FedEE Global Economic Bulletin
Taking the pulse for HR
May 16th 2019
Everything is not fine: look again
Because the everyday world looks normal through your window, and no alarm bells can be heard, does not mean all is well. It looked fine back in the Spring of 2007 – just before the economic earthquake struck and these are far more precarious times.
The economic circumstances twelve years ago were not the same as today. In many ways things were better. The world was a more peaceful place (with the clear exceptions of Lebanon and Iraq), currencies were strong and the Greek bailout hand not yet happened. What principally triggered the demise was simple irresponsible lending (toxic loans) and naive greed by the rapidly growing breed of untrained online stock market investors. Back then you did not need to read broker analyses – as most things were making money. Today, the world economy is being driven into a new recession by far different, and far deeper, forces. The world is far from a peaceful place and cold wars on many fronts are simmering. Political leaders lack competence and are being largely driven by insular nationalistic agendas and a good illustration why popular democracy does not work is the disastrous Brexit vote in 2016.
Suddenly, in the last two weeks, all the little tin soldiers have fallen into line and can be pushed down with one flick of the finger. A simple causal chain that produces a domino effect because all the necessary conditions exist at any one moment and are triggered – often by a single event.
What is the evidence for this view? Simple.
* Sharp Downswing: The OECD has a way to predict rises and falls in economies – it is called the Composite Longer-Leading Indicator. This has been found over many years to successfully predict downturns six to nine months before they happen. All economies go through regular upswings and downswings – with a full cycle normally taking 7-12 years. What is clear since the last figures were published on May 14th is that this predictive line has fallen below the lowest points since the 2007/9 crash. What is more, the downswing has already begun. If there will be a real crash of 2007/9 proportions it will happen next year. Curiously, an examination of GDP predictions by the IMF and other leading economic forecasting bodies does not reveal any signs of a recession – although some slowing of growth is predicted for many countries. Is this economic blindness on their part – or are they right and the weight of solid economic evidence wrong?
* Widespread Deflation: For many months now consumer prices in many of the advanced economies have been falling. For instance, the falls since September 2018 amount to -2.2% in Germany, -3.5% in Portugal, -1.6% in Spain and – 1.4% in UAE. This sounds at first a good thing, until we give it a name – “deflation”. Countries that suffer from deflation lack demand from consumers for the goods they produce – as people put off purchasing decisions hoping that tomorrow the goods will be cheaper. What is more, falling prices will put pressure on companies as many of their costs – particularly labour costs – are virtually fixed and cannot respond to the downward pressure. The only thing companies can do after cancelling bonuses is to shed labour. Deflation too, is a sign of fundamentally poor economic health, not wellbeing. A well functioning economy, with rising demand, will experience inflation (rising prices) instead. Up to a point this is good for the economy. The current deflation is a very worrying sign about what is happening under the surface at an international level. It is also clearly associated with the worst forms of recession. For instance, between 1929 and 1933 wholesale prices in the USA collapsed by a staggering 33%. The UK’s “Grocer” magazine has found prices declining in five of the last seven months. Across Europe the biggest fall since last Autumn has been in textiles and clothing. Already deflationary trends are very evident in the property market with annual house prices falling by 4.4% in New Zealand – over 2% of which was between March and April alone. This is also the case in England, where house prices are moving in a volatile way and the number of properties on the market for six months or more is growing. In the more upmarket areas of London they are down over by 4% from last Spring.
Economic straightjacket: Typically, governments slash interest rates to deal with a recession, but interest rates are already low. In the USA, for instance, the Fed overnight loan rate in 2007 was 5.25% – so there was scope for adjustment when the recession hit. But today it is just 2.5%. Hence they have not much scope to absorb the impact. Governments often also cut taxes on the corporate sector to encourage them from shedding jobs, but the US government already did that in the last two years without the driving force of a recession – so, again, there is little in the pot to draw on when things get tough.
Veiled unemployment: There have been excited announcements in recent months about falling unemployment – particularly in the USA and UK. However, look closer and there is a very different picture. What falling unemployment constitutes is the level of “registered unemployment” and what is driving the fall is not economic growth, but a failing welfare system. Governments work very hard to ensure that unemployment numbers stay low and the easiest way to do this is to massage the figures than to stimulate the economy. In fact the number of people discouraged to “sign on” has multiplied, most drift into very low paid casual and part-time jobs or into the grey economy. Official unemployment figures end up just reflecting those who can benefit from benefit payments and are allowed to apply for them.
The tax take: Although it has been estimated that only 0.3% of the 2.9% growth in GDP in the USA was due to the 2017 corporate tax reforms, the cut from a standard rate of 35% to 21% has clearly had a huge impact on corporation finances. The only problem is that it has fuelled the first significant rise in wage and salary levels for many years. As quickly as it has come in, it has gone out to employees – increasing the proportion of fixed costs in the business. Generally, however, the trend around the world has been towards a rise in the tax raised on businesses. In the UK, the 2018/19 sum of taxes on business rose by 4.3% compared to the year earlier, whilst in Ireland corporation tax receipts climbed by a staggering 26% last year, whilst in Italy corporate tax revenues rose by €477m in Q1 2019 compared to a year earlier. The tax take is growing and this is further stifling company profitability.
