Monday, 30 August 2010

Why do we pay people social welfare?

Nat O'Connor: We pay people social welfare because, in a democracy, every participant is entitled to a minimum share of our national wealth to provide themselves with the essentials for survival.

In which case, we should be worried if a proposed Government policy threatens to undermine the democratic basis for the social welfare system.

It is reported that the Minister for Social Protection has announced a new scheme for recipients of Jobseekers Allowance (JA) to engage in social employment "for 19.5 hours work every week by helping out with local after-school and childcare services, sports clubs, services for older people and environmental projects".

Note: JA is the allowance people apply for once the period of their Jobseekers Benefit (JB) expires. JB is an entitlement, based on social insurance payments, whereas JA has to be applied for and payments are means-tested. It is worth noting that recent budgets have shortened by three months the period for which people can claim JB, as well as doubling the amount of social insurance contributions required to receive it in the first place. So more people have been pushed towards JA, where payments to people under-25 have been much reduced.

The Minister is quoted as saying "We must create a better future for people who find themselves without a job; to provide them with work activity in the short term, to up-skill them and give them opportunities to get back into the mainstream workforce as speedily as possible."

These are real incentives and it is to be welcomed that people should have an opportunity to do some useful work while unemployed. However, the carrots are matched with a big stick. It is reported that "Those who fail to show up or miss hours will be struck off the dole under the plans."

The above report is not backed up by the official press release, which simply reports that employment schemes are being transfered to the Department of Social Protection, which was already flagged by the Taoiseach when he 'reshuffled' the cabinet recently. So, we can assume the Irish Independent had a further interview or some other information to draw on.

Anyway, if someone is flying a kite about 'workfare' there are a host of problems to be considered with this approach, including:
  1. Forcing people to engage in 'voluntary' work may undermine the volunteeristic spirit of those already taking part;
  2. Forcing people to work may result in very unhappy people with an attitude wholly unsuited to the role they are meant to play in voluntary activity;
  3. Cutting off welfare payments undermines the basic principle that in a democracy, we are all participants in decision-making and we all share the resources of our country;
  4. Cutting off welfare payments will lead to people suffering poverty, deprivation and a host of other problems - which could lead to increased mental ill health, addiction, crime, suicide, etc;
  5. It is likely that certain people will be badly affected, such are people who are already long-term unemployed due to mental health problems, including addiction. Neither forcing them to work, nor cutting off their dole, is in any way an intelligent or humane response. Dealing with our failing mental health system would be preferable. Offering people the option of work could be very constructive, but not as part of a work-or-else approach;
  6. These schemes are likely to rely on existing community and voluntary bodies providing supervision, training, etc in exchange for labour. This could overwhealm some of these bodies;
  7. There are other costs to be considered, such as insurance, transportation, etc.

To pick up on the final point, how will the additional costs be paid for? One of the reasons why many Western governments do not provide large schemes offering people useful work to do is because the operation of these schemes is likely to be significantly more expensive than simply giving people a basic umemployment payment. This is not to say that the longer-term benefits, in terms of upskilling, keeping people active, useful work achieved, etc. might not outweigh these costs, but it helps explain why the idea of 'workfare' hasn't be much developed.

I dislike the negative tone that so often surrounds the discussion about offering people on welfare some form of community work. It feeds into tired and disingenous arguments about forcing 'lazy scroungers' to work. But people receiving JA are not lazy scroungers. The vast majority of people who are unemployed want to work. The problem is economic. There are no jobs.

In economic terms, the supply of jobs is less than the demand for them. Hence, there is unemployment. In fact, in a well-functioning economy, there will always be an element of unemployment as people move between jobs. And moving between jobs is part of the vaunted flexibility we are supposed to be encouraging in our labour force.

The supply of jobs is low because (a) there is a lack of credit for businesses and (b) there is a lack of demand in the economy. The Government has done little to solve the credit problem, and has crushed demand with a will, by lowering welfare payments, cutting public pay and encouraging the private sector to cut pay. If people have less money, they spend less, so there are less jobs.

If the Government wants to fund thousands of worthwhile jobs in the community, then this should be a positive step towards addressing the unemployment crisis. Any such scheme would probably be over-subscribed by willing volunteers.

We don't need to cast a shadow over this by making community work manditory. This feeds into negative stereotypes about people claiming welfare payments and encourages sadistic diatribe about forcing 'lazy' people to work. That way lies the Gulag.

Pluck of the Irish?

Jim Stewart: Have they been reading Progressive Economy posts on Anglo Irish Bank? You can read the Financial Times editorial here.

Friday, 27 August 2010

The excuse factory

Michael Taft: During the Greek debt crisis, we were constantly told that we weren’t Spain or Portugal or Italy, that the international markets were treating us differently, better, because we had taken the difficult fiscal decisions (i.e. spending cuts). This was despite the fact that the main indices showed otherwise, that we were competing with Portugal for the worst bond performance once Greece exited the market. It was just one more case of commentators making excuses, after they had spent all last year assuring us that if we took harsh economic medicine, our borrowing costs would fall.

The excuses keep coming. Our deteriorating bond performance is due to S&P’s ill-informed ratings downgrade. Another excuse: it’s not so much that Irish bonds are weakening; the gap between the German 10-year bonds has more to do with the fall in German yields.

First, our bond performance was in pretty poor shape even before the downgrade. It was already 323 basis points above German bonds prior to S&P’s announcement – well above the level at which some commentators suggest we should all start drinking ouzo.

Second, the growing spread between Irish and German bonds is a combination of falling German yields and rising Irish yields. But 60 percent of the gap that has grown since August 16th has been deteriorating Irish bonds – not the fall in German yields.

I’m sure when the whole thing goes over the edge many of our commentators will find more scapegoats (I suggest here that it could be culinary).

One could despair of even getting a factual description of the problem, never mind an analysis that bears some relationship with reality. All we will get is ever more excuses from people who claimed that the bank guarantee was ‘bold and visionary’, that deflationary policies would please the international markets, that our bank bail-out policy is ‘affordable and manageable’ and that we are, finally, back in recovery mode.

Thank god it’s Friday.

Thursday, 26 August 2010

Destroying the Public Sphere?

James Wickham: The terms of reference for the ‘Review Group on State Assets...’ are about ‘asset disposal’ in the public sector. What do we know about the sale of state assets?

1. The impact on efficiency is debatable. If state enterprises provide services of general interest they have to be regulated, and the costs of regulation can be very high. Often the requirement of competition can produce duplication and/or lack of transparent information to customers. The privatisation of public transport provides plenty of examples. It’s also worth noting that when politicians believe that only privatisation can provide efficiency, they abdicate responsibility for enforcing improvement through other means. Thus we still have no publicly responsible authority for Dublin transport, because of course eventually there’s going to be privatisation...

2. What we do know is that privatisation increases inequality. Most obviously, because it leads to lower wages for the weaker employees and higher remuneration packages for senior managers. In the worst case, managers behave somewhat like the nomenklatura of Russia, appropriating to themselves a massive share of what was public property. Less obviously, what was public property becomes private property in the form of shares, and shares are the most unequally distributed forms of personal wealth. On all this see especially Florio (2004), The Great Divestiture (Cambridge, Mass.: MIT Press).

3. In some cases, privatisation destroys the public sphere, the non-market area where citizens meet as citizens not as consumers and not as members of a particularistic group, such as a family or an ethnic group. The obvious case is public broadcasting. One of the differences between most countries of Europe and the USA is that we have public broadcasting, they have Fox. We may not appreciate the impact of this on public life, others do. Read for example the American Steven Hill’s book Europe’s Promise on how European public discussion is broader than that of the USA, partly because of public broadcasting. Even the apparently mundane service of public transport also has this sort of public element.

4. Privatisation weakens trade unions. It’s probably the major reason for the collapse of British trade union membership between 1979 and the 1990s. Again see Florio’s study for starters. So privatisation reduces the most effective countervailing power to private wealth: it probably narrows the range of public debate and undermines effective democracy.

Of course, many people want more inequality, many people want weaker trade unions, many people want to live in a more privatised and individualistic world. There are even people who believe that the wealthy should have more political power. We could have a serious democratic discussion about these values. It would be rather more honest than a discussion about ‘asset disposal’.

