The Dark Side of Solar Power


Welcome to the second part of our solar series. While the principle of solar power seems friendly to our environment, there are quite a few drawbacks which need to be taken into consideration. They include (but are not limited to) land, water and hazardous materials use, their improper location as well as the impact of solar power generation on the electricity networks. Adding the drawbacks together darkens the carbon-free picture of solar.

dilbert green tech dubious

How to make friends at a Greenpeace rally

It takes lots of space
Last week we saw that currently, humanity needed around 3,200GW of power and that the yield of solar panels was currently around 100W per square meters.It implie that using solar power only would require 3,200 billion square meters of solar panels. This is equivalent to the land area of India.
Solar panels cannot be installed anywhere and have an uncanny habit of being set up near population centres and on/near arable land. There is currently around 16 million square kilometers of cultivated land. If solar panels were to take some of this space, this would reduce arable land size by 20%. Unlike wind farms, solar and agriculture struggle to cohabit. With a global population still rising, the question of the priority of solar panels over food crops will be acute in the coming years.


Let’s hope they just eat the grass

Water and hazardous materials use
Manufacturing solar panels is very resource intensive as we saw quickly last week. The most demanding phase is the two phases of purification of silica into polysilicon, representing ⅔ of the energy needed to manufacture a solar panel system (even Greenpeace says it).
Purifying silicon produces many by-product chemicals including the highly explosive and irritant silicon tetrachloride. The level of contamination deemed dangerous is 2 parts per million (there are 400ppm of Co2 in the air your breath for instance) and you can smell silicon tetrachloride when its concentration in the air is 1 to 5 ppm. In sum, once you smell it, you are in serious danger. This is only one step of the manufacturing process and the other steps also bring their lot of energy use and recycling challenges. So if producing a solar panel is requiring a lot of resources, at least once it is operating, it is payback time, right?

dilbert methane

Recycling irritant gas is tricky

Location Location Location
Sadly, as with real estate, location matters, more precisely it is better to put panels where it is sunny. You will smile at this obvious statement but as solar and renewable energy in general have become political issues, they have benefited from profligate national energy policies. Germany, one of the least sunny country globally has the largest installed capacity of solar panels globally (before probably being overtaken this year by China). A solar panel in Berlin in January receives on average nearly 7x less solar energy than the same panel in Khartoum, Sudan, one of the sunniest place on Earth.

insolation 2

Global insolation map

It affects massively the structure of electricity markets
Another notable issue with renewable energy is its impact on power markets. Power markets do not operate in real-time since a disruption of power production could crash the power grid, the famous blackouts. Rather, power producers engage in auctions where they bid their capacity of production at a certain price. This price depends primarily on their marginal cost of producing electricity. For a coal-fired power station, the cost of producing electricity depends primarily on the cost of the fuel: coal. For a solar power producer, the cost of the fuel is free.

Once the power market system operator receives all the bids from producers and the demands of energy from consumers, it will create a market price for the upcoming period. Any power producers having offered their capacity at a too high price will have its capacity idled for the next phase. Since renewable energy producers have a zero marginal cost of production, they are preventing these fossil fuels producers from offering large stable outputs of power as their bids are lower.

The consequence is that these fossil fuel power plants, designed to run continuously, are now operating as low as 20% of the time. Coal power plants are  slow to start – to compensate, power system operators will rely on very polluting oil-fired power station.

Paradoxically, more solar power has kept the very dirty power plants alive. Moreover, solar power output is sun-dependent. This variability of production is a new challenge for power system operators: on very sunny day around lunchtime, solar power can supply 80% of the German electricity demand. However, one big cloud and this power production can quickly drop, requiring the immediate start of dirty power plants.


The “Merit Order”

Solar power have been costly to pioneer countries like German. One last negative has been the huge subsidies absorbed for their deployment (retail power prices in Germany have quadrupled since solar subsidies were introduced). These drawbacks are being worked on and we will see next week how solar can now be an effective proposition.

