Friday, 30 September 2011
Tuesday, 27 September 2011
Monday, 26 September 2011
After the stock market and land price bubble burst in Japan in 1989 the economy went into a prolonged depression. In effect it has spent not one but two ‘lost decades’ since, recording miserably low levels of growth.
But it would be a misconception to believe that Japan has recorded no growth at all in the last 20 years. Over that time, real GDP as risen in 15 years and contracted in just 5 years. But the average annual growth over the entire period from 1989 has been just 0.7%. However, even this has been flattered by repeated bouts of deflation, that is, outright falls in prices. If prices fall faster than the fall in nominal growth, real growth will be recorded as positive.
It is not at all given that the US will experience Japanisation, most importantly because the starting-point for the level of debt in the corporate sector is not comparable to that of Japan at the end of the 1980s. As a result there is no financial compulsion to reduce private sector investment in the US, a key factor in the economic stagnation.
Why is this relevant to Ireland? Simply put, this economy is currently experiencing more severe deflation than Japan. In the table below we set out the pace of price changes (GDP price deflator) in Japan and Ireland and useful comparators.
Change In GDP Price Deflator (annual % change)
Source: World Bank
According to World Bank data deflation has been worse in Ireland than in Japan over the last 4years, prices falling by 6.8% versus 4.5% price declines in Japan. This is also very different to the experience of the OECD and the Euro Area as a whole, who have not experience deflation.
This is important in light of the recent GDP and GNP data for Q2, which have widely been described as a turning-point for the Irish economy and proof that ‘expansionary fiscal contraction’ is at work. In terms of GDP growth in the first half of this year, real GDP grew by 2.1% in H1 2011 compared to H2 2010. But nominal GDP rose by just 1.3%. This implies a GDP deflator of -0.8%, or -1.6% for the year as whole. This is not very different from the World Bank’s forecast for deflation in 2011 as a whole.
But the situation is even more pronounced in relation GNP. Given that the export sector is artificially inflated by (mainly) US MNCs booking profits in this jurisdiction to avail of low taxes, then GNP is decisive in terms of measuring the growth of the domestic economy and its ability to service government debts. In real terms GNP fell 4.7% in H1 from H2 2010, highlighting the extremely divergent paths of the domestic and export sectors. But nominal GNP fell by 6.5% over the same period, implying that the price deflator fell by 1.8% in the first 6 months of this year.
Price falls are not unequivocally bad news. For those fixed incomes, such as pensioners, real incomes rise. But if the majority of incomes also fall in the household, corporate and government sectors, then the effect is to increase the real burden of existing debts. Given that the economy is facing a debt crisis, as Japan did before it, deflation exacerbates the key problem facing the economy as a whole.
The latest data show that Ireland has not broken the deflationary cycle it entered in 2008. There can be no serious talk of turning-points unless it does.
The current market turmoil is intimately related to the fact that the prospect of a second dip in the ongoing economic crisis has not concentrated the minds of American and European policy makers. Instead it has promoted policy chaos and political infighting. The upshot on both sides of the Atlantic is the promise of more austerity. This can only serve to shrink Irish export markets. The IBEC optimism that Ireland can carve out a larger share of a shrinking pie amounts to nothing more than whistling in the dark.
What is the Irish government’s response to this situation? It can be easily summed up as a three point programme. Point number one is to sustain the health of the private banking system through the injection of public money. Point number two is the elimination of the budget deficit, primarily through cuts and secondarily through regressive tax increases on the ordinary Irish citizen. Point number three is to restore competitiveness through driving down wages. It is contended a low cost economy with a low spending, responsible government and a newly healthy banking system will set the stage for a recovery in investment, growth and employment. The problem is this programme will not work and will only succeed in making the crisis worse.
With apologies to Steven Spielberg, saving private banking has proved to be a mission impossible. Indeed, it has been the most manifest and abject failure. The previous government’s first response was the disastrous bank guarantee. This was followed by NAMA, designed to relieve the banks of toxic assets, replacing them with government bonds. The cleaned up banks were then to get lending again. The storm of protest which broke over this plan failed to stop it, but forced the government to acquire the assets at a much more substantial discount than originally planned. This only made sure the government would be forced to recapitalize the banks.
The forced recapitalization has not produced the desired results. Lending both to Irish households and non-financial businesses has not recovered and in fact has continued to decline. An Irish Central Statistics Office (CSO) study compared access to finance in 2007 and 2010. It found some decline in loan applications but identified a much bigger decline in loan approval rates which were 95% in 2007 but only 55% in 2010. Significantly, 61% of businesses believed that banks were less willing to provide finance. The Irish Small and Medium Enterprises Association (ISME) latest quarterly survey found that along with an increase in requests for credit, the rate of refusals was 54%. The deleveraging programme under the EU/IMF bailout programme requires the banks to shrink their assets by 72 billion euros by 2013. As loans are one class of assets, this hardly encourages new lending.
While it is unclear whether the government’s strategy has resulted in increased bank lending, there is no question that these actions have resulted in a substantial increase in the level of Irish government debt. In the establishment view this only lends urgency to the deficit cutting effort of programme point two. In addition to bailing out the banks, the government has been busy holing the public lifeboat.
Expenditure will be cut and taxes will be raised. The major unanswered question, however, is whether these actions will succeed in reducing the deficit. The belief that expenditure cutting reduces deficits is based on a false analogy with the family budget. If you cut spending and increase revenues your deficit would fall. It is not necessarily the same with the government’s budget. Spending cuts (and to a lesser extent tax increases) tend to damage demand in the economy, stifle growth, and lead to lower levels of economic activity and employment. This impairs government tax revenues and consequently may fail to reduce the deficit. It could conceivably actually lead to higher deficits. As unemployment rises, increased social benefit spending tends to counter cuts in other areas. Prof. Victoria Chick and Ann Pettifor have recently evaluated a century of UK data concerning the possibility of improving government finances by cutting expenditure. They find that “when expenditure rises comparatively rapidly, the debt ratio falls and the economy prospers, and when it levels off, the debt ratio worsens and macroeconomic indicators are less favourable.” Contrary to much conventional wisdom, “fiscal consolidations have not improved the public finances.”