Tuesday, 24 August 2010

Who benefits from Ireland's (im)balance of payments?

Michael Burke: In a recent discussion on this site,   there are some important points raised about Ireland's external sector. This follows on from Governor Honohan's recent remarks in Asia, to the effect that foreign investors should note Ireland's exceptional export performance. The importance of foreign investors grows with every widening of the public sector deficit.

But the remarks and the subsequent debate have led to some confusion, not least because the remarks themselves are confusing. The external sector for most economies is the most ruthlessly competitive. Strong export performance indicates a high degree of competiveness. Yet many insist, the Governor among them, that Ireland is 'uncompetitive'. If by that is meant that the domestic sector should become more like the export sector; high skills, investment, wages, benefits (and even union densities), then there would be unanimity, or at least overwhelming popular support. Yet the opposite policy is being pursued.

Place in the Global Economy

It is widely known that this economy maintains a very substantial trade surplus. The surplus was ¤29.2bn in 2009, accounting for ¤1 in every 6 generated in GDP. The export total is greater than GNP, and is equivalent to 87% of GDP.

However, it is far less widely remarked that this economy has a substantial net balance of payments deficit on its current account, amounting to ¤4.9bn. This is the lowest current account deficit since 2004, and is largely a function of the collapse in import demand. It could be expected to widen once more in line with any recovery in domestic demand (graph here). The current account comprises in the main the merchandise trade balance, the balance on trade in services and net income from abroad. Both of these latter categories have been in substantial deficit over a prolonged period. The services' deficit was ¤8.4bn in 2009, while net income from abroad (which is overwhelmingly investment income) registered a deficit of €27.9bn, almost equivalent, by itself, to the trade surplus.

Before examining how this deficit is comprised, it is important to state its significance. All income is either consumed or saved. For each economy domestic investment and consumption must equal domestic incomes plus the savings of other countries, ie borrowing/lending from abroad. This current account deficit, despite huge trade surpluses, has led to increased net foreign borrowing. At the end of 2008, the net international investment position (the accumulated stock of assets/liabilities) was a deficit of €106bn, compared to a surplus as recently as 1998 (graph here). That stock of debt also requires debt-servicing payments, implying an increasing outflow of funds from this economy to service that debt.

So how is that debt accumulating?

Net Deficits

Off-setting a huge trade surplus is a series of huge deficits elsewhere on the external accounts. But it is important to state that neither of these is provided by financial services, which is a minnow compared to other sectors, with imports of ¤4.2bn in 2009 and exports ¤5.7bn. Seven other (sub)sectors have greater degree of international openness. The main ones are set out in Table 1 below.

Table 1. Selected Service Sector Balances (€bn)

No single category can properly be viewed in isolation, since the huge surplus in computer services is partly accounted for as an input of imported royalties. Likewise, the merchandise exports themselves are boosted by the input of import royalties, and so on.

But there are two points to note- as before, financial services are a very small component of the overall trade in services and, secondly, the vast scale of the sums involved. To highlight the proportions, the value of business services' imports is equivalent to €15,740 for every person of working age in the State. Clearly, these services are not consumed in this State, they are either imports for re-export, or in the case of royalty payments, they are accounting method that reduces the taxable value of corporate profits arising from merchandise exports, or some combination of the two.

This accounting feature of the external accounts becomes obvious when the net investment account of the current account is examined. Here, the deficit was €27.9bn in 2009. The net investment account also has a number of components, but the deficit is almost wholly attributable to the deficit on income from foreign direct investment (FDI), which amounted to €27.1bn. This net outflow was almost equally comprised of the distribution of branch profits and the overseas reinvestment of earnings.

Foreign firms are booking profits here, but distributing them overseas. Because they are lsio doing that with sales, they create a net deficit on the curret account overwhelming the postive trade performance. They are also creating an increasign foreign indebtedness for the whole economy.

Who are the scammers?

The growth of FDI is one of the dramatic features of globalisation, allowing the increasing participation of all economies in world markets and the enormous efficiencies produced by investment to combine with the increasing (international) division of labour. For the host country, the benefits can be manifold, increasing employment, efficiency, skills' base, infrastructure and both export and taxation revenues.

However, by offering up this jurisdiction as a low-tax shelter, 'our international brand' as Messrs Cowen and Lenihan have it, and refusing to provide the necessary infrastructure investments, only the statistical benefit of fictitious exports has accrued, the rest is absent. In a recent Bloomberg investigation (highlighted here by Tom McDonnell), one US pharma company booked 70% of its sales through Ireland, even though less than 5% of its workforce is located here. And, contrary to the gombeen argument that 'well, at least we get 12.5% of that', the US company holds no special place in its heart for Ireland, further scams involving Bermuda, and employee-free subsidiaries in the Netherlands meant that it paid just 2.4% tax in Ireland.

These scams are overwhelmingly perpetrated by US companies. Ireland has a trade deficit in services with the US of some ¤17.4bn, whereas services trade with the Europe and the rest of the world is in surplus. US companies are not paragons of competitiveness, hence the US has the largest trade deficit in the world. Yet Ireland 'imported' €3.902bn from the US in market research services in 2008, and exported ¤1mn. Likewise there is a €3bn bilateral deficit in R&D, along with a ¤1bn deficit in management services and an enormous €7.5bn deficit in royalties, all with the US, while maintaining a balance or surplus with other geographical areas.

This scam has been facilitated by the actions of both governments, US and Irish, who are ware of these practices, yet have chosen to do nothing about them. However, of necessity recent US legislation is aimed at partially closing these loopholes. It might be an idea for the government here to move fast, before Uncle Sam's own deficit problems put Ireland in the Congressional cross-hairs.

A development-based approach to foreign investment would put a halt to these scams and raise the corporate tax rate, up to 20% (from lowest to second-lowest in the OECD). The huge increase in proceeds would be used to build up infrastructure, both material and educational, and allow the State to direct investment towards supplier industries for the foreign MNCs who actually produce here, including R&D, locking them into this location. In that way, the real success of openness to the world economy would be harnessed for sustained , high-quality growth, and the scammers could seek another jurisdiction to rip off.

What to do about Anglo Irish Bank?

Jim Stewart: Much comment argues that the increasing cost of Irish Government borrowing (the second/third highest in the eurozone and over twice the cost of German Government borrowing) is a direct consequence of Government economic policies in relation to the banking system. Other policies are also likely to be a factor, such as the emphasis on fiscal austerity in the belief that this will restore confidence and lead to economic success - what Paul Krugman has called the ‘confidence fairy’.

Removing the blanket guarantee on all bank liabilities, rather than extending it, is very likely to reduce the cost of Government borrowing (on August 19th, the Minister was quoted in the Irish Times as saying that "Elements of the guarantee will not be continued from September”).

However, amending the guarantee also gives an opportunity for a much more radical intervention.

In his Beal na mBlath speech, the Minister recently restated the Government’s policy of supporting the existing debt of Anglo Irish.

“...we must stand behind our banks in order to ensure that a sustainable financial system is established and, in the case of Anglo, to ensure that the resolution of its debts does not damage Ireland’s international credit-worthiness and end up costing us even more than we must now pay”.

It is false analysis to present the options in relation to Anglo Irish Bank as allowing it to fail (liquidation) or continuing to support it. Those who advocate continued support may justify this position by calling for a type of Special Resolution regime in Ireland for failing banks, to reduce the risk of bank failures in the future. As has been pointed out by others – most recently the Bank for International Settlements, p.3 – a Special Resolution regime within one country is unlikely to work for a large institution whose operations straddle a number of different countries. Assets in other countries cannot be seized unilaterally. Legal systems have differing requirements for creditor protection in the event of a firm being forced into liquidation, further complicating the efforts of any single regulator.

A third and less costly option is to negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.

There are some implications: Anglo Irish must not be allowed redeem any existing bonds, as it has done in the past, and then declare the difference as profit.

Such a solution is consistent with proposals for reform in the consultative document recently published by the BIS, which addresses the issue of banks which received public sector funds but most of whose long term capital did not suffer any losses.

