South Africa in the 21st Century

My exchange semester at Auckland University of Technology is officially over! Now I am waiting on my exam results and I am also about to head back to Germany tomorrow for the summer break. This is why today’s post is not going to be a long one. Rather I would like to share one of my research essays that I completed in my Growth and Development Economics paper at AUT.

The task was to choose one of the BRICS economies and write a research essay on their growth and development performance in the last decade. In particular, we were supposed to analyse the extent to which institutional development supported or hindered the process of economic development. The essay should include four parts: an introduction to the country, a section on growth and development trends, a section on institutional development and lastly a summary including policy implications.

I chose to focus on South Africa and I have to say that it was a very interesting assignment and it helped me significantly in developing my research skills. Doing all this research on South Africa also changed my impressions on the current state of human and economic development in the country. It has been 22 years since the end of apartheid but South Africa continues to face significant obstacles as highlighted in the essay. Despite a range of headwinds identified in the essay there is however the possibility for South Africa to regain its strength and play up to the expectations of becoming one of the future drivers of world economic growth as part of the BRICS as argued in the last part of the essay.

I hope you enjoy reading my research! The abstract of the essay is included below and complete file is available from here.

Jasse


SOUTH AFRICA IN THE 21ST CENTURY

Abstract

South Africa joined the BRICS for their 3rd BRICS Summit in 2011 after being predicted to become one of the future drivers of world economic growth. However, both in the area of economic growth and development as well as governance South Africa continues to face substantial challenges. The aim of the essay is to assess the country’s performance in these areas over the past decade. After a brief overview on South Africa the essay analyses growth and development trends with the use of the Human Development Index (HDI), the inequality adjusted HDI and the Multidimensional Poverty Index. In the second part, the essay focuses on institutional development employing the World Governance and Doing Business Indicators, as well as the Index of Economic Freedom.

The main findings are that South Africa’s economic development is impeded by sluggish growth rates and a contracting economy as well as the rising burden in fiscal debt and its servicing costs. South Africa’s society still faces racial and gender inequality as well as multidimensional poverty. The country’s potential human development in all three areas of health, education and income remains dampened by inequality which persists after the transition to a more open society and economy under the post-Apartheid regime. The country has suffered from a deterioration of institutional quality over the last years, especially in corruption coupled with an on-going underperformance in political stability. Furthermore, the ease of doing business is impeded by constraints in getting electricity and a deterioration of conditions regarding the access to credit.  A major concern is that business freedom, labour freedom and investment freedom have seen a long-term deterioration in conditions.

The essay’s policy recommendations centre on a holistic reform of South Africa’s institutional system in order to reshape incentives to invest in physical and human capital and to establish incentives for innovation. The recommendations derive from the World Bank Growth Commission’s 5 common growth ingredients of market incentives, trade openness, future orientation, macroeconomic stability and good governance with a focus on inclusive growth.


Droege, J. (2016). South Africa in the 21st Century. Auckland University of Technology, Auckland. Retrieved from https://theaspiringeconomist.files.wordpress.com/2016/05/south-africa-in-the-21st-century-jasmin-droege.pdf 

New Zealand Government Debt and Budget Balance 2003 – 2012

In today’s post I am going to look at the New Zealand government’s budget balance and debt over the period from 2003 to 2012. In particular, I am going to focus on changes in government debt in response to the global downturn of 2008/09 and some of the reasons for the country’s negative budget balance. In the last part of today’s post I will comment on the claim that the government did nothing in response to the recession.

Tax revenues and expenses, as well as central government debt for the period from 2003 to 2012 are graphed in figure 1. This is complemented with an overview on subsidies and other transfers (welfare payments) both in absolute terms as well as a share of government expenses in figure 2. Nominal data series are deflated to constant 2010 levels with the use of the CPI to account for inflation.

new zealand budget deficit 1
(Source: World Bank, 2016c)

New Zealand’s tax revenues and expenses were roughly balanced until 2008. Government expenses started at around 30.4 percent of GDP in 2003 and increased slowly to 32.9 percent of GDP in 2008. Likewise tax revenues increased slowly from 29.2 percent of GDP (2003) to 31.8 percent in 2008. The highest tax revenue was recorded in 2006 (32 percent). Over the same period government debt decreased by almost 11.8 percentage points to 36.4 percent of GDP in 2008. After 2008, however, the government’s tax revenues and expenses diverged significantly. While taxes fell to levels below 30 percent, government expenses increased by almost 13 percentage points within only one year. After stagnating in 2009/10, expenses increased further by 6.5 percentage points to an all-time high of 52.8 percent of GDP in 2012. This trend caused government debt to rise from 36.4 percent (2008) to 67.9 percent of GDP by 2012. This corresponds to an 86.5 percent increase in debt in only 4 years. In 2012, government expenses came down to 45.6 percent of GDP but are still considerably higher than in the early 2000s before the global financial crisis.

