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25 November 2022

2% - not 2% and above

In our main story we discuss why markets are complacent about the ECB's interest rate policies; we also have stories on the next supply chain shock - China's winter lockdown; on the increasingly bitter dispute over gas price capping in the EU; on Franco-German industrial collaboration; on why foreign banks cannot succeed in Germany; and, below, on a gravity-defying economic policy.

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Today's free story

Erdogan, the Kurds and the economy

Turkey is testing the West with its military operations against the US-backed Kurds in Syria while its economic experiment at home is defying economic orthodoxy and market expectations. Both military and economic narratives are framed by Recep Tayyip Erdogan as battles, against Kurdish terrorists and for economic independence. Both are tools of Turkey’s foreign policy, to define a space somewhere between the US, the EU, China and Russia and to defend its position in the region.

Turkey’s latest military attack against the Kurds came after they blamed Syrian Kurds for the bomb attack in Istanbul. The drone strike on Sunday hit Kurdish headquarters in their region of Syria, only 130m away from where US troops are. Even if it is not the full-blown operation on the ground, the increased likelihood of further attacks raises serious concerns over Syria’s security situation for US troops, Kurds and ISIS prisoners. Clearly, the two Nato partners, the US and Turkey, are not on the same page here. We also do not know what it means for Sweden and Finland’s accession process as it is pending on the two Nordic countries cutting ties with Syrian Kurds.

In economic terms, the difference with the West is most visible in monetary policy. Western economies raise interest rates when inflation rates gets to 9%. The Turkish central bank lowered its interest rate for the third time since August to 9%, and this is despite an inflation rate of over 85% in CPI terms and 150% in producer prices. The Turkish Lira is at an all-time low, losing 50% of its value against the dollar compared to last year, but it has been stable over the past couple of months.

The dynamics of a devaluing currency combined with high-cost imports push up inflation while exports are soaring, the main reason behind high GDP growth rates of 5.7%. But despite those high growth rates, export revenues and tourism still do not bring in enough foreign currency to balance the current account. Friendly central banks from China, Qatar, South Korea, UAE and Azerbaijan have had to help with swap loans. Saudi Arabia opened up a $5bn credit line this week, according to the FAZ. Russia is said to have transferred a similar amount in the summer. Domestically, the government also scraped foreign exchange and gold from private individuals and companies with the promise that they would compensate them for the exchange rate loss. The currency risk is thus shifted to the state budget. According to Reuters, the central bank netted $100bn this way and was thus able to stabilise the Turkish lira over recent months.

Can this continue? Rating agencies, market observers and the IMF are warning that this is unsustainable. The Turkish government does not relent on its narrative and prefers to focus on the bright side of soaring exports and high numbers of tourists this year. Market observers expect things to turn sour next year, and for GDP growth to fall to 3.5%, but what if Erdogan keeps the show going with some of his creative tricks? For how long?

It seems unlikely that Erdogan will change his tune before the elections and the Turkish republic's centennial celebrations next year. He wants to demonstrate that the Turkish economy runs under his rules, not the ones dictated by the West or the markets. And he wants to win the elections. So his model has to last at least for another seven months.

His economic agenda clearly has foreign policy implications. Given their need for cash to stabilise the exchange rate, Turkey’s economic connection with Russia and China is likely to deepen further, creating new dependencies. Can Turkey continue to be relied upon as a neutral broker for peace? This depends on how far Erdogan wants to take his operation against the Kurds and how the economy will cope with these price shocks. A high-wire act that requires none of these big bets go wrong, be it militarily or economically.

24 November 2022

23 birthdays

This is the decade of the supply chain: complex global networks of the flow of goods between companies. Twitter is a network, of course. And so is the crypto blockchain. And global financial markets. Many of our biggest misjudgements this century relate to a generalised failure to understand network dynamics. 

The simplest example we can think of mistaken network maths is an old problem from probability theory - though most people don't think of it this way: on average, how many people do you need in a room for two to share the same birthday? The counter-intuitive result is that it takes only 23 people. The reason our brains get this wrong is that we cannot intuitively compute simultaneous probabilities. We are prone to the fallacy of composition, which is ultimately a failure to understand networks. The chance of our own birthday falling on a given day in the year is 1 in 365. So we extrapolate, mistakenly, that it takes some 180 people for any two to share the same birthday. The mistake we are making is massive. 

Supply chain dynamics shares some characteristics of the birthday problem. Your output may be my input. It might only take 23 individual disruptions to disrupt a large chain.

