Government shutdown in the United States and recovery in Chinese growth in 2017

Macro Highlights - 1/25/2018

In short
  • Government shutdown in the United States and recovery in Chinese growth in 2017
  • Focus euro zone: A continuing lack of investment

Key takeaways of the week from Lisa Turk - Economist, the United States, François Léonet – Economist, Emerging countries, Matthias van den Heuvel - Economist
  • In the United States, the partial shutdown of federal public services illustrated growing division in the Senate. However, an agreement could be reached in the coming days
  • China closed out 2017 with an acceleration in annual real growth to 6.9%, a first since 2010
  • Beijing should continue its efforts to manage the country's debt and financial risks in 2018, as stated in the China Banking Regulatory Commission’s recent announcements

United states - is an agreement on the government shutdown in the cards in the coming days? 

  • In the United States, Senators were unable to reach agreement on the funding of the federal government. The 60 votes required to pass a budget were not reached. The government shutdown, which led to the stoppage of non-essential federal public services, began on Friday evening and continued Monday morning. The main point of disagreement concerns "Dreamers" whose right to residency the government is challenging. We anticipate that an agreement will be reached in the coming days. The president does not want the current division in the Senate to continue growing. Of the 18 shutdowns since 1977, nine lasted less than nine days. In 2013, the partial paralysis of the government lasted 16 days, but the macroeconomic impact was negligible.

China - growth recovery in 2017, strengthening of financial supervision in 2018    

2017 saw the Chinese economy's annual real growth accelerate for the first time since 2010. It was 6.9% in 2017 compared to 6.7% in 2016. The real growth of the secondary sector - which includes industry and construction - fell from 6.3% in 2016 to 6.1% in 2017, while the services sector grew by 8.0% compared to 7.7% in 2016. This is in line with the gradual transition of the Chinese economic model towards more services.

In the last quarter of 2017, annual real growth remained unchanged compared to the previous quarter, at 6.8%. The renewed growth in fixed-asset investment increased from 5.8% to 6.4% over the quarter. This was primarily the result of continuing strong investment in manufacturing despite the implementation of more severe anti-pollution standards in the industrial areas of Northern China which slowed industrial production. Investment in real estate fell from 7.3% to 4.1% over the quarter continuing a moderating trend resulting from the slowdown in mortgage loans and the application by certain cities of restrictive measures intended to control rising housing prices. Investment in infrastructure also slowed, from 14.6% to 12.7%, according to our calculations, as a result of Beijing's more restrictive approach to financing rules for projects initiated by local governments. Despite a drop in December, retail sales growth remained resilient over the quarter moving from 10.3% to 9.9%. The slowing real estate cycle had an impact on the decline given that it contributed to lower spending on furnishings and domestic appliance purchases, among other things.

The end of 2017 was marked by a less dynamic credit market. Growth in bank credit retreated from 13.3% in November to 12.7% in December while the newly-created aggregate financing - which includes certain sources of informal credit - fell by CNY 1,600 billion to CNY 1,140 billion over the period. While seasonal factors, notably banks reaching their annual credit quotas, accounted for the deceleration in bank credit, the slowdown seen in informal credit should persist as a result of increased supervision and a hardening of regulations. The China Banking Regulatory Commission has been particularly active since the beginning of the year. It announced measures intended to restrict certain informal credit practices, to strengthen the management of risks associated with interbank transactions and to increase banking supervision. The objective of these measures is to promote traditional bank intermediation activities intended for the real economy. The pursuit of a targeted debt reduction policy by the Chinese authorities could induce a moderate slowdown in the country's growth in 2018.

The National People's Congress, scheduled for early March, should include the announcement of the country's economic objectives for 2018. 

Lisa Turk - Economist, the United States
François Léonet – Economist, Emerging countries

Focus euro zone : A continuing lack of investment

  • While investment in the private sector should continue its dynamic growth over the coming quarters…
  • …the catch-up phenomena sustaining it would gradually run out of steam as the deficit in investment is made up
  • At the same time, the better health of public finances and the European Commission's investment plans should ensure that public investment grows again
  • The issue of investment quality remains, however, and is reducing the competitiveness of European companies and weighing on potential growth

Investment fell significantly in the euro zone during the crisis - it decreased by 18% between its high point in 2008 and its low point in 2013. The decline was particularly evident on the countries of Southern Europe. Spain and Portugal suffered a decrease in investment of nearly 40% over the period, while in Greece, investment fell by over 60%. Total investment began to pick up again in 2013 and has grown by 13% since; however, it remains nearly 5% below its pre-crisis level. GDP has also since returned to its pre-2015 level. As a result, the investment ratio, i.e. the share of investment in GDP, decreased in the euro zone from 23% in 2008 to 20.5% today, weighing on potential economic growth.

