Tuesday, 30 November 2010

Countering left-wing ideology

Slí Eile: It may have come to the attention of readers of this blog-site that contributors are ideologically of the left espousing solutions and advancing analysis which are not typical of the mainstream of economic and political analysis. In the interests of balance it is proposed to gather up some assertions, platitudes, assumptions and banalities in this particular contribution. Here goes:
‘We are where we are’
‘the worst is nearly over’
‘we can bounce back especially when we have been bounced into it’
‘we are all in this together’
‘we all were responsible – over-spending, two cars, credit cards, mortgages. We should all be ashamed of ourselves’
‘folks on the dole need an incentive to go out to work’
‘we would not start from here but we will not undo it either’
‘sure we would have done it ourselves if given the opportunity. Don’t be hard on anyone who got it wrong’
‘We are not Greece’
‘We are not Portugal’
‘We’ll get through this’
‘don’t mention emigration’
‘there will be pain for everyone’
‘Love the bondholders and turn the other cheek. They will love us for 6% per annum’
‘all our elderly uncles and creditors abroad said that we are good and responsible children in reducing the Irish economy to its knees. Salvation is only through austerity and all economic history proves this. Let the history of the pre-celtic 1980’s and the post Tiger 2008- be written this way’
‘never mind Krugman, Stiglitz, Blanchflower, the FT, WSJ, Guardian, der Spiegel – they don’t understand Ireland’
‘deflate and trust in expansionary fiscal contraction. Its all about trust’
‘the evidence fits the theory and theory is ideology-free’
‘its awful but we have no choice’
‘beggars cannot chose or negotiate’
‘a plan is a set of targets, soundbites and aspirations’
‘a strategy is based on tough choices’
‘ the tougher the decision, the greater the pain the more impact on market sentiment’
‘the pain should be shared equally so that someone on the bread line experiences the same quantum of pain as someone on an income of €200,000’
‘if corporate tax rates are increased foreign direct investment will flee. Loads of anecdotes and threats by various people confirm this’
‘growth will be 3% per annum because exports will grow by 5% because wages and other costs are cut and because the world will grow because….’
‘there is no relationship between GDP growth and domestic fiscal policy and if there is it doesn’t matter anyway’
‘if growth drops cut spending more and keep cutting spending until growth stops dropping’ (get it!).
‘all economists believe that austerity is the only way to recovery. Anyone who says otherwise is not patriotic and is not a qualified economist – they couldn’t be …’
‘compassion, fairness and equality are fine sentiments. Economics is a hard science and life is tough and in a small open economy you don’t have many choices. We can do all the moral and touchy-feely stuff after we get the country back to working order again = 3% deficit and debt/GDP = 60%’
‘leave moralising to feminists, liberation theologians and lefties – economics is for rational solutions trusting in markets and governments who know who to impress markets’
‘public expenditure was out of control’
‘for every 5 Euro spent we are collecting 3 Euro. So cut back from 5 to 3 Euro. Its as simple as book keeping’
‘an economy is just like a household – a cut in spending equals a saving of the same magnitude’
‘social welfare and public sector pay are the highest in the world (well almost)’
‘there are thousands of public service workers falling over each other’
‘public service pensions should be aligned with private sector pensions after the share market collapse. Likewise, public sector workers should be levelled down to the private sector level and all workers should be competing with workers in the Bric countries’
‘we were losing competitiveness largely because of high pay’
‘going forward we can restore order – repeat order – to the public finances repeat by cutting spending’
‘every empirical study demonstrates that cutting expenditure is more effective than raising taxes’
‘last time (1980s) we raised taxes too much. This time we’ll do it right according to a ratio of 2:1 cuts/tax hikes’
‘changing or reforming the tax code is terribly complex. Take your time. Set up commissions and taskforces. Delay, delay. Don’t do anything radical – especially in regard to capital taxes or corporate taxes – it might frighten the horses.’
‘the multiplier is terribly low in Ireland due to high import propensity. Fiscal stimulus would not work, has not worked and will not work (except to recapitalise zombie banks’)
‘if you let a bank – even just one bank – fail you will lose all credibility’
‘the way to restore market confidence is through penitential exercises – flog harder and impress – flog harder still and impress and shock even more’
For a truly effective shock treatment on the market lasting more than one weekend wipe out all welfare.
Trust in the experts – they know about banking and complicated terms like derivatives, spreads, debt swaps etc.
‘lets all get together and form a national government and put the people and the country first’
‘form an advisory council with all the top brains in the country’ They will come up with the right answer – there being only one right answer.
Postscript
No matter how hard it gets – the ‘insiders’ will always walk away and stand to lose much less than those on the outside. Problem is that the insiders have the power and they get to write the history when future generations read it.

Monday, 29 November 2010

Michael Burke in the Guardian: who's being bailed out?

Somewhat belated, but here is a link to PE blogger Michael Burke's opinion piece in Saturday's Guardian newspaper.

Ireland, bond markets and democracy

"Making the “market” the actor abstracts from the real world of speculators and financial fraud. It facilitates the mythology that the dysfunctional financial system is not the work of men and women (mostly the former) within institutions with socially irrational rules and norms, but a manifestation of the inexorable operation of the laws of nature that no government can change. This objectification is ideology: it is not “markets” that seek socially devastating budget reductions in Ireland, Greece and elsewhere, but a specific collection of financial speculators whose anti-social behaviour is possible because governments removed regulations of capital markets". You can read the rest of John Weeks' post on Social Europe Journal here.

UNITE letter to opposition parties

Michael Taft: Today, Jimmy Kelly, Regional Secretary of the trade union UNITE, sent a letter to the leaders of the opposition parties – Fine Gael, Labour and Sinn Fein. In it he called on them to make clear that they will not be bound by the terms of the IMF/EU bail-out. He further called on them to commit to re-opening negotiations based on the following principles:

(a) That the Irish Government will refuse to be bound by the debts generated by the banking sector, and

(b) Ring-fence the cash and assets available to the state in the National Pension Reserve Fund and the National Treasury Management Agency’s cash balances. These should be used for economic and social investment only and not to pay off the deficit or write-down debt.

The text of the letter is below.

On behalf of the UNITE trade union, I am writing to ask that your party declare they will not be bound by the agreement reached yesterday with the EU and the IMF. This agreement is not in the interests of the Irish economy, Irish workers or the Eurozone.

We are further asking that prior to the general election your party declare they will re-open negotiations based on the following principles:

(1) The Irish Government will refuse to be bound by debts generated in the banking sector. If no satisfactory mechanism can be agreed with the IMF and the EU, the Irish Government will engage in a substantial write-down of debt held by all bondholders – including both senior and subordinated debt;

(2) The cash and assets held in the National Pension Reserve Fund and the National Treasury Management Agency’s cash balance will be ring-fenced for public investment in the Irish economy. These resources will not be employed for deficit or debt reduction purposes as this will only undermine our ability to generate growth and employment and, so, defeat the objective of repairing our public finances.

UNITE believes that only by removing banking debt from the public balance sheet and employing our cash and assets for investment purposes can we hope to achieve economic recovery and fiscal stability.

I look forward to receiving your response which I will pass on to our 60,000 members in the Republic.

Thank you for your consideration.

Yours sincerely,

Jimmy Kelly

Implications of the IMF deal

Tom O'Connor: The IMF deal which has just being announced should be filed under fairy stories. It is economically unrealistic and would be an impossible burden on the country.

Let’s take the figures. The interest rate on the deal is 5.8% and the deal takes €17 billion from National Pension Reserve Fund and National Treasury Management Agency. Remember, the Greek deal was only 5.2% over five years. The longer time period on the Irish deal forces a significant hike in interest rate. The longer time frame increases the amount of interest significantly also.

Let’s put this figure in to the macroeconomic framework. In 2014 our national income measured by GDP, the measure used by the EU, will be €183 billion. At the end of 2009 our national debt stood at €75 billion. This year’s deficit plus the deficits to 2014 plus the bank recapitalisation will bring the national debt up to 183 billion by 2014, 100% of GDP, according to the government’s four year plan.
Now this 183 billion is the principal owed and doesn’t include the interest. This bailout will fund the 35 billion bank recapitalisation and 50 billion in deficit repayments and is in line with the governments own projections in its four year plan.

The interest on the deal will be €45 billion. The total €69 billion plus interest amounts to €114 billion. This is to be paid by the start of 2020 and covers 9 years. This forms part of the national debt from next year onwards. A further €50 billion will be added to the €100 billion which is not part of the IMF deal and which already exists. The total government debt in 2019 without anything paid off it will be €264 billion.

Now, the government’s own four year national recovery plan shows it will run a deficit by until 2014. It will be lucky to break even in 2015. Even during the best year of the Celtic tiger, the maximum surplus run by the government was €3 billion.
So, the government would be lucky to gather €1 billion a year in surplus from 2016 to 2019. This will give them a tiny repayment capacity of €4 billion to the IMF who with interest will be owed €114 billion. Even the sale of all semi-state companies would only pay off another €5 billion.

The fact that we will owe €114 of our national debt to a ruthless organisation like the IMF is a very worrying prospect indeed, given its track record in Eastern Europe, Africa and Latin America.

