Nils Bernstein: Globalisation, the Danish economy and Danish
agriculture
Speech by Mr Nils Bernstein, Governor of the National Bank of Denmark, at the Annual
Meeting and Congress of Danish Pig Production, Herning, 30 October 2007.
Basis for the speech. The spoken version applies.
* * *
Thank you for the invitation to speak here today.
I would like to start with globalisation. This will be followed by a snapshot of the Danish
economy, and an account of why Denmark is doing relatively well in an increasingly
globalised world. Finally, I will turn to Danish agriculture, primarily pig production.
Globalisation is a dynamic process whereby the global markets for goods, services, capital,
labour, technology, knowledge and ideas are being liberalised and integrated. Globalisation
opens up new possibilities and strengthens global competition, while productivity is
enhanced via a better and more efficient distribution of the factors of production.
Consequently, globalisation does not only lead to new trade flows. It also means that
production moves to the places that offer the best conditions for producing the relevant
goods or services.
It is important to understand that globalisation is not a zero-sum game where we just share
the existing production opportunities. If each country produces what it is relatively best at,
overall output, and thus real income, increases, compared with a situation where all countries
try to be self-sufficient.
In the transition process there will always be people who lose their jobs or companies. Not
surprisingly, they are against these changes. But the sooner they realise that they would be
better off doing something else, the sooner they can reap the benefits of specialisation.
The best safeguard against the changes brought on by globalisation is to acquire training
and skills to avoid getting stuck in an unprofitable job function.
Society as a whole benefits from being able to buy the same goods elsewhere at a lower
price, and naturally society should therefore facilitate the adaptation process - by promoting
education, supplementary training, the establishment of new companies, etc. These relatively
simple mechanisms have been acknowledged for a long time, and since World War II trade
restrictions have indeed been phased out, some more rapidly than others.
It is no secret that agriculture is among the sectors where the pace of liberalisation has been
slowest, in spite of the large potential gains from phasing out agricultural subsidies and the
rich countries accepting that much food production is relocated to less affluent countries.
There are many reasons for this sluggishness - but they are outside the scope of this
speech. I am pleased to note that Danish agriculture supports a controlled phasing-out of
agricultural subsidies. As we know, agriculture is one of the major hurdles to be overcome in
the current Doha negotiations. To me there is no doubt that liberalisation will come some
day. It is simply a question of when.
Globalisation is not a new phenomenon; in Denmark's case it has been going on for about a
century - albeit with some setbacks (slide 1). This period has been characterised by major
technological advances, e.g. within transport and communication. As you will know, cheap
transport via the new railways opened up for exports of wheat from the US prairie in the latter
half of the 19th century. This called for restructuring of Danish agricultural production from
mainly crops to mainly livestock. Danish agriculture was able to exploit the opportunities
offered by globalisation, and C.F. Tietgen's establishment of a telegraph connection from
Copenhagen to China was part of a clear globalisation strategy.
Following a period of protectionism, the last half century has been characterised by an
international political environment that has promoted free trade, and free movement of capital
and - to a lesser extent - people. Growing international trade and investments are
indications of increasing international division of work. Low-technology production moves to
countries whose strength is inexpensive labour. In turn, production in more developed
countries becomes increasingly concentrated on high-technology products and complex
services.
In the last few years, globalisation seems to have gained further momentum as populous
nations such as China and India are increasingly becoming part of the global market
economy. Once again, technological leaps within transport and communication have been
the catalysts for the process.
International integration is particularly advanced in the financial markets, and the last decade
has seen a tremendous rate of development (slide 2). The conditions for free movement of
capital are probably better than ever. Liberalisation of the international financial markets over
the last few decades has enabled more efficient employment of capital from a global point of
view. Savings are placed where the largest returns can be achieved, and borrowers can
raise capital from a wider range of investors. For investors, more open financial markets
mean more placement opportunities.
Typically, investments in foreign production capacity are still placed in neighbouring
countries. The shares of Danish direct investments in countries such as China and India are
increasing, but still at a low level overall. This also applies to Eastern Europe, actually.
The many borrowing and placement opportunities can be used to increase, reduce or spread
financial risks. This is generally an advantage, but also involves risks, as the current
subprime crisis illustrates. This began as an isolated phenomenon on the US housing
market, where the low level of interest rates made it attractive to offer loans to less
creditworthy homeowners. Many of the loans were "teaser loans", i.e. loans where the rate of
interest is artificially low for the first 2-3 years and then raised to the normal level for
borrowers in this category.
When interest rates began to normalise, many borrowers were unable to service the loans at
the new, higher rate, and since housing prices were falling at the same time, losses were
incurred on these mortgages. The losses soon proved to be spread on many different
investors, including a number of European banks that had purchased bonds with top ratings
based on "restructured" subprime mortgages.
