hike were 95% or better. That turned out to be true.
What wasn’t certain was what we would hear in Janet Yellen’s commentary and see in the projections of the FOMC participants. They gave us some things to talk about, and they even gave us their dot plots; but there is very little that’s certain in those. In next season’s Fed, executive produced by Donald Trump, those dot plots will have even less predictive power than they do now. There are some obvious reasons why the plots are continually wrong, but they’re about to be more wrong.
What We Learned from As the Fed Turns This Week:
1. The Fed thinks GDP growth is stuck in low gear.
2. They believe the US economy is at or near full employment.
3. Interest rates will rise but not too much.
4. They don’t want to think about fiscal policy.
5. Janet Yellen will stick around through 2017.
6. And the fun part – speculation about the drama surrounding new appointments to the FOMC. Will Trump get to appoint just two governors or the full monty of seven? Both scenarios are possible. As in any soap, you need to have some uncertainty to keep people off balance and paying attention. Trump’s appointees will make a difference in policy, but will their policy change the reality on the ground of the global economy?
Secular Stagnation Forever?
Promoting economic growth and employment is one of the Fed’s core missions, assigned to it by Congress in (I believe) 1974. It was a triumph of Keynesian thought over Hayek’s beliefs; and despite all evidence to the contrary, most market participants still think that monetary policy is the magic that drives the business cycle. Policy is supposed to moderate the boom-and-bust cycle and lift the economy out of recessions within a reasonable period. On that point, monetary policy has failed miserably. We’re seven years out of recession and have yet to see GDP growth break above 3%.
The Fed’s answer in this week’s episode was to throw in the towel: Expect more of the same. Here’s actual growth since 2011 and the FOMC’s projections through 2019. Notice that the top end of the range of growth is barely more than 2%.
You can see that 2013 was a “good” year. Ben Bernanke was confident enough to start talking about “tapering” down from quantitative easing. Staying on that path another year or two might have changed everything. But it didn’t. There was a global taper tantrum; Growth fell back again; and now even the most optimistic FOMC participants see little chance that it will climb much above 2% through 2019.
(One caveat – and it’s one that I feel the need to keep repeating: GDP is a deeply flawed statistical measure that doesn’t fully capture the way today’s economy works. We use it because we have nothing better.)
Former Treasury Secretary Larry Summers, who desperately wanted to star in the show Janet Yellen now headlines, famously called the current trend “secular stagnation.” He thinks we should all get used to it because its structural causes are impossible to change. Yellen and her crew might not use language that strong, but they appear to mostly agree with Larry.
Are they right? Maybe, but I think we can escape this dreary fate if we play our cards right.
Jobs, Jobs, Jobs
The unemployment trend is looking better. The rate has fallen pretty steadily and is now below 5%. The FOMC expects it to stay there, too.
The problem is that not all jobs are equal. The wealthy law firm partner and the student-debt-plagued law degree holder who is instead driving for Uber both count as “employed,” even though their situations are vastly different.
Also problematic: The unemployment rate is down in part because so many workers have left the labour force – or, increasingly, never entered it. My airplane reading this week included a short, fascinating book called Men Without Work: America’s Invisible Crisis, by Nicholas Eberstadt. He documents evidence that this abandonment of the labour force isn’t a new problem, either. It has been quietly building for decades. It has multiple causes that aren’t at all easily solved. Eberstadt’s data is both compelling and depressing.
Roughly 10 million American males of prime working age have literally dropped out of the workforce. And we wonder why productivity is low. Again, this problem has been building steadily since the ’60s. The trend has held steady through boom periods and recessions, and the Clinton/Gingrich welfare reforms didn’t affect it. France and Greece have significantly higher labour force participation rates than the US does. And no, these dropouts are not Trump voters, and it’s not just the labour force they don’t participate in. This is a major and very troubling social trend.