Figure 2 looks at the New Zealand government’s expenses more closely. In general, government expenses include (1) compensation of employees, (2) goods and services expenses, (3) interest payments, (4) subsidies and other transfers, as well as (5) other expenses. It can be shown that the spike in government expenses of 2008/09 was mainly caused by the fourth category. Thereby subsidies and other transfers are defined as “all unrequited, nonrepayable transfers on current account to private and public enterprises; grants to foreign governments, international organizations, and other government units; and social security, social assistance benefits, and employer social benefits in cash and in kind” (World Bank, 2016b). However, the lion share in this category are welfare payments made by the New Zealand government.

new zealand budget deficit 2
(Source: World Bank, 2016c)

While subsidies and other transfers remained relatively constant at a level of slightly above $20 billion from 2003 to 2008, they increased by more than $32 billion from 2008 to 2009. This is a 143 percent increase in government subsidies and transfers within only one year. It was mainly driven by increased government spending on family assistance to low income households. The lowest income decile in the population saw its transfers rise by more than 6 percent of disposable income while the second decile saw an increase of almost 10 percent from 2006/07 to 2009/10. Overall, 9 out of ten deciles benefited from an increase in transfers during this period. This includes Working For Families, NZS and Veterans pension, Income replacement and Housing Supplement (Ball & Ryan, 2013).

The second spike of 2010/11 was driven by the fifth category due to the two Canterbury earthquakes. The New Zealand government provided short-term income support, financed public infrastructure reconstruction and repairs and was liable for Earthquake Commission payments to households (Treasury, 2011). Earthquake Expenses were expected to accrue to a sum equivalent to 10 percent of GDP and the net cost to the Crown were estimated to be $13.5 billion in 2011 (Doherty, 2011).

new zealand budget deficit 3
(Source: World Bank, 2016c; own calculations)

Putting expenditures and tax revenues together, one can calculate the budget deficit of New Zealand for the period, as shown in figure 3, by subtracting government expenses from tax revenues. It should be noted though, that this is a simplified calculation of the budget deficit and differs from the cash surplus/deficit quoted in the World Bank database, which includes other revenue such as grants and deducts the net acquisition of nonfinancial assets in addition to expenses (World Bank, 2016a).

Figure 3 supports the findings from my analysis above, namely that New Zealand has been running large budget deficits since 2009 due to (1) the increase in welfare payments during the 2008/09 recession and (2) the costs related to the Canterbury earthquakes in 2010/11. Hence the claim that the government did nothing in response to the crisis does not hold if one looks at the numbers. The New Zealand government did respond with an almost 2.5 fold increase in welfare payments, especially to poorer households through family assistance. The government also had to bear higher costs in terms of unemployment benefits as the eligible population increased from 18,000 in June 2008 to 62,000 working age people in June 2010. It introduced a Youth Opportunities package including initiatives like the Job Ops or the Community Max programme as well as Youth Transition Services to tackle long-term unemployment through training and jobs funded or subsidized by the government (Ministry of Social Development, 2010).

I hope today’s post provided insights into how New Zealand reacted to the global recession of 2008/09 with the goal to shed light on the magnitude of the government’s spending increases and tax decreases over that period.

Thanks for reading!

Jasse


References

Ball, C. & Ryan, M. (2013). New Zealand Households and the 2008/09 Recession (New Zealand Treasury Working Paper 13/05). Wellington: The Treasury. Retrieved from: http://www.treasury.govt.nz/publications/research-policy/wp/2013/13-05/twp13-05.pdf

Doherty, E. (2011). Economic effects of the Canterbury earthquakes (Research Paper December 2011). Wellington: Parliamentary Library. Retrieved from: http://www.parliament.nz/resource/en-nz/00PlibCIP051/ccd96733060e8e3a1769b3a4ef3017e3de45df83

Ministry of Social Development (2010). Ministry of Social Development Annual Report 2009/2010. Wellington: New Zealand Government. Retrieved from: https://www.msd.govt.nz/documents/about-msd-and-our-work/publications-resources/corporate/annual-report/annual-report-2009-2010.pdf

Treasury (2011). Economic and Fiscal Impacts of the Canterbury Earthquakes. Budget Economic and Fiscal Update 2011, 95-101. Retrieved from: http://www.treasury.govt.nz/budget/forecasts/befu2011/befu11-whole.pdf

World Bank (2016a). Cash surplus/deficit (% of GDP). Retrieved from: http://data.worldbank.org/indicator/GC.BAL.CASH.GD.ZS

World Bank (2016b). Subsidies and other transfers (% of expense). Retrieved from: http://data.worldbank.org/indicator/GC.XPN.TRFT.ZS

World Bank (2016c). World Development Indicators: New Zealand [Data file]. Retrieved from: http://data.worldbank.org/country/new-zealand

Germany’s Energiewende – The New Electric Mobility Strategy

I am pleased to see that Germany continues to drive its energy transition. The so-called ‘Energiewende’ (German for energy transition) is overhauling the country’s energy concept fundamentally. Thereby the three pillars of the new energy concept are reliability, environmental sustainability and economic viability. The government’s vision is to transform the country into a role model for energy efficiency and a green economy coupled with competitive energy prices and a high level of prosperity (BMWi, 2010). The four main political objectives of the energy transition are to combat climate change, to avoid the risks of nuclear power, to improve Germany’s energy security and to increase competition and growth in the sector (Pescia and Graichen, 2015). But there are more potential benefits to it, including the reduction of energy imports and therefore oil dependency and exposure to external energy supply shocks, as well as the strengthening local economies and the provision of social justice (Morris and Pehnt, 2015).

