21/5/15: Global M&A and Economic Fundamentals

Here are some select slides from my presentation at this week's Alltech's Rebelation conference in Lexington, KY.

21/5/2105: The Darker Side of Transparency?

World Bank paper published earlier this month and titled "The Dark Side of Disclosure: Evidence of Government Expropriation from Worldwide Firms" raises some very interesting questions about the relationship between corporate transparency and government incentives.

The paper by Liu, Tingting and Ullah, Barkat and Wei, Zuobao and Xu, Lixin Colin (May 4, 2015, World Bank Policy Research Working Paper No. 7254: http://ssrn.com/abstract=2602586)  looks at "the effects of voluntary accounting information disclosure through auditing on firm access to finance, exposure to corruption, and sales growth." The authors use data for more than 70,000 firms in 121 countries.

The authors find that "…disclosure can be a double-edged sword" with overall effect depending on institutional capital present in a specific country.

"On the one hand, audited firms exhibit a slightly lower level of financial constraints than unaudited firms." This is in line with traditional theory whereby voluntary transparency increases information quality about the firm, but also signals self-selection of better-governed and better-performing firms to the markets.

"On the other hand, audited firms face a significantly higher level of corruption obstacles." Which is really surprising, until you understand the underlying logic.

"The net effects of voluntary information disclosure on firm growth are negative, which can largely be explained by the fact that most of the countries in the sample are developing countries where institutions are weak. The beneficial effect of disclosure increases as a country's property rights protection improves. The qualitative results are robust to considerations of the endogeneity of auditing and to alternative measures of corruption and financial constraints. The findings reveal the dark side of voluntary information disclosure: exposing firms to government expropriation where institutions are weak."

In other words, in more institutionally-advanced economies, voluntary disclosure is a positive factor for the firms, even she we control for self-selection bias. But in countries where institutional capital is weak, the effect is the opposite: in presence of corrupt and accountable governments, disclosing corporate information to the markets can trigger greater effort by the government to expropriate from the reporting firm.

There are serious ramifications for policy and development economics from this study. Traditionally, we tend to push more transparency and more disclosure for the firms operating in institutionally-weak emerging markets. In doing so, we may be aiding the predatory governments who, thus, gain greater ability to corruptly capture firm assets and/or profits over and above legally required taxation. This, in turn, strengthens the corrupt state institutions and government, instead of pushing them toward adopting more rule of law-styled reforms.

Beyond this, the study results suggest that at least in some setting, less transparency and greater ability for the corporates to operate within private information markets can actually be a good thing.

What is interesting is that in public domain, very little attention is paid to this issue. The results of this study, however, are broadly supportive of Acemoglu and Johnson ("Unbundling Institutions", Journal of Political Economy 113(5), 949–92005, 2005) work on the overwhelming importance of constraining government expropriation in facilitating economic development, ex ante other reforms.

On the other hand, transparency is value-additive in the advanced economies setting, where institutions are sufficiently high quality to preempt (or at the very least, diffuse significantly) the emergence of actionable incentives for state expropriation and information-led corruption.

20/5/15: Effects of commuting times on couples’ labour supply

"You’ve come a long way, baby. Effects of commuting times on couples’ labour supply" by Francesca Carta and Marta De Philippis, (Banca d'Italia, number 1003 - March 2015: http://ssrn.com/abstract=2600874) [comments within quotes are mine]"…explores the effects of husbands' commuting time on their wives' labour market participation and on family time allocation. We develop a unitary family model of labour supply, which includes commuting times and household production. In a pure leisure model [model where there is a binary choice: work or leisure; as opposed to work, leisure or work at home] longer commuting time for husbands increases their wives' labour market participation and reduces their own working hours. However, a model that includes household production might determine the exact opposite result."

So far so good for the theory: the paper shows that when the non-principal earner is faced with a choice of either enjoying leisure only or working only, absent household production, the second earner will opt, on average, for work and the principal earner will take less effort in their own work. However, once household production is an option or a requirement (as in the case of, say, a family with children or other dependents), then the secondary earner will more likely opt for staying out of the workforce and devoting their effort to increased household production, while the primary earner will apply more effort in their own work.