The government’s third point involves deep-sixing wages. The previous government’s attack on the poor through the reduction in the minimum wage was beaten back. Perhaps recognizing the old government’s mistake was in mounting an across the board assault, the new government has singled out those covered by the Joint Labour Committees. Unfortunately, there are sound economic reasons why wage cutting in the Irish economy is far from a good thing.
First, falling wages directly damage demand, cutting sales and creating further unemployment. An environment of wage cutting creates insecurity and reduced spending.
A second factor is that falling wages will compound the problem of our high levels of indebtedness. Falling incomes means that debt payments will take an ever larger percentage of income.
Thirdly, stable wage rates provide an anchor in the economy. All other prices are tied to them. Falling wages can cause falling prices which can trigger further falls in wages and prices. This is called deflation by economists. What’s wrong with falling prices? Would you buy a product now if you expected it to be cheaper in the future? Would you pay today’s prices to invest now if you could only eventually sell your product at tomorrow’s lower prices? Deflation has the potential to seize up an economy. Finally, falling wages will not recreate the Celtic Tiger. It is true that lower Irish wages initially contributed to attracting foreign investment. But it is not possible to wind the clock back to 1987. Much has changed. There are even lower wages available elsewhere and, with the enlargement of the EU, available not so far away.
While these three programmatic points are the essence of the austerity programme imposed by the EU/IMF, the elite consensus is that “these are things we would have to do anyway.” Indeed, the current government strategy is identical to the last government’s strategy. Thus the current policy represents a political consensus involving all the main political parties, Fine Gael, Labour and Fianna Fail. This political consensus is indicative of similarly wide-spread agreement among business, media, and academic elites.
Ireland has been seeking a neoliberal path out of a neoliberal crisis. That it has been joined in this effort by most of the Western economies makes it no less nonsensical and even less likely to succeed. Eventually, truly innovative and difficult measures will have to be taken. Debt forgiveness, monetary independence, publicly-owned banks and government job guarantees need to be put on the agenda. Irish elites have been echoing Margaret Thatcher in contending that there is no alternative. International investors have an alternative. They are moving their money into US bonds, Swiss Francs and gold. They are not political radicals, but they are sending governments a message. It would be wise of both governments and academic pundits to stop trying to ignore it.
Saturday, 24 September 2011
She argues that "diversification, this theoretical means of reducing specific risk, ... exacerbated systemwide risk."
What "institutional investors found, thanks to the 'creativity' of Wall Street, was the chance to make bets on assets they didn’t want." ... "The human costs of this game-playing are devastating. Citizens of several countries experienced double-digit surges in their citizen’s primary food staple. ... In Nigeria, sorghum rose 50% during a nine-month period in 2009. This translates directly into starvation."
The law governing pension funds directs funds into diversification as a 'prudent' step to avoid major losses. Domini argues that "taken together, these standards mandate the very behaviour that so crushed the lives of millions of people."
"Modern portfolio management gave birth to a healthy idea: diversification. But that healthy idea has been subverted. This is not a problem that markets can correct on their own: the strong arm of government must be utilised before the second wave occurs. Diversification into assets that produce no goods or services to humankind undermines capitalism."
How much of the activity and jobs in Dublin's International Financial Services Centre (IFSC) are based on financial assets of this kind, that do not benefit humankind? I don't know. But it is worth considering whether we are encouraging unsustainable and undesirable forms of investment. Legislation to regulate what types of financial products are permitted might be just as important as development aid and famine relief.
Friday, 23 September 2011
The labour market is also becoming polarized between “cool jobs and crap jobs”. At the top, owners and top executives are paying themselves obscene and utterly undeserved sums, as shareholders are unable to govern them. They have rewritten the rules of corporate governance in their favour – and that what makes government policy on taxation and on corporate governance so important.
There has also been a steady rise in the number of top jobs and in jobs at the bottom, with the proportion of jobs in the middle declining.
At the bottom, the shift in manufacturing from the west has eliminated some of the best jobs for unskilled or semi-skilled workers. It has also hit trade unions. In the middle, even with university education, jobs are becoming increasingly precarious – more short-term contracts, poor or no pensions, poorer public services – ironically as the squeezed middle is unwilling to pay for them and corporations do not.
I believe that the future will bring greater insecurity with stagnating incomes, increasingly precarious employment and uncertainty - unless there is a radical re-think of key issues like taxation and the governance of companies worldwide.
There are four factors which have assisted the change in the balance of power away from workers and citizens. It is not just the immense burden of debt which governments and bankers have hung around our necks, which is driving this shift.
Firstly, globalisation has exacerbated major trends in labour markets and in income distribution.
Secondly, there has been a decline in trade union density. This is a key to the decline in the relative share of labour income. Whether one like unions or not, this decline in density and unions as a countervailing power to corporations means demand is ebbing in all developed economies as people become less well-off and more insecure over time. The shift of national income has been to the very wealthiest, who do not spend their money (they have too much). Nor do they invest so readily – aggregate demand is down and so investment is becoming less profitable.
The third factor is that capitalists have become more aggressive in undermining the Social Contract with labour and with society in general.
Indeed, most do not realise the Crash of 2008 may have been only the first step in their own decline.
So far these trends have by-passed many emerging economies – but not for long, since most tend to ape the worst excesses of the West.
The fourth factor is the decline in progressive taxation. For example, corporation tax rates are declining in most countries, led by Ireland, as they compete for foreign direct investment. Fifteen OECD countries had wealth taxes in 1995, only three have today. Taxes on inheritances have been scaled back too. Lower tax rates are not a problem if they are accompanied by cuts to tax avoidance schemes, but governments have failed to eliminate most of these – leaving both lower rates and avoidance mechanisms in place for the rich and corporates.
Radical reform of taxation is one key driver in reform and changing the balance of power, and that will be the subject of my next post.
Tuesday, 20 September 2011
Many people are not aware that the vast majority of the Anglo/INBS debt has yet to be repaid. While the full amount has been placed on our general government debt, this was an accounting exercise. Under the current promissory note of €31 billion, of which Anglo Irish comprises €25 billion, the Department of Finance estimates the total cost to the state to be in the order of €65 billion, including interest on the promissory note, interest on borrowing and the capital payment made to Anglo Irish in 2009 (though this total could vary depending on future interest rates). This averages out to an annual bill of €4.2 billion over the next 14 years.
