Wednesday, 31 March 2010

Banks: elsewhere on the web ....

Over at Ireland after Nama, Declan Curran asks some pertinent questions. On Irish Economy, Karl Whelan takes a look at The Good, the Bad and the Ugly. Meanwhile, Ronan Lyons points out that the first tranche of loans may not be representative, and that subsequent tranches may show significantly larger discounts.

The 'I'm really getting tired of this nonsense' guide to bond yield trends

Michael Taft: There are others who will discuss intelligently the fall-out from Ireland’s financial Black Hole Day (Sli Eile, Stephen Kinsella and Nat O’Connor on this blog for instance). One thing that struck me during the Finance Minister’s robust, if economically-challenged, interview on Prime Time was his contention that things were, like, totally cool. Why? Since he announced the massive give-away, bond yields hadn’t moved. Wow. He made his announcement at 4:30 pm and by 10:00 pm bond yields hadn’t moved. This proved that not only that the international markets were not ‘concerned’ with our financial black hole, they were positively chill (or they just go to bed early).

One could really get tired of this. There’s an eerie anthropomorphic quality to discussions on bond markets. Apparently, these markets can ‘feel’, ‘be happy’, ‘become angry’, ‘contemplate’, etc. and on and on. The trend of commentary usually goes like this: ‘the markets will be concerned if the Government doesn’t get tough on trade unionists, the poor, public spending and businesses in debt’. And when the Government does do tough guy stuff, the bond markets ‘approve’ and so, are at peace.

All this comes from the sound-bite school of deep, thoughtful analysis. Tracking bond yields can tell us many things – and it’s amazing that what it usually tells us is what we want it to tell us: vide the Finance Minister last night. So in that spirit I have constructed my own way of explaining bond yield trends. I have used the gross redemption yields for 10-year plus bonds on the last day of the month, sourced from ISEQ (one of many ways to track borrowing costs). This is what the ‘markets’ are telling me.

APRIL 2008: We are still innocent. The ESRI has yet to discover the recession and predict 3.1 percent growth for 2009. There is talk of property prices but we are assured it will be a soft, gentle landing. AIB is trading at €13.25. In another country baseball season is starting and little boys will be playing well into the bright summer evenings.

Bond Yield: 4.40

SEPTEMBER 2008: The boys of summer are still playing baseball but the financial dogs in the street are muttering something about Irish banks and insolvencies. The Sunday Independent declares that if anything goes wrong, whatever that might be, it will of course be the fault of trade unions. Bank Guarantee announced at the end of the month. Markets don’t have time to react before month’s end because they go to bed early.

Bond Yield: 4.60

OCTOBER 2008: Bankers say everything is fine and they don’t need equity; the markets get worried. AIB trades at €5.00 but no one is fired. Bringing forward the Budget doesn’t help either – especially this budget.

Bond Yield: 4.84

DECEMBER 2009: Markets get less jittery. All that hysterics about the state being exposed to hundred of billions of bank Euros fade away. ISME calls for the suppression of trade unions. Their competitors, the Small Firms Association, call ISME weak on the issue of trade unions.

Bond Yield: 4.47

JANUARY 2009: Everything goes haywire. Markets up in arms. Is it because Anglo-Irish is nationalised or because the Government, only a few days before, was going to pump billions in it because they believed it was still viable? The markets unsure whether the Government was colluding in a tissue of lies and deceit or are just plain idiots. Live Register experiences biggest jump in two decades.

Bond Yield: 5.54

FEBRUARY 2009: The Government goes macho. They kick the unions out of Government buildings in the early morning (and don’t even call them a cab). The Finance Minister announces a pension levy on public sector workers and cuts in the number of special need teachers. Pumped abs and testosterone everywhere. Commentators note that even the weather has improved. The markets, however . . .

Bond Yield: 5.57

MARCH 2009: The Tánaiste declares the Government has public finances under control. No one, not even the omnipotent markets, knows what to make of this.

Bond Yield: 5.45

APRIL 2009: Just to prove the Tánaiste was right, the Government introduces an emergency budget. The markets don’t understand – consumer spending is collapsing, businesses reliant on domestic sales are collapsing; and the Government takes even more money out of people’s pockets. There’s counter-intuitive and there’s counter-intuitive; and then there’s Fianna Fail.

Bond Yield: 5.28

JUNE 2009: The markets reconsider the Government’s emergency budget and their deflationary strategy of cutting €11 billion out of an already debilitated economy over the next four years.

Bond Yield: 5.84

AUGUST 2009: For months the three major credit rating agencies have been downgrading Irish Government debt and are threatening more. Commentators are horrified and claim we’ll never be able to borrow again ever, the Sunday Independent blames trades unions, employers demand the minimum wage be cut (though no one can figure out how this will get cheaper money). The markets, however, prove they have a sense of humour.

Bond Yield: 4.68

THE AUTUMN RUN-UP TO THE BUDGET - NOVEMBER 2009: Everyone is giddy. If the Government keeps their promise to implement a puppy-crunching, Bruce Lee, in-your-face, take-no-prisoners budget, the markets will smile and investors will actually pay us to borrow from them. The Taoiseach promises blood, sweat and bankruptcies, the Tánaiste claims that what ever makes us redundant only makes us stronger; the Minister for Health (sic) goes one better and threatens IMF tanks in every town square in the country if we don’t take the pain.

Bond Yield: 5.16

DECEMBER 2010: The Government introduces a puppy-crunching, Bruce Lee, in-your-face, take-no-prisoners budget.

Bond Yield: 5.18

[For a few weeks everyone’s attention is on Greece and those irrational Greek workers striking and marching in the streets because they don’t want to be the fall-guys and fall-gals for maintaining a strong Euro, Germany’s current account surplus and finance capital’s hopes for a return to Alpha status.]

MARCH 30th 4:30 – 10: 00 pm: The Minister declares markets are totally cool with him shovelling up to €20 billion in Anglo-Irish (proves what shrewd market players the Cabinet are), that the economy has turned the corner, unemployment is stabilising and we’ll return to growth this year. Recession? What recession? The only recession is in your mind, dude.

Bond Yield: Moved not one cent according to the Minister.

* * *

All that – all that courageous action the Government has taken that has so impressed the markets – and bond yields are worse than when we started on this dismal path. Of course, there will be those who will claim that if the Government didn’t take courageous action, borrowing costs would have been worse. If so, then why is it high bond yields got worse every time they did?

That’s one way of looking at all this. For another perspective have a read of Michael Burke’s take on borrowing costs and the Government’s deflationary policies. You might have your own perspective. If so, go on to the Irish Stock Exchange website and build your own story.

But, please, just don’t make the markets ‘nervous’.

How much are the bank bailouts going to cost us?

Nat O'Connor: There is a lack of clarity about just how much the bank bailout will cost ordinary people. But based on recent news, the estimated costs are huge.

The Irish Independent states that "Every man, woman and child in the State will have to pay an average of €2,000 every year just to service interest payments on borrowings to pay for the bank bailout, estimated to cost €40bn."

In fairness, it's not clear that we have enough information to know that yet. If the banks raise their own capital we won't need to borrow as much. Also, if we part-recapitalise the banks out of the National Pension Reserve Fund (which is what we did before) we will borrow less again. But let's tease out the scale of what borrowing €40 billion would mean.

Unfortunately, not every man, woman and child in Ireland has an income. So will paying the bill fall on the shoulders of Ireland's 1.6 million households, rather than its 4.5 million people? The costs then comes out at roughly €5,600 per year per household. But with state pensioners and other people living on social welfare on incomes of around €12,000, are we talking about halving their incomes and plunging hundreds of thousands of people into destitution?

Alternatively, we could look at the 1.9 million people in employment, who would have to take on an average of €4,600 each (with couples, where both partners are employed, taking on €9,200).

Average earnings for someone in employment in Ireland in 2009 were around €36,300 per year (CSO). So, for example, a single person on this income, already on c. €29,500 after tax, will see their final income fall to around €24,900. (Of course those on lower incomes might pay less, and those on higher incomes might pay more... this is just the average cost applied to the average income).