What are the costs?

It is important to note that it is normal commercial practice to renegotiate with debt holders in the event of a corporate financial crisis. A well known example is Eurotunnel.

It has been argued that the costs in terms of reputational damage to the State would be large, the credit rating on existing Government debt would fall, and government debt yields would rise. The fact that Anglo Irish is State-owned gives some credence to these views. However, continuing with current policy to undertake to redeem most long-term debt at face value will ensure continued risk and uncertainty in relation to State finances.

These costs are likely to be exaggerated. Those firms who advise bond holders, and who may have a financial interest in maintaining the value of bank debt, are likely to complain the loudest.

Issues might arise in relation to increased risk to depositors and deposit withdrawals. The largest single source of deposits in the most recent accounts consisted of bank deposits (€33 billion), of which the largest single component is likely to be Irish Central Bank/ECB, whose deposits are automatically guaranteed. However, a risk of deposit withdrawal could be met with an extension of the guarantee to all depositors in Anglo Irish alone. The risk of not being able to issue new debt would be covered by specific guarantees.

There are fundamental changes taking place in the structure of Irish banking (the closure of Bank of Scotland, Halifax, Post Bank; the re-emergence of a banking system dominated by two banks). Government policy in recent years has been far too quick to allow – and even encourage – abandonment of the mutual form of ownership/control. This policy is continuing in the case of the EBS (see Irish Times 4/8/10 and Financial Times 4/8/2010).

Mutuals and credit unions play a key role in the financial architecture of all EU states (and for very good reasons). The largest and best-known is Rabo Bank in the Netherlands. With appropriate policies, these benefits could also accrue to Ireland (See here).

The costs associated with, and the excessive focus on, Anglo-Irish means that there has been little analysis of, or comment on, the important changes taking place in the structure of Irish banking and the implications for the sector’s likely future conduct and performance. Coupled with the absence of specific policies to provide finance to indigenous firms (a loan guarantee scheme as in the UK and other countries; a State Development Bank) these changes are unlikely to be conducive to economic success.

The rising cost of supporting Anglo Irish bank has at least clarified one issue – nationalizing this bank did not reduce the cost to the tax payer.

The State's Modus Operandi

Nat O'Connor: There are four stories in the press today that each illuminate part of a big, unanswered question, which is about what is the best way for the State to operate.

The newly elected president of the Irish Planning Institute makes a defence of planners and calls for better planning in future. Two Sandymount residents give a detailed critique of Dublin City Council's planned incinerator. An Taisce and the NRA dispute the data being used to justify the NRA's road-building programme. And NAMA seems set to decide the fate of 35 hotels.

What these stories recall is the balance that should exist between the role of the State in facilitating longer-term strategy and planning, versus the role of commercial bodies to provide more immediate goods and services (ideally within a regulatory framework that trammels market activity so that it aligns with long-term strategy).

Part of the aftermath of the economic crisis must be the widespread realisation that the over-reliance by Government and senior public servants on unregulated market forces led to a poorly planned housing system, an unsustainable hotel industry, and many other problems. Indeed, many public bodies seem to operate as if they are independent entities competing for finance and importance, rather than co-operating as partners in realising a democratically-mandated strategy.

Part of the solution must be the rise of more evidence-based policy-making and a reappraisal of the state's capacity to plan and strategize. (It is incredible that it was already the twenty-first century when, in 2004, a Taoiseach addressed a conference on the issue as if it were a great novelty!)

Yet, despite the need for strategic leadership from the State, the Government seems inevitably drawn by its 'Ireland Inc' reflex to attempt to fix our problems by relying on market-driven approaches. For example, from NAMA's business plan, we know that it will operate "as an independent commercial entity" (page 8). In relation to hotels, "Where a number of NAMA-funded hotels are competing in a location where there is only potential for a single facility, NAMA will make its decision based on the optimal commercial outcome." (page 12).

The Ireland Inc reflex is problematic. For example, NAMA will be the only market player in many situations where it owns hotels or developments of housing. Hence, there won't be a market to determine prices. And the relatively short-term decisions it makes may not reflect the long-term public interest. Hence there needs to be strategic leadership, based on solid evidence, to guide its decision-making.

The example of the incinerator critique suggests that Dublin City Council is acting like a private entity itself, by making a secret deal with Covanta that will last 25 years. The council's motivation seems to be getting a cut of the revenue stream. While I recognise the flawed funding system for local government, having individual councils make these kind of deals in order to raise money does not seem likely to be the most effective outcome for the public interest; because unlike a private company which has to pay its own way, the council is signing off on a deal that taxpayers must fund.

There needs to be a major culture shift within Government and senior public service to recognise that you simply don't run a country in the same way as a large corporation. So much of the logic underpinning the goals and purpose of the State - such as long-term planning, non-profit outcomes (like health and education), protecting the public interest and environmental sustainability - runs entirely counter to how a business operates. Yet, the row between An Taisce and the NRA, as well as the criticism of the incinerator, suggests that there is a fundamental weakness within the public service when it comes to complex analysis of data in order to guide decision-making. The NRA and An Taisce may both be making valid analyses from their different perspectives, one arguing for more roads and the other for more public transport, but where is the central strategy that describes the balance between these competing goals?

We need better quality data from the outset. Which means that public bodies need to be audited for their capacity to provide meaningful indicators relevant to the policy areas they influence. This requires a serious audit of the current data generation and data analysis capacity across the public sector - and how this can be analysed holistically by Government Departments. And, as a matter of course, all of this data should be readily available to citizens, so that secret deals become impossible!As part of public sector reform, serious attention should be paid to whether or not the universities provide enough qualifications to allow us to re-skill and up-skill senior public servants. One good example is the joint professional doctorate in Governance, jointly run by Queen's Belfast and the IPA. We need more people with MPAs not MBAs in the public service, yet nearly all the Irish universities offer MBAs but none offer MPAs.

It's time to do away with the Ireland Inc metaphor and the failed assumption that public bodies can be run along free market lines. We need a more professional approach to the role that Government must play in leading through strategic data analysis.

Tales from our lost boom

James Wickham: My summer reading has included an astonishing book: the global historian James Belich’s Replenishing the Earth: The Settler Revolution and the Rise of the Anglo-World, 1783-1939. It’s all about ‘settlerism’ – the dramatic sequence of booms and slumps through which the ‘Wests’ of the United States, Australia and so forth were created from almost nothing in just a few generations.

Part of the argument is about the nature of speculative settler booms. As Belich points out, the history of these booms is a strong antidote to those who still believe in the rationality of the market. And these settler booms have some curious echoes in our own recent history...

Belich claims that settler booms were self-sustaining: the business of growth was growth itself – shades of our housing boom when houses were being built by immigrants and the only people who would be filling them would be – the next immigrants. He stresses the hysterical commitment of boomtown politicians to their fantasy of continued exponential growth - remember Our Great Leader’s comment that people who doubted the boom should ‘commit suicide’? He notes the extraordinary casual destruction of natural resources. And finally, while all booms end in busts, not all busts end in recovery. Whole towns can ‘go ghost’ (approximately 700 in Australian Victoria after 1891) and stay that way forever; people can leave again (approximately 300,00 European immigrants from South Africa between 1904 and 1908)...

Monday, 23 August 2010

Airbrushing in

Michael Taft: Here is an antidote to recent attempts to airbrush out of the economic debate anyone who doesn’t follow the line. An Irish Times editorial stated, ‘There is near-universal agreement among this State’s independent economists that there is no option but to remain on the path of fiscal correction set out by the Government last December.’ Central Bank Governor Patrick Honohan stated that: ‘ . . we don’t have the flexibility to do a spending stimulus now. There’s no one who is even arguing for it.’

Never mind that a number of economists argued differently (and in the Irish Times) in the TASC open letter, something Sinéad Pentony reminded the leader writers.

There’s Paul Krugman writing (again, in the Irish Times) about ‘austerians’: ‘Anyone who doubts the suffering caused by slashing spending in a weak economy should look at the catastrophic effects of austerity programmes in Greece and Ireland.’

