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Five steps for closing the transatlantic productivity gap

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American companies embraced new information technologies 20 years ago, while Europeans are still hesitating. Bruno Maçães sets out a digital catch-up strategy.

The productivity gap between the United States and Europe has been widening steadily for 20 years. Labour productivity growth in the U.S. has accelerated from an annual 1.2% during 1973-1995 to 2.3% for 1995-2006. In the European Union, it declined from 2.4% to 1.5% during the latter period. Even if the two regions’ business cycles are not completely synchronised, the benefits they’ve derived from the Information and Communication Technologies (ICT) revolution clearly diverge.

Europe’s productivity slowdown is due to the later emergence and smaller size of IT investment in EU economies compared to the United States. In the U.S., productivity has grown faster than in the EU because of a larger share there of employment in the ICT producing sector, and faster productivity growth in services industries that make intensive use of ICT.

Post-World War II Europe had a relatively well-educated population and strong institutions, that favoured the rapid transfer and use of mainly U.S.-made new technologies. But since the mid-1990s, the patterns of productivity growth between Europe and the U.S. have changed dramatically. Labour market reforms meant that Europe’s labour input growth led to a decline in relative capital intensity. In the U.S. there was strong growth in industries producing information and communications technology equipment and a capital-deepening effect from investing in information and communications technology. In other words, for Europe the advent of the knowledge economy has been much slower.

EU governments should therefore use their array of policy levers, including tax, regulation, and procurement policies, to encourage greater ICT innovation

Since the onset of the financial and economic crisis in Europe, there has been widespread agreement that reforms are needed to boost the EU economy. GDP growth in the eurozone is stuck below 1%, unemployment above 11% and inflation is still falling, and at 0.3% in November 2014 was far from the European Central Bank’s 2% target. It is now dangerously near outright deflation. From a monetary standpoint, the ECB has been called to do its part by getting inflation back on track, but it cannot do everything on its own.

The importance of completing the Single Market for services and of reforming labour markets and social policies has been long emphasised by economists. But now we are being forced to seriously consider the possibility that growth will ultimately depend on encouraging the more widespread use of new technologies. Faster productivity growth will not only allow the EU to support a growing number of retired people without imposing higher taxes on those in work, but will also help maintain Europe’s global competitiveness.

Along with the EU’s productivity slowdown, there have also been low levels of investment. The EU is facing an investment gap that will hamper short-term recovery and long-term growth. The traditional catch-up and convergence model of the 1950s and 1960s has proved unsuccessful under some very different conditions, so it now appears that ICT’s increased adoption could become the key driver of productivity growth and an overall improvement in living standards.

Over the last decade, and with the encouragement of the European Commission, significant progress has been made by national governments with initiatives for improving productivity and competitiveness through ICT. The EU’s Digital Agenda is an example of how policy makers have tried to tackle the issue, but more work still needs to be done if suitable conditions for ICT investment are to be created.

First, EU governments must place productivity improvements at the core of their economic policies. There can be no negative relationship between higher productivity and job growth. The misguided argument that the more efficiently we work, the less work there is for workers to do must be abandoned. It is a view that fails to identify critical second order effects in which the savings from increased productivity are recycled back into the economy to create more demand that in turn creates more jobs. To improve living standards, EU governments must stop creating or maintaining inefficiencies through their neglect of ICT investment, and must instead engage in clear EU productivity enhancement policies.

Second, the EU should deepen the scope of its investments beyond ICT capital. Intangible capital may in many ways prove more important as it covers a broad spectrum of factors that include labour force skills, ICT training and institutional knowledge passed on across company divisions. Creating a skilled workforce and a school curriculum that has been designed in partnership with the ICT industry would help create the right environment for ICT investment.

Third, European institutions can actively support the digital transformation of industries through their own procurement of ICT products. The EU could purchase ICT goods and services in the early stages of development, and arrange with their suppliers training for officials to spur cooperation with the private sector. By doing so, the EU would address network externalities that exist in many sectors. The argument that ICT’s benefits will lead to externalities seems borne out by the concept of network effects and the notion that the larger the network the more valuable it becomes to individual users. EU governments should therefore use their array of policy levers, including tax, regulation, and procurement policies, to encourage greater ICT innovation and transformation.