Investment fell by 18% during the crisis, both in the private sector and in the public sector. Company investment was hampered by a significant decline in confidence and growth prospects. Household investment, virtually all residential, suffered from the collapse of real estate markets, particularly in countries which experienced a housing bubble before the crisis. In Spain, in particular, the drop of nearly 40% in property values led to a decline in residential investment of over 55% between 2008 and 2013. Lastly, the implementation of austerity measures to clean up public finances resulted in a drop in public investment. While real public spending in Portugal and Spain decreased by about 5%, public investment collapsed and is still 60% below its pre-crisis level today.

This lack of investment is putting a damper on growth potential in the euro zone. The drop in the number of machines, vehicles and research and development per employee directly affects the productivity of European workers. Between 2000 and 2007, hourly productivity increased by 1.3% on average each year, compared to 0.7% between 2014 and 2017. In addition, weak public and private investment led to the deterioration of infrastructure in the euro zone compared to that of other developed countries. This phenomenon isn't limited to Southern European countries. In 2007, Germany was the second-leading country in terms of infrastructure in the world, but was only in twelfth position in 2017 according to the World Economic Forum (WEF).

However, starting in 2013, stabilising GDP growth and the ECB's determination, illustrated by Mario Draghi's "whatever it takes" statement in July 2012, led to a rebound in private investment in the euro zone. Boosted by very favourable financing conditions and increased confidence and growth prospects, corporate and household investment began to grow again. The recovery was led primarily by France and Germany, as well as Spain, a country in which the lack of investment was particularly stark. These three countries account for 60% of the euro zone's GDP and have contributed nearly 70% of all growth in investment since 2013. For its part, public investment continued to decline until 2016, but began to grow again in 2017, according to the European Commission. It benefits from the implementation of the EU's 2014-2020 investment programme and the Investment Plan for Europe (the "Juncker Plan"). The latter should be particularly beneficial for the countries of Southern Europe which saw their private and public investment collapse. Portugal, Greece and Spain are among the five European Union countries to receive the most investment compared to GDP while France and Italy will receive the most financing in absolute terms.

Nevertheless, investment continues to be problematic for potential growth. Public investment only restarted in 2017, and is still 20% below its pre-crisis level. The decline is particularly damaging because this type of investment is often intended for public infrastructure which stimulates the entire economic fabric and, therefore, potential growth. For its part private investment, while dynamic over the past few years, is experiencing a quality issue. To illustrate, we look at the share of investment in information and communication technology (ICT). This type of investment is particularly productive because it enables new technologies to integrate the production chain. However, it is relatively weak in the euro zone. Only one euro zone country, the Netherlands, is among the six OECD countries which invest the most in ICT compared to their GDP. The poor quality of investment in the euro zone is also apparent in company access to new technology. This access is becoming increasingly more difficult than for the companies of other developed countries, according to the WEF's Global Competitiveness Report Survey. Therefore, even though investment is growing in quantity, worker productivity will continue to be hobbled unless quality improves.

Implications

  • Investment has been recovering since 2013 and should continue its robust growth during the coming quarters and soon return to its pre-crisis level. However, longer-term growth will probably be less sustained. The dynamic pace of the last quarters has been made possible by a catch-up phenomenon in economies which had lost ground in investment and it should gradually run out of steam. Household investment will also likely lose strength with the coming moderation in the growth of property prices.
  • Investment is also suffering from a quality issue. Access to new technology is more difficult for euro zone companies than for those of other developed economies. In addition, the quality of infrastructure is deteriorating, further weighing on potential productivity growth.
  • The European Commission is aware of the problem, as demonstrated by its Investment Plan for Europe and its 2014-2020 investment programme. However, a greater community effort and more public investment will be required to enable potential growth - which was 1.2% in 2016 - to return to the 2% level which prevailed between 1999 and 2007.

Matthias van den Heuvel - Economist