• In the next four years the cost of Anglo/INBS debt will make up almost a third of all state borrowing.;
• The annual repayments will exceed the entire budget for the nation’s primary school system;
• The average annual repayment for just one year exceeds the entire cost for a next generation broadband network;
• The total cost is equivalent in scale to half of our GNP this year.
The absorption of Anglo/INBS debt has currently added over 15 percent to total Government debt. Were it to be removed or substantially written down, Ireland’s debt levels would fall back towards the Eurozone average which stands at 87 percent of GDP. Even with the recent Anglo Irish interim report and the anticipated reduction in losses, the scale of future borrowing will be substantial.
In dealing with Anglo/INBS debt we have advantages. First, the promissory notes are not part of the EU-IMF Memorandum of Understanding. Therefore, further payments under the IMF-EU bail-out deal are not contingent upon maintaining the current promissory note schedule. Second, Anglo/INBS is for the most part detached from the European financial system; the issue of contagion to other financial institutions is extremely limited.
Bondholder debt makes up only a small part of Anglo/INBS liabilities – less than 10 percent. The major liabilities are made up of loans from central banks (€40.8 billion) of which the promissory note (€23.8 billion) makes up over half.
Renegotiating the Promissory Note
While the Central Bank of Ireland (CBI) is part of the Euro system of central banks (and, therefore, cannot act unilaterally), the promissory note is the CBI’s responsibility. The loans from other central banks look set to be covered by the non-promissory note assets on Anglo’s books (over €30 billion). Therefore, the renegotiation will, in the first instance, commence with our own Central Bank.
In a renegotiation, the Government should be seeking a complete write-down of the promissory note. This would require an innovative response from the CBI. We believe this will be done as the CBI has already accepted its critical role in the Anglo/INBS debacle.
In early January 2009, the Minister for Finance relied on advice from the CBI and the Financial Regulator when nationalising Anglo Irish. This led the Department of Finance at the time to state that Anglo Irish was ‘solvent’ and ‘open for business’. Subsequently, however, the CBI admitted they had been profoundly mistaken, stating that months before nationalisation and the bank guarantee both Anglo Irish and INBS ‘were well on the road towards insolvency’. Shortly after the Anglo Irish nationalisation, the CBI was compelled to notify the Gardaí and the Office of the Director of Corporate Enforcement (ODCE) of ‘certain matters’. These admissions are signals of a potentially positive response from the CBI to rectify some of the damage its mistakes have inflicted on the Irish public.
The crucial issue is the extent to which CBI can unwind its position without risking balance-sheet insolvency (through write-downs and other strategies). Anything short of that risk should be explored and negotiated. A Government announcement that it does not intend to proceed with the current repayment schedule would provide the incentive to parties to explore all the options.
Such a course would of course require sanction or, at least, tolerance from the ECB. However, it is a matter of debate as to what extent the ECB was aware of Anglo/INBS insolvency when negotiating with the Government over the fate of these banks. In this respect, it would be helpful in terms of accountability, transparency and clarification if the Government published all communication between itself, the CBI and the ECB regarding Anglo/INBS since the run-up to the bank guarantee starting in early 2008. Such publicly-released information can help progress the debate by establishing where different responsibilities lie for propping up insolvent banks with Irish taxpayer money and central bank loans.
A New Repayment Schedule
If, at the end of this process, an agreement is negotiated which imposes a debt on the Exchequer, the next issue is the repayment schedule. There are two approaches.
(a) Reschedule with the CBI
The debt could be repaid over a greatly extended period of time (e.g. 30/50 years) via a similar instrument to the existing one. The goal would be to significantly reduce borrowing in the short/medium term with either a repayment holiday for the period that we are reliant upon EU-IMF funding and/or a payment restructuring so as to back-load the annual liability. This also leaves open the possibility of revisiting the issue in the future with a view to further write-downs. This approach may provide the CBI with more flexibility than actually writing down the promissory note itself and could constitute an effective write-down via future inflation.
(b) Reschedule with the EFSF
Alternatively, the Government could seek to transfer the promissory note to the European Financial Stability Facility (EFSF) with whom the Government could then negotiate a greatly extended loan. As the EFSF can now lend to recapitalise banks, this would simply be taking advantage of a new opportunity. Even this option, on the basis of repayment of the Anglo Irish debt, would greatly reduce borrowing in the medium-term.
Restructuring the repayment schedule, even if there is no write-down of the promissory note, would provide the Irish economy with considerable breathing space. A further option would be to substitute a ‘bullet bond’ (similar to a normal Government bond) whereby only interest would be paid annually with the full amount redeemed after a greatly extended period (e.g. a 30-year bond). At the least, we could expect annual costs to fall by a minimum of two-thirds, saving the taxpayer €2 billion a year over the next 14 years and postpone the payment of the principle to a longer-term horizon where it would be easier and cheaper to roll-over the debt.
Bondholder debt, estimated to be approximately €6 billion, would be the subject of separate negotiation/actions. There is a clear argument in equity, as mooted by the Minister for Finance, to unilaterally write-down the unguaranteed debt. The ECB is reported to be opposed to this strategy because of contagion fears. However, the markets have already distinguished between the debts of viable banks and those of the dead banks Anglo and INBS. Financial analysts continue to criticise and express bemusement that the Government is continuing to honour unguaranteed debt: ‘because the two banks are effectively in the process of being liquidated, burden sharing by senior unsecured bondholders does not constitute a threat to financial stability’.
As for the guaranteed bondholders, it would be argued that not honouring this debt would undermine the credibility of similar guarantees underpinning the pillar banks, with implications for their ability to access the market. That is why this debt should be negotiated.
A Political Debate – in Ireland and Europe
The Government has a strong opportunity to strike a new deal on the Anglo/INBS debt. We have outlined a series of approaches which can provide the Government an opportunity to expunge this unjust debt. By opening up renegotiations on the entire amount of Anglo/INBS debt, the Government would give itself (and other parties) more flexibility across a range of issues (the promissory note, restructuring the payment schedule, and bondholder debt). This could allow for more give-and-take than focussing on one issue such as the unguaranteed senior debt.