Pollsters misjudged network dynamics when non-voters turned up at the polling both in the US presidential elections in 2016 and in the Brexit referendum. The failure to predict the global financial crisis was a failure to grasp financial networks. A minor fiscal crisis in Greece ended up being a life-threatening financial crisis for the entire euro area because of network effects. EU member states all imposed synchronous austerity.

Macroeconomists, whose reasoning is often based on linear logic, are particularly prone to misjudgements when they leave their reservation. The other day, we heard a well-known economist gloating about the collapse of the FTX crypto exchange, and concluding that crypto itself would be doomed. That's your classic fallacy of composition - making a macro judgement based, in this case, on a single case. There was, without a doubt, a bubble in the crypto markets that has now largely deflated. But crypto itself is rock-solid. The bitcoin blockchain, for example, did not have a moment of disruption since its start in 2008. The same goes for the other big blockchain, Ethereum. 

A technical expert, meanwhile, was quoted in newspapers last weekend saying that twitter's demise was imminent because Elon Musk had fired essential staff. But there has not been a single moment of disruption. That judgement was not so much a fallacy of composition, but simple wishful thinking. The experts were not so much afraid that Twitter would fail, but afraid that it would survive. Without them.

Many fearful Twitter users turned to Mastodon, a decentralised, open-source, social network, with Twitter-like features, and projected all their hopes into it. We think Mastodon has its uses, for scientific communities for example.  But it cannot replace Twitter because of network effects.

Just consider this: Many Twitter users have often spent more than a decade building up a large following. If you leave and join another network, you are starting from scratch. We, too, set up an account at Mastodon, and were shocked to find that we had a single follower after one week.

All of these examples stem from only two sources: globalisation and the internet. Both have had a tremendous impact on our lives this century. Neither will go away. What they both have in common is that they are networks, something we humans are not well equipped to understand intuitively. 

23 November 2022

Normad visas to attract skilled workers

Remember the golden visas that cash-strapped EU countries like Greece, Malta, Cyprus, and Portugal issued to foreigners in return for investments or cash? Now we are seeing a new category of visas emerging, the so-called nomad visas. These are temporary residence and work permits. Their popularity surged with the pandemic and its lockdowns, which allowed people to work from home or wherever they are as long as they have a good internet connection.

Greece and other southern EU countries see this as a way to attract young people who seek a nice place to stay and work. They bring in taxes and are good for the economy. Sifted listed all EU countries that are offering these kinds of visas. Most of them have some conditions attached, for example a lower threshold of monthly or annual earnings either as employee of or consultant (free lancers or self-employed) working mostly for foreign companies. The targeted group is not fruit-pickers but high earners from IT, financial services or the gaming industry. Some countries require a certain level of education or years of experience. It is similar to a job application only that the job itself is not defined only the entry requirements. Some are open to EU workers only, while others attract people from all over the world.

Spain is one of the large countries that is now trying out this kind of temporary immigration for mobile workers. They have one last hurdle to clear in the senate before it becomes active in January next year. The visa is for one year, extendable to five. Applicants must have a degree or a postgraduate diploma from a reputable university or business school, or have more than three years’ working experience. There is also a requirement of at least a €2000 minimum salary per month according to media reports. This is the Jet-set version of migration.

22 November 2022

Migration policy and political pressure

Migration is one of the thorniest and most divisive issues in EU politics. While member states all agree that the Dublin pact is not working, they do not agree on how to reform asylum procedures and burden sharing. Migration has given rise to the far-right in various member states, thus increasing the political risks for governments. And migrant numbers are rising from Africa and from over the Balkans.

Kicking the can down the road can only work for so long. Migration will remain on the agenda, and people will continue to flee conflicts and economic hardship to reach the shores of Europe. Ramping up border controls, as happened in a recent deal between France and the UK will still have to address asylum issues. Migrant reception centres are packed in countries like Belgium and Austria, Politico reports, while the number of migrants arriving in the Central Mediterranean region have doubled compared to last year. Most of those people do not qualify automatically for asylum under international protection against the real risk of harm in their homeland.

Politically, the divisions showed up recently in the spat between France and Italy over who is responsible for taking in migrants rescued by an NGO ship. Italy refused to let the 234 migrants disembark at a. Italian port. France then allowed the Ocean Viking to dock at one of their ports, accusing Italy of neglecting their duties. As a counter-measure France suspended plans to take 3300 asylum seekers from Italy, worsening the row even further. There are clearly domestic considerations for both in this. Emmanuel Macron is using Giorgia Meloni to get at Marine Le Pen. And Meloni is using France to please the far-right voter base. The spat is thus symptomatic of the mess the European system is in.