In order to achieve the ambitious vision, the government’s agenda includes:

  1. Cost-efficient expansion of renewables, e.g. expansion of offshore and onshore wind farming and increasing sustainability and efficiency in the use of bioenergy
  2. Enhancing energy efficiency of private households, the industry and the public sector, e.g. the modernisation campaign for buildings with the vision of energy-efficient buildings by 2050
  3. Shifting the energy mix away from nuclear power and fossil-fuel power plants toward renewable energy sources
  4. Improvements in the country’s grid infrastructure and storage technologies with demand-responsive electricity generation
  5. Electric mobility strategy with one million electric vehicles on Germany’s streets by 2020 and six million by 2030
  6. Energy research programme with focus on innovation and new technologies regarding renewable energies, energy efficiency and storage methods (BMWi, 2010).

Although some of the policy measures, which the government has adopted, are debatable, the overall plan is clearly well thought out. A month ago I already dedicated a blog post to the idea of ecological fiscal reforms (green tax shift) and eco-social market economies. In this post I used Germany as a textbook example for the evidence of the wide-ranging benefits of such green reforms.

In my opinion, the ‘Energiewende’ provides the necessary nudge to the industry, consumers as well as the public sector to enhance their energy efficiency and sustainability. It reshapes the incentives of economic actors in favour of green research, innovation and consumption. In addition, it is also a poster child for demonstrating that “coherent government policy can transform an industry” and that it is possible to “to blend low-risk feed-in tariffs with market price signals” (Fares, 2014).

The motivation for today’s post stems from the fact that Germany is now starting to implement its electric mobility strategy (item 5 on the agenda above). It is about to introduce a new nudge targeting electric cars. In particular, the German Federal Cabinet has just approved a new legislative package for the preferential treatment of electric cars. It will include a subsidy of 4,000 Euro when purchasing a new electric car and 3,000 Euro when purchasing a hybrid car. In addition, electric cars will be exempt from the motor vehicle tax for a period of 10 years (Tagesschau, 2016). This initiative for electric mobility will be funded jointly by the government and the automobile industry, each contributing 0.6 billion of funding. According to the government Daimler, VW and BMW have already agreed to the 50:50 split in costs (ZEIT, 2016). The initiative will be coupled with the roll out of charging points. This, in turn, will be funded by the Federal Government swallowing another 300 million of public funds.

The main goal of the latest initiatives for electric mobility is to achieve a more than ten-fold increase the amount of electric and hybrid cars from currently less than 50,000 to more than 500,000 in the short-run and to more than one million in the medium-run (Tagesschau, 2016). As noted earlier, electric mobility is at the heart of the country’s energy transition. Transport is currently one of the main drivers of Germany’s oil dependence. It continues to rely heavily on fossil fuels rather than renewable energy sources despite efforts like the development of the National Hydrogen and Fuel Cell Technology Innovation Programme (BMWi, 2010). This is why the government is now taking action. It is starting to pave the way for preferential treatment of electric cars in order to increase the incentives for both fleet operators and first-time private buyers to purchase an electric car and to drive its energy transition also in the area of transport.

Overall, the legislative package still has to be discussed and approved by the German Federal Parliament and Federal Council. However, the package is likely to go through shortly with the subsidy for the purchase of electric and electric cars being expected to already begin in May. Subsidies will be claimable through an online application facility (Tagesschau, 2016). So there are interesting times to come; especially whether the subsidy will be sufficient to increase the adoption of the electric mobility technology. Electric cars continue to carry an excessive price tag for their zero emissions image. Even under the assumption that both fleet operators and first-time private buyers care about the image associated with a zero-emission vehicle (BMWi, 2010), it is not clear whether this together with the government’s subsidy and tax exemption is an incentive large enough to justify the higher initial investment costs. One should not forget that it is ultimately the price which determines demand (and supply). The initiative has the potential to break ground, but it is unlikely to turn the larger share of society into electric car users; at least not yet. Still, I would argue that we are heading into the right direction due to the right policy mix. Firstly, Germany focuses on competition and market orientation. Secondly, Germany introduces incentives in favour of greener transportation without restricting society’s choices as well as important incentives for green innovation. Both are key to rethink transportation and mobility issues in a century where renewable energy sources are clearly on the rise.

 Thanks for reading,

Jasse


BMWi (2010). Energy Concept for an Environmentally Sound, Reliable and Affordable Energy Supply. Berlin: Federal Ministry of Economics and Technology. Retrieved from: http://www.bmwi.de/English/Redaktion/Pdf/energy-concept,property=pdf,bereich=bmwi,sprache=en,rwb=true.pdf

Fares (2014, 7 October). Energiewende. Two Energy Lessons for the United States from Germany. Retrieved from: http://blogs.scientificamerican.com/plugged-in/energiewende-two-energy-lessons-for-the-united-states-from-germany/

Morris, C., and Pent, M. (2015). Energy Transition: The German Energiewende. Berlin: Heinrich Böll Stiftung. Retrieved from: http://energytransition.de/wp-content/themes/boell/pdf/en/German-Energy-Transition_en.pdf

Pescia, D., and Graichen, P. (2015). Understanding the Energiewende: FAQ on the ongoing transition of the German power system. Berlin: Agora Energiewende. Retrieved from: https://www.agora-energiewende.de/fileadmin/Projekte/2015/Understanding_the_EW/Agora_Understanding_the_Energiewende.pdf

Tagesschau (2016, 18 Mai). Kaufprämien und Steuerboni für Elektroautos: Kabinett beschließt Förderung. Tagesschau Online. Retrieved from: http://www.tagesschau.de/wirtschaft/elektro-autos-103.html