It is important the Government keep the Irish public abreast of its goal and strategies and that this be done in an open and transparent manner (hence the publication of communications between the Government and the CBI/ECB regarding Anglo/INBS). For this is essentially a political project – to reverse the decision by the previous Government to place the private debt of dead banks on to the public balance sheet. That the new Government had no part in this vast transfer of resources (over €14,000 per person living in the State) gives it clean hands and greater moral capital.
But this is a Eurozone issue as well and it is necessary for the European public to become aware of the immense burden Ireland is carrying for non-existent banks. For instance, how would the German public react if they had to repay an equivalent dead-bank debt of over €700 billion, with annual repayments of around €50 billion for over a decade? Or if the French had to pay over €550 billion with annual repayments of around €40 billion (nearly four times the amount of the recently announced austerity package)? The appropriate Government Ministers could launch a Eurozone-wide information campaign – informing the public, commentators and policy makers of the immense debt burden that is Anglo/INBS. We believe this would elicit considerable sympathy (and not a little bit of shock), thus strengthening the Government’s negotiating position.
There are reasons why the ECB, under a new President, would be open to such a renegotiation. The Anglo/INBS debt is relatively small in comparison to the amount that the viable banks (e.g. AIB, Bank of Ireland) owe the ECB. The elimination or write-down of Anglo/INBS debt would reduce the burden on the economy. A strengthening economy, in itself, will increase the chances that the viable banks can return to private funding and that the ECB will be repaid in full.
This debate must be taken up by all sections of society – by individuals, civil society organisations, political parties; for the Anglo/INBS debt is a key component of the economic and fiscal crisis. While we cannot pre-empt or predict the ultimate outcome, we can call for the Government to suspend the current repayment schedule for the promissory notes (which requires a further €3.1 billion payment in March of next year) and enter into a renegotiation.
And if there are other, better alternatives than the ones outlined here, we welcome that. For we are only concerned here with starting the debate, not writing the last word. But that debate must start now before we spend one more cent on this invidious debt.
Friday, 16 September 2011
An Audit of Irish Debt is the result of 5 months of research from my colleagues Frances Shaw and John Garvey and myself, which has been an interesting journey that we hope has led to a useful picture of the current situation. The banking crisis and the decision in September 2008 to support all of the Irish banks has brought our debt far beyond sustainable levels. Through the Celtic Tiger years, our total long-term bonds increased, but remained comfortably below 40billion. Now they stand at over 90billion, or roughly twenty thousand euro for every woman, man and child in the country. We can add to this our contingent liabilities: the debts of the banks that we have guaranteed, the NAMA bonds, promissory notes, emergency overnight lending and guaranteed deposits. These potential liabilities come to 279bn euro, over three times the already inflated total for government bonds.
The Audit report spells out in clear language where these different categories of debt have come from, how they are inter-related, and discussed the nature of the anonymity that surrounds the names of bondholders. We also discuss other market activities which impact on the risk of Irish debt, such as Credit Default Swaps and short selling. We are grateful for the support of Afri, Unite and the Debt and Development Coalition, and we hope that the report is useful to all concerned people who want to learn more, and forms a foundation for future work in the area.
Tuesday, 13 September 2011
While a Greek default may be inevitable Yanis argues that Germany will not allow Greece to default before the Germans have put in place a plan for splitting Greece’s monetary system from that of the surplus countries. He fears the German plan will precipitate an uncontrolled disintegration of the Eurozone leading to a hard recession across the continent.
Monday, 12 September 2011
Philip points out that, notwithstanding the reduction in interest rates which should boost the prospect of hitting the -8.6 percent deficit target next year, problems arise from lower GDP growth. At the time of the EU-IMF deal, the last Government projected nominal GDP growth to be 6.9 percent over 2011 and 2012. Last April the current Government revised that growth downwards to 4.5 percent (and revised the deficit upwards). Recently, the ESRI and the Central Bank have projected nominal growth over this period at 3.3 and 2.5 percent respectively; a long way from the original projections underpinning the EU-IMF deal.
This is important as Philip notes:
‘A lower GDP make it more difficult to hit targets that are expressed as ratios to GDP; lower GDP also means a loss in tax revenues and an increase in welfare payments.’
However, Philip responds to this issue in a far more sophisticated manner than most commentators, making a clear distinction between ‘cyclical’ and ‘structural’ factors:
If the lower GDP forecast is classified as a temporary cyclical factor, then it means a widening in the cyclical component of the budget deficit but does not adversely affect the structural component that is the main concern in international policy and investor circles. A cyclical decline in the budget balance of itself does not call for additional austerity measures, since subsequent economic recovery will fix the cyclical component of the deficit.
Alternatively, if the lower GDP forecast is classified as a reduction in the long-term potential output level of the economy, then the implication is that the structural budget deficit has deteriorated, since cyclical recovery in the economy will not be enough to restore budget balance. If that is the case, then the government will need to plan for larger fiscal consolidation measures over the next number of years in order to achieve the sizeable improvement in the structural balance that is required for fiscal sustainability.
There is a lot of meat here so let’s chew slowly for the existence, extent and measurement of the structural deficit is a highly contentious issue, never mind how we go about eliminating it.
Potential output is the level of GDP if the economy was operating at full capacity and all factors of production are being fully utilised. However, when wealth is permanently destroyed, the potential level falls so that, even when the economy is at full tilt, it cannot generate enough tax revenue (or reduce unemployment) to balance the books. Hence we need to engage in fiscal adjustments, i.e. austerity.
There are a number of issues here. First, measuring potential output, or natural GDP, is a highly tenuous exercise. Ask 10 economists to measure potential output and you’ll get twenty different methodologies and forty different answers. Potential output is not something observable like unemployment or the retail sales index. It is estimated, and such estimates widely diverge. Therefore, extrapolating the potential output and, from that, a structural deficit can sometimes be a shot in the macroeconomic dark.