That's in theory. But empirical application is a bit less straight forward:  "We then examine the sign of these effects by using data from the German Socio-Economic Panel from 1997 to 2010. Employer-induced changes in home to work distances allow us to deal with endogeneity of commuting times. We find that a 1% increase in a husband's commuting distance reduces his wife's probability of participating in the labour force by 1.7 percentage points, 2% over the mean. Moreover, it increases his working hours by 0.2 hours per week. The average effect masks substantial heterogeneity: lower participation rates are concentrated in couples with children and where the husband has higher levels of education."

17/5/15: ‘High’ Achievers? Cannabis and Academic Performance

For the libertarians around, sorry - one deflationary piece of research… "‘High’ Achievers? Cannabis Access and Academic Performance (CESifo Working Paper No. 5: http://www.iza.org/en/webcontent/publications/papers/viewAbstract?dp_id=8900) looks at "…how legal cannabis access affects student performance."

To deal with a  bunch of pesky econometric issues, the study looks at data generated by "…an exceptional policy introduced in the city of Maastricht which discriminated legal access based on individuals’ nationality." So the authors used a difference-in-difference approach on a panel data set of over 54,000 course grades of local students enrolled at Maastricht University before and during the partial cannabis prohibition.

"We find that the academic performance of students who are no longer legally permitted to buy cannabis increases substantially. Grade improvements are driven by younger students, and the effects are stronger for women and low performers. In line with how THC consumption affects cognitive functioning, we find that performance gains are larger for courses that require more numerical / mathematical skills. We investigate the underlying channels using students’ course evaluations and present suggestive evidence that performance gains are driven by improved understanding of material rather than changes in students’ study effort."

Guess that explains why he wasn't any good in Topology either...

17/5/15: Forbes Opinion Piece on Ukrainian Crisis

An interesting, unorthodox - for Western media - perspective on the Ukrainian crisis and Russian longer term problem: http://www.forbes.com/sites/dougbandow/2015/05/11/ukraine-fight-flares-again-u-s-should-keep-arms-and-troops-at-home/


Note: as usual, my reposting of the material does not qualify as an endorsement of the views presented.

17/5/2015: BlackRock Institute Survey: N. America & W. Europe, April

BlackRock Investment Institute released the latest Economic Cycle Survey results for North America and Western Europe:

"This month’s North America and Western Europe Economic Cycle Survey presented a positive outlook on global growth, with a net of 48% of 56 economists expecting the world economy will get stronger over the next year, compared to 52% from previous report. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy. At the 12 month horizon, the positive theme continued with the consensus expecting all economies spanned by the survey to strengthen or stay the same except Canada and Denmark."

Country results 6 months forward compared to current conditions assessment:

Note: (0,0) Corner point denotes Austria, Denmark, Norway, Spain, Sweden and the Netherlands

Country results 12 months forward:

"Eurozone is described to be in an expansionary phase of the cycle and expected to remain so over the next 2 quarters. Within the bloc, most respondents described Finland, Greece and Italy to be in a recessionary state, with the even split between contraction or recession for Portugal. Over the next 6 months, the consensus shifts toward expansion for Italy. Over the Atlantic, the consensus view is firmly that North America as a whole is in mid-cycle expansion and is to remain so over the next 6 months except Canada where the consensus is split between mid-cycle or late-cycle states."

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

17/5/15: Ukraine's GDP down 17.6% in 1Q

Some pretty bad numbers out of Ukraine this week. 

Remember that 1Q 2015 Russian GDP shrunk 1.9% y/y in real terms and the forecasts for 2015 full year decline range between 3% (official forecast) to north of 7% (some Western banks analysts), with the consensus at around 3.8-4.0%.

Now, Ukraine's economy is in the IMF programme and the Fund latest forecast for 2015 full year growth was -5.548%. That is the base on which the so-called debt sustainability analysis is based. Even the World Bank - which forecast -7.5% real GDP decline for 2015 - was contrarian to the IMF optimism.

However, this week official data shows real GDP decline of 17.6% in 1Q 2015 y/y and down 6.5% on 4Q 2014. Exports to the EU are down 1/3rd, exports to Russia down 61% and industrial output is down more than 20%. With inflation at around 60% y/y in April, retail sales are down 31% at the end of 1Q 2015 y/y. 