Fourth, tax and trade policies can promote ICT by minimising the tax wedge on it. ICT investment by governments reduces costs and encourages the productivity effect. Trade policies can promote ICT adoption by providing expanded information and technology trade agreements, facilitating market access and increasing technological complementarities and knowledge spillovers.

Creating a skilled workforce and a school curriculum that has been designed in partnership with the ICT industry would help create the right environment for ICT investment

Fifth, European businesses would be better able to benefit from ICT if they could achieve larger economies of scale. Business leaders have called for a more flexible approach to labour, product, and capital markets as that could unlock growth and innovation. Reforms might include tackling obstacles to private investment, the bringing down of energy costs, lower taxes on labour and capital and a degree of harmonisation of corporate tax rules while making labour markets more flexible.

Deepening the European Single Market is crucial if resources are to flow to their most productive use and stimulate improvements in technology. Harmonising data protection laws across the EU would increase legal certainty for companies looking to invest in European markets, particularly in cross-border services. Removing administrative barriers to ICT service providers when they enter EU markets would help to simplify market entry, reduce investors’ costs and the inefficiencies that impede investment.

The investment plan announced by the incoming European Commission late last year could do much to drive this strategy, provided the projects selected exploit innovation for greater multifactor productivity growth. The projected Transatlantic Trade and Investment Partnership (TTIP) would expand market access for EU companies and will increase their return on investment on more ICT projects. Europe’s future economic competitiveness hinges on its ability to embrace the digital economy much more quickly. Now it is up to governments to set the right conditions. If they promote a political agenda for market reform, investment will follow.

 

This article first appeared in the Spring 2015 issue of Europe’s World. Reposted per author’s permission.

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Economy

Evergrande Crisis and the Global Economy

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China’s crackdown on the tech giants was not much of a surprise. Sure, the communist regime allowed the colossus entities like Alibaba Group to innovate and prosper for years. Yet, the government control over the markets was never concealed. In fact, China’s active intervention in the forex market to deliberately devalue Yuan was frequently contested around the world. Ironically, now the world awaits government intervention as a global liquidity crisis seems impending. The Evergrande Group, China’s largest property developer, is on the brink of collapse. Mounding debt, unfinished properties, and subsequent public pressure eventually pushed the group to openly admit its financial turmoil last week. Subsequently, Evergrande’s shares plunged as much as 19% to more than 11-year lows. While many anticipate a thorough financial restructuring in the forthcoming months, the global debt markets face a broader financial contagion – as long as China deliberates on its plan of action.

The financial trouble of the conglomerate became apparent when President Xi Jinping stressed upon controlled corporate debt levels in his ongoing drive to reign China’s corporate behemoths. It is estimated that the Evergrande Group currently owes $305 billion in outstanding debt; payments on its offshore bonds due this week. With new channels of debt ceased throughout the Mainland, repayment seems doubtful despite reassurances from the company officials. The broader cause of worry, however, is the impact of a default; which seems highly likely under current circumstances.

The residential property market and the real estate market control roughly 20% and 30% of China’s nominal GDP respectively. A default could destabilize the already slowing Chinese economy. Yet that’s half the truth. In reality, the failure of a ‘too big to fail’ company could bleed into other sectors as well. And while China could let the company fail to set a precedent, the spillover could devastate the financial stability hard-earned after a strenuous battle against the pandemic. Recent data shows that with the outbreak of the delta variant, the demand pressure in China has significantly cooled down while the energy prices are through the roof. Coupled with the regulatory crackdown rapidly pervading uncertainty, a debt crisis could further push the economy into a recession: a detrimental end to China’s aspirations to attract global investors.

The real question, therefore, is not about China’s willingness to bail out the company. Too much is at stake. The primal question is regarding the modus operandi which could be adopted by China to upend instability.

Naturally, the influence of China’s woes parallels its effect on the global economy. A possible liquidity crisis and the opaque measures of the government combined are already affecting the global markets: particularly the United States. The Dow Jones Industrial Average (DJIA) posted a dismal end to Monday’s trading session: declining by more than 600 points. The 10-year Treasury yields slipped down 6.4 basis points to 1.297% as investors sought safety amid uncertainty. The concern is regarding China’s route to solve the issue and the timeline it would adopt. While the markets across Europe and Asia are optimistic about a partial settlement of debt payments, a take over from state-owned enterprises could further drive uncertainty; majorly regarding the pay schedule of western bondholders amid political hostility.

