Saturday, October 17, 2009

Economics 17/10/2009: WalMart/IKEA Effect, Bull Markets in Stocks

Scroll for IKEA Effect discussion and Retail Sales Data below...

A superb note on the current markets from Robert Lenzner on the links between the Bull run we are experiencing and economic fundamentals is available from Forbes (here). To sum it up: that which can't go on usually doesn't.

What are the implications for Ireland?
  • Our exports are likely to suffer significant downward pressure in years to come - a combination of Obama Administration Healthcare Reform (driving down long-term returns to pharma sector and re-orienting US purchasing to more centralized and, more likely, heavily domestic-industry oriented purchasing will undermine majour pharma players - the dominant force in Irish exports) plus cyclical effects of patents expiration (Pfizer - Ireland's largest singular exporter - is facing tough times in coming up with new blockbusters as its existent ones are running out of patent protection) will act to depress future exports growth in the pharma and bio-phrama sector.
  • Our indigenous exports will remain uncompetitive for years to come as a combination of strong euro (especially if the ECB continues to move toward 'exit strategies' and higher interest rates) and the legacy of the crisis (high debt levels and severe maturity mismatch in Irish sectors) will continue to weigh on future growth.
  • Our domestic consumption will remain in doldrums for years to come under combined weight of higher taxation and stronger euro, with a resultant shift to imported substitutes (see IKEA effect below).
  • Our trading and investment block - the EEC - will remain anaemic growth partner.
  • Our internal investment will stay flat at low levels as a combination of higher investment costs (banks raising margins and engaging in wholesale capital destruction by re-drawing terms and conditions of existent loans to companies and households post-Nama) and precautionary savings (our households and corporates holding excessive cash reserves with demand-style access covenants on these holdings) will imply low returns to domestic investment, high cost of such investment all in the environment of subdued growth.
Can you see Bank of Ireland or AIB shares trading at Euro4.00-5.00 range with these prospects? I don't...


Ikea Effect: I wrote before on many occasions about the WalMart effect: give consumers better value for money (through more efficient purchasing, logistics, distribution, marketing and retailing) and they will vote for you in tens of thousands. Now we have a small glimpse at it in the form of IKEA.

Here it is - in this week's CSO data on retail sales: August retail sales down a massive 1.0% overall, after six months of shallow increases. Worse than that - core retail sales (ex-motors) down 1.8% on July breaking three months improvements pattern. Food sales were down 2.8% despite decent weather and more families staying at home instead of leaving for a vacation. But, Furniture & Lighting was up 26% - thanks to IKEA.

Few charts to illustrate trends.
So broader trends are dire. But look at what's happening in Furniture Sector (IKEA Effect):
Self-explanatory.

Now, per CSO CPI data: Furniture and Furnishings, plus Carpets & Floor Covering account for 1.0812% of total Household Expenditure in 2006, Household Textiles - for additional 0.2424%, Glassware, tableware & household utensils 0.2577%, so roughly 1.6% of household spending goes to items sold by IKEA. Per CSO data, 2008 personal consumption expenditure in Ireland was €93,863bn, so roughly speaking €1,500mln of this went to goods of the types sold by IKEA. If IKEA offers average savings on Irish-domestics in the sector of some 25-40% (and my own experience suggests it is actually greater than that, but let us be conservative), the savings potential due to IKEA Effect add up to some €375-600mln or some €133 per every person in this country.

Now, IKEA has been trying to get a store into Ireland since at least 2000, which implies that an average Irish household has lost up to €4,000 in savings that could have been achieved were the IKEA (or WalMart) effect present in this economy. All due to the corporatist and politicised nature of our planning and retail regulations. Some price to pay!

Of course, these savings would have been even greater as:
  • IKEA (WalMart) effect could have had spillover effects to other sectors of Irish economy were our policymakers not engaged in actively restricting competition in retail sector;
  • IKEA (WalMart) effect would have coincided with heavier purchasing of durable goods during the boom years of 2003-2007, thus offering greater level savings on more expensive items.
But let us not count 'small change' - after all, preserving a 'small town' character of retailing (with convenience shops littering every corner of our towns and gas-station shopping outside of Dublin instead of proper multiples retailing) is worth €4,000 per family. Isn't it?

A quick note on the WalMart effect in broader terms. Ireland is aiming to get its R&D spending (public and private) contribution up to 3% of GDP or in 2009 terms - roughly €5.1bn per annum. Now, assuming WalMart-type retail efficiencies can deliver a 10-15% savings on our retail spending, the gains from the WalMart effect will mean an addition to our GDP to the tune of €9-14bn per annum. Of these, some 30% will be accruing to the Exchequer in form of various taxes, so the second order increase in GDP will be €2.7-4.2bn. Total increase in GDP will, therefore exceed €11-18bn or 6.5-10.5% of GDP. (These are back of the envelope calculations, but you can see where it is going)...
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