Sunday, January 31, 2010

Economics 31/01/2010: S&P, Gold and forward view on risk

Couple articles worth reading:

1) China bubble - here. In my view - the analyst is spot on - there is a massive bubble in Chinese economy. So large, when it goes, the entire global growth will be derailed. We are, in effect, now treading to closely to the 1932-1934 period of the Great Depression, when the markets forgot fear for a sustained Bear rally before rediscovering that risk mispriced is a disaster waiting to happen.

2) Gold - here. Great chart on 89% loss line.
A very promising direction on gold, of course, which is in line with (1) above.

Prepare for some fun. Take a look at VIX:
All supports are out at this stage and risk appetite is falling since the beginning of the year. Bonds rallying, S&P is taking on water. The only way from here for the likes of Gold is up, for DJA and S&P - down. Back to that 89% rule line in (2) above.

Economics 31/01/2010: February look

This is an unedited version of my article in Business & Finance magazine for February, 2010.

Over the last few weeks, a host of data releases – both Irish and international – have provided an insight into our economy’s performance over 2009 relative to our major competitors. The news, while predominantly adverse, still show an occasional proverbial silver lining.

Let us start on a positive note first. Per US Federal Reserve data, the current crisis has been yielding improvements in our productivity over 2009. Table 1 highlights this development
Spurred on by the cuts in private sectors employment and nominal wages, Irish productivity has posted a 1.9% increase in 2009, just as the rest of the developed world experienced either deteriorating or much lower labour productivity growth. Of course, in part, our labour productivity performance was driven by a precipitous collapse in hours worked. It was also helped by the growing GDP/GNP gap. This makes our productivity expansion over 2009 somewhat superficial and attributable to the tear away performance of a handful of MNCs, especially those in pharma and medical devices sectors, where exports rose 20% on 2008 figures.

This means that although unemployment rose dramatically, cuts in hours and numbers worked were probably too shallow relative to cuts in output value. There is still some remaining surplus capacity clogging up domestic sectors – a problem that can only be corrected either via a significant increase in domestic demand or via a new wave of layoffs. Lacking the former, the latter is now appearing to be the case, with several larger employers announcing new rounds of redundancies in mid January.

Returning back to aforementioned data, it is interesting to consider just how large was the transfer pricing effect from our MNCs to our labour productivity growth. As no detailed data on such operations is available for Ireland, we have to look elsewhere for evidence as to what has been going on over the course of 2009.

One study from Germany – published last month by the CESIfo institute – shows that across 27 European countries, on average, multinational firms operating in lower tax regimes have managed to incur labour costs that are some 56% lower than those incurred by their domestic counterparts. These significant tax savings were, of course, taken not in the form of lower wages paid to the employees, but in higher profit margins booked through lower tax countries. And this was the average for 27 countries, of which Ireland sports one of the lowest corporate tax rates.

Incidentally, transfer pricing also explains the surprising data on FDI inflows revealed in mid-January by the UNCTAD. According to UNCTAD, 2009 was a bumper crop year for inward FDI into Ireland, with gross inflow of USD14 billion – a reversal of fortunes on USD20 billion gross outflow in 2008. These figures prompted a slew of rosy reports in the media. Of course, our gross FDI inflows also reflect the extent of transfer pricing being carried out through Ireland.

In 2009, Ireland-based MNCs booked record profits through their local operations in order to reduce their tax exposure back in the home countries. The proof of this is in robust corporate tax returns booked by the Exchequer. Now, there is a new push for tax arbitrage, and this time around its coming through beefing up the investment side of the balancesheet – higher investment in Irish subsidiaries today mean higher returns on investment booked tomorrow. Not surprisingly, there is no evidence of the USD14 billion new ‘investment’ to be found neither in terms of new employment in the MNCs-supported sectors, nor in much more realistic IDA end-of-year results.

One added point to our labour productivity growth figures is that even with record layoffs in 2009 we were clearly staying below historic productivity growth trend. In 1987-1995 our annual labour productivity grew by 2.4%, rising to over 3.4% in 1995-2000, before slowing down to 2.3% on 2000-2008. But the reversal of the economy out of full employment during the recession should have boosted our productivity growth beyond the 2.4-2.5 levels. Once again, the 1.9% productivity expansion, as positive as it is, shows that some slack capacity remains.

Clearly, shedding personnel with below average performance and reducing hours worked to their more optimal levels (reflective of the long term changes in private and public demand) has improved our competitiveness over the last two years. This, ultimately, leads to better prospects for future growth, and, as Table 2 below shows, is reflected in terms of labour input cuts over 2009. For example, Spain, which enjoyed higher rates of labour utlisation growth in 1995-2008 bubble than Ireland, recorded weaker hours contraction and thus lower productivity expansion during the crisis.

The net result of this is that despite having recorded the most dramatic of all EU15 states’ contraction in output, Ireland has emerged from 2009 with unchanged average per capita income position when compared against the US, as table 3 below shows.
Overall, these figures show that during 2009, private sector in Ireland has led the painful, but necessary process of productivity improvements that ultimately can provide a sound basis for restoring our economy to a new growth path. This is the good news.

The bad news is that despite having suffered unprecedented, compared to our competitors worldwide, cuts in overall employment (in terms of both numbers employed and hours worked), Ireland still remains below its historic trend for labour productivity growth. Barring a remarkable (and at this stage highly unlikely) return of robust domestic consumption growth, this means that 2010 will require further rationalization of employment to inflict deeper cuts into remaining surplus capacity.


The latest newsflow on Bank of Ireland and AIB strongly suggests that the current market valuation of the two banks is out of line with their balance sheet realities. Given current trends, the two banks may require a post-Nama recapitalization to the tune of €9.7-10.5 billion in total under conservative assumptions. Most of this recapitalization will have to take form of equity, as internationally, banking sector is moving toward much higher proportion of equity in overall composition of Tier 1 capital. Given that this amounts to over three-and-a-half times the current market value of the two banks and over 6.5 percent of Irish GNP, a recapitalization at these levels will mean two things for the current shareholders. Firstly, share prices target following the rights issue will be around €0.65-0.75 for AIB and around €0.5-0.6 for BofI – multiples below their current trading ranges. Second, barring a miracle spike in demand for distressed assets by international investors, the new rights will have to be mopped up by the Irish Exchequer. Even assuming extremely generous (to the banks) pricing conditions under the preference shares purchases back in 2008, the new rights issues will imply possible state ownership of up to 80% of AIB and up to 75% of BofI. Current shareholders, thus, are facing a double squeeze on their shares values – one from the volume of new issuance, and another from a massive dilution of their rights (by a factor of 5 times the current warrants held by the State).

