Thursday, 26 January 2012

The Greek fixed investment saga or how you can get everything wrong...

One chart in my last post was the spark that made me go back and try to make sense of something I’d written in a late 2011 post. Here’s that particular chart that made me stop and scratch my head in confusion.

source: AMECO, own calculations

The Greek corporate sector is a net lender, which can only mean that fixed investment must have been a bit restrained for the whole of the 00s. To put these words into a chart, here’s Greek corporate sector’s Gross Capital Formation (this figure is not exactly the same as Gross Fixed Capital Formation but it’s not that different).

source: AMECO, own calculations

The Greek corporate sector, ranks last among those of all peripheral Euro Area as far as gross capital formation is concerned. It turns out that the corporate sector being a net lender isn’t a such good thing after all...

This is the very point that is in stark contrast with that older post. Here’s that chart about fixed investment in equipment.

source: AMECO, own calculations

Investment in equipment should mostly concern the corporate sector, right? And it seems to rise sharply after 2000, right? Well, wrong on both counts, since investment in transport equipment is included in that figure too.

Just look at that chart, it is an indication of what a sorry excuse for a growth model Greece had these past few years.

source: AMECO, own calculations

Greece tops the peripheral Euro-Area ranks for investment in transport equipment. Probably cheap credit after EMU accession helped too (although cheap is relative).

But what about investment in actual equipment? Well, I think you can guess without even setting eyes on the chart. During the second half of the 90s, Greece was the peripheral countries laggard in that respect too, but during the 00s it was surpassed by Ireland, where property investment crowded out all other kinds. One more excuse for Ireland could be that its corporate sector is dominated by multinational corporations which tend to be mature companies (if that explanation’s lame and someone has a different opinion please enlighten me and say so in the comments section). The picture that the chart paints cannot be too good for the indigenous Irish corporate sector though.  

source: AMECO, own calculations
source: AMECO, own calculations

As you can see, before the 00s set in and abundant and cheap credit gave a push to the property sectors in Spain and Ireland (something that contributed to them reaching bubble-ish proportions) Greece comfortably led the table in investment in dwellings. Even at the height of the Irish and Spanish property bubbles, Greek investment in dwellings wasn’t that far behind.

When added, Investment in dwellings and in transport equipment should be the main ingredients of household fixed investment. Here’s one more chart to make your eyes hurt.

source: AMECO, own calculations

For the span of the 90s Greece topped that table too, with the exception of the years that the Irish property bubble was at its apogee. One could think that it couldn’t be bad that the households invested that much. In my humble opinion, it is. Investment in dwellings generally does not lead to higher labour productivity and in that scale it’s just evidence of distortions being present (or a bubble). It would be more preferable for the households to save more and their savings to be directed to other more productive forms of fixed investment (of course this is more easily said than done and particularly in the case of Greece I wouldn’t bet money that t would happen in the case that households did save more).

Finally, let’s have a look at investment in non-residential construction. I speculate that this could include investment in office buildings, warehouses, industrial structures, logistics hubs, malls, shops, big boxes, etc.

source: AMECO, own calculations

Greece is the laggard in that form of fixed investment as well. It’s not that all of the components of this type of fixed investment are particularly desirable in my humble opinion, but they are certainly more productive that investment in dwellings.

Let me wrap this up since you’re probably dizzy from that swarm of charts above. It wouldn’t be an exaggeration to say that not one of the charts gives away something positive concerning the Greek growth model and the way that resources were allocated. One could say that the least productivity-enhancing categories of gross fixed capital formation got all the juice and it would be spot on. The worst thing about this model is that the growth that was generated was short-lived and not the least bit sustainable. It seems to me that during the 00s Greece experienced a household gross capital formation bubble (but we have to note that level could be pernamently higher than in other countries, so either distirtionary factors are at work or we are just a very special case) and we’re now living through the hangover (among a million other things). The Greek growth model (if one would be that kind and call it that) was had its fair share of distortions and now that it’s past its expiry date a complete overhaul is needed…

Monday, 23 January 2012

Euro Area periphery and core: What lies behind the current account balance

In one of my usual data-trawls I happened to come across sectoral financial balances. That seems like a good thing to do a post on, especially since this is my first post for 2012. I know that at first it seems like an obscure topic but believe me it is pretty relevant to the mess we’re in.

First, a tiny bit of background. When a country runs a current account deficit this quite simplistically means that it consumes more than what it produces. In order to do that it has to borrow from abroad, so a country’s current account balance equals the overall financial balance of the economy. 

There are two ways to calculate this balance for each institutional sector (by that we mean the general government, the corporate sector and the households). This is how the OECD-iLibrary defines it. The simplest one out of the two is the difference between the accumulation-flows of financial assets and financial liabilities for each institutional sector.