An emergency meeting of EU interior ministers are to address the row between the two this Friday. Legally, there is a bit of a vacuum here. Under current provisions, Italy would have had to take in the migrants as they were the first port to call. But the Italian government argues that France is responsible for those migrants since the Ocean Viking, the NGO ship, was running under French flag. And it should be thus France to take in those migrants. Italy is not alone with this argument. Other Mediterranean countries like Greece, Cyprus and Malta also argue that flag state of these NGOs should indeed play a role.

The European Commission says there are actually no clear provisions under maritime law to advise what to do when migrants are rescued by privately owned ships. The meeting will also be used to encourage voluntary relocation according to a deal that member states signed up to in June. So far only 100 have relocated despite pledges by some to take in 8000. And the Commission is to recommend spending €600m to help African countries stem the flow of migrants heading towards Europe.

21 November 2022

IT layoffs and the Irish growth model

The IT sector is going through a wave of restructuring, laying off employees around the world. This restructuring could have some macro economic effects in Ireland, where the sector employs some 6% of total workforce and produced 18% of value added in the latest quarter, according to the Esri research institute.

Meta, formerly Facebook, started the downward spiral by laying off 11,000 jobs. Stripe, an online payments processor, cut 14% of its workforce. Twitter announced it will cut one in two jobs and Snapchat one in five. Two Irish companies, Wayflyer and Intercom, are also planning to reduce their workforce. And this is just the beginning. Amazon is to let go of 10,000 jobs, while Microsoft and Intel have revised their forecasts downward for next year.

Ireland’s growth miracle, which has also helped the country to recover so well after the financial crisis, relies on foreign investment. With its low corporate tax rate of 12.5% and access to the EU market, it was uniquely positioned for companies from abroad. It has proven to be attractive for young, educated people, especially in Silicon Docks, the tech quarter along Dublin's canal. The tech sector in Ireland attracts people from all over the world due to the career prospects, sociable lifestyle and English-language environment. Northern American companies are still the most present of all, representing 70% of all foreign investment. If one takes foreign companies and their local suppliers together, they employ 500,000 in a country of 5m. This is massive.

This growth strategy has also created dependencies. Tax revenues were boosted by tech companies during the pandemic. Corporate tax revenues represented €15bn, about 21% of all revenue in 2021 and even more this year. Half of that intake come from only 10 firms, including Apple, Microsoft, Intel, Meta and Pfizer. To counter the fallout from recessions, the government is about to pay into a rainy day fund, €6bn in total.

They are also counting on the fact that their economy is diversified enough to deal with the shock in the tech sector. Ireland has offered since 2011 via its Institute for Bioprocessing Research and Training a hub for science diploma, but also bio-tech apprenticeships. This education advantage, together with the low 12.5% corporate tax rate and access to the EU, continues to play an important role. These factors are now also attracting the Chinese. Huawei announced in October that they will open their first European data centre for Europe in Ireland. The Wuxi Biologics group is also building two factories in Ireland. How will this play out with the US government and the tech companies located there? Ireland is about to find out.

18 November 2022

France's offer to Australia

Remember Aukus? Australia's previous prime minister Scott Morrison abruptly tore up a contract with France to build a dozen diesel-powered submarines and announced after secretive talks with the US and the UK the Aukus deal to buy nuclear-powered submarines from them instead. This diplomatic incident that France perceived as a humiliation and an affront, has been a story of the past since Anthony Albanese took over as Australia’s new prime minister and his government settled the spat by paying €555m for a contract with the French submarine builder Naval group that was originally worth €33bn.

Since then, the situation has changed too for the Aukus partners. The US signalled that there could be long delays for the delivery of those nuclear submarines. This would leave Australia in a position of vulnerability and short of capacity just in a moment when China is about to increase its assertiveness in the Indo-Pacific.

It is not surprising that Emmanuel Macron now comes forward to assure that the French offer is still on the table. France won‘t supply nuclear submarines to foreign countries, so the offer relates only to conventional vessels. France has its own strategic interests in the Indo-Pacific, the only EU country with overseas territories there including New Caledonia and French Polynesia.