Interestingly, my estimate, based on the macroview of the banking system in Ireland as compared against the UK counterparts is basically in line with last month’s research note on the two banks by RBS which put post-rights price target of €0.70 for AIB and €0.52 for BofI, with the prospect of up to 75% state ownership of the banks.

Another interesting aspect of the RBS note is that it provides an estimate of €20bn of cumulative loan losses for the two banks; “majority of which will be crystalised over the next two years”. These losses are linked by the analysts, in part to the banks participation in NAMA, but also due to expected increases in funding costs and the real risk of political intervention. Of course, this column has warned about exactly these risks to the Irish banks valuations for over a year now.

Saturday, January 30, 2010

Economics 30/01/2010: Eurocoin and Obama's new-old plans

Two topics worth covering: the Eurozone leading indicator issued last week and President Obama’s new ‘Tougher on taxes’ talk to the Congress…

First, the usual monthly update on Eurocoin – a comprehensive leading indicator for Euroarea growth. After straight 12 months of rising, the indicator is now standing at the level not seen since March 2007.

This is consistent with a strong growth signal for months ahead for the Euroarea core economies.

Now to the story of the week that was not covered (at least not from this angle) in our press. In his State of the Union speech this Wednesday, President Obama said,

“To encourage ... businesses to stay within our borders, it is time to finally slash the tax breaks for companies that ship our jobs overseas, and give those tax breaks to companies that create jobs right here in the United States of America...”

Oh, boy – this is turning into one of those typically European sagas
: occasionally, the EU is prone to produce daft laws and proposals – the Insurance Gender Directive is a good example of one, the Lisbon Agenda is another. In a typical EU-fashion, bad ideas never die. They just get dragged into the closet, rested for a couple of years and then unleashed again. Until even the daftest policies pass into power.

Well, now it is starting to look like the Obama Administration is taking the same approach.

Under current law, income earned abroad is taxed according to two separate categories: general and passive. Passive income covers capital gains, dividends, and other returns on investment. What’s left is general income and it is subject to a higher rate of tax – the corporate tax.

Under the Obama proposal, a US corporation will have to compute its foreign tax credit on an aggregated basis – taking all foreign earnings and profits of all its foreign subsidiaries and subtracting total foreign taxes paid. If that isn’t bad enough, subsidiaries in higher tax countries will face a ceiling on how much credit they can claim against their earnings for the purpose of the Federal tax liability.

There is absolutely no reason for this, and in fact it is arguably a discriminatory policy, but hey – when it comes to ‘tax and spend’ madness, no one can beat the Democrats – the Feds are estimating the net revenue from the measure to reach between USD24.5bn (US Treasury estimate) and USD45.5bn (JC Committee on Taxation).

And all of these taxes will apply before the companies actually repatriate earnings back to the US.

Now, all of this has some connection to Ireland Inc. We’ve heard before some experts (usually from the companies that can’t really tell us what they think in fear of upsetting Government officials) saying that Obama Plan is not a biggy threat to Ireland. That, you see, our MNCs are here because our workforce is packed with Nobel Prize winners (we are that good at education!) and our energy/water/communications/transport/etc infrastructure is so world class. They are, the MNCs that is, here not because of tax arbitrage… But seriously – we do depend critically on US MNCs operations in the country.

Here is an interesting comment on the Obama speech from an Indian specialist site dealing with outsourcing:

“A tax expert from one of the top four auditing firms, who did not wish to be identified, said: "I think Obama is talking about the same thing when he took over as President. The way this works is; captive units of US firms in any other geography (it could be India, Philippines, China, etc.) are considered different entities under US tax rules. US firms pay tax on the income from these subsidiaries only when they repatriate these earnings (profits) to the US. Firms need to pay 34 to 35 per cent of federal tax on these earnings. In most cases, US firms do not send the money back to the US as they continued to invest this money in expansion and other operations. Now the US government is saying it will match deduction and income together, so they will not get the tax benefits," he said.

The thing is – India and China and many other locations will probably be ok, because they provide high productivity relative to low cost base. Ireland doesn’t do either. So what will keep the MNCs here if Obama gets his wish? For the next 5 years – the capital already sunk here. But after that? Not much. No, really, not much…

Friday, January 29, 2010

Economics 29/01/2010: News from the Knowledge Economy Front

Newsflash from Ireland's Knowledge Economy Front - our troops, led by heroic fighter for Knowledge, Batt O' "Modern Science" Keeffe, are now engaged in an orderly strategic retreat into the Darker Ages. Casualties are so far minimal - 228 scientific journals that Batt could not read.

As was reported by me earlier (here), Ireland's knowledge economics have suffered a fresh wound on our Government's hasty retreat from the world of the 21st century research back to the depth of the 19th century paper-based studies. Here's the latest dispatch:

"You will be aware that the current round of IReL funding came to an end in December 2009. The IUA Librarians' Group is engaged in positive discussions with the HEA and others to secure funding for IReL for 2010 onwards but it is likely that this will be at significantly reduced levels. Due to increasing publisher costs and other factors it is necessary for some IReL resources to be cancelled even if IReL funding were to be maintained at pre-2010 levels. Arising from this, and in the first of what will probably be a number of cancellation processes, the resources listed below will shortly become unavailable through IReL. To download the full list of journals and other resources, please click here."

I would encourage you going to the link and checking out the premier academic titles that will no longer be available on-time, on-demand via electronic libraries.

As one senior research academic commented on this: "What sort of insane gibbering
passes for our education and research policy?"

As I was informed by the sources close to the DofEducation - as a compensation for unnecessarily complicated scientific titles lost, the Government will supply our Universities with the latest edition of Gaelic translation of the EU Treaties - after all, our Brussels-based Irish language translators are:
  • costing us some 5 times the amount it would take to restore our library services back to the 21st century standard, and
  • have no readers for their output anywhere on the planet Earth...

Economics 29/01/2010: US Economy Blistering Growth

US GDP grew at annualized rate of 5.7% in real terms in Q4 2009 (q-o-q growth), according to the "advance" estimate released by the Bureau of Economic Analysis. This is a massive jump on 2.2% real rise in Q3 2009.