Of course, Professor Krugman can be dismissed on the grounds that he ‘doesn’t understand’ Irish exceptionalism. But the leader of the second largest union in ICTU, Jimmy Kelly of UNITE, wrote at length recently in the Sunday Tribune, arguing for an investment-led strategy to replace the failed fiscal policies pursued by the Government: ‘This is not a traditional stimulus programme, whereby the government temporarily boosts demand until such time as the private sector gets back on its feet. It is an investment-led programme constituting a major drive to modernise our economic base and boost productivity. It will increase job numbers and profitability throughout the private and public sectors.’

Yes, there is a debate going on – even if some don’t want to admit it and are doing everything possible to shield it from the public.

Friday, 20 August 2010

Were we reckless spenders?

Tom McDonnell: Tuesday’s €1.5 billion bond auction by the National Treasury Management Agency ensures that Ireland will successfully get through the year without defaulting.

One rare and related piece of good news is that Ireland has today dropped out of the top ten list of countries most likely to default (we were ninth as recently as Tuesday). The odds on us defaulting/restructuring are now just over 20 per cent. Greece, in contrast, is still considered to have a better than even chance of defaulting. Nonetheless the overall picture is still pretty grim and this brings us back to how we as a country tax and spend.

In a previous blog I looked at where Ireland prioritises its spending. The table of public spending shown below (click on it for a bigger view) compares Irish spending to EU 15 spending across the functional categories of government; for example, defence or health. Blue boxes show where Ireland spent a smaller proportion of its GDP on a particular functional category and orange boxes show where Ireland spent a higher proportion of its GDP on a particular functional category.













2007 is an interesting year because it provides a snapshot of spending just as it was just before the economic crash. In 2007, Ireland’s public spending/GDP ratio was just 79 percent of the EU15 average public spending/GDP ratio although this figure rises to 93 percent if we choose to use GNP as a better measure for Ireland (see table below). These numbers appear to indicate that Ireland’s public sector was smaller than European norms before the crash.
















The Eurostat data shown below indicates that Ireland had the lowest level of public spending in the EU15.


















However if we break the figures down by functional category we get a more complicated picture. Ireland (measured as public spending/GDP) spent relatively more than the EU 15 average on housing and community amenities; environmental protection; economic affairs (primarily physical infrastructure) and health. If we use GNP instead of GDP for Ireland then education spending and public order spending are also seen to have been above the EU 15 average.
















The very low unemployment rate prior to the crisis had kept public spending on social protection, which is by far the largest area of public spending, very low prior to the crisis. In GDP terms social protection spending was just three fifths of the EU 15 average. This was the main driver keeping overall public spending below the EU 15 average. Our relatively mild debt burden (part of general public services) also helped in keeping our public spending at low levels.

It is self-evident in retrospect that such a low level of social protection spending could not have been maintained in perpetuity. This is because levels of social protection spending move counter to the economic cycle. We were at the peak of the cycle in 2007 (a precipice as it turned out) and therefore social protection spending was at a natural trough. The figures for 2010 will paint a very different picture.

Public spending only tells half the fiscal story. I’ll turn to the tax revenue side next week.

Thursday, 19 August 2010

They shoot horses don't they?

James Wickham: One of the predictable consequences of high unemployment is the growth of hucksterism. As unemployment rises, so too do the voices that claim that you can get a job if you only try. ‘On your bike’ as Britain’s Lord Tebbit famously said. The unemployed are enjoined to become entrepreneurial, to invent new products, to sell new services, to sell themselves. The solution is to write a better CV, to hassle, to get motivated. Read for example the story “Jobseekers’ bootcamp all about the right attitude” in the Irish Times 17 August 2010.

Of course the reality is that what works for individuals doesn’t work for society as a whole. Improving CV writing just re-shuffles the job queues; it doesn’t create jobs. Dare we mention the word ideology? Don’t events like this ‘bootcamp’ reduce the pressure for realistic job creation policies? And what about realistic social policies to help people deal with life without paid work?

Holidaying in the financial sector

Michael Taft: Conor McCabe has produced an interesting and potentially disturbing set of figures over on Dublin Opinion. Based on World Trade Organisation data, he compares the exports per worker in the financial sector in the following countries:

Spain: $23,398
Italy: $15,492
Netherlands: $38,182

The figure for Ireland is, however, an astronomical $367,033. He goes on to ask whether these figures are based on a fiction – the same fiction we were fed only a few year ago:

‘Do you remember holiday homes? How every single unsold house in Ireland was a holiday home so there was nothing to worry about? That there was no bubble? In fact, we should keep on buying homes at inflated prices because there were no inflated prices? All those reports in the newspapers, all that property porn on RTE? We were told not to worry, that the purchases were real?’

So are the figures for Irish service exports this year’s holiday homes? We have to be cautious. One explanation could be that the Irish financial sector is more export-oriented than other EU countries which are dominated by home market activities – especially considering the presence of our IFSC. Still, an export of more than 10 times per other EU workers seems a tad on the high side.

The issue isn’t academic. If we are to have an ‘export-led recovery’ we must be confident that we can accurately measure those exports and that such measurements are robust enough to base future policy on. This calls for a critical approach that goes beyond the surface of headline figures. Are there other ways to compare our financial sector with other EU countries? Yes, courtesy of the EU Klems database. These comparisons mirror Conor’s figures:

We see that value-added per labour hour in the Irish financial sector is over 150 percent that of the Eurozone average; gross output is over 160 percent; while capital compensation – or profits (gross operating surplus) – is 250 percent of Eurozone average. Are these numbers credible? Or are we picking up something else – namely, transfer pricing activities (whereby the profits generated in other countries are counted as part of our GDP)?

Even if these numbers are capturing real economic activity, there are other reasons to be cautious about what the Central Bank Governor calls the ‘dynamism of Irish exports’. According to the CSO, financial/insurance exports increased by 47 percent between 2003 and 2007. During that same period employment increased by 17,000 jobs – or 4,250 on average.

The question is, will these exports return to that growth – a growth stimulated by a regime of financialisation that now seems like from another age; an age not plagued by credit constraints and substantial deleveraging? If anything, we may be heading into a period of considerable employment contraction if the IBOA’s fears are even partially realised.

And that’s if the exports figures are all above board.

Conor has opened up a new area of investigation and consideration. It’s about time we took a cold, hard look at some of the platitudes and easy assertions that pass for informed comment. Otherwise, we may end up with more empty assets, bankrupt policies and a future where recovery is statistical only.

Wednesday, 18 August 2010

The Leaving Cert is not Education

Nat O'Connor: The Leaving Certificate results are out today. It is appropriate that there is something of a debate going on about whether or not we should reform the system. Education underpins the economy. Investment in education is the single best way for a Government to increase the earning potential of an individual, and to increase economic growth through their presence in the economy. Therefore, there is every reason to examine whether our current system is fit for purpose.

IBEC claim that the Leaving Cert failed to produce "individuals who were adaptable, could think for themselves and had an appetite to learn" (Irish Independent), while Prof Tom Collins of Maynooth agrees that students don't have the right abilities to do well at Third Level (Irish Examiner). John Walsh lists circumstances where the system is unfair (Irish Independent) and the Irish Times editorial argues that reform is urgent.

The Minster for Education has quickly stepped in and quashed the suggestion of change, stating that "The harsh reality of life is that, over your lifetime, you will always have pressure" and that the current system is the "fairest way". (Irish Independent). There is some truth in the Minister's suggestion that the Leaving Certificate is (or is meant to be) a fair way of allocating college places. The basic problem is that, at some point down the line, success in the points race has become confused with actual education that is beneficial to individuals, the economy and society.


Let's consider three ways of changing the system, which are quick enough to implement.

First suggestion: Shrink the Junior Cert so that it is simply a test of the basics, especially the four Rs - reading, writing, arithmetic and (crucially) reasoning. For people who fail, replace their transition year with a 'second chance' intensive catch up on the basics. Third level institutions should never have to do this.

Second suggestion: Introduce an oral exam for all core subjects, like in France and Italy, worth a small but crucial number of points, so that students have to genuinely know what they are talking about, not just memorise rote written answers.

