High energy prices: the role of taxes and policies

Statistics Netherlands reported this week on household energy bills. At the rates applicable in June, an average family pays €2.320 for energy in a year. In June last year it was €630 less. The increase is 37%. Then we can count ourselves lucky, because if the rates of December last year had continued, the increase would have been more than € 1.300.

This is a weekly commentary on macroeconomic indicators and it is not intended to involve political positions. But here I make an exception. Of that €630 increase, €421 is caused by taxes. I understand the policy of using price incentives to steer people's behaviour. In the context of the energy transition, taxes will be increased on energy, which is largely produced with fossil fuels. But that tax increase is 1,3% of a net average annual income. That is a major drain on the wallet of the average citizen. Especially at a time when many other prices are also rising and many families are struggling.

Not to mention the underlying market prices. People sometimes pretend that the high market prices for energy have happened to us. So I think differently. Our policymakers have also played an important role in this. Let me sum it up.

• In recent decades, our policymakers have chosen to limit the exploration and production of oil and gas in Europe. While our American friends have rapidly become self-sufficient, our self-sufficiency rate has fallen sharply. We became increasingly dependent on Russian gas.
• After the war broke out in Ukraine, our leaders no longer wanted that gas from Russia.
• Because we then wanted to replenish our gas supplies frantically, our policymakers insisted that we buy all the LNG we could get our hands on last year. The traders were pleased and raised prices sharply. Although the market price for gas in Europe is currently 75% lower than a year ago, households still pay a much higher price because last summer's crazy price is of course still factored into current consumer prices. Otherwise the utilities will go bankrupt.
• I note that many countries are currently concluding long-term contracts for LNG. We don't. That can work out well, but it can also turn out disastrous. Why do our policymakers take that risk? Who can we hold accountable if things go wrong?

I can't figure it out. Households pay a lot more for energy. The role of policy makers in this is very remarkable. Two thirds of the increase in the energy bill is due to taxes. And as far as I'm concerned: the rest is mainly due to very poor energy policy. So, I lost that. It is written that a nation gets the leaders it deserves. Sometimes I wonder in despair what we did wrong...

Recession or not: no answer yet
The discussion among economists whether we are heading for a recession or not and how mild or deep it will be has not yet ended. The figures published this week do not tip the balance one way or the other.

When the European gas price rose to €350 per MWh last year, I quickly reached my conclusion. I think we were heading straight for a very nasty recession. Think about it: in the 70s, the world entered a deep recession when oil prices tripled. A gas price of €350/MWh in August last year represented a twenty-threefold (23x!) increase in the pre-pandemic price. Moreover, interest rates rose rapidly last year.

The world has now changed quite a bit. Gas prices are still higher than before the pandemic, but have fallen by more than 90% from their peak in August last year. That hurts quite a bit.

Nevertheless, I have maintained my view that a recession is still likely. The reasoning has changed somewhat. The crucial question is how restrictive monetary policy should be to control inflation. Although inflation will decline rapidly in the near future, I think that the inflation of the recent past, combined with the tightness of the labor market, is driving wage increases that will make it impossible to maintain 2% inflation when we get there. Therefore, I think that monetary policy should be sufficiently restrictive for a sufficient period of time to bring about a noticeable relaxation in the labor market.

Meanwhile, various other interesting and relevant developments are taking place. For example, the US budget deficit has risen spectacularly quite unnoticed, as the first chart shows. The overall deficit (measured over a 8,5-month period) reached no less than 1.291% of GDP in June. It is not the absolute level that is important for the influence on the business cycle, but the change in the budget balance. Between July last year and June this year, the deficit widened by $5 billion, or nearly XNUMX percentage points of GDP.

This is about cash flows. If the government sees its own cash flow deteriorate by approximately 5% of GDP in a year's time, that money will flow into the economy and should give the economy a strong boost. I've been amazed for some time that you hear or read so little about it. So I asked some American economist friends how they view it. The response was extremely poor. I got some detailed answers explaining why this deterioration is happening. Because last year was a very bad stock market year, the receipts are up capital gains tax much less this year. In addition, interest expenditure by the government is rising. But I heard nothing about the influence on the business cycle. Now I have to say that my American friends are all supporters of the Democrats and maybe they didn't want to say anything negative about what is happening under President Biden. Still, I think that such a spectacular increase in the budget deficit should provide some stimulus to activity. This will come to an end at some point.

