Thursday, 28 July 2011

The latest installment of Euro crisis

Slí Eile: Reactions to last week's Euro summit conclusions have been generally positive with much focus - at least in the Irish media - on the reduced interest charge. However, a range of authoritative commentaries are less enthusiastic including the following from Harald Hau writing on the excellent VOXEU website site here.

Wednesday, 27 July 2011

Questions that should be put to the Minister

Michael Taft: The Cabinet has approved the interim Household Charge of €100, designed to ‘raise’ €160 million from 1.8 million households. There are some exemptions: those in receipt of mortgage interest supplement, social housing tenants, commercial property and premises owned by a charity. Otherwise, the charge will be universal.

Is it inequitable? Yes, it is. Even Fine Gael opposed such a tax in opposition:

‘. . . flat rate charge means that houses in standard neighbourhoods worth a fraction of some mansions will pay the same rate of tax. It will be difficult to pay for asset-rich but income poor households, particularly the elderly and the unemployed; and it will be deeply unfair for a young generation that paid exorbitant amounts of stamp duty and VAT on the purchases on over-valued houses, many of whom now find themselves in negative equity.’

Question 1: Why is the Minister performing a U-turn, - committing to one thing before the election, and doing the exact opposite afterwards?

The Minister has claimed he had no choice – that it’s in the EU-IMF deal. Interesting, though, that Fine Gael published the above after the deal was signed. In addition,

There is no mention of a flat-rate charge in the EU-IMF deal.

Second, a property tax is stipulated for next year and the following year. But as Minister Noonan pointed out, the Government is free to substitute one fiscal measure for another as long as it yields the same fiscal result. The Government has done this already – with the Jobs Initiative. It has also announced there will be no income tax increases, even though the EU-IMF deal explicitly calls for such increases this year and next. So merely stating that something is in the EU-IMF agreement is not a sufficient explanation.

Question 2: Why is the Minister introducing a regressive, flat-rate household charge when (a) there is no reference to it in the EU-IMF deal, and (b) the Government has declared that it is free to substitute measures in the deal?

The imposition of the household charge is, to put it bluntly, a political choice. It is also, in economic terms, a highly irrational one.

Already, the spin being put out is that it’s only €2 a week. However, if we are to believe the findings of the ‘What’s Left’ tracker published by the League of Irish Credit Unions, that €2 will impose a further substantial burden on households and the economy.

The tracker found in July that 750,000 people (or approximately 20 percent of the adult population) had only €70 each month after paying bills. A €100 charge will reduce this discretionary spend by 12 percent.

A further 250,000 had no money left after paying their bills. The €100 charge will send them into negative balance.

For a million people, the charge will reduce their discretionary budgets by 12 percent or more. Of course, a proportion of these will be either tenants – public and private – while others will be receiving mortgage supplement. Still, many, if not most, will be liable to the charge. So when you hear someone going on about ‘only €2 a week’, just remember: there are significant sections of the population who only have €16 a week or less to spend after essentials.

Even if people had twice the amount left after paying bills - €140 – the charge will still amount to a substantial cut of 6 percent.

Question 3: What is the Minister’s Department (or the Department of Finance) economic impact assessment on households’ discretionary spending budgets (that is, after bills and essentials are paid for)?

There are other losers. What about the businesses dependent on the spending power of these households? Using the ESRI’s impact of an income tax, we should expect the household charge to result in a consumer decline of approximately €100 million next year. However, this figure is likely to be higher: the ESRI was estimating a rise in a progressive tax (income tax); the household charge will disproportionately hit low-average income earners.

Question 4: What is the Minister’s Department (or the Department of Finance) economic impact assessment on consumer spending and, so, economic growth?

And while the Government hopes to ‘raise’ €160 million, the benefit to the Exchequer will be less. Once you factor in the fall in consumer demand and, so, spending taxes; and the impact on employment (firms coming under pressure may reduce hours, pay and even let people go), the actual savings will be less. Again, based on the ESRI’s simulations, the actual benefit could be of the order of only €100 million. Again, as noted above, this figure could be lower because of the regressive and, therefore, more deflationary nature of a flat-rate tax.

Question 5: When the deflationary impact of the charge is assessed, how much will the Exchequer actually ‘save’, as opposed to how much the charge will ‘raise’?

The Government wants to promote growth, employment and demand. Yet they seem determined to do the opposite. A regressive flat-rate charge on top of pay cuts for JLC workers? These questions could help determine exactly what the Government’s strategy is.

And the answers could tell us a lot about what we can expect in the budget later this year.

Monday, 25 July 2011

All roads lead to Berlin

Michael Burke: The details of the latest EU Summit remain sketchy and on the surface overwhelmingly relate to Greece alone. The Agreement reached by the Euro Area heads of state only relates directly to both Ireland and Portugal via the cut in interest rates being applied. At the same time, there was great emphasis laid on the declaration that the other measures, including ‘haircut’ for bondholders was a wholly unique event, applying to Greece once and once only, and never to AN Other EU member state.

President Sarkozy was particularly adamant on this point. But it should also be clear that he doesn’t run in the EU, nor does M Trichet. Chancellor Merkel does, and what she says goes.

This is because the EU and especially the Euro Area is a project which allows a tremendous development of production across a continental scale. In a host of industrial sectors, even the German economy alone is too small to compete with key international rivals, the US, Japan and now China. The creation of a single market facilitated the development of transnational industries within Europe and the single currency deepened that integration not least by ruling out competitive devaluations.

Germany is the main beneficiary of that increased potential, even if it and others fail to realise it. The leadership of the main German political parties were all united that the Euro Area would not be broken up because German industry has the most to lose.

As a result, Mrs Merkel got her way that the private sector would take the haircut, against the fierce opposition of Messrs Trichet and Sarkozy, who represent the EU banks and the French banks exposed to Greece respectively. This is a start, a small beginning in rational policymaking in Europe.

At the time of writing, the heavens have not fallen in and the world still turns on its axis. This is despite claims both in Ireland and in continental Europe that similar calamities would follow any losses for the banks. In addition, the Agreement initiates a preventative measure to recapitalise ailing banks in the non-crisis countries. The banks in this jurisdiction are long past saving, and this State is very much in the thick of the crisis. But what the measures (of unspecified size) mean is that default can take place without bringing down the whole of the European banking system.

