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Thursday, January 31, 2008

Estonia Retail Sales and Industrial Output December 2007

Growth in Estonian retail sales and industrial production weakened in December, offering the latest signs that the economy is now cooling significantly and rapidly.

According to Statistics Estonia, in December 2007 retail sales for retail trade enterprises amounted to 5.4 billion kroons, which is 630 million kroons up on December 2006, in money but not real terms (inflation remember). Retail sales growth eased to an annual rate of 4 percent, the slowest since at least 2001, and industrial output declined 2.1 percent on an annual basis, the first contraction in more than five years, the Tallinin-based statistics office said today.

Retail sales slowed from a 6 percent growth rate in November, mostly as a result of consumers having less available to spend due to the ongoing increase in food prices, the statistics office said. Retail sales grew 14 percent on average in 2007, it added.

Consumer confidence fell in January to its lowest level in almost three years on worsening expectations for public and personal finances. The number of property transactions also fell in the fourth quarter to the lowest level in almost three years, as interest rates keep rising and banks have restricted lending terms.

Industrial Output

According to preliminary data from Statistics Estonia, industrial production in 2007 increased by 6% compared to 2006. Rapid growth in energy production and mining were the main factors producing growth in total industrial output. Growth in the manufacturing component first slowed and then turned negative towards the end of the year.

In December 2007, Estonia's seasonally adjusted industrial production fell 7.3 % compared with November. As compared with the month of December 2006, total industrial production fell 2%, and in manufacturing 5.7%.

This contraction in industrial output, adjusted for working days, followed a revised 4.5 percent expansion in November, the statistics office said. Manufacturing, which is the main contributor to gross domestic product growth at this point, shrank by 5.7 percent, the weakest showing since May 1999, led by a contraction in furniture, wood and construction materials' output. This is not good news for Q4 GDP, and when coupled with the steady downward movement in year on year retail sales begin to raise serious questions about what Q1 2008 GDP may actually look like.

Industrial output growth was hampered last year by rising costs as companies faced increasing labor shortages, unemployment was at a 16-year low and domestic demand started to cool after a three-year growth spurt.

Looking at the retail sales and industrial output charts, all I would say is that if this is marking the line of a "soft landing", then I would hate to see what a hard one looked like. Really, perhaps the most preoccupying part about all this looking through the comments you see in the press is just how little idea most of the professionally paid analysts have of what is actually going on here.

Domestic demand is going the same way as Hungary, and short of a major adjustment in relative prices (which means basically a big downward revision in currency values) exports will obviously not be able to drive growth. In other words if the currency value problem is not - for one reason or another - not addressed then you are going to see some of the most severe wage deflation in any developed country in recent times to put exports back onto a cometitive footing. Which means very weak domestic demand over a period of years while everything corrects, meaning very low GDP growth numbers, and these, remember are the key years before post 2012 the ageing population problem really starts to lock-in. It is the lack of urgency and shoulder shrugging you find almost everywhere that continues to preoccupy. Clearly most people are well out of their depth with all this, but does anyone really realise that the whole future of Estonia as a nation is now in play?


Jüri Saar said...

"Looking at the retail sales and industrial output charts, all I would say is that if this is marking the line of a "soft landing", then I would hate to see what a hard one looked like."

I'm tempted to point out that the situation might not be as gloomy as you make it out to be, if you look at a period longer than a year - say 10 years or even 5 years.

I'm an Estonian and manage a business incubator, where I've got my hand on the pulse of SME's is various different sectors - about 30 companies in all - and there's no panic or desperation in the air. Most realize that tougher time are coming and adjustments need to be made but nothing drastic.

It's also important to remember that what might seem like problematic structural rearrangements in EU 15 are for most Estonians quite natural - the adjustments necessary for changing from central planning to a market based system were difficult and we managed so far. I consider the coming wave of structural adjustments just the continuation of a process started more than a decade ago where-by Estonia is simply climbing the value-chain ladder.

You also wrote: "In other words if the currency value problem is not - for one reason or another - not addressed then you are going to see some of the most severe wage deflation in any developed country in recent times to put exports back onto a competitive footing."

I'm curious as to what you think should be done? Devaluing the currency is a short term solution that would wipe out any credibility our currency has. It's also quite likely to lead to different problems down the road. Proping up existing firms that are struggling with high labour costs and whose business model is built on cheap labour seems like a bad idea, especially if you taken into account the demographic realities faceing Estonia.

Currently there are labour market reforms in the works through (controversial) new employment legislation that would make the hiring and firing of workers easier. The main arguments for these reforms have been (1) better fit of people and jobs with resulting higher productivity and (2) encourage entrepreneurs to experiment with new business models and ways of organizing.

So yes, GDP growth will probably never be as spectacular as it was, but we're still integrating our businesses and economy into a larger European whole that will provide new opportunities.

Edward Hugh said...

Hello Juri,

And thanks for the reasoned and interesting comments.

I think what I would say is that there may well be a difference of perspectives here according to whether you look at things from a micro or macro economic perspective.

From a micro perspective there are always interesting business opportunities in a country, whatever the general economic outlook. This is what entrepreneurship is all about. To give you an example, my own father returned to the United Kingdom in 1933 - the worst year of the great depression - after having spent 10 years in the United States. What did he do? He started a small business in the motor industry, and not only that, he was reasonably successful. In fact most of the light industry sectors did comparatively well in the UK during the 1930s, despite the fact that heavy industry and agriculture had a hell of a time.

So even if the macro environment in the Baltic countries may well be very negative in the immediate future, you can still find very interesting and profitable business opportunities.

But I am a macro economist, and what I know something about are economic systems.

My point in this post is simply to say that I see no sign in the charts I am looking at that this slow down is heading for a soft landing. I think most of the people who sound off on this topic have no idea what they are talking about. The slope of the lines would need to be much softer to convince me that you were entering this dynamic.

GDP growth is going to turn negative at some point, and then there is going to be a battle of the wills about what to do next.

One paramater I am looking at which most other macro analysts are not is the ageing and declining population component. This is what makes me rather pessimistic. You need to look at what is happening in Hungary. I have been following this, and have a blog on it here. On the issue of currency devaluation, Ihave had an exchange in comments on this post which will save me repeating myself. I know all of this is going to be a very difficult situation, and I don't say any of this lightly, but I really do see no other way, not only for you, but also for Latvia, Lithuania, Bulgaria, and then for Romania and Hungary, which although they don't have formal pegs have their currency effectively tied to very high levels with the euro due to the exitence of a high level of non local currency debt in morgages and personal loans.

The issue as far as I can see is that it is virtaully impossible to sustain very high levels of catch up GDP growth in Eastern Europe without provoking a lot of inflation due to labour supply issues which are a by-product of low fertility and out migration. This problem even extends as far as Ukraine and Russia.

"I'm curious as to what you think should be done?"

Well basically there is now no easy solution here. We have a spin of from the US sub prime crisis due to the extension of the practice of issuing covered bonds rather than using bank deposits to fund mortgages to many East European countries, with the complicating element that the currency risk was all assumed by the borrowers. Many of these bonds have been given AAA rating by the credit agencies on the basis of the fact that the housing stock value and the ability to pay were thought to be virtually guaranteed by the ECB. This situation is not sustainable and the ECB cannot honour this obligation.

So there is going to have to be a substantial "haircut" for the owners of these bonds, since if the currencies fall you can't simply land all the young people with the responsibility to pay them over years to come.

So we are going to need quite a high level initiative on all this at some point, involving the EU Commission, the ECB and the IMF. At the moment people at the ECB are trying to wash there hand of the problem - Jurgen Stark, Lorenzo Binni Smaghi - by talking about an "unfortunate boom-bust tendency". They need to look themselves in the mirror and take responsibility for opening up these dynamics by accepting that euro membership would be obligatory - and not an option - for the new EU 10 countries, since this was a virtual guarantee of debt, a form of moral hazard and an open invitation to people to get in debt. As Oscar Wilde put it, losing one child could be an accident, but losing two (or more) has to be negligence. I think they can't simply pass the buck on the problem to the new member states. If you want to lead then you lead from the front. And if mistakes have been made, then you own up to them.

The thing is that after all this is over, of course there will be post-mortems. But unfortunately we have to go through the painful part first. Humans seem to be more or less like this, we seem to need situations to become almost unbearable before we react.

Perhaps you think what I am saying is rather extreme. But just look at how the US is pulling together, from Bernanke to Bush to the House Democrats to do something to solve the sub-Prime issue, and then tell me what is being done to resolve the obvious problems which are growing by the day in the East of Europe. I am completely frustrated. The first step to a solution passes through a recognition of what is happening. At the moment everyone is simply trying to hide.

"So yes, GDP growth will probably never be as spectacular as it was, but we're still integrating our businesses and economy into a larger European whole that will provide new opportunities."

Well, I don't disagree. My list of positive countries in the EU10 would start with the Czech Republic and then go to Estonia, but you need to take into account the ageing society component which will probably hit the Baltics much sooner than Western European societies due to the lower male life expectancy. Italy, Japan and Germany already need to live from exports, since now domestic demand growth is more or less a "limp dinghus". This is where we are going in Hungary, and this is what I expect to be the shape of things after the correction in the Baltics - don't even ask me about Bulgaria or Romania. But what this means is that you need to get relative prices right now, since if you don't you won't be able to get the export growth you need to pay the pensions and the health system as dmeand for these grows. You need to look at what happended to Germany following the correction of 1995/96 (which was a soft landing, but still important). Germany had to live for the best part of a decade with an overvalued currency, and this wasn't easy, ask people in Germany. Sorry if these comments have been a bit difuse, but thanks again for the comments, and best wishes to you and your country. I don't know whether you have picked this up, but I live in Catalonia, and everyone here is interested in all things Estonian these days, since they sympathise greatly with your situation as a small nation.