It has been a data-rich end of January. Last week we got fourth-quarter US and German growth numbers, with more countries reporting output statistics this week. On Tuesday, the IMF updated its economic forecasts, and the US reported quarterly employment cost data. Yesterday, the eurozone published the latest inflation rates.
The overall narrative taken from the IMF update goes roughly like this: growth will be worse this year before getting better again in advanced economies (in emerging and poor countries growth hit its low point in 2022 and is slowly accelerating). But 2023 won’t be as bad as we had feared. In return, growth will improve less in 2024 than previously thought. Among rich countries, the US will pick up speed sooner than Europe, where a sharp slowdown is predicted this year (and an outright contraction in the UK). Inflation is coming down, though somewhat slowly.
Some other new statistics would seem to support the same reading. The US recorded a solid 2.9 per cent annualised growth rate in the fourth quarter; Germany suffered a contraction of 0.2 per cent, or 0.8 on an annualised basis.
But there are many things that worry me that the shared narrative ignores. The US GDP number is not such good news when you look under the bonnet. Big contributions to the fourth-quarter growth rate came from companies building up inventories fast (that is to say, not selling all their output) and shrinking imports. Those are not the characteristics of a booming domestic economy.
And the IMF does not highlight anywhere near enough just how badly the past year has thrown advanced economies off course. The chart below, from the blog of its chief economist Pierre-Olivier Gourinchas, illustrates how the fund’s output forecast for 2024 changed from the eve of the pandemic to January 2022, and how the same forecast changed from January 2022 to today.
A year ago, advanced economies were — miraculously — set to achieve greater production by 2024 than if the pandemic had not occurred. This is what some of us insisted we should celebrate as a triumph of crisis policy. Only a year later, they are set to fall significantly behind the pre-pandemic trend, and that is after the fund’s upgrade since its October forecasts.
What is behind this deterioration? There are two obvious candidates. One is Russian president Vladimir Putin’s weaponisation of energy (and other commodity) prices. The other is the decision by central banks to reduce their economies’ rate of output and jobs growth. In other words, is the roughly 3 per cent shortfall one of supply or demand? It is no doubt a bit of both — but an important indication of which prevails is surely a question of how inflation is developing — rising inflation if the growth slowdown is driven by supply and falling if by demand.
My colleague Martin Wolf’s column on the IMF forecasts points out the fund’s judgment that “underlying (core) inflation has not yet peaked in most economies and remains well above pre-pandemic levels”. But for the most significant economies, this is just not true. In the US, price growth for non-food and energy personal consumption expenditures peaked last February. In the eurozone, the consumer price level excluding food and energy is falling, and is now at its lowest since September (the same is true for the overall price level).
US labour cost growth fell for the third quarter running, coming in at a quarterly increase of 1 per cent (or 4 per cent annualised) at the end of 2022. That is approaching the range consistent with 2 per cent inflation, especially if the strong labour market has led to job reallocation that will, in time, boost productivity. All this suggests to me that if our economies weaken in the coming year, that is the work of our own central banks more than Putin’s machinations.
In defiance of — or rather by passing over — such observations, the IMF holds on to the monetary dominance it pushed at its annual meetings last October. It says “the priority remains achieving sustained disinflation . . . Raising real policy rates and keeping them above their neutral levels until underlying inflation is clearly declining.” Wiser advice would be to stop tightening as soon as there is good reason to think inflation will abate by itself. As Free Lunch readers know, I have argued this for a long time (and I note some hawks are beginning to do so who, until very recently, chided central banks for not tightening more). For now, central banks seem to be following the fund’s advice, so I can only hope that it is right and I am wrong.
There are tax credits and then there are tax credits
I got a lot of reader reaction to my column this week on why the EU should welcome a green subsidy race. Many of those readers also wanted to correct me on one point: my warning that tax credits “only help companies in a position to pay tax, which favours established players over newcomers”. One of the blessings of writing for the FT is to have highly informed and intelligent readers, who in the case at hand have read the Inflation Reduction Act better than me.
So I am happy to stand corrected and relay that the IRA has an option for “direct payment”, which I understand as a refundable tax credit you can pocket even if you don’t owe any tax. This is mostly for non-profits and tax-exempt entities, but seems to be available to for-profit corporations for some of the green industrial activities that the act promotes.
In addition, the IRA allows for a (one-off) sale or transfer of unused tax credits. And many readers have also pointed out to me that the US has a market for “tax equity”, in which financial investors in a position to pay tax join forces with companies keen to invest in the targeted green industrial projects. With the right corporate structures, the tax credit can then be applied to the investor’s tax liability rather than be “lost”.
I would note that tax equity removes some of the simplicity and automaticity that is so appealing about tax credits, and the financial engineering obviously comes at some cost which means less than 100 per cent of the value of the credits can be realised in practice. And since the EU has nothing like the US’s federal taxes, such a practice can’t be as useful in Europe as in the US. My comment on tax credits referred as much to EU policy challenges as to US practice, but clearly, anything that works in the latter should be considered by the former. Making tax credits refundable, at least, seems essential — and plans in the works at the European Commission (which my eminent Brussels colleagues have sleuthed out) seem to go in that direction.
There are taxes and then there are taxes
I got a lot of reader emails about my newsletter on Norway’s exodus of billionaires, too. Not so much from the aggrieved billionaires themselves, but from people who thought I had missed out other important tax motivations for the migration of the very wealthy to Switzerland.
On top of the tax changes I mentioned in the piece, Norway’s centre-left government has increased the tax rate on dividends (which hurts in particular the extremely few business owners who have no liquid money and must take cash out of their companies to service their newly higher net wealth tax). The maximum effective marginal dividend tax rate (including corporation tax on distributed profits) has gone up to 51.5 per cent for this year from 46.7 per cent in 2021. Note that this is still below the 55.8 maximum effective rate for salaried income (including employer payroll tax).
And, “worst” of all, a loophole that could eliminate capital gains tax by spending five years abroad was removed late last year — a move that had been tabled in parliament months earlier. It worked like this: capital income is largely only taxed when realised by an individual in Norway, so you can postpone taxation as long as you keep investments inside a corporate wrapper. Move to a country that does not tax capital gains, largely the case for Switzerland, and you can enjoy your gains, with any deferred tax liability to Norway expiring after five years of Alpine residence.
But not anymore. If this was the main motivation for the exodus of the super-rich, it should presumably now dry up. Free Lunch will try to keep half an eye on the world’s least important migration crisis and report back.
Other readables
In the New Statesman, Anoosh Chakelian writes about the loss of public spaces around Britain — “‘places to meet’ are the top thing people in 225 ‘left behind’ neighbourhoods . . . say they lack”.
Sarah O’Connor notes that the young who graduated into the pandemic lockdowns have fared much better in the job market than we might have feared — at least, I would add, while governments were supporting a strong recovery.
The European Commission is consulting on how to redesign its electricity market. Two Twitter threads by Georg Zachmann and Conall Heussaff, both from Bruegel, summarise (and criticise) the consultation document and link to relevant proposals and analyses.
Numbers news
A new study of the UK benefits system, for the Deaton Review of Inequalities, shows that while it may have succeeded in bringing more people into work, it traps its beneficiaries in part-time low-wage work, effectively promoting poor “mini-jobs” with little prospect for career progression.
Source: Economy - ft.com