“Let the Sunshine in…”


2016 has arrived and on the excellent lyrics of Hair, I wanted to wish you a Happy New Year. Have you taken some good resolutions? I have certainly noticed more people in my gym this week. One of my goals for 2016 is to continue this column and manage to get an ever bigger readership. I am happy to dedicate some of my personal time for a few reasons:

  1. It is a great way to reconnect with you
  2. I love writing, especially about financial, economic and innovation topics
  3. I would like to have a column in a newspaper in the future.

To start this year, I am trying to skip the usual lists – I have no idea now in January what will be the most important events of the year. Rather, I am going to write a bit more about previously out-of-fashion countries / industries / ideas where I believe we are reaching an inflexion point. I am going to concentrate first over the next 3 stories on solar power. Billions were spent in recent years in many countries subsidizing solar power and colossal amount of capital wasted by investors on corporations building panels or operating solar farms. However, there could be good reasons that this industry is now more mature and ready to contribute to our lives in a bigger way.

'Following your 'barbecue summer' forecast, I'm revising predictions of your contract being reviewed.'

Why forecasting can be a waste of time

First, how do you generate electricity from the Sun?
Solar cells are not new – actually we can trace back the first solar electricity production to 1839, when Mr Becquerel casually exposed a chemical battery to the sun to see if it produced a voltage. It did and the current generated represented only 1% of the solar power received on the battery. In the 1880’s, Charles Fritts used gold-plated selenium to produce current, at a 1% efficiency rate again. He concluded that solar cells could replace traditional power plants with individually powered residences. Thomas Edison had just invented the light bulb in 1878. Quite a prescient man!

Today, the manufacturing process requires many intensive steps:

  1. Take some pure silica or quartz gravel, treat them with phosphorous or boron to create silicon. While silica/quartz is cheap and widespread, Boron is a “rare earth” and costs $5 per gram (10 times costlier than silver)
  2. This silicon is not pure so you have to purify it in 2 steps. The first step transforms it into a metallurgical silicon that can be used in metal alloys. For solar panel and semiconductors (the chips in your laptop and mobile phone), we need a second purification. This is mightily energy intensive and multiply the price of this purer silicon by a factor of 10!
  3. Once the pure silicon is produced, it goes through yet another converting process enabling the silicon atoms to be positioned in a more robust crystal shape.  The large blocks produced are then sliced into thin “wafers”. These wafers are cut by black diamonds and up to half the material is lost in the process.
  4. Assemble wafers together to form a panel, place electric contacts that will gather the electric current
  5. Add an anti-reflective coating: indeed, silicon reflects ⅓ of the light it receives so we need to reduce that loss.
  6. Seal the panel to protect it and you can mount it wherever you need
  7. Add electric cables, transformers, etc to complete the installation.  

Through these several steps, there is much waste – I detailed these steps more on the blog itself. However, while there is wastage, the sun is still sending us lots of energy.


Assembling a solar panel

Second, how much energy can we garner from the sun?
Our sun is pouring a deluge of energy on Earth. We receive on the ground around 120PW – 120 petawatts (i.e. not reflected by the upper atmosphere) of energy from the sun. A petawatt is one million gigawatts (GW). One gigawatt is one billion watts (definition of a billion here).
In comparison, the new EPR nuclear reactors under construction in Finland and France have an electrical power of 1.6GW, which is therefore 75 million times lower. The Earth nuclear reactor fleet comprises currently 437 units with 66 under construction, with an installed capacity of 375GW, which is still 320,000 times lower than what we receive from the sun. Since nuclear is 12% of the electrical power output globally, we can calculate that the sun still delivers roughly 40,000 times more energy than what we humans produce! All that for free!

there must be a source of nrg

It is above your nose

Harnessing this deluge of energy makes therefore sense.
The average power delivered per square meter on earth is calculated at 1,366W per square meter. Currently, solar panel technologies generally capture 20% of this power (remember that Mr becquerel and Fritts only managed a 1% efficiency). But this is achieved in best-case conditions such as peak insolation time, no clouds and being close to the equator for the best sunlight angle. Therefore, average operating conditions yield a more paltry 100W/sqm with the current technologies.