Good news is - it is likely that 2H 2015 will see some improvement in Ukrainian growth dynamics, just as the same is likely in Russia. But I fear that we are going to see a much sharper contraction for the full year overall, compared to the IMF forecasts. If that turns out to be the case, Ukraine can require restructuring of its IMF 'assistance' package, although much of that risk also hinges on the progress on haircuts negotiations with the private sector creditors. These negotiations have not been progressing too well, so far, but there may be a turnaround in the works. 

In short, Ukraine's 'debt sustainability' charade the IMF has put up is now firmly in crosshairs of two risks - the haircut slippage and economy collapse. And both risks are rising, not falling so far…

17/5/15: Public Debt, Private Debt… Someone Thinks There Might Be Consequences

Remember last year vigorous debate about whether debt (in particular real economic debt - as I call it, or non-financial debt - as officialdom calls it) matters when it comes to growth? Well, the debate hasn't die out… at least not yet. And some heavy hitters are getting into the fight. Òscar Jordà, Moritz HP. Schularick and Alan M. Taylor paper, "Sovereigns versus Banks: Credit, Crises and Consequences", Working Paper No. 3: http://ssrn.com/abstract=2585696

Ok, so some key preliminaries: "Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies." The problem is that the two 'narratives' "…may interact in important and understudied ways", most notably via debt and debt overhangs.

The authors examine "the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt."

Time for Krugmanites to pop some champagne? Err, not too fast: "However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression."

Wait, what? A state indebted to the point of losing its shirt (or rather default on pay awards to trade unionised workers and retirees) imposes cost on private sector that can be detrimental during private sector own deleveraging? Yeah, you betcha. It is called power of taxation. Just as during the current crisis the Governments world wide gave no damn as to whether you and I can pay kids schools fees, health insurance and mortgages, so it was thus before.

"We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870:

1. in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; 
2. the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and 
3. the path of recovery is worse still when a credit-fuelled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now."

Now, take a more in-depth tour of the changes in fiscal and private non-financial debt across 17 advanced economies since 1870s:

Oh, yeah… 1950s and 1960s public deleveraging was done by leveraging up the real economy. And it didn't stop there. It got much much worse… instead of deleveraging one side of the economy, both public and private sides continued to binge on debt. Through the present crisis.

So "what does the long-run historical evidence say about the prevalence and effects of private and public debt booms and overhangs? Do high levels of public debt affect business cycle dynamics, as the public debt overhang literature argues? Are the effects of either variety of debt overhang more pronounced after financial crisis recessions?"

So here are the results:

So the results provide "…a first look at over 100 years of the inter-relationships of private credit and sovereign debt. We end with five main conclusions":

1. "…while public debt has grown in most countries in recent decades, the extraordinary growth of private sector debt (bank loans) is chiefly responsible for the strong increase of total liabilities in Western economies. About two thirds of the increase in total economy debt originated in the private sector. ...Sovereign and bank debts have generally been inversely correlated over the long run, but have increased jointly since the 1970s. In modern times, the Bretton-Woods period stands out as the only period of sustained public debt reduction, both in expansions and recessions."
2. "…in advanced economies financial stability risks originate primarily in the private sector rather than in the public sector. To understand the driving forces of financial crises one has to study private borrowing and its problems. In the very long run, if we run a horse race between the impact of changes or run-ups in private credit (bank loans) and sovereign debt as a predictor of financial crisis and its associated distress, private credit is the more significant predictor; sovereign debt adds little predictive information. This fits with the events of 2008 well: with the exception of fiscal malfeasance in Greece most other advanced countries did not have obvious public debt problems ex ante. Of course, ex post, the fierce financial crisis recession would wreak havoc on public finances via crashing revenues and rising cyclical expenditures."
3. "…with a broader and longer sample we confirm that private debt overhangs are a regular feature of the modern business cycle. We find that once a country does enter a recession, whether it is an ordinary type or a financial-crisis type of recession, if it carries the legacy of a large private credit boom then the post-recession output path of the economy is typically adversely affected with slower growth."
4. "…our new data also allow us to see the distinct contribution of public debt overhangs. We find evidence that high levels of public debt matter for the path of economies out of recessions, confirming the results of Reinhart et al. (2012). But the negative effects of high public debt on the performance of the economy arise specifically after financial crises and in particular when private borrowing also ran high. While high levels of public debt make little difference in normal times, entering a financial crisis recession with an elevated level of public debt exacerbates the effects of private sector deleveraging and typically leads to a prolonged period of sub-par economic performance." In other words, not too fast on that champagne, Krugmanites… 
5. "…from a macroeconomic policy standpoint these findings could inform ongoing efforts to devise better guides to monetary, fiscal, and financial policies going forward…" blah… blah… blah… we can stop here.

