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On Business and Economics in Volatile Times
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July 28, 2009
Listening to the news today, I remember a little report that I had prepared for the World Bank about fifteen years ago. They had asked me to investigate why four state-owned 'development banks' had gone bust. I came with all my economic theories and models, and my bottom-up working experience in a German high street bank. Then, in one interview, a former board member of one of the banks explained to me: "We had this loan application, and the board agreed that it could not be approved. Then the telephone rang, the CEO answered it. He came back and told us 'that was the minister on the phone, the loan has been approved'." And all my theories went out of the window...
Why is this memory coming back now? Politicians around the world are telling their banks - some of which de facto are partially state-owned - to give loans more generously to small and medium size enterprises. Today it was UK chancellor Alistair Darling telling off British bankers, but there have been plenty of others. Sometimes this borders bullying. This is playing with fire!
Loan approvals have to be based on solid banking practice - that means a viable business plan, acceptable risk, and sufficient collateral. If loans are given for political reasons, then the politicians better be prepared to pay up for the defaulting loans of the future. If banks provide loans to businesses with a high chance of failure, this is stirring up trouble for the future. Big trouble indeed, my Peruvian experience suggests.
I can't resist the temptation, but it is just the sort of good news that our dear tabloids wish would never happen: Stock markets are moving up! And, it is not just one or two, it is all of them (at least all listed in The Economist's backpage). This week, the weekly changes are all positive - in recent weeks usually a handful were dogging the main trend. What is more, on July 22nd, all the stock market indices around the world are above their level of December 31st last year!
Does that mean the recession is over? That depends which indicator you look at. We have had a steady stream of positive indicators from countries around the world, such as manufacturing output and business confidence, since April. However, unemployment keeps rising. Most of these indicators suggest that the economies of the world are not getting worse, yet there is little evidence for a substantive recovery (apart from, arguably, some emerging economies). What the stock market indices really tell us that the world is doing better than investors expected in the dark days of the last winter.
Looking across the indices, I note that China's stock markets are up by over 80%. In conjunction with loose monetary and fiscal policy makes me a bit worried. The government has been trying to stimulate consumer spending by putting more money into Chinese people's pockets. Yet, they seem to spend it in the stock market rather than on consumption, as was intended. Thus, we might (just might) see the seeds of a new bubble here.
World trade statistics have been amongst the gloomiest indicators of the economic crisis last winter: In January, global exports were 30% down on the previous year - that is pretty dramatic, and contributed to gloomy forecasts of the depth and length of the crisis. Yet, global GDP is expect to drop be 'only' 1,4% in 2008 according to the latest figures from the IMF. How can that be?
Firstly, the drop in consumer demand has primarily affected purchases of durable goods (such as cars, kitchens, televisions) that can easily postponed. Yet these durables are far more likely to be imported; by their nature they are easier to ship.
Secondly, as companies cut their investment plans, they cut investment goods - machines - which again is a category of goods that is more traded than others.
Third, global supply chains are are tightly interlinked such that the components for a single product may in fact be shipped across borders several times (say, if you ship components to China, and the final products to Europe, that counts for 2 in the trade statistics). Hence, a reduction of goods purchased by consumers has a disproportionate effect on trade values.
Fourth, an immediate response to the crisis has been a reduction of inventories by retailers and manufacturers. This created a one-off effect on business-to-business transactions that was bigger than drop in consumer spending. Once businesses adjusted inventories to a new lower level, demand would pick up again.
So, where do we go from here? The trade statistics (summarized in the latest Economist) show that month-on-month changes since January are basically nil. In other words, trade fell from October to January, but is flat now on that lower level. So, we are at a lower level, but things are not getting worse (though there is considerably potential for politicians to create a mess if they resort to protectionism). Keep your fingers crossed...
The Economist (2009): Briefing World Trade: Unpredictable Tides, July 25th.
IMF (2009) World Economic Outlook Update, July 8th.
The Economist also has commented on the likely impact of swine flu, focusing on the macroeconomic impact. They cite two recent reports predicting respectively a 3% drop of UK GDP and a 5% drop of global GDP. However, so observes The Economist, financial markets seems to ignore the bad news, "Perhaps the media's habit of treating every potential crisis as an omen of the apocalypse made them cynical". Beautifully said!
They further dug out a very comprehensive Canadian study published in 2006 that analyzed the pandemics of 1918, 1957 and 1968 as well as SARS. It predicts that the economic effect on the affected countries would be a mere 1% drop in output because "People adapt and work around the shock; those unaffected work harder and longer to pick up the slack." Seems obvious - but would the media understand such human behaviour?
I have googled the authors and found that - in addition to their original study - they also have a powerpoint presentation online that has a lot of illustrative data, including the effects of SARS on Hong Kong. Again, the effect on some statistics was substantive (restaurant receipts, tourism arrivals), but the overall effect on the GDP growth path was minimal.