1366 watts

The sun pours dozens of petawatts on our heads at any given time. So why are we not using more solar power? There are many impediments which we will cover next week.

By the way, I am in New York the whole of next week – if you happen to be there and are available for a coffee or a burger, let me know.

Weather NY

Low voltage in New York next week

Is this the worst industry in the world?


This week, I will not talk about the over-commented US raising interest rates. Rather, there have been quite a few mergers in an industry which is central to our economies. I will tell you a bit more about this sector and why it deserves this title.

Worst in the world?
Imagine an industry where investments in productive assets are very large, so large in fact that buying one extra unit of capacity can bankrupt you if you misjudged the market. Your fixed costs are massive: your asset need constant care and will lose value and operational efficiency if you do not tend to it for just a few weeks. Having your asset idle will cost you nearly as much money as having it in operation, therefore you need jobs constantly to cover the large expenses.
There is a lot of competition on the market: the service you offer is not differentiated – everybody offers the same thing. Your only lifeline is your price (lower than rivals if possible).
For all that, the margin you can generate is probably 10-15% in great years (Apple margins are above 40%) and -10% or even lower in recessions – actually, over the cycle, you will be around break-even.

cartoon shipping

Strategy of the industry 101

In the long run, one positive is that there is structural growth. However, your and your rivals’ capacity is often growing as fast if not faster than demand, preventing prices to rise durably. More recently, some larger players have been able to increase capacity quickly by adding larger assets with much lower costs of operations: basically, they can generate a 5pp better margin than you, meaning they can gain market share by cutting prices.
Sadly, you have no other choice than cutting your prices to keep some business. You too are looking at buying these similar large assets so you can compete on price with these larger rivals. However, your smaller size means that you are taking a much larger risk. For you it is quit or double.

Would you invest in this industry?
Yet, despite the adverse fundamentals, maritime shipping is still attracting a lot of investor and banks’ money. I think it is a worse industry than airlines, another industry you may have thought of by reading these lines. At least in airlines, there is some differentiation in service and routes offered.
A quick nomenclature of shipping is helpful at this point:


What you can ship

Shipping is so bad that it is nearly impossible for a stockmarket investor to make good money in these stocks in the long run, whatever category you are looking at. The largest container shipping company globally is Maersk Lines, from Denmark. Maersk are the true market leader, the only company profitable in downturns. Since 1990, world container trade has expanded by close to 10% annually. Maersk has risen from outside the top 10 shipping companies in 1990 to global leadership by 2000, a position it has strengthened since.
Yet, the share price of the parent company has been rising by 8.5% per annum during that period. The best company could not grow its worth as fast as the market where it is becoming dominant! Imagine how it looks down below!

'Could you bring in that list of risk factors you downloaded yesterday?'

An investor checklist

A new hope?
As I eluded earlier, this industry has been traditionally very fragmented. However, we have seen over the last few years many mergers and acquisitions which are progressively reshaping the industry. Take container shipping again. The table below shows the growing control of the top firms on this market.

shipping ranking

This has been possible because the leading players have been investing in much larger ships, which costs less per TEU to operate, creating efficiency enabling them to lower prices and gain market share, which was reinvested into bigger and bigger ships – pushing down shipping rates further and squeezing out weaker players out of the market.
Current ships are massive. The Triple E container ships can hold 18,000 containers, enough to carry 180m IPADs or 36,000 cars or 108m pairs of shoes in one go. The ULCC tanker ships can carry up to 2m barrels of oil (enough to fill one million bath tubs).
This scale is helpful because it helps lower the cost of maritime shipping. For instance, the chart below displays the Baltic Dry Index, reflecting the cost of shipping dry bulk. As you can see, over the last 30 years, while there have been fluctuations, the index is nearly twice below the inception price of 1000. This is not taking into account inflation, which was 2.6% annually over the period. This means shipping dry bulk has cost clients 4.7% less each year other the last 31 years!