Trichet and Sarkozy may regard Greece’s selective default as equivalent to The Fall. But the political and banking systems cannot return to a pre-lapsarian state. Default is now on the table.

The actual size of the cut in the interest rate for Ireland is the subject of much heated debate over at Irish Economy. Karl Whelan has come in for some particularly harsh criticism merely for pointing out that the interest rate reduction owes nothing to the prostrate negotiating position of the Dublin government. He is correct. Instead, it arises from the fact that Italy was being drawn into the maelstrom and Chancellor Merkel does not want to allow the break-up of the Euro Area.

Separately, Michael Taft has a series of very useful suggestions as to how the possible €800mn to €1bn annual windfall could be used to stimulate economic growth and thereby increase tax revenues and reduce welfare outlays.

Clearly, that too would be a rational innovation. We shall see, but point 4 of the Agreement refers to the need to stimulate growth and create jobs. Unfortunately, this remains couched in terms of competitiveness, which for the EU Commission usually means deregulation, privatisation and wage cuts- which are the opposite of a growth and deficit-reduction strategy. What is clear is that deficits are rising in all the ‘bailed-out’ economies. Public spending cuts have had the opposite effect to that claimed- the deficit has risen as the economy has deteriorated.

So will this package work for Greece and stop contagion? In my judgement, not a chance.

First, while bondholders get an estimated 21% haircut on the face value of their bonds (if they participate - the FT reports that many won’t) Greece will only see an estimated 7% reduction in its total debt. This arises because Greece will participate in the recapitalisation of its own banks and from other measures. If a 7% debt reduction were enough, there would have been no crisis.

Second, the growth-sapping cuts remain in place. They will be joined by privatisations, leading to lay-offs and bigger welfare outlays, while removing revenue streams from the government’s accounts (but probably not the state-owned enterprises’ debts). The latest Italian cuts will only produce weaker growth and higher deficits. Spanish and Italian yields are still pushing up towards 6% again.
After Britain (equivalent to US$ 135bn) German banks have the highest exposures to Irish debt (US$118bn). Leaving the Euro and disorderly default would be a disaster for this economy. We know that the British Tory ‘friends of Ireland’ insisted their bilateral loan at punitive rates could only be repaid in Euros, and no other currency. It seems likely that others have as well. Irish indebtedness would soar with a Euro exit.

But the same scenario could equally prove disastrous for German banks; a lose-lose calamity. Chancellor Merkel is willing to face down powerful opponents to ensure that does not happen. A government of the Irish Republic worthy of the name would use all these new developments to the advantage of its own citizens: negotiated default, an end to cuts, stimulus measures, job-creation.

Our disappearing corporate taxes

An Saoi: Stand up and take a bow, the tax team of Microsoft Inc! You managed to reduce the effective corporate tax rate to just 17.53% for the year ended 30th June 2011 from 25% in the year ended 30th June 2010. This reduction saved the company $2,097M or $0.247 a share of the $0.60 increase in income per share. You have therefore contributed 41% of the increase in net income. I hope that Mr. Ballmer remembers you all at bonus time for your stakhanovite efforts on his behalf.

Let us not forget the helping hand of their Irish advisors KPMG for their consistently top class advice. This reduction in the effective rate was managed despite an increase of 25% in your headline Irish tax rate from 10% to 12.5%. Microsoft’s Irish operations account for between a quarter and a third of worldwide sales so Dutch sandwiches and Bermudan barbeques seem to be heavily on the menu.

It is a pity that Ireland seems to have been one of the countries that suffered at the hands of your new found ueber-aggressiveness where tax planning is concerned. I thought our May corporate tax figures were very low and it seems that you have now provided a good deal of the answer. You have of course protected most of your Irish operations, leaving just one company open to public scrutiny.

Historically, Microsoft was not an overly aggressive tax planner. The 2009 effective rate was 26.5% and 2008 slightly lower at 25.75%. Deferral seemed to be the name of the game rather than the over the top activities of Google. However corporate pressure seems to have changed the rules and you certainly have done your bit for earnings per share.

What is left for Ireland? Very little it seems. A few bones will continue be thrown from the table to the lazy dog lying underneath. But when the dog wakes he may find that all he is left with is an itch from some unwelcome visitors. Perhaps it was Microsoft that M. Sarkozy had in mind when he spoke about tax theft. Who would blame him for kicking such a lazy flea infested dog?

Friday, 22 July 2011

Thomas Palley on a global minimum wage system

Thomas Palley is Bernard L. Schwartz Economic Growth Fellow with the New America Foundation. This piece was originally published in the FT Economists' Forum. The proposal is drawn from his forthcoming book, From Financial Crisis to Stagnation: The Destruction of Shared Prosperity and the Role of Economic Ideas, Cambridge: Cambridge University Press.
The global economy is suffering from severe shortage of demand. In developed economies that shortfall is explicit in high unemployment rates and large output gaps. In emerging market economies it is implicit in their reliance on export-led growth. In part this shortfall reflects the lingering disruptive effects of the financial crisis and Great Recession, but it also reflects globalization’s undermining of the income generation process. One mechanism that can help rebuild this process is a global minimum wage system. That does not mean imposing U.S. or European minimum wages in developing countries. It does mean establishing a global set of rules for setting country minimum wages.

The minimum wage is a vital policy tool that provides a floor to wages. This floor reduces downward pressure on wages, and it also creates a rebound ripple effect that raises all wages in the bottom two deciles of the wage spectrum. Furthermore, it compresses wages at the bottom of the wage spectrum, thereby helping reduce inequality. Most importantly, an appropriately designed minimum wage can help connect wages and productivity growth, which is critical for building a sustainable demand generation process.

Traditionally, minimum wage systems have operated by setting a fixed wage that is periodically adjusted to take account of inflation and other changing circumstances. Such an approach is fundamentally flawed and inappropriate for the global economy. It is flawed because the minimum wage is always playing catch-up, and it is inappropriate because the system is difficult to generalize across countries.