Third suggestion: Change the model of college recruitment of students. I elaborate this point below.
 
Let's compare two models. In Model A, colleges only take the best performing students. In Model B, colleges let in greater numbers of students to first year, but then they really have to work hard because a large proportion of them will not make it into second year.

I think the elitist Model A is a major problem. Scarcity of places fuels the points race. It may be easier to adminster for colleges and the Department of Education, but ease of administration should not dictate the choices open to people.

And I don't accept the argument that the Department is skillfully matching the supply of college places to the number of different occupations required in the economy. If that were the case, we would have more scientists! Anyway, many people don't work in the occupations their primary degree prepared them for. Conversely, many occupations don't have an obvious match with a primary degree.

Many primary degrees, notably humanities but arguably all of them to some extent, give people a set of transferable skills that are widely applicable in the economy.

And what happened to choice in a free market? If we had a surplus of doctors, lawyers and accountants, that might nail the lack of deflation among professional fees once and for all!

There is another problem with Model A, which is that some people think that they are purchasing a qualification, and therefore cannot fail. And some colleges, regrettably, seem to go along with this.

Model B is arguably more democratic, but also makes more logical sense too. Why not let every student  enter college once he or she achieves a reasonable target result in the Leaving Certificate (with a high maximum number of places available based on the biggest lecture theatres available). The targets required should be published in advance by the college in question, as UK college's do with A-levels. That will retain some healthy pressure, but not insane competition.

By making the real cut at the end of first year in college, students will be judged on who is actually most suited and best performing at the actual subject. The Leaving Certificate really tells us very little about who will make a good doctor, lawyer, vet, teacher, etc. becaue the relevant subjects are not even on the syllabus.

Implementing Model B would require some of the funding to colleges to follow student's choices, so that highly subscribed courses would get extra money for teaching assistants and tutors. That would mean that some cash would reward teaching excellence at third level, which has been sadly neglected in the culture of 'publish or perish'. It might also require a more formal system for reallocating students who fail first year.

In the longer term, there are of course many more ways that education could be reformed, at every level, with the lack of pre-primary education and basic philosophy (i.e. critical thinking) obvious missing elements. But in the meantime, let us remind next years' students that the Leaving Certificate is only a sort of game; a twisted, artificial competition created out of the unnecessary restriction of the supply of available college places.

Tuesday, 17 August 2010

Local Government Reform

Nat O'Connor: A lot of people have heard of 'bord snip nua' and the various recommendations it made for cutting or changing public services. However, the Report of the Local Government Efficiency Review Group, published in July, got a lot less attention. It sets out a range of areas where costs could be reduced, but it also reviews local government services  in more general terms.

For anyone stuck for summer reading, there's 209 pages of detail. But for quick reference, its 106 recommendations are listed from page 171 to page 180.

Interesting items include:
  • Ending the situation where towns strike different commercial rates from their counties (Rec. 4), which businesses may welcome;
  • Reducing the number of city/county managers from 34 to 24 (Rec. 8), which is in effect a merger of those local authorities at the top managerial level;
  • Putting tolls on national roads (Rec. 56), which is madness;
  • Full cost-recovery for planning to be sought, especially for major developments (Rec 68), which is logical but could deter higher density development;
  • A €10 handling fee for non-online motor tax payments (Rec 75), which further punishes those who don't have Internet access, especially those who already pay the higher tax  rate charged quarterly.
In all, the recommendations are designed to raise €511 million a year.

Different recommendations will no doubt strike different readers. But a couple of general points surface for me.

Firstly, the local government estimated spend in 2010 will be €8.5 billion, including €4.7 billion current. The total efficiency savings amount to 6 per cent of the total, or 10.9 per cent of current spending. I suspect that a lot of the savings are from initiatives that were planned by local authorities anyway (at least, by the more efficient ones), and some suggestions won't be taken up for various reasons. So, that leaves a relatively modest level of cost savings to be squeezed out, on top of the job losses that have gone on across the local government sector over the last few years. And the suggestions do not resolve the long-standing issue of fixing the broken system for funding local government.

Secondly, the report's terms of reference were linked to the state's tax revenue crisis. However, there is more sophisticated analysis that could have been done about the economic value of local government. Is there a difference in terms of business activity between towns of comparable size that do or do not have a town council? If so, is it good for business? There are reasons to imagine that having some kind of local, elected representation could be good for local businesses. This leads on to the question of why some major towns (like Swords) don't have a town council, whereas for historical reasons, very small towns do. If there is an economic value in having representation, the equal representation of all towns, above a set size, might be a more significant reform to consider. And it could have positive economic outcomes in using local government to foster and support enterprise locally.

Thursday, 12 August 2010

US Lessons on the Failure of Pension Tax Arrangements

Sinéad Pentony: Last week, Professor Teresa Ghilarducci's spoke at a pensions seminar co-hosted by TASC, TCD Pension Policy Research Group and the INTO. See her presentation here. Professor Ghilarducci is the Bernard and Irene Schwartz Chair of Economic Policy Analysis and the Director of the Schwartz Center for Economic Policy Analysis at the New School for Social Research, New York.

Her presentation focused on the 401k pension system and showed that pension tax reliefs, as presently structured, result in a significant increase in inequality in the US and that a change in the balance of pension provision in favour of public rather than private pensions is necessary to provide a guaranteed income in retirement. As Ireland starts the process of implementing the National Pensions Framework, we need to take a step back and examine the experience in other jurisdictions. The 401k system has clearly not worked in the US, yet we are proposing to go down a very similar road here.

Ghilarducci’s research on the 401k (defined contribution) system of pension provision clearly shows that this system has failed to provide an adequate replacement income in retirement for millions of Americans. This system of pension provision is similar to Ireland’s PRSAs and they tell a very similar story:
• They are voluntary.
• They have failed to increase pension coverage - half of all workers in Ireland do not have a private pension and 64 million Americans at retirement age are without adequate pension provision.
• They are costly - because of the fees and charges of private providers.
• Tax reliefs have failed to increase pension coverage and they disproportionately benefit high earners -in Ireland 80 per cent of pension tax reliefs accrue to the top 20 per cent of earner; in the US, Ghilarducci contends that while pension tax reliefs in the USA are regressive, they are less regressive than in Ireland.
• They fail to provide an adequate income in retirement - as increasing the value of pension funds is largely dependent on the performance of the stock market and to a large degree, the gains in value are eroded by fees and charges, which is the case in both Ireland and the US.

Having researched 30 years of defined contribution pensions in the USA, Ghilarducci has developed a proposal for a Guaranteed Retirement Account (GRA), which resonates very stongly with the TASC/TCD model of pension provision. Her proposal highlights the importance of the social security pension, as this is what most people rely on for an income in retirement.

Her proposals are:
• A supplementary, mandatory and state-led system that requires all workers and employers to contribute through the social insurance system.
• The state also contributes through tax credits.
• Investments are managed by the State.
• People are provided with a guaranteed income (adjusted for inflation) in retirement.

Ghilarducci has estimated that state contributions to GRAs would be cost neutral if tax reliefs were redistributed (through tax credits) in favour of low and middle income earners.

The aim of the National Pension Framework is to deliver choice – but real choice can only be delivered if people are given the option of saving in a state-led and state-guaranteed supplementary system of pension provision. The evidence clearly supports the need for such a system. The proposals set out in the NPF are centred on a pension system based on tax reliefs which are costly, inefficient and inequitable, even at 33%; and managed by the private pension industry – an industry that has demonstratably failed to deliver security for many Irish workers in retirement.

VAT paid by people on low incomes

Nat O'Connor: This is a follow up to comments on the Corporation Tax post about VAT.

As was pointed out to me, although the main VAT rate is 21%, this means that for every €100 I spend, €17.35 is tax (i.e. 17.35 per cent). That is because €82.65 plus VAT at 21 per cent is €100. (That is, €100 minus €82.65 equals €17.35).

Similarly, if I buy things at the 13.5% reduced VAT rate, I pay €11.90 per €100. And I pay €4.58 per €100 at the 4.8% super reduced VAT rate.

Let's work out how much VAT I might pay if I was on a low income.