The Indo-Pacific is likely to become the theatre for confrontations between super powers if China is serious in its pursuit of Taiwan. More conflicts on the horizon. Amid these security risks and submarine delivery delays, Australia may have to reconsider the French offer. The return to a constructive relationship.

17 November 2022

Greek ports as geo-strategic assets

The ports of Alexandroupoli and Kavala in northern Greece will remain under state control, according to a surprise announcement by the Greek government. The government is calling off a tender for Alexandroupoli due to the geostrategic importance of the port and its facilities, and is also reconsidering its options in Kavala. Both ports are key in the next stage of conditions drawn up by Greece’s official creditors, writes Macropolis.

We remember back in the days when the troika were pressuring the Greek state to privatise and raise money as part of bailout programme requirements. The privatisation goals were never quite achieved, but ports and other infrastructure companies were privatised and companies from outside, like the Chinese container ship giant Cosco, got in with a strategic share in the port of Piraeus. The war in Ukraine and its ramifications on infrastructure in Europe changed the underlying logic of the mantra that privatisation is for the better. Suddenly, security and energy concerns trump economic considerations.

Kyriakos Mitsotakis ordered the tender revocation for strategic, geopolitical and energy considerations. Strategically, the port in the Aegean, close to the border with Turkey and Bulgaria, had been used in the past years by the US military. On the energy front, there have been plans for a floating storage and regasification terminal as the port is close to gas interconnectors for the Greece-Bulgaria and Trans-Anatolian pipeline. There were also concerns that the two remaining bidders in this final stage of the tender would not adhere to the terms and did not exclude resale. The privatisation fund HRADF is now writing up a new plan for a number of ports of strategic interest.

16 November 2022

Does Trump really have no chance?

In journalism, cognitive biases make for great stories. Sometimes, these stories become self-fulfilling if enough people believe in them. Narratives are what got the Tories to replace two leaders in close succession, in the belief that this would strengthen their chances of winning the next election.

The big story we hear from the US is that Donald Trump is on his way out. We are less sure than others that this prophecy will be a self-fulfilling one. 

In particular, you cannot infer from the fact that Trump-backed candidates for the Senate and governorships lost in the midterm election, that Trump himself will perform badly in two years. This falls under the category of biases known as fallacy of composition. Trump backed some truly lousy candidates in the midterms, like Hershel Walker in Georgia. But he himself is not a lousy candidate. The race is now on, after he declared his candidacy yesterday.

The rise and fall of Trump is a great story for the media. Everyone is telling it now. But be careful.

The salient facts of US political life are unchanged: the country is politically almost perfectly split. In both the 2016 and 2020 elections, Trump lost the popular vote, but narrowly prevailed in the first, and narrowly failed in the second election. This year's midterm elections have reaffirmed the same divisions. The Republicans are regaining the House of Representatives. The Democrats hang on to the Senate. Both have narrow majorities. Congress is as split as the US public, a perfect mirror image.

It is also not clear that Ron DeSantis, who won re-election as Florida governor, would necessarily thrive in a national election campaign. The fact that he scored well in Miami's inner cities is interesting. But his nationwide appeal has yet to be tested. 

Also, don't make too much of the fact that Rupert Murdoch's media empire has switched allegiances from Trump to DeSantis. They have a good track record of picking winners. But they, too, are professional storytellers, not sages. If Trump were to defeat DeSantis in the primaries, they will be the first to tell the story of Trump's comeback. They are not beholden to stories that are true, but to stories that sell. 

Have you considered another possibility: a Trump/DeSantis ticket?  Trump is in an unusual position of being a challenger with a one-term limit. Trump's vice president would be in an unusually strong position in 2028. We don't know what DeSantis thinks. But he will surely weigh those two options. As a VP, he remains in the game. He can only become president if the party is united behind him. How can that be if he defeats Trump in a bitter campaign? Those who cheer him on right now are not necessarily his friends. 

The other cognitive biases all of us have to watch out for are confirmation bias, or in the case of pollsters and academics, model bias. There is an almost perfect correlation between those who in the past predicted that Trump would lose and those who wanted him to lose. Remember the New York Times' 99% probability for a Hilary Clinton victory on the morning of the 2016 election? That is a newspaper that believes in its own fables. 

The same goes for us in Europe too. We are reducing our fears about the future of transatlantic relations to Trump personally. What Europe does not like to see is that the readiness of the US to pay for Europe's security is politically not sustainable under any administration. Joe Biden's inflation reduction act is unbelievably hostile to European interests, as is his semiconductor war with China. 