bdiy LT

Back to normal service

Last but not least.
To me, an industry were your price falls by nearly 5% a year deserves the title of worst industry in the world. However, the suffering of the ship investors and bankers is our gain, since it allowed a rapid expansion of global trade which in turn helps us buy inexpensive Chinese gadgets for our Secret Santa at work. To finish, two surprising facts about global shipping. First 15% of the global fleet is owned by the Greeks. Second, the next biggest container shipping company globally is MSC of Switzerland, a country with no access to the sea!

ship in 2 bits

One solution for parking your big ship: fold it.

Best Wishes
Thank you very much for reading me all these weeks. The Little Friday Stories will take a break for the festive season and come back on the 8th of January 2016.

Are we going to win the fight against greenhouse gases?


My home city of Paris is holding the Cop21 summit until tonight, where most nations are gathered to discuss ways to contain global warming to a rise of 2 degrees. There is even a coalition to contain warming to 1.5 degrees, with the USA as one strong proponent. Several things caught my eye around the Cop21 summit:

  1. Global Co2 emissions are falling for the first time ever (?) in economic expansion: I think they have peaked. Sadly, the stock of greenhouse gases will continue to increase
  2. Developing countries, led by China, are no longer adhering to the mantra of pollute now, clean later. This means they are going to pollute less than expected which in turns means that optimistic scenarios are probable
  3. Consensus is building for a carbon tax among industrialists which means that for the first time, politicians have an open road to finally act.

But first, let me tell you one key thing: I believe in climate change and its consequences.


Reindeer 2.0

Peak emissions
The most under reported event of 2015 is the fact that global greenhouse gases emissions look to have peaked this year, despite a global economic expansion of 3.1% and a global population growth of 1.1%. This follows a stagnation in 2014 despite a 3.4% global GDP growth. This breaks a cycle of a 2% annual rise in emissions since 1990 (and 2.4% annually since 2000).
The main culprit of the rise in emissions was China (emissions up 7.8% annually since 2000 and 6.1% annually since 1990). It is responsible for ⅔ of the rise in emissions globally since 2000. There is hope though. In China, emissions rises were mainly due to the infernal trio of power generation, industry and transportation. Power generation depends on coal for 80% of its input.
Good news, annual coal consumption growth is now stagnating: poor power plants are shut down, the remaining ones being more efficient. Industrial use of fossil fuels, such as metallurgical coal should now decline as Chinese use of these materials has peaked. For instance, Chinese steel demand peaked in 2013. It is falling 3.5% this year and will fall 2% next year according to the World Steel Association.

coal use

Finally, while the Chinese auto market boomed (2015 sales doubled compared to 2009’s for instance, at more than 20m units a year), emission standards are finally becoming more stringent. In 2007, China introduced its China-III emission standards which were as demanding as the Euro 3 standards introduced in 2000 in the EU, a 7 year delay. The new China-5 standards (I hope you noted how they went from a Roman to an Arabic digit), to be introduced nationally in 2018 but already compulsory since February 2013 in Beijing and April 2014 in Shanghai, match the EU Euro 6 standard introduced in September 2014, reducing the gap to a bit more than 3 years but ahead for the first time in major Chinese cities.

Developing countries are leading climate change fight
Another very important factor in the containment of emissions in the fact that major developing countries now put climate as the top of their agenda. China is in this group, the world’s worst emitter with 30% of the global total. In China, air quality has become so poor that it threatens the very dominance of the Communist party. China has the most ambitious programmes in favour of a greener economy, starting with cleaner power generation. By 2020, the country ambitions to have 300 GW of installed capacity in hydropower (damn), 200 GW in windpower (phew) and 100 GW in solar (blush). 500GW of capacity or roughly the installed capacity (all fuels combined) of the Benelux, France, Germany and the UK or a bit less than half the US.