Given that all the taxation increases will have been used up to bring down the deficit to 3% by 2014 to please the EU and taxes will then by quite high, there is no other avenue for the government to raise the rest of the money. The government cannot come even remotely close to paying. There are no Houdini tricks.

The government projects GDP will be €183 billion in 2014, based on its growth projections. Now, taking the very optimistic scenario that the economy will grow by an average of 3% in GDP terms to 2019, nominal GDP at that stage would be 205 billion. At that stage the €264 billion in national debt will be 129% of GDP.

This figure would include nine years of economic hardship and cutbacks. At the end of the period, Ireland would still owe one and a third of everything we produce in the country in one year, with the IMF being by far the biggest creditor.

The justification for the bailout is to save the euro and bring our economic figures in to synch with the EU’s Stability and Growth Pact. This is nonsense. True, we will be down to 3% in terms of our general government deficit by 2014. However, in that year our debt will still be 100% of GDP. Five years later it will be 129% of GDP. To achieve a worsening debt, we will have sacrificed hundreds of thousands to the emigration markets and unemployment will stay high.

In addition, at 2014, the government’s own four year plan shows that the amount of taxes going to service the interest on the national debt will be 20%. This is based on a rate of interest of 4.7%. This will rise to 25% just to pay the national/IMF interest bill only!

To make matters worse, by 2019 the pension bill will have risen considerably, given the ageing of the population. In fact, the National Pension Reserve Fund was set up to cover some of this cost. Even when the NPRF hadn’t been rifled by the government to recapitalise 7 billion to AIB/BOI and Anglo in the past two years, its total assets then of 25 billion was only equivalent to covering 25% of the pension bill by 2025.

This means that taking the NPRF money to pay the banks under this plan is ludicrous. There would be a strong case to take 8 billion from the fund to stimulate the economy and replace it in five years. This would drive down unemployment by 10,000 for every 1 billion spent and would improve the government finances. Squandering it on the banks, having already taken 11 billion from it for them, is nothing short of a national disgrace.

Even if we achieved an interest rate of 2% from the IMF, sold our semi state companies and ran an exchequer surplus of 6 billion by 2019, our debt GDP ratio would be still 107%. We need to fully nationalise the banks, burn the bondholders, amalgamate the big two banks and start afresh. Only depositors should be guaranteed.
We need to use some our NTMA and NPRF cash reserves of €40 billion to stimulate the economy. A partial long term loan without interest with our own un-borrowed reserves needs to be used to cover the deficits. Any partial EU loan should be without conditions over 20 years.
These are real alternatives - this deal isn’t. This deal is a monumental mistake. The deal cannot be passed until legislation goes through the Dail after Christmas to legalise it. It would be a national scandal if this government’s last sting of a dying wasp was to legally impose this deal on Ireland.This is an edited version of an article published in today's Irish Examiner

Sunday, 28 November 2010

The story keeps shifting

Slí Eile: 28 November we are told (1) 'Without this external support, the State would not be able to raise the funds required to pay for key public services for our citizens and to provide a functioning banking system to support economic activity' and (2) 'The Council has today extended the time frame by 1 year to 2015'. Last Wednesday we were told that there was no alternative to 2014 (it had been 2013). The goal posts keep changing as deflationary policy impacts negatively on domestic growth. And 10 days ago we were told that we were fully funded up to mid-2011. What story next? Nobody really believed 2013 (and then 2014). It may be 2020 before the public deficit is down to 3% of GDP and possibly longer if the current deflationary strategy of flogging the half-dead horse is continued.

Friday, 26 November 2010

Never a reckless lender be

Tom McDonnell: One of the images below is from Patrick Honohan's paper in the Economic and Social Review June 2009.  If you combine the two you can see how the foreign banks (as they were the main holders of the Irish banks' bonds) were what funded the last 1/3 of the Irish bubble, i.e. its wildest phase.[click to enlarge images]

The other gives the BIS's latest figures available on foreign banks claims on Irish banks (see the second line in the Ireland section). (See the bottom of the page for the reference). Some of this has been paid back, especially in August-September as a considerable amount of bonds were redeemed then at Irish people's expense, but most still remain.

In other words, the Irish people are bailing out the German, UK and other banks for funding the most crazy stage of the Irish bubble, which simply could not have happened without their investment in it. Now they want the Irish people to bail them out fully for their bad investments and the damage they have done. This is what the IMF/ECB loan is essentially about.

The clear implication is that these private institutions fuelled the boom through their unwise lending. They are at least partially responsible for it. Bubbles will go to the extent that banks will lend – that is the primary determining factor. So it is these private institutions that must take the vast majority of the pain – not the Irish taxpayer. If the ECB wants them bailed out then they should do it themselves.

We shouldn’t exonerate the IMF from blame either. We need to bear in mind the IMF's clean bill of health and encouragement to the Irish banks and their regulation in their assessments of the Irish banks (Honohan Report).

Four-Year Plan: Tax Expenditure

Nat O'Connor: I'm going to call the National Recovery Plan "the four-year plan" because I believe we should encourage the next government to publish four-year budgetary plans every year, as part of the opening up and improvement of Ireland's economic and fiscal management.

Having got that point out of the way, this year's four-year plan has a fair bit to say about tax expenditures. And so do I.

While this post is relatively positive towards the plan's actions in relation to tax expenditure, they represent the few positive aspects of a plan that is otherwise weak on jobs and highly regressive on tax measures.

It is to be welcomed that measures in the four-year plan move towards reducing tax expenditure, but significantly more can be done in this area and it can be done quicker.

The decision to standard rate pension tax reliefs is something TASC has called for for years. Tax reliefs at the marginal rate were inherently unfair. An ESRI study shows that 80 per cent of the benefit has gone to the top 20 per cent of earners. The four-year plan estimates that these tax breaks cost the state over €2.5 billion per year. This can be compared to the €6.5 billion spent on the state pensions in 2010.*

* Figure is the rounded sum of the Contributory Pension (€3.4bn), Widow(er)s Contributory Pension (€1.3 bn), Non-Contributory Pension (€0.9 bn), Invalidity Pension (€0.7 bn) and Transitional Pension (€0.1 bn). Source: Revised Book of Estimates 2010.

However, the phasing out of tax relief at the marginal rate will only begin from 2012, so this proposal may yet be changed by the next government. The decision to lower pension tax relief to 20 per cent is (fortunately) also contrary to the recently announced new national pensions’ framework, which advocated relief at an anomalous rate of 33 per cent, so we must be conscious that implementing the move to 20 per cent pension relief will require additional revisions to be made to the national pensions’ framework.

It is important to note that TASC’s objection is not only to the inequality of the pension tax reliefs but to the failure of the system of private pension provision to provide secure incomes for people in retirement. The value of Irish pension funds suffered real losses of 37.5 per cent in 2008, which the OECD (2009) Pensions at a Glance describes as the worst performance across 30 OECD countries. The current system simply does not work, which is why TASC continues to call for the creation of a new social insurance (retirement) fund involving a mandatory defined benefit scheme. Details are available in TASC’s updated pension policy: Making Pensions Work for People.

I note a potentially confusing note in the four-year plan around who benefits from pension tax relief. The plan states: “It is not the case that only those on higher incomes benefit from pension relief. The bulk of employee/individual pension contributions attract tax relief at the marginal or 41% tax rate” (p. 94). The point that many people pay tax at the marginal rate (and can claim relief at that rate) is not in dispute, but the importance of the ESRI study is that it showed that the vast bulk (80 per cent) of the benefits from tax reliefs went to the top 20 per cent of income earners.

It is welcome that the four-year plan acknowledges the risk of abuse, when it states: “Pension tax expenditures will be kept under constant review to ensure that abusive tax sheltering does not take place” (p. 94).

There are other welcome changes to tax expenditure in the four-year plan. Specifically, the plan is to abolish ten income tax expenditures and curtail another six, saving €355 million per annum once implemented.

A further €400 million worth of legacy costs from property-based incentives are also being phased out. I argue that the remaining property-based tax incentives need to be immediately halted in order to avoid last-minute use of the incentives, and consequentially less than €400 million being saved in this area.

There is also a commitment that “reliefs and exemptions from CGT, CAT and Stamp Duty will either be abolished or greatly restricted to ensure that there is an adequate base for these taxes and that all of society makes a fair contribution to the correction of the public finances” (pp. 99-100). A conservative estimate of €145 million is given for this. To date, TASC has focused on tax expenditure on income tax and corporation tax (following available data). But for every tax, there are tax breaks in the Irish system. So changes to CGT, etc are welcome.

The Cost of Tax Expenditure
The four-year plan proposes to reduce tax expenditure by €1.7 billion by 2014 (see pp. 93-97). For reference, the plan states that the cost of pension tax relief is just over €2.5 billion. TASC estimated that tax expenditure on income tax and corporation tax alone cost the Irish Exchequer €7.4 billion in 2009. So, it seems obvious that more could be done to reduce this than €1.7 billion in four years.