However, let’s not overlook progress we have made. We have indeed seen much improvement from the Great Recession’s depths. Businesses are expanding and creating new jobs. The problem is that we have a mismatch between the skills of jobless people and the kinds of work employers need done. That is not something lower interest rates can solve.
We Got Dot Plots
Now to the main course: Dot Plots du Jour. The dots that the FOMC members contribute to the plot indicate their expectations for the federal funds rate.
By the way, I saw a tweet this week in which someone said that the dot plots are not “forecasts.” It’s true that the Fed doesn’t use that word. They call the plot their “assessment of appropriate monetary policy” for certain points in the future. So technically, it’s what they think rates should be, not a prediction of what rates will be on those dates.
Is that a forecast? You can call it whatever you like. I think “forecast” is close enough.
But before we look at the whatever-you-call-it, here’s a rate history of the last 16 years:
I’ve highlighted this fact before, but it’s worth mentioning again: In 2007, less than a decade ago, the fed funds rate was over 5%. So were the interest rates for Treasury bills, CDs, and money market funds. People were making 5% on their money, risk-free. It seems like ancient history now, but that year marked the end of a halcyon era of ample rates that most of us lived through. The chart below shows historical certificate of deposit rates – but remember, you could put your money in a money market fund and do better than the six-month certificate of deposit yield, back in 2007.
Today’s young Wall Street hotshots have never seen anything like that. To them the jump from 0.5% to 0.75% must seem like a big deal. It’s really not. If the chart above were a heart monitor readout, we would say this patient is now dead and that last blip was an equipment glitch.
The point to all this is that these near-zero rates to which we have all adapted are by no means normal or necessary to sustain a vibrant economy. We’ve done fine with much higher rates before. They are even beneficial in some ways – they give savers a return on their cash, for instance. But there are likely to be consequences once we embark on this rate-increase cycle, and I’ll examine them later in this letter.
The FOMC cast members are all old enough to remember those bygone days of higher rates as well as I do. So we would think they might at least foresee a return to normalcy at some point in the future. Not so. They see nothing of the sort.
Here is the official dot plot published by the FOMC. (I have included their preferred heading so that no one complains about my calling it a forecast, even though that’s what it is.)
Each dot represents the forecast assessment of an FOMC member. That group includes all the Fed governors and the district bank presidents. All 17 of them submit dots, including the presidents of districts who aren’t in the voting rotation right now. There would be 19 dots if the two vacant governor seats had been filled.
That flat set of dots under 2016 represents a rare instance of Federal Reserve unanimity: They all agree where rates are right now. (See, consensus really is possible.) The disagreement sets in next year. For 2017 there’s one lone dot above the 2.0% line, but the majority (12 of 17) are below 1.5%.
Nevertheless, it will be a much different year than this one if they follow through. The dots imply that the fed funds rate will rise a total 75 basis points next year. Presumably, that would be three 25 bps moves, but they can split it however they want. They could ignore their expectations completely, too. This time last year, the FOMC said to expect a 100 bps rise, or four rate hikes, in 2016. We got only one.
Follow the dots on out and you see that their assessments trend a little higher in the following two years, and then we have the “longer run” beyond 2019. Most FOMC participants think rates at 3% or less will be appropriate as we enter the 2020s. The most hawkish dot is at 3.75%.
Think about what this means. Today’s FOMC can imagine raising rates only to the point they fell to about halfway through their 2007–2008 easing cycle. They see no chance that overnight rates will reach 5% again. None.
Here is another view of the same data, courtesy of Business Insider. They added the September dot plots, so we can see how the dots shifted.
Looking at each set of red (September) and blue (December) dots, we see only a slightly more hawkish tilt than we saw three months ago. The “Longer Term” sets are almost identical – two of the doves moved up from the 2.5% level, while the two most hawkish hung tight at 3.75% and 3.50%.
That word hawkish is relative here. By 2007 standards, these two voters are doves. But, Toto, I’ve a feeling we aren’t in 2007 anymore.
Trump? Who’s That?