But China is not alone. Many emerging countries have recently cut energy subsidies: Cameroon, Ivory Coast, Egypt, Haiti, India, Indonesia, and Malaysia have slashed their support to fossil fuels in recent months. This is needed given the $500+ bn spent yearly supporting fossil fuels. Even Saudi Arabia, probably the worst offender relating to energy subsidies is considering cutting them. This would reduce its current $100bn subsidy bill but mean that local motorists would no longer pay $0.05 per liter of gasoline.

china haze

Blame the camera, not the photographer!

The Carbon Tax

Of course, whatever politicians may want to achieve can often be defeated by lobbyists. In this case though, corporations are starting to reverse their thinking. Check these 59 multinationals signing a call for a carbon tax . Polluting industries such as Global Aviation or the Finnish Industries (emitting lots of Co2 via their paper and steel mills) are participating.
Let’s not kid ourselves: a carbon tax is another way to reduce competition from shakier rivals. However, the joint action means that politicians will not hide inaction for long.


A sight of the past

There is good hope that pessimistic projections on global warming can be defeated. I would even expect that a far-reaching agreement be signed tonight to conclude the summit since all major economies are aligned. To finish, another data point making me optimistic: the energy intensity per unit of GDP (see below). The world keeps being a more efficient user of resources. Developing economies use much more resources to create one unit of growth, making environmentalists fear for the future. For instance, India needs 4x more energy to create one unit of GDP than Europe. However, if intensity falls back quickly, then the energy use of these countries may rise very slowly and could be compensated by developed countries and green technologies.

globa energy intensity

Global energy intensity has fallen by 1.4% annually since 2000 – GDP rose 4.4% annually during that time, implying that the world used 2.9% more energy every year.

December competition
Well done to the participants. I thought there were two people not looking but having received several “3s”, I had to look again and found a third person indeed. A chocolate box is going to Switzerland (you have to appreciate the irony) this week-end.

We need to talk about Korea

I just visited my brother who lives in Korea – the opportunity to visit this country stuck between two major economic and touristic magnets that are Japan and China. On an economic and financial basis, Korea has been a very interesting subject of observation as it is probably the least known of the major global economies.


Gangnam – in real life less exciting than the song

A few facts
With an annual growth rate in GDP of 8% from 1962 to 1989, South Korea over compensated its low natural resources endowment and tiny home market to become an export powerhouse. Think of Samsung as a global household name.
Several aspects of the Korean capitalism are worthy of a mention:

  • The economy is in the global top15, the size of Canada’s, a member of the G8
  • The economy is dominated by a few industrial conglomerates called Chaebols
  • Most fortunes outside of the heirs of Chaebols were made in property

I will detail some observations below.

korea ghana

The Korean Tiger and the Ghanaian Eagle – a modern twist on La Fontaine.

Slowly becoming European
One aspect I did not expect was finding many marks of Europe. Some are great such as the well-developed coffee culture – there are tons of places to sip a cappuccino. Others are some economic ills such as large youth unemployment (20%), a rapidly aging workforce, a national pension fund which is facing bankruptcy without reform and taxation which is increasing for higher income individuals but decreasing for large domestic corporations. Last but not least, the government is adding rights for workers, such as severance pay at the smallest firms or extra holiday entitlement after a year of service (15 days vs one day off a week and the 1st of May), Paradoxically, as Europe tries to cut entitlements, Korea adds to the protection level. This will not affect the competitiveness of the economy much as Koreans are not confronting their employers: severance pay is therefore rarely paid at all to avoid losing face.

