Monday, June 7, 2010

Economics 07/06/2010: My points from CPA conference

The following is a quick transcript of the main points of my speech at CPA Ireland annual conference last Friday, with some of additional points in brackets.

Friday, June 4, 2010

Ireland is ten quarters into twin crises of credit contraction and house price declines which [can be expected] last for 33 quarters unless radical policy changes are made according to Dr Constantin Gurdgiev. Dr Gurdgiev was speaking at the annual national conference of the Institute of Certified Public Accountants (CPA) in Carton House, Maynooth, today.

Dismissing optimistic reports of an imminent recovery Dr Gurdgiev said: “Since May 2009, we’ve been “turning corners” to a recovery more often than Michael Schumacher on a World Grand Prix circuit.”

According to Dr Gurdgiev, Ireland’s combined Government and economy-wide debt is the worst of any of the other so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain) states and the other three EU member states which he groups with them in terms of economic difficulties – Belgium, Austria and the Netherlands (BAN).

“The structure of our fiscal spending is working against us”, Dr Gurdgiev told the conference. “Fiscally we have excessive structural deficits of 50-60% of the total deficit and, courtesy of the banks we are now accumulating off balance sheet structural deficits. Our deficits are the worst in BAN-PIIGS group.”

Ireland’s asset bubble implosion is also set to continue for some time. “Asset bubble crashes last longer than our policies anticipate”, he said. “The OECD average is 10 quarters of credit busts for 18% average contraction and 19 quarters of house price falls for a 29% average price decline. Ireland’s bubble of a 60% decline in credit supply implies 33 quarters of credit contraction and our 50% house price fall implies 33 quarters of price declines. We are currently roughly 10 quarters into these twin crises.”

Compounding these crises is the fact that Ireland has the least competitive economy in the BANPIIGS group in terms of relative unit labour costs. “We haven’t been competitive since at least the mid-1990s”, Dr Gurdgiev contended. “While the latest data from the Irish Central Bank provides some grounds for optimism on the competitiveness front, regaining our overall competitiveness compared to other small open economies around the world will require more hard choices on public sector reforms and restructuring of our public utilities and semi-state service providers.” [You can see more on these points here]

On the other hand, Ireland does have a healthy exporting sector dominated by multinational companies. “But it is struggling against uncompetitive capital, public services and utilities markets, has no credit support and is suffering from capital flight and assets downgrades. Our exporting sector alone cannot carry this economy out of the hole. We are in for a structural recession; unemployment will remain high and employment will continue to fall.” [Notice, I am stressing the word ‘alone’ – it is naïve to believe that we can move out of the crisis on the back of exports. In the longer run, exporting activities will have to dominate the overall economic structure, but we are very far away from this being a reality. More importantly, our exports are being held back – at the indigenous firms’ level – by uncompetitive domestic economic structures, with some of the most pressured areas relating to semi-state companies operations].

Looking at the international picture he claimed there will be decreased pool of foreign direct investment and portfolio investment for Ireland to compete for and there will also be a decreased appetite among investors globally for an ‘Irish story’; “Firm fundamentals will matter in future. In addition, competition for foreign direct investment and portfolio investment amongst the smaller EU states will heat up and as investment diversification becomes more important the flight of capital from Ireland will be significant.”

[There are several things going on here. First on inward FDI – it is clear that Ireland will have to be re-packaged for the future efforts by IDA and EI and in general as a location for inward FDI.

Tax advantage on the corporate side will have to be matched by tax advantages on labour side, especially on skills and entrepreneurship, creativity and knowledge. This means that just as we did with the corporate tax rates, we will have to move to lower tax on premium that skills and other forms of human capital earn in the market place. And this means the need for dramatically re-thinking the system of taxation of labour and the system of taxation in general.

In addition, Ireland will need to get more serious about importing not just raw corporate FDI, but also much higher risk and less anchored entrepreneurial investment. We need to actively pursue young, aggressive, promising start ups and even potential start ups. This too requires re-balancing tax rates, amongst other things, away from taxing labour returns and in favour of taxing immobile and less productive forms of capital. Land is clearly a good target for shifting tax burden.

Ireland will have to re-market itself. We need to put to rest the tourist brochure approach to presenting ourselves and start putting in place real and meaningful changes to our immigration regime, naturalization regime, visa agreements with the neighboring countries. We also need to start thinking about the problems of services provided by the public sector, our cities, to citizens and residents. These services will have to be world class, competitive, easily responsive to demand changes, efficient, individualisable and, frankly speaking, dramatically different from the ‘cattle-em-onto-a-bus’ type of service we supply currently. If Ireland were to become competitive as a location for younger, dynamic, globally mobile highly skilled workers and entrepreneurs of the future (home-grown and foreign alike), the idea of having people on trolleys in dirty hospital halls will have to be buried, fast. The idea of expecting public transport passengers stand in freezing rain for hours waiting for a bus that operates to the bus driver-own schedule has to be binned asap.]

Dr Gurdgiev told the CPA Annual Conference that he did see some opportunities for Ireland’s exporters in the near term, however, particularly among those countries experiencing a relatively high speed recovery - primarily in rapidly developing emerging markets in parts of Asia and to a lesser extent Latin America.