The cost to those in employment is likely to be lessened by further cuts in public expenditure (social welfare cuts, cuts to pensions, cuts to public capital expenditure, cuts to public services of all kinds, etc). Except that these cuts will also reduce quality of life, health, education, and increase households' costs to fill the gap created by the absence of public services.

And this is just to pay the interest on the loans to bail out the banks.

All the above assumes that NAMA will work and we will only have to pay the interest on the loans for a period of years. If NAMA makes a loss, or further bank bailouts are required, the burden of paying for all this will increase.

If that wasn't bad enough, some people will be further affected by mortgage interest increases. The Belfast Telegraph suggests that AIB "will respond to its latest bailout by raising mortgage rates by a further 1.5% this year." That's on top of this week's 0.5 per cent increase. Assuming the other banks follow suit, that will increase pressure on tens of thousands of households.

Not every household is affected by this double squeeze, but it is hard to see how households will be able to afford to pay another couple of thousand extra per year on their mortgage repayments, alongside bearing the tax increases to pay the interest on the loans to bail out the banks.

It is possible that we could see a major wave of mortgage default and repossession, which would trigger a further crisis in the banks, and a need for further recapitalisation. Those who don't default are likely to be paying way more than they can comfortably afford to keep their homes; all to avoid the nightmare of selling their homes at a low price, while still owing the bank the balance of their original (massive) mortgage loans.

In a year or so, the State could own all or most of the banks, but the citizens who own the State will be paying increased charges to the banks as customers at the same time as paying taxes for the loans to own them. The burden of paying the interest on the loans will all but rule out any productive investment in better infrastructure, better education, etc. Most of our potential for investment will be tied up for years in paying for the mistakes made by past governments.

There is a need for much more accurate information to be made available on exactly how the Government plans on paying for the banks and at what point it would be cheaper to let some of them go bust. We need to know exactly how much households will have to pay and what will be the opportunity cost in cuts to public services and the loss of a generation's ability to invest in a better future. At present we can only speculate. But based on the figures currently in the news, it's a perverse and gloomy situation and we haven't gotten to the bottom of it yet.

Tuesday, 30 March 2010

Groundhog Day

Stephen Kinsella: Super Tuesday has been and gone. Even those of us who study Irish public policy and the Irish economy on a daily basis were taken aback by the scale of the wealth transfers from state to private banks. What does it all mean? I’m a professional economist folks–don’t try this at home.

As I mentioned on Drivetime this evening, the injection of capital, combined with the government guarantee and NAMA, is supposed to heal banks’ balance sheets enough to get them into a position where they can borrow cheaply from abroad, and so resume lending again.
My opinion is that this increase in lending won’t happen, because canny investors know that residential loan defaults are on the way. We’ll have a groundhog day. This is not the one big moment to sort out our banking sector. This is a stage in a process, and nothing more. We’ll see the outright nationalisation of AIB by the end of 2010.
NAMA is getting going with its big 10 debtors, transferring 16 billion euros worth of loans in the next few weeks, representing perhaps 20% of the overall loans to be transferred by the end of the year. In particular, Anglo transfers €10bn at 50% discount, AIB transfers €3.29bn (43%), BoI transfers €1.93bn (35%), Nationwide transfers €670m (58%), and EBS transfers €140m (37%). Overall, the haircut is 47%. We need to be careful with that 47% discount number (or ‘haircut’) everyone is talking about. As usual, the bigger haircut, the greater the hole to fill in balance sheets to be filled by taxpayer’s money. While it might be the weighted average of the discounts being applied to each bank as the Minister says, we can’t back out the prices NAMA is going to pay for the loans in, say, AIB or Anglo. Update: Karl Whelan has more on this issue.
Notice also the rhetorical shift. We knew after guaranteeing the liabilities of the banks that a bad bank or asset management vehicle like NAMA was necessary, but also a further injection of capital and perhaps even full scale nationalisation. We were told NAMA was the only game in town, and all other options were not to be considered. Those who argued for nationalisation were derided or ignored. Now it looks highly likely that at least AIB, Anglo, INM, and EBS will be nationalised by the end of 2010, with the state taking a large piece of BoI as well.

Finally, notice the precise imprecision: promissory notes are being issued for several billions, but spread out over ‘10 or 15 years’. Surely we can do better? Not to worry though, we’ll have another crack at it, when groundhog day rolls around again.

Moral overload?

Slí Eile: No sooner was the ink dry on the Public Service Agreement (2010-2014) than the next news story broke on - NAMA. It just never dies down. We have now moved from dealing in billions to tens of billions. In Weimar Republic style numbers inflation we are moving into funny money territory. Except it is not funny for anyone. It is staggering. The figures dwarf any possible savings in public sector pay bill by a large multiple that the financial implications of the new deal on the public service (if is passed by union members) pale into insignificance. The negotiators deserve credit for their efforts. But, there is one snag - its paragraph 28 on page 9 - the very last sentence in the main document. It reads:
The implementation of this Agreement is subject to no currently unforeseen budgetary deterioration.
O dear. I think we might have just had an unforeseen budgetary deterioration over the six o clock news this evening. Even Minister Lenihan admits that this has serious implications for taxpayers (contrary to the McCarthyite dictum that NAMA and the fiscal crisis have nothing to do with each other). NAMA has everything to do with the crisis because it is going to magnify the mountain of debt, contraction and cost-cutting imposed by a general slump. With GNP falling at an annual rate of over 12%, tax receipts under-shooting for most months there is every prospect of an early budget or an early election or an early bank collapse or all three. Either we keep on feeding the junkie called Anglo or we allow the junkie to die. Pretty stark. But, the problem right now for Government is whether it can deliver on all of its promises to:
  • not cut public sector pay before 2014
  • reduce the General Government Deficit to 3% of GDP by 2014
  • keep the Anglo junkie fed with €10bn every few months (does anyone believe that another shot will not be demanded - we are in free fall)
  • and keep the economy from contracting by another 10-12% this year (the forecast for a decline of 3% but that remains to be seen).
And what of social welfare recipients? Any guarantee that they will not see another cut in rates before the end of this year? After all, with politically bought commitments on school class size, third level fees, public sector pay the room for manoeuvre is very, very limited especially if the Government is writing promissory notes fast to impose a haircut on the young generation by way of unemployment, public service cuts, emigration and deficit traps. It can always claim TINA (there is no alternative repeated daily 20 times until patient is dazed) having fixed spending options on public sector pay, education class size and under squeeze from NAMA and bank recapitalisations.

Worryingly, the Labour Party have pointed out (Strategic Investment Bank) that:
At the same time, Ireland’s fiscal position and the restrictions imposed by the
Stability and Growth Pact (SGP) represent a major constraint. There is little prospect that the level of investment necessary to improve our infrastructure can take place in the next decade given the current state of the public finances. And even without the fiscal crisis, the SGP, which includes public capital investment as part of its limit for the budget deficit, would restrict the State from making the necessary investments.
Where does that leave us if people are saying that we are under siege on all sides and to such an extent that we cannot invest our way out of this crisis along with other policy measures?


The statement outlining the 'haircut' is available here. The Minister's Statement on the banking situation is available here. Comments?

Monday, 29 March 2010

Guest Post by Gerry O'Hanlon S.J.: Asking the Right Question

Gerry O’Hanlon: We are understandably concerned about economic recovery in Ireland these days. But given that ‘recovery’ might be taken to imply a return to a previously desirable state, perhaps we need to reframe the question that we ask. If we ask ‘how do we recover’, we are in danger, in our public discourse, of letting conventional indicators like a pick-up in retail sales, an increase in property values, a rise in consumer sentiment, even – the Holy Grail! – growth in GDP and GNP, become the sole normative criteria for what might too easily become a return to ‘business as usual’. That would be a pity. Given what we have learned about the serious flaws in our ‘business as usual’ model, it might be better to ask a different sort of question that might push us in a more radical direction – so, for example, ‘how do we create a new economic model that is sustainable’?

The predominantly neo-liberal, infinite-growth model of the recent past has let us down. It was shot through with an economism which meant that an obsession with economic growth trumped so many other human values. It was riddled with inequalities both within and between nations, in ways which made solidarity unsustainable. And its focus on consumption did serious damage to our planet, as well as failing to make us happier.