ZEIT (2016, 27 April). 4.000 Euro Prämie für Kauf eines Elektroautos. ZEIT ONLINE. Retrieved from: http://www.zeit.de/politik/deutschland/2016-04/bundesregierung-elektroautos-subvention-kaufpraemie

Two Measures of Inflation in Theory and in the Context of New Zealand

Today’s post takes a closer look at two common measures of inflation, namely the Consumer Price Index (CPI) and the GDP deflator. The first part looks at key differences between inflation measured by the former and the latter indicator. In the second part I take a closer look at CPI and GDP deflator inflation in the context of New Zealand from 2000 to 2014 and the Reserve Bank of New Zealand’s performance in inflation targeting. This was part of a bigger assignment for my Macroeconomics in the Global Environment class. However, I think that it is valuable content for a blog post.

Two common measures of inflation are (1) the Consumer Price Index (CPI) and (2) the GDP deflator. Over the long-run they tend to move together. However, they can diverge for two reasons due to the way they are constructed.

Firstly, the CPI is based on a basket of goods and services, which proxies for the consumption of an average household. Because consumers do not only consume domestic goods, the CPI does include foreign consumption goods. The GDP deflator, on the other hand, only tracks domestic produce, because GDP measures all goods and services produced within a country. This also includes things like investment, which are not considered in the CPI, so that the composition of the baskets differs significantly. Overall, the CPI can rise due to price rises in imported goods while the GDP deflator can only rise if prices of domestic goods and services, investment etc. increase. This matters especially for small open economies which export most of their produce but import most of the goods and services consumed domestically. A good example is oil. When a country relies mostly on oil imports, then oil and oil-based products make up a much larger share of the CPI than of GDP. Therefore oil price changes weigh more on the CPI than the GDP deflator in this case (Mankiw, 2008).

Secondly, the components of the CPI basket are fixed, exogenously determined by Statistics New Zealand, while the GDP deflator’s basket can change over time. This is because the GDP deflator compares the prices of currently produced (domestic) goods to the prices of goods produced in the base year. Its basket is a unit of GDP, no matter what the GDP contains (Thoma, 2008). This can cause the CPI and the GDP deflator to diverge if the GDP deflator basket adjusts over time and the prices of the goods do not change proportionally (Mankiw, 2008).

The context for the following analysis of CPI inflation and GDP deflator inflation in New Zealand from 2000 to 2015 is that the Reserve Bank of New Zealand has officially pursued CPI inflation targeting to maintain price stability since the Reserve Bank of New Zealand Act 1989. This Policy Targets Agreement (PTA) set out a CPI inflation band of 0 to 2 percent per year. The PTA was last changed in September 2002 to a band of 1 to 3 percent per year. In the short-run, inflation is allowed to exceed the band but for no longer than 12 months (RBNZ, 2009). The Reserve Bank’s prime tool for inflation targeting is the Official Cash Rate (OCR). The bank reviews the OCR 8 times per year to achieve a 2 percent inflation target midpoint (RBNZ, 2016).

New Zealand Inflation 1
(Source: World Bank, 2016; own calculations)

Figure 1 shows inflation measured by the GDP deflator and the CPI for New Zealand from 2000 to 2015. Furthermore, it includes the difference between the two indicators by subtracting GDP deflator inflation from CPI inflation. It can be seen that the two inflation measures have diverged considerably in the case of New Zealand over the last couple of years. Inflation measured by the CPI was lowest in 2015 at 0.23 percent. It was highest in 2011 at around 4.43 percent. Overall, New Zealand’s Reserve Bank missed its CPI inflation target 7 out of 13 years since 2003 after the last band amendment.

Inflation measured by the GDP deflator was highest in 2007 at 5.19 percent inflation per annum. The lowest inflation occurred in 2012 with almost perfect price stability (0.03 percent), closely followed by the year 2002 (0.26 percent). Overall, GDP deflator inflation has been more volatile than CPI inflation. This, however, is at odds with the existing economic theory that the CPI tends to be much more volatile than the GDP deflator (Sexton, 2016). The positive divergence of the two measures was greatest in 2002 and 2011 with a difference of 2.4 percentage points. The greatest negative divergence occurred in 2007 and 2013 with 2.8 percentage points and 2.7 percentage points, respectively.

New Zealand is a small open economy and domestic consumption depends largely on imports. Hence any price increases abroad are transferred into the economy and are hard to tackle with monetary policy (inflation targeting) of the Reserve Bank.  This imported inflation can partly explain the spikes in the CPI of 2008 and 2011. In 2008, CPI inflation was mainly driven by rising petrol prices. New Zealand relies mostly on imported fuel from refineries in Asia, the Middle East and the Pacific (Ministry of Business, Innovation and Employment, 2015). The oil supply shock of 2008 pushed CPI inflation briefly above 5 percent (Statistics NZ, 2016). In 2011, CPI inflation was driven by higher prices in the categories transport, food and housing, as well as due to a GST (indirect tax) increase (Tarrant, 2011).

