Thursday, 17 December 2009

Using the recession as an opportunity for Irish economic development

Tom O'Connor: The ESRI expect national income GNP to fall by 9.4% overall in 2009, and by a further 1.8% in 2010, with growth returning in the last quarter of 2010. Accompanying these are falls in investment of 15.5% in 2009 and 30.5% in 2010. The ESRI prediction of a return to growth at the end of 2010 is consistent with Brian Lenihan’s statement that at the end of 2010 we will have turned the corner economically.

There is a dangerous complacency about these projections. Firstly, it is hard to see how growth will resume in the end of 2010 when the fall in investment is double what it was in 2010. The four billion Euro taken out of the economy next year, given that it is in wages and social welfare, is likely to have the effect of taking €8 billion in spending power out of an economy which is also predicted to see investment fall by a massive 30%.

The more likely outcome for 2010 is that GNP growth will not resume in the last quarter, and the outturn for the year is likely to see GNP fall by 4%. The figure of a 30% fall in investment would signal that there is no real expectation that the banks will start lending strongly in 2010. In fact, this has been strongly hinted at by senior bankers themselves.

As a consequence, we are unlikely to see live register unemployment fall below 400,000. The danger here is that, with combined business investment falls of 45% over 2009 and 2010, positive investment may only start in 2011 from a position where it has been going backwards for two years. This will delay significant reductions in unemployment as existing and new businesses are starved of cash.

Prof. Patrick Honohan of the Irish Central Bank told a Dail Committee yesterday that the banks would need further capitalisation. He wasn’t prepared to put a figure on this, or state whether it would be a 50% ownership by the state or more. It is believed by many that the banks will need another 9 billion, and that this will come from the National Pension Reserve Fund.

The Bank of Ireland and Allied Irish Banks have been recapitalised by €7 billion to date. This is written down as an ‘investment’ by the NPRF in the banks. A further investment of €9 billion would leave 5 billion in the National Pension Reserve Fund. This capital injection is seen as the final intervention to fully stabilise the banks.

As a result of the choreography needed to put NAMA and recapitalisation in place, money will not start to flow; this which underlies the ESRI projection of a 30% fall in investment. In the meantime, there are viable investment opportunities available which will not happen unless a new source of investment is found.

There are about 350 incubated companies at the moment, mainly in the high knowledge area, and the government has been and continues to pour €1 billion a year into them from exchequer funding. There are over 10,000 researchers, including PhDs, working here.

13 companies were ‘spun out’ as fully fledged trading companies. However, once they are spun out, they are at the mercy of venture capitalists to secure capital. This restricts their growth to employing only about 8 people per company, as they need to grow slowly, resulting from venture and other capital investment in them as businesses - which is far too low. Indigenous small high-knowledge companies of this type are either kept small or else bought up by huge global companies who can then make handsome gains on the research and development that was paid for by the Irish state.

This then further weakens our indigenous company base, and makes us more and more susceptible to global economic shocks where global companies shut down and set up elsewhere. It also involves a knowledge-stripping of Irish companies which the Irish taxpayer has paid for, which delivers the innovation profits to companies based in New York or elsewhere. This may make a handful of Irish entrepreneurs immensely wealthy overnight after the takeover of one of these Irish companies, but it delivers poor returns to the country.

Paradoxically, given the recession, we have an opportunity to try to redress this problem to some extent. If the Irish government were to use some or all of the €5 billion left in the National Pension Reserve Fund to spin hundreds of high knowledge companies on the market with sufficient capital to allow them to become large players rather than fledgling ones employing less than 10 people, a significant opportunity for long-term sustainability of Irish-owned high knowledge companies could be created for the first time.

Fledgling companies are currently bought out by huge global companies because they are too small to survive, despite their excellent business ideas. They do not have the economies of scale to compete seriously. The government now has an opportunity to spin out large companies with a large capital and asset base to allow them to compete on their own on International markets.

These in turn, within a reasonably short period of time, can employ hundreds of workers each at the very least, and become internationally sustainable. In turn, this would contribute to an improvement in our balance of payments as these Irish companies would not engage in either transfer pricing or profit repatriation, which most of the large global Trans National Corporations do.

The alternative to not investing significant resources from the NPRF and generating significant employment creation is that most of the 10,000 researchers, including PhDs, will continue to do more post docs as they do now, or emigrate; there will still be only a trickle of a dozen or less than 20 companies at most which will be spun out into the market, and because of their small venture capital funding and small size they will employ less than 10 people - and then get taken over by TNCS who will reap the benefits of years of Research and Development which will have cost the state up to €3 billion. Thus, the Irish state acts as a nursery for global capital. Once knowledge has been harvested, these companies may then site elsewhere.

A plan of this nature could create thousands of jobs. It would create sustainable employment and start the process of making Ireland a leader and not a follower. It would be attractive to all social partners, benefitting workers and entrepreneurs. It would also give the country an opportunity to start breaking the high-risk twin dependence on both construction and global capital.

Global companies will always play a huge part in Irish economic development, but we need to start the process of taking control of our own economic affairs. Through large Irish companies, in high-knowledge areas going forward, such as sustainable energy, biomedical, telematics and food, we can start to insulate the country from the economic shocks which cause recessions. In this way, the current recession can be used as an economic opportunity.


Ronan L said...

Interesting post. One comment - it assumes a one-to-one link between all things classed in the national accounts as capital formation/investment and job creation/unemployment.

I think it would be useful to look at capital formation that is neither construction nor inventories and analyse the trend in that, as it's likely to be a lot more closely related to the 'businesses borrowing to invest and create jobs' type of investment discussed in the article.

(That's not to say construction investment isn't a jobs-creator, rather that the article above seems to be talking about a particular type of investment.)

Proposition Joe said...

As someone who's been through the mill with a spin-out (from EU-funded research), I have a couple of observations on your thoughts ...

First, there's is a large swathe of the high-tech sector where the limiting factor is actually the failure at third level to produce a reliable stream of quality tech grads with first degrees. In many cases, this supply of foundational skills is actually more important than the PhDs of which you speak. And its this skills shortage that has in the past has driven a number of indigenous firms themselves to starting transplanting some activities abroad, prior to any acquisition.

Secondly, your ideas around knowledge-stripping smack a little of old-economy thinking. When a tech start-up is consumed by a bigger player, they don't literally go and suck the knowledge out of the founders' and employees' brains. Rather those guys quickly become free to move on to the next project and become serial innovators, applying the lessons of their previous startup cycles to their next iteration. This iterative model helps seed the tech environment with a culture of innovation along with a supporting ecosystem.

Tom O'Connor said...

I suppose the reality is that there is a hugely urgent need to invest in the economy. You're never going to have a perfect one to one link between investment and employment but its the best we have. We have to move quickly. I would hate to see the government employing a gang of economists to investigate the hit of various strands of investment and employment as an excuse to do nothing. Investment is certainly the key to employemtn and the article suggests how we can get a greater employment benefit from investing in high knowledge industries. Obviously, this can be far fare more fine tuned, but we still have to start immediatley and improve the investment to employment dividend from research insights. We will get significant jobs numbers from plans I suggest, so lets get the capital moving. If some group of economists and business people were to be employed to evaluate and improve the jobs dividen as the money is rolled out, then that would be even better and would give the stimulus a greater hit and value for money.