Q4 increase reflected gains in private inventory investment (two consecutive quarters rise), exports, and personal consumption expenditures (PCE). Imports, which reduce GDP, also increased in Q3, signaling improved consumer and producer (intermediates) demand, but the rate of growth fell in Q4. An upturn in nonresidential fixed investment was partially offset by slowdown in federal government spending.

Real personal consumption expenditures increased 2.0% in Q4, down from an increase of 2.8% in the third quarter. Durable goods decreased 0.9%, in contrast to an increase of 20.4% in Q3 2009. Nondurable goods increased 4.3%, compared with an increase of 1.5% in Q 3. Services increased 1.7%, compared with an increase of 0.8% in Q3. This suggests rather anemic holidays season and potential reversal in consumer confidence (see below). It certainly does not add up to a robust change in the crisis-driven increases in marginal propensity to save (up 4%+ in Q4) and enhanced risk-aversion (keeping durables sales down).

Real nonresidential fixed investment increased 2.9% in Q4, in contrast to a decrease of 5.9% in Q3. Nonresidential structures decreased 15.4%, compared with a decrease of 18.4%. Equipment and software increased 13.3 percent, compared with an increase of 1.5 percent. Real residential fixed investment increased 5.7 percent, compared with an increase of 18.9%. All indicating the beginnings of a new business investment cycle - a very good sign.

A note to European policy makers: weaker currency works magic: real exports of goods and services increased 18.1% in Q4, compared with an increase of 17.8% a quarter earlier. Real imports of goods and services increased 10.5%, compared with an increase of 21.3%. This again points to depressed consumer rebound, but it also signals that inventories rebuilding might have been completed by now - a sign that we might expect much weaker contribution to GDP growth from that side of the NA in the next 2-4 months.

Stimulus is thinning out and rapidly, but on the military spending side, not in civilian consumption. Real federal government consumption expenditures and gross investment increased 0.1% in the fourth quarter, compared with an increase of 8.0% in the third. But non-defense spending increased 8.1%, compared with an increase of 7.0% in Q3.

Another lesson to European leaders: cut taxes and see things grow faster. Current-dollar personal income increased $119.2 billion (+4.0%) in Q4, compared with an increase of $35.1 billion (1.2%) in Q3. Personal current taxes decreased $11.7 billion, in contrast to an increase of $3.5 billion in Q3. Thus, disposable personal income increased $130.8 billion (+4.8%) in the fourth quarter, compared with an increase of $31.6 billion (+1.2%) in the third.

The miracle that is the resilient US economy is about to swing into action, assuming no adverse news on the Federal Reserve side.

Charts on Consumer Confidence finding upward support, again... over the downward cycle
but not over a deviation from historic trend...
not yet. Which means that we are now in the optimistic (exuberantly) territory relative to historic trends:

Tuesday, January 26, 2010

Economics 26/01/2010: S&P Note on Irish Banks

Standard & Poor's has finally thrown in the towel and after having to “periodically increase” their “credit loss assumptions over the course of the current economic cycle” concluded “that Irish banks' asset quality and earnings will, in general, likely remain under significant pressure over the medium term”.

Anyone surprised so far?

“We have considered the implications for each rated Irish bank and lowered the ratings on some of them.” But even after that action, “the ratings on all Irish banks are currently uplifted because of our view of high systemic importance to Ireland and related government support, or their relationship with a higher-rated parent.”

We never would have guessed that if not for the State guarantee plus 11 billion worth of public capital, plus Nama’s countless billions of pledged support, the banks bonds would be junk. Wait, some of them actually would be ‘high risk junk’ as one Russian fund manager once described to me his own bonds (I ran away as fast as I could).

How junk? Take a load of honesty from S&P (with my emphasis added):

“We have lowered the ratings on Allied Irish Banks PLC (A-/Negative/A-2) by a notch. This reflects our view that the environment will remain challenging over the medium term, leading to high credit losses, and a weakened revenue base. We consider AIB to be of high systemic importance and the Irish government to have made a strong statement of support, as a result of which we have incorporated five notches of support into the ratings. The negative outlook reflects our view that AIB's anticipated recapitalization may not fully occur in 2010, and may be of an insufficient size to support an 'A-' rating, as well downside risk to our earnings expectations arising from the weak environment.”

Absent state support, AIB should be BB/Negative/C+. Errr, that is squarely in the junk bonds category.

“We have also lowered the ratings on Bank of Ireland (A-/Stable/A-2) by a notch. This reflects our view that the environment will remain challenging over the medium term and BOI's financial profile will be weaker than we had previously expected, with capital expected to be only adequate by our measures and BOI continuing to make losses through 2011. We consider BOI to be of high systemic importance and the Irish government to have made a strong statement of support, as a result of which we have incorporated four notches of support into the ratings. The stable outlook reflects our expectation that the government will remain highly supportive of BOI, BOI's core Irish banking franchise will remain materially intact, and it will raise significant equity capital in 2010, from the market or the government or both.”

So absent support, BofI would be at BB+/Negative/BB-. Junk status as well.

“The ratings on Irish Life & Permanent PLC (ILP; BBB+/Stable/A-2) are unchanged. In our view, ILP faces continuing uncertainty around its strategic direction and desired business profile, in addition to the near-term pressure on the banking operations from weak earnings prospects and difficult wholesale funding conditions. Nevertheless, the ratings continue to benefit from the relative strength of the ILP group's life assurance operations. They also incorporate two notches of government support, reflecting our view of ILP's high systemic importance and our expectation that the Irish government would provide further support if required. The expectation of government support also underpins the stable outlook.

Absent state aid IL&P would be, then, at BBB-/Negative/B. Barely above water line.

Please, be mindful – S&P expects (and prices in) that the Irish state will be likely to buy equity in the banks. So we all can become investors in junk bonds-issuing institutions.

Very good, although bland, outlook statement:

“We consider the current operating conditions for the Irish banking industry to be weak, and expect that any recovery in earnings prospects will prove to be sluggish. In the coming year, we anticipate that many of the Irish banks may undergo operational and financial restructuring, which will likely lead to consolidation in the sector. Our overall assessment of the sector incorporates our opinions reflected in the following key points:
  • The recovery in Irish economic performance appears likely to be gradual, with growth only consistently established in late 2010 at the earliest;
  • Loan losses will likely be elevated between 2009-2011 and will likely peak in 2010; Wholesale funding conditions appear likely to remain pressurized, with strong competition for retail deposits...
"Under our base case, we expect loan losses on bank lending to the Irish private sector to peak at about 4.6% or EUR16 billion in 2010, and to total about 10.7% or EUR37 billion over the period from 2009 to 2011."