“There is a substantial continued demand for investment in major public infrastructure in these countries [as well as in areas of domestic private demand]”, he said. “These regions are likely candidates for products and services from Ireland, but Irish firms need a differentiator in entering these markets. They have to attract and deploy top talent and deliver meaningful gains to local and foreign clients investing in these regions, while offering the legal and counterparty security of being domiciled in Ireland. The most likely pathway to these markets is by partnering in broader joint ventures with local providers in the countries themselves.” [This too requires a categorical change in indigenous enterprises. The Celtic Tiger ways of hiring ‘bright young foreigners’ for lower grade positions and retaining often unskilled, inexperienced senior staff with legacy tenure will have to go. The glass ceiling for younger and more ambitious and career driven, skilled foreign and domestic younger people will have to be broken.]

Growing knowledge economy in Ireland is the long term solution to Ireland’s economic problems, Dr Gurdgiev argued. “We have no choice but to develop our higher value added, traded services sectors. This is the real ‘knowledge’ economy.

[And I have gone to pains to explain that the ‘knowledge economy’ the policymakers have been talking about is just a small subset of the real knowledge economy. What differentiates my view of the knowledge economy from that of official policy-driven one is that to me knowledge economy reaches across various sectors of services that are largely neglected by our politicians and civil servants. Advertising and new media, e-games, health services, legal services, financial services, design and technology/creativity integration – these are some of the examples of real traded and high value added services that we should be developing here.]

But our prospects are not guaranteed here. The knowledge economy is human capital intensive and our taxation system creates no incentives to invest in human capital. We need to become more human capital focused.

“This requires a maximum flat rate income tax of 20%; a shift of the tax base to property; closing the welfare trap; and reducing the fiscal burden”. [I specifically pointed to the fact that we have a good policy on the books – the Land Value Tax – but that virtually no work is being done today to get this tax implemented in the next Budget. I also clearly stated that this should be a revenue-neutral shift in tax burden, not a new tax grab by the Exchequer. For links to background papers on SVT/LVT see here. On flat tax - back in 2006 I wrote a series of 3 articles in Business & Finance magazine on the issue of Ireland adopting flat income tax. I should dig them up and post them on my long run site...]

“We used to have a more productive and balanced economy”, Dr Gurdgiev concluded. “We’ve lost it to hype and construction, property, credit and fiscal bubbles. We need a productive knowledge based services economy next.”


Anonymous said...

Great analysis.However I doubt any substantial change will occur.
For instance in the area of immigration a parallel system of justice and case law has been developed by immigration quangos set up by FF.
For example the IBC/05 scheme was set up to give residency to approximately 100,000 illegal immigrants.(17,000 applicants ,an average family size of 5 with addtional births since 2005 approaches 100,000 figure).
This scheme was not backed by any legislation and was described by the supreme court as a 'very generous administrative scheme'.
They did not deliver a judement on the constitutionality of the schemee itself.
They had ruled it was unconstitutional not to consider applicants previously deported thus setting a precedent for case law.
There are many examples where the laws are subverted and over ridden by the minister for justice following lobbying by immigration quangos.
Thus a preferential system has been entrenched for illegal immigrants which over ride treatment given to those who abide by the rules.

In general quangos align the power of the State with their objectives and effectively bypass Oireachtais oversight and the enacted laws of the State.This pattern is found through almost every sector of government.

The alignment of State power with the corporate objectives of the quangos is a form of fascism .

In my opinion none of your proposals have a chance of working until all quangos are closed down.
Colm McCarthys report pointed the way but FF have not touched this area.

C. Flower said...

Thankyou for this summary. I've posted a link to this article for discussion on Political World internet forum.

Is there any way out of the appalling energy price mess into which we seem to have got ourselves?

Anonymous said...

You use OECD data which shows that, on average, house price falls of 29% take 19 quarters to conclude that we can expect that falls of 50% in Ireland will take 33 quarters.

Based on that logic falls of approx. 15% would be expected to take 10 quarters.

Given the fact that house prices in Ireland have fallen by 40% or more in 10 quarters, does that not suggest that this crash cannot be compared to the OECD average?

Could we not use the same logic you use above to argue that falls of 40% took 10 quarterss therefore falls of 50% will take 12.5 quarters?

TrueEconomics said...

Anonymous, you can impute relative relationship between the speed of appreciation and the speed of collapse, and then extrapolate this to the up-tick. I've done more deep analysis of this before on the blog, but the numbers come out even more horrific, reaching into 72-76 quarters.

33 quarters estimate is amazingly consistent across two markets. On the other hand, when you look at comparable property busts - many countries that experienced significant busts (>25% of peak valuations) have not recovered nominal (!) levels of pre-crisis valuations in over 20 years.

Of course, these are averages and comparative dynamics are even more 'noisy'. In addition, we are a small open economy, hence more volatile and less fundamentals-driven than the averages for OECD suggest. which would increase the range of confidence intervals.

It is not an absolute claim of 33 quarters, but a reference to the fact that to anticipate 'back to normal' being 2005-2007 levels of prices and activity in both asset markets is silly. This is what I am saying.

And while we are on the topic of the post - I spotted statements in the blogosphere that suggest that some people are not understanding fully my suggestion for introduction of a flat 20% income tax rate.

I am not arguing that we need overall lower tax burden. I am arguing that we need to shift tax burden onto different asset, other than human capital. In other words, we can make a 20% flat rate tax introduction to be revenue neutral.

Of course, I would have preferred to have a net reduction in tax burden. And indeed we need it, given that more than 50% of our economy is now accounted for by the State - a situation that is not sustainable and insolvent. But that is not what my call for 20% flat rate tax is about.