The rise in the GDP deflator from 2002 to 2003 might be explained by higher prices for key exports such as milk, butter, cheese and meat as well as higher grain prices (Statistics New Zealand, 2010; 2011). It could be argued that these production and export price increases are only indirectly reflected in the CPI through final consumption expenditures while they have a larger impact on New Zealand’s nominal GDP and therefore the deflator. Secondly, the land and housing bubble might have caused stronger GDP deflator inflation. Land, for example, is not included in the CPI anymore, but it saw a significant price rise over the period from 2001 to 2007, especially in Auckland (Zheng, 2013). Also the commercial property investment boom with the total value of sales increasing from $2.87 billion (2001) to $7.13 billion in 2007 and the subsequent drop to $4.04 billion in 2008 might explain the large difference between inflation rates in 2007 (Colliers International, 2015).

New Zealand Inflation 2
(Source: World Bank, 2016; own calculations)

Figure 2 shows the inflation trend over the period together with the lower and upper bound of the Reserve Bank’s inflation targeting strategy. The log difference of the CPI and the GDP deflator are equal to the respective inflation rates. The logarithmic scale also ensures that the percentage changes have the same vertical distance on the scale so that one can (1) include the linear inflation trend bounds and (2) estimate linear trend lines for both the CPI and the GDP deflator. Overall, the CPI index has grown by 2.59 percent on average while the GDP deflator has risen by 2.52 percent on average per year.  The Reserve Bank has therefore been successful in keeping inflation within the band on average and in the long-run while often failing in the short-run as noted above. This short run failure in controlling CPI inflation likely stems from imported inflation as New Zealand’s domestic consumption falls largely on foreign goods which the Reserve Bank cannot control. Furthermore, it can be seen that the bank kept inflation more closely to the upper bound than the 2 percent inflation target midpoint in the long run.

The diagram also reveals that after 2008 the indices have fluctuated more from another. The GDP deflator overtook the CPI in 2009 and 2010 as well as in 2013 and 2014. While CPI inflation has come down closer to the 2 percent midpoint target since 2011, the GDP deflator has been taking off.

So that’s me for today. I hope this blog post shed light on key differences between the CPI and the GDP deflator and why inflation measured by the indicators can differ at least in the short run. This is important especially for small open economies such as New Zealand. The second part of the post showed that CPI and GDP deflator inflation rates in New Zealand differed significantly over the period from 2000 to 2014 which is not normally the case. For example, if you were to plot the series for Germany they would differ less, because (1) the country consumes more of what it also produces and relies less on imports and (2) is also a significantly larger economy. Finally, the post also looked at how well the Reserve Bank performed at targeting a CPI inflation rate of between 1 to 3 percent.

Thanks for reading!

Jasse


Colliers International (2015). New Zealand Capital Markets Report: New Zealand Unleashed Q2 2015. Auckland: Colliers International. Retrieved from: http://truecommercial.nzherald.co.nz/download/12940

Mankiw, N.G. (2008). Principles of Macroeconomics (5th ed.). Mason, O.H.: South-Western Cengage Learning.

Ministry of Business, Innovation and Employment (2015). Fuel industry in New Zealand. Retrieved from: http://www.consumerprotection.govt.nz/for-consumers/goods/fuel-quality-1/fuel-quality-monitoring-scheme-1

RBNZ (2009). Explaining New Zealand’s Monetary Policy [pdf]. Retrieved from: http://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Factsheets%20and%20Guides/factsheet-explaining-new-zealands-monetary-policy.pdf

RBNZ (2016). Official Cash Rate (OCR) decisions and current rate. Retrieved from: http://www.rbnz.govt.nz/monetary-policy/official-cash-rate-decisions

Sexton, R.L. (2016). Exploring Economics (7th ed.). Boston, M.A.: Cengage Learning.

Statistics New Zealand (2010). Slicing and dicing meat and poultry prices. Retrieved from: http://www.stats.govt.nz/browse_for_stats/economic_indicators/CPI_inflation/slicing-and-dicing-meat-and-poultry-prices.aspx

Statistics New Zealand (2011). Tracking milk prices in the CPI. Retrieved from: http://www.stats.govt.nz/browse_for_stats/economic_indicators/prices_indexes/tracking-milk-prices-in-the-cpi.aspx

Statistics NZ (2016). 100 years of CPI – Price changes 1994-2014. Retrieved from: http://www.stats.govt.nz/cpichanges/cpipricechanges/index.html

Tarrant, A. (2011). NZ CPI hits 21 yr high of 5.3% on rising petrol, food, housing prices, Stats NZ says; Even without GST hike, inflation above RBNZ band. Retrieved from: http://www.interest.co.nz/news/54451/nz-cpi-hits-21-yr-high-53-rising-petrol-food-housing-prices-stats-nz-says-even-without

Thoma, M. (2008, 3 September). The GDP Deflator and the Inflation Rate. Retrieved from: http://economistsview.typepad.com/economistsview/2008/09/the-gdp-deflato.html

World Bank (2016). World Development Indicators: New Zealand [Data file]. Retrieved from: http://data.worldbank.org/country/new-zealand

Zheng, G. (2013). The effect of Auckland’s Metropolitan Urban Limit on land prices. Wellington: The New Zealand Productivity Commission. Retrieved from: http://www.productivity.govt.nz/sites/default/files/research-note-mar-13-auckland-mul.pdf

A Decade of Inflation* in Germany

I was keen to get my hands on more data on Germany and finally found out about the GENESIS online database of the Federal Statistical Office. It gives you access to a vast range of datasets, for example longitudinal data on the labour market, demographic trends or inflation. What I want to do today is to use the CPI and its sub-indices for the period 2005 to 2015 to analyse which goods and services have become much more expensive over the last decade. So what has really driven (and what has not driven) inflation in Germany? And what has contributed to the slowdown of inflation and deflationary pressures recently?

