December 2022

Accuracy Talks Straight #6 – Economic point of view

Hervé Goulletquer
Senior Economic Advisor, Accuracy

The twin green and digital transitions: resolve for investment and perspicacity for macroeconomic management

The world economy is facing numerous challenges. In the short term, we have an unusual rhythm in prices and a deterioration of growth prospects, taking place in complicated political environments internally in many countries and in a worrying environment internationally (actions of Russia in Ukraine, China around Taiwan and Iran with its Arab neighbours). In the long term, ageing populations are of concern in a number of regions around the globe, economic ‘regulation’ seems to be moving away from the neoliberal corpus towards a more Keynesian approach and the twin green and digital transitions are under way.

Let us pause on this last point. The green transition is essential. It is essential for the preservation of the planet and of all the species that live on it. We must ‘decarbonise’ industry and transport, succeed in the energy renovation of buildings and develop renewable energy on a large scale. The digital transition is also indispensable. It represents the continued process of enabling companies, administrations and households to incorporate new technologies (for example, the cloud, the internet of things or artificial intelligence) in many aspects of their activities. It is worth bearing in mind that the necessary transformations are not purely technological issues; there is a very significant human aspect, with cultural and behavioural adaptations to be made.

The amount of investment in play is impressive. For the eurozone alone, considering an annual envelope of €500 billion a year, for multiple years (certainly no less than 10), does not seem unreasonable. At least that is the order of magnitude determined when summarising some authoritative work on the subject. That represents more than four points of GDP!

The sums committed are so vast that questioning their macroeconomic implications would not be a futile exercise. Let us propose a simple forecast to 2032. The starting point is this resolve for investment linked to the twin transitions: the €500 billion a year, which, when changing from current currency to constant currency (the currency used when measuring the economic growth – that of GDP), becomes €440 billion. The other elements of demand, including investment spending outside of the twin transitions, remain on the same trajectory as observed over the past few years with one exception: extra investment is reflected by more imports and therefore by a reduction in external trade surplus. For this exercise, we assume that there will be no shock from prices or economic policy over the period.

THE TABLE ABOVE HIGHLIGHTS THE MAIN IMPLICATIONS TO CONSIDER.

THREE ARE PARTICULARLY NOTEWORTHY:

GDP growth would reach 1.5% a year. Though this forecast exercise appears reasonable, we must admit that potential for growth is estimated at 1% a year. Of course, we could consider that the additional investment effort will contribute to more growth. But we could also defend the idea that, at least in part, this new accumulation of capital would replace the destruction of fixed assets that have become obsolete.

We must not forget demographic developments either, which send a rather negative message about the active population (effect to be offset perhaps by a return to a situation with close to full employment).

In any case, one suspicion remains: is the quantification based on these assumptions too optimistic?

The share of household consumption in GDP would fall by 2.5 points over the period to reach 49.5%. The current level is already not particularly high: 52% against an average of 55% between 1995 and 2010 (and a high of 59% in 1980), a period that was therefore followed by a gradual decline. With the change in macroeconomic ‘regulation’ that we are starting to see, one that emphasises more inclusive growth, is this really credible?

If the investment / GDP ratio must progress by almost 4.5 points by 2032, then savings must follow; this is how macroeconomic balances work! Where could this come from? In part from lower savings in Europe heading towards the rest of the world. We have spoken about a fall in external trade after all…

For the remainder, it will be necessary to choose between greater efforts by households to save, an increase in corporate profits and/or a decrease in the public deficit.

NONE OF THESE OPTIONS IS SELF-EVIDENT.

The first brings us back to the question of a reduction of household consumption in GDP; we just saw it.

The second suggests a further distortion of wealth created in favour of business. But that might go against current sentiment (new ‘regulation’, including the development of ESG – environment, social and governance – criteria)…

The third seems reasonable, of course, but making the choice between bringing current spending down and increasing tax income is no easy task (public investment would most likely be protected).

If this scenario is not quite unacceptable, but still seems a bit ‘messed up’, then we need to try to imagine what would be reasonable to expect under the two constraints of succeeding in the twin transitions and not deluding ourselves on future economic growth.

In fact, the adjustment can only be made in two areas: either (i) on savings placed in the rest of the world (the counterpart of the external trade balance), with the possibility that flows would invert and that the eurozone would need to ‘import’ foreign savings, or (ii) on a slowdown in consumption spending (whether household or government).

The first solution would weaken Europe on the international stage.

In terms of macroeconomics, Europe would appear less solid, which would reinforce the impression already given by the microeconomy (lower profitability of companies in the Old World compared with those in the New World and smaller presence in the sectors of tomorrow) and by po li t ics (unreso lved issues of integration and its geopolitical role). The resulting financial balances will be more uncertain, whether in terms of interest rates or exchange rates; it would be impossible to think otherwise.

The second idea, which is obviously akin to frugality, seems difficult to put in place in a more Keynesian environment that is stamped by an ambition to share wealth more in favour of households. That is, of course, unless public authorities find the winning formula to incentivise households to save more.

We understand it; the ambition to drive investment, for innumerable sound reasons, has destabilising macroeconomic effects. We must anticipate them and prepare ourselves; after all, prevention is better than cure…

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