Corrected: INSIGHT: Debt overhang and demographics hobble chems

28 January 2013 17:10  [Source: ICIS news]

Correction: In the ICIS news story headlined “INSIGHT: Debt overhang and demographics hobble chems” dated 28 January 2013, please read in the 19th paragraph … will shrink by about 13% (by 15.8m people) and in Japan by about 30% (by 23.8m people) … instead of … will shrink by about 13% (to 15.8m people) and in Japan by about 30% (to 23.8m people)…. A corrected story follows.

By John Richardson

PERTH (ICIS)--Global chemicals operating rates had failed to return to where they were before the global financial crisis by as late as November last year, as data from the American Chemistry Council illustrate.

Is this just an exceptionally prolonged downturn that will eventually be resolved through the concerted efforts of western central banks, governments and companies?

Or have fundamental changes taken place in the global economy that require new solutions?

The Boston Consulting Group (BCG) is firmly of the view that new policy initiatives are essential for tackling the underlying causes of the crisis.

"Since the Second World War, debt levels in the developed economies have continually risen, with a notable increase since 1980,” wrote BCG in a study released last December.

"According to a study by the Bank for International Settlements (BIS), the combined debt of governments, private households, and non-financial companies in the 18 core countries of the OECD rose from 160% of GDP in 1980 to 321% in 2010.

“In real terms, after inflation is taken into account, governments have more than four times, private households more than six times, and nonfinancial companies more than three times the debt they had in 1980."

The vast majority of this debt had not been used to increase future income, but had instead been employed to speculate on stocks and real estate and to pay interest on previous debt, continued the study.

The threshold for sustainable government debt in the developed world was a debt to GDP ratio of roughly 60%.

"Applying that threshold to non-financial corporate debt and private-household debt as well gives an overall sustainable debt to GDP ratio of 180%. Currently, the amount of debt above that level is approximately $11 trillion [$11,000 bn] for the US and €7.4 trillion [€7,400bn] for the eurozone,” said BCG.

"Although it is nearly five years since the onset of the financial crisis, we are still just beginning to unwind these massive sums."

Debt was only part of the problem, as the developed world's crisis had been greatly exacerbated by the hidden liabilities of governments and companies, especially in the case of health-care related spending,” said the consultancy.

The problem was that life expectancy had doubled and fertility rates had declined by more than half in the developed world, BCG added.

Meanwhile, the retirement age had been lowered significantly - so much so that the number of retirees supported by the working population had grown precipitously.

"The financial implications of this growing welfare burden are dramatic,” said the study.

“According to another BIS study, even in a benign scenario in which current deficits were reduced to pre-crisis levels and age-related spending was frozen at current levels of GDP, public debt would continue growing at a significant rate.”

Other problems highlighted by BCG included:

  • Private households being over-reliant on rising home-asset prices
  • A shrinking workforce. “A critical problem in the decades to come will be labour scarcity. According to projections by the United Nations, between 2012 and 2050, the working-age population between the ages of 15 and 64 in Western Europe will shrink by about 13% (by 15.8m people). In Japan, it will drop by 30% (by 23.8m people). China will suffer the same problem,” said BCG
  • Deteriorating Education Systems. The deteriorating quality of education in most advanced countries also undermined future growth potential
  • Systemic underinvestment in the asset base. Despite record-high profit margins, businesses in the developed economies had significantly reduced their investment in new machinery and equipment

One of the first tasks was to deal with the debt overhang, the study continued.

“The critical starting point is to accept the fact that many of today's debts will never be repaid and to embrace debt restructuring and defaults,” wrote the authors.

“Current policies, designed to avoid that outcome, only postpone the ultimate resolution of the crisis and will result in even bigger losses down the road. Better to move quickly and act now, despite the likelihood of considerable near-term pain.”

Unfunded liabilities would also have to be reduced, which would involve raising the retirement age, reducing social-insurance payments and making healthcare provision more efficient.

Other suggestions made by the consultancy included developing smarter immigration policies to compensate for declining labour supply in the West.

“With the oldest native population and an immigrant population close to zero, Japan faces the most severe challenge,” said the consultancy.

Germany was also struggling to attract well-educated immigrants because of the language barrier, while US immigration policy had become far more regressive post 9/11.

More investment in education and infrastructure was also needed, argued the study.

“Education has to play a significant role in the future growth potential of the developed economies. Quality education will be the decisive factor in protecting and increasing GDP per capita,” added BCG.

“For more than a decade, the developed economies have reduced investments in public infrastructure and productive assets. “

BCG called for more spending by governments on word-class infrastructure and by western multinationals on what it called productive assets.

“Western multinationals have used their free cash flow mainly to invest in developing economies,” added the consultancy.

“Now that these investments are paying off, it is time for them to reinvest in the efficiency of production sites in their home markets and work off the investment backlog. Governments need to encourage private investment.”

The scale of what needs to be done is quite clearly huge.

“The problem is also that companies are too much focused on the next quarterly results to care enough about longer-term plans. And, if you’re nearing retirement, why worry?” said an executive with a global polyolefins producer, who agreed with many of the BCG conclusions.

As for politicians, Jean-Claude Juncker, prime minister of Luxembourg, was widely quoted as saying last November: "We all know what to do, we just don't know how to get re-elected after we have done it."

Global chemical capacity utilisation

($1 = €0.74)

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By: John Richardson
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