The four-year plan is incorrect and misleading in its explanation of the OECD finding that tax expenditure cost €11.49 billion in 2005. The four-year plan states that “80% or €9.72 billion of all the tax expenditures relate to personal allowances / credits / bands, pensions and savings” (p. 95). The OECD’s figures do not include the effects of the income tax bands. In addition, the OECD calculation shows that €7.2 billon from income tax relief came from other sources than basic personal credits (i.e. Single Person’s Credit, Married Person’s Credit and Widowed Person’s Credit). In other words, 62 per cent of the €11.49 billion tax expenditure on income tax came from other credits and allowances, which are not ‘basic’ or part of the ‘baseline’ tax system. TASC explained and replicated the OECD findings with 2006 data in its pre-Budget proposals submitted to the Department of Finance (see pages 28-29).

In fairness, the four-year plan is correct that there is a lack of public understanding about tax expenditure; due in no small part to the inadequate data available on this area. When the €7.2 billion of ‘non-basic’ tax credits and allowances are examined, they contain a wide range of things, including inter alia: the PAYE tax credit, tax relief on private medical insurance and health expenses, the tax exempt status of Child Benefit, relief for investment in films and TV, tax relief for paying third-level fees, approved profit-sharing schemes, and the various pensions/savings reliefs.

The reform of this area is complex and demands a commitment to substantial overhaul of the tax system to make it simpler, transparent and equitable. In particular, the removal of some tax reliefs may require balancing changes to be made in areas of economic or social policy. For example, TASC’s proposals about pension tax relief are not just about removing an unjust relief, but they also put forward a system for ensuring everyone has a better, more secure pension.

Nevertheless, there is a need to look at the overall distributional effects from the combination of the taxation, tax reliefs and the welfare system; it is hard to justify benefits to middle income earners, if the alternative is cuts to payments and services on which more vulnerable people depend.

TASC has proposed that all current and proposed tax expenditure should be subject to an equality audit and economic efficiency audit. In addition, they should all be subject to an annual check and vote by the Oireachtas, as they constitute a major area of public spending. Most developed countries report systematically on tax expenditure every year. The World Bank associates the absence of such reporting with developing and transition countries.

Thursday, 25 November 2010

Upcoming events ...

PE readers may be interested in a few upcoming events. On the morning of Saturday, November 27th, the Labour Party will be holding its Pre-Budget Forum at the Chartered Accountants' HQ, Pearse Street, Dublin 2; registration starts at 9.30 am. Speakers include Karl Whelan of UCD and Micheal Collins of TCD; to book a place contact cathy.flanagan@labour.ie. On December 2nd, the Feminist Open Forum's 'Women on the Economy' session will take place at 7.30 p.m. in the Central Hotel, Dublin 2; panellists will include TASC Director Paula Clancy. Finally, on December 6th, a public seminar on Implementing Social Health Insurance in Ireland will take place in DCU from 10 am to 4 pm. Although registration is free, places are limited and advance booking is required - contact anthony.staines@dcu.ie.

Wednesday, 24 November 2010

The €400 mn solution - a plan to recover bondholders' money

Michael Burke: There are some very large numbers bandied around in the misnamed ‘National Recovery Plan’ (NRP). €6bn of fiscal tightening this year and €15bn altogether over the next 4 years represents nearly 4% of GDP in the current year. If there is no growth over the next 4 years, then the reduction in government outlays and increased taxes will be just under 10% of GDP.

Of course, the DoF forecasts 2.75% real trend growth over the medium term, which would reduce that proportion. However, the projection for GDP in December Budget of €164.6bn was approximately €5bn over-estimated, and out by 3%. Given that the year only had 3 more weeks to run, this suggests at least a severe underestimate of the conjunctural deflationary forces at work in the economy, or, in light of the relative accuracy of other main macroeconomic data, potentially a structural misunderstanding of the key components of economic growth. In any event, an approach which fails the test of a 3 week forecast is unlikely to be very reliable over 4 years.

Where Are We?

There seems little point in rehearsing the arguments over the impact of fiscal contraction once more. The government is wedded to the notion that a reduction in its own output will prompt an increase in the activity of the private sector. This is based on a thorough misinterpretation of the history of this economy from the late 1980s onwards- which we should return to in a future post.

But, in the phrase that has become familiar, we are where we are. So, let us look instead at this economy as it is now and focus on one of the smaller numbers in the NRP. That number is €400mn.

That is the difference between two much larger numbers €15bn and €14.6bn, a difference of just 2.6%. €15bn is the threatened level of spending cuts and tax increases over the next 4 years. €14.6bn is the actual cuts and tax increases made over the last 2¼ years (p.5, which many here had asserted was precisely the cumulative fiscal tightening, and been criticised for exaggeration). Clearly, the previous measures were even more ‘front-loaded’ than the planned ones. And the composition of the packages is broadly similar – a 2:1 ratio of threatened spending cuts and tax increases compared to a 5:2 ratio for the measures already enacted.

A reasonable person might assume that the effect of the measures will therefore be broadly the same. The previous measures were accompanied by a €21bn decline in nominal GDP and a €26.2bn decline in GNP from Q3 2008 to Q2 this year. The decline in output accelerated in the second year of recession, which happened in no other European country. And, from end-2008, taxation revenues are due to fall by €12bn at the end of this year, while welfare outlays have increased despite entitlements being slashed.

But this is not how the DoF sees it; stating there is ‘an implied uncorrected (sic) deficit of 20% of GDP’ in 2010. This is the argument that, while the economy and therefore government finances have gone to the dogs, the government’s actions have saved the country from a far worse fate, in fact a deficit of just over €31bn, assuming unchanged growth in H2. (Table 1.3 in the NRP seems to imply €158.4bn GDP in 2010, which relies on zero growth for the rest of this year).

This cannot be true.

When this policy was first implemented in 2008 total government revenues were €46bn and the deficit was €13bn. The government both cut expenditure and raised taxes, and we are invited to believe that the deficit would now be €18bn worse if they hadn’t, at €31bn. But this implied deterioration in government finances is almost the entirety of the actual decline in GDP in the same period (over 85%), and nearly 70% of the decline in GNP.

A Little Analysis

DoF provides little in the any of analysis, despite a late section in the NRP on sensitivity analysis. However, even this poor contribution to understanding the relationship between government spending – growth – government finances is an improvement on what precedes it. Table A.2.2 shows the cumulative effects on the deficit (the General Government Balance) arising from a 1% change in output. The cumulative average change in the GGB over 4 years from that 1% change in output arising from lower rates or higher world growth is 1.9%.

This is based on the ESRI’s HERMES model, which may have its own faults (and certainly produces some quirks). What wasn’t put through the model, or at least wasn’t published, is the same effect from a change in government spending. To make a simple point, government spending is a category of GDP, so even without any attempt to assess the multiplier effects of a change to government spending the inescapable conclusion must be that a reduction in government spending will lead to lower GDP by at least that amount. The only alternative is that it will be offset by increased private sector activity - but that is to repeat the fallacy which created this crisis, centring on Expansionary Fiscal Contraction, a notion which has been demolished by the IMF.

The DoF says the results are ‘symmetric’- applying equally to the expansion or contraction of the economy. On that basis, all multipliers aside, a €14.6bn contraction in the fiscal position would lead to deterioration in the GGB of €27.75bn, or €13.15bn on a net basis, subtracting the tightening itself. And, since we are only two years into the tightening process the deterioration in government finances is on course to be worse than the DoF/ESRI/HERMES estimate.

So, an extra €400mn tightening in a second round of slash&burn isn’t a solution after all. Meanwhile, the level of national debt may just about double overnight as the ECB/EFSF insist on full repayment for bondholders, while the economy is bound hand and foot by ‘austerity’ measures. The solution to any debt crisis cannot be to double your debt and lower your income. Bond prices slumped today as the markets see what the policymakers refuse to acknowledge - that a default is increasingly likely. In fact it is imperative.

The bondholders should be burnt. Ireland has a history as a religious country. The millions who will suffer from this ‘recovery plan’ may feel that the bondholders, along with the others who brought the country to its knees, should burn in Hell.

National Recovery Plan

The Plan can be downloaded here. TASC's initial response is available here.

Equity Option Incentive Plan

Ger O’Toole, a property business professional, has come up with an Equity Option Incentive Plan as one solution to the mortgage debt problems that many households are facing. As the name implies, the basic idea is to give the banks equity in exchange for reducing the amount of money that is directly paid back to them. The site is also running a survey of mortgage holders - although there will be a self-selection bias in the sample - and invites comments.

Could someone please send the IMF the Spraoi Christmas Annual?


Rory O'Farrell: During my childhood in 1980s Ireland, one of the highlights of the school year was the arrival of the Spraoi Christmas Annual. Among the many life skills it taught were ‘join the dots’ and ‘spot the difference’.
Twenty years later the IMF have produced a similar publication termed ‘Lifting Euro Area Growth: Priorities for Structural Reforms and Governance’.
Just like Spraoi it makes use of colour, this time to show Ireland’s economic problems. We have two structural reform gaps marked red, infrastructure and network regulation. Given our lack of investment in such things as broadband this is perhaps unsurprising. When it comes to labour market inefficiency we get a green light, the IMF don’t see that as a major problem.
This would suggest to me that Ireland’s labour market regulation (such as the minimum wage) does not cause a problem, but we should probably invest in infrastructure. This would also create jobs and reduce future problems of long term unemployment. On page 22 the IMF report suggests we need to
“Raise employment to avoid persistence of current high unemployment rate; and
Improve competitiveness to promote exports as a sustainable source of growth”.