In addition to the risk of loss, some banks had taken on considerable liquidity risk by issuing
guarantees to investment firms investing in credit bonds, among other things. In several
cases, theses guarantees were exercised. This led the banks to exert greater restraint in
lending to other banks as they might need the liquidity themselves. In the UK, the lack of
borrowing opportunities in the money markets led to the first run on a bank, Northern Rock,
for more than 100 years.
The authorities have been compelled to provide extraordinary guarantees to the depositors.
Danish investors are only to a very limited extent directly involved in subprime investments,
but may be hit by derived effects. The course of events shows that globalisation also entails
less protection against ill-fated external dispositions.
Right now there is believed to be a growing risk that the slowdown in the US housing market
will spread to the rest of the US economy. If this happens, the rest of the world will also be
adversely affected.
For some time, the dollar has been depreciating vis-à-vis the euro. This is basically a natural
reaction to interest-rate expectations in Europe and the USA. In view of the large
currentaccount deficit in the USA and the corresponding surplus in e.g. China, the Chinese currency
would be expected to appreciate against the dollar. However, this effect has been postponed
due to massive Chinese intervention in the foreign-exchange market to keep the renminbi
stable against the dollar. Consequently, the euro has also strengthened vis-à-vis the
renminbi and the yen.
There are many speculations as to whether the dollar will fall further against the euro - and
thus the krone. I will not venture any opinion on this. Exchange-rate forecasts are notoriously
unreliable.
At present, the US annual current-account deficit is around 6 per cent of GDP, which is not
sustainable over a prolonged period. At some point an adjustment process is required,
involving not only the exchange rate. This process has already set in. We must keep our
fingers crossed for a gradual process, for if the adjustment is too abrupt, it may have
significant negative consequences for the global economy.
Now I would like to turn to the Danish economy, which is booming with high growth and
rapidly rising employment. Private-sector employment has increased strongly since 2005 and
unemployment is at the lowest level for 30 years. At the same time, the government surplus
was around 4 per cent of GDP in 2006 and will presumably also be among the highest in the
industrialised world this year.
There are, however, several indications that the economy has reached its capacity limit. The
shortage of labour, combined with rising interest rates, will dampen growth. The
currentaccount surplus is receding. This reflects the fact that demand must increasingly be met via
imports because domestic output cannot keep up with demand. On the other hand, the
prospects for many of Denmark's key export markets are good. This means that, capacity
allowing, the sales opportunities are there. Denmark has been leading the economic cycle
compared to the rest of Europe, and the economies of Germany and several other euro area
member states have only recently begun to take off.
As a result of the capacity pressures, Danish prices and wages have begun to show an
upward trend. The collective agreements concluded for parts of the private labour market in
the spring thus point to a substantially higher rate of wage increase than in the preceding
agreement period. Now the collective bargaining for the public sector is approaching, and
very high wage expectations among large groups of public-sector employees point to tough
negotiations.
Wage developments contribute to a stronger domestic price pressure, which is set to
intensify further. So far, low import price increases, due to e.g. the weakening of the dollar,
have kept inflation below 2 per cent p.a. However, wages are undoubtedly the one single
factor that could potentially derail the economy. History shows that a high rate of nominal
wage increase is by no means synonymous with higher real wages, i.e. higher purchasing
power (slide 3).
Against this background, Danmarks Nationalbank has recommended fiscal policy that is not
expansionary. After all, we want to maintain our favourable economy.
One of the main reasons why the Danish economy has been relatively sound in recent years
is that we have created favourable framework conditions for the economy - even better
conditions than many of our European partners offer. Let me highlight a few important areas.
Traditionally, Denmark has adhered to liberal industrial policies and no political measures
have been taken to artificially keep struggling sectors and individual business enterprises
alive. Restructuring has been permitted to take its course, which means that resources have
been moved from areas with little added value to industries with high added value, to the
benefit of the overall economy.
This process has been underpinned by a flexible labour market which supports such
restructuring instead of impeding it. The Danish labour-market model, referred to as
"flexicurity", is well-known even outside Denmark's borders. Flexicurity combines liberal
access to hiring and firing employees with a social safety net and active labour-market
policies. The dynamics of the Danish labour market are e.g. reflected in a very large number
of job shifts - approximately 600,000 a year. Consequently the average employment in the
same job is just 4.8 years, which is very low by international standards.