No reason to panic then - but good reason to be cautious, and prepared.
When business leaders come back from their summer holiday, they find a very different challenge landscape in front of them: The financial crisis has eased away, many banks are reporting profits again, and the IMF has revised its forecast for 2009 upwards in July after really dreadful numbers back in April.
Yet rather than the IMF, we may have to turn to the WHO for forecasts. Many countries seem to have given up trying to contain the flu (China still quarantines visitors found to carry the virus), but rather treat it like just another flu wave. Actually, it is a bit more serious than that, the WTO has declared it a pandemic, and people are dying from it. The fact that the flu is spreading in summer is indeed a bit scary, what will happen when it gets colder? We may have a foretaste of that in the U.K. where numbers have been jumping up during the recent old weather period. (The BBC has a good map tracking the pandemic).
So, what are we to do about it? The advice in the media may be a bit confusing (this one helps a bit). In my humble opinion (I am not medic!), the first thing to is what you should be doing always when there is a flu around:
This blog is supposed to be about business, not about sharing health advice. So, how should businesses prepare themselves:
Of course there is some investment advice to be extracted here as well. BUYs of the moment should be cleaning companies, pharmaceuticals, providers of fresh fruit, and home entertainment. SELLs should be entertainment places that bring lots of people together in small spaces...
UNCTAD has conducted extensive surveys aiming to indentify industries that can expect increases of foreign investment in the next years. The list has some similarities with the list of businesses likely to be important in the next upswing on my blog on April 2, which was based on brainstorming with my own audiences. However, the UNCTAD has more specific suggestions. I thought it may be worthwhile to reproduce a summary of their list here:
This list is based on expert interviews. Hence, we should probably treat it as the best available guess, rather than a forecast. However, as an aggregate of expert views, it provides us with a reasonable scenario of what the future might look like.
UNCTAD in Geneva are a valuable resource for data on foreign direct investment (FDI). Their data may have shortcomings, my academic colleagues would be quick to point out (notably their collection across countries is not entirely comparable). However, they are the best data available and anyone wishing to discuss macroeconomic trends of investment would be well advised to check the latest World Investment Report.
Recently, UNCTAD released a working paper discussing the latest data in view of the economic crisis. The main message is that FDI stock continues to increase, i.e. businesses are putting more money in new projects than they are withdrawing. Hence, FDI flows worldwide remain positive, and they are predicted to remain so throughout 2009. We have seen a particular large wave of FDI that peaked in 2007 at US$ 1.9 trillion and fell back to US$ 1.7 trillion in 2008. Data for the first quarter of 2009 suggest a sharp decline of this capital flow, though various indicators suggest that it may increase again from Q2.
The biggest drop in FDI is associated with mergers and acquisitions. With the decline of asset prices, this should not be a surprise. FDI value is measured by the amount paid for acquired companies - in 2007 many investors may well have overpaid for sought targets, and this accounts for much of the drop of FDI. Also, it is worth remembering that one firm's divestment may be another firms investment, i.e. when one foreign investors sells a business unit to another foreign investor (as in the case of Opel, for example).
There are considerable regional variations in FDI flows in 2008, for instance FDI into the U.S.A. was up, presumably because the liquidity squeeze and at the time a weak dollar created attractive opportunities to pick up assets relatively cheaply (similar to the Asian crisis; see April 7). Also, FDI from and into emerging economies held up fairly well in 2008.
The swine-flu pandemic that emerged earlier this year has the potential to not only cause havoc to peoples health, but it disrupt global business operations. The SARS crisis a few years ago has taught us how travel restrictions, isolation of possibly infected groups of people, and individual anxiety causes major disruptions to lives, and to businesses. Without travel, not only did the tourism industry suffer, but may important coordination tasks could not be done as effectively.
In the current pandemic (that's what the WHO calls it), it is striking how different countries react. In the U.K. the media have been full about the numbers of cases observed, schools being closed, and the sad deaths of to my knowledge three individuals to date. Coming to the US, where statistics suggest a much higher incidence of swine-flu, I am surprised how little the media talk about it. Michael Jackson swept the front pages for days now, and even Obama's health care reform barely got a few minutes on CNN last night. However, there is also less apparent preventive action. In the U.K., new posters have gone up everywhere reminding people to wash their hands frequently, cover their mouth when coughing, and bin their tissues safely and quickly. It should be common sense, but sadly it is necessary - I see so many people forgetting such basic hygiene. Such a public education campaign thus makes a lot of sense - but in San Diego, I have not noticed any signs of a public awareness campaign. Is the U.K. overly panicking, or the U.S.A. irresponsibly relaxed? Only history will tell.
This blog is supposed to be about business opportunities. Obviously, the flu provides opportunities for all those who help reducing the impact of the flu, from providers of video conferencing facilities, to developers of vaccines, to manufacturers of medical face masks. Its a risky strategy though - people will be praying that your products will not actually be needed.
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