Why don’t people feel happy despite high growth?
There has been a lot of discussions in this country as regards the veracity of growth figures. Not only monthly production figures obviously aren’t congruent with GDP data, which are a chained volume index only and measured based on administrative records, not on industry surveys as before, but also people think nobody feels like the economy is truly buoyant. In fact, in the old series almost half of the GDP couldn’t be directly measured, but imputed even when we look at GDP from the production side. Furthermore, since the growth model of Turkey has admittedly relied heavily on real estate & construction for so many years, the fact that the weight of this sector has increased in the new series and added to the fixed capital formation does sound logical. However, one thing is methodological innovation, another is the reliability of measurement despite methodological improvement. Anyhow, it is obvious that the head-on 2017 GDP print will be higher than 7 percent, surpassing even China’s 2017 growth rate of 6.9 percent. Where has all the income generated through such activity gone – since the great majority of households are indebted? Do consumer and sectoral confidence indices and suchlike reflect economic realities or not? Industrial production is strong, and is very closely correlated with GDP, but what has happened to employment? For instance, according to the latest survey, less people feel happy compared to 2016. Why don’t people feel happy?
We have already conjectured that growth is (was) real and the economy is still going to grow at high rates. In any case, nowcasting momentum pointed at a slightly higher than 7 percent in the first seven weeks of the year. If most people claim they don’t feel it, there must be an explanation. Look at corporate profits for instance. Large conglomerates have posted very high EBITDA increases widespread across sectoral activities, in some cases over 30 percent. Could it be that earnings growth is immersed only in profits, and wages deteriorate? If this is so, this squares with high real sector confidence and vibrant industrial production. Since the growth story isn’t momentum-driven alone, this drive will continue. From a fundamental analysis viewpoint, high EBITDAs provide a basis strong enough to issue bullish equity research reports, reports that predict around 20 percent bottom line increases over the next 12 months with a good dose of realism. Hence, there are two possible explanations. First, can it be that the distribution of income in the past year or years has become more unequal? Second, the sources of growth may not be conducive to inclusive growth.
How did it go? Well, first of all in the first three quarters of 2017 the contribution of fixed capital formation came entirely from construction investments, and we know that property development has visibly stalled in Q4 and possibly in Q1 2018. From the production side, qua sector, construction has only contributed 0.8 percentage points, but from the expenditures side fixed capital investments contributed to growth by 2.3 percentage points. Even when such investments looked vibrant in 9M 2017, the hedonic housing price index headed south, pulled by Istanbul house prices. Still, in 9M 2017 construction investments grew by 16 percent whereas machinery and equipment investments fell 2.4 percent. Now, investment is one thing, sales and real time pricing is another. Furthermore, there were times when mortgages fell, and they are rather weak currently. House prices that grow below inflation, given high bank deposit rates, point to a clear trend. Not only houses are not being bought for investment purposes, but existing homes lost value. This clearly implies a negative wealth effect. Even if current consumer expenditures continue in the main, many a middle-class household now think they are less wealthy than before because real estate property is an essential part of wealth.
Second, the real effective exchange rate stands at its lowest since… Again, for nearly a decade, people felt they were getting richer first on account of the appreciating lira, and second on account of its being perceived as stable. In 2004 and 2005, car loans and mortgages had blossomed, and that trend continued afterwards. Now, import prices are high, and given the spending habits of everyday folk – high-tech imported cell phones are pretty widespread for example - it is no wonder they don’t feel rich or even confident. These developments have found their way into confidence indices, spending patterns and so on. Clearly, consumer confidence fluctuates if not erodes. No, it doesn’t erode but it has fallen for five consecutive months, and now it looks, possibly temporarily, stable.
Third, banking is key. Loan rates are high, and loan volumes have fallen. With 14 percent (in fact it should be higher given related fee and commission items), mortgages look expensive to many because their duration is high by Turkish standards. Car loan rates are at 18 percent, high again. General purpose loans come in with even higher interest rate tags. Although total loans still grow at a hefty 20.2 percent annually (unadjusted), consumer lending growth – including credit cards - dropped to 0.1 percent per week (8-weeks average) and stands at 17 percent now. Annual figures don’t reflect current trends, and as incoming data replace old data, annual rates continue to fall. Housing loans’ annual growth receded to 14.8 percent, and car loans’ growth is stable at 4.8 percent annually.