The export deficits: The economies of both the USA and UK have long been living with substantial balance of payment deficits. This means that they can function ok as long as there is economic growth, but as soon as their economy falters then the reaction is hugely exaggerated. Brexit has seen a major siphoning of funds from the City of London to other financial centres such as Frankfurt and Paris. The UK economy has been able to function successfully because its high balance of imports relative to exports in goods has been offset by surpluses in financial services. Now this offset has been largely removed and the UK will consequently bleed. There was a temporary lift in manufacturing activity during the second half of 2018, as stock building took place ahead of the original Brexit deadline, but this now has ended. In the USA it would seem that the trade war with China and the imposition of 25% tariffs could benefit home industries, but much of the switch that will take place will be to other low cost sources around the world and, as much as home industries will gear up to take advantage of more competitive price levels, they will do so through automation and thus generate all too few jobs.
What will be the trigger?
Every major explosive force needs a trigger, a detonator to ignite the larger charge. In the last two weeks we can take our choice. If it is not the US-China Trade war itself, then it will be a new crisis in Brazil’s economy (see below) or the incidents around the Hormuz choke point where Iran has begun to attack oil shipments from other Gulf states – initially by proxy.
Often events necessary to set off a rapid downward slide come along by chance – like a natural disaster – or by the inevitable consequence of financial mismanagement, like the demise of Lehman Brothers. Before its collapse in 2008 Lehman was the US’s fourth largest investment bank with 26,000 employees. By the end of the year it had gone – and so too all its well-paid jobs.
Of course, Brexit itself could be a trigger if no deal is secured by the Summer. However, most companies have already factored in the worst case scenario resulting from a “no deal”. What is most surprising is that any company is left in the UK private sector at all. Better the devil perhaps – although the devil is going to be less benevolent when post-Brexit blues set in.
Probability of a recession
It is not in question that we are going to have a significant economic downturn during the next year, particularly in Europe and the Americas. What remains uncertain is how deep the collapse will be. The quicker that individual companies prepare for the worst, the stronger they will be when sales volumes or prices (or both) become problematic.
Essential preparatory actions
A seasoned HR professional will have seen recessions before.
The first step is to set a target for labour savings. This is best achieved in terms of money than total positions.
* It is unavoidable to begin anywhere than the freezing of job hires – or cutting them to “essential” jobs.
* A detailed review needs to take place to identify the most easily expendable positions. Selective early retirement may ease costs significantly, although it could denude operations of key expertise.
* One other solution would be contracting out and filling available positions with contractors.
* There should also be a pay freeze, with bonuses also reduced wherever possible. The company needs to build up a contingency fund to help it fight the downturn and savings in labour costs could help feed this. The difficulty will be that such a fund could just attract greater corporate taxation. That is why it should be built up through operations in a low tax economy – so that assets there could be realised to fund deficits elsewhere – as long as transfer pricing problems can be overcome.
INDIVIDUAL COUNTRY FOCUS
THE UNITED KINGDOM
Although the British government has been given an extension until the 31st of October 2019 to reach an agreement with the European Union concerning the UK’s departure from EU membership, the truth of the matter is that there can never be a deal. The Northern Irish Border problem cannot be resolved without erecting a wall to prevent a return to smuggling and other cross-border criminal activity. The Good Friday agreement has produced a fragile peace, but only by letting para military leaders become MPs and turning a blind eye to the mafia activities in both communities. No politician will ever address the “unspeakable solution” of accepting unification between north and south or letting the north become an independent state. Thus, the only option, apart from the unlikely prospect of another EU referendum, is to drift into a “No Deal Brexit”. Curiously, UK HR professionals remain almost entirely unaware of the coming downturn. In a recent CIPD survey there was a widespread intention to continue recruitment drives across most sectors.
This is such a substantial economy in its own right that it dominates the whole of Europe. Yet its economy is not as sound as it would appear. if we look at industrial production over the six months from October 2018 to March 2019 then it can be seen that it has been declining. In four out of the six months there was a decline and on a year-on-year basis the trend is even more spectacular – with a 4.5% cut in November 2018 and sustained cuts of between 1.6% and 3.1% since then. The economy has gone down and is staying down.
What is more, during the last recession Germany fended off many of the worst effects of the downturn through government support for temporary layoffs and a sustained effort to build up trade links with countries outside the EU. However, now German exports to countries outside Europe are no longer climbing – and the latest figures for 2016 suggest that, even by then, they were shrinking. This has been compensated by greater export levels with EU trading partners. This seems fine until we look more closely and see that its third largest EU export market is the precarious Italian economy – which, even before a general recession, has been experiencing little or no growth. Furthermore, the UK is Germany’s sixth biggest export market – a country that will be placing huge barriers on its future EU trading relationships.