Instead, countries should set a minimum wage that is a fixed percent (say fifty percent) of their median wage - which is the wage at which half of workers are paid more and half are paid less. This design has several advantages. First, the minimum wage will automatically rise with the median wage, creating a true floor that moves with the economy. If the median wage rises with productivity growth, the minimum wage will also rise with productivity growth.

Second, since the minimum wage is set by reference to the local median wage, it is set by reference to local economic conditions and reflects what a country can bear. Moreover, since all countries are bound by the same rule, all are treated equally.

Third, if countries want a higher minimum wage they are free to set one. The global minimum wage system would only set a floor: it would not set a ceiling.

Fourth, countries would also be free to set regional minimum wages within each country. Thus, a country like Germany that has higher unemployment in the former East Germany and lower unemployment in the former West Germany could set two minimum wages: one for former East Germany, and one for former West Germany. The only requirement would be that the regional minimum wage be greater than or equal to fifty percent of the regional median wage. Such a system of regional minimum wages would introduce additional flexibility that recognizes wages and living costs vary within countries as well as across countries. This enables the minimum wage system to avoid the danger of over-pricing labor, while still retaining the demand side benefits a minimum wage confers by improving income distribution and helping tie wages to productivity growth.

Finally, a global minimum wage system would also confer significant political benefits by cementing understanding of the need for global labor market rules and showing they are feasible. Just as globalization demands global trade rules for goods and services and global financial rules for financial markets, so too labor markets need global rules.

In sum, globalization has increased international labor competition, which has contributed to rupturing the link between wages and productivity growth. That rupture has undermined the old wage based system of demand growth, forcing a turn to reliance on debt and asset price inflation to drive growth. It has also increased income inequality. Restoring the wage – productivity growth link is therefore vital for both economic and political stability. A global minimum wage system can help accomplish this.

Wednesday, 20 July 2011

New Deal for Europe

Slí Eile: An extremely lucid and timely contribution by Miguel Carrion from at Eurointelligence here. He writes:
The "New Deal for Europe" would begin to address the trade imbalances by funding productive investment in the deficit countries through the European Investment Bank, a healthier way of recycling internal trade surpluses than fueling asset price bubbles. There would be a true "structural fund" spent on proactively improving the productive structure of the chronically underinvested areas in the eurozone. This is a way out of the crisis which will deliver the "growth and jobs" that the European Union has been promising with great fanfare for over a decade, rather than the biting austerity currently on offer, and which may last "for decades".

Enclave-led recovery

Michael Taft:The Enterprise Minister was extremely upbeat about the recent CSO report that the trade surplus had grown. Mind you, it was not due to rising exports – in value terms they fell back slightly over the previous month; rather, it was the reduced imports which could indicate depressed domestic activity (machinery and transport made up approximately 50 percent of the fall in imports). Still, with the growth in service exports in the first quarter, the Minister believes we are back on the path of export-led recovery. Let’s examine the first quarter numbers and see what this growth is likely to mean for the economy.

When we combine two different CSO reports (not always the most satisfactory) we find that combined goods and service exports increased by €3.4 billion in the first quarter this year over the first quarter in 2010 – a healthy 9 percent. For a small open economy this is good news. However, this good news is somewhat tempered when we go into the details.

On the goods side, the Chemical/Pharmaceutical sector was the main driver of exports. It increased by €1.7 billion out of a total goods increase of €1.8 billion. There were still other sectors that gained – notably the Food sector – with the main decline coming from ‘unclassified commodities’. The point is that the multi-national dominated Chemical sector was responsible for most of the growth.

It is commonly accepted that export growth in this sector will have little impact on the domestic economy. There is the benefit of high-skilled, well-paying jobs – and continued growth will help. However, this sector imports nearly all its inputs – the goods and services it needs to produce their products. And the direct employment gain will be minimal – according to Forfas, Chemical exports increased by 69 percent between 2000 and 2008. However, there was no direct employment increase. This is not surprising – it is a highly capital-intensive sector. So we shouldn’t expect much of a knock-on benefit to the domestic economy – nor a tax gain, given our ultra-low corporate tax rates.

On the services side, growth is less concentrated. Nonetheless, the computer services sector, which grew by 14 percent, accounted for 56 percent of all service export growth. The computer services sector is a key service export sector – making up 40 percent of all service exports. So how connected is this sector with the domestic economy?

First, among Forfas-clients, computer services exports are dominated by multi-nationals – over 97 percent. In the period of 2000-2008, total exports from this sector grew by 62 percent, or €14.6 billion. However, employment – in both the foreign and Irish sector – actually fell by 4,800 or 9 percent. This was due to substantially increased productivity – as measured by employees per sales.

Second, the amount of inputs sourced from Ireland is falling in both nominal and percentage terms. In 2000, Irish companies supplied over half (52 percent), providing €9.2 billion in goods and services. By 2008, this had fallen to a third, falling to €7.6 billion. More and more of the inputs into the computer services sector are being imported.

So we have a problem: as our export sector increases their sales, we may not expect either a direct employment gain in the medium-term (though there may be a short-term post-recession increase) or increased activity from downstream Irish companies supplying these export companies. Our GDP will rise, of course; but the increase in exports may, ironically, increase employment in other countries – from companies that are supplying ‘our’ export sector.

This is not to dismiss the value of growing our export sector. But just as every industrial/enterprise strategy report has highlighted – since the Telesis report in the early 1980s: if it is not rooted in the indigenous sector, the gains to the domestic economy will be limited.

Just take one example: for the service export sector as a whole, Irish firms purchased 65.3 percent of their inputs domestically; multi-nationals purchase only 30.1 percent. And while this percentage has remained the same for Irish firms since 2000, foreign firms used to purchase over 50 percent of their inputs domestically in 2000.

This is not to dismiss the role of multi-nationals – their size alone dwarfs the Irish sector and, so, while the percentage is smaller, the total amount is much higher. We need the IDA and other public agencies to succeed in bringing multi-nationals to Ireland, of only because there’s not much happening domestically.

However, we should appreciate that we get a bigger employment and domestic benefit from indigenous companies. This where the real gains can be made but promoting indigenous start-ups and expansion requires considerably more work and will take much longer to bring on stream.

If we’re not careful, we’ll be wondering why export growth is not translating into an equivalent amount jobs and domestic activity. And the last thing you’ll get from official sources is the reality – that instead of export-led growth, what we’re mostly getting is, as described by the IMF, enclave-led growth.