The Vincentians (http://www.budgeting.ie/) provide typical weekly baskets of goods in their analyses. Let’s imagine that I am living on an example weekly household budget they give, as follows:
  • €40 on Food;
  • €10.50 on Travel;
  • €63.00 on Housekeeping;
  • €19.24 on Clothing;
  • €11.00 on Rent;
  • €4.00 on Education.
This comes to €147.06 per week (although the point of the Vincentian study is that the family in question only had an income of €121.15).

But let’s just stick with the €147.06 total for the moment. I got more details on Ireland’s VAT from an EU publication. This gives the following information about VAT, based on the above spending:
  • Basic food has 0% VAT, but some processed food attracts 4.8% or 13.5%. Let’s split this three ways across my €40;
  • Travel is exempt from VAT;
  • Housekeeping includes ESB, fuel, telephone, TV licence (€3.50 a week), cleaning products, pocket money for kids, bus fares, chemist and €8 for social life. I’m going to assume 0% VAT for most of this, except for (a) the €8 social life, which I am going to allocate to two pints of beer at €4 each (VAT 21%), and (b) €10 telephone and €5 on cleaning materials at 21% VAT;
  • Clothing and shoes include 13.5% VAT;
  • Rent in social housing includes 13.5% VAT;
  • I’m going to count Education as 0% VAT as well (e.g. books are 0% as I’m not sure about education services; although newspapers include 13.5% VAT).

In this scenario, my VAT tax bill will come to €8.49 out of the €147.06 I spent; that is 5.75 per cent of my spending.

That’s surprises me, as I thought it would be higher given that I usually think about VAT at the standard rate of 21%. (Please let me know if I have missed something important in this calculation!)

I think I can reasonably include the TV licence as another €3.50 tax, for €11.99 total (8.1 per cent of my spending). Carbon tax, Excise, etc. are also relevant, but I haven’t time to make a full study out of this.

Nearly €12 paid in tax is highly relevant in the real-life context that the Vincentians are describing, where the family in question had a shortfall of €26.59 in making ends meet every week.

It also cannot be said, as one Government minister did recently, than many half of households in Ireland are “not paying a bob of tax”.


For contrast, in a 2010 report (on 2008 data) Revenue reports 56 cases of people earning more than €250,000 and paying less than 5% effective income tax. If we imagine €50,000 of this income is spent on goods at 21% VAT, this comes to another 3.5% of their income; that is, less than 8.5% tax in total. So on a very low income (€7,682 per year), I could be paying close to the same proportion of my income on tax as someone earning a quarter of a million euro!
And unlike people on high incomes, who can avail of many tax breaks, there is no relief from VAT for people with insufficient incomes to buy the essentials. Instead, many people on low incomes go to moneylenders who can legally charge 150% interest or more (see for example Life and Debt, TASC's latest report).

Wednesday, 11 August 2010

China (IV) - China and Western Economics

Paul Sweeney: Western economists believe that their model is superior because it is supposedly market-led, has better technology, better social structures, the rule of the law and better commercial applications, so says economist, Stephen King. He argues the contrary – that the West has dominated the world by rent-seeking and plundering the world’s physical, natural and human resources.

In a review of a book by King, “Losing Control: the emerging threat to the Western Prosperity,” FT columnist, Martin Wolf seems to concur with the author, stating that “Western policy makers do not understand how far the rise of emerging counties is changing the world. They suffer from the illusion they are in control of events. But events control them instead.” ... “Also important is the rise of “state capitalism”: governments, not markets are managing the outflow of capital from emerging countries, Wolf says.

A number of authors, economists and political commentators are now arguing that the world is changing rapidly, with the rise of Asia and the BRIC countries. Many policymakers have not yet realised the extent of the changes, which are well underway. Even the conservative Economist magazine this week (7th August) had a feature on increased state involvement in the economy and industrial policy. It warns, correctly, against political patronage using state assets. However, recognising the clear trend, it also set out its case for better state involvement in business and for industrial policy, with reasonable suggestions.

In the first blog I said that China, Asian, Russian and other major economies are not following the Western economic orthodoxy. Some are authoritarian states and all are highly critical of neo-liberal economics. They have a sceptical view of “free market” economics, which events have proven to be correct.

For example, the Russian state is backing a vertically integrated national champion in fertilisers. Andrei Sharonov, Former Deputy Economy Minister and banker said recently that “ideologically the state is interested in a national champion in the sector that can compete on a global level.” Russian holds one-third of world’s potash and wants to diversify from oil and gas and consolidate the industry which is predicted to grow at 2.4 per cent per annum to 2020, and also to safeguard food supplies.

For wild risk taking in the West, there is both a private big reward and then state bailout, which at present, looks as it will be permanently guaranteed and without significant behavioural change.

One aspect of the change is that many other states see an active role for state companies, which they may utilise in a mercantilist ways. Further, over time anyway, the role of the state and state activism in the economy waxes and wanes. It just seemed that privatisation and de-regulation was the order of the day, as it was for about 20 years. That has changed dramatically. The state is back in the market and thus the phase of privatisation and de-regulation is now on the wane (except in the minds of the Irish Cabinet, some in the Dept of Finance and the usual conservatives).

In fact nationalisation on a massive scale has taken place. Ironically, it occurred mainly in the West, where liberal economics dominated. This change has of course been re-active, unplanned, unanticipated and unprecedented. Yet the changes are worthy of study, particularly as the state apparatus often gets things wrong; reacts rather than acts; is slow to spot trends; and slower to see major changes.

Asian and BRIC policy-makers are especially critical of the supposed superiority of the neo-liberalism which they believe was at the root of the Crash of 2008 in the West. Embarrassingly, for free market fundamentalists, is that this is happening not long after many Western economists sneered at the Asian model after its crisis in 1997 (“Crony capitalism” it was dubbed, but from which Asia bounced back, in spite of IMF attempts to impose deep Washington Consensus policies on its economies – for which the IMF has been rightly criticised). And, as China is so large – it took over as the world’s largest exporter from Germany last year – it is already challenging the Western liberal orthodoxy on a large scale in practice, in many sectors and areas.

There are major implications for economic theory and for citizens worldwide if liberal economics and Western ideas cease to be dominant (not cease) in much of the world. Of course, there are differing views in the West, but even many social democratic parties, e.g. New Labour, did succumb to the siren calls of neo-liberalism, only to find their economies wrecked on its rocks. The collapse of the Soviet Union was supposed to lead to the universal adoption of liberal economic theory, within varietal frameworks of capitalism. To say that the programme is not going to plan is an understatement.

Another book on the subject is by Stefan Halper – with the unambiguous title “How China’s Authoritarian Model Will Dominate the Twenty-First Century.” In addition to the argument in the title, Halper also argues, as I did on the blog on China and Africa, that China is gaining influence by investment and cheap “no stings attached loans” (he does this in some detail). He says too that China has no qualms at doing business with nasty regimes either. (Did any of the imperial states and were they not nasty themselves?)

Twenty years ago it seemed that the state was on the defensive with Thatcher and Reagan breaking up the post-war consensus. Soviet Communism collapsed and the World Bank and the IMF were enforcing the “Washington Consensus” of privatisation and liberalisation on governments. Today, new and varying forms of state capitalism from Chinese to Mid Eastern and Russian varieties are on the ascendant.

And in the West, the state is now intervening in the economy on a scale perhaps even greater during the Second World War and its aftermath, nationalising and/or controlling banking, finance, the motor industry and also strengthening regulation. It is doing so reluctantly, without a real plan and is certain to make major errors, but may be involved for longer than it thinks. Then it may decide to remain consciously involved, and work to do so effectively.

Thus state intervention is not being undertaken in a considered, planned way, but in reaction to the near collapse the economy due to the excesses of liberal market economics, where de-regulation and a naïve belief that the market worked best on its own and that the perverse incentive structures in boardrooms led to apparently “great profits”. These views were so dominant that those who challenged them were largely unheard. Today the state is blundering its way in response and making many mistakes.

I hold that active state involvement in the economy has an important role, provided the form of governance is the best, especially for directly owned commercial enterprise, which must be at arms length.