In this context the reflections of the former Chief Rabbi of Ireland, David Rosen, are apt. Rosen quotes an old Jewish commentary on those who, according to chapter 11 of the Book of Genesis, showed hubris in attempting to build The Tower of Babel up to the heavens – ‘if in the course of building, a human being fell and was even killed, no one batted an eyelid: but if a brick fell and shattered, they all sat down and cried’. In other words, in this story of an ancient industrial collapse, work and growth were more important than human beings, and the enterprise went to the heads of its developers, showing ‘a profoundly distorted sense of values in which human life and dignity are subordinated to material achievements’.

Of course ‘material achievements’ are important: we want a future where people can work, where basic needs are satisfied, where human dignity is respected. But can that perhaps be done within a vision of the future articulated in terms of ‘prosperity without growth’ (Professor Tim Jackson), a ‘steady-state economy’ (Hermann Daly), ‘the richness of sufficiency’ (Bangkok letter of ecumenical group of Asian Churches in 1999)? And within that vision perhaps we need to create a culture which values society as well as the individual, a culture of the common good that respects solidarity and fairness and that commits itself to responsibility for inter-generational care of the earth?

That kind of new vision, those kinds of values, would have concrete implications. Banks would need to recognise that they have obligations to all stake-holders, not just to share-holders, that they have a social function in serving the ‘real economy’. Financial traders would need to be regulated in such a way that short-termism is eschewed – the introduction of a Tobin or Robin Hood tax on international currency and financial transactions might be a relatively simple and effective first step in this respect. Our economic priority should be to favour labour rather than capital, to put work and jobs as a prime target, and to consider salary caps or more progressive redistributive tax policies in order to bring about greater equality. It is estimated that CEOs in the USA were paid 344 times the average worker’s wage in 2007, as against 42 times in 1989. Why shouldn't we take up the suggestion of Paula Clancy of TASC and consider what it would be like if a policy objective was inserted in the Constitution that limited the top 20 per cent in Ireland to an income of 10 times, or even 5 times, that of the bottom 20 per cent?

The New Economics Foundation (The Great Transition, 2009) has tried to spell out concretely what such an economic model, with those kinds of values, might mean for Britain. They speak in terms of a fall of GDP by a third (to 2001 levels); of a four-day working week, to allow for full employment with less economic activity and to give a better work-life balance; market prices reflecting social and environmental costs; a redistribution of income to Danish levels of equality; capital markets functioning in such a way that company profitability would be linked to social and environmental value, so that share prices for listed companies would reflect this – and so on. All this would be premised on a democratic national determination of what the UK as a society deemed to be of social and environmental value, with government retaining the right to make determinations between competing interests. The net result, they estimate, would be a growth in ‘real value’, despite a reduction in consumption and economic growth.

Are we doing enough to raise these kinds of questions and research these kinds of solutions in Ireland? What is involved is a change of culture; a political class which is capable of the kind of leadership given at the height of the Northern Ireland crisis when a more radical approach was taken; a religious input that transcends the evil evidenced in Murphy and Ryan, not to mention the mediocrity of the kind of social conservatism so common in post-independence Ireland but which – as Habermas, Putnam, Rawls and Sandal all acknowledge – can draw on inspirational sources of self-transcendence which encourage believers to engage in a critique of the status quo and to join with fellow-citizens in the search for a better way forward.

Gerry O’Hanlon, S.J., Jesuit Centre for Faith and Justice, author of recently published Theology in the Irish Public Square, Dublin: Columba Press, 2010.

Lies, Damn Lies & Irish Economic Statistics - A Basic Lesson in Corporate Tax Planning

An Saoi: I have had enough of all of those stockbroker economists & politicians who lecture us incessantly that exports are the key to getting us out of their economic mess. I decided to put together this note on “Irish” exports, or more correctly Ireland’s role in worldwide tax planning. You will doubtless have heard that “Irish” exports have fallen very little through this depression. This post tries to explain why.

Please make the effort to read it all; I have tried my best to keep it as simple as possible.

The diagrams below show a basic simple structure used by many multi-nationals to avoid paying tax. Sales are booked through an Irish trading company for perhaps the whole of Europe, and the profits are quickly hoovered into another “Irish” company, but this one is actually in a tax haven. It is sometimes referred to as a “double Irish”.

Let us say a US multi-national wants to set up an Irish trading subsidiary or as they are normally described by the IDA a “European Headquarters”. Instead of setting up one company however it sets up two, a trading sub, which will carry out the activity and a holding company, which will move its centre of management and control to a tax haven, let us say the Bahamas, directly after formation. This company is Irish Registered and Non-Resident or an IRNR.

The IRNR will own the license or intellectual property required by the trading company and issues a sub-license to a Dutch BV.

The Dutch BV passes on a sub-license to the Irish trading company. This avoids the IRNR being deemed to be resident in Ireland and thus taxable in this State. It is the reason you interpose a Dutch BV, which acts as a conduit to get the profits tax free up to the IRNR.

The Irish trading company “sells” the license, goods or whatever the company makes or does throughout Europe, paying local subsidiaries a small commission to do the marketing. It passes most of the profit upwards in the form of a royalty payment. Instead of paying a tax rate of 12.5%, it actually has a tax rate of about 3% or even less.

The US accepts that companies are resident in the country where the company is resident, but Ireland looks at its so-called “centre of management and control”. The haven company therefore is Irish as far as the Yanks are concerned, but is not consider Irish by the Revenue Commissioners.

Fig. 1

Fig. 2

Kathleen Barrington of the Sunday Business Post described here how NCR washed most of its profits through Ireland and Simon Bowers writing in the Guardian showed how Google books all its sales through Google Ireland Ltd here.

Tax avoidance is a serious issue, which as an Oxfam publication issued in March 2009 showed costs lives. Ireland is a prime player in world tax avoidance because we happily co-operate with many of the largest multi-nationals, by not just allowing these types of structures, but actually marketing the country as the place to locate.

The accounts of the Irish trading entity would look something like this. This is not an extreme example, but should give a flavour of the type of “exports” we really produce.

(*I have assumed that Depreciation = Capital Allowances)

Friday, 26 March 2010

DDDA Reports

Leaked copies of Professor Niamh Brennan's three reports on the DDDA are available here (thanks to The Story for this link).

Wednesday, 24 March 2010

The day after the IMF's tomorrow

Michael Taft: The IMF has suggested that the Irish Government’s growth projections are too optimistic and should be scaled back. So has the EU Commission. This has grave implications for the Government’s current strategy; if growth doesn’t come right, fiscal targets will be missed, debt will pile up, unemployment will remain high and living standards low. The Government may well end up sinking further into deflationary quicksand.

The IMF has projected growth for Ireland up to 2014. While these projections were initially produced in the middle of last year, the IMF reconfirmed them in their recent World Economic Outlook. What would be that impact on the deficit given these growth projections? The following examines only the tax revenue side of the equation.

First, we find IMF growth projections much lower than the Government’s. Between 2010 and 2014, the Government expects the economy to grow by 17.4 percent in real terms; the IMF, 8.8 percent. This will have considerable implications for public finances, as tax revenue is a function of GDP – low economic growth equals low tax revenue growth.

If the Government’s ‘tax burden’ or ‘tax ratio’ holds, under the IMF scenario we would find that not only will we fail to meet the Maastricht guidelines by 2014, we will pile up considerably higher debt in the process. Under the IMF scenario, the annual deficit is unsurprisingly higher each year; by 2014 it still remains above Maastricht guideline levels by 2014.

More alarmingly, is the growth in overall debt levels. The Government expects gross debt to be at 80.8 percent of GDP. However, if the IMF projections hold, overall debt will soar to over 93 percent – a result of higher annual deficits, and lower nominal GDP. This is what the TASC letter referred to as the ‘low-growth, high debt’ future.

There are two major caveats: first, this doesn’t include higher unemployment costs. We should expect unemployment, under the IMF’s lower growth scenario, to remain higher than the Government’s forecasts. If so, spending will rise above current projected levels. Second, higher borrowing levels will incur higher debt service costs. Factor these in, and the deficit and overall debt levels will be higher still.

