True Economics is about original economic ideas and analysis concerning everyday events, news, policy views and their impact on the markets and you.
Enjoy and engage!
Thursday, July 15, 2010
Economics 15/7/10: IMF Article IV CP on Ireland: part 1
Amended (hat tip to Paul MacDonnell & Mack)
IMF Article IV consultation paper on Ireland. Several issues, previously stressed by this blog have made their way into Article IV – a good sign for those who read these pages regularly, and bad news for the Government. Emphasis is mine, throughout.
This is the first post of several on the Article IV consultation paper for Ireland:
2. …the path from crisis to stability and recovery is a narrow one. With some reversal in the earlier loss of competitiveness and improvements in the global economy, exports will lead the recovery. But spillovers to the domestic economy will be limited because of exports’ heavy reliance on imports, their tendency to employ capital-intensive processes, and the sizeable repatriation of profits generated by multinational exporters.
[This is bang on with my assessment of the earlier Government noises about the exports-led recovery]
Moreover, the unwinding of home-grown imbalances from the boom years—arising from rapid credit growth, inflated property prices, and high wage and price levels—will create deflationary tendencies that act as a drag on growth. Banks remain a source of downside risks from higher than expected losses, uncertainties in global regulatory trends, and continued financial market tensions that restrict access to funding.
[Note the assessment of the banking sector problems – especially lack of available credit – this will come handy later on when I highlight the self-contradictory nature of the IMF assessment of the banks levy. This is an issue raised as central to the IMF Article IV analysis in today’s Irish Times, which missed the point that the IMF does not actually call for the banks levy, but stresses that it is a controversial measure that will lead to further reduction in credit.]
[So in brief, the opening part of the IMF report does not bode well for the Government claims that we are on a road to recovery. And crucially, it does not put much credit in our Government’s claims that the recessionary adjustments have led to restoration of Ireland’s competitiveness. It also cuts across majority of our economics commentators and some MNC leaders. In contrast, I have always stressed the fact that by most metrics, our competitiveness ‘improvements’ have been either totally invisible or tentative at best.]
3. Along the long-haul path to normalcy, retaining policy credibility will require demonstrated commitment and active risk management. The appropriately ambitious fiscal consolidation plan demands years of tight budgetary control. Likewise, the weaning of the banking sector from public support and its eventual return to good health will proceed at only a measured pace.
[The IMF folks have to be wondering what the hell has happened to our Government commitment when Brian Cowen negotiated the Croke Park deal that effectively prevents any meaningful reforms of our public spending into 2014. That was some ‘demonstrated commitment and active risk management’.]
In the interim, unforeseen fiscal demands may occur. In this context, at times heavily bunched banks’ funding needs and episodes of market volatility could generate unwelcome pressures and disruption. With limited fiscal resources for dealing with contingencies, maintaining a steady policy course will require mechanisms for oversight and transparency, and high-quality communication to minimize risks and sustain the political consensus and market confidence.
[We have seen this all before – in a number of IMF previous statements. What the Fund is saying here is very clear – given the distortionary nature of our banks guarantee scheme and Nama, the Exchequer remains heavily exposed to the moral hazard problem on the banks side. In this environment, one needs a vigilant Exchequer, willing to impose severe pain on the banks in order to keep them in line and prevent future over-loading of publicly guaranteed liabilities. The IMF doesn’t openly claim we don’t have one, but we really do know that we do not. The IMF instead insists on the need for proper checks and balances in the system in order to at the very least cushion the adverse impact of banks perverse incentives to pile on publicly guaranteed debts. But the IMF does not realise (or at least does not acknowledge) that Ireland’s Government and the Dail operate effectively without any real checks and balances. How else can a democratic country run on regular unscheduled appearances of the Minister for Finance to announce another round of banks funding with no real debate, real votes, real accounts given?]
6. The economy is projected to resume growth in 2010. Short-term indicators present a mixed picture of prospects. After a sharp rise in January, industrial production has pulled back. Goods exports are recovering from a weak performance in the second half of 2009. Sentiment measures have also shown improvement, but they incorrectly predicted a much stronger 2009:Q4 and do not as yet reflect the recent financial market tensions. Recent unemployment data were disappointing.
[Errr… we’v turned the corner, as Brian Cowen keeps repeating on international news channels]
Consequently, likely outcomes are in a larger than usual zone of uncertainty. Even as the economy recovers through the year, staff projects the GDP for 2010 to be ½ percent lower than in 2009, but with a q4-on-q4 increase of about 2 percent.