Second, there is a fine line, and sometimes no line at all, between the cyclical and the structural. Is there a point at which a temporary, cyclical dip becomes structural? Let us take the example of an export-oriented company in a high value-added sector employing a high-skilled, well-paid workforce. This company has been years, if not decades, in the making. When external and domestic demand falls for their product in the recession (accompanied by a credit freeze), the company could go bust. However, after the recession the plant is rebuilt into a shopping mall and all the redundant employees are rehired in the shops. Full capacity has been restored (land, buildings, labour) but the output has been reduced from export, high-valued added activities to low value-added and low-waged work with all the fiscal impact that has.
And herein lies the problem. Full capacity has been restored but not the same level of economic output. And because the economy is not generating the tax and export revenue, the Government cuts its spending (or household spending through tax increases) – which exacerbates the cyclical element of the deficit, which in turn can aggravate future potential output.
Indeed, the pursuit of fiscal adjustments aimed at the ‘structural deficit’ can damage parts of the economy that would otherwise help us overcome structural problems. How many companies, which might otherwise grow – possibly into export markets – will be hit to the point of liquidation by the government cutting its own consumption (i.e. cutting contracts for public services or investments)? What will be the impact of emigration on our skill base, or the early retirement of public sector workers on the public sector skill base? What will be the future economic and social cost of letting too many people spend too long on the dole queues – structural, long-term unemployment? How will education cuts affect knowledge capital in the future?
What Philip does is take the lower potential output as a given and then, like a procrustean bed, cut the balance sheet to fit which, in turn, puts more downward pressure on future output. It’s a vicious cycle which will end up with an exhausted economy.
There is a better approach. If there is a structural deficit arising from lower potential output – fix the problem: which is the level of productive capacity itself. This calls for investment in key sectors to raise productivity and create a platform which increases the trend growth of potential output. How much would a next generation broadband network, pre-primary education, a state of the art water & waste system, one-on-one tutorials to improve literacy and numeracy skills, a network of free primary health services, electricity generation from ocean and tidal (the list goes on and on) – how much would any or all of these boost potential growth? We can argue the quantitative math but not the qualitative outcome.
And, has been pointed out and measured on numerous posts on Progressive-Economy and other sites, such investment generates employment in the short-term and higher growth (especially through the supply-side impacts) in the future.
And what about the structural deficit? Well, here’s the real benefit. Growth reduces the structural deficit –just as argued above, lack of growth can exacerbate it. The ESRI, working with x amount of fiscal adjustment, showed that under a low-growth (i.e. 3 percent) medium-term scenario we wouldn’t overcome the structural deficit. However, using the same fiscal adjustment, they showed that higher growth would actually reduce the structural deficit. In other words, the key is not fiscal adjustment, but growth.
This is not to say that fiscal adjustments will not be necessary. But that is a political choice, as Professor John Fitzgerald has pointed out. If we want European level of public services and social protection, we will need European levels of taxation. That, however, is another argument – and requires a detailed discussion of fiscal strategies that get us there without hitting domestic demand or undermining investment streams.
For the situation is deteriorating when viewed through the lens of the domestic economy. When the EU-IMF was signed nominal GNP for 2011 and 2012 was projected to grow by 5.6 percent. The Central Bank and ESRI have radically revised this into negative territory. With even the Government conceding that we will be in a domestic-demand recession next year, the only question is will that situation persist into 2013?
Ultimately, the argument does not boil down to spending cuts vs. tax increases, or the optimal level of (downward) fiscal adjustment. The issue is how we address the productive capacity of the economy. Philip argues that we should drive down our balance sheet to fit a low-growth scenario. The alternative rejects this self-defeating fiscal pessimism.
If we are heading into more difficulties arising from lower future growth, the solution becomes obvious: engage in strategies – namely, investment (public investment which can ‘crowd-in’ additional private investment) - to increase output and productivity.
For if we continue, never mind increase, austerity we will continue to destroy wealth – just as we have done in the last three years. We will end up with a depleted economy, incapable of rising to the new technological challenges facing us. And we will find the goal of fiscal stability as elusive as ever.
Friday, 9 September 2011
The author argues that "we have no choice but to step back and at least examine the course we have taken, and maybe change it altogether if we are to restore lasting confidence in government and financial markets, and avert future crises."
He asks "Have policymakers missed a golden opportunity to reset the balance between markets and governments, as many of them wanted to do at the height of the crisis?"
He warns [If governments] "succumb to undeserved short-term pressure from creditors, then the risks are large. For instance, important efforts to address climate change, green growth, biodiversity, social inclusion, poverty and countless other essential public policy objectives that were front-burner policy issues before the crisis will lose steam."
The article is perhaps weakest in its conclusion - or rather lack of any real conclusion other than asking "what can be done to defend the public interest?" But the questions (and there are more in the article) are a useful reminder that the roots of the crisis have not been addressed, and solid foundations have not been laid for a recovery that will benefit all of society.
The key issue seems to be how we define the public interest. This is highly contentious, but one flexible idea that merits some discussion is the 'triple bottom line' of the economic, social and environmental effect of a company's activity or a government's policies. Definitions of the triple bottom line vary, but The Economist offers a short one and here is a longer article in the Indiana Business Review. A critique of the idea can be read here.
It may be the case that all the triple bottom line does is remind us that we need to calculate the effect of economic activity on people and the planet. But that alone is such a major consideration that it must cause us to consider major changes in how we measure 'economic success'. And therefore it provides a very different frame of reference for what governments should be striving to do as they attempt to bring about economic recovery.
In this context, the need to reduce the deficit (which is a very real need!) needs to be balanced against the long-term damage to the economy, society and the environment.
For example, not only would the rapid sale of state-owned enterprises or other state assets result in a low price gained by the state in the depressed global market, but such a sale could have consequences on the wider economy, society and the environment; such as the possible loss of employment around the country (as a private entity might centralise operations), a loss of social conscience (such as with utility bills in arrears) or the unsustainable commercial exploitation of land sold along with a semi-state company (which might be a carbon sink or habitat for wildlife).
It might be argued that the concerns articulated as the triple bottom line can all be addressed through regulation. But, in most cases, such regulation is not in place and it will take careful consideration of all of these factors to put in place comprehensive rules; and to see if the costs of regulation outweigh the benefits of maintaining state ownership. None of which should be done in a rush.