This is all of a piece. In a previous post, Michael Burke and I showed how the Government’s current strategy will depress future growth. That is because the Government, rather than reducing the deficit, is embedding the deficit into the economic base.

So which scenario is more likely? The IMF projections are clearly pessimistic. The Government will take some comfort from recent projections. For 2011, Bloxham is projecting 3 percent growth; Friends First 3.1 percent. IBEC, however, is slightly more cautious, with a projection of 2.1 percent while PwC projects growth at 1.8 percent.

Some comfort, yes; but even the Department of Finance warns that GDP growth may not be tax-rich. This is because growth may be driven by exports from the multi-national sector.

So do all these numbers matter? Yes, very much so. NCB’s growth projections come up only slightly less than the Government by 2014, but even this has the potential to knock the Government’s fiscal targets off course. They, too, accept that the Government will miss its 2014 target, while piling up more debt than the Government expects.

In short, the Government’s fiscal strategy is built on quicksand. Its growth projections are optimistic and it has failed to factor in the deflationary effects of its current spending cuts policies. If they resort to further fiscal tightening to make up for this, all that will happen is that they will sink even further.

And the rest of us along with them.

Tuesday, 23 March 2010

IMF et al on Fiscal Stimulus

Michael Burke: Philip Lane has posted a link to a very useful IMF working paper here. The paper draws on a wide variety of leading macroeconomic models (IMF, EU, Fed, Bank of Canada, etc.) to examine the effectiveness of fiscal stimulus.

Some interesting features of the paper’s conclusion: “There are four broad conclusions flowing from our analysis.

First, there is no such thing as a simple fiscal multiplier. The response of the economy to temporary discretionary fiscal stimulus depends on a number of factors, including most importantly the type of fiscal instrument used and the extent of monetary accommodation of the higher inflation generated by the stimulus.

Second, temporary expansionary fiscal actions can be highly effective, particularly when the fiscal instrument is spending or well-targeted transfers, and when in addition monetary policy is accommodative.

Third, permanent stimulus, that is a permanent increase in deficits, is much more problematic than temporary stimulus. It leads to a long-run contraction in output, but in addition the perception that deficits will become permanent also substantially reduces short-run fiscal multipliers.

Fourth, the G20 stimulus should have significant effects on global GDP in 2009 and 2010.”

So, it seems that the rest of the world has good reason to believe in the ‘tooth-fairy’ of fiscal stimulus. No such naïveté to be found in the ranks of Irish policymaking, unfortunately.

In discriminating as to types of stimulus, the verdict is also rather clear,

“A number of results are consistent across all models.

First, the multipliers from government investment and consumption expenditures, which are roughly similar in size, are clearly larger than the multipliers from transfers, labor income taxes, consumption taxes and corporate taxes.

Second, multipliers are small for general transfers, labor income taxes and corporate taxes, and somewhat larger (but still small relative to government expenditures) for consumption

Third, only targeted transfers come close to having multipliers similar to those of government expenditures……[Yet....]
…it is of interest to note that in none of the regions [of the world adopting fiscal stimulus] do increases in government consumption play a predominant role.”

Figs. 22 and 31 show the very large multiplier effects of government investment and (slightly lower) effects of targeted transfers to the low paid in the US economy and Figs. 64 and 73 show the same for the EU.

There is one unproven assertion in the article on government finances, evident in the phrase above ”a permanent stimulus, that is a permanent increase in deficits.” If, as the models consistently find, the effects on GDP of government consumption and investment have multipliers that stretch to 2 over more than one year when interest rates are low (and have a cumulative five-year impact of more than 5), then the effects on government tax revenues would exceed the initial outlay by some considerable degree; ie investment and government consumption can lower the deficit, not create a permanently higher one. There is too the unacknowledged benefit to government finances from a growth-related decrease in welfare spending.

The alternative approach, based on ‘Expansionary Fiscal Contraction’, is dismissed in the IMF WP. An examination of how the EFC experiment has failed Ireland can be found on this blog.

The main argument against Ireland adopting a fiscal stimulus is openness (The debt and deficit arguments do not hold since Ireland’s debt level is below that of the peer group studied and the deficit matched by some). Yet the openness argument is tested (Fig.88) and found to have no appreciable impact on the effectiveness of fiscal stimulus - perhaps, unstated by the authors, because the propensity to import is offset by both a greater propensity to export and the greater efficiency that openness brings.

Creating a smart society

Colm O'Doherty: The grade inflation in the formal education system controversy failed to get to grips with the critical issue around what constitutes knowledge and more importantly what is it for. The dominant thinking on education and knowledge infrastructure is that formal education is a commodity which generates economic growth through the market place. Our education system is now in thrall to a global phenomenon-building knowledge capital.

Economists define capital as that which has been invested. In the past a different type of investment generated economic growth. Investment of financial assets in physical capital - plant buildings and machinery- has been superseded by investment in human capital –education and training. Resources committed by governments or organizations or individuals to education and training are treated as investments within a capitalistic framework.

Formal education is increasingly viewed as a vehicle for investment , yielding individual wealth creation opportunities rather than social and cultural goods. Irish third level institutions are inordinately proud of the academic capitalism which not only informs their research strategies but their teaching and learning methodologies as well. Innovation and technology parks, enterprise centres, entrepreneurial boot camps and other commercialised forms of knowledge infrastructure rule the roost. The expansionist agenda of the marketeers is warmly embraced by third level institutions. Commerce has succeeded in capturing higher education by replacing educators with managers.

The essence of Enlightenment thinking is that knowledge is power but within our groves of academe the inverse relation also holds - power is knowledge. Power defines not only a certain conception of reality but all aspects of reality – physical, economic, social and environmental. Managerial power is based on ideas which have been developed chiefly in the worlds of manufacturing and commerce. There is no evidence that this approach to formal education produces smart citizens or more importantly a smart society. Students' “learning” is managed on behalf of the commercial sector by administratively tasked operatives. This process results in intellectual mediocrity rather than innovation, or enterprise or authentic learning.

Real learning is, however, taking place outside of the formal education system. Non formal and informal learning gained through volunteering is, according to a recent EU Report, Volunteering in the E.U., promoting social and economic cohesion. The Report provides evidence that, right across Europe, volunteering is a particularly powerful means to develop citizens commitment to their society and to its political life. Not only does volunteering make a direct contribution to our economy (between 1% and 2% of GDP), but it provides education and training opportunities that deliver significant added benefits to volunteer , local communities and society in general. Volunteer work provides important employment training and a pathway into the labour force. It is also a useful way for young people to test out potential careers and therefore make an informed choice about future education and training pathways.

There is now a growing body of evidence indicating that well-being is better correlated with equality, health, work satisfaction and positive relationships than with marginal gains in income. Our crash has revealed the folly of relying on financial markets to steer and supply both economic and social development. In the education sector, the ascendancy of an economic or business model has contributed to a fragile and brittle culture of competitive individualism where what counts as knowledge is determined by economic vicissitudes. The only way to rescue this situation is through a rehabilitation of the belief in education as an expression of collective action for the benefits of interdependence and generalised wellbeing.

The state needs to discontinue its present educational policy of using third level institutions as a funding conduit for opportunist capitalism. This is not smart behaviour. On the other hand, Volunteering in the EU provides us with a framework for post crash learning based on a politics of common interest. The E.U. Report calls for the non formal and informal learning accruing from volunteering to be taken into account when measuring the well-being and the wealth of Member States. Volunteering provides a platform for pursuing both individual and collective well- being and making them mutually supportive.

It is somewhat ironic, given the evidence of the value of volunteering to the development of a smart society, that the government is disbanding 180 voluntary management boards in the Community Development Programme. An unintended consequence of our formal educational policy is the creation of a disconnect between competitive individualism and collective life. This damages the community and trust which are vital to the smooth running of an economy. A new educational agenda incorporating the values of non formal and informal learning is a better bet for post crash civic renewal and sustainable improvement in levels of collective well-being than the boom and bust possessive individualism of the so called smart economy.