Economists believe that, while a financial crisis doesn’t seem like a plausible threat, a delayed response or a clumsy reaction could permeate volatility in the capital markets globally. Furthermore, a default or a takeover would almost certainly pull down China’s economy. While the US has already turned stringent over Chinese IPOs recently, a debt default could puncture the economic viability of a wide array of Chinese companies around the world. And thus, while the global banking system is not at an immediate threat of a Lehman catastrophe, Evergrande’s bankruptcy would, nonetheless, erode both the domestic and the global housing market. Moreover, it would further dent Chinese imports (and seriously damage regional exchequers), and would ultimately put a damper on global economic recovery from the pandemic.

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Economy Contradicts Democracy: Russian Markets Boom Amid Political Sabotage

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The political game plan laid by the Russian premier Vladimir Putin has proven effective for the past two decades. Apart from the systemic opposition, the core critics of the Kremlin are absent from the ballot. And while a competitive pretense is skilfully maintained, frontrunners like Alexei Navalny have either been incarcerated, exiled, or pushed against the metaphorical wall. All in all, United Russia is ahead in the parliamentary polls and almost certain to gain a veto-proof majority in State Duma – the Russian parliament. Surprisingly, however, the Russian economy seems unperturbed by the active political manipulation of the Kremlin. On the contrary, the Russian markets have already established their dominance in the developing world as Putin is all set to hold his reign indefinitely.

The Russian economy is forecasted to grow by 3.9% in 2021. The pandemic seems like a pained tale of history as the markets have strongly rebounded from the slump of 2020. The rising commodity prices – despite worrisome – have edged the productivity of the Russian raw material giants. The gains in ruble have gradually inched higher since January, while the current account surplus has grown by 3.9%. Clearly, the manufacturing mechanism of Moscow has turned more robust. Primarily because the industrial sector has felt little to no jitters of both domestic and international defiance. The aftermath of the arrest of Alexei Navalny wrapped up dramatically while the international community couldn’t muster any resistance beyond a handful of sanctions. The Putin regime managed to harness criticism and allegations while deftly sketching a blueprint to extend its dominance.

The ideal ‘No Uncertainty’ situation has worked wonders for the Russian Bourse and the bond market. The benchmark MOEX index (Moscow Exchange) has rallied by 23% in 2021 – the strongest performance in the emerging markets. Moreover, the fixed income premiums have dropped to record lows; Russian treasury bonds offering the best price-to-earning ratio in the emerging markets. The main reason behind such a bustling market response could be narrowed down to one factor: growing investor confidence.

According to Bloomberg’s data, the Russian Foreign Exchange reserves are at their record high of $621 billion. And while the government bonds’ returns hover at a mere 1.48%, the foreign ownership of treasury bonds has inflated above 20% for the second time this year. The investors are confident that a significant political shuffle is not on cards as Putin maintains a tight hold over Kremlin. Furthermore, investors do not perceive the United States as an active deterrent to Russia – at least in the near term. The notion was further exacerbated when the Biden administration unilaterally dropped sanctions from the Nord Stream 2 pipeline project. And while Europe and the US remain sympathetic with the Kremlin critics, large economies like Germany have clarified their economic position by striking lucrative deals amid political pressure. It is apparent that while Europe is conflicted after Brexit, even the US faces much more pressing issues in the guise of China and Afghanistan. Thus, no active international defiance has all but bolstered the Kremlin in its drive to gain foreign investments.

Another factor at work is the overly hawkish Russian Central Bank (RCB). To tame inflation – currency raging at an annual rate of 6.7% – the RCB hiked its policy rate to 6.75% from the all-time low of 4.25%. The RCB has raised its policy rate by a cumulative 250 basis points in four consecutive hikes since January which has all but attracted the investors to jump on the bandwagon. However, inflation is proving to be sturdy in the face of intermittent rate hikes. And while Russian productivity is enjoying a smooth run, failure of monetary policy tools could just as easily backfire.