Yes, they seem to have mastered joining the dots. Our infrastructure deficit and network regulation doesn’t help our competitiveness position.
However, the specific measures they suggest are as follows.
To promote employment labour market:
  • Introduce gradual decrease of benefits over time of unemployment spell and stricter job search requirements
  • Provide more resources to the unemployment agencies (FÁS) to provide efficient job search assistance to the growing number of unemployed
  • Review the level of minimum wage to make it consistent with the general fall in wages
And to improve competitiveness:
  • Reform planning and licensing systems in network industries, so as to increase competition in sheltered services sectors
  • Focus public resources on high-priority projects in the knowledge-based economy
So, no plans for infrastructural investment. We just get supply side solutions for demand side problems. Have the IMF learned how to spot the difference?

With friends like these ..... Michael Burke on the view from the UK

PE's Michael Burke has an article on the Socialist Economic Bulleting putting the Irish situation into context for British readers:

Like Greece before it, the population of Ireland will experience the true nature of the bailout; a form of international loan-sharking. The economy and government finances have spiralled downwards because huge transfers of wealth and incomes have been made to the rich, led by the banks, to soften for them the effects of the recession. These transfers were from the poor.

The downward economic spiral naturally ran out of control, as incomes plummeted and new debts mounted. These were reflected in the soaring costs of government borrowing in the bond markets as investors viewed eventual default as an increasing likelihood. Now Irish taxpayers are being forced to take on even greater debts and to accept the extremes of further ‘austerity’ measures in a doomed attempt to pay for them. The Dublin government is the borrower - but the funds will be offered to existing creditors. As the Financial Times’s Martin Wolf remarked of the earlier Greek crisis, this is worse than Argentina’s debt crisis, as the creditors are being paid to escape, and there is no-one to replace them.


Click here to read the full article.

Tuesday, 23 November 2010

Krugman on the bailout - and why the markets aren't impressed

"The basic situation is that given the cost of rescuing Ireland’s banks, and the damage harsh austerity is inflicting on Ireland’s economy, investors are understandably skeptical that the Irish government will actually be able to meet its commitments. That’s why rates are high — to compensate for a possible default." You can read the rest of Paul Krugman's post today here.

FT on bailout and banking

"Ireland’s uninvited helpers seem set on perpetuating Dublin’s dysfunctional policy of throwing good money after bad and filling holes into which creditors refuse to step". You can read the rest of today's Financial Times editorial here.

Sunday, 21 November 2010

A sneak pre-view of the 4-year plan

Slí Eile: An interesting insight from former IMF director, Donal Donovan, is given here. He writes in the Irish Times, last Friday, that:

"These informal interactions – a common feature of such situations – are facilitated by the fact that most of the key personages are well known to each other as a result of interaction in other forums over the years.

So, my surmise is that yesterday the IMF team (which includes Ashoka Mody, who has led earlier IMF visits to Dublin) will have sat down with the latest drafts of the four-year and annual budget plan. (They will probably have had access to earlier versions also.)" (emphasis added)."

But what about Dáil Eireann? and what about Seán Citizen? A vital input to democratic debate is timely, relevant and reliable information. We have been poorly served on all three fronts. See for example a critique of the lack of adequate macro-economic data and forecasting capacity in the recent Joint Oireachtas Committee report here. Note, also, the extent to which false and misleading information served up the banks was cited as an issue by Fianna Fáil deputy Michael McGrath in a Dail committee hearing last Thursday. Misleading estimates of bad loans and underestimated discout rates costing billions have also been cited as a problem by Brendan Somers of NAMA.

Friday, 19 November 2010

The IMF: Bringing in more transparency?

Nat O'Connor: One of the clear risks to Ireland's economy and society is that we can go back to business as usual. In fact, if we don't make any particular effort to do otherwise, we are more likely than not going to slip back into bad habits, old networks and 'traditional' ways of doing business. Indeed, the IMF's mission chief, Ajai Chopra, is quoted as warning that it's important in boom times to be wary of claims that 'this time will be different' in respect of the risk of a crash. There is no better example of this risk than Ireland's obsession with secrecy. We can either continue to accept that politicians, bankers, devleopers and clergy 'know best' and so we don't need to know; or we can demand a new way of doing business: transparently.

A major cause of the ongoing banking crisis has been the drip-feeding of information from the banks, and the lack of total disclosure on just how bad their books are. One welcome aspect of the IMF's visit will be a forensic examination of the banks once and for all.

Meanwhile, the Governor of the Central Bank has been praised for giving clear information about what's likely to occur with the IMF, and why.

The Taoiseach said that the Governor's view did not necessarily reflect that of the Government. “The governor gave his view. He is entitled to give his view.”

The Taoiseach is quite right. The Governor is meant to be an independent officer of the state, and he should speak independently. What is wrong is that the Government chooses not give an equally clear (albeit divergent) explanation of the situation. Instead, the Taoiseach continued that "we have to determine what is the best option for our country and for our people at the time." In other words, the Government will decide for us - not with our participation in the discussion.

The Minister for Finance told the Dáil yesterday that "If the Government has been reticent in making public comment, it has been in the interest of protecting the taxpayer".

The Minster continued "Jumping to conclusions ahead of the facts is not to the benefit of the taxpayer, nor is it in our interest to do this in advance of the discussions that are now taking place." It is entirely reasonable that the Minister cannot be expected to have all facts to hand, but he can be expected to explain what he knows and what he intends to do.

It would be healthier for Ireland if we had a multitude of voices and a competition of ideas, based on expert knowledge and evidence. This would not threaten the Government. Yet, people in Ireland often have to look to foreign media for more balanced and varied coverage on our own crisis!

It is a cliché that we are living in an information age. But some practical implications of that are that it is easier than ever to access people's academic writings or more personal musings in blogs or newspaper articles. Hence, we can make up our own minds what we think of our 'leaders' and their point of view.

For example, there is no need for the IMF's mission chief, Ajai Chopra, to be a mystery. We can read his blog to get an idea about his analysis of economic matters. And we can look back over his previous work, such as his analysis of Korea in 2001, which has some similarities to the Irish case. He acknowledged then the need for growth stimulus as part of budgetary measures, and cautioned about austerity measures that were damaging to economic growth: "We are not advocating irresponsible fiscal policy. At the same time, however, there is a danger if fiscal conservatism is carried too far as it could exacerbate the downturn in the economy."

In a similar vein, transparency can bust the exaggerated myth of our lost sovereignty; for example, John Bruton's lament. He said "We’re now in a position where we’ll still be making the decisions but we won’t be making them on our own, we’ll have others looking over our shoulders". And what's the problem with making decisions in the open, and accepting comments on them?

Based on its track record, the IMF team is not going to tell the elected Irish Government what to do in the four-year plan or the Budget. It may advise or give a technical opinion, particularly on what they believe will or won't work. But national sovereignty over the choice of tax measures and cuts to public spending remains firmly in the hands of the Government and the Dáil. Any attempt to blame the IMF for directing cuts towards lower income families or people who depend on social welfare will be untrue. All the IMF can do, if announced austerity measures are not followed through on, is suspend access to the money we want them to lend us. But if we meet our targets on closing the deficit, than we'll be able to borrow. And a growth strategy must be part of our plan.

The Taoiseach has denied talking in riddles about the current situation. "Work has not been sufficiently completed, or options put before the Irish Government in sufficient detail, for us to decide what our ultimate position will be. We are engaged in those discussions in an open and transparent way," he said.

What this comes down to is that the Government does not appear to believe that its duty is to tell people what is going on, to explain or clarify the understandable confusion and worry about the arrival of the IMF. The Government will announce its decision, once that decision has been made.

We have a choice for the future. We can accept the old style of leadership from behind closed doors, or we can demand that in future our political leaders have a duty to tell us, in clear terms, what is going on and what our options are, before they make a final decision that may burden a generation with debt.

In this context, the Irish Examiner makes a worrying claim: "The EU-IMF investigators will uncover significant fraud and corruption in their examination of the Irish banking sector according to a leading European economist who worked with the IMF."

Ireland's banking sector is "not like the USA with a highly complicated system. Its simply three to five banks with loan books. It’s typical of what can happen in a small country where everyone knows everyone and as long as everything is going well, nobody notices," said Dr Gros.

"Iceland found that senior politicians, regulators and bankers were all at fault for bringing down the country’s economy." And Dr Gros fears something similar will be discovered here.

It is perhaps not surprising that during his first meeting with an Oireachtas committee, the open-speaking Governor of the Central Bank called for an inquiry into how the crisis began, in order to get to the root causes and to make sure we don't go back to business as usual.

By way of contrast, the traditionally secretive UK Government is today making available data on 195,000 items of spending for the first time ever. The Cabinet Office minister said "This government has the clear ambition is to make the UK the most transparent and accountable country in the world." The Guardian has a live blog on the experiment and diverse opinions on the benefits of openness.