[For an incisive historical survey of our distorted industrial and enterprise strategy, read Conor McCabe’s recently published ‘Sins of the Father’. If we repeat the past, we shouldn’t be surprised that the future is no different.]

Monday, 18 July 2011

Plan A for austerity; Plan D for default and devaluation

Slí Eile: Events are moving fast on the European monetary plains. Suddenly, various 'unthinkables' are being mentioned as real possibilities rather than impossibilities. Whatever the coming days and weeks hold a number of inconvenient truths are emerging:

European political leadership is at an all time low since the foundation of the European Coal and Steel community in the 1950s.

National interests are dominating over any sense of collective European 'esprit de coeur' and to the fore in various national interests are national financial interests.

The institutions of the European Monetary Union are not up to task - we have in some respects a house built on sand (and when the gales blew etc)

In the long-term (and possibly in the coming months) you can have a 'transfer union' and growing federalism or you have an EU without a single currency but you can't have both.

Like marriage single currencies are very attractive and lead to all sorts of mutual gains, lowering of transaction costs and increased market certainty when the partners are 'in it together'. But when communication breaks down so does trust and the current arrangements represent a pact 'til dissolution do us part'. Moreover, when the partners squabble endlessly over what is mine in terms of assets, debts and sharing of these then trouble is on the horizon. Responses at the European level have, to date, focussed on fiscal austerity with the addition of some clumsy attempts to rescue a number of peripheral countries in the Eurozone while all the time denying that there is a larger elephant in the European Euro parlour.

At the end of the day all of this comes down to who gets paid off and who has first claim to the assets of an insolvent corporation. Without wishing to over-simplify the current politico-economic crisis - financial institutions and funds in France, Germany, the UK and the US want to get paid back, the ECB wants to save the Euro and are ready to sacrifice absolutely anything for it, German and French politicians are watching their electoral backs. The IMF is playing good guy but you really would not want to be dependent on the IMF if you can help it. Read up on the last two decades of reform and adjustment in various nations in receipt of its magnificence. As for the domestic political response in the periphery let charity restrain this commentator.

'Plan A' meaning austerity (as Wolfgang Münchau terms it)is not working as it is compounding the problem by embedding debt through automatic fiscal stabilisers. Plan B is a muddle through involving some type of debt relief together with some fiscal transfer and contributions by bondholders. Plan C is Plan B plus a wider EFSF umbrella to save the big ones like Spain and Italy and Plan D is - you have guessed already - default and devaluation to continue with Münchau's terminology.

One way to prepare for the future is to deny it. Another is to assume the worst and prepare for it (secretly or openly). One wonders if policy makers and senior officials in Merrion Street are currently discussing 'what if' scenarios at a more leisurely and studied pace than what happened in September 2008. A good night's sleep would help.

And still more options include hoping for the best and proactively going for it while being prepared for the worst. The Euro is not dead yet. Even it if does not survive in the shape that we know it (in other words some countries exit in a more or less orderly fashion) it may be worth giving it another try. There is a lot to be gained and lost both ways. The protagonists for default and devaluation here in Ireland (the latter meaning the creation of An Punt Nua) need to spell out what that might mean for savings, deposits, capital controls, direct foreign investment, interest rates, mortgages and ultimately - jobs and living standards. They may argue that we are going down the swanny anyway and it is best to exit or threaten to exit before events impose themselves on us. Now they have a point bearing in mind the denial of reality in September 2008 and again in the latter half of 2010. However, the risks involved in wholesale and large-scale sovereign default allied to currency break-up are huge, unknown and without precedent. Ireland, Greece, Portugal, Spain and Italy are not Russia, Mexico or Argentina.

Right now citizens and progressive movements in Europe need to act together and reason out a number of solutions. One modest - very modest - way forward is for a European wide push that henceforth bondholders for insolvent banks should not be paid a cent. It will not - of itself - kick start economic growth and job creation but it points in the right direction and would help countries who desperately need some fiscal elbow room to crowd in investment where economic activity is being crucified by a thousand cuts. The idea of letting these categories of bondholders take the hit is hardly a revolutionary proposal as economist Colm McCarthy argues in the Sunday Independent here that:

Minister Noonan should now be seeking European support for an end to payments to holders of bonds, guaranteed or unguaranteed, in the Irish banks. Every cent paid to them is at the expense of the holders of Ireland’s sovereign debt, who have been treated in quite cavalier fashion at the behest of the European Central Bank and apparently in response to threats from this unique organisation.

Surely progressive economists and commentators can be a tad more radical and courageous than an existing pillar of economic orthodoxy?

Can we hope that at last the cent is beginning to drop on politicians, economists and progressives?

Friday, 15 July 2011

Guest post by Arthur Doohan: Grandmaster level chess

Arthur Doohan: In chess, the quality that separates the 'grandmaster' from the 'talented amateur' is the number of moves ahead that each player can mentally keep in mind and manipulate. Something similar is said to be true for champion tennis and snooker players.

I am not one for conspiracy theories as experience has to date shown me far more evidence supporting the 'Murphy's Law' theory of management of human affairs.

None the less, there are in all realms, whether jurisdictional or professional, at any given time a handful of competent persons with both a breadth of vision and a depth of ability.

The 'European Project' was built by men widely adjudged to be 'political grandmasters'. Adenauer, de Gaulle, Brandt, Mitterand, Delors; none of these were, or are, regarded as vain or shortsighted or incompetent. Patiently and with great care and at considerable cost and in the face of much dissent, the various layers of the EU have been put together.

Yes, there have been many compromises and the 'project' is far from complete and the final form is not clear to anyone. But there was a vision behind the efforts of these men and there was, most certainly, a bitter awareness of what the possible costs of failure could be and what the outcome of failure would look like.

In the context of all that wisdom, ability and effort we now have to re-examine the crisis that envelopes the 'European Project'. The 'design flaws' in the single currency were clearly enunciated before its adoption. The bumpy evolution of the ERM gave ample warning of how tough life might be for some members of the monetary union.

The driving ambition of the proponents was not merely to enhance European trade or reduce the profits of foreign exchange traders. They did not seek some empty token of pseudo-unity for Europe.