[In other words, April 2010 forecast remains untouched by the IMF. The Fund sees, apparently no ‘turn around’ that would require it to raise their forecasts. More importantly, the IMF also shows 2011 and 2012 projections for growth. Thus, DofF predicted in its SPU 2010 GDP growth of 3.3% in 2011 and a whooping 4.5% growth in 2012. IMF in contrast expects growth of 2.3% in 2011 and 2.5% in 2012. That’s a massive difference on DofF. And should IMF forecasts come true, Ireland Inc will require even more cuts in deficits in years ahead.]
8. The high and persistent unemployment reflects ongoing structural changes. The headline [unemployment] rate is likely to peak this year at 13¾ percent before declining to a still high 9½ percent by 2015. In addition to the cyclical component, the large increase in unemployment reflects significant structural changes with the unwinding of the boom years. The sharpest decrease in employment has occurred in construction and manufacturing. Some of these lost jobs may never come back, especially as the duration of unemployment increases, with the attendant depreciation of human capital and future growth prospects.
[Oh, and the IMF doesn’t hold much trust in Fas’ ability to retrain all those construction and manufacturing workers with relatively low skills and education into ‘knowledge economy’ workers? I wonder why… The key phrase here is ‘structural unemployment’ – the phrase that implies that no return to growth at the level of long term economic potential will ever reduce that portion of unemployment.]
Persistent unemployment may become a policy challenge going forward, and the younger generation could face discouragement and loss of human capital.
[Again, current policies do absolutely nothing to address this issue. We are facing education cuts, education grants for the unemployed are basically unavailable in real terms.]
10. The pace of recovery remains constrained by continuing imbalances. …By staff’s estimates, the potential growth rate will rise gradually to about 2½ percent by 2015 as the internal imbalances—arising from rapid credit growth, overvalued property prices, and high price and wage levels—are corrected.
[Again, nothing new here for the readers of this blog. I have been on the record for some time now saying that long term growth for Ireland should be around (and below) 2%. In my view, IMF estimate of potential GDP growth of 2.5% by 2015 is pretty much bang on with my view. Potential GDP is the trend line. If the trend line is 2-2.5%, while the economy experiences a long term structural underperformance, then long term growth average of 1.5-2% is highly probable. And this is exactly my estimate for Ireland 2010-2020.]
The analysis cautions that the Irish economy may be in a regime with the relatively-modest potential growth and the high unemployment reinforcing each other. The authorities recognize these dislocations but are more optimistic about the medium-term growth prospects. They judge that the traditional flexibility and international openness of the Irish labor market will provide a self-correcting mechanism towards more robust growth.
[This is really a damning statement. It contains two important things. First, the explicit statement that Irish Government is excessively optimistic in its forecasts and is basically ignoring the risk of twin shocks of unemployment and low growth capacity, despite being aware of them. Second, the IMF put it on the record that the entire long term Government recovery programme is based on the hope that large enough number of Irish people will emigrate to sufficiently reduce the labour force and unemployment. This is really equivalent to a country Government wishing for a natural disaster or a plague in order to reduce economic pressures through Malthusian per capita wealth model.]
13. Even before the crisis hit, the rapid rise of Irish wage levels and increasing global competition had diminished traditional Irish advantages. The departure of Dell, …to Poland in early 2009 was symbolic of a loss of edge in low-end manufacturing [amazing, Dell operates in High tech Manufacturing sector. To call its operations in Europe ‘low-end’ is most likely an honest admission by the IMF that what was going on in its Ireland facilities was nothing more than a 'screwdriver' assembly of imported components - aka a transfer pricing 'manufacturing']. Ireland’s share of the value of global and European manufactured exports, which had risen sharply between 1995 and 2001, fell steadily thereafter. In recent years, export growth has been sustained, though at lower levels than in the 1990s, by the repositioning of Ireland as a service exporter and “knowledge hub.”
[So we were not competitive up until now. Nothing new here, but a good reminder. Again, the bit about ‘knowledge hub’ is puzzling – Ireland doesn’t register on the international radar in terms of exporters of education services or healthcare. We do not export patents produced domestically. We do not ship much of indigenous software or biotech/pharma formulas. What ‘knowledge hub’ are we talking about that accounts for our services exports? Full 90+% of our services exports are MNCs, not indigenous firms.]
14. The recent decline in unit labor costs from their high levels will need to be sustained to close the competitiveness gap and make a material difference to growth prospects. …the high Irish price and wage levels will require a period of “internal devaluation” over the next few years to support export growth. …For now, however, unit labor costs have fallen primarily because of improvements in labor productivity. [Oh, sounds so great – we became more productive… err.. not really:] …the productivity increase reflects mainly compositional shifts in the labor force as the relatively-unproductive construction industry has contracted. Thus staff was concerned that productivity increases may not continue and, hence, the decline in unit labor costs to competitive levels is not yet assured. The authorities expect wage compression to continue on account of continuing weakness in and flexibility of the Irish labor market.