For this I obtained the CPI data from the GENESIS database. Originally it was indexed to 2010. However, to spot trends more easily, I changed the base year to 2005. So let’s look at the basket of the typical German consumer first. What is included?

  1. Food and non-alcoholic beverages
  2. Alcoholic beverages and tobacco
  3. Clothing and footwear
  4. Housing, water, electricity, gas and other fuels
  5. Furniture, lighting equipment, appliances etc.
  6. Healthcare
  7. Transport
  8. Communication
  9. Recreation, entertainment and culture
  10. Education
  11. Accommodation and restaurant services
  12. Miscellaneous goods and services

The CPI consists of 12 categories of which some contain further sub-indices. For example food is separated into bread, meat, dairy, fruits etc. while transport contains the purchase of vehicles as well as maintenance and service costs or the cost of transport services (railway, road, air, waterway).

Germany Inflation CPI 1
(Source: Destatis, 2016)

So let’s look at the data. The CPI rose by 15.6 percent over the period from 2005 to 2015. This means that inflation, on average, was at around 1.6 percent per annum which is close to the ECB’s desired target of just under 2 percent. However, this does not reveal the significant differences among the categories and the differences in price increases between certain years. While categories 4, 7 and 12 saw a similar total increase as the overall CPI over the period, others rose a lot more rapidly, as shown in the diagram above. Germany saw the most significant price increases in the areas of food, beverages and tobacco. On the other hand, prices actually fell in the area of communication, driven by much cheaper prices for telephones and other communication devices and cheaper telecommunication services. Prices in categories like healthcare or recreation, entertainment and culture rose to a lesser extent than the CPI in total. Overall, inflation came almost to a halt in the period from 2008 to 2010 (global financial crisis) and again recently since 2014.

Germany Inflation CPI 2
(Source: Destatis, 2016)

Let’s take a closer look at the first category – food and non-alcoholic beverages. For example, there is a significant difference among animal source foods. Dairy and eggs saw a price spike in 2008 and 2014. Compared to 2005, the price for dairy and eggs was more than 25 percent higher in 2015. Meat prices rose by 22.6 percent over the decade but prices were much less volatile than dairy prices. The most significant price increase in animal source foods was recorded in fish and fish products of more than 36 percent over the decade.

Germany Inflation CPI 3
(Source: Destatis, 2016)

The highest total price increase in the food category for the complete period was recorded in the price of fruit. Compared to 2005, fruit prices today are more than 40 percent higher. One can also see that prices fell during the global recession 2008/09 but thereafter picked up again. In comparison, vegetable prices actually saw higher price increases until 2010 with a similar drop during the global recession. After 2010, however, vegetable prices decreased in some periods and increased in others, so that the total price increase over the decade turned out to be only around 27.9 percent. Prices for edible fats and oils peaked in 2013 with a total price increase of almost 45 percent from 2005 to 2013. Since 2013 prices in this category have fallen by 6.72 percent.

Germany Inflation CPI 4
(Source: Destatis, 2016)

Bread and cereal prices as well as prices for sugar, jam, honey etc. rose more than the overall CPI over the decade but with less price fluctuations than the other food categories. However, while inflation has almost come to a halt recently, prices in these two categories still increase. Bread and cereal prices rose by more than 5 percent from 2012 to 2015. Sugar, jam and honey prices rose by more than 7 percent. Over the same period the CPI only rose by 2.7 percent.

Germany Inflation CPI 5
(Source: Destatis, 2016)

Regarding non-alcoholic beverages prices for coffee, tea and cocoa were relatively volatile from 2005 to 2015. They increased by 10.6 percent from 2010 to 2011, that is in only one year. Since 2013 the prices have picked up again. Both prices for coffee, tea and cocoa as well as mineral water, soft drinks and juices stagnated or actually fell during the period from 2008 to 2010 due to the global recession. Since 2014, however, mineral water, soft drinks and juices have become cheaper.

Germany Inflation CPI 6
(Source: Destatis, 2016)

In the second category the main price driver is tobacco. Prices for alcoholic beverages rose in tandem with the CPI. In comparison, tobacco prices rose by more than 38 percent over the decade. This has been a steady increase, even during the recession.

Germany Inflation CPI 7
(Source: Destatis, 2016)

Another important category is housing and in particular gas and electricity. Germany passed its green energy agenda in the last decade in order to turn to more sustainable sources of energy in the long run. Many have argued that this has contributed to the significant cost increases in electricity. Electricity prices increased steadily from 2005 to 2014 by more than 63 percent. From 2014 to 2015 they fell slightly. From 2012 to 2013 alone electricity prices rose by almost 12 percent. However, the price of liquid fuels at its peak in 2012 was actually even higher; compared to 2005 it was almost 66 percent higher. Liquid fuel (oil) prices were much more volatile than electricity prices over the last decade. During the recession liquid fuel prices fell to 2005 levels and since 2012 they have become significantly cheaper for German consumers. The tremendous fall in oil prices is also one of the reasons for low inflation recently and might push Germany into deflation if the fall continues. In comparison, gas and central heating rose a lot until 2009 but have recently receded to 2008/09 levels.