Thursday, 8 September 2011
Donal Palcic and Eoin Reeves: Yesterday the Minister for Transport signalled the possibility of selling the remaining 25 per cent stake in Aer Lingus (as recommended by the report of the Review Group on State Assets and Liabilities published last April). News of other planned sales, such as the sale of a partial stake in the ESB, is expected over the coming days. So does the sale of the remaining government held shares in Aer Lingus make sense? This can be assessed in terms of the government’s objectives. First, this is about raising exchequer revenues, so how much can the government expect to realise? With shares trading at 67.5 cent as of this morning (compared to the IPO price of 220 cent) a 25 per cent stake is likely to be worth in the region of €90m (leaving a lot more to be sold if the €2bn target in the programme for government is to be reached). Net revenues will of course be reduced when professional expenses and discounts are taken into account.
Are there any other advantages to be accrued from the mooted sale? The common argument in support of selling state owned enterprises (SOEs) is that performance will improve under private ownership. But Aer Lingus operates as a privately owned enterprise and is not subject to obvious political interference (a problem traditionally faced by some SOEs). So selling the remaining 25 per cent will not have any impact in terms of improving enterprise performance.
What are the likely downsides to the possible sale? The obvious one is that the 25 per cent stake constitutes an important degree of state influence over the island economy’s airline. We have discussed the importance of the state retaining control over strategically important industries before here and here. But suffice to say that Eircom provides an example of one of the biggest privatisation failures worldwide and this could have been avoided if the state had not relinquished complete control when it privatised the company. The lessons in relation to Aer Lingus are obvious.
One of the big strategic issues in relation to Aer Lingus concerns the Heathrow slots. The Minister for Transport stated that the strategic reasons for retaining a stake in the airline no longer exist and that the issue of Heathrow landing slots was not as important as it was since people are now using connections other than Heathrow. Aer Lingus has 23 landing slots in Heathrow. Currently 13 slots are being used on the Dublin route [BMI also operates on this route and has 4 landing slots], 4 on the Cork route, 3 on the Shannon route and 3 on the Belfast route.
Data from the UK’s Civil Aviation Authority shows that, in 2010, over 9.5 million passengers travelled from the Republic of Ireland to the UK, with just over 51 per cent of all passengers travelling to London. A quick glance at the traffic on the Dublin, Cork and Shannon to Heathrow routes for 2010 (see table above) illustrates the importance of the Heathrow link, with slightly over 44 per cent of passengers to London going through Heathrow. In general, the vast majority of passengers from Ireland to Heathrow are carried by Aer lingus (they are the sole operator from Cork and Shannon; while on the Dublin Heathrow route they operate significantly more flights than BMI).
While the number of passengers travelling to airports in London other than Heathrow has increased considerably over the years, based on the above figures for 2010, it is hard to see how the Minister can claim that the “strategic” argument for retaining a stake in Aer Lingus no longer applies. For an island nation like Ireland, which is heavily dependent on international connectivity, the Dublin/Cork/Shannon to Heathrow routes are of considerable strategic importance. Although the sale of the government’s 25 per cent stake does not mean that flights on these routes will stop overnight, it does leave the government powerless to prevent an undesirable change in ownership in the future (think Eircom).
Given the relatively small amount of cash that is likely to be raised, one must question whether this mooted proposal makes sense. Our scepticism appears to be shared by the company itself, which reportedly is not in favour of a quick sale. Moreover, Joe Gill of Bloxham sounded a sceptical note when interviewed by Matt Cooper on Today FM yesterday. Mr. Gill raised the issue of the Heathrow slots and also highlighted the difficulties posed by the company’s pension deficit (in the region of €400m). He also suggested that a special dividend by cash-rich Aer Lingus (it has cash balances of approximately €350 million) offers an easier way for the government to raise much needed cash from the company. Notwithstanding the issues that arise in forcing a special dividend one wonders if this route makes more sense than relinquishing full control over the airline.
Wednesday, 7 September 2011
Last year, TASC published Life and Debt 2010 – Financial Exclusion in the Age of NAMA, which included a list of recommendations. More recently, the ESRI published a study on Financial Exclusion and Over-Indebtedness in Irish Households, and the Government published its own Strategy for Financial Inclusion Final Report, which noted that “The low level of financial literacy of most financially excluded people can translate into high margins for providers of financial services, so it is critically important to give people the tools to make wise financial choices, and to protect themselves from predatory lenders/insurance providers".
Promoting financial literacy is thus crucial to combating financial exclusion. Research findings published today by the National Adult Literacy Agency and the EBS show that two-thirds of Irish people struggle to understand financial terms. With that in mind, NALA and the EBS have re-vamped their financial information website www.makingcents.ie, a free resource aimed at anyone who wants to understand different areas of finance.
Read the rest of the post here:
There is more realism abroad. Here is an interview with the FT’s Martin Wolf on Austerity vs Stimulus. It is part of that paper’s debate on the subject. Unlike most of the Irish media, the FT gives two sides. Wolf in an article says Britain is in the worst depression since the Great Depression of the 1930s. I’m sure the figures are similar for Ireland. The 1950s were bad, but were they as bad as now on the length and especially the depth of the Depression? I suspect so, but don’t have the data.
He is quite critical of policy and thinks “the forecasts are hopelessly rosy”. He says we are heading for “a historic disaster.”
Also, Wolfgang Munchau of the same paper, the FT, had a piece on Monday 5th September which argued that the worst of the crisis is yet to come. Why? Because “all countries are deflating simultaneously.”
And even small Ireland contributes to this downward spiral. There is a growing nationalism in the Irish business and economic establishment which is developing further in response to the crisis. It is a “beggar thy neighbour” attitude on our exports doing the “heavy lifting.” This Green Jersey line is similar to the establishment’s autarkic view of our low corporation tax.
Munchau argues that “The very least one should expect is for the eurozone to abandon all austerity programmes with immediate effect and to return to a fiscally neutral stance, allowing the automatic stabilisers to kick in fully.”
He continues: “At present, such a shift is not even on the agenda. As is so typical in the eurozone, each country behaves like a small open economy at the edge of the world. Each assumes its actions have no impact on the others.”