[Great, Mr Cowen’s plan to ship unemployed out of the country, while cutting wages for those remaining behind is working, then… Really, folks, this is IMF’s admission (in polite society terms) of our comprehensive failure to drive up productivity! On a side note – I have been running regularly updated posts on Irish competitiveness indicators based on data from CSO, ECB and CB, so stay tuned for more… And another side note, the IMF do not say anything explicitly about public sector wages, but on page 12 they show a chart that highlights the fact that wages in the public sector and industry (also dominated by unions contracts) have driven up wages across the entire economy in Q3 2009 relative to Q3 2008.]
16. Even with faster growth, the spillover from exports to the domestic economy will remain limited. An increase in Ireland’s exports, being highly correlated with an increase in imports, generates a much smaller increase in domestic value-added. Moreover, foreigners have large claims on the value-added generated in the export activity, as demonstrated by high correlation between the change in net trade and the change in income outflow on account of direct investment—the exceptions being the crisis years when imports fell for domestic reasons. Finally, Irish exporting activity has traditionally been relatively capital intensive, becoming more so with the downscaling of lower-skilled electronic assembly.
[In other words, the GDP/GNP gap is real and it matters to the economy, from the point of view of the IMF. I’ve said this all along. But the Government continues to insist that it collects tax on the gap as MNCs repatriate profits from Ireland. This is the joke that passes for our economic analysis. Tax we collect on profit earnings of MNCs is 12.5% after net deductions on transfer pricing through internal company billings etc. The same profits earned by domestic firms are recycled into the economy in form of dividends, wages, investment etc. Which means that while Exchequer earns at most 12.5% on MNCs profits, it earns multiples of that on profits from the domestic firms. This difference is further amplified by the fact that, as IMF also point out, MNCs are less labour intensive in production and returns on labour are taxed at much higher rates of income tax than returns on capital. It is frustrating to have to point these simple things out again and again in the face of denials from the official commentariate.]
18. The decline in prices reflects the high Irish price levels prior to the crisis and the collapse in domestic demand. Despite Ireland’s extensive trade relationships with the U.K., the depreciation of the British pound relative to the euro does not, in staff’s view, appear to be a primary source of the price decline. Irish import prices seem to have fallen after goods prices. Rather, Irish price levels were substantially higher than eurozone price levels prior to the crisis, mainly reflecting higher services prices but also higher goods prices (possibly because of the domestic distribution component).
[Finally, someone of IMF’s authority has confirmed what myself and a handful of other economists were saying for years – public sector-driven inflation (services such as education, health, sectors such as energy and transport) plus our Governments staunch resistance to introducing meaningful competition into retail and logistics (the Wal-Mart or Ikea effect) – are the core culprits in our prices being out of touch with our trading partners. Has anyone heard any discussion of reforming these bottlenecked areas of Ireland Inc’s economy from the Government? I haven’t. In fact, price inflation continues in state-dominated sectors. In the preceding paragraph, the IMF states that: “The annual pace of price decline was 2½ percent in April, but moderated to 1.9 percent in May, largely due to higher energy costs.” Guess who sets prices for energy in Ireland? Bingo – the Irish state.]
Ireland is currently among the most vulnerable nations to continued deflation. An index, capturing deflationary pressure based on indicators such as GDP growth, the output gap, the real exchange rate, equity prices, housing prices, credit growth, and monetary aggregates, suggests that Irish deflation is likely to persist into next year. After a 1.8 percent decline in prices this year, staff projects a further fall of 0.5 percent in 2011. The authorities expect inflation to turn positive next year. They view staff’s focus on domestic demand as unduly influenced by the experience of larger economies and, noting recent month-on-month price increases, emphasize that in Ireland’s small open-economy setting, exchange rate movements and short-run energy and food price increases would prevent further deflation.
[Again, the backward thinking of our ‘authorities’ is fully reflected in the above paragraph. The IMF staff concerns that deflation will continue are based on their view that Ireland is at a risk of continued slump in consumer demand and investment activities. The disagreement from our ‘authorities’ suggests that they think that charging higher food prices, gauging consumers on energy prices and raising the cost of living in areas where the demand is relatively price inelastic will be the good news going forward. This suggests that our ‘authorities’ really have no clue how economy operates in the real world. Shocking! But more on this in a second…]
This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.
“It is not true that people stop pursuing dreams because they grow old, they grow old because they stop pursuing dreams.” Gabriel García Márquez
Nassim Nicholas Taleb was asked whether public protests in Athens is a Black Swan Event. He replied: “No. The real Black Swan Event is that people are not rioting against the banks in London and New York.”
"Getting worse more slowly is not the same as getting better", Prof. Brad DeLong