What they wanted was a means of preventing a repetition of the abuse of power and the greedy expropriation of financial wealth that the US imposed on the rest of the world when it unilaterally and without warning or dialogue abandoned the Bretton Woods agreement in 1971.

The only way to achieve this would be to build a currency with the strength and depth of the 'mighty dollar'.

That level of integration has always been regarded as politically impossible to achieve and, in many ways, has been 'tabu' to both those who would propose it, as well as to its instinctive opponents.

Nobody 'walks the plank' out of choice. Standing at the end of the plank, one jumps into the water because certain death awaits at the other end and there is some hope, however slight, amongst the fish and the sharks.

The designers were well aware of the risks and the flaws of the design of the Euro. They had knowledge of, and personal experience of, financial disasters of national and supra-national scale and impact. A crisis of the type we are currently dealing with was inevitable with only its timing as a matter of debate. Almost certainly it has come sooner than most observers expected and has probably been brought on and exacerbated by the US debt crisis.

We are now hearing calls for the 'federalization' of problem debts from predictable, and from most unlikely, sources. Of course, no one mentions the corollary of this federalization which would have to be federal tax raising powers. At which point the EU project would be complete.

This is an alternative to the disintegration of the Euro and the EU as a solution to the unviability of the debt mountain that has been piled high in the storehouses of Europe. And as solutions go, while unpalatable to many, it looks less painful than the alternative.

So I leave you with this thought and a quote.

Did the designers of the Euro hope to achieve, through a crisis, a level of European integration that would never be possible by normal negotiations?

“And whether or not it is clear to you, no doubt the universe is unfolding as it should.”
- Desiderata by Max Ehrmann

Thursday, 14 July 2011

The butler did it

Michael Taft: On Morning Ireland, Fergal O’Brien, economist from IBEC, stated:

“Austerity is not killing the economy."

Oh. We are treading into, what Michal Burke called ‘the realm of forgetting’. Forgetting the past, forgetting the link between fiscal policy and economic impact, forgetting basic lessons in Economics 101. Fortunately we have a source to help us remember – and from no less an institution that has done its fair share of forgetting: the Department of Finance.

In the previous Government’s Information Note on the Economic and Budgetary Outlook, published prior to the last budget, it stated that it’s growth projections:

‘ . . . takes account of budgetary adjustments amounting to €6 billion, which are estimated to reduce the rate of growth by somewhere in the region of -1½ - 2 percentage points.’

In other words, for every 1 billion of fiscal contraction (spending cuts, tax increases), economic growth is, on average, cut by -0.25 and -0.33 percent. If this ratio has held since the beginning of the crisis, the result is unnerving.

Since early 2009 there have been effectively four budgets: the February measures (pension levy, current spending cuts), the April Supplementary Budget and Budgets 2010 and 2011. In total these contractions totalled 16.8 billion.

Current spending: 8.4 billion
Capital spending: 3.5 billion
Tax measures: 4.9 billion

There were tax increases and spending cuts in Budget 2009 but much of this was offset by tax cuts (extending the standard rate tax band) and social welfare increases. So we’ll leave that out, though it should be noted that the contractions in this budget amounted to a minimum of 2 billion.

Taking the DoF’s recent fiscal adjustment/growth reduction ratio, we would find that these budgets cut economic growth between -4.2 percent and -5.5 percent. Given that overall economic growth has fallen by -10.4 percent, this would mean that government policy is responsible for between 40.3 and 52.9 percent of the fall in GDP.

This should be treated as indicative. When the full model of the macro-economic impact of fiscal measures on the economy is eventually done, we might find the impact to be less. For instance, capital spending has been cut 3.5 billion, but some of this was absorbed by the fall in tender prices. Not all current spending cuts have the same impact – the fall in procurement prices from multi-nationals will not have the same impact as cutting whole contracts with the indigenous private sector.

However, we should note that fiscal adjustments impact more negatively on the domestic economy. The ESRI, for instance, shows that cutting 1 billion from government spending on public services reduces the GDP in the medium term by -0.9 percent, but cuts GNP by -1.3 percent; cutting public sector wages hits GNP twice as hard as GDP.

So the DoF adjustment/growth ratio may even underestimate the deflationary impact, especially as the fall in GNP was even greater: - 12.3 percent.

The Irish recession was not driven by external demand; exports increased in this period in volume terms. It was driven by a collapse in domestic demand; in particular, investment. Austerity’s impact was mostly felt here, not in the external sector.

Even the DoF admits that austerity policies have lengthened and deepened the recession. But IBEC and many others, including the current Government, refuses to acknowledge this relationship.

It might be convenient for some to ‘forget’. But we shouldn’t. Proceeding with further austerity will undermine growth even further with little to suggest that this is the pathway to fiscal stabilisation.

No, the butler didn’t do it. What killed the economy was the irrational pursuit of deflation at a time when the economy was already deflating. When we ‘remember’ that, we will be starting on a real path to economic recovery and fiscal stabilisation.

Wednesday, 13 July 2011

Why Irish debt is cut to junk status

Michael Burke: Moody’s is the first of the credit ratings agencies to cut Irish government debt to below investment grade – the sovereign debt is now ‘junk’. It will be recalled that when the ‘austerity’ programme was introduced- in reality a project to drive down wages and the social wage in order to revive profits- a key justification was that the financial markets needed reassurance that Ireland would remain credit-worthy.

Along with junk status, Irish 10yr yields at the time of writing are 13.65% and Irish 2yr yields are at 18.64%. This ‘inversion’ of the yield curve indicates the perceived market risk of the imminence of default. When the price of shorter-maturity debt falls below that of longer maturities it reflects the perceived risk of an immediate default. Currently Greek long and short-term debt are both trading fractionally above 50 cents in the Euro. Irish 2yr debt is just above 60 cents, while 10yr debt is around 55 cents.

This can be summarised as the view in the bonds market is that both are highly likely to default, and that Greece may do so very soon; Ireland might take a little longer.

There is some anger at Moody’s decision. The complaint is that successive Irish governments have done everything asked of them, that the programme agreed with the Troika is on track and that the real failing is the insufficient capital of the European Stability Mechanism.