In country rankings analysis, S&P highlights that they expect the need for significant deleveraging by the banks in the future, reflective, presumably, of the lack thereof so far in the crisis – a risk I warned about consistently over time.

“The impact of the continuing challenging economic environment, which we view as weakening asset quality and earnings prospects” – presumably the S&P is on the same note as the rest of sane analysts: poor economy will drag banks down. Which means that Government logic – restore banks and see economy recover – is out of the window

Next – a gem: “We have additionally revised our assessment of Gross Problematic Assets (GPAs) in the system to 15%-30% from 10%-20%. GPAs are our estimation of a country's potential problem loans to the private sector and nonfinancial public enterprises in a severe economic downturn, such as that being experienced in Ireland, and includes restructured and foreclosed assets, as well as overdue loans, and nonperforming loans sold to special-purpose vehicles.”

Oh yes – up to 30% GPA means that we can expect 45-50% of the loans to be stressed one way or the other at some point in time – some defaulting, some skipping couple of payments, some restructuring with various haircuts. That is, potentially, up to €200 billion in loans in various forms of distress for the 6 guaranteed banks alone.

With this sort of an outlook, not surprisingly, AIB's CDSs are now at around 650bps, BofI's at 250bps and virtually no action is taking place in bonds. Which, of course, does hint at the market reading Irish banks' bonds as being in effect a purely speculative bet on one probability - that of survival...

The share prices are yet to follow the same path of logic.

Economics 26/01/2010: House affordability in Ireland

Demographia International issued Housing Affordability Survey: 2010 (based on Q3 2009 data) (hat tip to Ronan Lyons).

Couple of interesting points highlighted below:
  1. Irish dynamics are improving, but not fast enough; and
  2. International evidence suggests that land (site) value taxation might be a better way of cooling the overheating markets than draconian planning and regulatory restrictions on land use.

The ratings are based on a house price relative to a median multiple of income, with table below showing the relative categories.The authors use gross median income, which, of course implies that taxes are not considered to be an impediment to affordability. Now, Australia, Canada, Ireland, New Zealand, the United Kingdom and the United States are the markets considered, and in general Ireland stands out as the higher tax economy here.

The ratings are based on major urban centres' data for 272 markets surveyed across the countries listed above.

For the entire sample, the study found that in 2009 there were 103 affordable markets, 98 in the United States and 5 in Canada. None in Ireland.

Note that of 5 regional markets surveyed for Ireland, 3 were found to be moderately unaffordable and 2 were seriously unaffordable.

In other words, we are still way off from actually reaching affordability that would be consistent with our house price declines and income uncertainty (ca x2.5-2.75 multiple). Or, put differently, we are far away from getting support for this property market.

But what about regional variation?
Now, I am not going to pass a judgment as to whether Limerick is more desirable than Cork or Galway... One has to enjoy though a comparative: Limerick is ranked next to Portland (Oregon). I had a laugh. Galway is between Sacramento (California) and Austin (Texas). Cork is ranked next to Atlantic City (NJ) - somewhat reasonably, but more expensive than Quebec in Canada. Waterford is, apparently, comparable to Philadelphia and Tucson Arizona. Hmmm...

An interesting chart: relationship between housing affordability and land regulation. Notice the reds - these correspond with more prescriptive nature of land regulation - regulation based on more planning, stricter planning and more state/local authorities' controls. Predictably - greater controls, higher prices, lower affordability.
Unfortunately, I cannot tell out of this chart or the discussion in the report as to what exactly comprises prescriptive model of regulation. Only a glimpse:

"Severely Unaffordable Markets: There were 62 severely unaffordable markets this year, down from 64 in 2008. The least affordable markets were concentrated in Australia (22) the United Kingdom (19) and the United States (11). Nine of the 11 US severely unaffordable markets were in California. There were 5 severely unaffordable markets in New Zealand and 5 in Canada (Table ES-3). However, many of these severely unaffordable markets have experienced steep price declines in the last year. Among the major markets, Vancouver is the least affordable, with a Median Multiple of 9.3, followed by Sydney (9.1), Melbourne (8.0), Adelaide (7.4), London (7.1), New York (7.0) and San Francisco (7.0). As in the past, all of these markets were characterized by more prescriptive land use regulation (such as “compact city,” “urban consolidation,” “growth management” or “smart growth” policies), which materially increase the price of land, which makes housing unaffordable."

This is interesting, for it really does suggest that some other means - other than direct regulation/rationing of land - must be used to cool the markets at the times of excess demand. Not a restriction on supply, but, perhaps, a reduced incentive to speculatively invest in land? Indeed - bring on land (or site) value tax...

Sunday, January 24, 2010

Economics 24/01/2010: A Mexican stand-off: Eurozone v Greeks

It is nice to note that the theme picked up by the post below has been followed upon by the continued media debate today:

According Der Spiegel today: the European Commission warned that the euro area’s chances of survival would depend on adjusting the internal imbalances. DG Ecfin apparently claims in a new paper that internal imbalances would weaken confidence in the euro and endanger the cohesion of the monetary union. Rising deficits and weakening competitiveness in several countries, notably Ireland, Spain and Greece are singled out by the Commissions as the main causes of the pressure on the euro. DG Ecfin, allegedly says the necessary adjustment in the deficit countries will require wage moderation to address rising unemployment in the above countries.

And another one from today: here.

So what is going on with Greece? Not much, it appears. Just like Ireland did before it, Greece decided to throw some smoke around its fiscal debacle with promises of reaching the 3% SGP limit by 2012 (Ireland is now saying it will be 2014, although ESRI’s presentation last Monday was clearly showing they expect deficit to be well above 3% level then).

And like Ireland, Greece has elected to cut some easy expenditure targets – capital investment and irregular payments and some social services. Ireland has gone slightly further by imposing a modest cut on wages and passing a gratuitous tax on pensions in the public sector. Of course, wage cuts were far from what was necessary, while the pensions tax was not even enough to cover the expected future increases in pensions liabilities that will arise due to, frankly Marcian in its surreality, practice of indexing future public sector pensions to wage rises in the sector.

And so, like Ireland, Greece has not been reckoning with the reality of its deficits. Unlike Ireland, however, it was not able so far to fool the markets, and it was unable to raise taxes. And unlike Ireland, Greece was a serial offender on the front of deficits (see charts) in recent years, during the boom. Note, this, of course, does not reflect the fact that Greek’s deficit accounts for their banks supports measures (negligible), while ours does not (massive).
And this means, everyone is still wondering – what is going to happen with Greece?