Monday, 22 March 2010

Fiscal recklessness and the TINA mantra

Tom McDonnell: The startling change in mood that has come upon the Irish people in this post Tiger era is reminiscent of a hangover after the ball. Indeed the drunken sense of hubris during the boom was such that our leaders seemed to have genuinely felt we had moved beyond such trivialities as economic cycles. The Government had reached such arrogant heights that Bertie Ahern even saw fit to recommend suicide to those few with the clarity of vision and understanding to warn of the impending collapse. Questioning the narrative was forbidden. Just as questioning the narrative that ‘there is no alternative’ (the TINA mantra) is now forbidden.

The Government was asleep at the wheel. Budgeting and economic planning had become so dysfunctional under Brian Cowen and Charlie McCreevy that the country’s public finances had become reliant on a single commodity rising in price year-on-year. A decade of giveaways had opened up a huge structural fiscal deficit which could remain hidden provided that the value of this one asset kept on surging. But asset prices move in cycles, and when the property crash inevitably took place (and it was inevitable) it was suddenly revealed to all that Ireland had a gaping hole in its public finances. It’s important to understand that this gaping hole already existed at the time the crisis struck. The crisis merely removed the illusion. During a time of unprecedented boom the Government had done all of the wrong things. They pursued pro-cyclical policies to remain in power, and now the taxpayer is left with the bill. The result of these policies is that at a time of severe economic crisis we have no nest egg available to provide any sort of stimulus. We are told that there is no alternative to the strategy of slash and burn.

But what is done is done, and the important question now is what can be learned from this folly. How can we ensure that our public finances are never mismanaged so badly in the future? Part of the difficulty with Keynesian demand management is that during those times of economic boom a purely self-interested political party will run pro-cyclical policies. Irish economic history is littered with such examples. Instead of seeking to manage the economy with the long term interests of the country at heart the party in power is concerned with maximising the number of jobs and maximising growth levels at precisely the time of the next election regardless of the consequences. The long term health and sustainability of the economy is therefore sacrificed to ensure present day electoral success. As Irish economic history has shown, the party in power cannot be trusted not to abuse long term sustainability in this way.

To prevent history repeating itself, there is an argument for governments being deprived of the power to buy elections at the expense of the long term. One option for achieving this aim would be a Constitutional amendment.

The details of such a Constitutional amendment would be up for debate but one possibility would be to require the Government to run a minimum budget surplus equal to half the previous year’s rate of GNP growth. To ensure long term planning, the government would also be required to set out indicative budgets for the next three to five years. Finally, the Constitutional amendment would set up an independent group of experts with the power to veto the budget if the Government’s estimates of both revenue and expenditure are unrealistic or are heavily reliant on temporary phenomena such as asset price swings. Politicians would, of course, still have power to decide levels and composition of tax/expenditure.

These changes should ensure more long term economic planning and would guarantee that the option exists during times of recession to engage in demand management through massive capital expenditure increases. We would not be in the perverse position of needing to slash and burn at exactly the time when capital projects are likely to have their greatest economic net benefit. Instead of the current ‘There is No Alternative’ (TINA) strategy there could have been a strategy focused on job creation.

No one disputes that the budget does have to be balanced in the long term, but to ignore the jobs crisis will devastate a generation and compromise Ireland’s economic future by running down the national store of human capital. Addressing the jobs crisis will involve the up skilling of a whole generation of former construction workers. This will be expensive but it has to be done. The old jobs aren’t coming back and the alternative to up skilling is to condemn these cohorts to long term unemployment or emigration.

So where is future economic growth to come from? The Government’s strategy is evidently to place all of its hopes on export led growth. They hope that Ireland will grab a larger slice of the international market through improving competitiveness and that this improved competitiveness will be achieved primarily through downwards pressure on wages. One side effect of this downwards pressure will be to reduce consumption in the short term but the Government is hoping that the increase in net exports will outweigh this drop in consumption. Brian Lenihan has already signalled that we can expect a further €3billion in cuts this year in the form of a drop of 1€billion in capital investment and a drop of €2billion in current expenditure. So the vicious circle of economic contraction seems set to continue. Of course Brian Cowen is still claiming that the NAMA exercise will increase the flows of private credit in the economy. However the sad reality is that the International Monetary Fund is telling the Government that NAMA will not lead to a significant increase in lending by the banks. NAMA and underlying issues may end up impairing the economy for years to come.

So what is to be done? In an ideal world we would be in a position to engage in a stimulus to deal with the jobs crisis. The ESRI’s fiscal multipliers from last April and the Benetrix/Lane historical multipliers both show that investment can be effective in generating jobs and growth despite Ireland’s status as a small open economy. However the sheer seriousness of the fiscal position will make demand stimulation extraordinarily difficult to fund through borrowing. But the jobs crisis must now be given equal precedence with the fiscal crisis. The real question then becomes one of whether the potential damage to the fiscal position is outweighed by the benefits of a stimulus.

Targeted investment chosen on the basis of strict cost benefit criteria must now be pursued. Investment projects with long term productivity enhancing benefits can, by increasing growth and creating jobs, actually improve the public finances. With levels of private investment so low at the moment, the likelihood of crowding out is minimal. Also, as actual output in the economy is lower than potential output the likelihood of capital projects successfully increasing growth is higher than usual. The Government can begin to move in this direction by reversing its planned cut of 1€billion in the capital budget. However alternative sources of funding for job creation projects must also be pursued and dipping into the National Pension Reserve Fund must now seriously be considered as a source of funding for as long as the crisis continues. At the same time a commitment should be made to start repaying the money to the NPRF once the crisis has passed.

Finally there must be recognition that the goal of economic policy is not economic growth per se but sustainable improvements in the quality of life of citizens. With this understanding in mind, it becomes clear that a more holistic approach to budgeting is appropriate. Economic growth is one indicator of progress, but so too are equality, long term environmental sustainability, job creation, health, education and other life outcomes. In the long term the budget must be designed with a mind to the impact on these areas, and the budget must be designed within the constraints of prudent fiscal policy.
Tom McDonnell is Policy Analyst with TASC

Economically damaging and fiscally irrelevant

Michael Burke & Michael Taft: It is often stated that to reduce the fiscal deficit we must cut public spending. There is an assumption, never substantiated, that cuts equal savings. However, the evidence shows otherwise: public spending cuts will not significantly reduce the fiscal deficit and, in some scenarios, may actually increase it.

In April 2009 the ESRI assessed the economic impact of various fiscal measures (tax increases, spending cuts) on a number of variables over a six year period: GDP/GNP growth, consumption, employment, output, wages, borrowing, etc. On the basis of their estimates we will assess the impact of the Government’s current spending cuts on growth and the deficit up to 2014.

Impact on GDP

Since the 2009 budget the Government has announced slightly more than €6 billion in current spending cuts. These include wage cuts, employment reductions, cuts in purchases of goods and services, and social transfer cuts.

Public sector wage cuts: the ESRI estimates that the first year impact of public sector wage cuts on GDP was – 0.335, or -0.2 percent That is, for every €1 billion reduction in public sector wages, the GDP falls by €335 million. This is primarily due to reduced consumer spending (falling by 0.8 percent or approximately €700 million) with a knock-on effect on employment (a loss of 0.1 percent, or approximately 2,000 jobs).

The ESRI also projected that the deflationary effect accelerates – so that by the fifth year the impact on GDP is approximately -0.774, or -0.4 percent of GDP causing further loss in consumer spending and employment.

Other current spending cuts: The ESRI only provides a simulation for employment cuts. Here, they estimate a first year impact of -1.179, or -0.7 percent: for every €1 billion reduction through job losses, the GDP declines by €1,179 million. The driving force behind this impact is the loss of employment – 1 percent, or approximately 19,000 jobs in the first year. There is only a slight easing of the deflationary effect through the years. In the fifth year, the impact is estimated to be approximately -1.165 or -0.6 percent of GDP.