Thursday, 18 November 2010

Terry McDonough puts the Irish crash in a global context

"The current coalition’s ‘solution’ to the crisis is precisely the intensification of global neo-liberalism. Ultimate salvation will come from renewed international expansion – in the meantime, Irish banks are to be rescued unconditionally with wads of public money, while being maintained in private hands to the greatest extent possible. Social services and programmes are to be drastically cut to prove to international markets that Ireland is fiscally responsible. Wage cutting in the public sector is meant to signal open season on private sector wages and conditions, but falling wages and falling government spending will only intensify the crisis. Taken as a whole, this programme tries to solve the crisis on the backs of the ordinary Irish citizen. However, any remote possibility that this might work on its own terms has been lost as the revenues and savings are pumped into an insolvent banking system in order to rescue international bondholders – a strategy that threatens the state with bankruptcy". You can read the full text of Terry McDonough's article putting the Irish crash in a global context in the latest edition of The Citizen here.

Wednesday, 17 November 2010

Crisis shedding light on the Irish state

Peadar Kirby: We may live in very exceptional times, in which the speed of how the Irish crisis is developing is literally breathtaking. Yet, for all that, what is most disturbing is how it manifests just how little has actually changed, illustrating yet again in stark terms some long-standing features of how the Irish state operates. Despite the intense focus on the immediate pressure of events, it is most important that we recognise the very familiar posture adopted by Irish policy makers and by the Irish state, since it highlights what will have to change if we are to have any hope of building a more sustainable and equitable future. Another way of putting this is to state that the largely economic and financial discourse that dominates debate needs to be balanced by a discourse that focuses on the administrative and the political features of the current crisis.

While it is true that a crisis requires crisis management, what we need to examine is how this crisis is being managed, as it is this which is very revealing. What is most striking is that politicians and policy makers give the impression of being dragged along by events to which they are reacting, with little sense of forward planning. While this might be understandable amid a crisis that is far more severe than could have been reasonably anticipated, it also needs to be recognised that the intensity of the crisis right at this moment derives from the fact that the state has a very poor capacity for longer-term forward planning and has failed to even begin to address the challenge of designing a more adequate system of taxation. These failures cannot be blamed on the present crisis as they are very familiar features of the Irish state. Why did it take so long to realise that the present crisis required multi-annual budgetary planning (indeed long before the present crisis, this capacity should have been developed) and, even more glaringly, why have the recommendations of the Commission on Taxation not been used as the basis for a re-design of the taxation system? If this had been done, not only would it help inform the budgetary strategy but it would also have helped give a sense of confidence that the state would be able to deal with the crisis.

Take the issue of corporation tax. What is remarkable about the present debate on these issues is just how successfully powerful vested interests have created a firm consensus throughout Irish society that the present level of corporation tax is untouchable. It is simply ruled out as a possible subject of debate any time it is raised, and the Irish media and Irish society as a whole (judging by the complete lack of debate on the issue) seem to acquiesce in this. Is this not extremely revealing? At a time when we are agonising over cutting back welfare payments, pensions, various supports for the most vulnerable in our society, and core funding for our health and education services, and are being told that the pain must be widely shared, we all seem to accept that powerful global corporations who declare a very high level of profits in Ireland should share absolutely no part of the adjustment. This remarkably benign and subservient treatment is based on the claim that raising corporation tax by a percentage point or two might undermine a core part of the state’s development strategy. But instead of debating whether this might be so, and seeking evidence as to what impact it might have, we simply succumb to a response based on fear.

Long before the present crisis, it was evident that the normal posture of the Irish state, particularly in the social sphere, was reactive crisis-management. There are very few examples where the state proactively instituted an ongoing process of reforming itself so as to avoid the emergence of crises. Indeed, the very term ‘reform’ appears to be equated to a process of cost-cutting rather than to a complex process of institutional design so as to more effectively achieve public goals. One could adduce numerous other examples which illustrate both the lack of policy-making based on hard evidence and also the lack of a process of robust and wide deliberation in the formulation of policy. The first weakness derives in part from the gap that has for too long separated those who make policy from those who could provide evidence that might inform the process; instead, civil servants all too often rely on consultants who are not intimately familiar with the latest research nationally or internationally. The second gap derives from the weakness of a culture of robust deliberation, not only in the political realm but also in the media. One can only hope that the present crisis will make policy makers more aware of the need to draw on social scientific evidence and generate a broader debate on the options facing us as a society. There is some evidence that the latter is happening; I’m not aware of much evidence that the former has begun.

Tuesday, 16 November 2010

Cometh the moment of truth

Slí Eile: Some international organs of the media are showing a particular interest in Ireland which extends to the voices crowded out in the national media. See here. And the New York Times is saying: 'That might force Ireland to raise its ultra-low corporation tax rate, a magnet for foreign investment, to help cut its debt. The tax has long been seen as a form of unfair competition by higher-taxed countries.'

The new Irish Famine?

“The Irish famine killed more than a million people, but it killed poor devils only. To the wealth of the country, it did not the slightest damage.” So wrote Karl Marx back in 1867. As 21st century Ireland peers out over the debt drop, beneath which lie the open jaws of an EU/IMF “bailout”, I’d like to make some outrageous parallels between then and now.
You can read the rest of Gerry Feehily's post on the presseurop site here. (Hat-tip to An Saoi for the link)

The Banking Crisis is Unresolved

Nat O'Connor: Today's 'crisis' seems to be more about the timing of key EU meetings than about anything of substance that requires Ireland to tap into the EU/IMF fund this week, or even this year. One key question is what is the ECB's attitude towards the Irish banks.

We know that Ireland is fully funded until mid-2011. And we could then tap the NPRF if we really needed to, which would fund us up to Christmas 2011. So, in terms of borrowing to bridge the current deficit, there is no crisis that requires Ireland to tap the EU/IMF fund today or tomorrow.

The problem is the banks. Our banks can't borrow money from the bond markets, so they are borrowing from the ECB - using the promissory notes our Government has issued them. The situation is not clear, but it seems plausible to suggest that the ECB is not happy with lending so much money to Ireland's banking system. In a similar way to the Austrian announcement that they won't make their €190 million share of the next EU/IMF fund payment available to Greece due to a lack of reform (Guardian report at 2.24pm), we could speculate that the ECB does not like giving money to the Irish banking system without seeing a strategy for the restructuring and reform of that sector.

And hiding behind the current problems of the Irish banks is the personal debt crisis that could trigger a second wave of problems, that would require further bank bailouts.

Of course, since the bank guarantee, the banks debts have become part of the sovereign, national debt. Although we can credibly make the annual interest payments on this for the next few years, it may make our overall national debt too big for us to ever pay back. And that spooks the bond markets from lending to Ireland at all. Which brings us back to contemplating the need to use the EU/IMF fund again. But is there any point in using the fund if we don't reform our banks?

And what should we do with the banks? With another wave of recapitalisation we could own all of them. Should we restructure them into good/bad, household/business or retail/investment? Should we be inviting a foreign-owned bank to buy one of the main banks - or at least its branch network and performing assets?

There are a lot of jobs at stake here, both directly in the banking sector and indirectly in the wider economy that needs a resolution to the banking crisis. The ECB may not be forcing Ireland to take a bailout. But they may be forcing us to make some decisions to resolve the banking crisis in a more definitive way, once and for all.

Anthony Leddin on Ireland's export competitiveness

Proinnsias Breathnach: Last Friday’s Irish Times (November 12) contained an article by Dr Anthony Leddin, Head of the Department of Economics at the University of Limerick, which raises further serious questions about the quality of advice on economic policy emanating from Irish academic economists.

The basic thrust of the article was that Ireland’s international competitiveness declined seriously for most of the 2000s due mainly to rising costs, but that a fall in costs and wage restraint since 2007 helped reverse this trend. Leddin concludes that a deflationary budget, through further containing wage and other costs, will work to Ireland’s long-term advantage by enhancing competitiveness.
Leddin cites trends in what he terms net exports (i.e. exports minus imports) in support of his argument. He states that net exports fell from a surplus of €226 millions in 1999 to a deficit of €10.124 billions in 2007 (reflecting falling competitiveness) but then recovered to a deficit of €4.85 billions in 2009 (indicating improving competitiveness).

Even if these data were accurate, they would indicate a highly unlikely speed of response on the part of trade volumes to changes in costs. However, much more seriously, not only are the data inaccurate, but the trends derived from the data are the opposite of actual trends in net exports. In 1999, according to CSO Balance of International Payments data, total exports of goods and services exceeded imports by €12 billions, not the €226 millions claimed by Leddin. Between 1999 and 2007, the excess of exports over imports increased by €6.7 billions (to €18.7 billions), directly contrary to the fall of €10.3 billions postulated by Leddin.
Over the next two years Ireland’s trade surplus grew by a further €9 billions to €27.7 billions (according to Leddin there was a deficit of €4.85 billions in 2009).
The data cited by Leddin refer, not to net exports, but the so-called “balance on current account” which includes not only net flows of export revenues but also net flows in factor income and transfer payments. By far the biggest component of the latter elements is net direct investment income i.e. income earned by transnational firms from overseas operations.