On the opposite side, we have German Finance Minister Wolfgang Schauble of Germany arguing for Austerity. Here we have John Fitzgerald, Philip Lane and most Irish academics arguing for more Austerity. Interestingly, however, on the ground, groups like Congress and IBEC are argueing for less austerity in the forthcoming Budget. If we go for a package of as high as €4bn, there will be no growth (GNP) again next year, the fifth year of our Depression!
Munchau concludes by saying that, when the downturn hits the eurozone, the crisis will “turn ugly.”
Ugly? Looking out the window I see “real ugly” already. If our soothsayers have their way, Ireland’s Five Year Depression will become like Japan’s – A Ten Year Depression!
What is really surprising is that the penny has not dropped yet on the ineffectiveness of the Irish Austerity Programme. It will have taken a staggering €20.6bn out of the economy by year end. All indicators show it is much too severe and is killing off domestic demand. To take a further €4bn our in the next Budget, as the Macho Economists demand, will be real folly.
It should be far less and must include a real “Jobs Programme.” It will cost money, but we have some left in our Pension Fund.
Tuesday, 6 September 2011
However, this last contention, that ‘austerity works’, is not supported by the authors’ findings themselves. To quote their own summary of their paper, ‘[Our projected debt ratios are] much lower than had been projected in official figures earlier in the year, partly because the cost of the bank recapitalisation was much lower than anticipated and also because of the reduction in EU interest rates’.
So, the lower projections are based on the lower level of bank recapitalisation and lower rates for bailout funds for those recapitalisations. According to the authors’ abstract of their own findings, none of the projected improvement is attributable to ‘austerity’ measures.
Quality of Forecasts
But how ‘good’ are these forecasts, in both senses? First, what is the quantum of improvement that is being forecast by the ESRI? Secondly, how likely is it that these forecasts will prove correct? The debt ratios forecast by the ESRI are set out in the table below:
Debt Ratios, % GDP
Source: ESRI, Eurostat, IMF databank, Euro Area Spring Forecasts
The first point to note is that the ESRI is not projecting any reduction in the level of government debt over the period 2010 to 2015. Over that period, debt will rise from 94.9% of GDP to a projected 106.2%. It is in effect projecting a deterioration in the debt level to next year, then stabilisation and then a reduction. Both the IMF and Eurostat forecasts are much worse.
This disparity is a function of two factors. First, the Eurostat and IMF forecasts were made before the reduction in interest rates and before the lower projections for the level of the bank bailout were made. Secondly, the ESRI has stronger real growth projections than either Eurostat or the IMF.
Before dealing with the substantial point of how large the bailout and interest rate savings are, it is worth highlighting the main source of the discrepancy in growth forecasts. In effect, ESRI has a much larger growth forecast of +1.8% real GDP in 2010 than either Eurostat (+0.6%) or the IMF (+0.5%). The difference arises because whereas the IMF and Eurostat both have prices rising by 0.6% in 2010 to reduce real GDP by that degree, the ESRI projects falling prices of 1.1% (implied from the gap between real and nominal GDP (Table 7). Given that deflation both reduces the nominal level of taxation revenues while also increasing the ratio of existing debt to nominal GDP, there can be little argument that this ‘stronger’ growth forecast is responsible for the ESRI’s more optimistic debt/GDP forecasts.
Instead, it is the combination of lower interest rates and a lower projected bank bailout cost which is responsible for the projections of a substantially improved debt outlook. On the former, the consensus appears to be that the annual saving will be in the order of €1bn per annum, perhaps slightly more. Implicitly the ESRI authors assume a saving of €1.125bn per annum, on the basis of a former interest rate of 6% (p.20, point 2.). Compounded, this saving over a 5 year period amounts to €8.5bn or approximately 4.6% of the GDP level projected for 2015.
On the lower bank bailout costs, the international bailout of creditors to Irish banks in November 2010 included €10bn of immediate bank recapitalisation plus another contingency amount of €20bn. To date, of this a total of €17bn has been provided by the State (banks funding €7bn themselves in the financial markets for a total of €24bn). The ESRI authors expect €3bn to be repaid to the State by 2014. This ‘saving’ of €13bn also incurs interest. However, the authors now argue that funding from the Troika will be needed in 2014, even though the terms of the original bailout were that the government would return to the financial markets in 2013. Therefore, there will be no net interest saving, based on the authors’ projections. Instead, there will be an additional cost of approximately €0.5bn (based on the 3.5% interest rate, rather than a projected interest rate of 6% in the financial market borrowings that are also assumed in the ESRI paper). As a result, the projected saving from a less onerous bank bailout is a net €12.5bn.
Taken together the actual interest rate saving of €8.5bn and projected saving on the bank bailout of €12.5bn combine for a total €21bn. This is equivalent to 11.4% of projected 2015 GDP.
Without these actual and projected windfalls, the ESRI forecast would otherwise have been 117.6% of GDP in 2015. This compares to a debt/GDP ratio of 94.9% in 2010.
The idea that there will be no more bank bailouts has firmly taken hold and is largely responsible for the specific rally in Irish government debt in recent weeks. This is despite the fact that the EBA’s stress tests were widely discredited by the failure of two small Spanish banks shortly after publication, with total losses exceeding the EBA’s estimate of EU-wide recapitalisation requirements.
It may be the case that further losses do not require further recapitalisations. But the key exposure of the Irish banks is to the domestic economy, which continues to deteriorate on all forecasts, including those of the ESRI. This has an impact on the banking sector. Currently, this is most evident in the rise in the rate of mortgage defaults.
This highlights a key misconception regarding the relationship between the banking sector, government finances and the real economy. It is assumed that, if the banking sector is stabilised to the extent that it requires no further taxpayer funds, this will restore government finances to health, as long as public spending is reduced towards the level of taxation revenues (sufficient to provide a ‘primary surplus’, that is before interest payments are included). It is argued that, if all three occur, bank stabilisation, no more bailouts, a swing toward a primary surplus, then the crisis ‘will be over in 3 years’.
This is the premise that underlies a section of the ESRI paper dealing with debt dynamics. It is not denied that significant remedial action was required to resolve the crisis in the banking sector, even while many argue that a bailout of all their creditors was one of the least effective means of doing so. But, ever-greater contraction of the domestic economy can only be fatal to any ambitions to remove the banking sector from the life support it has been given by taxpayers. In effect, the ESRI and many others look through the world through the wrong end of the telescope. Neither banks’ balance sheets nor government finances can be restored to health until and unless there is an economic recovery.