The ESRI does not provide simulations for reduction in government consumption or social transfers. Therefore, we will use the employment reduction multiplier as a proxy. This can be justified on the following grounds:

The fiscal shock from increasing government non-wage consumption was projected by Lane and Benetrix to have a first-year multiplier of in excess of 2.0. While it cannot be assumed the opposite will hold (an equivalent negative multiplier from a cut in consumption), it does show the Irish economy is very sensitive to this type of shock (given that Lane-Benetrix was measuring over a period of 20 years, this impact is likely to be higher during a recession).

While there are no Irish measurements for social transfers, in the US extension of unemployment benefits and transfers to food stamp recipients had higher multipliers (1.64 and 1.73 respectively) than other forms of spending increases or tax reductions. This should not be surprising. The size of the multipliers is directly related to the ‘propensity to consume’; i.e. what proportion of each additional € in income is consumed and what is saved. Transfers to the poor or low-paid are likely to have a stimulative effect since they are obliged to consume a greater proportion of their incomes. Again, while not assuming the opposite is true here, it is expected that such cuts will provoke a significant negative shock among groups with a high propensity to consumer.

Therefore, we find the following (assuming, for the purposes of this exercise, that the cuts of €6 billion took place in 2009 and taking the Government’s growth projection as the base-line):

The first year impact will result in a GDP decline of €4.9 billion, or -3 percent of GDP. In the long-term, the decline accelerates to a decline of €6.4 billion or -3.1 of GDP. These are significantly deflationary.

Impact on Borrowing Requirement

Turning to the impact on the borrowing requirement (EBR), the ESRI simulations estimate that:

(a) A reduction of €1 billion through public sector wage cuts, results in a reduction of 0.3 percent in the EBR in the first year. Because of the acceleration of the deflationary impact, this falls to 0.2 percent in the fifth year.

(b) A reduction of €1 billion through public sector employment losses results in a reduction in the EBR of 0.2 percent in the first year. By the second year, this is reduced to a mere 0.1 percent and continues at this level through to the fifth year.

Therefore, we find the impact on the EBR to be:

The Government’s current spending cuts reduce the EBR by 1.4 percent in the first year; declining to a mere 0.8 percent by the fifth year.

It is important to put this in perspective. The Government intends to reduce the General Government Balance by 8.7 percent of GDP between 2009 and 2014 (a reduction of 7.3 percent in the Exchequer balance).

Yet, the ESRI estimates that current spending cuts will, after factoring in the deflationary impact on the economy, make only the smallest of contributions to that reduction.

However, the ESRI simulations themselves may seriously under-estimate the debilitating impact on the economy and, therefore, over-estimate the reduction in borrowing.

• First, the ESRI simulations are based on long-run average behaviour, which includes both booms and busts. Fiscal tightening in a recession, when there is already spare capacity, will have a greater depressing effect than the same during a boom.

• Second, the ESRI model may assume certain behaviour – ‘crowding in’ of private investment, lower bond yields, increased economic activity, emigration levels – which may not occur. Factors such as the continuing credit crunch, household deleveraging, structural deficits in our infrastructure and indigenous enterprise base may overwhelm such theoretical assumptions.

• Third, the ESRI measures impact in tranches of €1 billion. However, when these tranches are multiplied (e.g. the impact of the April Budget tax/levy increases was €2.8 billion) the cumulative impact may be higher.

• Fourth, the ESRI simulations analyse fiscal measures in isolation. When combinations of these measures are introduced the cumulative impact may be higher.

• Fifth, when access to credit is constrained, the depressing impact on activity arising from fiscal contraction is also likely to be amplified.

In other words, such are the downside risks to the ESRI estimates, that we may experience perverse results: that the fiscal deficit burden may actually rise as a result of public spending cuts.


The Department of Finance is correct: quantifying impacts ‘requires a combination of econometric model simulations and judgement’. Judgement and experience tells us that cutting spending during a recession (a) reduces economic activity and (b) reduces tax revenue and increases unemployment costs. That this occurs is beyond doubt; what we need to do is find the extent.

We have shown that ‘savings’ are minimal and the impact on GDP severe. And such is the fractional impact on borrowing there is a distinct downside possibility that such cuts will increase the deficit burden. This is reinforced when we note the deflationary impact on the domestic economy is even more severe. Whereas GDP will decline by -3.1 percent by 2014 as a result of the current spending cuts, GNP will decline by -3.8 percent. This is what the TASC letter referred to as ‘a low-growth, high debt future’.

Cuts do not equal savings. Cuts degrade economic activity with only a marginal impact on borrowing. The next time a commentator says ‘we’re borrowing €400 million a week’ as a justification for more spending cuts, they can easily be answered: cutting spending won’t affect that ‘€400 million a week’ and it may only make things worse.

To bring the deficit under control we need another alternative – one based on growth and not deflation.

Benchmarking Working Europe

The European Trade Union Institute (Brussels) has recently brought out a publication comparing European countries in areas such as income, unemployment, and social protection, amongst others.

It can be bought or downloaded from here.

Friday, 19 March 2010

Jobs and recovery

Tom O'Connor: The Labour Party are holding a public seminar in Cork tomorrow on solutions to Ireland's economic crisis. The speakers including myself will look at the causes of Ireland’s economic crisis and solutions to it with a particular emphasis on job creation and national recovery.

I will be focusing on jobs and national recovery. My starting position is that to tolerate 430,000 unemployed on the live register is economically disastrous for the economy. Just as importantly, it is morally and socially unacceptable.

Two years ago this June I predicted in the national media that unless the economy received a significant short term stimulation, that it would spiral downwards in to recession.

I said (Summer 2008) on national radio that this would be accompanied by constant increases in unemployment and a resultant falling tax take and widening hole in the public finances. It was obvious two years ago that this perilous situation, in the absence of economic stimulation, would necessitate further cuts, more economic depression, more unemployment, more falls in tax takes, increased deficits and then more a spiral downwards.

In the summer of 2008 a huge hole was opening in the government finances: reports at that time were that it was running a deficit of 4 billion. By the start of December, the government stated that it’s deficit for the first 11 months of 2008 was 8 billion. In fact, its end of year deficit for 2008 was 12.7 billion.
The government announced in its October 2008 budget that it expected the end of year deficit for 2009 to be 13.4 billion. In the extra budget in April, the government forecasted and far bigger end of 2009 deficit of 20.35 billion. On the sixth of January 2010, the government announced that the final end of year deficit for 2009 was 24.6 billion.

In May 2008 as the government’s finances started to deteriorate, live register unemployment stood at 201,800 (deficit 4 billion). In February 2009 live register unemployment was 352,453 (deficit of 12.7 billion). In January 2010, this figure was 436,936 (deficit of 24.6 billion) and in February it was 436,956.

That amounts to clear evidence for the cuts- economic depression- unemployment- falling tax takes- ballooning budget deficit prediction. The overall government tax take at end of 2007 amounted to around 47.8 billion (unemployment 198,000 Feb 08). At the end of 2008, with the recession after starting in June, this figure was 41.6 billion (Feb 09 352,000 unemployed). By the end of 2009, the tax take came in at 33 billion (unemployment 437,000 Jan 2010).

So, the government tax take fell by 15 billion over the 24 months in 2008 and 2009 accompanied by a rise in unemployment of 240,000 over the period. Over that period, the budget deficit rose from 1.6 billion to 24.6 billion. In 2009, the government also spend 4 billion out of exchequer funds to recapitalise Anglo Irish Bank. Consequently, 19 billon of the total accumulated deficit from the end of 2007 to 2009 can be accounted for by a huge tax fall, due to untreated unemployment and 4 billion spent on Anglo Irish Bank.

This is a critical observation: it shows that the government’s finances are mostly caused by a fall in aggregate demand due to the recession. Were it not for unemployment and Anglo Irish Bank, our government deficit would have accumulated only to 6 billion over 2 years, which does mean that some tightening is needed, but this is not the main problem. The main problem is unemployment.

The government should have tackled this head on. It still needs to. All the opposition parties and social partners in the past two years have called for the government to stimulate the economy: Fine Gael and Labour proposed stimulus packages in last summer’s local elections worth around 13 and 5 billion respectively. The Greens called for a 2 billion sustainable energy stimulus package last autumn. The Irish Congress of Trades Unions, the Construction Industry Federation and the Irish Small and Medium sized Enterprise associations have all called for similar interventions.