In 1999, the net outflow of direct investment income came to €13.5 millions, which exceeded the trade surplus. However, a surplus in other investment income gave a small surplus in the overall current account of €226 millions which is the figure given by Leddin for the trade surplus. By 2007 the net outflow in direct investment income had doubled to €26.3 billions, €7.7 billions greater than the trade surplus. Deficits in transfer payments and other income flows produced the overall current account deficit of €10.1 billions which Leddin presented as the trade deficit.

Over the next two years the net outlow of direct investment income rose by €2.6 billions but a much sharper rise in the trade surplus (of €9 billions) produced the substantial fall in the current account deficit which Leddin presented as a fall in the trade deficit.

Overall, therefore, where Leddin claimed that Ireland’s net exports fell by €10.4 billions between 1999-2007, they actually rose by €6.7 billions. This, of itself, undermines Leddin’s argument that Ireland’s competitiveness deteriorated in this period. Indeed, the key factor in the difference between Leddin’s purported net export data and the true position, i.e. rapid growth in the net outflow direct investment income, is itself an indicator of rising rather than falling competitiveness, to the extent that it reflects rising profitability among foreign firms based in Ireland.

It is shocking that a senior academic economist would make such a glaring mistake in the presentation of basic macroeconomic data. What is more disturbing is that this is just the latest instance of misinterpretation (or non-interpretation) of data by a wide range of economists in support of an erroneous view that Ireland’s competitiveness was undermined in the first decade of the current century. I have already refuted this view in some detail in a series of articles on the Ireland After Nama website (May 2010).

Almost unanimously, these economists further attribute this postulated loss of competitiveness for the most part to rising labour costs (itself not true, at least insofar as it applies to Ireland’s main export sectors). The idea that international competitiveness is primarily dictated by labour costs is extraordinarily simplistic (and of course untrue, at least for the markets in which Ireland participates).

What is even more extraordinary is how widely held this idea is among Irish economists. It is a view very firmly held, for example, by Alan Aherne, Brian Lenihan’s economic advisor who wrote in the Sunday Tribune (January 11, 2009) that “if we are to regain competitiveness, we have to do it the difficult way – through wage cuts” and followed this up on RTE’s Morning Ireland programme (January 19, 2009) with the view that “the only way to improve export competitiveness is through wage cuts in the export sector”.

This immediately rules out enhanced productivity, design and performance improvement, technological upgrading, marketing and branding, to mention just a few of the standard approaches used by firms to improve market share in the real world. If the Irish government’s economic policy is based on views and analyses of the level of accuracy and sophistication indicated here, then there really is little hope for us at all.

Friday, 12 November 2010

Ireland's forgotten deficit

Rory O'Farrell: What is the bottom line for the Irish economy?

It is well known that the economic bubble was inflated by borrowed money, largely in the private sector. What is largely being ignored is that the total economy, public and private sector, is still being financed from abroad.

Ireland has successfully managed a trade surplus in our recent history, exporting more than we import. We have had a steady income. However, for most of the 21st Century we have shown a Current Account deficit. But why is this important? The Current Account in the National Accounts in many ways is similar to the current account a private citizen has in a bank (it is complicated in that it measures flows rather than stocks). It measures the day to day items of the national economy. It includes our trade balance, but crucially for Ireland, it includes some of our day to day expenses in the global economy. Each quarter the Irish economy must send money abroad to pay interest bills and the profits to multinationals. Given our liabilities, Ireland has to run very fast to stay still. Even having a trade surplus of €10 billion may not be enough push us back in the black.

Though the fiscal deficit is important, the Current Account serves as the bottom line for the economy as a whole. If we want to pay back our private sector debt (such as in Anglo or AIB) without just lumping it onto the National Debt, we must show a Current Account surplus.


What can be done?

It is inevitable that our debt overhang will resolve itself eventually, but as with everything in economics there are choice as to how to deal with the issue. Continuing with government policy will lead to debts being resolved through bankruptcy.

The most obvious way to reduce out international liabilities would have been to allow private sector debt stay private, and allow the bank bondholders take a hit. This would have been the correct thing to do. Unfortunately this is getting more and more difficult to do as the Government added private debt to the public debt.

We can increase exports. Unfortunately this is difficult, though not impossible. We cannot change demand from abroad but we can make ourselves more competitive.
One suggested way is to lower wages. However how would this benefit the current account? It might increase inward investment in the medium term, but as wage rates are already competitive it is unlikely it would have much of an effect. Also, as our export sector is dominated by multinationals cutting wages would simply increase the profits that are sent abroad, so a wage cut could actually harm our Current Account position. Alternatively we could try reduce non-wage costs by investing in public infrastructure.

We can reduce imports. This is something we have far more control over. One possible way is through massive Government cut backs to kill off domestic demand for imports. This is a strategy that was pursued by the IMF in South America, but they have moved away from this. The social consequences are too severe. Also a social wasteland does not make for a good export platform, so such a tactic could also reduce exports, and not improve the Current Account balance. As most government spending is done domenstically. There is some leakage abroad, but government spending can be targetted in a way to minimise this.

The government could look at which income groups spend the most on imports and increase their income tax rather than that of other groups. Also Ireland imports a disproportionate amount of goods, mainly due to our dependence on foreign energy. Investing in alternative energy is a good substitute, but also the simpler solution of public transport and cycle lanes would reduce the amount of fuel we import.

Finally we can reduce capital outflows and have one big inflow. Repatriating the National Pension Reserve Fund would be the obvious inflow. But what of outflows? Saving does not always equal investment. We should look at which income groups save their money abroad and tax them more. This will help to keep money in the domestic economy, and reduce our external liabilities.

It may be argued that this policy is protectionist, but we simply cannot afford to keep importing at the rate we have been.

Is Mr (Bond) Market in Charge?

Jim Stewart: (The Governor of the Central Bank, Patrick Honohan is quoted as stating to the Oireachtas Committee on Economic Regulatory Affairs :- “though we may not like it, we have to jump to what the lenders expect and convince lenders we can get to the situation where debt is not spiralling out of control”).

The interest paid or yields on Irish Government debt have soared in the past two weeks. The yield on ten year debt is nearly 9%, below that of Greece at 11.6% and above that of Portugal at 7.2%. The economic problems of Ireland, Greece, Portugal and Spain are regularly discussed as being at the centre of ‘investor concerns’ (New York Times, November 7). There is renewed speculation about the break up of the Euro, re-adoption of national currencies and devaluation (Victor Mallet and Peter Wise, Financial Times November 8). The rise in bond yields in the peripheral countries of Europe caused the Euro to fall against the dollar and stock markets to fall on Monday, Tuesday and Wednesday of this week according to the Financial Times (Financial Times, November 9,10,11).

Yet at the same time, bond prices in many other countries are at historic highs, yields are at historic lows. The real yield on inflation-linked 5 Year UK bonds is -0.44%. Despite low interest rates, falling yields and rising prices have meant that returns on, for example, German and US government debt have been over 8% so far this year (Keith Jenkins, Bloomberg, November 8) This has led to considerable debate as to whether there is a bubble in bond markets. (See for example:- Financial Times, October 31). Much media attention focuses on the price of gold - up over 30% in the past year - but commodity prices have risen even more:- sugar is up 40%, corn 55%, cotton 76%. These prices, if sustained, will result in higher inflation. Hence it is likely that long term bond yields in countries such as Germany will rise.

Why have interest rates on government debt in peripheral countries risen so high so quickly? In the case of Ireland, the cost of the bank bailout and resulting Government borrowing requirement has been roughly known for some time, and yet the markets are only reacting now.

One factor is undoubtedly due to German Government policy which led to what Der Spiegel (8 November) has referred to as the ‘Merkel crash’. That is the proposal, apparently agreed to by the European Council at the instigation of the German Government, that bond holders would suffer losses in the event of a country borrowing from the European Financial stability Facility. The Financial Times recently reported this decision as agreement on “an automatic” default by borrowing countries (David Oakley and Richard Milne, November 9). However the European Council press release of conclusions at its meeting merely agreed to ‘endorse’ the Van Rompuy report. The Van Rumpuy proposals are however aspirational. The only phrase include the word automatic is in par. 26, as in ‘increasing the automaticity’ of decision making.

Much more serious was Merkel’s statement that a new bankruptcy mechanism will be established which will ensure private investors bear some of the costs in any future crisis. The German finance minister recently stated in relation to the crisis mechanism, “we are working out the details within the German Government and at the European level. Its already clear today that the new mechanism will not apply to old debt but only to new debt” (Der Spiegel 11/8/2010). These policy statements are more likely to be driven by domestic German concerns (politicians cannot be seen to be bailing out the feckless Greeks and Irish by the virtuous Germans with ‘Swabian’ housewife values) than by broader issues relating to financial and economic crisis in eurozone and other countries.

Partly as a result, it is not clear what rules will emerge and how bondholders both new and old might be affected. Commentators have conflicting versions of what the German Government proposes and what might be implemented at EU level.

German Government proposals have created uncertainty and bond yields have risen as a result. This was indeed forecast at the meeting of the Council of Ministers (29 October) by the President of the ECB (See Jack Farchy, Financial Times November 9).