Let’s consider wage formation relative to productivity and employment trends. The minimum wage increase has had an impact on unrecorded employment patterns both in 2016 and in 2017, according to a BETAM report. Accordingly, unrecorded employment, which has been falling throughout since 2005, dropped down by only 0.2 percentage point in 2015, and in 2016 it went up. Just one example: Unrecorded employment increased by 1.1 percent in 2016, although it had fallen by 1.3 percent the year before. The negative impact has basically found its way through low wage earners, but it is not only confined to those, and it is not even confined to wage earners alone. The whole employment structure has been affected by the raise, and the main reason is possibly the burden of insurance premia on employers. We can see the overall effect in the wage unit index graphic. Labour costs rose, and so did the unit wage index. However, productivity remained flat. Low wage earners – minimum wage and below - were hit most. So, we can assume that the low- est Gini 20 percent quintile has been pushed to unrecorded jobs, a development unseen in the last decade or so. Furthermore, the initial boost given by the minimum wage increase may have triggered consumer confidence in the low wage sectors at first, only to be curtailed through rising inflation and the shift towards informal jobs in the second round. In 2017, starting from Q2, both productivity and wages headed south, as the graphic depicts.
Still, there is growth and there will be growth in 2018 also. In the first three quarters of 2017, household expenditures added 3.8 percentage points to growth. We see that the consumer spent a lot but mainly when banking sector loans were rampant. Now, growth not only means value-added but also expenditures and earnings. If expenditures are quite sensitive to loans, then they are financed through debt. Where did earnings go then? This is the last argument. Profits are good. The pricing be- haviour has changed. In the landscape of industrial relations, there is no union power, and there has been almost none in the last decade. Still, regulations protecting some types of labour to a certain extent, government transfers, pay raises above productivity gains, availability of abundant and cheap credit, had rendered the debt/expenditure surface of the middle classes smooth for many a year. Now, the movements beneath the all-covering high GDP and industrial production growth rates, there are undercurrents that cut the other way round.
In conclusion, I offer the following tentative arguments. First, the lowest 20 percent Gini in the income distribution were positively affected at first, but the second-round effects seem to have wiped out the initial boost. That may have caused a loss of confidence, and a feeling of unhappiness through falling purchasing power in the last 3 or 4 quarters. Second, the two upper 20 percent Gini echelons that constitute the lower middle classes may also feel uneasy on account of slowing bank loans, rising credit interest rates, and for some of them even falling house prices that may have already caused a negative wealth effect. Third, lira depreciation has helped exports bloom – although the Euro/ USD parity and the growing confidence and buoyancy in the Euro zone may have helped even more - but it always causes a feeling of loss from the viewpoint of the consumer. Prices of imported goods go up visibly. Upper middle classes feel that effect. I also conjecture that the negative wealth effect can’t be totally offset by raising deposit interest rates because it isn’t easy to switch from real estate investments to TRY or FX-denominated deposits. Those who can, try to do that as we speak, albeit possibly at a cost over the initial expected return of property purchases.
Consumer confidence barely stands on its feet, I presume. Because what matters ahead of elections is the relative movement and the relative feeling vis-à-vis the recent past, we might well see further incentives, not only offered atop the real sector, but also to the consumer. For the rest, I don’t think non-core resource provisions from overseas will dry up, and I find interest rates already high. The likelihood of renewing syndications, securitizations and suchlike at a cost that is scandalously higher than last year is very low, even after the Fed curve sits tight in the neighborhood of its new equilibrium. From what I gather from the wage and employment data – by the way employment obviously couldn’t catch up with growth at the same rate as it would in yesteryears and with the old GDP series, but it is holding up and even rising, the liberal argument to the effect that increasing the minimum wage indiscriminately and at a high rate wouldn’t be conducive to the welfare of the worst-off is vindicated again.