But the Irish government will is ignoring these and the experience of other countries such as the USA, the UK and Australia. It is doing this principally because it wants to ‘correct ‘what it and others perceive as a structural weakness in the economy, living wages. Its solution is to leave unemployment high and with no or negative inflation alongside cuts in social welfare, people will work for a lower minimum wage and wage cuts will become widespread. This will not succeed as countries in Eastern Europe, China and elsewhere will always work for a fraction of even these lower wages.

The solution is not to have very high wages either but living wages. These wages can be maintained by securing a competitive advantage and technological advantage over other countries engaged in lower knowledge work. Productivity and profits for business can be kept up in this way. Significant government investment is needed in high knowledge areas coupled with synchronised up skilling. This is one part of the stimulus package which will be sustainable. The other is the investment in key infrastructural areas which are badly needed: mental health services with the implementation of Vision for Change (700 million); schools building programmes and others.

This can work as follows: There are about 350 incubated companies mainly in the high knowledge area at the moment and the government has been and continues to pour 1 billion a year in to them from exchequer funding. There are over 10,000 researchers, including PhDs working here. The areas which a high proportion of these are researching are new areas for global demand for the next 12 years according to the government’s Expert Strategy Group Report: Ahead of the Curve. Some of the areas identified are:

• Sustainable energy (govt cut SEI budget in April!!)
• Telematics
• Biomedical devices
• Biopharma (govt cut funding for courses!!)
• High quality food exports
• Health and education services for export

Research clusters here need to be mainstreamed or ‘spun out’ in to the Irish economy. Other business ideas should also be considered. There were 13 companies ‘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 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 wealth overnight after the takeover of one of these Irish companies but this 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 for the first time be created.

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, his 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 chain of events needed might look like the following:
• Government needs 5 billion at least stimulus 2010 + 2011
• Companies should be vetted and viable one’s aided within 3 months
• Government should give 50% grants in return for shares to be redeemed over 10 years and 50% in loans
• High quality retraining should happen in parallel through state training agencies to match the skills needs necessary
• Re-training allowance of 330 euros
• Priority should be given to indigenous
• Viable and strong State Owned Enterprises which would pay dividends to state and should be part of this
• A state Development Bank should be set and work alongside higher budgets for Enterprise Ireland.

The alternative of not investing significant resources from the NPRF and significant employment creation is: 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 most which will be spun out in to 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 Euros and where 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 to 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 and 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.

Thursday, 18 March 2010

Another take on healthcare

"There is a startling commonality between the root causes and defects of the ongoing banking crisis and those that continue to gain momentum within our health system. There are lessons to be learned." Read the rest of Professor Ray Kinsella's take on our healthcare system - and what can be done to fix it - here.

Ireland still off course on deflationary path to nowhere

Slí Eile: The assessment by the European Commission makes for chilling reading.
It states:
… Despite five consolidation packages adopted since mid-2008, these developments have also produced a dramatic deterioration in the Irish public finances, with the general government balance moving from a surplus position in 2007 to a double-digit deficit ratio in 2009 and government debt exceeding the 60% of GDP reference value in 2009.
The statement goes to confirm the need to reach a Government deficit of less than 3% of GDP by 2014. The Irish authorities are urged to press ahead with measures to raise taxes or cut spending or both. Either way, it is a position of continuing deflation as GDP – and with it tax receipts – are in freefall. Yes, freefall. The real value of GNP in the third quarter of 2009 declined by 15% in real terms compared to the total for the same quarter in 2008 (Deflation can be as great a danger as our surging deficit). With public spending set to rise or hold its own simply due to demographics or social welfare payments arising from increased unemployment Irish macro-economic and fiscal policy is not in a pretty place.
The Commission give an important clue about what we might expect in the next budget (which could be any time between June 2010 and December – I would guess closer to the June end unless there is a general election in the meantime). It states:
With a view to improving the long-term sustainability of public finances, reforming the pension system is another important challenge.
There you have it. Pensioners survived the 2010 Budget relatively intact (OK the Christmas bonus went). Next time it is their turn. Nothing is ruled out including:
  • Further cuts in nominal public sector pay
  • Further cuts in social welfare payments and tightening of rules
  • Further cuts in capital spending and cancellation or postponement of major projects
  • Further cuts in programme spending with implications for health care, education, research, local services
  • Further ‘levies’ and service charges (water etc)
And yet, all of this may not be enough to placate the market gods. Moreover, all existing projections assume (naively):
  • (explicitly) significant early turn round in the world economy(i.e. no double-dip)
  • (implicitly) no major recapitalisations of our glorious banks
  • (implicitly) emigration as a safety value to contain social discontent (and the high fiscal costs of unemployment and associated social costs)
  • (implicitly) widespread social acceptance of this purgatory as a necessary evil to bring us to a better place.
The latter assumption will only hold true as long as most people take the view ‘I don’t agree with it; I don’t like it; but what can we do?; there is no alternative.
But, when people begin to realise that the strategy – if it could be called that – is not working and is not delivering jobs, remission of debt but is, instead, piling up debt and permanent loss of human skills and dignity – then there will be serious trouble and serious questioning of all that we assumed and relied on up to now.
At some point, someone, somewhere in high authority is going to say ‘this isn’t working’ – the deficit is stuck at such and such a percentage well above the 3% target set of the EU and agreed by the Government, here. Moreover, there will be political realities to address including noisy people on the streets. Large surplus & capital-lending countries will find it near impossible to back down.
I can’t see any chance whatsoever of Government, Unions and EU commission agreeing on an approach to reducing pension liability – which is what the coded quotation, above, is about.
In common with the Dublin consensus, Brussels sees the achievement of competitiveness as the key to recovery. This will be made up of cuts in wages, cuts in public spending (and therefore services) and investment in skills, R&D and new infrastructure (the sugar on the pill).
I am not clear on what is meant by the following sentence: ‘a modest package of stimulus measures to support economic activity of 0.7% of GDP in line with the European Economic Recovery Programme (EERP).’
However, it is clear that given the overall deflationary stance of fiscal policy since late 2008 talk of a stimulus is not in accord with what is going on. Rather, some redirection of spending within the overall total may be viewed as a stimulus. But, I would like to see more transparency around that claim.
The commission estimate that the (negative) impact on GDP arising from fiscal adjustment was 3.25% in 2009 and 2.5% in 2010 (page 7)
The Commission points to lack of appropriate data on many aspects of the consolidation programme. In particular, they go on to point out that the revenue and expenditure projections in the outer years are of an indicative nature and the consolidation efforts in these years are not underpinned by broad measures.

Wednesday, 17 March 2010

Report of the Innovation Taskforce

An Saoi: I read the Report of the Innovation Taskforce and wept. The Government’s big idea is per Brian Cowan’s piece in Saturday’s Irish Times “We are open for business as a global innovation hub”. I would more accurately describe it as “We are (still) open for business as a global hub of tax planning & scamming”.

There are some reasonable proposals in the document. But when you cut through the waffle, many of the proposals are designed to move Ireland from a low corporate tax environment to a no corporate tax environment, in the hope we get a few jobs as our reward. In Germany or any other sane country a task force with such a remit would be stuffed full of engineers and scientists. Not so in Ireland.

I am a sucker for word searches. It gives you a feel for the document. In this report, the word “tax” is mentioned 127 times, the word “food” eight times and the words “manufacture” or “manufacturing” just 24 times. When “tax” pops up you will always find those three letters “FDI” are not far behind and sure enough they are there 35 times.

Therefore this is a report which pays lip service to Irish SMEs, barely mentions the Public Sector, and almost all of the serious proposals are in relation to tax scamming for multi-nationals. But there are four direct representatives of multi-nationals on the taskforce.

The nub of the Report is contained in Appendix Six, which sets out six tax proposals, which have little to do with the development of innovation in Ireland. I ask for your forgiveness in advance because I am now going to talk tax.