While political dissent or international sanctions remain futile, inflation is the prime enemy which could detract the Russian economy. For years Russia has faced a sharp decline in living standards, and despite commendable fiscal management of the Kremlin, such a steep rise in prices is an omen of a financial crisis. Moreover, the unemployment rates have dropped to record low levels. However, the labor shortage is emerging as another facet that could plausibly ignite the wage-price spiral. Further exacerbating the threat of inflation are the $9.6 billion pre-election giveaways orchestrated by President Putin to garner more support for his United Russia party. Such a tremendous demand pressure could presumably neutralize the aggressive tightening of the monetary policy by the RCB. Thus, while President Putin sure is on a definitive path of immortality on the throne of the Kremlin, surging inflation could mark a return of uncertainty, chip away investors’ confidence: eventually putting a brake on the economic streak.

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Synchronicity in Economic Policy amid the Pandemic

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business-economy

Synchronicity is an ever present reality for those who have eyes to see.Carl Jung

The Covid pandemic has elicited a number of deficiencies in the current global governance framework, most notably its weaknesses in mustering a coordinated response to the global economic downturn. A global economy is not fully “global” if it is devoid of the capability to conduct coordinated and effective responses to a global economic crisis. What may be needed is a more flexible governance structure in the world economy that is capable of exhibiting greater synchronicity in economic policies across countries and regions. Such a governance structure should accord greater weight to regional integration arrangements and their development institutions at the level of key G20 decisions concerning international economic policy coordination.

The need for greater synchronicity in the global economy arises across several trajectories:

· Greater synchronicity in the anti-crisis response across countries and regions – according to the IMF it is a coordinated response that renders economic stimulus more efficacious in countering the global downturn

· Synchronicity in the withdrawal of stimulus across the largest economies – absent such coordination the timing of policy normalization could be postponed with negative implications for macroeconomic stability

· Greater synchronicity in opening borders, lifting lockdowns and other policy measures related to responding to the pandemic: such synchronicity provides more scope for cross-country and cross-regional value-added chains to boost production

· Greater synchronicity in ensuring a recovery in migration and the movement of people across borders.

Of course such greater synchronicity in economic policy should not undermine the autonomy of national economic policy – it is rather about the capability of national and regional economies to exhibit greater coordination during downturns rather than a progression towards a uniform pattern of economic policy across countries. Synchronicity is not only about policy coordination per se, but also about creating the infrastructure that facilitates such joint actions. This includes the conclusion of digital accords/agreements that raise significantly the potential for economic policy coordination. Another area is the development of physical infrastructure, most notably in the transportation sphere. Such measures serve to improve regional and inter-regional connectivity and provide a firmer foundation for regional economic integration.

The paradox in which the world economy finds itself is that even as the current crisis is leading to fragmentation and isolationism there is a greater need for more policy coordination and synchronicity to overcome the economic downturn. This need for synchronicity may well increase in the future given the widening array of global risks such as risks to cyber-security as well as energy security and climate change. There is also the risk of the depletion of reserves to counter the Covid crisis that has been accompanied by a rise in debt levels across developed and developing economies. Also, the speed of the propagation of crisis impulses (that effectively increases with technological advances and globalization) is not matched by the capability of economic policy coordination and efficiency of anti-crisis policies.

There may be several modes of advancing greater synchronicity across borders in international relations. One possible option is a major superpower using its clout in a largely unipolar setting to facilitate greater policy coordination. Another possibility is for such coordination to be supported by global international institutions such as the UN, the WTO, Bretton Woods institutions, etc. Other options include coordination across the multiplicity of all countries of the global economy as well as across regional integration arrangements and institutions.

Attaining greater synchronicity across countries will necessitate changes in the global governance framework, which currently is characterized by weak multilateral institutions at the top level and a fragmented framework of governance at the level of countries. What may be needed is a greater scope accorded to regional integration arrangements that may facilitate greater coordination of synchronicity at the regional level as well as across regions. The advantage of providing greater weight to the regional institutions in dealing with global economic downturns emanates from their greater efficiency in coordinating an anti-crisis response at the regional level via investment/infrastructure projects as well as macroeconomic policy coordination. Regional development institutions also have a comparative advantage in leveraging regional interdependencies to promote economic recovery.

In conclusion, the global economy has arguably become more fragmented as a result of the Covid pandemic. The multiplicity of country models of dealing with the pandemic, the “vaccine competition”, the breaking up of global value chains and their nationalization and regionalization all point in the direction of greater localization and self-sufficiency. At the same time there is a need from greater synchronicity across countries particularly in the context of the current pandemic crisis. Regional integration arrangements and institutions could serve to facilitate such coordination in economic policy within and across the major regions of the world economy.

From our partner RIAC

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