The Chaebols
One of the fascinating aspects of Korea is the Chaebols. They dominate the economy, with the top10 representing 3/4 of GDP! In the US, Berkshire Hathaway, Warren Buffett’s conglomerate, owns only 5 of the Fortune 500 companies. If it had as much reach as Samsung in Korea, it would own 140 of them!
The biggest ones are by order Samsung, Hyundai / Kia, SK, Hanwha, LG and Lotte. Most economic sectors will be oligopolies controlled by a few Chaebols. For instance, electronics are dominated by Samsung, LG (think of the TVs) and SK (owner of Hynix, making the memory of your Apple products). This has one major consequence: the Small and Medium Enterprises cannot develop since their clients are the Chaebols. Which created a feudal relationship whereby SMEs are paid and given contracts when the Chaebol so wish. All is well when the Chaebols are growing fast but growth has slowed recently. SMEs cannot bring innovation to the market since their main customer would then block them off. This can explain why Chaebols are controlling an ever-bigger part of the economy while the average GDP growth has slowed. Clearly not the good recipe for the long run.


Korea’s very own 1% tale

South Korea welcomes around 250,000 immigrants every year, which is needed to combat the rapid demographic aging (the fertility rate is an ultra-low 1.2x). Around 2/3 of the immigrants come from China and are ethnic Koreans. Other immigrants come from the Philippines, Thailand, Vietnam and increasingly from the Asian Caucasus nations such as Uzbekistan. On a 50 million population, this compares well to the million immigrants to the US (population of 320m), 400,000 in Germany (80m) or 300,000 in the UK (65m). This topic is quite controversial given the youth unemployment and rarely broached in public. It is different to Japan where immigration is not only a taboo but also insignificant.

Reunification of both Koreas – prospects
A reunion of both Koreas would combine the strength of the North: large mineral wealth, access to many rail links to China and Europe, a young population to rejuvenate the whole, with the current prosperity in the South. However, the German experience show how complicated such process can be. Let’s look first at a few numbers to compare Germany and Korea.

Translating this into ratios may help us further.


There are three scenarios:

  • Full integration by the South

When you visit the DMZ, the demilitarized zone marking the frontier, the guides and tourist videos entertain the aim of reunification, with the South leading. It seems that the appetite for this scenario comes from the North mainly as they look favourably at the financial support in offer. Looking at the tables above, the cost of reunification would be a factor of magnitude higher than the German experience. South Korea cannot shoulder this level of expense. What the tables do not highlight is the total lack of infrastructure in the North. It has no banks for instance: even if the South were to send money, the population would not be able to receive it!

  • One Country – Two Systems

This is the preferred view of the South, on the model of China and Hong Kong (reversed for this case). A strong cooperation would allow the North to catch up with the South over a few decades before a reunion can be envisaged. This scenario would be less costly and more flexible but the North is obviously less keen.

  • No reunification

This is my belief. Both countries have started to diverge culturally – the language spoken is not the same anymore while the younger South Korean generation does not care about the North. Given the difference in GDP per capita ratios, if the North were to grow at 8% pa while the South grew at 2% pa going forward, there would be junction in 62 years only. Imagine a peaceful to democracy transition within 10 years in the North. Add these 62 years and it will be 2087 before both countries are matched economically. Both countries were separated since 1948 – it is unlikely to me that both populations could consider a reunion after such a hiatus. In addition, there has to be a strong support in the region for a reunion. Neither China nor Japan want to see a 75million people economy with nuclear weapons on their doorsteps.


How many North Koreans do you need to change a light bulb?

December Competition
Once again, I would like to invite the winner to have breakfast with me and if we cannot be in the same city, I will send him/her some chocolate before Christmas.
One amazing feature of Seoul were the people glued to their phones, which promises many neck pain and eye conditions going forward. Look at the following video. Count the number of people not on their phones and leave your answer in the comments section of the blog or by email before Wednesday 9th of December. I will then draw the winner among the right answers.

Seoul Metro Mobile Phone Lovers

How to reduce inequalities through better taxation?