These are strange complaints. It is true that successive governments have done everything asked of them – and more. In Fianna Fail’s case severe cuts were imposed when no international body was calling for them. But everything is not on track. Final domestic demand (the bit that actually generates jobs and taxes) is contracting at an annual rate of 5.5%. As a result, despite higher taxes and the imposition of the USC, tax revenues are actually below target and the shortfall seems to be growing. The complaint that the ESM is now not large enough to cope with the crisis in Greece, Ireland and Portugal (let alone Italy) is actually an admission that the problems are deepening.

Of course the interconnected European crisis is also a key factor. But this is far from a one-way street. The failed loans of German, British and French banks to the Irish banking sector and to the State are an important factor in the general crisis.
Moody’s offered this reason for the downgrade. “Ireland has shown a strong commitment to fiscal consolidation and has, to date, delivered on its programme objectives, the rating agency nevertheless notes that implementation risks remain significant, particularly in light of the continued weakness in the Irish economy”.
‘Implementation risk’ is a strange term in this context. It is often used, quite spuriously, in relation to Greece- the implication being that the protestors outside the Parliament in Syntagma Square are somehow preventing the implementation of the cuts and privatisations. On the contrary, all necessary legislation has been passed.
But there are no similar protests outside Leinster House. So in this context especially ‘implementation’ is an abuse of the language. All the packages have been implemented. But they have not been successful, the domestic economy continues to contract and tax revenues to decline as a result.

The reason they have not been successful is suggested in the Moody’s statement; “in light of the continued weakness in the Irish economy”. It is the weakness of the economy that is the source of the crisis, and the downgrade to junk status.
Without policies to re-establish growth, the Troika and the government are navigating the economy towards the rocks.

PS: if there is any silver lining from this round of the crisis, it is this: all talk that the widows and orphans of Ireland (or anywhere else) would be hurt by a default can end. Most pension or insurance funds would have exited high-risk sovereign debt markets a long time ago. But they are simply not allowed to invest in sub-investment grade debt, that is the point of the rating. The private holders of Irish debt are now banks, hedge funds, vulture funds and other parasites.

Monday, 11 July 2011

June tax figures

An Saoi: The half year tax figures came out during the week and there have been various comments published around them. Constantin Gurdgiev’s piece is available here and is full of nice colourful graphs and gives a multi-year view of payments. I want to focus in on just two of the tax heads, Corporation Tax & Income Tax this month. Both suggest trouble ahead.

Corporation Tax paid in June was €824M net against a monthly target or profile of €871M. This follows on the May when €310M net against the profile figure €450M. All companies have now made the first of their two Corporation Tax payments and the Revenue now have all of the information required to figures are extremely worrying.

The figure is also well below the cumulative figure at June 2010 €1,424M against €1,610M. The 2010 figure would surely have been heavily influenced by refunds arising from losses made by companies in their trading years 2008 & 2009. This makes the continued slippage in 2011 even more alarming and suggests that the final CT figure for 2011 will hardly break €3,400M or around €600M below profile. Back in April after the March tax returns, I had expected Corporation Tax figures to come in at €4,800M, well ahead of profile. This projection was based on the level of trading of many International firms with large presences in Ireland. All of these companies have now at least part paid their current liabilities and there is no way the Exchequer will get close to its target.

We know that the level of trading losses within the financial services industry was at least €34,309M arising from a Dail question. The only journalist to pick up the importance of the story was Kathleen Barrington here in the Sunday Business Post. The level of payments being made by the historically large payers outside of the financial services sector must also be falling, suggesting greater internal pressure to reduce the tax cost of doing business in Ireland. Even 12.5% is too high. This is despite increasing profitability and turnover in those companies.

Few Valued Added Tax returns fall due in June and the overall level of payments for the month was small. However the figure €208M was €42M or 16.8% short of profile. However timing of refunds may explain such a large discrepancy.

The May/June VAT returns are due this month (July) and should be reasonably good. June was the last month and as can be seen from these SIMI Stats, it was a good month in the motor trade. However the rest of year will surely be poor as over 40% of car sales were part of the scrappage scheme. Preliminary retail sales figures for May showed non motor trade spending continues to fall. This would suggest that VAT for the year is unlikely to break €10,000M for the year, probably coming in somewhere between €9,600M & €9,800M.

Income Tax incorporating the USC remains on target. While it is nominally ahead of last year, when you take the substantial tax changes in the Finance Act and the replacement of the Health Levy with the USC, it is behind perhaps €300M against the same month last year on a like for like basis. There is an expectation of increased income tax payments for the rest of the year, which seems more of a hope than expectation, but only time will tell. Employment and wage levels continue to fall but perhaps self employed payments will bail the State out later in the year?

Excise Duty remains ahead of target buoyed by the new car sales. The next six months may reflect a different story. Stamp duty remains in the doldrums.

Movements in the other taxes do not materially change the picture as their collective contribution is so small. Customs Duties are collected by the State on behalf of the European Union and while included in the figures are remitted to the EU, minus 40% to cover local costs.

The final outcome suggests that the cumulative tax changes introduced by the outgoing Government have not improved the Exchequer position. Retail activity other than in the car trade continues to fall and with the tax take following suit. The fall in Corporation Tax was not expected, least of all by me and shows just how fickle the multi national sector’s relationship with Ireland is.

June’s figures may also explain Mr. Noonan’s comments about the necessity to find even more than the €3,600M in planned cuts. It would be helpful if he let us all in on the information he has been given by his officials. The final tax yield for 2011 looks as it will fall a good deal short of the €34,900M.

There is an urgent need to expand the Tax base and the Social Insurance base by withdrawing without delay all the various tax breaks, deductibility of interest against property purchase, carry forward of losses, exemptions applied to certain income etc.

The effects of the tax changes introduced this year also make it clear that there is a need to selectively reduce the tax burden but certainly not to increase rates. Proposed changes in the standard rate (21%) VAT rate should not be introduced under any circumstances and a substantial rowing back on the effects of individualisation should also be considered to protect the position of many one income households.

The need to get property related business costs down without delay needs to be tackled with the same alacrity as Richard Bruton has pursued the low paid.