Last week several significant statements were made on the subject. First, Handelsblatt reported that "the EU has put the thumb-screws to the Greeks", noting that "under massive European pressure the Greek government has agreed to have its state finances cleaned up faster than initially planned". Greece has now pledged to reduce its budget deficit from around 12.7% in 2009 to under 3% of GDP by the end of 2012.

Handelsblatt information de facto denied by senior EU figures. In an interview with Il Sole 24 Ore, ECB Executive Board Member Juergen Stark said that the EU would not help bail out Greece, arguing: "Greece is in dire straits: not only has the deficit reached very high levels, but the country has also witnessed a serious loss of competitiveness [haven’t Ireland?]. Such problems are not due to the global crisis, since they are substantially homemade. …Rules... are unequivocal: being part of the Monetary Union doesn't guarantee any right to claim for financial support by other member states."

Of course, if pressure was applied on Greece [per Handelblatt], there must have been some sort of a threat. What can such a threat be?

Could the EU officials told Greek Government ‘Shape up or you are out of the Eurozone’? Nope – no such possibility even in theory.

Could they have told the Greeks ‘If you don’t resolve the problems with you deficit optics, we can’t give you a bailout’? Oh, yes, that could have happened. In fact, the threat of ‘no EU goodies, unless…’ threat is just what EU has used before on other countries –Switzerland and Norway (access to EU markets), and Ireland and Denmark (access to ‘influence’ within the EU).

So let us take it as a possibility, no mat6ter how remote, that the EU folks told the Greeks to get working on some sort of a face-saving formula to allow for their rescue by the EU/ECB.

Last Friday Wall Street Journal reported that the EU Commission spokeswoman outright denied such a rescue plan being worked on, saying she wasn't aware of any financial bailout packages being arranged. But then, in an interview to Die Welt Chief Economist of Deutsche Bank Thomas Mayer (a man whose statements are not to be taken lightly) said: "The situation [in Greece] is more serious than it has ever been since the introduction of the euro. The trouble in Greece plays a key role for future development... If the Greece situation is handled badly, the Euro-zone could break down, or suffer major inflation. Neither the European Central Bank nor the Commission nor any other EU body can force Greece to implement necessary reforms in exchange for help."

What does he mean ‘no body in the EU can force Greece’? He means here not the political infeasibility of the EU actually slapping on the conditions on Greece to implement austerity measures in exchange for funding. That can be done. What cannot be achieved is the enforcement of such conditions.

The problem is really simple and, thus, grave.
The EU can give Greece a loan – via ECB, say, for 10 years at 2-3% per annum, in the amount of 30% of its debt. That would be fine. It will not solve Greece’s problem, but it will alleviate pressures on deficit side, as country interest bill will fall substantially, allowing it some room to reduce structural side of deficit more gradually. But the EU will have to impose severe restrictions on Greek fiscal policy in order to discourage other potential would-be-defaulters today and in the future. They would have to require, as a condition of the loan, a constraint on Greek deficits going forward so severe that other PIGIES (note the renaming of the club – Austria is out, Estonia is in) don’t dare roll their massive deficits into debt into perpetuity in hope of a similar rescue.

That won’t work – the Greeks will take the money and will do nothing to adhere to the conditions, for there is no claw back in such a rescue.

Alternatively, the EU might commit ECB to finance existent Greek debt on an annual basis. This will allow some policing mechanism, in theory. If Greeks default on their deficit obligations, they get no interest repayment by ECB in that year. Sounds fine in theory but what happens if the Greeks for political reasons default on their side of the bargain?

If ECB enforces the agreement and stop repayment of interest, we are back to square one, where Greece is once again insolvent and its insolvency threatens the Euro existence. Who’s holding the trump card here? Why, of course – the Greeks. And, should the ECB play chicken with Greeks on that front, the cost of financing Greek bonds will rise stratospherically, and that will, of course, hit the ECB as the payee of their interest bill.

Thus, in effect, we are now in a Mexican standoff. The Greeks are dancing around the issue and promising to do something about it. The EU is brandishing threats and tough diplomacy. And the problem is still there.

Martin Wolf of Financial Times: "the crisis in the eurozone's periphery is not an accident: it is inherent in the system. …When the eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters."

Indeed, we are about to find out… hold on to your socks, folks.

Economics 24/01/2010: Consumer side of the economy equation

Before posting my Sunday Times article, couple of interesting links from elsewhere:

Myles Duffy on Revenue's 2009 figures - here. Good and concise view.

Excellent essay on Google v Apple battle and why Google just might be losing it - here.

Now to my article, as usual, unedited version:

The latest retail sales figures show continued weakness in consumer demand through November 2009 with core sales (ex-motors) up a poultry 0.3% in volume and down 0.3% in value on October. In twelve months to December, Irish retail sector has recorded a massive 8.2% drop in the volume of sales, while the value of good and services sold collapsed 12.9%.

This weakness in retail sales is important for three reasons – both overlooked by the analysts. First, this was a month usually characterised by higher spending in anticipation of Christmas holidays. Second, this was the beginning of the Christmas season that concluded the decade and came after extremely poor 2008 holidays shopping. Penned up demand was great, going into November, but consumers opted to stay away from the shops. Third, even November retail sales were out of synch with forward looking consumer confidence indicators.

Combined, these facts suggest that the retail sector is suffering from a structural change that is here to stay, even if the broader economic activity and consumer confidence were to bounces into positive growth.

This observation is far from trivial. Despite all of our hopes for a recovery based on exports, any growth momentum in the economy can be sustained only on the back of improving private consumption and investment. In Q3 2009, the latest for which data is available, personal consumption of goods and services accounted for 63.5% of our GNP and over 50% of GDP. During the crisis, due to a much deeper collapse in investment, the importance of consumer spending has increased. At the peak of the bubble in 2007, consumption spending amounted to 57% of our national output.

Retail sales form a significant component of the overall consumer expenditure and it is also strongly correlated with other components, especially communications and professional services. These links are highlighted by the anaemic revenues generated by mobile and fixed line service providers, and dramatic declines in demand for insurance.

Thus, overall, retail sales offer some insight into what is going on at the aggregate personal consumption level.

Earlier this week, PwC released an in-depth analysis of emerging trends in Irish retail sector that sound a warning for the future of our consumer economy. The report found that in response to the crisis, some 55% consumers are now reporting lower spending on goods and services, while 65% are saying they are spending more time shopping for value.

