The looming downturn in capex and the rise of EVs

I think Simon Ward is right to predict that a downturn in investment will be the next shoe to drop in developed market business cycles, even as easing inflation offers respite for households’ inflation-adjusted disposable income and spending. This has been a key theme for me and my colleagues at Pantheon Macroeconomics for a while. In the U.S., Ian Shepherdson believes that this will drive the economy into a mild recession, while we are a bit more sanguine in Europe for the simple reason that the euro area economy effectively has been close to recession since the end of last year. Simon Ward notes that the capital goods component of the global PMI hit a new low in April, that inflation-adjusted profits in G7 slowed sharply last year, and that nominal money is contracting. Crucially, he adds that credit standards are now tightening significantly in Europe, as well as across the pond. Flat-lining profits in inflation-adjusted terms, a contraction in nominal deposits, the lagged effect of higher interest rates and tightening credit standards is bad news for private capex, including inventories, as measured by the national accounts. The silver lining is that a slowdown in investment should, combined with softening inflation, persuade DM central banks to kick back from the table on rate hikes. The key question, however, remains whether a slowdown in investment and aggregate demand is adequately priced-in by equities. I doubt it.

The inevitable rise of EVs?

Noah Smith stands up for EVs in his latest missive (subscribers only) claiming in his usual modest fashion that “All arguments against EVs are wrong”. He addresses four criticisms against EVs; 1) That we’re running out of minerals, and that we are exploiting poor countries as EV demand ramps up 2) That the range of EVs, which is currently inferior to internal combustion engines—though improving substantially—and supporting infrastructure will improve significantly, over time 3) That EVs in fact emit less carbon than their internal combustion brethren despite the oft-cited example that the energy used to power EVs often are generated through CO2-emitting energy sources, and finally 4) That the proliferation of EVs will entrench suburbia, which seems to be mainly a U.S.-centric argument. I think Noah does a decent job arguing the long-term case for EVs, but being a self-proclaimed techno-optimist, his focus is concentrated on the end point; an electrified transportation grid, a complete EV infrastructure, and a fully developed global, and socially responsible (?), industrial mining supply of the minerals needed to produce EV batteries. The problem with this perspective is that many voters and consumers today won’t live to see the benefits of the utopian end-point that Noah is describing, but they will absolutely be around to cover the costs.

To the extent that the transition to EVs is part of a broader green energy transition, and as a result the write-off of existing energy technology, it adds to the more general regressive tax hike that governments currently are imposing on its citizens via the energy transition. The economics of this are simple. If you want to alter aggregate behaviour via public policy, in this case reduce the reliance on and use of CO2-emitting energy sources, a regressive tax hike is exactly the right tool. This is because it increases the cost of energy consumption for the population groups, which are most likely to reduce their consumption in response to a small rise in the price of legacy energy sources. Remember, the inherent logic of the energy transition is an increase in the cost of CO2-emitting energy sources as investment in new supply is curtailed, and it is unrealistic to assume that non-CO2 emitting energy supply with increase fast enough to hold down the price of energy consumption, given constant, if not still-rising, aggregate demand for energy. The counterpoint, often invoked in the context of fairness, that the rich should bear the burden doesn’t work. Rich people are unlikely to reduce their energy consumption unless you increase energy taxes to such an extent that the energy consumption of the poor and middle-income people would be all but wiped out, at great economic costs. And even if you come up with a way to impose a progressive carbon tax—and there are ways to do this—you still don’t solve the key problem of a reduction in aggregate CO2-emitting energy consumption. This is because the rich, in aggregate, consume much less energy than poor and middle-income households, due to the pointy nature of the income pyramid.

At this point, Noah and his fellow techno-optimists will probably retort that this problem is solved by technological progress, powered by public investment, which will work swiftly to level the playing field by increasing the supply, and reducing the cost, of green technologies, in this case EVs. I hope they’re right, but unless you take an unrealistically rosy view of the speed with which this happens, the transition itself comes with economic costs, and political consequences, that policymakers and techno optimists find it hard to grapple with. I think this is a question of honest, perhaps with a dose of naivety. In the context of personal transportation, this means a reduction in the supply—and increase in the cost— of internal combustion technology, if not an outright ban, as is now being mulled in many European countries. The much maligned and debated ULEZ scheme in greater London is a case in point. On the face of it, it is a no brainer. Air quality is a huge problem in London, as it is in other population dense areas, and if you could flick a switch and ban anything but EVs, London’s air quality will improve by several orders of magnitude overnight, increasing the quality of life for the city’s population immensely. Indeed, even if we assume that EVs emit as much CO2 as internal combustion engines, Noah presents evidence to the contrary, the improvement in air quality alone point to a significant advantage of underwriting the proliferation of EVs. The ULEZ, of course, doesn’t go this far, but the method by which it works is simple enough in the end. The scheme seeks to increase the cost of running relatively old cars, who tend to be run by relatively low- income households and businesses with limited financial ability to switch to a less polluting model. In doing so, the ULEZ seeks to reduce the number of journeys made by relatively poor people in their personal vehicles. This is a difficult message to send for a supposedly left-leaning mayor, even if the main benefit of the reduction in car journeys by relatively polluting cars almost surely will primarily benefit low-income people, as regards air quality, in precarious neighbourhoods with lots of traffic. As anyone who has followed the uproar over the announcement to expand the ULEZ will attest to, it can be difficult to sell to the public even the simplest and most obvious trade-offs.

I am willing to accept the techno-optimist view that this will be for the better in time, but I am also a relatively well-endowed white-collar worker who can afford an EV or a hybrid. That said, the political and economic ramifications of people bearing the cost of energy transition with little prospect of enjoying the spoils within a reasonable time frame are important too. Noah will, with some justification, complain that I am knocking down a strawman of his argument. After all, the reasons he invokes the inevitable rise of EVs can exist despite the regressive tax cost of the energy transition more generally. But the speed and success with which EVs supplant internal combustion engines does, critically, depend on the political and economic viability of the energy transition, as a general process.