I said that I would return to the idea of a new invigorated role for the Irish state companies, possibly emulating some aspects of Chinese strategy in my conclusion of this mini series on China. However, since them I have written on it in the Irish Times (link here) and so will not repeat the points made.

It was seen that 37 of the Fortune top 500 global companies in are Chinese companies, most of which are state controlled and many more are state owned or former companies.

For the first time a Chinese company entered the top ten world companies in turnover (not market cap) in 2008 at 10th. And last year, it rose to 7th place.

In the top 100 there is the China National Petroleum at 13th largest company in the world, Japan Post at 11th, Pemex (the Mexican state Petroleum Company) at 31st, Norway’s Statoil at 36th, France’s state-owned EDF at 57th largest company and Deutsch Telecom at 61st. And many more.

I just heard that Sany, one of the largest Chinese machinery groups, is to establish a manufacturing base near Cologne which will employ several hundred Germans making concrete pumps! It will also have and R&D unit, challenging German’s best engineering firms within its own heartland. It employs 60 there in a subsidiary already.


It was interesting that the Chinese sovereign wealth company was behind a possible bid for Liverpool last week. (Why, I don’t know, except that the team has a big following in Asia).

An active expansion of Irish commercial state owned companies into foreign markets, on their own or in partnership with Irish and indeed foreign, including Chinese firms, will add value. To sell them off is to take the Low Road. It would be deeply regrettable if McCarthy recommend this, but the Terms of Reference are as narrow as a boreen.

We also seriously need to clean up Irish entrepreneurship, reform its appalling corporate governance, shift its core focus from “shareholder value,” to a wider stakeholder basis; from short-termism; dull introspection; and to force many corporations to bring in fresh talent to their boards, within a framework of radical reform of Irish company law.

However, this reform of corporate governance has to include a reform of a) the way in which people are appointed to the boards of state companies too; b) the way in which their strategies are determined by government and by the elite civil servants in the major governing Departments. Civil servants should no longer have to worry about commercial companies day to day policy, except to ensure it is adhering to broad guidelines. These strategies should be more explicit.

This can be made more transparent for commercial state companies under a State Holding Company as Congress proposed in 2005 and which FG have adopted. Not alone will it set clearer objectives, give access to capital (and rapidly too), but also assist Ireland in a major investment programme outside the strictures of the Growth and Stability Pact. Eurostat has made clear determinations which would allow a commercial state holding company borrow and such would be outside the G&SP. It, with specialists, would be far able to assist in major investment strategies than civil servants do today, when a state company has major investment /divestment plan.

It has been seen in the series of blog posts that the Chinese state companies are being utilised strategically by their Government to spread their investment widely, sectorally and geographically; to buy technology through ownership and control; to control vast natural resources in many areas; to grow their state companies and generate wealth and employment; and to train Chinese management to the highest levels and in the widest areas of skills.

In a somewhat similar way, but on a lesser scale, and with no “imperial” ambitions, Irish State companies should be harnessed, with the private sector, to again play a major role in developing the Irish economy. Instead of the passive, small-scale approach, as has been the weak Government policy on state companies up to now, we could be bolder and more innovative. If FDI does begin to dry up, and with the appalling legacy of so many “leading” Irish private sector companies, the next government really do not have a choice but to take the High Road – the developmental road – with our state companies.

I have pointed out that Ireland has a major (private sector) enterprise deficit. We also know that the state has made major policy errors which have cost citizens and indeed many good businesses dearly and will continue to do so for many years. Ireland has had the biggest collapse in national income of a staggering 20 per cent (GNP) in just three years. Our economy has lost many years of income and wealth and many have suffered hugely. Much of this was avoidable.

But the gross errors made in both the private sector and in economic policy in the public sector have both emerged from the same root problem. This is the commitment to a delusional belief in the workings of markets on their own, without supervision, and to a turbo-version of shareholder value and destructive competition –  was competition, the more intense, not always good? – within the boards of Irish banks and other companies, boosted by perverse executive incentives. The former dominated and regrettably, still strongly influences the highest levels in the public sector and the latter was in the private sector, especially banking. If certain key public servants and public regulators had not been in awe of self-regulating markets and the apparent superiority of the private sector, the Crash of 2008 would have been far smaller.

There have been changes in bank regulation and at the Central Bank, but much more reform is required. Without major changes in attitudes, especially to a realistic view of markets and of what is the public interest by some top public policymakers /regulators, combined with major changes in company law and national and international regulation, the crisis will be prolonged and is likely to recur.

Tuesday, 10 August 2010

Monday, 9 August 2010

Medicine killing the patient

"The key question is … has the medicine worked? Has what the government said would happen happened in terms of reviving economic growth?The resounding answer is: Absolutely not. This medicine isn't working,it's actually killing the patient." PE bloggers Michael Burke and Stephen Kinsella were among those interviewed recently by the Los Angeles Times for an article which asked: "As Ireland slashes spending, is it model or cautionary tale?" You can read the full article here.

Friday, 6 August 2010

July tax figures

An Saoi: That paragon of objective comment, the Sunday Independent, informed us last Sunday that "Public finances (were) buoyed by July Revenue takings", which sort of gave the game away. The Government had something to hide. The by-line informed us that “Income tax receipts 'better than expected'”, and so they were. Income Tax paid in the month to the Revenue Commissioners was €852M against €837M expected, though still far below the July remittances of previous years. To emphasise this possible little green shoot the Dept. of Finance “Information Note” also informs us that “it is important to note that it came in ahead of its monthly target for July.”

July’s unemployment figure goes some way to explain the discrepancy, available here. No longer are the foreigners being let go (Table 9), no longer are the forms P45 going to shop workers and those in the building trade. Table 6 provides a stark analysis of those recently sent on their way. No: this time, 24.3% were professionals and 31.7% in administrative roles. Accrued holiday pay and ex-gratia termination payments paid as they walk through the door for the last time provided a temporary boost in the tax yield, which will be claimed as refunds over the next few months. 75.6% of those let go this month were female, but 82.1% of the professionals sacked were women and 86.4% of clerical/admin staff let go were women. These were core staff to most of the businesses in which they worked. And they have few immediate job prospects

Income Tax is in fact €289M behind a target set less than six months ago, and a massive €483M behind July 2009. Refunds of tax due to the recently unemployed will no doubt increase that discrepancy.

Next, let us look at Excise & VAT together. Excise yield has held up well despite (because) of the reduction in duties on alcohol and the cut on VRT charged on imported new cars. The substantial differential that has opened up between diesel & petrol prices along the border has also boosted fuel sales in this State. However, VAT remains nearly 7% below last year’s figure. The continued decline in retail prices is clearly one factor; however, the continuing decline in demand for goods and services is the real problem. Spending on credit cards is a very good barometer of consumer sentiment and dropped substantially in June 2010 over June 2009, despite glorious weather for the whole month. Approx. two thirds of the annual VAT liability is paid in the first seven months, suggesting that the final outcome is unlikely to break €9,700M, nearly €1,000M short of last year’s outcome.

Our yield from consumption taxes remain very much at the whim of currency movements and UK tax policy. The UK Government are thankfully playing Russian roulette with the Northern economy, with their VAT increase in January next. There is little we can do about currency movements; however, targeted cuts in VAT would give us some protection in ensuring that prices remain attractive on this side of the border.

Corporation Tax looks like the one possible source of Revenue picking up. Most of the big refunds arising from losses in banking and property should have been washed through at this stage, while many of the US multi-nationals who use Ireland to launder their EMEA sales are announcing bumper profits. I have tried to project forward for the last five months of the year using the preliminary tax paid to date & would expect to see the final CT yield in excess of the target, though still well below 2009 and earlier years, say in the region of €3,400M. This should not be seen as a sign of improvement in local economic conditions, but rather as reflecting the activities of a handful of large multi-nationals using Ireland as their sales base.

The other tax sources remain anaemic, though Capital Acquisitions Tax remains robust. Very simple adjustments could dramatically improve the yield. Capital Gains Tax is low with little activity in the sales of assets. The same applies to Stamp Duties. The tax base remains very worryingly narrow as we approach a further slowdown in activity. Yields from the main four sources may yet dry up to a mere trickle.