Over the last year, only aggressive price cuts kept the volume of sales from reaching the levels of 1999-2000 in real terms. 71% of Irish retailers have increased their promotional activities, while 67% have offered aggressive discounts (63% of retailers plan further realignments of costs in 2010).

In other words, the impact of the current economic crisis on consumer behaviour has been deeper than a normal recessionary dynamic would support. PwC survey has found that 53% of all retailers believed the changes in consumer attitudes to shopping we are witnessing today are long term or permanent in nature.

This permanent nature of change is due to what in a 2004 theoretical paper on household consumption I called ‘learning-by-consuming’ effect. While searching aggressively for better value, the households simultaneously improve their expenditure efficiency and discover that buying cheaper does not always mean sacrificing quality. PwC research confirms my theoretical model by showing that 86% of consumers who shopped for value perceived cheaper goods to be of the same quality as higher priced goods.

The permanence of change in consumer behaviour is worrisome. Barring dramatic improvements in consumer willingness to spend, two negative developments will persist in our economy.

First, any return to growth will be short-lived and prone to sudden reversals with the risk of a double-dip recession.

Second, any recovery absent robust growth in private expenditure will imply further widening of our GDP/GNP gap as MNCs tear away from the lagging domestic economy. Over the long run, this gap will have to be closed either through a massive downsizing of the foreign investment sector (as costs bear down on companies operating here), or via a return of another credit bubble. Neither development would be welcomed.

In the nutshell, we can expect retail price deflation to continue in 2010. According to NCB Stockbroker’s economist Brian Devine, further deflation in 2010 can lead to a statistical bounce in overall retail sales. “With prices declining, consumer confidence stabilizing and consumer attitudes shifting towards value expect the volume of retail sales to grow in 2010,” says Devine. But, “job losses and emigration will weigh on overall consumption and as such we can expect consumption to contract marginally in 2010."

In other words, the prognosis for improved consumer confidence carrying sustained recovery in 2010 is not good.
Should the changes in consumer behaviour be permanent, we can expect consumption to grow at 1.5-3% per annum as wages stabilize and the savings rate begins to decline from its 2009 high of over 11%. And even from this low growth scenario, the risks are firmly to the downside.

Given the expected impact of Nama on mortgage interest rates, credit and deposit rates, it is highly likely that our savings will remain elevated well through the first half of this decade. The ESRI forecasts personal savings rates to stay above 10% through 2013 and close to 8% thereafter. In contrast, over 2000-2007 our savings rates averaged just above 6%. Higher savings, of course, will mean lower consumer spending and private investment. Rising cost of borrowing and credit will add to our woes.

Finally, subdued consumer spending means lower Exchequer revenue through VAT and Excise duties. This is likely to lead to higher tax burden in Budget 2011 and a further downward pressure on consumer spending.
In this environment, the Government simply cannot afford inducing more uncertainty and pressure on already over-stretched households’ balance sheets. Restoration of consumer confidence requires an early and committed signal from the Exchequer that Budget 2011 will not see new increases in taxation. From here on through 2014, all and any fiscal adjustments should take the form of permanent cuts to public expenditure and elimination of tax loopholes, not a series of raids on taxpayers’ incomes.

The Government should also reverse its decision to limit Banks Guarantee coverage of ordinary deposits to Euro100,000 that is scheduled to come into force later this year. Lower guarantee protection will act to increase precautionary savings as well as deplete the already razor thin deposits base in Irish banks. The twin effects of such an eventuality will be greater demand for public capital from our financial institutions, plus lower consumer spending. Does Irish economy need another twin shock just as the recession begins to bottom out?

It appears that despite all pressures, the Government is staunchly refusing to carry out a public inquiry into the causes of our banking sector crisis. Instead of confronting with decisiveness this matter of overarching public interest, our Taoiseach has resorted to deflecting all queries with his favourite catch phrase: “We are where we are”. One wonders whether the Government would be as willing to use this phrase if the subject of the proposed inquiry was a series of major transport accidents, or a systemic failure in our health sector. Institutions responsible for over 80 percent of the entire banking sector in the country came close to a collapse and have to be rescued by the taxpayers at a total cost (including Nama) of Euro72-89 billion or 46-57 percent of our annual national output. What else but a fully public inquiry with live television coverage of all hearings can one expect in a democratic society? An inquiry into the systemic failure of our financial system must be not only public, but comprehensive. It should cover all the lending institutions in receipt of state assistance as well all policy-setting, regulatory and supervisory bodies – from the Financial Regulator to the Department of Finance – responsible for ensuring stability of our financial system. This inquiry should have powers to fine those who failed in fulfilling their contractual and/or statutory duties. And it must be conducted by people who have no past (since at least the year 2000) or present connections with the any of institutions called in for questioning. Anything less than that will be an affront to all hard working men and women of this country who are expected to pay for the mess caused by the systemic failures in our banking sector.

Economics 24/01/2010: Knowldge Economy and Irish academia

Charles Larkin and Brian Lucey are having a go at the issues clogging up Irish third level policies in Sunday Business Post today.

Here are few takes and my views on them:

Hardly a week goes by without a government spokesperson discussing an aspect of the "Smart Economy". In the public and perhaps government mind this is equated with technology. We suggest that a truly "Smart Economy" is not based on technology -- the really smart economy is about flexibility, especially mental flexibility. Developing this should be the primary focus of the higher education sector. We suggest that there exist a set of interlinked issues that make the sector as it stands unable to do this.

Yes – Knowledge Economy is not about quantity of labs / patents / ICT applications etc. It is about our abilities to create new applications and tools, but more importantly – ability to deploy these in profit earning undertakings (I mean, of course, a broader notion of profit that can, should the individual owners of technology and/or skills elect to do so, include pursuit of non-monetary returns).

Irish higher education suffers from a severe conflict of mission. It is expected to deliver on innovation, education, social enrichment, economic growth, public health, improved lifestyles and put a chicken in every pot. Though research suggests that all of these and more arise from higher education, the effect varies across individuals and disciplines. The context is further complicated by the regional imperative.

Also spot on – the conflict between objectives of the universities that are political (and this now also includes science policies) and that are academic is best highlighted by the fact that Irish universities are no longer the hot beds of subversive thoughts. Instead, they are staffed and run by bureaucrats with singular mode of thinking – coalescence, assimilation and homogenization of staff to achieve pleasant singularity of view that can then be monetized via Irish and European grants.