Germany Inflation CPI 8
(Source: Destatis, 2016)

Transport includes air, waterway, road and railway but CPI data on the latter is only available from 2010. Hence it is not included in the diagram. One can easily see that, while all means of transport have become more expensive, waterway is by far the most expensive today. It increased by more than 63 percent from 2005 to 2015. Air travel prices rose significantly until 2012 and have more or less stagnated since then. The highest increase in air travel prices occurred over the period from 2010 to 2012 where prices went up by more than 20 percent. In comparison, road transport actually rose in tandem with the CPI at least until 2013. But over the year from 2014 to 2015 prices in this category increased by more than 12 percent, despite the stagnating CPI, making other alternatives like air travel more attractive.

Germany Inflation CPI 9
(Source: Destatis, 2016)

As mentioned earlier, communication was the only category that actually saw a decline in prices. This is largely due to cheaper telephones (smartphones) and the advancement of technology. Over the last decade, telephone prices have fallen by more than 68 percent. Prices for telecommunication services fell by almost 19 percent. On the other hand, postal and courier services prices stagnated until 2012 but have picked up recently.

Germany Inflation CPI 10.png
(Source: Destatis, 2016)

Price increases in the category newspapers, books and stationery differed in the last decade. While newspapers and periodicals have become more expensive, i.e. more than 45 percent more expensive than in 2005, the price for books has risen to a much lesser extent and actually declined slightly from 2014 to 2015. Book prices stagnated until 2008 and were back to 2005 levels in 2011. On the other hand, stationery and drawing materials rose in tandem with the CPI.

Germany Inflation CPI 11
(Source: Destatis, 2016)

Lastly, I want to take a closer look at education. The CPI component ‘services of secondary education’ is only available from 2010 and therefore not included in the diagram. Still, the picture is an interesting one. By 2008 tertiary education prices had more than doubled. This was caused by the introduction of tertiary tuition fees. But in the years that followed these fees were abolished step by step and by 2015 none of the federal states charged tuition fees anymore. The spike in the price for tertiary education also drove the CPI Education index (in green) in total. It therefore hides the fall in the price of pre-primary and primary education from 2007 to 2012. By 2012 prices in this category had fallen by more than 10 percent. In 2015, they were back at 2005 levels.

I hope you enjoyed today’s exercise. It gives some insight into the major differences in inflation across different categories of the CPI basket. Thanks for reading!

Jasse


*moderate to low inflation

Destatis (2016). Consumer price index: Germany, years, individual consumption
by purpose (COICOP 2-4-digit hierarchy) [Data file]. Retrieved from: https://www-genesis.destatis.de/genesis/online/data;jsessionid=B59BF66301C1C234D86C5CD4208C6CFF.tomcat_GO_1_1?operation=abruftabelleAbrufen&selectionname=61111-0003&levelindex=1&levelid=1462699226069&index=3

Germany’s Shrinking Middle Class

The DIW has released an alarming new study on the shrinking middle class in Germany. It also links neatly into the debate of rising income inequality. New calculations based on the Socio-Economic Panel (SOEP) revealed that Germany’s middle class shrunk by 6 percentage points from 1991 to 2013 (Grabka, Goebel, Schröder and Schupp, 2016). This is as alarming as the adverse developments in the USA.

Germany income inequality 1
Diagram 1 (Source: Grabka et al., 2016; World Bank, 2016)

Germany’s middle income class includes all people in households that earn a gross total income of 67 to 200 percent of the median. The country’s middle class is still the largest income group today. However, the DIW study reveals that Germany’s middle class is now on decline. This is due to the fall in the middle-income group’s share in the adult population, meaning that less people earn a wage (high or low enough) to be classified as ‘middle class’. On the other hand, there has been an equal increase in people earning more or less (Grabka et al., 2016).

The DIW states that over the period from 1983 to 2013 the middle income group’s share in the adult population declined from 62 percent to 54 percent. This 8 percent decrease has been redistributed evenly to the other income groups. While 4 percent entered the low income and lower-middle income group, the other 4 percent entered the upper-middle income and high income group (diagram 1). Furthermore the middle class also saw a significant decrease in its share in total income while the high income group saw a significant rise in its share in total income. The study finds that the middle class’ share fell by more than 10 percentage points over the period from 1991 to 2010 (Grabka et al., 2016).

 Table 1

Gini Coefficient – Net Household Income

Year Germany West East
1991 0.247 0.245 0.205
2011 0.288 0.291 0.257

(Source: Sachverständigenrat Wirtschaft, 2015)

The DIW findings are not completely new. The Sachverständigenrat Wirtschaft releases a periodic study on income and wealth distribution in Germany. Its analysis published in 2014/15 (also based on the SOEP) showed similar trends. The study revealed that Germany’s Gini coefficient in net household incomes increased from 0.247 to 0.288 in 2011. Thereby it actually peaked in 2005 with a coefficient of 0.293. Importantly, income inequality is still greater in West Germany (0.291) compared to East Germany with a Gini coefficient of only 0.257 (2011).

