May 8, 2015
Recently, I have attended a debate on the re-industrialisation of Europe. Frankly, my response was simple. It was a question, really. What is this debate about?
Europe has as much industry as it can retain (in the case of old EU member states) or attract (in the case of CEE countries). The process of industry declining as a share of GDP has been taking place in developed economies for a couple of decades now, and has many sources. One is technological advancement, increased productivity, and rapid development of the services sector which occurs as nations grow wealthier. The other is direct foreign investments, or transferring manufacturing operations to poorer countries to benefit from lower labour costs. But not all low-cost countries attract foreign investors. The thing is that the host country must offer decent conditions for doing business, but also that investors need a guarantee that their profits can be repatriated. One such flagship guarantee in the case of FDI host countries is WTO membership (World Trade Organisation established in 1995).
How critical this factor is can be seen from the recent economic history of China, which joined the WTO in December 2001 and has enjoyed a fast-paced growth and influenced the global economy ever since. Exports of cheap consumer goods from China acted as a damper on inflation in developed countries (and Poland) and ultimately led to the creation of a low interest rate environment. Low interest rates were an incentive to borrow money and invest it in property, whose inflated prices gave its owners the sense of being wealthier, encouraging them to spend more on consumption. The spending was facilitated by the thriving financial markets and institutions. Some researchers have suggested a connection between central banks’ effectiveness in curbing inflation and the growing popularity of direct inflation targeting (Poland adopted its direct inflation targeting strategy in 1998, when the average annual inflation rate was 11.8%).But I think it was China’s accession to the WTO that played a key role in this process.
If China had not entered the WTO in 2001, the property market would probably have not crashed in 2008. Oil prices would not have skyrocketed between 2003 and 2008 and the US would have found it harder to achieve breakthroughs in its oil and gas extraction technologies, and the country would not have seen energy prices drop and its industry return home, also from China (in the most industrialised parts of China labour costs are not as attractive as they used to be and energy prices are definitely high). Sketching this alternative scenario, I am far from placing the blame on China for the acute impact of the financial crisis that Europe is still suffering from. I have used China as an example to demonstrate that sovereign economic policy of a large nation has the power to alter the economic landscape globally. The US dollar strengthening against other currencies, including the złoty, is a sign that the American economy is ever stronger and that the financial markets expect the Federal Reserve to start raising interest rates soon. The strong dollar benefits the eurozone, as it reinforces the European Central Bank’s measures designed to drive the value of the euro down, which bolsters the competitiveness of eurozone economies on international markets. Poland being outside the eurozone, the conditions for doing business in our country are driven by the implications of the depreciating euro (the złoty gaining value against the euro) and the appreciating dollar (the złoty losing value against the dollar). Fuel prices rise on the stronger dollar, while the złoty appreciating against the euro makes non-fuel imports (with their lion’s share originating in the eurozone) cheaper and causes revenue from exports to decline.
Now back to the re-industrialisation of Europe, which, of course, brings to mind the EU economic policy, which shapes the business environment within the Community and outside it. Businesses compare prices, costs, taxes, and business conditions in alternative locations, and select the most viable option. In the European Union, high energy prices and the environmental and climate change levies have taken their toll. The European Commission, armed with economic policy instruments, has managed to rid its territory of most of the ‘harmful’ industry, wiping out a great number of permanent semi-skilled jobs in the process. This cannot be reversed without changing the economic policy.
The first thing to do is to eliminate the regulatory risks arising from the current energy and climate policy. These risks affect the energy sector and inflate the cost of energy, thus ousting energy-intensive industries from the list of potential investors (energy-intensive industries include steel industry and metallurgy, which are also directly exposed to the risk of climate policy changes). These industrial sectors, together with energy generation, form the beginning of the value chain, and their presence is a powerful stimulus for the next generations of the processing industry and associated services to locate their operations in the vicinity.
The principal source of regulatory risk in the EU is the system of subsidising the preferred technologies on a discretionary basis (where subsidies are subject to arbitrary decisions), as well as uncertainty about the prices of carbon allowances, which surged from just EUR 3 per tonne a year ago to EUR 7 per tonne today. The reason? Demand triggered by recent climate policy decisions (the current target of cutting emissions by 40% by 2030 and the expected withdrawal of a part of carbon allowances from the market) and the EU decision-makers delaying the free allocation of carbon credits for the previous year to large emitters. As a consequence, the companies set aside provisions in case they have to buy credits on the market. A king’s ransom to whoever correctly predicts the trajectory of the price of carbon allowances throughout the life of a power plant (spanning 20 to 30 years), particularly given the recent debate on what the European Energy Union should look like as a vehicle for coordinating the security of energy supply and the national energy policies. No wonder that some energy majors have made the decision to site their power plants outside the EU. Other market players often opt for government subsidies, which push up the cost of energy in the long run.
What can be done? We need to make a prompt shift towards a wise industrial policy, implemented with innovation-friendly methods that do not bet on winners before the race starts. We need to begin with a vision for the EU’s economic growth and its place in the international arena, and then find the resources to fund targeted research and … wait for the results. If everything goes well, these will appear in a place and time we least expect. After all, innovations tend to surprise us.