What is also happening in the US is that people with student loans will have to pay off again from October, after those payments were halted for three years due to the pandemic. Estimates of how much this will squeeze purchasing power overall vary, but it will certainly put the brakes on spending.

For example, the question of whether or not we are heading for a recession remains unanswered as far as I am concerned. I think so, but it is very uncertain. Anyway, let me say that I'm less sure than I was a while back.

Good and less good grades: first the good
As mentioned, this week's numbers paint a mixed picture. The labor market remains tight. Statistics Netherlands reported this week that unemployment in our country was unchanged in June compared to May: 3,5%. And that is equal to the average for the first half of the year. In March, the CPB predicted an unemployment rate of 3,9%. So far it doesn't look like that.

The labor market in the US is also as tight as ever. In the week of July 15, 228.000 applications were filed for unemployment benefits. That was the lowest number in two months.

Then the less good...
Less positive are the figures on industry, China and world trade. For example, production in the US manufacturing industry fell 0,3% in June compared to May and also 0,3% compared to June last year.

Chinese GDP was 6,3% higher in the second quarter than a year earlier. That is a good figure and certainly better than the 4,5% from the first quarter. However, the figure was disappointing because last year the country was largely in a heavy lockdown in the second quarter. Then the economy contracted by 2,2% compared to the first quarter. Other Chinese figures are also by no means convincing. Retail sales in June were only 3,1% higher than a year earlier, much worse than May's +12,7%. You might say that the Chinese consumer needs a boost. Chinese manufacturing production in June was 4,4% above June 2022 levels in volume, better than May's +3,5%, but remains a modest growth rate for China. Most alarmingly, youth unemployment is high and rising sharply. In June, unemployment among people up to the age of 24 was 21,3%. In May that was still 20,8% and in December last year 16,7% (approximately 7,8% for us).

We received signs from the Rotterdam port authority this week that things are not going very well with world trade. Total cargo throughput in the first half of the year was 5,5% lower than in the first half of 2022. However, that figure masks a significant deterioration over the course of the year. In April, the port authority reported a decline in cargo throughput of just 1,5% year-on-year for the first quarter. If the second quarter is compared to the second quarter last year, the decrease is no less than 9,2%. Of course the sharp drop in trade with Russia plays a role, but still…

An equally negative signal for world trade came from Taiwan this week. Export orders in June were no less than 24,9% lower than a year earlier. In May a decrease of 17,6% was recorded. Taiwan is an early cyclical economy and exports a lot of semiconductors. ASML reported a drop in order intake this week. So that's consistent with what we're seeing in Taiwan.

Less chance of recession
I can get quite excited sometimes. I used to have less trouble with that. Is it me? This week I was very excited after reading the CBS report on household energy bills. Forgive me, I can afford a higher energy bill and I won't eat less for it. But many families are having a harder time. At 37%, the energy bill is considerably higher than a year ago. Two-thirds of this is due to higher taxes and another part to energy policy that, in my view, is having a dramatic impact on citizens. Policy makers pretend that the higher energy prices have happened to us, but in my view energy policy plays an important role. The sad thing is that no one seems to feel responsible and we can't hold anyone accountable.

Whether or not the global economy is heading for a recession is still not a foregone conclusion. The fact that the European gas price has fallen sharply reduces the chance of a recession here. On the other hand, inflation is really not yet under control and the increased interest rates are starting to bite more and more.

In the US, the government deficit has risen spectacularly. I think that this has given the economy a boost, but the deficit cannot continue to rise. When that increase ends, the growth impulse also disappears. And in October, Americans with student loans have to start paying off again. That reduces their purchasing power.

The labor market remains tight. This will support the economy in the short term. On the other hand, the Chinese economic recovery is not getting off the ground and everything indicates that world trade is in dire straits.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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