Funny how no one can get the right idea, though - the reason public debt matters is because the state always has a first call on all resources. As the result, the state faces a choice at any point of deleveraging cycle:

• (A) leverage up the State to allow deleveraging of the real economy; or
• (B) tax there real economy to deleverage the State.

In the US, the choice has been (A) in 2008-2014. In Europe, it has been (B). The thing is: both Europe and US are soon going to face another set of fine choices:

• (Y) reduce profligacy in the long run to deleverage the State; or
• (Z) get the feeding trough of pork barrel politics rocking again.

No prizes for guessing which one they both will make… after all, they did so from 1970s on, and there are elections to win and seats to occupy...

17/5/15: Two Asias and the U.S. European Incentives

If you want to see the context to the ongoing geopolitical re-distribution of power that is threatening the world order, do not look at the margins of the European realm, like Ukraine. Look at Asia.

Here is an excellent discourse that supports the thesis of the emergence of two Asia:

• Asia dominated (already) economically by China; and
• Asia dominated (for now) military-wise and geopolitically by the U.S.

Read the full text here: http://belfercenter.ksg.harvard.edu/files/Summary%20Report%20US-China%2021.pdf and a summary here: http://www.businessinsider.com/major-change-in-world-order-china-us-economy-2015-5.

Europe has already decoupled with the U.S. on the issue of Chinese-led Asian Infrastructure Investment Bank, while BRICS have decoupled from the U.S. on a vast range of initiatives. But European signals of willingness to engage with the new Asia are going to continue being half-hearted, principally because of the second bullet point above - economic cooperation will not resolve the growing tension on geopolitical stage. Sooner or later, the U.S. dominance in Asia Pacific will be weakened to the point of the Western block playing a second (albeit not insignificant, by any means) role.

There are two levers for retaining direct and active links to the Asia Pacific centre of power that are currently available to Europe: India and Russia. Alas, both are lost to Europeans for now, one for the reason of perpetual neglect and the other for the reason of perpetual antagonisation.

Oh, and one last piece of 'food for thought' breakfast: as the U.S. is being squeezed in Asia Pacific, is it more or less likely that the U.S. will need to amplify cohesion of its allies around the Atlantic? And if you think the answer to this question is 'more likely' (as I do), what other means can the U.S. find to doing so other than by playing centuries old angsts across EU's Eastern borders? 

17/5/15: Irish Merchandise Trade: 1Q 2015

Irish trade in goods statistics - the ones responsible for the tax-induced economic dizziness in the National Accounts over 2014 - are back at posting more absurd numbers.

Take a look at data through March 2015:

• 1Q 2015 imports of goods stood at EUR14,819 million which represents an increase of 10.5% y/y and 18.6% cumulative rise over the last two years. Relative to 2000-2007 period average, Irish imports of goods are up 3.8%. These are pretty large numbers, even allowing for currency valuations. 
• 1Q 2015 exports of goods from Ireland stood at EUR24,957.6 million, which represents an increase of 17.4% y/y. Yep, apparently Irish exports outputs are growing at a rate that implies doubling of the entire export capacity every 4 years, plus a month or so. No, seriously, folks - at this rate of building manufacturing facilities and logistics parks to accommodate all this stupendous growth, there won't be any cranes and construction crews left in the entire UK and probably none in France either. All would have been busy adding new land to Ireland.
• Now, we can compute % change in exports per 1% change in imports as the latter are often inputs into production of the former. Even recognising that imports of goods are also growing on foot of improving domestic demand, current exports elasticity with respect to imports is the third largest - lagging behind only two out the last 25 years: 1992 and 2004. What happened back in 1992? Ah, yes, new FDI in ICT manufacturing sector pushed Irish exports by 16% y/y in one year off a low base. It took couple of years thereafter for imports to catch up with this tremendous 'value creation' by stuffing computers and software disks into boxes. And in 2004? Well, that arrived on foot of abysmal 2003, when exports sunk and trade surplus went into largest y/y decline on record. So here we have it: the miracle of Irish exports growth: more of 1992 (tax arbitrage) and less 2004 (post collapse bounce).