I got an email from the brilliant Peter Boockvar after the FOMC news. He said, “If something changed on November 8th, the Fed didn’t see it.” That was a good way to put it. The same election that jolted markets into some of the sharpest moves in years barely affected the FOMC participants. That’s very clear from the near-identical red and blue dots in the chart above. Peter’s take?
Now the dots predict 3 in 2017, and the market this time actually believes we may get it because of Trumponomics and the reality that Fed forecasts must shift higher. Three rate hikes, though, will only take us to a whopping fed funds rate of 1.375%. Even with a zero rate for 8 straight years, the 25-year average in the fed funds rate is still about 2.75%. Headline CPI today is expected to print 1.7%. We should still see negative real interest rates in 2017. The dollar doesn’t care about the absolute level of rates as it continues to rip on the continued growing rate differentials. I’m waiting for the Trump tweet complaining about the strong dollar. I find that to be inevitable if he wants to bring manufacturing jobs back to the US.
Are the Fed governors and bank presidents in denial? I don’t think so. Whether they supported the election outcome or not, they know what happened. They know how markets reacted. They know a whole bunch of things are about to change. So why are they so stubbornly sticking to their guns?
This may surprise some of you, but I’m going to defend the Fed on this point.
I wholeheartedly believe Donald Trump and the Republican majority will enact a sweeping package of tax cuts, at least a modest infrastructure spending program, and hopefully some radical deregulation. It won’t be exactly what any of us want, but they’ll make some good moves that should help the economy, which is badly in need of some help. (As we will see below, there are other forces that are problematic.)
But here’s the rub. We don’t yet know exactly what it will all look like. Right now, we’re hearing a lot of ideas and speculation. Presidents never get everything they want from Congress. Trump may get more than most, but I doubt he’ll get it all. Senators and Representatives have their own ideas and incentives. Serious prognosticators are paying a lot more attention to House Ways and Means Chairman Kevin Brady than the media is. Brady’s ideas are well-known, but they’d be a radical departure from current policy. And every economist knows that any change comes with a time lag before its effects are truly seen in the economy.
Likewise, the details matter. Tax reductions are generally good, but they can have more or less growth impact depending how they are constructed. There’s also the question of how they will affect the debt. That problem isn’t going away. The same with spending and deregulation.
There’s a lot we don’t know, and right now what we do have is mostly guesswork. Do we really want a Federal Reserve that reacts to guesswork? I don’t. I want them to look at hard data and make their best judgment calls. This week’s hike was probably going to happen no matter how the election turned out. They told us in the dot plot to expect more hikes next year, totalling 0.75%. They have plenty of time to react to whatever fiscal policy changes make it to the president’s desk.
The same applies to their morose GDP projections. Do they think the coming changes will have no effect? Probably not. But they don’t know exactly what the changes will be, which makes their impact hard to assess. Plus, while I don’t agree with Summers on secular stagnation, I do agree that long-term forces are causing a generally slower growth environment.
We’ll get a new dot plot at the mid-March FOMC meeting. By then we should have a much better sense of fiscal policy changes. I suspect the impact will be visible in that meeting’s projections, and certainly by the meeting in June.
The Great Shake-Up
The current FOMC may have some new voters by March. There are two vacant seats Trump can fill as soon as he takes office and gets the Senate to confirm them. But it appears Janet Yellen isn’t going anywhere. Asked about her own future at the news conference, she noted that the Senate had confirmed her to a four-year term as chair and that she plans to finish it on schedule, that is, on February 3, 2018.
And this is where we get some drama. Trump could have anywhere from a minimum of two appointments in his first term to possibly all seven. We’ll start with some facts and then throw in some speculation. I should note that I have talked about this with a number of people who have deep insights and contacts in the Federal Reserve, but I owe a special word of thanks to Danielle DiMartino Booth, whose new book on the Fed will be out on Valentine’s Day.