This week, Pfizer, a US pharmaceutical behemoth, proposed to buy US rival Allergan for $160bn. One of the attractions for Pfizer was the ability to save $21bn in tax through the process of tax inversion. A tax inversion is the relocation of your tax domicile in a lower tax country. Allergan is registered in Ireland, where the corporate tax rate is 12.5% versus the US’s 35%. This is another example of a multinationals shifting profits.

dilbert tax inversion

Tax inversion can lead you to unsavoury juridictions

It is obvious that tax savings are helpful to create value for Pfizer’s shareholders. This made me think of the fundamental difference between corporation and income taxes, their role in wealth creation and why, in order to reduce inequalities, we actually need to lower income tax rates and increase corporate tax rates. Yup, you read correctly.
The misunderstanding comes from the fact that the base for corporate and income tax are very different. Let’s imagine a country where income tax is 30% and corporate tax 20%. Imagine two consultants. They have the same skills, generate the same income of €100,000 per annum and have the same spending patterns as illustrated below:john and jane spendingThere is one major difference though: John is employed while Jane is an independent consultant, billing her work through her own corporation.While in appearance, John and Jane have the same decent revenue, they will not accumulate the wealth at the same pace. Let’s start with John.

john taxation

Note that this is a good result as many people fail to save.

What about Jane? She bills her clients €100,000 pa through her corporation. However, a corporation allows her to expense many items. She works from home often? Then half her mortgage and bills can be expensed as a “home office cost”. She travels to meet the clients? Then she can expense her travel and the lease costs on her car. Dining out and the Golf Club membership are marketing outlays to woo clients. Laptop and phones are deducted as office equipment. Finally, she conducts her annual board meeting in the Bahamas where she happens to take her vacation. Jane’s corporation’s tax return will look that way:
jane taxationSince her corporation was taxed, Jane can draw some dividends from this net result free of income tax, I spare you the details of the calculation and give a rough €30,000 estimate. Jane will now be taxed on her income from her corporation:Jane Taxation 2While (V) looks lower than John’s, remember that Jane already deducted most of her expenditures through her corporation. She just has to pay half her mortgage and utility bills by herself and the discretionary spending items or €25,000.  What is left to save is therefore €23,200, which is €8,200 more than John.Jane puts one third more than John in her pocket from the same revenue. This money can be reinvested to generate bigger profits down the line.  This is how inequality is created through the tax system. This is why either income tax rates must fall or corporate tax rates must rise or both in combination.

shoes dilbert

Jane may struggle to expense her shoes though

Of Symmetry
Therefore, when I hear calls to increase income tax rates, I cringe. It ignores the fundamentals: an employee earns money, gets taxed and then can spend. A corporation earns money, spends and then gets taxed. Demanding higher income tax rates can only increase this asymmetry.

Now, let’s check some national examples. In the UK, the current Conservative government is working to cut corporation tax rate from 25% to 18% by 2020 while keeping the 45% income tax rate. They thus confirmed their reputation as working for the wealthy.

In France or Switzerland, there are many allowances for individuals to reduce their taxable base. Dividends are taxed at high rates, further reducing the advantages of corporations. However for France, the “prélèvements sociaux”, another tax, suddenly wipe out the previous positive impacts.

Last but not least, the US. The 2001 Bush tax cuts helped reduce marginal income tax rates but they also slashed capital gain and dividend tax rates from the marginal income tax rate to 15%. In the end, the asymmetry was not eliminated and the lower rate on dividends explain easily why former presidential candidate and millionaire Mitt Romney can pay an effective tax rate of 15%.

To solve the inequality crisis, the US needs comprehensive tax code reform. The US presidential election is in less than a year – let me know if you saw an astute tax reform in the candidates’ platforms.

tax rate dilbert

Citizen Warren Buffett is also donating most of his shares to attract a sizeable tax break.

PS: this week and next I am travelling so you may not hear from me next Friday. Have a great week-end.

Will the Paris terror attacks derail the economic recovery?