The first proposal relates to IP (intellectual property) and is about “the competitiveness of our tax regime for internationally mobile IP rich businesses.” This is basically a proposal to weaken Section 291A further. This enables multi-nationals to take profits from high tax jurisdictions and move them to a low tax location such as Ireland. You can write off 80% of the “cost” of the IP, i.e. reducing your effective tax rate from 12.5% to 2.5%, before of course deducting any other expenses. Outside of accountancy and legal firms, I can see no jobs here as the real activities will be outside of Ireland.

Proposal number two is in relation to tax credits for R & D, covered by Sections 766 & 766A. This enables a company to deduct the cost of R & D, and also to get an additional tax credit of 25% of the cost incurred. They suggest that the amount of outsourcing be increased and in relation to many SMEs this would make sense. However, again the main concern is multi-nationals “For example, for pharmaceutical companies, clinical trials must be outsourced and they are a significant part of the R&D cost.“ This work would also not be done in Ireland.

Proposal number three is in relation to “Carried Interest”, which is basically a method of senior managers in venture capital firms earning loads and paying no tax.

Proposal number four is in relation to the pooling of foreign tax credits. Credit for foreign tax is specific to that income source, e.g. tax withheld on Spanish income can only be offset against profits from your activities in Spain. The problem arises that the withholding tax payable in some countries exceeds the Irish tax payable on the Irish measure of income. The taskforce want pooling, i.e. you can claim your excess Spanish tax against, say, your profits from Germany. This proposal runs counter to all normal treatment to avoid double taxation.

Proposal number five in relation to withholding tax on payments is just another sop to multi-nationals.

The final proposal is in relation to Patent Income Exemptions, which the 3rd Commission on Taxation, which has recently reported suggested should be terminated. They of course feel it should be retained.

Tuesday, 16 March 2010

Radical options for EU reform

Slí Eile: In a thoughtful, radical and no doubt controversial assessment of EU economic policy Irish Left Review has cited a report: Eurozone Crisis: Beggar thyself and thy neighbour. The full report can be downloaded here. Perhaps our debates on fiscal, banking, sectoral and macro-economic policy, in Ireland, are too narrowly local without paying more attention to the global and European crisis that is emerging. It is as much a political crisis and a questioning of assumptions and models that were viewed as intact and victorious ever since the triumph of neo-liberalism from the 1980s.

Options for future economic policy in the EU

Slí Eile: I very much agree with Paul Sweeney, writing on this blog site recently
It seems to me that we need more effective EU institutions. We also need EU leadership which is more responsible to its people. Neither are in this plan. But the European people gave the conservatives the majority – even after the collapse of a virulent form of liberalism espoused by those conservatives.
In the new draft strategy for EU2020, as with many EU communications we have a case of all things to all people with something for everyone in the audience – competitiveness, innovation, green technology and of course social inclusion.

While the EU plays an important role as a global player – its institutions and provision for coordination of fiscal and monetary policy across the Union remain weak relative the scale of the challenge, the competition from other world players and the diversity of cultures and levels of economic development within the Union –including the Eurozone.

A major criticism of the draft Strategy is that it speaks of ‘growth’ (growth in GDP) as this is the holy grail and the basis on which various other policy goals can be realised. What about the work of the ‘Sarkozy Commission’ on measuring progress that goes beyond simple GDP?

There are some ideas in the document about addressing unemployment – especially youth unemployment – (e.g. Eures jobs) based on ‘mobility across the EU’ [a slightly ambiguous matter given the history of unemployment and migration in an Irish context]. However, there is a complete lack of how this will be implemented and coordinated and, more to the point, how the devastating increase in unemployment among young Europeans can be reduced as fast as possible. Europe will pay a high price if this problem is not tackled effectively and quickly.

A key question to be asked – just as with the Lisbon Agenda for 2010 – can the EU and its Member States deliver on the multiple goals it can set itself? If the future needs to be very different to the past (pre-recession) modes of production and consumption is the political will there to effect change and to learn the lessons from the catastrophic failure of governance, regulation, trust and market stability witnessed in 2008?

The social dimension of EU2020 is weak and needs to be greatly strengthened.
May be I am missing something – but was there a debate on this draft in the Oireachtas recently? Someone might point to a web link. And has anything replaced the work of the (valuable) National Forum on Europe (axed in line with the Big Snip) in facilitating exchange of information and ‘townhall’ meetings up and down the country?

Social Justice Ireland made a good input during the consultation process towards Europe2020 here.

to quote directly –
The EU 2020 Strategy should therefore speak about values; it must address how the EU proposes to deliver solidarity and a just distribution of resources and well-being; how it proposes to contribute to the development of the impoverished parts of the world as well as fostering a people-centred and green economy.
The document reminds us that
‘80 million people were at risk of poverty prior to the crisis. 19 million of them are children. 8 per cent of people in work do not earn enough to make it above the poverty threshold. Unemployed people are particularly exposed.’
A notable feature of EU2020 is the absence of hard quantitative targets and specification of pathways to achieve particular goals - e.g. ‘Reduce the number of Europeans living below national poverty lines by 25%, lifting 20 million people out of poverty’. Why not just abolish poverty? Important as rolling out ‘ultra-fast’ (‘fast’ isn’t good enough you know) internet connections is – isn’t abolishing poverty more urgent? How about ultra-fast progress on tackling poverty and the causes of poverty to borrow a phrase from another domain.

Really, McCoy?

Michael Burke: In yesterday's Irish Times, IBEC's General Director Danny McCoy said wages increased much more rapidly in Ireland than in other countries in the Euro Area during the period from 2002-2008, precipitating a serious decline in competitiveness.

“As a result, unit labour costs increased by 31 per cent in the period, compared with an increase of 9 per cent in the euro area,” he added. “In a single currency, there is no currency depreciation option to restore lost competitiveness.
“This can only be achieved by unit cost reductions, brought about by a combination of pay reductions and productivity gains.”

Mr McCoy seems to be referring to the EU Commission's Euro Area Report, and its statistical annex, which tends to group data in five-year periods, and does so from 2002 to 2006, while also providing data for later years individually. However, while these do indeed show Ireland's labour cost rising by 30.9% over those years, the average rise for the Euro Area was 13.7%, not 9% as stated. (Perhaps the mistake made was to leave 2008 out of the equation for the Euro Area average, since then the total is 9.9%).

But these are nominal increases in unit labour costs, not real costs. In the table below that one (Table 28) these are also provided. On this measure, real unit labour costs in Ireland (nominal costs divided by the GDP price deflator) rose by 9.7%, nearly all of that coming in 2008 as output plumetted. The cumulative rise in the six prvious years was just 2.8%. And the average real chage in unit labour costs in the Euro Area was -2.7% 2002/08.

However, there was also a difference in the rate of growth in productivity. Irish productivity grew by 11.7% in 2002/08 compared to a rise of 7.4% in the Euro Area as a whole. So, Ireland's productivity rose by 4% compared to the Euro Average over the period (111.7/107.4) while Ireland's real relative unit labour costs rose 5.75% prior to the recession (102.8/0.973). According to EU estimates and forecasts for 2009/10, the overwhelming bulk of this modest relative change is already being corrected, 3.8%.

Of course, none of this tells us anything about the absolute levels of costs, or relative costs. Still less about competitiveness.

But the trends in the external accounts do highlight relative changes in competitiveness. Over the period 2002 to 2008, exports of goods and services grew at exactly the same rate as those from the Euro Area as a whole, while they fell by 3.4% in 2009, compared to a 14.2% fall for the Euro Area. Imports also grew at exactly the same rate as the Euro Area 2002 to 2008 and fell by 8.5% compared to 12.5% for the Euro Area as a whole in 2009. This less pronounced decline in imports is associated with the much stronger export performance; as everyone knows, a large proportion of Ireland's imports are for re-export.

There is nothing in these data to support the IBEC assertions that rising unit labour costs have led to a loss of competitiveness. Despite that, the clamour for lower wages is unabated.

Perhaps, if Mr McCoy remains anxious on the issue of competitiveness, he could suggest to his IBEC members they address its key determinant, namely investment? Investment in equipement has fallen by 37.6% in the last 2 years in Ireland, compared to a 16.6% fall in the Euro Area as a whole.