But the sudden rise in bond yields is also due to other factors. The President of the ECB is also quoted as stating that, by encouraging short selling of bonds of those countries with large deficits, they are facilitating ‘US speculators’. The relationship between rising debt costs and hedge funds/speculators has also been made by others. Speculation against eurozone bonds may be linked with beliefs in relation to the break-up of the eurozone.


The Trading Strategy of Hedge Funds

Credit Default Swaps (CDS) may be an integral part of the trading strategy of hedge funds (very large investment funds, for example Soros Fund Managers with assets of €27 billion, which are typically highly leveraged, lightly regulated, and limited to a small number of large investors). CDS provide insurance on the underlying debt asset but also allow speculative trading because CDS contracts do not require any insurable interest (an analogy is with rival criminal gang members taking out life insurance on their opponents).

There is a positive correlation between yield on debt and Credit Default Swaps. For example the yield on Irish government debt will approximately equal the cost of a CDS plus the risk free rate that is the yield on German Government debt of the same maturity.

Y on Irish debt = CDS cost + risk free yield (German Bund yield) or

CDS cost = Y – risk free yield.

If the cost of a CDS rises, the yield on government debt rises. The market for CDS and Irish Government bonds is narrow (New York Times 10 November) and the market for Government debt has become more illiquid. The collateral requirements of those trading Irish Government debt increased on 10th November, meaning those trading Irish Government debt had to post higher margins or sell debt. The Financial Times (11/11/2010) reports the Bank of Ireland chose to post higher margins requiring extra cash of €250 million. The net effect is that liquidity and trading in Irish government debt will be further reduced. In addition most bonds are held to maturity. A sudden demand for CDS will drive up the price and drive down the price of bonds. Holders of CDS swaps on Irish Government debt purchased some weeks ago have now large gains. Holders of Irish Government debt have large losses. This has implications for example for banks, pension funds, etc., to the extent that they have suffered and realised losses on their holdings of Irish Government debt.

Implications

Irish and other countries’ bond yields are a function of hedge fund trading strategies. Hedge funds thrive on uncertainty. Part of their strategy is to create uncertainty by media reports, ‘research’, etc. One widely cited report on Bloomberg asserted that Ireland was going bankrupt, would run out of cash in 60 days, and that debt restructuring of peripheral countries as proposed by Germany would mean “the whole thing is gone”. In contrast, the NTMA state they have sufficient cash reserves to fund the projected government deficit until June/July 2011 and furthermore do not need to refinance debt until November 2011.

Strategies pursued by hedge funds have driven up yields. High yields means the Irish and other Governments are in effect shut out of the bond market. The recently announced extension of the guarantee on bank debt is meaningless, as bank debt guaranteed by the State is unlikely to have a lower cost than the cost of debt issued by the State. The Irish State is currently the only possible source of long term funds.

An election would reduce uncertainty, but other uncertainties remain. For example, a continuing decline in property values, failure to obtain economic value from the large stock of existing housing, hotel and other assets will mean further capital losses by banks, company insolvencies, negative equity, etc.

Yields once driven up are likely to be ‘sticky’. Even if they fall likely to a large premium over German Government bonds is likely to remain.

Use of the Economic Financial Stability Facility (ESFF) by any country is likely to be conditional on rules for this fund. Rules that exempt existing bond holders, but seek to impose losses on new bond holders (debt restructuring and write downs), may simply ensure that the interest cost of debt in peripheral countries remains high and countries such as Ireland may cease to be able to borrow. Hence the only source of debt will be from the ESFF.

The loss of control by the Irish Government of policy decisions, while predictable, has suddenly arrived. But it is not inevitable that bond markets determine policy. EU rules in relation to the use of the ESFF have yet to be determined. Policies that equate macroeconomic management with the economics of households (the ‘Swabian’ housewife) can and should be countered. Restrictions should be imposed on the use of Credit Default Swaps. Earlier this year, the French Economy Minister was quoted as being in favour of restrictions on the use of Credit Default Swaps. One effect of ECB policies of providing liquidity at low cost to the banking sector is that such liquidity can be used to speculate against sovereign debt, but the ECB is prohibited from lending directly to sovereign states.

Ireland would not be alone in making these arguments.

Thursday, 11 November 2010

Running out of logic

Michael Burke: The Finance Minister's statement that, if the government's Budget is not passed the country will run out of money, has been examined in an earlier post, and found to be politically untrue.

It is also untrue from a simple matter of accounting.

It is also not what investors have been told by NTMA, the body responsible for managing the national debt. This piece on IE has a link to an NTMA presentation which shows that NTMA has cash balances of €20bn, somewhat greater than the €19bn shortfall referred to by Mr Lenihan. It's true that a further €4.4bn in bonds fall due for repayment next year, but NTMA alone could fund all government financing requirements without further borrowing until about September next year.

Then there is the €24bn in assets at the NPRF, which have been identified as a potential source of increased investment. The returns on the NPRF assets need boosting, having achieved a paltry 1.7% annualised since inception in April 2001 (NTMA Annual Report 2009). What better returns are available than the 14%-18% of the National Development Plan projects? This would boost the NPRF holdings in real terms, which are actually declining annually under current investment policies.

Then there are the assets of the central bank, €129bn in 2009, €93bn lent to banks. This is achieving an even lower return than the NPRF, just €1bn in 2009, less than 1% (Central Bank Annual Report 2009).

Finally, it should be pointed out to the Finance Minister that the government is not the same as the country. In 2009, the income of the private sector was €71bn, compared to household income which was €73bn (CSO Institutional Sector Accounts 2009). Yet taxes on production were just €15bn and could rise to prevent any ‘running out of cash’. Of course, an increase in the level of economic activity would multiply the effects of any increased tax rates on production.

According to the DoF, the sensitivity of government finances to changes in GDP is 0.6. We are told that €6bn in cuts are needed this year. On the DoF’s maths, a €10bn increase in GDP would achieve the same, based on the 0.6% sensitivity. Now, because the economy is in a Depression, that is a tall order, a 6.3% nominal growth rate. But increasing the notoriously low levels of taxation on output at the same time would help. Let’s say taxes were increased to Iceland’s disastrously low levels, 15% corporate tax from 12.5% currently. That’s an increase of 20% if repeated across the board. That would bring the required nominal growth rate down to 5%, which is eminently achievable from 2.5% growth and inflation. And investment would help to achieve that. Deflation won’t.

Now, Mr Lenihan doesn’t seem mind giving one last push, even when the economy is standing on the cliff edge. So the soft option of investing to revive the economy, combined with a modest adjustment in taxes is not for him. Clobbering the poor, the unemployed, lone parents and the blind is his preferred option.

Mr Lenihan either knows these basic facts about the assets of key government agencies, like any Finance Minister should, yet has decided to say the opposite. Or he is actually unaware of them. It's uncertain which is the more reprehensible.

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Wednesday, 10 November 2010

Ireland will not run out of money if the December Budget fails

Nat O'Connor: The front page of The Irish Times runs with the Taoiseach claiming that if the Budget is not passed, the country will run out of money. That is technically untrue.

The Taoiseach is absolutely correct that major fiscal adjustments have to be made this year and in subsequent years, but the evidence does not necessarily weigh behind the current plan of frontloading €6 billion.

The Taoiseach is also correct that if Ireland reached the middle of next year, with no coherent economic strategy and a weak Budget that fudged the issues, we could find ourselves running out of money. He is correct that you can't spend €50 billion a year, if you only bring in €31 billion in tax.

But none of the areas where the Taoiseach is factually correct supports his contention that if the Government's Budget is not passed on December 7, that Ireland will then run out of money.

Under the Constitution, only the Dáil deals with 'money' bills, like the Budget, the Finance Act, etc. The Seanad can only make commentary. So, passing the Budget is down to the Dáil vote.

The Budget could at this point easily fail to be passed, if the Green Party defects, if a very small number of backbench Fianna Fáil TDs vote against it, or if a slightly larger number of pro-Government TDs abstain or don't turn up. This assumes that all the Opposition TDs do turn up, and vote against it.

If the Budget is defeated in the Dáil, what will happen next is very predictable based on Ireland's prior parliamentary history. The Opposition will put down a Motion of No Confidence in the Government, which the Government will counter with a Motion of Confidence in themselves. Under the parliamentary rules, the Government's motion gets to be debated first, so there will be some heated speeches in the Dáil. Then the TDs will vote on the motion. It seems to me highly unlikely that the Government would win such a vote. If they lose the Budget vote, they'll almost certainly lose the confidence vote, and a General Election will be called.

Once the election is called, arrangements will be made for what the now 'caretaker' Government will do in its final weeks. The Opposition may be asked to agree a compromise and pass parts of the Budget. That could go in various ways. Fianna Fáil and Fine Gael might agree an alternative €6 billion adjustment at that point. Alternatively, a wider range of TDs might agree a skeleton Budget that simply ensures money is there so that hospitals, schools, etc will all remain open in January.