I’d mostly like to take a look at peripheral Euro-Area countries that run current account deficits and discern what the sectoral balances are. This could throw some light onto which sector’s behavior was the main catalyst behind each country’s current account balance. So, here we go.

First, let’s start with Greece. It certainly is no secret that Greece has been running a current account deficit ever since AMECO data run. What I haven’t seen explored anywhere is the financial balances of the individual sectors.

source: AMECO, own calculations

As we can see from the chart, post-1999 Greek households become net borrowers (wasn’t that the time that the equities bubble burst?). I hardly need to mention that the General government was a net borrower throughout this period (1995-2010). The corporate sector (comprised by non-financials and financials) was a net lender for the span of the post-1999 period. 

source: AMECO, own calculations

Portugal also runs a current account deficit, hence is a net borrower. Portuguese households were net lenders for the whole 1995-2010 period. The Portuguese corporate sector was a net borrower for the whole period.

source: AMECO, own calculations

Now let’s take a look at Italy. After the 1992 Lira devaluation, the country ran a current account surplus till the end of the decade. The government cut the budget deficit to meet the EMU accession criteria and pretty much kept it into check after that (especially if we take into account the country’s track record). Italian households were net lenders since 1980 when data run, although the sectoral surplus shrank significantly and progressively over the years. Finally, the corporate sector, since the early 90s was a borderline net borrower (maybe the fall in gross fixed capital formation during that period is to blame).

source: AMECO,own calculations

Moving on to Spain, we can see that the country’s current account deficit can be blamed entirely on the fact that the country’s corporate sector became a net borrower progressively after 1995. The Spanish general government after the country EMU accession was rather prudent and even managed to become a net lender until the onset of the crisis when the budget deficit exploded. What is interesting to see is that the general government balance and the household sector one are mirror images of each other. Moreover, it is noteworthy that post-crisis the household sector became a net lender again as did the corporate sector, for the first time since the late 90s. 

I now want us to have a look at a couple of “core” Euro-Area countries. With all the fuss being made about it, Germany has to be the first one. Here is the chart.

source: AMECO, own calculations

The country, moved from being a borderline net borrower throughout the 90s to become a net lender post-2000. The German government wasn’t as prudent as it likes to come across (the Spanish general government was more prudent). The households sector was a net lender during the years featured in the chart and the corporate sector became a net lender post-2000. The consistent drop in gross fixed capital formation may have played a part to that.

Finally, let’s see what the situation in the Netherlands was. Here comes the chart.

source: AMECO, own calculations

The country was a net lender for the span of the period that the data cover. The current account surplus increased further from the late 90s onwards. The trimming of the general government budget deficit may be partly to blame for that. The household sector was oscillating between being a net lender and net borrower during the 00s (the sector’s indebtness became exorbitant during that time) but of course the sector’s balance again appears to be a mirror image of that of the general government. On the other hand the corporate sector became a net lender after the onset of the 00s (plummeting gross fixed capital formation could be partly blamed for that). After the crisis set in, one could say that the corporate sector’s balance became a mirror image of that of the general government’s.

As one could deduct from all my blabbing above, the two core countries are indeed net lenders while the four peripheral countries mentioned above are indeed net borrowers. Differences between them are noteworthy, nonetheless some themes can be outlined. 

Household sectors are in most of the cases net lenders or did become after the crisis set in, a notable exception to that is Greece, where household balance sheets appear to be too battered to swing into being net lenders (of course the current policy of over-taxation doesn’t help the least in that nor does the depletion of deposits to support consumption), as is Holland, where too much debt has been piled onto household balance sheets.

Towards the late 90s - early 00s, households' sectors in most of the countries featured above saw their surpluses fall sharply, Portugal and Germany being the exceptions. One explanation for that is the fact that governments trimmed budget deficits to achieve the EMU accession targets and no matter what way this was brought about (either by raising taxes or by slashing spending) it did have a negative effect on households balance sheets. One further reason could have been the simultaneous bursting of equity bubbles, due to which households’ wealth took a beating. It is no coincidence that the countries where households appear to have been less affected from the equity bubble bursting are Portugal and Germany.

Sectoral balances are of course interconnected. If you observe charts closely you can see (as mentioned before) that in most cases the households’ balance is a mirror image of that of the general government one (as is the one of corporations) and so on. For one sector to run a surplus or reduce its deficit it means that it curtails spending and/or gross fixed capital formation. This process is what actually deleveraging is and most economies were used to debt spending (be it for consumption or fixed investment), whether this originated from the private sector or the general government or both. Of course this is not exactly expansionary for the total economy. This is why deleveraging is a painful process and the years ahead will probably be totally different from what we were used to up until now…