Economics 11/03/2010: Replying to Prof Krugman

Updated: 14/03/2010

I have a choice today - to either deal with the notoriously influential article by Paul Krugman, or respond to a large number of responses to my commentary on the Letter of 28.

I will do both in proportional terms, relative to their substantive weight.

On L28 debate:

I received a number of supportive comments, including from the people who are self-identifying with the Left in their traditional views. Many thanks to all who commented. Please, continue to read the blog and comment on its posts.

I received a number of negative comments:

• A large number of simple 'I do not agree...' ones. Thank you for you comments. Hope you continue reading this blog and commenting on other posts in better force;
• A very small number (3) public comments in other venues that were constructive, engaging, one even funny (Mrs G posted one on her Facebook). I linked one of them (the best one, to my judgment) on the original post. Thank you for these. I strongly disagree with their main points, but I am sure we will continue debating these and I am looking forward to this;
• a large number of anonymous, outright rude and bizarre comments.
  

Now to Professor Krugman.

You are all familiar with his article in New York Times (link here). What's wrong with Prof Krugman's exposition?

"Ireland had none of the American right’s favorite villains: there was no Community Reinvestment Act, no Fannie Mae or Freddie Mac."

Sloppy job. Ireland had one Social Partnership and one 'last standing Socialist' Government of Bertie Ahearn (with Bertie's famous exclamation on the point as "I'm one of the last socialists left in Irish politics," (December, 2004)). This dynamic duo (see Mr Ahern's speech on the role of Social Partnership here, especially the sections on Community and Voluntary Sector incorporation into this structure - a clear sign of Social Partnership becoming over-weight on 'Social' agenda) presided over the gravy train of Exchequer (and local authorities, semi-states, Quangoes and Social Partners) feeding off the property boom. If this was not equivalent to the Federal and Local Authorities in the US fueling property boom through their policies, I am not sure what is.

Note: the World Bank confirms the 'social' nature of the Partnership here.

We had a 20% social housing 'dividend' which inflated prices and restricted supply. Local authorities had an option of either exercising the 20% allocation in full, or substituting in financial contributions from developers. They took charge of this subsidy and run with it. We had zoning and planning laws and practices (perpetuated and perpetrated by the State in its various guises) that:

• pushed development into marginal areas,
  
• reduced supply of suitable land,
  
• curtailed re-development of poorly utilized properties,
  
• supported rural small-scale build up and
  
• lavished tax breaks aligned with the National Spatial Strategies and National Development Plans on shoe-box apartments in depressed and depressing areas where few sustainable buyers would opt to live.
  

We had the Government that was taking over 40% of the value of each new unit built in this country in taxes and levies, thus directly benefiting from this artificial scarcity-driven boom.

We topped the cake with a cherry of one Grand Socialist Scheme that envisioned moving people around the country physically - the Decentralization. It required 'volunatry' relocations, but in the end boiled down to giving public sector workers a fine choice - keep your current job or get re-asigned to something else. No matter what, alongside with the State purchasing vast amounts of 'Decentralization'-bound real estate (that now sits unoccupied) the promise of tens of thousands of public sector employees moving to new locations contributed to expectations of price appreciation in remote areas.

We had some other - Stalinesque in the planning terms (not execution, fortunately) schemes - remember the promises of investment and jobs flowing to BMW, the West, the North West? The Western Rail Corridor? Hardly 'market forces' at their best, these boosted expectations of future returns on property. Taking the case of Luas driving appreciation of land in Dublin and applying this to Western Rail Corridor implies that land and property values in the relatively de-populated parts of the country along the northern arm of the route have increased by 15-20% instantaneously upon the scheme announcement.

Just because we did not have the State pushing jumbo mortgages underwritten by state-owned mortgage lenders onto low income households, does not mean that the hands of the Government and its Partners are not imprinted on the facade of our own property bubble.

Instead of all the American Acts, we had the Social Partners telling the Government "we need more construction for our constituents". The Government did as it was told and collected tax revenue in sacks. It run rings around the handsomely paid and complacent regulators and supervisory authorities, who sat on their hands as the bubble was inflating. Most were appointed into their positions as the 'retirement perk' from their life-long complacency filled civil services jobs. Others - because they were 'friends' of the regime (recall Mr Ahearn famous admission on RTE). The Social Partners weren't cheering them on, they were shouting 'We need more...'. Inchdoney Accord resulted. And appointments of their friends to the positions of power.

The new NDP - with it 'social investment' taking up a third of the funds allocated for the entire 'capital' programme followed. Social housing lists swell in response, as did the coffers of local authorities, who spent the cash on grandiose Palaces of Peoples - their own headquarters. And Gateways to Excellence - shining campuses for FAS and numerous ITs - that remain empty or half-empty. The merry-go-round was spinning.

So we pushed jumbo mortgages from our non-State banks onto ordinary folks to pay for the above largess of the 'Social' State and its 'Social Partners'. Hardly the forces of 'market capitalism' these were.

We distorted returns on every other form of capital:

• Productive physical capital carried a 25% direct rate of tax or 12.5% corporate rate, or both - depending on whether you were a small or a medium business;
• Human capital was taxed at 42%, then 41%, now up to 56% margins;
• Currently vacant apartments sit taxed at 0%.
  

The 'Left' did occasionally protest against the latter - never against the former, and often against the 'low' physical capital taxes. But these protests were not about the bubble - they were about the Irish Left's demands for even more state transfers. By 2005-2007 they were calling on the Government to start pushing property development into becoming a vehicle for financing not only domestic welfarist policies, but even the aid to foreign countries.

The squeeze on the property market was complete - the supply was artificially restricted, demand was artificially inflated and the Government was actively 'talking the market up'. The banks were encouraged to lend and the regulators were directly selected to be complacent, inactive and on some occasions - outright unsuited to run the complex world of finance. Our former Governor of the Central Bank had no idea he could do anything to alter reserve requirement ratios on Irish banks - he was a career bureaucrat, not a central banker.


Prof Krugman says that "What really mattered was free-market fundamentalism." And refers to Ronald Reagan. Ireland never had a single Ronald Reagan moment in its history. Where Reagan believed in the right of people to engage in free enterprise, Irish Government only believed in the right of the State to tax the free enterprise. Post 2002 EU ruling, most of the taxing took place through indirect means, while the Government maintained a low tax rhetoric. Before 2003, during the height of the 'free-market fundamentalism' we had two-tiered tax system, with a 10% or less tax for big MNCs and a punitive 32% for mere mortals. MNCs were encouraged into this country by the wavers and indirect subsidies that reduced their indirect taxes which were levied through the system of state-controlled bodies and companies. This can fool outsiders like Prof Krugman and some insiders (e.g. the Letter 28 authors) to believe that Ireland was some sort of the Friedmanite Happy Land of free markets, but it does not change the reality.

Let me postulate the following theorem to Prof Krugman:

"Independent of how many fingerprints a forensic analyst can collect at any economic crime scene, invariably, there will be one set of fingerprints always present - that of the State"

And a corollary:
"These fingerprints will invariably lead an investigator to something with a word 'Social' or its derivative on it as a core entity partaking in the event".

'Social' as in 'Socialist'. Doesn't really chime with 'free-market fundamentalism'...

Per arguments above, QED.


Note: Hat tip to Anonymous on typos.