Once the election is over, the new Government will then propose, and pass, their own Budget (probably in January). Any new Government must have a working majority in the Dáil, so this New Year Budget would almost certainly pass. Depending on its content - and the economic logic of its approach - the bond markets will react accordingly. If the markets react favourably, the new Government could borrow a relatively small amount in the first quarter to 'test the water' and then go back to the markets again in late summer. As ever, what will matter to the markets is a coherent, sustainable growth strategy to demonstrate that Ireland is serious about generating the funds to pay them back.

The Taoiseach is right that Ireland does need to pass a strong Budget and four-year plan before very early next year. But it does not have to be his Budget.

I would go further and suggest that Ireland could be more likely to 'run out of money' if the Government's planned €6 billion budget is passed. If the austerity measures kill growth and stagnate the economy, and if there is no robust plan on jobs, then the bond markets will demand far too high interest rates, making it effectively impossible for Ireland to borrow. And then we really will run out of money.

Tuesday, 9 November 2010

Public sector workers - some awkward facts

Peter Connell: Never let the facts get in the way of a good story. Surely a good epithet for much of what masquerades as analysis of our current crisis. And there’s no more eloquent commentator than Senator Eoghan Harris. Harris is passionate about ideas. From intellectual powerhouse of the Workers' Party to speech writer for David Trimble and public advocate for Bertie Ahern, ideas are his stock in trade.

And his latest big idea is to see high public sector wages as the obstacle to resolving our current economic crisis. Public sector pay and pensions is ‘the fattest of fat cats’. His solution, as outlined in last Sunday’s piece, is to bring public sector wages and penions back to their 2003 level. Harris dismisses Fintan O’Toole’s recently publish book Enough is Enough on the grounds that in offering solutions to the crisis the author fails to address the ‘scandal’ of high public sector pay. What we need, according to Harris are facts, or ‘awkward facts’ as he calls them. But all he offers are pronouncements and second hand, second rate analysis. Such as ‘Irish teachers are the best paid in Europe’. Of course this simply isn’t true. Harris doesn’t quote the source of his statement, he doesn’t do primary research. The awkward facts are available from the OECD (2008 data). Since 2008 teachers have had a 2.5% pay increase in October 2008 followed by pay cuts of, on average, 12-15%% (pension levy in March 2009 and pay cut in January 2010). So, if we examine the data published by the OECD, and assuming a modest 3% increase for teachers in other countries since 2008, we find that the starting salary for a primary school teacher in Ireland is below that of Luxemburg, Germany, Switzerland, Denmark, Netherlands, Spain, Norway, Scotland, England and Finland. At the top of a long incremental scale Irish national school teachers are well paid but less well paid than those in Luxemburg, Germany, Switzerland, Austria and Portugal. Exactly the same pattern is true of second level teachers. When I last checked my atlas all of these were European countries.

Harris’s ‘research’ also claims that Irish secondary school teachers ‘take the most holidays [in Europe]’. Again, let’s consult the OECD for some awkward facts regarding actual teaching hours. According to Chart D4 in Education at a Glance 2010, at lower secondary level Irish teachers spend 720 hours in class each year, above the OECD average of 703 and above that of 17 other European countries. His snide remarks about teacher’s holidays simply expose his bias.

When it comes to public sector pay Senator Harris is equally sloppy in his research. The public sector pay bill has increased significantly since 2003 but that’s more a reflection of increased public sector numbers than any pay bonanza for your average public sector worker. Let’s look at some more awkward facts. Our starting point is June 2003 when the first phase of the infamous benchmarking award was paid. Let’s say our employee is awarded a 10% increase under benchmarking. Between June 2003 and October 2008 (s)he enjoyed ten pay increases, three arising from benchmarking, three from the Sustaining Progress agreement and three from Towards 2016. The total percentage increase up to that point was 27%, when inflation over the same period was just over 20%. So, a 7% increase in real gross income. Not bad, but not a bonanza. Since October 2008 pay cuts amounting to about 13% have been imposed. Add in deflation of -5.5% and we find that the average public sector worker in 2010 has a gross salary 14% higher than in 2003 while inflation over the same period was 15%. So, in terms of gross income public sector workers are right back to where they were in 2003. Add in recently imposed income and health levies and Harris’s notion of the average public sector worker being a ‘fat cat’ is simply indefensible. He rightly feels empathy with private sector workers who have lost their jobs. He singularly fails to relate to the experience of low and middle income public sector workers who, like their private sector colleagues, are seeing their living standards assailed on all sides.

Harris claims that ‘the Government could find the €6bn it needs by simply cutting back public pay and pensions to 2003 levels’. The public sector pay and pensions bill is about €21.8 billion. To save a net €6 billion the gross bill would have to be cut by at least €8.5 billion or by almost 40%. The reason is that public servants pay PAYE, health levies, income levies, PRSI and make pension contributions to the State. Cut their pay and you cut all these sources of income to the State. Cuts don’t translate into savings. It’s a mistake repeated by most commentators. It’s simple maths. Senator Harris should try it some time.

Stephen Kinsella on moral hazard

"Everyone from the Financial Regulator to the staff in RTE to my mother will cry ‘Moral Hazard!’ when talking about bailing out homeowners who signed their names to forms and borrowed money they couldn’t pay back. Moral hazard is a widely misused term." You can read the rest of Stephen Kinsella's thought-provoking post here.

Unemployment, emigration and growth

Tom O'Connor: The seasonally adjusted unemployment figures show a fall of 6,500 signing on the live register. This is totally due to emigration. In fact, it is highly likely that the figures would have risen and not fallen, were it not for the scale of emigration right now, which is now at its highest annual level in living memory.

In the year to last April, the CSO show that emigration stood at 65,300 and the net figure when we subtract the numbers entering the country was 34,500. These immigrants numbered 30,800, a very sharp fall.

Taking the first figure, 5,441 people per month up to last April were leaving the country presumably due to unemployment. Allowing for the outside possibility that 12,000 of the 30,800 immigrants were coming here to draw the dole, which the government would say is outside its control, the numbers leaving the live register due to emigration , up to April last, was 4,441 per month. Over that period, unemployment rose by 51,000 and would have risen thus to 104,292 were it not for emigration. This is in one year!

Now, if we look at the most recent ESRI predictions, things have gotten worse: In the year up to next April, they are predicting net migration to be 60,000 people. This means that the numbers leaving the country minus the numbers coming in will be 60,000 leaving.

If we take it that the numbers coming back will be a maximum of 30,000 per year up to next April, then this would indicate emigration of 90,000. Consequently, 7,500 people are leaving these shores every month at the moment.

Even if we adjust this figure downwards on the off chance that 12,000 of the 30,000 immigrants will come here to draw the dole, the numbers of people being removed from the live register due to net emigration stands at 6,500. This is exactly the same figure as the seasonally adjusted fall in unemployment for the month of October.

So there is no real drop in unemployment, and even with the illusion of a fall of 6,500, there are still 443,000 people on the live register. To make matters worse, were it not for emigration since April, this figure would now stand at 482,000, only 17,000 shy of a half a million people.

Ah, but the government will say that the public finances are stabilising. This is stretching the limits of credulity even further. The government paid €7 billion to the Anglo Irish Bank and the National Pension Reserve Fund last year, bringing the deficit to 25 billion. Netting out this 7 billion to compare last year’s deficit with this year where this 7 billion spending won’t occur, shows that the deficit will widen considerably at the end of this year.

The deficit net of Anglo/NPRF at the end of 2010 was €18 billion last year and it will be €22 billion at the end of this year. Consequently, the government will have saved 4.3 billion mostly by cutting services to those such as old people, children with special needs, community groups, home helps and social welfare recipients and it will have increased the deficit by 4 billion!

Of course the answer is to grow the economy and not deflate it. A whopping 15 billion of the 18 billion deficit last year was due to the fall in tax receipts from €48 to 33 billion from Dec 07 to Dec 09. This was due to unemployment which the government has done nothing about.

In this context, the Irish Congress of Trades Unions have made a very compelling observation this week, that it is the government’s inability to grow the economy and reduce unemployment that is causing the bond interest cost of government borrowing to rise.

The markets know the government is making no headway and the solution is to bring down unemployment. They can see the abject failure of government policy in this regard, which is driving down their confidence and driving up the cost of borrowing.

So, the endorsement by business groups of front loading cuts of 6 billion to reduce borrowing costs is based on the incorrect premise that the markets are looking for this deflationary course of action, when instead they would prefer to see a solution to unemployment and the deflationary cycle in order to grow the economy!
This would reduce unemployment, grow taxes and reduce the deficit alongside a move out of recession and markets know that this would be a far superior result to the current deflation and borrowing policies.

Consequently, the Irish Congress of Trade Unions has called for a wide ranging six billion fiscal stimulus to get the economy growing, reduce unemployment and thus reduce the deficit. This is something that I have been calling for since the summer of 2008 to halt the government’s suicide pact in driving the economy continuously down in to a debt-deflationary cycle.

The Nobel Prize winning economists, Joseph Stiglitz and Paul Krugman have also been advocating this approach and the latter has strongly criticised the failure of the Irish government not to stimulate the economy. TASC has also called for fiscal stimulus. The evidence is overwhelming. Government policy must be radically altered and fast. These are lessons for any alternative incoming government also.
This is a slightly edited version of an opinion piece published in yesterday's Irish Examiner