Unlike their UK counterparts, German companies would appear to be very much aware of the threatened downswing and have begun to take steps to contain costs. In fact, labour costs have grown in a very subdued way since the end of 2016 and the latest quarterly figure available (Q4 2018) actually records a 0.1% fall in labour costs on a quarter by quarter basis.
Back in 1939 Churchill said of Russia that he could not predict what it would do because it was “a riddle, wrapped in a mystery inside an enigma”. The same could be said of China today. It would appear to be a highly successful economy, with a high, sustained level of economic growth.
The problem for western economists is that the “enigma” can only really be cracked by China’s own statistics and it remains uncertain whether these can be entirely trusted. What we do know for sure is how much China exports to its major international markets. Top of its export list remains the USA, although since January 2019 this has been cut by 25% – even before the actual imposition of tariffs. But a 25% cut in exports to the USA has only a 1% impact on Chinese GDP. With increasing activity in other markets – especially in Europe – that shortfall has already effectively been made up. What is more, and contrary to the belief of President Trump, the 25% tariffs on Chinese goods will just be a tax on Americans and leave China stronger, rather than weaker.
Although China is far from a well-run economy it succeeds in spite of itself simply because of its huge size, internal economic freedoms, focus on high speed digital and physical communications and a well-run, unbureaucratic financial system. Labour costs are rising fast, but this only serves to stimulate domestic demand and the government is freer than many western countries to thrown money at economic problems because it is not overburdened by a costly welfare system. The country can ride out any future downturn and even exploit the weakness of their western rivals to end more ready than ever to exploit the next global upturn.
One of the most likely triggers for a global recession is Brazil. The country only pulled out of a two-year recession, of its very own making, early in 2018 and now the omens are bad once again.
A Reuters report on May 14th led with the statement that “Brazil’s government and central bank said the country’s economic and fiscal health was deteriorating rapidly”. This is a highly significant admission because Brazil is the world’s fifth biggest economy.
Although the government has officially cut its growth forecast to an annual rate of 1.5% it is also reported unofficially that the economy actually shrank during the first quarter of 2019. What has been more confidently reported, however, is that “Brazil’s services sector, which accounts for some 70% of economy activity, shrank by 0.7% in March from February and by 2.3% compared with the same month last year.”
Business confidence is low and both the government and central bank have been slow to catch up. Although interest rates are standing at 6.5%, that is an historically low figure for Brazil. However, remaining competitive in the world economy is a huge task for Brazil as its productivity levels are extremely low. Investment consequently remains at less than 20% of GDP – way below most of its international competitors. The country’s recovery last year led to renewed confidence and a hope that the necessary structural reforms – such as the raising of retirement ages, pension reforms, the aligning of public with private sector pay levels and the combatting of poverty – would be made. But reform is slow in this deeply corrupt and nepotistic society.
Maybe it will all become clearer on May 22nd when the next revised GDP forecasts will be published. If Brazil does fall back into a recession, it will have a much bigger impact than the China-USA trade war on the world economy.
The World is heading for a recession by next year. How deep this will be is not certain, but this fact is extremely important to all HR professionals in multinational enterprises. We are not sure why this fact is not reported in the press, media or admitted by governments – but the evidence is there. It can only be assumed that the message will eventually come to light. FedEE is unusual because we do not just look at data through annualised movements – but the detailed course of the underlying indices and the breakdown of general price and GDP changes to its various elements.
We hope our forecast is not true, but it is better to prepare for the worst than have it thrust upon you out of the blue. Many will disagree with our analyses, and we respect such differences in perspective. It is certainly not our intention to “cry wolf”. What is for certain, FedEE will be monitoring its course over the next year. If we see hopeful signs we will highlight them, although sometimes surprising things appear, even though the landscape is otherwise barren, reminding us how things were or could have been. Like a majestic pedestal in the middle of a desert as “boundless and bare the lone and level sands stretch far away”.
Copyright: FedEEConsult Ltd 2019 v2.3.
The FedEE Economic Research Unit, Adam House, 7-10 Adam Street, the Strand, London WC2N6AA, UK. Telephone: London, UK (HQ): (+44) (0) 203 608 4412, Australia: (+61) 1800 – 874 940 (Freephone), Boston, USA: (+1) 857 – 30 22256, Sapporo, Japan: (+81) 112 – 066814, Beijing, China: (+86) 108 – 7833218 Nicosia, Cyprus: (+357) 222 – 56381. Press: email@example.com.
This information is provided for general guidance purposes only. Neither the Federation of International Employers, nor FedEE Corporate Services Limited, nor FedEEConsult Ltd takes any responsibility whatsoever for any actions or decisions taken on the basis of this report. Please consult your individual professional advisors before addressing any of the issues covered.