Not a single Irish university today would have seen Keynes offering a job to Hayek. Only senior faculty are allowed, and even then – unwillingly – to express dissenting views. Any junior faculty member peeping their head above the grey mass will be thrown out as soon as their contract comes for a renewal. ‘Does not match strategic direction’ on a rejection letter for a job means that the candidate is simply not ‘slottable’ into the Borg collective of some department.

Can anyone expect any sort of creative excellence out of this?

Academic freedom is perhaps the simplest and yet most profound step. In essence this would involve the granting of "university" (i.e. degree granting) status to all third and fourth level institutions (inclusive of exceptional legal entities, for example the research-orientated facilities, such as the Royal Irish Academy and the Dublin Institute for Advanced Studies). The announcement by Minister O'Keeffe that he is to abolish the NUI is a first, faltering step towards this...
Care needs to be taken that we do not replicate the failures of the UK and Australia in similar reforms. Within the IOT sector new programmes go through a very rigorous evaluation. The issue is that existing programmes need root and branch reform to ensure that they are at the same quality and intellectual standard. With freedom comes responsibility, and the most important responsibility will be to offer educational programmes aligned with the fostering of flexible minds.

I fully agree – which probably means the authors are now at a risk of being branded ‘extreme’ in their views – freedom must be given to universities and all third level institutions, and they must be self-accountable for their actions. If one chooses to pursue EU and Irish academic handouts through so-called ‘collaborative’ piggy-back-riding on other EU researchers grants, so be it. They will sink in the long run, having reduced themselves to the backwater of unoriginality in thinking and output. If other universities chose to take a bolder position and once again become centres for debate, discussion, challenge and search (breaking away from their current tradition of serving as yes-men to the social regime of singular ideological hue) – they will thrive in the long term as their creativity will allow them to command a premium. The same premium the relative start ups of Stanford, UofChicago, University of California campuses, and so on – having arrived to the university game in the US well after the Ivy League institutions – now command over the majority of previously mighty, now completely mediocre Ivy League institutions.

Last night, RTE was showing the documentary about the Bog Bodies discoveries. In the entire lengthy feature, there was not a single point at which the documentary managed to show any disagreements between numerous Irish and international researchers. Instead, it was a saccharine, sonorous and harmonious blandness of: ‘Yes, I agree with my colleague on this point’ and ‘We all agree with our colleagues on all points’. I am certain that there were probably different views discussed by scientists amongst themselves. But the telling feature of the documentary was just how important consensus is to science’s image in the public. And this is frightening. Not a single major breakthrough discovery in science was delivered by consensual group-think of collaborative researchers.

Back to Brian and Charles’ essay:

Freedom should be extended to faculty wages. At present, within narrow bands, the best are paid the same as the worst, the most active the same as the least. …Evidence from the US indicates that salary freedom can assist in incentivising staff, but this can arise at the cost of over-reliance on casual and adjunct lecturers at the undergraduate level. …we need to ensure that in the newly freed institutions a motto of "every scholar a teacher, every teacher a scholar" is taken just as seriously.

I am not sure about the ‘over-reliance on casual and adjunct lecturers’. In my view, and a disclosure is due here – I am adjunct myself, adjunct lecturers are usually self-selected individuals with passion for teaching and with different sets of skills from other researchers and academics. If selected on merit, they can add serious diversity of thought and experiences to the universities. They are also key to linking universities to the real world. What is really sad about Irish universities is that casual lecturers are often selected for a single shot teaching, filling in for absent full time faculty. There is neither coherence, nor open-mindedness as to how adjuncts are selected, appointed and contractually hired.

Freedom must also of course mean freedom to fail. If a university were unable to deliver on the required educational outcomes then it ultimately would be required to fold or to be subsumed by another more successful university and mechanisms need to be put in place to deal with the fall-out if this happens.”

This really needs no qualification. Superb! I lamented on many occasions the lack of consolidation and closure in the process by which universities that thrive can gain market shares.

We suggested earlier that a truly smart economy involves the production of flexible thinkers. Such an education must be more than purely discipline-focused at the third level. …We can broadly consider three domains of intellectual activity in universities- humanities, letters and the social sciences (arts), life sciences and natural sciences. Mapping degrees to one of these we suggest that a true university education would involve an annual minimum of 15 per cent engagement with each domain.

Very well put. Again, on many occasions I raised this concern that we are not producing flexible, creative thinkers, but are focused on producing standardized degree-holders. Like a commodity product, these degree holders are then released into the real world where they go on to form a mass of uncreative, unchallenged and unproductive middle managers and functionaries. The future of Ireland Inc rests with people who can deploy creative and innovative thinking in management (not necessarily in the labs alone, but at all stages of production, marketing, delivery, sales etc). This is what I would call a real ‘knowledge-based’ economy. It is good to see that at least two of my colleagues are now publicly in agreement.

To adequately provide these postgraduate courses all academic staff in the university would be required to be active researchers, which would be achieved by a rolling tenure system. This would involve the granting of tenure for a prospective 5-7 year period, with biannual reviews.

Spot on!

Research activity and research quality are only loosely related but quality requires activity as a prerequisite. To ensure quality of teaching we suggest that again there be biannual reviews of teaching based on best modern practice. This would involve some element of student feedback but would also involve reflective portfolios and classroom observation. To oversee this quality issue we suggest a single evaluation unit within the above suggested ministry.

Sadly, although I agree with the idea of a review, I am not yet ready to place my trust in Ministry bureaucrats to deliver on such an objective. Fas experience shows that our public officials cannot be entrusted to do this job in an impartial, efficient and effective manner. I would rather suggest use of class numbers, relative to faculty averages, as a partial metric for academic wages. Taken, of course, over a period of time and within comparable disciplines. Students tend to vote with their feet.

A third element relates to funding. …Separating undergraduate from postgraduate education we suggest allows greater clarity to emerge. Persons seeking to take masters or doctoral qualifications in an area do so for one of two reasons -- a desire to seek entry to an area or profession (investment) or from a personal interest (consumption). There is no obvious reason why the government should fund the latter over other consumptions. In any case the operation of the tax/PRSI system should, in most circumstances, offer a return to society partly via the increased taxable earnings that the better qualified persons achieve, thus capturing the public good element of an increase in, for example, dentists, or telecommunication engineers, or doctors of literature.”