Thursday, 7 July 2011

Guest post by Colm O'Gorman: Linking human rights and economics

Colm O'Gorman: We do not know where money allocated in the Irish budget goes. We do not know how effective it is, whether it gets to where it is needed, or how its impact is monitored.

A survey carried out for Amnesty International late last year by Lansdowne found that 81 per cent of people felt they did not understand how Government ministers make decisions about how our money is spent. The same number did not believe there were effective systems in place to ensure the money goes where it is supposed to.

A September 2009 report carried out by Indecon Consulants showed the Health Service Executive could not explain how its mental health budget is spent because of flaws in its accounting systems.

At a recent symposium on economics and human rights organised by Amnesty International Ireland, Dr Mícheál Collins of Trinity College explained that, of 131 identified government tax breaks, figures only exist for the cost of 89 of them. And in some cases where there are figures, all we have are the rough estimates that were provided when the tax break was introduced by the Oireachtas.

In bringing together economists and experts in the field of human rights, we were trying to investigate how we can make Ireland’s budget more accountable. It is the first time we have held an event like this; indeed, it’s a first as well for our global organisation.

But why is this a human rights issue at all? Why is an organisation best known for working to free prisoners of conscience or to end the death penalty taking an interest in the labyrinth of the Irish budgeting process?

It is because decisions made around how we spend our money affect our human rights in Ireland. You have a right to health, a right to education, a right to social security. These are not figures of speech or slogans: they are rights laid down in legally binding international human rights treaties signed and ratified by Irish governments.

Under international law, governments are obliged to deliver on these human rights. But the resources available to a country to deliver them must be taken into account.

It is not up to human rights organisations, nor the courts for that matter, to decide how taxpayers’ money is spent. That’s the job of our elected representatives. But in making those decisions, they must fulfil their responsibility to ensure resources are allocated in a transparent way that protects our human rights and grows our economy.

It might seem that talking about these issues at a time of economic recession, when the IMF is effectively in charge, is a luxury we cannot afford. But the current economic climate is also an opportunity to change the old rules. We need better quality standards, more information about how public services are delivered and paid for. Those people using services, and those providing them whether in the public or private sector, need more information from our budget process.

One of the reasons that we, as a nation, have found ourselves in this place is the lack of accountability in our financial and budgetary system. In the middle of such a grave economic crisis, it has never been more important to examine how we allocate scarce resources.

How do we ensure the decisions around our budget are made in a way that protects human rights and is effective, efficient and accountable? How do we decide where we spend our money and ensure we’re getting good value? And how do we do this in a way that ordinary people can understand? Unless we work to restore faith in our budgetary system, we will have failed to learn from this crisis.

And in the discussions about bondholders, banks, interest rates and bailouts, we must focus not only on the numbers, but on the bigger question of the kind of society we want to build. Our vision for Ireland must be of something more than simply a balanced set of accounts.

It must include a society where our government ensures our fundamental human rights. Later this year the United Nations will review the progress made on fulfilling those rights for people living in Ireland. While there have been improvements there is no doubt they will find a lot left undone, so much that could have been accomplished during the boom years had human rights been a priority.

Included in the Programme for Government is the line “we will require all public bodies to take due note of equality and human rights in carrying out their functions”. This must include all government departments, including finance and public expenditure in particular. And yet, how will that happen and how will it work in practice?

There is an extraordinary level of distrust in our budgetary system, but given recent events that’s hardly surprising. Only once we begin to appreciate how the system works can we start to properly investigate how our money is spent and, most importantly, ensure accountability in the allocation of our resources. Political and economic reforms being contemplated by our new government must take this into account.

Human rights activists need to understand more about economics, about how wealth is generated and growth sustained. Economists need to appreciate that human rights is not necessarily about spending more. It is about transparency, about ensuring accountability in how we spend our money and in how we make those decisions. It is from that common ground that we can work together.
Colm O’Gorman is executive director of Amnesty International Ireland. He was previously founder and director of One in Four.

Trapped in an analytical prison

Michael Taft: Seamus Coffey has written a provocative post over at Irish Economy on the recent Exchequer statement, showing that Government borrowing is not falling even after the €20 billion fiscal contraction over the last few budgets. Some of the commentators on the post find this surprising but it shouldn’t be. The TASC open letter signed by a number economists and analysts predicted this would happen. Contributors on this blog have gone through the numbers to show why this would happen. Nonetheless, the failure to reduce Government borrowing will no doubt spark renewed demands for more contraction; this may explain the Finance Minister’s warning that cuts will be even deeper than anticipated in the Programme for Government.

The problem, however, goes much deeper than argument over numbers. It goes to the heart of how we debate the economy – a debate that currently inhibits a proper understanding of fiscal contraction, public finances and economic growth. In short, we are trapped in an analytical prison.

The current debate over fiscal policy is based on a fundamental confusion – that the finances of a government are analogous to household finances. When spending in the household, exceeds income, goes the argument, the household must reduce its expenditure. People go out less, buy less, take less holidays, postpone major purchases, etc. The key point here is that if I cut my spending, this doesn’t reduce my wage or income. My wage is unaffected by me buying less books. Therefore, spending reductions are a net gain. It is a rational act at household level.

However, governments are not households. When a government cuts its spending, it cuts its revenue as well – because it cuts the economy’s revenue. This is fairly straight-forward and the ESRI has published two studies on this subject. For example, it found that cutting public sector employment equivalent to reducing spending by 0.6 percent of GDP, actually drives down the domestic economy (GNP – where our tax base lies) by over twice that amount in the short-term: -1.1 percent. Therefore, after the fall in demand and business output, and the rise in unemployment (which they measure) the actual ‘savings’ to the Government in the form of deficit reduction is minimal: 0.2 percent. We get little bang for our contraction buck, but we have weakened the economy’s ability to generate revenue in the future by the resulting deflation.

That is why, when using the ESRI measurements, we find that the Government policy of cutting over 20,000 jobs from the public sector will make almost no contribution to fiscal reduction. But it will drive more businesses out of business and more people on to the dole queues or the emigration planes.

Again, this shouldn’t be surprising. If you cut social welfare, people will spend less thus cutting domestic demand which impacts negatively on businesses reliant on that demand. Tax revenue falls, unemployment costs rise; the ‘savings’ turns out to be no such thing.