In the last 10 years, fiscal policy in Denmark has been based on a "medium-term orientation",
whereby not only current, but also future expenditure is taken into account. This is a sound
principle. Government finances are very sensitive to economic trends, oil prices and
fluctuations in interest rates and securities prices in the financial markets. For this reason,
among others, it is not appropriate to plan fiscal policy on the basis of the government budget
balance in any single year. The large surpluses seen these years are of a temporary nature
and will decline in the future, partly on account of population ageing. The surplus does not
mean that there is scope for unfunded tax reductions or lasting improvements of
publicsector services.
The final framework condition for the economy that I would like to emphasise is the
fixedexchange-rate policy. This policy has been a tremendous success, and I doubt if anyone
would question it today. Maintaining a fixed exchange rate against the D-mark, and since
1999 the euro, has anchored inflation expectations at a level close to 2 per cent p.a., and in
recent years the yield spread to Germany has been negative at times.
Success in the global economy is not merely a question of economic policy in a narrow
sense, and nor is it purely a question of wage competitiveness. In recent years other issues
have increasingly come into focus. These include the importance of a sound institutional
framework, e.g. an efficient public sector, suitable business regulations, infrastructure,
noncorruption and more intangible concepts such as "social capital", a measure of whether
people basically trust each other and the authorities.
Numerous efforts are being made to capture all these factors in one single weighted
measure of a country's competitiveness. Typically Denmark performs well in such surveys. In
a global index prepared by the World Economic Forum, Denmark came 4th overall in 2006
(slide 4). And in fact, The Economist's recent survey of the countries with the best framework
for operating a business put Denmark in 1st place. In other words, a small country with a
large public sector and thus a high tax burden can actually perform well in international
competition. It is worth noting that the top performers on the list include both small and large
countries, and countries with both large and small public sectors.
The pharmaceutical industry is one of several Danish success stories. In volume terms,
production and exports of medicine have more than doubled over the last 10 years. As if that
was not enough, sales prices in the export markets have risen by approximately 40 per cent
in the same period (slide 5).
Another example is the textile industry, which at one time employed a very large number of
people, particularly in Jutland. Today, most low-wage jobs in the textile industry have been
relocated to countries with lower hourly wages than Denmark, but over the last decade
export volumes have risen at almost the same rate as medicine exports. This shows that
Danish textile production has moved further up the value chain. The remaining Danish labour
is engaged in design, marketing, branding, etc., which are areas with high added value.
An export-oriented economy such as Denmark's has benefited from the general increase in
international trade. Unlike many other industrialised countries, Denmark has also benefited
from better overall terms of trade (slide 6). This also applies if energy is excluded. Not only
the pharmaceutical companies, but also a wide range of other Danish enterprises have been
able to sell their products at still higher prices, while the prices of Danish imports have
stagnated or even fallen. Often imported goods are manufactured in low-wage countries,
which keeps prices at bay. Improved terms of trade contribute to Danish affluence just as
higher production does since both boost real incomes.
Agricultural production is not part of the explanation for the improved terms of trade. In this
sector, prices have been stagnant or even receding, and in many cases the prices of
agricultural products fluctuate strongly. As you all know, this is certainly true of the price of
pork (slide 7).
In a global perspective, pig farmers are currently faced with strong increases in feed prices,
partly reflecting more extensive international use of feed for bioethanol production. In the
longer term, higher feed prices can be expected to pass through to pork prices, but in the
short term contribution margins will be squeezed. Looking ahead, the development may give
Denmark a competitive edge, since I understand that Danish pig farmers are close to holding
the world record for transforming feed units into pork.
The upward pressure on feed prices may intensify further if China, which is by far the world's
largest pig producer, abandons its self-reliance strategy and opens up its market for imports
of grain and feed. In general, the development in less industrialised countries will gain
importance in relation to the future development in pork prices. Today, industrialised
countries account for only around 1/3 of global production of and demand for pork, and their
share is falling.
In the longer term, population growth and rapidly rising incomes, and thus meat consumption
per capita, in the low- and middle-income countries will buoy up pork prices, although
production is also increasing in these countries.
The OECD, and the UN Food and Agriculture Organization, FAO, have projected food prices
over the next 7-8 years. The OECD/FAO expect the price of pork to rise slightly to
somewhere in the range of kr. 9.5-10 per kg. These are current prices, which means that in
actual fact pork prices will continue to fall.
Such projections are, of course, subject to considerable uncertainty, and particularly in the
short term they can be affected by exchange-rate fluctuations, diseases, weather conditions,
etc., and likewise changes in agricultural policy and trade restrictions may have an impact.
Nevertheless, the projection serves as a key indicator for pig farmers. If the expected price
level cannot provide a satisfactory profit, the farmer will eventually be squeezed out of the
market.