I actually disagree. PRSI and income tax place a surplus taxation burden on individual investment. If a person invests their own funds in education, they should be able to deduct the cost of this investment before they pay tax on capital gains. Secondly, if the society at large already benefits from the social good nature of higher education, then a person having invested in it for private benefit must be reimbursed for society benefit accruing not to themselves, but to others. After all, if my money paid for my PhD and I get a return of x% per annum, while the society gets y% per annum and a tax return on my PhD – is this not a case of double taxation?

This means that, while I fully agree that the state should not provide funding – except that based on merit and inability to pay considerations – for post-graduate studies, I disagree that PRSI/income tax should be viewed as fully functional means for capturing individual gains.

Saturday, January 23, 2010

Economics 23/01/2010: Knowledge economy infrastructure

Some interesting data from a study "Broadband Infrastructure and Economic Growth" by Nina Czernich, Oliver Falck, Tobias Kretschmer and Ludger Woessmann, CESIfo Working Paper 2861 published in December last year that provides good comparatives for Ireland relative to the peers in terms of what I would call rudimentary 'Knowledge Economy' infrastructure -
  • the relationship between physical capital and knowledge-related capital (broadband penetration and education); and
  • the relationship between GDP per capita and the above
all taken over a long period of time (1996-2008).

First, broadly, the findings of the study itself: "We estimate the effect of broadband infrastructure, which enables high-speed internet, on economic growth in the panel of OECD countries in 1996-2007. Our instrumental-variable model ... [shows] voice-telephony and cable-TV networks predict maximum broadband penetration. We find that a 10 percentage-point increase in broadband penetration raises annual per-capita growth by 0.9-1.5 percentage points. ...We verify that our instruments predict broadband penetration but not diffusion of contemporaneous technologies like mobile telephony and computers."

Interesting - a 10% increase in broadband penetration ups the growth rate by 0.9-1.5%. In other words, to get a 10% increase in GDP per capita out of a 10% rise in broadband penetration requires 6.4-10.7 years. Not a bad return. The problem here is that, of course, the starting levels from which this effect is measured are low, so the law of diminishing marginal returns has to kick in somewhere.

I took their data and run through some of it in a very crude way to see if I can glimpse other interesting aspects. Here are the results.
Maximal (for the period GDP per capita, PPP-adjusted) with 2 standard-deviation 'candles' around it. Notice two broadly defined groups of countries: Overperformers (including Ireland) and Underperformers. Now, I know - I shouldn't be using GDP here, but I am not about to make a statement about the actual 'wealth' or 'riches' of Ireland, so GDP will do.

Next, take a look at scatter plot relating GDP per capita to two measures of communications sector performance: broadband penetration for 2008 (the end score, if you want) and starting point measure (voice telephony penetration back in 1996).
It looks like GDP per capita in the end is much more responsive to increases in broadband penetration than to the starting position. In other words, economies with low legacy stock of communications seem to be catching up through broadband penetration improvements. Is this suggesting that a country can leapfrog weak communications sector legacy by jumping straight into broadband age? Well, sort of. The problem here is that we do not separate out the twin effects of growth in broadband penetration (much higher for countries doing leapfrogging) and simultaneous growth in voice telephony penetration (also likely to be much higher for countries doing leapfrogging).

A very revealing chart next:
Let us take physical capital as a share of GDP and compare its effects on overall GDP per capita, against the same effect being induced by education. What is unambiguous is that countries with higher physical capital base share of GDP tend to have lower GDP per capita. How come? Because they are physical capital-intensive, i.e their production is stuck in the late industrial age. Countries with higher education are more labour-intensive and especially skilled-labour intensive, and thus have higher GDP per capita.

Note Ireland. It is relatively poor in physical capital per GDP and yet relatively rich in GDP per capita. Why? Because we do have a modern economy - an economy where value is added through human capital side (of course this happens much more on the side of MNCs, where transfer pricing is used to import, artificially, human capital-intensive value-added, but it also happens in services economy, in our IFSC, etc). And yet, our education measure is far from being impressive.

The gap between our unimpressive levels of education and the levels of education consistent with the 'average' OECD pattern of relationship between education and GDP per capita, to me, clearly shows the importance of transfer pricing in our GDP figures. This gap is captured here by, in effect, showing that our capital and human capital stocks cannot support our GDP fully!

Here is more detailed view of our physical capital stock relative to our education (human capital stock).
Ouch. We are an outlier precisely in the direction suggested by the gap identified above. Note that moving to a 'Sweet Spot' of highly productive economies with significant rates of utilization of human capital requires both - more physical capital formation and even more education. Also note just how inefficient is the stock of education in the upper 'bubble' group of countries that includes all Nordics, Japan and France. These countries are simply not being able to derive the same returns to education in terms of GDP per capita as the 'Sweet Spot' nations.

So here is a question no one is asking - is there such a thing too much of education? Is there an inverted U-curve for the relationship between education and income, whereby too smart for its onw good society leads to suboptimal levels of growth? After all, since the 1990s we are seeing an emerging trend in the developed world whereby the new generations of slackers are increasingly composed of highly educated people...

This is not an argument out of the blue - take example of a potentially 'too livable city' concepts discussed in a brilliant article here. Can the same happen to the 'too-knowledgeable-economy'?

Ok, couple more charts on the same point. Broadband penetration is positively correlated with capital formation... Hmmm. This might reflect the fact that higher stock of capital imply better infrastructure through which broadband can be delivered. The relationship is not very strong, though.

And there is an even weaker, and negative, relationship between education and physical capital. This negative coefficient of correlation does suggest, though, that we are in the early stages of the process whereby physical capital takes second seat to human capital in characterising modern economy. If so - good news for 'Knowledge' economists out there - machines do not possess knowledge. People do. But it is also bad news to all social engineers out there who still think technocratic management of economy/society is possible. Knowledge requires heterogeneity and creativity. And these are antitheses of planning and policy-driven controls and incentives.

Far from being dead, the age of Friedmans' Freedom to Choose is only dawning!

And the final point: education and broadband infrastructure are much more strongly (almost 4:1) positively correlated with each other than they are with physical capital.
This, of course, can be interpreted as a warning to the folks interested in restricting the freedom of people to communicate. If China, and other countries that impose controls on internet, want to have a 'Knowledge'-intensive, modern economy, they will have to deliver real (i.e. free of political ideologies and biases) education and meaningful (i.e. free of political 'bottlenecks') knowledge infrastructure (in this case, broadband).

If they don't, the risk is they will end up being physical capital giants - countries where the world does its 'dirty work' of mass manufacturing widgets...