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Economics as Framework for Corporate Strategy in 2010

U.S. Review

Economics as Framework for Corporate Strategy in 2010

• Despite all the news we receive, there are four economic issues that must be addressed before a corporate strategy can be rationally formulated. For the real economy, the challenge is the post-recovery pace of consumer spending and housing.

• From the regional perspective, has the era of California/Florida dreaming come to an end?

• Finally, what are the Federal Reserve’s and the Obama Administration’s exit strategies for monetary and fiscal policy?

Corporate Strategy in an Era of Uncertainty

Since World War II, the pace and character of consumer spending has defined the U.S. economy. Going forward, will this all change and what are the implications? What about housing? Finally, has the era of California/Florida dreaming come to an end?

If the American consumer has truly changed her spots and become a greater saving, less credit-using, more bargain-hunting species, then what will be the character of this recovery and the longer-run pace of economic growth? With consumer spending approximately 70 percent of the economy, this issue is in the forefront of corporate strategy discussions as the annual review of corporate direction begins this time each year.

Historically, corporate strategy for the year ahead has been a fairly perfunctory straight-line projection based on recent business performance. However, both the cyclical and secular character of consumer spending and housing are likely to be far different in the year(s) ahead and so straight-line projections are likely to lead straight to corporate underperformance.

Consumer spending is and will continue to be hampered by income and credit constraints and low consumer confidence. The jobless recovery has already started—we will see three percent plus growth in the economy for the third quarter along with continued job losses. In addition, the average workweek remains low and wage growth very weak. Thus, income gains are modest at best for most workers and will likely remain so for 2010, a sharp contrast to traditional economic recoveries and straight-line forecasts of a rebound in many corporate plans. Meanwhile, consumer credit remains constrained and limited. Consumer and residential credit delinquencies have yet to turn around from the rising rate of the past two years. We remain cautious on recent improvement in the consumer confidence index, as the current conditions component has barely risen off its lows. Weekly first-time unemployment claims have clearly peaked, but the absolute level of claims remains relatively high, and the number of people exhausting their unemployment insurance and filing for extended benefits has surged.

Despite improvement in home sales and new construction, the question of the pace of housing construction if/when the Federal programs are removed remains. Historically, housing has helped lead the economy out of recession as sharply lower interest rates attracted buyers. Moreover, if household expectations for home price appreciation are permanently downshifted, and with the rise in sales and income taxes reducing disposable personal income, then the demand for both housing and remodeling will likely be permanently downshifted.

Dreams of endless summers in California and luxurious retirement in Florida now appear to be under a cloud of home price depreciation and wealth losses on retirement funds. In addition, the limits of congestion, water supply and high baseline housing costs are likely to change the patterns of in-migration. For corporate strategy making, the straight-line prosperity forecasts for both states are likely a relic of the past.

Global Review

The Roaring Brazilian Economy

• The Brazilian economy came roaring back during the second quarter of the year through an important expansion of monetary and fiscal policy that pushed domestic consumption higher. While the economy dropped on a year-earlier basis, it grew by 1.9 percent compared to the first quarter, seasonally adjusted.

• The central bank will have to keep a watchful eye on the price level. Right now foreign consumption (exports) is weak while domestic consumption is strong. If exports begin to grow the country will start to experience supply constraints that could put pressure on inflation.

Brazilian Economy: Thank Active Economic Policies

When the worldwide financial crisis hit last year, the Brazilian economy was riding high as the fairly recent decision to transform the country into a major world exporter was yielding impressive results. The Chinese were buying everything the Brazilians could produce, from raw materials to manufactured goods, while the Europeans were buying diesel-powered motors. The result was the Brazilian economy was able to grow at a 5.1 percent rate in 2008. Growth would have been stronger except that the performance during the fourth quarter was very weak.

Then the financial crisis hit, affecting trade through two sources: lack of credit and a worldwide collapse in demand. The severity of the decline in the auto manufacturing sector was impressive due to the fact that while the Brazilian auto sector produces diesel motors for European consumption, Brazilian laws prohibits diesel-powered cars for its internal market, a policy that was born out of the development of sugar cane ethanol as an alternative fuel. Thus, not only were the Europeans not buying, but firms could not redirect that production to the domestic market.

The collapse in external demand pushed the da Silva administration to come up with plan B: rely more on the domestic consumer market until the rest of the world recovers. Thus, the administration went back to the drawing board and designed fiscal programs to increase domestic consumption that seem to have worked reasonably well, at least temporarily. At the same time, the Brazilian central bank took notice and produced an impressive about-face in terms of monetary policy, helped by the collapse in commodity prices. In fact, the central bank increased the benchmark interest rate by 75 basis points, from 13.0 percent to 13.75 percent in September 2008 (just as the crisis was hitting the world economy) and kept it there until December of that year. However, by January, it had recognized the problems in the economy and started to lower interest rates, taking the benchmark Selic rate from 13.75 percent in December 2008 to 8.75 percent today.

All these measures, fiscal and monetary, plus the stabilization of the international markets, have allowed the Brazilian economy to grow by 1.9 percent during the second quarter of the year compared to the first quarter, while dropping by only 1.2 percent compared to the second quarter of last year. Thus, monetary and fiscal policies have done the trick, at least temporarily, as domestic consumption was strong in the second quarter of the year, increasing by 2.1 percent on a quarter-0ver-quarter basis after posting a 0.6 percent growth rate during the first quarter.

With the international market stabilizing and growing again, foreign consumption will start competing with domestic consumption and could start creating problems for prices. This has always been the Brazilian economy’s Achilles heel due to lack of infrastructure to support both foreign and domestic consumption, that is, supply constraints. But this problem will probably be something for next year. Right now, inflationary pressures are reassuring, and the central bank will stay put for the time being and probably into early next year.

PRIYA KUSHWAHA

P.G.D.M

3rd SEM.