The authors argue that, absent any further negative ‘shocks’, the debt/GDP ratio will begin to fall from 2013 onwards. The horizon for an imminent improvement never seems to alter. It is always 18 months hence. But the Irish economy received no external shocks in the way that economists use the term. The recession began here nearly a year before it began in the world economy, the slump in investment also a year earlier (which preceded the recession in both cases).
Three years ago in the Autumn 2008 Quarterly Economic Commentary the ESRI was forecasting a general government debt of 47.5% of GDP in 2009 and was fully supportive of government efforts to cut the deficit, in particular urging cuts in public sector pay. But this contractionary fiscal policy was a shock to the economy and the effect was slower growth, rising unemployment and falling tax revenues.
In the event, the debt/GDP ratio was 65.6% of GDP, not 47.5% in 2009, even while the government implemented ‘austerity’ measures equivalent to 9.1% of GDP. In effect the ESRI was forecasting a near-term deterioration in the debt level followed by stabilisation and then reduction, based on ‘austerity’. In fact a trawl through the QECs since 2008 shows that this debt profile is what the ESRI has been forecasting since 2008.
The authors clearly haven’t asked themselves the key question, so we must: Why will it be different this time?
Monday, 5 September 2011
The eurozone’s public finance crisis continues to fester, reflecting both political and intellectual failure. The intellectual failure is the crisis has been interpreted exclusively as a debt crisis when it is also a central bank design crisis resulting from the euro’s flawed architecture. The flaw is the inability of eurozone governments to harness the central bank’s power to assist government finances. This systemic weakness explains why U.S. and U.K. government bonds are weathering the storm, whereas Spain confronts default rumors despite having roughly similar debt and deficit profiles.
The euro solved the problem of exchange rate speculation by creating a single currency but in doing so made countries vulnerable to bond market speculation. That is because European Central Bank (ECB) support buying of member country bonds is prohibited under the “no bail-out” provision. This prohibition is appropriate as buying one country’s bonds would subsidize it relative to others. However, it means country governments lack access to central bank help to ward off speculative bond market attacks; to finance budget deficits; and to conduct quantitative easing (QE) programs of the sort conducted by the Federal Reserve and Bank of England.
One proposal to address the crisis is the idea of a “blue bond”. Countries would have the right to issue blue bonds up to sixty percent of their GDP that would be guaranteed collectively by euro member countries. This would significantly lower interest rates charged to troubled countries, helping them attain solvency. In effect, financially strong countries would de facto lend their creditworthiness to weak countries.
The blue bond proposal would undoubtedly help solve the current crisis. However, there are two problems. First, it relies on an implicit transfer from the strong who take on a guarantee liability but get nothing in return. That is a political non-starter. Second, it does not solve the structural problem of lack of a government banker. That leaves eurozone governments vulnerable to future crises, and it also maintains persistent market pressure on government finances that will ultimately destroy Europe’s social democratic project.
A second proposal is a “euro bond”. The ECB would issue euro bonds and countries could elect to have the ECB use the proceeds to buy their existing debt up to sixty percent of their GDP. Individual countries would then be responsible for their share of the interest on euro bonds. This proposal would also help solve the current crisis but it too has problems. First, it would violate the “no bail-out” clause because all countries would pay the same interest rate on euro bonds but the ECB would be responsible for the higher interest rate on debt it purchased. Second, perversely, higher income countries could transfer relatively more debt under the sixty percent of GDP rule. Third, and most importantly, the scheme fails to address the government banker problem.
I have advanced a third proposal that solves both the debt crisis and government banker problems. Stage one would have eurozone countries establish a European Public Finance Authority (EPFA) that would be governed by member countries, with votes allocated on a per capita basis. EPFA would then issue bonds that the ECB can buy and sell through standard open-market operations. These bonds would be collectively guaranteed and countries would cover EPFA’s interest on a per capita basis. Bond proceeds would be used to buy existing country debt, again on a per capita basis. Countries with low levels of existing debt (like debt-free Luxembourg) would simply receive their share of EPFA proceeds as cash and they could buy EPFA bonds to cover their EPFA interest obligation. This debt swap would solve the debt crisis; create conditions for the ECB to engage in open-market operations to manage government bond interest rates; and create conditions for QE policies.
Stage two would have EPFA annually issuing new bonds to help finance government budget deficits. The amount issued would be democratically decided by EPFA’s governing council, presumably acting on instructions from national governments. New issue proceeds would be deposited with governments to spend as they wish. Those wishing to run surpluses could retire debt or create a sovereign wealth fund. Three features are important. First, EPFA would never spend money and all spending would be determined by governments. Second, the ECB could assist budget financing by managing bond interest rates just as the Federal Reserve and Bank of England do. Third, the eurozone would have a democratic financial union but no fiscal transfer union.
The critical feature is EPFA bonds have no taint of “national identity”, enabling the ECB to trade them without violating its “no bail-out” clause. Moreover, there are no financial transfers between countries and the per capita rule means all countries are treated equally.
The EPFA proposal solves both the debt crisis and government banker problem, and it does so without imposing unfunded obligations or unilateral transfers on any country. It therefore meets all German objections. Moreover, the EPFA proposal creates the financial space for eurozone countries to grow and continue with their social democratic projects should voters choose. This makes it more democratic than existing arrangements which impose financial constraints that restrict space for democratically determined social and economic policy.
Sunday, 4 September 2011
Saturday, 3 September 2011
Friday, 2 September 2011
He finds that more unequal societies are characterised by lower levels of social trust and by greater feelings of inferiority at the bottom of the income scale. He forwards the argument that his empirical findings suggest these factors explain the lower levels of mental well-being in more unequal countries which contribute to higher levels of mental illness. High levels of inequality also stack the odds against poorer children succeeding.
The pro-inequality arguments were perhaps most memorably articulated by Michael McDowell.
While some of the privileged six-figure-salary brigade are conveniently quick to justify high inequality on economic growth and ‘incentive’ grounds, the actual empirical evidence does not appear to corroborate their arguments. As Layte points out, the more equal societies in Europe are also on average richer.