(Falco, Pixabay, Public domain)
CE Financial Observer: A year ago you told me that we shouldn’t exaggerate concerns about wage pressures and production capacity utilization. Will you repeat this opinion following the publication of the Quick Monitoring Survey from July 2019?
Piotr Boguszewski: It is generally a good idea to maintain restraint when evaluating “hot new facts”, and that principle was confirmed in this case. In the latest edition of the report we see subtle signs of cooling in the labor market, and slightly declining, although still very high levels of production capacity utilization.
What does „cooling in the labor market” mean? How much will the surveyed companies increase salaries this year?
In recent quarters real wages have been growing at the rate of 5-6 per cent y/y. I’m not saying that this is a low growth rate, but this value is comparable with the current high rate of GDP growth. It can also be assumed that some of the processes generating wage increases are losing their momentum and that this growth could even slow down slightly. For example, the process of shifting workers to more productive departments with significantly higher wages has probably been completed in some industries.
In the Q4’18 the financial results of the companies surveyed by the Statistics Poland (GUS) declined, in comparison with the previous year, by as much as 40 per cent. Was this only a temporary drop?
Yes. The aggregated total net financial result in the Q1’19 amounted to about PLN26bn (EUR6.03bn). Admittedly, this result is approximately 4.5 per cent lower y/y, but still indicates a clear rebound after a weak Q4’18. A rebound that was expected. Moreover, our analysis shows that this year’s result was negatively impacted by a combination of various factors, including one-off events — such as the large write-downs in one of the companies. The result would have been better had it not been for these incidental events.
What new trends are visible in the GUS data for the Q1, which were analyzed in the July edition of the report?
There has been an obvious improvement in the levels of business investment, which grew by more than 20 per cent y/y in medium-sized and large enterprises. This good result was to be expected based on the GUS’s preliminary estimates of the GDP for the Q1. Our analyses also show, however, that an investment boom is occurring in many sectors. Moreover, the share of investment in buildings and structures was high. These are usually projects with a longer life cycle, which suggests that this recovery in investment will not be temporary. It is true that in the case of construction projects we are somewhat concerned about the intensification of supply-side barriers, but this does not change the fact that the demand in this area seems to be very strong.
What are the motives of business investment in the Q1’19?
There is a number of factors involved: a high degree of capacity utilization, favorable financing conditions, also including the level of interest rates. It’s also worth paying attention to the demand-side conditions — which, after all, constitute one of the fundamental factors influencing investment activity. It seems that the companies have understood the demand-side effects of the extension of the child benefits program, although this is not a direct conclusion from the Quick Monitoring Survey but rather from the GUS’s consumer confidence surveys. Apart from its effects relating strictly to incomes, the program has also had an important psychological effect that changed the perception of financial security of many households and changed their consumption habits in different areas.
If that is the case, then the level of optimism in the companies should be high, but the synthetic indicator, which allows you to directly compare the sentiments of the enterprises is not at the highest level.
That’s right. An aggregated indicator of the situation of enterprises, calculated on the basis of the broadest possible set of data included in the monitoring survey, was introduced in our report in the July 2019 edition. There is a lot of data to synthesize, because the companies themselves assess their own situation by answering almost 40 questions. This indicator is currently near zero, that is, close to its multi-annual average. This is a good situation from the point of view of macroeconomic stability. The self-assessments of the companies indicate that the situation in this sector is currently neither too hot nor too cold. At the same time it is worth noting that the long-term average in the enterprise sector is favorable.
Do you see any potential risks that companies face? We were worried about labor costs, but maybe we should take a closer look at the costs of raw materials or energy prices?
Of course, the companies should watch out for cost increases. Paradoxically, this doesn’t necessarily have to be easy in conditions of strong growth. Firstly, in times of prosperity we rarely think about austerity and savings. This is to some extent natural and deeply consistent with our psychological foundations, but it is important to stay within certain limits. Secondly, in conditions of strong demand and excellent consumer sentiment companies are oftentimes forced to fight hard to attract new customers, even in order to maintain their market position. And this sometimes forces them to make quick decisions that can be sub-optimal in terms of costs or prices. We must remember that low prices still matter the most for many consumers.
Does this mean there are no problems on the horizon?
When it comes to temporary shocks — I believe in the great adaptive potential of Polish enterprises. This clearly helps in cushioning some of the shocks, including the cost shocks. However, it must be emphasized that this potential is not unlimited. There are also certain challenges, which could intensify in the medium and longer term, and which could be more difficult to overcome.
What are these challenges?
We should assume that labor resources could be a barrier, if only for demographic reasons. If this is not compensated with an increase in productivity, labor costs will probably grow at a faster rate. We must also take into account the trend of growth in the prices of energy and a number of other materials and commodities. These problems probably cannot be solved without investment, deep structural changes, systematic improvement in the quality of human capital, etc.
So the question is whether our companies will be able to utilize, for example, modern technologies, or better management methods, in order to increase their profit margins, so that they provide a sufficient buffer against the cost pressures. This is especially true in conditions of global competition.
And what is your opinion — will they be able to do that?
I’m somewhat optimistic. The situation is pretty good for the time being — the profitability of gross sales in the Q1’19 is approximately 4.5 per cent. However, it should be even better, because if we were to subtract the risk margin of doing business from that profit margin, then the result is not much better than that offered by a bank deposit.
Does this mean that only few things are profitable?
It’s not the case that profitability is falling only in our country. This tendency can be observed in many places, including the developed economies, where the profit margins are sometimes equal to the earnings offered by bank deposits. This seems to be one of the reasons for the relatively weaker investment activity. However, this has a positive side. This is, generally speaking, the Schumpeterian effect of globalization — go on and build your business, but only if your idea is a lot better than that of your competitors.
How does that work?
Let me ask you — what would have to happen for you to consider starting a business?
I’d have to see a business area in which I have an advantage.
Exactly. It usually only makes sense for us to invest, when we have a significant demand signal or a technological advantage. Except that in the modern economy both of these things are hard to come by. There are now very few significant demand signals.
Let’s say that you want to transport parcels between city A and city B, because there is a lot of customers for that. Ok, you’ll start doing that, but if it proves to be profitable, then after a month you could face competitors even from the other end of the world, who will do it for 5 per cent less. And the cost of entry into such a service is not that high. So after a while you are left without customers, but with the rented warehouse, unused delivery trucks and other liabilities.
In the long term, this is a pessimistic conclusion, even for the companies that are already operating in Poland.
Don’t take this the wrong way — the fact that there are few reasons to expand one’s economic activity, and that the low-hanging fruit have already been picked, does not imply, that there are no such reasons. After all, investments have accelerated, there are some opportunities. But this is a long process that involves finding niches, conquering one local market after another, etc. And this also requires the accumulation of capital and experience. Often, it also requires skillful cooperation with the stronger players or smaller companies joining their forces.
So what should we be paying attention to in the upcoming editions of the Quick Monitoring Survey?
We should be looking at the more broadly defined effectiveness of companies, including the changes in costs. This includes all sorts of costs, and not just labor costs. Another thing are investments, including the foundations for the longevity of the current acceleration in the area of investment. We also need to look carefully at how these investments contribute to the innovativeness of Polish enterprises.
Piotr Boguszewski, PhD, works at Poland’s central bank, NBP and coordinates the survey of the economic situation of enterprises, known as the Quick Monitoring Survey.
The views expressed in this article are the private views of the author and are not an expression of the official position of the NBP.