On a global scale, Danish pig farmers produce 2 per cent of all pork, but account for almost
13 per cent of exports. It may seem surprising that Denmark, which has one of the highest
wage levels in the world, has been able to maintain and strengthen its position as one of the
world's largest exporters of pork in a fully commercial international market.
The explanation is that pig farmers have been able to increase productivity at an astounding
pace. For many years, productivity has been far higher in agriculture than in the rest of the
economy, including the industrial sector (slide 8).
Paradoxically, however, the individual farmer has gained very little from the increase in
productivity since fierce competition means that most of it is immediately passed on to
consumers via lower food prices. The situation resembles that of a hamster in a treadmill: it
runs and runs, but never gets anywhere. But if it stops running, it is slung out.
According to accounts statistics for pig farmers, the "profit per hour" has been just under kr.
50 over the last five years, i.e. only half the minimum wage in the industrial sector. The profit
per hour reflects the farmer's hourly income after deduction of costs and return on capital
employed. According to the accounts statistics, income generation in pig farming is thus
lagging behind many other sectors. However, there are considerable differences within the
sector.
Statistical extracts show that the average profit per hour for the third of farms that in 2005
(slide
exceeded the kr. 50 threshold was kr. 140, while the rest averaged kr. 40 9). 2/3 of the
farms had a negative profit per hour. The most profitable third of the farms produced 60 per
cent of the pigs. The figures speak for themselves about the advantages of economies of
scale. Moreover, there is a tendency for the farms that produce their own piglets to achieve
the best profits.
One third of all farms, accounting for just under 25 per cent of production, have a negative
profit per hour combined with high debts. How long can they last, I wonder. The structural
development will continue. Others will take over and form larger units. This will be necessary
if the Danish pig-farming sector is to remain competitive.
You might safely say that Danish agriculture has embraced the opportunities in the
liberalised capital markets. Indebtedness has risen substantially over the years, particularly
in the period when interest rates were falling. Lower debt-servicing costs have not led to
consolidation, but to higher indebtedness.
Farmers are among the most frequent customers for adjustable-rate and
deferredamortisation loans. In addition, a large part of the debt is denominated in foreign exchange.
For some years, the Swiss franc has been a popular currency for Danish farmers to borrow
(slide
in 10). Whereas other sectors often seek to hedge foreign-exchange risks, many
farmers take on such risks on a large scale. But this is not the whole issue. In some cases,
foreign-exchange loans are not used to finance operations, but are invested in high-yield
currencies. This is a purely financial transaction that is unrelated to running a farm.
For a number of years it has indeed been possible to profit from these "carry trades",
whereby money is borrowed in a low-yield currency such as the Swiss franc or the yen and
invested in a high-yield currency such as the Turkish lira, the Icelandic krona or the New
Zealand dollar. However, such transactions always entail considerable risk, and much is to
be said for exercising caution, even in favourable periods. Exchange-rate adjustments can
be abrupt and substantial. The question is whether everyone has been sufficiently aware of
these risks when chasing "cheap money". In any case, if a farm primarily yields a profit as a
result of purely financial transactions, it is, perhaps, time for the farmer to find other
employment. The banks are short of staff!
The future for Danish pig farming will be a continued elimination race in which only the fittest
will survive. In addition to external competition and sustained price pressures, environmental
and animal welfare regulations are becoming stricter. The pig-farming sector will have to
accept this, even if the requirements sometimes exceed those imposed on foreign
competitors.
As you already know, it will be increasingly difficult to attract Danish labour to the farms.
Around one fourth of all work permits for people from Eastern Europe are exercised within
agriculture and horticulture.
Pig production can have a serious adverse impact on the environment and in many cases
also on the local environment - it smells. With more than two pigs per capita, Denmark has a
high pig density. In some parts of the country, the figure is much higher, and the problems
much greater, than elsewhere. At the same time, the public are very sensitive to animal
welfare issues, as reflected in the recent years' cases of pig transports and shoulder ulcers in
sows. These issues must be addressed by the sector.
Unless the environmental and animal-welfare issues are resolved, the restraints on pig
farmers will become even tighter, and it will be increasingly difficult to continue to expand
production as in the last decades.
Some take the consequences and invest in places like Poland and Ukraine. This is
globalisation in the true sense of the word and offers good growth opportunities.
With the initiative and enterprising spirit that characterises Danish agriculture, and
particularly the strong technological foundations that the pig-farming and processing industry
rest on, I have no doubt that pigs will also be farmed and slaughtered in Denmark in the
coming years. However, you will probably need a smaller and smaller venue.
I wish you a good congress.
BIS Review 125/2007
BIS Review 125/2007
BIS Review 125/2007
BIS Review 125/2007
BIS Review 125/2007
BIS Review 125/2007