Be careful what we wish for, as the saying goes. And then be careful what you predict. 

15 November 2022

Rekindling Franco-UK relations

France opened one door for migrants when they allowed the Ocean Viking to dock at one of its ports in the south of France. At the same time the French government closes another one in the north by signing an accord with the UK to prevent boats from leaving its shores to reach the UK.

As part of the deal, the UK government will pay €72.2m for France to increase by 40% the number of security forces that patrol its northern beaches, and to use drones to detect, monitor and intercept boats. Also for the first time, a team of observers will be sent to both sides of the Channel.

The deal comes after the UK government announced that more than 40,000 migrants have crossed the Channel to Britain so far this year, a new record compared with the 28,000 last year.

The new agreement also reflects a new atmosphere in the bilateral relationship between the two countries under Rishi Sunak’s premiership, after years of acrimony under Boris Johnson and Liz Truss. Sunak has struck a different tone, calling France an ally. He has already met twice with Emmanuel Macron, at the sidelines of COP27 in Egypt and the G20 meeting in Bali. The two sides plan to hold a bilateral summit meeting focused on defence in early 2023.

A change in tone it is, but it is not a fundamental shift in migration policies since the Touquet treaty in 2003 that basically shifted the border for UK entry to French shores. The deal focusses on cracking down on criminal smuggling and preventing small boats from leaving the French coast. Rescue missions in the Channel to deal with small boat emergencies are entirely absent from the deal, according to Le Monde. There is also no mention of establishing a safe route. For example, the UK could be allowing asylum requests at their Uk consulates on British soil. Nor are there any provisions for unaccompanied minors or family reunions. The purpose of the deal is internal politics: Sunak gives a token to Tory MPs, who expect to be punished in the next elections for not securing the UK's borders after Brexit. A solution to deal with migration at the northern shores of France it is not.

14 November 2022

What now for Europe’s Atlanticists?

So far, the US mid-term elections have been mixed for Europe’s Atlanticists. There will be no Republican wave severely complicating cooperation between the US and its allies in Nato, though they are might still regain control over the House of Representatives. But they will, sooner or later, face a reckoning with their position, and along with it their hostility to European integration. 

Quite a few of the Atlanticists are actually, at least superficially, quite close to the Republicans in their new Trumpian incarnation. This is certainly true of at least some British conservatives, and Law and Justice in Poland. But it is even more the case for Giorgia Meloni, a recent convert to enthusiasm for the trans-Atlantic alliance and a darling of the US far-right. 

But the possibility of the Republicans assuming power again, if not this time then from 2024 or some point further in the future, is a real problem for them. While Trump himself might not lead the Republicans going forward, his politics have made a mark on the party. Meloni or Jaroslaw Kaczynski might have previously found their counterparts in the Republican Atlanticist establishment. Now, however, the party is more firmly isolationist, regardless of who leads it. Speeches at CPAC will not be worth very much if, or when, domestic politics begins to intrude. 

Their options are only somewhat better with the Democrats. Although they are more invested in foreign relationship-building in general than the Republicans, what both parties share in common is their waning enthusiasm for entanglements in Europe or the Middle East. We will start to see this dynamic develop more with Ukraine very soon. Joe Biden’s administration has been able to hide behind France and Germany on Ukraine for the past several months, but that will be harder for them to do. It will be a sign of things to come: that central and Eastern Europe is no longer the focal point of Eurasian geopolitics. 

That will have implications for the Atlanticists’ relations with the EU, and their attitudes towards European integration. This will be clearest in the UK, the most enthusiastic of the Atlanticists. One strand of the pro-Brexit camp argued that the UK should substitute its relationship with the EU for a closer one with the US, a special relationship that being part of the union was getting in the way of. So far, this has perhaps been the most clearly disappointing aspect of Brexit. The British government has now largely given up on the idea of a comprehensive trade agreement with the US. Whatever a post-Brexit British future looks like, it will not involve closer ties with the Americans. If future US governments decide that they are as unenthusiastic about Nato as they are about new trade deals, that puts the UK in a very difficult position. 

In the EU itself, Atlanticism often goes hand-in-hand with Euroscepticism, as is the case for both Fratelli d’Italia and Law and Justice. If you favour closer ties with the US, it makes a more geopolitical EU and strategic autonomy at best ITT relevant, and at worst dangerous. But in a world where the US is not inclined to spend time, money or effort on its European allies, they will need a different plan.