Now to the drama. At Yellen’s press conference she made a couple of notable points. She specifically noted that Federal Reserve appointments aren’t tied to presidential elections. I think that was a hint that she will defend the Fed’s independence, or at least try to.
She also left open the possibility of staying on the Board of Governors even after her term as chair is over. Those are separate appointments. She can stay on the board until January 31, 2024. At age 70 now, I doubt she will, but it’s possible. We know Supreme Court justices delay retirement so that a president they like can appoint their successor. I think Yellen was reminding Trump that she has that option.
The same is true for Vice Chair Stanley Fischer, by the way. His board term lasts until January 31, 2020, so if he chooses to stay it will be until either Trump’s second term or someone else’s first .
You all know that I think the Fed needs a major shake-up. I think Trump can do it, too, but only to the extent there are vacancies he can fill. There are the two current openings, but beyond them he will need some of the current five governors on the FOMC to step down voluntarily. The others’ terms all extend through 2022 or later.
For the record, the other three serving Board of Governors members are Daniel Tarullo, whose term does not end until January 31, 2022; Jerome Powell, whose term isn’t over until January 31, 2028; and Lael Brainard, whose term ends on January 31, 2026. They can all elect to stay.
Now, I am told that Yellen actually wanted to raise rates in September but that she would have had two dissenting votes from members of the Board of Governors. It’s one thing to get dissenting votes from the district Federal Reserve presidents who are serving as voting members on the FOMC; it’s another thing to get dissenting votes from the members who are appointed to the Board of Governors. There has not been a dissenting vote from a governor since 1996 – not to say it couldn’t happen next meeting, but just to give you an idea how rare it is.
If Yellen and Fischer decided they wanted to stay and the other three current board members also agreed to stay on, together with the generally dovish district Federal Reserve presidents, they could seriously hamstring any real shift in Federal Reserve policy that Trump might prefer.
That means the two appointments that he initially makes may be his only true options to eventually become chairman and vice chairman. While I don’t think this outcome is likely, is clearly an option in everybody’s back pocket. That ratchets up the importance of the first two appointments.
Fortunately for Trump, it’s pretty rare for Fed governors to complete their full 14-year terms. First of all, you have to realize that they get something like $169,000 a year. That’s a rounding error in their speaking income, not to mention what they can get by sitting on major corporate boards and consulting. And seriously, you have to be a total data wonk to get any excitement out of some of the responsibilities they have. So consequently, they either retire or seek other opportunities (and maybe a bit more fun). So there’s a good chance Trump appointees will hold at least four of the seven Board of Governors seats by the end of his first term. That could happen as soon as mid-2018 if Yellen and Fischer retire when their leadership positions end.
Okay, let’s ratchet up the drama. Lael Brainard was hoping to be appointed Secretary of the Treasury under a Clinton administration. Clearly, that’s not going to happen. She’s young enough that a future Democratic president could appoint her to the position, but does she want to hang around on the Federal Reserve for a minimum of four more years? I am told she doesn’t.
By people who know Governor Tarullo (and like him), I am told that he is likely to leave sooner rather than later. Currently, he is head of the Federal Financial Institutions Examination Council, a spot he is certainly qualified for but one that is generally given to the Federal Reserve vice chair. He is 64 years old, and I don’t think he will want to hang around just holding down a spot.
Jerome Powell’s background is impressive, but I wonder if he would want to be the last man standing of the current governors. I have heard nothing either way and no one seems to really know, other than Governor Powell. He is actually the lone Republican on the board but has not proven as hawkish as some people thought he would.
Also for the record, I know that both John Taylor and Kevin Warsh would like to be Fed chairman. Either one would be a good chairman, but my true preference would be Richard Fisher, the former Dallas Federal Reserve president. The coming times are going to be extremely difficult to navigate by the limited means of monetary policy, but within that scope, the wisdom and counsel of Richard Fisher would be a great addition. There are any number of good governor nominees, but let me put the names of Dr. Lacy Hunt and David Malpass on the list. Especially Lacy. True aficionad