It is very hard to see how the current Government can hold to their promises of no pay cuts in the Public Service, when they will be cutting services and Social Welfare payments left, right and centre. A 10% cut looks probable with serious consequences for tax yield.

The outlook for the current year remains poor, with 2011 also beginning to look ominous.

Thursday, 5 August 2010

Finding the money

Michael Taft: Even before the Live Register figures were released, Tom O’Connor put forward a powerful critique of the Government’s failed fiscal strategy when being interviewed on the recent Exchequer returns on Morning Ireland. As he, and so many others on this blog, have emphasised – it’s about investment, it’s about jobs. Get those right and you’re on the way to sustainable fiscal consolidation.

After Tom, it was Senator Dan Boyle’s turn to comment. Sen. Boyle is on record as questioning the desirability of continuing with deflationary policies after Budget 2011. And he appears to be open to arguments for increasing economic investment which means, for the time being, public investment. However, while discussing the stimulating effect of the Government’s recent capital expenditure review, Sen. Boyle stated:

‘But to get even more money for stimulus in the economy means borrowing that money. First of all, there is questions about the capacity to borrow that money and, secondly, the cost of borrowing that money.’

No, money for stimulus does not necessarily mean more borrowing. A partial solution may be to source funding from money what has already been borrowed. Let’s look at the Exchequer cash balance or the liquidity buffer. This is the money that the Government has on hand to protect itself in against volatility in the international markets.

The Government has approximately €20 billion on hand, representing approximately 12.6 percent of GDP. This is a large buffer (in pre-recession years, the buffer was 4 percent). That we need a large buffer now is incontestable and fair dues to the NTMA for starting its pre-borrowing drive in late 2008 in anticipation of more difficult times ahead. However, this large buffer comes with a cost. One of those costs is highlighted by the ESRI:

‘It [the Exchequer cash balance] means that, unlike some other governments, the Irish government, through the NTMA, has considerable flexibility in terms of when it borrows on financial markets and through what instruments. However, this cushion of liquidity comes at a price. The Irish government is currently holding around €20 billion in cash or on very short-term deposit. This asset attracts only a small interest payment. However, the funds to provide this liquidity have been borrowed at an interest rate of between 4.5 per cent and 5 per cent. Thus the total “excess” interest payments could amount to around €800 million . . . ‘.

So to hold this amount of money costs us €800 million. That’s the first cost. But then there’s the opportunity cost. The Government has cut (and will continue to cut in real terms) capital investment – investment that would both get people back to work, increase tax revenue, cut unemployment costs and increase future productivity. We have maintained a high and costly buffer while effectively cutting employment. Is this rational?

Wednesday, 4 August 2010

Where should we be spending?

Tom McDonnell: The current economic crisis has centred attention, in some parts, on the affordability of the current levels of public spending in Ireland. Much less attention is given to where this public money is actually spent, yet other OECD countries have very different breakdowns of spending to Ireland. At the macro level the breakdown of spending in Ireland has remained unchanged since at least the early 1990s and this suggests there hasn’t been any serious reflection given in Ireland to what it is we should be prioritising. For example, there is an abundance of economic literature pointing to the long term value of education spending, yet education spending has remained unchanged as a proportion of GDP since 1995. Should we therefore be giving greater priority to education spending at the expense of other public services? It doesn’t appear that much consideration is given to issues like these and the general practice at budget time is for across the board increases in good times and across the board decreases in bad times. Ireland can no longer afford to be so laissez-faire about how we prioritise spending.

OECD data (Table 1) shows the comparative level of government spending as a proportion of GDP during the Celtic Tiger years, for Ireland and for a selection of other Western European countries. What the data shows, is that before the onset of the economic crisis, public spending was low by Western European standards. Even if we measure public spending as a proportion of GNP, instead of as a proportion of GDP, we find that public spending was still lower in Ireland than it was in the EU 15 overall.

However, focusing on aggregate public expenditure by itself only reveals so much information. Table 2 shows the breakdown of public spending in Ireland, in 2008, by functional type. The ten categories shown in the table are those of the United Nations COFOG (category of the functions of government) system of classification. The underlying data is extracted from the OECD website.

As table 2 clearly highlights, social protection measures made up by far the largest proportion of overall public spending (33 per cent) in 2008, this was followed by health spending (19 per cent) and then education spending (13 per cent) and spending on economic affairs (13 per cent). Defence spending and cultural spending were the least costly of the ten categories of expenditure.

The set of pie charts reveals the breakdown of public spending in a selection of OECD member states for 1995 and for 2008. The big shift in the composition of public spending in Ireland over this period, was a movement away from spending on general public services (down from 17 per cent in 1995 to less than 8 per cent in 2008) and towards health spending (from 14 per cent in 1995 to 19 per cent in 2008).

The reduction in general public service payments is simply a reflection of Ireland’s ever reducing debt interest burden over the course of this 13 year period. With regard to health spending, the charts show that it had increased as a proportion of total spending for all six countries.

There is clearly a wide divergence in the overall levels of public spending in these countries. But it is also useful to note the wide divergence in the priorities accorded by the different countries to the various functions of government. This reflects the absence of any universal consensus about the appropriate role of government. The composition of public spending in any individual country, as well as the aggregate amount of spending, can be seen more as a matter of choice rather than a matter of agreed technical efficiency.
For example Germany devotes over 45 per cent of public spending to social protection measures, whereas the United States devotes just 19 per cent of public spending to social protection measures. On the other hand the United States allots the highest proportion of overall public spending to education (16 per cent) and Germany the lowest proportion (9 per cent).

Geopolitical considerations can also skew the composition of public spending; for historical reasons both the United Kingdom and the United States treat their military and their defence industry as active tools of state policy and consequently defence spending is given a much higher priority in these countries than it is in Ireland. On the other the relatively high priority accorded by Ireland to economic affairs (13 per cent) is better understood as ‘catch up’ when we consider Ireland’s infrastructural deficit compared to other advanced economies. By comparison, Belgium, with a much more mature infrastructure network than Ireland, devotes only 5 per cent of public spending to economic affairs.

The point here is that the appropriate levels of public spending, and the prioritisation given to certain functions of government, are not independent of the political, historical and economic contexts of different countries. As the context changes the appropriate level and composition of public spending will also change.
In this light we can see that the general context in Ireland post 2007/2008 is one of economic collapse and rising unemployment. The result of this was that in 2008 the level of public spending exceeded 40 per cent of GDP for the first time since 1995. Needless to say as GDP and unemployment have continued to move in opposite directions, the public spending ratio has continued to increase. However to look at the public spending ratio in 2010 is misleading because it captures the extreme negative edge of the economic cycle. Instead it is more informative to look at levels of public spending over an entire economic cycle, and over the economic cycle Ireland has had a comparatively small public sector.

Returning to the composition of public spending in Ireland, it is interesting to note the similarities in the breakdown of spending in 1995 and 2008. For example, despite an interim period when the public spending ratio was reduced by a quarter, we can see that social protection measures took up almost exactly the same proportion of national output in 2008 (13.8 per cent) as they did in 1995 (13.7 per cent). Education spending was 5.3 per cent of GDP in 1995 and in 2008. Public order & safety also remains practically unchanged at 1.9 per cent. There therefore seems to be a degree of consistency in the prioritisation given to different areas of spending. General public services was the only area of public spending to decline by more than 1 per cent of GDP, and as mentioned earlier, this change is merely a reflection of Ireland’s reduced debt interest obligations. Health spending which had been particularly badly affected by the public sector cuts of the late 1980s and early 1990s was the only area of public services that increased its share of GDP by more than 1 per cent from 1995 to 2008.

What all this suggests is that there has not been a fundamental rethink or serious reflection upon about how best to prioritise public spending between the different functional areas of public service. Rather there seems to have been a general attitude of increase each spending in each department by x per cent when times are good and reduce spending in each department by y per cent when times are bad. This is not good enough and Ireland can no longer afford such unthinking decision making. There is no reason to assume that what suited Ireland in 1995 or 1955 is in any anyway appropriate for 2010. It is time for Ireland to take public spending seriously.