Following the sad new terrorist events in Paris but also in other locations around the globe, I was astonished to see global stock markets rising on Monday the 16th (the CAC, the French stock market index fell a small 0.1%). Are markets really that insensitive or are they missing the economic impact of such barbaric acts? Indeed, looking at the data, the first piece of bad news is that terror is on the rise globally.

deaths from terrorim

This is from the 2015 Global Terrorism Index Report link. A ninefold increase in deaths from terrorism since 2000!

As more people lose their lives, I would expect the global economy to start being affected, either immediately or in the long run (the loss of lives detracting GDP as seen with the concept of value of life). I have looked at economic and financial markets studies on the impact of terror. Looking at financial markets is a good indicator of short term impact as markets usually over-react. For instance, Andrew Karolyi of Ohio State University looked at 75 terror events, including the 11/09/2001 in the US which saw the US financial markets closing down for a week. I was interested in the following findings:

Firms closely related to the terrorist attacks feel the largest impacts
In 2001, airlines’ share prices halved in the following month of 9/11 given the new restrictions on air travel. This week, shares in French hotels, airlines and luxury companies fell by a few percent. Some shares/sectors move the opposite way: for instance, defence or security companies exhibit gains as the markets expect higher revenues due to heightened security spending. Also, some companies’ shares gain at the expense of their hit competitors as it implies market share gains.

Durable economic losses are linked to asset losses
If you are an oil company with one oil platform and this one is damaged, your shares may never recover because your source of revenue is impaired. If a truck delivering Coke bottles is destroyed, the ability of Coca-Cola to generate profits will not change and its share price will not move. Looking at Paris last week, the Bataclan concert hall and the cafés owners should suffer temporary losses but these assets could be repaired.

paris rose balle

Sadly only the building can be repaired

Firm value impact remains modest
Another finding which was important in significance is the average market capitalisation impact. Market capitalisation is the value of all outstanding listed company shares. The study finds an average impact of $401m. If you compare to LVMH, a luxury goods maker, owning for instance Louis Vuitton, whose market value nears $90bn, we would talk about a 0.6% impact.

An explanation for the minor stock market impact could be that some countries and companies are diversified to withstand the effect of terrorism. For instance, while France tourism is a major sector of the economy, it represents only 7% of its GDP. In other words, the French economy is diversified and this is reflected in the stock market index being resilient.

The corollary to these findings is that it is unlikely that terrorism would impact the stock market decisively – other factors are more prominent. For instance, India is one of the worst-hit country from terrorism globally. Yet, Indian GDP growth is more affected by the lack of infrastructure, bureaucracy and corruption than terrorism. From that perspective, it is not surprising that bourses in the developed world did not blink.

Where financial markets can be wrong
Two important findings of many studies on the impact of terror on the economy is linked to the scale of damages and the protracted level of threat. In Iraq or Syria, the level of damages are colossal and these states have now failed. Looking at the Paris events, while the material damage is insignificant relative to the size of the economy, what now matters is the psychological damage.

terror damages

The material cost can hide the total impact

A low-level of permanent threat can discourage investment, reduce consumer spending, frighten foreign capital and therefore reduce growth. There are numerous examples. Israel computed a 4% GDP loss due to the 2nd Intifada between 2000 and 2005 despite much higher security spending as consumer spending dived. Spain may have seen its GDP amputated by around 10% since the 1970’s due to the low-level terror in the Basque Country: many entrepreneurs curtailed investment faced with the revolutionary tax claimed by ETA, the local terrorist organisation. In Colombia, 1.2% of current GDP is spent annually compensating victims of the civil war.

To finish
To encourage ourselves, let me examine a positive example: in the US post 9/11, the feeling of security was restored quickly. Employment in tourism fell 3% in September and October 2001 before rallying the next months. Looking at the cost of hotels in New-York, I cannot see signs of low tourist demand. Let us be confident that our democratic governments are working to suppress threat levels and therefore ensure long term growth will not be affected.

image paris tour eiffel tricolore

Last tribute to my home city