 Table 2

Gini Coefficient – Equalised Disposable Income

Year Germany West East
1991 0.411 0.406 0.375
2011 0.485 0.472 0.529

(Source: Sachverständigenrat Wirtschaft, 2015)

When one looks at equalised disposable incomes (Marktäquivalenzeinkommen), the problem of income inequality becomes even more apparent. The Gini based on equalised disposable incomes has seen an increase from 0.411 in 1991 to 0.485 in 2011. Importantly, East Germany has seen a significantly greater increase than West Germany and is now more unequal than its counterpart. While East Germany’s Gini was 0.375 in 1991 it had risen to 0.529 in 2011. Over the same period West Germany’s Gini only rose from 0.406 to 0.472.

Germany income inequality 2
Diagram 2 (Source: BPB, 2014; Sachverständigenrat Wirtschaft, 2015)

The rise in the Gini coefficient can be shown graphically if one constructs Germany’s Lorenz curve for 1991, 2005 and 2011 based on the SOEP data (diagram 2). It has shifted outward and, because the Lorenz curves do not cross, it is clear that income inequality has risen from 1991 to 2005 while it somewhat improved from 2005 to 2011. The diagram shows nicely that the main shrinking in the middle class happened in the 1990s and the early 2000s. When one looks at equalised disposable incomes, the story remains the same even if it is less pronounced (diagram 3). However, this Lorenz curve was already significantly farer away from the line of equality than the net household income distribution Lorenz curve in 1991.

Germany income inequality 3
Diagram 3 (Source: BPB, 2014; Sachverständigenrat Wirtschaft, 2015)

 

While Germany’s middle class is in decline and income inequality on the rise, it should be noted, that the country still performs considerably better than the OECD average and other highly developed countries. Germany’s society is still a rather equal society in international comparison. The inequality adjusted HDI sat at 0.853 in 2014 and recorded a loss of 6.9 percent in potential human development due to inequality. Thereby inequality in life expectancy at birth (3.7 percent) and inequality in education (2.4 percent) played only a minor role. The main driver is income inequality at 14.1 percent, dampening potential human development. In international comparison, however, inequality in income is at 22.5 percent for very high HDI countries and even at 23.6 percent for OECD countries (UNDP, 2015).

Hence income inequality is of concern now but it is not too late to revert these adverse developments. It should be a key priority to stop a further increase in income inequality so that the fruits of economic growth and development continue to benefit the larger share of the population. Germany needs to ensure that it does not miss out on people at the lower end of the income distribution and does not further diminishes its middle class which has been one of the drivers of the country’s economic success since the mid-2000s.

Thanks for reading my post today as this is an issue one should care about.

Jasse


BPB (2014). Die Soziale Situation in Deutschland: Zahlen und Fakten – Einkommen und Vermögen [pdf]. Retrieved from: http://www.bpb.de/system/files/dokument_pdf/08%20Einkommen%20und%20Verm%C3%B6gen_1.pdf

Grabka, M.M., Goebel, J., Schröder, C., and Schupp, J. (2016). Shrinking Share of Middle-Income Group in Germany and the US. DIW Economic Bulletin, 18, 199-210. Retrieved from: https://www.diw.de/documents/publikationen/73/diw_01.c.533123.de/diw_econ_bull_2016-18.pdf

Sachverständigenrat Wirtschaft (2015). Analyse: Einkommens- und Vermögensverteilung in Deutschland [pdf]. Retrieved from: http://www.sachverstaendigenrat-wirtschaft.de/fileadmin/dateiablage/gutachten/jg201415/JG14_09.pdf

UNDP (2015). Human Development Report 2015: Briefing note – Germany [pdf]. Retrieved from: http://hdr.undp.org/sites/all/themes/hdr_theme/country-notes/DEU.pdf

World Bank (2016). World Development Indicators: Germany. Retrieved from: http://data.worldbank.org/country/germany

The OECD Brexit Tax

While I do not have a blog post for today, I would like to point you at an informative study on BREXIT carried out by the OECD together with a speech of OECD Secretary-General Angel Gurría on the OECD’s key findings.

The key conclusions of Angel Gurría (2016) are:

  • the United Kingdom’s current EU membership is mutually beneficial
  • there is no upside for the UK in BREXIT
  • there are only costs involved in leaving the EU, both in the short-run due to increased uncertainty and in the long-run from a weakening in the UK’s international position
  • the future advantages for the UK stem from remaining in the EU

The OECD coins this bundle of negative economic outcomes, which the UK would buy itself into , the BREXIT Tax. It would weigh on the UK’s economy essentially for an unlimited time period, which is the worst case scenario for the still fragile economy after its sluggish recovery from the GFC. The UK would essentially kick itself out of the world race for the highest standards of living, making itself only worse off. What is more, Gurría points out that there are already real costs today. Firstly, the Pound has depreciated against the Euro and also business confidence has taken a hit in the weeks or even months leading up to the referendum. Secondly, the uncertainty regarding the outcome of the vote has also stifled economic growth.

It is more than worth reading or – alternatively – listening to!

Jasse


Gurría, A. (2016, 27 April). To Brexit or not to Brexit: A Taxing Decision [transcript]. OECD. Retrieved from: http://www.oecd.org/economy/to-brexit-or-not-to-brexit-a-taxing-decision.htm

OECD (2016). OECD study finds Britons will be paying a heavy “Brexit tax” for many years if UK leaves EU. Retrieved from: http://www.oecd.org/economy/oecd-study-finds-britons-will-be-paying-a-heavy-brexit-tax-for-many-years-if-uk-leaves-eu.htm