If you cut contracts to the private sector (which account for one-third of spending on public services), domestic business activity contracts. So don’t be surprised when tax revenue falls and, again, unemployment costs increase.

This is what happens in normal times (and the ESRI simulations were based on a growth base-line). But to do this at the same time as private sector output is contracting is a recipe for accelerating the recession (which is what happened) and embed low-growth into the economy going forward (which is what is happening).

All this because the current debate is based on a false analogy.

A related problem is that the debate confuses means and ends. The goal is to reduce the deficit. However, the debate obsesses over spending cuts and tax increases and measures success in the amount of (downward) fiscal adjustments we can come up with. This is known at the ‘arithmetic’ approach and we see this popping up everywhere. If we cut x, then we save x – but as we know, cuts do not equal savings. We do not debate fiscal effectiveness; we debate different numbers on the revenue and spending balance sheet and delude ourselves that we are discussing fiscal stability. As Seamus has shown, however, this is not happening.

Most crucially, we don’t even acknowledge that the nation’s balance sheet is made up of three elements – revenue, spending and investment. The latter is rarely referred to even though it has been the driving force in the Irish recession. Investment is a tool of fiscal consolidation – a down-payment on future income; an activity that drives up demand in the short-term and continues to contribute to economic growth and revenue raising in the long-term through its supply input.

We are left with a wholly inadequate framework with which to understand, never mind debate, the continuing economic and fiscal crisis. All we get, with every fresh round of bad economic and fiscal news, is call to ‘tighten’ our belt even more, take ‘tough’ decisions, and make ‘sacrifices’. It is depressing that those calls are part of the problem, not part of the solution.

What we need is a new analytical framework – a new fiscal framework if you will. One that can explain why we are still mired in this mess. One that can help explain how an economy – households and businesses – interact with fiscal and investment measures. On that can provide a platform for sustainable pathways back to economic recovery and fiscal stability.

Otherwise, we will continue to sink. And all we will get is ‘solutions’ that will sink us even further.

Monday, 4 July 2011

Chemical solutions to economic problems?

Rory O'Farrell: I feel it rare that I have reason to be thankful to the FF/PD government of 2002-2007. However, they had one policy that was so dramatic, that we can smell the change.

Last Saturday evening, while enjoying the Tall Ships festival in Waterford, a friend and I decided to go for a beer in a popular city centre pub. The lack of indoor seating pushed us outdoors into the 'smoking area'. At one point a stranger interrupted our conversation and asked for a light. I told him I don't smoke, and we looked around the 'smoking area' to find someone who did. We noticed only a minority of people smoking, and in the relaxed atmosphere and dimming sunlight of the summer evening the stranger laughed at how even in the smoking area people don't smoke. Since Charlie Haughey was Minister for Health Ireland has been at the vanguard of restricting the advertising of tobacco, a tradition which continued when Micheál Martin banned smoking in the workplace. The success of these policies are measured by reduced lung cancer, lower levels of tobacco use, and the fact that our policies have been imitated throughout Europe, rather than vice-versa. Let’s hope Micheál Martin is selective in how he emulates his predecessor as both Minister for Health and leader of Fianna Fáil.

In an article from the Sunday Independent that contained errors in as diverse a range of topics as etymology, and statistics, Marc Coleman says "high taxes on drink and cigarettes are not designed to curtail drinking or smoking" and "unless we want another civil war, we have to put an end to highly paid servants of the State using spurious morality to defend indefensible restrictions on our right to live the way we want to live." I am not sure which highly paid public servants he is referring to (certainly not I as I’m not a public servant).

To back up his claim he states "Those in the lowest income decile spend one-tenth of their income on drink and tobacco, compared with 4 per cent for those in the highest income decile." In fact, Table 2 of the 2004-2005 Household Budget Survey gives very interesting details of spending by income group. Marc Coleman does make a silly error when he calculates "the lowest income decile spend one-tenth of their income on drink and tobacco, compared with 4 per cent for those in the highest income decile". He appears to confuse the average gross income for the bottom (top) ten percent with the upper (lower) bound for that group. Accurate data can be seen in the below Figures, 1 and 2. The first shows average weekly expenditure on a selection of items, and the second give the expenditure as a share of gross income (one could argue that disposable income is more appropriate, but as the CSO only gives percentiles by gross income, this was used). Nevertheless, the core point that the poor spend a larger proportion of their income on cigarettes and alcohol than the rich remains.

However is this information shocking to the average follower of the TASC blog? Does it alter the general policy prescriptions for recovery? Not at all. It is common knowledge, that across the world, that the poor spend all their income, while the rich are more likely to save. In fact, the poorest 10% spend more than their income, possibly incurring debts or getting some help from others. The poorest spend less on drink and tobacco, but their income is also lower. It is said that “as with stamp duty and other taxes, the penal levels of indirect taxation are bringing our social contract into disrepute and killing the economy.” As Marc Coleman correctly states, indirect taxation (such as VAT, or excise duty) is usually regressive. This is commonly accepted. A more egalitarian tax policy will boost the economy, by increasing demand in the economy. Other policies, such as maintaining the minimum wage, and proper enforcement of JLCs, can also help boost the economy.

However, Marc Coleman also says “high taxes on drink and cigarettes are not designed to curtail drinking or smoking. It is precisely because the Government knows that the consumption of these products is inelastic that they are easy targets for a selfish state-driven tax trap”. Past governments are open to accusations of economic illiteracy, but if past governments were cynically trying to wring cash from smokers, would they really have banned tobacco advertising and smoking in pubs? It’s not a government conspiracy. Smoking is bad for you.

Of course economics is the study of choices over scarce resources. Irish alcohol and tobacco cost 70% more than the EU average. This is not a problem of structural competitiveness, it is purely due to taxation. As a country we made a choice to put high taxes on these items, and this choice could be reversed tomorrow if we wanted to. If we slash prices on tobacco it is unlikely to be a major boost to competitiveness. Tourists are unlikely to flock to Ireland because 20 John Player Blue no longer cost €8.65 (which coincidentally is the minimum wage). A choice has been made that it is better to tax tobacco highly, and questions of equality are not best dealt with through excise duty.

There is no chemical solution to an economic problem.