Now, take a look at some dizzying numbers for March:

As the above shows, March marked the third highest value of goods exports for any month on record. Year on year, imports of goods were up 14.21% in March after posting 12.08% growth in February. Meanwhile, exports of goods rose 20.85% y/y in March after posting 16.92% growth in February. Trade balance rose 32.61% y/y in March having grown 24.21% in February.

Put frankly, even Google's big data analysts would struggle connecting these numbers to any tangible reality.

Chart below shows shorter range for dynamics.

16/5/15: Russian Trade in Goods: 1Q 2015

Per BOFIT latest data, exports of Russian gas were down 10% y/y in 2014 with total of 175bn cubic meters (bcm) of gas exported. exports to Ukraine were down 44% to 15bcm, to Europe and Turkey down 9% to 126bcm. Russian LNG exports stood at around 14bcm in 2014, virtually unchanged on 2013.

Meanwhile, the latest figures for external trade, covering 1Q 2015 show exports of goods down 28% y/y (predominantly due to price effects - ruble devaluation and lower prices charged). Volume of exports actually rose across several categories, including crude oil (+13% y/y in volume), petroleum products (+24% y/y in volume), as well as exports of copper, fertilisers and grain. Share of oil and gas in overall exports remained largely unchanged at around 2/3rds.

Biggest volume of exports went to the EU, as usual, although value of exports shipped to the EU fell by roughly 1/3rd. Overall, EU received about 1.2 of Russian goods exports with APEC taking 20%.

On imports side, the opposite holds: APEC became the largest supplier of goods to the Russian market as imports from the EU dropped 44% y/y in 1Q 2015 more sharply than the overall imports decline of 37% y/y. Imports from China fell by 1/3rd, but China remained the largest single supplier to the Russian markets with 20% share of overall Russian imports of goods.

Ireland's bilateral trade in goods with Russia also suffered in 1Q 2015. Per latest CSO data, released this week, Irish merchandise exports to Russia totalled EUR78mln in 1Q 2015 against EUR157mln in 1Q 2014 - a 50% drop y/y. Irish merchandise imports from Russia totalled EUR52mln over the 1Q 2015, down only 1.6% y/y. As the result, trade balance (merchandise trade only) has deteriorated significantly: in 1Q 2015, Irish trade surplus vis-a-vis Russia stood at EUR104mln, this has now declined to EUR26mln (a drop of 75% y/y).

It is worth noting that in 2008-2009, Irish merchandise exports to Russia declined 30% y/y over 1Q-4Q period.

15/5/15: Irish Construction PMI: April Stronger PMI, but Overall Activity is Weak

Irish Construction Sector PMI for April was released by Markit earlier this week. Here are the main points:

Overall Activity Index in Irish construction rose to 57.2 in April from 52.9 in March, bringing index back to the levels of January 2015. Current 3mo average is at 54.0 against 3mo average through January 2015 at 61.2, showing a clear slowdown in activity growth over most recent three months.

All three components of the index posted increases in April, with Civil engineering Activity index reaching above 50 marker (to read 51.0) for the first time since January 2015.

It is worth noting that Construction Sector PMIs have been pretty much out of touch with actual construction sector activity. Current readings on PMIs side signal blistering growth in activity and this is sustained, on average from the start of Q2 2013. Yet, Irish construction sector remains the second worst performing sector in the EU since the start of the crisis:

You can see the disconnection between PMIs (these are quarterly averages) and Construction sector actual performance setting in post Q2 2013 here: