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European de-industrialization. The "silent Depardieu"

This article was published in “El Confidencial” on February 1st, 2013

“When you act like Europe, you get growth rates like Europe” Rick Santelli
“The European periphery will likely remain in recession for at least 10 years” IFO Institute

A few days ago I was invited to give a talk at the London Business School and a student asked me what was the biggest mistake of European politics. “The conscious decision to support expensive and inefficient sectors, instead of promoting a process of substitution through quality, price and competitiveness.” Why? Because “picking winners” is easier, public funds are treated as if they belonged to no one, demand estimates are always optimistic and cost does not matter to politicians… Meanwhile, even the most patient investor gives up and leaves.The silent Depardieu.

I admire Gerard Depardieu, an excellent actor. After years of contributing tens of millions in taxes, he decided to leave his country due to the unbearable tax system. It was his right. That is why I use the term “silent Depardieu” to illustrate the process of European de-industrialization  which is essential to understand the current economic environment and the loss of potential GDP.

The de-industrialization of Europe can not be attributed to liberal policies. In fact, if anything it is characterized by the implementation of giant “industrial policies”, Soviet-like plans of public spending on infrastructure, and government support to dinosaur-type national champions in “strategic” sectors. What our politicians call “growth plans.” Hundreds of billions … in debt.

The problem created by these plans is an enormous cost that citizens pay in taxes and excessive tariffs, and an “eviction effect” on companies, which need to close or leave to other countries because costs soar and the system penalizes start-ups. And now politicians ask for more of the same. Nothing like repeating a formula that has failed.

“Government’s view of the economy can be summed up in a few sentences: If it moves, tax it. If it keeps moving, Regulate it.And if it stops moving, subsidize it. ” Ronald Reagan

Blaming China or India, cursing globalization and promoting protectionism lead us to where we are. Stagnation and praying that next year “will be better.”

Governments have a role in the economic transformation of a country, of course. But their mission is not to  maintain low-productivity sectors at all costs. Governments’ job is to understand globalization and facilitate the transition to high productivity economic models, encourage innovation, not subsidize it, and promote high education.The problem is that politicians do not like it, because it does not give photo opportunities inaugurating bridges.

The current model of “intervention-subsidy-fail-debt-impoverishment-subsidy” leads Europe, and peripheral countries in particular, to compete only through internal devaluation . This is our great success. We can produce cheap cars for another. Wow.

When the economic model is the policy of the ostrich of burying one’s head and wait for 2005 to return, hoping that the world will recognize our acquired privileges -that we refuse to other countries, the outcome is only recession and devaluation. Impoverishment.

No, exports of low value-added products and the destruction of domestic demand are not economic successes. They are the result of maintaining GDP through excessive government expenditure, uneconomic investment and overtaking China in unnecessary infrastructure and ghost towns. China may be able to afford it. We don’t.

Producing low added-value products for others, focusing on construction and concessions, leads to seeking competitiveness through lower wages. It’s a patch, but it impoverishes. There will always be a country willing to produce the same good at a lower price. The point is that the production of such good must not only have an adequate cost, but a technological and logistical advantage. Growth through margin expansion. Europe must change a rapidly decaying model and let change and innovation thrive, not try to go back to 1977.

The solution is not to make low cost components for other European countries, which in turn will impoverish to compete for the same factory. The race to zero always ends in nothing.

The industrial plans promoted by the European Union have been characterized by:

– A huge cost to the taxpayer. Industrial plans have always been promoted through spending, more debt, not through tax incentives and deductions. Now most of Europe has public debt above 90% of GDP.

Capricious and non-economic political decisions to pick “winning sectors”, only to let them fall after a fake price and demand signal created by subsidies. Supporting non-competitive industries.

Defending decadent sectors to “sustain employment” and keep alive zombie companies through subsidies, only to remove them, achieving neither a strengthened “national champion” nor wealth and employment. This creates a problem of  managers that are “private-sector civil servants” and cronyism.

When the money flows, states spend in low-productivity sectors and forget to invest in R & D. When the fund flow stops, they also forget. See the chart. Better not to subsidize, just give tax incentives.

All this would not be a serious issue if it wasn’t financed with debt, or if the tax policy and costs for businesses were bearable. However, when countries spend amounts exceeding 5-10% of Europe’s GDP per annum in subsidies and wasteful spending, the tax burden and costs escalate.

“Growth Plans” do not create jobs, they subsidize them for a very short period of time… leaving behind a load of debt. Remember the Plan E, the green initiative, the 20-20-20 plan… For every euro spent, according to our estimates, 1.25 euros of debt since 2006 virtually no net job creation. “It would have been worse otherwise”, we hear. No, when we have created such a debt problem. Not at all.

A system that in recession increases the tax burden by five percentage points and makes energy tariffs (Germany, Spain) rocket 30% above any commodity, is unacceptable for a company, especially small and medium enterprises, which account for 70% of value added in the periphery. They close or emigrate.

A parasitic European Union where there are too many “supervisors” and too little “doers” … makes the “silent Depardieu” happen more and more, as the assault on the entrepreneur deepens. Think of the recent examples of threats to nationalize Arcelor-Mittal’s operations in France, or how public administrations don’t pay suppliers but demand them to pay VAT of the unpaid bills in time!.

It’s not just just the money spent on maintaining declining sectors, is the accumulated debt and the cost of losing the opportunity to pursue innovation.

That is why they have to lower taxes, ensure legal certainty and reduce the size of the public sector . These three problems are engulfing any real recovery option and long-term productive investment.

This has repeatedly been alerted by the IFO institute and the Natixis report “The Vicious Cycle for Europe”.

We have proven for decades that “stimulating”-giving the State a check-book with debt- does not work. We now know that the “internal devaluation” only brings more taxes, less disposable income, less consumption, debt is not reduced, which leads to structural unemployment.

And, of course, due to the reducing number of companies and additional debt … lower of tax revenue, new adjustments and start again. Five steps back to take a step forward. It is no coincidence that the vicious circle is monopolized by peripheral countries, the most stubbornly committed to support declining sectors and promoting non-competitive industries through subsidies.

The solution is, and always has been, to attract capital, not reject it.

The new production model is not going to be created in a committee or a summit. Private investors will doi it. The State should facilitate the transition not through intervention, but by investing in education, lowering taxes for entrepreneurs, reducing bureaucratic obstacles and, above all, not subsidizing the expensive and inefficient sectors.

At the end of my talk in London, a student asked me, “Why does Spain not create a Spotify, or a Core Labs?” He is an Engineering Technology student and is preparing a start-up.

I asked: “Where are you opening your business, here or in Spain?”

He said: “In Westminster they have told me that I might not pay taxes during the first three years, so probably here … Why?”.

“You’ve just answered yourself”.

Energy Predictions for 2010

(Published in Cotizalia on Dec 24 2009)

First, I do not agree at all with those who see the dollar appreciated in 2010. We are living in the greatest appropriation of wealth in recent history, and if the dollar has fallen so much so far, wait to see the effect of the 1.3 trillion dollars that the U.S. has to refinance and the $700 billion in pending stimulus plans. The weak dollar is part of the reason why I am more positive than other investors in oil and gas prices.

Second, everyone expects interest rate hikes. I do not think so. With the UK and US together needing to refinance $2 trillion, debt to GDP of 300% and 10% unemployment, interest rate hikes are more a dream than a reality.

In the world of oil, we face a year of anemic demand and abundant supply. The supply problems and decline rates that are so appealing for the market are not an issue for 2010. Demand is likely to be above 85.4 million barrels a day, but this means that we will have a capacity surplus of around 4 million barrels a day. Therefore, the production cuts from OPEC and its adherence to the quotas in place (at very low levels today, 58%) will be decisive.

But what we are likely to see are aggressive moves in Asian demand due to lower nuclear production and the already mentioned infrastructure projects. Thus, it is not surprising that we might see a period of high volatility. Certainly in 2010 oil will likely continue to be a hedge against the dollar. I also expect demand from emerging countries to grow by around 6%, so it would be reasonable to see oil reach $85/barrel as inventories are reduced to normal levels, which I do not expect to happen until 2011.

On the supply side, with a 5-6% decline from existing fields, non-OPEC production is likely to fall to around 50.8 mbpd instead of the estimated 51.3. And forget refining. With nearly 7 mbpd of excess capacity and anemic demand, refining margins will not be a riot.

The gas market in 2010 will likely see a drastic drop before the recovery, which will be even more drastic. Demand continues to be the problem because it depends on electricity consumption and we will see coal to gas switches, but no real demand increases in a year in which producers will increase LNG supply capacity by 10%.

But beware, because the market is exaggerating the gas overcapacity in at least 20BCM. I am convinced that we will see lower exports to Russia (145BCM instead of 162 expected), Norway and Qatar reducing exports, leaving the market “only” with 10BCM of overcapacity, more than enough to justify spot price of $ 5.5 -6/MMBTU and 35p per therm … but before the recovery we will see gas prices to record lows, until the recovery in demand in winter.

The electricity market in Europe will probably live a delayed pickup in demand, where we still need an industrial demand still heavily damaged by the crisis. A drop in electricity demand of 0.5% in Europe could be feasible. Reserve margins (excess capacity) in Europe are at levels of 25% considering the additional 15GW of wind capacity, and we probably will not see an environment of demand-supply balance until 2012. In such an environment is difficult to see higher electricity prices. And in oil, gas and electricity, high volatility leads to reductions in investment, which explains in part my positive view of future prices.

2010 will, in my opinion, be a year of divestments and capital increases, and energy companies can take advantage of the market opening to preserve the strength of their balance sheets in the bottom of the cycle. I estimate around $35 billion in the oil and electricity sectors. Pay attention to balance sheets, it seems that everyone has forgotten debt in 2009. It will also be an exercise in which well-capitalized companies will continue to aggressively buy assets, particularly in exploration and production and “shale gas. The war for natural resources is not going to stop, and I reckon a figure of about $30 billion in mergers and acquisitions.

I believe that 2010 will not be a bad year for investments by taking advantage of occasional corrections. Everyone is negative or cautious, money remains cheap, the cost of capital of companies continues to fall, bonds are overpriced … This generates expansion of multiples even with stagnant profits. Remember Buffett, the market is never wrong. Use it as a tool, not as a guide.